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A brief on 397/398 of Companies Act, 1956?

Durga Rao 
on 04 January 2010

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I have earlier written articles on oppression and mismanagement under section 397/398 of the Companies Act, 1956. I am of the strong opinion that than any provision of law under the Companies Act, 1956, the provisions dealing with oppression and mismanagement are very interesting and so complicated.   Every shareholder is entitled for certain rights in the Company and at the same time, the rights of majority in a Company should not be ignored. A good balance is to be made between the propriety of the majority in a Company and the rights of minority shareholders.  If a shareholder is allowed to question the majority very frequently and allowed to ask for relief having the potential of stalling the business of entire company, then, the process may very frequently gets abused. But, still, the majority should not be allowed to oppress the minority and mismanage the company’s properties.

When the majority in a company exceeds their limits, oppresses the minority and mismanages the company’s properties, the Act provides a relief to the minority from the Company Law Board and the minority can approach the Company Law Board seeking various reliefs against the Company or the majority in a Company. If we look at the wording used in the relevant provisions dealing with oppression and mismanagement, there will not be any doubt that there exist limits on the powers of Company Law Board while entertaining an application under section 391/398 of the Act. But, the fact and the practice prove otherwise. 

It may be rare to see an application under section 397/398 of the Act against Listed Public Companies, but, it is very frequently seen in case of private companies and closely held public companies.  In view of SEBI (DIP) guidelines, every Listed Public Company is supposed to have the presence of retail investors, institutional investors and every Listed Public Company needs to adhere to “Corporate Governance” requirements. In view of the regulations governing Listed Public Companies, the role of SEBI, plethora of SEBI regulations, the shareholding patterns, the role of institutional investors, the listing agreement with Stock Exchanges, Listed Public Companies are well regulated than Private Companies or  unlisted Public Companies. This is the reason why we see many applications under section 397/398 of the Companies Act, 1956 very frequently in respect of Private Companies or closely held Public Companies.

Only few sections dealwith the issue of oppression and mismanagement under Companies Act, 1956, but, we can find so many interesting areas and complicated aspects. An adjudication forum dealing with an application under section 397/398 plays a commendable role and the discharge of responsibility or the process of adjudication is so complicated and sensitive in most of the cases.

Though, a lot of comment can be written on various aspects of oppression and mismanagement and on the provisions dealing with oppression and mismanagement under the provisions of Companies Act, 1956, I would like to emphasize few interesting and complicated areas without detailed brief.

Chapter – VI of Companies Act, 1956 deals with oppression and mismanagement and contains sections 397 to 409, important sections being 397, 398, 399, 402 and 403 of the Act. While section 399 deals with the issue of qualification for approaching the Board seeking relief under section 397/398, sections 397/398 deal with the issues as to what constitutes oppression and mismanagement and the powers of the Board. While section 402 is specific to the powers of Company Law Board, section 403 deals with the scope of passing interim orders by the Company Law Board pending a main petition under section 397/398.

Few interesting and complicated issues in the law or provisions dealing with Oppression and Mismanagement under the Companies Act, 1957, are as follows.

  1. Complications under section 399:

Section 399 of the Companies Act, 1956 deal with the issue as to who can approach the Company Law Board under section 397/398. It lays down a qualification. Among the minority group, every shareholder may not be able to pursue the issue before the Board against the Majority. As such, the provision talks about consent of members in favour of applicant who signs the papers and presents the application to the Board under section 397/398. We have precedents even on the issue of consent, the complicated thing being the precedent saying that the shareholders giving consent should apply their mind as to why they are consenting.

    A shareholder is nothing but a member of a Company. An illegal transfer of shares and the dilution of existing shareholding are normally construed as oppression. When a past member challenges the transfer of his shares by the majority in the Company and when the application is not maintainable if it is assumed that the transfer by majority is legal, there will be complications as to whether the application itself is maintainable or not. We have many precedents on this preliminary issue and it is complicated.

       Again, the issue of legal representatives? Normally, an adjudication before the Board under section 397/398 takes time and many disputes get settled in the process. The issue of proceeding against the legal representatives of the majority is another complicated area to look into.

       Thus, even without going into the issue of oppression and mismanagement, there will be lot of complications in the process and on preliminary issues like maintainability of petition under section 397/398.

