T.S Pl. S. Thinnappa... v. G. Rajagopalan, Offi...

The Judgment of the Court was delivered by

Leach, C.J:— These three appeals arise out of proceedings instituted under Section 235 of the Companies Act, by the Official Liquidator of the Oriental Investment Trust Ltd., which is in the process of being wound up compulsorily under an order of this Court passed on 21st July 1939. The company was incorporated on 9th September, 1936. The first directors were C. Abdul Hakim, P.V Swanithan, V. KR. ST. Kasi Viswanathan Chettiar, S. Subbaraya Mudaliar, T. RM. T. SP. P.L Palaniappa Chettiar and PL. VA. V. Ramanathan Chettiar. C. Abdul Hakim and P.V Swaminathan died before the liquidation commenced and Kasi Viswanathan after the misfeasance summons had been heard. On 1st April 1937, T.S PL. SP. Thinnappa Chettiar joined the board. Charges of misfeasance were preferred against Kasi Viswanathan, S. Subbaraya Mudaliar, Palaniappa, Ramanathan and Thinnappa. It was claimed that as the result of their misconduct they were liable jointly and severally in the sum of Rs. 2,77,531-5-9. The learned Judge (Bell J.) considered that S. Subbaraya Mudaliar had not acted unreasonably and was entitled to the benefit of Section 281 of the Companies Act. He found that the Official Liquidator had established a charge of misfeasance against the other respondents and that the loss was to be apportioned as follows: Kasi Viswanathan and Ramanathan were to be jointly and severally liable for Rs. 1,11,909-10-0, Palaniappa for Rs. 18,651-9-8 and Thinnappa for Rs. 18,651-9-8. Appeal No. 44 of 1942 has been preferred by Thinnappa, App No. 47 of 1942 by the legal representatives of Kasi Viswanathan and App No. 52 by Palaniappa. Ramanathan has not appealed. He absconded on 22nd June, 1939 after it has been discovered that he had misappropriated large sums belonging to the company.

2. The principal promoters of the company were Kasi Viswanathan and Ramanathan who were appointed joint managing directors. Kasi Viswanathan was the managing member of a joint Hindu family which carried on a money-lending business under the vilasam of V.K.R.S.T in the Madras Presidency with its Head Office at Devakottah and a branch at Madras. The firm was of considerable standing. Ramanathan was its agent in Madras. Kasi Viswanathan's brother Narayanan, with whom he was joint, was in charge of the business there but there is no doubt that the management of the Madras branch was largely in the hands of Ramanathan. Ramanathan had acquired a good reputation in the Chettiar community and was its representative on the Madras Board of Directors of the Reserve Bank of India. The authorised capital of the company was Rs. 25,00,000 divided into 25000 shares of Rs. 100 each. At the time of the liquidation, only 6068 shares had been issued and they were merely paid up to the extent of Rs. 25 per share. This gave a working capital of a little over Rs. 1,50,000. The objects for which the company was formed were those of an investment trust company, but very little investment business was done. Ramanathan was allowed to control the business of the company and at once commenced gambling in differences in shares. He did this with the full knowledge and consent of his brother directors. This matter has been discussed in the judgment which we have just delivered in O.S.A No. 40 of 19421 and it is unnecessary to repeat all we have said there.

3. The paid up capital of the company was not sufficient for the transactions which Ramanathan was entering into on behalf of the company and he was authorised by the directors to borrow money from the V.K.E.S.T firm. Including interest the company owed to the firm at the date of the winding up the sum of Rs. 1,36,274-1-2. The magnitude of the gambling which was indulged in is to be gathered from the fact that notwithstanding the comparatively small amount of capital available the transactions entered into during the short existence of the company aggregated in value Rs. 1,61,77,443-0-8. The value of the investments held by the company at the time of the liquidation was only Rs. 20,000. Ramanathan betrayed the trust which was placed in him. He also indulged in gambling in differences on his own behalf and to a large extent he utilised for his own purposes the moneys which he borrowed from the V.K.E.S.T firm on behalf of the company. He succeeded in deceiving his brother directors, the auditors of the company and the partners of the firm until the month of March 1939, when he debited to his personal account with the company the moneys which he had borrowed for the company from the firm. On 13th June, 1939 the auditors prepared a balance sheet which showed that Ramanathan had taken altogether Rs. 1,42,632-6-3. The board very complacently agreed to treat this amount as representing loans from the company to Ramanathan. This was done because he said that he possessed securities in Bombay which were sufficient to meet his liability and he undertook to hand them over to the company. Kasi, Viswanathan sent his representative with Ramanathan to Bombay to take delivery of the alleged securities, but when they arrived in Bombay Ramanathan absconded. Criminal proceedings were instituted against him and a warrant was issued for his arrest, but this has never been executed. The amount which Official Liquidator sought to recover in the misfeasance proceedings represented what the company had lost by reason of these gambling transactions and what the company had to pay to the V.K.E.S.T firm in respect of Ramanathan's borrowings. O.S.A No. 40 of 1942 arose out of an action instituted by the firm to recover what Ramanathan had borrowed under the authority given to him by the company. The action was tried by Bell, J. who held that the company was not liable to make repayment. The firm appealed and we have felt constrained to disagree with the learned Judge's finding. We have held that the company is liable to the firm for the moneys borrowed by Ramanathan.

