Cases and Materials On Company Law PDF

CASES AND MATERIALS ON COMPANY LAW
Arjya B. Majumdar
Assistant Professor, Assistant Dean (Academic Affairs)
Executive Director, Michigan-Jindal Centre for Global Corporate and Financial Law and Policy
Jindal Global Law School
For Private Circulation Only

CASES AND MATERIALS ON COMPANY LAW ARJYA B. MAJUMDAR
FALL 2016 FOR PRIVATE CIRCULATION ONLY
Contents
MODULE I - INTRODUCTION TO THE CORPORATE FORM ....................................................... 8
Principles of Corporate Law ................................................................................................................... 8
Meaning of the word ‘Company’ ................................................................................................... 18
Tennant v. Stanley [In re Stanley] (1906) 1 Ch. 131 – .................................................................. 18
Independent Legal Entity ..................................................................................................................... 18
Section 9– Incorporation ................................................................................................................ 18
Corporate Personality in India ....................................................................................................... 19
Salomon v. Salomon [1897] A.C. 22 ............................................................................................. 27
In Re: The Kondoli Tea Co. Ltd. (1886) ILR 13 Cal. 43 ............................................................... 27
Lifting of the corporate veil .................................................................................................................. 28
In re Dishaw Maneckjee Petit AIR 1972 Bom 371 ....................................................................... 28
Daimler Co. Ltd v. Continental Tyre & Rubber Co. Ltd. (1916) 2 AC307 ................................... 32
Macaura v. Northern Assurance Company (1925) AC 619 ........................................................... 34
Prest v Petrodel Resources Limited [2013] UKSC 34 ................................................................... 35
State of U.P. & Ors v. Renusagar Power Co. & Ors. (1988) 4 SCC 59......................................... 40
Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613 .................................. 40
State of Rajasthan v. Gotan Lime Stone Khanji Udyog Pvt. Ltd. .................................................. 44
Fundamental rights of a company ........................................................................................................ 47
R.C. Cooper v. Union of India 1970 AIR SC 564 ......................................................................... 47
Bennett Coleman & Co. & Ors vs Union Of India & Ors 1973 AIR SC 106 ................................ 51
National Company Law Tribunal and Appellate Tribunal ................................................................... 57
MODULE II - TYPES OF BUSINESS ORGANISATIONS................................................................. 60
MODULE III - INCORPORATION AND FORMATION OF COMPANIES ................................... 61
Incorporation of a Company ................................................................................................................. 61
Memorandum of Association ............................................................................................................... 63
Articles of Association ......................................................................................................................... 64
Doctrine of constructive notice, ultra vires and indoor management ................................................... 65
Royal British Bank v. Turquand (1856) 6 E&B 327 ..................................................................... 65
Ashbury Rly. Carriage & Iron Company v. Riche (1875) LR 7 HL 653 ....................................... 66
Lakshmanaswami Mudaliar v. L.I.C. AIR 1963 SC 1185 ............................................................. 69
Modifications to the articles and memorandum of association ............................................................ 70
Conflict between a shareholders agreement and AoA.......................................................................... 72
V.B. Rangaraj vs V.B. Gopalakrishnan And Others AIR 1992 SC 453, 1992 .............................. 73
Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613 .................................. 76
World Phone India Pvt. Ltd v. WPI Group Inc USA, (2013) 178 Comp Cas 173 ........................ 78
MODULE IV - SHARE CAPITAL AND SHAREHOLDERS ............................................................. 82
Pre-incorporation contracts .................................................................................................................. 82
Kelner v. Baxter, (1866) LR 2 CP 174 .......................................................................................... 82
Specific Relief Act ......................................................................................................................... 82
What is a share? .................................................................................................................................... 82
Borland's Trustee -v- Steel Brothers & Co Ltd [1901] 1 Ch 279 1901.......................................... 82
Types of share capital ........................................................................................................................... 83
43. Kinds of share capital- ............................................................................................................. 83
Who is a shareholder; who is a promoter? ........................................................................................... 85
Shareholders meetings .......................................................................................................................... 86
Section 96. Annual general meeting. ............................................................................................. 86
Section 100. Calling of extraordinary general meeting ................................................................. 86
LIC of India v. Escorts Ltd. [1986] 59 Comp Cas 548 .................................................................. 87
Pre-requisites of a valid meeting .......................................................................................................... 91
Section 101. Notice of meeting. ..................................................................................................... 91
Section 102. Statement to be annexed to notice............................................................................. 91
Section 103. Quorum for meetings ................................................................................................ 92
Chandrakant Khare v. Shantaram Kale, (1989) 65 Comp Cas 121 SC.......................................... 93
M.S. Madhusoodan v. Kerela Kaumudi (P.) Ltd. (2003) 46 SCL 695 (SC) .................................. 95
Voting 97
Section 106. Restriction on voting rights. ...................................................................................... 97
Section 107. Voting by show of hands .......................................................................................... 97
Section 108. Voting through electronic means .............................................................................. 97
Section 109. Demand for poll. ....................................................................................................... 98
Section 111. Circulation of members’ resolution .......................................................................... 98
Resolutions and Minutes ...................................................................................................................... 99
Section 114. Ordinary and special resolutions. .............................................................................. 99
Section 115. Resolutions requiring special notice ....................................................................... 100
Section 116. Resolutions passed at adjourned meeting. .............................................................. 100
Section 117. Resolutions and agreements to be filed................................................................... 100
Section 118. Minutes of proceedings of general meeting, meeting of Board of Directors and other
meeting and resolutions passed by postal ballot. ......................................................................... 101
Dividend as return on investments ..................................................................................................... 102
Section 123. Declaration of dividend........................................................................................... 102
MODULE V – MANAGEMENT AND CORPORATE GOVERNANCE ......................................... 104

Agency Problems, Legal Strategies And Enforcement ...................................................................... 104
Kinds of directors ............................................................................................................................... 113
Section 149. (1) Company to have Board of Directors ................................................................ 113
Appointment of Directors ................................................................................................................... 115
Meetings of directors .......................................................................................................................... 117
Section 173. Meetings of Board................................................................................................... 117
Section 174. Quorum for meetings of Board. .............................................................................. 118
Section 175. Passing of resolution by circulation. ....................................................................... 118
Role of directors ................................................................................................................................. 119
Reliance Natural Resources Ltd v. Reliance Industries Ltd. 2008 82 SCL 303 Bombay ............ 119
Duties and liabilities of directors ........................................................................................................ 121
Codification of Directors’ Duties: Is Common Law Excluded? .................................................. 122
Aberdeen Railway Co v Blaikie Brothers (1854) 1 Macq 461 .................................................... 124
George Bray v. John Rawlinson Ford [1896] A.C. 44 ................................................................. 125
North-West Transportation Co. Ltd. v. Beatty 12 S.C.R. 598 ..................................................... 131
Dale & Carrington v. Prathapan (2005) 1 SCC 212 .................................................................... 134
Sangramsinh P. Gaekwad & Ors vs Shantadevi P. Gaekwad AIR 2005 SC 809 ........................ 141
Eclairs Group Ltd (Appellant) v JKX Oil & Gas plc (Respondent) ............................................ 150
Baldev Krishna Sahi v. Shipping Corporation of India 1987 AIR 2245 ..................................... 162
Bank of Baroda v. Official Liquidator (1992) 73 Comp. Cas. 688 (MP) .................................... 163
Lakshmiratan Cotton Mills Ltd v. Aluminium Corp of India Ltd., AIR 1970 SC 1482 .............. 164
Powers and restrictions of board of directors ..................................................................................... 166
Section 179. Powers of Board. ..................................................................................................... 166
Section 180. Restrictions on powers of Board. ............................................................................ 168
Remedies against Directors' Undue Gains: Personal or Proprietary? .......................................... 169
Corporate Governance ........................................................................................................................ 171
Enron, Fraud and Securities Reform: An Enron Prosecutor’s Perspective .................................. 171
Sarbanes Oxley Act...................................................................................................................... 181
Independent Directors .................................................................................................................. 185
Section 150. Manner of selection of independent directors and maintenance of databank of
independent directors ................................................................................................................... 185
History and Development of Corporate Governance in India ..................................................... 186
Corporate reporting – Annual report to shareholders and role of auditors ......................................... 190
Section 128. Books of account, etc., to be kept by company. ...................................................... 191
Section 129. Financial statement. ................................................................................................ 192

Section 130. Re-opening of accounts on court’s or Tribunal’s orders. ........................................ 193
Section 131. Voluntary revision of financial statements or Board’s report. ................................ 193
Section 134. Financial statement, Board’s report, etc.................................................................. 194
Section 136. Right of member to copies of audited financial statement. ..................................... 196
Section 137. Copy of financial statement to be filed with Registrar. .......................................... 197
Corporate Social Responsibility ......................................................................................................... 199
MODULE VII- TRANSFER OF SHARES .......................................................................................... 200
Transfer of shares ............................................................................................................................... 202
Model Articles of Association – Schedule I, Table F, Companies Act, 2013 ............................. 202
Acquisitions in Public Listed Companies........................................................................................... 203
Takeover Code, 2011 ................................................................................................................... 203
Reporting Requirements .............................................................................................................. 206
MODULE VI- CORPORATE FUNDRAISING .................................................................................. 207
Issue of shares/ convertible instruments/ debt .................................................................................... 207
Section 23. Public offer and private placement ........................................................................... 207
Section 62. Further issue of share capital. ................................................................................... 207
Private placement ............................................................................................................................... 209
Section 42. Offer or invitation for subscription of securities on private placement. ................... 209
Preferential Issue of Shares in Public Listed Companies ............................................................ 210
Pre-emptive rights .............................................................................................................................. 212
Public offer ......................................................................................................................................... 213
Sahara India Real Estate Corporation Limited & Ors v. Securities and Exchange Board of India
..................................................................................................................................................... 213
Section 25. Document containing offer of securities for sale to be deemed prospectus. ............. 215
Section 26. Matters to be stated in prospectus. ............................................................................ 216
Section 27. Variation in terms of contract or objects in prospectus. ............................................ 218
Section 28. Offer of sale of shares by certain members of company. .......................................... 219
Section 34. Criminal liability for misstatements in prospectus.................................................... 219
Section 35. Civil liability for misstatements in prospectus. ......................................................... 220
Peek v Gurney (1873) LR 6 HL 377 ............................................................................................ 221
Derry v. Peek (1889) LR 14 AC 337 ........................................................................................... 222
Sundaram Finance Service & Ltd. v. Grandtrust Finance Ltd. (2003) 42 SCL 89 (Mad) ........... 224
Shiromani Sugar Mills Ltd v. Debi Prasad, AIR 1950 All 508 ................................................... 228
Weavers Mills v. Balkis Ammal, AIR 1969 Mad 462 ................................................................. 233
Crowdfunding..................................................................................................................................... 237
Buyback .............................................................................................................................................. 247
Section 68. Power of company to purchase its own securities. ................................................... 247
Section 70. Prohibition for buy-back in certain circumstances.................................................... 249
MODULE VIII - CORPORATE BORROWING, LENDING AND INVESTMENTS .................... 251
Borrowing powers of the company .................................................................................................... 251
Krishna Kumar Rohatagi v. State Bank of India (1980) 50 Comp. Cas. 722 .............................. 251
What constitutes a pledge of goods? .................................................................................................. 255
Lallan Prasad v. Rahmat Ali and Anr. AIR1967SC1322 ............................................................ 255
Charge 257
Inter-corporate borrowing and investments........................................................................................ 257
Section 186. Loan and investment by company. ......................................................................... 257
Debentures .......................................................................................................................................... 259
Narendra Kumar Maheshwari v. Union of India, (1989) 2 Comp LJ 95 ..................................... 259
MODULE XI - MINORITY PROTECTION ....................................................................................... 263
Rule in Foss v. Harbottle .................................................................................................................... 263
Exceptions to the rule in Foss v. Harbottle......................................................................................... 265
Rajahmundry Electric Supply Co. v. Nageshwara Rao AIR 1956 SC 213 .................................. 265
What constitutes oppression? ............................................................................................................. 268
Shanti Prasad Jain v. Kalinga Tubes AIR 1965 SC 1535 ............................................................ 268
Remedies for oppression and mismanagement .................................................................................. 270
Class Actions ...................................................................................................................................... 281
Satyam ......................................................................................................................................... 281
Section 245- Class Actions .......................................................................................................... 282
Powers of Investigation – SFIO ......................................................................................................... 286
Section 211. Establishment of Serious Fraud Investigation Office. ............................................ 286
Section 212. Investigation into affairs of Company by Serious Fraud Investigation Office. ...... 286
MODULE X - CORPORATE RESTRUCTURING ............................................................................ 290
Procedure for merger .......................................................................................................................... 290
MODULE XI - WINDING UP ............................................................................................................... 293
Methods of winding-up ...................................................................................................................... 293
Section 270. Modes of winding up. ............................................................................................. 293
Compulsory winding-up ..................................................................................................................... 293
Section 271. Circumstances in which company may be wound up by Tribunal. ........................ 293
Who can commence the compulsory winding-up proceedings and when? ........................................ 294
Section 272. Petition for winding up. .......................................................................................... 294

Winding up as a Debt Recovery Mechanism ..................................................................................... 295
Harinagar Sugar Mills v M. W. Pradhan , Court Receiver, High Court, Bombay [1966] 36 Comp
Cas 426 ........................................................................................................................................ 295
Smt. Nagaveni Bhat v. Canara Leasing Ltd ILR 2001 KAR 5569 .............................................. 297
Substratum of the Company ............................................................................................................... 298
Madhusudan Gordhandas & Co. v. Madhu Woollen Industries Pvt. Ltd. (1972) 42 Comp. Cas.
125 ............................................................................................................................................... 298
Voluntary winding-up ........................................................................................................................ 300
Section 304. Circumstances in which company may be wound up voluntarily........................... 300
Section 305. Declaration of solvency in case of proposal to wind up voluntarily. ...................... 300
Section 306. Meeting of creditors. ............................................................................................... 301
Section 307. Publication of resolution to wind up voluntarily..................................................... 301
Ranking of claims ............................................................................................................................... 301
Section 324. Debts of all descriptions to be admitted to proof. ................................................... 302
Section 325. Application of insolvency rules in winding up of insolvent companies ................. 302
Section 326. Overriding preferential payments ........................................................................... 303
Section 327. Preferential payments .............................................................................................. 304
MODULE I - INTRODUCTION TO THE CORPORATE FORM
Principles of Corporate Law
What is Corporate Law?

Henry Hansmann and Reinier Kraakman
Yale Law School - Research Paper No. 300 - http://ssrn.com/abstract=568623
1.1 Introduction
What is the common structure of the law of business corporations—or, as it would be put in the UK,
company law—across different national jurisdictions? Although this question is rarely asked by corporate
law scholars, it is critically important for the comparative investigation of corporate law. Recent scholarship
emphasizes the divergence among European, American, and Japanese corporations in corporate
governance, share ownership, capital markets, and business culture.1 But, notwithstanding the very real
differences across jurisdictions along these dimensions, the underlying uniformity of the corporate form is
at least as impressive. Business corporations have a fundamentally similar set of legal characteristics—and
face a fundamentally similar set of legal problems—in all jurisdictions.
Consider, in this regard, the basic legal characteristics of the business corporation. To anticipate our
discussion below, there are five of these characteristics, most of which will be easily recognizable to anyone
familiar with business affairs. They are: legal personality, limited liability, transferable shares, delegated
management under a board structure, and investor ownership. These characteristics are—for reasons we
will explore—induced by the economic exigencies of the large modern business enterprise. Thus, corporate
law everywhere must, of necessity, provide for them. To be sure, there are other forms of business enterprise
that lack one or more of these characteristics. But the remarkable fact—and the fact that we wish to stress—
is that, in market economies, almost all large-scale business firms adopt a legal form that possesses all five
of the basic characteristics of the business corporation. Indeed, most small jointly-owned firms adopt this
corporate form as well, although sometimes with deviations from one or more of the five basic
characteristics to fit the special needs of closely held firms. (Throughout this book, we will follow the usual
practice of using the term ‘closely held’ to refer to corporations whose shares— unlike those of ‘publicly
held’ corporations—do not trade freely in impersonal markets, either because the shares are held by a small
number of persons or because they are subject to restrictions that limit their transferability.)
Self-evidently, a principal function of corporate law is to provide business enterprises with a legal form that
possesses these five core attributes. By making this form widely available and user-friendly—i.e., by
altering background property rights and providing off-the-shelf housekeeping rules—corporate law enables
entrepreneurs to transact easily through the medium of the corporate entity, and thus lowers the costs of
business contracting. Of course, the number of provisions that the typical corporation statute devotes to
defining the corporate form is likely to be only a small part of the statute as a whole. Nevertheless, these
are the provisions that comprise the legal core of corporate law that is shared by every jurisdiction. In this
Chapter, we briefly explore the contracting efficiencies (some familiar and some not) that accompany these
five features of the corporate form, and that, we believe, have helped to propel the worldwide diffusion of
the corporate form.
1.2 What is a Corporation?

As we noted above, the five core structural characteristics of the business corporation are: (1) legal
personality, (2) limited liability, (3) transferable shares, (4) centralized management under a board structure,
and (5) shared ownership by contributors of capital. In virtually all economically important jurisdictions,
there is a basic statute that provides for the formation of firms with all of these characteristics, at least as
the default regime. This is to say that firms formed under the statute will have these characteristics unless
(if the statute permits) those who form the firm make explicit provision for omitting one or more of them.
As this pattern suggests, these characteristics have strongly complementary qualities for many firms.
Together, they make the corporation uniquely attractive for organizing productive activity. But these
characteristics also generate tensions and tradeoffs that lend a distinctively corporate character to the agency
problems that corporate law must address.
While our principal focus is on companies that share all five of these core characteristics, firms that have
only some but not all of these characteristics are also commonplace. Sometimes these firms are formed
under a jurisdiction’s basic corporation statute, taking advantage of the statute’s flexibility to omit one or
more of the characteristics that are provided for simply as defaults. Other times these firms are formed
under special ‘close’ corporation statutes that, in addition, provide mechanisms for restricting the
transferability of shares—such as those governing the German Gesellschaft mitbeschrankter Haftung
(GmbH), the French Socie´te´ a` responsabilite´ limite´e (SARL), the British private corporation, the
Japanese close corporation, and the close corporation forms that are provided for in some U.S. jurisdictions.
Most of the larger firms organized under these statutes are full corporations in precisely the sense that we
intend. But even when a closely held firm drops a core feature of the corporate form (typically the board of
directors), it shares the remaining characteristics and problems of this form. Likewise, our analysis extends
to important aspects of legal regimes addressed to the regulation of corporate groups, such as the German
Konzernrecht.
Much of what we say here also applies to firms that are governed by special statutes—such as those for
limited liability companies10 or business trusts that omit one or more of the core characteristics from their
default regime. While these statutes are not corporate law statutes, our analysis offers insight into the
interpretation of these bodies of law, and we shall occasionally address them explicitly.
1.2.1 Legal personality

As an economic entity, a firm fundamentally serves as a nexus of contracts: a single contracting party that
coordinates the activities of suppliers of inputs and of consumers of products and services. The first and
most important contribution of corporate law, as of other forms of organizational law, is to permit a firm to
serve this role by providing for the creation of a legal person—a contracting party distinct from the various
individuals who own or manage the firm, or are suppliers or customers of the firm.
The core element of legal personality (as we use the term here) is what the civil law refers to as ‘separate
patrimony.’ This is the ability of the firm to own assets that are distinct from the property of other persons,
such as the firm’s investors, and that the firm is free not only to use and sell but—most importantly—pledge
to creditors. Elsewhere we have termed this asset-pledging effect of legal personality ‘affirmative asset
partitioning’ to emphasize that it involves shielding the assets of the entity—the corporation—from the
creditors of the entity’s managers and owners.
Where corporations are concerned, there are two relatively distinct rules of law involved. The first is a
priority rule that grants to creditors of the firm, as security for the firm’s debts, a claim on the firm’s assets
that is prior to the claims of the personal creditors of the firm’s owners. This rule is shared by all modern
legal forms for enterprise organization, including partnerships. The consequence of this priority rule is that
a firm’s assets are automatically pledged as security for all contractual liabilities entered into by the firm.
Its obvious advantage is to increase the credibility of the firm’s contractual commitments.
The second rule—a rule of ‘liquidation protection’—provides that the individual owners of the corporation
(the shareholders) cannot withdraw their share of firm assets at will, thus forcing partial or complete
liquidation of the firm, nor can the personal creditors of an individual owner foreclose on the owner’s share
of firm assets. This liquidation protection rule serves to protect the going concern value of the firm against
destruction either by individual shareholders or their creditors. In contrast to the priority rule just mentioned,
it is not found in some other standard legal forms for enterprise organization, such as the partnership.
Legal entities, such as the business corporation, that are characterized by both these rules—priority for
business creditors and liquidation protection—can therefore be thought of as having ‘strong form’ legal
personality, as opposed to the ‘weak form’ legal personality found in partnerships, which are characterized
only by the priority rule and not by liquidation protection.
The pattern of creditors’ rights created by strong form legal personality is, in effect, the converse of that
created by limited liability. It protects the assets of the firm from the creditors of the firm’s owners, while
limited liability protects the assets of the firm’s owners from the claims of the firm’s creditors. Strong form
legal personality reinforces the stability and creditworthiness of the firm and, when combined with limited
liability, isolates the value of the firm from the personal financial affairs of the firm’s owners sufficiently
to permit the firm’s shares to be freely traded.
The priority rule component of corporate legal personality requires special legal doctrine to be effective. It
could not feasibly be replicated, in the absence of such doctrine, simply by contracting among a business’s
owners and their creditors because contracts among these parties cannot bind the individual creditors of the
firm’s owners. The same is true of the liquidation protection feature of corporate law so far as it binds the
creditors of a firm’s owners. (The owners could bind themselves not to liquidate the firm simply by contract,
as members of partnerships in fact often do.) This distinguishes legal personality from the other four basic
elements of the corporate form discussed here, which could all in theory be crafted by contractual means
even if the law did not provide for a standard form of enterprise organization that embodies them.
1.2.2 Limited liability

The corporate form effectively imposes a default term in contracts between a firm and its creditors whereby
the creditors are limited to making claims against the assets that are the property of the firm itself, and have
no further claim against the personal assets of the firm’s shareholders (or managers). This limitation of
owner liability distinguishes the corporate form from some other important forms of organization that have
legal personality (as we define the latter feature here), including in particular partnerships.
Historically, limited liability has not always been associated with the corporate form. Some important
corporate jurisdictions long made unlimited shareholder liability for corporate debts the governing rule.18
Nevertheless, today limited liability has become a nearly universal feature of the corporate form. This
evolution indicates strongly the value of limited liability as a contracting tool and financing device.
Elsewhere we have described limited liability as ‘defensive asset partitioning’ to distinguish it from the
‘affirmative’ partitioning effects of legal personality. While legal personality permits the business to own
assets, and thus serves as a kind of floating lien favoring business creditors over the individual creditors of
investors and managers, limited liability reserves shareholders’ individual assets exclusively for their
personal creditors. Thus, legal personality and limited liability together set up a default regime whereby a
shareholder’s personal assets are pledged as security to his personal creditors, while corporation assets are
reserved for corporation creditors. In an enterprise of any substantial magnitude, this allocation generally
increases the value of both types of assets as security for debt. It permits creditors of the corporation to have
first claim on the corporation’s assets, which those creditors have a comparative advantage in evaluating
and monitoring. Conversely, it permits an individual’s personal creditors to have first claim on personal
assets, which those creditors are in a good position to evaluate and monitor and which creditors of the
corporation, conversely, are not in a good position to check. As a consequence, legal personality and limited
liability together can reduce the overall cost of capital to the firm and its owners.
A related aspect of asset partitioning is that limited liability permits firms to isolate different lines of
business for the purpose of obtaining credit. By separately incorporating, as subsidiaries, distinct ventures
or lines of business, the assets associated with each venture can conveniently be pledged as security just to
the creditors who deal with that venture. Those creditors are commonly well positioned to assess and keep
track of the value of those assets, but may have little ability to monitor the corporation’s other ventures.
Finally, by virtue of limited liability, the formation of corporations and subsidiary corporations can be used
as a means of sharing the risks of transactions with the parties with whom a firm contracts, in situations in
which the latter parties are in a better position to bear those risks. Thus, limited liability can play a valuable
contracting role even in situations where a corporation has a single shareholder who does not require the
corporate form to raise equity capital, as in the case of the parent company of a wholly owned subsidiary.
Beyond this function of defensive asset partitioning, limited liability permits flexibility in the allocation of
risk and return between equityholders and debtholders, reduces transaction costs of collection in case of
insolvency, and simplifies and substantially stabilizes the pricing of stock—something we shall say more
about below in the discussion of transferability of shares. Limited liability also plays an important
function—but more subtle and less often remarked—in facilitating delegated management, which is the
fourth of the core characteristics of the corporate form. In effect, by shifting downside business risk from
shareholders to creditors, limited liability enlists creditors as monitors of the firm’s managers, a task which
they may be in a better position to perform than are the shareholders in a firm in which share ownership is
widely dispersed.
We should emphasize that when we refer to limited liability, we mean specifically limited liability in
contract—that is, limited liability to voluntary creditors who have contractual claims on the corporation.
The compelling reasons for limited liability in contract generally do not extend to limited liability in tort—
that is, limited shareholder liability to persons who are involuntary creditors of the corporation, such as
third parties who have been injured as a consequence of the corporation’s negligent behavior. Limited
liability to involuntary creditors is arguably not a necessary feature of the corporate form, nor even a socially
valuable one.
1.2.3 Transferable shares

Fully transferable shares in ownership are yet another basic characteristic of the business corporation that
distinguishes the corporation from the partnership and from various other standard-form legal entities as
well. Transferability permits the firm to conduct business uninterruptedly as the identity of its owners
changes, thus avoiding the complications of member withdrawal that are common among, for example,
partnerships, cooperatives, and mutuals. This in turn enhances the liquidity of shareholders’ interests and
makes it easier for shareholders to construct and maintain diversified investment portfolios.
Fully transferable shares do not necessarily mean freely tradable shares. Even if shares are transferable,
they may not be tradable without restriction in public markets, but rather just transferable among limited
groups of individuals or with the approval of the current shareholders or of the corporation. Free tradability
maximizes the liquidity of shareholdings and the ability of shareholders to diversify their investments. It
also gives the firm maximal flexibility in raising capital. For these reasons, all jurisdictions provide for free
tradability as the default regime for at least one class of corporations (sometimes referred to as ‘open’
corporations). However, free tradability can also make it difficult to maintain negotiated control
arrangements. Consequently, all jurisdictions also provide mechanisms for restricting transferability.
Sometimes this is done by means of a separate statute, such as the special European statutes for close
corporations, while other jurisdictions simply provide for restraints on transferability as an option under a
basic corporation statute.
Transferability of shares, as we have already suggested, is closely connected both with the liquidation
protection that is a feature of strong form legal personality, and with limited liability. Absent either of these
rules, the creditworthiness of the firm as a whole could change, perhaps fundamentally, as the identity of
its shareholders changed. Consequently, the value of shares would be difficult for potential purchasers to
judge. Perhaps more importantly, a seller of shares could impose negative or positive externalities on his
fellow shareholders depending on the wealth of the person to whom he chose to sell. It is therefore not
surprising that strong form legal personality, limited liability, and transferable shares tend to go together,
and are all features of the standard corporate form everywhere. This is in contrast to the conventional
general partnership, which lacks all of these features.
1.2.4 Delegated management with a board structure

Delegated management is an attribute of nearly all large firms with numerous fractional owners. Delegation
permits the centralization of management necessary to coordinate productive activity. Equally important,
delegation of decision-making power to specific individuals notifies third parties as to who in the firm has
the authority to make binding agreements. The authority issue, in particular, quickly becomes intractable in
a firm in which numerous owners and managers are not distinct, as in a large general partnership that fails
to allocate authority by agreement and to signal this allocation of authority clearly to third parties.
Organizational forms differ, however, in the way in which they delegate management power and authority.
The limited partnership and the common law private trust, for example, typically invest full control rights
in a general partner or trustee who cannot be displaced without cause. By contrast, corporate law typically
vests principal authority over corporate affairs in a board of directors or similar committee organ that is
periodically elected, exclusively or primarily, by the firms’ shareholders. More specifically, business
corporations are distinguished by a governance structure in which all but the most fundamental decisions
are put in the hands of a board of directors that has four basic features
First, the board is, at least as a formal matter, separate from the operational managers of the corporation.
The nature of this separation varies according to whether the board has one or two tiers. In two-tier boards,
top corporate officers occupy the board’s second (subordinate) tier, but are generally absent from the first
(supervisory) tier, which is at least nominally independent from the firm’s hired officers (i.e. from the firm’s
senior managerial employees). In single-tier boards, in contrast, hired officers may be members of, or even
dominate, the board itself. Regardless of the actual allocation of power between a firm’s directors and
officers, the legal distinction between them formally divides all corporate decisions that do not require
shareholder approval into those requiring approval by the board of directors and those that can be made by
the firm’s hired officers on their own authority. This formal distinction between the board and hired officers
facilitates a separation between, on the one hand, initiation and execution of business decisions, which is
the province of hired officers, and on the other hand the monitoring and ratification of decisions, and the
hiring of the officers themselves, which are the province of the board. That separation serves as a useful
check on the quality of decision-making by hired officers. It also performs the key function—noted
earlier—of permitting third parties to rely on a well-defined institution to formally bind the firm in its
transactions with outsiders.
Second, the board is formally distinct from the firm’s shareholders. This separation economizes on the costs
of decision-making by avoiding the need to inform the firm’s ultimate owners and obtain their consent for
all but the most fundamental decisions regarding the firm. Beyond this, a separately-constituted board can
also provide a check on opportunistic behavior by controlling shareholders— either toward their fellow
shareholders or toward other parties who deal with the firm, such as creditors or employees—by providing
a convenient target of personal liability for decisions made by the firm. Membership on the board can
likewise provide minority shareholders or other constituencies, such as employees or creditors, with a
means for obtaining credible access to information or direct participation in firm decision-making. Also,
by assigning designated individuals a specific role as decision-makers on behalf of the enterprise, the
corporate form enhances the probability that those individuals will respond in a principled fashion to the
interests of all corporate constituencies simply through moral principles and social pressure, quite apart
from formal legal or electoral accountability.
Third, the board of a corporation is elected—at least in substantial part—by the firm’s shareholders. The
obvious utility of this approach is to help assure that the board remains responsive to the interests of the
firm’s owners, who bear the costs and benefits of the firm’s decisions and whose interests, unlike those of
other corporate constituencies, are not strongly protected by contract. This requirement of an elected board
distinguishes the corporate form from other legal forms, such as nonprofit corporations or business trusts,
that permit or require a board structure, but do not require election of the board by the firm’s (beneficial)
owners.
Fourth, the board ordinarily has multiple members. This structure—as opposed, for example, to a structure
concentrating authority in a single trustee, as in many private trusts—facilitates mutual monitoring and
checks idiosyncratic decision-making. However, there are exceptions. For example, most close corporation
statutes, such as those governing Germany’s GmbH or France’s SARL, permit business planners to
dispense with a collective board in favor of a single general director or one-person board—the evident
reason being that, for a very small corporation, most of the board’s legal functions, including its service as
shareholder representative and focus of liability, can be discharged effectively by a single elected director
who also serves as the firm’s principal manager.
1.2.5 Investor ownership

There are two key elements in the ownership of a firm, as we use the term ‘ownership’ here: the right to
control the firm, and the right to receive the firm’s net earnings. The law of business corporations is
principally designed to facilitate the organization of investor-owned firms—that is, firms in which both
elements of ownership are tied to investment of capital in the firm. More specifically, in an investor-owned
firm, both the right to participate in control— which generally involves voting in the election of directors
and voting to approve major transactions—and the right to receive the firm’s residual earnings, or profits,
are typically proportional to the amount of capital contributed to the firm. Business corporation statutes
universally provide for this allocation of control and earnings as the default rule.
There are other forms of ownership that play an important role in contemporary economies, and other bodies
of organizational law—including other bodies of corporate law—that are specifically designed to facilitate
the formation of those other types of firms. For example, cooperative corporation statutes— which provide
for all of the four features of the corporate form just described except for transferable shares, and often
permit the latter as an option as well— allocate voting power and shares in profits proportionally to acts of
patronage, which may be the amount of inputs supplied to the firm (in the case of a producer cooperative),
or the amount of the firm’s products purchased from the firm (in the case of a consumer cooperative).
Indeed, business corporations are effectively a special kind of producer cooperative, in which control and
profits are tied to supply of a particular type of input, namely capital. As a consequence, business
corporations could, in principle, be formed under a well-designed general cooperative corporation statute.
But the law provides, instead, a special statutory form for corporations owned by investors of capital
(‘capital cooperatives,’ as we might think of them).
This specialization follows from the dominant role that investor-owned firms have come to play in
contemporary economies, and the consequent advantages of having a form that is specialized to the
particular needs of such firms, and that signals clearly to all interested parties the particular character of the
firm with which they are dealing. The dominance of investor ownership among large firms, in turn, reflects
several conspicuous efficiency advantages of that form. One is that, among the various participants in the
firm, investors are often the most difficult to protect simply by contractual means. Another is that investors
of capital have (or can be induced to have) peculiarly homogeneous interests among themselves, hence
minimizing the potential for costly conflict among those who share governance of the firm.
Specialization to investor ownership is yet another respect in which the law of business corporations differs
from the law of partnership. The partnership form typically does not presume that ownership is tied to
contribution of capital, and though it is often used in that fashion, it is also commonly used to assign
ownership of the firm in whole or in part to contributors of labor or of other factors of production—as in
the prototypical two-person partnership in which one partner supplies labor and the other capital. As a
consequence, the business corporation is less flexible than the partnership in terms of assigning ownership.
To be sure, with sufficient special contracting and manipulation of the form, ownership shares in a business
corporation can be granted to contributors of labor or other factors of production, or in proportion to
consumption of the firm’s services. Moreover, as the corporate form has evolved, it has achieved greater
flexibility in assigning ownership, either by permitting greater deviation from the default rules in the basic
corporate form (e.g., through restrictions on share ownership or transfer), or by developing a separate and
more adaptable form for closely held corporations. Nevertheless, the default rules of corporate law are
generally designed for investor ownership, and deviation from this pattern can be awkward. The complex
arrangements for sharing rights toearnings, assets, and control between entrepreneurs and investors in high-
tech start-up firms offer a familiar example.
Sometimes corporate law itself deviates from the assumption of investor ownership to permit or require
that persons other than investors of capital— for example, creditors or employees—participate to some
degree in either control or net earnings or both. Worker codetermination is a conspicuous example.
The wisdom and means of providing for such non-investor participation remains one of the basic
controversies in corporate law. Most jurisdictions also have one or more corporate forms—such as the U.S.
nonprofit corporation, the civil law foundation and association, and the UK company limited by
guarantee—that provide for formation of nonprofit firms. These are firms in which no person may
participate simultaneously in both the right to control and the right to residual earnings (which is to say,
they have no owners). These nonprofit corporations, however, like cooperative corporations, will not be
within the specific focus of our attention here. Thus, when we use the term ‘corporation’, we refer only to
the business corporation, and not to other types of incorporated entities.
1.3 What Does Corporate Law Include?

All jurisdictions have a least one statute that establishes a basic corporate form with the five characteristics
described above. Nevertheless, corporate law as we understand it here generally extends well beyond the
bounds of this core statute.
1.3.1 Secondary and partial corporations forms

First, all major jurisdictions have multiple secondary or partial corporate law statutes. Secondary statutes
include separate statutes for special classes of firms such as foreign firms or governmentally owned
enterprise. Partial corporate law statutes provide for separately defined statutory entities that have, or at
least are permitted to have, some but not all of the five core characteristics described above. Examples
include limited partnerships, limited liability companies, and statutory business trusts. To the extent that
these forms include the core characteristics of the corporation, our discussion will help to illuminate their
role and structure.
We consider close companies—the German GmbH, the French SARL, the Japanese close corporation, the
American close corporation, and the British private corporation—to exhibit all of the canonical features of
the corporate form. They differ from public companies chiefly because their shares, though transferable at
least in principle, do not trade freely in a public market. By contrast, statutes that merely permit business
planners to create firms with the legal characteristics of business corporations, such as typical American
limited liability company statutes and business trust statutes, are not corporate law statutes. Large scale
enterprise, regardless of its statutory origins, tends to exhibit most or all of the core characteristics of the
corporation form. But a body of statutory or decisional law belongs to corporate law only to the extent that
it provides for, or at least responds to, these characteristics. It does not belong to the extent that it is merely
an empty vessel within which planners may, by contracting, create a contractually-devised corporate form.
On the other hand, the analysis offered in this book also offers insight into the interpretation of those bodies
of law where they are used to form entities that share the characteristics of business corporations.
1.3.2 Additional sources of corporate law

There are bodies of law that, at least in some jurisdictions, are incorporated in statutes or decisional law
that are separate from basic corporate law, and from the alternative forms just described, but that are
nonetheless exclusively concerned with particular core characteristics of the corporate form as we define
them here.
To begin, the well-known German law of groups, or Konzernrecht, qualifies limited liability and limits the
discretion of boards of directors in corporations that are closely related through cross ownership, seeking
to protect the creditors and minority shareholders of corporations with controlling shareholders. Where
subsidiaries are organized under the open corporation statute (Aktiengesetz), the rights of controlled
companies are delimited by this statute itself, which provides for the regulation of both contractually
formalized group relationships and de facto control relationships among corporations. Where subsidiaries
are organized under the close corporation statute (GmbH-Gesetz), the parallel law of corporate groups is
judge-made rather than statutory. Either way, however, Konzernrecht is clearly an integral part of German
corporate law.
Similarly, the statutory rules in many jurisdictions that require employee representation on a corporation’s
board of directors—such as, conspicuously, the German or Dutch law of codetermination—qualify as
elements of corporate law even though they occasionally originate outside the principal corporate law
statutes, because they impose a detailed structure of employee participation on the boards of directors of
large corporations. American securities law, which applies to large corporations, importantly structures
board representation by establishing elaborate election procedures, regulating transferability of shares in
various contexts, and imposing detailed disclosure rules. Stock exchange rules, which can regulate
numerous aspects of the internal affairs of exchange-listed firms, can also serve as an additional source of
corporate law, as can other forms of self-regulation, such as the UK’s City Code rules on takeovers and
mergers.
These supplemental bodies of law are necessarily part of the overall structure of corporate law, and we shall
be concerned here with all of them.
1.3.3 Non-corporate law constraints
There are, of course, many constraints imposed on companies by bodies of law designed to serve objectives
that are largely unrelated to the core characteristics of the corporate form, and therefore do not fall within
the scope of corporate law as we define it here.
Bankruptcy law, or ‘insolvency law,’ as it is termed in the UK, is an example. As wehave noted, a major
contribution of the corporation as a legal form is the ability to partition assets for purposes of pledging them
as security to different groups of creditors. Bankruptcy law plays an important role in enforcing the claims
that derive from this partitioning.
Nevertheless, the problems of bankruptcy presented by corporations are often shared by other types of legal
entities, and the elements of bankruptcy law that address those problems are not, in many jurisdictions,
confined to entities formed as business corporations.31 Consequently, we do not treat most aspects of
bankruptcy law here as part of corporate law.
Similarly, although the types of firms that typically organize as corporations present particular problems
for tort liability—especially when it comes to the liability of the corporation for the acts of corporate
employees—these and other problems addressed by tort law are often presented by other types of entities,
and we do not address them here directly. Much the same is true, moreover, for the types of issues
traditionally considered within the realm of contract law, criminal law, and labor law. While, in each of
those areas, firms organized as corporations present, to some degree, particular problems, those problems
are not so distinctively connected to the core features of a corporation as to lead us to address them
here as part of what we consider basic corporate law. There are, however, some exceptions. For example,
the UK doctrine of ‘wrongful trading’ in insolvency, while formally an aspect of bankruptcy law, focuses
specifically on the duties of corporate directors. The problems of labor contracting presented by large firms
are, in some jurisdictions, addressed by specific regulation of the basic elements of the corporate form as
we have described them here, such as the composition of the firm’s board of directors. The extension of
limited liability beyond contract to tort, which has come to be considered a basic feature of the corporate
form nearly everywhere, is another exception. In cases such as these, there is a blurring of the boundaries
between corporate law and other fields of law—bankruptcy, labor, or tort law—that must be addressed here.
1.4 What is the Goal of Corporate Law?

What is the goal of corporate law, as distinct from its immediate functions of defining a form of enterprise
and containing the conflicts among the participants in this enterprise? As a normative matter, the overall
objective of corporate law—as of any branch of law—is presumably to serve the interests of society as a
whole. More particularly, the appropriate goal of corporate law is to advance the aggregate welfare of a
firm’s shareholders, employees, suppliers, and customers without undue sacrifice—and, if possible, with
benefit—to third parties such as local communities and beneficiaries of the natural environment.
This is what economists would characterize as the pursuit of overall social efficiency. It is sometimes said
that the goals of corporate law should be narrower. In particular, it is sometimes said that the appropriate
role of corporate law is simply to assure that the corporation serves the best interests of its shareholders or,
more specifically, to maximize financial returns to shareholders or, more specifically still, to maximize the
market price of corporate shares. Such claims can be viewed in two ways.
First, these claims can be taken at face value, in which case they neither describe corporate law as we see
it, nor do they offer a normatively appealing aspiration for that body of law. There would be little to
recommend a body of law that, for example, permits corporate shareholders to enrich themselves through
transactions that make creditors or employees worse off by $2 for every $1 that the shareholders gain.
Second, such claims can be understood as saying, more modestly, that focusing principally on the
maximization of shareholder returns is, in general, the best means by which corporate law can serve the
broader goal of advancing overall social welfare. In general, creditors, workers, and customers will consent
to deal with a corporation only if they expect to be better off themselves as a result.
Consequently, the corporation—and, in particular, its shareholders—has a direct pecuniary interest in
making sure that corporate transactions are beneficial, not just to the shareholders, but to all parties who
deal with the firm. We believe that this second view is—and surely ought to be—the appropriate
interpretation of statements by legal scholars and economists asserting that shareholder value is the proper
object of corporate law.
Whether, in fact, the pursuit of shareholder value is generally an effective means of advancing social welfare
is an empirical question on which reasonable minds can differ. While each of the authors of this book have
individual views on this claim, we do not take a strong position on it in the Chapters that follow. Rather,
we undertake the broader task of offering an analytic framework within which this question can be explored
and debated. To say that the pursuit of aggregate social welfare is the appropriate goal of corporate law is
not to say, of course, that the law always serves that goal.
Legislatures and courts are sometimes less attentive to overall social welfare than to the particular interests
of some influential constituency, such as corporate managers, controlling shareholders, or organized
workers. Moreover, corporate law everywhere continues to bear the imprint of the historical path through
which it has evolved, and reflects as well various non-efficiency-oriented intellectual and ideological
currents that have sometimes influenced its formation. The corporate law of all jurisdictions clearly shows,
to a greater or lesser degree, the weight of these various influences.
Meaning of the word ‘Company’

 Section 2(20) – company registered under this Act or a previous company law
 Section 2 (22) - company having the liability of its members limited by the memorandum
to the amount, if any, unpaid on the shares respectively held by them
Tennant v. Stanley [In re Stanley] (1906) 1 Ch. 131 –

Facts –
- Sir Henry Morton Stanley empowered the trustees of his will to invest monies in stocks, funds and
securities of “any corporation or company”, municipal, commercial or otherwise.
Issues -
- Whether upon the true construction of the will the trustees were empowered to invest the trust
money in stocks, funds and securities of any corporation or company formed or registered in the
United Kingdom, but carrying on business abroad; and any corporation or company formed or
registered outside the United Kingdom.
- What is the meaning and scope of the word “company”?
Discussion –
- The word “company” has no strictly technical meaning. It involves two ideas:
o Firstly, the association is of persons so numerous as not to be aptly described as a firm; and
o Secondly, the consent of all the members is not required to the transfer of a member’s
interest.
- It may include an incorporated company. The phrase used in the will is “any corporation or
company, municipal, commercial or otherwise” is of wide import and includes associations that are
“corporations” within the meaning of domestic law as well as associations that are formed and
registered outside the State.
- Thus, The trustees were empowered to invest the trust money in stocks, funds and securities of
corporations or companies of formed or registered in the United Kingdom, but carrying on business
abroad and those formed or registered outside the United Kingdom.
The term “company” has no strict legal meaning. Loosely, it refers to a group of people (too numerous to
be a firm) who come together for a common purpose (usually profit) and create a separate legal entity for
that purpose.
Independent Legal Entity
Section 9– Incorporation
From the date of incorporation mentioned in the certificate of incorporation, such subscribers to the
memorandum and all other persons, as may, from time to time, become members of the company, shall be
a body corporate by the name contained in the memorandum, capable of exercising all the functions of an
incorporated company under this Act and having perpetual succession and a common seal with power to
acquire, hold and dispose of property, both movable and immovable, tangible and intangible, to contract
and to sue and be sued, by the said name.
Corporate Personality in India
Arjya B. Majumdar
Introduction
The instant paper deals with certain questions pertaining to the rights and liabilities that a company and the
persons associated with it, are subject to. The concept of corporate personality has long been a significant
issue in the study of corporate law and indeed, commercial systems in general. The concept throws up a
number of concerns regarding how a company is to be treated in the eyes of the law.
For the purposes of the present paper, the following three issues have been dealt with-
 The concept of the company as an entity separate from its members and other associated persons,
 The circumstances under which this ‘corporate veil’ may be lifted, and
 Whether a company may be treated as a ‘citizen’ under the Constitution of India and the Indian
Citizenship Act, 1955
To fully understand and appreciate the above concerns, the nature of the company must be comprehended
first. Although the legal definition is somewhat vague and ambiguous, from common parlance we do have
some idea about what a company is. A company is an artificial body- an association of persons too
numerous to be a firm, united for profit.
The ordinary law of the land does not let a sole proprietor segregate his private means from those of his
business. Consequently, in the event of a business-related crisis, financial or otherwise, his debts relating
to his business will have to be met from his private finances. Thus, some unfortunate miscalculation on part
of his business may leave him and his family facing bankruptcy and financial ruin and it may not be
worthwhile to carry on in other commercial ventures.
In the case of a partnership, the position is even more precarious. A partner would not only be responsible
for his acts committed in the course of business, he would also be liable for the acts of his partner. The
partnership relation is itself based on mutual confidence. If a partner misuses this confidence, he may land
the other partners in insurmountable difficulties, since a partner’s liability is unlimited.
Thus, the advantages of a company in this case are huge, especially in relation to investment, technical
expertise, limited liability, resources, etc. However, one of the most coveted benefits that is to be gained
from the formation of a company and consequently, the main thrust of this paper, deals with the concept of
the company as a legal person separate from its members.
A Separate Entity
In the previous chapter, it had been mentioned that one of the foremost advantage of the formation of a
company was that it has a legal personality separate from that of its members. When a company is
registered, it is clothed with a legal personality. It comes to have almost the same rights and powers as a
human being. Its existence is distinct and separate from that of its members. Members may change or die
but the company goes on until it is wound up on the grounds specified by the Companies Act, 1956. In
other words, it means that it has perpetual succession. A company can own property, have a banking
account, be liable for taxes, raise loans, incur liabilities, and enter into contracts. Even members can contract
with the company, acquire rights against it or incur liability to it. For the debts of the company, however,
only its creditors can take legal action against it, and not its members. In addition, according to Section 34
(2) of the Act, on registration of the company, the association of persons becomes a body corporate by the
name contained in the memorandum.
Salomon v. Salomon & Co. Ltd.

Before the concept of a separate personality of a corporate body is further delved into, it is believed that the
celebrated case of Salomon v. Salomon & Co. Ltd. should be elucidated. The facts are as follows-
Salomon carried on business as a leather merchant. He sold his business for a sum of ₤ 30,000, to a company
formed by him along with his wife, a daughter and four sons. The purchase consideration was satisfied by
allotment of 20,000 shares of ₤ 1 each and issue of debentures worth ₤ 10,000 secured by floating charge
on the company’s assets in favour of Mr. Salomon. All the other shareholders subscribed for one share of
₤ 1 each. Mr. Salomon was also the managing director of the company. The company almost immediately
ran into difficulties and eventually became insolvent and winding up proceedings were initiated against it.
At the time of winding up, the total assets of the company amounted to ₤ 6,050; its liabilities were ₤ 10,000
secured by the debentures issued to Mr. Salomon and ₤ 8,000 owing to unsecured trade creditors. The
sundry unsecured creditors claimed that the company was a mere alias for Salomon.
Lord Macnaughtan in the instant case observed that-
“A company at law is a different person altogether from its subscribers…; and though it may be
that after incorporation the business is precisely the same as it was before, and the same persons
are managers, and the same hands receive the profits, the company is at law, neither an agent for
the subscribers, nor a trustee for them. Nor are the subscribers as members liable, in any shape or
form, except to the extent and in the manner provided by the Act.”
In addition, Lord Herschell remarked-
“In a popular sense, a company may in every case be said to carry on business for and on behalf of
its members; but this certainly does not in point of law constitute the relation of principal and agent
between them or render the shareholders liable to indemnify the company against the debts which
it incurs.”
It was eventually held that the contention of the trade creditors could not be maintained because the
company being in law, a person quite distinct from its members, could not be regarded as an ‘alias’ or agent
or trustee for Salomon. Also, the company’s assets must be applied in the payment of the debentures as a
secured creditor is entitled to payment out of the assets on which his debt is secured in priority to unsecured
creditors.
Thus, this case clearly established that the company has its own existence and as a result, a shareholder
cannot be liable for the acts of the company even though he holds virtually the entire share capital. The
whole law of incorporation is, in fact, based on this theory of corporate entity.
In another case, Lee v. Lee Air Farming Limited1, a company was formed for the purpose of manufacturing
aerial top dressings. Lee, a qualified pilot, held all but one of the shares in the company, and by the articles
of association, was appointed as governing director of the company and chief pilot. Lee was killed while
piloting the company’s aircraft, and his widow claimed compensation for his death under the (United
Kingdom) Workmen Compensation Act. The company opposed the claim on the grounds that Lee was not
a ‘worker’ per se as the same person could not be employer and the employee at the same time.
Relying upon the principles laid down in Salomon v. Salomon & Co. Ltd., the Privy Council held that there
was a valid contract of service between Lee and the company, which was an entity separate from himself,
and that Lee was, therefore, a worker. Mrs. Lee’s contention was upheld.
In Bacha F. Gudzar v. The Commissioner of Income-Tax, Bombay2, the plaintiff, Mrs. Guzdar, received
certain amounts as dividend in respect of shares held by her in a tea company. Under the Income Tax Act,
agricultural income is exempted from payment of income tax. As income of a tea company is partly
agricultural, only forty percent of the company’s income is treated as income from manufacture and sale
and is therefore, liable to tax. The plaintiff argued that the dividend income in her hands should be treated
as agricultural income upto sixty percent, as in the case of a tea company, on the ground that dividends
received by the shareholders represented the income of the company.
It was held by the apex court that though the income in the hands of the company was partly agricultural,
yet the same income when received by Mrs. Guzdar as dividend could not be regarded as agricultural
income. This judgment followed the principle that shareholders are not, in the eyes of the law, part holders
of the undertaking. That is to say, he is not the part owner of the company, he is only given certain rights
by law to vote, or attend meetings, to receive dividends, etc.
Hence, the law, both in the United Kingdom as well as in India is well settled that a company has a separate
legal personality different from its members. However, as will be seen in the next chapter, this disparity
may be removed, but only under some very special circumstances.
Lifting the Corporate Veil

The advantages of incorporation are allowed only to those who want to make an honest use of the
‘company’. In case of a dishonest and fraudulent use of the facility of incorporation, the law lifts the
corporate veil and identifies the persons (members) who are behind the scene and responsible for the
perpetration of fraud. The term ‘lifting the corporate veil’ has been defined as ‘looking behind the company
as a legal person, that is, disregarding the corporate entity and paying regard, instead, to the realities behind
the legal façade’. As to the when may the corporate veil be lifted, the Supreme Court in State of Uttar
Pradesh v. Renusagar Power Co.3 observed that-
“The concept of lifting the corporate veil is a changing concept. The veil of corporate personality, even
though not lifted sometimes, is becoming more and more transparent in modern jurisprudence. It is high
time to reiterate that, in the expanding horizon of modern jurisprudence, lifting of the corporate veil is
permissible; its frontiers are unlimited. But it must depend primarily upon the realities of the situation.”
1
(1960) 3 All ER 420 PC
2
AIR 1955 SC 74
3
(1991) 70 Comp. Cas. 127 SC
Similarly, in Life Insurance Corporation of India v. Escorts Ltd.4, the apex court identified the
circumstances under which the corporate veil may be lifted. The Court observed that-
“While it is firmly established ever since in Salomon v. Salomon & Co. Ltd. that a company has an
independent and legal personality distinct from the individuals who are its members, it has since been held
that the corporate veil may be ignored and the individual members recognise for who they are in certain
exceptional circumstances. Generally, and broadly speaking, the corporate veil may be lifted where a statute
itself contemplates lifting the veil, or fraud or improper conduct is intended to be prevented, or a taxing or
beneficent statute is sought to be evaded or where associated companies are inextricably connected as to
be, in reality, part of one concern. It is neither desirable, nor necessary to enumerate the classes of cases,
where lifting of the veil is permissible, since that must necessarily, depend upon the relevant statutory or
other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element
of public interest, the effect on parties who may be interested, etc.”
Some of the important circumstances are now dealt with-
For the protection of revenue-
The Court may not recognise the separate existence of the company where the sole purpose for which it
appears to have been formed is the tax-evasion or circumvention of tax5. In the case of In re Dinshaw
Maneckjee Petit6, Mr. Maneckjee was a wealthy person having dividend and interest income. He wanted to
avoid surtax. For this purpose, he formed four private companies, in all of which he was the majority
shareholder. The companies made investments and whenever interest and dividends were received by the
companies, he would apply for loans which were immediately granted and never repaid. In a legal
proceeding, it was held that the corporate veils of all these companies were to be lifted and the incomes of
the companies to be treated as if they were of the person himself.
Where the Company is acting as an agent of the shareholders
In such a case, the shareholders will be liable for its acts. This is drawn from Sections 222 and 223 of the
Indian Contract Act, 1872 and more generally, based on the maxims of respondeat superior and qui facit
alium facit per se. There may be an express agreement to this effect or such an agreement may be implied
from the facts of the particular case.
Where the company has been formed in order to avoid valid contractual obligations
The defendant sold his business to the plaintiff and agreed not to compete with him for a given number of
years within reasonable local limits. The defendant, desirous of re-entering business, in violation of the
contractual obligation, formed a private company with majority shareholdings. The plaintiff initiated legal
proceedings against him and the private company. The court granted an injunction restraining the plaintiff
and his company with continuing on with the business.
Where the company has been formed for some fraudulent purpose or is a ‘sham’
4
(1986) 59 Comp. Cas 548 SC
5
S. Beresden Ltd. v. Commissioner of Inland Revenue [1953] 1 Ex Ch. 132; Juggilal v. Commissioner of
Income Tax AIR (1969) SC 932
6
In re Dishaw Maneckjee Petit AIR 1972 Bom 371
In Delhi Development Authority v. Skipper Construction Company Pvt. Ltd.7, the company failed to pay the
full purchase price of a plot to the DDA. In addition, construction was started and space sold to various
persons. The two sons of the directors who had businesses in their own names claimed that they had
separated from the father and the companies they were running had, in fact, nothing to do with the properties
of the parents. But no satisfactory proof in support of their claim could be produced. It was held that the
transfer of the shareholding between the father and the sons must be treated as a sham. The fact that the
director and members of his family had created several corporate bodies did not prevent the court from
treating all of them as one entity belonging to and controlled by the director and his family.
Where the company formed is against public interest or public policy
In Daimler Co. Ltd. v. Continental Tyre and Rubber Co.8, the respondent company was floated in London
for marketing tyres manufactured in Germany. The majority of the company’s shares were held by German
nationals also residing in Germany. During World War I, the company filed a suit against Daimler Co. Ltd.,
the appellant, for the recovery of trade debt. The appellant company contented that the respondent company
was an alien enemy company (Germany being at war with England at the time) and that the payment of the
debt would amount to trade with the enemy, leading to an action against public interest. The court agreed
with the appellant and held that where the company formed is against public interest or public policy, for
the purpose of determining the characters of the members, the corporate veil may be lifted.
Where the holding company holds all the shares in a subsidiary company
In State of Uttar Pradesh v. Renusagar Power Co.9, it was held that in such cases, the corporate veil may
be ignored. However, it must be established that the holding company was created only for that purpose.
Where the number of members falls below the statutory minimum
If the number of members of a company falls below the minimum as laid down in Section 45 of the
Companies Act, 1956, and the company carries on its business for a period of more than six months while
the number is reduced, individual members may be legally acted upon by the creditors of the company.
Both the privileges of limited liability and that of separate entity are lost and the creditors are permitted to
look beyond the company to the shareholders for the satisfaction of their claims.
Where the prospectus of the company includes a fraudulent misrepresentation
In case of a prospectus containing fraudulent misrepresentation as to a material fact, Section 62 and 63 of
the Companies Act, 1956 make the promoters, directors, etc. personally liable not only in terms of damages
but they may also be prosecuted in terms of a fine upto Rs. 5,000 or imprisonment of upto two years or
both.
Where a negotiable instrument is signed on behalf of the company without mentioning the name of the
company
In such a case, under section 147 (4) (c), the officer who signed the instrument would be liable to the holder
of the instrument, unless the company had already made the payment to that effect on the instrument.
7
[1996] 4 SCALE 202
8
(1916) 2 AC 307 as cited in Sealy, L. S., CASES AND MATERIALS IN COMPANY LAW, Butterworths, London,
2001, pg 175
9
(1991) 70 Comp. Cas. 127 SC
Holding and Subsidiary Companies

In the eyes of the law, the holding company and its subsidiaries are separate legal entities. However, in the
following cases, a subsidiary company may lose its separate identity to a certain extent-
Where at the end of its financial year, the holding company lays down before its members in a general
meeting, not only the accounts of the holding company, but also that of the subsidiaries and a set of group
accounts showing the profit or loss earned or suffered by the holding company and its subsidiaries
collectively, and their combined state of affairs at the end of the year.
Where the Central Government feels it to be necessary to direct the holding and subsidiary companies to
synchronise their financial years.
Where the court, based on the facts of the case, treat the subsidiary company as merely a branch or
department of one large undertaking owned by the holding company.
Investigation into related companies
Section 239 of the Companies Act, 1956 provides that is it is necessary for the satisfactory completion of
the investigation into the affairs of a company, the Inspector appointed to the investigation may look into
the affairs of another related company in the same management or group.
Investigation of ownership of company
The separate legal entity may be disregarded under Section 247 of the Companies Act, 1956. This section
authorises the Central Government to appoint one or more Inspectors to investigate and report on the
membership of any company for the purpose of determining the true persons who are financially interested
in the company and who control or materially influence its policy.
Winding up of a company
Where in the course of winding up of a company, it appears that any business of the company has been
carried on, with intent to defraud creditors of the company, or any other persons, or for any fraudulent
purpose, the Court, on the application of the liquidator, or any creditor or contributory of the company,
may, if it thinks proper, declare that any persons who are knowingly parties to the carrying on of business
in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of
the debts or liabilities of the company as the Court may direct.
Economic Offences
In Santanu Ray v. Union of India, The Delhi High Court10 held that where a company had failed to pay
proper excise duty, the individual directors could well be served notices to show cause so that the
adjudicating authorities could determine as to which of the directors was involved with the evasion of the
excise duty by reason of fraud, concealment or wilful misstatement or suppression of facts, or contravention
by the provisions of the Act or Rules made thereunder.
Where the company is used as a medium to avoid welfare legislation
10
(1989) 65 Comp. Cas 196 (Del)
The leading case on this exception is that of Workmen of Associated Rubber Industry Limited v. Associated
Rubber Industry Limited11. The facts of the case are that the bonus paid to the workmen of the industry in
any year depended upon the amount of gross profit in that particular year. The company transferred part of
its shareholding to a newly formed, wholly owned subsidiary company, thus reducing its own profits on
paper. It was held that since the new company was incorporated only for the purpose of reducing the annual
gross profits for the holding company, the workers would not be benefited and hence, the corporate veil
could be ignored.
Where a device of incorporation is used for some illegal or improper purpose
In PNB Finance Ltd. v Shital Prasad Jain12, the respondent was a financial adviser to the public limited
appellant company and was given a loan of fifteen lakhs by the company to purchase some immoveable
properties in Delhi. The respondent diverted the amount to three companies floated by him and his son.
These companies in turn, applied the amount in purchasing the said properties. The Delhi High Court
refrained the respondent from in any manner alienating, transferring, disposing of or encumbering the
properties in question.
Determination of technical competence of a company
The Supreme Court in the case of New Horizons Ltd. v. Union of India13 held that the experience of the
promoters could well be considered as the experience of the company in determining technical competence.
Thus, summarily, the doctrine of the lifting of the corporate veil has been applied, in the words of Palmer,
into five categories of cases-
 Where companies are in the relationship of holding and subsidiary (or sub-subsidiary) companies
 Where a shareholder has lost the privilege of limited liability and has become directly liable to
certain creditors of the company on the ground that, with his knowledge, the company continued
to carry on business six months after the number of members had been reduced below the legal
minimum
 In certain matters pertaining to the law of taxes, particularly where the question of the ‘controlling
interest’ is in issue
 In the law relating to exchange control and
 In the law relating to trading with the enemy, where the test of actual control is adopted
Thus, it is clear that in spite of the concept of a corporate body having a separate personality by itself exists;
there also exist a large number of exceptions to the rule where individual members of the company may be
held liable for the actions of the company. The next chapter moves on to whether a company may be held
as a ‘person’ and consequently, as a ‘citizen’.
Conclusion
In the past chapters, we have seen how the company is used as a façade in certain cases in order to carry on
some illegal activity, or is used as an alias, etc. Now, the question arises as to whether a company is a
juristic ‘person’ and consequently, is the company a ‘citizen’ and subsequently, if so, would a company be
capable of protection under Part III of the Constitution.
11
(1986) 59 Comp. Cas 134 SC: AIR 1986 SC 1
12
(1983) 54 Comp. Cas 66 (Del)
13
(1995) 1 Comp LJ 100 (SC)
To fully understand and appreciate this much-debated issue, we must first understand what is meant by the
terms ‘person’ and ‘citizen’. The word ‘person’, while has not been defined in the Companies Act, 1956, it
has been mentioned in the General Clauses Act, 1897 as well as the Indian Penal Code as inclusive of body
corporates. It means a legal entity that is recognised by law as the subject of rights and duties. Thus, it is
well established that a company is held to be a ‘person’ in every sense of the term.
Therefore, the answer to the question of whether a juristic person like a company is a citizen naturally
depends upon the meaning of the word ‘citizen’ in Part III of the Constitution where it has not been defined.
While it determines the persons who are Indian citizens at the commencement of the Constitution, it
empowers the Parliament by Article 11 to regulate by legislation questions relating to acquisition and
termination of citizenship and all other allied matters. In pursuance of that power, the Parliament has
enacted the Indian Citizenship Act, 1955.
While the Indian Citizenship Act, 1955 has denied personality to artificial persons such as companies, the
leading case on this issue is State Trading Corporation v. Commercial Tax Officer14. The majority
judgement, delivered by Sinha C. J. (as he then was) held that the word ‘citizen’ is intended to refer only
to natural persons and that, therefore a juristic body like a corporation cannot claim the status of a ‘citizen’
for the purpose of invoking fundamental rights under Part II of the Constitution. In fact, this had been the
opinion of the apex court in Tata E. & L. Co. Ltd. v. State of Bihar15 where the then Chief Justice
Gajendragadkar held that in such a case where Part III of the Constitution was to apply to companies, lifting
the corporate veil would not come to any use as because then the members of the company would be able
to do indirectly what they could not have done directly.
In addition, it has been held in Heavy Engineering Mazdoor Union v. State of Bihar16 that a company was
not a citizen under the Constitution of India. A company may, however, claim protection of those
fundamental rights that are available to all persons, whether citizens or not. Also, the fundamental rights of
the shareholders as citizens are not lost when they associate to form a company. When their fundamental
rights are impaired by State action, their rights as shareholders are protected. The reason is that the
shareholder’s rights are equally and necessarily affected if the rights of the Company are affected.
Hence, as of now, the debate seems well settled- that an artificial person cannot claim protection of
fundamental rights under Part III of the Constitution. However, a company is a ‘person’ in the general sense
of the term and should be treated as such.
The object of this paper has been to elucidate the nature of a corporate body with regard to whether it is the
same as its members and whether it has any similarity with a natural person. It has been established that
while members of a company are not directly liable for the acts of the same, there are circumstances under
which the barrier that stands between the members and third parties may be broken down. It has also been
established that while a company is a person (although artificial), it is not a citizen under the Constitution,
nor under the Citizenship Act, 1955 and hence cannot claim protection of its fundamental rights. With
sweeping changes in the law relating to companies with regard to the 2003 amendment to the Companies
Act, it is but to be expected that this area of Indian jurisprudence is continually expanding and changing.
14
AIR 1963 SC 1811
15
AIR 1965 SC 40
16
(1969) 39 Comp Cas 905 (SC)
Salomon v. Salomon [1897] A.C. 22

Facts –
- A trader sold, for an excessive price, a solvent business to a limited company with a nominal capital.
The company consisted only of the vendor, his wife, a daughter and four sons, who subscribed for
one share each. All the terms of sale were known to and approved by the shareholders.
- In part payment of the purchase-money debentures forming a floating security were issued to the
vendor. 20,001 shares were also issued to him and were paid for out of the purchase-money. These
shares gave the vendor the power of outvoting the six other shareholders. No shares other than these
20,007 were ever issued.
- All the requirements of the Companies Act 1862 were complied with. The vendor was appointed
managing director.
- Bad times came and the company was wound up. However, after satisfying the debentures there
was not enough to pay the ordinary creditors.
Issues-
- Was the company merely an agent or nominee of the vendor (trader)?
- Were the company’s unsecured creditors entitled to be indemnified by the appellant?
Discussion
- Shareholders are shareholders for all purposes with their respective rights and liabilities. The extent
or degree of interest which each shareholder had or their influence over the other shareholders is
irrelevant. Moreover, the shareholder need not be an independent and beneficially interested person
- Once the company is legally incorporated it must be treated like any other independent person with
its rights and liabilities. The motives of those who took part in the promotion of the company are
absolutely irrelevant in discussing what those rights and liabilities are.
- In a popular sense, a company may in every case be said to carry on business for and on behalf of
its members; but this certainly does not in point of law constitute the relation of principal and agent
between them or render the shareholders liable to indemnify the company against the debts which
it incurs
- Company being in law, a person quite distinct from its members, could not be regarded as an ‘alias’
or agent or trustee for Salomon
- Company’s assets (and not the member’s assets) must be applied in the payment of the debentures
as a secured creditor is entitled to payment out of the assets on which his debt is secured in priority
to unsecured creditors
In Re: The Kondoli Tea Co. Ltd. (1886) ILR 13 Cal. 43

Facts-
- A tea garden jointly owned by eight gentlemen was transferred to the Kondoli Tea Company for
certain consideration. These eight gentlemen were also the only shareholders of this transferee-
company.
- The consideration was payable in shares and debentures of the transferee-company.
- It was contended that this was not really a conveyance or transfer by way of sale, but a mere handing
over of the property from one name to one’s own self under another name.
Issues-
- Whether a document carrying out a particular transaction is a conveyance within the meaning of
the definition contained in Clause 9 of Section 3 of the Stamp Act, and within the meaning of
Article 21 of Schedule I of that Act?
Discussion
- A company is a legal entity or body separate from and capable of surviving beyond the lives of its
members.
- Whoever the shareholders in the Kondoli Tea Company Ltd were, the company was a separate
person, a separate body, and a conveyance to the Company of property which was the property of
the sharers in their individual capacity, was just as much a conveyance, a transfer of the property
as if the shareholders in the Company had been totally different persons.
- The impugned document is a conveyance and the proper stamp to be put upon this document is the
ad valorem stamp mentioned in Article 21 of Schedule I of the Stamp Act, and that it must be
calculated on the amount of the consideration mentioned in the instrument.
Lifting of the corporate veil
In re Dishaw Maneckjee Petit AIR 1972 Bom 371
1. For the financial year 1925-26, the assessee Sir Dinshaw Petit has been assessed for super-tax on an
aggregate income of Rs. 11,35,302 arising in the previous year. Of this sum he objects to Rs. 3,90,804 made
up of two sums of Rs. 2,76,800 and Rs. 1,14,004, the former of which arises from Government and other
fixed interest bearing funds, and the latter from dividends in companies. Nothing appears to turn on this
distinction, and 1 shall accordingly ignore it. Admittedly the assessee is the legal owner of moat of these
funds in the sense that they stand in his name and the interest and dividends are paid to him direct.
Admittedly as regards the rest, the apparent legal owners are his nominees, and he receives the interest and
dividends. Admittedly he has retained all the above interest and dividends, and applied the same to his own
use. But he contends that he is only a trustee for certain family companies which he has formed: that the
interest and dividends are theirs and not his: that he has credited them in account, and that though he has
had the benefit of them in specie this is because the family companies have lent him these moneys at interest
which he has credited to them in account, although he has not actually paid the interest in cash. He says
that the family companies are under no obligation to declare a dividend, and are entitled to lend out their
income in this way, even though it results over a series of years in the fixed preference dividends being
unpaid and a large sum representing back income being accumulated in the hands of the assessee.
2. The Advocate General on the other hand contends that the alleged disposition by the assessee in favour
of each family company is a sham, as is also the declaration of trust, that the transactions are all paper
transactions and not real. That if the family company carries on any business, it does so solely as the agent
of the assessee, and that in any event the alleged loans are not genuine loans. He consequently claims that
the sums in dispute represent taxable income of the assessee under Sections 2 (15), 3, 6,12, 55, 56 and 58
of the Indian Income-tax Act, 1922.
3. In consequence of this dispute, the Commissioner of Income-tax has stated a case for our opinion on the
four questions of law submitted in para 15. Question (4) deals with the genuineness of the alleged loans,
but in para. 33 the Commissioner explains the basis on which he has submitted this question, although in
one sense it may be said to be a question of fact.
4. Turning to the facts, it appears that in the year 1921 the assessee formed four private companies which I
will call family companies for convenience of reference, although in fact no other member of his family
took any direct benefit thereunder. The names of these four companies were Petit Limited; The Bombay
Investment Company Limited; The Miscellaneous Investment Limited ; and the Safe Securities Limited ;
Each of these companies took over a particular block of investments belonging to the assessee. But as the
modus operandi was substantially the same in each case, it will suffice to follow out the fortunes of Petit
Limited.
5. Taking then Petit Limited as an example, this family company was incorporated about April 12, 1921
(see Exhibit D), with a nominal capital of rupees ten millions divided ultimately into 9,99,900 ordinary
shares of Rs. 10 each and one hundred preference shares of Rs. 10 each carrying a fixed cumulative
preferential dividend of six per cent. Its issued and subscribed capital consists of 3,48,604 fully paid
ordinary shares all held by the assessee, and three fully paid preference shares held by throe persons who
are alleged in para. 24 of the case to be his subordinates and to be entirely under his control, the first being
the Secretary of the Petit Charities, the second being the Secretary of the four family companies, and the
third being a clerk in the same companies. Its primary object as set out in Clause 3 (1) of its Memorandum
of Association was to enter into the agreement of April 12, 1921, Exhibit B, under which the assessee sold
to the family company 498 shares in Maneckji Petit Manufacturing Company Limited for Rs. 34,86,000 at
the rate of Rs. 7,000 per share in consideration of the family company allotting him 3,48,600 fully paid
shares of Rs. 10 each in its capital.
6. By a contemporaneous indenture of April 12, 1921, Exhibit C, the assessee executed a declaration of
trust which recited an agreement that the 498 shares should not be transferred until the family company
should call upon the assessee to do so, and that in the meanwhile the assessee and his nominees would hold
the 498 shares as agents and trustees of this family company. The testatum then contained a formal
declaration of trust of these shares by the assessee for the family company and an agreement by him to
cause his nominees to make a similar admission. The schedule showed that of these 498 shares, 254 stood
in his name and 200 in the name of his wife, and the rest in the names of some thirteen other nominees. It
is common ground that hitherto no formal transfers have been called for by the family company.
Consequently the formation of the family company has made no difference to the names in which these 498
shares are held on the register of the Maneckji Petit Manufacturing Company Limited.
7. As regards the interest and dividends on the 498 shares, admittedly they have been ultimately paid to the
assessee throughout. Taking for example the entries of September 10, 1924, in the books of the family
company itself the cash book Exhibit F shows a receipt of Rs. 24,900 for a half year's dividend which
appears at p. 18 of the ledger Exhibit H, and is then debited at p. 19 to the current account of the assessee.
This current account also contains a debit of Rs. 40,549 in respect of interest due by the assessee on the
alleged moneys of the family company as shown in the journal entry Exhibit G. It also shows a total debit
balance against the assessee of Rs. 7,14,103 which is included in the balance sheet Exhibit I. Accordingly,
on the assessee's own showing, the family company has been accumulating all its past income by handing
it over to the assessee at interest with the result that by December 31, 1924, the total had reached Rs.
7,14,103. It has not even paid its preference dividend of in all Rs. 30 per annum on the three preference
shares held by the three subordinates of the assessee. It, however, purported in its balance sheet Exhibit I
to set aside rupees six laces to a Depreciation and Reserve Fund Account. This, says counsel for the
assessee, was a wise provision for a rainy day.
8. So much for the accounts. I need not go into them in any greater detail. It suffices to say that the dividends
on the 498 shares remained in fact with the assessee from first to last. All the rest represented book entries,
which might represent the truth or might not.
9. As for the family company itself, its activities were of the most modest description, despite the thirty-
eight objects mentioned in its memorandum. Indeed, apart from the primary object of entering into the
above agreement with the assessee, it has done little or nothing except to vary it in an important particular
by the declaration of trust, Exhibit C. There has been no additional buying or selling as contemplated by
object 2. The 498 shares remain-as they were-in the safe hands of the assessee or his nominees. So does the
income also. The company has been too timid to indulge in any active business. It has been content to be a
holding company, and as counsel for the assessee truly points out, there is no general law against that.
10. Turning to the Articles of Association, they give the assessee complete control as governing director
(see Art. 93); and indeed there is no other director, for Article 96 which prescribes a minimum of two
directors only applies if there is no governing director (see Art. 95). Accordingly, under Articles 120 and
93 he may exercise all the powers of the company not required to be done at a general meeting. This would,
I think, enable him to lend money under object 4. But dividends have to be declared by a general meeting
(see Articles 72, 127 and 128). The fiduciary position of the assessee is to be no bar to the company being
bound by the agreement Exhibit B (see Article 4); though, having regard to Article 95, it is perhaps not
clear that Article 103 enabling directors to contract with the company applies to the assessee. The
declaration of trust Exhibit C is not referred to. The audited accounts when approved by a general meeting
are to be conclusive except as regards errors discovered within three months. (See Article 150).
11. It is clear, then, that the company has to act as the assesses wills, provided the terms of the Indian
Companies Act are complied with.
14. Let us start then clearly with this that there was here a company duly incorporated under the Indian
Companies Act, and that this company was a separate entity from the assessee Sir Dinshaw Petit, just as
much as, say, his secretary or any other third party might be. But because there was this separate entity
which I will call X, it does not necessarily follow that every alleged transaction between the assessee and
X was valid or that it represented a real transaction. We in this country are extremely familiar with the
benamidar. Benami transactions abound, for they are employed extensively to hide the truth from
inquisitive eyes. For instance, in a mofussil appeal last term we had a case of the truth being hidden for
over thirty-seven years, the modus operandi being for many years a sham mortgage, and later on for even
greater security a sham sale to a third party (see Patel Dahyabhai Maneklal v. Bai Matu (1026) First Appeals
Nos. 316 of 1924 and 251 of 1925, decided by Marten C.J. and Patkar J. on August 21, 1926 (Unrep.)). In
that particular case the motive was to defeat creditors, should a speculative business prove unfortunate. No
doubt in many cases the rules of evidence prevent the parties to the instrument from giving oral evidence
to show that the document is not what it purports to be. But these rules do not prevent the Crown from
enquiring into the truth in the present case, for, in my judgment, Section 92 of the Indian Evidence Act does
not apply here. (See Maung Kyin v. Ma Shwe La (1917) L.R. 44 I.A. 236, 245, s.c. 20 Bom. L.R. 278.).
15. It is contended by counsel for the assessee that we are bound to accept the agreement Exhibit B, and
declaration of trust Exhibit C of April 12, 1921, as effecting in law what they purport to effect. In my
judgment, that contention is erroneous. Whether the separate entity is a company or an individual matters
little or nothing in this respect. With the company just as with the individual you may start with the
presumption that a duly executed transfer is a genuine document. But you may yet eventually find on proper
evidence that in fact it was an instance of the sham transfer which we are all familiar with in the ease of
individuals, even though the transaction ends with the formal registration of the document before the
Registrar, and the handing over of the purchase consideration in cash in his presence- cash which is
conveniently provided by a third party for a few hours or minutes, and which will be restored to him after
the conclusion of the ceremony before the Registrar. It is on a par with funds provided for what is known
as "window dressing purposes" in the City of London at the close of a particular financial period. And as
regards the point I am now on, I see no vital difference between cash in the shape of coin or notes on the
one hand and shares on the other hand. Coin or notes are more easy to manipulate, for coin cannot easily
be traced and notes probably will not be in this country. Shares can be traced, but they have this advantage
over coin that only a printing press is requisite. And should the transaction be upset, it only means that the
shares will never in* law have left their slumber as uncalled or nominal capital, or at any rate must be
restored to their slumber. There is consequently no risk of any one depriving any of the parties of what does
really matter, viz., the coin or notes of the Realm.
17. Now the main facts here are not disputed. I have already set them out, and need not repeat them. And
one striking element is that the company has never yet obtained sole legal possession and control of the
property which it purported to buy. Nor can one point to clear and definite evidence that the Company is
carrying on a genuine business as a separate entity. The registered agreement of sale of April 12, 1921,
Exhibit B, which was mentioned in the Memorandum and Articles of Association, was an ordinary contract
for the sale and purchase of a block of shares. In the natural course of events that contract should have been
completed by a formal transfer and delivery of the share certificates, and the subsequent entry of the
company's name as share-holder. (See Maneckji Pestonji Bharucha v. Wadilal Sarabhai & Co. (1926) L.R.
53 I.A. 92, s.c. 28 Bom. L.R. 777) Why then should there be the unregistered document, Exhibit C, of the
same date by which the company was not to get the ordinary rights of a purchaser, and to that extent was
not to carry into effect the agreement, Exhibit B, mentioned in Clause 3 (1) of the Memorandum ? What
advantage could the company get by being content with a declaration of trust by the vendor alone ? And if
it represented a genuine bargain, why should it be thus concealed from those inspecting the Memorandum
or searching the Register ? On the other hand, one can clearly see the disadvantages to the company by the
course the alleged transaction took. Substantially the company could not begin the business contemplated
by Clauses 3(2) and (3) of the Memorandum until they de facto acquired the shares which constituted their
only asset. A law suit might be necessary to force the alleged trustee or his nominees to execute the
necessary transfers or to deliver up the share certificates. And there were other risks in thus leaving all their
property in the hands of a sole trustee or his nominees, for he and they could have given a good title to any
third parties who presumably would be quite ignorant of the alleged but concealed trust. On the evidence
before us, the company has not even got any admission of this trust by the fourteen nominees of the assessee
set out in the schedules to Exhibits B and 0. For all we know, they may not even be aware of it, despite the
agreement by the assessee in Exhibit C that he will cause these nominees to admit the trust. It is true that
the agreements set out the denoting numbers of the shares. And so the shares may be said to be earmarked
as being the company's property. In this respect the copy agreements in the case stated have made a serious
omission. They do not contain the denoting numbers, but I have called for the originals, and find that in
fact these numbers were inserted. I have also called for and inspected the file of the company kept by the
Registrar of joint stock companies, and I find that although neither of the original documents bears any
registration mark, the inference I should otherwise draw from the minute of April 12, 1921, Exhibit D, is
correct, viz., that the agreement Exhibit B was registered but that the declaration of trust, Exhibit C, was
not registered. Should, however, the Maneckji Petit Manufacturing Company Limited have Articles of
Association in a common form giving it a prior lien for advances to any individual shareholders, then it
may be that the family company might be postponed should the assessee or his nominees be indebted to the
Maneckji Company.
18. No substantial argument was advanced to us to explain why the device of this concealed declaration of
trust was resorted to. One can hardly accept the excuse given to the Income-tax authorities that it was to
save trouble that formal transfers were not executed. If so, why go to the trouble of two documents Exhibits
B and C instead of one ? The real reason may be to preserve the assessee's voting powers in the Maneckji
Company. But that is a matter again for his benefit, and not necessarily for the company's advantage. It
would be quite consistent with the transaction being a sham one.
19. Turning next to the alleged loans of the dividends year by year to the assessee, it appears clear that it is
the assessee who receives these dividends in the first instance from the Maneckji Company. There is no
suggestion that the Maneckji Company has been instructed to pay those dividends to the family company.
Accordingly, the rest is merely a matter of book entries, viz., to credit the cash to the company and then to
transfer it to the debit of the assessee's account. The actual cash which after all is the important thing is kept
by the assessee throughout. And one startling circumstance is that beyond the accounts we have nothing in
writing whatever to establish the alleged agreement for loan by the family company. Of the importance of
this alleged agreement there can be no doubt. By it the family company practically bound itself hand and
foot to do no business, for its cash immediately on receipt was to be handed back to its vendor and promoter
at a fixed rate of interest. And yet there is not even a minute on the subject. And we are asked to infer the
agreement from the accounts and the yearly balance-sheets. If, however, this was a genuine agreement, why
should it also not see the light of day, or at any rate find a place in the company's minute book ? And none
the less so because the governing director with his wide powers was purporting to lend the company's
money to himself.
20. The result is that we have here a case which is the exact opposite of Salomon v. Salomon & Co., [1897]
A.C. 22 in the essential facts which I am now considering. There was a genuine and prosperous business in
Salomon's case, viz., that of a boot and shoe manufacturer (see p. 47). That business was transferred to the
limited company, and there was no question but that thenceforth the limited company carried on that
business. That the company subsequently fell on evil days was no fault of Mr. Salomon. He tried to save it
(p. 49), and Lord Macnaghten expressly negatived any fraud or dishonesty on his part (p. 52). Nor was there
any concealment. The creditors were, therefore, forced to argue that in effect no separate entity was created
by the Statute, and that a person holding the bulk of the shares might be held liable as if he was the sole
proprietor or a partner. That contention the House of Lords demolished.
33. After giving then my best consideration to the able arguments presented by counsel, I have arrived at
the clear conclusion that there was here in law evidence on which the Commissioner might reasonably find
as a fact (1) that there was no genuine transfer or declaration of trust in favour of the family company, and
(2) that the alleged loans were not genuine loans. I would, according, hold on questions Nos. 1 and 4 that
in law the Commissioner was entitled on the facts to decide question No. 1 in the affirmative and question
No. 4 that the loans in question were not genuine loans but were merely withdrawals of income disguised
as loans.
Daimler Co. Ltd v. Continental Tyre & Rubber Co. Ltd. (1916) 2 AC307
Facts-
- A company was incorporated in England for the purpose of selling in England tyres made in
Germany by a German Company, who held the bulk of the shares in the English company.
- The holders of the remaining shares (save one) and all the directors were Germans resident in
Germany. The one share was registered in the name of the secretary, who was born in Germany,
but resided in England and had become a naturalized British subject.
- After the outbreak of the war between England and Germany an action was commenced in the
name of the English company by specially indorsed writ, issued by the company’s solicitors on the
instructions of the secretary, for payment of a trade debt.
- In answer to a summons, the defendants alleged that the company was an alien enemy company
and that payment of the debt would be a trading with the enemy.
Issues-
- Whether the company was an alien enemy company and whether payment of the debt would
amount to trading with the enemy?
Discussion
- A natural person, though an English-born subject of His Majesty, may bear an enemy character and
be under liability and disability as such by adhering to His Majesty’s enemies. If he gives them
active aid, he is a traitor; but he may fall far short of that and still be invested with enemy character.
If he has what is known in prize law as a commercial domicile among the King’s enemies, his
merchandise is good prize at sea, just as if it belonged to a subject of the enemy Power. Not only
actively, but passively, he may bring himself under the same disability. Voluntary residence among
the enemy, however passive or pacific he may be, identifies an English subject with His Majesty’s
foes.
- However, in transferring the application of the rule against trading with the enemy from natural to
artificial persons, something more than the mere place or country of registration or incorporation
must be looked at:
o As a general principle, a company incorporated in the United Kingdom is a legal entity, a
creation of law with the status and capacity which the law confers. It is not a natural person
with mind or conscience. It can be neither loyal nor disloyal. It can be neither friend nor
enemy.
o Such a company can only act through agents properly authorized, and so long as it is
carrying on business in this country through agents so authorized and residing in this or a
friendly country it is, prima facie to be regarded as a friend, and all His Majesty’s lieges
may deal with it as such.
o Such a company may, however, assume an enemy character. This will be the case if its
agents or the persons in de facto control of its affairs, whether authorized or not, are resident
in an enemy country, or, wherever resident, are adhering to the enemy or taking instructions
from or acting under the control of enemies. A person knowingly dealing with the company
in such a case is trading with the enemy.
o The character of individual shareholders cannot of itself affect the character of the
company. This is admittedly so in times of peace, during which every shareholder is at
liberty to exercise and enjoy such rights as are by law incident to his status as shareholder.
It would be anomalous if it were not so also in a time of war, during which all such rights
and privileges are in abeyance. The enemy character of individual shareholders and their
conduct may, however, be very material on the question whether the company’s, agents,
or the persons in de facto control of its affairs, are in fact adhering to, taking instructions
from, or acting under the control of enemies. This materiality will vary with the number of
shareholders who are enemies and the value of their holdings. The fact, if it be the fact, that
after eliminating the enemy shareholders, the number of shareholders remaining is
insufficient for the purpose of holding meetings of the company or appointing directors or
other officers may well raise a presumption in this respect.
o In a similar way a company registered in the United Kingdom, but carrying on business in
a neutral country through agents properly authorized and resident here or in the neutral
country, is prima facie to be regarded as a friend, but may, through its agents or persons in
de facto control of its affairs, assume an enemy character.
o A company registered in the United Kingdom but carrying on business in an enemy country
is to be regarded as an enemy.
o There is no reason why a company should not trade or be regarded as an enemy company
merely because enemy shareholders may after the war become entitled to their proper share
of the profits of such trading. The prohibition against doing anything for the benefit of an
enemy contemplates his benefit during the war and not the possible advantage he may gain
when peace comes.
o In matters of public policy, the corporate veil may be lifted
- In the present case, even if the secretary had been fully authorized to manage the affairs of the
company and to institute legal proceedings on its behalf, the fact that he held one share only out of
25,000 shares, and was the only shareholder who was not an enemy, might well throw on the
company the onus of proving that he was not acting under the control of, taking his instructions
from, or adhering to the King’s enemies in such manner as to impose an enemy character on the
company itself. It is an a fortiori case when the secretary is without authority and necessarily
depends for the validity of all he does on the subsequent ratification of enemy shareholders.
- The company was in substance a hostile partnership and was therefore incapable of suing, and that
any payment to it would be illegal as a trading with the enemy.
Macaura v. Northern Assurance Company (1925) AC 619