  1. Scope of sections 397/398 of the Act:

    There are many precedents on the object and the scope of section 397/398 of the Act. However, the reference made by the Bombay High Court, in Mauli Chand Sharma and another Vs. Union of India and others, (1977) 47 Com Cases 92 explains the object and the scope of provisions dealing with oppression and mismanagement. The important portion of the judgment is extracted hereunder.

“that chapter II of the Act, which includes section 255, deals with corporate management of the company through directors in normal circumstances, while Chapter VI, which contains sections 397, 398 and 402, deals with emergent situations or extraordinary circumstances where the normal corporate management has failed and has run into oppression or mismanagement and steps are required to be taken to prevent oppression and/or mismanagement in the conduct of the affairs of the company. In the context of this scheme having regard to the object that is sought to be achieved by sections 397 and 398 read with sections 402, the powers of the court under the sections can not be read as subject to the provisions contained in the other chapters which deal with normal corporate management of a company. Further, an analysis of the sections contained in Chapter VI of the Act will also indicate that the powers of the court under sections 397 and 398 read with section 402 can not be read as being subject to the other provisions contained in sections dealing with usual corporate management of a company in normal circumstances. The topic or subjects dealt with by sections 397 and 398 are such that it becomes impossible to read any such restriction or limitation on the powers of the court acting under section 402. Without prejudice to the generality of the powers conferred on the court under these sections, section 402 proceeds to indicate what types of orders the court could pass. Under clause (a) of section 402, the court’s order may provide for the regulation of the conduct of the company’s affairs in future and under clause (g) the courts order may provide for any other matter for which in the opinion of the court it is just and equitable that provision should be made. An examination of the aforesaid sections brings out two aspects; first, the very wide nature of the power conferred on the court, and secondly, the object that is sought to be achieved by the exercise of such power, with the result that the only limitation that could be impliedly read on the exercise of the empower would be that nexus must  exist between the order that may be passed thereunder and the object sought to be achieved by those sections and beyond this limitation which arises by necessary implication it is difficult to read any other restriction or limitation on the exercise of the court’s power. Further, section 397 and 398 are intended to avoid winding up of the company if possible and keep it going while at the same time relieving in minority shareholders from acts of oppression and mismanagement or preventing its affairs being conducted in a manner prejudicial to public interest and, if that be the objective, the court must have power to interfere with the normal corporate management of the company, and to supplant the entire corporate management, or rather, mismanagement, by resorting to non-corporate management which may take the form of appointing an administrator or a special officer or a committee of advisers, etc., who would be in charge of the company”.

  1. Power of Company Law Board or the Tribunal while entertaining an application under section 397/398 of the Act and the nature of powers:

    We can find plethora of judgments on the powers of Company Law Board or the Tribunal under section 397/398 of the Act. While the precedents refer the wording under section 397/398 of the Act which confers widest powers on the Board, there exist complicated issues. Basically, the plain reading of the provisions and the logical analysis makes it very clear that the powers exercised by the Board under section 397/398 of the Act are preventive in nature. Then, what should a shareholder do to get an illegality committed by the majority undone? It’s a very very complicated issue and scope of remedial measures under section 397/398 of the Act is interesting and the issue needs to be addressed.

  1. Can a majority approach the Board under section 397/398 of the Act:

     It is another interesting issue. How to construe “majority” under section 397/398 of the Act and can the majority approach the Board under section 397/398 of the Act, are very very interesting issues. The concept is that the majority controls the Company and they can not be overtaken by the minority. But, there can be practical problems where the minority controls the Company warranting interference by the adjudicatory forums like Company Law Board or the Tribunal. It is another interesting area under section 397/398 of the Act.

  1. How to construe “oppression”/”mismanagement” and what constitutes “oppression”/”mismanagement”?

      We can find any number of judgments dealing with the term “oppression” under section 397 and can find so much narration and precedents on what constitutes “oppression”. In view of number of precedents and the law of precedents, a professional is often had to look at all the judgments under section 397/398 of the Act in order to substantiate the allegations or counter the Petition. Issue is not that much simple as wording under section 397/398 and an order can not be passed in an application under section 397/398 without a detailed probe and enquiry.

  1. Whether mere non-compliance of the provisions of the Act be construed as “Oppression” and “Mismanagement”:

      There is no need on the part of the Companies to ignore the provisions of the Act when their actions are legal. Again, it can not be said that the mere non-compliance of provisions of the Act be construed as “Oppression” and “Mismanagement”. It is very very complicated issue to dealwith and there can not be any straight proposition on this issue.