4. The main questions which arise in the present appeals are whether the appellants are liable to replace the moneys which Ramanathan lost in the course of the transactions in differences which he entered into on behalf of the company and whether they are liable to make good the money which the company has had to repay to the firm. The learned Judge held that they were liable in respect of the gambling losses, but not in respect of the borrowings because he considered that the company was not liable to repay the firm. If, however, on appeal the company was found liable in respect of the borrowings the appellants' liability would, he said, be correspondingly increased.

5. We concur entirely with the finding of the learned Judge that the appellants are liable for the loss incurred by the company in permit, ting Ramanathan to gamble in differences. Contracts of such a nature are unenforceable under the general law and they certainly did not fall within the transactions contemplated by the memorandum of association. The company had, of course, the power to buy shares and to sell them again should it be deemed advisable to do so, but by no stretch of imagination can it be said that gambling in differences on the stock exchange is legitimate business for an investment trust. All that the learned counsel have been able to say on behalf of the appellants is that all the directors bona fide believed that this was legitimate business and that therefore the Court should exercise its discretion under Section 281 of the Companies Act. Before S. 281 can be invoked it must be shown that the directors have acted reasonably as well as honestly and in permitting Ramanathan to gamble in differences they were not acting reasonably. They cannot even say that they came to know of the nature of these transactions at a later stage. In the statutory report which was prepared on 10th April, 1937 it was disclosed that the company had received in payment of differences Rs. 11,904-14-8 and had paid out in similar transactions the sum of Rs. 41,671-11-6. While directors are not trustees in the technical sense they hold a fiduciary position with regard to the assets of the company and the appellants were guilty of a grave breach of duty in allowing the company's funds to be dissipated in this way. It has been pointed out that all the balance sheets, except the last one, which was drawn up as on 31st March 1939 were approved of by the company in general meeting. But this makes no difference to the position. There can be no ratification of an illegal contract so far as the company is concerned: see (1875) 7 H.L 6632 and (1882) 21 Ch. D. 6193. In the former case, Lord Cairns said:

“Now I am clearly of opinion that this contract was entirely, as I have said, beyond the objects in the memorandum of association. If so, it was thereby placed beyond the powers of the company to make the contract. If so, my Lords, it is not a question whether the contract ever was ratified or was not ratified. If it was a contract void at its beginning, it was void because the company could not make the contract. If every share-holder of the company had been in the room, and every share-holder bad said: ‘That is a contract which we desire to make, which we authorise the directors to make, to which we sanction the placing the seal of the company,’ the case would not have stood in any different position from that in which it stands now. The share-holders would thereby, by unanimous consent, have been attempting to do the very thing which, by the Act of Parliament, they were prohibited from doing.”

6. It is admitted that the loss on these transactions amounted to Rs. 1,36,092-3-6. We shall deal later with the matter of the individual liability of the appellants.

7. The more difficult question is whether the appellants can be called upon to make good to the company the Rs. 1,36,274-1-2 which the company has to repay to the V.K.E.S.T firm in respect of Ramanathan's borrowings. That Ramanathan was duly authorized to borrow from the firm is not, and cannot be, disputed. It is now common ground that he used these moneys for the payment of his own gambling transactions. If the directors had been aware of the fact that Ramanathan was using the company's funds in this way and had neglected to interfere they would undoubtedly be liable, but we are satisfied that they did not know until all the money had been borrowed and misappropriated. Therefore the Court has to decide whether their ignorance was due to their own negligence. On behalf of Thinnappa and Palaniappa it is said that they should not be judged by the same standard as Kasi Viswanathan, as he was a managing director. We will first discuss the law so far as it applies to ordinary directors and then consider the position of Kasi Viswanathan as a managing director. In passing it may be mentioned that the assets are sufficient to pay all the creditors and therefore only the shareholders are concerned.