Facts-
- The owner of a timber estate sold the whole of the timber thereon to a timber company in
consideration of fully paid up shares in the company.
- Subsequently by policies effected in his own name with several insurance companies he insured
this timber against fire.
- The greater part of the timber having been destroyed by fire, he sued the insurance companies to
recover the loss, but the actions were stayed and the matter was referred to arbitration in pursuance
of the conditions contained in the policies.
- The claimant was the sole shareholder in the company and was also a creditor of the company to a
large extent.
- The arbitrator held that the claimant had no insurable interest in the goods insured, either as
shareholder or creditor, and disallowed the claim on the ground.
Issues:
- Did the claimant have any insurable interest in the goods insured?
Discussion
- Legal ownership is not necessary for insurable interest. So to confine it would be adding a
restriction to a contract of insurance which does not arise out of its nature. To be interested in the
preservation of a thing is to be so circumstanced with respect to it as to have benefit from its
existence, prejudice from its destruction. If there is a legal certainty of loss arising from the
destruction of the property insured then there is an insurable interest.
- A shareholder in a company is entitled to insure the goods of the company to the extent of his
holding in order to protect the value of his shares.
- A creditor may insure his debtor’s life to the extent of his debt, because of the probability that if
the debtor continues to live he will earn the money to pay the debt. To succeed, the creditor must
prove that the loss (arising from the destruction of the thing insured) was at all material times
inevitable.
- However, neither a simple creditor nor a shareholder in a company has any insurable interest in a
particular asset which the company holds.
- It is true that the timber was owned by the company, but practically the whole interest in the
company was owned by the appellant. He would receive the benefit of any profit and on him would
fall the burden of any loss.
- But the principles on which the decision of this case rests must be independent of the extent of the
interest held. The appellant could only insure either as a creditor or as a shareholder in the company.
And if he was not entitled in virtue of either of these rights he can acquire no better position by
reason of the fact that he held both characters.
- As a creditor the appellant’s position appears to be quite incapable of supporting the claim. If his
contention were right it would follow that any person would be at liberty to insure the furniture of
his debtor, and no such claim has ever been recognized by the Courts. For example, the probability
that if the debtor’s ship should be lost he would be less able to pay his debts does not give to the
creditor any interest, legal or equitable, which is dependent upon the safe arrival of the ship.
- Turning now to the appellant’s position as shareholder, this must be independent of the extent of
his share interest. If he were entitled to insure holding all the shares in the company, each
shareholder would be equally entitled, if the shares were all in separate hands. Now, no shareholder
has any right to any item of property owned by the company, for he has no legal or equitable interest
therein. He is entitled to a share in the profits while the company continues to carry on business
and a share in the distribution of the surplus assets when the company is wound up. If he were at
liberty to effect an insurance against loss by fire of any item of the company’s property, the extent
of his insurable interest could only be measured by determining the extent to which his share in the
ultimate distribution would be diminished by the loss of the asset - a calculation almost impossible
to make. There is no means by which such an interest can be definitely measured and no standard
which can be fixed of the loss against which the contract of insurance could be regarded as an
indemnity.
- There is a difficulty in understanding how a moral certainty can be so defined as to render it an
essential part of a definite legal proposition. In the present case, though it might be regarded as a
moral certainty that the appellant would suffer loss if the timber which constituted the sole asset of
the company were destroyed by fire, this moral certainty becomes dissipated and lost if the asset
be regarded as only one in an innumerable number of items in a company’s assets and the
shareholding interest be spread over a large number of individual shareholders.
- The appellant, neither as a simple creditor nor as a shareholder in a company, has any insurable
interest in a particular asset which the company holds. Therefore, corporate veil is not lifted and
the claim of the appellant fails.
Prest v Petrodel Resources Limited [2013] UKSC 34
This appeal arises out of proceedings for ancillary relief following a divorce. The principal parties before
the judge, Moylan J, were Michael and Yasmin Prest. He was born in Nigeria and she in England. Both
have dual Nigerian and British nationality. They were married in 1993, and during the marriage the
matrimonial home was in England, although the husband was found by the judge to have been resident in
Monaco from about 2001 to date. There was also a second home in Nevis. The wife petitioned for divorce
in March 2008. A decree nisi was pronounced in December 2008, and a decree absolute in November 2011
The husband is not party to the appeal in point of form, although he is present in spirit. The appeal concerns
only the position of a number of companies belonging to the group known as the Petrodel Group which the
judge found to be wholly owned and controlled (directly or through intermediate entities) by the husband.
There were originally seven companies involved, all of which were joined as additional respondents to the
wife’s application for ancillary relief. They were Petrodel Resources Ltd (“PRL”), Petrodel Resources
(Nigeria) Ltd (“PRL Nigeria”), Petrodel Upstream Ltd (“Upstream”), Vermont Petroleum Ltd (“Vermont”),
Elysium Diem Ltd, Petrodel Resources (Nevis) Ltd (“PRL Nevis”) and Elysium Diem Ltd (Nevis). Three
of these companies, PRL, Upstream and Vermont, all incorporated in the Isle of Man, are the respondents
in this court. PRL was the legal owner of the matrimonial home, which was bought in the name of the
company in 2001 but was found by the judge to be held for the husband beneficially. There is no longer
any issue about that property, which is apparently in the process of being transferred to the wife. In addition,
PRL was the legal owner of five residential properties in the United Kingdom and Vermont is the legal
owner of two more. The question on this appeal is whether the court has power to order the transfer of these
seven properties to the wife given that they legally belong not to him but to his companies.
In this case, the husband’s conduct of the proceedings has been characterised by persistent obstruction,
obfuscation and deceit, and a contumelious refusal to comply with rules of court and specific orders. The
judge, Moylan J, recited in his judgment the long history of successive orders of the court which were either
ignored or evaded, the various attempts of the husband to conceal the extent of his assets in the course of
his evidence, and the collusive proceedings in Nigeria by which he sought declarations that certain of the
companies were held in trust for his siblings. The only evidence on behalf of the respondent companies was
an affidavit sworn by Mr Jack Murphy, a director of PRL and the corporate secretary of the three respondent
companies, who failed to attend for cross-examination on it. The judge rejected his excuse that he was in
bad health, and found that he was “unwilling rather than unable to attend court.” His conclusion was that
“as a result of the husband’s abject failure to comply with his disclosure obligations and to comply with
orders made by the court during the course of these proceedings, I do not have the evidence which would
enable me to assemble a conventional schedule of assets.” However, he found that the husband was the sole
beneficial owner and the controller of the companies, and doing the best that he could on the material
available assessed his net assets at £37.5 million.
By his order dated 16 November 2011, Moylan J ordered that the husband should procure the conveyance
of the matrimonial home at 16, Warwick Avenue, London W2 to the wife, free of incumbrances, and that
he should make a lump sum payment to her of £17.5 million and periodical payments at the rate of 2% of
that sum while it remained outstanding, together with £24,000 per annum and the school fees for each of
their four children. In addition he awarded costs in favour of the wife, with a payment of £600,000 on
account. The judge ordered the husband to procure the transfer of the seven UK properties legally owned
by PRL and Vermont to the wife in partial satisfaction of the lump sum order. He directed those companies
to execute such documents as might be necessary to give effect to the transfer of the matrimonial home and
the seven properties. Moreover, in awarding costs to the wife, the judge directed that PRL, Upstream and
Vermont should be jointly and severally liable with the husband for 10% of those costs.
Corresponding orders were made against certain of the other corporate respondents to the original
proceedings, but they did not appeal, either to the Court of Appeal or to this court, and are no longer
relevant, save insofar as the facts relating to them throw light on the position of the three respondents. No
order was made (or sought) for the transfer of any assets of Upstream, but that company is interested in the
present appeal by virtue of its liability under the judge’s order for part of the wife’s costs.
The distinctive feature of the judge’s approach was that he concluded that there was no general principle of
law which entitled him to reach the companies’ assets by piercing the corporate veil. This was because the
authorities showed that the separate legal personality of the company could not be disregarded unless it was
being abused for a purpose that was in some relevant respect improper. He held that there was no relevant
impropriety. He nevertheless concluded that in applications for financial relief ancillary to a divorce, a
wider jurisdiction to pierce the corporate veil was available under section 24 of the Matrimonial Causes
Act.
Subject to very limited exceptions, most of which are statutory, a company is a legal entity distinct from its
shareholders. It has rights and liabilities of its own which are distinct from those of its shareholders. Its
property is its own, and not that of its shareholders. In Salomon v A Salomon and Co Ltd [1897] AC 22,
the House of Lords held that these principles applied as much to a company that was wholly owned and
controlled by one man as to any other company. In Macaura v Northern Assurance Co Ltd [1925] AC 619,
the House of Lords held that the sole owner and controller of a company did not even have an insurable
interest in property of the company, although economically he was liable to suffer by its destruction.
Against this background, there are three possible legal bases on which the assets of the Petrodel companies
might be available to satisfy the lump sum order against the husband:
(1) It might be said that this is a case in which, exceptionally, a court is at liberty to disregard the corporate
veil in order to give effective relief.
(2) Section 24 of the Matrimonial Causes Act might be regarded as conferring a distinct power to disregard
the corporate veil in matrimonial cases.
(3) The companies might be regarded as holding the properties on trust for the husband, not by virtue of his
status as their sole shareholder and controller, but in the particular circumstances of this case.
I should first of all draw attention to the limited sense in which this issue arises at all. “Piercing the corporate
veil” is an expression rather indiscriminately used to describe a number of different things. Properly
speaking, it means disregarding the separate personality of the company. There is a range of situations in
which the law attributes the acts or property of a company to those who control it, without disregarding its
separate legal personality. The controller may be personally liable, generally in addition to the company,
for something that he has done as its agent or as a joint actor. Property legally vested in a company may
belong beneficially to the controller, if the arrangements in relation to the property are such as to make the
company its controller’s nominee or trustee for that purpose. For specific statutory purposes, a company’s
legal responsibility may be engaged by the acts or business of an associated company. Examples are the
provisions of the Companies Acts governing group accounts or the rules governing infringements of
competition law by “firms”, which may include groups of companies conducting the relevant business as
an economic unit. Equitable remedies, such as an injunction or specific performance may be available to
compel the controller whose personal legal responsibility is engaged to exercise his control in a particular
way. But when we speak of piercing the corporate veil, we are not (or should not be) speaking of any of
these situations, but only of those cases which are true exceptions to the rule in Salomon v A Salomon and
Co Ltd [1897] AC 22, i.e. where a person who owns and controls a company is said in certain circumstances
to be identified with it in law by virtue of that ownership and control.
Most advanced legal systems recognise corporate legal personality while acknowledging some limits to its
logical implications. In civil law jurisdictions, the juridical basis of the exceptions is generally the concept
of abuse of rights, to which the International Court of Justice was referring in In re Barcelona Traction,
Light and Power Co Ltd [1970] ICJ 3 when it derived from municipal law a limited principle permitting
the piercing of the corporate veil in cases of misuse, fraud, malfeasance or evasion of legal obligations.
These examples illustrate the breadth, at least as a matter of legal theory, of the concept of abuse of rights,
which extends not just to the illegal and improper invocation of a right but to its use for some purpose
collateral to that for which it exists.
English law has no general doctrine of this kind. But it has a variety of specific principles which achieve
the same result in some cases. One of these principles is that the law defines the incidents of most legal
relationships between persons (natural or artificial) on the fundamental assumption that their dealings are
honest. The same legal incidents will not necessarily apply if they are not.
Almost all the modern analyses of the general principle have taken as their starting point the brief and obiter
but influential statement of Lord Keith of Kinkel in Woolfson v Strathclyde Regional Council 1978 SC(HL)
90. This was an appeal from Scotland in which the House of Lords declined to allow the principal
shareholder of a company to recover compensation for the compulsory purchase of a property which the
company occupied. The case was decided on its facts, but at p96, Lord Keith, delivering the leading speech,
observed that “it is appropriate to pierce the corporate veil only where special circumstances exist indicating
that it is a mere facade concealing the true facts.”
The first systematic analysis of the large and disparate body of English case law was undertaken by a strong
Court of Appeal in Adams v Cape Industries plc [1990] Ch 433 (Slade, Mustill and Ralph Gibson LJJ). The
question at issue in that case was whether the United Kingdom parent of an international mining group
which was, at least arguably, managed as a “single economic unit” was present in the United States for the
purpose of making a default judgment of a United States court enforceable against it in England. Among
other arguments, it was suggested that it was present in the United States by virtue of the fact that a wholly
owned subsidiary was incorporated and carried on business there. Slade LJ, delivering the judgment of the
court, rejected this contention: pp 532-544. The court, adopting Lord Keith’s dictum in Woolfson v
Strathclyde, held that the corporate veil could be disregarded only in cases where it was being used for a
deliberately dishonest purpose: pp 539, 540. Apart from that, and from cases turning on the wording of
particular statutes, it held at p 536 that “the court is not free to disregard the principle of Salomon v A
Salomon & Co Ltd [1897] AC 22 merely because it considers that justice so requires. Our law, for better
or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their
parent companies, will nevertheless under the general law fall to be treated as separate legal entities with
all the rights and liabilities which would normally attach to separate legal entities.”
In my view, the principle that the court may be justified in piercing the corporate veil if a company’s
separate legal personality is being abused for the purpose of some relevant wrongdoing is well established
in the authorities. It is true that most of the statements of principle in the authorities are obiter, because the
corporate veil was not pierced. It is also true that most cases in which the corporate veil was pierced could
have been decided on other grounds. But the consensus that there are circumstances in which the court may
pierce the corporate veil is impressive. I would not for my part be willing to explain that consensus out of
existence. This is because I think that the recognition of a limited power to pierce the corporate veil in
carefully defined circumstances is necessary if the law is not to be disarmed in the face of abuse. I also
think that provided the limits are recognised and respected, it is consistent with the general approach of
English law to the problems raised by the use of legal concepts to defeat mandatory rules of law.
The difficulty is to identify what is a relevant wrongdoing. References to a “facade” or “sham” beg too
many questions to provide a satisfactory answer. It seems to me that two distinct principles lie behind these
protean terms, and that much confusion has been caused by failing to distinguish between them. They can
conveniently be called the concealment principle and the evasion principle. The concealment principle is
legally banal and does not involve piercing the corporate veil at all. It is that the interposition of a company
or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from
identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding
the “facade”, but only looking behind it to discover the facts which the corporate structure is concealing.
The evasion principle is different. It is that the court may disregard the corporate veil if there is a legal right
against the person in control of it which exists independently of the company’s involvement, and a company
is interposed so that the separate legal personality of the company will defeat the right or frustrate its
enforcement. Many cases will fall into both categories, but in some circumstances the difference between
them may be critical. This may be illustrated by reference to those cases in which the court has been thought,
rightly or wrongly, to have pierced the corporate veil.
These considerations reflect the broader principle that the corporate veil may be pierced only to prevent the
abuse of corporate legal personality. It may be an abuse of the separate legal personality of a company to
use it to evade the law or to frustrate its enforcement. It is not an abuse to cause a legal liability to be
incurred by the company in the first place. It is not an abuse to rely upon the fact (if it is a fact) that a
liability is not the controller’s because it is the company’s. On the contrary, that is what incorporation is all
about. Thus in a case like VTB Capital, where the argument was that the corporate veil should be pierced
so as to make the controllers of a company jointly and severally liable on the company’s contract, the
fundamental objection to the argument was that the principle was being invoked so as to create a new
liability that would not otherwise exist. The objection to that argument is obvious in the case of a consensual
liability under a contract, where the ostensible contracting parties never intended that any one else should
be party to it. But the objection would have been just as strong if the liability in question had not been
consensual.
I conclude that there is a limited principle of English law which applies when a person is under an existing
legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose
enforcement he deliberately frustrates by interposing a company under his control. The court may then
pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller
of the advantage that they would otherwise have obtained by the company’s separate legal personality. The
principle is properly described as a limited one, because in almost every case where the test is satisfied, the
facts will in practice disclose a legal relationship between the company and its controller which will make
it unnecessary to pierce the corporate veil. Like Munby J in Ben Hashem, I consider that if it is not necessary
to pierce the corporate veil, it is not appropriate to do so, because on that footing there is no public policy
imperative which justifies that course. I therefore disagree with the Court of Appeal in VTB Capital who
suggested otherwise at para 79. For all of these reasons, the principle has been recognised far more often
than it has been applied. But the recognition of a small residual category of cases where the abuse of the
corporate veil to evade or frustrate the law can be addressed only by disregarding the legal personality of
the company is, I believe, consistent with authority and with long-standing principles of legal policy.
In the present case, Moylan J held that he could not pierce the corporate veil under the general law without
some relevant impropriety, and declined to find that there was any. In my view he was right about this. The
husband has acted improperly in many ways. In the first place, he has misapplied the assets of hiscompanies
for his own benefit, but in doing that he was neither concealing nor evading any legal obligation owed to
his wife. Nor, more generally, was he concealing or evading the law relating to the distribution of assets of
a marriage upon its dissolution. It cannot follow that the court should disregard the legal personality of the
companies with the same insouciance as he did. Secondly, the husband has made use of the opacity of the
Petrodel Group’s corporate structure to deny being its owner. But that, as the judge pointed out at para 219
“is simply [the] husband giving false evidence.” It may engage what I have called the concealment principle,
but that simply means that the court must ascertain the truth that he has concealed, as it has done. The
problem in the present case is that the legal interest in the properties is vested in the companies and not in
the husband. They were vested in the companies long before the marriage broke up. Whatever the husband’s
reasons for organising things in that way, there is no evidence that he was seeking to avoid any obligation
which is relevant in these proceedings. The judge found that his purpose was “wealth protection and the
avoidance of tax”. It follows that the piercing of the corporate veil cannot be justified in this case by
reference to any general principle of law.
State of U.P. & Ors v. Renusagar Power Co. & Ors. (1988) 4 SCC 59
Hindalco established an aluminum factory in U.P. on the assurance that cheap electricity and power
would be available. For the purposes of generating cheaper electricity and power Hindalco
established its wholly owned subsidiary Renusagar Power Co. Renusagar Power Co. was
incorporated separately and had its own Memorandum and Articles of Association. After the
enforcement of U.P. Electricity (Duty) Act in 1953, a duty was sought to be levied on the
consumption of electrical energy in the State of U.P. An amendment to the Act provided for
different rates of charge on consumption and sale of electrical energy in different capacities.
Therefore, the duty levied on sale of electrical energy by licensees was different from the duty
levied on generation of electrical energy that was generated for self-consumption. Renusagar
applied to the UP govt for an exemption under Section 3(4) of the UP Electricity Duty Act, but this
was denied
Issues:
- Whether the generator of electrical energy (Renusagar Power Co.) was the same as the consumer
(Hindalco)? In other words, was the wholly owned subsidiary company the “own source of
generation” for Hindalco?
Discussion
Renusagar was brought into existence by Hindalco who consumed all of the power generated. There were
no other transmission lines going anywhere. The capacity of Renusagar was made specifically for the
requirements of Hindalco. Further, power lines to Hindalco from the state grid were cut on the basis that it
had its own power source. Renusagar has no independent existence- it cannot sell power to anyone by
Hindalco.
The concept of lifting the corporate veil is a changing concept. In the expanding horizon of modern
jurisprudence, lifting of corporate veil is permissible. Its frontiers are unlimited. It must, however, depend
primarily on the realities of the situation. The veil on corporate personality, even though not lifted
sometimes, is becoming more and more transparent in modern company law jurisprudence. “Own source
of generation” is an expression connected with the question of lifting or piercing the corporate veil. The
following three factors must be considered:
o Renusagar Power Co. was the wholly owned subsidiary of Hindalco. The former was under
the complete control of the latter, even with regard to its day-to-day affairs. This includes
the undertaking of various obligations for the running of the subsidiary company.
Renusagar Power Co. did not indicate its independent volition at any point in time.
o Hindalco was the sole consumer of the electrical energy generated by Renusagar Power
Co.
o Renusagar Power Co. only generated electrical energy to the extent required by Hindalco.
Lifting the corporate veil the court held that Renusagar Power Co. was the own source of generation for
Hindalco. Thus, Hindalco and Renusagar must be considered to be one and the same entity
Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613
Facts:
This matter concerns a tax dispute involving the Vodafone Group with the Indian Tax Authorities
[hereinafter referred to for short as “the Revenue”], in relation to the acquisition by Vodafone International
Holdings BV [for short “VIH”], a company resident for tax purposes in the Netherlands, of the entire share
capital of CGP Investments (Holdings) Ltd. [for short “CGP”], a company resident for tax purposes in the
Cayman Islands [“CI” for short] vide transaction dated 11.02.2007, whose stated aim, according to the
Revenue, was “acquisition of 67% controlling interest in HEL”, being a company resident for tax purposes
in India which is disputed by the appellant saying that VIH agreed to acquire companies which in turn
controlled a 67% interest, but not controlling interest, in Hutchison Essar Limited (“HEL” for short).
According to the appellant, CGP held indirectly through other companies, 52% shareholding interest in
HEL as well as Options to acquire a further 15% shareholding interest in HEL, subject to relaxation of FDI
Norms. In short, the Revenue seeks to tax the capital gains arising from the sale of the share capital of CGP
on the basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets.
Issue-
Whether Indian tax authorities had territorial jurisdiction to tax the offshore transaction, and therefore,
whether Vodafone is liable to withhold Indian taxes? In other words, the question was as to whether the
acquisition of shares by Vodafone would give rise to capital gains tax in India since CGP’s underlying asset
base was Indian?
Discussion-
- When it comes to taxation of a Holding Structure, at the threshold, the burden is on the Revenue to
allege and establish abuse, in the sense of tax avoidance in the creation and/or use of such
structure(s). In the application of a judicial anti-avoidance rule, the Revenue may invoke the
“substance over form” principle or “piercing the corporate veil” test only after it is able to establish
on the basis of the facts and circumstances surrounding the transaction that the impugned
transaction is a sham or tax avoidant. To give an example, if a structure is used for circular trading
or round tripping or to pay bribes then such transactions, though having a legal form, should be
discarded by applying the test of fiscal nullity. Similarly, in a case where the Revenue finds that in
a Holding Structure an entity which has no commercial/business substance has been interposed
only to avoid tax then in such cases applying the test of fiscal nullity it would be open to the
Revenue to discard such inter-positioning of that entity.
- However, this has to be done at the threshold. In this connection, we may reiterate the “look at”
principle enunciated in Ramsay (supra) in which it was held that the Revenue or the Court must
look at a document or a transaction in a context to which it properly belongs to. It is the task of the
Revenue/Court to ascertain the legal nature of the transaction and while doing so it has to look at
the entire transaction as a whole and not to adopt a dissecting approach. The Revenue cannot start
with the question as to whether the impugned transaction is a tax deferment/saving device but that
it should apply the “look at” test to ascertain its true legal nature [See Craven v.White (supra) which
further observed that genuine strategic tax planning has not been abandoned by any decision of the
English Courts till date]. Applying the above tests, we are of the view that every strategic foreign
direct investment coming to India, as an investment destination, should be seen in a holistic manner.
While doing so, the Revenue/Courts should keep in mind the following factors:
o the concept of participation in investment, the duration of time during which the Holding
Structure exists; the period of business operations in India; the generation of taxable
revenues in India; the timing of the exit; the continuity of business on such exit. In short,
the onus will be on the Revenue to identify the scheme and its dominant purpose.
o The corporate business purpose of a transaction is evidence of the fact that the impugned
transaction is not undertaken as a colourable or artificial device. The stronger the evidence
of a device, the stronger the corporate business purpose must exist to overcome the
evidence of a device.
- At the outset, we need to reiterate that in this case we are concerned with the sale of shares and not
with the sale of assets, item-wise. The facts of this case show sale of the entire investment made by
HTIL, through a Top company, viz. CGP, in the Hutchison Structure. In this case we need to apply
the “look at” test. In the impugned judgment, the High Court has rightly observed that the
arguments advanced on behalf of the Department vacillated. The reason for such vacillation was
adoption of “dissecting approach” by the Department in the course of its arguments. Ramsay
(supra) enunciated the look at test.
- According to that test, the task of the Revenue is to ascertain the legal nature of the transaction and,
while doing so, it has to look at the entire transaction holistically and not to adopt a dissecting
approach. One more aspect needs to be reiterated. There is a conceptual difference between
preordained transaction which is created for tax avoidance purposes, on the one hand, and a
transaction which evidences investment to participate in India. In order to find out whether a given
transaction evidences a preordained transaction in the sense indicated above or investment to
participate, one has to take into account the factors enumerated hereinabove, namely, duration of
time during which the holding structure existed, the period of business operations in India,
generation of taxable revenue in India during the period of business operations in India, the timing
of the exit, the continuity of business on such exit, etc. Applying these tests to the facts of the
present case, we find that the Hutchison structure has been in place since 1994. It operated during
the period 1994 to 11.02.2007. It has paid income tax ranging from `3 crore to `250 crore per annum
during the period 2002-03 to 2006-
- Even after 11.02.2007, taxes are being paid by VIH ranging from INR 394 crore to INR 962 crore
per annum during the period 2007-08 to 2010-11 (these figures are apart from indirect taxes which
also run in crores). Moreover, the SPA indicates “continuity” of the telecom business on the exit
of its predecessor, namely, HTIL. Thus, it cannot be said that the structure was created or used as
a sham or tax avoidant. It cannot be said that HTIL or VIH was a “fly by night” operator/ short time
investor. If one applies the look at test discussed hereinabove, without invoking the dissecting
approach, then, in our view, extinguishment took place because of the transfer of the CGP share
and not by virtue of various clauses of SPA. In a case like the present one, where the structure has
existed for a considerable length of time generating taxable revenues right from 1994 and where
the court is satisfied that the transaction satisfies all the parameters of “participation in investment”
then in such a case the court need not go into the questions such as de facto control vs. legal control,
legal rights vs. practical rights, etc.
- Be that as it may, did HTIL possess a legal right to appoint directors onto the board of HEL and as
such had some “property right” in HEL? If not, the question of such a right getting “extinguished”
will not arise. A legal right is an enforceable right. Enforceable by a legal process. The question is
what is the nature of the “control” that a parent company has over its subsidiary. It is not suggested
that a parent company never has control over the subsidiary. For example, in a proper case of
“lifting of corporate veil”, it would be proper to say that the parent company and the subsidiary
form one entity. But barring such cases, the legal position of any company incorporated abroad is
that its powers, functions and responsibilities are governed by the law of its incorporation. No
multinational company can operate in a foreign jurisdiction save by operating independently as a
“good local citizen”. A company is a separate legal persona and the fact that all its shares are owned
by one person or by the parent company has nothing to do with its separate legal existence. If the
owned company is wound up, the liquidator, and not its parent company, would get hold of the
assets of the subsidiary. In none of the authorities have the assets of the subsidiary been held to be
those of the parent unless it is acting as an agent. Thus, even though a subsidiary may normally
comply with the request of a parent company it is not just a puppet of the parent company. The
difference is between having power or having a persuasive position. Though it may be
advantageous for parent and subsidiary companies to work as a group, each subsidiary will look to
see whether there are separate commercial interests which should be guarded. When there is a
parent company with subsidiaries, is it or is it not the law that the parent company has the “power”
over the subsidiary. It depends on the facts of each case. For instance, take the case of a one-man
company, where only one man is the shareholder perhaps holding 99% of the shares, his wife
holding 1%. In those circumstances, his control over the company may be so complete that it is his
alter ego. But, in case of multinationals it is important to realise that their subsidiaries have a great
deal of autonomy in the country concerned except where subsidiaries are created or used as a sham.
Of course, in many cases the courts do lift up a corner of the veil but that does not mean that they
alter the legal position between the companies. The directors of the subsidiary under their Articles
are the managers of the companies. If new directors are appointed even at the request of the parent
company and even if such directors were removable by the parent company, such directors of the
subsidiary will owe their duty to their companies (subsidiaries). They are not to be dictated by the
parent company if it is not in the interests of those companies (subsidiaries). The fact that the parent
company exercises shareholder’s influence on its subsidiaries cannot obliterate the decision-
making power or authority of its (subsidiary’s) directors. They cannot be reduced to be puppets.
The decisive criteria is whether the parent company’s management has such steering interference
with the subsidiary’s core activities that subsidiary can no longer be regarded to perform those
activities on the authority of its own executive directors.
- U.S. Supreme Court in United States v. Bestfoods 524 US 51 (1998) explained that it is a general
principle of corporate law and legal systems that a parent corporation is not liable for the acts of its
subsidiary, but the Court went on to explain that corporate veil can be pierced and the parent
company can be held liable for the conduct of its subsidiary, if the corporal form is misused to
accomplish certain wrongful purposes, when the parent company is directly a participant in the
wrong complained of. Mere ownership, parental control, management etc. of a subsidiary is not
sufficient to pierce the status of their relationship and, to hold parent company liable. In Adams v.
Cape Industries Plc. (1991) 1 All ER 929, the Court of Appeal emphasized that it is appropriate to
pierce the corporate veil where special circumstances exist indicating that it is mere façade
concealing true facts.
- Courts, however, will not allow the separate corporate entities to be used as a means to carry out
fraud or to evade tax. Parent company of a WOS, is not responsible, legally for the unlawful
activities of the subsidiary save in exceptional circumstances, such as a company is a sham or the
agent of the shareholder, the parent company is regarded as a shareholder. Multi-National
Companies, by setting up complex vertical pyramid like structures, would be able to distance
themselves and separate the parent from operating companies, thereby protecting the multi-national
companies from legal liabilities.
- Lifting the corporate veil doctrine is readily applied in the cases coming within the Company Law,
Law of Contract, Law of Taxation. Once the transaction is shown to be fraudulent, sham, circuitous
or a device designed to defeat the interests of the shareholders, investors, parties to the contract and
also for tax evasion, the Court can always lift the corporate veil and examine the substance of the
transaction. This Court in Commissioner of Income Tax v.Sri Meenakshi Mills Ltd., Madurai, AIR
1967 SC 819 held that the Court is entitled to lift the veil of the corporate entity and pay regard to
the economic realities behind the legal fagade meaning that the court has the power to disregard
the corporate entity if it is used for tax evasion. In Life Insurance Corporation of India v. Escorts
Limited and Others (1986) 1 SCC 264, this Court held that the corporate veil may be lifted where
a statute itself contemplates lifting of the veil or fraud or improper conduct intended to be prevented
or a taxing statute or a beneficial statute is sought to be evaded or where associated companies are
inextricably as to be, in reality part of one concern. Lifting the Corporate Veil doctrine was also
applied in Juggilal Kampalpat v.Commissioner of Income Tax, U.P. , AIR 1969 SC 932 :(1969) 1
SCR 988, wherein this Court noticed that the assessee firm sought to avoid tax on the amount of
compensation received for the loss of office by claiming that it was capital gain and it was found
that the termination of the contract of managing agency was a collusive transaction.
- Court held that it was a collusive device, practised by the managed company and the assessee firm
for the purpose of evading income tax, both at the hands of the payer and the payee.
- Lifting the corporate veil doctrine can, therefore, be applied in tax matters even in the absence of
any statutory authorisation to that effect. Principle is also being applied in cases of holding
company - subsidiary relationship- where in spite of being separate legal personalities, if the facts
reveal that they indulge in dubious methods for tax evasion.
- Impugned transaction between HTIL and VIH, when looked at, is not a sham nor a tax evasion
device, nor a preordained tax evasive transaction, nor a fiscal nullity. It was entered into for genuine
business/commercial purposes. It was a bona fide participative investment.
State of Rajasthan v. Gotan Lime Stone Khanji Udyog Pvt. Ltd.
The State of Rajasthan is aggrieved by the quashing of its order dated 16th December, 2014 whereby it
declared its earlier order dated 25th April, 2012 as void and cancelled the mining lease No.45 of 1993. By
the said earlier order the aforesaid lease was permitted to be transferred in favour of Respondent No.1.
Question for consideration is whether looking at the substance of the transaction in question, an illegal
transfer of mining lease was involved? Whether transformation of partnership into company and transfer
of lease rights to such company, though apparently valid and permitted, has to be seen with the next
transaction of transfer of the entire shareholding to a third company for a price thereby avoiding declaration
of real transaction of sale of mining lease which was not permissible.
Further question is whether on this basis the State is justified in cancelling the lease which the High Court
has quashed.
M/s. Gotan Limestone Khanji Udhyog (GLKU), a partnership firm, held a mining lease for mining
limestone at village Dhaappa, Tehsil Merta, District Nagaur in area of 10 sq. km at fixed rent of
Rs.1,42,85,224/- per annum for which third renewal for 30years was granted w.e.f. 8th April, 1994. The
said lessee applied for transfer of the lease in favour of respondent No.1 herein, M/s. Gotan Limestone
Khanji Udhyog Pvt. Ltd. (GLKUPL) on 28th March, 2012. The application dated 28th March, 2012 states
that the lessee was a partnership firm and wished to transfer the lease to a private limited company which
was mere change of form of its own business by converting itself from a partnership firm into a private
limited company. The partners of the firm and Directors of the company were the same and on transfer, no
illegal benefit, price or premium was taken from the transferee. The lease was 40 years old and there was
no impediment in the transfer. The transferee will comply with the rules and regulations. The transfer was
allowed on 25th April, 2012 on that basis. After seeking the said permission, the newly formed private
limited company instead of operating the mining lease itself sold its entire shareholding to another company
allegedly for Rs.160 crores which is alleged to be the sale price of mining lease.
4. On this development, a show cause notice dated 21st April, 2014 was issued to Respondent No.1
proposing to cancel the transfer order on the ground that contrary to the statement in the application for
transfer that the partners of the partnership firm will be Directors of the private limited company, the
Directors of the private limited company who were partners of the firm were replaced by new Directors on
6th August, 2012 and the private limited company was listed as subsidiary of Ultra Tech Cement Limited
Company (UTCL) with the Bombay Stock Exchange. This development showed that the transfer was
secured by a conspiracy and in circumvention of the rules.
5. Respondent No.1 contested the show cause notice. In its reply, it stated that the State Government itself
had defended the transfer in its affidavit in reply to the Writ Petition No.404 of 2013 filed by M/s. J.K.
Cement Limited (JKCL). There was no bar to the change of Directors and shareholding of a company under
the rules. Thus, transfer of shareholding and change of Directors did not amount to transfer of mining lease
nor it affected validity of permission for transfer from GLKU to GLKUPL.
6. This stand was held to be unsatisfactory by the competent authority. Accordingly, the order dated 25th
April, 2012 was rescinded and declared void vide order dated 16th December, 2014. It was also observed
that the department had filed its revised reply before the High Court and according to the said reply, the
transfer was in violation of Rule 15 of the Rajasthan Minor Mineral Concession Rules, 1986 (the Rules)
The respondent No.1 filed S.B. Civil Writ Petition No.9669 of 2014 seeking quashing of show cause notice
dated 21st April, 2014, the order dated 16th December, 2014 and other consequential orders. It was
submitted that the order dated 25th April, 2012 permitting transfer of lease from the partnership firm to the
private limited company was in order. After the said transfer, the entire shareholding of the company was
transferred by the promoter directors in favour of UTCL in July, 2012, except some shares which were
transferred in joint names of UTCL with some private persons who were employees of the said company.
Thus, the writ petitioner-Respondent No.1 became wholly owned subsidiary of UTCL. The Directors were
replaced by the nominees of the holding company. JKCL had made an application seeking permission of
part transfer of the mining lease and its application was rejected on 5th September, 2012 against which Writ
Petition No.404 of 2013 was filed. The State Government in its reply defended its order dated 25th April,
2012. After the assembly election in December, 2013, show cause notice dated 21st April, 2014 was issued
and a supplementary reply was filed by the State in October, 2014 taking a different stand. It was submitted
that the order dated 16th December, 2014 had not dealt with the objection regarding applicability of Rule
72 (treating the lease void) and the judgments relied upon by the writ petitioner in its reply. Change in the
pattern of shareholding and directorship of the company was of no consequence for purposes of the Rules.
The mining rights are vested in the writ petitioner company as a consequence of order dated 25th April,
2012 and change in pattern in shareholding or directorship did not affect the said rights. Shareholders and
directors are not the owners of the assets of the company. Company was a distinct entity and mining lease
was owned by the Company.
9. The writ petition was defended by the State with the plea that change of all the directors and shareholding
amounted to transfer of the lease in violation of Rule 15 which was void under Rule 72. Thus, the order
dated 16th December, 2014 was valid.
As already stated the question for consideration is whether in the given fact situation the transfer of entire
shareholding and change of all the directors of a newly formed company to which lease rights were
transferred by a declaration that it was mere change of form of partnership business without any transfer
for consideration being involved can be taken as unauthorized transfer of lease which could be declared
void.
22. In the present case there are two transactions. Viewed separately, there may be nothing wrong with
either or both but if real nature of transaction is seen, the illegality is patent.
In first transaction of transfer of lease from the firm to the company, with the permission of the competent
authority, only disclosure made while seeking permission for transfer is of transforming partnership
business into a private limited company with same partners as directors without there being any financial
consideration for the transfer and without there being any third party. There is perhaps nothing wrong in
such transfer by itself. In the second transaction, the entire shareholding is transferred for share price and
control of mining lease is acquired by the holding company without any apparent price for lease.
Technically lease rights are not sold, only shares are sold. No permission for transfer of lease hold rights
may be required. Let us now see the combined effect and real substance of the two transactions. The
partnership firm holding lease hold rights has successfully transferred the said rights to a third party for
consideration in the form of share price which is nothing but price for sale of mining lease which is not
allowed and for which no permission has been granted. Thus, if these facts were disclosed to the competent
authority, permission for transfer of mining rights for financial consideration could not be allowed. Mining
rights belong to the State and not to the lessee and the lessee has no right to profiteer by trading such rights.
In fact the lessee has also not claimed such a right. Lessee can either operate the mine or surrender or
transfer only with the permission of the authority as legally required. In the present case, the lessee has
achieved indirectly what could not be achieved directly by concealing the real nature of the transaction. Is
it legally permissible, is the question.
The principle of lifting the corporate veil as an exception to the distinct corporate personality of a company
or its members is well recognized not only to unravel tax evasion but also where protection of public interest
is of paramount importance and the corporate entity is an attempt to evade legal obligations and lifting of
veil is necessary to prevent a device to avoid welfare legislation8. It is neither necessary nor desirable to
enumerate the classes of cases where lifting the veil is permissible, since that must necessarily depend on
the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the
involvement of the element of the public interest, the effect on parties who may be affected etc
24. In State of U.P. vs. Renusagar Power Co.10 this Court observed:
“66. It is high time to reiterate that in the expanding horizon of modern jurisprudence, lifting of
corporate veil is permissible. Its frontiers are unlimited. It must, however, depend primarily on the
realities of the situation. The aim of the legislation is to do justice to all the parties.
The horizon of the doctrine of lifting of corporate veil is expanding………
67. In the aforesaid view of the matter we are of the opinion that the corporate veil should be lifted
and Hindalco and Renusagar be treated as one concern and Renusagar’s power plant must be treated
as the own source of generation of Hindalco and should be liable to duty on that basis. In the
premises the consumption of such energy by Hindalco will fall under Section 3(1)(c) of the Act.
68. The veil on corporate personality even though not lifted sometimes, is becoming more and more
transparent in modern company jurisprudence. The ghost of Salomon case (1897 AC 22) still visits
frequently the hounds of Company Law but the veil has been pierced in many cases.”
It is thus clear that the doctrine of lifting the veil can be invoked if the public interest so requires or if there
is allegation of violation of law by using the device of a corporate entity. In the present case, the corporate
entity has been used to conceal the real transaction of transfer of mining lease to a third party for
consideration without statutory consent by terming it as two separate transactions – the first of transforming
a partnership into a company and the second of sale of entire shareholding to another company. The real
transaction is sale of mining lease which is not legally permitted. Thus, the doctrine of lifting the veil has
to be applied to give effect to law which is sought to be circumvented.
It is also well settled that mining rights are vested in the State and the lessee is strictly bound by the terms
of the lease. Cases of Arun Kumar Agrawal vs. Union of India, BALCO Employees’ Union vs. Union of
India and Vodafone International Holdings B.V. versus Union of India cited by learned counsel for the
respondent have no application to the present case once real transaction is found to be different from the
apparent transactions. In fact, the principle of law laid down in Vodafone case that the court can look to the
real transaction goes against the respondent .
In Vodafone case the dispute arose out of claim by the income tax department to tax capital gain arising out
of sale of share capital of a company called CGP by HEL to Vodafone. Question was whether income
accrued in India. Negativing the claim of the Revenue, it was held that transaction took place outside
territorial jurisdiction of India and was not taxable. This Court observed that “it is the task of the court to
ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a
whole and not to adopt a dissecting approach.” In so concluding, the court reconciled the apparent
conflicting approach in earlier decisions in Mc. Dowell & Co. vs. Commercial Tax Officer and Union of
India vs. Azadi Bachao Andolan with reference to English decisions in IRC vs. Westminister and W.T.
Ramsay vs. IRC dealing with the question whether the Court must accept a transaction on face value or not.
Thus, while discerning true nature of the entire transaction, court has not to merely see the form of the
transaction which is of sale of shares but also the substance which is the private sale of mining rights
avoiding legal bar against transfer of sale rights circumventing the mandatory consent of the competent
authority.
Consent of competent authority is not a formality and transfer without consent is void. The minerals vest
in the State and mining lease can be operated strictly within the statutory framework. There is nothing to
rebut the allegation that receipt of Rs.160 crores styled as investment in shares is nothing but sale price of
the lease. No precedent has been shown permitting such a private sale of a mining lease for consideration
without any corresponding benefit to the public.
Fundamental rights of a company
R.C. Cooper v. Union of India 1970 AIR SC 564
Facts -
On July 19, 1964, the Acting President promulgated, in exercise of the power conferred by cl. (1) of Article
123 of the Constitution, Ordinance 8 of 1969, transferring to and vesting the undertaking of 14 named
Commercial Banks, which held deposits of not less than rupees fifty crores, in the corresponding new Banks
set up under the Ordinance. Petitions challenging the constitutionality of the Ordinance were lodged in this
Court, but before they were heard Parliament enacted the Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1969. The object of the Act was to provide for the acquisition and transfer of the
Undertakings of certain banking companies in order to serve better the needs of development of the
economy in conformity with the national policy and _objectives and for matters connected therewith or
incidental thereto. The Act repealed the Ordinance and came into force on July 19, 1969, i.e., the day on
which the Ordinance was promulgated, and the Undertaking of every named Bank with all its rights,
liabilities and assets was deemed, with effect from that date, to have vested in the corresponding new bank.
By s. 15(2) (e), the named Banks were entitled to engage in business other than banking which by virtue of
s. 6(1) of the Banking Regulation Act, 1949, they were not prohibited from carrying on. Section 6 read with
Schedule 11 provided for and prescribed the method of determining compensation for acquisition of the
undertaking. Compensation to be determined was for the acquisition of the undertaking as a unit and by
section 6(2), though separate valuation had to be made in respect of the several matters specified in Schedule
11 of the Act, the amount of compensation was to be deemed to be a single compensation. Under Schedule
11 the compensation payable was to be the sum -total of the value of the assets under the heads (a) to (h),
calculated in accordance with the provisions of Part I less the sum total of the liabilities and obligations
calculated in accordance with the provisions of Part 11.
The corresponding new Banks took over vacant possession of the lands and buildings of the named Banks.
By Explanation I to cl. (e) of Part I of Schedule It the value of any land or building to be taken into account
in valuing the assets was to be the market value or the ascertained value whichever was less; by Explanation
2 cl. (1) ascertained value”‘ in respect of buildings wholly occupied on the date of the commencement of
the Act was to be twelve times the amount of annual rent or the rent for which the building could reasonably
be expected to be let out from year to year, reduced by certain deductions for maintenance, repairs etc.;
under cl. (3) of Explanation 2 the value of open land with no building thereon or which was not appurtenant
to any building was to be determined with reference to the price at which sale or purchase of comparable
lands were made during the period of three years immediately preceding the commencement of the Act.
The compensation was to be determine, in the absence of agreement, by a tribunal and paid in securities
which would mature not before ten years.
Issue-
The petitioner held shares in some of the named Banks, had accounts, current and fixed deposit, in these
Banks and was also a Director of one of the Banks. In petitions ‘under Article 32 of the Constitution he
challenged the validity of the Ordinance and the Act on the following principal grounds
(i) the Ordinance was invalid because the condition precedent to the exercise of the power under Article 23
did not exist:
(ii) the Act was not within the legislative competence of Parliament, because, (a) to the extent to which the
Act vested in the corresponding new Banks the assets of business other than Banking the Act trenched upon
the authority of the State Legislature and (b) the power to legislate for acquisition of property in entry 42
List III did not include the power to legislate for acquisition of an undertaking;
(iii) Articles 19(1)(f) and 31(2) are not mutually exclusive and a law providing for acquisition of property
for a public purpose could be tested for its validity on the ground that it imposed limitations on the right to
property which were not reasonable; so tested, the provisions of the Act which transferred the Undertaking
of, the named Banks and prohibited those Banks from carrying on business of Banking and practically
prohibited them from carrying on non-banking business, impaired the freedoms guaranteed by Articles
19(1) (f) and (g);
(iv) the provisions of the Act which prohibited the named Banks from carrying on banking business and
practically prohibited them from carrying on non-banking business violated the guarantee of equal
protection and were, therefore, discriminatory;
(v) the Act violated the guarantee of compensation under Article 31(2);
(vi) the Act impaired the guarantee of ‘freedom of trade under Article 301; and
(vii) -retrospective operation given to Act 22 of 1969 was ineffective since there was no valid Ordinance in
existence and the provision in the Act retrospectively validating infringement of the fundamental rights of
citizens was not within the competence of Parliament. On behalf of the Union of India a preliminary
objection was raised that the petitions were not maintainable because, no fundamental right of the petitioner
was directly impaired as he was not the owner of the property of the undertaking taken over.
Discussion-
HELD : (Per Shah, Sikri, Shelat, Bhargva, Mitter, Vaidialingam Hegde, Grover, Reddy and Dua, JJ.)
The Attorney-General contended that the petitions are not maintainable, because no fundamental right of
the petitioner is,’ directly impaired by the enactment of the Ordinance and the Act, or by any action taken
thereunder. He submitted that the petitioner who claims to be a shareholder, director and holder of deposit
and current accounts with the Banks is not the owner of the property of the undertaking taken over by the
corresponding new banks and is on that account incompetent to maintain the petitions complaining that the
rights guaranteed under Arts. 14, 19 and 31 of the Constitution were impaired.
The petitions were maintainable. A company registered under the Indian Companies Act is a legal person,
separate and distinct from its individual members. Hence a shareholder, a depositor or a director is not
entitled to move a petition for infringement of the rights of the company unless by the action impugned his
rights are also infringed. But, if the State action impairs the right of the share-holders as well as of the
company the Court will not, concentrating merely upon the technical operation of the action deny itself
jurisdiction to grant relief. In the -present case the petitioner’s claim was that by the Act and the Ordinance
the rights guaranteed to him under Articles 14, 19 and 31 of the Constitution were impaired. He thus
challenged the infringement of his own rights and not of the Banks.
A company registered under the Companies Act is a legal person, separate and distinct from its individual
members. Property of the Company is not the property of the shareholders. A shareholder has merely an
interest in the Company arising under its Articles of Association, measured by a sum of money for the
purpose of liability, and by a share in the profit. Again a director of a Company is merely its agent for the
purpose of management. The holder of a deposit account in a Company is its creditor: he is not the owner
of any specific fund lying with the Company. A shareholder, a depositor or a director may not therefore be
entitled to move a petition for infringement of the rights of the Company, unless by the action impugned
by him, his rights are also infringed.
By a petition praying for a writ against infringement of fundamental rights, except in a case where the
petition is for a writ of habeas corpus and probably for infringement of the guarantee under Arts. 17, 23 and
24, the petitioner may seek relief in respect of his own rights and not of others. The shareholder of a
Company, it is true, is not the owner of its assets; he has merely a right to participate in the profits of the
Company subject to the contract contained in the Articles of Association. But on that account the petitions
will not fail. A measure executive or legislative may impair the rights of the Company alone, and not of its
shareholders; it may impair the rights of the shareholders and not of the Company: it may impair the rights
of the shareholders as well as of the Company. Jurisdiction of the Court to grant relief cannot be denied,
when by State action the rights of the individual shareholder are impaired, if that action impairs the rights
of the Company as well. The test in determining whether the shareholder’s right is impaired is not formal:
it is essentially qualitative: if the State action impairs the right of the shareholders as well as to the Company,
the Court will not, concentrating merely upon the technical operation of the action, deny itself jurisdiction
to grant relief.
The petitioner claims that by the Act and by the Ordinance the rights guaranteed to him under Arts. 14, 19
and 31 of the Constitution are impaired. He says that the Act and the Ordinance are without legislative
competence in that they interfere with the guarantee of freedom of trade and are not made in the public
interest; that the Parliament had no legislative competence, to enact the Act and the President had no power
to promulgate the Ordinance, because the subject-matter of the Act and the Ordinance is (partially at least)
within the State List; and that the Act and Ordinance are invalid because they vest the undertaking of the
named banks in the new corporations without a public purpose and without setting out principles and the
basis for determination and payment of a just equivalent for the property expropriated. He says that in
consequence of the hostile discrimination practised by the State the value of his investment in the shares is
substantially reduced, his right to receive dividend from his investment has ceased, and he has suffered
great financial loss, he is deprived of the right as a shareholder to carry on business through the agency of
the Company, and that in respect of the deposits the obligations of the-- corresponding new banks -not of
his choice are substituted without his consent. (1) [1954] S. C. R. 674.
In Dwarkadas Shrinivas v. The Sholapur Spinning & Weaving Co. Ltd. and Others this Court held that a
preference shareholder of a company is competent to maintain a suit challenging the validity of the
“Sholapur Spinning and Weaving Company (Emergency Provisions) Ordinance” 2 of 1950 (which was
later replaced by Act 27 of 1950), which deprived the Company of its property without payment of
compensation within the meaning of Art. 31. Mahajan, J., observed: “The plaintiff and the other preference
shareholders are in imminent danger of sustaining direct injury as a result of the enforcement of this
Ordinance, the direct injury being the amount of the call that they are called upon to pay and the consequent
forfeiture of their shares.” Das, J., in the same case examined the matter in some detail and observed at p.
722 :
“The impugned Ordinance,......the preference shareholders by imposing on them this liability, or the risk-
of it, and gives them a sufficient interest to challenge the validity of the Ordinance,.... Certainly he can
show that the Ordinance under which these persons have been appointed was beyond the legislative
competence of the authority which made it or that the Ordinance had not been duly promulgated. If he can,
with a view to destroy the locus standi of the persons who have made the call, raise the question of the
invalidity of the Ordinance.... I can see no valid reason why, for the self same purpose, he should not be
permitted to challenge the validity of the Ordinance on the ground of its unconstitutionality for the breach
of the fundamental rights of the company or of other persons.” A similar view was also taken in Chiranjit
Lal Chowduri v. The Union of India(1) by Mukherjea, J., at p. 899, by Fazl Ali, J., at p. 876, by Patanjali
Sastri, J., at p. 889 and by Das, J., at p. 922.
The judgment of this Court in The State Trading Corporation of India Ltd. & Others v. The Commercial
Tax Officer, Visakhapatnam & Ors.(2) has no bearing on this question. In that case in a petition under Art.
32 of the Constitution the State Trading Corporation challenged the infringement of its right to hold
property and to carry on business under Art. 19 (1) (f) & (g) of (1) [1950] S. C. R. 869. (2) [1964] 4 S.C.R.
99.
The Constitution and this Court opined that the Corporation not being a citizen was incompetent to enforce
the rights guaranteed by Art. 19. Nor has the judgment in Tata Engineering and Locomotive Co. Ltd. v.
State of Bihar and Ors. (1) any bearing on the question arising in these petitions. In a petition under Art.
32, of the Constitution filed by a Company challenging the levy of sales-tax by the State of Bihar, two
shareholders were also impleaded as petitioners. It was urged on behalf of the shareholders that in substance
the interests of the Company and of the shareholders were identical and the shareholders were entitled to
maintain the petition. The Court rejected that contention, observing that what the Company could not
achieve directly, it could not relying upon the “doctrine of lifting the veil” achieve indirectly. The petitioner
seeks in this case to challenge the infringement of his own rights and not of the Banks of which he is a
shareholder and a director and with which he has accounts-, current and fixed deposit.
It was urged that in any event the guarantee of freedom of trade does not occur in Part III of the Constitution,
and the petitioner is not entitled to maintain a petition for breach of that guarantee in this Court. But the
petitioner does not seek by these petitions to enforce the guarantee of freedom of trade and commerce in
Art 301: he claims that in enacting the Act the Parliament has violated a constitutional restriction imposed
by Part XIII of its legislative power and in determining the extent to which his fundamental freedoms are
impaired, the statute which the Parliament is incompetent to enact must be ignored. It is not necessary to
consider whether Art. 31 A ( 1 ) (d) of the Constitution bars the petitioner’s claim to enforce his rights as a
director. The Act prima facie does not (though the Ordinance purported to) seek to extinguish or modify
the right of the petitioner as a director : it seeks to take away expressly the right of the named Banks to
carry on banking business, while reserving their right to carry on business other than banking. Assuming
that he is not entitled to set up his right to enforce his guaranteed rights as a director, the petition will not
still fail. The preliminary objection raised by the Attorney-General against the maintainability of the
petitions must fail.
Bennett Coleman & Co. & Ors vs Union Of India & Ors 1973 AIR SC 106
Facts-
The Import Control Order 1955 passed by the Central Government under ss. 3 and 4A of the Imports and
Exports Control Act 1947 laid restrictions on the import of newsprint. As an essential commodity newsprint
was also subject to control under s.3 of the Essential Commodities Act 1955. The Newsprint Control Order
1962 was passed under s. 3 of the Essential Commodities Act. Sub-clause 3 of clause 3 of the 1962 Order
states that no consumer of newsprint shall in any licensing period consume or use newsprint in excess of
quantity authorised by the Controller from time to time. Sub-clause 3A of clause 3 states that no consumer
of newsprint other than a publisher of text books of general interest shall use any kind of paper other than
newsprint except with the permission in writing of the Controller. Sub-clause (5) of Clause 3 of the 1962
Order states that in issuing an authorisation under this clause the Controller shall have regard to the
principles laid down in the Import Control Policy with respect to newsprint announced by the Central
Government from time to time. The newsprint Policy for 1972-73 was challenged in this Court in petitions
under Art. 32 of the Constitution.
Issues -
(i) whether the petitioners being companies could invoke fundamental rights;
(ii) whether Art. 358 of the Constitution was a bar to any challenge by the petitioners on violations
of fundamental rights;
(iii) whether the restriction on newsprint import under the 1955 Order was violative of Art. 19(1)
(a) of the Constitution;
(iv) whether the newsprint Policy fell within clause 5(1) of the Import, Control Order 1955 and was
valid;
(v) whether clauses 3 and 3A of clause 3 of the 1962 Newsprint Order were violative of Arts.
19,(1) (a) and 14 of the Constitution;
(vi) whether Remarks V, VII(a), VII(c), VIII, and X of the Newsprint Policy for 1972-73 were
violative of Arts. 19(1) (a) and 14 of the Constitution because of the following objectionable
features : (a) No new paper or new edition could be started by a common ownership unit (i.e.,
a newspaper establishment or concern owning two or more news interest newspapers including
at least one daily) even within the authorised quota of newsprint; (b) there was a limitation on
the maximum number of pages to 10, no adjustment being permitted between circulation and
the pages so as to increase the pages; (c) no interchangeability was permitted between different
papers of common ownership unit or different editions of the same paper; (d) allowance of 20
per cent increase in page level up to a, maximum of 10 had been given to newspapers with less
than 10 pages; (e) a big newspaper was prohibited and prevented from increasing the number
of pages, page areas, and periodicity by reducing circulation to meet its requirement even
within its admissible quota; (f) there was discrimination in entitlement between newspapers
with an average of more than 10 pages as compared with newspapers of 10 or less than 10
pages.
The Bank Nationalization case has established the view that the fundamental rights of shareholders as
citizens are not lost when they associate to form a company. When their fundamental rights as shareholders
are impaired by State action their rights as shareholders are protected. The reason is that the shareholders’
rights are equally and necessarily affected if the rights of the company are affected. The rights of
shareholders with regard to Article 19(1) (a) are projected and manifested by the newspapers owned and
controlled by the shareholders through the medium of the Corporation. In the present case the individual
rights of freedom of speech and expression of editors, Directors and Shareholders are all expressed through
their newspapers through which they speak. The locus standi of the shareholder petitioners is beyond
challenge after the ruling of this Court in the Bank Nationalisation case. The presence of the company is on
the same ruling not a bar to the grant of relief.
The present- petitions which were originally filed to challenge the Newsprint Policy for 1971-72 were
amended to challenge the 1972-73 policy. The impeached policy was a continuation of the old policy.
Article 358 does not apply to executive action taken during the emergency if the same is a continuation of
the prior executive action or an emanation of the previous law which prior executive action or previous law
would otherwise be violative of Art. 19 or be otherwise unconstitutional. Executive action which is
unconstitutional is not unusual during the proclamation of emergency. During the proclamation Art. 19 is
suspended. But it would not authorise the taking of detrimental executive action during the emergency
affecting the fundamental rights in Art. 19 without any legislative authority or in purported exercise of
power conferred by any pre-emergency law which was invalid when enacted.
The power of the Government to import newsprint cannot be denied. The power of the Government to
control the distribution of newsprint cannot equally be denied. This Court cannot adjudicate on such policy
measures unless the policy is alleged to be mala fide. The Court could also not go into the dispute as to the
quantity of indigenous newsprint available for newspapers.
The records with regard to the making and publication of the news print policy for 1972-73 showed that the
policy was published under the authority of the Cabinet decision. The policy was therefore validly brought
into existence.
Although Art. 19(1) (a) does not mention the freedom of the Press, it is the settled view of this Court that
freedom of speech and expression includes freedom of the Press and circulation. The Press has the right of
free propagation and free circulation without any previous restraint on publication. If a law were to single
out the press for laying down prohibitive burdens on it that would restrict the circulation, penalise its
freedom of choice as to personnel, prevent newspapers from being started and compel the press to
Government aid, this would violate Art. 19(1) (a) and would fall outside the Protection afforded by Art.
19(2).
The concept of regulation of fundamental rights borrowed and extracted from American decisions cannot
be accepted. The American First Amendment contains no exceptions like our Art. 19(2) of the Constitution.
This Court has established freedom of the press to speak and express. That freedom cannot be abridged and
taken away by the manner the impugned policy has done.
A newspaper control policy is ultra vires the Import Control Act and the Import control Order. The
machinery of Import Control cannot be utilised to control or curb circulation or growth or freedom of
newspapers in India. The pith and substance doctrine is used in ascertaining whether the Act falls under
one Entry while incidentally encroaching upon another Entry. Such a question does not arise here. The
Newsprint Control Policy is found to be newspaper control order in the guise of framing an Import Control
Policy for newsprint.
This Court in the Bank Nationalisation case laid down two tests. First it is not the object of the authority
making the law impairing the right of the citizen nor the form of action that determines the invasion of the
right. Secondly, it is the effect of the law and the action upon the right which attracts the jurisdiction of the
court to grant relief. The direct operation of the Act upon the rights forms the real test. An examination of
the provisions of the newsprint policy indicates how the petitioner’s fundamental rights had been infringed
by the restrictions on page limit, prohibition against new newspapers and new editions. The effect and
consequence of the impugned policy upon the newspapers is directly controlling the growth and circulation
of newspapers. The direct effect is the restriction upon circulation of newspapers. The direct effect is upon
growth of newspapers through pages. The direct effect is that newspapers are deprived of their area of
advertisement. The direct effect is that they are exposed to financial loss. The direct effect is that freedom
of speech and expression is infringed.
It is indisputable that by freedom of the press is meant the right of all citizens to speak, publish and express
their views. The freedom of the press embodies the right of the people to read. The freedom of the press is
not antithetical to the right of the people to speak and express.
In the present case fixation of page limit will not only deprive the petitioners of their economic vitality but
also restrict the freedom of expression by reason of the compulsive reduction of page level entailing
reduction of circulation and demanding the area of coverage for news and views. If as a result of reduction
in pages the newspapers will have to depend on advertisements as the main source of their income, they
will be denied dissemination of news and views. That will also deprive them of their freedom of speech and
expression. On the other hand if as a result of restriction on page limit the newspapers will have to sacrifice
advertisements and thus weaken the limit of financial strength, the Organisation may crumble., The loss on
advertisements may not only entail the closing down but also affect the circulation and thereby infringe on
freedom of speech and expression.
The impeached policy violates Art. 14 because it treats newspapers which are not equal equally in assessing
the needs and requirements of newsprint. The 7 newspapers which were operating above 10 page level are
placed at a disadvantage by the fixation of 10 page limit and entitlement to quota on that basis. There is no
intelligible differentia. The basic entitlement in Remark V to quota for newspapers operating above 10 page
level violates Article 19(1)(a) because the quota is hedged in by direction not increase the page number
above 10. The reduction of page limit to 10 for the aforesaid reasons violates Article 19(1)(a) and Article
14 of the Constitution.
Under Remark VII(C) those-newspapers within the ceiling of 10 pages get 20 per cent increase in the
number of pages. They require circulation more than the number of pages. They are denied circulation as a
result of the policy. The big English dailies which need to increase their pages are not permitted to do so.
Other dailies which do not need increase in pages are permitted quota for increase but they are denied the
right of circulation. This is not newsprint control but newspaper control.
Discrimination is apparent from Remark VII in the newsprint Policy for 1972-73 by which newspapers with
less than 1,00,000 circulation have been given 10% increase in circulation whereas those with more than
1,00,000 circulation have been given only 3% increase in circulation.
The first part of Remark VIII prohibits increase in pages by reducing circulation in the past adjustability
between pages and circulation was permitted. The individual requirements of different dailies render it
eminently desirable in some cases to increase the number of pages than circulation. The denial of this
flexibility or adjustment is rightly said to hamper the quality, range and standard of the dailies and to affect
the freedom of the press. Big dailies are treated to be equal with newspapers who are not equal to them thus
violating Art. 14.
The second prohibition in Remark VIII prevented common ownership units from adjusting between them
the newsprint quota alloted to each of them. The prohibition is to use the newsprint quota of one newspaper
belonging to a common ownership unit for another newspaper belonging to that unit. Newsprint is allotted
to each paper. The newspaper is considered to be the recipient. A single newspaper will suffer if common
ownership units are allowed to adjust quota within their group.
Under Remark X a common ownership unit could bring out a newspaper or start a new edition of an existing
paper even from their allocated quota. it is an abridgment of the freedom of expression to prevent a common
ownership unit from starting a new edition or a new newspaper. A common ownership unit should be free
to start a new edition out of their allotted quota and it would be logical to say that such a unit can use the
allotted quota for changing the page structure and circulation of different editions of the same paper.
Newspapers however cannot be permitted to use allotted quota for starting a new newspaper. Newspapers
will have to make necessary application for allotment of quota in that behalf. It will be open to the
appropriate authorities to deal with the application in accordance with law.
The liberty of the press remains an Ark of the Covenant. The newspapers give the people the freedom to
find out which ideas are correct. Therefore the freedom of the press is to be enriched by removing the
restrictions on page limit and allowing them to have new editions of newspapers.
The Press is not exposed to any mischief of monopolistic combination. The newsprint policy is not a
measure to combat monopolies. The newsprint policy should allow the newspapers that amount of freedom
of discussion and information which is needed or will appropriately enable the members of the society to
preserve their political expression of comment not only upon public affairs but also upon the vast range of
views and matters needed for free society.
Clause 3(3A) of the 1962 Order provides that no consumer of newsprint other than a publisher of text books
of general interest shall use any kind of page other than newsprint except with the permission of the
Controller. It was therefore wrong to say that it was open to newspapers to make unrestricted use of any
form of paper so long as newspapers did not apply for newsprint.
In the result the provisions in remarks V, VII(a), VII(C) and VIII of the Policy being violative of Arts. 14
& 19 (1) (a) of the Constitution must be struck down as unconstitutional. The prohibition in Remark X
against common ownership unit from starting a new newspaper periodical or a new edition must be declared
unconstitutional and struck down as violative of Art. 19 (1) (a) of the Constitution.
National Company Law Tribunal and Appellate Tribunal
408 - The Central Government shall, by notification, constitute, with effect from such date as may be
specified therein, a Tribunal to be known as the National Company Law Tribunal consisting of a President
and such number of Judicial and Technical members, as the Central Government may deem necessary, to
be appointed by it by notification, to exercise and discharge such powers and functions as are, or may be,
conferred on it by or under this Act or any other law for the time being in force.
419. (1) There shall be constituted such number of Benches of the Tribunal, as may, by notification, be
specified by the Central Government.
(2) The Principal Bench of the Tribunal shall be at New Delhi which shall be presided over by the President
of the Tribunal.
(3) The powers of the Tribunal shall be exercisable by Benches consisting of two Members out of whom
one shall be a Judicial Member and the other shall be a Technical Member:
Provided that it shall be competent for the Members of the Tribunal authorised in this behalf to function as
a Bench consisting of a single Judicial Member and exercise the powers of the Tribunal in respect of such
class of cases or such matters pertaining to such class of cases, as the President may, by general or special
order, specify:
Provided further that if at any stage of the hearing of any such case or matter, it appears to the Member that
the case or matter is of such a nature that it ought to be heard by a Bench consisting of two Members, the
case or matter may be transferred by the President, or, as the case may be, referred to him for transfer, to
such Bench as the President may deem fit.
(4) The President shall, for the disposal of any case relating to rehabilitation, restructuring, reviving or
winding up, of companies, constitute one or more Special Benches consisting of three or more Members,
majority necessarily being of Judicial Members.
(5) If the Members of a Bench differ in opinion on any point or points, it shall be decided according to the
majority, if there is a majority, but if the Members are equally divided, they shall state the point or points
on which they differ, and the case shall be referred by the President for hearing on such point or points by
one or more of the other Members of the Tribunal and such point or points shall be decided according to
the opinion of the majority of Members who have heard the case, including those who first heard it.
420. (1) The Tribunal may, after giving the parties to any proceeding before it, a reasonable opportunity of
being heard, pass such orders thereon as it thinks fit. (2) The Tribunal may, at any time within two years
from the date of the order, with a view to rectifying any mistake apparent from the record, amend any order
passed by it, and shall make such amendment, if the mistake is brought to its notice by the parties:
Provided that no such amendment shall be made in respect of any order against which an appeal has been
preferred under this Act.
(3) The Tribunal shall send a copy of every order passed under this section to all the parties concerned.
421. (1) Any person aggrieved by an order of the Tribunal may prefer an appeal to the Appellate Tribunal.
(2) No appeal shall lie to the Appellate Tribunal from an order made by the Tribunal with the consent of
parties.
(3) Every appeal under sub-section (1) shall be filed within a period of forty-five days from the date on
which a copy of the order of the Tribunal is made available to the person aggrieved and shall be in such
form, and accompanied by such fees, as may be prescribed:
Provided that the Appellate Tribunal may entertain an appeal after the expiry of the said period of forty-
five days from the date aforesaid, but within a further period not exceeding forty-five days, if it is satisfied
that the appellant was prevented by sufficient cause from filing the appeal within that period.
(4) On the receipt of an appeal under sub-section (1), the Appellate Tribunal shall, after giving the parties
to the appeal a reasonable opportunity of being heard, pass such orders thereon as it thinks fit, confirming,
modifying or setting aside the order appealed against.
(5) The Appellate Tribunal shall send a copy of every order made by it to the Tribunal and the parties to
appeal.
422. (1) Every application or petition presented before the Tribunal and every appeal filed before the
Appellate Tribunal shall be dealt with and disposed of by it as expeditiously as possible and every
endeavour shall be made by the Tribunal or the Appellate Tribunal, as the case may be, for the disposal of
such application or petition or appeal within three months from the date of its presentation before the
Tribunal or the filing of the appeal before the Appellate Tribunal.
(2) Where any application or petition or appeal is not disposed of within the period specified in sub-section
(1), the Tribunal or, as the case may be, the Appellate Tribunal, shall record the reasons for not disposing
of the application or petition or the appeal, as the case may be, within the period so specified; and the
President or the Chairperson, as the case may be, may, after taking into account the reasons so recorded,
extend the period referred to in sub-section (1) by such period not exceeding ninety days as he may consider
necessary.
423. Any person aggrieved by any order of the Appellate Tribunal may file an appeal to the Supreme Court
within sixty days from the date of receipt of the order of the Appellate Tribunal to him on any question of
law arising out of such order
Provided that the Supreme Court may, if it is satisfied that the appellant was prevented by sufficient cause
from filing the appeal within the said period, allow it to be filed within a further period not exceeding sixty
days.
424. (1) The Tribunal and the Appellate Tribunal shall not, while disposing of any proceeding before it or,
as the case may be, an appeal before it, be bound by the procedure laid down in the Code of Civil Procedure,
1908, but shall be guided by the principles of natural justice, and, subject to the other provisions of this Act
and of any rules made thereunder, the Tribunal and the Appellate Tribunal shall have power to regulate
their own procedure.
(2) The Tribunal and the Appellate Tribunal shall have, for the purposes of discharging their functions
under this Act, the same powers as are vested in a civil court under the Code of Civil Procedure, 1908 while
trying a suit in respect of the following matters, namely:—
(a) summoning and enforcing the attendance of any person and examining him on oath;
(b) requiring the discovery and production of documents;
(c) receiving evidence on affidavits;
(d) subject to the provisions of sections 123 and 124 of the Indian Evidence Act, 1872, requisitioning any
public record or document or a copy of such record or document from any office;
(e) issuing commissions for the examination of witnesses or documents;
(f) dismissing a representation for default or deciding it ex parte;
(g) setting aside any order of dismissal of any representation for default or any order passed by it ex parte;
and
(h) any other matter which may be prescribed.
(3) Any order made by the Tribunal or the Appellate Tribunal may be enforced by that Tribunal in the same
manner as if it were a decree made by a court in a suit pending therein, and it shall be lawful for the Tribunal
or the Appellate Tribunal to send for execution of its orders to the court within the local limits of whose
jurisdiction,—
(a) in the case of an order against a company, the registered office of the company is situate; or
(b) in the case of an order against any other person, the person concerned voluntarily resides or carries on
business or personally works for gain.
(4) All proceedings before the Tribunal or the Appellate Tribunal shall be deemed to be judicial proceedings
within the meaning of sections 193 and 228, and for the purposes of section 196 of the Indian Penal Code,
and the Tribunal and the Appellate Tribunal shall be deemed to be civil court for the purposes of section
195 and Chapter XXVI of the Code of Criminal Procedure, 1973.
425. The Tribunal and the Appellate Tribunal shall have the same jurisdiction, powers and authority in
respect of contempt of themselves as the High Court has and may exercise, for this purpose, the powers
under the provisions of the Contempt of Courts Act, 1971, which shall have the effect subject to
modifications that—
(a) the reference therein to a High Court shall be construed as including a reference to the Tribunal and the
Appellate Tribunal; and
(b) the reference to Advocate-General in section 15 of the said Act shall be construed as a reference to such
Law Officers as the Central Government may, specify in this behalf.
SPRING 2016 FOR PRIVATE CIRCULATION ONLY
MODULE II - TYPES OF BUSINESS ORGANISATIONS
Organisation Sole Partnership LLP One person Private company Public company
proprietorship company
Ownership Individual Partners Partners Individual 2 to 7 shareholders Shareholders in

excess of 7
Liability Unlimited Unlimited- Each Limited to the Limited to Limited to Limited to

Partner is jointly extent of partner’s shareholding shareholding shareholding
and severally contribution.
liable
Management Owner Partners Partners Board of Directors Board of Directors Board of Directors
Succession None None after death Separate legal Separate legal Separate Legal Separate Legal Entity
of all partners entity- will continue entity- but requires a Entity
after death of nominee
partners
Formation Minimal Optional Compulsory Considerable Considerable Considerable

registration registration but paperwork. paperwork. paperwork.
minimal paperwork Application to RoC Application to RoC Application to RoC
to be made to be made and SEBI to be made
Profits Individual Partners Partners Individual Shareholders Shareholders

MODULE III - INCORPORATION AND FORMATION OF COMPANIES
Section 9 - From the date of incorporation mentioned in the certificate of incorporation, such subscribers
to the memorandum and all other persons, as may, from time to time, become members of the company,
shall be a body corporate by the name contained in the memorandum, capable of exercising all the functions
of an incorporated company under this Act and having perpetual succession and a common seal with power
to acquire, hold and dispose of property, both movable and immovable, tangible and intangible, to contract
and to sue and be sued, by the said name
Section 3. (1) A company may be formed for any lawful purpose by—
(a) seven or more persons, where the company to be formed is to be a public company;
(b) two or more persons, where the company to be formed is to be a private company; or
(c) one person, where the company to be formed is to be One Person Company that is to say, a private
company,
by subscribing their names or his name to a memorandum and complying with the requirements of this Act
in respect of registration
Incorporation of a Company
7. (1) There shall be filed with the Registrar within whose jurisdiction the registered office of a company is
proposed to be situated, the following documents and information for registration, namely:—
(a) the memorandum and articles of the company duly signed by all the subscribers to the memorandum in
such manner as may be prescribed;
(b) a declaration in the prescribed form by an advocate, a chartered accountant, cost accountant or company
secretary in practice, who is engaged in the formation of the company, and by a person named in the articles
as a director, manager or secretary of the company, that all the requirements of this Act and the rules made
thereunder in respect of registration and matters precedent or incidental thereto have been complied with;
(c) an affidavit from each of the subscribers to the memorandum and from persons named as the first
directors, if any, in the articles that he is not convicted of any offence in connection with the promotion,
formation or management of any company, or that he has not been found guilty of any fraud or misfeasance
or of any breach of duty to any company under this Act or any previous company law during the preceding
five years and that all the documents filed with the Registrar for registration of the company contain
information that is correct and complete and true to the best of his knowledge and belief;
(d) the address for correspondence till its registered office is established;
(e) the particulars of name, including surname or family name, residential address, nationality and such
other particulars of every subscriber to the memorandum along with proof of identity, as may be prescribed,
and in the case of a subscriber being a body corporate, such particulars as may be prescribed;
(f) the particulars of the persons mentioned in the articles as the first directors of the company, their names,
including surnames or family names, the Director Identification Number, residential address, nationality
and such other particulars including proof of identity as may be prescribed; and
(g) the particulars of the interests of the persons mentioned in the articles as the first directors of the
company in other firms or bodies corporate along with their consent to act as directors of the company in
such form and manner as may be prescribed.
(2) The Registrar on the basis of documents and information filed under sub-section (1) shall register all
the documents and information referred to in that subsection in the register and issue a certificate of
incorporation in the prescribed form to the effect that the proposed company is incorporated under this Act.
(3) On and from the date mentioned in the certificate of incorporation issued under sub-section (2), the
Registrar shall allot to the company a corporate identity number, which shall be a distinct identity for the
company and which shall also be included in the certificate. (4) The company shall maintain and preserve
at its registered office copies of all documents and information as originally filed under sub-section (1) till
its dissolution under this Act.
(5) If any person furnishes any false or incorrect particulars of any information or suppresses any material
information, of which he is aware in any of the documents filed with the Registrar in relation to the
registration of a company, he shall be liable for action under section 447.
(6) Without prejudice to the provisions of sub-section (5) where, at any time after the incorporation of a
company, it is proved that the company has been got incorporated by furnishing any false or incorrect
information or representation or by suppressing any material fact or information in any of the documents
or declaration filed or made for incorporating such company, or by any fraudulent action, the promoters,
the persons named as the first directors of the company and the persons making declaration under clause
(b) of subsection (1) shall each be liable for action under section 447.
(7) Without prejudice to the provisions of sub-section (6), where a company has been got incorporated by
furnishing any false or incorrect information or representation or by suppressing any material fact or
information in any of the documents or declaration filed or made for incorporating such company or by any
fraudulent action, the Tribunal may, on an application made to it, on being satisfied that the situation so
warrants,—
(a) pass such orders, as it may think fit, for regulation of the management of the company including changes,
if any, in its memorandum and articles, in public interest or in the interest of the company and its members
and creditors; or
(b) direct that liability of the members shall be unlimited; or
(c) direct removal of the name of the company from the register of companies; or
(d) pass an order for the winding up of the company; or
(e) pass such other orders as it may deem fit:
Provided that before making any order under this sub-section,—
(i) the company shall be given a reasonable opportunity of being heard in the matter; and
(ii) the Tribunal shall take into consideration the transactions entered into by the company, including the
obligations, if any, contracted or payment of any liability.
Memorandum of Association
4. (1) The memorandum of a company shall state—

(a) the name of the company with the last word “Limited” in the case of a public limited company, or the
last words “Private Limited” in the case of a private limited company:
Provided that nothing in this clause shall apply to a company registered under section 8;
(b) the State in which the registered office of the company is to be situated;
(c) the objects for which the company is proposed to be incorporated and any matter considered necessary
in furtherance thereof;
(d) the liability of members of the company, whether limited or unlimited, and also state,—
(i) in the case of a company limited by shares, that liability of its members is limited to the amount unpaid,
if any, on the shares held by them; and
(ii) in the case of a company limited by guarantee, the amount up to which each member undertakes to
contribute—
(A) to the assets of the company in the event of its being wound-up while he is a member or within one
year after he ceases to be a member, for payment of the debts and liabilities of the company or of such debts
and liabilities as may have been contracted before he ceases to be a member, as the case may be; and
(B) to the costs, charges and expenses of winding-up and for adjustment of the rights of the contributories
among themselves;
(e) in the case of a company having a share capital,—
(i) the amount of share capital with which the company is to be registered and the division thereof into
shares of a fixed amount and the number of shares which the subscribers to the memorandum agree to
subscribe which shall not be less than one share; and
(ii) the number of shares each subscriber to the memorandum intends to take, indicated opposite his name;
(f) in the case of One Person Company, the name of the person who, in the event of death of the subscriber,
shall become the member of the company.
(2) The name stated in the memorandum shall not—
(a) be identical with or resemble too nearly to the name of an existing company registered under this Act
or any previous company law; or
(b) be such that its use by the company—
(i) will constitute an offence under any law for the time being in force; or
(ii) is undesirable in the opinion of the Central Government.
(3) Without prejudice to the provisions of sub-section (2), a company shall not be registered with a name
which contains—
(a) any word or expression which is likely to give the impression that the company is in any way connected
with, or having the patronage of, the Central Government, any State Government, or any local authority,
corporation or body constituted by the Central Government or any State Government under any law for the
time being in force; or
(b) such word or expression, as may be prescribed, unless the previous approval of the Central Government
has been obtained for the use of any such word or expression.
(4) A person may make an application, in such form and manner and accompanied by such fee, as may be
prescribed, to the Registrar for the reservation of a name set out in the application as—
(a) the name of the proposed company; or
(b) the name to which the company proposes to change its name.
(5) (i) Upon receipt of an application under sub-section (4), the Registrar may, on the basis of information
and documents furnished along with the application, reserve the name for a period of sixty days from the
date of the application.
(ii) Where after reservation of name under clause (i), it is found that name was applied by furnishing wrong
or incorrect information, then,—
(a) if the company has not been incorporated, the reserved name shall be cancelled and the person making
application under sub-section (4) shall be liable to a penalty which may extend to one lakh rupees;
(b) if the company has been incorporated, the Registrar may, after giving the company an opportunity of
being heard—
(i) either direct the company to change its name within a period of three months, after passing an ordinary
resolution;
(ii) take action for striking off the name of the company from the register of companies; or
(iii) make a petition for winding up of the company.
(6) The memorandum of a company shall be in respective forms specified in Tables A, B, C, D and E in
Schedule I as may be applicable to such company.
(7) Any provision in the memorandum or articles, in the case of a company limited by guarantee and not
having a share capital, purporting to give any person a right to participate in the divisible profits of the
company otherwise than as a member, shall be void.
Articles of Association
5. (1) The articles of a company shall contain the regulations for management of the company.
(2) The articles shall also contain such matters, as may be prescribed:
Provided that nothing prescribed in this sub-section shall be deemed to prevent a company from including
such additional matters in its articles as may be considered necessary for its management.
(3) The articles may contain provisions for entrenchment to the effect that specified provisions of the articles
may be altered only if conditions or procedures as that are more restrictive than those applicable in the case
of a special resolution, are met or complied with.
(4) The provisions for entrenchment referred to in sub-section (3) shall only be made either on formation
of a company, or by an amendment in the articles agreed to by all the members of the company in the case
of a private company and by a special resolution in the case of a public company.
(5) Where the articles contain provisions for entrenchment, whether made on formation or by amendment,
the company shall give notice to the Registrar of such provisions in such form and manner as may be
prescribed.
(6) The articles of a company shall be in respective forms specified in Tables, F, G, H, I and J in Schedule
I as may be applicable to such company.
(7) A company may adopt all or any of the regulations contained in the model articles applicable to such
company.
(8) In case of any company, which is registered after the commencement of this Act, in so far as the
registered articles of such company do not exclude or modify the regulations contained in the model articles
applicable to such company, those regulations shall, so far as applicable, be the regulations of that company
in the same manner and to the extent as if they were contained in the duly registered articles of the company.
(9) Nothing in this section shall apply to the articles of a company registered under any previous company
law unless amended under this Act.
10. (1) Subject to the provisions of this Act, the memorandum and articles shall, when registered, bind the
company and the members thereof to the same extent as if they respectively had been signed by the company
and by each member, and contained covenants on its and his part to observe all the provisions of the
memorandum and of the articles.
(2) All monies payable by any member to the company under the memorandum or articles shall be a debt
due from him to the company.
Doctrine of constructive notice, ultra vires and indoor management
Royal British Bank v. Turquand (1856) 6 E&B 327
Facts -
The defendant is the official manager of ‘Cameron’s Coalbrook Steam, Coal, and Swansea and London
Railway Company’. Plaintiff declared a registered joint stock Company against defendant, on a bond that
was signed by two of the company’s directors, under the seal of the Company; and it was through the bond
that the Company acknowledged themselves to be bound to plaintiff.
By the registered deed of settlement of the Company, the directors were authorized, under certain
circumstances, to give bills, notes, bonds or mortgages: and one clause provided that the directors might
borrow on bond such sums as should, from time to time, by a general resolution of the Company, be
authorized to be borrowed. The defendant alleged that there had been no such resolution authorizing the
making of the bond, and that the same was given and made without the authority or consent of the
shareholders of the Company.
The plaintiffs alleged that, at a general meeting of the Company it was resolved “that the directors of the
said Company should be, and they were thereby, authorized to borrow on mortgage, bond or otherwise,
such sums for such periods and at such rates of interest as they might deem expedient, in accordance with
the provisions of the deed of settlement and Act of Parliament. And the said resolution and determination
has thence hitherto remained unrescinded.” They further alleged that afterwards, in accordance with the
authority granted by the general meeting, the directors agreed to enter into the bond, and appointed two
directors to affix their seal, and the secretary to sign the bond, which bond, so sealed and signed, plaintiffs
took “in full faith and belief of the validity of the said resolutions, and that the said bond was authorized
by, and would be a valid and binding security upon, the said Company.”
Issue-
Are the plaintiffs entitled to the recover the money borrowed by the defendant company’s directors even
though such money was borrowed in non-compliance with the internal rules and regulations of the
company?
Discussion-
Parties dealing with companies are bound to read the statute and the deed of settlement. But they are not
bound to do more. When there are persons conducting the affairs of the company in a manner which appears
to be perfectly consonant with the articles of association, those so dealing with them externally are not to
be affected by irregularities which may take place in the internal management of the company. In other
words, people transacting with companies are entitled to assume that internal company rules are complied
with, even if they are not. This is the doctrine of indoor management.
The company resolution goes far enough to satisfy the requisites of the deed of settlement. The deed allows
the directors to borrow on bond such sum or sums of money as shall from time to time, by a resolution
passed at a general meeting of the Company, be authorized to be borrowed: and the replication shews a
resolution, passed at a general meeting, authorizing the directors to borrow on bond such sums for such
periods and at such rates of interest as they might deem expedient, in accordance with the deed of settlement
and the Act of Parliament; but the resolution does not otherwise define the amount to be borrowed. That is
enough.
We may take for granted that the dealings with these companies are not like dealings with other
partnerships, and that the parties dealing with them are bound to read the statute and the deed of settlement.
But they are not bound to do more. And the party here, on reading the deed of settlement, would find, not
a prohibition from borrowing, but a permission to do so on certain conditions. Finding that the authority
might be made complete by a resolution, he would have a right to infer the fact of a resolution authorizing
that which on the face of the document appeared to be legitimately done.
The company is bound by the impugned bond and the plaintiff is entitled to recover from the company
Ashbury Rly. Carriage & Iron Company v. Riche (1875) LR 7 HL 653

Mr. John Ashbury had carried on at two places in Lancashire a very extensive business in making railway
carriages and waggons, turn-tables, points, crossings, and roofs, and other things of a like sort needed by a
railway company, but had not been concerned in the construction of railways themselves.
A company called “The Ashbury Railway Carriage and Iron Company,” incorporated under the Companies
Act, 1862, was started for the purpose of buying Mr. John Ashbury’s business, and among the other articles
in the agreement for its purchase was this, that the said John Ashbury shall not be interested (except as
shareholder in a company) in “the business of a railway- carriage maker, iron manufacturer or contractor,
or any other business or branch of business theretofore carried on by him at the said works.”
A Memorandum of Association of the company, dated on the 12th of September, 1862, was drawn up. By
the 3rd clause of this memorandum of association the objects of the company were thus defined:
“The objects for which the company is established are to make and sell, or lend on hire, railway-carriages
and waggons, and all kinds of railway plant, fittings, machinery, and rolling-stock; to carry on the business
of mechanical engineers and general contractors; to purchase and sell, as merchants, timber, coal, metals,
or other materials; and to buy and sell any such materials on commission, or as agents.”
The Articles of Association recited an agreement to purchase the business of John Ashbury. The first portion
of these articles need not be referred to. In a second portion (which was marked by a different enumeration
of clauses), under the heading “Business” the 4th clause was in these terms: “An extension of the company’s
business beyond or for other than the objects or purposes expressed or implied in the memorandum of
association shall take place only in pursuance of a special resolution.” By clause 36 of the articles it was
provided that “the directors may, with the sanction of a special resolution of the company, previously given
in general meeting, increase its capital,”. By clause 68 the directors were to have the general conduct of the
business of the company, and to “exercise all such powers of the company as are not, by the Act of
Parliament or the regulations of the company” to be exercised in general meeting. By clause 70 the directors
might “at any board meeting direct the affixing of the seal of the company to any deed or document.” By
clause 85 the directors might delegate “any of their powers to committees consisting of such member or
members of their body as they shall think fit.”
In 1864 Mr. Riche, the Defendant in Error, was carrying on business in Belgium, in partnership with his
brother (since deceased) as a railway contractor. On the 14th of March, 1864, the Belgian Government
granted to certain persons named Gillon and Bertsoen a provisional concession for making a line of railway
from Antwerp to Tournay, the payment of two sums of £4000 and £ 16,000 being settled as what is called
“caution money.” The two concessionaries desired a company to be formed to carry this concession into
effect. It was agreed that Messrs. Riche were to have the construction of the line; and in the early part of
1865 the two concessionaries and Messrs. Riche and the directors of the Ashbury Company met together,
and agreed to form a company (Société Anonyme) to work the concession. The arrangement was for the
Ashbury Company to purchase the concession from Messrs. Gillon for £70,000, and to give the contract
for its construction to Messrs. Riche, the company thus becoming, in fact, the contractor for the construction
of the line. In this negotiation Mr. James Ashbury, one of the directors of the English company, represented
that company, and entered into the contracts. Sir Cusack Roney afterwards acted in the same character.
The formation of a société anonyme in Belgium, and the agreement with Messrs. Riche that they should
construct the line--the Ashbury company undertaking to supply the société anonyme with the requisite
funds--was said to have been adopted because the rails, &c., supplied by a Belgian house would be free
from the duty that the Belgian Government imposed on rails imported from England, and consequently the
profit from the construction of the line would be increased. Messrs. Riche began and for some time
continued the works for the construction of the line; and for some time, too, the Ashbury directors paid, in
the name of their company, money to the société anonyme to which Messrs. Riche had become entitled.
Difficulties about payment arose as the work went on, the English shareholders not adopting the views of
their directors as to the speculation.
In May, 1867, there was an “extraordinary meeting of the shareholders of the company,” at which a report
was read from a committee previously appointed at the general meeting of December, 1866. This report
disapproved of what had been done by the directors in the matter of the Belgian railway (and likewise of
what had been done by them in a similar manner with respect to a Spanish railway), and contained the
following declarations:
“As regards the two railway concessions, the committee consider the items appertaining to these
concessions should not have appeared in the company’s books, nor in the balance sheets. But, looking at
the important interests involved, and the extent to which they would be jeopardised by proceedings in
Chancery, extending over a considerable period, they would recommend the shareholders to endeavour to
effect an amicable settlement with the directors, without having recourse to legal proceedings.”
The annual meeting was held on the 14th of May, 1867, to consider (among other things) this report. This
recommendation in the report of an “amicable settlement with the directors” was considered, and an
arrangement was proposed by which the Directors were to “purchase from the Ashbury Company any estate
or interest which the company may have in the Antwerp and Tournay railway contract or concession.” The
Ashbury Company was, by the same arrangement, to allow legal proceedings to be taken to enforce the
claims or defend any actions, or otherwise, in relation to the said businesses, which might be required, in
the name of the Ashbury Company, but “at the expense of the said purchasers” (the Directors), who were
to indemnify the company against all liabilities.
At a general meeting on the 24th of December, 1867, this arrangement was sanctioned, and though a
resolution was proposed “That the accounts be approved and adopted, with the exception that the term
‘advances or contracts’ be expunged,” that was withdrawn and the accounts passed, including that item.
The Company, however, dealing with the brothers Riche repudiated the contract for constructing the line
as one ultra vires. Messrs. Riche brought an action for damages for breach of contract.
The question of ultra vires was that on which the decision was to depend on the following considerations:
First: The declaration of the objects of the company made in the Memorandum of Association.
Secondly: The words of several of the Articles of Association.
Thirdly: The acts of the Directors, and of meetings of the Company.
The objects of this company, as stated in the Memorandum of Association, were to supply and sell the
materials required to construct railways, but not to undertake their construction. The contract here was to
construct a railway, using Messrs. Riche only as the persons to be employed in the construction. That was
contrary to the memorandum of association; what was done by the directors in entering into that contract
was therefore in direct contravention of the provisions of the Company Act, 1862. The 12th section of that
statute permits a company, limited by shares, so far to modify the conditions contained in its memorandum
of association (subject to certain regulations therein stated) as to increase its capital by the issue of new
shares, or so as to divide its shares in a different manner, or to convert its paid-up shares into stock; “but
save as aforesaid, and save as is hereinafter provided in the case of a change of name, no alteration shall be
made by any company in the conditions contained in its memorandum of association.” It was, therefore,
not merely in excess of legal powers, but was absolutely illegal for the directors to change those conditions.
No consent of the shareholders could make such a contract legal. But in fact no such assent was ever given.
The whole body of the shareholders could not give such an assent, and never had intended or attempted to
give it.The objects of a company proposed to be incorporated under that Act, as stated in the Memorandum
of Association required by the 8th section of the Act, cannot be departed from, except so far as the 12th
section permits the change. The Memorandum is the Charter of the company.
Consequently a contract made by the directors of such a company upon a matter not included in the
Memorandum of Association is ultra vires of the directors, and is not binding on the company.
Nor can such a contract be rendered binding on the company though afterwards expressly assented to at a
general meeting of shareholders. Being in its inception void, as beyond the provisions of the statute, it
cannot be ratified even by the assent of the whole body of shareholders.
Held, that this contract, being of a nature not included in the Memorandum of Association, was ultra vires
not only of the directors but of the whole company, so that even the subsequent assent of the whole body
of shareholders would have no power to ratify it.
Observations upon what must have been done to constitute a ratification of any contract which, though not
absolutely void, as unwarranted by the Memorandum of Association, had been in excess of the powers
possessed by the directors under the articles of association.
The 50th section only authorizes alterations which are within the limits provided by the Memorandum of
Association.
Lakshmanaswami Mudaliar v. L.I.C. AIR 1963 SC 1185