  1. Need of giving full particulars and the consequence of not giving full particulars:

       There is a proposition and it is also expected that a Petitioner who approaches the Board under section 397/398 of the Act to give full particulars. Again, corporates may not be able to disclose everything for the reasons known. In such a case, the issue of non-disclosure of certain facts and its bearing on the adjudication of a petition under section 397/398 of the Act is really interesting to look into.

  1. Conditions precedent for maintaining an application under section 397/398 of the Act:

           We have so many precedents on section 397/398 of the Act. A Petitioner or a professional dealing with an application under section 397/398 should go through all the precedents under the provisions in order to understand the condition precedents for maintaining an application under section 397/398 of the Act.

  1. Whether events subsequent to presenting a Petition under section 397/398 of the Act to be considered by the Board or the Tribunal?

       It is very very complicated issue to dealwith. When disputes arise among shareholders, they tend to do certain acts fearing at the protection of their respective shareholdings. As such it is very often seen where shareholders commit certain things or act in a harsh way against their opponents even during the pendency of an application under section 397/398. This is very very complicated issue having a bearing even on the entire adjudication process. Technically, the Petitioner before the Board should amend the Petition to challenge the actions by the majority or the Respondents when he wants to challenge the further illegalities committed by the majority even during the pendency of a Petition under section 397/398. Company Law Board may not be in a position to pass orders without any pleading warranting an amendment to the Petition and an additional pleading. Its true that amending a Petition before the Company Law Board is not like amending a Plaint in a Civil Court, still, it is a very very interesting and complicated issue to dealwith.

  1. How to construe “disputed facts” and can the disputed facts be decided by Company Law Board:

           Company Law Board can not overlook other general substantial laws. For example, Company Law Board should rely on the Contracts Act while deciding the validity of an “agreement” entered into by the Company apart from other provisions and the law. Normally, a challenge to agreements and contracts are decided after a full trial and it is the practice before Civil Courts. We see the change in the procedure before Debt Recovery Tribunal which are allowed to decide the validity of agreements and contracts with documentary evidence and giving liberty to the Tribunals to decide as to whether a trial is required or not. This will be a complicated area under section 397/398 of the Act needing clarity and the issue needs to be addressed in the proposed new companies act.

  1. Application of law of arbitration?

            There is a settled proposition that an Arbitration Agreement or a clause can not oust the jurisdiction of Company Law Board or the Company Court. But, the issue is not that much simple. Some times, there may not be any need for the Board or the Company Court to interfere and it may be enough if a particular issue is decided among the shareholders with the process agreed by them. As such, as I feel, a straight proposition on the application of law of arbitration to the company disputes can not be laid and the issue will remain interesting and complicated.

  1. Application of settled legal principles to an adjudication under section 397/398 of the Act:

       It is another interesting area to dealwith. It can not be said that the settled general legal principles are not applicable to a proceeding before the Board under section 397/398 of the Act and again it can not be said that all the settled legal principles applies even to an application before the Board under section 397/398 of the Act. For example, it is very frequently seen that an averment or a dispute in an application under section 397/398 of the Act, could have been the subject matter before some other forum like Civil Court, but, still the Company Law Board can not say that it will not look into the issue applying the principle of sub-judice. Differentiation has been made between corporal rights and general civil rights. The issue is very very interesting and complicated to dealwith.

  1. Enforcement of orders of the Board and law of contempt?

      Though the procedure differs for initiating a contempt action before the Board, the provisions of Contempt of Courts Act are to be relied on even by the Board. Will the provisions of Contempt of Courts Act enough for the Board in view of the stakes involved and the complications; is an interesting question to be looked into. There is no clarity on the powers of contempt and the procedure for moving a contempt application before the Board despite precedents. The issue will remain important and interesting.

        I have just highlighted very few interesting and complicated areas under section 397/398 of the Companies Act, 1956 among plethora of issues. A lengthy commentary can be written on section 397/398 of the Companies Act, 1956 itself.

          I do strongly feel that an effective enforcement of provisions like 397/398 of the Act and the protection of rights of all shareholders without any scope for misuse or abuse is very very important for the growth of industry or the corporate world. It is true that we have good regulations regulating the functioning of listed public companies, but, a good focus also to be made on the regulations governing private limited companies and especially the rights of shareholders in a private limited companies and unlisted public companies.

Note: I have just expressed my views on very very few interesting and complicated areas under section 397/398 of the Act, 1956 and I am aware of the vastness of the subject.        




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