Hanuman Prasad Bagri & Others v. Bagrees Cereals Pvt. Limited & Others

The Judgment of the Court was delivered by

Sanjib Banerjee, J.:— The cuisine is English, the flavour unmistakably Indian. The blend in the appellants' plaint is on a base of the classical exceptions to the rule in Foss v. Harbottle, it has a generous dollop of Loch v. Blackwood as Indianised by Hind Overseas and it carries a suggestion that it be tasted with a side order of Clemens v. Clemens Bros Ltd. The underlying theme of the plaint is that the first defendant is merely the corporate avatar and repository of ancestral Hindu family business in which partnership principles should apply such that the exercise of majority rights therein would be subject to equitable considerations.

The suit is on rebound, as any student of company law would know. The appellants' petition of the late 1980s under Sections 397 and 398 of the Companies Act was stultified on a reading of the petition that it carried only a directorial complaint that did not meet the exalted test of just and equitable winding up that an oppressed shareholder has to establish before progressing to seek any relief. In the judgment reported at (2001) 4 SCC 420 (Hanuman Prasad Bagri v. Bagrees Cereals Pvt. Ltd.), the Supreme Court upheld the Division Bench view of this Court but left room for a suit to be based on the substance of the original complaint.

The plaint seeks a declaration that the first appellant herein continues as a director of the first defendant company, challenges several resolutions of Board and general meetings of the company and implores that a scheme be framed for the management of the company upon ousting the defendant Nos. 2 to 8 wrongdoers. The first appellant is the youngest of five brothers and the plaint says the other brothers had conspired to deprive the first appellant and his branch from the family business and wealth by resorting to a series of illegal acts in the late 1980s. The suit is a derivative action styled to make out as if the company would be the beneficiary of the reliefs claimed.

The background is essential for the interlocutory application questioning an issue of right shares in the company some three years after the suit was lodged, to be seen in perspective. The plaintiffs are in appeal from the limited protection they were granted. They urge that the rights issue of shares was engineered only to consolidate the wrongdoers' inequitable stranglehold over the company with knowledge that the plaintiffs would not be enthused in spending good money after bad only to cling on to their 18% shareholding in the company.

Counsel for the appellants harps on the much-exploited argument of the fiduciary duties of company directors in matters relating to a further issue of shares. The appellants refer to a notice of February 7, 2005 issued by the Board proposing to offer further shares of and in the company at par of aggregate value of Rs. 20 lakh. The offer announced that holders of existing equity shares in the company whose names appeared on the members' register on February 5, 2005 would be issued a further equity share for two existing shares of Rs. 100/- each; that shareholders who accepted the offer in full would be entitled to apply for additional shares, but shareholders would have no right of renunciation; that the Board may allot or otherwise dispose of the shares not accepted to such persons and on such terms as it deemed fit; and that the proposed issue was subject to prior approval of the appropriate authority. As to the rationale for the further issue of shares, the notice had this to say:

“The fund to be so raised will be entirely used for the construction, development and modernization of the facilities to the properties of the Company at Kolkata and Nokha and also for acquisitions of new properties for starting warehousing business on a commercial basis.”

According to the appellants the latent reason for the issue was to dilute the appellants' shareholding percentage in the company and the stated reason for the increase was vague and irrational. The appellants say that nearly four years down the line, at the time of hearing of the appeal, nothing had been done with the money garnered by the company in furtherance of the reasons proffered for the issue. The appellants allege that the company's accounts for the year ended March 31, 2004 did not justify the issue and there was no commercial basis for increasing the paid up capital of the company. They claim that the persons who had usurped control of the company had masterminded the issue for their personal aggrandisement without even intending to deploy the additional funds for the reasons given in obtaining the same.

Such conduct, the appellants assert, was illegal and the issue was liable to be cancelled. The appellants refer to the judgment reported at (1981) 3 SCC 333 (Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd.) to say that the principal purpose for issuance of further shares in a company has to be for the benefit of the company and if it is assessed that the company was in need of funds then the incidental benefit of the issue to the directors would be disregarded. Paragraph 111 of the report is placed for such purpose:

“111. Whether one looks at the matter from the point of view expressed by this Court in Nanalal Zaver or from the point of view expressed by the Privy Council in Howard Smith the test is the same, namely, whether the issue of shares is simply or solely for the benefit of the Directors. If the shares are issued in the larger interest of the Company, the decision to issue shares cannot be struck down on the ground that it has incidentally benefited the Directors in their capacity as shareholders. We must, therefore, reject Shri Seervai's argument that in the instant case, the Board of Directors abused its fiduciary power in deciding upon the issue of rights shares.”