On July 15, 1955, at an Extraordinary General Meeting of the shareholders of the United India Life
Assurance Company Ltd., a resolution was passed, among other matters sanctioning a donation of Rs. 2
lakhs from out of the Shareholders’ Dividend Account to a Trust proposed to be formed with the object
inter alia of promoting technical or business knowledge, including knowledge in insurance.
On July 1, 1956, the Life Insurance Corporation Act came into force by the provisions of which on the
appointed day all the assets and liabilities appertaining to the controlled business of an insurer vested in the
Life Insurance Corporation by Section 15(l)(a) of the Life Insurance Corporation Act power was given to
the Corporation to apply to the Tribunal for relief in respect of payments made by the insurers, during the
five years preceding the date of vesting, not reasonably necessary for the purpose of the controlled business.
The Corporation applied to the Tribunal for relief in respect of the payments of Rs. 2 lakhs by the Company
to the appellants on the ground that the said payment was ultra vires the powers of the company and was
not reasonably necessary for the purpose of the controlled business. The Tribunal ordered the appellants to
restore the sum of Rs. 2 lakhs to the Corporation.
On appeal by special leave.
Held, that the Shareholders’ Dividend Account provided for by the Articles did not confer any proprietary
interest on the shareholders, though if was charged for the purpose of paying dividends to the shareholders
and that the mere description of the dividend account as the exclusive property of the shareholders did not
thereby create a proprietary interest in the shareholders. The right to dividend depends upon the
recommendation to be made by the Directors without which the shareholders acquire no right to the fund
or any part thereof.
Bacha P. Guzdar v. Commissioner of Income-tax, Bombay, [1955] 1 S.C.R. 876, referred to.
Held, further, that the meeting in which the resolution was passed was a meeting of the Company &ad it
could not be contended that it was a meeting of the shareholders in their individual capacity.
Held, further, that the resolution of the company and the acceptance by the appellants of the amount did not
constitute a contract there being no consideration to support it.
Held, further, that the object of the company viz. to invest and deal with funds and assets of the company
upon such securities or investments” could not authorise the making of the donation and such a power
which was not expressly provided for by the memorandum could not be found by reference to the general
clause of the Memorandum giving power to do incidental things.
Egyptian Salt & Soda Company v. Port Said Salt Association, (1931) A. C. 677 and Ashbury Railway
Carriages and Iron Company v. Riche, (1875) L. R. 7. HI L. 653, referred to.
Held, further, that the resort to the Articles of Association for the purpose of construing the Memorandum
was permissible only on matters regarding which the Memorandum was silent or ambiguous.
Angostura Bitters & Company Ltd. v. Kerr, [1933] A.C. 550, referred to.
Held, further, that the making of donations to the Trust which may or may not provide indirect or remote
benefits to the business of insurance was not within the power of the company.
Tomkinson v. South Eaatern Railway, (1887) 35 Ch, D, 675, referred to
Held, also, that the action of the Company being ultra vires, it created no legal effect and could not be
ratified even if all the shareholders agreed and payments made pursuant to such action created no rights in
the appellants and they were rightly directed under s. 15 of the Life Insurance Corporation Act to personally
refund the amount.
Modifications to the articles and memorandum of association
13. Alteration of Memorandum (1) Save as provided in section 61, a company may, by a special resolution
and after complying with the procedure specified in this section, alter the provisions of its memorandum.
(2) Any change in the name of a company shall be subject to the provisions of subsections (2) and (3) of
section 4 and shall not have effect except with the approval of the Central Government in writing:
Provided that no such approval shall be necessary where the only change in the name of the company is the
deletion therefrom, or addition thereto, of the word “Private”, consequent on the conversion of any one
class of companies to another class in accordance with the provisions of this Act.
(3) When any change in the name of a company is made under sub-section (2), the Registrar shall enter the
new name in the register of companies in place of the old name and issue a fresh certificate of incorporation
with the new name and the change in the name shall be complete and effective only on the issue of such a
certificate.
(4) The alteration of the memorandum relating to the place of the registered office from one State to another
shall not have any effect unless it is approved by the Central Government on an application in such form
and manner as may be prescribed.
(5) The Central Government shall dispose of the application under sub-section (4) within a period of sixty
days and before passing its order may satisfy itself that the alteration has the consent of the creditors,
debenture-holders and other persons concerned with the company or that the sufficient provision has been
made by the company either for the due discharge of all its debts and obligations or that adequate security
has been provided for such discharge.
(6) Save as provided in section 64, a company shall, in relation to any alteration of its memorandum, file
with the Registrar—
(a) the special resolution passed by the company under sub-section (1);
(b) the approval of the Central Government under sub-section (2), if the alteration involves any change in
the name of the company.
(7) Where an alteration of the memorandum results in the transfer of the registered office of a company
from one State to another, a certified copy of the order of the Central Government approving the alteration
shall be filed by the company with the Registrar of each of the States within such time and in such manner
as may be prescribed, who shall register the same, and the Registrar of the State where the registered office
is being shifted to, shall issue a fresh certificate of incorporation indicating the alteration.
(8) A company, which has raised money from public through prospectus and still has any unutilised amount
out of the money so raised, shall not change its objects for which it raised the money through prospectus
unless a special resolution is passed by the company and—
(i) the details, as may be prescribed, in respect of such resolution shall also be published in the newspapers
(one in English and one in vernacular language) which is in circulation at the place where the registered
office of the company is situated and shall also be placed on the website of the company, if any, indicating
therein the justification for such change;
(ii) the dissenting shareholders shall be given an opportunity to exit by the promoters and shareholders
having control in accordance with regulations to be specified by the Securities and Exchange Board.
Alteration of memorandum.
(9) The Registrar shall register any alteration of the memorandum with respect to the objects of the company
and certify the registration within a period of thirty days from the date of filing of the special resolution in
accordance with clause (a) of sub-section (6) of this section.
(10) No alteration made under this section shall have any effect until it has been registered in accordance
with the provisions of this section.
(11) Any alteration of the memorandum, in the case of a company limited by guarantee and not having a
share capital, purporting to give any person a right to participate in the divisible profits of the company
otherwise than as a member, shall be void.
14. Alteration of Articles (1) Subject to the provisions of this Act and the conditions contained in its
memorandum, if any, a company may, by a special resolution, alter its articles including alterations having
the effect of conversion of—
(a) a private company into a public company; or
(b) a public company into a private company:
Provided that where a company being a private company alters its articles in such a manner that they no
longer include the restrictions and limitations which are required to be included in the articles of a private
company under this Act, the company shall, as from the date of such alteration, cease to be a private
company:
Provided further that any alteration having the effect of conversion of a public company into a private
company shall not take effect except with the approval of the Tribunal which shall make such order as it
may deem fit.
(2) Every alteration of the articles under this section and a copy of the order of the Tribunal approving the
alteration as per sub-section (1) shall be filed with the Registrar, together with a printed copy of the altered
articles, within a period of fifteen days in such manner as may be prescribed, who shall register the same.
(3) Any alteration of the articles registered under sub-section (2) shall, subject to the provisions of this Act,
be valid as if it were originally in the articles.
15. Alteration of memorandum or articles to be noted in every copy (1) Every alteration made in the
memorandum or articles of a company shall be noted in every copy of the memorandum or articles, as the
case may be.
(2) If a company makes any default in complying with the provisions of sub-section (1), the company and
every officer who is in default shall be liable to a penalty of one thousand rupees for every copy of the
memorandum or articles issued without such alteration.
Conflict between a shareholders agreement and AoA
6. Act to override memorandum, articles, etc. Save as otherwise expressly provided in this Act—
(a) the provisions of this Act shall have effect notwithstanding anything to the contrary contained in the
memorandum or articles of a company, or in any agreement executed by it, or in any resolution passed by
the company in general meeting or by its Board of Directors, whether the same be registered, executed or
passed, as the case may be, before or after the commencement of this Act; and
(b) any provision contained in the memorandum, articles, agreement or resolution shall, to the extent to
which it is repugnant to the provisions of this Act, become or be void, as the case may be
V.B. Rangaraj vs V.B. Gopalakrishnan And Others AIR 1992 SC 453, 1992
The main question that falls for consideration in both the appeals is whether the shareholders can among
themselves enter into an agreement which is contrary to or inconsistent with the Articles of Association of
the company.
The third defendant is a private limited company which all along had a total shareholding of 50. Before the
joint family of the plaintiffs and defendants came to hold all the 50 shares of the company, the family was
a minority shareholder holding 13 shares, the rest 37 shares being held by outsiders. In course of time, the
family acquired the rest 37 shares and became the sole shareholder of the company. The family consisted
of Baluswamy Naidu and Guruviah Naidu who were brothers, and each of the brothers held 25 shares in
the company. The plaintiffs and defendants 1 and 2 and one Selvaraj are the sons of Baluswamy Naidu and
defendants 4 to 6 are the sons of Guruviah Naidu. Baluswamy Naidu died on February 5, 1963 and Guruviah
Naidu died on January 10, 1970. The plaintiffs alleged that in 1951 there was an oral agreement between
Baluswamy Naidu and Guruviah Naidu that each of the branches of the family would always continue to
hold equal number of shares, viz., 25 and that if any member in either of the branches wished to sell his
share/shares, he would give the first option of purchase to the members of that branch and only if the offer
so made was not accepted, the shares would be sold to others. Although on behalf of defendants, it was
disputed that there was any such agreement entered into between the two brothers, the finding recorded by
all the courts below is against the defendants. It is not in dispute that the Articles of Association of the
company were not amended to bring them in conformity with the said agreement.
Contrary to the said agreement, the first defendant, i.e., son of Baluswamy Naidu sold the shares to
defendants 4 to 6 who are the sons of Guruviah Naidu. Hence the plaintiffs who are Baluswamy’s sons filed
the present suit for (i) a declaration that the said sale was void and not binding upon the plaintiffs and the
second defendant (who is also the son of Baluswamy Naidu but was joined as a pro forma defendant) and
for (ii) an order directing defendants 1 and 4 to 6 to transfer the said shares to the plaintiffs and the second
defendant and for (iii) a permanent injunction restraining defendants 4 to 6 from applying for registering
the said shares in their names and from acting adversely to the interests of the plaintiffs and the second
defendant on the basis of the transfer of the said shares.
Shri Parasaran appearing for defendants 4 to 6 in C.A. No. 1946 of 1980 contended that the agreement in
effect imposed an additional restriction on the right to transfer the shares. The restriction was not envisaged
by any of the Articles of Association. Hence it was not binding on any shareholder or a vendee of the shares
from the shareholders. It was also unenforceable at law and, therefore, not binding on the company. Hence
the sale of the shares by the first defendant to defendants 4 to 6 was not invalid and the High Court was
wrong in directing the transfer of shares in favour of the plaintiffs. Shri Bhatt appearing for the first
defendant (appellant in C.A. No. 1946 of 1980) contended that assuming that the sale of shares by the first
defendant to defendants 4 to 6 was invalid in view of the agreement, the High Court could only have
declared that the sale was invalid and it could not have further directed the transfer of shares in favour of
plaintiffs. The first defendant could not be forced to sell the shares to the plaintiffs. Shri Krishnamurthy, on
the other hand, contended that (i) the shareholders were bound by the agreement of 1951; (ii) the agreement
was entered into to maintain the ownership of the company in the family and to ensure that the two branches
of the family had an equal share in the management and profits and losses of the company; (iii) there was
nothing in the Articles of Association which prohibited such agreement and (iv) the two branches of the
family being party to the agreement, it was enforceable against them, and the courts have done nothing
more than to enforce the agreement.
It is necessary to understand the true position of law in this behalf. Section 3(iii) of the Companies Act
(hereinafter referred to as ‘the Act’) defines private company to mean a company which by its Articles,
restricts the right to transfer its shares, if any, and limits the number of its shares to 50 (excepting employees
and ex-employees who were and are members of the company) and prohibits any invitation to the public to
subscribe for any shares in, or debentures of, the company. Section 26 of the Act provides that in the case
of a private company limited by shares, such as the third defendant-company, there shall be registered with
the Memorandum, Articles of Association signed by the subscribers of the Memorandum prescribing
regulations for the company. Section 28 provides that the Articles of Association of a company limited by
shares may adopt all or any of the regulations contained in Table A in Schedule I of the Act. Section 31
provides for alteration of the Articles by a special resolution of the company. Section 36 states that when
the Memorandum and Articles of Association are registered, they bind the company and the members
thereof. Section 39 provides for supply of the copies of Memorandum and Articles of Association to a
member. Section 40 makes it mandatory to incorporate any changes in the Articles of Association in every
copy of the Articles of Association. Section 82 defines the nature of shares and states that the shares or
other interests of any member in a company shall be movable property transferable in the manner provided
by the Articles of Association of the company.
These provisions of the Act make it clear that the Articles of Association are the regulations of the company
binding on the company and its shareholders and that the shares are a movable property and their transfer
is regulated by the Articles of Association of the company.
Whether under the Companies Act or Transfer of Property Act, the shares are, therefore, transferable like
any other movable property. The only restriction on the transfer of the shares of a company is as laid down
in its Articles, if any. A restriction which is not specified in the Articles is, therefore, not binding either on
the company or on the shareholders. The vendee of the shares cannot be denied the registration of the shares
purchased by him on a ground other than that stated in the Articles.
We may refer to certain authorities which reinforce the above proposition.
In S.P. Jain v. Kalinga Tubes Ltd. , it was also a case of a battle between two groups of shareholders led by
P & L as they were named in the decision. In July 1954 these two groups who held an equal number of
shares of the value of Rs. 21 lakhs, out of a total share capital of Rs. 25 lakhs, in the company which was
then a private company, entered into an agreement with the appellant who was a third party and certain
terms were agreed to. Various resolutions were passed by the company to implement the agreement.
However, neither the Articles of Association were changed to embody the terms of the agreement nor the
resolutions passed referred to the agreement. In 1956-57, the company desired to raise a loan from the
Industrial Finance Corporation and as per the requirement of the Corporation, in January 1957 the company
was converted into a public company and appropriate amendments for the purpose were made in the
Articles. However, even on this occasion, the agreement of July 1954 was not incorporated into the Articles.
Disputes having arisen, the matter reached the Court. The appellant claimed the benefit of the agreement
of July 1954. It was held by this Court that the said agreement was not binding even on the private company
and much less so on the public company when it came into existence in 1957. It was an agreement between
a non-member and two members of the company and although for some time the agreement was in the main
carried out, some of its terms could not be put in the Articles of Association of the public company. As the
company was not bound by the agreement it was not enforceable.
In Re Swaledale Cleaners Ltd. (1968) 1 All ER 1132 it was held that it is well-established that a share in a
company is an item of property freely alienable in the absence of express restrictions under the Articles.
This view is reiterated in Tett v. Phoenix Property and Investment Co. Ltd. and Ors. 1986 2 BCC 99, 140.
In Chapter 16 of Gore-Browne on Companies (43rd Ed.) while dealing with transfer of shares it is stated
that subject to certain limited restrictions imposed by law, a shareholder has prima facie the right to transfer
his shares when and to whom he pleases. This freedom to transfer may, however, be significantly curtailed
by provisions in the Articles. In determining the extent of any restriction on transfer contained in the
Articles, a strict construction is adopted. The restriction must be set out expressly or must arise by necessary
implication and any ambiguous provision is construed in favour of the shareholder wishing to transfer.
In Palmer’s Company law (24th Ed.) dealing with the ‘transfer of shares’ it is stated at page 608-9 that it is
well-settled that unless the Articles otherwise provide the shareholder has a free right to transfer to whom
he will. It is not necessary to seek in the Articles for a power to transfer, for the Act (the English Act of
1980) itself gives such a power. It is only necessary to look to the Articles to ascertain the restrictions, if
any, upon it. Thus a member has a right to transfer his share/shares to another person unless this right is
clearly taken away by the Articles.
In Halsbury’s Laws of England (4th Ed.) para 359 dealing with ‘attributes of shares’ it is stated that “a share
is a right to a specified amount of the share capital of a company carrying with it certain rights and liabilities
while the company is a going concern and in its winding. The shares or other interest of any member in a
company are personal estate transferable in the manner provided by its articles and are not of the nature of
real estate”.
Dealing with ‘restrictions on transfer of shares’ in Penington’s Company Law (6th Ed.) at page 753 it is
stated that shares are presumed to be freely transferable and restrictions on their transfer are construed
strictly and so when a restriction is capable of two meanings, the less restrictive interpretation will be
adopted by the court. It is also made clear that these restrictions have to be embodied in the Articles of
Association.
Against the background of the aforesaid legal position, we may now examine the Articles of Association
of the third defendant-company. It is not disputed before us that the only Article of the Articles of
Association of the company which places restriction on the transfer of shares is Article 13. The Article
reads as follows:
13. No new member shall be admitted except with the consent of the majority of the members on the death
of any member of his heir or heirs or nominee, shall be admitted as member. If such heir, heirs or nominee
is/are unwilling to become a member, such share capital shall be distributed at par among the members
equally or transferred to any new member with the consent of the majority of the members.
The aforesaid Article in effect consists of three parts. The first part states that no new member shall be
admitted except with the consent of the majority of the members. The second part states that on the death
of any member, his heir or heirs or nominee/s shall be admitted as members. The third part states that if
such heir or heirs or nominee/s is/are unwilling to become member/s, the share capital of the deceased
member shall be distributed among the existing members equally or transferred to any new member with
the consent of the majority of the members. It is, therefore, clear that even a new member can be admitted
provided the majority of the members are agreeable to do so. It also appears from the word “nominee” that
a living member has a right to nominate even a third party to succeed to him as a member on his death.
Further the restriction on transfer by way of a right of pre-emption which is incorporated in the third part
of the Article is only in respect of the shareholding of the deceased member and not of a living member.
Whereas the heirs/nominees are as a matter of right entitled to become members if they are willing to do
so, the restriction on the transfer of shares steps in only when they are unwilling to become members. The
restriction states that in the latter event the shares of the deceased member shall be first distributed among
the existing members equally and if they are to be transferred to any new member, it would be done so with
the consent of the majority of the existing members. It may be noticed from this restriction, that firstly there
is no limitation on the transfer of his shares by a living member either to the existing member or to a new
member. The only condition is that when the transfer is made to a new member, it will have to be approved
by the majority of the members. The transfer may be to any existing member whether he belongs to one or
the other branch of the family and in such case there is no need of a consent of the majority of the members.
The Article in fact envisages the distribution of the shareholding of the deceased member (and not of the
living member) equally among the members of both branches of the family and not of any one of the
branches only. Even the shares of the deceased member can be transferred to any new member when his
heirs/nominees are not willing to become members. However, this can be done only with the consent of the
majority of the members.
Hence, the private agreement which is relied upon by the plaintiffs whereunder there is a restriction on a
living member to transfer his shareholding only to the branch of family to which he belongs in terms
imposes two restrictions which are not stipulated in the Article. Firstly, it imposes a restriction on a living
member to transfer the shares only to the existing members and secondly the transfer has to be only to a
member belonging to the same branch of family. The agreement obviously, therefore, imposes additional
restrictions on the member’s right to transfer his shares which are contrary to the provisions of the Article
13. They are, therefore, not binding either on the shareholders or on the company. In view of this legal
position, the finding recorded by the courts below that the sale by the first defendant of his shares to
defendants 4 to 6 is invalid as it is in breach of the agreement, is erroneous in law. In view of our above
finding, it is unnecessary to go into the question whether the High Court was justified in directing the
transfer of shares by defendants 4 to 6 to the plaintiffs even if its finding that the sale was invalid was
correct.
In the circumstances, the appeals are allowed, the decree of the High Court is set aside and the plaintiffs’
suit is dismissed with costs.
Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613
Shareholders’ Agreement ( for short SHA) is essentially a contract between some or all other shareholders
in a company, the purpose of which is to confer rights and impose obligations over and above those provided
by the Company Law. SHA is a private contract between the shareholders compared to Articles of
Association of the Company, which is a public document. Being a private document it binds parties thereof
and not the other remaining shareholders in the company. Advantage of SHA is that it gives greater
flexibility, unlike Articles of Association. It also makes provisions for resolution of any dispute between
the shareholders and also how the future capital contributions have to be made. Provisions of the SHA may
also go contrary to the provisions of the Articles of Association, in that event, naturally provisions of the
Articles of Association would govern and not the provisions made in the SHA.
The nature of SHA was considered by a two Judges Bench of this Court in V. B. Rangaraj v. V. B.
Gopalakrishnan and Ors. (1992) 1 SCC 160. In that case, an agreement was entered into between
shareholders of a private company wherein a restriction was imposed on a living member of the company
to transfer his shares only to a member of his own branch of the family, such restrictions were, however,
not envisaged or provided for within the Articles of Association. This Court has taken the view that
provisions of the Shareholders’ Agreement imposing restrictions even when consistent with Company
legislation, are to be authorized only when they are incorporated in the Articles of Association, a view we
do not subscribe. This Court in Gherulal Parekh v. Mahadeo Das Maiya (1959) SCR Supp (2) 406 held that
freedom of contract can be restricted by law only in cases where it is for some good for the community.
Companies Act 1956 or the FERA 1973, RBI Regulation or the I.T. Act do not explicitly or impliedly forbid
shareholders of a company to enter into agreements as to how they should exercise voting rights attached
to their shares.
Shareholders can enter into any agreement in the best interest of the company, but the only thing is that the
provisions in the SHA shall not go contrary to the Articles of Association. The essential purpose of the
SHA is to make provisions for proper and effective internal management of the company. It can visualize
the best interest of the company on diverse issues and can also find different ways not only for the best
interest of the shareholders, but also for the company as a whole. In S. P. Jain v. Kalinga Cables Ltd. (1965)
2 SCR 720, this Court held that agreements between non-members and members of the Company will not
bind the company, but there is nothing unlawful in entering into agreement for transferring of shares. Of
course, the manner in which such agreements are to be enforced in the case of breach is given in the general
law between the company and the shareholders. A breach of SHA which does not breach the Articles of
Association is a valid corporate action but, as we have already indicated, the parties aggrieved can get
remedies under the general law of the land for any breach of that agreement.
SHA also provides for matters such as restriction of transfer of shares i.e. Right of First Refusal (ROFR),
Right of First Offer (ROFO), Drag-Along Rights (DARs) and Tag-Along Rights (TARs), Pre-emption
Rights, Call option, Put option, Subscription option etc. SHA in a characteristic Joint Venture Enterprise
may regulate its affairs on the basis of various provisions enumerated above, because Joint Venture
enterprise may deal with matters regulating the ownership and voting rights of shares in the company,
control and manage the affairs of the company, and also may make provisions for resolution of disputes
between the shareholders. Many of the above mentioned provisions find a place in SHAs, FWAs, Term
Sheet Agreement etc. in the present case, hence, we may refer to some of those provisions.
(a) Right of First Refusal (ROFR): ROFR permits its holders to claim the transfer of the subject of the right
with a unilateral declaration of intent which can either be contractual or legal. No statutory recognition has
been given to that right either in the Indian Company Law or the Income Tax Laws. Some foreign
jurisdictions have made provisions regulating those rights by statutes. Generally, ROFR is contractual and
determined in an agreement. ROFR clauses have contractual restrictions that give the holders the option to
enter into commercial transactions with the owner on the basis of some specific terms before the owner
may enter into the transactions with a third party. Shareholders’ right to transfer the shares is not totally
prevented, yet a shareholder is obliged to offer the shares first to the existing shareholders. Consequently,
the other shareholders will have the privilege over the third parties with regard to purchase of shares.
(b) Tag Along Rights (TARs): TARs, a facet of ROFR, often refer to the power of a minority shareholder
to sell their shares to the prospective buyer at the same price as any other shareholder would propose to
sell. In other words, if one shareholder wants to sell, he can do so only if the purchaser agrees to purchase
the other shareholders, who wish to sell at the same price. TAR often finds a place in the SHA which
protects the interest of the minority shareholders.
(c) Subscription Option: Subscription option gives the beneficiary a right to demand issuance of allotment
of shares of the target company. It is for that reason that a subscription right is normally accompanied by
ancillary provisions including an Exit clause where, if dilution crosses a particular level, the counter parties
are given some kind of Exit option.
(d) Call Option: Call option is an arrangement often seen in Merger and Acquisition projects, especially
when they aim at foreign investment. A Call option is given to a foreign buyer by agreement so that the
foreign buyer is able to enjoy the permitted minimum equity interests of the target company. Call option is
always granted as a right not an obligation, which can be exercised upon satisfaction of certain conditions
and/or within certain period agreed by the grantor and grantee. The buyer of Call option pays for the right,
without the obligation to buy some underlying instrument from the writer of the option contract at a set
future date and at the strike price. Call option is where the beneficiary of the action has a right to compel a
counter-party to transfer his shares at a pre-determined or price fixed in accordance with the pre-determined
maxim or even fair market value which results in a simple transfer of shares.
(e) Put Option: A put option represents the right, but not the requirement to sell a set number of shares of
stock, which one do not yet own, at a pre-determined strike price, before the option reaches the expiration
date. A put option is purchased with the belief that the underlying stock price will drop well before the
strike price, at which point one may choose to exercise the option.
(f) Cash and Cashless Options: Cash and Cashless options are related arrangement to call and put options
creating a route by which the investors could carry out their investment, in the event of an appreciation in
the value of shares.
SHA, therefore, regulate the ownership and voting rights of shares in the company including ROFR, TARs,
DARs, Preemption Rights, Call Options, Put Options, Subscription Option etc. in relation to any shares
issued by the company, restriction of transfer of shares or granting securities interest over shares, provision
for minority protection, lock-down or for the interest of the shareholders and the company.
Provisions referred to above, which find place in a SHA, may regulate the rights between the parties which
are purely contractual and those rights will have efficacy only in the course of ownership of shares by the
parties.
World Phone India Pvt. Ltd v. WPI Group Inc USA, (2013) 178 Comp Cas 173
The facts in brief for the purposes of this appeal are that Appellant No.1, WPIPL, is a private company
incorporated on 7th September 1992 under the Act within the jurisdiction of the Registrar of Companies
(‘ROC’), Delhi and Haryana, having its registered office at D-100, IInd Floor, Okhla Industrial Area, Phase-
I, New Delhi-110020. The Respondent, WPIGI holds 43.75% of the total paid up equity share capital of
WPIPL. While Mr. Vivek Dhir, Appellant No.2, holds 43.75% of the equity shares of WPIPL, Mr. Pankaj
Patel held the balance 12.5%. WPIGI is represented by its Chairman, Mr. Aditya Ahluwalia.
There was a meeting to be held to consider the proposal to go in for a rights issue of 1,49,303 equity shares
of the company having a face value of Rs.100 each and offering them to the existing shareholders in 1:1
ratio. It is alleged that the agenda for the Board meeting was sent without giving any details of financial
projections and how the figure of 1,49,303 equity shares was arrived at.
It is not in dispute that there was a joint venture agreement (‘JVA’) dated 1st May 1999 entered into between
the parties, in terms of which Mr. Aditya Ahluwalia had an affirmative vote in matters relating to the
company. It was under the same JVA that the shareholding pattern of Mr. Vivek Dhir, WPIGI and Mr.
Pankaj Patel was decided. Despite Clause 6.2 of the JVA giving an affirmative vote to Mr. Aditya Ahluwalia
at the Board meeting held on 31st October 2012 the resolution for approving the rights issue as proposed
was approved without his being present and voting. This according to him, therefore, severely prejudiced
his rights.
One of the questions that was considered by the CLB in CA No. 566 of 2012 was whether Clause 6.2
incorporated in the JVA could ipso facto bind the company inasmuch as there was no corresponding
amendment to the articles of association (‘AoA’) of the company. The question framed by the CLB, as is
evident from the impugned order dated 15th November 2012 was whether the approval of WPIGI was
required to raise equity for the company and whether Mr. Ahluwalia had sufficient time to examine issues
since at the relevant time he was in New Jersey (USA) which was hit by a hurricane.
The findings of the CLB in the impugned order were that since the company was a private one and not
covered by Sections 81 to 89 and 171 to 176 of the Act, it had the liberty to carve out the rules which were
not repugnant to the other provisions of the Act. The company was governed by the AOA as to its internal
management. Therefore, any agreement entered into amongst the shareholders “is not binding to the extent
repugnant to the AOA of the company.” The CLB further proceeded to hold that Section 9 of the Act which
stated that the Act prevailed over both the Memorandum of Association (‘MoA’) and AoA, was not
applicable to a private company like Appellant No.1. It was further held that the terms and conditions in
the JVA were not inconsistent with the AoA, nor were they explicitly barred under the AoA. The cases
cited by the Appellants were distinguished by the CLB on the ground that they did not relate to instances
involving a JVA.
The CLB held that, in the present case, since there were only three shareholders and all of them were also
Directors, the holding of the Board meeting in the absence of a party who had an affirmative vote was in
violation of the JVA. Consequently, the Board meeting of 31st October 2012 was held null and void and a
direction was issued to hold a fresh Board meeting over the rights issue in compliance with Clause 6.2 of
the JVA.
The first question that arises for consideration is whether the CLB was justified in holding that since there
was no bar to the affirmative vote in the AoA of the company, Clause 6.2 of the JVA which provides for
the affirmative vote must be given effect to. This, in turn, requires the interpretation of Section 9 of the Act
which the CLB has understood as not being applicable to private companies.
Section 9 of the Act reads as under:
“9. Act to override memorandum, articles, etc. - Save as otherwise expressly provided in the Act--
(a) the provisions of this Act shall have effect notwithstanding anything to the contrary contained
in the memorandum or articles of a company, or in any agreement executed by it, or in any
resolution passed by the company in general meeting or by its Board of directors, whether the same
be registered, executed or passed, as the case may be, before or after the commencement of this
Act; and
(b) any provision contained in the memorandum, articles, agreement or resolution aforesaid shall,
to the extent to which it is repugnant to the provisions of this Act, become or be void, as the case
may be.”
14. While Sections 81 to 89 and 171 to 186 of the Act insofar as they relate to issuance of shares do not
apply to private companies, there is no basis for concluding that Section 9 of the Act per se does not apply
to private companies. A plain reading of Section 9 makes no such exception. The following features of
Section 9 are required to be noted:
(a) The very title to the provision makes it clear that it has an overriding effect over the MoA and AoA of
the company.
(b) Section 9 is subject to other provisions of the Act which may provide to the contrary. At the same time,
Section 9(a) makes it clear that the Act would have effect notwithstanding anything to the contrary in the
MoA or the AOA of the company, “or any agreement executed by it or the resolution passed by the company
in general meeting or by its board of directors.”
(c) Section 9 (a) makes no distinction between agreements entered into by the company itself or agreements
entered into between the directors or shareholders of the company. Section 9 makes no distinction between
a public company and a private company.
(d) Section 9 (b) clearly states that if any provision in the MoA, AoA, agreement or resolution “is repugnant
to the provisions of the Act”, such provision in the MoA/AoA would be void. This further underscores the
overriding effect of the provisions of the Act.
The legal position is that where the AoA is silent on the existence of an affirmative vote, it will not be
possible to hold that a clause in an agreement between the shareholders would be binding without being
incorporated in the AoA. The question to be asked is whether the provisions of an agreement, that are not
inconsistent with the Act, but are also not part of the AoA, can be said to be applicable. All that Section 9
states is that clauses in the agreement that are ‘repugnant’ to the Act shall be ‘void’. This does not mean
that clauses in the agreement which are not repugnant to the Act would be enforceable, notwithstanding
that they are not incorporated in the AoA.
Mr. Virender Ganda, learned Senior counsel for the Respondent, has placed extensive reliance on the
decision of the Supreme Court in Reliance Natural Resources Limited v. Reliance Industries Limited (2010)
7 SCC 1 (hereinafter referred to as the ‘RNRL case’) and, in particular, the observations made in paras 56
and 59 thereof. In the said case, a submission was made on behalf of RNRL that, in terms of the ‘doctrine
of identification’, Reliance Industries Limited (‘RIL’) was identified by “such of its key personnel through
whom it works”, and that in that case, the key persons were Smt. Kokilaben Ambani, Mr. Mukesh Ambani
and Mr. Anil Ambani, who had entered into a family arrangement which was reduced in writing in the form
of a Memorandum of Understanding (‘MoU’). The submission was that in terms of the said doctrine of
identification, the actions of the key personnel should be taken to be the actions of the company itself. Mr.
Ganda has submitted that in the present case, the JVA was in the nature of an agreement between the key
personnel of the Appellant No.1 company and since their actions were taken to be the actions of the
company itself, Clause 6.2 which provided for an affirmative vote should be taken to be applicable and
enforceable notwithstanding the fact that no amendment was made to the AoA to incorporate such an
affirmative vote of WPIGI.
The above submission overlooks the fact that even in the RNRL case, the Supreme Court was not prepared
to treat the MoU as binding. It was emphasised that the company in that case, i.e., Reliance Industries
Limited was ‘separate’ from the key personnel. The observations made in para 58 of the said judgment that
the doctrine of identification “may be applicable only in respect of small undertakings” does not mean that
irrespective of the facts of the case, it would be applicable to all small undertakings.
The ratio of the decision in the RNRL case must be understood by the conclusions in para 125 of the
judgment, which reads as under:
“125. The MoU was signed as a private family arrangement or understanding between the two
brothers, Mukesh and Anil Ambani, and their mother. Contents of the MoU were not made public,
and even in the present proceedings, they were revealed in parts. Clearly, the MoU does not fall
under the corporate domain - it was neither approved by the shareholders, nor was it attached to the
scheme. Therefore, technically, the MoU is not legally binding. Nevertheless, cognizance can be
taken of the fact that the MoU formed the backdrop of the scheme and therefore, contents of the
scheme have to be interpreted in the light of the MoU.”
19. The offshoot of the above discussion is that the JVA in the present case cannot be said to bind the
company as such. What the company can do has to be ascertained with reference to the AoA. In the present
case, although the JVA was entered into in 1999 itself, there was no move made by Mr. Aditya Ahluwalia
or WPIGI to have the AoA amended at any point in time to incorporate the affirmative vote provided to
WPIGI under Clause 6.2 of the JVA. Nothing prevented WPIGI from doing so. Unless the AoA was actually
amended, WPIGI could not insist on exercise of the affirmative vote. This law has been clearly explained
by the Supreme Court in V.B. Rangaraj v. V.B. Gopalakrishnan AIR 1992 SC 453. Referring to the decision
in S.P. Jain v. Kalinga Tubes Ltd. [1965] 2 SCR 720, the Supreme Court observed:
“it was also a case of a battle between two groups of shareholders led by P & L as they were named
in the decision. In July 1954 these two groups who held an equal number of shares of the value of
Rs. 21 lakhs, out of a total share capital of Rs. 25 lakhs, in the company which was then a private
company, entered into an agreement with the appellant who was a third party and certain terms
were agreed to. Various resolutions were passed by the company to implement the agreement.
However, neither the Articles of Association were changed to embody the terms of the agreement
nor the resolutions passed referred to the agreement. In 1956-57, the company desired to raise a
loan from the Industrial Finance Corporation and as per the requirement of the Corporation, in
January 1957 the company was converted into a public company and appropriate amendments for
the purpose were made in the Articles. However, even on this occasion, the agreement of July 1954
was not incorporated into the Articles. Disputes having arisen, the matter reached the Court. The
appellant claimed the benefit of the agreement of July 1954. It was held by this Court that the said
agreement was not binding even on the private company and much less so on the public company
when it came into existence in 1957. It was an agreement between a non-member and two members
of the company and although for some time the agreement was in the main carried out, some of its
terms could not be put in the Articles of Association of the public company. As the company was
not bound by the agreement it was not enforceable.”
The appeal is disposed of in the above terms, but in the circumstances, with no order as to costs.
MODULE IV - SHARE CAPITAL AND SHAREHOLDERS

Pre-incorporation contracts
Kelner v. Baxter, (1866) LR 2 CP 174
The promoters of a hotel company entered into a contract on its behalf for the purchase of wine. When the
company formally came into existence it ratified the contract. The wine was consumed but before payment
was made the company went into liquidation. The promoters, as agents, were sued on the contract. They
argued that liability under the contract had passed, by ratification, to the company. It was held, however,
that as the company did not exist at the time of the agreement it would be wholly inoperative unless it was
binding on the promoters personally and a stranger cannot by subsequent ratification relieve them from that
responsibility.
On the other hand, a promoter can avoid personal liability if the company, after incorporation, and the third
party substitutes the original pre-incorporation contract with a new contract on similar terms. Novation, as
this is called, may also be inferred by the conduct of the parties such as where the terms of the original
agreement are changed.
A promoter can also avoid personal liability on a contract where he signs the agreement merely to confirm
the signature of the company because in so doing he has not held himself out as either agent or principal.
The signature and the contractual document will be a complete nullity because the company was not in
existence
Specific Relief Act

Section 15 of the Specific Relief Act - Except as otherwise provided by this Chapter, the specific
performance of a contract may be obtained by the company when the promoters of a company have, before
its incorporation, entered into a contract for the purposes of the company, and such contract is warranted
by the terms of the incorporation
Section 19 of the Specific Relief Act - specific performance of a contract may be enforced against a
company when the promoters of a company have, before its incorporation, entered into a contract for the
purpose of the company and such contract is warranted by the terms of the incorporation - PROVIDED
THAT the company has accepted the contract and communicated such acceptance to the other party to the
contract
What is a share?
Section 2(84) - “share” means a share in the share capital of a company and includes stock;
Borland's Trustee -v- Steel Brothers & Co Ltd [1901] 1 Ch 279 1901
Mr Borland was a shareholder. The company's articles contained pre-emption rights, such that on a
shareholder's bankruptcy, he had, on receiving a transfer notice from the directors, to transfer his shares to
a manager or assistant at a fair value calculated in accordance with the articles. His trustee said that the
transfer articles were void because, among other reasons, they amounted to a fraud upon the bankruptcy
laws, and could not prevail when bankruptcy had supervened, since the trustee was forced to part with the
shares at less than their true value, and the asset was not fully available for creditors. Held: Farwell J said:
"a simple stipulation that upon a man's becoming bankrupt that which was his property up to the date of the
bankruptcy should go over to some one else and be taken away from his creditors, is void as being a
violation of the policy of the bankrupt law". It was a commercial arrangement, and the provisions were
were a fair agreement for the business of the company. They were binding equally on all shareholders.
There was no suggestion of fraudulent preference, and nothing obnoxious to the bankruptcy law in a clause
which provided that if a man became bankrupt he should sell his shares. The price was a fixed sum for all
persons alike, and no difference in price arose in the case of bankruptcy. The purpose was that there should
be in the company, if it were so desired, none but managers and workers in Burma. There was nothing
repugnant in the way in which the value of the shares was to be ascertained. It would have been different if
there were any provision in the articles compelling persons to sell their shares in the event of bankruptcy at
something less than the price that they would have otherwise obtained, since such a provision would be
repugnant to the bankruptcy law
He described the nature of a company share: "It is the interest of a person in the company, that interest
being composed of rights and obligations which are defined by the Companies Act and by the memorandum
and articles of association of the company." and one with limited liability in a company: "A share is the
interest of the shareholder in the company measured by a sum of money, for the purpose of liability in the
first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by
all the shareholders inter se in accordance with section 16 of the Companies Act 1862. The contract
contained in the articles of association is one of the original incidents of the share. A share is an interest
measured by a sum of money and made up of various rights contained in the contract, including the right
to a sum of money of a more or less amount."
Types of share capital
43. Kinds of share capital-
The share capital of a company limited by shares shall be of two kinds, namely:—
(a) equity share capital—
(i) with voting rights; or
(ii) with differential rights as to dividend, voting or otherwise in accordance with such rules as may be
prescribed; and
(b) preference share capital:
Provided that nothing contained in this Act shall affect the rights of the preference shareholders who are
entitled to participate in the proceeds of winding up before the commencement of this Act.
Explanation.—For the purposes of this section,—

(i) ‘‘equity share capital’’, with reference to any company limited by shares, means all share capital which
is not preference share capital;
(ii) ‘‘preference share capital’’, with reference to any company limited by shares, means that part of the
issued share capital of the company which carries or would carry a preferential right with respect to—
(a) payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may either
be free of or subject to income-tax; and
(b) repayment, in the case of a winding up or repayment of capital, of the amount of the share capital paid-
up or deemed to have been paid-up, whether or not, there is a preferential right to the payment of any fixed
premium or premium on any fixed scale, specified in the memorandum or articles of the company;
(iii) capital shall be deemed to be preference capital, notwithstanding that it is entitled to either or both of
the following rights, namely:—
(a) that in respect of dividends, in addition to the preferential rights to the amounts specified in sub-clause
(a) of clause (ii), it has a right to participate, whether fully or to a limited extent, with capital not entitled to
the preferential right aforesaid;
(b) that in respect of capital, in addition to the preferential right to the repayment, on a winding up, of the
amounts specified in sub-clause (b) of clause
( ii), it has a right to participate, whether fully or to a limited extent, with capital not entitled to that
preferential right in any surplus which may remain after the entire capital has been repaid.
44. The shares or debentures or other interest of any member in a company shall be movable property
transferable in the manner provided by the articles of the company.
45. Every share in a company having a share capital shall be distinguished by its distinctive number:
Provided that nothing in this section shall apply to a share held by a person whose name is entered as holder
of beneficial interest in such share in the records of a depository.
46. (1) A certificate, issued under the common seal of the company, specifying the shares held by any
person, shall be prima facie evidence of the title of the person to such shares.
(2) A duplicate certificate of shares may be issued, if such certificate —
(a) is proved to have been lost or destroyed; or
(b) has been defaced, mutilated or torn and is surrendered to the company.
(3) Notwithstanding anything contained in the articles of a company, the manner of issue of a certificate of
shares or the duplicate thereof, the form of such certificate, the particulars to be entered in the register of
members and other matters shall be such as may be prescribed.
(4) Where a share is held in depository form, the record of the depository is the prima facie evidence of the
interest of the beneficial owner.
(5) If a company with intent to defraud issues a duplicate certificate of shares, the company shall be
punishable with fine which shall not be less than five times the face value of the shares involved in the issue
of the duplicate certificate but which may extend to ten times the face value of such shares or rupees ten
crores whichever is higher and every officer of the company who is in default shall be liable for action
under section 447.
47. (1) Subject to the provisions of section 43 and sub-section (2) of section 50,—
(a) every member of a company limited by shares and holding equity share capital therein, shall have a
right to vote on every resolution placed before the company; and
(b) his voting right on a poll shall be in proportion to his share in the paid-up equity share capital of the
company.
(2) Every member of a company limited by shares and holding any preference share capital therein shall,
in respect of such capital, have a right to vote only on resolutions placed before the company which directly
affect the rights attached to his preference shares and, any resolution for the winding up of the company or
for the repayment or reduction of its equity or preference share capital and his voting right on a poll shall
be in proportion to his share in the paid-up preference share capital of the company:
Provided that the proportion of the voting rights of equity shareholders to the voting rights of the preference
shareholders shall be in the same proportion as the paid-up capital in respect of the equity shares bears to
the paid-up capital in respect of the preference shares:
Provided further that where the dividend in respect of a class of preference shares has not been paid for a
period of two years or more, such class of preference shareholders shall have a right to vote on all the
resolutions placed before the company.
Who is a shareholder; who is a promoter?
Section 2(55) “member”, in relation to a company, means—

(i) the subscriber to the memorandum of the company who shall be deemed to have agreed to become
member of the company, and on its registration, shall be entered as member in its register of members;
(ii) every other person who agrees in writing to become a member of the company and whose name is
entered in the register of members of the company;
(iii) every person holding shares of the company and whose name is entered as a beneficial owner in the
records of a depository;
Section 2(69) “promoter” means a person—

(a) who has been named as such in a prospectus or is identified by the company in the annual return referred
to in section 92; or
(b) who has control over the affairs of the company, directly or indirectly whether as a shareholder, director
or otherwise; or
(c) in accordance with whose advice, directions or instructions the Board of Directors of the company is
accustomed to act:
Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional
capacity;
Shareholders meetings
Section 96. Annual general meeting.

(1) Every company other than a One Person Company shall in each year hold in addition to any other
meetings, a general meeting as its annual general meeting and shall specify the meeting as such in the
notices calling it, and not more than fifteen months shall elapse between the date of one annual general
meeting of a company and that of the next:
Provided that in case of the first annual general meeting, it shall be held within a period of nine months
from the date of closing of the first financial year of the company and in any other case, within a period of
six months, from the date of closing of the financial year:
Provided further that if a company holds its first annual general meeting as aforesaid, it shall not be
necessary for the company to hold any annual general meeting in the year of its incorporation:
Provided also that the Registrar may, for any special reason, extend the time within which any annual
general meeting, other than the first annual general meeting, shall be held, by a period not exceeding three
months.
(2) Every annual general meeting shall be called during business hours, that is, between 9 a.m. and 6 p.m.
on any day that is not a National Holiday and shall be held either at the registered office of the company or
at some other place within the city, town or village in which the registered office of the company is situate:
Provided that the Central Government may exempt any company from the provisions of this sub-section
subject to such conditions as it may impose.
Explanation.—For the purposes of this sub-section, “National Holiday” means and includes a day declared
as National Holiday by the Central Government.
Section 100. Calling of extraordinary general meeting

(1) The Board may, whenever it deems fit, call an extraordinary general meeting of the company.
(2) The Board shall, at the requisition made by,—
(a) in the case of a company having a share capital, such number of members who hold, on the date of the
receipt of the requisition, not less than one-tenth of such of the paid-up share capital of the company as on
that date carries the right of voting;
(b) in the case of a company not having a share capital, such number of members who have, on the date of
receipt of the requisition, not less than one-tenth of the total voting power of all the members having on the
said date a right to vote, call an extraordinary general meeting of the company within the period specified
in subsection (4).
(3) The requisition made under sub-section (2) shall set out the matters for the consideration of which the
meeting is to be called and shall be signed by the requisitionists and sent to the registered office of the
company.
(4) If the Board does not, within twenty-one days from the date of receipt of a valid requisition in regard to
any matter, proceed to call a meeting for the consideration of that matter on a day not later than forty-five
days from the date of receipt of such requisition, the meeting may be called and held by the requisitonists
themselves within a period of three months from the date of the requisition.
(5) A meeting under sub-section (4) by the requisitionists shall be called and held in the same manner in
which the meeting is called and held by the Board.
(6) Any reasonable expenses incurred by the requisitionists in calling a meeting under sub-section (4) shall
be reimbursed to the requisitionists by the company and the sums so paid shall be deducted from any fee or
other remuneration under section 197 payable to such of the directors who were in default in calling the
meeting.
LIC of India v. Escorts Ltd. [1986] 59 Comp Cas 548
With a view to earn foreign exchange by attracting non-resident individuals of Indian nationality or origin
to invest in shares of Indian companies, the Government of India decided to provide incentives to such
individuals and formulated a "Portfolio Investment Scheme". This scheme was announced by the
Government on 27.2.1982 was incorporated in Circular No.9 dated 14.4.1982 of the Reserve Bank of India
issued under section 73(3) of the Foreign Exchange Regulation Act.
Paragraph 4(a) thereof provides that under the liberalized policy non-residents of Indian nationality or
origin will be permitted to make portfolio investment in shares quoted on stock exchanges in India with full
benefits of repatriation of capital invested and income earned subject to provisos therein. This was followed
by further circulars No. 10 dated 22.4.1982, No.15 dated 25.8.1982, No.27 dated 10.12.82, No.12 dated
16.5.1983 and No.18 dt. 19.9.83.
The net result of all the circulars was that non-resident individuals of Indian nationality/origin as well as
overseas companies, partnership firms, societies, trusts and other corporate bodies which were owned by
or in which the beneficial interest vested in non-resident individuals of Indian nationality/origin to the extent
of not less than 60 per cent were entitled to invest, on a repatriation basis, in the shares of Indian companies
to the extent of one per cent of the paid up equity capital of such Indian company provided that the aggregate
of such portfolio investment did not exceed the ceiling of 5 per cent. It was immaterial whether the
investment was made directly or indirectly. What was essential was that 60 per cent of the ownership or the
beneficial interest should be in the hands of non-resident individuals of Indian nationality/origin. Though a
limit of one per cent was imposed on the acquisition of shares by each investor there was no restriction on
the acquisition of shares to the extent of one per cent separately by each individual member of the same
family or by each individual company of the same family (group) of companies.
Desiring to take advantage of the Non-Resident Portfolio Investment Scheme and to invest in the shares of
Escorts Ltd., (an Indian company), thirteen overseas companies, twelve out of whose shares was owned
100% and the thirteenth out of whose shares was owned 98 per cent by Caparo Group Ltd., designated the
Punjab National Bank as their banker (authorised dealer) and M/s. Raja Ram Bhasin & Co. as their broker
for the purpose of such investment.
Their designated bankers M/s Punjab National Bank E.C.E. Branch informed the Reserve Bank of India
through their letter dated 4.3.1983 that according to OAC & RPC forms received the Caparo group of
companies were incorporated in England and that 61.6 per cent of the shares thereof are held by the Swaraj
Paul Family Trust, one hundred per cent of whose beneficiaries are one Swaraj Paul and the members of
his family, all non-resident individuals of Indian origin and requested the Reserve Bank to accord their
approval for opening Non-Resident External Accounts in the name of each of thirteen companies for the
purpose of "conducting investment operations in India" through the agency of Raja Ram Bhasin and Co.
Stock Investment Adviser and member of the Delhi Stock & Share Department Delhi. It was mentioned in
the letters to the Reserve Bank that the proposed accounts would be "effected" by remittances from abroad
through normal banking channels and credits and debits would be allowed only in terms of the scheme
contained in the scheme for investment by non-residents.
Though a remittance of $1,30,000 equivalent to Rs.19,63,000 made by Mr. Swaraj Paul to the Punjab
National Bank, Parliament Street Branch on 28.1.1983 for the purpose of opening on N.R.E. account in the
name of Swaraj Paul, his bankers advised the Reserve Bank that only four remittances had been received
from Caparo Group Ltd. the holding company on 9.3.83, 12.4.83, 13.4.83 and 23.3.83, of amounts
equivalent to Rs.1,35,36,000, Rs.2,36,59,000, Rs.76,35,000 and Rs.1,31,38,681.13p.
In the meanwhile, on 31.5.83, Punjab National Bank wrote to Escorts Ltd. informing them that the thirteen
companies had been making investments in shares of Escorts Ltd. in terms of the scheme for Investment
by overseas corporate bodies predominantly owned by non- residents of Indian nationality/origin to an
extent of at least 60% and that the thirteen overseas companies had designated them as their banker and
M/s Raja Ram Bhasin & Co. as their brokers for the purpose of investment.
Escorts Ltd., sought detailed information from Punjab National Bank and the brokers about the names of
investors and also whether the Reserve Bank of India had accorded permission to them. As there was no
response from either of them, Escorts Ltd. constituted a committee to look into the question of transfer of
shares in their books and according to its recommendations the Board of Directors passed a resolution
refusing to register the transfer of shares.
Escorts Ltd., although they had already refused to register the transfer of shares, wrote to the Punjab
National Bank for information on several points as they desired to make a representations to the Reserve
Bank of India, intervene and assist in the inquiry being conducted by the Reserve Bank at the behest of the
Government of India. They also wrote several letters to the Reserve Bank purporting to give information
regarding various irregularities committed in the purchase of shares of their company by the thirteen foreign
companies, suppressing the fact that they have refused to register the transfer of shares in their favour.
In accordance with the clarificatory letter dated 17.9.83 from the Government of India, its Press Release
of the same date and its circular No. 18 dated 19.9.83, the Reserve Bank, by a telex message conveyed to
the Punjab National Bank their permission to release the money remitted by Caparo Group Ltd. from abroad
for making payment against the shares of DCM and Escorts Ltd. Subsequent to the grant of permission by
the Reserve Bank of India, another attempt was made to have the transfer of shares registered. The request
was turned down once again by Escorts Ltd. who by their letter dated 13.10.83 stated that apart from the
question of obtaining the permission of the Reserve Bank of India, the decision of the Board to refuse to
register the shares was based on other grounds which contained to be valid. Respondent No.19, therefore,
preferred an appeal to the Central Government under section 111(3) of the Companies Act.
Escorts Ltd. alleging undue pressure from the financial institutions like ICICI, IFC, LIC, IDBI and UTI for
the registration of the transfer of shares and explaining the circumstances and instances commencing from
the meeting held on 18.10.83 onwards upto 29.12.83, filed Writ Petition No.3068/83 on 29.12.83 under
Article 226 of the Constitution challenging the validity of Circular No.18 dated 19.9.83 and the Press
Release of the same date as arbitrary and violative of not only Articles 14, 19(1)(c) and 19(1)(g) of the
Constitution, but also the provisions of Foreign Exchange Regulations, the provisions of Securities Contract
Regulation Act etc.
Subsequent to the filing of the Writ Petition the Life Insurance Corporation of India who along with other
financial institutions held as many as 52% of the total number of shares in the company, issued a requisition
dated 11.2.84 to the company to hold an extra ordinary general meeting for the purpose of removing nine
of the part-time Directors of the company and for nominating nine others in their place. Alleging that the
action of the Life Insurance Corporation of India was malafide and part of a concerted action by the Union
of India, the Reserve Bank of India and the Caparo Group Ltd. to coerce the company to register the transfer
of shares and to withdraw the Writ Petition, the Writ Petitioners sought to suitably amend the Writ Petition
and to add prayers (ia), (ib), (ic) and (id) to declare the requisition to hold the meeting arbitrary, illegal,
ultra vires etc. The writ petition was amended. Paragraphs 149A(1) to (44) were added as also prayers (ia),
(ib), (ic) and (id).
The High Court of Bombay allowed the writ petition and granted reliefs in favour of Escorts Ltd. Aggrieved
by the said judgment and decree the Life Insurance Corporation of India has come in appeal, and cross-
appeals have been filed by Escorts Ltd. and Mr. Nanda, the Managing Director of Escorts.
Allowing CA 4598/84 filed by the Life Insurance Corporation of India, Union of India and the Reserve
Bank of India and dismissing the cross appeals No.497-499/85 filed by Escorts Ltd. and Nanda, the Court
HELD : 1.1 The action of the Life Insurance Corporation of India in issuing the requisition notice dated
11.2.84 to hold an extra ordinary general meeting of the Escorts Company Ltd. for the purpose of removing
nine of the part time Directors of the company and for nominating nine others in their place is neither
contrary to the provisions of section 284 of the Companies Act, 1956 nor ultra vires the powers vested in
the Life Insurance Corporation under section 6 of the Life Insurance Corporation of India Act.
The notice does not offend the principle of natural justice. The said action of the L.I.C. cannot be said to be
arbitrary and malafide and taken for collateral purpose or violative of Article 14 of the Constitution of India.
1.2 A company is, in some respects, an institution like a State functioning under its "basic constitution"
consisting of the Companies Act and the Memorandum of Association. "The members in general meeting"
and the directorate are the two primary organs of a company comparable with the legislative and the
executive organs of a Parliamentary democracy where legislative sovereignty rests with Parliament, while
administration is left to the Executive government, subject to a measure of control by Parliament through
its power to force a change of Government. Like the Government, the Directors will be answerable to the
Parliament constituted by the general meeting. But in practice (again like the government), they will
exercise as much control over the parliament as that exercises over them. Although it would be
constitutionally possible for the company in general meeting to exercise all the powers of the company, it
clearly would not be practicable (except in the case of one or two-man companies) for day to day
administration to be undertaken by such a cumbersome piece of machinery. So the modern practice is to
confer on the Directors the right to exercise all the company's powers except such as the general law
expressly provides must be exercised in general meeting. Of course, powers which are strictly legislative
are not affected by the conferment of powers on the Directors as section 31 of the Companies Act provides
that an alteration of an article would require a special resolution of the company in general meeting. Under
the Company Act, in many ways the position of the Directorate vis-a-vis the company is more powerful
than that the Government vis-a-vis the Parliament. The strict theory of Parliamentary sovereignty would
not apply by analogy to a company since under the Companies Act, there are many powers exercisable by
the Directors with which the members in general meeting cannot interfere. The most they can do is to
dismiss the directorate and appoint others in their place or alter the articles so as to restrict the powers of
the Directors for the future. The only effective way the members in general meeting can exercise their
control over the Directorate in a democratic manner is to alter the Articles of Association so as to restrict
the powers of the Directors for the future or to dismiss the Directorate and appoint others in their place. The
holders of the majority of the stock of a Corporation have the power to appoint, by election, Directors of
their choice and the power to regulate them by a resolution for their removal. This is the essence of corporate
democracy.
In the instant case, the financial institutions which held 52% of the shares of Escorts company had a very
big stake in its working and future and were aggrieved that the management did not even choose to consult
them or inform them that a Writ Petition was proposed to be filed which would launch and involve the
company in difficult and expensive litigation against the Government and the Reserve Bank of India. The
institutions were anxious to withdraw the writ petition and discuss the matter further. As the Management
was not agreeable to this course, the Life Insurance Corporation thought that it had no option but to seek a
removal of the non-Executive Directors so as to enable the new Board to consider the question whether to
reverse the decision to pursue the litigation. Evidently the financial institutions wanted to avoid a
confrontation with the Government and the Reserve Bank and adopt a more conciliatory approach. At the
same time, the resolution of the Life Insurance Corporation did not seek removal of the Executive Directors,
obviously because they did not intend to disturb the management of the company Therefore, the Life
Insurance Corporation of India cannot be said to have acted mala fide in seeking to remove the nine non-
Executive Directors and to replace them by representatives of the financial institutions. No aspersion was
cast against the Directors proposed to be removed. It was the only way by which the policy which had been
adopted by the Board in launching into a litigation could be reconsidered and reversed, if necessary. It was
a wholly democratic process. A minority of shareholders in the saddle of power could not be allowed to
pursue a policy of venturing into a litigation to which the majority of the shareholders were opposed. That
is not how corporate democracy may function.
1.3 Every shareholder of a company has the right, subject to statutorily prescribed procedural and
numerical requirements to call an extra ordinary general meeting in accordance with the provisions of the
Companies Act, 1956. He cannot be restrained from calling a meeting and he is not bound to disclose the
reasons for the resolution proposed to be moved at the meeting. Nor are the reasons for the resolutions
subject to judicial review.
1.4 It is true that under section 173(2) of the Companies Act, there shall be annexed to the notice of the
meeting a statement setting out all material facts concerning each item of business to be transacted at the
meeting, including in particular, the nature of the concern or the interest, if any therein, of every director,
the managing agent, if any, the secretaries and treasures, if any, and the manager if any. That is a duty cast
on the management to disclose, in an explanatory note, all material facts relating to the resolution coming
up before the general meeting to enable the shareholders calling a meeting to disclose the reasons for the
resolutions which they propose to move at the meeting. The Life Insurance Corporation of India, though an
instrumentality of the State, as a shareholder of Escorts Ltd. has the same right as every shareholder to call
an extraordinary general meeting of the company for the purpose of moving a resolution to remove some
Directors and appoint others in their place. The Life Insurance Corporation of India cannot be restrained
from doing so nor is bound to disclose its reasons for moving the resolutions.
1.5 When a requisition is made by a shareholder calling for a general meeting of the company under the
provisions of the companies Act validly to remove a director and appoint another, an injunction cannot be
granted by the Court to restrain the holding of a general meeting.
1.6 Every action of the State or an instrumentality of the State must be informed by reason. In appropriate
cases, actions uninformed by reason may be questioned as arbitrary in proceedings under Article 226 or
Article 32 of the Constitution. But Article 14 cannot be construed as a charter for judicial review of state
action, to call upon the State to account for its actions in its manifold activities by stating reasons for such
actions. If the action of the State is political or sovereign in character, the Court will keep away from it.
The Court will not debate academic matters or concern itself with the intricacies of trade and commerce. If
the action of the State is related to contractual obligations or obligations arising out of tort, the Court may
not ordinarily examine it unless the action has some public law character attracted to it. Broadly speaking
the Court will examine actions of State if they pertain to the public law domain and refrain from examining
them if they pertain to the private law field.
When the State or an instrumentality of the State ventures into the corporate world and purchases shares
of a company it assumes to itself the ordinary role of a shareholder and dons the robes of a shareholder,
with all the rights available to such a shareholder. Therefore, the State as a shareholder should not be
expected to state its reasons when it seeks to change the management by a resolution of the company, like
any other shareholder.
Pre-requisites of a valid meeting

Section 101. Notice of meeting.
(1) A general meeting of a company may be called by giving not less than clear twenty-one days’ notice
either in writing or through electronic mode in such manner as may be prescribed:
Provided that a general meeting may be called after giving a shorter notice if consent is given in writing or
by electronic mode by not less than ninety-five per cent. of the members entitled to vote at such meeting.
(2) Every notice of a meeting shall specify the place, date, day and the hour of the meeting and shall contain
a statement of the business to be transacted at such meeting.
(3) The notice of every meeting of the company shall be given to—
(a) every member of the company, legal representative of any deceased member or the assignee of an
insolvent member;
(b) the auditor or auditors of the company; and
(c) every director of the company.
(4) Any accidental omission to give notice to, or the non-receipt of such notice by, any member or other
person who is entitled to such notice for any meeting shall not invalidate the proceedings of the meeting.
Section 102. Statement to be annexed to notice.
(1) A statement setting out the following material facts concerning each item of special business to be
transacted at a general meeting, shall be annexed to the notice calling such meeting, namely:—
(a) the nature of concern or interest, financial or otherwise, if any, in respect of each items of—
(i) every director and the manager, if any;
(ii) every other key managerial personnel; and
(iii) relatives of the persons mentioned in sub-clauses (i) and (ii);
(b) any other information and facts that may enable members to understand the meaning, scope and
implications of the items of business and to take decision thereon.
(2) For the purposes of sub-section (1),—
(a) in the case of an annual general meeting, all business to be transacted thereat shall be deemed special,
other than—
(i) the consideration of financial statements and the reports of the Board of Directors and auditors;
(ii) the declaration of any dividend;
(iii) the appointment of directors in place of those retiring;
(iv) the appointment of, and the fixing of the remuneration of, the auditors; and
(b) in the case of any other meeting, all business shall be deemed to be special:
Provided that where any item of special business to be transacted at a meeting of the company relates to or
affects any other company, the extent of shareholding interest in that other company of every promoter,
director, manager, if any, and of every other key managerial personnel of the first mentioned company shall,
if the extent of such shareholding is not less than two per cent. of the paid-up share capital of that company,
also be set out in the statement.
(3) Where any item of business refers to any document, which is to be considered at the meeting, the time
and place where such document can be inspected shall be specified in the statement under sub-section (1).
(4) Where as a result of the non-disclosure or insufficient disclosure in any statement referred to in sub-
section (1), being made by a promoter, director, manager, if any, or other key managerial personnel, any
benefit which accrues to such promoter, director, manager or other key managerial personnel or their
relatives, either directly or indirectly, the promoter, director, manager or other key managerial personnel,
as the case may be, shall hold such benefit in trust for the company, and shall, without prejudice to any
other action being taken against him under this Act or under any other law for the time being in force, be
liable to compensate the company to the extent of the benefit received by him.
(5) If any default is made in complying with the provisions of this section, every promoter, director,
manager or other key managerial personnel who is in default shall be punishable with fine which may
extend to fifty thousand rupees or five times the amount of benefit accruing to the promoter, director,
manager or other key managerial personnel or any of his relatives, whichever is more.
Section 103. Quorum for meetings
(1) Unless the articles of the company provide for a larger number,—
(a) in case of a public company,—
(i) five members personally present if the number of members as on the date of meeting is not more than
one thousand;
(ii) fifteen members personally present if the number of members as on the date of meeting is more than
one thousand but up to five thousand;
(iii) thirty members personally present if the number of members as on the date of the meeting exceeds five
thousand;
(b) in the case of a private company, two members personally present, shall be the quorum for a meeting of
the company.
(2) If the quorum is not present within half-an-hour from the time appointed for holding a meeting of the
company—
(a) the meeting shall stand adjourned to the same day in the next week at the same time and place, or to
such other date and such other time and place as the Board may determine; or
(b) the meeting, if called by requisitionists under section 100, shall stand cancelled:
Provided that in case of an adjourned meeting or of a change of day, time or place of meeting under clause
(a), the company shall give not less than three days notice to the members either individually or by
publishing an advertisement in the newspapers (one in English and one in vernacular language) which is in
circulation at the place where the registered office of the company is situated.
(3) If at the adjourned meeting also, a quorum is not present within half-an-hour from the time appointed
for holding meeting, the members present shall be the quorum.
Chandrakant Khare v. Shantaram Kale, (1989) 65 Comp Cas 121 SC
After the election of Members, the first meeting of the Aurangabad Municipal Corporation was held on
May 6, 1983 at 2 P.M. and the Municipal Commissioner announced that the polling for the offices of Mayor,
Deputy Mayor and Members of the standing Committee would commence from 2.30 p.m. onwards. But at
2.30 P.M. some of the Councillors belonging to the Opposition Party sat on the ballot boxes and some
others surrounded the Municipal Commissioner and demanded that the meeting be adjourned to a
subsequent date. The Councillors belonging to the ruling party demanded that the meeting and election be
held later on that day. Total confusion and bedlam prevailed and the rival groups started throwing Chairs
at each other, leading to a pandemonium. It was a free for all, and even outsiders were present. When the
situation was brought under control, the Municipal Commissioner announced that the meeting would
continue and the elections would be held at 4.30 p.m.
The petitioner filed a protest at 4.15 p.m. stating that the meeting had been adjourned by the Municipal
Commissioner for the day and, therefore, the holding of the meeting later on the same day would be
improper and illegal.
Thereafter, the opposition group abstained from participating in the meeting held at 4.30 p.m., in which
Respondents 1 and 2 were declared elected as Mayor and Deputy Mayor respectively and Respondents 3-
8 as Members of the Standing Committee.
In a Writ Petition filed before the High Court, the appellant questioned the election, on the basis that the
meeting in which the election was held, was invalid. The High Court held that the meeting was not
adjourned for the day or sine die, but was only postponed, to be held as soon as peace was restored on the
very day and upheld the election of Respondents 1 to 8. Against the judgment of the High Court, the
petitioner has filed the present special leave petition.
On behalf of the petitioner, it was contended that the meeting was not adjourned to a definite point of time
and must therefore be regarded as adjourned for the day or adjourned sine die.
The contention of the Respondents was that the meeting had not been adjourned sine die but the proceedings
had merely been suspended at 2.45 p.m. and the adjourned meeting held at 4.30 p.m. was a continuation of
the original meeting and no new notice of an adjourned meeting had to be given.
It was also contended that there was no warrant for interference under Art. 136 of the Constitution since a
finding of fact had been reached by the High Court on consideration of the material on record.
Dismissing the petition,
HELD:
1. A properly convened meeting cannot be postponed. The proper course to adopt is to hold the meeting as
originally intended, and then and there adjourn it to a more suitable date. If this course be not adopted,
members will be entitled to ignore the notice of postponement, and, if sufficient to form a quorum, hold the
meeting as originally convened and validly transact the business thereat. Even if the relevant rules do not
give the chairman power to adjourn the meeting, he may do so in the event of disorder. Such an adjournment
must be for no longer than the chairman considers necessary and the chairman must, so far as possible,
communicate his decision to those present.
2.1 In the instant case, the High Court was right in holding that the first meeting of the Municipal
Corporation fixed by the Municipal Commissioner for May 6, 1988 was not 'adjourned for the day' or
'adjourned sine die' but had only been put off to a later hour i.e. the proceedings had only been suspended,
to re-commence when peace and order were restored.
2.2 There is nothing on record to sustantiate the petitioner's submission that the first meeting scheduled to
be held on May 6, 1988 at 2 P.M. was 'adjourned for the day' or 'adjourned sine-die' without transacting
any business i.e. without consideration of the agenda for the day. On the contrary, it is not in dispute that
the business for the day was partly transacted when the Councillors met at 2 p.m. as scheduled and the
Municipal Commissioner declared that the polling would commence from 2.30 p.m. onwards. The trouble
started at 2.30 p.m. when the Councillors belonging to the petitioner's party prevented the casting of votes
by snatching away the ballot boxes from the polling booths and sat upon them. There was a pre-determined
plan on their part not to allow the first meeting to be held on that day. But the Municipal Commissioner did
not give way to the commotion and pandemonium and he did not put off the meeting to another day. In the
prevailing situation, the Municipal Commissioner had no other alternative but to adjourn the meeting.
Under the scheme of the Act, when the term of the elected Councillors is a period of five years which in
terms of sub-section (2) of section 6 of the Act is deemed to commence on the date of the first meeting, the
Municipal Commissioner obviously could not adjourn the meeting for another day or adjourn it sine die. If
the contention that the meeting having been adjourned without specifying a definite point of time were to
prevail, it would give rise to a serious anomaly. The effect of adjourning the first meeting to another day
would imply the coming into existence of another deemed date under s. 6(2) of the Act for commencement
of the term of the Councillors. The fact that the Municipal Commissioner did not leave the House or vacate
the seat lends support to the version that he had merely suspended the proceedings till order was restored.
M.S. Madhusoodan v. Kerela Kaumudi (P.) Ltd. (2003) 46 SCL 695 (SC)
Facts: there were four brothers who owned the family business. There were other family concerns other
than Keralal Kaumudi but the main subject matter of litigation is Kerala Kaumudi which is into publishing
newspaper.
M.S. Madhusoodan is one of the four brothers and the other three (Srinivasan, Ravi and Mani) are against
him. The company had a total share capital of Rs. 20 lakhs divided into 2000 shares of Rs. 1000/- each. The
shareholding was as follows:
Sl. No. Name of shareholder No. of shares

1. Mani 222 shares
2. Valsa Mani (Mani’s Daughter) 84 shares
3. Sukumaran Mani (Mani’s Son) 84 shares
4. Maghusoodhanan 390 shares
5. Srinivasan 390 shares
6. Ravi 390 shares
7. Madhavi 3 shares
8. Sukumaran 9 shares
9. Kaumudi Investments Private Limited 3 shares
10. Total 1575 shares
Sukumaran (sl. No. 8) was the Managing Director and then the chairman from 1973 onwards till his death
in 1981. Madhavi (sl. No. 7) his widow succeeded him as chairman. Madhusoodhanan was appointed as
MD and editor of the company for life. Srinivasan (sl. no. 5) and Ravi (sl. no. 6) were appointed general
manager and director respectively for life. Appropriate articles of AOA were amended to reflect the
changes.
There were various disputes amongst the brothers and hence two agreements were entered into to divide
the business amongst the four brothers. Kerala Kaumudi’s control was to be with Mahusoodhanan.
Later a third agreement (16.1.1986) was entered into between Madhavi (the widow) and the four brothers
for effective control of the family business. According to Madhusoodhanan, Mani and his children had
transferred all their shares to Madhusoodhanan and his children.
After the agreements the shareholding stood as follows:
Sl. No. Name of shareholder No. of shares

1. Madhusoodhanan Child 1 84 shares
2. Madhusoodhanan Child 2 84 shares
3. Madhusoodhanan 612 shares
4. Srinivasan 222 shares
5. Ravi 222 shares
6. Madhavi 3 shares
7. Late Sukumaran 9 shares

8. Anju (Srinivasan’s daughter) 168 shares
9. Deepu (ravi’s son) 168 shares
10. Kaumudi Investments Private Limited (KIPL) 3 shares
11. Total 1575 shares
Later in the month of July and August two board resolutions were passed. In the first resolution ouster of
Maadhusoodhanan was purported and in the second, a resolution allowing issuance of further 425 shares
of Rs. 1000 each was passed. These shares were issued to Ravi and Srinivasan and later Ravi transferred
one share to Mani. Madhusoodhanan disputes both these resolutions passed. On 16th august, 1986 at an
EGM Madhusoodhanan was removed as MD and article 74 of AOA which gave Mdhusoodhanan the
powers was completely deleted.
Issues: Various suits were filed by various parties. They were:
For a declaration that the transfer of 320 shares of Mani and his children to Madhusoodhanan were void
For a declaration that Madhusoodhanan continued to be the MD and that the resolutions and meetings of
July and August were ultra vires the AOA.
Cancellation of 425 additional shares allotted to Ravi and Srinivasan
Single Judge of the HC gave the order in favour of Madhusoodhanan. The division bench of the HC over
turned all the decisions of the single judge and hence, the present appeal is before the SC.
Arguments:
Mani and his children argued that the transfer of shares that had taken place were invalid because there was
no adequate consideration paid, no proper documents were executed and the minor children had no
knowledge about the transfer of shares.
According to Madhusoodhanan the decisions taken in the meetings ousting him from the company and
issue of additional shares were invalid because when these resolutions were passed he was not present at
these meetings because a notice for such meeting was not served to him and according to the charter
documents 75% votes were required to amend the AOA and Madhusoodhanan along with his family and
KIPL held 50% shares of the company. According to the organic documents of the company there are
certain conditions to be fulfilled before the meeting could be held. These conditions were that there should
be atleast 21 days prior notice for holding the meeting stating the intention of the resolution and 75% vote
was required for passing the resolution.
There was no proper delivery of the notice informing Madhusoodhanan of the meeting for issuance of
additional shares. The records kept are also unclear as to whether the sealed envelope delivered to the
assistant of Mdhusoodhanan did in actuality have the notice for the meetings.
Decision:
The share transfer was valid because the minutes of the meeting in which the shares were transferred by
Mani and his children to Madhusoodhanan were signed by Mani. There were resolutions showing that Mani
had resigned from the directorship position. The court held that even though the agreement allowed for the
determination of consideration at a later stage, the intention to transfer can be clearly seen from the minutes
of the meeting. The court also held that section 9 of the Sale of Goods Act also allows for such a transaction.
The transfer of the shares of Mani and family to Madhusoodhanan was also recorded in the company ledger.
There was a notice publication in the newspaper stating the transfer of shares to Madhusoodhanan. There
should be proper documents in place for transfer of the shares and that fixation of a price was not a condition
precedent.
The notice for the meeting did not have the fact that the deletion of article 74 would be considered.
According to section 189(2)(a) of the Act the notice should be sufficiently specific so to inform each
member of the actual resolution to be passed. The notice is to be frank and clear. If not then the notice is
bad and the special resolution is vitiated and cannot be acted upon. Hence deletion of article 74 was wrong
and Madhusoodhanan continues to be the MD of the company. Also according to section 53 of the Act here
are only two methods envisaged of serving the notice which are personal service or service by post. But
neither method was used for informing Madhusoodhanan and KIPL of the meeting.
The notice for the holding of the meeting has not been produced and there is a presumption against
Srinivasan and others. This general rule regarding certificates of posting has not been changed under
Section 53 of the Companies Act. Although it does provide that if a document is sent by post in the manner
specified "service thereof shall be deemed to be effected". The word "deemed" literally means "thought of"
or, in legal parlance "presumed”. This is a rebuttable presumption even though the words used are ‘shall
presume”. There are letters by Madhusoodhanan to Madhavi which prove that he was not aware of the
meeting in which the resolution to issue additional shares were taken. Thus, the additional issuance and
allotment of shares are invalid.
Voting
Section 106. Restriction on voting rights.

(1) Notwithstanding anything contained in this Act, the articles of a company may provide that no member
shall exercise any voting right in respect of any shares registered in his name on which any calls or other
sums presently payable by him have not been paid, or in regard to which the company has exercised any
right of lien. (2) A company shall not, except on the grounds specified in sub-section (1), prohibit any
member from exercising his voting right on any other ground.
(3) On a poll taken at a meeting of a company, a member entitled to more than one vote, or his proxy, where
allowed, or other person entitled to vote for him, as the case may be, need not, if he votes, use all his votes
or cast in the same way all the votes he uses.
Section 107. Voting by show of hands
(1) At any general meeting, a resolution put to the vote of the meeting shall, unless a poll is demanded
under section 109 or the voting is carried out electronically, be decided on a show of hands.
(2) A declaration by the Chairman of the meeting of the passing of a resolution or otherwise by show of
hands under sub-section (1) and an entry to that effect in the books containing the minutes of the meeting
of the company shall be conclusive evidence of the fact of passing of such resolution or otherwise.
Section 108. Voting through electronic means
The Central Government may prescribe the class or classes of companies and manner in which a member
may exercise his right to vote by the electronic means.
Section 109. Demand for poll.

(1) Before or on the declaration of the result of the voting on any resolution on show of hands, a poll may
be ordered to be taken by the Chairman of the meeting on his own motion, and shall be ordered to be taken
by him on a demand made in that behalf,—
(a) in the case a company having a share capital, by the members present in person or by proxy, where
allowed, and having not less than one-tenth of the total voting power or holding shares on which an
aggregate sum of not less than five lakh rupees or such higher amount as may be prescribed has been paid-
up; and
(b) in the case of any other company, by any member or members present in person or by proxy, where
allowed, and having not less than one-tenth of the total voting power.
(2) The demand for a poll may be withdrawn at any time by the persons who made the demand.
(3) A poll demanded for adjournment of the meeting or appointment of Chairman of the meeting shall be
taken forthwith.
(4) A poll demanded on any question other than adjournment of the meeting or appointment of Chairman
shall be taken at such time, not being later than forty-eight hours from the time when the demand was made,
as the Chairman of the meeting may direct.
(5) Where a poll is to be taken, the Chairman of the meeting shall appoint such number of persons, as he
deems necessary, to scrutinise the poll process and votes given on the poll and to report thereon to him in
the manner as may be prescribed.
(6) Subject to the provisions of this section, the Chairman of the meeting shall have power to regulate the
manner in which the poll shall be taken.
(7) The result of the poll shall be deemed to be the decision of the meeting on the resolution on which the
poll was taken.
Section 110. Postal ballot
(1) Notwithstanding anything contained in this Act, a company—
(a) shall, in respect of such items of business as the Central Government may, by notification, declare to be
transacted only by means of postal ballot; and
(b) may, in respect of any item of business, other than ordinary business and any business in respect of
which directors or auditors have a right to be heard at any meeting, transact by means of postal ballot, in
such manner as may be prescribed, instead of transacting such business at a general meeting.
(2) If a resolution is assented to by the requisite majority of the shareholders by means of postal ballot, it
shall be deemed to have been duly passed at a general meeting convened in that behalf.
Section 111. Circulation of members’ resolution
(1) A company shall, on requisition in writing of such number of members, as required in section 100,—
(a) give notice to members of any resolution which may properly be moved and is intended to be moved at
a meeting; and
(b) circulate to members any statement with respect to the matters referred to in proposed resolution or
business to be dealt with at that meeting.
(2) A company shall not be bound under this section to give notice of any resolution or to circulate any
statement unless—
(a) a copy of the requisition signed by the requisitionists (or two or more copies which, between them,
contain the signatures of all the requisitionists) is deposited at the registered office of the company,—
(i) in the case of a requisition requiring notice of a resolution, not less than six weeks before the meeting;
(ii) in the case of any other requisition, not less than two weeks before the meeting; and
(b) there is deposited or tendered with the requisition, a sum reasonably sufficient to meet the company’s
expenses in giving effect thereto:
Provided that if, after a copy of a requisition requiring notice of a resolution has been deposited at the
registered office of the company, an annual general meeting is called on a date within six weeks after the
copy has been deposited, the copy, although not deposited within the time required by this sub-section,
shall be deemed to have been properly deposited for the purposes thereof.
(3) The company shall not be bound to circulate any statement as required by clause (b) of sub-section (1),
if on the application either of the company or of any other person who claims to be aggrieved, the Central
Government, by order, declares that the rights conferred by this section are being abused to secure needless
publicity for defamatory matter.
(4) An order made under sub-section (3) may also direct that the cost incurred by the company by virtue of
this section shall be paid to the company by the requisitionists, notwithstanding that they are not parties to
the application.
(5) If any default is made in complying with the provisions of this section, the company and every officer
of the company who is in default shall be liable to a penalty of twenty-five thousand rupees.
Resolutions and Minutes
Section 114. Ordinary and special resolutions.

(1) A resolution shall be an ordinary resolution if the notice required under this Act has been duly given
and it is required to be passed by the votes cast, whether on a show of hands, or electronically or on a poll,
as the case may be, in favour of the resolution, including the casting vote, if any, of the Chairman, by
members who, being entitled so to do, vote in person, or where proxies are allowed, by proxy or by postal
ballot, exceed the votes, if any, cast against the resolution by members, so entitled and voting.
(2) A resolution shall be a special resolution when—
(a) the intention to propose the resolution as a special resolution has been duly specified in the notice calling
the general meeting or other intimation given to the members of the resolution;
(b) the notice required under this Act has been duly given; and
(c) the votes cast in favour of the resolution, whether on a show of hands, or electronically or on a poll, as
the case may be, by members who, being entitled so to do, vote in person or by proxy or by postal ballot,
are required to be not less than three times the number of the votes, if any, cast against the resolution by
members so entitled and voting.
Section 115. Resolutions requiring special notice
Where, by any provision contained in this Act or in the articles of a company, special notice is required of
any resolution, notice of the intention to move such resolution shall be given to the company by such
number of members holding not less than one per cent. of total voting power or holding shares on which
such aggregate sum not exceeding five lakh rupees, as may be prescribed, has been paid-up and the
company shall give its members notice of the resolution in such manner as may be prescribed.
Section 116. Resolutions passed at adjourned meeting.
Where a resolution is passed at an adjourned meeting of—
(a) a company; or
(b) the holders of any class of shares in a company; or
(c) the Board of Directors of a company,
the resolution shall, for all purposes, be treated as having been passed on the date on which it was in fact
passed, and shall not be deemed to have been passed on any earlier date.
Section 117. Resolutions and agreements to be filed.
(1) A copy of every resolution or any agreement, in respect of matters specified in sub-section (3) together
with the explanatory statement under section 102, if any, annexed to the notice calling the meeting in which
the resolution is proposed, shall be filed with the Registrar within thirty days of the passing or making
thereof in such manner and with such fees as may be prescribed within the time specified under section
403:
Provided that the copy of every resolution which has the effect of altering the articles and the copy of every
agreement referred to in sub-section (3) shall be embodied in or annexed to every copy of the articles issued
after passing of the resolution or making of the agreement.
(2) If a company fails to file the resolution or the agreement under sub-section (1) before the expiry of the
period specified under section 403 with additional fee, the company shall be punishable with fine which
shall not be less than five lakh rupees but which may extend to twenty-five lakh rupees and every officer
of the company who is in default, including liquidator of the company, if any, shall be punishable with fine
which shall not be less than one lakh rupees but which may extend to five lakh rupees.
(3) The provisions of this section shall apply to—
(a) special resolutions;
(b) resolutions which have been agreed to by all the members of a company, but which, if not so agreed to,
would not have been effective for their purpose unless they had been passed as special resolutions;
(c) any resolution of the Board of Directors of a company or agreement executed by a company, relating to
the appointment, re-appointment or renewal of the appointment, or variation of the terms of appointment,
of a managing director;
(d) resolutions or agreements which have been agreed to by any class of members but which, if not so
agreed to, would not have been effective for their purpose unless they had been passed by a specified
majority or otherwise in some particular manner; and all resolutions or agreements which effectively bind
such class of members though not agreed to by all those members;
(e) resolutions passed by a company according consent to the exercise by its Board of Directors of any of
the powers under clause (a) and clause (c) of sub-section (1) of section 180;
(f) resolutions requiring a company to be wound up voluntarily passed in pursuance of section 304;
(g) resolutions passed in pursuance of sub-section (3) of section 179; and
(h) any other resolution or agreement as may be prescribed and placed in the public domain.
Section 118. Minutes of proceedings of general meeting, meeting of Board of Directors and other meeting
and resolutions passed by postal ballot.
(1) Every company shall cause minutes of the proceedings of every general meeting of any class of
shareholders or creditors, and every resolution passed by postal ballot and every meeting of its Board of
Directors or of every committee of the Board, to be prepared and signed in such manner as may be
prescribed and kept within thirty days of the conclusion of every such meeting concerned, or passing of
resolution by postal ballot in books kept for that purpose with their pages consecutively numbered.
(2) The minutes of each meeting shall contain a fair and correct summary of the proceedings thereat.
(3) All appointments made at any of the meetings aforesaid shall be included in the minutes of the meeting.
(4) In the case of a meeting of the Board of Directors or of a committee of the Board, the minutes shall also
contain—
(a) the names of the directors present at the meeting; and
(b) in the case of each resolution passed at the meeting, the names of the directors, if any, dissenting from,
or not concurring with the resolution.
(5) There shall not be included in the minutes, any matter which, in the opinion of the Chairman of the
meeting,—
(a) is or could reasonably be regarded as defamatory of any person; or
(b) is irrelevant or immaterial to the proceedings; or
(c) is detrimental to the interests of the company.
(6) The Chairman shall exercise absolute discretion in regard to the inclusion or non-inclusion of any matter
in the minutes on the grounds specified in sub-section (5).
(7) The minutes kept in accordance with the provisions of this section shall be evidence of the proceedings
recorded therein.
(8) Where the minutes have been kept in accordance with sub-section (1) then, until the contrary is proved,
the meeting shall be deemed to have been duly called and held, and all proceedings thereat to have duly
taken place, and the resolutions passed by postal ballot to have been duly passed and in particular, all
appointments of directors, key managerial personnel, auditors or company secretary in practice, shall be
deemed to be valid.
(9) No document purporting to be a report of the proceedings of any general meeting of a company shall be
circulated or advertised at the expense of the company, unless it includes the matters required by this section
to be contained in the minutes of the proceedings of such meeting.
(10) Every company shall observe secretarial standards with respect to general and Board meetings
specified by the Institute of Company Secretaries of India constituted under section 3 of the Company
Secretaries Act, 1980, and approved as such by the Central Government.
(11) If any default is made in complying with the provisions of this section in respect of any meeting, the
company shall be liable to a penalty of twenty-five thousand rupees and every officer of the company who
is in default shall be liable to a penalty of five thousand rupees.
(12) If a person is found guilty of tampering with the minutes of the proceedings of meeting, he shall be
punishable with imprisonment for a term which may extend to two years and with fine which shall not be
less than twenty-five thousand rupees but which may extend to one lakh rupees.
Dividend as return on investments
Section 123. Declaration of dividend.
(1) No dividend shall be declared or paid by a company for any financial year except—
(a) out of the profits of the company for that year arrived at after providing for depreciation in accordance
with the provisions of sub-section (2), or out of the profits of the company for any previous financial year
or years arrived at after providing for depreciation in accordance with the provisions of that sub-section and
remaining undistributed, or out of both; or
(b) out of money provided by the Central Government or a State Government for the payment of dividend
by the company in pursuance of a guarantee given by that Government:
Provided that a company may, before the declaration of any dividend in any financial year, transfer such
percentage of its profits for that financial year as it may consider appropriate to the reserves of the company:
Provided further that where, owing to inadequacy or absence of profits in any financial year, any company
proposes to declare dividend out of the accumulated profits earned by it in previous years and transferred
by the company to the reserves, such declaration of dividend shall not be made except in accordance with
such rules as may be prescribed in this behalf:
Provided also that no dividend shall be declared or paid by a company from its reserves other than free
reserves.
(2) For the purposes of clause (a) of sub-section (1), depreciation shall be provided in accordance with the
provisions of Schedule II.
(3) The Board of Directors of a company may declare interim dividend during any financial year out of the
surplus in the profit and loss account and out of profits of the financial year in which such interim dividend
is sought to be declared:
Provided that in case the company has incurred loss during the current financial year up to the end of the
quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not
be declared at a rate higher than the average dividends declared by the company during the immediately
preceding three financial years.
(4) The amount of the dividend, including interim dividend, shall be deposited in a scheduled bank in a
separate account within five days from the date of declaration of such dividend.
(5) No dividend shall be paid by a company in respect of any share therein except to the registered
shareholder of such share or to his order or to his banker and shall not be payable except in cash:
Provided that nothing in this sub-section shall be deemed to prohibit the capitalisation of profits or reserves
of a company for the purpose of issuing fully paid-up bonus shares or paying up any amount for the time
being unpaid on any shares held by the members of the company:
Provided further that any dividend payable in cash may be paid by cheque or warrant or in any electronic
mode to the shareholder entitled to the payment of the dividend.
(6) A company which fails to comply with the provisions of sections 73 and 74 shall not, so long as such
failure continues, declare any dividend on its equity shares.
MODULE V – MANAGEMENT AND CORPORATE GOVERNANCE
Agency Problems, Legal Strategies And Enforcement
John Armour, Henry Hansmann, Reinier Kraakman