8. In (1884) 25 Ch. D. 7524, Chitty J., held that an innocent director cannot be held liable for the fraud practised by his co-directors in issuing to the share-holders false reports and balance sheets, provided that the books and accounts of the company have been kept and; audited by duly appointed and responsible officers and he has no ground for suspecting fraud. In that case Chitty, J. pointed out that no one was bound to presume a fraud and that the directors were not bound to examine entries in the company's books. The opinion that directors are not bound to examine entries in the company's books had previously been expressed by Jessel M.R in (1878) 9 Ch. D. 3295 and Lord Davey in 1901 A.C 4776 agreed with what was said in these cases. In the present case it cannot be said that either Thinnappa or Palaniappa had any ground for suspecting that Ramanathan was acting fraudulently. The company had appointed a firm of qualified auditors and until Ramanathan had completed his misappropriations the auditors themselves were entirely in the dark. The balance sheets of 31st May 1937, and 31st October 1937, which were the last to be drawn up until the fraud had been discovered, had been passed by the auditors. When the statutory report was drawn up on 3rd April, 1937, there was owing by the company to the firm Rs. 1,06,000. The balance sheet of 31st May 1937, showed that the amount owing to the creditors had been reduced to Rs. 54,967-0-4 and that of 31st October 1937, showed that there was only due to the V.K.R.S.T firm Rs. 5575-11-0. Therefore, it may safely be taken that the directors had no ground for suspicion. They acted improperly in allowing Ramanathan to gamble on the stock exchange and for this we hold them liable, but they were not put on inquiry whether Ramanathan was borrowing money from the firm on behalf of the company and utilising it for himself. As Palaniappa and Thinnappa were entitled to rely on their auditors and had no reason for suspecting Ramanathan, they cannot be held liable for sums which Ramanathan took from the firm.

9. Does Kasi Viswanathan stand in a different position? It is true that he was a joint managing director with Ramanathan, but he cannot be imputed with knowledge of Ramanathan's fraud simply because he was a co-managing director. The principles laid down by the House of Lords in 1928 A.C 17 which we have discussed in our judgment in O.S.A No. 40 of 1942 apply equally here. The acceptance of the office of a co-managing director undoubtedly involved special responsibilities but on 10th April, 1937, the Board of Directors passed a resolution which put into Ramanathan's hands, and his hands alone, the conduct of the company's business and by another resolution authorised him to borrow from the firm. Kasi Viswanathan was not present at this meeting, but it may be taken that he had knowledge of what had been decided on. Moreover, Kasi Viswanathan was living near Tinnevelly, some 400 miles away from Madras and it could never have been intended that he should take an active part in the management of the company. Even if it were otherwise, the fact remains that with common assent everything was left to Ramanathan who deceived Kasi Viswanathan as much as he deceived the other directors. A managing director like an ordinary director, is entitled to place reliance on the company's auditors, unless there exists ground for suspicion which was not the case here. Had Kasi Viswanathan examined the books before March 1939, he would not have found any indication of Ramanathan's misappropriations, and he was equally justified in trusting Ramanathan. For these reasons we hold that Kasi Viswanathan is in no worse position than his co-directors. It may be added that the company's accountant was not called 1 upon to give evidence. He was present in Court at the trial and was assisting the Official Liquidator in instructing counsel. Had there been any ground for suspecting Ramanathan surely the company's accountant would have known it.

10. The result is that the appellants together with Ramanathan must be held liable for the loss sustained by the company as the result of the gambling in differences, but not for the loss caused by Ramanathan's misappropriations. Kasi Viswanathan's legal representative says that the learned Judge erred in differentiating between the appellants, as they are jointly and severally liable to the company for the loss incurred. We consider that this argument is sound, except that Thinnappa cannot be made, liable for any loss suffered before he joined the board. This is not a case in which the appellants can invoke Section 281 of the Companies Act. It is common ground that the losses up to the date when Thinnappa joined the board amounted to Rs. 31,111-7-6. The total loss on transactions in differences was Rs. 1,36,092-3-6 and Kasi Viswanathan, Ramanathan and Palaniappa must be held jointly and severally liable in this sum. The liability of Thinnappa will be Rs. 1,04,980-12-0 (Rs. 1,36,092-3-6 less Rs. 31,111-7-6). Ramanathan will, of course, be liable for the Rupees 1,41,439-2-3 as well. Interest at the court rate will run from 17th July, 1942, the date of the final order of the learned Judge.

11. That order will be amended in accordance with this judgment. We do not propose to decide whether in law there is any right of contribution between the directors inter se. This question must be left to be decided in other proceedings should the occasion arise. At the moment the Court is only concerned with the loss suffered by the company by reason of the misfeasance of the appellants as directors, and so far as the company is concerned they are all liable to make good the loss on the gambling, subject to the deduction of Rs. 81,111-7-6 in the case of Thinnappa. The decision of the learned Judge that S. Subbaraya Mudaliar should be exonerated has not been challenged. The Official Liquidator will receive costs from the appellants on the sum of Rs. 1,36,092-3-6. He will pay to the appellants out of the assets of the company costs on Rs. 1,41,439-2-3 (one set). He will have his own costs out of the estate. We certify for two counsel.

C.R.K/R.K

12. Order accordingly.