The appellants rely on the Privy Council dictum in the judgment reported at 1974 (1) All ER 1126 (Howard Smith Limited v. Ampol Petroleum Limited) for the principle that if an issue of shares in a company is founded on the improper motive of the directors consolidating their control in the company, it would amount to breach of their fiduciary duty. The proposition is captured in the following passage:

“In their Lordships' opinion it is necessary to start with a consideration of the power whose exercise is in question, in this case a power to issue shares. Having ascertained, on a fair view, the nature of this power, and having defined as can best be done in the light of modern conditions the, or some, limits within which it may be exercised, it is then necessary for the court, if a particular exercise of it is challenged, to examine the substantial purpose for which it was exercised, and to reach a conclusion whether that purpose was proper or not. In doing so it will necessarily give credit to the bona fide opinion of the directors, if such is found to exist, and will respect their judgment as to matters of management; having done this, the ultimate conclusion has to be as to the side of a fairly board line on which the case falls.”

The respondents contend that there was no illegality about the offer made by the Board to the shareholders in February, 2005 and that if the Board felt that the company was in need of funds, the Court would scarcely take upon itself the burden of inquiring into the basis of the decision. They refer to paragraph 118 of the Needle Industries case:

“118. It is necessary to clear a misunderstanding in regard to the power of Directors to issue shares. It is not the law that the power to issue shares can be used only if there is need to raise additional capital. It is true that the power to issue shares is given primarily to enable capital to be raised when it is required for the purposes of the company but that power is not conditioned by such need. That power can be used for other reasons as, for example, to create a sufficient number of shareholders to enable the company to exercise statutory powers (see Punt v. Symons & Co.), or to enable it to comply with legal requirements as in the instant case. In Hogg v. Cramphorn, Buckley, J., (p. 267) agreed with the statement of law of Byrne, J., in Punt. And so did Lord Wilberforce (pp. 835-36) in Howard Smith where he said:

“It is, in their Lordship's opinion, too narrow an approach to say that the only valid purpose for which shares may be issued is to raise capital for the company. The discretion is not in terms limited in this way: the law should not impose such a limitation on Directors' powers. To define in advance exact limits beyond which directors must not pass is, in Their Lordships' view, impossible. This clearly cannot be done by enumeration, since the variety of situations facing Directors of different types of company in different situations cannot be anticipated.”

The Australian decision in Harlowe Nominees took the same view of the directors' power to issue shares. It was said therein:

“The principle is that although primarily the power is given to enable capital to be raised when required for the purposes of the company, there may be occasions when the directors may fairly and properly issue shares for other reasons, so long as those reasons relate to a purpose of benefiting the company as a whole, as distinguished from a purpose, for example, of maintaining control of the company in the hand of the directors themselves or their friends.”

We have already expressed our view that the rights shares were issued in the instant case in order to comply with the legal requirements, which, apart from being obligatory as the only viable course open to the Directors, was for the benefit of the company since, otherwise, its developmental activities would have stood frozen as of December 31, 1973. The shares were not issued as a part of a take-over war between the rival groups of shareholders.”

The respondents also refer to a judgment reported at 19 Comp Cas 175 (N.V.R. Nagappa Chettiar v. Madras Race Club) to say that a high burden is placed on the plaintiffs in such an action to establish mala fides on the part of the directors which the appellants in the present case had failed to discharge. The respondents also rely on the judgments reported at 35 Comp Cas 351 (Shanti Prasad Jain v. Kalinga Tubes Ltd.) and 88 Comp Cas 759 (Jute Jacques Taru Lalvani v. J.B.A Printing Inks Ltd.) to suggest that oblique motive on the directors' part has to be clearly established which the appellants had failed to do.

The learned Single Judge held that mere allegation of mala fides or absence of bonafides would not suffice in such a case; that the plaintiffs were required to demonstrate that the decision to issue further shares was improper. The learned Judge noticed that a plausible explanation had been put forth by the company and its directors and merely because the plaintiffs had shown that the company had surplus funds would not be enough to make an order restraining the issue.