Discussion Paper No. 644 7/2009 Harvard Law School Cambridge, MA 02138
THREE AGENCY PROBLEMS
As we explained in the preceding Chapter 1 corporate law performs two general functions: first, it
establishes the structure of the corporate form as well as ancillary housekeeping rules necessary to support
this structure; second, it attempts to control conflicts of interest among corporate constituencies, including
those between corporate ‘insiders,’ such as controlling shareholders and top managers, and ‘outsiders,’ such
as minority shareholders or creditors. These conflicts all have the character of what economists refer to as
‘agency problems’ or ‘principal-agent’ problems. For readers unfamiliar with the jargon of economists, an
‘agency problem’—in the most general sense of the term—arises whenever the welfare of one party, termed
the ‘principal’, depends upon actions taken by another party, termed the ‘agent.’
The problem lies in motivating the agent to act in the principal’s interest rather than simply in the agent’s
own interest. Viewed in these broad terms, agency problems arise in a broad range of contexts that go well
beyond those that would formally be classified as agency relationships by lawyers. In particular, almost any
contractual relationship, in which one party (the ‘agent’) promises performance to another (the ‘principal’),
is potentially subject to an agency problem. The core of the difficulty is that, because the agent commonly
has better information than does the principal about the relevant facts, the principal cannot easily assure
himself that the agent’s performance is precisely what was promised. As a consequence, the agent has an
incentive to act opportunistically, skimping on the quality of his performance, or even diverting to himself
some of what was promised to the principal. This means, in turn, that the value of the agent’s performance
to the principal will be reduced, either directly or because, to assure the quality of the agent’s performance,
the principal must engage in costly monitoring of the agent. The greater the complexity of the tasks
undertaken by the agent, and the greater the discretion the agent must be given, the larger these ‘agency
costs’ are likely to be.
Three generic agency problems arise in business firms. The first involves the conflict between the firm’s
owners and its hired managers. Here the owners are the principals and the managers are the agents. The
problem lies in assuring that the managers are responsive to the owners’ interests rather than pursuing their
own personal interests.
The second agency problem involves the conflict between, on one hand, owners who possess the majority
or controlling interest in the firm and, on the other hand, the minority or noncontrolling owners. Here the
noncontrolling owners can be thought of as the principals and the controlling owners as the agents, and the
difficulty lies in assuring that the former are not expropriated by the latter. While this problem is most
conspicuous in tensions between majority and minority shareholders, it appears whenever some subset of
a firm’s owners can control decisions affecting the class of owners as a whole. Thus if minority shareholders
enjoy veto rights in relation to particular decisions, it can give rise to a species of this second agency
problem. Similar problems can arise between ordinary and preference shareholders, and between senior and
junior creditors in bankruptcy (when creditors are the effective owners of the firm).
The third agency problem involves the conflict between the firm itself—including, particularly, its
owners—and the other parties with whom the firm contracts, such as creditors, employees, and customers.
Here the difficulty lies in assuring that the firm, as agent, does not behave opportunistically toward these
various other principals—such as by expropriating creditors, exploiting workers, or misleading consumers.
In each of the foregoing problems, the challenge of assuring agents’ responsiveness is greater where there
are multiple principals—and especially so where they have different interests, or ‘heterogeneous
preferences’ as economists say. Multiple principals will face coordination costs, which will inhibit their
ability to engage in collective action. These in turn will interact with agency problems in two ways. First,
difficulties of coordinating between principals will lead them to delegate more of their decision-making to
agents. Second, the more difficult it is for principals to coordinate on a single set of goals for the agent, the
more obviously difficult it is to ensure that the agent does the ‘right’ thing. Coordination costs as between
principals thereby exacerbate agency problems.
Law can play an important role in reducing agency costs. Obvious examples are rules and procedures that
enhance disclosure by agents or facilitate enforcement actions brought by principals against dishonest or
negligent agents. Paradoxically, mechanisms that impose constraints on agents’ ability to exploit their
principals tend to benefit agents as much as—or even more than—they benefit the principals. The reason
is that a principal will be willing to offer greater compensation to an agent when the principal is assured of
performance that is honest and of high quality. To take a conspicuous example in the corporate context,
rules of law that protect creditors from opportunistic behavior on the part of corporations should reduce the
interest rate that corporations must pay for credit, thus benefiting corporations as well as creditors.
Likewise, legal constraints on the ability of controlling shareholders to expropriate minority shareholders
should increase the price at which shares can be sold to noncontrolling shareholders, hence reducing the
cost of outside equity capital for corporations. And rules of law that inhibit insider trading by corporate
managers should increase the compensation that shareholders are willing to offer the managers.
In general, reducing agency costs is in the interests of all parties to a transaction, principals and agents alike.
It follows that the normative goal of advancing aggregate social welfare, as discussed in Chapter 1,8 is
generally equivalent to searching for optimal solutions to the corporation’s agency problems, in the sense
of finding solutions that maximize the aggregate welfare of the parties involved—that is, of both principals
and agents taken together.
LEGAL STRATEGIES FOR REDUCING AGENCY COSTS
In addressing agency problems, the law turns repeatedly to a basic set of strategies. We use the term ‘legal
strategy’ to mean a generic method of deploying substantive law to mitigate the vulnerability of principals
to the opportunism of their agents. The strategy involved need not necessarily require legal norms for its
implementation. We observed in Chapter 1 that, of the five defining characteristics of the corporate form,
only one—legal personality—clearly requires special rules of law. The other characteristics could, in
principle, be adopted by contract—for example, through appropriate provisions in the articles of association
agreed to by the firm’s owners. The same is true of the various strategies we set out in this section.
Moreover, the rule of law implementing a legal strategy may be, as discussed in Chapter 1, either a
mandatory or a default rule, or one among a menu of alternative rules.
Legal strategies for controlling agency costs can be divided into two subsets, which we term, respectively,
‘regulatory strategies’ and ‘governance strategies’. Regulatory strategies are prescriptive: they dictate
substantive terms that govern the content of the principal-agent relationship, tending to constrain the agent’s
behavior directly. By contrast, governance strategies seek to facilitate the principals’ control over their
agent’s behavior. The efficacy of governance strategies depends crucially on the ability of the principals to
exercise the control rights accorded to them. Coordination costs between principals will make it more
difficult for them either to monitor the agent so as to determine the appropriateness of her actions, or to
decide whether, and how, to take action to sanction nonperformance. High coordination costs thus render
governance strategies less successful in controlling agents, and regulatory strategies will tend to seem more
attractive. Regulatory strategies have different preconditions for success. Most obviously, they depend for
efficacy on the ability of an external authority—a court or regulatory body—to determine whether or not
the agent complied with particular prescriptions. This requires not only good-quality regulatory institutions,
the hallmarks of which are expertise and integrity—but effective disclosure mechanisms to ensure that
information about the actions of agents can be ‘verified’ by the regulator.
In contrast, governance strategies—where the principals are able to exercise them effectively—require only
that the principals themselves are able to observe the actions taken by the agent, for which purpose ‘softer’
information may suffice. Table 2-1 sets out ten legal strategies—four regulatory strategies and six
governance strategies—which, taken together, span the law’s principal methods of dealing with agency
problems. These strategies are not limited to the corporate context; they can be deployed to protect nearly
any vulnerable principal-agent relationship. Our focus here, however, will naturally be on the ways that
these strategies are deployed in corporate law. At the outset, we should emphasize that the aim of this
exercise is not to provide an authoritative taxonomy, but simply to offer a heuristic device for thinking
about the functional role of law in corporate affairs. As a result, the various strategies are not entirely
discrete but sometimes overlap, and our categorization of these strategies does not quadrate perfectly with
corporate law doctrine.
Regulatory strategies
Consider first the regulatory strategies on the left hand side of Table 2-1.
Rules and standards
The most familiar pair of regulatory strategies constrains agents by commanding them not to make
decisions, or undertake transactions, that would harm the interests of their principals. Lawmakers can frame
such constraints as rules, which require or prohibit specific behaviors, or as general standards, which leave
the precise determination of compliance to adjudicators after the fact.
Both rules and standards attempt to regulate the substance of agency relationships directly. Rules, which
prescribe specific behaviors ex ante, are commonly used in the corporate context to protect a corporation’s
creditors and public investors. Thus corporation statutes universally include creditor protection rules such
as dividend restrictions, minimum capitalization requirements, or rules requiring action to be taken
following serious loss of capital. Similarly, capital market authorities frequently promulgate detailed rules
to govern tender offers and proxy voting.
By contrast, few jurisdictions rely solely on the rules strategy for regulating complex, intra-corporate
relations, such as, for example, self-dealing transactions initiated by controlling shareholders. Such matters
are, presumably, too complex to regulate with no more than a matrix of prohibitions and exemptions, which
would threaten to codify loopholes and create pointless rigidities. Rather than rule-based regulation, then,
intra-corporate topics such as insider self-dealing tend to be governed by open standards that leave
discretion for adjudicators to determine ex post whether violations have occurred. Standards are also used
to protect creditors and public investors, but the paradigmatic examples of standards-based regulation relate
to the company’s internal affairs, as when the law requires directors to act in ‘good faith’ or mandates that
self-dealing transactions must be ‘entirely fair’.
The importance of both rules and standards depends in large measure on the vigor with which they are
enforced. In principle, well-drafted rules can be mechanically enforced. Standards, however, inevitably
require courts (or other adjudicators) to become more deeply involved in evaluating and sometimes
moulding corporate decisions ex post. In this sense, standards lie between rules (which simply require a
decision-maker to determine compliance) and another strategy that we will address below—the trusteeship
strategy, which requires a neutral decision-maker to exercise his or her own unconstrained best judgment
in making a corporate decision.
Setting the terms of entry and exit
A second set of regulatory strategies open to the law involve regulating the terms on which principals
affiliate with agents rather than—as with rules and standards— regulating the actions of agents after the
principal/agent relationship is established. The law can dictate terms of entry by, for example, requiring
agents to disclose information about the likely quality of their performance before contracting with
principals.
Alternatively, the law can prescribe exit opportunities for principals, such as awarding to a shareholder the
right to sell her stock, or awarding to a creditor the right to call a loan. The entry strategy is particularly
important in screening out opportunistic agents in the public capital markets. Outside investors know little
about public companies unless they are told. Thus it is widely accepted that public investors require some
form of systematic disclosure to obtain an adequate supply of information. Legal rules mandating such
disclosure provide an example of an entry strategy because stocks cannot be sold unless the requisite
information is supplied, generally by the corporation itself. A similar but more extreme form of the entry
strategy is a requirement that the purchasers of certain securities meet a threshold of net worth or financial
sophistication. The exit strategy, which is also pervasive in corporate law, allows principals to escape
opportunistic agents.
Broadly speaking, there are two kinds of exit rights. The first is the right to withdraw the value of one’s
investment. The best example of such a right in corporate law is the technique, employed in some
jurisdictions, of awarding an appraisal right to shareholders who dissent from certain major transactions
such as mergers.
The second type of exit right is the right of transfer—the right to sell shares in the market—which is of
obvious importance to public shareholders. (Recall that transferability is a core characteristic of the
corporate form.) Standing alone, a transfer right provides less protection than a withdrawal right, since an
informed transferee steps into the shoes of the transferor, and will therefore offer a price that impounds the
expected future loss of value from insider mismanagement or opportunism. But the transfer right permits
the replacement of the current shareholder/principal(s) by a new one that may be more effective in
controlling the firm’s management.
Thus, unimpeded transfer rights allow hostile takeovers in which the disaggregated shareholders of a
mismanaged company can sell their shares to a single active shareholder with a strong financial interest in
efficient management.Such a transfer of control rights, or even the threat of it, can be a highly effective
device for disciplining management. Moreover, transfer rights are a prerequisite for stock markets, which
also empower disaggregated shareholders by providing a continuous assessment of managerial performance
(among other things) in the form of share prices.
Governance strategies
Thus far we have addressed the set of regulatory strategies that might be extended for the protection of
vulnerable parties in any class of contractual relationships. We now turn to the six strategies that depend
on the hierarchical elements of the principal agent relationship.
Selection and removal
Given the central role of delegated management in the corporate form, it is no surprise that appointment
rights—the power to select or remove directors (or other managers)—are key strategies for controlling the
enterprise. Indeed, these strategies are at the very core of corporate governance. The power to appoint
directors is a core strategy not only for addressing the agency problems of shareholders in relation to
managers, but also, in some jurisdictions, for addressing agency problems of minority shareholders in
relation to controlling shareholders, and of employees in relationship to the shareholder class as a whole.
Initiation and ratification
A second pair of governance strategies expands the power of principals to intervene in the firm’s
management. These are decision rights, which grant principals the power to initiate or ratify management
decisions. Again, it is no surprise that this set of decision rights strategies is much less prominent in
corporate law than are appointment rights strategies. This disparity is a logical consequence of the fact that
the corporate form is designed as a vehicle for the delegation of managerial power and authority to the
board of directors. Only the largest and most fundamental corporate decisions (such as mergers and charter
amendments) require the ratification of shareholders under existing corporation statutes, and no jurisdiction
to our knowledge requires shareholders to initiate managerial decisions.
Trusteeship and reward
Finally, a last pair of governance strategies alters the incentives of agents rather than expanding the powers
of principals. These are incentive strategies. The first incentive strategy is the reward strategy, which—as
the name implies—rewards agents for successfully advancing the interests of their principals. Broadly
speaking, there are two principal reward mechanisms in corporate law. The more common form of reward
is a sharing rule that motivates loyalty by tying the agent’s monetary returns directly to those of the
principal. A conspicuous example is the protection that minority shareholders enjoy from the equal
treatment norm, which requires a strictly pro rata distribution of dividends.
As a consequence of this rule, controlling shareholders— here the ‘agents’—have an incentive to maximize
the returns of the firm’s minority shareholders—here the ‘principals’— at least to the extent that corporate
returns are paid out as dividends. The reward mechanism that is less commonly the focus of corporate law
is the pay-for-performance regime, in which an agent, although not sharing in his principal’s returns, is
nonetheless paid for successfully advancing her interests.
Even though no jurisdiction imposes such a scheme on shareholders, legal rules often facilitate or
discourage high-powered incentives of this sort. American law, for example, has long embraced incentive
compensation devices such as stock option plans, while more skeptical jurisdictions continue to limit them.
The second incentive strategy—the trusteeship strategy—works on a quite different principle. It seeks to
remove conflicts of interest ex ante to ensure that an agent will not obtain personal gain from disserving
her principal. This strategy assumes that, in the absence of strongly focused—or ‘high-powered’—
monetary incentives to behave opportunistically, agents will respond to the ‘low-powered’ incentives of
conscience, pride, and reputation, and are thus more likely to manage in the interests of their principals.
One well-known example of the trusteeship strategy is the ‘independent director’, now relied upon in many
jurisdictions to approve self-dealing transactions. Such directors will not personally profit from actions that
disproportionately benefit the firm’s managers or controlling shareholders, and hence are expected to be
guided more strongly by conscience and reputation in making decisions. Similarly, reliance on auditors to
approve financial statements and certain corporate transactions is also an example of trusteeship, provided
the auditors are motivated principally by reputational concerns. In certain circumstances other agents
external to the corporation may be called upon to serve as trustees, as when the law requires an investment
banker, a state official, or a court to approve corporate action.
Ex post and ex ante strategies
The bottom row in Table 2-1 arranges our ten legal strategies into five pairs, each with an ‘ex ante’ and an
‘ex post’ strategy. This presentation merely highlights the fact that half of the strategies take full effect
before an agent acts, while the other half respond—at least potentially—to the quality of the agent’s action
ex post. In the case of the regulatory strategies, for example, rules specify what the agent may or may not
do ex ante, while standards specify the general norm against which an agent’s actions will be judged ex
post. Thus, a rule might prohibit a class of self-dealing transactions outright, while a standard might
mandate that these transactions will be judged against a norm of fairness ex post.
Similarly, in the case of setting the terms of entry and exit, an entry strategy, such as mandatory disclosure,
specifies what must be done before an agent can deal with a principal, while an exit device such as appraisal
rights permits the principal to respond after the quality of the agent’s action is revealed.34 The six
governance strategies also fall into ex ante and ex post pairs. If principals can appoint their agents ex ante,
they can screen for loyalty; if principals can remove their agents ex post, they can punish disloyalty.
Similarly, shareholders might have the power to initiate a major corporate transaction such as a merger,
or—as is ordinarily the case—they might be restricted to ratifying a motion to merge offered by the board
of directors.
Finally, trusteeship is an ex ante strategy in the sense that it neutralizes an agent’s adverse interests prior to
her appointment by the principal, while most reward strategies are ex post in the sense that their payouts
are contingent on uncertain future outcomes, and thus remain less than fully specified until after the agent
acts. We do not wish, however, to overemphasize the clarity or analytic power of this categorization of
legal strategies into ex ante and ex post types. One could well argue, for example, that the reward strategy
should not be considered an ex post strategy but rather an ex ante strategy because, like the trusteeship
strategy, it establishes in advance the terms on which the agent will be compensated. Likewise, one could
argue that appointment rights cannot easily be broken into ex ante and ex post types, since an election of
directors might involve, simultaneously, the selection of new directors and the removal of old ones. We
offer the ex post/ex ante distinction only as a classification heuristic that is helpful for purposes of
exposition. Indeed, as we have already noted, it is in the same heuristic spirit that we offer our categorization
of legal strategies in general.
The ten strategies arrayed in Table 2-1 clearly overlap, and any given legal rule might well be classified as
an instance of two or more of those strategies. Again, our purpose here is simply to emphasize the various
ways in which law can be used as an instrument, not to provide a new formalistic schema that displaces
rather than aids functional understanding.
COMPLIANCE AND ENFORCEMENT
Legal strategies are relevant only to the extent that they induce compliance. In this regard, each strategy
depends on the existence of other legal institutions—such as courts, regulators, and procedural rules—to
secure enforcement of the legal norms. In this section, we consider the relationship between enforcement
and compliance. We then discuss three modalities by which enforcement may be effected.
Enforcement and intervention
Enforcement is most directly relevant as regards regulatory strategies such as rules and standards. These
operate to constrain the agent’s behavior; they cannot do this credibly unless they are in fact enforced. This
necessitates well-functioning enforcement institutions, such as courts and regulators, along with
appropriately structured incentives to initiate cases.
In contrast, governance strategies rely largely upon intervention by principals to generate agent compliance.
Whether this intervention takes the form of appropriate selection of agents and structure of rewards, credible
threats of removal, or effective decision-making on key issues, its success in securing agent compliance
depends primarily upon the ability of principals to coordinate and act at low cost. To be sure, governance
strategies rely upon background legal rules to support their operation; in particular, they rely on rules
defining the decision-making authority of the various corporate actors.
They therefore also require legal enforcement institutions to make such delineations of authority effective.
However, governance strategies require less sophistication and information on the part of courts and
regulators than is required to enforce agents’ compliance more directly through regulatory strategies.39
Enforcement institutions, therefore, are of first-order importance for regulatory strategies, but only of
second-order importance for governance strategies.
Modes of enforcement
Turning now to the nature of these ‘enforcement institutions’, we distinguish three modalities of
enforcement, according to the character of the actors responsible for taking the initiative: (1) public
officials, (2) private parties acting in their own interests, and (3) strategically placed private parties
(‘gatekeepers’) conscripted to act in the public interest. Modalities of enforcement might of course be
classified across a number of other dimensions. Our goal here is not to categorize for its own sake, but to
provoke thought about how the impact of substantive legal strategies is mediated by different modalities of
enforcement. We therefore simply sketch out a heuristic classification based on one dimension—the
character of enforcers—and encourage readers to think about how matters might be affected by other
dimensions along which enforcement may vary. The categorization we have chosen, we believe, has the
advantage that it likely reflects the way in which agents involved in running a firm perceive enforcement—
that is, as affecting them through the actions of public officials, interested private parties, and gatekeepers.
Public enforcement
By ‘public enforcement’, we refer to all legal and regulatory actions brought by organs of the state. This
mode includes criminal and civil suits brought by public officials and agencies, as well as various ex ante
rights of approval—such as for securities offering statements—exercised by public actors. In addition to
formal measures, public enforcement also encompasses reputational sanctions that may accompany the
disclosure that a firm is under investigation. Public enforcement action can be initiated by a wide variety
of state organs, ranging from local prosecutors’ offices to national regulatory authorities that monitor
corporate actions in real time—such as the U.S. Securities and Exchange Commission (SEC) monitoring
corporate disclosures—and have the power to intervene to prevent breaches.
We also describe some self-regulatory and quasi-regulatory authorities, such as national stock exchanges
and the UK’s Financial Reporting Council, as ‘public enforcers’. Such bodies are enforcers to the extent
that they are able in practice to compel compliance with their rules ex ante or to impose sanctions for rule
violations ex post, whether these sanctions are reputational, contractual, or civil. Moreover, they are
meaningfully described as public enforcers where their regulatory efficacy is spurred by a credible threat
of state intervention, and they can be seen as public franchisees. Where no such credible threat exists, then
such organizations are better viewed as purely private.
Private enforcement
‘Private enforcement’ most obviously encompasses civil lawsuits brought by private parties, such as
shareholder derivative suits and class actions. Importantly, however, we wish to emphasize that it also
should be understood as including informal, or reputational, sanctions imposed by private parties, which
might take the form of lower share prices, a decline in social standing, or a personal sense of shame.
All of these may be inflicted by private parties on misbehaving corporate actors as private responses to
wrongdoing. As with public enforcement, private enforcement embraces a wide range of institutions. At
the formal end of the spectrum, these include class actions and derivative suits, which require considerable
legal and institutional infrastructure in the form of a plaintiffs’ bar, cooperative judges, and favorable
procedural law that facilitates actions through matters as diverse as discovery rights and legal fees.
Similarly, at the informal end of the spectrum, market reputation can only ‘penalize’ misconduct by
corporate wrongdoers to the extent that there is a mechanism for dissemination of information about
(possible) malfeasance and reasonably well- functioning factor and product markets in which the terms on
which the firm contracts become less favorable in response to that information.
Unlike public enforcement, the modality we term private enforcement depends chiefly on the mechanism
of deterrence—that is, the imposition of penalties ex post upon the discovery of misconduct. There are few
direct analogs in private enforcement to the ex ante regulatory approval we have included within the mode
of public enforcement. One example of such enforcement may be the UK’s ‘scheme of arrangement’
procedure, whereby a company wishing to undertake a major restructuring transaction and having obtained
requisite votes from shareholders (and creditors, if they are parties) may seek court approval of the
arrangement.
The court will scrutinize the procedural steps taken at this point, and if its sanction is given to the scheme,
it cannot be challenged ex post. However, if the focus is widened to include not only enforcement in the
strict sense, but means of securing agent compliance more generally, there is an important counterpart:
private actors are of course very much involved in ex ante governance interventions to secure compliance
by agents. Indeed, while the discussion in this section has focused on public and private actors as initiators
of the enforcement of legal norms, the same conceptual distinction can also be made in relation to
governance interventions.
Public actors may also be involved in governance interventions, for instance where the state is a significant
stockholder. This position is not observed in most of the jurisdictions we survey, but in some countries—
most notably China—state ownership of controlling shares in publicly-traded companies is common. Under
such circumstances, public actors—namely government agencies—take decisions regarding governance

intervention.
Gatekeeper control
Gatekeeper control involves the conscription of non-corporate actors, such as accountants and lawyers, in
policing the conduct of corporate actors. This conscription generally involves exposing the gatekeepers to
the threat of sanction for participation in corporate misbehavior, or for failure to prevent or disclose
misbehavior. The actors so conscripted are ‘gatekeepers’ in the sense that their participation is generally
necessary, whether as a matter of practice or of law, to accomplish the corporate transactions that are the
ultimate focus of the enforcement efforts. We call the mode ‘gatekeeper control’ to emphasize that it works
by harnessing the control that gatekeepers have over corporate transactions, and giving them a strong
incentive to use that control to prevent unwanted conduct.
Gatekeeper control is probably best viewed as a form of delegated intervention: principals do not
themselves engage in scrutiny of the agent, but leave this to the gatekeeper. Compliance is generally secured
through the ex ante mechanism of constraint (e.g., auditors refuse to issue an unqualified report) rather than
through the ex post mechanism of penalizing wrongdoers. Such delegation of course creates a new agency
problem between the gatekeeper and the principals. This is dealt with through the application of the basic
legal strategies to the gatekeepers themselves, with chief reliance on the standards and trusteeship strategies.
DISCLOSURE
Disclosure plays a fundamental role in controlling corporate agency costs. As we have already noted, it is
an important part of the affiliation rights strategies. Most obviously, prospectus disclosure forces agents to
provide prospective principals with information that helps them to decide upon which terms, if any, they
wish to enter the firm as owners. To a lesser extent, periodic financial disclosure and ad hoc disclosure—
for example, of information relevant to share prices, and of the terms of related party transactions—also
permits principals to determine the extent to which they wish to remain owners, or rather exit the firm.
However, continuing disclosure also has more general auxiliary effects in relation to each of the other
strategies; hence we treat it separately at this point in our discussion. In relation to regulatory strategies that
require enforcement, disclosure of related party transactions helps to reveal the existence of transactions
that may be subject to potential challenge, and provides potential litigants with information to bring before
a court. In relation to governance strategies, disclosure can be used in several different, but complementary,
ways. First, and most generally, mandating disclosure of the terms of the governance arrangements that are
in place allows principals to assess appropriate intervention tactics. Second, and specifically in relation to
decision rights, mandatory disclosure of the details of a proposed transaction for which the principals’
approval is sought can improve the principals’ decision. Third, disclosure of those serving in trustee roles
serves to bond their reputations publicly to the effective monitoring of agents.
There is of course a need to ensure compliance with disclosure obligations themselves. This is a microcosm
of the more general problem of securing agent compliance. For periodic disclosures, where the type of
information is expected but the content is not yet known (so-called ‘known unknowns’), no additional
compliance mechanism may be required beyond a public statement that the disclosure is expected. If the
principals are made aware that a particular piece of information (for example, annual financial statements,
the structure and composition of the board, or executive compensation arrangements) is expected to be
disclosed in a particular format, then non-disclosure itself can send a negative signal to principals,
stimulating them to act.
The compliance issue with periodic disclosure is not so much whether it happens, but its quality, and hence
a trusteeship strategy—in the form of auditors—is typically used to assist in assuring this. For ad hoc
disclosure, the compliance issues are different, because by definition, principals do not expect particular
disclosures in advance (that is, these are so-called ‘unknown unknowns’). Here vigorous legal enforcement
alone seems to be able to ensure compliance.
Kinds of directors
Section 149. (1) Company to have Board of Directors
Every company shall have a Board of Directors consisting of individuals as directors and shall have—
(a) a minimum number of three directors in the case of a public company, two directors in the case of a
private company, and one director in the case of a One Person Company; and
(b) a maximum of fifteen directors:
Provided that a company may appoint more than fifteen directors after passing a special resolution:
Provided further that such class or classes of companies as may be prescribed, shall have at least one woman
director.
(2) Every company existing on or before the date of commencement of this Act shall within one year from
such commencement comply with the requirements of the provisions of sub-section (1).
(3) Every company shall have at least one director who has stayed in India for a total period of not less than
one hundred and eighty-two days in the previous calendar year.
(4) Every listed public company shall have at least one-third of the total number of directors as independent
directors and the Central Government may prescribe the minimum number of independent directors in case
of any class or classes of public companies.
Explanation.—For the purposes of this sub-section, any fraction contained in such one-third number shall
be rounded off as one.
(5) Every company existing on or before the date of commencement of this Act shall, within one year from
such commencement or from the date of notification of the rules in this regard as may be applicable, comply
with the requirements of the provisions of sub-section (4).
(6) An independent director in relation to a company, means a director other than a managing director or a
whole-time director or a nominee director,—
(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and
experience;
(b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company;
(ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate
company;
(c) who has or had no pecuniary relationship with the company, its holding, subsidiary or associate
company, or their promoters, or directors, during the two immediately preceding financial years or
during the current financial year;
(d) none of whose relatives has or had pecuniary relationship or transaction with the company, its
holding, subsidiary or associate company, or their promoters, or directors, amounting to two per
cent. or more of its gross turnover or total income or fifty lakh rupees or such higher amount as
may be prescribed, whichever is lower, during the two immediately preceding financial years or
during the current financial year;
(e) who, neither himself nor any of his relatives—
(i) holds or has held the position of a key managerial personnel or is or has been employee
of the company or its holding, subsidiary or associate company in any of the three financial
years immediately preceding the financial year in which he is proposed to be appointed;
(ii) is or has been an employee or proprietor or a partner, in any of the three financial years
immediately preceding the financial year in which he is proposed to be appointed, of—
(A) a firm of auditors or company secretaries in practice or cost auditors of the
company or its holding, subsidiary or associate company; or
(B) any legal or a consulting firm that has or had any transaction with the company,
its holding, subsidiary or associate company amounting to ten per cent. or more of
the gross turnover of such firm;
(iii) holds together with his relatives two per cent. or more of the total voting power of the
company; or
(iv) is a Chief Executive or director, by whatever name called, of any non-profit
organisation that receives twenty-five per cent. or more of its receipts from the company,
any of its promoters, directors or its holding, subsidiary or associate company or that holds
two per cent. or more of the total voting power of the company; or
(f) who possesses such other qualifications as may be prescribed.
(7) Every independent director shall at the first meeting of the Board in which he participates as a director
and thereafter at the first meeting of the Board in every financial year or whenever there is any change in
the circumstances which may affect his status as an independent director, give a declaration that he meets
the criteria of independence as provided in sub-section (6).
Explanation.—For the purposes of this section, “nominee director” means a director nominated by any
financial institution in pursuance of the provisions of any law for the time being in force, or of any
agreement, or appointed by any Government, or any other person to represent its interests.
(8) The company and independent directors shall abide by the provisions specified in Schedule IV.
(9) Notwithstanding anything contained in any other provision of this Act, but subject to the provisions of
sections 197 and 198, an independent director shall not be entitled to any stock option and may receive
remuneration by way of fee provided under sub-section (5) of section 197, reimbursement of expenses for
participation in the Board and other meetings and profit related commission as may be approved by the
members.
(10) Subject to the provisions of section 152, an independent director shall hold office for a term up to five
consecutive years on the Board of a company, but shall be eligible for reappointment on passing of a special
resolution by the company and disclosure of such appointment in the Board's report.
(11) Notwithstanding anything contained in sub-section (10), no independent director shall hold office for
more than two consecutive terms, but such independent director shall be eligible for appointment after the
expiration of three years of ceasing to become an independent director:
Provided that an independent director shall not, during the said period of three years, be appointed in or be
associated with the company in any other capacity, either directly or indirectly.
Explanation.—For the purposes of sub-sections (10) and (11), any tenure of an independent director on the
date of commencement of this Act shall not be counted as a term under those sub-sections.
(12) Notwithstanding anything contained in this Act,—
(i) an independent director;
(ii) a non-executive director not being promoter or key managerial personnel, shall be held liable, only in
respect of such acts of omission or commission by a company which had occurred with his knowledge,
attributable through Board processes, and with his consent or connivance or where he had not acted
diligently.
(13) The provisions of sub-sections (6) and (7) of section 152 in respect of retirement of directors by rotation
shall not be applicable to appointment of independent directors.
Appointment of Directors
Section 152. Appointment of directors

(1) Where no provision is made in the articles of a company for the appointment of the first director, the
subscribers to the memorandum who are individuals shall be deemed to be the first directors of the company
until the directors are duly appointed and in case of a One Person Company an individual being member
shall be deemed to be its first director until the director or directors are duly appointed by the member in
accordance with the provisions of this section.
(2) Save as otherwise expressly provided in this Act, every director shall be appointed by the company in
general meeting.
(3) No person shall be appointed as a director of a company unless he has been allotted the Director
Identification Number under section 154.
(4) Every person proposed to be appointed as a director by the company in general meeting or otherwise,
shall furnish his Director Identification Number and a declaration that he is not disqualified to become a
director under this Act.
(5) A person appointed as a director shall not act as a director unless he gives his consent to hold the office
as director and such consent has been filed with the Registrar within thirty days of his appointment in such
manner as may be prescribed:
Provided that in the case of appointment of an independent director in the general meeting, an explanatory
statement for such appointment, annexed to the notice for the general meeting, shall include a statement
that in the opinion of the Board, he fulfils the conditions specified in this Act for such an appointment.
(6) (a) Unless the articles provide for the retirement of all directors at every annual general meeting, not
less than two-thirds of the total number of directors of a public company shall—
(i) be persons whose period of office is liable to determination by retirement of directors by rotation; and
(ii) save as otherwise expressly provided in this Act, be appointed by the company in general meeting.
(b) The remaining directors in the case of any such company shall, in default of, and subject to any
regulations in the articles of the company, also be appointed by the company in general meeting.
(c) At the first annual general meeting of a public company held next after the date of the general meeting
at which the first directors are appointed in accordance with clauses (a) and (b) and at every subsequent
annual general meeting, one-third of such of the directors for the time being as are liable to retire by rotation,
or if their number is neither three nor a multiple of three, then, the number nearest to one-third, shall retire
from office.
(d) The directors to retire by rotation at every annual general meeting shall be those who have been longest
in office since their last appointment, but as between persons who became directors on the same day, those
who are to retire shall, in default of and subject to any agreement among themselves, be determined by lot.
(e) At the annual general meeting at which a director retires as aforesaid, the company may fill up the
vacancy by appointing the retiring director or some other person thereto.
Explanation.—For the purposes of this sub-section, “total number of directors” shall not include
independent directors, whether appointed under this Act or any other law for the time being in force, on the
Board of a company.
(7) (a) If the vacancy of the retiring director is not so filled-up and the meeting has not expressly resolved
not to fill the vacancy, the meeting shall stand adjourned till the same day in the next week, at the same
time and place, or if that day is a national holiday, till the next succeeding day which is not a holiday, at the
same time and place.
(b) If at the adjourned meeting also, the vacancy of the retiring director is not filled up and that meeting
also has not expressly resolved not to fill the vacancy, the retiring director shall be deemed to have been re-
appointed at the adjourned meeting, unless—
(i) at that meeting or at the previous meeting a resolution for the re-appointment of such director
has been put to the meeting and lost;
(ii) the retiring director has, by a notice in writing addressed to the company or its Board of
directors, expressed his unwillingness to be so re-appointed;
(iii) he is not qualified or is disqualified for appointment;
(iv) a resolution, whether special or ordinary, is required for his appointment or re-appointment by
virtue of any provisions of this Act; or
(v) section 162 is applicable to the case.
Explanation.—For the purposes of this section and section 160, the expression “retiring director” means a
director retiring by rotation.
Meetings of directors
Section 173. Meetings of Board.
(1) Every company shall hold the first meeting of the Board of Directors within thirty days of the date of
its incorporation and thereafter hold a minimum number of four meetings of its Board of Directors every
year in such a manner that not more than one hundred and twenty days shall intervene between two
consecutive meetings of the Board:
Provided that the Central Government may, by notification, direct that the provisions of this sub-section
shall not apply in relation to any class or description of companies or shall apply subject to such exceptions,
modifications or conditions as may be specified in the notification.
(2) The participation of directors in a meeting of the Board may be either in person or through video
conferencing or other audio visual means, as may be prescribed, which are capable of recording and
recognising the participation of the directors and of recording and storing the proceedings of such meetings
along with date and time:
Provided that the Central Government may, by notification, specify such matters which shall not be dealt
with in a meeting through video conferencing or other audio visual means.
(3) A meeting of the Board shall be called by giving not less than seven days’ notice in writing to every
director at his address registered with the company and such notice shall be sent by hand delivery or by
post or by electronic means:
Provided that a meeting of the Board may be called at shorter notice to transact urgent business subject to
the condition that at least one independent director, if any, shall be present at the meeting:
Provided further that in case of absence of independent directors from such a meeting of the Board,
decisions taken at such a meeting shall be circulated to all the directors and shall be final only on ratification
thereof by at least one independent director, if any.
(4) Every officer of the company whose duty is to give notice under this section and who fails to do so shall
be liable to a penalty of twenty-five thousand rupees.
(5) A One Person Company, small company and dormant company shall be deemed to have complied with
the provisions of this section if at least one meeting of the Board of Directors has been conducted in each
half of a calendar year and the gap between the two meetings is not less than ninety days:
Provided that nothing contained in this sub-section and in section 174 shall apply to One Person Company
in which there is only one director on its Board of Directors.
Section 174. Quorum for meetings of Board.
(1) The quorum for a meeting of the Board of Directors of a company shall be one third of its total strength
or two directors, whichever is higher, and the participation of the directors by video conferencing or by
other audio visual means shall also be counted for the purposes of quorum under this sub-section.
(2) The continuing directors may act notwithstanding any vacancy in the Board; but, if and so long as their
number is reduced below the quorum fixed by the Act for a meeting of the Board, the continuing directors
or director may act for the purpose of increasing the number of directors to that fixed for the quorum, or of
summoning a general meeting of the company and for no other purpose.
(3) Where at any time the number of interested directors exceeds or is equal to two thirds of the total strength
of the Board of Directors, the number of directors who are not interested directors and present at the
meeting, being not less than two, shall be the quorum during such time.
Explanation.—For the purposes of this sub-section, “interested director” means a director within the
meaning of sub-section (2) of section 184.
(4) Where a meeting of the Board could not be held for want of quorum, then, unless the articles of the
company otherwise provide, the meeting shall automatically stand adjourned to the same day at the same
time and place in the next week or if that day is a national holiday, till the next succeeding day, which is
not a national holiday, at the same time and place.
(i) any fraction of a number shall be rounded off as one;
(ii) “total strength” shall not include directors whose places are vacant.
Section 175. Passing of resolution by circulation.
(1) No resolution shall be deemed to have been duly passed by the Board or by a committee thereof by
circulation, unless the resolution has been circulated in draft, together with the necessary papers, if any, to
all the directors, or members of the committee, as the case may be, at their addresses registered with the
company in India by hand delivery or by post or by courier, or through such electronic means as may be
prescribed and has been approved by a majority of the directors or members, who are entitled to vote on
the resolution:
Provided that, where not less than one-third of the total number of directors of the company for the time
being require that any resolution under circulation must be decided at a meeting, the chairperson shall put
the resolution to be decided at a meeting of the Board.
(2) A resolution under sub-section (1) shall be noted at a subsequent meeting of the Board or the committee
thereof, as the case may be, and made part of the minutes of such meeting.
Role of directors
Reliance Natural Resources Ltd v. Reliance Industries Ltd. 2008 82 SCL 303 Bombay
This matter dates back to 1999 when the Indian Government allowed limited private sector participation in
gas exploration. Having received “blocks” in the Krishna-Godavari basin, known as KG-D6 to Reliance
Industries Limited (RIL) Consortium and entered into a Production Sharing Contract (PSC) with the Union
of India. In 2003, RIL entered into an agreement for the supply of gas to the National Thermal Power
Corporation (NTPC), at a specified quantity of gas at $2.34/mmBtu. Due to difference in the family, a
Memorandum of Understanding (MoU) was entered into between the two brothers and their mother on 18
June, 2005. The MoU gave RNRL, owned by Anil Ambani a specified entitlement of oil and gas at the
price at which RIL had agreed to supply gas to NTPC – in short, $2.34/mmBtu for a period of 17 years.
The Bombay High Court approved the consequent scheme, which required that “suitable arrangements” be
made for the supply of gas by RIL to RNRL, and the scheme became effective on 21 December, 2005.
Issue:
 The maintainability of a petition under s. 392 of the Companies Act

 Whether the PSC overrides all other contracts, and affords the Government the power to control
prices?
 The legal nature of a MoU and the applicability of the doctrine of “identification” or “attribution”
 The binding nature of a MoU on a company in the absence of an express provision in its Articles
of Association
Discussion:
 The RIL and RNRL Boards (controlled at the time by the MDA Group) approved a draft Gas Sale
Master Agreement (GSMA) and Gas Sale Purchase Agreement (GSPA). Once control was
transferred to the ADA Group, RNRL contended that the GSPA and GSMA were inconsistent with
the scheme.
 After some time, the Ministry of Petroleum and Natural Gas declined to approve RIL’s request to
supply gas to RNRL at the NTPC price of $2.34/mmBtu.
 Soon after, RNRL filed an application in the Bombay High Court requesting the Court to direct
RIL to supply gas at the price agreed in the MoU.
 In its final judgment and order dated, 15.06.2009, the Division Bench of the Bombay High Court
gave the following decisions:
1. A fixed quantum of gas, i.e. 28 mmscmd for a period of 17 years stands allocated to RNRL from
the KG D6 field.
2. RIL will have to supply RNRL natural gas at rates prescribed in the private arrangements
irrespective of Government decisions on the same.
3. The price, quantity and tenure as decided in the private arrangement between Mukesh Ambani
and Anil Ambani will prevail over the Government fixed price, quantity or tenure. RIL was free,
as per the terms of the PSC, to sell the natural gas extracted at any price since the price fixed by
the Government was only for purposes of valuation.
4. Government decisions will apply only to the 10% of the natural gas extracted and saved, i.e.,
“profit gas”.
5. Any further allocations of gas made by the Government will apply only to the 10% of the gas
which is the “government’s take”.
 Aggrieved by the same, all the parties concerned filed appeals before the Supreme Court of India.
The Union of India was specifically aggrieved since the High Court’s judgment had completely
subordinated the Government’s power to regulate the natural gas sector to the private arrangements
between parties.
 The majority opinion, authored by Justice Sathasivam, with which Chief Justice Balakrishnan
concurred, found in RNRL’s favour on the jurisdictional issue and in RIL’s on the remainder.
Justice Sudershan Reddy found in RIL’s favour on all issues, and the Court set consequently aside
the order of the Bombay High Court.
 RIL argued that a distinction exists between s. 392 and 394 of the Companies Act, and that s. 392
does not apply to a company which falls under ss. 391 and 394 and argued that the power of
supervision under s. 392 does not extend to altering the Scheme in the manner envisaged by RNRL.
 Justice Sathasivam rejected this contention, holding that the power of the Court to alter the Scheme
is “unlimited” provided its “basic fabric” remains the same. Justice Sudershan Reddy, on the other
hand, considered that granting RNRL’s requests would amount to interfering with the “basic
fabric” of the scheme, and held that the Bombay High Court should not have assumed jurisdiction.
 The majority held that the MoU could not bind the companies, because it was entered into by private
persons. Justice Reddy also held that the doctrine of identification applies mainly in cases of
criminal or tortious liability. Both the majority and Justice Reddy referred to s. 293 of the
Companies Act to establish that the Board retained power to act, although it is not clear what the
“undertaking” in question was.
 Also, Justice Sudershan Reddy observed that directors owe a “fiduciary duty” to shareholders.
Construed literally, this is a departure from the settled proposition that such duties are owed to the
company. However, although this point is not free from doubt, it appears to be a passing
observation, and the reference to shareholders seems to be intended to refer to the company as a
“body” of shareholders.
 Finally, in perhaps the most significant issue in the context of the case, the majority and Justice
Reddy agreed that the power of the Union to distribute natural resources for the good of the
community overrides private agreements.
 In this respect, the Court relied on Art. 297 of the Constitution, which vests natural resources in the
Union of India, Art. 39(b), which requires distribution of resources to sub serve the common good,
commercial practice in the oil and gas industry the international principle of permanent sovereignty
over natural resources adopted by the UN General Assembly in Resolution 1803, the provisions of
the PSC, the doctrine of public trust etc.
Conclusion:
1. Both the learned Single Judge and the Division Bench committed a serious error in exercising
jurisdiction in the manner they did under Section 392 of the Companies Act, 1956, for such
interference has resulted in the provisions of a document (MoU) which was not before the
shareholders supersede the Scheme of Arrangement. Such a document could not have been read
into and incorporated in the Scheme propounded by the Board, approved by the shareholders and
sanctioned by the Company Court;
2. The courts have rightly directed the parties to negotiate, and further having rightly refused to grant
the prayers in the Company Application, however, fell into error directing the MoU to be binding
and the basis for further negotiations between the parties. MoU is a private pact between the
members of Ambani family which is not binding on RIL;
3. The EGOM decisions, regarding the utilization of the natural gas and the price formula/basis etc.
do not suffer from any legal or constitutional infirmities. They shall apply to all supplies of natural
gas under the PSC. The parties are bound by the governmental policy and approvals regarding
price, quantity and tenure for supply of gas;
4. Under the PSC in issue the Contractor (RIL) does not become the owner of natural gas, and there
is nothing like specified physical quantities of natural gas to be shared by the GoI and the
Contractor;
5. The court directed the parties to renegotiate as to the suitable arrangements for supply of gas de-
hors the MoU. Such renegotiations shall be within the framework of governmental policy and
approvals regarding price, quantity and tenure for supply of gas. The renegotiations shall
commence within eight weeks from today at the initiative of RIL and shall be completed within a
period of six weeks from the day of commencement of negotiations.
Duties and liabilities of directors
Section 166. Duties of Directors

(1) Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of
the company.
(2) A director of a company shall act in good faith in order to promote the objects of the company for the
benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders,
the community and for the protection of environment.
(3) A director of a company shall exercise his duties with due and reasonable care, skill and diligence and
shall exercise independent judgment.
(4) A director of a company shall not involve in a situation in which he may have a direct or indirect interest
that conflicts, or possibly may conflict, with the interest of the company.
(5) A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to
himself or to his relatives, partners, or associates and if such director is found guilty of making any undue
gain, he shall be liable to pay an amount equal to that gain to the company.
(6) A director of a company shall not assign his office and any assignment so made shall be void.
(7) If a director of the company contravenes the provisions of this section such director shall be punishable
with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.
Codification of Directors’ Duties: Is Common Law Excluded?

Umakanth Varotill
Background
Hitherto, directors had negligible guidance under company law as regards their duties and liabilities. The
preexisting Companies Act, 1956 (the 1956 Act) did not explicitly stipulate directors’ duties, which made
it necessary to fall back on common law principles (to be articulated by courts while delivering specific
decisions). The statutory uncertainty was compounded by the absence of significant cases of director duties
and liabilities before Indian courts.
This somewhat unsatisfactory situation has been mended in the Companies Act, 2013 (the 2013 Act), which
is rather explicit about directors’ duties (somewhat similar to the codification of directors’ duties under the
UK Companies Act of 2006, section 172). The new provisions not only provide greater certainty to directors
regarding their conduct, but also enable the beneficiaries as well as courts and regulators to judge the
discharge of directors’ duties more objectively.
The duties of directors are set forth in section 166 of the 2013 Act, and are principally as follows:
 To act in accordance with the articles of association of the company;

 To act in good faith to promote the objects of the company;
 To act in the best interests of the company, its employees, the shareholders, the community and for
the protection of the environment;
 To exercise duties with due and reasonable care, skill and diligence and to exercise independent
judgment;
 To not be involved in a situation of direct or indirect conflict with the interests of the company; and
 To not achieve any undue gain or advantage.
These duties can broadly be classified into two:

(i) duty of care, skill and diligence; and
(ii) fiduciary duties.
The duty of care, skill and diligence requires directors to devote the requisite time and attention to affairs
of the company, pursue issues that may arise through “red flags” and take decisions that do not expose the
company to unnecessary risks. Fiduciary duties, on the other hand, require the directors to put the interests
of the company ahead of their own personal interests. Rules that prevent conflict of interest and self-dealing
on the part of directors are integral to this set of duties.
Section 166 also provides for the consequences of breach of these duties. Sub-section (5) provides for civil
liability that requires a breaching director to return any undue gain or advantage received as a result of such
breach. Sub-section (7) is a penal provision that imposes a fine of Rs. 1 lac to Rs. 5 lac (i.e. rupees 0.1
million to 0.5 million) on directors who have contravened the section.
Comparative Position
The effort to codify directors’ duties is not altogether novel, as it has been undertaken in other common law
jurisdictions such as the UK and Singapore. However, in one significant respect, the Indian codification
exercise is different from the UK and Singapore. Under the 2013 Act in India, there is no provision that
reserves the application of common law following codification. Contrastingly, both in the UK and in
Singapore, the applicability of common law has been preserved to the extent that it can be utilized to
interpret the statutory provisions relating to directors’ duties.
The following provisions in the UK Companies Act of 2006 are relevant:
Section 170 Scope and nature of general duties
[….]
(3) The general duties are based on certain common law rules and equitable principles as they apply
in relation to directors and have effect in place of those rules and principles as regards the duties
owed to a company by a director.
(4) The general duties shall be interpreted and applied in the same way as common law rules or
equitable principles, and regard shall be had to the corresponding common law rules and equitable
principles in interpreting and applying the general duties.
(emphasis added)
The relevant provision in the Singapore Companies Act (Cap. 50, Rev. Ed. 2006) is as follows:
S. 157 As to the duty and liability of officers
[….]
(4) This section is in addition to and not in derogation of any other written law or rule of law relating
to the duty or liability of directors or officers of a company.
In stark contrast, the 2013 Act in India does not carry a similar provision explaining whether the principles
of common law are applicable (or excluded) in the interpretation of the directors’ duties as codified in
common law. This would give rise to an interpretational issue as discussed below. While this issue is
somewhat technical in nature from a jurisprudential standpoint, it could turn out to be a reality once cases
relating to directors’ duties under section 166 of the 2013 Act come up for litigation before the courts.
The legislative history appears to be silent regarding the rationale for the manner in which section 166 has
been drafted. Furthermore, this specific issue has also not received the attention of the Parliamentary
Standing Committee on Finance that extensively reviewed the Companies Bill prior to its enactment.
Issue
Whether section 166 of the Companies Act, 2013 is exhaustive regarding duties or company directors, or
whether directors are also bound by common law duties (that are either in addition to the statutory duties
or that can be used to interpret or explicate the statutory duties)?
Options
Similar to a format previously followed on this Blog, I propose to refrain from expressing any preferences
or stating arguments on this issue. Instead, I set out two possible views along with some rationale for each,
and invite readers to post their comments on these or other possible views or arguments on the issue.
Option 1: Section 166 is exhaustive of directors’ duties and is a complete code.

According to this view, the codification exercise is exhaustive, and directors’ duties must be determined
solely by the language of the statutory provision. It leaves no room for the application of common law.
This option emerges from a plain and simple textual interpretation. It is also consistent with the objective
of codification, which is to introduce certainty and clarity. If directors are nevertheless subjected to common
law principles, the codification exercise might be rendered redundant (at least partially). Moreover, unlike
the company law statutes in countries such as the UK and Singapore, there is no express provision that
preserves the use of common law either in addition to the statutory duties or by way of an aid to interpret
the statutory provisions.
Option 2: Section 166 is only a partial codification of directors’ duties, and the principles of common law
are preserved through implication and operate in addition to the statutory provisions or to at least aid in
their interpretation.
In this dispensation, the codification in the 2013 Act is incomplete as the statutory provisions lay down
only the broad and basic principles, and do not provide the details as to how the duties must be discharged
by the directors. Moreover, it is not possible for the statute to envisage all possible situations in which
directors must discharge their duties and also the manner in which they are to do so. Those details are to be
determined by the courts based on the facts and circumstances of each case, which is where common law
comes into the picture.
Furthermore, if common law were not resorted to, the remedies would be inadequate as well apart from the
substantive duties themselves. For example, Mihir has elaborately discussed in an earlier post, the statutory
remedy for breach of directors’ duties is only a return of profits or undue gains. This is only a personal
remedy, and there is no provision for proprietary remedies such as constructive trust. Moreover, staying
with personal remedies, there could be scenarios where a director has not received a gain but the company
has suffered a loss. In that case, without resorting to common law, it is not possible for the company to
recover such losses from the director by way of damages or compensation. Therefore, any inability to import
principles of common law will substantially diminish the scope of remedies for breaches of directors’
duties.
Finally, and more specifically, the 2013 Act does not have a section corresponding to section 170 (3) of the
UK Companies Act of 2006 (extracted above) which specifically states that that the duties in section166
(are based on common law rules and equitable principles and) shall have effect in place of such rules and
principles. In other words, there is no express provision to state that the statutory duties replace the common
law duties.
Aberdeen Railway Co v Blaikie Brothers (1854) 1 Macq 461
The plaintiff needed a large quantity of iron chairs (rail sockets) and contracted for their supply over an 18-
month period with Blaikie Bros a partnership. Thomas Blaikie was the managing partner of Blaikie Bros
and a director and the chairman of the Aberdeen Railway Company. The contract was partly performed but,
having taken delivery of about two-thirds of the iron chairs, the Aberdeen Railway Company refused to
accept any more. The defendant sought to enforce the contract or for damages for breach.
Held: The railway company’s defence succeeded on the grounds that Mr Blaikie’s self-dealing rendered
the contract voidable at its suit.
The equitable rule as to the accountability of directors is not limited to cases in which there is a maturing
business opportunity but extends to cases in which the director either has or can have a personal interest
conflicting, or which possibly may conflict, with the interests of whose whom he is bound to protect. ‘This,
therefore, brings us to the general question, whether a Director of a Railway Company is or is not precluded
from dealing on behalf of the Company with himself, or with a firm in which he is a partner. The Directors
are a body to whom is delegated the duty of managing the general affairs of the Company. A corporate
body can only act by agents, and it is of course the duty of those agents so to act as best to promote the
interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a
fiduciary nature towards their principal. And it is a rule of universal application, that no one, having such
duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal
interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect.
So strictly is this principle adhered to, that no question is allowed to be raised as to the fairness or unfairness
of a contract so entered into.
Mr Blaikie was not only a Director, but (if that was necessary) the Chairman of the Directors. In that
character it was his bounden duty to make the best bargains he could for the benefit of the Company. While
he filled that character, namely, on the 6th of February, 1846, he entered into a contract on behalf of the
Company with his own firm, for the purchase of a large quantity of iron chairs at a certain stipulated price.
His duty to the Company imposed on him the obligation of obtaining these chairs at the lowest possible
price. His personal interest would lead him in an entirely opposite direction, would induce him to fix the
price as high as possible. This is the very evil against which the rule in question is directed, and I here see
nothing whatever to prevent its application. I observe that Lord Fullerton seemed to doubt whether the rule
would apply where the party whose act or contract is called in question is only one of a body of Directors,
not a sole trustee or manager. But, with all deference, this appears to me to make no difference. It was Mr
Blaikie’s duty to give his co-Directors, and through them to the Company, the full benefit of all the
knowledge and skill which he could bring to bear on the subject. He was bound to assist them in getting the
articles contracted for at the cheapest possible rate. As far as related to the advice he should give them, he
put his interest in conflict with his duty, and whether he was the sole Director or only one of many, can
make no difference in principle. The same observation applies to the fact that he was not the sole person
contracting with the Company; he was one of the firm of Blaikie Brothers, with whom the contract was
made, and so interested in driving as hard a bargain with the Company as he could induce them to make.’
George Bray v. John Rawlinson Ford [1896] A.C. 44
In an action for libel the judge misdirected the jury in favour of the plaintiff upon a material part of the libel
and the jury gave a verdict for large damages. The Court of Appeal thought that the nature of the libel was
such that the jury would have been entitled to give, and would probably have given, the same verdict, even
if the direction had been the other way, and refused the defendant's application for a new trial on the ground
that in their opinion no “substantial wrong or miscarriage” had been occasioned by the misdirection, within
the meaning of Order XXXIX. r. 6:— Held, reversing the decision of the Court of Appeal, that since the
assessment of damages is the peculiar province of the jury in an action for libel, and since the jury had not
had the defendant's real case submitted to them and might, in assessing the damages, have been influenced
by the misdirection, there had been a substantial wrong or miscarriage within Order XXXIX. r. 6 and that
there must be a new trial. THE appellant was a governor of the Yorkshire College, of which the respondent
was vice-chairman. The respondent had also acted as solicitor to the college and had been paid his charges
under the circumstances related in the judgment of Lord Herschell. The appellant wrote a letter to the
respondent beginning thus: “Sir, during last summer, as you are aware, it came to my knowledge that whilst
holding the fiduciary position of vice-chairman of the Yorkshire College you were illegally and improperly,
as you know, making profit as its paid solicitor.” The letter, which was long, contained comments upon the
respondent's conduct, with imputations as to motives and allusions to swindlers, which might be construed
as highly libellous. This letter the appellant circulated among the governors of the college and other persons.
The jury returned a verdict for the plaintiff for 600l. The appellant having moved for a new trial on the
grounds of misdirection, that the verdict was against the weight of evidence, and that the damages were
excessive, the Court of Appeal (Lord Esher M.R., Lopes and Rigby L.JJ.) held that Cave J. had misdirected
the jury as to the effect of the clause, but being of opinion that no substantial wrong or miscarriage had
been thereby occasioned in the trial within the meaning of Order XXXIX. r. 6, and that the verdict was right
and the damages not excessive, dismissed the application with costs. Their Lordships appear to have
considered that looking at the nature of the libel, even if the direction had been the other way the jury might
properly, and would probably, have given the same verdict. Against this decision the defendant brought the
present appeal. Order XXXIX. r. 6 of the Rules of the Supreme Court provides that “a new trial shall not
be granted on the ground of misdirection or of the improper admission or rejection of evidence, … unless
in the opinion of the Court to which the application is made some substantial wrong or miscarriage has been
thereby occasioned in the trial.
Sir E. Clarke Q.C. and Bigham Q.C. (Atherley Jones and H. Greenwood with them) for the appellant. The
defendant was entitled to have his case put to the jury, but it was not put. An erroneous case instead of the
real case was put. The jury were told in fact that it was a libel and they would be justified in giving their
verdict upon that assumption. The fact that the Court may think that the result was right is not conclusive
on the question of substantial wrong or miscarriage. So to hold would be to substitute the Court for the jury,
whose peculiar province it is to assess the damages in an action of libel. No one can say for certain how far
the jury may have been influenced by the misdirection which was upon a material point. The judge having
withdrawn the principal part of the defendant's case from the jury, there was a substantial wrong to the
defendant and a miscarriage of justice.
Sir F. Lockwood Q.C. and Odgers Q.C. (Scott Fox with them) for the respondent. The evidence shewed
that the appellant had long had a grudge against the respondent, and the jury manifestly thought that he was
actuated by malice, or they would not have given such damages. And the worst part of the libel was not the
allegation as to the respondent making a profit as solicitor, but the comments and allusions to swindlers.
There is no reason to suppose that even if the direction of Cave J. had been in favour of the appellant the
jury would have given smaller damages for a libel so malicious and unfounded. The question whether there
has been a substantial wrong or miscarriage is for the opinion of the Court and if the Court consider (as the
Court of Appeal did) that the jury would have given, and would have been justified in giving the same
verdict, if there had been no misdirection, there ought not to be a new trial. The clause in the memorandum
was difficult, of construction and the respondent might well construe it to mean that he was entitled to profit
costs. There was not the slightest evidence in support of the appellant's reflections upon the respondent's
character: that was the main point, and the question under the clause was of minor importance.
Dec. 18.
LORD HALSBURY L.C.
My Lords, in this case, an action for libel, the learned judge directed the jury that the plaintiff, who was a
solicitor, was entitled to charge an institution, of which he was himself both occasionally the solicitor and
also a governor—that is, a person entrusted with the government and management of the institution in
question—the profit costs which he would have been entitled to charge if he had not filled that character.
It is not necessary to consider whether the institution could have given such a consent as would have enabled
him to have taken such profit, because I am of opinion that no such consent was, in fact, given; the matter
relied upon is absolutely irrelevant to such a question. It cannot now be denied that this was a misdirection.
The only question, therefore, which we have to deal with is whether, in the language of the rule applicable
to this matter, a substantial wrong or miscarriage has been thereby occasioned at the trial. My Lords, I think
there has been a substantial wrong and a miscarriage. I think there has been a substantial wrong, since I
think the defendant was not permitted to present his case to the jury with the argument that his original
complaint was true. This seems to me a substantial wrong, and I am not prepared to say what a jury might
think if they were told that the original complaint was itself unfounded, or if they were told that, though
this original complaint was well founded, there was excess in the language by which that original complaint
was made; but it appears to me that it was, in this case, withdrawing from the jury a question which the
defendant had a right to have submitted—a right which was so relevant and important to the discussion that
I must say I cannot regard it as trivial or immaterial matter; and I think it was a miscarriage, as this view
was not presented to the jury. What influence such a wrong might have had upon the verdict or upon the
amount of damages I am not disposed to consider. The case must be tried again, and I desire to say nothing
which can in any way influence the arguments upon the trial which must take place. It is nothing to the
purpose to say that the rest of the printed matter complained of as a libel would justify a verdict to the same
amount of damages. I absolutely decline to speculate what might have been the result if the judge had
rightly directed the jury. It is enough for me that an important and serious topic has been practically
withdrawn from the jury, and this is, I think, a substantial wrong to the defendant. I do not think it desirable
to say what would be my own construction of the rule in other cases not now before media am, therefore,
of opinion that the judgment of the Court of Appeal should be reversed, and that a new trial should be
ordered; and I move your Lordships accordingly.
LORD WATSON.
My Lords, I shall endeavor, without recapitulating the facts of this case, to indicate the considerations which
have led me to differ from the conclusion arrived at by the learned judges of the Appeal Court. The error
committed by the presiding judge consisted in his directing the jury that the respondent, as a governor of
the Yorkshire College, was legally justified in charging and accepting payment of full professional
remuneration in respect of services rendered by him to the college in his capacity of solicitor. Your
Lordships can entertain no doubt that the respondent was neither entitled to charge profit costs in respect
of these services, nor to retain them when received by him. Such a breach of the law may be attended with
perfect good faith, and it is, in my opinion, insufficient to justify a charge of moral obliquity, unless it is
shewn to have been committed knowingly or with an improper motive. Order XXXIX. r. 6 of the Supreme
Court Rules makes it imperative that a new trial shall not be granted on the ground of misdirection, unless,
in the opinion of the Court, “some substantial wrong or miscarriage has been thereby occasioned in the
trial.” I think it is clear that the misdirection given by Cave J. at the trial was such as to occasion a
miscarriage in the sense in which that word was understood by the legal profession at the time when the
Rules of 1883 were framed. The only question, therefore, which your Lordships have to consider is, whether
the miscarriage has been substantial within the meaning of the order. Every party to a trial by jury has a
legal and constitutional right to have the case which he has made, either in pursuit or in defence, fairly
submitted to the consideration of that tribunal. In the present instance the case made in evidence by the
appellant was not submitted to the jury. The whole imputations in his letter of February 26, 1894, which
are said to be libellous, arise out of and are strung upon the allegation that the respondent’s acceptance and
retention of full remuneration for the professional services rendered by him to the college were in violation
of the law. The text or basis of these imputations was, in point of fact, true; but the case went to the jury on
the footing that it was false. It is plain that the learned judge did not regard its falsity as an immaterial
feature of the case which the jury had to consider. He told the jury: “In my judgment he” (i.e., the
respondent)“was not making a profit illegally or improperly, and if it was not illegal or improper, of course
Mr. Ford could not know that it was either; and that does impute to him conduct which, if it were true,
would no doubt tend to lower him in public estimation, and properly so tend. “I have already indicated my
opinion that the illegality of the respondent's conduct would not necessarily justify a charge of acting
improperly if the impropriety imputed meant anything more than illegality; and I agree with the learned
judges of the Appeal Court in thinking that, assuming illegality, there are other imputations in his letter
which might sustain a verdict against the appellant. I do not profess to know all the considerations by which
juries are influenced in arriving at their verdict; but it does appear to me that, in assessing damages, a jury
might reasonably take into their consideration whether the charge upon which libellous imputations were
made by way of comment was or was not in itself a libel. In the one aspect, the appellant's letter conveyed
a wholly baseless and libellous charge; in the other, a well-founded accusation, followed up by language
which conveyed other and libellous imputations. I do not feel myself in a position to affirm that, in each of
these cases, the same jury would have awarded the same sum of damages. I could not possibly arrive at that
conclusion without first assessing the damages in each case for myself; and that is a duty which, in my
opinion, I ought not to undertake in a case like the present. In such a case the assessment of damages does
not depend upon any definite legal rule, and is the peculiar function of the jury, by whom the party liable
is entitled to have the measure of his pecuniary liability determined. For these reasons I have come to the
conclusion that there has been a substantial miscarriage within the meaning of Order XXXIX. r. 6, and that
the case must be remitted for a new trial. I have purposely abstained from suggesting any general rule
applicable to the construction of Order XXXIX. r. 6. I doubt the possibility of formulating any rule which
would be useful, and I do not doubt the inexpediency of making the attempt. Each case must depend upon
its own circumstances. My noble and learned friend Lord Macnaghten, who is unable to be present, has
requested me to state that he concurs in the views which I have expressed.
LORD HERSCHELL. My Lords, in this case the respondent obtained a verdict for GBP 600 in an action
of libel tried before Cave J. and a special jury at Leeds. The respondent is a solicitor, and has been for some
years vice-chairman of the council of the Yorkshire College. He has manifested his interest in the work of
the college by large pecuniary contributions. Either alone or in conjunction with his partner he has acted as
solicitor to the college since its incorporation nearly twenty years ago. Prior to 1878, in which year he
entered into partnership with another solicitor, he made a present of his time and labour to the college. After
entering into partnership he considered that he was not at liberty to do so. He informed the college of this,
and bills of costs were afterwards delivered to and charged against the college in the usual way. The total
amount of the profit received by the respondent on these bills of costs, which covered the period from 1879
to 1893, was 103l. 10s. His annual subscriptions to the college during the same period considerably
exceeded that amount. The libel complained of was a copy of a letter addressed to the respondent, which
was sent to more than 300 of the governors of the college and to some other persons. The letter commenced
by stating that the respondent, whilst holding the fiduciary position of vice-chairman of the college, had
been illegally and improperly, as he knew, making profit as its paid solicitor. On this were founded some
comments which a jury would be, to say the least, justified in regarding as gravely libellous. At the trial it
was contended that the respondent was, by virtue of the fourth clause of the college’s memorandum of
association, entitled to receive remuneration for his services, notwithstanding the position he held as vice-
chairman of the council. The learned judge adopted this view, and so directed the jury. The Court of Appeal
have held that this was erroneous, and I agree with them. I do not think the words relied on have the effect
contended for. It is not now in controversy that if this be so the respondent was not warranted in making a
charge for his professional services. It is an inflexible rule of a Court of Equity that a person in a fiduciary
position, such as the respondent's, is not, unless otherwise expressly provided, entitled to make a profit; he
is not allowed to put himself in a position where his interest and duty conflict. It does not appear to me that
this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the
consideration that, human nature being what it is, there is danger, in such circumstances, of the person
holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom
he was bound to protect. It has, therefore, been deemed expedient to lay down this positive rule. But I am
satisfied that it might be departed from in many cases, without any breach of morality, without any wrong
being inflicted, and without any consciousness of wrong-doing. Indeed, it is obvious that it might sometimes
be to the advantage of the beneficiaries that their trustee should act for them professionally rather than a
stranger, even though the trustee were paid for his services. It is clear, however, that the learned judge
misdirected the jury, and that, as the misdirection cannot be said to have been on a point wholly immaterial,
the appellant would have been entitled, prior to the Judicature Act, to a new trial as of right. Order XXXIX.
r. 6 provides that a new trial shall not be granted on the ground of misdirection, unless, in the opinion of
the Court, some substantial wrong or miscarriage has been thereby occasioned in the trial. The Court of
Appeal came to the conclusion that there had been no such wrong or miscarriage in the present case. They
thought, as I understand, that the nature of the libel was such that the jury would have been entitled to give,
and would probably have given, the same verdict, even if the direction of the learned judge had been the
other way. If I had thought that the enactment relied on sanctioned dealing with the case in this way, I am
far from saying that I should have differed from the conclusion at which they arrived. But I have come,
with some reluctance, I own, to the conclusion that it does not. The provision is, in my opinion, a very
beneficial one, and I should be sorry to say anything to narrow its scope further than the language employed
seems to me to render necessary. In cases in which the question is what are the facts, or the proper inferences
to be drawn from the facts, if the Court think that the verdict of the jury is in accordance with the true view
of the facts and of the inferences to be drawn from them, it may be that they would have done right in
refusing to grant a new trial on the ground of misdirection, even where the parties had a right to claim that
the action should be tried by a jury. But in the case of an action for libel, not only have the parties a right
to trial by jury, but the assessment of damages is peculiarly within the province of that tribunal. The
damages cannot be measured by any standard known to the law; they must be determined by a consideration
of all the circumstances of the case, viewed in the light of the law applicable to them. The latitude is very
wide. It would often be impossible to say that the verdict was a wrong one, whether the damages were
assessed at GBP 500 or GBP 1000. Where, then, the judge so directs the jury as to lead them to take an
erroneous view of any material part of the alleged libel, and this view may have affected their minds in
considering what damages they should award, I think there has been a substantial miscarriage within the
meaning of the rule. The Court may think, as I might think in the case before your Lordships, that the jury
would have given the same damages if the law had been correctly expounded; but this is a mere matter of
speculation: it cannot be asserted with the least certainty that they would have done so. The jury have
returned their verdict on what they were erroneously led to think was the case, and not on the real case
which the defendant was entitled to have submitted to them. I find it impossible to say that the case upon
which the jury ought to have adjudicated ever was wholly before them, and that they were allowed to give
to all the circumstances which might legitimately have influenced the verdict their due weight. This seems
to me to establish that there has been a substantial miscarriage, and that the appellant is entitled to a new
trial.
LORD SHAND. My Lords, I am of the same opinion, and, after the judgments already delivered, I shall
endeavour to state shortly the reasons which have satisfied me that a substantial wrong or miscarriage was
occasioned at the trial by the misdirection of the learned judge, and that in consequence the appellant is
entitled to have the verdict set aside. The plaintiff complained of the alleged libel, that it imputed to him
that he had wilfully and knowingly acted illegally and improperly in claiming and receiving profits when
acting as solicitor for the Yorkshire College while he held the fiduciary position of a member of the council
and was vice-chairman of the college, and further that he acted from base, selfish and sordid motives, and
was a man of the same character as the wire-pullers in the Liberator group of swindling companies, and
that he had used religious, educational and philanthropic schemes as a hypocritical cover for the purpose of
serving his own ends. In the conduct of the case before the jury the plaintiff maintained what is very material
to the present controversy, that the libel thus complained of was wholly unjustifiable, because there was no
foundation for even the charge of his having claimed and received profits to which he was not legally and
properly entitled, as by the memorandum of association of the college he was entitled to claim and receive
the fees for business which had been paid to him. The important bearing on the issue before the jury of the
question whether the plaintiff was or was not entitled to charge and receive fees for professional business
done for the college is apparent. If the plaintiff was entitled to these fees or profits then the libel was entirely
unjustifiable, and the defendant was completely deprived of even the suggestion that to any extent he had
acted in the public interest. If the plaintiff was not entitled to make the charges the defendant was in a
position to plead that the plaintiff was so far in the wrong that to this extent the libel was justified, and that
he had truly acted in the public interest—considerations which had a material bearing on the question of
damages. The plaintiff asked and obtained from the learned judge who presided at the trial a direction in
law in his favour on the point of his legal right to make the charges; but it has been found, on a more careful
consideration of the matter than could be given in the hurry of a trial, that this direction was erroneous.
What was the effect of this, or what is it reasonable to infer was the effect? It appears from the charge of
the learned judge that he treated the legal question as having an important bearing on the verdict. His
Lordship said: “In my judgment he” (the plaintiff) “was not making a profit illegally or improperly, and if
it was not illegal or improper, of course Mr. Ford could not know that it was either; and that” (meaning the
alleged libel) “dose impute to him conduct which, if it were true, would no doubt tend to lower him in
public estimation, and properly so tend.” And in another passage he said: “It is for you to say whether it is
true that the defendant was actuated by an honest desire to improve the public service, or whether under the
guise of doing a public service he was seeking to gratify a feeling of spite and ill-will to the plaintiff.” It is
obvious that it was a very material consideration in the determination of this question whether the alleged
libel was a gratuitous charge entirely without foundation, because the plaintiff was by law entitled to the
profits he had made, or whether, on the contrary, the defendant was right in saying that the plaintiff was not
entitled to these profits. The misdirection was therefore on a matter clearly material to the issue, which in
reference to the point last noticed might possibly have even affected the question whether the plaintiff was
entitled to a verdict, and which in any view might seriously affect the question of damages. There was
therefore primâ facie a substantial wrong or miscarriage occasioned by the misdirection. It has been argued,
however, and the argument has found favour with the judges of the Court of Appeal, that if the case be
looked further into it will be found that no such wrong or miscarriage was occasioned. It is said that in any
view the libel contained unfounded charges of a most serious nature, imputing base motives to the plaintiff
in his conduct and seriously affecting his moral character, and that the sum of damages found by the jury
only does substantial justice in this view of the case. I agree with your Lordships in holding that this view
cannot be sustained. It in effect asks that another and different case than that presented to the jury shall be
tried, and tried, not by the proper tribunal of a jury, but by a Court of Appeal. The Court is asked to consider
the libel and the evidence for the purpose of seeing whether liability exists on a view different from that
formerly presented, and whether the damages given on the case formerly presented will not fit in suitably
with this different case. I am clearly of opinion that, useful as the provision of rule 6 of Order XXXIX. may
prove in other cases it ought not to be carried so far as the respondent's argument would carry it, and that
the Court cannot be asked, in order to sustain a verdict which involves a substantial wrong to the defendant,
not merely to assess damages, but to do so in trying a case materially different from that laid before the
jury. The plaintiff may be fully warranted in believing that he will again obtain a verdict for an amount not
less than the jury has awarded; but the defendant is entitled to have the real case submitted to the jury, and
to have the amount of damages on that case assessed by them.
Judgment and order appealed from reversed: directed that a new trial be had, the costs of the proceedings
in both Courts below to abide the event of the new trial: the respondent to repay to the appellant all damages
and costs already paid to him, and to pay the appellant's costs in this House: cause remitted to the Queen's
Bench Division. Lords Journals December 18, 1895.1.Clause 4 was as follows: “The income and property
of the association, whencesoever derived, shall be applied solely towards the promotion of the objects of
the association, as set forth in this memorandum, and no portion thereof shall be paid or transferred, either
directly or indirectly, by way of dividend, bonus, or otherwise howsoever by way of profit to the persons
who at any time are or have been members of the association, or to any of them, or to any person claiming
through any of them, provided that nothing herein shall prevent the payment in good faith of remuneration
to any officers or servants of the association, or to any members of the association, or other person, in return
for any services actually rendered to the association, or by way of reimbursement of payments made, or
costs, charges, or expenses incurred in or about the business of the association, or on behalf of the
association, or the award or payment in good faith to any member of the association of any honorary
distinction or emolument to which he would be entitled according to the rules and regulations of the
association, independently of his being a member.
North-West Transportation Co. Ltd. v. Beatty 12 S.C.R. 598
The facts of the case, which are fully set out in the first report may be briefly stated as follows:—
James H. Beatty, one of the directors of the North-West Transportation Company, had a boat called the
“United Empire,” which he was desirous of selling to the company. In order to effect such sale he became
the owner of more than half the shares of the company, a few of which he transferred to the defendants,
Rose and Laird, and at the first annual meeting thereafter the said James H. Beatty, and the defendants Rose
and Laird, were elected directors and constituted a majority of the board, which was composed of five.
The board passed a by-law authorizing the purchase by the company of the said boat, and a meeting of the
shareholders was subsequently called at which such by-law was confirmed, the said James H. Beatty being
present and voting for such confirmation. Without his vote the resolution could not have been passed as he
himself voted on nearly half the stock of the company, the capital stock being 600 shares, and there was
only a majority of seventeen in favor of the resolution.
The plaintiff Henry Beatty, one of the shareholders of the company who voted against the resolution to
confirm the by-law, took proceeding on behalf of himself and the other dissentient shareholders to have the
sale of the said boat to the company set aside, and a decree was made by the chancellor ordering it to be set
aside. The Court of Appeal reversed this decree, holding that though the by-law was illegal the action of
the shareholders was lawful, and effected a valid contract of sale. From this decision the plaintiff appealed
to the Supreme Court of Canada.
Sir W.J. RITCHIE C.J.—Though it may be quite true, as a general proposition, that a shareholder of a
company, as such, may vote as he pleases, and for purposes of his own interest, on a question in which he
is personally interested, does that proposition necessarily cover this case? Is it not abundantly clear that,
whatever a simple stockholder may do, no director is entitled to vote, as a director, in respect to any contract
in which he is personally interested? Directors cannot manage the affairs of the company for their own
personal and private advantage; they cannot act for themselves and, at the same time, as the agents of the
corporation whose interests are conflicting; they cannot be the sellers of property and the agents of the
vendee; there must be no conflict between interest and duty; they cannot occupy a position which conflicts
with the interests of the parties they represent and are bound to protect. Is it not somewhat of a mockery to
say that this by-law and sale were invalid and bad, and not enforceable against the company as being
contrary to the policy of the law by reason of a director entering into the contract for his personal benefit
where his personal interests conflicted with the interests of those he was bound to protect, but that it can be
set right by a meeting of the shareholders, by a resolution carried by the vote of the director himself against
a large majority of the other shareholders? If this can be done how has the conflict between self-interest
and integrity ceased?
While recognizing the general principle of non-interference with the powers of the company to manage its
own affairs, this case seems to me to be peculiarly exceptional; a director, acting for the company, makes
a sale, acting for himself, to the company, a transaction admittedly indefensible; this purchase is submitted
to the shareholders, and the director, having acquired a controlling number of votes for this purpose, secures
a majority by his own votes thus obtained without which the purchase would not have been sustained, and
confirms as a shareholder his invalid act as a director, and thus validates a transaction against which the
policy of the law utterly sets its face.
It does seem to me that fair play and common sense alike dictate that if the transaction and act of the director
are to be confirmed it should be by the impartial, independent, and intelligent judgment of the disinterested
shareholders, and not by the interested director himself who should never have departed from his duty. If
he had done his duty and refrained from acting in the transaction as a director the by-law might never have
been passed, and the contract of sale never entered into; and having acted contrary to his duty to his
co‑shareholders he disqualified himself from taking part in the proceedings to confirm his own illegal act;
and then to say that he was a legitimate party to confirm his own illegal act seems to me simply absurd, for
nobody could doubt what the result in such a case would be, as the futileness of the interested, but
discontented shareholders attempting to frustrate the designs of the interested director with his majority is
too manifest; but he, if he had done his duty towards them and refrained from entering into the transaction,
would never have been in the position of going through this farce of submitting this matter to the
shareholders, and when so submitted of himself voting that he, though he had acted entirely illegally, had
done right, and thereby binding all the other shareholders who thought the purchase undesirable; or in other
words, by his vote carrying a resolution that the bargain he himself had made for the company as buyer,
from himself as seller, was a desirable operation and should be confirmed.
I cannot distinguish this case in principle from Erlanger v. The New Sombrero Phosphate Co., in which a
sale by promoters of a company was made to the company. Lord Penzance thus states the general doctrine:
The principles of equity to which I refer have been illustrated in a variety of relations, none of them perhaps
precisely similar to that of the present parties, but all resting on the same basis, and one which is strictly
applicable to the present case. The relations of principal and agent, trustee and cestui que trust, parent and
child, guardian and ward, priest and penitent, all furnish instances in which the courts of equity have given
protection and relief against the pressure of unfair advantage resulting from the relation and mutual position
of the parties, whether in matters of contract or gift; and this relation and position of unfair advantage once
made apparent, the courts have always cast upon him who holds that position the burden of showing that
he has not used it to his own benefit.
And Lord Cairns, speaking of the duty of promoters of a company, makes these observations:
It is now necessary that I should state to your lordships in what position I understand the promoters to be
placed with reference to the company which they proposed to form. They stand, in my opinion, undoubtedly
in a fiduciary position. They have in their hands the creation and moulding of the company; they have the
power of defining bow, and when, and in what shape, and under what supervision it shall start into existence
and begin to act as a trading corporation.
If they are doing all this in order that the company may, as soon as it starts into life, become, through its
managing directors, the purchaser of the property of themselves, the promoters, it is, in my opinion,
incumbent upon the promoters to take care that in forming the company they provide it with an executive,
that is to say, with a board of directors, who shall both be aware that the property which they are asked to
buy is the property of the promoters, and who shall be competent and impartial judges as to whether the
purchase ought or ought not to be made. I do not say that the owner of property may not promote and form
a joint stock company and then sell his property to it, but I do say that if he does he is bound to take care
that he sells it to the company through the medium of a board of directors who can and do exercise an
independent and intelligent judgment on the transaction, and who are not left under the belief that the
property belongs, not to the promoter, but to some other person.
The following American cases, also, contain the same doctrine. Ogden v. Murray.
This brings the case within the rule, which rests in the soundest wisdom, and is sustained by the best
consideration of the infirmities of our human nature, and called for by the only safe protection of the
interests of cestui que trust, or beneficiaries, viz., that trusties, and persons standing in similar fiduciary
relations, shall not be permitted to exercise their powers, and manage or appropriate the property, of which
they have control for their own profit or emolument, or, as it has been expressed, “shall not take advantage
of their situation, to obtain any personal benefit to themselves at the expense of their cestui que trust.”
This by no means assumes that the trustees were not, in this case, in the actual exercise of the highest
integrity. I cannot for a moment doubt that, in reference to the particular case before us; but the principle is
one of great importance, and it forbids any inquiry into the honesty of a particular case.
The three leading cases in this country are Michaud v. Girod; Coal and Iron Company v. Sherman; and the
Hoffman Steam Coal Company v. Cumberland Coal and Iron Company. In these cases will be found a full,
able and exhaustive discussion of the question and a thorough examination of the English and American
cases.
If this is so as regards promoters, why should it not apply with equal force to directors and shareholders
selling to the company? This sale was not made through the medium of aboard of directors who would,
could and did exercise an independent and intelligent judgment on the transaction, and it will be a bold man
who will say that Mr. Beatty, either as a director or shareholder, was a competent and impartial judge as to
whether the purchase ought or ought not to be made.
In my opinion, the whole policy of the law is against the recognition of such a transaction as this, which, if
permitted, would open a door by which directors would be enabled successfully to subvert that wise rule
which prevents a party from being at the same time buyer and seller, to the injury and wrong of dissatisfied
shareholders, and whereby directors recreant to their duty may illegally benefit themselves at the expense
of those whose interests it is their duty to protect by forcing the property on unwilling purchasers on their
own terms, thereby subverting the commonly received idea, and treating as a vulgar error the ordinarily
received notion, that it requires two to make a bargain.
I think it is clear in this case that the defendant, a director, by his action as director, and by means of the
majority secured by his own vote, obtained a benefit for himself at the expense of the minority, the rest of
the shareholders. It may possibly be that the act of Mr. Beatty as a director in obtaining the passage of this
by-law and making this sale and obtaining a sufficient number of votes to enable him thereby to carry a
resolution, at a meeting of the shareholders, to confirm such sale, and by reason thereof ratifying and
confirming the sale, may not be properly characterized as fraudulent; if not actually fraudulent it was, in
my opinion, an illegal and oppressive proceeding on his part whereby the minority of shareholders were
overreached and deprived of their right, and therefore the transaction was such a one as such a majority
could not confirm and as should not be sustained in a court of justice.
I rest this case entirely on the position Beatty held as a director and the duty which pertained to that office.
In that view it is not necessary to discuss how far, or rather under what circumstances a shareholder may
vote at a general meeting of shareholders on matters on which he is individually interested. I cannot,
however, but look upon it as rather a bold and startling proposition that a shareholder should be able to
offer a property for sale to the company from a bare majority of votes and by such vote, against the will of
all the other shareholders, compel the company to become the purchaser at his own price and on his own
terms, against the wish of all the other shareholders who may, as in this case, be a minority of 289 votes
against 306.
HENRY J.—I concur in the decision of my learned brothers. In the first place, it involves a decision as to
whether or not a shareholder has a right to vote on a matter in which he is personally interested, because, if
he had such a right, then he could vote for this sale. I think it is competent for a shareholder so to vote at a
meeting properly called. But this case does not depend upon that, because, in my opinion, the by-law passed
by the directors was improperly passed and could not be confirmed by the shareholders.
I may have no reason to suppose that Beatty did not consider it in the best interests of the company that
they should become the owners of his vessel, and the evidence is favorable on that point; and without
attributing any intentional wrong to him, we may inquire whether the by-law was, independent of that
consideration, valid.
The decision of the directors in favor of the by-law was obtained by the votes of the party who was selling
the property. It is well settled that the same party cannot be buyer and seller; a director of a company has a
fiduciary character, and he is bound to exercise his functions in the best interests of the company. Where
he is himself personally placed in interest in antagonism to the company, his acts are to be considered
illegal. The by-law was, in this case, the foundation of the resolution of the shareholders; the directors
would not have passed it, but for the vote of the party who was interested in making the sale. The
shareholders would not have confirmed the by-law if Beatty had not purchased sufficient additional shares
to give him a majority of the votes, so that, by his own act he occupied such a position as director and
shareholder as enabled him to deal altogether in his own interests. Now this, if such were tolerated, would
enable any person who intended to wrong a company to compel them to purchase, at an exorbitant price,
property of which he was the owner. To sanction the exercise of such a power would be dangerous and
wrong. I think the sale in this case was illegal, and the judgment of the court below should be reversed with
costs.
Dale & Carrington v. Prathapan (2005) 1 SCC 212

Ramanujam had returned to Kerala, his native place, after resigning his job as an accountant in England in
the year 1983. He was looking for an opportunity to work. Prathapan, also native of Kerala, had been
working in Muscat since long and was staying there along with his family. The mother of Parthapan, named
Kalyani Kochuraman, was living in Kerala. Prathapan had two sons. According to Prathapan his sons were
desirous of returning to India and settling down in their native place.
Therefore, Prathapan wanted to set up some business in India in order to settle his sons. Since the parties
are relations they were in touch with each other. Towards the middle of 1987 Ramanujam informed
Prathapan that a hotel called 'Hotel Siddharth' in a town called Chalakudy, was available for sale. The hotel
building had ten rooms, besides a restaurant with a bar attached to it. The partners who were running the
hotel were interested in selling it immediately. Ramanujam further informed Prathapan that the hotel was
available for down payment of Rs. 6 lakhs (Rupees six Lakhs). The purchaser, in addition, had to take upon
a liability of about Rupees 18 lakhs (Rupees eighteen lakhs) which was standing on the hotel. Ramanujam
offered to look after the business of the hotel till Prathapan decided to return to India. The parties decided
to go ahead with the purchase of the hotel for which Prathapan agreed to send Rs. Five Lakhs. Ramanujam
was to get a salary for the services to be rendered by him in looking after the business of the hotel.
A company by the name of Dale and Carrington Investments Private Limited was incorporated on 4th
November, 1986 for the hotel business. Ramanujam and his wife Draupathy were shown as the promoters
of company. On the request of Ramanujam, Prathapan sent a Bank Draft in the sum of Rs. 5 lakhs (Rupees
Five Lakhs) favouring his mother Kalyani Kochuraman on 3rd March, 1987. The draft was sent in the name
of the mother because Prathapan was an NRI and the company could not receive money directly form him.
The device of money being first sent in the name of Prathapan's mother and thereafter the mother
transferring it to the company, was suggested by Ramanujam in his letter dated 25th February, 1987 to
Prathapan. The Hotel was accordingly acquired by the company in March, 1987. A sum of Rs. 6 lakhs
(Rupees Six Lakhs) was required to be paid in cash to the vendors out of which Rs. 5 lakhs (Rupees five
lakhs) were received from Prathapan and a sum of Rs. 50,000 (Rupees Fifty Thousand) was invested by
Muralidharan, brother of Prathapan. The rest of the amount came from other respondents. There was no
financial contribution by Ramanujam.
Initially Ramanujam and his wife Draupathy were the Directors of the company. However in December,
1988 Draupathy was dropped as Director and in her place Muralidharan, brother of Prathapan and Suresh
Babu, brother of Prathapan's wife, were taken as Directors of the Company. 5000 (five thousand) equity
shares worth Rupees five lakhs were allotted in the name of Smt. Kalyani Kochuraman, mother of Prathapan
against the investment of Rupees Five Lakhs. These 5000 equity shares were subsequently transferred in
the name of Prathapan and his wife, 2500 (two thousand five hundred) each, subject to the transferees
obtaining requisite permission of the Reserve Bank of India under the Foreign Exchange Regulation Act
(FERA). The transfer of shares in the name of Prathapan and his wife Pushpa was duly record in the Register
of Members maintained by the company. Thus Prathapan and his wife Pushpa became shareholders of the
company to the extent to 2500 equity shares each.
Initially the company was making losses. However, by about year 1991-92, the company turned the corner.
Copies of balance sheets of the company for a few years of its working have been placed on record by the
appellant which show that till 31st March, 1992 there were no profits in the company. For the first time
some profits was shown as on 31st March, 1993. Till 31st March, 1993, under the head 'Advance towards
share capital pending allotment' only a sum of Rs. 3000 (Rupees Three Thousand) was shown whereas as
on 31st March, 1994 under the said head, a balance of Rs. 6,86,500 (Rupees six lakhs eighty six thousand
five hundred only) was shown. We have mentioned this figure here because it will be relevant for the main
controversy in this case.
It is the case of Prathapan that he continued to provide finance to the company by sending money to
Ramanujam from time to time. The details of some of such disbursements are as under :
 A sum of Rs. 1,00,000 in March, 1989;

 US$ 6300 in favour of Maruthi Udyog Ltd. for allotment of a vehicle for the use of second appellant
in November 1991;
 A sum of Rs. one lakh in February, 1994;
 A deposit of Rs. one lakh with State Bank of India in the year 1996 to provide bank guarantee in
favour of the sales tax authorities at Kerala;
 A sum of Rs. Nine lakhs in January, 1996 for making remittance in favour of the Sales Tax
Authorities.
According to Prathapan he was to be issued shares of the company against these remittances while
according to Ramanujam the remittances were on personal account in view of the close relationship between
the parties. The fact remains that the remittances were to Ramanujam and not to the company.
Sometime in the year 1998 Prathapan is said to have come to India to consider acquiring another Hotel for
expanding the business of the company. At that time he is said to have discovered certain startling facts
about the company. The most important fact which is at the centre of the controversy in this case is that the
company's authorised capital was increased from Rs. 15 lakhs to Rs. 25 lakhs and thereafter to Rs. 35 lakhs
without the knowledge of Prathapan, a principal, shareholder of the company. Further in an alleged meeting
of the Board of Directors of the company said to have been held on 24th October, 1994, chaired by
Ramanujam, the Board of Directors of the company is said to have been informed about a sum of Rs.
6,86,500 (Rupees six lakhs eighty six thousand five hundred only) standing standing to the credit of
Ramanuajum in the books of the company. He made a proposal for allotment of shares in lieu of that amount
in his favour. As per the case of Ramanujam the Board allotted 6,865 equity shares of Rs. 100 each in the
said meeting in his favour.
According to Prathapan he was never made aware of the increase in authorised share capital of the Company
and the alleged allotment of additional equity shares of the company in favour of Ramanujam. The alleged
allotment reduces Prathapan, who was a majority shareholder in the company, to a minority shareholder in
the company. Prathapan challenged this alleged allotment of shares in favour of Ramanujam by filing a
Company Petition under Sections 397 and 398 of Companies Act before the Company Law Board in July,
1999. The main challenge in the Company Petition filed by Prathapan alongwith his wife as co-petitioner,
was to the said alleged allotment of 6865 equity shares of Rs. 100 each of the company. This was alleged
to be an act of oppression on the part of Ramanujam who was managing the company. Prayer was made
that the allotment of shares be set aside, and necessary correction be made in the Register of Members of
the company.
According to Prathapan Ramanujam did not contribute any money from his own resources for purposes of
the company while all along he drew a handsome salary for working as the Managing Director. His
maximum investment in the company could not be more than Rs. 20,000. He committed fraud and breach
of trust as a result of which Prathapan and his wife had been totally marginalised in the company. In fact,
Muralidharan, brother of Prathapan was removed from the Board of Directors of the company on 1st
October, 1994 while Suresh Babu, brother-in-law of Prathapan and brother of Pushpa, (Prathapan's wife)
was removed was Director on 30th September, 1996: Prathapan also alleged that Ramanujam siphoned off
funds of the company for personal gains.
Issue – Whether the allotment of equity shares in favour of Ramanujam from is a bonafide act in the interest
of the Company on the part of Directors of the Company?
At this stage it may be appropriate to consider the legal position of Directors of companies registered under
the Companies Act. A company is a juristic person and it acts though its Directors who are collectively
referred to as the Board of Directors. An individual Director has no power to act on behalf of a company of
which he is a Director unless by some resolution of the Board of Directors of the Company specific power
is given to him/her. Whatever decisions are taken regarding running the affairs of the company, they are
taken by the Board of Directors. The Directors of companies have been variously described as agents,
trustees or representatives, but one thing is certain that the Directors. act on behalf of a company in a
fiduciary capacity and their acts and deeds have to be exercised for the benefit of the company. They are
agents of the company to the extent they have been authorized to perform certain acts on behalf of the
company. In a limited sense they are also trustees for the shareholders of the company. To the extent the
power of the Directors are delineated in the Memorandum and Articles of Association of the company, the
Directors are bound to act accordingly. As agents of the company they must act within the scope of their
authority and must disclose that they are acting on behalf of the company. The fiduciary capacity within
which the Directors have to act enjoins upon them a duty to act on behalf of a company with utmost good
faith, utmost care and skill and due diligence and in the interest of the company they represent. They have
a duty to make full and honest disclosure to the shareholders regarding all important matters relating to the
company. It follows that in the matter of issue of additional shares, the directors owe a fiduciary duty to
issue shares for a proper purpose. This duty is owed by them to the shareholders of the company. Therefore,
even though Section 81 of the Companies Act which contains certain requirements in the matter of issue of
further share capital by a company does not apply to private limited companies, the directors in a private
limited company are expected to make a disclosure to the shareholders of such a company when further
shares are being issued. This requirement flows their duty to act in good faith and make full disclosure to
the shareholders regarding affairs of a company. The acts of directors in a private limited company are
required to be tested on a much finer scale in order to rule out any misuse of power for personal gains or
ulterior motives. Non-applicability of Section 81 of the Companies Act in case of private limited companies
casts a heavier burden on its directors. Private limited companies are normally closely held i.e. the share
capital is held within members of a family or within a close knit group of friends. This brings in
considerations akin to those applied in cases of partnership where the partners owe a duty to act with utmost
good faith towards each other. Non-applicability of Section 81 of the Act to private companies does not
mean that the directors have absolute freedom in the matter of management of affairs of the company. In
the present case Article 4 (iii) of the Articles of Association prohibits any invitation to the public for
subscription of shares or debentures of the company. The intention from this appears to be that the share
capital of the company remains within a close knit group. Therefore, if the directors fail to act in the manner
prescribed above they can in the sense indicated by us earlier be held liable for breach of trust for
misapplying funds of the company and for misappropriating its assets.
The learned counsel for the appellants argued that Articles of Association of the company give absolute
power to the Board of Directors regarding issue of further share capital. The Board of Directors exercised
the power while issuing further shares in favour of Ramanujam and the same cannot be challenged. In our
view, this argument has no merit because the facts of the case do not support the argument. Firstly, the
Articles of Association require such decisions regarding issue of further share capital to be taken in a
meeting of the Board of Directors and we have found that the alleged meeting of the Board of Directors in
which the additional shares are purported to have been issued in favour of Ramanujam was sham. Secondly,
assuming for the sake of argument that meetings of Board of Directors did take place the manner in which
the shares were issued in favour of Ramanujam wihtout informing other shareholders about it and without
offering them to any other shareholder, the action was totally malafide and the sole object of Ramanujam
in this was to gain control of the company by becoming a majority shareholder. This was clearly an act of
oppression on the part of Ramanujam towards the other shareholder who has been reduced to a minority
shareholder as a result of this act. Such allotments of shares have to be set aside.
On the role of Directors, the law is well settled. The position has been the subject matter of various
decisions. Some of them are :
In Regal (Hastings) Ltd. v. Gulliver and Others, (1942) l All ER 379 Lord Russel of Killowen observed as
under :
"Directors of a limited company are the creatures of a statute and occupy a position peculiar to themselves.
In some respects they resemble trustees, in others they do not. In some respects they resemble agents, in
others they do not. In some respects they resemble managing partners in others they do not. The said
judgment quotes from Principles of Equity by lord Kames. In one sentence the entire concept is conveyed.
The sentence runs "Equity prohibits a trustee from making any profit by his management, directly or
indirectly. Ultimately the issue in each case will depend upon facts of that case".
Lindley MR observed in Alexander v. Automatic Telephone Co., (1900) 2 Ch. 56 at page 66-67 :
"The Court of Chancery has always exacted from directors the observance of good faith towards their
shareholders and towards those who take shares from the company and become co-adventurers with
themselves and others who may join them. The maxim "Caveat emptor" has no application to such cases,
and directors who so use their powers as to obtain benefits for themselves at the expense of the shareholders,
without informing them of the fact, cannot retain those benefits and must account for them to the company,
so that all the shareholders may participate in them."
Piery v. S. Mills & Co. Ltd., (1920) l Ch. 77 applied the same principle while holding :
"the basis of both cases is, as I understand, that Directors are not entitled to their powers of issuing shares
merely for the purpose of maintaining their control or the control of themselves and their friends over the
affairs of the company, for merely or the purpose of defeating the wishes of the existing majority of
shareholders."
In Hogg v. Cramphorn Ltd., (1967) l Ch. 254, Buckley, J. reiterated the principle in Punt and in Piercy. It
was held that if the power to issue shares was exercised for an improper motive the issue was liable to be
set aside and it was immaterial that the issue was made in a bona fide belief that it was in the interests of
the company.
The principle deduced from these cases is that when powers are used merely for an extraneous purpose like
maintenance or acquisition of control over the affairs of the company, the same cannot be upheld.
Courts in the Commonwealth countries including England and Australia have emphasized that the duty of
the Directors does not stop at "to act bonafide" requirement. They have evolved a doctrine called the 'proper
purpose doctrine' regarding the duties of company directors. In Hogg v. Cramphorn, (supra), explicit
recognition was given to the proper purpose test over and above the tribunal bonafide test. In this case the
director had allotted shares with special voting rights to the trustees of a scheme set up for the benefit of
company employees with the primary purpose of avoiding a takeover bid. Buckley, J. found as a fact that
the directors had acted in subjective good faith. They had indeed honestly believed that their actions were
in best interest of the company. Despite this it was observed :
"an essential element of the scheme, and indeed its primary purpose, was to ensure control of the company
by the directors and those whom they could confidently regard as their supporters."
As such, he concluded that the allotment was liable to be set aside as a consequence of the exercise of the
power for an improper motive. He also held that the power to issue shares was fiduciary in nature. In
Howard Smith Ltd. v. Ampol Petroleum Limited, (1974) AC 821, the Privy Council confirmed the above
view expressed by Buckley, J. which shows a preference for the proper purpose doctrine. The Privy Council
felt that the bonafide test was not sufficient to meet the challenge because it failed to encompass the
obligation of directors to be fair. The directors' acts should not only satisfy the test of bonafides, they should
also be done with a proper motive, Any lingering doubts over the status of the proper purpose doctrine as a
separate and independent head of directors duty within the common law jurisdiction have been laid to rest
by two decision of the Court of Appeal in England in Rolled Steel Products (Holdings) Limited v. British
Steel Corporations, (1986) Ch. 246 and Bishopsgate Investment Management Ltd. (in liquidation) v.
Maxwell (No. 2), [1994] l All ER 261. It was held by the Court of Appeal in Bishopsgate that the bonafides
of the directors alone would not be determinative of the propriety of their actions. In a parallel development
in Australia the proper purpose doctrine has been approved in a decision of the High Court in Whitehouse
v. Carlto Hotel Pty. Ltd., (1987) 162 CLR 285.
The Tea Brokers (P) Ltd. and Others v. Hemendra Prosad Barooah, (1998) 5 Company Law Journal 463
was also a case of a minority shareholder who on becoming managing director of the company, issued
further share capital in his favour in order to gain control of management of the company. Barooah and his
friends and relations were majority shareholders of the respondent company having 67% of the total issued
capital of the company. Barooah personally held 300 equity shares out of 1155 shares issued by the
company. He was at all material times a director of the company. His case was that he was wrongfully an
illegally ousted from the management of the company. One Khaund, who initially started as an employee
of the company had 110 shares in the company and belonged to theminority goup. Khaund was appointed
as the managing director of the company. Barooah's grievance was that Khaund took advantage of his
position as managing director and acted in a manner detrimental and prejudicial to the interests of the
company and in a manner conducive to his own interest. Khaund had hatched a plan with other directors to
convert petitioner Barooah into a minority and to obtain full and exclusive control and management of the
affairs of the company. In a petition filed under Sections 397 and 398 of the Companies Act, 1956, acts of
Khaund were found to be by way of 'oppression and mismanagement' within the meaning of Sections 397
and 398 of the Companies Act. Allotment of 100 equity shares by the company to Khaund at a meeting of
the Board of Directors said to have been held on 14th January, 1971 was held to be illegal. The Board of
Directors of the company was superseded and a special officer was appointed to carry on manage-ment of
the company with the advice of Barooah, Khaund and a representative of labour union. There were several
other directions issued by the court which are not necessary to be mentioned here. The Division Bench
considered in detail the relevant legal position. Without using the phrase 'proper purpose doctrine' the
principle enunciated therein, was applied. The following observations of Justice A.N. Sen are reproduced:
"It is well settle that the directors may exercise their powers bona fide and in the interest of the company.
If the directors exercise their powers of allotment of shares bona fide and in the interest of the company,
the said exercise of powers must be held to be proper and valid and the said exercise of powers may not be
questioned and will not be invalidated merely because they have any subsidiary additional motive even
though this be to promote their advantage. An exercise of power by the directors in the matter of allotment
of shares, if made mala fide and in their own interest and not in the interest of the company, will be invalid
even though the allotment may result incidentally in some benefit to the company."
Further it was held that if a member who holds the majority of shares in a company is reduced to the position
of minority shareholder in the company by an act of the company or by its Board of Directors malafide, the
said act must ordinarily be considered to be an act of oppression to the said member. The member who
holds the majority of shares in the company is entitled by virtue of his majority to control, manage and run
and affairs of the company. This is a benefit or advantage which the member enjoys and is entitled to enjoy
in accordance with the provisions of company law in the matter of administration of the affairs of the
company by electing his own men to the Board of Directors of the company.
On the question of relief, the court observed :
"A majority shareholder should not ordinarily be directed to sell his shares to the minority group of
shareholders, if per chance through fortuitous circumstances or otherwise, the minority group of
shareholders come into power and management of the company. The majority shareholders by virtue of
their majority will usually be in a position to redress all wrongs done and to undo the mischief done by the
minority group of shareholders, as it will always be possible for the majority group of shareholders to regain
control of the company so long as they remain in majority in the company by virtue of the majority. Except
in unusual circumstances, the majority group of shareholders, in my opinion, should never be ordered or
directed to sell their shares to the minority group of shareholders. An orders directing the majority group
of shareholders to sell his shares to the minority group of shareholders will not redress the wrong done to
the majority group of shareholders and will not give him sufficient compensation or relief against the act
of oppression complained of by him, and, on the other hand, may add to his suffering and grievance and
cause him greater hardship. Such an order will not further the ends of justice and indeed the cause of justice
may be defeated."
On the question of issue of fresh share capital, it was held to be illegal to issue shares to only one
shareholder. This was held to be a violation of common law right of every shareholder. Common Law
recognized a pre-emptive right of a shareholder to participate in further issue of shares however. In India
in view of Section 81 of the Companies Act, such a right cannot be found for sure. However, the test to be
applied in such cases which requires the court to examine as to whether the shares were issued bonafide
and for the benefit of the company, would import such considerations in case of private limited companies
under the Indian Law. Existence of right to issue shares to one director may technically be there, but the
question whether the right has been exercised bonafide and in the interests of the company has to be
considered in facts of each case and if it is found that it is not so, such allotment is liable to be set aside.
Reference has been made to the case of Piercy v. S. Mills & Co. Ltd., (1920) l Ch 77 (Ch.D) where directors,
who controlled merely a minority of the voting power in the company allotted shares to themselves and
their friends not for the general benefit of the company, but merely with the intention of thereby acquiring
a majority of the voting power and of thus being able to defeat the wishes of the existing minority of
shareholder, it was held that, even assuming that the directors were right in considering that the majority's
wishes were not in the best interests of the company, the allotments were invalid and ought to be declared
void. It follows from this case that the exercise by directors of fiduciary powers for purposes other than
those for which they were conferred is invalid. It may be said that although the power of issuing shares is
given to directors primarily for the purpose of enabling them to raise capital when required for the purpose
of the company, this was not the object of the directors in this case..."
It will be seen from the judgment Tea Brokers (supra) that the courts in India have applied the same tests
while testing exercise of powers by directors of companies as in other Commonwealth countries.
In the present case we are concerned with the propriety of issue of additional share capital by the Managing
Director in his own favour. The facts of the case do not pose any difficulty particularly for the reason that
the Managing Director has neither placed on record anything to justify issue of further share capital nor it
has been shown that proper procedure was followed in allotting the additional share capital. Conclusion is
inevitable that neither the allotment of additional shares in favour of Ramanujam was bonafide nor it was
in the interest of the company nor a proper and legal procedure was followed to make the allotment. The
motive for the allotment was malafide, the only motive being to gain control of the company. Therefore, in
our view, the entire allotment of shares to Ramanujam has to be set aside.
Even the Company Law Board found that the allotment of additional shares by Ramanujam to himself was
an act of oppression on his part. The Company Law Board drew this conclusion solely for the reason that
no offer had been made to the majority shareholders regarding issue of further share capital. The High Court
accepted the finding of oppression. However, it placed it on a much broader base by taking into
consideration various other factors. The High Court's finding is based on a much stronger footing. In fact,
the High Court has gone on to conclude that Ramanujam has played a fraud on the minority shareholders
by manipulating the allotment of shares in his favour. We find no reason to differ with the finding of the
High Court.
Sangramsinh P. Gaekwad & Ors vs Shantadevi P. Gaekwad AIR 2005 SC 809
Sir Pratapsinghrao Gaekwad was the Ruler of Baroda. Maharani Shantadevi Gaekwad was his wife. They
had eight children. For certain reasons with which we are not concerned, the estate of Gaekwad came into
the hands of their elder son, Fatesinghrao P. Gaekwad (FRG) even during the life time of Sir Pratap Singh.
FRG floated several companies, three of which are Baroda Rayon Corporation Ltd. (BRC), Gaekwad
Investment Corporation Company Ltd. (GIC) and Alaukik Trading & Investment Corporation Pvt. Ltd.
(Alaukik). BRC came into existence in 1958. At the outset, it was being run under Managing Agency
System which was abolished in or about 1968 and later on the same was being managed by the Board of
Directors with the assistance of professional executives. Appellant No. 1 herein, the youngest son of
Pratapsinghrao Gaekwad, joined the said company in 1968. He was the Director of Managing Agents till
31.12.1969 whereafter he became the Additional Director with effect from 1st January, 1970. He in the
same year became Joint Managing Director. In April 1976, he became the Managing Director of BRC. He
was reappointed as Managing Director for two periods of five years each with effect from 19th February,
1980 and 19th February, 1985. FRG passed away on 1st September, 1988, whereafter he was appointed as
Chairman and Managing Director on 23.9.1988.
GIC was a small investment company. Its equity capital consisted of 425 shares of Rs. 100/- each. The said
shares were mainly held by the family members. A large chunk of shares was held by Jaisingh Ghorpade
Trust of which FRG was a trustee. The beneficiaries of this Trust are said to be outsiders. Some shares of
GIC were held by outsiders also.
Allegedly, GIC suffered a loss during the financial years ending 31st March, 1987 and 31st March, 1988
as a result whereof substantial parts of the equity and reserves were wiped out. It could not even pay off the
loans and credits. It had no funds to subscribe for the rights issue made in 1989 by BRC. Its shareholding
in BRC was likely to fall with which its forged fortunes were closely linked as the dividend from the shares
of BRC was the major source of income of the company. GIC came into financial trouble when BRC did
not declare dividend in 1986-87. The value of BRC shares also declined and, thus, it became difficult to
avail of an overdraft facility from the Banks. It was then decided to raise funds from the existing members.
The Board of Directors of GIC in a meeting held on 10.11.1987, decided to broad-base the company,
whereafter an extraordinary general meeting was convened on 17.12.1987. In the said EGM, a decision was
taken to increase the capital by issuing 25000 equity shares of Rs. 100/- each. The matter was again placed
in a Board Meeting of GIC on 8th January, 1988. In the said Board Meeting presided over by Appellant
No. 1 and attended by Mr. P.U. Rana and Mr. P.H. Chinoy, a resolution was passed that 15000 equity shares
of Rs. 100/- each be issued at par to the members of the company.
Pursuant to or in furtherance of the said resolution, the Company Secretary, Mr. M.N. Khade issued a
circular letter dated 12.2.1988 to all the existing shareholders requesting them to subscribe for the equity
shares at par wherefor a time limit of three weeks was fixed. It was stated that if no reply is received by
10th March, 1988 it would be presumed that the concerned shareholder was not interested in the offer.
On or about 13th February, 1988, another meeting was convened which was chaired by FRG wherein the
resolution passed in the meeting dated 8th January, 1988 was confirmed. The Managing Committee, having
regard to the fact that no offer was received from the existing shareholders, in its meeting dated 21st March,
1988 extended the time for the aforesaid offer. It was further decided that out of 15000 shares, 8000 shares
be kept apart for the time being for FRG and the balance 7000 shares be kept apart for other existing
members. Allegedly, on instructions of Appellant No. 1 herein, the Company Secretary gave first option to
the other family members to subscribe for shares according to their request and the remaining were put in
the name of Appellant No. 1 and his family; pursuant whereto only two persons, Mrs. Puar asked for
allotment of 500 shares and Mrs. Shubhanginidevi Gaekwad for 25 shares respondent and, thus, the
remaining 6475 shares were allotted to Appellant No. 1 and family.
It is further alleged that FRG became disinterested in the 8000 shares allotted to him. The contention of the
Appellants herein is that the balance 7500 shares were renunciated by FRG in his favour and in favour of
his children in June, 1988 as the same remained unallotted as other members specifically refused to take up
any share. His sons and daughters applied for further 3000 shares through Appellant No. 1 as guardian and
the same was allowed. The remaining 4500 shares, however, remained unallotted. The issue is said to have
been closed on 10.12.1988.
Allegedly, by way of tax planning, the Appellants herein decided to transfer 9415 shares in favour of Indreni
Holding Pvt. Ltd. (Indreni), a wholly owned company of the Appellants herein.
On or about 20th July, 1990, the Appellant No. 1 issued a letter to the Board of Directors that if the transfer
of shares was found to be irregular, he should be permitted to remove transfer notice as per articles. On
9.8.1990, allegedly, a Board meeting was held and the shares transferred to Indreni were rescinded. The
Respondents contend that the said plea is by way of an afterthought inasmuch as dividend had been paid to
Indreni and TDS on the amount of dividend was deposited in State Bank of India after 9.8.1990.
The said suits are still pending.
Indisputably, Respondent Nos. 1 and 12 herein took inspection of the Registers of Members and other
documents on 10.12.1996 and the relevant extracts were taken and notarised.
An Annual General Meeting was allegedly held on 20.12.1990 wherein except for appointment of auditors
all other resolutions e.g. seeking appointment of Directors in favour of Appellant No. 1, his wife (Appellant
No. 2) and his group were rejected. In the said meeting the share holdings said to have been acquired by
Indreni i.e. 9415 shares was not taken into account and the voting rights of the Appellants were kept
confined to 66 shares. It is also not in dispute that prior to the said meeting, Appellant No. 1 lodged a First
Information Report apprehending trouble in the said meeting.
Respondent No. 1 filed an application under Sections 397 and 398 before the Gujarat High Court on or
about 4th March 1991 wherein she initially prayed for the following reliefs:
(A-i) Declaration that she is allottee of 8000 equity shares of respondent No. 6 company.
(A-ii) Direction to issue share certificates immediately to her of these 8000 shares.
(B) Declaration that issue and allotment of 3000 shares in excess of 6475 shares to respondent No. 1 (present
Appellant No. 1) or nominees of respondent No. 1 to 5 (present Appellant No. 1 to 5) is null and void ab-
initio.
(C) Declare that she is sole heir of Late F.P.G. and as such she is entitled to be in majority and control of
respondent No. 6 company. (D) Declare respondent No. 1,2 (present Appellant No. 1&2) 9, 10 and 11
(present Respondent No. 9,10,11) have ceased to be directors in respondent No. 6 company.
(E) Restrain by injunction respondent No. 1,2 (present Appellant No. 1&2) 9, 10 & 11 (present Respondent
No. 9,10,11) from acting as director, officer of respondent No. 6 company. (F) Declare any act deed or
thing done after A.G.M. of 20-12-1990 by respondent No. 1,2 (present Appellant No. 1&2)9,10&11(present
Respondent No. 9,10,11) as null and void.
(G) Declarations in regard to resolutions passed at the E.G.M. dated 14-1- 1991.
(H) Appointment of receiver.
(I) Pending Admission respondent No. 1 & 2 (present Appellant No. 1 &
2) be directed to produce before this Hon'ble Court or receiver all documents, papers, etc. (J) Pending
admissions interim injunction against respondent No. 1,2 (present Appellant No. 1&2) 9, 10 & 11 (present
Respondent No. 9,10,11) from acting as directors or officers of the company. (K) Ad-interim relief's in
terms of para H, I & J above.
Issue - Whether the Appellant No. 1 in his capacity as Director of the Company had a fiduciary duty towards
the shareholders.
Chapter IX of the Indian Trusts Act provides for certain obligations in the nature of trusts. The Trust Act
recognizes various kinds of trusts including resulting trust. An express trust, however, may be created by
reason of an agreement between the parties. By reason of Section 88 of the Indian Trusts Act, a person
bound in fiduciary character is required to protect the interests of other persons but the heart and soul thereof
is that as between two persons one is bound to protect the interests of the other and if the former availing
of that relationship makes a pecuniary gain for himself; Section 88 would be attracted. What is sought to
be prevented by a person holding such fiduciary benefit is unjust enrichment or unjust benefit derived from
another which is against conscience that he should keep. When a person makes a pecuniary gain by reason
of a transaction, the cestui qui trust created thereunder must be restored back.
The purported breach of trust on the part of Appellant No. 1 herein relate to :
(i) Issuance of additional 15000 shares;
(ii) Allotment of 6475 shares to himself and his family members as also an HUF; and
(iii) Allotment of 3000 shares out of 8000 shares which had been allotted to FRG in favour of his minor
children.
(iv) Transfer of 9415 shares in favour of Indreni.
Issuance of equity based capital shares under the Companies Act in relation to a private company would be
governed by its Memorandum of Association and Articles of Association. It has not been pointed out that
in terms of Memorandum of Association the Board of Directors acted ultra vires in adopting a resolution
as regard issuance of 25000 capital shares; out of which 15000 shares were to be issued at the first instance.
Section 81 of the Companies Act indisputably has no application in relation to a private company, the pre-
requisite thereof is, thus, not attracted in the instant case. Appellant No. 1, therefore, apart from Section 88
of the Indian Trusts Act in the event of its applicability did not have any statutory obligation to discharge
as a trustee in this behalf.
A Director of a Company indisputably stands in a fiduciary capacity vis-`-vis the Company. He must act
for the paramount interest of the company. He does not have any statutory duty to perform so far as
individual shareholders are concerned subject of course to any special arrangement which may be entered
into or a special circumstance that may arise in a particular case. Each case, thus, is required to be considered
having regard to the fact situation obtaining therein and having regard to the existence of any special
arrangement or special circumstance.
The question came up for consideration as far back in 1901 in Percival Vs. Wright [1902 (2) Ch. 421]. In
that case, the shares of the company were in few hands which were transferable only with the approval of
the Board of Directors. The shares did not carry any market price and were not to be quoted at the stock
exchange. The plaintiffs therein intended to dispose of certain shares wherefor they offered 12 l.5s. per
share purported to be based on a valuation which they had obtained from independent valuers a few months
prior thereto. The said offer was accepted. The transaction pertaining to the said agreement was entered
into but it was later on discovered by the plaintiffs that prior to and during their own negotiations for sale
the Chairman and the Board were approached by one Holden with a view to the purchase the entire
undertaking of the company with a view to resell the same at a profit to a new company. The question of
fiduciary obligation on the part of the Directors arose therein when the plaintiff brought an action against
the Chairman and the two other purchasing Directors asking for setting aside the sale on the ground that the
defendants as Directors ought to have disclosed the feature of negotiations with Holden when negotiating
purchase of their shares. The question therein posed was: Assuming that directors are, in a sense, trustees
for the company, are they trustees for individual shareholders? The Chancery Division despite holding that
the Directors must act bonafide and for the best interest of the company did not accept the argument that
the relationship between the shareholders inter se are the same as that of partners in an unincorporated
company holding :
"The contrary view would place directors in a most invidious position, as they could not buy or sell shares
without disclosing negotiations, a premature disclosure of which might well be against the best interests of
the company. I am of the opinion that directors are not in that position.
There is no question of unfair dealing in this case. The directors did not approach the shareholders with the
view of obtaining their shares. The shareholders approached the directors, and named the price at which
they were desirous of selling."
Percival (supra) was noticed by a 4-Judge Bench of this Court in Nanalal Zaver and Another Vs. Bombay
Life Assurance Co. Ltd. and Others [1950 SCR 391] in the following terms:
"It is clear that until the Singhania group get their names entered in the register of the members they are not
shareholders but are complete strangers to the company. It has been held in Percival v. Wright [L.R. (1902)
2 Ch. 421] that ordinarily the directors are not trustees for the individual shareholders. Even if the directors
owe some duty to the existing shareholders on the footing of there being some fiduciary relationship
between them as stated in some cases [see for example In re Gresham Life Assurance Society] [L.R. 8 Ch.
App. 446 at p. 449] I see no cogent reason for extending this principle and imputing any kind of fiduciary
relationship between the directors and persons who are complete strangers to the company. In my judgment,
therefore, the conduct of the respondents 2 to 9 cannot be judged on the basis of any assumed fiduciary
relationship existing between them and the Singhania group. In my opinion, the respondents 2 to 9 owed
no duty to the Singhania group and, therefore, the motive to exclude them cannot be said to be mala fide
per se."
The Court further held that having regard to Regulation 42 read with Section 105-C of 1936 Companies
Act vis-`-vis Regulation 27 of 1882 Act, the directors exercise a larger power to issue additional capital
shares.
It is true that while referring to 'Percival', the court used the expression 'ordinarily', but if a special situation
arises, it would be for the person complaining to plead and demonstrate the same.
We, however, do not intend to put our seal of approval on Percival (supra) in its entirety. The situation may
be different when a special contract, special relationship or special circumstances arise. Percival (supra)
may not also be applicable in a case of take over bid or when the general body of shareholders is only two
of them. In Palmer's Company Law, 23rd edition, page 848, it is stated:
"64-02. Relationship is with company: The fiduciary relationship of a director exists with the company: the
director is not usually a trustee for individual shareholders. Thus, a director may accept a shareholder's offer
to sell shares in the company although he may have information which is not available to that other, and
the contract cannot be upset even if the director knew of some fact which made the offer an attractive
proposition. So in Percival v. Wright a person who had approached a director and sold him shares in the
company, afterwards, upon discovering that the director had known at the time of the contract that
negotiations were on foot for the purchage by an outsider of all the shares in the company at a higher figure,
could not impeach the contract. In his judgment Swinfen-Eady J. said "there is no question of unfair dealing
in this case. The directors did not approach the shareholders with the view of obtaining their shares. The
shareholders approached the directors and named the price at which they were desirous of selling."
In Pennington's Company Law 6th Edn. at page 608-09, it is stated :
"Directors owe no fiduciary or other duties to individual members of their company in directing and
managing the company's affairs, acquiring or disposing of assets on the company's behalf, entering into
transactions on its behalf, or in recommending the adoption by members of proposals made to them
collectively. If directors mis-manage the company's affairs, they incur liability to pay damages or
compensation to the company or to make restitution to it, but individual members cannot recover
compensation for the loss they have respectively suffered by the consequential fall in value of their shares,
and they cannot achieve this indirectly by suing the directors for conspiracy to breach the duties which they
owed the company. However, there may be certain situations where directors do owe a fiduciary duty and
a duty to exercise reasonable skill and care in advising members in connection with a transaction or situation
which involves the company or its business undertaking and also the individual holdings of its members."
In Dawson International plc vs. Coats Patons plc [1988 SLT 854] Percival (supra) was relied upon holding
that the Directors are, in general, under no fiduciary duty to shareholders and in particular current
shareholders with respect to the disposal of their shares in the most advantageous way as directors are not
their agents and as such are not normally entrusted with the management of their shares. It was, however,
observed that if the directors take it upon themselves to give advice to current shareholders they have a duty
to act in good faith and not fraudulently nor can mislead the shareholders whether deliberately or carelessly,
in which event, they may have a remedy.
A distinction, thus, has been carved out as regards the fiduciary duty of the directors with regard to the
property and funds of the company as contra-distinguished from the duty of directors to current shareholders
as sellers of their shares. In case of conflict between two interests, the company's interest must be protected.
The directors, however, will have a fiduciary relation if they have taken unto themselves the burden of
giving advice to current shareholders.
The aforementioned principles of law found favour with the Court in Needle Industries (India) Ltd. and
Others Vs. Needle Industries Newey (India) Holding Ltd. and Others [(1981) 3 SCC 333] wherein it was
held:
"Where directors of a company seek, by entering into an agreement to issue new shares, to prevent a
majority shareholder from exercising control of the company, they will not be held to have failed in
fiduciary duty to the company if they act in good faith in what they believe, on reasonable grounds, to be
the interests of the company. If the directors' primary purpose is to act in the interests of the company, they
are acting in good faith even though they also benefit as a result."
In Needle (supra), this Court furthermore noticed Punt vs. Symons [(1903) 2 CH 506] and opined in the
following terms :
"105. In Punt v. Symons ((1903) 2 Ch 506 : 72 LJ Ch 768 : 89 LT 525 : 52 WR 41), which applied the
principle of Fraser v. Whalley (71 ER 361 : 11 LT 175), it was held that :
Where shares had been issued by the Directors, not for the general benefit of the company, but for the
purpose of controlling the holders of the greater number of shares by obtaining a majority of voting power,
they ought to be restrained from holding the meeting at which the votes of the new shareholders were to
have been used.
But Byrne, J. stated :
There may be occasions when Directors may fairly and properly issue shares in the case of a company
constituted like the present for other reasons. For instance it would not be at all an unreasonable thing to
create a sufficient number of shareholders to enable statutory powers to be exercised.
106. Peterson, J. applied the principle enunciated in Fraser (71 ER 361 : 11 LT 175) and in Punt (((1903) 2
Ch 506 : 72 LJ Ch 768 : 89 LT 525 : 52 WR 41) in the case of Piercy v. S. Mills & Company Ltd. ((1920)
1 Chancery 77 : (1918-19) All ER Rep 313 (Ch D) : 122 LT 20 : 35 TLR 703). The learned Judge observed
at page 84 : "The basis of both cases is, as I understand, that Directors are not entitled to use their powers
of issuing shares merely for the purpose of maintaining their control or the control of themselves and their
friends over the affairs of the company, or merely for the purpose of defeating the wishes of the existing
majority of shareholders What is considered objectionable is the use of such powers merely for an
extraneous purpose like maintenance or acquisition of control over the affairs of the Company..."
In Needle Industries (supra), Nanalal Zaver (supra) was affirmed stating the sole test is whether the issue
of shares is simply or solely for the benefit of the Directors holding:
"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."
Fiduciary duty of the Directors to the company should not be equated with the duty to the shareholders.
In Peskin and Another Vs. Anderson and Others [2001] 1 BCLC 372, Percival (supra) as also other
decisions taking similar or contrary view were noticed by the Court of Appeal including the judgment of
the Court of Appeal in New Zealand in Coleman vs. Myers as also Court of Appeal of New South Wales
in Brunninghausen vs. Glavnics (1999) 46 NSWLR and held that the directors had no fiduciary duty to the
shareholders in the facts and circumstances obtaining therein. However, observations were made therein
that such duties may arise in special circumstances demonostrating the salient features and well-established
categories of fiduciary relationship such as agency which involves duties of trust, confidence and loyalty.
Absence of special circumstances or special reasons as pointed out hereinbefore normally would not bring
in the concept of fiduciary relationship in a director vis-`-vis the current shareholders. However, in Coleman
(supra) and Brunninghausen (supra) it was held that the fiduciary duties of directors to the shareholders
exist in the specially strong context of the familial relationships having regard to their personal position of
influence in the company concerned.
M/s. Dale & Carrington Invt. P. Ltd. & Anr. Vs. P.K. Prathapan & Ors. [2004 (7) SCALE 586] requires a
closer scrutiny. Evidently, therefore, the ratio which emerges from the decision is that the duty to disclose
as regard issue of additional shares is relatable to proper purpose thereof. If the purpose is proper and the
action of the director is bonafide, the ratio should not be extended so as to hold that such a duty of the
director towards the shareholder is absolute despite the fact that there is no legal requirement therefor. Duty
of disclosure to shareholders in that case had a strong nexus with the affairs of the company. Dale &
Carrington (supra) is not an authority for the proposition that the purported fiduciary duty of a director
towards the shareholder is absolute although the transaction in question may not have a direct co-
relationship with the affairs of the company.
Moreover, the Bench did not have the advantage of considering the 4- Judge Bench decision of this Court
in Nanalal Zaver (supra). It furthermore did not have the advantage of noticing the decisions of other
jurisdictions which had been noticed hereinbefore.
The Court, it is interesting to note, noticed Needle Industries (supra) as regards the power of the company
to issue new shares but the legal effect thereof was not considered in details. The directors have a power to
issue additional capital shares and in the process may obtain some pecuniary gain but only when such
pecuniary gain is obtained through ulterior motive, they would be answerable to the shareholders.
It is also interesting to note that while applying the 'extraneous purpose test' or 'ulterior motive test', the
Court noticed Piercy Vs. S. Mills & Co. Ltd. (1920) 1 Ch. 77 wherein it was held: "The basis of both cases
is, as I understand, that Directors are not entitled to use their powers of issuing shares merely for the purpose
of maintaining their control or the control of themselves and their friends over the affairs of the company,
or merely for the purpose of defeating the wishes of the existing majority of shareholders."
The expression 'merely' assumes significance.
Significantly, in Needle Industries (supra) it was categorically held that the Directors have power to issue
shares at par even if their market price is higher being primarily a matter of policy. (See para 120) 'Proper
purpose' doctrine and the doctrine of 'fairness' vis-`-vis the doctrine of 'bona fide' was considered in view
of its findings that the allotment of all additional shares was gained by Ramanujam through manipulations
and commission of acts of frauds upon becoming the Managing Director of the Company with a view to
gain sole control of the management thereof and to the exclusion of Prathapan.
The ratio in Dale and Carrington (supra), thus, must be understood to have been rendered in the fact situation
obtaining in that case. It does not lay down a law that fiduciary duty of a director to the company extends
to a shareholder so as to entitle him to be informed of all the important decisions taken by the Board of
Directors. Such a broad proposition of law, if understood to have been laid down in Dale and Carrington,
would be inconsistent with the duty of a director vis-`-vis the Company and the settled law that the statutory
duty of a direction is primarily to look after the interest of the company.
In Bajaj Auto Ltd. Vs. N.K. Firodia and Another etc. [(1970) 2 SCC 550], the Court was concerned with
the discretionary exercise of power by the Directors in terms of Section 111(3) of the Companies Act. In
the light of refusal by director to register a transfer, the Court held that it is necessary for the directors to
act bonafide and not arbitrarily in the following terms:
"12. Article 52 of the appellant company provided that the Directors might at their absolute and uncontrolled
discretion decline to register any transfer of shares. Discretion does not mean a bare affirmation or negation
of a proposal. Discretion implies just and proper consideration of the proposal in the facts and circumstances
of the case. In the exercise of that discretion the Directors will Act for the paramount interest of the company
and for the general interest of the shareholders because the Directors are in a fiduciary position both towards
the company and towards every shareholder. The Directors are therefore required to act bona fide and not
arbitrarily and not for any collateral motive."(emphasis supplied) This Court therein also applied the bona
fide test of the Director and for the benefit of the company as a whole. In that case, the directors assigned
reasons which were tested from three angles view, viz., (i) whether the directors acted in the interest of the
company; (ii), whether they acted on a wrong principle; and, (iii) whether they acted with an oblique motive
or for a collateral purpose. It was observed in M/s. Harinagar Sugar Mills Ltd. Vs. Shyam Sunder
Jhunjhunwala & Others [(1962) 2 SCR 339] that the action of the directors must be set aside if the same
was done oppressively, capriciously, corruptly or in some other way malafide. In this case, this Court is not
faced with such a situation.
In Coleman and Others Vs. Myers and Others [(1977) 2 NZLR 225] the gist of the complaint made by the
appellants against the first respondent was that he planned to acquire total control of the company at
virtually no cost to himself by means of selling the Strand-Coburg and other properties of the company and
making use of its liquid capital reserves; that his inside knowledge of the company's affairs and the advice
he obtained showed him that there were good prospects of accomplishing this, leaving him sole owner of
an unencumbered asset worth some millions; and that he not only refrained from disclosing to the
shareholders generally his plan and the magnitude of his potential gain, but also made misrepresentations
tending to conceal the plan.
In the aforementioned factual backdrop while holding that mere status of a company director would not
create any responsibility towards a shareholder but it was observed that the standard of conduct required
from a Director in relation to dealings with them will depend upon all the surrounding circumstances and
the nature of responsibility which in a real and practical sense he has assumed.
In Pennington's Company Law, at page 609, on Coleman (supra), it is commented:
"It is uncertain whether this reasoning can be extended to other situations where directors owe duties to the
company but the relevant decision has to be made by its members individually or collectively, and the
directors advise them as to the decision they should make. Such situations would include a proposed sale
or disposal of the company's assets and undertaking, a proposed merger or division of the company, a
proposed reorganization of the company's share capital affecting existing members and a proposal for the
voluntary liquidation of the company."
No law in absolute terms, thus, had been laid down therein. In the instant case, there had been no transaction
of sale and purchase of shares between the director and the shareholder.
The said decisions, therefore, have no application in the instant case.
It is interesting to note that in Needle Industries (supra), this Court said even in certain cases the Directors
attempt to maintain their control over the company or in newly acquiring may not amount to abuse of their
fiduciary power stating:
"Applying this principle, it seems to us difficult to hold that by the issue of rights shares the Directors of
NIIL interfered in any manner with the legal rights of the majority. The majority had to disinvest or else to
submit to the issue of rights shares in order to comply with the statutory requirements of FERA and the
Reserve Bank's directives. Having chosen not to disinvest, an option which was open to them, they did not
any longer possess the legal rights to insist that the Directors shall not issue the rights shares. What the
Directors did was clearly in the larger interests of the Company and in obedience to their duty to comply
with the law of the land. The fact that while discharging that duty they incidentally trenched upon the
interests of the majority cannot invalidate their action. The conversion of the existing majority into a
minority was a consequence of what the Directors were obliged lawfully to do. Such conversion was not
the motive force of their action."
No argument in this case was advanced as regard the purported breach of fiduciary duty on the part of the
Appellant No. 1 in the matter of increase of shares during the life time of FRG before the learned Single
Judge; on the other hand it was admitted that FRG during his life time was controlling the company, and,
thus, the Appellants herein in no way can be held to have any fiduciary liability towards other shareholders
in respect of issuance of 6475 shares in their favour.
Directors may have a fiduciary duty where a take over bid is made for a company and its directors advise
its shareholders whether to accept or reject the bid as they owe a duty to advice honestly. The standard of
conduct expected of a director in relation to transaction with the shareholders will differ and would
necessarily depend upon the circumstances and the nature of the responsibility.
It is, thus, not possible to lay down a law which will have universal application. No authority has been
brought to our notice which states that there exists a duty in a director to advise the shareholder as to whether
they should purchase the share of the company or avail the benefit of an offer. In an appropriate case, a
fiduciary relationship may come into being having regard to the responsibility undertaken by the directors
towards the shareholders by way of a special contract.
The law which emerges from the discussions made hereinbefore is that the directors do not have any
fiduciary duty to advice shareholders as to when and in what manner they should enter with the transactions
with the company including acceptance of offer of additional shares. Such a fiduciary duty would arise inter
alia in exceptional situations when the directors take upon themselves the task of advising the shareholders
who may be his family members or when a transaction of purchase or sale is entered into by and between
the director and the shareholders wherein the former taking undue benefit or having ill or improper or
ulterior motive or malafide act solely to make pecuniary benefit and gain for himself and to the detriment
of such shareholders. If a general fiduciary duty of a director vis-à-vis shareholders is laid down the same
would lead the directors to the risk of multiple legal actions by dissenting minority shareholders.
Eclairs Group Ltd (Appellant) v JKX Oil & Gas plc (Respondent)
JKX Oil [“JKX”] is a company listed on the London Stock Exchange. Eclairs and Glengary, both
incorporated in the British Virgin Islands, owned substantial minority shareholdings in JKX, sufficient to
block special resolutions: 27.55% and 11.45% respectively. Eclairs was owned beneficially by Ukrainian
politician-businessmen, Mr. Kolomoisky and Mr. Bogulyubov, both having acquired the reputation of
‘raiders’. Glengary was owned by a Mr. Zhukov.
Relations between JKX and Eclairs/Glengary do not appear to have been particularly cosy: by 2013, the
directors of JKX perceived that they were the target of a raid by the two minority shareholders. From 2010
to 2012, JKX (which was going through a financially challenging time) attempted to raise capital, but these
attempts fell through in view of the blocking minority with the raider group. In March 2013, Eclairs and
Gregory wrote to JKX, calling for an extraordinary general meeting to consider resolutions for removal of
the existing CEO of JKX, Mr. Dixon, from the Board. An AGM was convened for June 2013. The agenda
included the re-election of Dr Davies, the approval of the directors’ remuneration report and resolutions
empowering the board to allot shares for cash.
JKX issued disclosure notices to Eclairs and Glengary (as permissible under UK law), calling upon
Glengary to provide information about their shareholding, their beneficial ownership and any agreements
or arrangements between the various persons interested in them. Prompt responses gave information about
the shareholding, but denied that the addressees were party to any agreement or arrangement among
themselves.
Article 42 of the Articles of JKX empowered the Board to issue restriction notices (restricting the exercise
of voting rights) in respect of specified shares, in case the Board had reasonable cause to believe that
information in response to disclosure notices was incomplete. Believing Eclairs and Glengary to have
provided incomplete information, the Board issued restriction notices in respect of the shareholding of
Eclairs and Gregory. The effect was that Eclairs and Gregory could no longer use their blocking minority
at the AGM.
The validity of the exercise of powers by the Board in issuing restriction notices was challenged by Gregory
and Eclairs. They contended that although the Board was empowered to issue the restriction notices, the
Board had issued the notices for an improper purpose (of ensuring that the blocking minority could not be
used). Based on the evidence led at first instance, the trial Judge came to the finding of fact that the Board
exercised its powers to prevent the Gregory/Eclairs from being able to block resolutions at the AGM, and
that the Board acted in good faith and believed that this was for the interests of the company as a whole.
On the basis of these findings, the trial Judge held that the powers were not exercised for proper purposes
(as the only proper purpose was to ensure that the information sought in the disclosure notices was provided,
not to prevent blocking minorities from exercising their rights). The Court of Appeal by majority reversed
these conclusions. They held that restrictions on voting rights was the very thing that article 42 was designed
to permit. Once the board had reached that conclusion that disclosure notices had not been complied with,
there was no further limitation on their power to issue restriction notices. Eclairs/Gregory appealed to the
Supreme Court.
JKX argued that in determining for what purposes powers could be used for, regard must be had to
principles of contractual interpretation and implication of terms: “Where the purpose of a power was not
expressed by the instrument creating it, there was no limitation on its exercise save such as could be implied
on the principles which would justify the implication of a term.” They further contended that such a term
could only be implied on grounds of necessity.
The proper purpose rule
14. Part 10, Chapter 2 of the Companies Act 2006 codified for the first time the general duties of directors.
The proper purpose rule is stated in section 171(b) of the 2006 Act, which provides that a director of a
company must “only exercise powers for the purposes for which they are conferred”. The rule thus stated
substantially corresponds to the equitable rule which had for many years been applied to the exercise of
discretionary powers by trustees. “It is a principle in this court”, Sir James Wigram V-C had observed in
Balls v Strutt (1841) 1 Hare 146, “that a trustee shall not be permitted to use the powers which the trust
may confer upon him at law, except for the legitimate purposes of the trust.” Like other general duties laid
down in the Companies Act 2006, this one was declared to be “based on certain common law rules and
equitable principles as they apply in relation to directors and have effect in place of those rules and
principles as regards the duties owed to a company by a director”: section 170(3). Section 170(4)
accordingly provides that the general duties are to be “interpreted and applied in the same way as common
law rules or equitable principles, and regard shall be had to the corresponding rules and equitable principles
in interpreting and applying the general duties”.
15. The proper purpose rule has its origin in the equitable doctrine which is known, rather inappropriately,
as the doctrine of “fraud on a power”. For a number of purposes, the early Court of Chancery attached the
consequences of fraud to acts which were honest and unexceptionable at common law but unconscionable
according to equitable principles. In particular, it set aside dispositions under powers conferred by trust
deeds if, although within the language conferring the power, they were outside the purpose for which it was
conferred. So far as the reported cases show the doctrine dates back to Lane v Page (1754) Amb 233 and
Aleyn v Belchier (1758) 1 Eden 132, 138, but it was clearly already familiar to equity lawyers by the time
that those cases were decided. In Aleyn’s Case, Lord Northington could say in the emphatic way of 18th
century judges that “no point was better established”. In Duke of Portland v Topham (1864) 11 HLC 32,
54 Lord Westbury LC stated the rule in these terms: “that the donee, the appointor under the power, shall,
at the time of the exercise of that power, and for any purpose for which it is used, act with good faith and
sincerity, and with an entire and single view to the real purpose and object of the power, and not for the
purpose of accomplishing or carrying into effect any bye or sinister object (I mean sinister in the sense of
its being beyond the purpose and intent of the power) which he may desire to effect in the exercise of the
power.” The principle has nothing to do with fraud. As Lord Parker of Waddington observed in delivering
the advice of the Privy Council in Vatcher v Paull [1915] AC 372, 378, it “does not necessarily denote any
conduct on the part of the appointor amounting to fraud in the common law meaning of the term or any
conduct which could be properly termed dishonest or immoral. It merely means that the power has been
exercised for a purpose, or with an intention, beyond the scope of or not justified by the instrument creating
the power.” The important point for present purposes is that the proper purpose rule is not concerned with
excess of power by doing an act which is beyond the scope of the instrument creating it as a matter of
construction or implication. It is concerned with abuse of power, by doing acts which are within its scope
but done for an improper reason. It follows that the test is necessarily subjective. “Where the question is
one of abuse of powers,” said Viscount Finlay in Hindle v John Cotton Ltd (1919) 56 Sc LR 625, 630, “the
state of mind of those who acted, and the motive on which they acted, are all important”.
16. A company director differs from an express trustee in having no title to the company’s assets. But he is
unquestionably a fiduciary and has always been treated as a trustee for the company of his powers. Their
exercise is limited to the purpose for which they were conferred. One of the commonest applications of the
principle in company law is to prevent the use of the directors’ powers for the purpose of influencing the
outcome of a general meeting. This is not only an abuse of a power for a collateral purpose. It also offends
the constitutional distribution of powers between the different organs of the company, because it involves
the use of the board’s powers to control or influence a decision which the company’s constitution assigns
to the general body of shareholders. Thus in Fraser v Whalley (1864) 2 H & M 10, the directors of a statutory
railway company were restrained from exercising a power to issue shares for the purpose of defeating a
shareholders’ resolution for their removal. In Cannon v Trask (1875) LR 20 Eq 669, which concerned the
directors’ powers to fix a time for the general meeting, Sir James Bacon VC held that it was improper to
fix a general meeting at a time when hostile shareholders were known to be unable to attend. In Anglo-
Universal Bank v Baragnon (1881) 45 LT 362, Sir George Jessel MR held that if it had been proved that
the power to make calls was being exercised for the purpose of disqualifying hostile shareholders at a
general meeting, that would be an improper exercise of the directors’ powers. In Hogg v Cramphorn Ltd
[1967] 1 Ch 254, Buckley J held that the directors’ powers to issue shares could not properly be exercised
for the purpose of defeating an unwelcome takeover bid, even if the board was genuinely convinced, as the
current management of a company commonly is, that the continuance of its own stewardship was in the
company’s interest. The company’s interest was an additional and not an alternative test for the propriety
of a board resolution.
17. In all of these cases, either there was no dispute about the directors’ purpose or else the only purpose
which could plausibly be ascribed to them was an improper one. But what if there are multiple purposes,
all influential in different degrees but some proper and others not? An analogy with public law might
suggest that a decision which has been materially influenced by a legally irrelevant consideration should
generally be set aside, even if legally relevant considerations were more significant: R(FDA) v Secretary
of State for Work and Pensions [2013] 1 WLR 444, at paras 67-69 (per Lord Neuberger of Abbotsbury
MR). In some contexts, such as rescission for deceit or breach of the rules relating to self-dealing, equity is
at least as exacting. But the proper purpose rule, at any rate as applied in company law, has developed in a
different direction. Save perhaps in cases where the decision was influenced by dishonest considerations or
by the personal interest of the decisionmaker, the directors’ decision will be set aside only if the primary or
dominant purpose for which it was made was improper. To some extent this is a pragmatic response to the
range of a director’s functions and the conflicts which are sometimes inseparable from his position. The
main reason, however, is a principled concern of courts of equity not just to uphold the integrity of the
decision-making process, but to limit its intervention in the conduct of a company’s affairs to cases in which
an injustice has resulted from the directors’ having taken irrelevant considerations into account.
18. In his seminal judgment in the High Court of Australia in Mills v Mills (1938) 60 CLR 150, 185-186,
Dixon J pointed out the difficulties associated with too rigorous an application of the public law test to the
decisions of directors: “… it may be thought that a question arises whether there must be an entire exclusion
of all reasons, motives or aims on the part of the directors, and all of them, which are not relevant to the
purpose of a particular power. When the law makes the object, view or purpose of a man, or of a body of
men, the test of the validity of their acts, it necessarily opens up the possibility of an almost infinite analysis
of the fears and desires, proximate and remote, which, in truth, form the compound motives usually
animating human conduct. But logically possible as such an analysis may seem, it would be impracticable
to adopt it as a means of determining the validity of the resolutions arrived at by a body of directors,
resolutions which otherwise are ostensibly within their powers. The application of the general equitable
principle to the acts of directors managing the affairs of a company cannot be as nice as it is in the case of
a trustee exercising a special power of appointment. It must, as it seems to me, take the substantial object
the accomplishment of which formed the real ground of the board’s action. If this is within the scope of the
power, then the power has been validly exercised.”
19. Once one accepts the need to compare the relative significance of different considerations which
influenced the directors, the question inevitably arises what is the “primary” or “dominant” purpose, and
how is it to be identified. One possibility is that it is the “weightiest” purpose, ie the one about which the
directors felt most strongly. The other is that it is the purpose which caused the decision to be made as it
was. Of course, the two things are connected. The ordinary inference is that the “weightiest” purpose (in
this sense) will also have been causative, and that minor purposes will not have been. In most cases the two
tests will in practice lead to the same result. But that will not always be so and, as will be seen, it is not
necessarily the case here.
20. The first test seems to me to be difficult to justify, for reasons of both practicality and principle. The
practical difficulty was pointed out by Dixon J in the passage which I have quoted. It would involve a
forensic enquiry into the relative intensity of the directors’ feelings about the various considerations that
influenced them. A director may have been influenced by a number of factors, but if they all point in the
same direction he will have had no reason at the time to arrange them in order of importance. The attempt
to do so later in the course of the dispute is likely to be both artificial and defensive. Moreover, a realistic
appreciation of the directors’ position will show that it is liable to lead to the wrong answer. Directors of
companies cannot be expected to maintain an unworldly ignorance of the consequences of their acts or a
lofty indifference to their implications. A director may be perfectly conscious of the collateral advantages
of the course of action that he proposes, while appreciating that they are not legitimate reasons for adopting
it. He may even enthusiastically welcome them. It does not follow without more that the pursuit of those
advantages was his purpose in supporting the decision. All of these problems are aggravated where there
are several directors, each with his own point of view.
21. The fundamental point, however, is one of principle. The statutory duty of the directors is to exercise
their powers “only” for the purposes for which they are conferred. That duty is broken if they allow
themselves to be influenced by any improper purpose. If equity nevertheless allows the decision to stand in
some cases, it is not because it condones a minor improper purpose where it would condemn a major one.
It is because the law distinguishes between some consequences of a breach of duty and others. The only
rational basis for such a distinction is that some improprieties may not have resulted in an injustice to the
interests which equity seeks to protect. Here, we are necessarily in the realm of causation. The question is
which considerations led the directors to act as they did. In Hindle v John Cotton Ltd (1919) 56 Sc LR 625,
631, Lord Shaw referred to the “moving cause” of the decision, a phrase taken up by Latham CJ in Mills v
Mills, supra, at p 165. But this cryptic formula does not help much in a case where the board was
concurrently moved by multiple causes, some proper and some improper. One has to focus on the improper
purpose and ask whether the decision would have been made if the directors had not been moved by it. If
the answer is that without the improper purpose(s) the decision impugned would never have been made,
then it would be irrational to allow it to stand simply because the directors had other, proper considerations
in mind as well, to which perhaps they attached greater importance. This was the point made by Dixon J in
the passage immediately following the one which I have cited from his judgment in Mills v Mills “But if,
except for some ulterior and illegitimate object, the power would not have been exercised, that which has
been attempted as an ostensible exercise of the power will be void, notwithstanding that the directors may
incidentally bring about a result which is within the purpose of the power and which they consider
desirable.” Correspondingly, if there were proper reasons for exercising the power and it would still have
been exercised for those reasons even in the absence of improper ones, it is difficult to see why justice
should require the decision to be set aside.
22. Dixon J’s formulation has proved influential in the courts of Australia. As the majority (Mason, Deane
and Dawson JJ) pointed out in the High Court of Australia in Whitehouse v Carlton House Pty (1987) 162
CLR 285, 294: “As a matter of logic and principle, the preferable view would seem to be that, regardless
of whether the impermissible purpose was the dominant one or but one of a number of significantly
contributing causes, the allotment will be invalidated if the impermissible purpose was causative in the
sense that, but for its presence, ‘the power would not have been exercised’.” I thing that this is right. It is
consistent with the rationale of the proper purpose rule. It also corresponds to the view which courts of
equity have always taken about the exercise of powers of appointment by trustees: see Birley v Birley
(1858) 25 Beav 299, 307 (Sir John Romilly MR), Pryor v Pryor (1864) 2 De G J & S 205, 210 (Knight
Bruce LJ), Re Turner’s Settled Estates (1884) 28 Ch D 205, 217, 219, Roadchef (Employee Benefits
Trustees) Ltd v Hill [2014] EWHC 109 (Ch), para 130, and generally Thomas on Powers, 2nd ed (2012),
paras 9.85-9.89.
23. The leading modern case is Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821, a decision of
the Privy Council on appeal from New South Wales, which proceeded on the basis that the law was the
same in England and in New South Wales. It was another case of a board decision to issue and allot new
shares against the background of a takeover bid, although rather unusually it was the directors who wanted
the bid to succeed over the opposition of two existing shareholders who together held a majority of the
shares. Delivering the advice of the Privy Council, Lord Wilberforce observed at p 834: “The directors, in
deciding to issue shares, forming part of Millers’ unissued capital, to Howard Smith acted under clause 8
of the company’s articles of association. This provides, subject to certain qualifications which have not
been invoked, that the shares shall be under the control of the directors, who may allot or otherwise dispose
of the same to such persons on such terms and conditions and either at a premium or otherwise and at such
time as the directors may think fit. Thus, and this is not disputed, the issue was clearly intra vires the
directors. But, intra vires though the issue may have been, the directors’ power under this article is a
fiduciary power: and it remains the case that an exercise of such a power though formally valid, may be
attacked on the ground that it was not exercised for the purpose for which it was granted.”
24. The main interest of the decision for present purposes lies in the fact that it was a case of multiple
concurrent purposes. The company was genuinely in need of fresh capital, and the directors had received
legal advice that this was the only ground on which they could properly authorise an issue of shares. The
number of shares to be issued and the amount of the subscription had been carefully calculated to match
the company’s capital requirements. After a trial lasting 28 days in which the four directors supporting the
share issue gave evidence, Street J had found that the company’s need for capital, although urgent, was not
yet critical and that its normal practice had been to meet its capital requirements by borrowing rather than
issuing shares. For this reason he rejected the evidence of the four directors that their sole purpose was to
meet the company’s shortage of capital and found that their primary purpose was in fact to dilute the
shareholdings of those who opposed the bid. Lord Wilberforce adopted the primary purpose test which had
been applied by the judge (p 832B-C) and affirmed his decision (p 832F-H): “when a dispute arises whether
directors of a company made a particular decision for one purpose or for another, or whether, there being
more than one purpose, one or another purpose was the substantial or primary purpose, the court, in their
Lordships’ opinion, is entitled to look at the situation objectively in order to estimate how critical or
pressing, or substantial or, per contra, insubstantial an alleged requirement may have been. If it finds that a
particular requirement, though real, was not urgent, or critical, at the relevant time, it may have reason to
doubt, or discount, the assertions of individuals that they acted solely in order to deal with it, particularly
when the action they took was unusual or even extreme.” Lord Wilberforce did not express the point in
terms of causation, but it is I think clear that by the “substantial or primary purpose”, he meant the purpose
which accounted for the board’s decision. He approved the judge’s adoption of Dixon J’s test (pp 831-832),
and went on to adopt an analysis of the facts based on that test. Although the directors were influenced by
the company’s need for capital, the decisive factor in Howard Smith Ltd v Ampol Petroleum Ltd was that
but for their desire to convert the majority shareholders into a minority, the directors would not have sought
to raise capital by means of a share issue, nor at that point of time. The judgment of Mann J
25. In Mann J’s view, the only purpose for which the power to impose restrictions was conferred by article
42 was to “provide a sanction or an incentive to remedy the default” (para 206). In a meticulous judgment
he went on to make the following findings of fact, at paras 168-79 and 183-200: (1) He expressed no view
of his own on the merits of the dispute between the company and Messrs Kolomoisky and Bogolyubov and
their associates. But he found that the board had reasonable cause to believe (whether or not it was right)
that they were parties to an agreement or arrangement relating to shares in JKX with a view to carrying out
a raid on the company. The board believed that the objective of the raiders was to depress the value of the
shares so as to enable them to buy other shares more cheaply and eventually to take control of the company’s
Ukrainian subsidiary. They regarded the removal of Dr Davies and Mr Dixon and their replacement by
inexperienced associates of the raiders as part of that plan. They therefore had reasonable cause to believe
that the answers to the disclosure notices had been false. (2) Of the seven directors who took part in the
decision, six gave evidence and were cross-examined. The seventh was not cross-examined in relation to
purpose for want of time, and no point was taken on that. Of the six, one was found to have had the primary
purpose of extracting the information from the addressees of the disclosure notices. Another took a
“balanced” view which attached substantially the same importance to extracting the information and
preventing the raiders from voting against the resolutions at the AGM. The judge summarised the motives
of the other four as follows (para. 189): “While they may (and in all probability actually did) appreciate
that the restrictions would have to be lifted if the information was provided, they did not regard the ability
to impose restrictions as being one designed to protect the company pending the provision of information;
they regarded it as one which they could use, and did actually use, to get an advantage (the opportunity to
pass the resolutions) for its own sake, not linked to the extraction of information. Putting the matter another
way, they did not regard the opportunity to get special resolutions passed which would otherwise not be
passed (and the increased chance of getting the ordinary ones passed too) as an incidental benefit of
imposing restrictions as an incentive to provide information; they elevated it in their minds, and in their
purposes, to something with its own independent merit as a way of doing down the ‘raiders’ for the benefit
of the shareholders.” (3) The judge concluded (para. 200): “The differences between relevant states of mind
can be quite subtle in this situation, but I find that the evidence demonstrates that the following purposes,
beliefs and states of mind existed among the voting directors: (a) They all knew that the purpose of the
notices was to get information. (b) They all appreciated that the effect of restrictions would be (unless the
information was provided before the AGM) that Eclairs/Glengary would be prevented from voting, with
the effect that all the resolutions would be likely to be passed, or that there was a very enhanced prospect
of that happening. (c) They all saw that as operating for the benefit of the company as a whole, and as
hindering the cause of the ‘raiders’. (d) The majority of the voting directors (Mrs Dubin, Mr Moore, Mr
Miller and Lord Oxford) saw that as a sort of standalone proper and useful objective, and achieving it was
a substantial purpose of voting for the restrictions, separate from the need to have information. Those
directors did not have in mind the protection of the company pending the provision of the information; they
had in mind protecting the company full stop. The restrictions were thus a useful weapon to be used against
the ‘raiders’. The disenfranchisement of the ‘raiders’ at the AGM was not just an incidental effect of the
imposition of restrictions; it was the positively desired effect, seen as beneficial to the company in the long
term. (e) The bona fides of those directors, and the genuineness of their desire to benefit the company as a
whole, was not challenged, and in my view cannot be challenged.” (4) It followed that the primary purpose
of the board in issuing the restriction notices was to influence or determine the fate of the resolutions before
the AGM. The directors “took the opportunity of using the power to alter the potential votes at the
forthcoming AGM in order to maximise the chances of the resolutions being passed in a manner which they
thought was in the best interests of the Company” (para 227).” Since this was beyond the purpose for which
the power to impose restrictions was conferred, he set aside the restriction notices and the board resolutions
authorising them with effect from the time that they were made.
26. In the course of final speeches, the judge raised with the parties the question whether the board would
have reached the same decision even if they had not taken account of the impact of the restriction notices
on the resolutions at the AGM. “On the basis of what I heard, and the shape of the case before me” he said,
he thought it “likely, and to be frank virtually inevitable” that the board would have reached the same
conclusion and imposed the same restrictions even if they had confined themselves to the proper purpose
of inducing the addressees of the disclosure notices to comply with them and imposing sanctions for their
failure to do so to date. He “provisionally” concluded that on this alternative factual hypothesis the court
would have had a discretion whether to set aside the board resolution and restriction notices, which it might
have exercised in favour of the company. The alternative factual hypothesis had not, however, been pleaded
or addressed by the relevant witnesses and had formed no part of the company’s case. For this reason the
judge, having raised the point, refused to allow the company to take it at that late stage. He put the position
as follows (para 232): “… on the evidence that I have heard, I find it very hard indeed to believe that the
directors would have come to any different conclusion. I deal with this in a short section below in which I
consider the facts. However, in circumstances in which the directors have not made such a case in their own
evidence in chief (or in the pleadings of the company), it would, in the end, be a step too far to allow them
to say my purpose was X, but if I had been told that that was an improper purpose and I had to consider a
legitimate purpose Y, I would have arrived at the same decision. If that were to be their case then it should
have been positively advanced at some stage during the hearing. Although on the evidence I heard I find it
difficult to see that the directors would have come to a different decision, none the less I can see that the
claimants might have wished to have advanced their case differently, perhaps devoting more attention to
the earlier events leading up to the service of the notices and what happened, and what the thinking was,
between then and the board meeting.” The “short section below” was paras 235-237. In these paragraphs,
the judge summarised what he would have found if he had allowed the company to advance the alternative
factual hypothesis and had been obliged to deal with it on the basis of the existing evidence. He appears to
have done this in case there was an appeal against his refusal to allow the point to be taken. In the event,
however, there was no appeal on that point. The judgments of the Court of appeal
27. The appeals were heard by Longmore and Briggs LJJ and Sir Robin Jacob. There was no challenge to
the judge’s findings of fact. The appeal revolved entirely around their legal significance. By a majority, the
court allowed the appeal.
28. The majority (Longmore LJ and Sir Robin Jacob) considered that the proper purpose doctrine had “no
significant place in the operation of article 42 or Part 22 of the 2006 Act” (para 138). They appear to have
reached this conclusion for three overlapping reasons. The first was that restrictions arising from a
shareholder’s failure to comply with a disclosure notice did not reflect a “unilateral” exercise of power by
the board. By this they meant that the shareholder could avoid the restrictions by complying with the
disclosure notice. “Why should the law protect him when all he had to do was tell the truth?” (para 136).
Their second reason was that the restrictions on the voting and other rights attaching to the shares was the
very thing that article 42 was designed to permit if the directors reasonably considered that the disclosure
notices had not been complied with. So once the board had reached that conclusion, there was no further
limitation on their power to issue a restriction notice. The majority’s third reason was that no limitation on
the proper purpose of a restriction notice was expressed, either in Part 22 of the 2006 Act or in article 42 of
JKX’s articles. In their view there was no room for the implication of such a purpose, because in the nature
of things the statutory disclosure procedure was most likely to be operated at a time of controversy in the
company’s affairs. They thought, at para 141, that the draftsman was unlikely to have intended a detailed
enquiry into the minds of directors “in what may often be a rapidly changing scene”; and, at para 142, that
in a battle for control against predators who were “up to something subversive but secret” the directors
would naturally want to see them disenfranchised. In their view, the result of applying the proper purpose
rule would be to emasculate the statutory scheme and the corresponding provisions of article 42. Underlying
much of this reasoning was the view expressed in their peroration, that any other view “would only be an
encouragement to deceitful conduct and not something which English company law should countenance”
(para 143). 29. In a formidable dissent, Briggs LJ set out the rationale for the proper purpose test and the
authorities for its application to the exercise of discretionary powers by companies. He accepted the view
of Mann J that the purpose of article 42 was to encourage or coerce the provision of information which had
been requested under section 793, with the rider that it was also to prevent the accrual of any unfair
advantage to any person as a result of the failure to comply with such a request. Even with that limited
expansion, on the judge’s findings of fact the directors’ decision to impose restrictions under article 42 was
improper, and there were no satisfactory reasons why the rule should not be applied to the draconian powers
conferred by article 42 of JKX’s articles. He added (para 122): “Furthermore, I consider it important that
the court should uphold the proper purpose principle in relation to the exercise of fiduciary powers by
directors, all the more so where the power is capable of affecting, or interfering with, the constitutional
balance between shareholders and directors, and between particular groups of shareholders. The temptation
on directors, anxious to protect their company from what they regard as the adverse consequences of a
course of action proposed by shareholders, to interfere in that way, whether by the issue of shares to their
supporters, or by disenfranchisement of their opponents’ shares, may be very hard to resist, unless the
consequences of improprieties of that kind are clearly laid down and adhered to by the court.”
The proper purpose of article 42
30. The submission of Mr Swainston QC, who appeared for the company, was that where the purpose of a
power was not expressed by the instrument creating it, there was no limitation on its exercise save such as
could be implied on the principles which would justify the implication of a term. In particular, the
implication would have to be necessary to its efficacy. In my view, this submission misunderstands the way
in which purpose comes into questions of this kind. It is true that a company’s articles are part of the contract
of association, to which successive shareholders accede on becoming members of the company. I do not
doubt that a term limiting the exercise of powers conferred on the directors to their proper purpose may
sometimes be implied on the ordinary principles of the law of contract governing the implication of terms.
But that is not the basis of the proper purpose rule. The rule is not a term of the contract and does not
necessarily depend on any limitation on the scope of the power as a matter of construction. The proper
purpose rule is a principle by which equity controls the exercise of a fiduciary’s powers in respects which
are not, or not necessarily, determined by the instrument. Ascertaining the purpose of a power where the
instrument is silent depends on an inference from the mischief of the provision conferring it, which is itself
deduced from its express terms, from an analysis of their effect, and from the court’s understanding of the
business context.
31. The purpose of a power conferred by a company’s articles is rarely expressed in the instrument itself.
It was not expressed in the instrument in any of the leading cases about the application of the proper purpose
rule to the powers of directors which I have summarised. But it is usually obvious from its context and
effect why a power has been conferred, and so it is with article 42. Article 42(2) authorises the issue of a
restriction notice only in the event that a disclosure notice has been issued under section 793 of the 2006
Act and the company has received either no response or a response which it knows or has reasonable cause
to believe is false or materially incorrect. Under article 42(4) in the event that the information is supplied
after the restrictions have been imposed (ie that a response has been received which the directors have no
reasonable cause to regard as wrong), they are automatically lifted seven days thereafter. Any dividends or
other payments in respect of the shares which were withheld while the restrictions were in force will then
become payable under article 42(6). As Millett J observed in In re Ricardo Group Plc [1989] BCLC 566,
572 about the corresponding power of the court to impose restrictions under what was then section 216 and
Part XV of the Companies Act 1985, these restrictions “are granted as a sanction to compel the provision
of information to which the company is entitled. It follows, in my judgment, that once the information is
supplied, any further justification for the continuance of the sanction disappears”. The inescapable inference
is that the power to restrict the rights attaching to shares is wholly ancillary to the statutory power to call
for information under section 793.
32. It follows that I accept the view of Mann J that the purpose of article 42 is to provide a “sanction or
incentive” to remedy a failure to comply with the disclosure notice. But I would not limit it to inducing the
defaulter to comply, any more than I believe Mann J to have done in this case or Millett J in In re Ricardo
Group. Otherwise the board would be disabled from imposing restrictions in a case where the defiant
obduracy of the defaulter made it obvious that the restrictions would not produce compliance. I would
therefore identify the purpose in slightly different terms. In my view article 42 has three closely related
purposes. The first is to induce the shareholder to comply with a disclosure notice. This is the purpose
which Millett J and Mann J regarded the restrictions as serving, and it is the least that they can have been
intended to achieve. Secondly, the article is intended to protect the company and its shareholders against
having to make decisions about their respective interests in ignorance of relevant information. As Hoffmann
J observed in In re TR Technology Investment Trust Plc [1988] BCLC 256, 276, “the company, through its
existing board, is given the unqualified right to insist that contests for the hearts and minds of shareholders
are conducted with cards on the table.” Thirdly, the restrictions have a punitive purpose. They are imposed
as sanctions on account of the failure or refusal of the addressee of a disclosure notice to provide the
information for as long as it persists, on the footing that a person interested in shares who has not complied
with obligations attaching to that status should not be entitled to the benefits attaching to the shares. That
is the natural inference from the range and character of restrictions envisaged in article 42(3), which affect
not only the right to participate in the company’s affairs by voting at general meetings, but the right to
receive dividends. These three purposes are all directly related to the nonprovision of information
requisitioned by a disclosure notice. None of them extends to influencing the outcome of resolutions at a
general meeting. That may well be a consequence of a restriction notice. But it is no part of its proper
purpose. It is not itself a legitimate weapon of defence against a corporate raider, which the board is at
liberty to take up independently of its interest in getting the information.
33. Basing himself on the observation of Hoffmann J in In re TR Technology Investment Trust Plc, Mr
Swainston argued that the purpose of a restriction notice was related to the non-provision of the information
in a broader sense. The argument was that for as long as the addressee of a disclosure notice failed to put
his “cards on the table”, the directors were justified in treating the restrictions as a free-standing technique
for frustrating the raiders’ plans. In my view this extends the purpose of a restriction notice beyond its
proper limits. It treats failure to comply with a disclosure notice as no more than a “gateway” or condition
precedent to the directors’ right to impose and maintain the restrictions for any purpose which they bona
fide conceived to be in the interests of the company, including securing their preferred outcome at the AGM.
But as the judge put it, at para 206, the “nonprovision of information is not to be taken as a justification for
opening up a new front against the predator with the benefit of a new weapon.” Otherwise, directors would
be entitled to impose restrictions in a case where they attached no importance to the information
requisitioned in the disclosure notice. However difficult it may be to draw in practice, there is in principle
a clear line between protecting the company and its shareholders against the consequences of non-provision
of the information, and seeking to manipulate the fate of particular shareholders’ resolutions or to alter the
balance of forces at the company’s general meetings. The latter are no part of the purpose of article 42.
They are matters for the shareholders, not for the board.
34. We were pressed with a number of arguments about the purpose of article 42 based on an analogy with
Part 22 of the Companies Act 2006. I did not find these arguments helpful. The two schemes are both
directed at an assumed failure to comply with a statutory disclosure notice, and have a number of other
points in common. But they differ in a number of respects, some of them significant. Arguments based on
language which is to be found in the statute but not in the articles are unlikely to throw any light on the
purpose of the latter. Does the proper purpose rule apply?
35. At this stage, two preliminary observations are called for.
36. The first is that the imposition of restrictions under article 42 is a serious interference with financial and
constitutional rights which exist for the benefit of the shareholder and not the company. In the case of listed
companies such as JKX a restriction notice is also an interference with the proper operation of the market
in its shares, in which there is not only a private but a significant public interest. One would expect such a
draconian power to be circumscribed by something more than the directors’ duty to act in the company’s
interest as they may in good faith perceive it.
37. The second preliminary observation concerns the role of the proper purpose rule in the governance of
companies. The rule that the fiduciary powers of directors may be exercised only for the purposes for which
they were conferred is one of the main means by which equity enforces the proper conduct of directors. It
is also fundamental to the constitutional distinction between the respective domains of the board and the
shareholders. These considerations are particularly important when the company is in play between
competing groups seeking to control or influence its affairs. The majority of the Court of Appeal were right
to identify this as the background against which disclosure notices are commonly issued. But they drew the
opposite conclusion from the one which I would draw. They seem to have thought it unrealistic, indeed
undesirable, against that background to expect directors to distinguish between the proper purpose of
enforcing the disclosure notice and the improper purpose of defeating the ambitions of one group of
shareholders. I find this surprising. The decision to impose restrictions under article 42 requires the directors
to recognise the difference between the purpose of a decision and its incidental consequence. That certainly
calls for care on their part and possibly for legal advice. But there is nothing particularly special in this
context about a decision to issue a restriction notice under a provision such as article 42. The directors’ task
is no more difficult than it was in the many cases like Howard Smith Ltd v Ampol Petroleum Ltd in which
other fiduciary powers, such as the power to issue shares, have been held improperly exercised because in
the face of pressures arising from a battle for control the directors succumbed to the temptation to use their
powers to favour their allies. I would agree with the majority of the Court of Appeal that in that situation
the board would naturally wish to have the predators disenfranchised. That is precisely why it is important
to confine them to the more limited purpose for which their powers exist. Of all the situations in which
directors may be called upon to exercise fiduciary powers with incidental implications for the balance of
forces among shareholders, a battle for control of the company is probably the one in which the proper
purpose rule has the most valuable part to play.
38. I therefore approach with some scepticism the suggestion that in this of all contexts the proper purpose
rule has no application. Of the three reasons given by the majority of the Court of Appeal, I have already
dealt with their second reason, which was essentially a slightly repackaged version of Mr Swainston’s
“gateway” argument, and with their third, which is that no limiting purpose can be implied in a case where
the directors are likely to exercise their powers for the purpose of disenfranchising a predator. I reject both
of them as contrary to principle. I would add that I am unimpressed by the suggestion that it is impractical
to examine the state of mind of the directors in a rapidly changing situation such as a takeover bid or an
attempted raid. The present proceedings were begun on the day before the AGM. The interests of both
parties were sufficiently protected pending the decision by the orders made on the same day by David
Richards J, and the dispute was heard by Mann J within seven weeks and decided within three months. In
some cases, for example where a tight timetable is imposed under the City Code on Takeovers and Mergers,
it may be necessary to accelerate the procedure even more drastically, but the judges of the Chancery
Division are perfectly capable of responding to these exigencies as they arise.
39. That brings me to the majority’s first and, I think, main reason, which was that the power to impose
restrictions under article 42 was not a “unilateral” power. The addressees of the disclosure notices had only
to answer the questions fully and truthfully to bring the restrictions to an end. I reject this also. The short
and principled objection to it was given by Briggs LJ. The limitation of the power to its proper purpose
derives from its fiduciary character. If its exercise would otherwise be an abuse, it cannot be an answer to
say that the person against whom it is directed had only himself to blame. Moreover, the majority’s
proposition assumes that that person is the only one whose interests are adversely affected. But that is not
right. Other shareholders who agreed with them would be deprived of their support. In Anglo-Universal
Bank v Baragnon, supra, Sir George Jessel MR considered that the proper purpose rule would apply to a
board decision to make calls on shareholders if the object was to prevent particular shareholders from voting
at general meetings, although any shareholder could remove the disability by paying. There is no trace in
this or any other authority of a distinction between unilateral and non-unilateral powers. Moreover, I reject
the majority’s premise. The problem cannot always be resolved by unilaterally complying with the
disclosure notice. Under a provision in the form of article 42 there may be a deemed non-compliance with
a disclosure notice even in a case where the answers are prompt, complete and accurate. This is because the
directors may reasonably though erroneously conclude that the answers are defective. This is not a fanciful
hypothesis. The “interest” in shares about which information may be sought under section 793 of the 2006
Act is very broadly defined. It will often be a highly debatable question whether it exists. An alleged
omission to disclose a relevant agreement or arrangement between persons with a relevant interest may be
just as debatable. An agreement sufficient to give rise to a concert party may be informal. An arrangement
may be no more than a nod and a wink or a tacit understanding. Reasonableness in these circumstances is
very much in the eye of the decision-maker. It will depend on what other facts or inferences are available
to him. With the best will in the world, things may look very different on the other side of the partition. The
weapon which the majority’s analysis puts into the hands of the board is a blunderbuss whose shot is liable
to injure the just and the unjust alike.
40. That is part of the reason why I am unable to accept the majority’s parting assertion, at para 143, that
the application of the proper purpose rule would be an “encouragement to deceitful conduct” by predators
with “subversive but secret” projects. There is, however, a more fundamental objection to it, which is that
it is incoherent once the operation of the rule is properly understood. If the “deceit” consists simply in the
secrecy, ie in the withholding or deemed withholding of the information, a decision to impose restrictions
which is based simply on that fact will be entirely consistent with the proper purpose of the power. But
secrecy is one thing, subversion another. If the real objection is to the subversion, it is nothing to do with
the issue or enforcement of disclosure notices. Directors owe a duty of loyalty to the company, but
shareholders owe no loyalty either to the company or its board. Within broad limits, derived for the most
part from Part 30 of the Companies Act 2006 (Protection of Members against Unfair Prejudice) and the
City Code on Takeovers and Mergers, they are entitled to exercise their rights in their own interest as they
see it and to challenge the existing management for good reasons or bad.
The present case
41. What the judge’s findings amount to is that although at the critical board meeting the majority genuinely
wanted to receive the information which they had requisitioned, once they were satisfied that it had not
been provided and turned to consider the issue of restriction notices, they were interested only in the effect
that this would have on the outcome of the forthcoming general meeting. They “did not have in mind the
protection of the company pending the provision of the information; they had in mind protecting the
company full stop” (para 200(d)). In any case where concurrent purposes are being considered, they must
have been actual purposes in the minds of the directors, not merely possible or hypothetical ones. If the
only consideration which actually influenced the decision was an improper one, it is difficult to envisage
any basis on which their decision could have been sustained.
42. I have drawn attention earlier in this judgment to the relevance of causation in this field. The judge
posed the question (para 228) whether the notices could be “saved” on the footing that although the
directors’ purpose was improper, they would have acted in the same way if the improper considerations had
been ignored and they had applied their minds to proper ones. Suppose that the directors had decided to
issue the restriction notices as a sanction for the non-provision of the information and to protect the
company from the consequences of its non-disclosure pending its provision. Suppose that they also made
the decision in order to secure the passing of the resolutions, but would have done the same thing even if
that had never entered their minds. On that hypothesis, it would be difficult to regard the impact on the
resolutions as a primary consideration. The want of the information would have been a sufficient
justification of the restrictions and the resolutions would have been irrelevant, in fact no more than a
welcome incidental consequence.
43. That, however, was not the company’s case. As summarised by the judge (paras 181, 207-208), their
case was that once the raiders had failed to provide the information, the power to make a restriction order
could properly be exercised for the purpose of defeating their attempt to influence or control the company’s
affairs, provided that this was conceived in good faith to be in the company’s interests. Indeed it could
properly be exercised for the purpose of ensuring the passage of the resolutions at the general meeting in
the face of their objections. There was no attempt to justify the decision on some narrower basis if these
purposes were found to be improper. Forensic judgments of this kind are often required and they are not
easy. This one was no doubt a realistic approach in the face of the facts. But for whatever reason, none of
the parties focused on the possibility that the same decision might have been reached without reference to
the desire to defeat the raiders, until the judge drew their attention to its possible relevance. By that time it
was too late to explore the point with the witnesses. In his judgment (paras 235-237), the judge summarised
the findings of fact which he would have made if he had allowed the company to rely on the alternative
hypothesis that the directors had disregarded their desire to defeat the raiders. He thought that they would
have applied their minds to the right point and made the same decision. But the judge did not allow the
company to take the point and there has been no appeal against that refusal. Since his reason for refusing
was that the claimants had not had a proper opportunity to challenge the alternative hypothesis in the course
of the evidence, it seems to me that the judge’s hypothetical alternative findings are not properly before this
court.
44. I would allow the appeal and restore the decision of Mann J.
45. In the light of the observations of other members of the court, I should record that while we received
no oral argument on the role of causation in identifying the relevant purpose(s) of a board decision, full and
helpful written submissions on the point were delivered after the hearing, at the invitation of the court.
Baldev Krishna Sahi v. Shipping Corporation of India 1987 AIR 2245
Sub-section (l ) of s. 630 of the Companies Act, 1956 provides for launching of prosecution against an
officer or employee of a company, who (a) wrongfully obtains possession of any property of a company,
or (b) having any such property in his possession wrongfully withholds or knowingly misapplies the same.
The petitioner who was given a flat by the company for his residence during the period of his employment
did not vacate it on his retirement. He was granted six months’ time on humanitarian grounds upon his
undertaking to comply with.
Upon his failure to vacate the premises the company lodged a complaint against him under s. 630 of the
Act for wrongful withholding of its property. The Magistrate took cognizance of the complaint and directed
issue of process.
Dismissing the writ petition filed by him under Art. 227 of the Constitution read with s. 482 Cr. P.C. seeking
to quash the proceedings, the High Court following its consistent view in a series of cases that the term
'officer or employee' in sub-s. (1) of s. 630 must be interpreted to mean not only the present officer or
employee of company but also to include past officers and employees of the company and that the words
'any such property' in cl. (b) qualify the words 'any property of a company' appearing in cl. (a), held that
the case does not call for interference.
In the special leave petition it was contended for the petitioner that the provision contained in s. 630 of the
Act is a penal provision and, therefore, must be subject to a strict construction and there is no room for
intendment, that the term 'officer or employee' occurring in sub-s. (1) of s. 630 refers only to the existing
officers and employees of a company, and not the past officers, and that cl. (b) of sub-s. (I) does not stand
by itself but is interconnected with cl. (a) thereof and therefore cl. (a) and cl. (b) must be read
together and when so read the words 'any such property' in cl. (b) do not qualify the words 'any property of
a company' in cl. (a) and only relate to the property of company wrongfully taken possession of by a present
officer.
Dismissing the special leave petition,
HELD:
Section 630 of the Companies Act, 1956 plainly makes it an offence if an officer or employee of the
company who was permitted to use any property of the company during his employment, wrongfully retains
or occupies the same after the termination of his employment.
The term 'officer or employee' of a company in s. 630(1) applies not only to existing officers or employees
but also to past officers or employees if such officer or employee either (a) wrongfully obtains possession
of any property, or (b) having obtained such property during the course of his employment, withholds the
same after the termination of his employment.
The beneficent provision contained in s. 630 of the Companies Act though penal, has been purposely
enacted by the legislature with the object of providing a summary procedure for retrieving the property of
the company. It is the duty of the Court to place a broad and liberal construction on the provision in
furtherance of the object and purpose of the legislation which would suppress the mischief and advance the
remedy.
Sub-s. (1) of s. 630 of the Act by clauses (a) and (b) creates two distinct and separate offences: (1) Where
an officer or employee of a company wrongfully obtains possession of any property of the company during
the course of his employment, to which he is not entitled. Normally, it is only the present officers and
employees who can secure possession of any property of a company. It is also possible for such an officer
or employee after termination of his employment to wrongfully take away possession of any such property.
This is the function of cl. (a) 170 and although it primarily refers to the existing officers and employees, it
may also take in past officers and employees. (2) Where an officer or employee of a company having any
property of a company in his possession wrongfully withholds it or knowingly applies it to purposes other
than those expressed or directed in the articles and authorized by the Act. It may well be that an officer or
employee may have lawfully obtained possession of any such property during the course of his employment
but wrongfully withholds it after the termination of his employment. That appears to be one of the functions
of cl. (b). Clause (b) also makes it an offence if any officer or employee of a company having any property
of the company in his possession knowingly applies it to purposes other than those expressed or directed in
the articles and authorized by the Act. That would primarily apply to the present officers and employees
and may also include past officers and employees. There is therefore no warrant to give a restrictive
meaning to the term 'officer or employee' appearing in sub-s. (1) of s. 630 of the Act.
It is quite evident that clauses (a) and (b) are separated by the word 'or' and therefore are clearly disjunctive.
The whole object of enacting the provision is the preservation of the property of a company by the creation
of two distinct offences by clauses (a) and.(b) which arise under different sets of circumstances, and it
would be rendered nugatory by projecting cl. (a) into cl. (b).
According to the plain construction, the words 'any such property' in cl. (b) relate to 'any property of a
company' as mentioned in cl. (a). It is wrongful withholding of such property meaning the property of the
company after termination of the employment, which is an offence under s. 630(l)(b) of the Act.
The petitioner given one month's time to vacate the premises failing which the respondents to take such
proceedings as the law provides. The Additional Chief Metropolitan Magistrate to proceed with the trial
and dispose it of expeditiously.
Bank of Baroda v. Official Liquidator (1992) 73 Comp. Cas. 688 (MP)
Facts:
Cotton Dealers Pvt. Ltd. (Defendant no. 1) took loans from the plaintiff bank and the managing director
and three other directors (defendants 2 – 5) of the defendant no. 1 were the guarantors of the loan.
The defendant no. 1 opened cash credit account with plaintiff bank and to secure advances pledged the
goods with plaintiff bank. The cash limit of the account was increased by defendant no. 1 and the rate of
interest was also varied as and when the rate of interest was changed by RBI. The varied rate of interests
were accepted by the defendants and the defendants 2 – 5 signed a document for continuing security and
also a security bond in favour of the plaintiff bank for due payment of all amounts due.
Defendant no. 1 was carrying out business unprofessionally and even though the bank asked the defendant
no. 1 to clear the advances every year, but it wasn’t done. Despite giving assurances defendant no. 1 did
not clear the advance and plaintiff bank filed the suit for recovery of the outstanding amount along with
interest (rate of 9 ½ % as decided) against the defendants 1-5 in October, 1969.
Arguments:
Defendants 4 and 5 argued that they are no longer directors of defendant no. 1 as they have resigned in
1966, the same being informed to the plaintiff bank and that fresh guarantees were executed by new
directors, defendants 2 and 3 in replacement. They argued that they thus, stood discharged of the liability
of suretyship.
The defendants 4 and 5 argued in the appeals court that in accordance with the banking regulations (as
signed by the two witnesses of the plaintiff bank) when the directors of a company are changed then new
documents are taken by the bank to continue the facility, subject to ex-directors agreeing to execute the
fresh guarantee. The regulation further states that the ex-directors will be absolved of their liability only if
the plaintiff bank is sure about the creditworthiness of the new directors.
Defendant 3 argues that he is no longer the director of defendant no. 1, since April, 1969.Defendants also
argue that the suit is barred by limitation. In the appeals court the plaintiff bank argued that rate of interest
for a commercial transaction should be the same as decided between parties via contract, and not at the
discretion of the court, unless circumstances warrant it.
The plaintiff bank argues that in case of continuing guarantee it can be revoked at any time by the guarantor
for future transactions by giving a notice of the same to the creditor under section 130 of the Contract Act,
and no such notice was given by defendants 4 and 5 to the plaintiff bank.
The plaintiff bank also argued that the personal guarantee signed by the defendants 2 – 4 didn’t have any
provision which absolved the defendants 4 and 5 of their liability once they resigned from defendant no. 1.
The plaintiff bank also argued that since the guarantee given by defendants 4 and 5 still continue, the suit
is not barred by limitation.
Decision:
The trial court ordered in favor of the plaintiff bank and allowed them to recover the full amount with an
interest at the rate of 6% p.a with adjustments of amount already paid by the defendants.
The appellate court keeping in mind the facts and circumstances of the present case decreed in favour of
the plaintiff bank and held that the guarantee given by defendants 4 and 5 had not ceased to operate on new
guarantee being entered into by defendants 2 and 3.
That the subsequent guarantee was entered into by defendants 2 and 3 could be treated as additional
guarantee and by this fact merely the interest of the plaintiff bank in the guarantee given by defendants 4
and 5 could not be jeopardized.
Lakshmiratan Cotton Mills Ltd v. Aluminium Corp of India Ltd., AIR 1970 SC 1482
Prior to January 18, 1944 six companies including M/s. Lakshmiratan. Cotton Mills Co. Ltd. (the appellant-
company) and the Aluminium Corporation of India Ltd. (respondent corporation) were jointly managed by
two groups known as the Singhania and Gupta groups. As a result of disputes between the two groups there
was a reference to arbitration.
After January 18, 1944, the date of the award, the aforesaid six concerns were brought under the
management and control of one or the other of the two groups- The Corporation came under the control
and management of the Singhania group. In cl. 9 of the award it was said that the award did not cover the
advances which either party or their separate firms may have made to all or any of them or their moneys
which may be in deposit with them and that they would be payable and paid in their usual course. After the
award the appellant Company sent a statement of account in respect of advances made to the respondent
corporation, and expenditure incurred on its behalf. The statement was objected to on the ground that the
appellant company had not properly maintained its accounts during the period of joint management. Efforts
at reconciliation of accounts having faded the appellants filed two suits claiming Rs. 3,56,207.9.6 and Rs.
72,595.4.6 from the Corporation, being suits Nos. 63 and 65 of 1949. In suit No. 63 of 1949 it was claimed
that the suit was within time as after adjustment of several items in 1946 and 1947 a sum of Rs.
2,96,110..11.6 was found due to the appellant- company and that in any event the suit was saved from being
barred by limitation by a letter (Ex.. 1) dated April 16, 1946 addressed by s the Secretary-cum-Chief
Accountant of the Corporation, thereby acknowledging the liability of the Corporation to pay the amount
which would be found due and payable under the said accounts.
Similar averments were made in, Suit No. 65 of 1949. The written statements filed on behalf of the
Corporation inter alia pleaded that the said claim was barred by limitation, that the said letter did not amount
to an acknowledgement within the meaning of s. 19 of the Limitation Act, 1908 which was then applicable
to the suits, and lastly, that even if the said letter did amount to an acknowledgement, it was not binding on
the Corporation. The trial court decreed the suits but the High Court dismissed them as being time-barred.
In appeals to this Court the questions that fell for consideration were (i) whether the letter in question
amounted to an acknowledgment;(ii) whether it was an acknowledgement by the corporation, and if not
(iii) whether the Secretary-cum- Chief Accountant had authority express or implied. To acknowledge
liability on behalf of the Corporation so as, to bind that corporation. Allowing the appeals,
HELD: (1) (a) From the provisions of s. 19(1) of the Limitation Act, 1908 it is clear that the statement on
which the plea of acknowledgement is founded must relate to a subsisting liability as the section requires
that it must be made before the expiration of the period prescribed by the Act. It need not, however, amount
to a promise to pay, for an acknowledgement does not create a new right of action but merely extends the
period of limitation.
The statement need not indicate the exact nature or the specific character of the liability. The words used in
the statement in question, however, must relate to a present subsisting liability and indicate the existence
of jural relationship between the parties such as, for instance, that of a debtor and a creditor and the intention
to admit such a jural relationship Such an intention need not be in express terms and can be inferred by
implication or the nature of the admission and the surrounding circumstances.
Generally speaking a liberal construction of the statement in question should be given. That of course does
not mean that where a statement is made without intending to admit the existence of a particular jural
relationship, such an intention should be fastened on the person making the statement by an involved or a
far-fetched reasoning.
(b) From the correspondence between the parties and the surrounding circumstances it must follow that
there was a subsisting account in the name of the appellant company in the books of the Corporation in
which interest on the balance shown therein from time to time was being credited and in which amounts in
respect of items passed during the course of reconciliation were also duly credited. The statement in the
letter Ex. 1 that "after all the above adjustments the position will be as per statement attached", that is to
say, that there 'was a balance of Rs. 107447/13/11 due and payable to the appellant company must clearly
amount to acknowledgement within the meaning of S. 19(1). If the letter be looked at in the background of
the controversy between the parties which controversy was limited to the question as to the correct-ness of
the amount claimed by the appellant company as also the correspondence which ensued in regard to it, it
would be impossible to say that the letter and the statement of account enclosed therewith were merely
explanatory and did not amount to an admission of the jural reship of debtor and creditor and of the liability
to pay the amount found due at the foot of the account on finalisation.
The mere fact that letter called for confirmation of the amount of the balance mentioned therein and the fact
that the appellant company failed to confirm it, could not lead to a conclusion that the admission of liability
was conditional and therefore could not operate as an acknowledgement. The confirmation sought in the
letter was not a condition to the admission as to the existence of a subsisting account and the liability to pay
when accounts were finalised but to the specific amount which according to the corporation would be the
amount payable by it according to its calculation. 'There was no condition subject to which the admission
was to be made which remained unperformed.
(ii) The plea that the letter Ex. I should be regarded as an acknowledgement by the corporation itself was
not included among the issues formulated before the courts below. It could not be allowed to be raised for
the first time in this Court.
(iii) If the correspondence between the parties together with the statements of accounts enclosed therewith
was closely examined it became clear that S was authorised to scrutinise the claim made by the appellant
company, the various items for which the appellant _company claimed credit and to reject the same and,
what is important, to allow others. That he had such an authority was clear from the fact that in respect of
such of the items which he allowed, credit was given to the appellant and necessary entries to the credit of
the appellant company were posted in the account maintained by the Corporation in its books of account.
It was impossible to say that in the course of finalising the accounts, S accorded his assent to various items
claimed by the appellant company without having been authorised so to do. Nor was it possible to say that
on his passing those items necessary entries were made in the books of accounts of the corporation without
his having so authorised. Further, he could not have sent to the appellant company statements of account
showing the balance due to it "as per the ledger" unless he was authorised to finalise the accounts and arrive
at the amount due and payable to, the company.
Powers and restrictions of board of directors
Section 179. Powers of Board.
(1) The Board of Directors of a company shall be entitled to exercise all such powers, and to do all such
acts and things, as the company is authorised to exercise and do:
Provided that in exercising such power or doing such act or thing, the Board shall be subject to the
provisions contained in that behalf in this Act, or in the memorandum or articles, or in any regulations not
inconsistent therewith and duly made thereunder, including regulations made by the company in general
meeting:
Provided further that the Board shall not exercise any power or do any act or thing which is directed or
required, whether under this Act or by the memorandum or articles of the company or otherwise, to be
exercised or done by the company in general meeting.
(2) No regulation made by the company in general meeting shall invalidate any prior act of the Board which
would have been valid if that regulation had not been made.
(3) The Board of Directors of a company shall exercise the following powers on behalf of the company by
means of resolutions passed at meetings of the Board, namely:—
(a) to make calls on shareholders in respect of money unpaid on their shares;
(b) to authorise buy-back of securities under section 68;
(c) to issue securities, including debentures, whether in or outside India;
(d) to borrow monies;
(e) to invest the funds of the company;
(f) to grant loans or give guarantee or provide security in respect of loans;
(g) to approve financial statement and the Board’s report;
(h) to diversify the business of the company;
(i) to approve amalgamation, merger or reconstruction;
(j) to take over a company or acquire a controlling or substantial stake in another company;
(k) any other matter which may be prescribed:
Provided that the Board may, by a resolution passed at a meeting, delegate to any committee of directors,
the managing director, the manager or any other principal officer of the company or in the case of a branch
office of the company, the principal officer of the branch office, the powers specified in clauses (d) to (f)
on such conditions as it may specify:
Provided further that the acceptance by a banking company in the ordinary course of its business of deposits
of money from the public repayable on demand or otherwise and withdrawable by cheque, draft, order or
otherwise, or the placing of monies on deposit by a banking company with another banking company on
such conditions as the Board may prescribe, shall not be deemed to be a borrowing of monies or, as the
case may be, a making of loans by a banking company within the meaning of this section.
Explanation I.—Nothing in clause (d) shall apply to borrowings by a banking company from other banking
companies or from the Reserve Bank of India, the State Bank of India or any other banks established by or
under any Act.
Explanation II.—In respect of dealings between a company and its bankers, the exercise by the company
of the power specified in clause (d) shall mean the arrangement made by the company with its bankers for
the borrowing of money by way of overdraft or cash credit or otherwise and not the actual day-to-day
operation on overdraft, cash credit or other accounts by means of which the arrangement so made is actually
availed of.
(4) Nothing in this section shall be deemed to affect the right of the company in general meeting to impose
restrictions and conditions on the exercise by the Board of any of the powers specified in this section.
Section 180. Restrictions on powers of Board.
(1) The Board of Directors of a company shall exercise the following powers only with the consent of the
company by a special resolution, namely:—
(a) to sell, lease or otherwise dispose of the whole or substantially the whole of the undertaking of
the company or where the company owns more than one undertaking, of the whole or substantially
the whole of any of such undertakings.
Explanation.—For the purposes of this clause,—
(i) “undertaking” shall mean an undertaking in which the investment of the company exceeds
twenty per cent. of its net worth as per the audited balance sheet of the preceding financial year or
an undertaking which generates twenty
per cent. of the total income of the company during the previous financial year; (ii) the expression
“substantially the whole of the undertaking” in any financial year shall mean twenty per cent. or
more of the value of the undertaking
as per the audited balance sheet of the preceding financial year;
(b) to invest otherwise in trust securities the amount of compensation received by it as a result of
any merger or amalgamation;
(c) to borrow money, where the money to be borrowed, together with the money already borrowed
by the company will exceed aggregate of its paid-up share capital and free reserves, apart from
temporary loans obtained from the company’s bankers in the ordinary course of business:
Provided that the acceptance by a banking company, in the ordinary course of its business, of
deposits of money from the public, repayable on demand or otherwise, and withdrawable by
cheque, draft, order or otherwise, shall not be deemed to be a borrowing of monies by the banking
company within the meaning of this clause.
Explanation.—For the purposes of this clause, the expression “temporary loans” means loans
repayable on demand or within six months from the date of the loan such as short-term, cash credit
arrangements, the discounting of bills and the issue of other short-term loans of a seasonal
character, but does not include loans raised for the purpose of financial expenditure of a capital
nature;
(d) to remit, or give time for the repayment of, any debt due from a director.
(2) Every special resolution passed by the company in general meeting in relation to the exercise of the
powers referred to in clause (c) of sub-section (1) shall specify the total amount up to which monies may
be borrowed by the Board of Directors.
(3) Nothing contained in clause (a) of sub-section (1) shall affect—
(a) the title of a buyer or other person who buys or takes on lease any property, investment or
undertaking as is referred to in that clause, in good faith; or
(b) the sale or lease of any property of the company where the ordinary business of the company
consists of, or comprises, such selling or leasing.
(4) Any special resolution passed by the company consenting to the transaction as is referred to in clause
(a) of sub-section (1) may stipulate such conditions as may be specified in such resolution, including
conditions regarding the use, disposal or investment of the sale proceeds which may result from the
transactions:
Provided that this sub-section shall not be deemed to authorise the company to effect any reduction in its
capital except in accordance with the provisions contained in this Act.
(5) No debt incurred by the company in excess of the limit imposed by clause (c) of sub-section (1) shall
be valid or effectual, unless the lender proves that he advanced the loan in good faith and without knowledge
that the limit imposed by that clause had been exceeded.
Remedies against Directors' Undue Gains: Personal or Proprietary?
What is the appropriate remedy against a director who makes secret profits? Should the remedy be merely
a personal one, or should it be a proprietary one? This issue is one of great importance and several
jurisdictions have been debating the issue for years now. The rules against conflict and profit are at the core
of a director’s duties; and it is essential for a legal system to provide a coherent set of remedies to maintain
the strength of this rule. Whether the remedy against the director is personal or proprietary in nature is
important, and not only for theoretical neatness. A recent decision of the English Court of Appeal explained
the importance of the distinction between personal and proprietary remedies thus:
“In some cases it matters because the fiduciary is insolvent; and the establishment of a proprietary remedy
may mean that the profit is unavailable for distribution among his creditors… In some cases it is said to
matter because the secret profit has been invested in an asset that has itself increased in value... Sometimes
it matters because the defaulting fiduciary no longer has the profit and the principal wishes to recover it
from a third party into whose hands it has come…”
The question of whether secret profits derived by a fiduciary are held in constructive trust or not has long
been a matter of debate. In England, cases such as Lister v. Stubbs indicated that the remedy against the
defaulting fiduciary is purely personal in nature. The Privy Council in an appeal from Hong Kong however
favoured a proprietary remedy – AGHK v. Reid. Since Reid, the debate has intensified in England: see
Sinclair v. Versailles and FHR European Ventures v. Mankarious. Other common law jurisdictions have
tended to favour a proprietary remedy. The leading Australian case, Grimaldi v. Chameleon Mining (No.
2), saw an extensive analysis of the position across several countries. Finn J. ultimately concluded that the
law must – and does – recognize a proprietary remedy. (Part of – but not the entire – reasoning depends on
the different nature in which the law of constructive trusts is approached in Australia.)
In FHR, the English Court of Appeal recognized that the English insistence on a personal remedy runs
counter to the law in Australia, Canada, Hong Kong, Singapore, New Zealand and the US. English Courts
have shown a tendency to recognize a proprietary remedy by reading down Lister, though perhaps, a
complete departure has not yet been made.
In India, section 88 of the Trusts Act seemed to be fairly clear that a proprietary remedy is available.
However, section 166(5) of the Companies Act, 2013 appears to provide only a personal remedy against
directors. If this is correct, India would perhaps be a unique jurisdiction – one which has moved from a
proprietary to a personal remedy. This does not seem desirable; indeed, it is hard to believe that a conscious
draftsperson intended this result. The language of s. 166(5) does however seem to indicate an exclusive
personal remedy. The section says:
“A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to
himself or to his relatives, partners, or associates and if such director is found guilty of making any undue
gain, he shall be liable to pay an amount equal to that gain to the company…”
Thus, the company is given the right to an amount equal to the gain: not the gain itself. The section does
not provide that the gain shall be held in trust or for the benefit of the company. All it says is that the director
shall be liable to pay an amount to the company; and the measure of that amount shall be the gain which he
received. (This also highlights some difficult but interesting questions on how the ‘gain’ is to be measured
etc.)
It is noteworthy that none of the other sub-sections (1) to (6) prescribe any measure of liability against the
directors. Sub-section (5) is peculiar in this regard. Sub-section (7) imposes a statutory penal fine: it can be
inferred that sub-section (7) would not bar the other remedies of the wronged company. What is hard to
understand is why a specific remedy is provided in sub-section (5) alone. It could be argued that including
this specific remedy (coupled with the absence of a provision saving other legal remedies) would mean that
section 166(5) provides the sole remedy for “making an undue gain”.
It is not easy to harmonise s. 166(5) with the remedies found elsewhere in the law – say in s. 88 of the
Trusts Act. Textually, one may attempt to ‘harmoniously’ read the two sections: s. 166(5) speaks of “any
undue gain”, while s. 88 speaks of “pecuniary advantage from adverse dealings”. On a reading of the
language, s. 166(5) covers a broader scope. One could perhaps try to say that s. 88 deals only with a no-
conflicts rule, for which a proprietary remedy remain; while s. 166(5) deals only with the no-profit rule, for
which only a personal remedy is available. The principled basis for such a distinction is hard to find; and it
is also hard to say why a breach of the no-profit rule should have less harsh consequences than the breach
of a no-conflict rule. Further, distinguishing between the rules against conflicts and the rules against profits
is no easy matter: conflicts naturally lead to profits – what does one apply in such cases? Finally, the
language of the two sections in any event does not fit easily with the proposed categorization.
It could be said, perhaps, that s. 166(5) gives an additional option – it allows a personal as well as a
proprietary remedy, and clarifies that the personal remedy can be compensatory as well as restitutionary
(subject to a double recovery bar). First, the language does not really support this conclusion. Secondly,
non-statutory common law and equitable rules would in any case have allowed an option to the claimant
for following a personal remedy if he so chooses; and can demand an account for profits. So, even on this
reading, a major portion of s. 166(5) would be rendered unnecessary. What, then, does one make of this?
Once harmonization of the two is not possible, one would have to say that s. 166(5) – being both the later
and the specific rule – would have to prevail. The only realistic conclusion seems to be that the proper
interpretation of the statute would make a personal remedy as the only available remedy; and s. 166(5)
would prevail over s. 88. As a matter of policy, this raises serious concerns: the company will be left less
well-protected than it would have been at common law. The Standing Committee Report appears not to
have considered these issues; and how Courts will interpret the phrase “an amount equal to that gain” cannot
easily be predicted. The section appears to codify the law relating to the remedy of an account for profits,
but fails to consider the availability of other remedies. It would have been ideal if the legislature had adopted
the statutory solutions found in Singapore or England. In Singapore, for example, s. 157 deals with available
remedies, and sub-section (4) provides “This section is in addition to and not in derogation of any other
written law or rule of law relating to the duty or liability of directors or officers of a company.” Section 178
of the UK Companies Act dealing with the civil consequences of breaches by directors of ss. 172-177 states
that the consequences would be the same as if the “corresponding common law rule or equitable principle
applied.” Indian Courts will either have to apply the statute as it stands to conclude that only personal
remedies are available; or will somehow have to reason towards effectively implying the Singapore or
English solution. How the latter can be legitimately achieved is hard to understand.
CASE LAW - Regal (Hastings) v Gulliver [1942] 1 All ER 378

Regal were in negotiation for the purchase of two cinemas in Hastings. There were five directors on the
board, including Mr Gulliver, the chairman. Regal incorporated a subsidiary, Hastings Amalgamated
Cinemas Ltd, with a share capital of £5,000. There were six directors on its board, who included the five
directors of Regal. Regal was only prepared to subscribe £2,000. Consequently, it was agreed that each of
the directors of Amalgamated would themselves subscribe for 500 shares each, with the exception of Mr
Gulliver. He said that he would find investors. He duly did so, and as a result 200 shares in Amalgamated
were allotted to a Swiss company called Seguliva; 200 to a company called South Downs Land Co Ltd and
100 to a Miss Geering. Mr Gulliver himself held 85 out of 500 shares in Seguliva and 100 out of 1,000
shares in South Downs Land Co. He was a director of Seguliva and the managing director of South Downs
Land Co, and signed the subscription cheques on their behalf. Miss Geering was a friend of his. The shares
in Amalgamated were subsequently sold at a profit; and the issue was whether the directors were liable to
account to Regal for their profit.
Held: Directors are liable to account for activities outside the company if (i) what the directors did was so
related to the affairs of the company that it can properly be said to have been done in the course of their
management and in utilisation of their opportunities and special knowledge as directors and (ii) what they
did resulted in profit for themselves.
Viscount Sankey said: ‘In my view, the respondents were in a fiduciary position and their liability to account
does not depend upon proof of mala fides. The general rule of equity is that no one who has duties of a
fiduciary nature to perform is allowed to enter into engagements in which he has or can have a personal
interest conflicting with the interests of those whom he is bound to protect. If he holds any property so
acquired as trustee, he is bound to account for it his cestui que trust.’
Lord Russel of the Killowen said: ‘The rule of equity which insists on those, who by use of a fiduciary
position make profit, being liable to account for the profit, in no way depends on fraud, or absence of bona
fides; or upon such questions or considerations as whether profit would or would otherwise have gone to
the plaintiff, or whether the profiteer was under a duty to obtain the source of the profit for the plaintiff, or
whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff has in fact
been damaged or benefited by his action. The liability arises from the mere fact of a profit having, in the
stated circumstances, been made. The profiteer, however honest and well-intentioned, cannot escape the
risk of being called upon to account.’
Corporate Governance
Enron, Fraud and Securities Reform: An Enron Prosecutor’s Perspective