When this appeal was admitted on April 6, 2006 an interim order was made to the following effect:

“There will be an unconditional stay for two weeks and the company shall not allot 18% share to any other person/persons without the leave of the court. The petitioner shall deposit a sum equivalent to the price of 18% shares in cash with the Registrar, Original Side of this High Court within two weeks from date. The Registrar shall keep the said amount in an interest bearing fixed deposit account with any nationalised bank. In default of payment of such amount the stay will stand vacated. Upon depositing the amount with the Registrar, Original Side such stay will continue until further order of this Court.”

In the Privy Council case the conflict was between two groups of shareholders with Howard Smith Limited on one side and Ampol Petroleum Limited and Bulkships Limited on the other. Ampol made an announcement to purchase shares from the existing shareholders in the company to which Howard Smith made a counter offer. Ampol thereafter joined hands with Bulkships; the two together having 55 per cent of the paid up capital in company R.W Miller (Holdings) Limited. Ampol and Bulkships then issued a statement that they would act jointly as to the future operation of the company and that they had decided to reject any offer for their shares from any other. Despite such being the shareholding composition of the company, its board of directors accepted a proposal from Howard Smith to issue further shares to Howard Smith such that the combined might of Ampol and Bulkships was reduced to a minority. The directors split over the decision, returning a 4-2 verdict in favour of issuing shares to Howard Smith, with the seventh director present not being permitted to participate for his interest as a director of Bulkships.

What is the point of singular importance in the Howard Smith case is that the decision to issue further shares was taken by the board of directors of the company and the result was that the controlling shareholders lost their majority status to the allottees. The breach of the fiduciary duty that the court recognised was on the court's appreciation that the decision to issue further shares would not have been carried at any general meeting of the company where the majority shareholders could not be expected to commit hara-kiri and hand over control to the allottees. The principle would be applicable, though in diminished degree, to all cases where the status of a group of shareholders was being reduced or increased, consequent upon the impugned issue, below or beyond the immediate relevant threshold. If the issue of further shares could be shown to have brought a group of shareholders controlling 25 per cent of the paid-up capital or more to below such level which would have allowed them to block a special resolution; or such issue resulted in a group's shareholding being reduced from above 10 per cent to a single-digit control; or, in the best case scenario, of a majority being reduced to a minority - the principle would apply if the decision were that of the board of directors of a company.

That is not to suggest that a majority can ride roughshod over the minority and use its numerical superiority to subdue the minority voice in a company. The decision of the majority shareholders, however legally made, is subject to equitable considerations. But the complaining minority has to show - even in the absence of any palpable illegality - a degree of unfairness and the element of consequent prejudice. Needle Industries recognises the principle that if the directors incidentally benefit from an issue of further shares which can be shown to be otherwise for the benefit of the company, such incidental benefit would be overlooked. The appellants have, however, relied on such judgment to urge that the benefit to the directors (or the majority shareholders in this case) cannot be the dominant purpose, but it is a question of fact as to whether the further issue was motivated by self-interest or was incidental to augmenting the paid-up capital of the company.

A civil court would not sit in judgment over the commercial wisdom of corporators. The appellants do not show that the decision to issue further shares was ultra vires the powers of the directors under the articles of association of the company. In the absence of any apparent illegality, the propriety of the issue hinges on the collective wisdom of the Board against the assertion of the appellants. The learned Single Judge exercised his discretion to make a limited order and the appellants have not been able to demonstrate that the exercise of discretion was perverse or contrary to accepted judicial principles.

The appeal fails. The interim order of April 6, 2006 is vacated. In the event the appellants do not exercise their option to receive the rights shares by writing to the company within four weeks from date, it would be open to the directors of the company to deal with the shares in accordance with their authority under the articles of association of the company. In such case the appellants will be entitled to receive the money deposited with the Registrar, Original Side, together with all accretions thereto. If the appellants are desirous of investing in the rights shares, they shall write to Registrar to forthwith make over the deposit, with the accumulated interest thereon, to the company. There will be no order as to costs.

Urgent certified photostat copies of this judgment, if applied for, be supplied to the parties upon compliance with all requisite formalities.

Surinder Singh Nijjar, C.J

I agree.