John R. Kroger
When Enron went bankrupt on December 2, 2001, after stunning revelations about the company's insider
deals and faulty accounting, some 4500 Enron workers lost their jobs in Houston alone.6 Enron's
employees, who had been encouraged to place their retirement savings in Enron stock, lost some $1.3 billion
in 401(k) accounts. Nationwide, Enron's countless investors, who had seen the stock price decline over the
course of the year from $84 to mere pennies per share, lost some $61 billion. This disaster occurred largely
because of a troubling gap between perception and reality.
Throughout the 1990s and up to late 2001, most investors and commentators believed Enron was one of the
most successful, innovative and profitable companies in America. Fortune, for example, rated Enron "The
Most Innovative Company in America" for five straight years, from 1997 to 2001. At its peak, Enron traded
at a price-earnings ratio of fifty-five to one, four times higher than comparable energy and trading firms. In
2001, in the midst of the dot.com implosion, Fortune even identified Enron as one of the most reliable
"Stocks to Last the Decade." These assessments were horribly inaccurate. In truth, Enron was a deeply
troubled company, well on its way to financial collapse.
The extent of the gap in the Enron case between outsider perceptions and company reality inevitably draws
our attention to the role of Enron's senior management, who created and profited from this gap. We must
not let our concern with individual conduct distract us, however, from the larger issue. The next time senior
management of a major American company tries to mislead investors by making their company appear
more successful than it truly is, will we catch the problem before it explodes, or will we be fooled again?
Since the 1930s, America has relied on a complex and evolving public private system of checks and
deterrents to prevent companies and their executives from misleading investors. This regime relies on four
primary institutional watchdogs to prevent and deter misconduct before it happens and to catch and disclose
actual misconduct when it occurs: independent auditors, corporate boards of directors, private securities
analysts, and securities regulators at the Securities and Exchange Commission (“SEC”). Behind this initial
line of defense lies a fifth institutional force, the criminal prosecutors with the United States Department of
Justice (“DOJ”), who enforce the federal criminal laws. Though motivated by disparate goals, these five
players collectively work to protect investors from false and misleading information and ensure that our
securities market functions in a safe, reliable, and efficient manner.
Simply put, Enron sought to mislead investors about its financial position and commercial success, and it
got away with this deception from 1997 to late 2001 because all five institutional players failed massively
in their task. Enron’s board of directors was apparently clueless, possessing no idea it was presiding over a
sinking ship; Arthur Andersen’s accountants helped perpetuate the fraud rather than working to stop it;
Wall Street’s securities “analysts” were more interested in pumping up Enron’s stock price and repeating
Enron management's inaccurate claims than they were in analyzing the company’s actual business
performance; the SEC was asleep at the wheel, not even bothering to review Enron’s publicly filed quarterly
financial statements;16 and the federal criminal laws ultimately proved to be no real deterrent at all.
In 1985, a large mid-western gas pipeline company called InterNorth, headquartered in Omaha, Nebraska,
acquired HNG. The InterNorth acquisition is something of a legend in Houston business circles. Though
InterNorth thought it was buying HNG, within a short period of time it became clear that HNG's
management was calling all the shots for the newly merged company. HNGInterNorth was based in
Houston, not Omaha, and the CEO of HNG ran the show. His name was Ken Lay, and he renamed the new
company "Enron."
Enron was a company built on deregulation. From the 1930s to the 1980s, natural gas was heavily regulated
by the federal government, which set the price for both the sale and transportation of the product. In the
mid-1980s, however, the Reagan Administration began to eliminate price controls and give gas producers
and pipeline companies the ability to contract freely. Some major companies like Columbia Gas
Transmission could not adjust to the rapidly changing market and perished. Others thrived, and none more
than Enron.
Enron understood that the newly deregulated market was grossly inefficient, with a large number of
producers struggling to identify and contract with an even vaster number of customers. Enron exploited
these inefficiencies, stepping into the middle between producers and users and rationalizing the entire
market. It bought huge quantities of gas from producers at steep discounts, often obtained by financing gas
exploration and production in the tight 1980s Texas credit market, and then delivered that gas to wholesale
customers through its own nationwide pipeline system. Soon, both producers and users gave up trying to
enter the market on their own, preferring simply to deal with Enron. Within a few short years, Enron's
strategy totally transformed the gas sector. The company captured a huge percentage of the market and
pocketed substantial profits. By the early 1990s, Enron was the leading natural gas company in the United
States.
Unfortunately, Enron's success in the rapidly deregulating natural gas sector held the key to the company's
ultimate demise. Success built on exploiting a rapidly deregulating market is inevitably short-lived. Other
companies watch the market leader's operations, copy its innovations, and compete for the same business.
As the market becomes more efficient, opportunities decline, competition stiffens, and profit margins
shrink. This happened rapidly in natural gas. Companies like El Paso and Dynegy monitored Enron closely
and based their own business models on Enron's. As early as 1993, Enron's profit margins in gas began to
decline.
As the low-hanging fruit in the natural gas market disappeared, Enron's management faced a difficult
business strategy decision: it could remain a natural gas company and grow content with a smaller return
on its capital, or it could diversify into other sectors of the economy and try to replicate its great success in
natural gas. Enron was a confident and aggressive company. It chose to diversify.
Enron's Diversification Strategy and Cost Structure
Over the course of the 1990s, Enron rapidly diversified into an enormous array of new business areas in the
United States, Europe, and the developing world: energy derivatives trading, water, power generation, coal,
paper and forest products, telecommunications, retail electricity, metals. This diversification strategy was
asset-heavy. Enron, for example, built or purchased pipelines in Brazil, steel mills in Thailand, newsprint
mills in Canada, and power plants in the United Kingdom, the Philippines, Guatemala, India and Guam.
These investments cost tens of billions of dollars. Enron paid out approximately $1 billion to construct its
Dahbol power plant in India30; some $2.4 billion for purchase of the Wessex water utility in the United
Kingdom; $3.2 billion for Portland General Electric; $2 billion in cash and debt for metals trading company
MG; $1.3 billion for an electricity company in Brazil; $300 million for a paper mill in Quebec. The rate of
investment was dizzying. In July 1998, Wall Street equity analysts from DLJ noted that Enron had spent
some $3.5 billion to purchase water and electricity assets within a few short weeks alone.
Enron's diversification strategy should serve as a case study for business students for years to come, for it
teaches important lessons. As Enron expanded into new areas, it did not generally hire experienced senior
managers from these sectors of the economy to guide its business operations. Instead, Enron dispatched
senior natural gas and energy trading executives to drive its new businesses. Enron assumed that success in
natural gas and trading could be replicated in other fields because markets are markets, functioning in more
or less the same manner. Enron failed to understand, unfortunately, that its success in natural gas was the
direct result of its superior knowledge about the market, knowledge gained through decades of experience
as a gas producer, transporter, and retail marketer. When Enron's extremely successful gas executives were
plugged into new industrial sectors, they failed virtually across the board, often through sheer ignorance,
producing very little or no revenue for the company.
By decade's end, Enron's costly diversification strategy had put the company in a very vulnerable position.
Though the energy trading business may have been prospering, virtually every other major new Enron
initiative— international power, retail electricity, water, telecommunications—was failing.
The true extent of Enron's losses in these years may never be known with precision, but informed estimates
are staggering. In India, Enron's Dabhol power plant never became operational, with an ultimate cost to
Enron of almost $1 billion. Enron's telecommunications division, Enron Broadband Services, lost at least
another $1 billion within two short years.45 Metals: at least $400 million in losses. These losses were
matched or exceeded in other areas. Fortune Bethany McClean and Peter Elkind, two of Enron's most savvy
observers, have estimated Enron's total business losses in the late 1990s at "well over $10 billion in cash"—
a figure that boggles the mind.
Enron's difficulties were exacerbated by a cost structure that was totally out of control. In the first half of
the 1990s, before Jeff Skilling took control of the company, Enron had kept a tight lid on personnel costs,
with virtually no employment growth during a five-year period of increasing revenue and profits. Under
Skilling, however, Enron abandoned serious cost controls. Employment rolls sky-rocketed as Enron
diversified, from 7500 in 1996 to over 20,000 in 2001.51 Employee compensation also went through the
roof. In 2000, for example, some 200 Enron executives made $1 million or more in compensation, and 26
made over $10 million. A new office tower in Houston added another $200 to 300 million in costs
How do you stay in business if, like Enron, you are spending billions of dollars per year to buy expensive
new assets and hire more well-paid staff, but none of your new business ventures are generating sufficient
profit to meet these costs? There is really only one answer: you meet your costs by raising money in capital
markets, by issuing equity or going into debt. Enron chose debt, borrowing some $30 billion over a few
short years. What made Enron unique was the way it borrowed these sums.
Corporations that precipitously increase their debt load are taking a serious risk. Publicly traded companies
are required to report their debt positions to the SEC, and this can have a huge impact on the company's
fortunes. If, for example, a company raises billions of dollars on capital markets over a very short period of
time, credit rating agencies will lower the company's credit rating. This, in turn, will increase the company's
cost of capital and, in extreme situations, cause access to capital to dry up altogether. When, for example,
lenders got an accurate picture of Enron's true debt position in late November 2001, they immediately cut
off access to funds and Enron went bankrupt.
Raising capital is particularly tricky for companies like Enron that engage in substantial derivatives trading.
Over the course of the 1990s, Enron had become a major player in energy futures markets, and though this
may have been profitable, it increased Enron's vulnerability. When companies sell futures, they are
promising to deliver a commodity to their customer at a future date. This entails risk for the customer, since
there is no guarantee that the selling company will be in a position to meet its obligation when the future
delivery date arrives.
As a result, only companies with solid credit ratings and a reputation for reliability can play in derivatives
markets in any substantial way. If one's credit rating declines, counter-parties demand more collateral before
entering into trades, making extensive trading prohibitively expensive. Unfortunately for Enron, nothing
drives down one's credit rating faster that large-scale borrowing. Thus, Enron's cash-hungry diversification
strategy posed enormous risks to Enron's critical energy trading business.
In summary, poor management put Enron in a very difficult position by the late 1990s. Enron needed to
raise billions of dollars to meet its costs, but it needed to do this in a manner that would not spook capital
markets and jeopardize its trading business. Surprisingly, Enron managed to pull this trick off, quietly
borrowing over $30 billion to meet its costs without significant impact on its credit rating. The company
accomplished this miracle through deception.
Enron's Financial Statements: An Introduction

How do you know if a company is successful or not? In the past, you could actually use a company's product
or service, or talk to persons who did, and judge for yourself. Indeed, the first time I read a book on
investing, back in the 1980s, investment guru Peter Lynch recommended just this approach. In today's
world of multi-national conglomerate corporations with radically diverse product and service offerings, this
method is useless for all but the smallest companies.
Today, investors trying to decide whether to invest in a company or not have only one real option: to search
for and read as much information about a company as possible. Interestingly, however, there are very few
objective sources of information available to investors about any particular company. Instead, investors,
stock analysts, and business journalists are forced to base their judgments largely upon the company's own
statements—its press releases, annual meeting statements, stock analyst presentations, and, above all, the
financial statements it files with the SEC. The fact that we now rely almost exclusively on information
provided by large companies themselves to judge their operations is a dangerous development. In the Enron
case, investors had no idea Enron was heavily in debt and losing money fast for a very simple reason: Enron
did not tell them.
The most important way in which companies communicate with investors is through the mandatory
securities reporting system established by the Securities Exchange Act of 1934 and overseen by the SEC.
Under this system, publicly traded companies file mandatory financial statements with the SEC at the end
of each quarter, and these reports are then made available to investors and analysts.
These reports, referred to by investors and securities lawyers as "10-Qs," and "10- Ks," inform investors
about a company through two different mechanisms. First, companies provide a narrative description of
their operations and new initiatives during the relevant reporting period in a "Management's Discussion and
Analysis of Financial Condition and Results of Operations," or "MD&A." Second, the company supports
this narrative by disclosing hard financial data covering basic performance metrics, such as the amount of
company's debt, revenue, and cash flow. Companies are required to report information accurately and in
compliance with "generally accepted accounting principles," or "GAAP." They are also required to report
any additional "material" information needed to insure that its disclosures in the MD&A or metric sections
are not misleading. The materiality requirement means, in practice, that companies must disclose all major
developments, both good news and bad. The importance of these publicly filed financial statements to
equity and debt markets cannot be over-estimated.
Ultimately, virtually all business news and analysis available to lenders and investors is based on these
quarterly SEC reports. In the Enron case, the investing public did not know Enron was falling apart because
from 1997 onward, its 10-Qs and 10-Ks were grossly inaccurate.
In late 2001, William Powers, Dean of the University of Texas Law School, joined the Enron Board of
Directors and began to investigate the true condition of the company. What he found, he later testified
before Congress, was "appalling": a "systematic and pervasive attempt by Enron's Management to
misrepresent the Company's financial condition." Enron's narrative descriptions of company operations in
10-Q and 10-K MD&A disclosures was misleading, according to bankruptcy examiner Neil Batson. Enron,
Batson found, kept important "bad news" to itself, hiding the corporation's growing economic vulnerability,
its reliance on structured finance transactions for liquidity, and the extent of its financial obligations to
lenders. This was accomplished through both simple non-disclosure and by "incomplete and uninformative"
footnotes that were virtually incomprehensible.
Ultimately, however, a company's narrative disclosures are less important than the hard financial data
included in the financial statements. Even if a company wants to put a positive spin on its setbacks, numbers
don’t lie, right?
Alas, the Enron case demonstrates conclusively that if a company wants to deceive investors, it can easily
do so by manipulating its publicly disclosed financial data. This is the crux of the Enron case.
From a financial reporting perspective, Enron faced two "challenges." First, the company was making very
little money the old fashioned way, by selling a product or service, particularly from its new business
initiatives. To state the obvious, revenue and cash shortfalls matter to investors and lenders. Revenue and
cash flow are two of the most important metrics that companies report in their 10-Qs and 10-Ks, and if a
company reports bad numbers, or numbers that are positive but lower than expected, investors and lenders
will head for the hills. Second, Enron desperately needed cash—billions of dollars of cash—to meet the
company's exploding costs, compensate for its poor business performance, and fuel its diversification
strategy. If, however, the company met these cash needs through traditional means, such as additional stock
offerings or loans, investors reading Enron's financial statements would quickly realize that Enron was not
making enough money to pay for its operations and the company's stock price and credit rating would
decline accordingly. Enron, then, faced a conundrum. It could either report its financial condition accurately
or take its lumps in the market, with potentially disastrous results for its credit rating and trading business,
or it could try to conceal its true financial position.
Enron, fatefully, chose the second option. In the late 1990s, senior Enron executives set out to manipulate
Enron's reported financial data to improve the company's apparent financial success. As Enron CFO
Andrew Fastow explained in his recent guilty plea allocution to federal securities fraud charges, "While
CFO, I and other members of Enron's senior management fraudulently manipulated Enron's publicly
reported financial results. Our purpose was to mislead investors and others about the true financial position
of Enron and, consequently, to inflate artificially the price of Enron's stock and maintain fraudulently
Enron's credit rating." Enron Treasurer Ben Glisan confirmed these facts in his own recent guilty plea
allocution, stating: "I and others at Enron engaged in a conspiracy to manipulate artificially Enron's
financial statements."
How did this fraud work?
In a rudimentary securities fraud case, a company wishing to mislead investors simply reports inaccurate
financial data to the SEC and to investors. This, for example, is what happened at WorldCom. There, the
company took billions of dollars in costs and improperly reported them as capital expenditures, a simple
mechanism that transformed a $662 million loss in 2001 into a reported 2.4 billion profit. Enron's deception
was significantly more sophisticated.
Enron's Pre-Pay Transactions
Let's begin with Enron's biggest problem in the late 1990s: it needed to borrow billions of dollars without
reporting the loans to investors. How do you borrow billions of dollars without disclosing that fact? One of
Enron's methods of accomplishing this trick was to create a financial transaction called a "prepay."
Say, for example, that Enron needed to borrow $1 billion from a bank to meet its expenses or buy a steel
mill in Thailand. Enron could simply borrow the money from a lender, but this debt, once reported on the
company's 10-Q and 10-K statements, would lower the company's credit rating and alarm investors. To
avoid this outcome, Enron would offer to sell to major financial institutions energy futures for $1 billion.
At the same time, Enron would offer to buy back the same energy futures in one year for, say, $1.2 billion.
The bank would agree to this proposal because for all intents and purposes it is a loan: the bank would
provide Enron $1 billion for one year, and in return receive the principal back plus $200 million in interest
once the term of the loan was over.
For Enron, too, the pre-pay transactions were loans, functionally and practically: it borrowed money for a
period of time and in return assumed obligations to pay the money back with interest. Since, however,
Enron structured and labeled these debt transactions as "trades of energy futures," it would record the $1
billion it borrowed as cash flow from trading operations, and the $1.2 billion it owed as a "price risk
management liability"—a derivative trading liability.71 As a result, $1.2 billion that should have been
reported to the SEC and investors as debt was hidden in the corporation's enormous multi-hundred billion
dollar derivatives trading budget. Investors reading Enron's financial statements would have no way to learn
that Enron was going further into debt.
How important were these pre-pays to Enron? According to the bankruptcy examiner, pre-pay transactions,
primarily conducted with Citibank and JPMorgan, became "the quarter-to-quarter cash flow lifeblood of
Enron." From 1992 to 2001, Enron borrowed at least $8.6 billion through pre-pays—money, according to
the examiner, that should have been reported as debt. Pre-pays increased in importance to Enron as the
company headed toward bankruptcy. In 2000 alone, for example, pre-pays provided over 50% of Enron's
reported funds flow from operations. By June 2001, Enron was keeping over $5 billion in debt improperly
hidden on its balance sheet as "price risk management liabilities." These transactions violated GAAP,
because they resulted in substantial underreporting of Enron's true debt position.
Mark-to-Market Manipulation and Accounting Hedges
Pre-pays brought in badly needed cash, but the transactions led to a revenue loss. This would not have been
a problem if Enron had substantial real revenue to report to investors and the SEC, but unfortunately, it did
not. Thus, Enron faced another tough question: how do you find revenue to report to investors when you
do not have cash coming in from sales of products and services?
Enron's answer was, in part, to manipulate mark-to-market accounting. Under traditional accrual
accounting, a company typically records revenue when cash comes in the door from its customers or is
otherwise realized. Not so under mark-to-market accounting ("MTM"). Under MTM, a company's assets
are carried on the books not at purchase price, but at "fair value." Each quarter, companies using MTM
value their assets and record quarterly changes in the fair value of those assets as gains or losses. So, for
instance, if a company using MTM originally bought 10 units of a commodity at a unit price of $1, and the
price of the commodity shot up to $2 in a particular quarter, the company would record $10 in revenue in
that quarter, even though it had not sold the commodity in question. If the price subsequently dropped back
to $1, and the company still owned the commodity, the company would report a $10 loss. Companies that
are engaged almost exclusively in the trading of stocks, commodities or their derivatives often use MTM
accounting because it arguably provides a more accurate picture of the company's true financial position.
Unfortunately, the Enron case shows that in the wrong hands, MTM can be severely misused.
In 1992, after extensive lobbying, Enron received approval from the SEC to use MTM to value its natural
gas trading business. This made good sense at the time, for the value of natural gas, at least in the short-
term, is not based on speculative estimates, but is set daily by the market. Over the course of the 1990s,
however, and without SEC approval, Enron gradually began to use MTM to value much of its non-trading
operations. This led to chronic accounting abuses.
MTM allowed Enron to record estimated future profits from transactions as current operating revenue long
before the transactions actually generated any cash earnings. For example, if Enron signed a long-term
energy contract, it would estimate how much the contract might be worth over the lifetime of the deal and
then record the estimated long-term profit as current revenue in the quarter the deal was signed. This
situation created a strong incentive for Enron employees to enter into long-term deals regardless of whether
those deals would actually make money or not, as long as the employees could, through use of overly
optimistic estimates, claim the deals would make money. The fact that Enron bonuses were tied to the size
of the estimated future profits, and not to a deal's actual performance over time, only made matters worse.
In one case, Enron actually paid a customer $50 million up front in cash to induce the party to sign a long-
term energy contract. This made sense for Enron, from a financial statement perspective, because it could
use MTM to immediately record enormous revenue far in excess of the $50 million expense. Indeed, since
Enron used MTM to book all of its expected future revenue in the quarter a large transaction was signed,
Enron employees often viewed making real profit as deals went forward as irrelevant. This focus on
generating paper revenue for reporting purposes, rather than generating actual cash flow and actual profits,
exacerbated Enron's need to find cash elsewhere, through, for example, its pre-pays.
MTM abuses did not end when the initial "earnings" from a deal were recorded. Many of Enron's physical
and contractual assets were sui generis and non-fungible, or had value based on necessarily speculative
assumptions about the long-term price of commodities. Since there was no clear and definitive market price
for these assets, Enron was forced to "estimate" fair market value for MTM purposes. Inevitably, Enron
"estimated" that its assets were rising in value.
This allowed Enron to report the subsequent "gain" in estimated fair value as revenue on its financial
statements. For example, Enron marked up its investment in Mariner Energy, a private oil and gas
exploration company, from $185 million in 1996 to $367 million in 2001, and reported the difference as
revenue. Later, after bankruptcy, Enron conceded that this figure was inflated by some $256 million.
Of course, some of Enron's assets did have definite concrete market prices, and these posed another MTM
"challenge": what do you do if the value of these assets declines? The correct answer, from an MTM
accounting perspective, is simple: you record the decline in value as a loss. Enron had another idea. In 2000,
Enron and LJM 2, a private investment fund created and run by Enron executives, created four special
purpose entities—companies that exist only as names on transaction documents—called the "Raptors."
Enron then entered into hedging transactions with the Raptors, pursuant to which the Raptors would be
obligated to pay Enron one dollar for every dollar in the decline in the price of certain highly speculative
Enron investments. This would allow Enron to offset any MTM losses from the investments with
corresponding MTM gains from the increase in value of the Raptor obligations.
Not surprisingly, the assets covered by the Raptor hedges plummeted almost $1 billion in value in 2000, an
enormous loss indicative of Enron's poor diversification strategy. Pursuant to the hedging agreements,
however, the Raptors were obligated to pay Enron the same amount to offset the loss. This allowed Enron
to convert some $954 million in losses into a reported $1.1 billion in income from the third quarter of 2000
through the third quarter of 2001.91 As Enron board member William Powers later stated to Congress, the
result of these transactions was that "more than 70% of Enron's reported earnings from this period were not
real."
Unfortunately, the Raptors did not provide a true economic risk hedge, but only an accounting hedge. In
setting up the Raptors, Enron had capitalized them using its own stock. Thus, the Raptors' ability to
compensate Enron for its investment losses was tied directly to Enron's own stock price. The scheme would
"work" as long as Enron's stock price remained sufficiently high to insure that the Raptors were solvent. If,
however, Enron's stock price declined, the Raptors would become insolvent and Enron would have a serious
problem on its hands. The transactions inevitably ended in disaster in fall of 2001 when Enron's stock price
dropped rapidly, leaving the Raptors insolvent and Enron with no choice but to write off the entire mess
with a $710 million pre-tax loss. Disclosure of these facts by Enron on October 16, 2001—even remarkably
hazy and partial disclosure —ultimately helped kill off the company.
The Raptor hedges violated GAAP. As Enron Treasurer Ben Glisan explained as part of his guilty plea,
"this transaction violated existing accounting principles in that its form was misleading and was accounted
in a manner inconsistent with its economic substance." The transactions also violated federal criminal
securities laws. Recently, Enron CFO Andrew Fastow admitted in his guilty plea that the entire Raptors
scheme was criminal, because the accounting hedge was "set up as a way to conceal the poor performance
of certain Enron assets" and "misled investors by fraudulently improving the appearance of Enron's
financial statements."
Monetizations
Mark-to-Market manipulations generated revenue on paper, but the company needed cash. Instead of
relying exclusively on the pre-pays to meet this need, Enron began in 1998 to enter into another type of
structured finance transaction, known as "monetizations," that generated both cash and reportable revenue.
These transactions were, in essence, simple sales of financial assets.
Enron, however, gave these "sales" a new twist.
Let's start with a simple example. Assume that Enron signed a contract with another company pursuant to
which Enron agreed to sell the company energy over a twenty-year period. Using MTM, Enron could record
the estimated future profits as revenue at the time of the deal, and then retain the contract and slowly try to
collect its payments. This course produced good financial statement results but no immediate cash.
Alternatively, Enron could try to "monetize" the contract—sell the expected revenue stream from the
contract for a price calculated by totaling the estimated future profits and then subtracting a discount
representing the time-value of money and execution/performance risk. For example, if the contract was
estimated to be worth $40 million in profit over the course of the contract's life, Enron might try to sell the
contract to another energy company for, say, $25 million. If Enron could find a buyer, then Enron would
get both badly needed cash and a nice boost for its financial statements, for it could record the $25 million
as cash flow from operations.
There is nothing wrong with monetizations—they are simply discounted sales of financial assets that
transform future prospects into ready cash. Unfortunately, Enron's poorly managed expansion left it with
few valuable assets to sell, and this led to serious monetization abuses. Enron, as we have seen, liked big
deals, because big deals produced large and immediate reportable revenues under MTM accounting.
Unfortunately, many of those "big deals" were actually
How, then do you get a buyer to buy something like an energy contract that may be, and probably is,
ultimately worthless? The answer? You provide the buyer a guarantee.
In 2000, for example, Enron and Blockbuster, the video rental company, agreed to develop a home video-
on-demand business. This "business" never left the testing phase, generating only several thousand dollars
in revenue after hundreds of millions of dollars in development costs. Nevertheless, Enron was able to "sell"
this business to the Canadian Imperial Bank of Commerce (CIBC) in late 2000 and early 2001 for
approximately $110 million dollars. Why, one wonders, would a bank buy a highly speculative media
delivery business for $110 million?
For one thing, Enron agreed to continue to control and operate the business through a subsidiary—CIBC
would not have to do anything. More important, CIBC was guaranteed not to lose money. Under Enron's
interpretation of the relevant accounting rules, Enron believed it could treat the transfer of an asset to
another business entity as a "sale" as long as the other entity took 3% of the ensuing business risk. Based
on this interpretation, Enron guaranteed in writing that CIBC would receive at least 97% of its money back
after a specified term of years through a mechanism called a total return swap. Still, why would a bank risk
losing even 3% of its money? Again, the answer is another guarantee, this time orally and in secret, that
CIBC would get all of its capital back plus interest, regardless of whether the "sold" asset made any money
in the future or not. In short, the transaction, like the pre-pays, was a loan. CIBC gave Enron $110 million,
and Enron agreed to pay the money back with interest. Because, however, Enron treated the loan as an asset
sale, it recorded the proceeds of the transaction—$110 million in the Blockbuster deal alone—as revenue
from Enron Broadband Services ("EBS"), Enron's telecommunications division. The transaction thus
served multiple purposes. It reassured Enron's investors that EBS had significant cash flow when in fact it
did not; boosted reported revenue for the company as a whole; brought in actual cash to meet spiraling
costs; and kept $110 million in debt from being reported as debt. Brilliant? Alas, the bankruptcy examiner
has concluded that the Blockbuster deal and similar monetizations violated GAAP, the relevant accounting
rules, because the outcomes reported to investors did not accurately reflect the substance of the transactions
and because Enron did not report to investors the existence of its secret guarantees to repay lenders the
capital Enron received from the "sales."In short, loans must be accounted for as loans.
Interestingly, Enron discovered that even with guarantees, it could not convince lenders to "buy" certain
assets. Starting in 1997, Enron solved this problem by creating its own investment funds to buy Enron's
under-performing assets. These funds had names like "Chewco," "Whitewing," "LJM Cayman," and
"LJM2."
The LJM transactions were deceptively simple. As Enron Treasurer Ben Glisan recently explained in his
guilty plea to federal securities charges, "LJM enabled Enron to falsify its financial picture to the public; in
return, LJM received a pre-arranged profit." Here's how it worked.
In the LJM transactions, Enron executives raised money on Wall Street by promising that LJM would be
able to cherry-pick the best investment opportunities from Enron, due to the close relationship between
fund executives—including Enron's own CFO—and Enron. LJM then bought under-performing assets from
Enron with the money it had raised, giving Enron a badly needed infusion of cash. Enron, in return, provided
LJM with a secret oral promise that Enron would eventually buy the assets back from LJM for the purchase
price plus a profit, regardless of whether the "sold" assets retained their value or not. Enron liked these
deals because it allowed Enron to "sell" assets that were otherwise unmarketable and report the resulting
proceeds as cash flow from operations, giving its financial statements a badly needed illicit bump. LJM and
its investors liked the deals as well, for they resulted in enormous risk-free profits. Indeed, Enron's CFO
pocketed some $30 million from the deals. The only persons who lost were Enron's investors, who had no
idea what was happening.
Whitewing worked in a similar fashion. Enron raised money for its Whitewing fund by secretly promising
that the raised funds would be repaid by Enron itself at a future date. Enron then "sold" assets of limited or
decreasing value to the Whitewing fund. Enron was, in practice, both buyer and seller in the deals, and it
remained the true equitable owner of the "warehoused" assets. It treated the transactions as sales, however.
This allowed Enron to move valueless assets off its books while hiding substantial debt. The size of these
"sales" was ultimately staggering. According to the bankruptcy examiner, Enron ultimately "sold" some
$1.6 billion in under-performing assets to its own Whitewing fund.
Monetizations with independent financial institutions like CIBC and Enron-created funds like LJM,
Chewco and Whitewing effectively disguised loans as sales. They allowed Enron to raise billions of dollars
in capital markets and report that cash infusion as revenue or cash flow, not debt. The transactions violated
GAAP because, among other things, Enron used the transactions to improperly overstate its "earnings" and
never disclosed that it was ultimately obligated to repay the sums.
Enron did an enormous number of these deals, and they had a significant impact on Enron's financial
statements. The bankruptcy examiner has concluded, for example, that in 2000, monetizations with outside
parties like CIBC increased Enron's reported revenue by over $351 million, comprised 36% of Enron's
reported revenue, and kept $1.4 billion in debt off Enron's balance sheet. Similarly, the examiner has
concluded that "related party" deals with Chewco and the LJM funds alone helped Enron over-state its
income by nearly $1.5 billion from 1997 to June 2001 and understate its debt by almost $900 million.
Results of Enron's Financial Statement Manipulations
Pre-pays, MTM manipulation, and fraudulent "assets sales" were only the tip of the iceberg at Enron. Enron
also engaged in many additional types of transactions designed, like those discussed above, to mislead
investors into thinking that that the company had less debt, more revenue, and greater cash flow than it
actually did. Enron's efforts to manipulate and "improve" its financial statements had an enormous impact
on investors' perceptions about the company.
As bankruptcy examiner Neal Batson has concluded, "through pervasive use of structured finance
techniques using SPE's and aggressive accounting practices, Enron so engineered its reported financial
position and results of operations that its financial statements bore little resemblance to its actual financial
condition or performance. This financial engineering in many cases violated GAAP and applicable
disclosure laws, and resulted in financial statements that did not fairly present Enron's financial condition,
results of operations or cash flows." This manipulation was driven not just by Enron's desire to raise cash
without issuing equity or incurring debt, but also by "the need to mask Enron's business failures." The
cumulative impact of these schemes on Enron's financial statements is almost unbelievable. For 2000, 96%
of Enron's reported net income and 105% of its reported funds flow were the direct result of accounting
manipulation. Using these same accounting schemes, Enron managed to keep almost $12 billion in debt off
its books. Financial data manipulation, in short, transformed Enron from a dog into a Wall Street champion.
Sarbanes Oxley Act
The Sarbanes–Oxley Act of 2002 (Pub.L. 107–204, 116 Stat. 745, enacted July 30, 2002), also known as
the "Public Company Accounting Reform and Investor Protection Act" (in the Senate) and "Corporate and
Auditing Accountability and Responsibility Act" (in the House) and more commonly called Sarbanes–
Oxley, Sarbox or SOX, is a United States federal law that set new or expanded requirements for all U.S.
public company boards, management and public accounting firms. There are also a number of provisions
of the Act that also apply to privately held companies, for example the willful destruction of evidence to
impede a Federal investigation.
The bill, which contains eleven sections, was enacted as a reaction to a number of major corporate and
accounting scandals, including Enron and Worldcom. The sections of the bill cover responsibilities of a
public corporation’s board of directors, adds criminal penalties for certain misconduct, and required the
Securities and Exchange Commission to create regulations to define how public corporations are to comply
with the law.
TITLE II—AUDITOR INDEPENDENCE
SEC. 201. SERVICES OUTSIDE THE SCOPE OF PRACTICE OF AUDITORS.
PROHIBITED ACTIVITIES.—Except as provided in subsection (h), it shall be unlawful for a registered
public accounting firm (and any associated person of that firm, to the extent determined appropriate by the
Commission) that performs for any issuer any audit required by this title or the rules of the Commission
under this title or, beginning 180 days after the date of commencement of the operations of the Public
Company Accounting Oversight Board established under section 101 of the Sarbanes-Oxley Act of 2002
(in this section referred to as the ‘Board’), the rules of the Board, to provide to that issuer,
contemporaneously with the audit, any non-audit service, including—
(1) bookkeeping or other services related to the accounting records or financial statements of the audit
client;
(2) financial information systems design and implementation;
(3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports;
(4) actuarial services;(5) internal audit outsourcing services;
(6) management functions or human resources;
(7) broker or dealer, investment adviser, or investment banking services;
(8) legal services and expert services unrelated to the
audit; and
(9) any other service that the Board determines, by regulation, is impermissible.
‘‘(h) PREAPPROVAL REQUIRED FOR NON-AUDIT SERVICES.—A registered public accounting firm
may engage in any non-audit service, including tax services, that is not described in any of paagraphs (1)
through (9) of subsection (g) for an audit client, only if the activity is approved in advance by the audit
committee of the issuer, in accordance with subsection (i).
(b) EXEMPTION AUTHORITY.—The Board may, on a case by case basis, exempt any person, issuer,
public accounting firm, or transaction from the prohibition on the provision of services under section
10A(g) of the Securities Exchange Act of 1934 (as added by this section), to the extent that such exemption
is necessary or appropriate in the public interest and is consistent with the protection of investors, and
subject to review by the Commission in the same manner as for rules of the Board under section 107.
SEC. 202. PREAPPROVAL REQUIREMENTS.
(1) IN GENERAL.—
(A) AUDIT COMMITTEE ACTION.—All auditing services (which may entail providing comfort letters
in connection with securities underwritings or statutory audits required for insurance companies for
purposes of State law) and non-audit services, other than as provided in subparagraph (B), provided to an
issuer by the auditor of the issuer shall be preapproved by the audit committee of the issuer.
(B) DE MINIMUS EXCEPTION.—The preapproval requirement under subparagraph (A) is waived with
respect to the provision of non-audit services for an issuer, if—
(i) the aggregate amount of all such non-audit services provided to the issuer constitutes not more than 5
percent of the total amount of revenues paid by the issuer to its auditor during the fiscal year in which the
nonaudit services are provided;
(ii) such services were not recognized by the issuer at the time of the engagement to be non-audit services;
and
(iii) such services are promptly brought to the attention of the audit committee of the issuer and approved
prior to the completion of the audit by the audit committee or by 1 or more members of the audit committee
who are members of the board of directors to whom authority to grant such approvals has been delegated
by the audit committee.
(2) DISCLOSURE TO INVESTORS.—Approval by an audit committee of an issuer under this subsection
of a non-audit service to be performed by the auditor of the issuer shall be disclosed to investors in periodic
reports required by section 13(a).
(3) DELEGATION AUTHORITY.—The audit committee of an issuer may delegate to 1 or more
designated members of the audit committee who are independent directors of the board of directors, the
authority to grant preapprovals required by this subsection. The decisions of any member to whom authority
is delegated under this paragraph to preapprove an activity under this subsection shall be presented to the
full audit committee at each of its scheduled meetings.
(4) APPROVAL OF AUDIT SERVICES FOR OTHER PURPOSES.—
In carrying out its duties under subsection (m)(2), if the audit committee of an issuer approves an audit
service within the scope of the engagement of the auditor, such audit service shall be deemed to have been
preapproved for purposes of this subsection.
SEC. 203. AUDIT PARTNER ROTATION.
It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead
(or coordinating) audit partner (having primary responsibility for the audit), or the audit partner responsible
for reviewing the audit, has performed audit services for that issuer in each of the 5 previous fiscal years of
that issuer.
SEC. 204. AUDITOR REPORTS TO AUDIT COMMITTEES.
Each registered public accounting firm that performs for any issuer any audit required by this title shall
timely report to the audit committee of the issuer—
(1) all critical accounting policies and practices to be used;
(2) all alternative treatments of financial information within generally accepted accounting principles that
have been discussed with management officials of the issuer, ramifications of the use of such alternative
disclosures and treatments, and the treatment preferred by the registered public accounting firm; and
(3) other material written communications between the registered public accounting firm and the
management of the issuer, such as any management letter or schedule of unadjusted differences.
SEC. 302. CORPORATE RESPONSIBILITY FOR FINANCIAL REPORTS.
(a) REGULATIONS REQUIRED.—The Commission shall, by rule, require, for each company filing
periodic reports under section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m,
78o(d)), that the principal executive officer or officers and the principal financial officer or officers, or
persons performing similar functions, certify in each annual or quarterly report filed or submitted under
either such section of such Act that—
(1) the signing officer has reviewed the report;
(2) based on the officer’s knowledge, the report does not contain any untrue statement of a material fact or
omit to state a material fact necessary in order to make the statements made, in light of the circumstances
under which such statements were made, not misleading;
(3) based on such officer’s knowledge, the financial statements, and other financial information included
in the report, fairly present in all material respects the financial condition and results of operations of the
issuer as of, and for, the periods presented in the report;
(4) the signing officers—
(A) are responsible for establishing and maintaining internal controls;
(B) have designed such internal controls to ensure that material information relating to the issuer and its
consolidated subsidiaries is made known to such officers by others within those entities, particularly during
the period in which the periodic reports are being prepared;
(C) have evaluated the effectiveness of the issuer’s internal controls as of a date within 90 days prior to the
report; and
(D) have presented in the report their conclusions about the effectiveness of their internal controls based on
their evaluation as of that date;
(5) the signing officers have disclosed to the issuer’s auditors and the audit committee of the board of
directors (or persons fulfilling the equivalent function)—
(A) all significant deficiencies in the design or operation of internal controls which could adversely affect
the issuer’s ability to record, process, summarize, and report financial data and have identified for the
issuer’s auditors any material weaknesses in internal controls; and
(B) any fraud, whether or not material, that involves management or other employees who have a significant
role in the issuer’s internal controls; and
(6) the signing officers have indicated in the report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls subsequent to the date of their
evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
(b) FOREIGN REINCORPORATIONS HAVE NO EFFECT.—Nothing in this section 302 shall be
interpreted or applied in any way to allow any issuer to lessen the legal force of the statement required
under this section 302, by an issuer having reincorporated or having engaged in any other transaction that
resulted in the transfer of the corporate domicile or offices of the issuer from inside the United States to
outside of the United States.
(c) DEADLINE.—The rules required by subsection (a) shall be effective not later than 30 days after the
date of enactment of this Act.
SEC. 303. IMPROPER INFLUENCE ON CONDUCT OF AUDITS.
(a) RULES TO PROHIBIT.—It shall be unlawful, in contravention of such rules or regulations as the
Commission shall prescribe as necessary and appropriate in the public interest or for the protection of
investors, for any officer or director of an issuer, or any other person acting under the direction thereof, to
take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified
accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose
of rendering such financial statements materially misleading.
(b) ENFORCEMENT.—In any civil proceeding, the Commission shall have exclusive authority to enforce
this section and any rule or regulation issued under this section.
(c) NO PREEMPTION OF OTHER LAW.—The provisions of subsection (a) shall be in addition to, and
shall not supersede or preempt, any other provision of law or any rule or regulation issued thereunder.
(d) DEADLINE FOR RULEMAKING.—The Commission shall—
(1) propose the rules or regulations required by this section, not later than 90 days after the date of enactment
of this Act; and
(2) issue final rules or regulations required by this section, not later than 270 days after that date of
enactment.
SEC. 304. FORFEITURE OF CERTAIN BONUSES AND PROFITS.
(a) ADDITIONAL COMPENSATION PRIOR TO NONCOMPLIANCE WITH
COMMISSION FINANCIAL REPORTING REQUIREMENTS.—If an issuer is required to prepare an
accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any
financial reporting requirement under the securities laws, the chief executive officer and chief financial
officer of the issuer shall reimburse the issuer for—
(1) any bonus or other incentive-based or equity-based compensation received by that person from the
issuer during the 12-month period following the first public issuance or filing with the Commission
(whichever first occurs) of the financial document embodying such financial reporting requirement; and
(2) any profits realized from the sale of securities of the issuer during that 12-month period.
(b) COMMISSION EXEMPTION AUTHORITY.—The Commission may exempt any person from the
application of subsection (a), as it deems necessary and appropriate.
Independent Directors
Section 150. Manner of selection of independent directors and maintenance of databank of independent
directors
(1) Subject to the provisions contained in sub-section (5) of section 149, an independent director may be
selected from a data bank containing names, addresses and qualifications of persons who are eligible and
willing to act as independent directors, maintained by any body, institute or association, as may by notified
by the Central Government, having expertise in creation and maintenance of such data bank and put on
their website for the use by the company making the appointment of such directors:
Provided that responsibility of exercising due diligence before selecting a person from the data bank
referred to above, as an independent director shall lie with the company making such appointment.
(2) The appointment of independent director shall be approved by the company in general meeting as
provided in sub-section (2) of section 152 and the explanatory statement annexed to the notice of the general
meeting called to consider the said appointment shall indicate the justification for choosing the appointee
for appointment as independent director.
(3) The data bank referred to in sub-section (1), shall create and maintain data of persons willing to act as
independent director in accordance with such rules as may be prescribed.
(4) The Central Government may prescribe the manner and procedure of selection of independent directors
who fulfil the qualifications and requirements specified under section 149.
History and Development of Corporate Governance in India
The earliest piece of corporate legislation in India was the Joint Stock Companies Act of 1866. This was
followed by several amendments and replacement legislations, largely mirroring the developments in the
United Kingdom (‘U.K’). The first comprehensive overhaul of company law was undertaken in the years
immediately following Indian independence and led to the enactment of the Companies Act of 1956. This
was later subject to numerous amendments until the 2013 legislation replaced it.
Formal institutions of corporate governance in India have been in place for a large number of years, though
corporate governance issues came to the forefront only following the adoption of the structural adjustment
and globalization programme by the government in July 1991. The legal framework for regulating all
corporate activities including governance and administration of companies has been in place since the
enactment of the Companies Act 1956. However, since then, there has been a sustained effort on the part
of the Indian regulators to strengthen corporate governance norms and to induce more stringent governance
practices among Indian listed companies. These initiatives have been strongly influenced by developments
that occurred in other parts of the world. Clause 49 of the Equity Listing Agreement encapsulates India’s
corporate governance norms, and that can be said to owe its genesis to the Cadbury Committee Report in
the U.K. from which it drew broad principles. Subsequent revisions to Clause 49 can be primarily attributed
as a reaction to the Sarbanes Oxley Act of 2002 in the U.S.
Analysis of Corporate Governance norms and laws
In India companies have concentrated shareholding pattern where the majority shares are held by few
people belonging to the same family, who are also the promoters of the company. Multiple layers of
investment into subsidiary companies through stock pyramids or cross-holding is not uncommon in India
and it is difficult to enquire into such forms of holding structures. Concentration of shareholding allows
majority shareholders to elect and appoint most of the directors to the company. However, in terms of
appointment of directors, the 2013 Act enables small shareholders to elect ‘one’ director to the Board of a
listed company. In spite of this provision for the ‘small shareholders director’ the cause of the small
shareholders in terms of Board representation is not furthered. All the decisions of the Board require simple
majority (fifty percent or more) or a special majority (seventy-five percent or more).
Having majority shareholding, the promoters and promoter group do not only influence the Board decisions,
but they are also in a position to take decisions at shareholder meetings that are beneficial to them, without
assessing the impact on other minority shareholders. In the absence of special contractual rights, minority
shareholders are unable to outvote or even veto decisions taken by the majority shareholders. This
concentration of ownership and power leads to greater benefits to the controlling shareholders at the cost
of the minority shareholders. Such practices can also have an adverse effect on the development of capital
markets as minority shareholders are considerably exposed to the actions of controlling shareholders.
Another effect of the concentrated family ownership structure is that the management has little or no stake
in the company and constitutes less than 5 per cent of large, listed companies. It is not uncommon to see
majority shareholders and their family members as members of the Board. In a company managed by
owners, there is a very strong motivation for management to work for a long-term share price increase. In
a majority of firms there is no separation of chief executive officers and chair and therefore, family
supremacy is more than covert. This is because controlling shareholders are in a position to shape the
composition of the board of directors. All directors owe their allegiance to the controlling shareholders as
their appointment, renewal and continuance in office are subject to the wishes of the controlling
shareholders. Managers who are not on the board also owe their allegiance to controlling shareholders as
the board of directors that appoints managers are within the control of such shareholders. All these are
evidence of ownership concentration in Indian listed companies, with significant powers to the controlling
shareholders.
Several listed companies are also majority owned by multinational companies. However, diffused
ownership can be found only in a handful of Indian listed companies, where such structures exist more as
a matter of exception rather than the rule. Examining the ownership aspect empirically, we find that even
as late as 2002, the average shareholding of promoters in all Indian companies was as high as 48.1%. A
more recent study conducted, using data as of June 2015, as issued by the National Stock Exchange
confirms that the shareholding of Indian promoters and promoter groups is at an average of 55.53%.
There were several developments with respect to corporate governance in India and the first among the
many came through the Report of the Kumar Mangalam Birla Committee on corporate governance. The
Securities Exchange Board of India (SEBI) appointed the Committee on Corporate Governance on May 7,
1999 under the Chairmanship of Shri Kumar Mangalam Birla, member SEBI Board, to promote and raise
the standards of Corporate Governance. The Report was the first formal and comprehensive attempt to
evolve a Code of Corporate Governance, in the context of prevailing conditions of governance in Indian
companies, as well as the state of capital markets. The report also suggested suitable amendments to the
listing agreement executed by the stock exchanges with the companies and any other measures to improve
the standards of corporate governance in the listed companies, in areas such as continuous disclosure of
material information, both financial and non-financial, manner and frequency of such disclosures,
responsibilities of independent and outside directors; to draft a code of corporate best practices; and to
suggest safeguards to be instituted within the companies to deal with insider information and insider trading.
Subsequently the Narayana Murty Report which was also the report of the SEBI committee on corporate
governance was released. This committee was constituted because it was the belief of the Securities and
Exchange Board of India (“SEBI”) that efforts to improve corporate governance standards in India must
continue. This is because these standards themselves were evolving in keeping with market dynamics. The
issues discussed by the Committee primarily related to audit committees, audit reports, independent
directors, related parties, risk management, directorships and director compensation, codes of conduct and
financial disclosures. The Committee’s recommendations in the final report were selected based on
parameters including their relative importance, fairness, accountability, transparency, ease of
implementation, verifiability and enforceability.
The adoption of Clause 49 of the Equity Listing Agreement on August 23rd, 2003, was a seminal event in
Indian corporate governance. It established a number of governance requirements for listed companies with
a focus on the role and structure of corporate boards, internal controls, and disclosure to shareholders. The
reforms introduced by Clause 49 closely aligned to international best practice at the time and set higher
governance standards for listed companies than most other jurisdictions in Asia. The hallmark of Clause 49
was the introduction of independent directors into the Indian corporate governance system. Clause 49
includes a requirement that all listed companies have independent directors and sets forth some specific
duties and obligations for independent directors. These reforms were phased in over several years, and now
apply to thousands of listed Indian companies. This was further modified on April 17th, 2014 after the new
Companies Act, 2013 was enacted on August 30th, 2013 and provides for a major overhaul in the corporate
governance norms for all companies.
India follows a corporate governance system which is hybrid of the outsider dominated market based
systems of the UK and the US and the insider model. The outsider model displays dispersed share ownership
with large institutional shareholdings. The concept of separation of ownership and control ensures that the
role of directors in control of a company is placed higher than the individual opportunism of shareholders.
This model is called as the outsider model because shareholders typically have no interest in managing the
company and retain no relationship with the company except for their financial investment. At the same
time, appointment or removal of directors proves to be difficult on an individual basis, due to the costs
involved in co-ordination of large numbers of dispersed shareholders.
On the other hand, a close knit group of shareholders wielding considerable voting rights in a general
meeting of shareholders gives rise to the insider model. Such insiders would also have an increased long
term relationship with the company. With the remainder of the shareholding being diffused and held by
institutions or individuals constituting the public, insiders naturally tend to have a controlling interest in the
company. By virtue of being able to appoint and remove directors at will, they possess the ability to exercise
dominant control over the company’s affairs. As to the identity of the controlling shareholders they tend to
be mostly business family groups or the state.
A number of committees have been established over time to recommend measures to improve corporate
governance, investor protection, independent audit, etc in the country. The recommendations of these
committees and other stakeholders culminated in the enactment of the Companies Act in 2013 – possibly
the single most important development in India’s history of corporate legislation, next only to the
Companies Act 1956 which it replaces.
The Companies Act, 2013 provides for a number of corporate governance reforms which were hitherto
absent in the previous 1956 iteration. A third of the board of listed companies must be independent directors
if the chairman of the board is a non-executive member. In the event that the chairman is an executive
member, half of the board is required to be independent. Fresh out of the Satyam Computer Services
accounting scandal, the qualifications and liability of independent directors was revamped. Independent
directors must possess integrity, relevant expertise, experience and must not be related to the company or
its associate or subsidiary companies as a past promoter, director, or any of their relatives. Independent
directors cannot have had a pecuniary relationship the company, its holding, subsidiary or associate
company, or their promoters, or directors, during the two immediately preceding financial years or during
the financial year of appointment. The Companies Act, 2013 also provides for a code of conduct that
independent directors are expected to adhere to.
The Companies Act, 2013 also provides for the creation of three board committees. The Audit Committee
must be constituted of at least three financially educated directors out of which independent directors are
in majority. The terms of reference for the Audit Committee include the recommendation for appointment,
remuneration and terms of appointment of auditors of the company, review and monitoring of the auditor’s
independence and performance, and effectiveness of audit process, examination of the financial statement
and the auditors’ report thereon, and scrutiny of inter-corporate loans and investments. Similar to the Audit
Committee, the Nomination and Remuneration Committee must also be constituted of three or more non-
executive directors of which majority shall be independent directors. The duties of the Nomination and
Remuneration Committee include identification and recommendation of appropriate senior management
and directors to the board and the committee must formulate a policy to provide for appointment and
remuneration of directors, key managerial personnel and other employees. A Stakeholder Grievance
Committee must also be set up to resolve the grievances of the security holders of the company. While the
minimum strength for the committee is not provided for, the chairman must be a non-executive director.
Independent and objective boards committed to the welfare of the company and equitable treatment to all
its shareholders is the cornerstone of good corporate governance. The 2013 Initiatives have strengthened
many existing regulatory requirements and introduce some new ones too. For the first time, the Act
enumerates the qualifying criteria both in affirmative and negative terms. Thus, the person should, in the
board’s opinion, be one of integrity and possess relevant expertise and experience or should possess such
other prescribed qualifications (in other words, should be a fit and proper person).
A number of restrictions also apply to the appointment of independent directors in India. The proposed
independent director should not be a promoter of the company or its holding, subsidiary or associate
company or related to promoters or directors of the company, its holding, subsidiary or associate company
nor he should have any pecuniary relationship with the company, its holding or subsidiary or associate
companies or their promoters or directors during the current or immediately preceding two financial years.
None of his relatives should have (or have had) pecuniary relationships or transactions with the company,
its holding or subsidiary or associate companies, or directors, amounting to more than 2% or more of its
gross turnover or total income or fifty lakhs rupees or such higher amount as may be prescribed, whichever
is lower, during the current or immediately preceding two years. He should not, together with his relatives,
hold 2% or more of the of the total voting power of the company and Should not have been the CEO or
director of any not-for-profit entity that receives 25% or more of its receipts from the company, any of its
promoters,, directors, its holding, subsidiary or associate company or that holds 2% or more of the total
voting power of the company.
A director of a company shall act in accordance with the Articles of the company. He shall act in good faith
in order to promote the objects of the company for the benefit of its members as a whole and in the best
interest of the company, its employees, the shareholders, the community and for the protection of the
environment. A director of a company shall exercise his duties with due and reasonable care, skill and
diligence and shall exercise independent judgment; he shall not involve in a situation in which he may have
a direct or indirect interest that conflicts or possibly may conflict with the interest of the company; he shall
not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives and if
found guilty he shall be punished by imposing an amount equal to that gain and he shall not assign his
office and any assignment.
In their monitoring role, outside independent directors can help address corporate governance concerns of
controlled entities. The monitoring role of independent directors is particularly important in jurisdictions
like India, where the legal rights of minority stockholders may be limited. In controlled entities, independent
directors can help prevent business decisions that improperly benefit controlling stockholders at the expense
of minority stockholders. In addition, independent directors can help protect the interests of minority
shareholders and reduce extractions by controlling shareholders through publicizing, or threatening to
publicize, majority shareholder abuses even if the directors have limited power to decide important issues
without consent of the controlling stockholder.
As a direct result of the Satyam case, provisions relating to auditor appointment and liability have been
tightened as well. An individual auditor can be appointed for one term of 5 years and an audit firm for two
terms of 5 years each. In addition, the partner and team of an audit firm engaged in the audit of a company
must be changed every year. A successive re-appointment of the audit firm post the initial appointment
requires a cooling-off period of 5 years and the incoming and outgoing firm should not have common
partners. Auditors are prohibited from providing non-audit services including accounting and book keeping
services, internal audit, design and implementation of any financial information system, actuarial services,
investment advisory services, investment banking services, rendering of outsourced financial services or
management services to companies for which they have been engaged as an auditor. Auditors should not
hold any interest in the company or its subsidiaries, be indebted to it, have any business interest with the
company or have a relative who is a director of that company.
Listed companies, companies with a paid up share capital of INR 100 million and companies with loans of
more than INR 250 million must appoint an internal auditor to evaluate the functions and activities of the
company. While the internal audit is required to be conducted under the aegis of the Audit Committee,
internal auditors are separate from statutory auditors mentioned above. Such internal auditor may be a
chartered or a cost accountant or other professional appointed by the board- may also engage an external
agency.
The concept of class action suit has been introduced in the aftermath of the Satyam corporate scandal. While
the law on class action suits is still in its infancy, the rationale given by the Ministry of Corporate Affairs
for insertion of this provision was to see that “the shareholder feels like a king” in the matters like
managerial remuneration. Traditionally, there are four kinds of class action suits that can arise against a
company, namely, product liability or personal injury class actions, consumer class actions, employment
class actions, and securities class action but in India the right to file a class action suit under Section 245 of
the Companies Act, 2013 is only given to shareholders and depositors. It is imperative that for a class action
suit to arise there must be one or more legal or factual claims common to the entire class; the representative
parties must adequately protect the interests of the class, the class must be so large as to make individual
suits impractical; the claims or defences must be typical of the plaintiffs or defendant. Grounds for filing a
class action suit in India include an act which is ultra vires or a breach of the constitutional documents of
the company, fraudulent, unlawful or wrongful act or omission or conduct by the directors, auditors and
experts engaged by the company. While the provisions relating to class action suits in India seem to have
been inspired by the US Federal Rules of Civil Procedure, class actions in the United Stated have been
around for a while and are more sophisticated. Certain aspects including an opting out clause or an enabling
provision for a lead plaintiff or even consumer class actions are missing in Indian class action provisions.
Corporate reporting – Annual report to shareholders and role of auditors

Section 128. Books of account, etc., to be kept by company.
(1) Every company shall prepare and keep at its registered office books of account and other relevant books
and papers and financial statement for every financial year which give a true and fair view of the state of
the affairs of the company, including that of its branch office or offices, if any, and explain the transactions
effected both at the registered office and its branches and such books shall be kept on accrual basis and
according to the double entry system of accounting:
Provided that all or any of the books of account aforesaid and other relevant papers may be kept at such
other place in India as the Board of Directors may decide and where such a decision is taken, the company
shall, within seven days thereof, file with the Registrar a notice in writing giving the full address of that
other place:
Provided further that the company may keep such books of account or other relevant papers in electronic
mode in such manner as may be prescribed.
(2) Where a company has a branch office in India or outside India, it shall be deemed to have complied
with the provisions of sub-section (1), if proper books of account relating to the transactions effected at the
branch office are kept at that office and proper summarised returns periodically are sent by the branch office
to the company at its registered office or the other place referred to in sub-section (1).
(3) The books of account and other books and papers maintained by the company within India shall be open
for inspection at the registered office of the company or at such other place in India by any director during
business hours, and in the case of financial information, if any, maintained outside the country, copies of
such financial information shall be maintained and produced for inspection by any director subject to such
conditions as may be prescribed:
Provided that the inspection in respect of any subsidiary of the company shall be done only by the person
authorised in this behalf by a resolution of the Board of Directors.
(4) Where an inspection is made under sub-section (3), the officers and other employees of the company
shall give to the person making such inspection all assistance in connection with the inspection which the
company may reasonably be expected to give.
(5) The books of account of every company relating to a period of not less than eight financial years
immediately preceding a financial year, or where the company had been in existence for a period less than
eight years, in respect of all the preceding years together with the vouchers relevant to any entry in such
books of account shall be kept in good order:
Provided that where an investigation has been ordered in respect of the company under Chapter XIV, the
Central Government may direct that the books of account may be kept for such longer period as it may
deem fit.
(6) If the managing director, the whole-time director in charge of finance, the Chief Financial Officer or
any other person of a company charged by the Board with the duty of complying with the provisions of this
section, contravenes such provisions, such managing director, whole-time director in charge of finance,
Chief Financial officer or such other person of the company shall be punishable with imprisonment for a
term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which
may extend to five lakh rupees or with both.
Section 129. Financial statement.
(1) The financial statements shall give a true and fair view of the state of affairs of the company or
companies, comply with the accounting standards notified under section 133 and shall be in the form or
forms as may be provided for different class or classes of companies in Schedule III:
Provided that the items contained in such financial statements shall be in accordance with the accounting
standards:
Provided further that nothing contained in this sub-section shall apply to any insurance or banking company
or any company engaged in the generation or supply of electricity, or to any other class of company for
which a form of financial statement has been specified in or under the Act governing such class of company:
Provided also that the financial statements shall not be treated as not disclosing a true and fair view of the
state of affairs of the company, merely by reason of the fact that they do not disclose—-
(a) in the case of an insurance company, any matters which are not required to be disclosed by the Insurance
Act, 1938, or the Insurance Regulatory and Development Authority Act, 1999;
(b) in the case of a banking company, any matters which are not required to be disclosed by the Banking
Regulation Act, 1949;
(c) in the case of a company engaged in the generation or supply of electricity, any matters which are not
required to be disclosed by the Electricity Act, 2003;
(d) in the case of a company governed by any other law for the time being in force, any matters which are
not required to be disclosed by that law.
(2) At every annual general meeting of a company, the Board of Directors of the company shall lay before
such meeting financial statements for the financial year.
(3) Where a company has one or more subsidiaries, it shall, in addition to financial statements provided
under sub-section (2), prepare a consolidated financial statement of the company and of all the subsidiaries
in the same form and manner as that of its own which shall also be laid before the annual general meeting
of the company along with the laying of its financial statement under sub-section (2):
Provided that the company shall also attach along with its financial statement, a separate statement
containing the salient features of the financial statement of its subsidiary or subsidiaries in such form as
may be prescribed:
Provided further that the Central Government may provide for the consolidation of accounts of companies
in such manner as may be prescribed.
Explanation.—For the purposes of this sub-section, the word “subsidiary” shall include associate company
and joint venture.
(4) The provisions of this Act applicable to the preparation, adoption and audit of the financial statements
of a holding company shall, mutatis mutandis, apply to the consolidated financial statements referred to in
sub-section (3).
(5) Without prejudice to sub-section (1), where the financial statements of a company do not comply with
the accounting standards referred to in sub-section (1), the company shall disclose in its financial
statements, the deviation from the accounting standards, the reasons for such deviation and the financial
effects, if any, arising out of such deviation.
(6) The Central Government may, on its own or on an application by a class or classes of companies, by
notification, exempt any class or classes of companies from complying with any of the requirements of this
section or the rules made thereunder, if it is considered necessary to grant such exemption in the public
interest and any such exemption may be granted either unconditionally or subject to such conditions as may
be specified in the notification.
(7) If a company contravenes the provisions of this section, the managing director, the whole-time director
in charge of finance, the Chief Financial Officer or any other person charged by the Board with the duty of
complying with the requirements of this section and in the absence of any of the officers mentioned above,
all the directors shall be punishable with imprisonment for a term which may extend to one year or with
fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with
both.
Explanation.—For the purposes of this section, except where the context otherwise requires, any reference
to the financial statement shall include any notes annexed to or forming part of such financial statement,
giving information required to be given and allowed to be given in the form of such notes under this Act.
Section 130. Re-opening of accounts on court’s or Tribunal’s orders.
(1) A company shall not re-open its books of account and not recast its financial statements, unless an
application in this regard is made by the Central Government, the Income-tax authorities, the Securities and
Exchange Board, any other statutory regulatory body or authority or any person concerned and an order is
made by a court of competent jurisdiction or the Tribunal to the effect that—
(i) the relevant earlier accounts were prepared in a fraudulent manner; or
(ii) the affairs of the company were mismanaged during the relevant period, casting a doubt on the reliability
of financial statements:
Provided that the court or the Tribunal, as the case may be, shall give notice to the Central Government, the
Income-tax authorities, the Securities and Exchange Board or any other statutory regulatory body or
authority concerned and shall take into consideration the representations, if any, made by that Government
or the authorities, Securities and Exchange Board or the body or authority concerned before passing any
order under this section.
(2) Without prejudice to the provisions contained in this Act the accounts so revised or re-cast under sub-
section (1) shall be final.
Section 131. Voluntary revision of financial statements or Board’s report.
(1) If it appears to the directors of a company that—

(a) the financial statement of the company; or
(b) the report of the Board,
do not comply with the provisions of section 129 or section 134 they may prepare revised financial
statement or a revised report in respect of any of the three preceding financial years after obtaining approval
of the Tribunal on an application made by the company in such form and manner as may be prescribed and
a copy of the order passed by the Tribunal shall be filed with the Registrar:
Provided that the Tribunal shall give notice to the Central Government and the Incometax authorities and
shall take into consideration the representations, if any, made by that Government or the authorities before
passing any order under this section:
Provided further that such revised financial statement or report shall not be prepared or filed more than
once in a financial year:
Provided also that the detailed reasons for revision of such financial statement or report shall also be
disclosed in the Board's report in the relevant financial year in which such revision is being made.
(2) Where copies of the previous financial statement or report have been sent out to members or delivered
to the Registrar or laid before the company in general meeting, the revisions must be confined to—
(a) the correction in respect of which the previous financial statement or report do not comply with the
provisions of section 129 or section 134; and
(b) the making of any necessary consequential alternation.
(3) The Central Government may make rules as to the application of the provisions of this Act in relation
to revised financial statement or a revised director's report and such rules may, in particular—
(a) make different provisions according to which the previous financial statement or report are replaced or
are supplemented by a document indicating the corrections to be made;
(b) make provisions with respect to the functions of the company's auditor in relation to the revised financial
statement or report;
(c) require the directors to take such steps as may be prescribed.
Section 134. Financial statement, Board’s report, etc.
(1) The financial statement, including consolidated financial statement, if any, shall be approved by the
Board of Directors before they are signed on behalf of the Board at least by the chairperson of the company
where he is authorised by the Board or by two directors out of which one shall be managing director and
the Chief Executive Officer, if he is a director in the company, the Chief Financial Officer and the company
secretary of the company, wherever they are appointed, or in the case of a One Person Company, only by
one director, for submission to the auditor for his report thereon.
(2) The auditors’ report shall be attached to every financial statement.
(3) There shall be attached to statements laid before a company in general meeting, a report by its Board of
Directors, which shall include—
(a) the extract of the annual return as provided under sub-section (3) of section 92;
(b) number of meetings of the Board;
(c) Directors’ Responsibility Statement;
(d) a statement on declaration given by independent directors under sub-section (6) of section 149;
(e) in case of a company covered under sub-section (1) of section 178, company’s policy on directors’
appointment and remuneration including criteria for determining qualifications, positive attributes,
independence of a director and other matters provided under sub-section (3) of section 178;
(f) explanations or comments by the Board on every qualification, reservation or adverse remark or
disclaimer made—
(i) by the auditor in his report; and
(ii) by the company secretary in practice in his secretarial audit report;
(g) particulars of loans, guarantees or investments under section 186;
(h) particulars of contracts or arrangements with related parties referred to in sub-section (1) of section 188
in the prescribed form;
(i) the state of the company’s affairs;
(j) the amounts, if any, which it proposes to carry to any reserves;
(k) the amount, if any, which it recommends should be paid by way of dividend;
(l) material changes and commitments, if any, affecting the financial position of the company which have
occurred between the end of the financial year of the company to which the financial statements relate and
the date of the report;
(m) the conservation of energy, technology absorption, foreign exchange earnings and outgo, in such
manner as may be prescribed;
(n) a statement indicating development and implementation of a risk management policy for the company
including identification therein of elements of risk, if any, which in the opinion of the Board may threaten
the existence of the company;
(o) the details about the policy developed and implemented by the company on corporate social
responsibility initiatives taken during the year;
(p) in case of a listed company and every other public company having such paid-up share capital as may
be prescribed, a statement indicating the manner in which formal annual evaluation has been made by the
Board of its own performance and that of its committees and individual directors;
(q) such other matters as may be prescribed.
(4) The report of the Board of Directors to be attached to the financial statement under this section shall, in
case of a One Person Company, mean a report containing explanations or comments by the Board on every
qualification, reservation or adverse remark or disclaimer made by the auditor in his report.
(5) The Directors’ Responsibility Statement referred to in clause (c) of sub-section (3) shall state that—
(a) in the preparation of the annual accounts, the applicable accounting standards had been followed along
with proper explanation relating to material departures;
(b) the directors had selected such accounting policies and applied them consistently and made judgments
and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the
company at the end of the financial year and of the profit and loss of the company for that period;
(c) the directors had taken proper and sufficient care for the maintenance of adequate accounting records in
accordance with the provisions of this Act for safeguarding the assets of the company and for preventing
and detecting fraud and other irregularities;
(d) the directors had prepared the annual accounts on a going concern basis; and
(e) the directors, in the case of a listed company, had laid down internal financial controls to be followed
by the company and that such internal financial controls are adequate and were operating effectively.
Explanation.—For the purposes of this clause, the term “internal financial controls” means the policies and
procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including
adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and
errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable
financial information;
(f) the directors had devised proper systems to ensure compliance with the provisions of all applicable laws
and that such systems were adequate and operating effectively.
(6) The Board’s report and any annexures thereto under sub-section (3) shall be signed by its chairperson
of the company if he is authorised by the Board and where he is not so authorised, shall be signed by at
least two directors, one of whom shall be a managing director, or by the director where there is one director.
(7) A signed copy of every financial statement, including consolidated financial statement, if any, shall be
issued, circulated or published along with a copy each of—
(a) any notes annexed to or forming part of such financial statement;
(b) the auditor’s report; and
(c) the Board’s report referred to in sub-section (3).
(8) If a company contravenes the provisions of this section, the company shall be punishable with fine
which shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees and
every officer of the company who is in default shall be punishable with imprisonment for a term which may
extend to three years or with fine which shall not be less than fifty thousand rupees but which may extend
to five lakh rupees, or with both.
Section 136. Right of member to copies of audited financial statement.
(1) Without prejudice to the provisions of section 101, a copy of the financial statements, including
consolidated financial statements, if any, auditor’s report and every other document required by law to be
annexed or attached to the financial statements, which are to be laid before a company in its general meeting,
shall be sent to every member of the company, to every trustee for the debenture-holder of any debentures
issued by the company, and to all persons other than such member or trustee, being the person so entitled,
not less than twenty-one days before the date of the meeting:
Provided that in the case of a listed company, the provisions of this sub-section shall be deemed to be
complied with, if the copies of the documents are made available for inspection at its registered office
during working hours for a period of twenty-one days before the date of the meeting and a statement
containing the salient features of such documents in the prescribed form or copies of the documents, as the
company may deem fit, is sent to every member of the company and to every trustee for the holders of any
debentures issued by the company not less than twenty-one days before the date of the meeting unless the
shareholders ask for full financial statements:
Provided further that the Central Government may prescribe the manner of circulation of financial
statements of companies having such net worth and turnover as may be prescribed:
Provided also that a listed company shall also place its financial statements including consolidated financial
statements, if any, and all other documents required to be attached thereto, on its website, which is
maintained by or on behalf of the company:
Provided also that every company having a subsidiary or subsidiaries shall,—
(a) place separate audited accounts in respect of each of its subsidiary on its website, if any;
(b) provide a copy of separate audited financial statements in respect of each of its subsidiary, to any
shareholder of the company who asks for it.
(2) A company shall allow every member or trustee of the holder of any debentures issued by the company
to inspect the documents stated under sub-section (1) at its registered office during business hours.
(3) If any default is made in complying with the provisions of this section, the company shall be liable to a
penalty of twenty-five thousand rupees and every officer of the company who is in default shall be liable
to a penalty of five thousand rupees.
Section 137. Copy of financial statement to be filed with Registrar.
(1) A copy of the financial statements, including consolidated financial statement, if any, along with all the
documents which are required to be or attached to such financial statements under this Act, duly adopted at
the annual general meeting of the company, shall be filed with the Registrar within thirty days of the date
of annual general meeting in such manner, with such fees or additional fees as may be prescribed within
the time specified under section 403:
Provided that where the financial statements under sub-section (1) are not adopted at annual general meeting
or adjourned annual general meeting, such unadopted financial statements along with the required
documents under sub-section (1) shall be filed with the Registrar within thirty days of the date of annual
general meeting and the Registrar shall take them in his records as provisional till the financial statements
are filed with him after their adoption in the adjourned annual general meeting for that purpose:
Provided further that financial statements adopted in the adjourned annual general meeting shall be filed
with the Registrar within thirty days of the date of such adjourned annual general meeting with such fees
or such additional fees as may be prescribed within the time specified under section 403:
Provided also that a One Person Company shall file a copy of the financial statements duly adopted by its
member, along with all the documents which are required to be attached to such financial statements, within
one hundred eighty days from the closure of the financial year:
Provided also that a company shall, along with its financial statements to be filed with the Registrar, attach
the accounts of its subsidiary or subsidiaries which have been incorporated outside India and which have
not established their place of business in India.
(2) Where the annual general meeting of a company for any year has not been held, the financial statements
along with the documents required to be attached under sub-section (1), duly signed along with the
statement of facts and reasons for not holding the annual general meeting shall be filed with the Registrar
within thirty days of the last date before which the annual general meeting should have been held and in
such manner, with such fees or additional fees as may be prescribed within the time specified, under section
403.
(3) If a company fails to file the copy of the financial statements under sub-section (1) or sub-section (2),
as the case may be, before the expiry of the period specified in section 403, the company shall be punishable
with fine of one thousand rupees for every day during which the failure continues but which shall not be
more than ten lakh rupees, and the managing director and the Chief Financial Officer of the company, if
any, and, in the absence of the managing director and the Chief Financial Officer, any other director who
is charged by the Board with the responsibility of complying with the provisions of this section, and, in the
absence of any such director, all the directors of the company, shall be punishable with imprisonment for a
term which may extend to six months or with fine which shall not be less than one lakh rupees but which
may extend to five lakh rupees, or with both.
Corporate Social Responsibility

135. (1) Every company having net worth of rupees five hundred crore or more, or turnover of rupees one
thousand crore or more or a net profit of rupees five crore or more during any financial year shall constitute
a Corporate Social Responsibility Committee of the Board consisting of three or more directors, out of
which at least one director shall be an independent director.
(2) The Board's report under sub-section (3) of section 134 shall disclose the composition of the Corporate
Social Responsibility Committee.
(3) The Corporate Social Responsibility Committee shall,—
(a) formulate and recommend to the Board, a Corporate Social Responsibility Policy which shall indicate
the activities to be undertaken by the company as specified in Schedule VII;
(b) recommend the amount of expenditure to be incurred on the activities referred to in clause (a); and
(c) monitor the Corporate Social Responsibility Policy of the company from time to time.
(4) The Board of every company referred to in sub-section (1) shall,—
(a) after taking into account the recommendations made by the Corporate Social Responsibility Committee,
approve the Corporate Social Responsibility Policy for the company and disclose contents of such Policy
in its report and also place it on the company's website, if any, in such manner as may be prescribed; and
(b) ensure that the activities as are included in Corporate Social Responsibility Policy of the company are
undertaken by the company.
(5) The Board of every company referred to in sub-section (1), shall ensure that the company spends, in
every financial year, at least two per cent. of the average net profits of the company made during the three
immediately preceding financial years, in pursuance of its Corporate Social Responsibility Policy:
Provided that the company shall give preference to the local area and areas around it where it operates, for
spending the amount earmarked for Corporate Social Responsibility activities:
Provided further that if the company fails to spend such amount, the Board shall, in its report made under
clause (o) of sub-section (3) of section 134, specify the reasons for not spending the amount.
Explanation.—For the purposes of this section “average net profit” shall be calculated in accordance with
the provisions of section 198.
MODULE VII- TRANSFER OF SHARES

Parties to a merger or an acquisition may have their own ideas as to how the transaction is to be structured
or carried out, or the rights and obligations of each party. However, in order for the transaction to be
enforced or upheld in a court of law, thereby giving each party the assurance that the transaction itself
would not be rendered immaterial, certain laws that are applicable to each transaction must be adhered to.
In this chapter, we shall discuss the scope and applicability of some of these laws and the potential legal
obstacles that may arise in course of mergers and acquisitions in India.
The importance of a consensus cannot be understated. While a consensus may be arrived at orally, it is
imperative that the consensus be captured in a document in the form of an agreement. The two primary
reasons for the documentation of a consensus are:
(a) Promises made by either party are often vague and must be reduced to specific rights and
obligations in order to avoid ambiguity; and
(b) In the event that the parties to the merger or the acquisition become involved in a dispute regarding
the merger or the acquisition, and are required to refer the dispute to adjudication (whether to a court of law
or an alternative adjudicatory forum, such as an arbitration tribunal), much reliance will be placed upon the
consensus to ascertain the intention of the parties.
The consensus would also be subject to a number of laws which may restrict or prohibit the operation of
certain parts of the consensus. Further, even if the consensus is not prohibited or restricted, timely
information must be provided to relevant regulatory authorities. In some cases, the consensus cannot be
implemented without the sanction of a regulatory authority.
In this chapter, we provide an overview of some of the laws that are applicable to every or most forms of
mergers and acquisitions. Please note that while this chapter provides a general guide to the provisions of
law that would apply to mergers and acquisitions, it should not be taken as legal advice. The value of an
experienced legal consultant to advise on the merger or acquisition process as well as the legal due diligence
cannot be replaced by a guide.
The basis of a merger or an acquisition is the transfer of assets and/or liabilities from one entity to another,
for reasons discussed elsewhere in this book. The transfer of assets and liabilities could take place in any
number of ways:
(a) By the transfer of assets and/or liabilities from the target to the acquirer
(b) By the transfer of the entity owning the assets and liabilities in its entirety or in part, to the acquirer
(c) By the merger of the target entity into the acquiring entity
Each option has its own pros and cons, which are more pronounced when the target entity is a company.
In case of an acquisition, the deal is usually implemented by the sale and purchase of either the shares,
business or the assets of the target company or the issue of shares of the target company in favour of the
acquirer. A consensus relating to that transfer of shares, business or assets is usually encapsulated in a
contract. Therefore, one must begin with the Indian Contract Act, 1872, as it lays the cornerstone for the
basis of contract enforceability in India and what contracts are valid and what are not.
The transfer or issue of shares, are subject to the Indian Companies Act, 2013 which also contains specific
provisions for the merger or amalgamation of companies. There are other ancillary matters involved in the
M&A process, including information rights and appointment of directors, which are provided for in the
Companies Act. It must be noted however, that the existing Companies Act, 2013 may be replaced shortly
by the Companies Bill 2012, which is awaiting discussion and ratification in Parliament.
While the Contract Act and the Companies Act would be applicable in every instance of a merger or an
acquisition of shares of a target company, there may be situations which bring other legislations into play.
In certain cases which may have an adverse effect on competition, a specific merger or an acquisition may
trigger the provisions of the Competition Act, 2002, along with its subordinate legislation. In cases of
mergers and acquisitions of listed companies, the Securities and Exchange Board of India (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 would also be triggered. A cross border acquisition
would attract the provisions of the extant Policy on Foreign Direct Investment or the Overseas Direct
Investment guidelines. This chapter would provide an overview of each of these abovementioned laws.
India has a plethora of laws, a number of which are restricted in their application to certain industry sectors.
In certain cases, a merger or an acquisition of a target company operating within one of these industry
sectors would be subject to the sector specific laws. For example, a concession granted by the Government
of India in favour of a power generation company is likely to have a minimum requirement as to the
percentage of shareholding that the promoters of the company may continue to retain. Given the multitude
of sector specific laws, we have not delved into the same.
In a typical acquisition scenario, once the contact and preliminary talks with the target have been concluded,
the acquisition model and basic conditions of the acquisition are determined. The model, basic conditions
and often the business valuation is captured in a preliminary document which may be called a memorandum
of understanding, memorandum of agreement, term sheet, heads of terms or a variation of the same. The
object of a term sheet is not to bind the parties to the acquisition, but to ensure that the parties have a
commercial understanding and continue concrete discussions and negotiations. This also gives an
opportunity to the acquirer to undertake a detailed due diligence exercise.
The term sheet need not be detailed. Outlining the commercial understanding, including the number of
shares to be issued or transferred, the valuation and certain important provisions would suffice. It must be
ensured however, that the term sheet includes provisions on exclusivity and confidentiality. It would be
counter-productive for the acquirer to continue its diligence and discussions with the target while the target
itself is shopping for a better deal.
While a term sheet under Indian law is not binding by itself per se, a provision stating that the term sheet is
binding is recommended. On numerous occasions, Indian courts have upheld such provisions and have
enforced the binding nature of term sheets.
Other provisions that may be included in the term sheet are terms and conditions as to:
(a) conditions to be fulfilled prior to the execution of the acquisition agreement or the investment
agreement or the merger scheme, as the case may be. Often, in case the acquirer is a foreign entity, prior
approval may be required. Or the acquirer may require the target to prepare new financial statements, etc.
(b) who pays for the costs of the transaction. This is important as the costs of an acquisition may be
substantial, involving payments to be made to financial, accounting and legal advisors, stamp duty, etc.
(c) the procedure to be followed in case of a dispute with regard to the term sheet. Usually, parties opt
for an alternative dispute resolution mechanism, using negotiations or mediation in the first instance and
arbitration in case the mediation or negotiation fails.
Transfer of shares
Consider a scenario where the entire or substantial part of a company is to be acquired. In case of an
acquisition of shares of a company, the consensus is typically captured in what is referred to as a share
transfer or a share purchase agreement. The agreement contains specific provisions setting out the identity
of the purchaser and the seller, the number of shares to be transferred and the price at which such shares
are to be transferred. There may be price restrictions applicable in case the company is listed on a stock
exchange, or if the either of the parties is non resident in India. We will discuss these price restrictions in
sections 6 and 7 of this chapter respectively.
It is also important that the target company be made a party to the share transfer agreement. While this may
seem counter-intuitive, since the company has no role to play in the formation of the consensus, the
definitive procedural step for the transfer of shares lies in an action to be taken by the Company. Therefore,
it would be advisable to bind the company to its obligations to honour the transfer of shares.
Often, the purchaser would require the vendor and the target company to undertake certain actions prior to
the actual transfer of shares. These may include obtaining the necessary regulatory and other approvals,
authorisations in favour of the signatories to the agreement, carrying out a detailed audit of the company,
or actions to mitigate any risks that may have been discovered during the due diligence process. This is to
ensure that at the time of the acquisition, the affairs of the company are in order and that the company is in
good standing. These actions that the vendor and/ or the company are required to carry out to the satisfaction
of the purchaser are specifically set out and are referred to as conditions precedent. Any actions to be carried
out by the parties (including the company) post the transfer of shares is also set out as conditions subsequent.
The actual transfer of shares takes place only when the conditions precedent have either been satisfied or
have been waived by the purchaser. The process of transfer is governed by the Companies Act, 2013.
The acquisition agreement must also contain clauses that set out the representations and warranties made
by each of the parties, under what conditions would an event of default take place and the consequences of
such events of default.
Model Articles of Association – Schedule I, Table F, Companies Act, 2013

19. (i) The instrument of transfer of any share in the company shall be executed by or on behalf of both the
transferor and transferee.
(ii) The transferor shall be deemed to remain a holder of the share until the name of the transferee is entered
in the register of members in respect thereof.
20. The Board may, subject to the right of appeal conferred by section 58 decline to register—
(a) the transfer of a share, not being a fully paid share, to a person of whom they do not approve; or
(b) any transfer of shares on which the company has a lien.
21. The Board may decline to recognise any instrument of transfer unless—
(a) the instrument of transfer is in the form as prescribed in rules made under sub-section (1) of section 56;
(b) the instrument of transfer is accompanied by the certificate of the shares to which it relates, and such
other evidence as the Board may reasonably require to show the right of the transferor to make the transfer;
and
(c) the instrument of transfer is in respect of only one class of shares.
22. On giving not less than seven days’ previous notice in accordance with section 91 and rules made
thereunder, the registration of transfers may be suspended at such times and for such periods as the Board
may from time to time determine:
Provided that such registration shall not be suspended for more than thirty days at any one time or for more
than forty-five days in the aggregate in any year.
Acquisitions in Public Listed Companies
There are special laws that apply to listed companies. The primary agency for the governance of listed
companies in India (in addition to the Registrar of Companies, as mentioned in section 3.5) is the Securities
and Exchange Board of India (SEBI). It acts to protect the rights of investors and to develop and regulate
the securities market in India.
In case of an acquisition of a listed company, the acquisition may take place either by an issue of shares, or
by the transfer of shares by existing shareholders. Both of these scenarios have been dealt with by SEBI in
various legislations. The key purpose of these legislations is to ensure that the rights of public shareholders
are protected.
Takeover Code, 2011
Under certain circumstances, the allotment of shares as described under section 5.1 or the transfer of shares
as described in sections 2.2 and 3.1 may attract the provisions of the SEBI (Substantial Acquisition of
Shares and Takeovers) Regulations 2011 (Takeover Code). The provisions of the Takeover Code relating
to the requirement of making an open offer pursuant to an acquisition of shares of a listed company is
triggered in the following two events:
(a) An acquisition of 25% or more of the paid up share capital or voting rights of the company.
(b) An acquisition of 5% or more in any financial year, where the acquirer already holds 25% or more
of the paid up share capital or voting rights of the Target Company.
An open offer is the offer made by a potential acquirer to the public shareholders of the company. The
purpose behind the concept of an open offer is that in case of a change of management of a listed company,
the public shareholders must be given an opportunity to exit the company. An open offer is made by the
acquirer for a minimum of 26% of the share capital of the company. Since, as an initial trigger, the open
offer is to be made only when the shareholding of the acquirer hits 25%, the offer to purchase a further 26%
would lead the acquirer to have a simple majority of 51% of the company. This would enable the acquirer
to replace the board of directors and to change the management structure of the company.
However, in case the acquirer already holds 25% or more of the shareholding of the company, an increase
in 5% of its shareholding in a financial year would also lead to an open offer, thus potentially increasing
the acquirer’s shareholding to atleast more than 56%. However, in reality, there are few shareholders who
hold between 25% and 51% of the shares of a company. Such shareholders cannot participate in the
management of the company, except on matters that require special resolutions. By agreement, such
shareholders may potentially be able to appoint a minority number of directors on the board of the company.
This mechanism is typically used by majority shareholders who wish to consolidate their holdings. It also
prevents large shareholders from making ‘creeping acquisitions’ i.e. acquisitions that build up the
shareholding of the acquirer over time.
A key element of listed companies must also be noted here. Companies listed in India are required to have
atleast 25% of their shares held by public shareholders. Any reduction of the public shareholding below
25% must be removed by a further issue of shares or transfer of shares to the public within a year of the
reduction. While this provision is not particularly important for the purposes of acquisitions of listed
companies, it does play a vital role in the open offer mechanism.
When making an open offer, an acquirer is ordinarily required to offer to purchase atleast 26% of the share
capital of the company. However, if the offer were to be successful in its entirety, there may be a situation
wherein the public shareholding may be reduced to below 25%. In such cases, the open offer may be made
for a number of shares which would take the shareholding of the acquirer beyond the maximum permissible
non -public shareholding limit, but the acquirer would be required to increase the public shareholding within
one year of the open offer.
In case of a negotiated acquisition of a listed company, wherein the acquirer negotiates the takeover of the
listed company from the existing controlling shareholders of the company, the acquirer and the selling
shareholding typically enter into a share purchase agreement as described in section 2.2. However, due to
confidentiality issues and given that the news of a potential takeover may trigger volatility in the share
price, the company may not be made a party to the share purchase agreement. As there are no restrictions
on the share transferability of public companies, therefore the company cannot refuse the registration of the
transfer under the share purchase agreement, even if it is not a party to the agreement. The provisions of
the Takeover Code are triggered at the time the share purchase agreement is signed. In order to carry out
the open offer there a number of steps which are to be followed:
(a) At least three days prior to signing the share purchase agreement, the acquirer is required to appoint
a merchant banker who will act as the manager for the open offer process
(b) Simultaneously with the signing of the share purchase agreement, a public announcement of the
intention of the acquirer to takeover the company is required to be made. This public announcement must
be made to SEBI, all Stock Exchanges and the registered office of the target.
(c) Within 3 days of the signing of the agreement, an escrow account is opened. This escrow account
will hold the funds to be paid to public shareholders who accept the acquirer’s offer
(d) Within 2 days of the opening of the escrow account, the acquire issues a detailed public statement
which is to be sent to SEBI, all Stock Exchanges and the registered office of the target and published in all
editions of any one English national daily with wide circulation, any one Hindi national daily with wide
circulation, and any one regional language daily with wide circulation at the place where the registered
office of the target company is situated and one regional language daily at the place of the stock exchange
where the maximum volume of trading in the shares of the target company are recorded during the sixty
trading days preceding the date of the public announcement. The detailed public statement contains basic
details about the acquirer, the company and must contain a specific statement as to the creation of the
escrow account
(e) Within 5 days of the detailed public statement being made, a draft letter of offer is to be filed with
SEBI and a copy of the same is sent to the target company at its registered office address and to all stock
exchanges where the shares of the target company are listed. The draft letter of offer must contain the
following:
i. Tentative schedule
ii. Risk factors
iii. Background of acquirers and pac
iv. Background of company
v. Offer price and financial arrangement
vi. Terms and conditions of the offer
vii. Procedure for acceptance and settlement
viii. Documents for inspection
ix. Declaration by the acquirer
x. Form of acceptance - cum - acknowledgment
(f) SEBI shall review the draft letter of offer and make its observations, if any, within 15 days of the
filing of the draft letter of offer. If SEBI does not send any observations within 15 days, it is deemed that
SEBI has no observations to make.
(g) Within 7 days of SEBI observations the final letter of offer is to be issued to all shareholders, SEBI,
Stock Exchanges and custodian of shares having underlying depository receipts (if any). Care must be taken
to ensure that the observations of SEBI have been included in the final letter of offer
(h) An advertisement relating to the open offer is to be published in the same publications as the
detailed public statement one day before the period for acceptance of the offer (tendering period) opens
(i) Tendering period opens 12 days after receipt of SEBI observations (5 days after dispatch of final
letter of offer)
(j) Tendering period closes 10 days after opening
(k) Within 10 days of tender period closing, the escrow account is open and payments are released to
shareholders. The acquirer then acquires the shares from the public shareholders.
(l) Within 5 days of payment to shareholders, a post offer advertisement is to be published in the same
publications as the detailed public statement.
(m) Within 15 days of the expiry of the tendering period, the merchant banker appointed is to submit a
report to SEBI confirming that the requirements of the open offer have been satisfied.
Under usual circumstances, the share purchase agreement entered into by the acquirer and the controlling
shareholder may be completed only after the submission of the merchant banker’s report.
Since the acquisition of a listed company involves publicly traded shares, there are restrictions on the share
price at which the open offer must be made. The pricing guidelines set out in Regulation 10 (1) of the
Takeover Code provide for the pricing of shares which are frequently as well as infrequently traded shares.
Therefore, in the event the shares of the Target Company are frequently traded, the acquisition price per
share shall not be higher by more than 25% (twenty-five per cent) of the volume-weighted average market
price for a period of 60 (sixty) trading days preceding the date of issuance of notice for the proposed inter
se transfer, as traded on the stock exchange where the maximum volume of trading in the shares of the
Target Company are recorded during such period.
However, if the shares of the Target Company are infrequently traded, the acquisition price shall not be
higher by more than 25% (twenty-five percent) of the price determined taking into account valuation
parameters including, book value, comparable trading multiples, and such other parameters as are
customary for valuation of shares of such companies.
Usually, in case of open offers being triggered by the signing of a negotiated share purchase agreement, the
open offer price is the same as the share price negotiated with the controlling shareholder.
Reporting Requirements
Apart from the above mentioned disclosures involved in the open offer process, it must be noted that the
Parties would be required to make the following disclosures under Chapter V of the Takeover Code to the
stock exchanges where the shares of the Target Company are listed and to the Securities and Exchange
Board of India (“SEBI”):
(a) Disclosure of every acquisition of shares in excess of 2% of the shares of the Target Company
where the acquirer holds more than 5% of the shares; and
(b) Annual disclosure of the aggregate shareholding of the promoters of the Target Company and of
shareholders holding more than 25% of the shares of the Target Company.
MODULE VI- CORPORATE FUNDRAISING

Let us now consider a scenario where the acquisition of a company takes place by the issue of fresh shares.
In such cases, the purchaser (here known as the investor) would typically take a minority position, as
opposed to a controlling stake in the company. Usually, such acquisitions are for investment purposes only
and the acquirer does not actively participate in the management of the company. The investment agreement
would contain similar clauses to the acquisition agreement, except that the shares acquired would be by
way of a subscription and issue of fresh equity, rather than a transfer of shares. Further, since the issue of
shares is an action to be undertaken by the company and the share price is to be paid to the company, the
role of the company is further enhanced in this case.
Issue of shares/ convertible instruments/ debt

Section 23. Public offer and private placement
(1) A public company may issue securities—

(a) to public through prospectus (herein referred to as "public offer") by complying with the provisions of
this Part; or
(b) through private placement by complying with the provisions of Part II of this Chapter; or
(c) through a rights issue or a bonus issue in accordance with the provisions of this Act and in case of a
listed company or a company which intends to get its securities listed also with the provisions of the
Securities and Exchange Board of India Act, 1992 and the rules and regulations made thereunder.
(2) A private company may issue securities—
(a) by way of rights issue or bonus issue in accordance with the provisions of this Act; or
(b) through private placement by complying with the provisions of Part II of this Chapter.
Explanation.—For the purposes of this Chapter, "public offer" includes initial public offer or further public
offer of securities to the public by a company, or an offer for sale of securities to the public by an existing
shareholder, through issue of a prospectus.
Section 62. Further issue of share capital.

(1) Where at any time, a company having a share capital proposes to increase its subscribed capital by the
issue of further shares, such shares shall be offered—
(a) to persons who, at the date of the offer, are holders of equity shares of the company in proportion, as
nearly as circumstances admit, to the paid-up share capital on those shares by sending a letter of offer
subject to the following conditions, namely:—
(i) the offer shall be made by notice specifying the number of shares offered and limiting a time not being
less than fifteen days and not exceeding thirty days from the date of the offer within which the offer, if not
accepted, shall be deemed to have been declined;
(ii) unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a
right exercisable by the person concerned to renounce the shares offered to him or any of them in favour of
any other person; and the notice referred to in clause (i) shall contain a statement of this right;
(iii) after the expiry of the time specified in the notice aforesaid, or on receipt of earlier intimation from the
person to whom such notice is given that he declines to accept the shares offered, the Board of Directors
may dispose of them in such manner which is not dis-advantageous to the shareholders and the
company;
(b) to employees under a scheme of employees’ stock option, subject to special resolution passed by
company and subject to such conditions as may be prescribed; or
(c) to any persons, if it is authorised by a special resolution, whether or not those persons include the persons
referred to in clause (a) or clause (b), either for cash or for a consideration other than cash, if the price of
such shares is determined by the valuation report of a registered valuer subject to such conditions as may
be prescribed.
(2) The notice referred to in sub-clause (i) of clause (a) of sub-section (1) shall be despatched through
registered post or speed post or through electronic mode to all the existing shareholders at least three days
before the opening of the issue.
(3) Nothing in this section shall apply to the increase of the subscribed capital of a company caused by the
exercise of an option as a term attached to the debentures issued or loan raised by the company to convert
such debentures or loans into shares in the company:
Provided that the terms of issue of such debentures or loan containing such an option have been approved
before the issue of such debentures or the raising of loan by a special resolution passed by the company in
general meeting.
(4) Notwithstanding anything contained in sub-section (3), where any debentures have been issued, or loan
has been obtained from any Government by a company, and if that Government considers it necessary in
the public interest so to do, it may, by order, direct that such debentures or loans or any part thereof shall
be converted into shares in the company on such terms and conditions as appear to the Government to be
reasonable in the circumstances of the case even if terms of the issue of such debentures or the raising of
such loans do not include a term for providing for an option for such conversion:
Provided that where the terms and conditions of such conversion are not acceptable to the company, it may,
within sixty days from the date of communication of such order, appeal to the Tribunal which shall after
hearing the company and the Government pass such order as it deems fit.
(5) In determining the terms and conditions of conversion under sub-section (4), the Government shall have
due regard to the financial position of the company, the terms of issue of debentures or loans, as the case
may be, the rate of interest payable on such debentures or loans and such other matters as it may consider
necessary.
(6) Where the Government has, by an order made under sub-section (4), directed that any debenture or loan
or any part thereof shall be converted into shares in a company and where no appeal has been preferred to
the Tribunal under sub-section (4) or where such appeal has been dismissed, the memorandum of such
company shall, where such order has the effect of increasing the authorised share capital of the company,
stand altered and the authorised share capital of such company shall stand increased by an amount equal to
the amount of the value of shares which such debentures or loans or part thereof has been converted into.
Private placement
Section 42. Offer or invitation for subscription of securities on private placement.
(1) Without prejudice to the provisions of section 26, a company may, subject to the provisions of this
section, make private placement through issue of a private placement offer letter.
(2) Subject to sub-section (1), the offer of securities or invitation to subscribe securities, shall be made to
such number of persons not exceeding fifty or such higher number as may be prescribed, [excluding
qualified institutional buyers and employees of the company being offered securities under a scheme of
employees stock option as per provisions of clause (b) of sub-section (1) of section 62], in a financial year
and on such conditions (including the form and manner of private placement) as may be prescribed.
Explanation I.—If a company, listed or unlisted, makes an offer to allot or invites subscription, or allots, or
enters into an agreement to allot, securities to more than the prescribed number of persons, whether the
payment for the securities has been received or not or whether the company intends to list its securities or
not on any recognised stock exchange in or outside India, the same shall be deemed to be an offer to the
public and shall accordingly be governed by the provisions of Part I of this Chapter.
Explanation II.— For the purposes of this section, the expression—
(i) "qualified institutional buyer’’ means the qualified institutional buyer as defined in the Securities and
Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 as amended
from time to time.
(ii) "private placement" means any offer of securities or invitation to subscribe securities to a select group
of persons by a company (other than by way of public offer) through issue of a private placement offer
letter and which satisfies the conditions specified in this section.
(3) No fresh offer or invitation under this section shall be made unless the allotments with respect to any
offer or invitation made earlier have been completed or that offer or invitation has been withdrawn or
abandoned by the company.
(4) Any offer or invitation not in compliance with the provisions of this section shall be treated as a public
offer and all provisions of this Act, and the Securities Contracts (Regulation) Act, 1956 and the Securities
and Exchange Board of India Act, 1992 shall be required to be complied with.
(5) All monies payable towards subscription of securities under this section shall be paid through cheque
or demand draft or other banking channels but not by cash.
(6) A company making an offer or invitation under this section shall allot its securities within sixty days
from the date of receipt of the application money for such securities and if the company is not able to allot
the securities within that period, it shall repay the application money to the subscribers within fifteen days
from the date of completion of sixty days and if the company fails to repay the application money within
the aforesaid period, it shall be liable to repay that money with interest at the rate of twelve per cent. per
annum from the expiry of the sixtieth day:
Provided that monies received on application under this section shall be kept in a separate bank account in
a scheduled bank and shall not be utilised for any purpose other than—
(a) for adjustment against allotment of securities; or
(b) for the repayment of monies where the company is unable to allot securities.
(7) All offers covered under this section shall be made only to such persons whose names are recorded by
the company prior to the invitation to subscribe, and that such persons shall receive the offer by name, and
that a complete record of such offers shall be kept by the company in such manner as may be prescribed
and complete information about such offer shall be filed with the Registrar within a period of thirty days of
circulation of relevant private placement offer letter.
(8) No company offering securities under this section shall release any public advertisements or utilise any
media, marketing or distribution channels or agents to inform the public at large about such an offer.
(9) Whenever a company makes any allotment of securities under this section, it shall file with the Registrar
a return of allotment in such manner as may be prescribed, including the complete list of all security-
holders, with their full names, addresses, number of securities allotted and such other relevant information
as may be prescribed.
(10) If a company makes an offer or accepts monies in contravention of this section, the company, its
promoters and directors shall be liable for a penalty which may extend to the amount involved in the offer
or invitation or two crore rupees, whichever is higher, and the company shall also refund all monies to
subscribers within a period of thirty days of the order imposing the penalty.
Preferential Issue of Shares in Public Listed Companies
For a listed company, any issue of share may be made to all existing shareholders (a rights issue) or to the
public (a further public offer) or to a specified entity or entities (a preferential issue). The issue of shares of
a public listed company is governed by the SEBI (Issue of Capital and Disclosure Requirements)
Regulations 2009 (ICDR). The primary requirement of a preferential issue is the approval of the existing
shareholders of the company, since the issue is being made to an entity in preference over the public or the
shareholders.
In order to make a preferential issue of shares, a listed company must satisfy the following requirements:
(a) A special resolution must be passed by the shareholders of the company in favour of the preferential
issue
(b) If the proposed allottees hold any shares in the company prior to the preferential issue, these share
must be in dematerialised form. This requirement has been made to discourage preferential issues of shares
to the promoters of the company who would typically hold shares in physical form
(c) The company must be in compliance with the requirements for being listed.
(d) The company must have been provided with the permanent account numbers of the proposed
allottees
The special resolution to be passed by the shareholders must contain specific information relating to the
preferential issue. The purpose of the preferential issue, the shareholding pattern of the company prior to
and after the preferential issue and the proposal of the management of the company to issue share
preferentially must necessarily form a part of the resolution to be passed. The company must also ensure
that the price at which the shares are issued must be re-computed, if necessary, in accordance with the
pricing guidelines laid in the ICDR and that, until payment for the recomputed price has been made by the
proposed allottees, the shares proposed to be issued shall be locked in. In other words, after the preferential
issue has taken place, in the event that the price for the shares is required to be recomputed and the
recomputed price is higher than the original price of the shares paid, the allottees would not be allowed to
transfer their shares until the additional payment has been made.
Within fifteen days of the passing of the special resolution by the shareholders, the preferential issue must
be made. There are circumstances under which this fifteen day period may be relaxed, primarily in the event
that the company or the allottees are required to seek government approval. For example, as we have seen
in Section 4, in case of certain acquisitions, the approval of the CCI may be required. In certain other cases,
the allottees may be required to make an offer to the public shareholders of the company, which will be
discussed below in section 5.2. In such cases, the fifteen day period begins from the date on which the
approvals have been granted and not the date of the special resolution.
In the event that the allotment is not made within the fifteen day period a fresh special resolution must be
passed by the shareholders.
There are considerations to be made with regard to the pricing of the shares to be allotted. An arbitrary
pricing of the share may prove to be detrimental to the interests of the public shareholders. Since the shares
are of a listed company, share prices would be guided by the stock markets. There are two mechanisms for
determining the price at which these shares are to be allotted. The first is in the event that the company
making the issue has been listed for atleast twenty six weeks. In such cases, the average of the weekly high
and low of the closing prices of the shares quoted on the recognised stock exchange during the twenty six
weeks preceding the relevant date and the average of the weekly high and low of the closing prices of the
related equity shares quoted on a recognised stock exchange during the two weeks preceding the relevant
date must first be determined. The shares to be allotted on a preferential basis must be priced no less than
the higher of the above two prices.
On the rare occasion that the company issuing the shares has not been listed for more than twenty six weeks,
there is a separate mechanism to determine the price at which a preferential issue of shares may be made.
In such cases, the following prices must be determined:
(a) the price at which equity shares were issued by the company in its initial public offer
(b) the value per share arrived at in a scheme of arrangement (refer section 3.3), pursuant to which the
equity shares of the issuer were listed, if applicable;
(c) the average of the weekly high and low of the closing prices of the related equity shares quoted on
the recognised stock exchange during the period shares have been listed preceding the relevant date; and
(d) the average of the weekly high and low of the closing prices of the related equity shares quoted on
a recognised stock exchange during the two weeks preceding the relevant date.
In such cases, the price at which the preferential issue of shares is made must not be lower than the highest
of the above four.
For the purposes of ascertaining the share price as mentioned above, the relevant date is taken as thirty days
prior to the date of the shareholders meeting held to pass the special resolution.
20% of the shares allotted on a preferential basis to promoter or promoter group, shall be locked-in for a
period of 3 (three) years from the date of allotment. The remainder of the shares allotted would be locked-
in for 1 (one) year from the date of their allotment. In case the shares are allotted to non-promoters, the
securities allotted on a preferential basis would be locked-in for a period of 1 (one) year from the date of
allotment.
At the time of the allotment, the company is required to inform the depositories as to the lock-in. In case
the shares allotted are in physical form, the company is required to stamp the share certificates as ‘not
transferable’ indicating the period of non-transferability.
In the event that the acquisition of shares in a listed company leads to the acquirer subscribing to shares
such that the shareholding of the acquirer exceeds 25% of the total post-acquisition share capital of the
company, the transaction would be subject to the provisions of the Takeover Code, 2011.
Pre-emptive rights
In addition to the clauses mentioned for an acquisition agreement, an investment agreement would also
typically include provisions setting out how the company is to be jointly managed between the investor and
the existing shareholders. These include veto rights in certain matters (known as affirmative voting rights),
the rights of the investor to appoint board members, to inspect the documents of the company, etc. The
investment agreement would also contain minority protection rights, including exit provisions.
Exit provisions are conditions under which a minority investor may sell its shares. An investor may choose
to sell its shares in order to generate funds from the proceeds, or as a reaction to an event of default
committed by the majority shareholder or the company. There are certain terms relating to exit provisions
that are typically used in an acquisition agreement or an investment agreement. We will discuss each of
these as follows.
A put option is the right or entitlement, but not the obligation, of a person to buy or sell an asset (which for
our purposes comprises shares in the Company). Such options are created by contract (in this case, the
Shareholders Agreement) and essentially represent contractual obligations of transacting parties. When the
option is exercised by such shareholder, the other person (being the buyer) will be obligated to purchase
the shares at a pre-determined price.
Put options are essentially exit rights available to private equity and venture capital investors in companies.
Such investors invest in portfolio companies (that are usually unlisted) with a view to profiting from a
subsequent floatation of the shares in the public markets thereby providing ample liquidity and exit
opportunities. However, since listing of shares may not always be feasible, private equity and venture
capital investors seek fallback exit options in their contracts with portfolio companies and their controlling
shareholders. The first is a put option on the company, which requires the company or the majority
shareholders to buy back the shares of the investor upon exercise of the option. However, under Indian
company law, a buyback of shares by the company is subject to a number of limitations that reduce the
attractiveness of such a put option on the company. Therefore, investors tend to insist on the second
possibility, which is a put option on the controlling shareholders of the company, where the limitations
applicable to a buyback by the company do not operate.
A call option is the reverse of a put option. It provides the holder of the option to purchase (or ‘call’ upon)
the shares held by the other shareholders at a price either determined, or determinable at the time of the
exercise of the option. This is typically used by majority shareholders when seeking to consolidate their
holdings.
The call and the put options are occasions when one of the shareholders exit the company in favour of the
other shareholders. However, a third party transfer, that is, a transfer of shares to an entity who is not a
shareholder of the company is also possible. However, there may be restrictions placed on such third party
transfers. For example, a promoter may insist that a strategic investor first offer its shares to the promoter
in the event that the strategic investor chooses to exit the company. In case the offer made by the promoter
is not agreeable to the investor, the investor is free to sell its shares to a third party. This is known as a right
of first offer.
A variation of the right of first offer is the right of first refusal. In this case, the exiting shareholder obtains
a firm offer from a third party transferee. This offer is then revealed to the non-exiting shareholder who
may choose to match the offer, or ignore it. If the non-exiting shareholder matches the offer, then the exiting
shareholder is constrained to sell its shares to the remaining shareholder. If not, a third party transfer is
possible.
At the time of the third party transfer, there are two other mechanisms that often fine their way into an
acquisition investment or an investment agreement. These are tag along rights (also known as a right of co-
sale) and drag along rights. When a shareholder is selling its shares to a third party, the right of the other
shareholders to sell its shares to the same third party investor at the same conditions and price is known as
a tag along right. This right may be exercised even without the consent of the selling shareholder or the
third party purchaser. This is typically used by minority shareholders who perceive the value of the
company to be dependent upon the majority shareholder. Therefore, the exit of the majority shareholder
may lead to a decline in the value of the company, hence the desire to exit along with the selling shareholder.
The converse of the tag along right is the drag along right. In this case, the third party purchaser may require
to purchase more shares than selling shareholder holds. The drag along right requires that the non-selling
shareholder would be constrained, upon instructions of the selling shareholder, to sell its shares to the third
party purchaser at the same price and conditions. Similar to the tag along right, this right may be exercised
even without the consent of the non-selling shareholder or the third party purchaser.
In a number of cases, where an investment is made, not for strategic purposes, but for the investor to seek
a return on the appreciation of the share valuation. A number of agreements may include provisions for an
initial public offering where the investor would be allowed to exit the company by way of an offer for sale
to the public.
Public offer
Sahara India Real Estate Corporation Limited & Ors v. Securities and Exchange Board of India
Two unlisted companies belonging to the Sahara Group of Companies - Sahara India Real Estate
Corporation Limited (hereinafter referred as SIRECL) and Sahara Housing Investment Corporation Limited
(hereinafter referred as SHICL), sought to raise funds by issuing optional fully convertible debentures on a
private placement basis. The Red Herring prospectus filed by Sahara companies provided that the Sahara
companies did not intend to list these securities on any recognized stock exchange. Further, the RHP
provided that only those persons to whom the information memorandum was distributed and/or friends,
associated group companies, workers/employees and other individuals associated with Sahara Group were
eligible to apply for the issue of these OFCDs. The extant law at the time provided that a prospectus inviting
investments against the issue of securities by a company must be filed with the Registrar of Companies,
Ministry of Corporate Affairs and the Securities and Exchange Board of India. Since the OFCDs were not
intended to be listed, it was the opinion of the Sahara companies that the prospectus would only be required
to be filed before the Registrar of Companies and not the Securities and Exchange Board of India.
The information memorandum, as a pre-cursor to the prospectus, was issued through approximately a
million agents and three thousand branch offices to more than thirty million persons, inviting them to
subscribe to the OFCD. The Securities and Exchange Board of India was of the opinion that this amounted
to a public offer and took cognizance of the distribution of the information memorandum while processing
the draft RHP (DRHP) submitted by Sahara Prime City Limited, another Sahara group company, for its
initial public offering.
At the time, Sahara Prime City Limited had sought to raise up to INR 30 billion through the IPO in order
to raise funds for its various housing projects across the country. As part of its draft red herring prospectus,
it was required to disclose fundraising details of its group companies, including the Sahara companies
mentioned above. Upon the issue and notification of the draft red herring prospectus, SEBI invited
comments and objections from the general public. A number of complaints were received in respect of the
disclosures made regarding the group companies of Sahara Prime City Limited including SIRECL and
SHICL. These complaints alleged that SIRECL and SHICL were issuing convertible bonds to the public
throughout the country for many months and the same was not disclosed in the Sahara Prime City Limited
DRHP.
In spite of SEBI seeking clarifications on the issue of the OFCDs from the Sahara companies on a number
of occasions, the Sahara companies did not furnish the details sought by SEBI. There evidently seemed to
be reluctance on the part of the companies in providing the relevant details as sought by SEBI, which would
enable SEBI to decide whether the OFCD issuances made by them are in compliance with the relevant
provisions of the Act and applicable laws administered by SEBI. Eventually, SEBI initiated an investigation
and passed a final order on June 23, 2011. SEBI concluded that neither SIRECL nor SHICL had issued
OFCDs by way of “private placement” and that the issue of the OFCDs did in fact, amount to a public issue,
over which SEBI would have jurisdiction. The Sahara companies appealed first before the Securities
Appellate Tribunal, and when the appeal was dismissed, to the Supreme Court of India.
One of the issues that arose inter alia before the Supreme Court of India was whether the OFCDs issued by
SIRECL and SHICL were by way of “private placement”- as claimed by the Sahara Companies on appeal,
or by way of an invitation “to the public” - as counter claimed by the SEBI?
Sahara contended that they were not bound by the Companies Act or the ICDR since theirs was not a public
issue. The RHP explicitly stated that the OFCD was open to only those to whom the information
memorandum was circulated or to those who were affiliated with the Sahara Group or were affiliated to
people affiliated with the Sahara Group. Further their securities were unlisted in the stock exchange and
would continue to remain so subsequent to their placement.
Firstly, the Supreme Court considered Section 67 of the Act which deals with the issue of shares and
debentures to the Public. Section 67 (1) deals with the offering of shares and debentures to the public.
Section 67(2) deals with what constitutes an invitation to the public to subscribe for shares and debentures.
Section 67 (3) deals with the circumstances when the offer or invitation would not be deemed to be made
to the public. However, the court held that proviso to section 67 (3) clearly elucidated that any offer made
to 50 persons or more would be deemed to be a public offer and outside the purview of section 67 (3).
Further, the Court pointed out that private placement is any offer or invitation to subscribe to securities to
less than fifty persons or as per the provisions of section 67 (3) of the Companies Act.
The court then considered the persons to whom the OFCD’s were offered. It observed that people who were
not affiliated to the Sahara group were permitted to subscribe to the shares provided they were introduced
by people affiliated with the Sahara Group. The court held that ‘private placement connotes the issue of
securities to close and associated people without issuing any advertisements with such conditions in which
circumstances; the offering may not be construed as “offering securities to the public or invitation to public
to subscribe for those securities. In this instance introduction would be required only by those not affiliated
with the Appellant’s Companies; in other words the general public’.
Secondly, the court also held that the since the issue had been made to the public through the use of the
information memorandum, provisions of Section 60B(9) requiring the filing of prospectus of the SEBI were
attracted. The Sahara companies’ conduct of issuing the information memorandum through approximately
a million agents and three thousand branch offices to more than thirty million persons was indeed a public
issue and therefore sufficient in order to attract the provisions of Section 73. The Court accepted SEBI’s
contention that the OFCDs issued by SIRECL and SHICL was by way of an invitation “to the public”.
Lastly, after establishing that the securities were offered to the public, the Court took into account, the
provisions of Section 73 of the Companies Act which provided for the mandatory listing of the securities
in a recognised stock exchange when offered to the public.
Section 25. Document containing offer of securities for sale to be deemed prospectus.
(1) Where a company allots or agrees to allot any securities of the company with a view to all or any of
those securities being offered for sale to the public, any document by which the offer for sale to the public
is made shall, for all purposes, be deemed to be a prospectus issued by the company; and all enactments
and rules of law as to the contents of prospectus and as to liability in respect of mis-statements, in and
omissions from, prospectus, or otherwise relating to prospectus, shall apply with the modifications specified
in subsections (3) and (4) and shall have effect accordingly, as if the securities had been offered to the
public for subscription and as if persons accepting the offer in respect of any securities were subscribers for
those securities, but without prejudice to the liability, if any, of the persons by whom the offer is made in
respect of mis-statements contained in the document or otherwise in respect thereof.
(2) For the purposes of this Act, it shall, unless the contrary is proved, be evidence that an allotment of, or
an agreement to allot, securities was made with a view to the securities being offered for sale to the public
if it is shown—
(a) that an offer of the securities or of any of them for sale to the public was made within six months after
the allotment or agreement to allot; or
(b) that at the date when the offer was made, the whole consideration to be received by the company in
respect of the securities had not been received by it.
(3) Section 26 as applied by this section shall have effect as if —
(i) it required a prospectus to state in addition to the matters required by that section to be stated in a
prospectus—
(a) the net amount of the consideration received or to be received by the company in respect of the securities
to which the offer relates; and
(b) the time and place at which the contract where under the said securities have been or are to be allotted
may be inspected;
(ii) the persons making the offer were persons named in a prospectus as directors of a company.
(4) Where a person making an offer to which this section relates is a company or a firm, it shall be sufficient
if the document referred to in sub-section (1) is signed on behalf of the company or firm by two directors
of the company or by not less than one-half of the partners in the firm, as the case may be.
Section 26. Matters to be stated in prospectus.
(1) Every prospectus issued by or on behalf of a public company either with reference to its formation or
subsequently, or by or on behalf of any person who is or has been engaged or interested in the formation of
a public company, shall be dated and signed and shall—
(a) state the following information, namely:—
(i) names and addresses of the registered office of the company, company secretary, Chief Financial Officer,
auditors, legal advisers, bankers, trustees, if any, underwriters and such other persons as may be prescribed;
(ii) dates of the opening and closing of the issue, and declaration about the issue of allotment letters and
refunds within the prescribed time;
(iii) a statement by the Board of Directors about the separate bank account where all monies received out
of the issue are to be transferred and disclosure of details of all monies including utilised and unutilised
monies out of the previous issue in the prescribed manner;
(iv) details about underwriting of the issue;
(v) consent of the directors, auditors, bankers to the issue, expert’s opinion, if any, and of such other persons,
as may be prescribed;
(vi) the authority for the issue and the details of the resolution passed therefor;
(vii) procedure and time schedule for allotment and issue of securities;
(viii) capital structure of the company in the prescribed manner;
(ix) main objects of public offer, terms of the present issue and such other particulars as may be prescribed;
(x) main objects and present business of the company and its location, schedule of implementation of the
project;
(xi) particulars relating to—

(A) management perception of risk factors specific to the project;
(B) gestation period of the project;
(C) extent of progress made in the project;
(D) deadlines for completion of the project; and
(E) any litigation or legal action pending or taken by a Government Department or a statutory body during
the last five years immediately preceding the year of the issue of prospectus against the promoter of the
company;
(xii) minimum subscription, amount payable by way of premium, issue of shares otherwise than on cash;
(xiii) details of directors including their appointments and remuneration, and such particulars of the nature
and extent of their interests in the company as may be prescribed; and
(xiv) disclosures in such manner as may be prescribed about sources of promoter’s contribution;
(b) set out the following reports for the purposes of the financial information, namely:—
(i) reports by the auditors of the company with respect to its profits and losses and assets and liabilities and
such other matters as may be prescribed;
(ii) reports relating to profits and losses for each of the five financial years immediately preceding the
financial year of the issue of prospectus including such reports of its subsidiaries and in such manner as
may be prescribed:
Provided that in case of a company with respect to which a period of five years has not elapsed from the
date of incorporation, the prospectus shall set out in such manner as may be prescribed, the reports relating
to profits and losses for each of the financial years immediately preceding the financial year of the issue of
prospectus including such reports of its subsidiaries;
(iii) reports made in the prescribed manner by the auditors upon the profits and losses of the business of the
company for each of the five financial years immediately preceding issue and assets and liabilities of its
business on the last date to which the accounts of the business were made up, being a date not more than
one hundred and eighty days before the issue of the prospectus:
Provided that in case of a company with respect to which a period of five years has not elapsed from the
date of incorporation, the prospectus shall set out in the prescribed manner, the reports made by the auditors
upon the profits and losses of the business of the company for all financial years from the date of its
incorporation, and assets and liabilities of its business on the last date before the issue of prospectus; and
(iv) reports about the business or transaction to which the proceeds of the securities are to be applied directly
or indirectly;
(c) make a declaration about the compliance of the provisions of this Act and a statement to the effect that
nothing in the prospectus is contrary to the provisions of this Act, the Securities Contracts (Regulation) Act,
1956 and the Securities and Exchange Board of India Act, 1992 and the rules and regulations made
thereunder; and
(d) state such other matters and set out such other reports, as may be prescribed.
(2) Nothing in sub-section (1) shall apply—

(a) to the issue to existing members or debenture-holders of a company, of a prospectus or form of
application relating to shares in or debentures of the company, whether an applicant has a right to renounce
the shares or not under sub-clause (ii) of clause (a) of sub-section (1) of section 62 in favour of any other
person; or
(b) to the issue of a prospectus or form of application relating to shares or debentures which are, or are to
be, in all respects uniform with shares or debentures previously issued and for the time being dealt in or
quoted on a recognised stock exchange.
(3) Subject to sub-section (2), the provisions of sub-section (1) shall apply to a prospectus or a form of
application, whether issued on or with reference to the formation of a company or subsequently.
Explanation.—The date indicated in the prospectus shall be deemed to be the date of its publication.
(4) No prospectus shall be issued by or on behalf of a company or in relation to an intended company unless
on or before the date of its publication, there has been delivered to the Registrar for registration, a copy
thereof signed by every person who is named therein as a director or proposed director of the company or
by his duly authorised attorney.
(5) A prospectus issued under sub-section (1) shall not include a statement purporting to be made by an
expert unless the expert is a person who is not, and has not been, engaged or interested in the formation or
promotion or management, of the company and has given his written consent to the issue of the prospectus
and has not withdrawn such consent before the delivery of a copy of the prospectus to the Registrar for
registration and a statement to that effect shall be included in the prospectus.
(6) Every prospectus issued under sub-section (1) shall, on the face of it,— (a) state that a copy has been
delivered for registration to the Registrar as required under sub-section (4); and
(b) specify any documents required by this section to be attached to the copy so delivered or refer to
statements included in the prospectus which specify these documents.
(7) The Registrar shall not register a prospectus unless the requirements of this section with respect to its
registration are complied with and the prospectus is accompanied by the consent in writing of all the persons
named in the prospectus.
(8) No prospectus shall be valid if it is issued more than ninety days after the date on which a copy thereof
is delivered to the Registrar under sub-section (4).
(9) If a prospectus is issued in contravention of the provisions of this section, the company shall be
punishable with fine which shall not be less than fifty thousand rupees but which may extend to three lakh
rupees and every person who is knowingly a party to the issue of such prospectus shall be punishable with
imprisonment for a term which may extend to three years or with fine which shall not be less than fifty
thousand rupees but which may extend to three lakh rupees, or with both.
Section 27. Variation in terms of contract or objects in prospectus.
(1) A company shall not, at any time, vary the terms of a contract referred to in the prospectus or objects
for which the prospectus was issued, except subject to the approval of, or except subject to an authority
given by the company in general meeting by way of special resolution:
Provided that the details, as may be prescribed, of the notice in respect of such resolution to shareholders,
shall also be published in the newspapers (one in English and one in vernacular language) in the city where
the registered office of the company is situated indicating clearly the justification for such variation:
Provided further that such company shall not use any amount raised by it through prospectus for buying,
trading or otherwise dealing in equity shares of any other listed company.
(2) The dissenting shareholders being those shareholders who have not agreed to the proposal to vary the
terms of contracts or objects referred to in the prospectus, shall be given an exit offer by promoters or
controlling shareholders at such exit price, and in such manner and conditions as may be specified by the
Securities and Exchange Board by making regulations in this behalf.
Section 28. Offer of sale of shares by certain members of company.
(1) Where certain members of a company propose, in consultation with the Board of Directors to offer, in
accordance with the provisions of any law for the time being in force, whole or part of their holding of
shares to the public, they may do so in accordance with such procedure as may be prescribed.
(2) Any document by which the offer of sale to the public is made shall, for all purposes, be deemed to be
a prospectus issued by the company and all laws and rules made thereunder as to the contents of the
prospectus and as to liability in respect of mis-statements in and omission from prospectus or otherwise
relating to prospectus shall apply as if this is a prospectus issued by the company.
(3) The members, whether individuals or bodies corporate or both, whose shares are proposed to be offered
to the public, shall collectively authorise the company, whose shares are offered for sale to the public, to
take all actions in respect of offer of sale for and on their behalf and they shall reimburse the company all
expenses incurred by it on this matter.
Section 32. Red herring prospectus
(1) A company proposing to make an offer of securities may issue a red herring prospectus prior to the issue
of a prospectus.
(2) A company proposing to issue a red herring prospectus under sub-section (1) shall file it with the
Registrar at least three days prior to the opening of the subscription list and the offer.
(3) A red herring prospectus shall carry the same obligations as are applicable to a prospectus and any
variation between the red herring prospectus and a prospectus shall be highlighted as variations in the
prospectus.
(4) Upon the closing of the offer of securities under this section, the prospectus stating therein the total
capital raised, whether by way of debt or share capital, and the closing price of the securities and any other
details as are not included in the red herring prospectus shall be filed with the Registrar and the Securities
and Exchange Board.
Explanation.—For the purposes of this section, the expression "red herring prospectus" means a prospectus
which does not include complete particulars of the quantum or price of the securities included therein.
Section 34. Criminal liability for misstatements in prospectus.
Where a prospectus, issued, circulated or distributed under this Chapter, includes any statement which is
untrue or misleading in form or context in which it is included or where any inclusion or omission of any
matter is likely to mislead, every person who authorises the issue of such prospectus shall be liable under
section 447:
Provided that nothing in this section shall apply to a person if he proves that such statement or omission
was immaterial or that he had reasonable grounds to believe, and did up to the time of issue of the prospectus
believe, that the statement was true or the inclusion or omission was necessary.
Section 35. Civil liability for misstatements in prospectus.
(1) Where a person has subscribed for securities of a company acting on any statement included, or the
inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or
damage as a consequence thereof, the company and every person who—
(a) is a director of the company at the time of the issue of the prospectus;
(b) has authorised himself to be named and is named in the prospectus as a director of the company, or has
agreed to become such director, either immediately or after an interval of time;
(c) is a promoter of the company;
(d) has authorised the issue of the prospectus; and
(e) is an expert referred to in sub-section (5) of section 26, shall, without prejudice to any punishment to
which any person may be liable under section 36, be liable to pay compensation to every person who has
sustained such loss or damage.
(2) No person shall be liable under sub-section (1), if he proves—
(a) that, having consented to become a director of the company, he withdrew his consent before the issue
of the prospectus, and that it was issued without his authority or consent; or
(b) that the prospectus was issued without his knowledge or consent, and that on becoming aware of its
issue, he forthwith gave a reasonable public notice that it was issued without his knowledge or consent.
(3) Notwithstanding anything contained in this section, where it is proved that a prospectus has been issued
with intent to defraud the applicants for the securities of a company or any other person or for any fraudulent
purpose, every person referred to in subsection (1) shall be personally responsible, without any limitation
of liability, for all or any of the losses or damages that may have been incurred by any person who
subscribed to the securities on the basis of such prospectus.
Section 36. Punishment for fraudulently inducing persons to invest money.
Any person who, either knowingly or recklessly makes any statement, promise or forecast which is false,
deceptive or misleading, or deliberately conceals any material facts, to induce another person to enter into,
or to offer to enter into,—
(a) any agreement for, or with a view to, acquiring, disposing of, subscribing for, or underwriting securities;
or
(b) any agreement, the purpose or the pretended purpose of which is to secure a profit to any of the parties
from the yield of securities or by reference to fluctuations in the value of securities; or
(c) any agreement for, or with a view to obtaining credit facilities from any bank or financial institution,
shall be liable for action under section 447.
Peek v Gurney (1873) LR 6 HL 377
A company issued a prospectus in July 1865 to the general public inviting them to subscribe for shares in
the company. The prospectus contained material misrepresentations. Peek, who was not an original allottee,
bought his shares in the company on the stock market in October and December 1865. The company having
gone into liquidation Peek became liable as a contributory and paid £100,000 on his shares in the winding
up. Peek sought an indemnity from the directors of the company on the ground that their misrepresentations
in the prospectus had caused him to buy the shares.
The issue before the court was whether the prospectus was addressed to Peek or only to the original allottees
of the company; viz did the directors of the company intend the prospectus only to invite persons to become
allottees of the shares?
The last question to be considered is, whether the Appellant, who alleges that he purchased his shares upon
the faith of the prospectus, has a remedy against the Respondents for the misrepresentations which it
contains. The Appellant contends that the prospectus being addressed to the public for the purpose of
inducing them to join the proposed company, any one of the public who is led by it to take shares, whether
originally as an allottee, or by purchase of allotted shares upon the market, is entitled to relief against the
persons who issued the prospectus. The Respondents on the other hand insist that the prospectus, not being
an invitation to the public ultimately to become holders of shares, but to join the company at once by
obtaining allotments of shares, those only who were drawn in by the misrepresentations in the prospectus
to become allottees, can have a remedy against the Respondents...
But the learned counsel for the Appellant, not denying the original purpose of the prospectus, contended,
upon the authority of decided cases, that the prospectus, having reached the hands of the Appellant, and he,
relying upon the truth of the statement it contained, having been induced to purchase shares, the
Respondents were liable as for a misrepresentation made to him personally...
It appears to me that there must be something to connect the directors making the representation with the
party complaining that he has been deceived and injured by it; as in Scott v Dixon, by selling a report
containing the misrepresentations complained of to a person who afterwards purchases shares upon the faith
of it, or as suggested in Gerhard v Bates, by delivering the fraudulent prospectus to a person who thereupon
becomes a purchaser of shares, or by making an allotment of shares to a person who has been induced by
the prospectus to apply for such allotment. In all these cases the parties in one way or other are brought into
direct communication; and in an action the misrepresentation would be properly alleged to have been made
by the Defendant to the Plaintiff; but the purchaser of shares in the market upon the faith of a prospectus
which he has not received from those who are answerable for it, cannot by action upon it so connect himself
with them as to render them liable to him for the misrepresentations contained in it, as if it had been
addressed personally to himself. I therefore think that the Appellant cannot make the Respondents
responsible to him for the loss he has sustained by trusting to the prospectus issued by them inviting the
public to apply for allotments of shares.
Derry v. Peek (1889) LR 14 AC 337
By a special Act the Plymouth, Devonport and District Tramways Company was authorized to make certain
tramways. The carriages used on the tramways might be moved by animal power and, with the consent of
the Board of Trade, by steam or any mechanical power for fixed periods and subject to the regulations of
the Board. By sect. 34 of the Tramways Act 1870, which section was incorporated in the special Act, "all
carriages used on any tramway shall be moved by the power prescribed by the special Act, and where no
such power is prescribed, by animal power only."
In February 1883 the appellants as directors of the company issued a prospectus containing the following
paragraph:--
"One great feature of this undertaking, to which considerable importance should be attached, is, that by the
special Act of Parliament obtained, the company has the right to use steam or mechanical motive power,
instead of horses, and it is fully expected that by means of this a considerable saving will result in the
working expenses of the line as compared with other tramways worked by horses."
Soon after the issue of the prospectus the respondent, relying, as he alleged, upon the representations in
this paragraph and believing that the company had an absolute right to use steam and other mechanical
power, applied for and obtained shares in the company.
The company proceeded to make tramways, but the Board of Trade refused to consent to the use of steam
or mechanical power except on certain portions of the tramways.
In the result the company was wound up, and the respondent in 1885 brought an action of deceit against the
appellants claiming damages for the fraudulent misrepresentations of the defendants whereby the plaintiff
was induced to take shares in the company.
At the trial before Stirling J. the plaintiff and defendants were called as witnesses. The effect given to their
evidence in this House will appear from the judgments of noble and learned Lords. Stirling J. dismissed the
action; but that decision was reversed by the Court of Appeal (Cotton L.J., Sir J. Hannen, and Lopes L.J.)
who held that the defendants were liable to make good to the plaintiff the loss sustained by his taking the
shares, and ordered an inquiry. Against this decision the defendants appealed.
The law as laid down by the Court of Appeal goes much further than any previous decision and is unsound.
To support an action of deceit it always was necessary at common law and still is both there and in Chancery
to prove fraud, i.e., that the thing was done fraudulently. Fraud never has been and never will be
exhaustively defined, the forms which deceit may take being so many and various. There is a negative
characteristic: it must be something which an honest man would not do; not merely what a logical or clear-
headed man would not do. However unbusinesslike a man may be he is not fraudulent if he acts honestly.
The natural consequences of words or acts must be taken to have been intended, but not so as to impute
fraud to honesty. No honest mistake, no mistake not prompted by a dishonest intention, is fraud. The shape
of the mistake does not make it more or less a fraud if it is a mistake. Once establish that a man honestly
intended to do his duty, the consequences cannot turn his words or acts into a fraud. There may be an
obligation to see that no untrue statement is made, but the failure to meet that obligation is not fraud, if
there is no dishonest intention. The statement may be inaccurate, yet if the defendants honestly-though
mistakenly--believed that it substantially represented the truth, there is no fraud, and an action of deceit will
not lie. The decision of the Court of Appeal is that to such a statement the law attaches a meaning which
makes it fraudulent. A material misstatement may be a ground for rescinding the contract, but the
consequences of fraud and of breach of contract are widely different. In an action for breach of contract the
defendant must make good his words. In an action founded on fraud he must bear the whole of the
consequences which have been induced by the fraudulent statement, which may be very extensive. The
essence of fraud is the tricking a person into the bargain. If the fact that the consent of the Board of Trade
was necessary was suppressed by these defendants in order to make the bait more alluring there was fraud.
The issue then is one of fact, was there an intention to make the bait more alluring? It is not the carelessness
leading to an untrue statement which makes fraud; it is the carelessness whether the statement is untrue or
not. It is in this sense that the authorities have held defendants liable for fraud when they have made untrue
statements "recklessly." The above propositions are the result of the authorities. The law laid down in the
earlier cases is well exemplified by Taylor v. Ashton, where, however, the headnote does not truly represent
the effect of the decision, and Joliffe v. Baker. In Polhill v. Walter -which may be relied on by the
respondent--the Court considered that the misrepresentation was made by the defendant knowing it to be
untrue. The idea that something less than fraud was necessary to found an action of deceit crept in first in
Lord Chelmsford's observations in Western Bank of Scotland v. Addie, and was extended by Cotton L.J. in
Weir v. Bell, where he treats "recklessly" as if it meant "negligently," whereas it means "indifferent whether
the statement be true or false."
This confusion has arisen mainly since the Judicature Act, actions of deceit being tried in Chancery by
judges who, sitting without juries, have confounded issues of fact with issues of law. Here the Court of
Appeal held that an action of deceit lies if the defendant makes an untrue statement, without reasonable
ground for believing it to be true, though he did in fact honestly believe it to be true. If that be the law a
negligent, improvident, or wrong-headed man is a fraudulent man. A want of reasonable ground may be
evidence of fraud, but it is not the same thing as fraud.
As to the facts, Stirling J. found that the defendants believed the misstatement to be true, and that finding
ought to be conclusive. The Court of Appeal do not contradict that finding.
The misstatement complained of really meant that the company had obtained the necessary statutory
authority to use steam power, without which authority no consents could have given authority, because by
the Tramways Act 1870 steam power is prohibited except where the special Act authorizes steam power. It
may be that the defendants knew the statement was not strictly accurate, but if so they honestly thought that
the statement conveyed a substantially accurate representation of the fact, either because they thought it not
worth while to encumber the prospectus with the qualifications, or because those qualifications were not
present to their minds when they made the statement. In the prospectus reference is made to the special Act,
so that any one who consulted the Act could see for himself what the authority was.
Lastly, the plaintiff was no doubt in some degree influenced by the misstatement, but there was no evidence
that he would not have taken the shares if the statement had contained the full truth as to the necessary
consents being obtained.
It is not necessary that there should be carelessness whether the statement is true or not: it is enough if there
be carelessness or negligence in making the statement. Making an untrue statement without reasonable
ground is negligence which will support an action of deceit.
In an action of deceit the plaintiff must prove actual fraud. Fraud is proved when it is shewn that a false
representation has been made knowingly, or without belief in its truth, or recklessly, without caring whether
it be true or false.
A false statement, made through carelessness and without reasonable ground for believing it to be true, may
be evidence of fraud but does not necessarily amount to fraud. Such a statement, if made in the honest belief
that it is true, is not fraudulent and does not render the person making it liable to an action of deceit.
A special Act incorporating a tramway company provided that the carriages might be moved by animal
power, and, with the consent of the Board of Trade, by steam power. The directors issued a prospectus
containing a statement that by their special Act the company had the right to use steam power instead of
horses. The plaintiff took shares on the faith of this statement. The Board of Trade afterwards refused their
consent to the use of steam power and the company was wound up. The plaintiff having brought an action
of deceit against the directors founded upon the false statement.
Held, reversing the decision of the Court of Appeal and restoring the decision of Stirling J. (37 Ch. D. 541),
that the defendants were not liable, the statement as to steam power having been made by them in the honest
belief that it was true.
Sundaram Finance Service & Ltd. v. Grandtrust Finance Ltd. (2003) 42 SCL 89 (Mad)
This petition is filed under Section 482 Cr.P.C to quash the private complaint in E.O.C.C.No.128 of 1999,
pending on the file of the learned Additional Chief Metropolitan Magistrate (Economic Offences No.1 ),
Egmore, Chennai, filed by M/s.Granttrust Finance Limited represented by its Authorised Agent and Credit
Officer Mr.M. Prabhakar against the petitioners, along with two other accused, who are not before this
Court, for offences under Section 68 and 628 of the Companies Act, 1956 and under Sections 409, 420 read
with 120-B of the Indian Penal Code.
The gist of the complaint is as follows:
a) The first accused namely the first petitioner M/s.Sundaram Finance Services Limited is the Sponsor for
the third accused namely M/s. Vishnu Forge Industries. In order to expand their business operations, the
third accused company required finance and accordingly for the said purpose, had along with the first
accused approached and induced the complainant to subscribe for shares. Accordingly, the complainant
believing their representation to be true subscribed for 50000 equity shares of face value Rs.10 each with a
premium of Rs.6/- for each share and in that process, enclosed therewith a cheque, addressed to the first
petitioner along with the cheque for Rs.8,00,000/-. The said cheque no doubt was drawn in favour of the
third accused. Accordingly the first accused received the cheque amount and placed it to the third accused
for having received the said amount.
b) Apart from the above, it was represented to the complainant by the first accused that there is a possibility
of the shares being sold for a price not less than Rs.25/- per share, as the third accused company was going
public. It is on the basis of this representation that the complainant purchased the shares.
c) It is also sunderstood that the first and the third accused entered into a Sponsorship Agreement on 1.9.95
and the very first clause in the Sponsorship Agreement dated 1.9.95 provides that the first accused shall be
the Sponsor and shall arrange to offer the Equity Shares for sale to the public not later than April 30 1996
and to get them listed at the Over the Counter Exchange of India (OTCEI), on such terms and conditions
as may be decided by the Sponsor in its absolute discretion. It is seen that the copy of the Sponsorship
Agreement was also served on the complainant on the same day.
d) In continuance to the above stated agreement, the first accused and the third accused as one party and
the complainant along with the other Co-investors as another party, entered into a Divestment Agreement
on 1.9.95. Clause 15 of the Divestment Agreement dated 1.9.95, runs as follows: "The sponsor shall arrange
to offer the Equity Shares for sale to the public not later than April 30, 1996, to get them listed at the OTCEI,
on such terms and conditions as may be decided by the Sponsor in its absolute discretion"
e) About three days prior to the last day for the company to go public i.e on 27.4.96, the first and the third
accused wanted a few clause to be amended in the Divestment Agreement already entered into and therefore
amended the same and entered into a Supplementary Agreement to the Divestment Agreement with the
same parties, in which the second and the fourth accused being the representatives of the first and the third
accused, signed the agreement. Pursuant to the substituted Clauses in the Divestment Agreement, the
following amendments were carried out.
i)The word "Over The Counter Exchange of India (OTCEI) shall stand altered and be read as "OTCEI or
any other Stock Exchange".
ii) The meaning of the word "the shares" stands altered to mean the shares subscribed by the subscribers
and bonus shares, if any, issued to the investors before the date of offer for sale.
In all other respects, the other Clause and Terms and Conditions of Divestment Agreement stood unaltered.
f) Here, it is important to note that Clause 15 of the Divestment Agreement dated 1.9.95, namely, the
Sponsor shall arrange to offer the equity shares for sale to the public not later than 30.04.96, stood unaltered.
The complainant only on such representation made by the accused and further it is only on the basis of
these Terms and Conditions in the Sponsorship Agreement and Divestment Agreement, believed the same
to be true and had purchased the shares to the tune of Rs.8,00,000/-.
g) However, contrary to such representations, promises made and the agreements entered into, the first
accused failed to arrange to offer the equity shares for sale to the public by 30.04.96 and moreover, no
efforts had been taken by the accused either to list the shares or any thing was done in the direction of going
public.
h) In the meantime, surprisingly, pursuant to the criminal conspiracy between them, the first and the third
accused had entered into a Supplementary Agreement to Sponsorship Agreement among themselves
without the knowledge of the investors, including the complainant on 27.4.96 to the effect that "The sponsor
shall arrange to offer the shares for sale to the public and to get them listed at the OTCEI, or any other stock
exchange on such terms, conditions and at such time as may be decided by the sponsor in its discretion"
i) Therefore, the complainant is said to have been mislead, or a false promise has been given to the
complainant by the Sponsor even at the time of representing that the shares would be offered for sale on
30.4.96, but did not do so and consequently, the offence mentioned above has been committed by the
accused.
The learned counsel for the petitioner would first argue that the entire transaction would be a civil
consequence, in other words, the learned counsel would say that it is only a breach of agreement, for which
the remedy is only in the civil court and the parties cannot seek their vengeance through the Criminal Courts.
In support of his contention, the learned counsel would cite before me a decision of this Court, reported in
R.Ramakrishnan and others Vs. V.S.Dhanasekar (198 1 L.W.Crl 178), wherein his Lordship has held that
"the parties should not be encouraged to resort to criminal Courts in a case, in which the point at issue
between them is one, which can more appropriately be decided by a civil Court by unfolding the panoramic
facts and the parties should not be allowed to appease their anger by resorting to criminal proceedings".
Yet another case has been cited by the learned counsel for the petitioner reported in S.W.Palanitkar and
Others Vs. State of Bihar and Another (2002 SCC (Cri) 129), wherein their Lordships have followed an
earlier decision of the Supreme Court, reported in Punjab Natioinal bank Vs. Surendra Prasad Sinha (1993
Supp(1) SCC 499) wherein it has been stated that judicial process should not be used as an instrument in
the hands of the private complainant as vendetta to harass the person needlessly.
The learned counsel would further rely upon paragraph 9 of the judgment cited supra in S.W.Palanitkar's
case, wherein, it is held as follows:
The ingredients in order to constitute a criminal breach of trust are : (i) entrusting a person with property or
with any dominion over property, (ii) that person entrusted (a) dishonestly misappropriating or converting
that property to his own use; or (b) dishonestly using or disposing of that property or wilfully suffering any
other person so to do in violation
(i) of any direction of law prescribing the mode in which such trust is to be discharged, (ii) of any legal
contract made, touching the discharge of such trust.
The learned counsel for the petitioners would further persuade this Court that what has to be seen is that
whether there is any intention of cheating at the time of making the representation and he would stress that
the agreement dated 1.9.95 has alone to be considered and on going through the agreement, it is seen that
there is absolutely no element of cheating and according to the agreement the date mentioned for the
company to go public was on 30.4.96. But due to certain unforeseen circumstance, the said company could
not go public and at best, it may only amount to a breach of an agreement, for which the complainant would
be entitled to seek remedies before the civil Court.
The second limb of the argument advanced by the learned counsel is that even assuming that the company
did not go public wilfully, the third accused is the company who has committed an offence and the first
accused is also similarly placed as that of the complainant, who has also invested about Rs.21,00,000/- for
having purchased shares and he has also been victimised. In such circumstances, if at all anybody is said to
have been committed an offence, it is only the third and the fourth accused, who may at best be called upon
to answer charges and not the petitioners herein.
The learned counsel for the complainant would place a decision of the Supreme Court reported in Maratt
Rubber Ltd. Vs. J.K. Marattukalam (JT 2000 (4) SC 387), wherein their Lordships have stated that Section
482 Cr.P.C should be sparingly and cautiously exercised and only when the Court on consideration comes
to a conclusion that otherwise it would be a case of abuse or process of Court or that there will be gross
miscarriage of justice. Further more, the learned Judge has also held that mere pendency of civil proceedings
before any civil Court, will not be a ground for quashing criminal proceedings, or to frame a charge against
the accused.
In M/s.Medchil Chemicals and Pharma Pvt. Ltd Vs. M/s. Biological E. Ltd and Others (JT 2000 (2) SC
426, their Lordships have followed a decision of Supreme Court reported in Nagpur Steel and Alloys Pvt.
Ltd V. P.Radhakrishna (1997 SCC (Crl 1073) wherein it has been stated that merely because the offence
was committed during the course of commercial transaction, would not be sufficient to hold that the
complaint did not warrant a trial. Whether or not the allegations in the complaint were true was to be decided
on the basis of evidence to be led at the trial in the complaint case. It certainly was not a case in which the
criminal trial should have been cut short. Their Lordships would further go on to state that the High Court
while exercising its inherent power, the only requirement is to see whether the continuance of the
proceeding would be a total abuse of the process of Court. The Criminal Procedure Code contains a detailed
procedure for investigation, charge and trial and in the event, the High Court is desirous of putting a stop
to the known procedure of law, the High Court must use a proper circumspection and as noticed above,
very care and caution to quash the complaint in exercise of its inherent jurisdiction.
Bearing the above propositions of law in mind, I have to now consider the materials before the Court. The
respondent has clearly averred in his complaint that the first accused is the Sponsor for the third accused
company who tried to float the shares and bring in for sale on or before 30.04.96. An agreement had been
entered into between the complainant and the accused with regard to the same. But however three days
prior to the expiry of the date i.e on 27.4.96, a Supplementary Agreement has been entered into between
the complainant and the third accused in which only certain amendments had been made and those two
amendments are to the effect that the words found in the earlier agreement namely "Over The Counter
Exchange of India (OTCEI) would stand altered and be read as "OTCEI or any other Stock Exchange" and
the second amendment was to the effect that the words "the shares" stands altered to mean the shares
subscribed by the subscribers and bonus shares, if any, issued to the investors before the date of offer for
sale. In all other respects, the earlier Divestment agreement stood unaltered, that is to say that the earlier
commitment made by the third accused along with the first accused that the shares shall be brought for sale
on or before 30.04.96 shall stand valid.
However, the case of the complainant is that on the very same day namely on 27.4.96, without his
knowledge, A-1 and A-3 have clandestinely entered into an Supplementary agreement to Sponsorship
Agreement, wherein they have made an amendment in relation to Clause 15 of the Sponsorship Agreement,
which reads as follows:
"The sponsor shall arrange to offer the equity shares for sale to the public not later than April 30 1996 to
get them listed at the OTCEI on such terms and conditions as may be decided by the Sponsor in its asbolute
discretion be altered and read as "The Sponsor shall arrange to offer the shares for sale to the public and to
get them listed at the OTCEI or any other stock exchange on such terms, conditions and at such time as
may be decided by the Sponsor in its absolute discretion.
Apart from the above stated amendment, there has also been an amendment with regard to the date, which
runs as follows:
"The date "30th April 1996 stands altered and be read as "date to be decided by the Sponsor in his sole
discretion"
This clause has been found in the document executed by the first and the third accused which has been
signed by the second and the fourth accused dated 27.4.96. Further, in the said document, neither the
complainant was a party nor was he informed about this amendment.
The learned counsel for the petitioner would argue that this document cannot be taken into consideration,
since what has to be seen in a case of cheating is the document that pertains to the earliest representation,
on the basis of which the accused had parted with the money and this Court has to see whether there was
any false representation or deception on that date on which such a representation was made and
consequently, any offence is said to have been made out.
True, the court must be satisfied to hold that there was deception at the time of representation. But that
cannot be gauged only on the basis of the earliest representation alone. No one would ever at the first
instance itself come forward with any misstatements, enabling the person to fall into the trap. On the other
hand, a sharpwitted cheat would try to make it appear as if he is making a genuine offer at the first instance
and lure people into the transaction and it is only later on, he will bring out his true colours and ultimately
cheat him. Therefore, when the matter relates to a chain of events, we cannot take into consideration the
earliest document alone and come to a conclusion that there was an element of cheating at the time of
representation. The subsequent documents which has been entered into especially the two documents in the
form of agreements of one relating to the complainant and the accused herein and the other between the
first and the third accused intersee, have been prepared only on 27 .4 .96 and the agreement in which the
complainant is a party does not contain any amendment, or it does not show that the shares should be
brought for sale by the Sponsor on the date and time as may be decided by the Sponsor in its absolute
discretion. However, in the agreement between A-1 and A-3 this amendment has been carried out. This
obviously, is to drag on the process of bringing the shares for sale and admittedly, it transpires that the
shares have not yet been brought for sale.
The complainant has filed these two agreements along with the complaint. The details of the entire thing
have not been brought to this Court and it may not be necessary for me to go into those documents at this
stage. In these circumstances, I am again reminded of the decision of the Apex Court reported in Hridaya
Ranjan Prasad Verma Vs. State of Bihar (2000 (4) SCC 168), wherein their Lordships have held that the
intention of the accused depends upon the inducement, which may be judged by his subsequent conduct
also. The facts of this case reveals that there are chain of events taking place from the year 19 95 to April
1996 and consequently, I find there is sufficient ground for the Magistrate to take cognizance of the offence
as against the accused.
Yet another argument has been advanced by the learned counsel for the petitioners that for the offence
under the Companies Act, the complaint has to be given only by the Registrar. Hereagain, at the risk of
repetition, I may state that none of the parties have stated under what Section the Magistrate had taken
cognizance and at any rate, this is a matter which could be raised at the time of framing charges by the
Magistrate.
In the above circumstances, I do not find any reason to quash the complaint. Accordingly, this petition is
dismissed. Consequently, connected Crl.M.Ps are closed.
Shiromani Sugar Mills Ltd v. Debi Prasad, AIR 1950 All 508
1. This and civil Revisions NOS. 122 to 154 of 1945 are applications in revision under Section 25, Small
Cause Courts Act, against judgments passed by the Small Cause Court Judge, Gorakhpur, in suits filed by
the Official Liquidator of the Shiromani Sugar Mills Limited, Khalilabad against a number of ex share-
holders of the Shiromani Sugar Mills Ltd. for allotment, first call and second-call moneys. There were as
many suits as there are revisions; they were all of similar nature and the same disputes were involved in all.
They were consolidated by the learned Small Cause Court Judge and tried together. He delivered one
judgment dismissing all the suits.
2. The Company which was a public limited Company was formed with a large number of objects, the first
and most important object being :
"to manufacture in India or abroad all kinds of sugar by up-to-date and latest scientific method and
machinery, and for this purpose to erect and construct a factory or factories at one or several places in or
outside India."
It was incorporated on 7th November 1933 on which date the Memorandum of Association and the Articles
of Association were registered with the Registrar, Joint Stock Companies. The prospectus was published
on 16th October 1933 and was registerd with the Registrar on 26th February 1934. On 24th November
1933, a meeting of the promoters of the Company unanimously elected the following persons as first
Directors: (1) Pandit D. P. Pandey, (2) Pandit P. P. Pandey, (3) Pandit S. K. Pandey, (4) Chaudhri Bhagwati
Prasad, (6) Mahant Vishwanath Bharthi, (6) Pandit Ganga Narain Tewari, (7) Thakur Saran Singh, (8) Dr.
P. C. Bhattacharjee, (9) Mukut Behari Lal, (10) Pandit Tirath Raj Pandey, (11) Sahu Baldeo Prasad, (12)
Abdul Qadir Khan, (13) R. D. Sharma, ex officio and (14 N. K. Varma.
3. The authorised capital of the Company was fixed at RS. 20,00,000 divided into Rs. 15,000 preferred
shares of Rs. 100 each and RS. 50,000 ordinary shares of Rs. 10 each. The earned capital according to the
prospectus was Rupees 16,00,000 divided into Rs. 12,000 preference shares and Rs. 40,000 ordinary shares.
In most of these revisions we are concerned with only preference shares and I shall deal only with them.
Out of Rs. 100, the price of a preference share, Rs. 20 were payable on application for the share, Rs. 30
were payable on the share being allotted and the balance of Rs. 60 was payable in such call or calls as might
be decided by the Directors from time to time. Under Article 32 of the Articles of Association a share
became liable to forfeiture if the call or instalment or allotment money was not paid by the share-holder
within the fixed time. The business of the Company was to be conducted by Managing Agents, subject to
the control of the Directors and Messrs. Sharma, Varma and Company were the first Managing Agents.
The maximum number of Directors fixed under Article 172 are 17. The qualification of a Director as fixed
under Article 156 was "the holding of shares of Rs. 5,000 at least In the capital of the Company in his own
name and right."
Article 157 provided that:
"A Director may act as Director before acquiring his qualification but shall in any case acquire the game
within two months from his appointment and unless he shall do so he shall be deemed to have agreed to
take the said share from the Company and the same shall be forthwith allotted to him accordingly,"
The office of a Director was vacated under Article 168 on his ceasing to hold the required number of shares
or stock to qualify him for office, or on his accepting any other office or place of profit under the Company.
One fourth of the number of Directors were to retire every year by rotation though they were eligible for
re-election. Four Directors formed a quorum for a meeting of the Directors. Article 131 laid down that:
"All acts done by any committee of Directors or by any person acting as a Diretor shall, notwithstanding
that it be afterwards discovered that there are some defects in appointments of any such directors or persons
acting as aforesaid or that they or any of them are disqualified, be as valid as if every such perion have been
duly appointed and was qualified to be a Director."
4. The defendants-opposite parties were all share-holders of the Company. Some of them did not pay even
the allotment money and others did not pay the first and second call moneys. Consequently their shares
were forfeited through resolutions passed by the Directors in three meetings held on 14th June 1939, 23rd
July 1939 and 16th October 1939. An order for the winding up of the company was passed on 7th December
1941. The official liquidator then instituted the suits to recover the balance of the allotment and first and
second-call moneys.
5. The suits were contested by the opposite parties. The grounds with which we are concerned in these
applications were (1) that the original contract for the purchase of the shares was procured by the promoters
of the Company by fraudulent misrepresentation, (2) that the promises held out to the opposite parties at
the time of the purchase were not carried out by the Company and consequently the opposite parties were
justified in not making further payment, (3) that the resolutions passed by the Directors allotting the shares
to the opposite parties were invalid because the Directors voting for the resolutions had ceased to be
Directors and (4) that the resolutions forfeiting the shares also were invalid for the same reason. The learned
Judge upheld all these contentions of the opposite parties and dismissed the suits. In these applications the
official liquidator challenges the learned Judge's findings on these four points.
7. The misrepresentation must be of a material fact, the share-holder must have been induced by it and he
must plead and prove so. The learned Judge has relied mainly upon one misrepresentation in the prospectus.
It is the sentence "the Managing Agents with their friends, promoters and directors have already promised
to subscribe share worth Rs. 6,00,000," printed in red on the cover of the prospectus. The opposite parties
did not specifically plead that it is a misrepresentation and that they were induced by it to purchase the
shares. There is no proof, and of course there is no finding of the learned Judge, that the Managing Agents
with their friends, promoters and directors had not promised to subscribe to shares worth Rs. 6,00,000. I do
not know how this statement could be assailed as a misrepresentation of fact, The only fact asserted was of
the existence of promise. Unless it were false, there was no misrepresentation of fact. It was not asserted
that the Managing Agents, etc. had subscribed to shares worth Rs. 6,00,000. When it was said that they had
only promised, it meant that they had not carried out their promise, otherwise the statement would have
been that they had already subscribed to shares worth Rs. 6,00,000 Nobody should have been misled by
this statement and nobody should have understood it to mean that, shares worth six lacs of rupees had
already been-subscribed to. If the opposite parties misunderstood this statement to mean that the shares had'
already been subscribed to and applied for shares under that misapprehension, they are to blame themselves
and not the promoters of the company.
9. When there is absence of proof that the Managing Agents, etc., had not made the promise, the existence
of the promise is not falsified by the breaking of it. The Managing Agents, etc. might not have kept their
promise, but the opposite parties are not entitled to say that they were misled by their promising. Every
document, as against its author, must be read in the sense which it was intended to convey. As observed by
Lord Chelmsford in Peek v. Gurney, (1873) 6 H. L. 877 at p. 886 : (43 L. J. Ch, 19) a prospectus may
contain statements, which are perhaps literally true, yet really false in the sense in which the promoters
should know, they would be understood by the public. The promoters in the present case could not possibly
have intended the impugned statement in the prospectus to mean that shares worth Rs. 6,00,000 had already
been subscribed to. Even if it amounted to misrepresentation, there is no proof that it induced the opposite
parties to buy the shares. The learned Judge has mentioned that the Directors had not paid the application
money for the qualification shares. This is immaterial. The Directors had two months within which to
acquire the qualification shares. If their names were mentioned in the prospectus without their having
acquired the qualifications shares, it does not mean that it contained a misrepresentation of fact, Even if the
Directors did not acquire the qualification shares within two months, Article 157 of the Articles of
Association forced the shares upon them. It is stated in the prospectus that "our shareholders will be highly
and satisfactorily benefited by way of dividend.'
10. There is also the evidence of a Director to the effect that the shareholders were told that the company
would start its work of producing sugar very soon. These are not representations of fact. Some amount of
puffing must be allowed in a prospectus; it must not amount to a misrepresentation of fact
11. The statements in question do not imply the existence of facts which were really nonexistent and there
is no evidence that they formed a material term in the contract.
12. The learned Special Judge has taken notice of certain non-disclosures in the prospectus. Under Section
93, Companies Act a prospectus must state the number of shares fixed by the Articles as the qualification
of a Director, the names and addresses of the vendors of any property purchased or acquired by the
company, and the debts of, and parties to, every material contract. The prospectus does not contain this
information. But there is no penalty prescribed in the Act for non-compliance with the provisions of Section
93. When the non-compliance involves misstatement of a material fact, there will, of course, be a right of
rescission under the general law. But otherwise the omission of any of the particulars will not per se entitle
a shareholder to rescission of his contract to take shares. It will not do for promoters of a company to plead
that everything which is stated in the prospectus is liter-rally true; they must be able to meet the objection,
''not that it does not state the truth as far as it goes, but that it conceals most material facts with which the
public ought to have been made acquainted, the very concealment of which gives to the truth which is told
the character of falsehood"; see Oakes v. Turquand, (1867) 2 H. L. 325 at p. 342 : (36 L. J. Ch. 949) per
Lord Chelmsford L. C.
According to Peek v. Gurney, (1873) 6 H. L. 377 : (43 L. J. Ch. 19), if there is such a partial and fragmentary
statement of fact, as that the withholding of that which is not stated makes that which is stated absolutely
false, it would form ground for an action for misrepresentation.
Judged according to these authorities, the omissions in the present case do not amount to a
misrepresentation; what is left out does not make what is stated false.
13. The learned Judge has gone out of his way In taking into consideration the various acts of breach of
rules; if the managing directors and other directors committed any breach of rules, the shareholders may
have other remedy against them but not that of rescinding the contract of purchase of shares. They might
have acted dishonestly and inefficiently and filed false declarations before the Registrar, but even that
would not entitle the share-holders to rescind their contract. The learned Judge has observed that on account
of these breaches and acts of dishonesty and inefficiency, the share-holders were justified in withholding
further payment of their allotment and call moneys. He has not quoted any authority in support of his view.
So long as the contract of purchase of shares is not rescinded, the liability of a share-holder to pay their
price remains. Apart from the right to rescind the contract of purchase of shares, a share-holder has no right
to withhold payment lot the price.
14. A share-holder's contract to purchase shares is only voidable, and not void on account of
misrepresentation in the prospectus. This means that the contract is valid till rescinded. But a share-holder
has not unlimited time within which to rescind the contract; he must rescind it promptly, that is within
reasonable time of his becoming aware of the fraud giving him the right to rescind.
17. Even repudiation of shares, without taking active steps, is insufficient because the contract to take shares
stands on a different footing from another contract.
19. In the present case, the shares were allotted to the opposite parties in 1934 and they have allowed their
names to remain in the register of shareholders. They have taken absolutely no active steps to avoid the
contract. They gave no indication of their intention to avoid the contract at any time; the earliest intention
that they gave is through their written statements in the suit, It has been found by the learned Civil Judge
that the assets of the company were in a very bad state from the very beginning. Sugar industry was a
prosperous industry and this company could not start any business for five years. The directors and
managing directors were inefficient and guilty of breaches of rules; Managing directors had to be changed
repeatedly and a stage arrived when nobody was prepared to become the managing director and the office
had to be thrust upon a person who had already proved himself unfit. No dividends were at all granted and
general and statutory meetings were not held as frequently as required under the Articles. All this state of
affairs could not have remained unknown to the shareholders and we are not dealing with one or two
shareholders but a very large number of them. Even when calls were made in 1936 and 1937 they did not
repudiate the shares. I have, therefore, no doubt that they have lost their right to rescind the contract by their
laches.
20. In addition to the laches, the winding up of the company raises another bar in the way of the opposite
parties to repudiate their shares. The law is that a share-holder cannot be relieved from his shares after a
winding up application. If a shareholder has started active proceedings to be relieved of his shares, the
passing of a winding up order during their pendency would not prevent his getting the relief. The reason
why a shareholder cannot throw back his shares upon the Company after winding up is that rights of third
parties have intervened .
21. When the Legislature has provided the shareholders' register as the means of enabling persons dealing
with the Company to know to whom and to what they had to trust, it would be no answer to a creditor that
the shareholder sought to be charged had been induced by fraud to become a shareholder just as it would
be no answer to creditor that a partner sought to be charged had been induced by fraud to become one.
23. But the case of the opposite parties does not rest only upon avoiding the contract of purchase of shares
; they have another string to their bow which is that there was no valid contract at all. The argument is that
the Directors who voted for the allotment of the shares to them were disqualified to act as Directors, that
the allotment was ultra vires and that consequently no contract to purchase the shares came into being at
all, I have given the names of the original Directors ; they were appointed as such on 24th November 1933.
Under the Articles of Association, they were bound to acquire shares of the minimum value of Rs. 5,000
within two months that is by 24th January 1934. If they failed to acquire the shares, they were to be deemed
to have acquired them. They were, therefore, bound to pay the application and allotment moneys by 24th
January 1931 and also the first and the second call moneys. Directors Nos. 2, 4, 5 and 8 did not pay even
the application money in full by 24th January 1934; Director No. 4, as a matter of fact, did not pay any
application money. Directors Nos. 1 to 9 and 11 and 12 did not pay the full allotment money in time ;
Directors Nos. 4 and 12 did not pay any allotment money. The resolution for the first call was passed on
36th November 1936 and the call-money was to be paid within six months, that is by 26th May 1937.
Directors Nos. 4, 5, 8 and 11 to 14 did not pay the first call-money at all and Directors NO. 7 did not pay it
in time. The resolution for the second-call money was passed on 5th July 1937 ; though the prescribed
period for time was six months, the resolution allowed a longer period which was illegal. Still Directors
NOS. 1, 5, 8 and 11 to 14 did not pay the call-money at all and Directors Nos. l, 2 and 7 did not pay it
within time. Thus all the Directors except Directors NOS 10, 13 and 14 ceased to be Directors under Section
85, Companies Act, on 24th January 1931 and Directors Nos. 13 and 14 ceased to be Directors on 26th
May 1937. In 1934 only three persons were qualified to act as Directors whereas the quorum for a meeting
was four. Consequently the resolutions allotting the shares and making calls for the money were passed in
meetings in which there was no quorum, The Official Liquidator relied upon Article 181 which is couched
in the same words as s. 85, Companies Act, 1913, by which we are governed in these applications. This
Article, widely worded as it is, supports his contention that in spite of the disqualifications of the Directors
the resolutions passed by them are valid.
In the present case, the Directors certainly knew that they had not paid the allotment and call moneys, but
there is nothing to indicate that the fact that they had thereby disqualified themselves was present to their
minds at the time when they allotted the shares and made the calls. There was no defect in their appointment
as Directors ; the only defect is that they continued to act as Directors even after their disqualification.
There is no suggestion that they acted dishonestly in passing the resolutions of allotment and making the
calls. It seems that they acted bona fide, oblivious of the fact of their disqualification. There is no evidence
of the fact of their disqualification having ever been brought to their minds. The language of Article 181
fully protects their actions. Had it been a case of only one or two Directors continuing to act as such despite
the disqualification, I would have had no hesitation in forming the conclusion that I have. Here we have to
deal with a large number of Directors acting as such despite the qualification. But there is no other
circumstance f com which it can be said that they were conscious of the fact of their disqualification and
yet continued to act as Directors So I come to the conclusion, though not without some hesitation, that the
acts of allotting the shares to the opposite parties and making the first and second calls were valid.
24. For the same reason the act of forfeiting the opposite parties' shares also must be held to be valid, The
liability of the opposite parties to pay the moneys that are being demanded of them by the Official
Liquidator arose before and is not wiped off by, the forfeiture. The only effect of the forfeiture is that the
shares pass out of their hands the liability incurred previously to pay the allotment and call-moneys remains.
25. Some of the opposite parties purchased only ordinary shares. This only affects the amounts due from
them : otherwise there is no difference between their cases and those of preferred share-holders.
27. I would, therefore, allow all these applications and decree the suits; but I would not allow any costs to
the Official Liquidator. The company must bear its costs of both Courts itself because it has not come out
clean from this litigation and though justice lies on its side as regards the subject-matter of this litigation
there is much for which its Directors and Managing Directors had to account to the opposite parties.
Weavers Mills v. Balkis Ammal, AIR 1969 Mad 462
1. These appeals arise out of the same judgment of the Subordinate Judge. Ramanathapuram, at Madurai,
in a suit instituted by the appellant in A. S. 28 of 1962 for declaration of its title to the suit properties and
for an injunction restraining the first defendant from executing the decree obtained by her (the first
defendant who is the appellant in the other appeal A. S. 178 of 1962) in O. S. 16 of 1949 or in the alternative
to set aside the judgment and decree in O. S. 3 of 1958, both on the file of the same Subordinate Judge. The
appellant in A. S, 28 of 1962 is a limited liability company incorporated under the provisions of the Indian
Companies Act, on 12-7-48, with its registered office at Raja-palayam. Two of Its promoters, one of them
the 2nd defendant in the suit and the other by name Ayyadurai alias Madeswamy Moopanar, purchased the
suit lands under two registered sale deeds dated June 17th and June 18th of 1945, for a total consideration
of Rs. 11000 from one Ramaswami Raja and Rangammal. In O. S. 16 of 1949, the 1st defendant obtained
a decree against defendants 2 and 3 for a sum of Rs. 10000 due under a promissory note that had been
executed by them. Admittedly, the loan was obtained by the promisors for their personal purposes. In
execution of the decree, the first defendant attached the suit properties and brought them to sale in E, P. 60
of 1955. An application of the second defendant representing the company in E. A. 301 of 1956 under O.
21. R. 58, Civil P. C., was dismissed on 29-10-1957 and thereafter he instituted, in his capacity as Managing
director of Jayam and Co, the Managing Agents of the company, O. S. No. 3 of 1958 to set aside the order
in E. A. 301 of 1956, but without success. No appeal was filed from the decree in O. S. 3 of 1958.
By resolutions dated 27-7-1959, the second defendant was removed from the Managing directorship of
Jayam and Co., and of the plaintiff-company and one A. M. Chinna Guruswami Moopanar was appointed
in his place. The present suit put of which the appeals arise has been instituted by the company through its
managing agency Jayam and Co. Ltd. represented by its Managing director Chinna Guruswami Moopanar.
The plaintiff's case is that the suit properties were purchased by the second defendant and Ayyadurai alias
Madasami Moopanar as representatives and on behalf of Raiapalayam Weavers Mills which was to be
incorporated later and that on its incorporation the Municipal registry of the properties stood in the name
of the company and it has been paying the Municipal tax therefore. According to the plaintiff, nevertheless,
defendants 2 and 3 colluded with the first defendant and allowed the application under Order 21, Rule 58,
Civil P. C. and O. S. 3 of 1958, to be dismissed and thus fraudulently allowed the properties to be attached
and brought to sale in discharge of their own personal debts. On those averments, the plaintiff company
sought the reliefs mentioned by us at the outset. It claimed that the suit properties belonged to the company,
that this position had been accepted on all hands and building for the purpose of the company has since
been erected before the attachment and that though the company was economies a party to the claim
application and the suit, as the interests of the company were not properly placed and represented before
the Court on account of the collusion between the defendants and their fraudulent conduct, the decree in O.
S. 3 of 1958 was null and void and was not binding on the plaintiff.
2. The first two defendants filed separate written statements while the third defendant remained ex parte._
The first defendant denied any collusion or fraudulent conduct on her part and asserted that the properties
belonged to the second defendant and that ever since their purchase, they had been in the possession and
enjoyment of the second defendant himself. The first defendant also pleaded that both the application under
Order 21 Rule 58, C. P. C. and the claim suit were hotly fought out by the second defendant and that,
therefore, the present suit was barred by res judicata by reason of the judgment and decree in O. S. 3 of
1958. The Second defendant also denied the plaint allegations of fraud and collusion on his part and
maintained that all the directors of the company knew full well the decree in O. S. 3 of 1958 and its
execution. He did not accept that he mismanaged the affairs of the company and stated that he could not be
removed from directorship until the expiry of 20 years from the date of the incorporation of the plaintiff-
company. On that ground he urged that the suit itself as framed was not maintainable. At the trial, the
second defendant remained absent and his counsel reported no instructions.
3. The Court below framed appropriate issues and found that the suit properties belonged to the plaintiff
company, that the judgment and decree in O. S. 3 of 1958 on account of fraud and collusion on the part of
defendants 2 and 3 were not binding on the plaintiff and that the plaint prayers should be granted. It also
found that removal of the second defendant from the managing directorship was true, valid and binding on
him and the suit was maintainable. This last finding is no longer in dispute before us. While granting a
decree to the plaintiff as prayed for, the Court below directed it to deposit a sum of Rs. 23,301, for which
the properties were purchased by the first defendant in execution of her decree within a specified period, as
a condition to recover possession. The company aggrieved by the direction has appealed to this Court and
likewise the first defendant against the decree declaring the title of the plaintiff-company to the suit
properties and for possession.
4. On the view the Court below took on the plaintiff's claim to title and possession, we cannot but express
our surprise at the Court below having directed the company to deposit a sum of money as a condition to
recover possession. We fail to see how in view of the findings arrived at by the Court below, it could
properly direct the plaintiff to do that. If the plaintiff was entitled to the properties and also to recover
possession, it is certainly not under an obligation to deposit any sum of money as a condition for recovery
of possession. In fact, the Court below has given no justification in its judgment for making such a direction.
Since we have come to the conclusion for the reasons which would presently appear, to allow the appeal of
the first defendant and dismiss the suit, it should follow that App. No. 28 of 1962 should be dismissed.
5. In the other appeal, substantial contentions for the appellant are (1) that the declaration of the Court
below of the plaintiff's title to the suit properties is erroneous and (2) that in any case the judgment and
decree in O. S. 3 of 1958 bar the present suit by res judicata. The first contention is not quite free from
difficulty but we have reached the conclusion that the finding of the Court below on this question does not
call for interference. But the second contention, in our opinion, has force and we accept it.
We shall, however, proceed to consider the first ground relating to the plaintiffs' title to the suit properties
on the merits. It is said that though they were purchased in June 1945, by the 2nd defendant and another,
they did so as representatives of the Weavers Mills Ltd, Rajapalayam, that the purchasers as promoters
stood in a fiduciary position to the company to be incorporated and that on its incorporation in July 1948,
the properties automatically vested in it as the true owner. The contention is reinforced by stating that the
prospectus set out the properties as those belonging to the company, that there was a resolution of the
General body adopting the purchases of the properties by the second defendant for the company and that
subsequently after the incorporation, the plaintiff-company assumed possession and constructed pucca
buildings thereon. It is pressed upon us that when property was purchased by promoters, they held the same
in trust which on incorporation vested in the company and that such a transfer was a valid one not required
to be in writing. On this process of reasoning, it is maintained for the company that at the time of the
attachment of the properties, they belonged to it by adoption and recognition. The argument for the decree-
holder purchaser is that short of a conveyance by the promoters, who purchased the properties, to the
company after its incorporation, the company could not claim title thereto. Inasmuch as there was in fact
no transfer of the properties to the company by a registered conveyance, the mere fact of its having assumed
possession and put up buildings thereon or even the fact that the properties were shown in the prospectus
as belonging to the company will not invest It with the ownership of the properties.
15. The question thus raised is of general importance. On facts, there is no doubt on record before us that
the company after its incorporation had assumed possession of the lands purchased by the second defendant
and another and built on them, though the constructions were left unfinished and the company never started
its business. The prospectus has not been filed in this case, nor the resolution of the General Body, and it is
not, therefore, possible to say whether the properties were treated as belonging to the company by adoption
and recognition. One other fact which admits of no doubt is that the second defendant never claimed that
the funds for the purchase of the properties ever came from him or the one who joined with him, personally.
It is in the setting of these circumstances we have to consider whether the company became the owner of
the properties.
16. There is very little guidance in the Companies Act, 1913 and the new Act to decide the question before
us. One of us in W. P. Nos. 475, 555 and 1249 of 1960 (Mad), Nandi Transport (P.) Ltd. v. S. T. A. T., had
occasion to consider in a different context the legal implications in relationship of a promoter and the
company under incorporation. There was there an elaborate consideration of that matter with reference to
authorities, A Division Bench in appeal W. A. Nos. 85 and 86 of 1963 (Mad), Palaniswami v. Nandi
Transports (P.) Ltd., and etc, arising out of those petitions also covered the question in some detail. But, for
our present purpose, we think it is not necessary to cover the entire ground. A pro-motor according to
Cockburn C. J. in Twycross v. Grant. (1877) 2 C. P. D. 469 is one who undertakes to form a company with
reference to a given project and to set it going and who takes the necessary steps to accomplish that purpose.
6 Halsbury's Laws of England, 3rd Edn, page 91 and Palmer's Company Law 19th Edn. 322, elaborate this
idea. In the writ petitions, one of us after referring to these authorities summed up the position of a promoter
:--
"A 'Promoter' therefore, is a compendious term given to a person who undertakes, does and goes through
all the necessary and incidental preliminaries, keeping in view the objects, to bring into existence an
incorporated company. This process leading to the genesis of a company may include a variety of things,
not the least of them, I think, being some of the steps taken by a promoter to ensure commencement, within
a reasonable time, of the business, for the carrying on of which the company is formed. He makes purchase
of moveable and immoveable assets, enters into contracts involving rights and obligations and applies to
authorities for a variety of things, all on behalf of the company to be formed,"
As to the exact legal status of promoters, the statutory provisions, both in England and in this country are
silent in most part except for a couple of sections in the Specific Relief Act, both old and new ones. It
appears that a promoter is neither an agent nor a trustee of the company under incorporation but certain
fiduciary duties have been imposed on him both under the English Companies Act 1948 and the Indian
Companies Act, 1956. He is not an agent because there is no principal and he is not a trustee as there is no
cestui que trust in existence. There can be no agent for a non-existing principal, nor a trustee for a non-
existing cestui que trust. It is on this ground that the doctrine of ratification by the company was regarded
as inapplicable to the actual promoter vis-a-vis the company under incorporation. We do not refer to the
earlier view held in 1821 in England which assumed that Corporation could on its incorporation ratify, or
hold the promoter personally liable as it liked. The dictum of Lord Cottenham in Edwards v. Grand Junction
Ry. Co., (1836) 1 My & Cr 650, at p. 672 that 'if the company and the projectors cannot be identified, still
it is clear that the company have succeeded to, and aie now in possession of, all that the projectors had
before; they are entitled to all the rights and subject to all their liabilities", does not appear to have been
endorsed as correct in every respect by the House of Lords after 1856. In Kelner v. Baxter, 1866-2 CP 174,
it was held that a contract entered into by a promoter could not be ratified by a company after its
incorporation. Willes, J. one of the learned Judges who decided that case observed at page 184--
"I apprehend the company could only become liable, upon a new contract. It would require the assent of
the plaintiff to discharge the defendants. Could the company become liable by a mere ratification? Clearly
not. Ratification can only be by a person ascertained at the time of the act done---by a person in existence
either actually or in contemplation of law."
Lord Davey in Natal Land and Colonisation Co. Ltd. v. Pauline Colliery Syndicate. 1904 AC 120, speaking
for the Judicial Committee stated that a company could not by adoption or ratification obtain the benefit of
a contract purporting to have been made on its behalf before the company came into existence and that in
order to do so a new contract must be made with it after its incorporation on the terms of the old one.
Sections 21 (f), 23 (h) and 27 (e) of the Specific Relief Act, 1877, were perhaps based on the doctrine of
Lord Cottenham that a company after its incorporation was a successor to and took the place of the
promoters in relation to contracts entered into by them for the purposes of the company and warranted by
the terms of the incorporation. Though the first two sections do not seem to be rested on any theory of
agency or trust, Section 27 (e) was possibly founded on some kind of quasi agency or of trust. To this
extent, the Indian Legislature in enacting the Specific Relief Act, 1877, would appear to have departed from
the English view in 1866-2 CP 174 and 1904 AC 120. These sections in the Specific Relief Act are
concerned with executory contracts and cannot possibly be applied to conveyances of immoveable
properties in favour of promoters of a company under incorporation.
While we accept the position that a promoter is neither an agent nor a trustee of the company under
incorporation, we are inclined to think that in respect of transactions on behalf of it, he stands in a fiduciary
position. For the plaintiff- company Sections 92 and 94 of the Indian Trusts Act, 1882, were relied upon. It
seems to us that neither of these sections is of assistance to it. These sections, as we think, contemplate
transactions as between persons in existence. In any case, it seems to us that no trust as denned by Section
3 of the Act is brought about by the purchases made by the promoters.
The legal position of a promoter in relation to his acts, particularly purchase of immoveable properties on
behalf of the company under incorporation, is a peculiar one not capable of being brought not any
established or recognised norms of the law as to its character as an agent or a trustee. But, at the same time,
it is impossible, to our minds, to deny that he does stand in a certain fiduciary position in relation to the
company under incorporation. When he does certain things for the benefit of it, as for instance, purchase of
immoveable properties, he is not at liberty to deny that benefit to the company when incorporated, We are
prepared to hold that in such a case the benefit of the purchase will pass on to the company when
incorporated. 6 Halsbury's Laws of England, 3rd Edn. paragraph 194, says that a promoter stands in a
fiduciary position with respect to the company which he promotes from the time when he first becomes
until he ceases to be a promoter thereof. It is also pointed out that a promoter may acquire assets as a trustee
for a company. Though the cases relied on for these propositions were of the year 1877 or thereabouts, we
do not see why the principle of the dictum of Lord Cottenham should not, in justice and equity, be invoked
to clothe the promoter with the mantle of fiduciary position with respect to the company under incorporation
with the implication that when incorporated the company will succeed to the beneficial acts transacted on
its behalf by the promoter.
19. As we already noted, the second defendant and another purchased these properties expressly stating that
they did so as representatives of the company to be formed, that the funds therefore did not belong to them
and that on incorporation the company assumed possession and built upon them. These facts clearly show
that the company adopted the benefit of the purchase, if adoption is a requisite at all for passing of such
benefits to the company on incorporation. On this view, it follows that the suit properties did belong to the
plaintiff company.
20. App. No. 178 of 1962 is allowed with costs, App. No. 28 of 1962 is dismissed but with no costs.
Crowdfunding
Crowdfunding is an umbrella term used to describe a method of mass communication, typically the Internet,
to solicit funds from the community at large, with the project creator receiving small individual amounts of
funding from a large number of donors or investors . It essentially represents the natural convergence of
microfinance and crowdsourcing . Crowdfunding may be carried out in four ways -
1. Donation crowd-funding – where funds are transferred from contributors without any expectation
or liability for returns on such funds transferred. Typically donation crowdfunding is undertaken for
charitable causes
2. Reward crowd-funding – funds are transferred from contributors with an agreement, tacit or
otherwise, that fund-raisers would reward contributors in myriad of ways including pre-payment of a future
product, free merchandise. Donation and rewards based crowdfunding do not typically offer any yields or
returns on investment. As a variation of the rewards crowdfunding model, fundraisers may also engage a
pre-purchase model . In the pre-purchase model, contributors receive the product that the entrepreneur is
making. For example, if the entrepreneur is seeking to raise funds to produce and sell a watch which can
interact with Android and iOS devices, contributors would receive a watch for every USD 120 they
contributed .
3. Peer-to-peer lending – individual lenders and borrowers are matched using an online platform. Bulk
loan requirements are covered by individual lenders who may choose to provide funds for part of the
requirement. These smaller portions are aggregated by the platform and the loan is originated and released
to the borrower.
4. Equity crowdfunding –an equity stake in the company raising funds is offered, proportionate to the
quantum invested. Contributors assume the risks and liabilities of shareholders in the company.
Governments and securities regulators are typically concerned (as is this paper) with peer-to-peer lending
and equity crowdfunding (collectively referred to as financial return crowdfunding) primarily since they
fall within the jurisdiction of debt and equity regulation. As a result, most of the doctrinal or socio-economic
commentary on crowdfunding, including this paper, is centered on these two models.
Equity crowdfunding typically involves a company requiring funds for a defined purpose (the fundraiser)
which then describes its requirement for funds and the purpose for which the funds will be used, on a
crowdfunding website (the portal). The fundraiser also sets out the rewards, financial or otherwise at the
portal. Visitors to the portal (contributors) may choose to enter into an electronic transaction, based upon
the representations offered by the fundraiser. Funds are electronically transferred from the contributors’
accounts to the portal. Once the quantum of required funds is met, the portal releases the funds to the
fundraiser. Simultaneously, the fundraiser issues securities, in the form of equity, to the contributors.
Contributors look to receive a return in the form of a dividend stream or capital gain- similar to buying
shares of a startup company or an MSME . The portal is paid a fee for its services.
b. Advantages and Risks of Crowdfunding
This mechanism offers a number of advantages, primarily to the fundraiser, but also to the contributor and
the portal. One of the biggest advantages that fundraisers have as on date is curiously enough, the lack of
regulation. Companies that raise funds from fifty or more investors are required to undertake a public offer,
regulated under the Companies Act, 2013 as well as the Securities and Exchange Board of India (Issue of
Capital and Disclosure Requirements) Regulations, 2009. Using the Internet, an entrepreneur can sell an
idea that is viable and can be monetized- to literally millions of potential investors . No intermediary such
as a merchant bank or an underwriter is needed . Other advantages include the spreading of risk and the
boost to the economy through encouragement in the growth of SMEs .
However these benefits must necessarily be balanced against a number of risks. The first of these include
the risk of investing in an early-stage company. Because of the low cost of capital and the relative ease with
which entrepreneurs may access and engage with crowdfunding portals, crowdfunding has been used by
many startup companies to raise smaller amounts of money for their initial stage . Startup companies have
an inherent risk of failure. Failure statistics universally show that over 50% of newly founded firms will
fail during their first five years . In the event that such newly founded business ventures are also
crowdfunded, contributors’ expectations of dividends or capital appreciation may well be blighted.
Consider the case of Bubble and Balm - a fair trade soap company. In 2011 it raised GBP 75,000 through
an equity crowd-funding platform Crowdcube, based in the UK. In return, it issued 15 per cent of the
company’s equity. In July 2013 the business closed abruptly, leaving contributors in the lurch. The
contributors, having no way to recoup their losses or even contact the company, lost their entire investment.
Crowdfunding portals and their operations create causes for concern as well – primarily due to the lack of
a secondary market. Typically in a company which has issued securities to the public, such securities are
freely tradable on stock markets. The Companies Act, 2013 also prohibits restrictions on transferability of
public, listed company shares . Conversely, crowdfunded securities cannot be traded on crowdfunding
portals as on date- leading to illiquidity. As a result, contributors cannot sell their securities to recoup their
investments . This risk is exacerbated in cases of default or fraud, where an immediate exit option from the
company does not exist. As intermediaries, portals face a significant risk of liability arising out of false
disclosures by fundraisers . However, crowdfunding portals in unregulated jurisdictions, having no
requirements to register themselves with the securities regulator, have little to lose from closing operations
overnight . Finally, the lack of standardized security measures across platforms give rise to issues relating
to cybercrimes.
The third risk posed to contributors is the lack of transparency and information asymmetry , coupled with
the lack of experience of many investors. A large number of startups are engaged in deriving revenue from
technological advancements. The question of whether a technological advance is viable, or convertible into
revenue, requires some level of expertise. While it is possible that a number of contributors to a tech startup
may well be educated in aspects and viability of the technology concerned, it is not always the case.
Similarly, music or visual art related projects involve a high degree of subjectivity as to its revenue
generation capability . This too, requires specialized knowledge of the music or visual art industries, which
contributors may not possess. Further, when investing in a crowdfunded project, contributors are reliant
solely upon the representations of fundraisers and do not undertake a due diligence on the company that
they are investing into . Portals typically do not offer any certification as to the veracity of the claims of
fundraising companies. The lack of a detailed review on the fundraising company opens up the possibility
of fundraising companies to conceal information relevant to the future of the company, whether actively or
passively . Some studies show that instead of detailed disclosures as to the crowdfunded project, stronger
and more verifiable social networks of the fundraiser are associated with a higher chance of success .
Further, there is no independent perspective offered by an industry specialist as typically seen in securities
acquisition transactions.
As mentioned earlier, Indian law prohibits companies from offering to issue shares to more than two
hundred potential investors in a financial year or from allotting shares to fifty or more shareholders, without
undertaking a public offer. A public offering of shares or convertible debt securities involves the
appointment of one or more merchant bankers, a registrar to the issue, filing of a draft offer document with
SEBI, eligibility requirements such as previous track record, minimum promoter’s contribution, lock-in
requirements, requirement to have a monitoring agency, etc., apart from detailed disclosure requirements .
For a public issue of debt securities, a similar, albeit simpler regime is applicable in terms of the SEBI
(Issue and Listing of Debt Securities) Regulations, 2008. Further, once listed on a stock exchange,
companies are required to comply with the various continuous disclosure requirements of the listing
agreement.
The case of Sahara, wherein the two companies raised approximately INR 176.5 billion from 30 million
investors, is not unlike the mechanism used by crowdfunded companies. While Sahara relied on its network
of offices and agents, fundraisers place considerable dependence on their social networks. One key
difference, of course, is the usage of the internet and online social networks in cases of crowdfunding.
When placed in perspective of the large numbers of contributors typically associated with crowdfunding, it
is apparent that such fundraising mechanisms will run afoul of Section 42 of the Companies Act, 2013.
Such instances are not unheard of. In February 2011, one of the leading equity crowdfunding portals at the
time was asked to register itself as a broker-dealer under California law or cease its operations of selling
securities . While there have not been equity crowdfunding portals in India as yet, the Securities and
Exchange Board of India has considered giving startups and SMEs access to capital markets to provide an
additional channel of early stage funding while balancing the same with investor protection .
Contributors to crowdfunded companies typically make small investments and in most cases, would not
meet the minimum investment requirements of the VCF or the AIF regulations . VCFs and AIFs would also
require registration and would be restricted in their investments. VCFs and AIFs are also required to have
a diversified portfolio of investments.
This sets up a necessity for an exemption from the existing laws on fundraising. Specifically, it requires an
amendment in the extant fundraising provisions to allow startups and SMEs to enter into crowdfunding
activities without having to undertake a public offering. In doing so, India joins a number of other
jurisdictions which have also considered or are in the process of considering such exemptions.
1. Cross Border Acquisitions
Ever since India gained independence, the nation’s socio-economic development programmes have strived
to achieve economic self-reliance and social equity. There is a near unanimity among political parties on
economic reforms in India. With the benefits flowing from the economic reforms undertaken by successive
governments in the country, this political consensus has broadened on a national scale.
Extended reforms in almost every sector have ensured macro-economic stabilization in the country. Some
of these reforms have been in the form of opening up of the Indian economy to foreign investment as well
as allowing Indian investments overseas. This has arguably led to a rise in M&A activity in India. This
section discusses the regulatory aspects of cross border acquisitions in India.
Investments into Indian companies under the Foreign Direct Investment Policy
With the economy clearly charting the course of global integration and international competitiveness over
the last decade, there has been substantial flow of Foreign Direct Investment (FDI) in various core sectors
of the economy. FDI has gained importance globally as an instrument of international economic integration.
FDI policies along with trade policies have, in fact, become the focus of liberalization efforts in almost
every country.
In India, the primary objective of the FDI policy is to invite and facilitate foreign investment to achieve
faster economic growth. The policy guidelines of the Government of India for FDI in India are reviewed
on an ongoing basis taking into account the economic requirements of the country. The regulations have
been structured to identify the industrial sectors, with or without sectoral caps, for investments, to minimize
the procedural formalities and finally to introduce an automatic route for foreign investors to bring in
investment by merely informing the RBI.
The provisions, which apply only to entry of FDI, emanate from the Foreign Exchange Management Act,
1999 (FEMA) and the rules and regulations framed thereunder. The route to foreign investment has been
made easier as the thrust is more on the management of foreign investment rather than on regulation as was
prevalent under its predecessor regulation, Foreign Exchange Regulation Act (FERA), 1973. India’s foreign
investment regulations are two pronged, one relates to the authorisations or licenses required by a foreign
investor, and the other deals with the relationship between the subsidiary or joint venture company and its
foreign parent company or investor, as the case may be (profit repatriation, royalties, etc.).
Basic Regulations Governing the entry by Foreign Investors
The basic rules regulating possible entry by foreign investors are as follows:
 No investment is permitted in a few sensitive sectors such as atomic energy and tobacco.
 Specific approval is required in a few sectors such as power exchanges. Approvals are not automatic
in these sectors and they are accorded on a case-to-case basis on merit.
 In all other sectors, foreign investment is allowed on an automatic basis up to the permissible limit
set for a sector, i.e., it does not require prior approval of the Government of India, and the
investment is required to be notified within a specified period.
 Investments, once approved and implemented as per the approval conditions, are valid permanently
and qualify for future repatriation of profits and capital.
 Approvals can follow one of the two routes, namely the Automatic route or the Approval route.
 The government, from time to time, notifies “sector specific guidelines for FDI” delineating the
percentage of FDI permitted in specified sectors/activities. The guidelines also specify if the foreign
investment would fall under the automatic or approval route. In the sectors/ activities not listed in
the guidelines, FDI is permitted up to 100 per cent under the automatic route, subject to the
applicable sectoral rules/regulations.
The automatic route applies to all proposals that are completely in line with the investment guidelines
prescribed for the sector. No prior approval is necessary for investments under the automatic route.
However, the name of the collaborators, details of allotment, copy of the foreign collaboration agreement,
the original foreign inward remittance certificate from the authorized dealer and other specified information
are to be provided to the RBI within a specified period. Automatic route extends to all proposals:
 Where the proposed investment is within the specified ceilings prescribed for automatic route;
 Subject to sectoral norms, FDI in Special Economic Zones (SEZs), Export Oriented Units (EOUs),
Electronic Hardware Technology Park (EHTP), Software Technology Park (STP) and Industrial
Parks;
FDI activity not covered under the automatic route requires prior government approval and is considered
by the Foreign Investment Promotion Board, Department of Economic Affairs, Ministry of Finance (FIPB)
on a case-to-case basis. Prior approval of the Government of India is necessary for foreign investment with
respect to sectors in which foreign investment can only be by prior government approval as per the notified
sectoral policy.
Apart from the ceiling on the amount of foreign investment that may be made in a company, depending
upon the sector, there may be other
An issue or transfer of shares to a foreign resident must be made within 180 days of receipt of the share
purchase funds. Upon the expiry of the 180 day period, the share purchase funds must be returned
immediately. Further, there are restrictions upon the price at which shares may be issued to a non-resident
investor. If the shares are of a listed company, then the pricing guidelines of the ICDR and the Takeover
Code would be applicable. In case of unlisted companies, the share price must be based on the fair valuation
of shares as per the discounted free cash flow method.
Investments from Indian companies under the Overseas Direct Investment Policy
Indian residents, including companies are permitted to make overseas investments or financial
commitments in the form of corporate guarantees, loans without requiring approval, provided that such
investment does not exceed 400% of the net worth of the resident. For the purposes of calculating net worth,
only the paid up capital and free reserves of the resident company are taken into account.
Overseas investments by Indian residents are also subject to the following restrictions:
(a) The Indian party should not be on the Reserve Bank’s Exporters caution list / list of defaulters to
the banking system or under investigation by any investigation / enforcement agency or regulatory
body;
(b) The transfer of funds must be routed through an authorised dealer bank designated by the Indian
investor;
(c) For acquisitions of value in excess of USD 5 million, valuation of the shares of the company shall
be made by a Category I Merchant Banker registered with SEBI or an Investment Banker /
Merchant Banker outside India registered with the appropriate regulatory authority in the host
country;
(d) For acquisitions of less than USD 5 million, the valuation may be carried out by a Chartered
Accountant or a Certified Public Accountant;
In terms of the regulatory aspects of Indian investments overseas, the laws of the investee country must
also be taken into account.
Tax concerns and double taxation avoidance agreements
The Government of India, under section 90 of the Income-tax Act, has been authorized to enter into Double
Taxation Avoidance Agreements (DTAAs) with other countries. The object of such DTAAs is to evolve an
equitable basis for the allocation of the right to tax different types of income between the ‘source’ and
‘residence’. These DTAAs generally provide for relaxation in the taxation rates at which the resident of a
State which is a party to such tax treaty may be taxed on the income generated by him in the other
contracting State. Thus, the assessee is not taxed in two States for the same income generated in one of the
contracting States. This approach to cross border taxation has been widely acknowledged to promote
international trade and cross border investments. For example, a non-resident, under the income tax law,
becomes liable to tax in India in respect of income arising here by virtue of it being the country of source
and then again, in his own country in respect of the same income by virtue of the inclusion of such income
in the ‘total world income’ which is the tax base in the country of residence. Tax incidence, therefore,
becomes an important factor influencing the non-residents in deciding about the location of their
investment, services, technology etc.
These DTAAs follow a near uniform pattern in as much as India has guided itself by the UN model of tax
treaties. The DTAAs allocate jurisdiction between the source and resident country. Wherever such
jurisdiction is given to both the countries, the DTAAs prescribe maximum rate of taxation in the source
country, which is generally lower than the rate of tax under the domestic laws of that country. The resident
country agreeing to give credit for tax paid in the source country avoids the double taxation in such cases,
thereby reducing tax payable in the resident country by the amount of tax paid in the source country.
These DTAAs give the right of taxation in respect of income of the nature of interest, dividend, royalty and
fees for technical services to the country of residence. However, taxation in the source country has to be
limited to the rates prescribed in the tax treaty. The rate of taxation is on gross receipts without deduction
of expenses. So far as income from capital gains is concerned, gains arising from transfer of immovable
properties are taxed in the country where such properties are situated. Gains arising from the transfer of
movable properties forming part of the business property of a ‘Permanent Establishment’ or the ‘Fixed
Base’ are taxed in the country where such Permanent Establishment or the Fixed Base is located. Different
provisions exist for taxation of capital gains arising from transfer of shares. In a number of DTAAs, the
right to tax is given to the State of which the company is resident. In some others, the country of residence
of the shareholder has this right and in some others, the country of residence of the transferor has the right
if the shareholding of the transferor is of a prescribed percentage.
So far as the business income is concerned, the source country gets the right to tax only if there is a
‘Permanent Establishment’ or a ‘Fixed Place of Business’ there. Taxation of business income is on net
income from business at the rate prescribed in the relevant Finance Act.
Income derived by rendering of professional services or other activities of independent character are taxable
in the country of residence except when the person deriving income from such services has a Fixed Base in
the other country from where such services are performed. Such income is also taxable in the source
country, if the person’s stay exceeds 183 days in that financial year.
Income from dependent personal service, i.e. from employment is taxed in the country of residence unless
the employment is exercised in the other State. Even if the employment is exercised in any other State, the
remuneration will be taxed in the country of residence if –
- The recipient is present in the source State for a period not exceeding 183 days;
- The remuneration is paid by a person who is not a resident of that State; and
- The remuneration is not borne by a Permanent Establishment or a Fixed Base.
DTAAs also contain clauses for non-discrimination of the national of a contracting State in the other State
vis-à-vis the nationals of that other State. The fact that higher rates of tax are prescribed for foreign
companies in India does not amount to discrimination against the Permanent Establishment of the non-
resident company. This has been made explicit in certain DTAAs such as the one with U.K. Provisions also
exist for mutual agreement procedure which authorizes the competent authorities of the two States to
resolve any dispute that may arise in the matter of taxation without going through the normal process of
appeals etc. provided under the domestic law. Another important feature of some DTAAs is the existence
of a clause providing for exchange of information between the two contracting States which may be
necessary for carrying out the provisions of the DTAA or for effective implementation of domestic laws
concerning taxes covered by the tax treaty. Information about residents getting payments in other
contracting States necessary for proper assessment of total income of such individual is thus facilitated by
such DTAAs.
It may sometimes happen that owing to reduction in tax rates under the domestic law, after coming into
existence of the treaty, the domestic rates become more favourable to the non-residents. Since the object of
the DTAAs is to benefit the non-residents, they have, under such circumstances, the option to be assessed
either as per the provisions of the treaty or the domestic law of the land.
In order to avoid any demand or refund consequent to assessment and to facilitate the process of assessment,
it has been provided that tax shall be deducted at source out of payments to nonresidents at the same rate at
which the particular income is made taxable under the DTAAs. For example, as a result of amendments
made, exempting dividend income from taxation, no deduction of tax is required to be made in respect of
such income.
DTAA with Mauritius
Mauritius is a traditional hub through which foreign investment in India is routed because of it being a tax
haven State. Mauritius has firmly established itself as the principal source of foreign fund flows into India
accounting for more than a third of the aggregate FDI flows into India over the past 12 years and a third of
aggregate actual inward remittance. The reason for this is that the Agreement provides for attractive tax
benefits for investing shareholders as it provides for no Indian withholding tax on capital gains tax on
transfer of shares in the Indian company.
Additionally, the Mauritius Government charges its resident company with negligible rate of tax and
therefore the company set up in Mauritius for investing in India gains from both the sides, in the sense that
they do not pay tax for the income generated by them from investing activities carried out in India and also
save tax in the home country, i.e. Mauritius.
It is apparent from the above that there are substantial benefits arising from investing through Mauritius.
As of now, there is nothing to indicate that the tax authorities in India have started questioning the use of
Mauritius entity and also there is no indication of any change being suggested by the Ministry of Finance
in India. It also may be pointed out that in several treaties, which India has entered into with other countries;
there are special provisions for anti-treaty shopping. No such anti-treaty shopping provision exists in the
case of Indo-Mauritius DTAA.
The significant terms of this Agreement between India and Mauritius include Article 13, which provides
the manner of taxation of capital gains. Article 13 of the Agreement provides that gains from the alienation
of immovable property may be taxed in the State in which the property is situated. Gains derived by a
resident of a contracting State from the alienation of movable property forming part of the business property
of a Permanent Establishment, which an enterprise of a contracting State has in the other contracting State
or of movable property pertaining to a Fixed Base available to a resident of a contracting State in the other
contracting State for the purpose of performing independent personal services including such gains from
the alienation of such a Permanent Establishment may be taxed in that other State.
In terms of Circular no. 682 dated March 30, 1994 issued by the Central Board of Direct Taxes (“CBDT”)
under section 90 of the Income Tax Act 1961, the Government of India clarified that the capital gains of
any resident of Mauritius by alienation of shares of an Indian company shall be taxable only in Mauritius
according to taxation laws of Mauritius and will not be liable to tax in India. This circular prompted many
FIIs, which were resident in Mauritius to invest huge amounts of capital in shares of Indian companies with
expectations of making profits by sale of such shares without being subjected to tax in India.
Incidentally, this clarification came at a time when many foreign companies were planning to invest in India
to take advantage of the liberalisation process started by the Government in the year 1991. The impact was
so huge that companies, which were planning to invest in India, incorporated a subsidiary in Mauritius for
the purpose of investing in India to avail the benefit of low dividend taxation and zero capital gains for
taxation in India.
These companies incorporated in Mauritius for the purpose of investing in India were shell companies with
no business of their own and were allegedly also controlled and managed from a country other than
Mauritius. Since benefits of the Indo-Mauritius Agreement are available only to those persons who are
‘resident’ in either of the country, doubts were raised whether these FIIs, which were incorporated in
Mauritius to invest in India but being managed from a country other than Mauritius, were ‘resident’ in
Mauritius. These doubts were however clarified in 2000 by the Finance Minister. It was stated that the
views taken by some of the Income tax officers pertained to specific cases of assessments only and did not
represent or reflect the policy of the Government of India with regard to denial of tax benefits to such FIIs.
This move was intended to put the FIIs proposing to invest in India at a comfort level from taxation point
of view.
To further clarify the position, the CBDT issued Circular No. 789 dated April 13, 2000 which provided that
if the certificate of residence has been issued by the Mauritius authorities, such certificate shall constitute
sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the
Agreement accordingly. The circular was to be applicable to proceedings which are pending at various
levels.
However, with the Supreme Court of India’s decision on the Hutch-Vodafone case, there may be wide
sweeping changes to the extant tax policy insofar as it applies to M&As outside India. As part of a global
transaction, Vodafone acquired the shares of a company based in the Cayman Islands which was hitherto
owned by Hutchison and Vodafone. The Indian tax authorities were of the view that since the consideration
paid for the shares included capital gains arising out of Indian assets, namely Hutchison Essar Limited, an
Indian subsidiary of the Cayman Islands entity. In 2012 the Supreme Court disagreed with the Indian tax
authorities, holding that the transfer of shares of a non-resident entity would not give rise to an incidence
of capital gains tax in India. In May 2012, four months after the Supreme Court judgement, the Indian
income tax authorities passed an amendment with retrospective effect which would effectively bring such
transactions under the purviews of Indian income tax laws. While this move has brought on mostly negative
reactions, a review petition of the Supreme Court judgement is presently pending and the apex court of the
country would have the opportunity to review the May 2012 amendment. In the event that the amendment
is upheld by the Supreme Court, cross border acquisitions involving Indian entities would have to be viewed
in a different light.
Buyback
Section 68. Power of company to purchase its own securities.
(1) Notwithstanding anything contained in this Act, but subject to the provisions of sub-section (2), a
company may purchase its own shares or other specified securities (hereinafter referred to as buy-back) out
of—
(a) its free reserves;
(b) the securities premium account; or
(c) the proceeds of the issue of any shares or other specified securities:
Provided that no buy-back of any kind of shares or other specified securities shall be made out of the
proceeds of an earlier issue of the same kind of shares or same kind of other specified securities.
(2) No company shall purchase its own shares or other specified securities under sub-section (1), unless—
(a) the buy-back is authorised by its articles;
(b) a special resolution has been passed at a general meeting of the company authorising the buy-back:
Provided that nothing contained in this clause shall apply to a case where—
(i) the buy-back is, ten per cent. or less of the total paid-up equity capital and free reserves of the company;
and
(ii) such buy-back has been authorised by the Board by means of a resolution passed at its meeting;
(c) the buy-back is twenty-five per cent. or less of the aggregate of paid-up capital and free reserves of the
company:
Provided that in respect of the buy-back of equity shares in any financial year, the reference to twenty-five
per cent. in this clause shall be construed with respect to its total paid-up equity capital in that financial
year;
(d) the ratio of the aggregate of secured and unsecured debts owed by the company after buy-back is not
more than twice the paid-up capital and its free reserves:
Provided that the Central Government may, by order, notify a higher ratio of the debt to capital and free
reserves for a class or classes of companies;
(e) all the shares or other specified securities for buy-back are fully paid-up;
(f) the buy-back of the shares or other specified securities listed on any recognised stock exchange is in
accordance with the regulations made by the Securities and Exchange Board in this behalf; and
(g) the buy-back in respect of shares or other specified securities other than those specified in clause (f) is
in accordance with such rules as may be prescribed:
Provided that no offer of buy-back under this sub-section shall be made within a period of one year reckoned
from the date of the closure of the preceding offer of buy-back, if any.
(3) The notice of the meeting at which the special resolution is proposed to be passed under clause (b) of
sub-section (2) shall be accompanied by an explanatory statement stating—
(a) a full and complete disclosure of all material facts;
(b) the necessity for the buy-back;
(c) the class of shares or securities intended to be purchased under the buy-back;
(d) the amount to be invested under the buy-back; and
(e) the time-limit for completion of buy-back.
(4) Every buy-back shall be completed within a period of one year from the date of passing of the special
resolution, or as the case may be, the resolution passed by the Board under clause (b) of sub-section (2).
(5) The buy-back under sub-section (1) may be—
(a) from the existing shareholders or security holders on a proportionate basis;
(b) from the open market;
(c) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option
or sweat equity.
(6) Where a company proposes to buy-back its own shares or other specified securities under this section
in pursuance of a special resolution under clause (b) of sub-section (2) or a resolution under item (ii) of the
proviso thereto, it shall, before making such buy-back, file with the Registrar and the Securities and
Exchange Board, a declaration of solvency signed by at least two directors of the company, one of whom
shall be the managing director, if any, in such form as may be prescribed and verified by an affidavit to the
effect that the Board of Directors of the company has made a full inquiry into the affairs of the company as
a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be
rendered insolvent within a period of one year from the date of declaration adopted by the Board:
Provided that no declaration of solvency shall be filed with the Securities and Exchange Board by a
company whose shares are not listed on any recognised stock exchange.
(7) Where a company buys back its own shares or other specified securities, it shall extinguish and
physically destroy the shares or securities so bought back within seven days of the last date of completion
of buy-back.
(8) Where a company completes a buy-back of its shares or other specified securities under this section, it
shall not make a further issue of the same kind of shares or other securities including allotment of new
shares under clause (a) of sub-section (1) of section 62 or other specified securities within a period of six
months except by way of a bonus issue or in the discharge of subsisting obligations such as conversion of
warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity
shares.
(9) Where a company buys back its shares or other specified securities under this section, it shall maintain
a register of the shares or securities so bought, the consideration paid for the shares or securities bought
back, the date of cancellation of shares or securities, the date of extinguishing and physically destroying the
shares or securities and such other particulars as may be prescribed.
(10) A company shall, after the completion of the buy-back under this section, file with the Registrar and
the Securities and Exchange Board a return containing such particulars relating to the buy-back within thirty
days of such completion, as may be prescribed:
Provided that no return shall be filed with the Securities and Exchange Board by a company whose shares
are not listed on any recognised stock exchange.
(11) If a company makes any default in complying with the provisions of this section or any regulation
made by the Securities and Exchange Board, for the purposes of clause (f) of sub-section (2), the company
shall be punishable with fine which shall not be less than one lakh rupees but which may extend to three
lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for
a term which may extend to three years or with fine which shall not be less than one lakh rupees but which
may extend to three lakh rupees, or with both.
Explanation I.—For the purposes of this section and section 70, “specified securities” includes employees’
stock option or other securities as may be notified by the Central Government from time to time.
Explanation II.—For the purposes of this section, “free reserves” includes securities premium account.
Section 70. Prohibition for buy-back in certain circumstances
(1) No company shall directly or indirectly purchase its own shares or other specified securities—
(a) through any subsidiary company including its own subsidiary companies;
(b) through any investment company or group of investment companies; or
(c) if a default, is made by the company, in the repayment of deposits accepted either before or after the
commencement of this Act, interest payment thereon, redemption of debentures or preference shares or
payment of dividend to any shareholder, or repayment of any term loan or interest payable thereon to any
financial institution or banking company:
Provided that the buy-back is not prohibited, if the default is remedied and a period of three years has lapsed
after such default ceased to subsist.
(2) No company shall, directly or indirectly, purchase its own shares or other specified securities in case
such company has not complied with the provisions of sections 92, 123, 127 and section 129.
MODULE VIII - CORPORATE BORROWING, LENDING AND INVESTMENTS

Borrowing powers of the company
Section 179 (3)(d) - The Board of Directors of a company shall exercise the following powers on behalf of
the company by means of resolutions passed at meetings of the Board (including) to borrow monies
Section 180 (1) (c) - The Board of Directors of a company shall exercise the following powers only with
the consent of the company by a special resolution (including) to borrow money, where the money to be
borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up
share capital and free reserves, apart from temporary loans obtained from the company’s bankers in the
ordinary course of business:
Provided that the acceptance by a banking company, in the ordinary course of its business, of deposits of
money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or
otherwise, shall not be deemed to be a borrowing of monies by the banking company within the meaning
of this clause.
Explanation.—For the purposes of this clause, the expression “temporary loans” means loans repayable on
demand or within six months from the date of the loan such as short-term, cash credit arrangements, the
discounting of bills and the issue of other short-term loans of a seasonal character, but does not include
loans raised for the purpose of financial expenditure of a capital nature;
Krishna Kumar Rohatagi v. State Bank of India (1980) 50 Comp. Cas. 722
1. The appellants in these two appeals were defendants in a money suit which had been filed on behalf of
the Bank of Bihar Ltd. (hereinafter to be referred to as “the bank”) for a decree of Rs. 1,82,728.99 along
with interest pendente lite and future.
2. According to the respondent-bank, on March 5, 1947, M/s. Indian Electric Works Ltd. (hereinafter to be
referred to as “the company”), defendant No. 1, which is appellant in F.A. No. 409 of 1967, approached the
bank for a loan of rupees five lakhs for the purpose of its business and a sum of rupees five lakhs was
advanced to it. The company executed a promissory note for rupees five lakhs in favour of the bank. The
promissory note used to be renewed from time to time and the defendent-company used to make payments
towards the amount advanced to it. Shri Binay Krishna Rohatgi, who was the father of appellants Nos. 1 to
6 and husband of appellant No. 7 in F.A. No. 386 of 1967, guaranteed the repayment of the aforesaid loan
by executing guarantees in favour of the bank. On April 24, 1953, again a promissory note for Rs. 2,50,000
was executed by the company and the aforesaid Shri Binay Krishna Rohatgi executed a guarantee for that
amount. On June 23,1956, the company again renewed the pronote for Rs. 1,50,000, which was the amount
due against it, and Shri Binay Krishna Rohatgi executed a guarantee for the repayment of the said loan.
Finally, on June 23, 1959, the last pronote was renewed by the company for an amount of Rs. 1,62,000,
agreeing to pay interest thereon at the rate of 7 1/2 per cent, per annum. Shri Binay Krishna Rohatgi again
executed a guarantee for that amount in favour of the bank. This amount was, however, not paid by the
company and ultimately the bank filed the money suit in question on May 12, 1962. Till that date the total
dues including interest was at Rs. 1,82,728-99. Along with the plaint, the details of the transactions from
1947 up to 1962 were also annexed. As on the date of the suit the aforesaid Shri Binay Krishna Rohatgi
was dead, bis heirs, who are appellants in F.A. No. 386 of 1967, were impleaded as defendants Nos. 4 to
16.
3. Written statements were filed on behalf of the company as well as on behalf of some of the heirs of Shri
Binay Krishna Rohatgi. The defence of the company in a nutshell appears to be that the managing director
of the defendant-company had no authority to execute the pronote, in the absence of a resolution duly
adopted by the board of directors authorising the managing director to borrow Rs. 1,62,000, and, as such,
it was not binding on the defendant-company. The heirs of Shri Binay Krishna Rohatgi, the guarantor, have
questioned their liability in respect of the transaction in question primarily on the ground that the said
guarantee was offered by Shri Binay Krishna Rohatgi in his individual capacity and it cannot be enforced
against his heirs who were neither party to the transaction in question nor had any concern with the same.
At the trial, parties produced documents and examined witnesses in support of their respective contentions.
4. The learned subordinate judge, on a consideration of the materials on the record, came to the conclusion
that the company is liable to repay the loan in question. He also held that Shri Binay Krishna Rohatgi had
executed the letter of guarantee, whereby on default by the principal debtor, he took upon himself the
liability to pay the sum of Rs. 1,62,000 with interest thereon and in such a situation, his liability was co-
extensive with the liability of the principal debtor, and as such, his heirs cannot be absolved from that
liability. On that finding, he passed a decree against the company (defendant No. 1) as well as against the
heirs of Shri Binay Krishna Rohatgi, i.e., defendant Nos. 4 to 10 and 12 to 16. In the appeals filed before
this court the aforesaid findings have been challenged on behalf of the appellants in the two appeals on the
question of fact as well as on the question of law.
5. The relevant portion of the promissory note dated June 23, 1959, is as follows ;
" On Demand we jointly and severally promise to pay the Bank of Bihar Ltd. or order at Patna or Calcutta
the sura of rupees one lakh sixty-two thousand only for value received with interest at 3 1/2 per cent, over
the Reserve Bank of India rate with a minimum of 7 1/2 per cent, per annum with monthly rests."
6. This was signed by the chairman of the company. It also bears the signature of one Shri Anandi Lall
Poddar as the director of the company. I propose to first deal with the question as to whether in the facts
and circumstances of the present case the company is liable to repay the amount in question.
7. Learned Advocate-General appearing on behalf of the company submitted that as the pronote was
executed by the chairman of the company without there being a resolution of the board of directors
authorising him to execute the said pronote, the company is not liable to pay the amount in question. In that
connection, in support of his contention that the board of directors had passed resolutions authorising the
managing director of the company to borrow the specified sum as loan from the bank and authorising him
to execute necessary documents as required by the bank. It appears that the resolution dated February 23,
1953, is in respect of the aforesaid pronote which was executed on February 3, 1953, and the resolution
dated April 4, 1956, is in respect of the pronote which was executed on June 23, 1956. No similar resolution
has been produced in respect of the pronote in question which was executed on June 23, 1959.
Now, the question is as to whether, in the absence of a resolution authorising the person who executed the
pronote in question, or due to non-production of any such resolution even if it may be in existence, it can
be held that the bank is not entitled to realise the amount in question. In this connection, learned Advocate-
General made reference to Section 292(1)(c) of the Companies Act, 1956, hereinafter referred to as " the
Companies Act ", and submitted that there must be a resolution of the board of directors authorising the
managing director to borrow any amount from the bank or any other company. Sections 291 and 292 of the
Companies Act specify the power of the board of directors while managing a company. It places certain
restrictions on the power of the managing director. In the present case, there is no dispute that the initial
loan of rupees five lakhs was taken after a resolution by the board of directors of the company. From the
account book, a copy whereof has been produced on behalf of the bank, it appears that from time to time
payments were made by the company and after every three years a new pronote was executed for the balance
amount.
On June 23, 1959, the total amount due to the bank, as shown in the account of the bank, was about Rs.
1,62,000 and the managing director of the company executed the pronote in question for that amount on
behalf of the company. The original pronote bears the seal of the company as well. D.W. 1, who is the law
clerk of the company, has stated that to his knowledge, there was no resolution of the year 1959, by which
Shri Anandi Lall Poddar, who has executed the pronote in question, has been empowered to execute the
same or renew it. The minutes book containing the resolution of the board of directors of the company for
the year 1959 has not been proved and marked as an exhibit in the case. Perhaps, it was only filed and later
withdrawn from the record of the case. In my opinion, in such a situation, on the statement of D.W. 1 only,
it will not be proper to infer that there was no resolution by the board of directors authorising the managing
director to execute the pronote in question. Even if it is assumed that there is no resolution, in my view, the
right of the bank to realise the amount which it has advanced to the company cannot be defeated on this
ground. It is not the case of the company that Shri Poddar, its managing director, had executed the pronote
in question in his personal capacity, rather, it is almost admitted that he had executed the pronote in question
in favour of the bank on behalf of the company. After the execution of the pronote in question, a receipt
had been granted on behalf of the company saying that it had received from the bank a sum of Rs. 1,62,000,
on account of consideration money of pronote executed by them in favour of the bank dated June 23, 1959.
In such a situation, it is not open to the company to say that the managing director of the company was not
duly authorised to execute the pronote in question. Any defect, for which the company (sic) of the bank for
realisation of the amount in question. This aspect of the matter has been considered in the cases of T.R.
Pratt (Bombay) Ltd. v. E. D. Sassoon & Co. Ltd. [1936] 6 Comp Cas 90 (Bom) and Shri Kishan Rathi v.
Mondal Brothers and Co. (P.) Ltd. [1967] 37 Comp Cas 256 (Cal). In the former case [1936] 6 Comp Cas
90 (Bom), it was held that under the general principle of law when an agent borrows money for a principal
without the authority of the principal, but if the principal takes benefit of the money so borrowed or when
the money so borrowed have gone into the coffers of the principal, the law implies a promise to repay. In
that connection it was further observed that there appears to be nothing in law which makes this principle
inapplicable to the case of a joint stock company and even in cases where the directors or the managing
agent had borrowed money without there being authorisation from the company, if it has been used for the
benefit of the company, the company cannot repudiate its liability to repay. The aforesaid view of Kania J.
of the Bombay High Court expressed in connection with a liquidation proceeding was also affirmed by a
Bench of that court, on appeal, and it was pointed out by Beaumont C.J. that distinction has to be drawn
between the cases where the borrowing is ultra vires the directors and not ultra vires the company and in
such cases the money could be recovered in an action for money had and received. The aforesaid judgment
was also affirmed by the Privy Council in the case of T.R. Pratt (Bombay] Ltd. v. M. T. Ltd. [1938] 8 Comp
Cas 137 (PC). In the case of Shri Kishan Rathi v. Mondal Brothers and Co. (P.] Ltd. [1967] 37 Comp Cas
256 (Cal), Section 292 of the Companies Act was itself considered in connection with a dispute as to
whether there was a resolution by the board of directors empowering the director to take loans. It was
pointed out that in such a situation the dispute being in respect of an internal management, the onus was on
the company to prove that the director had no authority to borrow and any such violation shall not defeat
the bona fide claim of the creditor against the company because the creditor can assume that all
requirements of internal management have been complied with.
8. It was then submitted that Shri Anandi Lalj Poddar, who executed the pronote in question, had not
executed the said pronote as the managing director of the company, but only as chairman and the chairman
of the company had no such power. In my opinion, this submission is against the pleading of the company
itself. In para. 7 of its written statement it has been stated that the managing director of the company had
no authority to execute the pronote in the absence of a resolution duly adopted by the board of directors
authorising the managing director to borrow Rs. 1,62,000. Thus, it is admitted that on the relevant date Shri
Anandi Lall Poddar was also the managing director of the company and he executed it in that capacity.
Witness No. 3 examined on behalf of the company (D.W. 3) has stated that Binay Babu, who was the
managing director of the company, was ill in the year 1959, and, as such, Anandi Lall Poddar, the chairman
of the company, began to look after the business of the company. In view of the statement made in the
written statement, it is not open to the company to urge that the pronote in question was not executed by
the managing director of the company. Accordingly, I hold that, in the facts and circumstances of the case,
the company is liable to pay the amount in question which had been advanced to it by the bank and the
learned subordinate judge has rightly held that the company cannot repudiate its liability in respect of the
transaction in question.
9. So far as the appeal on behalf of the heirs of Shri Binay Krishna Rohatgi, the guarantor, is concerned,
learned counsel appearing for the appellants has challenged the judgment and decree of the court below on
several grounds. While disputing the liability of the appellants in question, it was also urged that, in the
facts and circumstances of the present case, the company itself was not liable to pay the amount in question.
Learned counsel urged that in view of Section 64 of the Negotiable Instruments Act, 1881, the promissory
note in question should have been presented to the company by the bank for payment, and, as in the present
case merely a notice was given by the bank to the company, it will not be deemed to be a presentation
within the meaning of that section and the suit could not have been filed. Section 64 of the Negotiable
Instruments Act requires the holder of a pronote to present it for payment to the maker thereof and it further
provides that in default of such presentment the parties thereto are not liable thereon to such holder. But, in
that very section, there is a clause in the nature of a proviso which says that " Where authorised by
agreement or usage, a presentment through the post office by means of a registered letter is sufficient ".
Admittedly, the demand was made by registered letters which have been proved and marked as Exs. 5
series. The bank has also produced a letter dated June 23, 1959, of the company forwarding the pronote in
question and waiving the right of the presentment under the Negotiable Instruments Act. It has been marked
as Ex, 7. In view of this document by which the right of presentment was waived, it cannot be urged that
the suit was premature because the pronote was not physically presented for payment before filing of the
suit.
Even if it is assumed that as nothing was advanced to the company at the time of the execution of the
promissory note and guarantee, the agreements in question were in respect of a past debt, still the two
agreements cannot be held to be without consideration. Under Section 2(d) of the Contract Act not only
some act done for the promisor but even abstinence on the part of the promisee will be deemed to be a good
consideration. But for the execution of the pronote the bank in the usual course would have filed the money
suit, as the pronote which was executed in the year 1956 was getting time-barred.
In the facts and circumstances of the case, it has to be held that the pronote was executed by the company
for consideration. If the pronote was executed for consideration, then, in view of Section 127 of the Contract
Act, the letter of guarantee will also be deemed to have been executed for consideration, because anything
done for the benefit of the principal debtor, shall be sufficient consideration to the surety for giving the
guarantee.
19. According to the appellants no liability can be saddled against the company or the guarantor, Shri Binay
Krishna Rohatgi because Section 34 of the Evidence Act says in unmistakable terms that such entries by
themselves shall not be sufficient evidence to charge any person with liability. But, in the instant case, the
entries are not the only evidence on behalf of the bank. I have already pointed out that on behalf of the
bank, apart from the entries in its account book, reliance has been placed on the pronote which was executed
on behalf of the company, as well as on the receipt for Rs. 1,62,000, which was granted on behalf of the
company, saying that the aforesaid amount has been received from the bank. The witnesses examined on
behalf of the bank have also stated about the advance of the amount to the company and about its having
operated the account in question. Accordingly, I hold that the liability of the company for repayment of the
loan in question, and in case of default by the company the liability of Shri Binay Krishna Rohatgi for
repayment of the loan is established.
What constitutes a pledge of goods?
Lallan Prasad v. Rahmat Ali and Anr. AIR1967SC1322

Facts:
On January 10, 1946 the appellant advanced Rs. 20,000/- to the first respondent against a promissory note
and a receipt. The first respondent also executed an agreement whereby he agreed to pledge as security for
the debt the said aeroscraps and to deliver them at the appellant’s house and keep them there in his custody.
The appellant’s case, however, was that the first respondent failed to deliver the said goods to him, stored
them in a plot adjacent to the aerodrome at Allahabad and therefore the said agreement did not ripen into a
pledge. Consequently, he was entitled to recover the amount advanced by him in the suit based on the said
promissory note and the said receipt. In his written statement the first respondent admitted the said loan but
alleged that in pursuance of the said agreement he delivered 147 tons of aeroscraps of the value of Rs.
35,000/- to the appellant. He claimed that the appellant was not entitled to obtain a decree unless he was
ready and willing to redeliver the said goods pledged with him.
Issue:
Whether the appellant was entitled to any relief when his case was that the first respondent never delivered
to him the said goods and the said agreement never ripened into a pledge.
Discussion:
Under the Common Law a pawn or a pledge is a bailment of personal property as a security for some debt
or engagement. A pawner is one who being liable to an engagement gives to the person to whom he is liable
a thing to be held as security for payment of his debt or the fulfilment of his liability. The two ingredients
of a pawn or a pledge are: (1) that it is essential to the contract of pawn that the property pledged should be
actually or constructively delivered to the pawnee and (2) a pawnee has only a special property in the pledge
but the general property therein remains in the pawner and wholly reverts to him on discharge of the debt.
A pawn therefore is a security, where, by contract a deposit of goods is made as security for a debt. The
right to property vests in the pledgee only so far as is necessary to secure the debt. In this sense a pawn or
pledge is an intermediate between a simple lien and a mortgage which wholly passes the property in the
thing conveyed. (See Halliday v. Holygate I.L.R. [1968] Ex. 299.. A contract to pawn a chattel even though
money is advanced on the faith of it is not sufficient in itself to pass special property in the chattel to the
pawnee. Delivery of the chattel pawned is a necessary element in the making of a pawn. But delivery and
advance need not be simultaneous and a pledge may be perfected by delivery after the advance is made.
Satisfaction of the debt or engagement extinguishes the pawn and the pawnee on such satisfaction is bound
to redeliver the property. The pawner has an absolute right to redeem the property pledged upon tender of
the amount advanced but that right would be lost if the pawnee has in the meantime lawfully sold the
property pledged. A contract of pawn thus carries with it an implication that the security is available to
satisfy the debt and under this implication the pawnee has the power of sale on default in payment where
time is fixed for payment and where there is no such stipulated time on demand for payment and on notice
of his intention to sell after default. The pawner however has a right to redeem the property pledged until
the sale. If the pawnee sells, he must appropriate the proceeds of the sale towards the pawner’s debt, for,
the sale proceeds are the pawner’s monies to be so applied and the pawnee must pay to the pawner any
surplus after satisfying the debt. The pawnee’s right of sale is derived from an implied authority from the
pawner and such a sale is for the benefit of both the parties. He has a right of action for his debt
notwithstanding possession by him of the goods pledged. But if the pawner tenders payment of the debt the
pawnee has to return the property pledged. If by his default the pawnee is unable to return the security
against payment of the debt, the pawner has a good defence to the action. (Halsbury’s Laws of England,
3rd ed. Vol. 29 page 221.)
There is no difference between the common law of England and the law with regard to pledge as codified
in sections 172 to 176 of the Contract Act. Under section 172 a pledge is a bailment of the goods as security
for payment of a debt or performance of a promise. Section 173 entitles a pawnee to retain the goods pledged
as security for payment of a debt and under section 175 he is entitled to receive from the pawner any
extraordinary expenses he incurs for the preservation of the goods pledged with him. Section 176 deals with
the rights of a pawnee and provides that in case of default by the pawner the pawnee has (1) the right to sue
upon the debt and to retain the goods as collateral security and (2) to sell the goods after reasonable notice
of the intended sale to the pawner. Once the pawnee by virtue of his right under section 176 sells the goods
the right of the pawner to redeem them is of course extinguished. But as aforesaid the pawnee is bound to
apply the sale proceeds towards satisfaction of the debt and pay the surplus, if any, to the pawner. So long,
however, as the sale does not take place the pawner is entitled to redeem the goods on payment of the debt.
It follows therefore that where a pawnee files a suit for recovery of debt, though he is entitled to retain the
goods he is bound to return them on payment of the debt. The right to sue on the debt assumes that he is in
a position to redeliver the goods on payment of the debt and therefore if he has put himself in a position
where he is not able to redeliver the goods he cannot obtain a decree. If it were otherwise, the result would
be that he would recover the debt and also retain the goods pledged and the pawner in such a case would
be placed in a position where he incurs a greater liability than he bargained for under the contract of pledge.
The pawnee therefore can sue on the debt retaining the pledged goods as collateral security. If the debt is
ordered to be paid he has to return the goods or if the goods are sold with or without the assistance of the
court appropriate the sale proceeds towards the debt. But if he sues on the debt denying the pledge, and it
is found that he was given possession of the goods pledged and had retained the same, the pawner has the
right to redeem the goods so pledged by payment of the debt. If the pawnee is not in a position to redeliver
the goods he cannot have both the payment of the debt and also the goods. Where the value of the pledged
property is less than the debt and in a suit for recovery of debt by the pledgee, the pledge denies the pledge
or is otherwise not in a position to return the pledged goods he has to give credit for the value of the goods
and would be entitled then to recover only the balance. That being the position the appellant would not be
entitled to a decree against the said promissory note and also retain the said goods found to have been
delivered to him and therefore in his custody. For, if it were otherwise the first respondent as the pawner
would be compelled not only to pay the amount due under the promissory note but lose the pledged goods
as well. That certainly is not the effect of section 176.
The appeal fails and is dismissed with costs.
Charge
Fixed charges are charges over a specified asset or property while floating charges are charges over a class
of asset which is constantly changing. A fixed charge prevents the company from dealing with the charged
asset without the consent of the charge holder and is therefore not used in connection with assets which are
constantly changing, such as stock in trade, raw material and finished articles. A fixed charge holder does
not claim against the general assets of the company on winding up, he claims against the asset that is subject
to the charge.
There is no statutory definition of a 'floating charge' and what the parties call a charge is not conclusive
evidence of its status, but case law (eg, Illingworth v Houldsworth (1904)) does show that certain factors
need to be present if a charge is to be classified as a floating charge. These are (i) that the charge is over a
class of assets both present and future; (ii) that the class is one which, in the ordinary course of business,
changes from time to time; and (iii) that the charge leaves the company free to deal with the charged asset
in the ordinary course of the company's business. The type of assets frequently subject to a floating charge
are stock in trade, raw material and finished articles, but it is possible, as here, for a floating charge to
comprise the company’s entire undertaking
Inter-corporate borrowing and investments
Section 186. Loan and investment by company.
(1) Without prejudice to the provisions contained in this Act, a company shall unless otherwise prescribed,
make investment through not more than two layers of investment companies:
Provided that the provisions of this sub-section shall not affect,—
(i) a company from acquiring any other company incorporated in a country outside India if such other
company has investment subsidiaries beyond two layers as per the laws of such country;
(ii) a subsidiary company from having any investment subsidiary for the purposes of meeting the
requirements under any law or under any rule or regulation framed under any law for the time being in
force.
(2) No company shall directly or indirectly —
(a) give any loan to any person or other body corporate;
(b) give any guarantee or provide security in connection with a loan to any other body corporate or person;
and
(c) acquire by way of subscription, purchase or otherwise, the securities of any other body corporate,
exceeding sixty per cent. of its paid-up share capital, free reserves and securities premium account or one
hundred per cent. of its free reserves and securities premium account, whichever is more.
(3) Where the giving of any loan or guarantee or providing any security or the acquisition under sub-section
(2) exceeds the limits specified in that sub-section, prior approval by means of a special resolution passed
at a general meeting shall be necessary.
(4) The company shall disclose to the members in the financial statement the full particulars of the loans
given, investment made or guarantee given or security provided and the purpose for which the loan or
guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security.
(5) No investment shall be made or loan or guarantee or security given by the company unless the resolution
sanctioning it is passed at a meeting of the Board with the consent of all the directors present at the meeting
and the prior approval of the public financial institution concerned where any term loan is subsisting, is
obtained:
Provided that prior approval of a public financial institution shall not be required where the aggregate of
the loans and investments so far made, the amount for which guarantee or security so far provided to or in
all other bodies corporate, along with the investments, loans, guarantee or security proposed to be made or
given does not exceed the limit as specified in sub-section (2), and there is no default in repayment of loan
instalments or payment of interest thereon as per the terms and conditions of such loan to the public financial
institution.
(6) No company, which is registered under section 12 of the Securities and Exchange Board of India Act,
1992 and covered under such class or classes of companies as may be prescribed, shall take inter-corporate
loan or deposits exceeding the prescribed limit and such company shall furnish in its financial statement
the details of the loan or deposits.
(7) No loan shall be given under this section at a rate of interest lower than the prevailing yield of one year,
three year, five year or ten year Government Security closest to the tenor of the loan.
(8) No company which is in default in the repayment of any deposits accepted before or after the
commencement of this Act or in payment of interest thereon, shall give any loan or give any guarantee or
provide any security or make an acquisition till such default is subsisting.
(9) Every company giving loan or giving a guarantee or providing security or making an acquisition under
this section shall keep a register which shall contain such particulars and shall be maintained in such manner
as may be prescribed.
(10) The register referred to in sub-section (9) shall be kept at the registered office of the company and —
(a) shall be open to inspection at such office; and
(b) extracts may be taken therefrom by any member, and copies thereof may be furnished to any member
of the company on payment of such fees as may be prescribed.
(11) Nothing contained in this section, except sub-section (1), shall apply—
(a) to a loan made, guarantee given or security provided by a banking company or an insurance company
or a housing finance company in the ordinary course of its business or a company engaged in the business
of financing of companies or of providing infrastructural facilities;
(b) to any acquisition—
(i) made by a non-banking financial company registered under Chapter IIIB of the Reserve Bank of India
Act, 1934 and whose principal business is acquisition of securities:
Provided that exemption to non-banking financial company shall be in respect of its investment and lending
activities;
(ii) made by a company whose principal business is the acquisition of securities;
(iii) of shares allotted in pursuance of clause (a) of sub-section (1) of section 62.
(12) The Central Government may make rules for the purposes of this section.
which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and
every officer of the company who is in default shall be punishable with imprisonment for a term which may
extend to two years and with fine which shall not be less than twenty-five thousand rupees but which may
extend to one lakh rupees.
(a) the expression “investment company” means a company whose principal business is the acquisition of
shares, debentures or other securities;
(b) the expression “infrastructure facilities” means the facilities specified in Schedule VI.
Debentures
Narendra Kumar Maheshwari v. Union of India, (1989) 2 Comp LJ 95
Reliance Industries Ltd. (RIL) and Reliance Petrochemicals Industries Ltd. (RPL) are inter-connected and
represented Companies in the large industrial house known as Reliance Group. RIL had promoted RPL.
RPL was incorporated on 11.1.1988 and has been a cent percent subsidiary of RIL.
It was claimed that RPL would set up the largest petrochemical complex in India with foreign collaboration.
RPL proposed to issue convertible debentures for raising capital for the project.
The Controller of Capital Issues (CCI), who functions under the Capital Issues (Control) Act, 1947 had, on
15th September, 1984 by way of press release issued certain non-statutory guidelines for approval of issue
of secured convertible and non-convertible debentures. These guidelines were subsequently amended on
8.3.1985. Guidelines were also given by the CCI for issue of convertible cumulative preference shares, and
for employees stock option scheme.
RPL had, on 4.5.1988, made an application to CCI for issue of debentures of the face value of Rs.200 crores
fully convertible into equity shares on the following terms:
(i) A sum of Rs. 10 being 5% of the face value of each debentures by way of first conversion immediately
into one equity share at par on allotment;
(ii) A sum of Rs.40 being the 20% of the face value of each debenture by way of second conversion after
three years but before four years from the date of allotment at a premium to be fixed by the Controller of
Capital Issues;
(iii) The balance of Rs. 150 representing 75% of the face value of each debenture as third conversion after
five years but not later than seven years from the date of allotment at a premium to be fixed by the Controller
of Capital Issues.
The CCI accorded his sanction for the issue of debentures on 4.7.1988. However, the sanction was amended
on 19th July, 1988. The amendment put a non-transferability condition on the preferential share-holders of
RPL. It was limited to the corporate shareholders of RIL and relaxed for individual share-holders of RIL.
The amendment also stipulated that the Company should obtain prior approval of the
Reserve Bank of India, Exchange Control Department, for the allotment of debentures to the nonresidents
as required under the Foreign Exchange Regulation Act, 1973. On 26th July 1988, there was another
amendment which restricted the transfer of shares allotted to the employees of RPL and RIL.
The consent orders issued by the CCI were challenged in various High Courts, by way of writ petitions and
a suit. Some High Courts issued injunctions restraining the issue of the debentures.
This Court, on 19th August, 1988, restrained the aforesaid issuance of injunctions by the High Courts, and
issued directions for the issue of debentures. The cases pending in various High Courts were transferred to
this Court.
In these transferred cases the consent orders of the CCI were challenged mainly on the grounds that:
Despite the fact that RPL did not fulfil the requirements of a proper application and the necessary consent
andapproval, RPL's application was. entertained and processed by the CCI with undue expedition and
without application of mind;
RPL in its brochures has misled the public by describing the debentures as fully secured convertible
debentures;
The security for the debentures was inadequate;
RPL has been permitted to create securities which would have priority over the securities available to the
present debenture holders and without their consent;
RPL has misled the public in that in its prospectus it had stated that security would be provided to the
satisfaction of the trustees;
6.2. RPL is a company-not the State or a State instrumentality that is issuing the shares and debentures. It
is entirely for the company to issue the shares and debentures on such terms as they may consider practicable
from their point of view. There is no reason why they should not so structure the issue that it confers certain
great advantages and benefits on the existing share holders or promoters than on the new subscribers. It is
not permissible for the CCI to withhold consent only for this reason or to stipulate that consent can be given
only if the share holders and promoters as well as prospective debenture holders are all treated alike. The
subscribers to the debenture are only lenders to the company who have an option to convert their debt into
equity on certain terms. It is perfectly open to the subscribers to balance the pros and cons of the issue and
to desist from taking the debentures if they feel that the dice are loaded unfavourably in favour of the
"proprietors" of the company.
7.1. In the present case, a legal mortgage has been created by RPL in favour of the trustees in respect of its
immovable and movable assets, except book debts, in respect of which financial institutions will hold a first
charge on account of foreign loan. RPL does not have any existing loans. Therefore, the charge in favour
of the debenture holders is presently the first charge. No further borrowing is contemplated at this stage
except the foreign currency loan to the extent of Rs.84 crores. Even if the value of the foreign currency
which has been sanctioned in principle by the three financial institutions is taken into account, the assets
coverage goes down at each stage and does not make any critical difference to the value of the security of
the debenture holders under the Trust Deed. The purposes of borrowings, namely, termloan borrowings,
deferred payment credits/guarantees and borrowing for financing new projects do not, on analysis, raise
any difficulty. There are sufficient in-built checks and controls. The company, being an MRTP company
would have to obtain both MRTP permission for creating any security irrespective of its value and fresh
CCI consent under the CCI Act, except in case of exempted securities.
7.2. With the escalation in the value of the fixed assets due to passage of time on the one hand and the
redemption of a good portion of the debentures by the end of three years on the other, the security provided
is complete and, in any event, more than adequate to safeguard the interests of the debenture holders.
8. Clauses 5 and 6 are only enabling clauses and in the nature of permitting the Company, despite the
mortgage in favour of the debenture holders, to carry on his business normally. What is referred to therein
as residual charge is really a floating charge. The Company's normal business activities would necessarily
involve alienation of some of its assets from time to time such as goods manufactured by it as well as
procurement and discharge of loan and accommodation facilities from banks, financial institutions and
others. The entire progress of the company would come to a standstill in the absence of such enabling
provisions. They are not only usual but essential because the basic idea is that the finances raised by the
debentures should be employed for running the project profitably and thereby generate more and more
funds and assets which will also be available to the debentures holders. Further what the clauses provide is
only that the consent and concurrence of the debenture holders need not be obtained by the company before
creating securities that may have priority over the present issue of debentures. But the trustees for the
debenture holders have to concur before the company can raise any future borrowings and create, therefor,
the security which will have priority over the security available to the present debenture holders. The ICICI
is not only a financial institution in the public sector but also one of the institutions financing the project
and thus has a stake in its success and so can be trusted to safeguard the interests of the debenture holders.
The debenture trust deed also contains a provision by which at the time of creation of any future charge the
terms and ranking have to be agreed upon between RPL and ICICI. Clause 16 of the trust deed authorises
the trustees to intervene and crystallise the charge in certain circumstances and stultify an attempt by the
company to create higher ranking charges. There are also restraints on the company under the Companies
Act and the MRTP Act involving the consent of public financial institutions, Commercial Banks, the term
lenders, share holders, the MRTP Commission, the Central Govt. and the CCI before the creation of such
securities.
9. In certain brochures and pamphlets issued by RPL, the debentures were described as "fully secured
convertible debentures". The company admitted that there was such a description but explained that this
was due to an oversight; the words "fully secured convertible debentures" were printed in some brochures
instead of the words "secured fully convertible debentures" without meaning or intending any change. It
was stated that the company's representation was that the debentures were "secured fully convertible" ones.
This is also what had been set out in the application for consent. Though the company did claim that the
debentures were also fully secured, the emphasis in the issue was that the debentures were fully convertible
and secured. This explanation is plausible. No importance or significance need be attached to the different
description in some places particularly. in the context of the nature of security actually provided for the
debentures.
10. Prospectus issued by RPL is not misleading because it stated that security will be provided to the
satisfaction of the trustees and the CCI accepted that statement in the application for consent. The debenture
trustees are well known financial institutions and it is not possible for the CCI to ensure more than the usual
practice which was followed in the present case.
11. The CCI modified paragraph 5 of the consent by his letter of the 19th July, 1988 to say that allotment
to the employees shall not exceed 50 debentures per individual. It does not appear that the restriction of the
allotments to the employees was at the instance of the Company; nor does it seem that any discrimination
was intended in respect of the allotments to the employees. Nor has attention been invited to any legal
requirements or guidelines prescribing any fixed or minimum quota of allotment to the employees of the
Company. Under the circumstances, the question of discrimination does not arise.
12. The consent order of the CCI clearly indicated that the consent conveyed in the letter shall lapse on the
expiry of 12 months from the date thereof. The consent order categorically stated that the approval was
without prejudice to any other approval/permission that may be required to be obtained under any other
Acts and laws in force. It necessarily follows that the obligation to obtain other permissions continued.
There was no legal conditions that other approvals should be examined by the CCI before grant of its own
consent.
13.1. As defined in the Companies Act, a debenture need not be secured. Therefore, guideline 10 means
that security should be provided as is customarily adopted in corporate practice. In the present case, the
debentures are compulsorily convertible and so no repayment is really involved.
The debenture is essentially an acknowledgement of debt with a commitments to repay the principal with
interest. The question of security becomes relevant for the purpose of payment of interest only in the
unlikely event of winding up. The guidelines did not provide for the quantum and the nature of the security.
A debenture may, therefore, be secured or unsecured. An ordinary debenture has to be distinguished from
a mortgage debenture which necessarily creates mortgage on the assets of a Company. A compulsorily
convertible debenture does not postulate any repayment of the principal and so does not constitute a
debenture in the classic sense. Even a debenture which is only convertible at option has been recognised as
a hybrid debenture. The guidelines for the protection of debenture holders issued on 14.1.1987 recognise
the basic distinction between convertible and non-convertible debenture. Compulsorily convertible
debentures in corporate practice were adopted in India sometime after 1984. Wherever the concept of
compulsorily convertible debenture is involved, various guidelines issued by the Government of India treat
them as equity and not as loan or debt. Even a non-convertible debenture need not always be secured. In
fact, modern tendency is to raise loan by unsecured stock which does not create any charge on the assets of
a Company. Whenever a security is created, it is invariably in the form of a floating charge. In addition they
are frequently secured by a trust deed as in the present case where specific property/land etc. has been
mortgaged to the trustees.
13.2. In the instant case, if the permission of the debenture holders were required or is insisted upon to
create future security, 2.5 million debenture holders have to be informed and invited for the meeting. The
extravagant effects of this course would be collosal especially when a shareholders meeting is also
additionally called for the same body of persons. It is, therefore, incorrect to say that a floating charge
creates an illusory charge because future securities can be created ranking in priority over it.
MODULE XI - MINORITY PROTECTION

Rule in Foss v. Harbottle
Facts:
Richard Foss and Edward Starkie Turton were two minority shareholders in the “The Victoria Park
Company”. The company had been set up in September 1835 to buy 180 acres (0.73 km2) of land
near Manchester to establish a residential area to the east of Wilmslow road. Subsequently, an Act of
Parliament incorporated the company. The claimants alleged that property of the company had been
misapplied and wasted and various mortgages were given improperly over the company’s property. The
two shareholders also claimed that the defendants had defrauded the company in various ways and in
particular that the defendants had sold land belonging to them to the company at exorbitant price. The
defendants were the five company directors (Thomas Harbottle, Joseph Adshead, Henry Byrom, John
Westhead, Richard Bealey) and the solicitors and architect (Joseph Denison, Thomas Bunting and Richard
Lane); and also H Rotton, E Lloyd, T Peet, J Biggs and S Brooks, the several assignees of Byrom, Adshead
and Westhead, who had become bankrupts. The claimants took the help of the court to order that the
defendants make good the losses to the company.
Issue:
- Whether the minority shareholders sue the company and its director
- Whether the company seek to redress in its corporate character
Discussion:
- The principle of majority rule was recognized in Foss vs. Harbottle (1843). It is also known as
“proper plaintiff principle”, which states that, in order to redress a wrong done to a company or to
the property of the company or to enforce rights of the company, the proper claimant is the company
itself, and the court will not ordinarily entertain an action brought on behalf of the company by a
shareholder.
- The “majority rule principle” stands for the proposition that the decisions and choices of the
majority will always prevail over those of the minorities. In practice, the greater the amount of
shareholding of an individual member, the greater rights and powers accrued to that individual
member within the company. As a general principle laid down in Foss v Harbottle, where it is
alleged that a wrong has been done to the company then proper claimant in such an action is the
company itself and where the company is competent to settle the alleged wrong itself or, the
company is competent to ratify or condone an irregularity by its own internal procedure, then no
individual member may bring action.
- It was held by Vice-Chancellor Wigram that since the company’s board of directors was still in
existence, and since it was still possible to call a general meeting of the company, there was nothing
to prevent the company from obtaining redress in its corporate character, and the action by the
claimants could not be sustained.
- One important point which relates to the charges and incumbrances alleged to have been illegally
made on the property of the company is open to the reasoning that individual members are at liberty
to complain in the form adopted by the bill. The case made with regard to these mortgages or
incumbrances is that they were executed in violation of the provisions of the Act. The mortgagees
are not defendants to the bill, nor does the bill seek to avoid the security itself. The bill prays
inquiries with a view to proceedings being taken allude to set aside these transactions against the
mortgagees. The object of this bill against the defendants is to make them individually and
personally responsible to the extent of the injury alleged to have been received by the corporation
from the making of the mortgages
Basis of the Rule-
- The right of the Majority Rule

The court has said in some of the cases that an action by a single shareholder cannot be entertained
because the feeling of the majority of the members has not been tested and that they may be
prepared to waive their right to sue.
- Company is a Legal Person

The court has also said from time to time that since a company is a person at law, the action is
vested in it and cannot be brought by a single member.
- The prevention of multiplicity of Actions

This situation could occur if each individual member was allowed to commence an action in respect
of a wrong done to the company.
- The court’s order may be made ineffective

The court’s order could be overruled by an ordinary resolution of members in a subsequent general
meeting.
Conclusion:
The court dismissed the suit on the ground that the acts of the directors were capable of
confirmation by the majority members and held that the proper plaintiff for wrongs done to the
company is the company itself and not the minority shareholders and the company can act only
through majority shareholders.
The rationale in that line of reasoning is that a company is a separate legal entity from the members
who compose it and as such, if any right of the company is violated, it is the company which can
bring an action through the majority.
It was also held that, it is elementary principle of law relating to joint stock companies that the
court will not interfere with the internal management of the company, acting within their powers
and jurisdiction to do so. Again it is clear that in order to redress a wrong done to the company or
to recover money or damages due to the company the action should prima facie be brought by the
company itself.
Exceptions to the rule in Foss v. Harbottle
Rajahmundry Electric Supply Co. v. Nageshwara Rao AIR 1956 SC 213
This appeal arises out of an application filed by the first respondent under section 162, clauses (v) and (vi)
of the Indian Companies Act for an order that the Rajahmundry Electric Supply Corporation Ltd., be wound
up. The grounds on which the relief was claimed were that the affairs of the Company were being grossly
mismanaged, that large amounts were owing to the Government for charges for electric energy supplied
by them, that the directors had misappropriated the funds of the Company, and that the directorate which
had the majority in voting strength was "riding roughshod" over the rights of the shareholders. In the
alternative, it was prayed that action might be taken under section 153-C and appropriate orders passed to
protect the rights of the shareholders. The only effective opposition to the application came from the
Chairman of the Company, Appanna Ranga Rao, who contested it on the ground that it was the Vice
Chairman, Devata Ramamobanrao, who was responsible for the maladministration of the Company, that
he had been removed from the directorate, and steps were being taken to call him to account, and that there
was accordingly no ground either for passing an order under section 162, or for taking action under section
153-C.
The learned Judge of the Andhra High Court before whom the application came up for hearing, held that
the charges set out therein had been substantially proved, and that it was a fit case for an order for winding
up being made under section 162(vi). He also held that under the circumstances action could be taken under
section 153-C, and accordingly appointed two administrators for the management of the Company for a
period of six months vesting in them all the powers of the directorate and authorising them to take the
necessary steps for recovering the amounts due, paying the debts and for convening a meeting of the
shareholders for the purpose of ascertaining their wishes whether the administration should continue, or
whether a new Board of Directors should be constituted for the management of the Company.
Against this order, the Chairman, Appanna Ranga Rao, acting in the name of the Company preferred an
appeal to a Bench of the Andhra High Court. The learned Judges agreed with the trial Judge that the affairs
of the Company, as they stood, justified action being taken under section 153-C, and dismissed the appeal.
Against this order, the Company has preferred this appeal by special leave.
On behalf of the appellant, it was firstly contended that the application in so far as it was laid under section
153-C was not maintainable, as there was no proof that the applicant bad obtained the consent of the
requisite number of shareholders as provided in sub-clause (3)(a)(i) to section 153-C. That clause provides
that a member is entitled to apply for relief only if he has obtained the consent in writing of not less than
one hundred in number of the members of the company or not less than one-tenth in number of the members,
whichever is less. The first respondent stated in his application that he bad obtained the consent of 80
shareholders, which was more than onetenth of the total number of members, and had thus satisfied the
condition laid down in section 153-C, sub-clause (3) (a)
(i). To this, an objection was taken in one of the written statements filed on behalf of the respondents that
out of the 80 persons who had consented to the institution of the application, 13 were not share-holders at
all, and that two members had signed twice. It was further alleged that 13 of the persons who had given
their consent to the filing of the application had subsequently withdrawn their consent. In the result,
excluding these 28 members, it was pleaded, the number of persons who had consented would be reduced
to 52, and therefore the condition laid down in section 153-C, sub- clause (3) (a) (i) was not satisfied.
This point is not dealt with in the judgment of the trial court, and the argument before us is that as the
objection went to the root of the matter and struck at the very maintainability of the application, evidence
should have been taken on the matter and a finding, recorded thereon. We do not find any substance in this
contention. Though the objection was raised in the written statement, the respondents did not press the same
at the trial, and the question was never argued before the trial Judge. The learned Judges before whom this
contention was raised on appeal declined to entertain it, as it was not pressed in the trial court, and there are
no grounds for permitting the appellant to raise it in this appeal. Even otherwise, we are of opinion that this
contention must, on the allegations in the statement, assuming them to be true, fail on the merits. Excluding
the names of the 13 persons who are stated to be not members and the two who are stated to have signed
twice, the number of members who had given consent to the institution of the application was 65. The
number of members of the Company is stated to be 603. If, therefore, 65 members consented to the
application in writing, that would be sufficient to satisfy the condition laid down in section 153-C, subclause
(3)(a) (i). But it is argued that as 13 of the members who had consented to the filing of the application bad,
subsequent to its presentation, withdrawn their consent, it thereafter ceased to satisfy the requirements of
the statute, and was no longer maintainable. We have no hesitation in rejecting this contention. The validity
of a petition must be judged on the facts as they were at the time of its presentation, and a petition which
was valid when presented cannot, in the absence of a provision to that effect in the statute, cease to be
maintainable by reason of events subsequent to its presentation. In our opinion, the withdrawal of consent
by 13 of the members, even if true, cannot affect either the right of the applicant to proceed with the
application or the jurisdiction of the court to dispose of it on its own merits.
It was next contended that the allegations in the application were not sufficient to support a winding up
order under section 162, and that therefore no action could be taken under section 153-C. We agree with
the appellant that before taking action under section 153-C, the court must be satisfied that circumstances
exist on which an order for winding up could be made under section 162. The true scope of section 153-C
is that whereas prior to its enactment the court had no option but to pass an order for winding up when the
conditions mentioned in section 162 were satisfied, it could now in exercise of the powers conferred by that
section make an order for its management by the court with a view to its being ultimately salvaged. Where,
therefore, the facts proved do not make out a case for winding up under section 162, no order could be
passed under section 153-C. The question therefore to be determined is whether the facts found make out a
case for passing a winding up order under section 162. In his application the first respondent relied on
section 162, clauses (v) and (vi) for an order for winding up. Under section 162(v), such an order could be
made if the company is unable to pay its debts. It was. alleged in the application that the arrears due to the
Government on 25-6-1955 by way of charges for energy supplied by them amounted to Rs. 3,10,175-3-6.
But there was no evidence that the Company was unable to pay the amount and was commercially insolvent,
and the learned trial Judge rightly held that section 162(v) was inapplicable. But he was of the opinion that
on the facts established it was just and equitable to make an order for winding up under section 162(vi),
and that view has been affirmed by the learned Judges on appeal.
It was argued for the appellant that the evidence only established that the Vice-Chairman, Devata
Ramamohan Rao, who had been ineffective management was guilty of misconduct, and that by itself was
not a sufficient ground for making an order for winding up. It was further argued that the words "just and
equitable" in clause (vi) must be construed ejusdem generis with the matters mentioned in clauses (i) to (v),
that mere misconduct of the directors was not a ground on which a winding up order could be made, and
that it was a matter of internal management for which resort must be bad to the other remedies provided in
the Act.
The contention of the appellant is that as all the charges made in the application amounted only to
misconduct on the part of the directors, and as there was no proof that the Company was unable to pay its
debts, an order for winding up under section 162 could not be made.
"The words 'just and equitable' in the enactment specifying the grounds for winding up by the court are not
to be read as being ejusdem generis with the preceding words of the enactment".
When once it is held that the words "just and equitable" are not to be construed ejusdem generis, then
whether mismanagement of directors is a ground for a winding-up order under section 162(vi) becomes a
question to be decided on the facts of each case. Where nothing more is established than that the directors
have misappropriated the funds of the Company, an order for winding up would not be just or equitable,
because if it is a sound concern, such an order must operate harshly on the rights of the shareholders. But
if, in addition to such misconduct, circumstances exist which render it desirable in the interests of the
shareholders that the Company should be wound up, there is nothing in section 162(vi) which bars the
jurisdiction of the court to make such an order. Loch v.John Blackwood.(1)was itself a case in which the
order for winding up was asked for on the ground of mismanagement by the directors, and the law was thus
stated at page 788:
"It is undoubtedly true that at the foundation of applications for winding up, on the 'just and equitable' rule,
there must lie a justifiable lack of confidence in the conduct and management of the company's affairs. But
this lack of confidence must be grounded on conduct of the directors, not in regard to their private life or
affairs, but in regard to the company's business. Further more the lack of confidence must spring not from
dissatisfaction at being outvoted on the business affairs or on what is called the domestic policy of the
company. On the other hand, wherever the lack of confidence is rested on a lack of probity in the conduct
of the company's affairs, then the former is justified by the latter, and it is under the statute just and equitable
that the company be wound up". Now, the facts as found by the courts below are that the Vice-Chairman
grossly mismanaged the affairs of the Company, and had drawn considerable amounts for his personal
purposes, that arrears due to the Government for supply of electric energy as on 25-6-1955 was Rs.
3,10,175-3-6, that large collections had to be made that the machinery was in a state of disrepair, that by
reason of death and other causes the directorate had become greatly attenuated and "a powerful local junta
was ruling the roost", and that the shareholders outside the group of the Chairman were apathetic and
powerless to set matters right. On these findings, the courts below had the power to direct the winding up
of the Company under section 162(vi), and no grounds have been shown for our interfering with their order.
It was urged on behalf of the appellant that as the Vice- Chairman who was responsible for the
mismanagement had been removed, and the present management was taking steps to set things right and to
put an end to the matters complained of, there was no need to take action under section 153-C. But the
findings of the courts below are that the Chairman himself either actively co-operated with the
ViceChairman in various acts of misconduct and maladministration or that he had, at any rate, on his own
showing abdicated the entire management to him, and that as the affairs of the Company where in a state
of confusion and embarrassment, it was necessary to take action under section 153-C. We are of opinion
that the learned Judges were justified on the above findings in passing the order which they did.
It was also contended that the appointment of administrators in supersession of the directorate and vesting
power in them to manage the Company was an interference with its internal management. It is no doubt the
law that courts will not, in general, intervene at the instance of shareholders in matters of internal
administration, and will not interfere with the management of a company by its directors, so long as they
are acting within the power conferred on them under the Articles of Association. But this rule can by its
very nature apply only when the company is a running concern, and it is sought to interfere with its affairs
as a running concern. But when an application is presented to wind up a company, its very object is to put
an end to its existence, and for that purpose to terminate its management in accordance with the Articles of
Association and to vest it in the court., In that situation, there is no scope for the rule that the court should
not interfere in matters of internal management. And where accordingly a case had been made out for an
order for winding up under section 162, the appointment of administrators under section 153-C cannot be
attacked on the ground that it is an interference with the internal management of the affairs of the Company.
If a Liquidator can be appointed to manage the affairs of a company when an order for winding up is made
under section 162, administrators could also be appointed to manage its affairs, when action is taken under
section 153-C. This contention must accordingly be rejected.
In the result, the appeal fails and is dismissed with costs, of the first respondent. The costs of the
administrator will come out of the estate.
What constitutes oppression?

Shanti Prasad Jain v. Kalinga Tubes AIR 1965 SC 1535
In July 1954, two groups of shareholders led by P and 1, who, together held an equal number of shares of
the value of Rs. 21 lakhs out of a total share capital of Rs. 25 lakhs in the respondent company (then a
private ate company), entered into a private agreement with the Appellant, whereby, (i) the share capital of
the company was to be increased by Rs. 10 1/2 lakhs and shares of this value allotted to the appellant so
that the total shares held by him would be equal to the holding of each of the other two groups; (ii) each of
these three groups of shareholders would have an equal number of representatives on the Board of Directors;
(iii) the appellant undertook to arrange certain credit facilities for the company; and (iv) the appellant was
to be the Chairman of the Board. In accordance with this agreement, the appellant was made the Chairman
and though various resolutions were passed by the company to implement the agreement, these resolutions
did not in terms refer to the agreement. and no change was made in the Articles of Association of the
company so as to embody the terms of the agreement. Some time later, the subscribed capital of the
company was increased to Rs. 61 lakhs and the new shares were so allotted as to maintain the parity in the
shareholdings of the three groups. When one of the two minority shareholders sold 250 shares, these were
equally divided between the three groups and one odd share was held by P, L and the Appellant jointly.
In 1956-57, the company desired to raise a loan from the Industrial Finance Corporation and as this
Corporation made advances only to public limited companies, in January 1957 the company was converted
into a public company.
Appropriate amendments were made in its Articles of Association, but even on this occasion, no attempt
was made to incorporate into the Articles the terms of the Agreement of July 1954. After sanction had been
obtained of the Controller of Capital Issues for the issue of additional share capital, the appellant suggested
at a meeting of the board of directors in March 1958 that the new shares should be issued proportionately
to the existing shareholders in accordance with the provisions of Section 81 of the Companies Act, 1956.
On the other hand those representing the P and L groups proposed that the new shares should be offered
privately in the best interests of the company at the sole discretion of the directors; this proposal was made
because these two groups did not have money to subscribe for the new capital and they feared that if shares
were offered in the first instance to existing shareholders, the appellant could get all of them and thus
acquire control of the company. In view of the majority of the P and L groups in the Board, their proposal
was adopted and subsequently a resolution to that effect was also accepted at a General Meeting of the
shareholders held in March 29, 1958. The appellant thereafter instituted a suit to have the resolution
declared illegal and void and obtained an ex parte injunction against the company from allotting shares
pursuant to this resolution. On July 13, 1958, the appellant's suit was dismissed by the Subordinate Judge
and the injunction vacated by him at 11 A.M. The Board of Directors at a meeting held on that date,
immediately on receiving the news that the injunction had been vacated, allotted the new shares to seven
persons who had previously applied for them. On the same day, the appellant filed an appeal and applied
for and obtained an order staying the operation of the order of the Subordinate Judge. Eventually these
appeals were also dismissed and the stay vacated.
In September 1960 another General meeting of the company was called to approve a proposal to increase
the share capital of the company from Rs. 1 crore to Rs. 3 crores. It was also intended that these new shares
should be offered to outsiders with a view to making the company more broad-based.
At that stage the appellant filed a petition in the High Court under Section 397 and 398 of the Companies
Act, 1956, complaining inter alia, that the issue of new shares was in furtherance of a continuing oppression
of the appellant’s minority group; that by allotting such shares to benamidars of P and L in disregard of the
agreement of July 1954, it was intended to exclude the appellant from all control of the affairs of the
company; that the resolutions passed in March 1958 as to the manner of allotment of new shares
contravened s. 81 of the Companies Act, 1 956 and this resolution as well as the hasty allotment on July
30, 1958 were in abuse of the power of the P and L groups and oppressive of the minority. The petition was
allowed by the single Judge but this decision was reversed in appeal by a Division Bench of the High Court.
On appeal to the Supreme Court.
HELD : (i) On the facts no case had been made out, of oppression within the meaning of section 397.
For a petition under section 397 to succeed, it is not enough to show that there is just and equitable cause
for winding up the company, though that must be shown as preliminary to the application of section 397. It
must further be shown that the conduct of the majority share-holders was oppressive to the minority as
members and this requires that events have to be considered not in isolation but as a part of a consecutive
story. There must be continuous acts on the part of the majority shareholders, continuing up to the date of
the petition, showing that the affairs of the company were being conducted in a manner oppressive to some
part of the members. The conduct must be burdensome, harsh and wrongful and mere lack of confidence
between the majority shareholders and the minority shareholders would not be enough unless lack of
confidence springs from oppression of the minority by a majority in the management of the company's
affairs, and such oppression must involve at least an element of lack of probity or fair dealing to a member
in the matter of his proprietary rights as a shareholder.
(ii) The agreement of July 1954 on which the case of oppression was based was not binding even on the
private company and much less so on the public company when it came into existence in 1957. It was really
an agreement between a non-member and two members of the company and although for some time the
agreement was in the main carried out, clearly some of its terms could not be put in the articles of association
of the public company. As the company was not bound by the agreement, the mere fact that it was decided
at the meeting in March 1958 to offer the new shares to outsiders and not the existing shareholders did not
necessarily amount to an oppression of the minority shareholders. The majority shareholders were not
bound to accept a proposal of the minority shareholders that the new shares should be allotted only to the
existing shareholders. Furthermore the general meeting having decided that new shares should not be issued
to the existing shareholders but to others, there was no contravention of s. 81 of the Companies Act 1956
and the resolution of March 28, 1958 was in accordance with law as it stood at the time.
(iii) it could not be said that the allottees of new shares were benamidars or stooges of the P or L group and
that by allotment of shares to them, the majority shareholders were oppressing the minority. These allottees
were independent persons and the fact that the P and L groups might be able to get the support of the holders
of the new shares did not necessarily mean oppression of the appellant, for the new shareholders may
support the P and L groups on the ground that such support would be for the benefit of the Company.
(iv) The haste in issuing now shares upon the vacation of the injunction of July 30, 1958 could not be held
to be a part of the design to oppress the minority. The company was in need of money for expansion and
its ability to obtain a loan from the Finance Corporation depended upon the increase of its subscribed share
capital. The haste became necessary because the injunction was vacated on that day and it was felt that if
immediate action was not taken and the new shares allotted, there might be a further injunction and
consequent delay. The haste in the allotment of shares arose out of circumstances brought about by the
appellant's conduct.
Held also, that no case had been made out for action under section 398 on the ground that the affairs of the
company were being conducted in a manner prejudicial to its interests.
Remedies for oppression and mismanagement
Needle Industries (India) Ltd. and Ors. Vs. Needle Industries Newey (India) Holding Ltd. and Ors.
Facts-
Needle Industries India was held by 2 groups, the majority (60%) located in U.K. and the minority (40%)
in India. In 1973, FERA Regulations came in which brought a ceiling limit of 40% shareholding by non-
residents in Indian Companies. Needle Industries were thus required to reduce its non-resident holding from
60% to 40%. The Indian shareholding group led by Mr. D tried to negotiate with the non-resident
shareholders to transfer the excess shares to the Indian shareholders. But none of the negotiations
materialized. This forced Mr. D to issue rights issue without informing the non-resident holders in time
about the same. Therefore, the entire issue was subscribed by the Indian holders thereby raising their stake
to 60% and reducing the non-resident holding to 40%.
Issue-
Whether the act of Mr. D of performing Rights Issue without properly informing the non-resident
shareholders, amounted to oppression and mismanagement?
Discussion
The question sometimes arises as to whether an action in contravention of law is per se oppressive. It is
said, as was done by one of us, N.H. Bhagwati J. in a decision of the Gujarat High Court in S.M. Ganpatram
v. Sayaji Jubilee Cotton & Jute Mills Co. [1964] 34 Company Cases 830-31 that “a resolution passed by
the directors may be perfectly legal and yet oppressive, and conversely a resolution which is in
contravention of the law may be in the interests of the shareholders and the company”. On this question,
Lord President Cooper observed in Elder v. Elder [1952] S.C. 49:
The decisions indicate that conduct which is technically legal and correct may nevertheless be such as to
justify the application of the ‘just and equitable’ jurisdiction, and, conversely, that conduct involving
illegality and contravention of the Act may not suffice to warrant the remedy of winding up, especially
where alternative remedies are available. Where the ‘just and equitable’ jurisdiction has been applied in
cases of this type, the circumstances have always, I think, been such as to warrant the inference that there
has been, at least, an unfair abuse of powers and an impairment of confidence in the probity with which the
company’s affairs are being conducted, as distinguished from mere resentment on the part of a minority at
being outvoted on some issue of domestic policy.
Neither the judgment of Bhagwati J. nor the observations in Elder are capable of the construction that every
illegality is per se oppressive or that the illegality of an action does not bear upon its oppressiveness. In
Elder a complaint was made that Elder had not received the notice of the Board meeting. It was held that
since it was not shown that any prejudice was occasioned thereby or that Elder could have bought the shares
had he been present, no complaint of oppression could be entertained merely on the ground that the failure
to give notice of the Board meeting was an act of illegality. The true position is that an isolated act, which
is contrary to law, may not necessarily and by itself support the inference that the law was violated with a
mala fide intention or that such violation was burdensome, harsh and wrongful. But a series of illegal acts
following upon one another can, in the context, lead justifiably to the conclusion that they are a part of the
same transaction, of which the object is to cause or commit the oppression of persons against whom those
acts are directed. This may usefully be illustrated by reference to a familiar jurisdiction in which a litigant
asks for the transfer of his case from one Judge to another. An isolated order passed by a Judge which is
contrary to law will not normally support the inference that he is biased; but a series of wrong or illegal
orders to the prejudice of a party are generally accepted as supporting the inference of a reasonable
apprehension that the Judge is biased and that the party complaining of the orders will not get justice at his
hands.
- In Kalinga Tubes, Wanchoo J. referred to certain decisions under Section 210 of the English Companies
Act including Meyer and observed :
These observations from the four cases referred to above apply to Section 397 also which is almost in the
same words as Section 210 of the English Act, and the question in each is whether the conduct of the affairs
of the company, by the majority shareholders was oppressive to the minority shareholders and that depends
upon the facts proved in a particular case. As has already been indicated, it is not enough to show that there
is just and equitable cause for winding up the company, though that must be shown as preliminary to the
application of Section 397. It must further be shown that the conduct of the majority shareholders was
oppressive to the minority as members and this requires that events have to be considered not in isolation
but as a part of a consecutive story. There must be continuous acts on the part of the majority shareholders,
continuing up to the date of petition, showing that the affairs of the company were being conducted in a
manner oppressive to some part of the members. The conduct must be burdensome, harsh and wrongful
and mere lack of confidence between the majority shareholders and the minority shareholders would not be
enough unless the lack of confidence springs from oppression of a minority by a majority in the
management of the company’s affairs, and such oppression must involve at least an element of lack of
probity of fair dealing to a member in the matter of his proprietary rights as a shareholder. It is in the light
of these principles that we have to consider the facts...with reference to Section 397.
At pages 734-735 of the judgment in Kalinga Tubes, Wanchoo J. has reproduced from the judgment in
Meyer, the five points which were stressed in Elder. The fifth point reads thus :
The power conferred on the Court to grant a remedy in an appropriate case appears to envisage a reasonably
wide discretion vested in the Court in relation to the order sought by a complainer as the appropriate
equitable alternative to a winding-up order.
- It is clear from these various decisions that on a true construction of Section 397, an unwise, inefficient
or careless conduct of a Director in the performance of his duties cannot give rise to a claim for relief under
that section. The person complaining of oppression must show that he has been constrained to submit to a
conduct which lacks in probity, conduct which is unfair to him and which causes prejudice to him in the
exercise of his legal and proprietary rights as shareholder. It may be mentioned that the Jenkins Committee
on Company Law Reform had suggested the substitution of the word ‘Oppression’ in Section 210 of the
English Act by the words ‘unfairly prejudicial’ in order to make it clear that it is not necessary to show that
the act complained of is illegal or that it constitutes an invasion of legal rights (see Gower’s Company Law,
4th edn., page 668). But that recommendation was not accepted and the English Law remains the same as
in Meyer and in Re H.R. Hartner Ltd., [1959] WLR 62 as modified in Re Jermyn St. Turkish Baths. We
have not adopted that modification in India.
- These contentions of the Holding Company have been controverted by Shri Nariman, according to whom,
the appellate Court has taken a one-sided view of the matter which is against the weight of evidence on the
record. Counsel contends that Devagnanam had done all that lay in his power to persuade the Holding
Company to disinvest so as to reduce its holding in NIIL to 40%, that the Directors of NIIL were left with
no option save to decide upon the issue of rights shares, since disinvestment was a matter of the Holding
Company’s volition, that the wording of the agenda of the meetings of April 6 and May 2 conveyed all that
there was to say on the subject since, in the background of the negotiations which had taken place between
the parties, it was clear that what was meant by ‘Policy-Indianization’ and ‘Allotment of Shares’ was the
allotment of rights shares in order to effectuate the policy of the Reserve Bank that the Indianization of the
Company should be achieved by the reduction of the non-resident holding to 40%, that Coats refused
persistently, both actively and passively, either to disinvest or to consider the only other alternative of the
issue of rights shares, and that the impugned decisions were taken by the Board of Directors objectively in
the larger interests of the Company. According to Shri Nariman, Coats left no doubt by their attitude that
their real interest lay in their worldwide business and they wanted to bring the working of NIIL to a grinding
halt with a view to eliminating an established competitor from their business. It is denied by counsel that
important facts or circumstances were deliberately suppressed from the Holding Company or that the letter
of offer and the notice of the Board’s meeting of May 2 were deliberately posted late on April 27. It is
contended that neither by the issue of rights shares nor by the failure to give the right of renunciation to the
Holding Company was any injury caused to its proprietary rights as a shareholder in NIIL. As a result of
the operation of FERA, the directives issued by the Reserve Bank there under and because of the fact that
NIIL had retained its old Articles after becoming a public company under Section 43A of the Companies
Act, the Holding Company could neither have participated in the issue of rights shares nor could it have
renounced the rights shares offered to it in favour of an outsider, not even in favour of a resident Indian
Company like Madura Coats. It is denied that Silverston was not a disinterested Director or that his
appointment as an additional Director was otherwise invalid. Counsel sums up his argument by saying that
the Board of Directors of NIIL had in no manner abused its fiduciary position and that far from their conduct
being burdensome, harsh and wrongful, it was the attitude of Coats which was unfair, unjust and
obstructive. Coats having come into an equitable jurisdiction with unclean hands, contends Shri Nariman,
no relief should be granted to them assuming for the sake of argument that Devagnanam from the position
of Managing Director, are characterised by counsel as wholly uncalled for, transcending the exigencies of
the situation.
- It seems to us unquestionable that Devagnanam played a key role in the negotiations with the Holding
Company and ultimately master-minded the issue of rights shares. He occupied a pivotal position in NIIL,
having been its Director for over twenty years and a Managing Director over fifteen years, in which capacity
he held an undisputed sway over, the affairs of NIIL. The Holding Company had nominated only one
Director on the Board of NIIL, namely, N.T, Sanders, who resided in England and hardly ever attended the
Board’s meetings. Devagnanam was thus a little monarch of all that he surveyed in Ketty. He had a large
personal stake in NIIL’s future since he and his group held nearly 30% shares in it, the other Indian
shareholders owning a mere 10%. In the 60% share capital owned by the Holding Company, Coats and
NEWEY were equal sharers with the result that Coats, NEWEY and Devagnanam each held an
approximately 30% share capital in NIIL. This equal holding created tensions and rivalries between Coats
and Devagnanam, NEWEY preferring to side with the latter in a silent, unspoken manner. Eventually, after
the filing of the Company Petition, Coats bought over NEWEY’s interest in NIIL sometime in July 1977.
- On January 20, 1977, the Reserve Bank sent a reminder to NIIL. After referring to the letter of May 11,
1976, the Reserve Bank asked NIIL to submit at an early date the progress report regarding dilution of the
non-resident interest. In reply, a letter dated February 21, 1977 was sent by NIIL to the Bank, stating :
We confirm that we are following up the matter regarding dilution of non-resident interest and we confirm
our commitment to achieve the desired Indianization by the stipulated date, i.e. 17th May, 1977.
It is very important to note that a copy of this letter was forwarded both to Whitehouse and Sanders. They
must at least be assumed to know that not only was Indianization to be achieved by May 17, 1977, but that
NIIL had committed itself to do so by that date.
- Shri Seervai relies strongly on a letter dated March 9, 1977 written by Raeburn to Devagnanam. After
saying that on the Friday preceding the 9th March, he had discussions with Mackrael and three high-ranking
personnel of Coats, Raeburn says in that letter that Coats had refused to agree that the Indian shareholders
should acquire a 60% shareholding in NIIL that this had created a new situation and that he was appending
to the letter an outline of what he believed, but could not be sure, would be agreeable to Coats/Needle
Industries. Raeburn stated further in that letter:
I know that all this will be difficult for you and your fellow Indian shareholders, but I urge you to support
this view and get their acceptance, and to come here to be able to negotiate. If these or similar principles
can be agreed during your visit, I have no doubt that the detailed method can be quickly arranged.
Raeburn stated that the proposal annexed to the letter had not been agreed with Coats but he, on his own
part, believed that Coats could be persuaded to agree to it. Stated briefly, the proposal annexed by Raeburn
to his letter aforesaid involved (i) the existing Indian shareholders holding 49% of the shares, (ii) new Indian
independent institutional shareholders holding 11 % of the shares, and (iii) the existing U.K. shareholders,
either directly or indirectly, holding 40% of the shares. The proposed Board of Directors was to consist of
representatives of the shareholders appointed by them thus :
Existing Indian shareholders 3, New independent Indian shareholders 1, existing U.K. shareholders 2, and
an independent Indian Chairman acceptable to all parties.
- It is contended by Shri Seervai that these proposals are crucial for more than one reason since, in the first
place, the proposal to increase the holding of the existing Indian shareholders to 49% and the offer of 11%
to new Indian independent institutional shareholders was inconsistent with the charge that Coats wanted to
retain control over NIIL, directly or indirectly. The second reason why it is said that the proposal is crucial
is that Raeburn’s letter of March 9 must have been received by Devagnanam before March 14 since it was
replied to on the 14th. Therefore, contends Shri Seervai, the negotiations between the parties were still not
at an end. Counsel says that it was open to Devagnanam to refuse to negotiate on the terms suggested and
insist that the Indian shareholders must have 60% of the shares. Instead of conveying his reactions to the
proposal Devagnanam, it is contended, went to the United Kingdom to discuss the question. The minutes
of discussions which took place in U.K., Mackrael and Sanders not taking any part therein, show that
NEWEY continued to plead that the Indian shareholders and Coats should consider the compromise
formula and that Devagnanam undertook to put to the Indian shareholders further proposals for compromise
and to consider what other proposals or safeguards they might suggest. Reliance is also placed by counsel
on a letter which Devagnanam wrote to Raebnrn on April 5, in support of the submission that the
negotiations were still not at an end. The last but one paragraph of that letter reads thus :
As undertaken, I shall place the compromise formula, very kindly suggested by you, before my colleagues
later today. We shall discuss it fully at the Board Meeting tomorrow and I shall communicate the outcome
to you shortly thereafter.
- We are unable to agree that the proposal annexed to Raeburn’s letter of March 9. 1977 was either a
proposal by or on behalf of Coats or one made with their knowledge and approval. Were it so, it is difficult
to understand how Raeburn could write to Mackrael on June 8, 1977 that Coats were still insistent on the
entire 20% of the excess equity holding not going to the existing Indian shareholders. There is also no
explanation as to why, if the proposal annexed to Raeburn’s letter of March 9 was a proposal by or on
behalf of Coats, Raeburn said at the U.K. meeting of March 29-31, 1977 that it was better to ‘let Coats
declare their hand’. It is indeed impossible to understand why Coats, on their own part, did not at time
communicate any compromise proposal of theirs to the Indian shareholders directly. They now seem to take
shelter behind the proposal made by Raeburn in his letter of March 9 adopting it as their own. Even in the
letter which Crawford Bayley & Co., wrote on June 21, 1977 on behalf of Sanders to the Reserve Bank of
India, no reference was at all made to any proposal by or on behalf of Coats to the Indian shareholders. The
vague statement made in that letter is that ‘certain proposals’ were being considered and would be submitted
‘shortly’ before the authorities. No such proposals were ever made by the Solicitor or their client to anyone.
- These letters and events leave no doubt in our mind that the negotiations between the parties were at an
end that there were no concrete proposals by or on behalf of Coats which remained outstanding to be
discussed by the Indian shareholders. To repeat, Devagnanam declared his hand in his letter of December
14, 1976 by reiterating, beyond the manner of doubt, that nothing less than 60% share in the equity capital
of NIIL would be acceptable to the Indian shareholders. Coats never replied to that letter nor indeed did
they convey their reaction to it in any other form or manner at any time. In fact, it would be more true to
say that Coats themselves treated the matter as at an end since, they were wholly opposed to the stand of
the Indian shareholders that they must have 60% share in the equity capital of NIIL. What happened in the
meeting of April 6, 1977 has to be approached in the light of the finding that the negotiations between the
parties had fallen through, that Coats had refused to declare their hand and that all that could be inferred
from their attitude with a fair amount of certainty was that they were unwilling to disinvest.
- On March 18, 1977 NIIL’s Secretary gave a notice of the Board meeting for April 6, 1977. The notice
was admittedly received by Sanders in U.K., well in time but did not attend the meeting. The explanation
for his failure to attend the meeting is said to be that the item on the agenda of the meeting, ‘Policy-
Indianisation’ was vague and did not convey that any matter of importance was going to be discussed in
the meeting, like for example, the issue of rights shares. We find it quite difficult to accept this explanation.
Just as a notice to quit in landlord-tenant matters cannot be allowed to split on a straw, notices of Board
meetings of companies have to be construed reasonably, by considering what they mean to those to whom
they are given. To a stranger, ‘Policy-Indianisation’ may not convey much but to Sanders and the U.K.
shareholders it would speak volumes. By the time that Sanders received the notice, the warring camps were
clearly drawn on two sides of the battle-line, the Indian group insisting that they will have nothing less than
a 60% share in the equity capital of NIIL and the U.K. shareholders insisting with equal determination that
they will not allow the existing Indian shareholders to have anything more than 49%. In pursuance of a
resolution passed by the Board, a letter had already been written to the Reserve Bank confirming the
commitment of NIIL to achieve the required Indianisation by May 17, 1977. A copy of NIIL’s letter to the
Reserve Bank was sent to Sanders and Whitehouse. In view of the fact that to the common knowledge of
the two sides there were only two methods by which the desired Indianisation could be achieved, namely,
either disinvestment by the Holding Company in favour of the existing Indian shareholders or a rights issue,
the particular item on the agenda should have left no doubt in the mind of the U.K. shareholders as to what
the Board was likely to discuss and decide in the meeting of the 6th. Disinvestment stood ruled out of
consideration, a fact which was within the special knowledge of the Holding Company, since whether to
disinvest or not was a matter of their volition.
- After the despatch of the notice dated March 18,1977 two important events happend. Firstly, Devagnanam
went to Birmingham, where discus ions were held from March 29-31, 1977 in which Indianisation of NIIL
was discussed, as shown by the minutes of that discussion. NEWEY were willing to accept Indianisation,
by the existing Indian shareholders acquiring a 60% interest in the share capital of NIIL while “COATS
were adamantly opposed” to that view. It is surprising that during the time that Devagnanam was in
Birmingham, Sanders did not meet him to seek an explanation of what the particular item on the agenda of
the meeting of April 6 meant Sanders had received the notice of March 18 before the Birmingham
discussions took place, and significantly he has made no affidavit at all on the question as to why he did
not meet Devagnanam in Birmingham, or why he did not attend the meeting of April 6 or what the particular
item on the agenda meant to him.
- The second important event which happened after the notice of March 18 was issued was that on April 4,
1977 NIIL received a letter dated March 30, 1977 from the Reserve Bank. The letter which was in the
nature of a stern reminder left no option to NIIL’s Board except to honour the commitment which it had
made to the Reserve Bank. By the letter the Reserve Bank warned NIIL : “Please note that if you fail to
comply with our directive regarding dilution of foreign equity within the stipulated period, we shall be
constrained to view the matter seriously.”
- We do not see any substance in the contention of the Holding Company that despite the commitment
which NIIL had made to the Reserve Bank, the long time which had elapsed in the meanwhile and the
virtual freezing of its developmental activities as of December 31, 1973, NIIL should have asked for an
extension of time from the Reserve Bank. In the first place, it could not be assumed or predicated that the
Bank would grant extension, and secondly, it was not in the interest of NIIL to ask for such an extension.
- The Board meeting was held as scheduled on April 6, 1977. The minutes of the meeting show that two
directors, Sanders and M.S.P. Rajes, asked for leave of absence which was granted to them. Sanders, as
representing the U.K. shareholdes on NIIL’s Board, did not make a request for the adjournment of the
meeting on the ground that negotiations for a compromise had not yet come to an end or that the Indian
shareholders had not yet conveyed their response to the “Coats’ compromise formula”. Nor did he
communicate to the Board his views on ‘Policy-Indianisation’, whatever it may have meant to him. Seven
Directors were present in. the meeting, with Devagnanam in the chair at the commencement of the meeting.
C. Doraiswamy, a Solicitor by profession and admittedly an independent Director, was amongst the seven.
In order to complete the quorum of two “independent” directors, other directors being interested in the issue
of rights shares, Silverston was appointed to the Board as an Additional Director under Article 97 of NIIL’s
Articles of Association. Silverston then chaired the meeting, which resolved that the issued capital of the
Company be increased to Rs. 48,00,000/- by the issue of 16,000 equity shares of Rs. 100/-each to be offered
as rights shares to the existing shareholders in proportion to the shares held by them. The offer was decided
to be made by a notice specifying the number of shares which each shareholders was entitled to, and in case
the offer was not accepted within 16 days from the date of the offer, it was to be deemed to have been
declined by the shareholder concerned.
- The aforesaid resolution of the Board raises three important questions, inter alia, which have been passed
upon us by Shri Seervai on behalf of the Holding Company : (1) Whether the Directors of NIIL, in issuing
the rights shares, abused the fiduciary power which they possessed as directors to issue shares; (2) Whether
Silverston was a ‘disinterested Director’; and (3) Whether Siverston’s appointment was otherwise invalid,
since there was no item on the agenda of the meeting for the appointment of an Additional Director. If
Silverston’s appointment as an Additional Director is bad either because he was not a disinterested director
or because there was no item on the agenda under which his appointment could be made, the resolution for
the issue of rights shares which was passed in the Board’s meeting of April 6 must fall because then, the
necessary quorum of two disinterested directors would be lacking.
- On the first of these three questions, it is contended by Shri Seervai that notwithstanding that the issues
of shares is intra vires the Directors, the Directors’ power is a fiduciary power, and although an exercise of
such power may be formally valid, it may be attacked on the ground that it was not exercised for the purpose
for which it was granted. It is urged that the issue of shares by Directors which is directed to affect the right
of the majority of the shareholders or to defeat that majority and convert it into a minority is
unconstitutional, void and in breach of the fiduciary duty of Directors, though in certain situations it may
be ratified by the Company in the General Meeting. Any reference by the Company to a general meeting
in the present case, it is said, would have been futile since, without the impugned issue of rights shares, the
majority was against the issue. It was finally argued that good faith and honest belief that in fact the course
proposed by the Directors was for the benefit of the shareholders or was bona fide believed to be for their
benefit is irrelevant because, it is for the majority of the shareholders to decide as to what is for their benefit,
so long as the majority does not act oppressively or illegally. Counsel relies in support of these and allied
contentions on the decision of the Privy Council in Howard Smith Ltd. and of the English Courts in Fraser,
Punt, Piercy and Hogg,
- In Punt v. Symons, which applied the principle of Fraser v. Whallcy it was held that :
Where shares had been issued by the Directors, not for the general benefit of the company, but for the
purpose of controlling the holders of the greater number of shares by obtaining a majority of voting power,
they ought to be restrained from holding the meeting at which the votes of the new shareholders were to
have been used.
In the instant case, the issue of rights shares was made by the Directors for the purpose of complying with
the requirements of FERA and the directives issued by the Reserve Bank under that Act. The Reserve Bank
had fixed a deadline and NIIL had committed itself to complying with the Bank’s directive before that
deadline.
- In Hogg v. Cramphorn Ltd. it was held that if the power to issue shares was exercised from an improper
motive, the issue was liable to be set aside and it was immaterial that the issue was made in a bonafide
belief that it was in the interest of the Company. Buckley J. reiterated the principle in Punt and in Piercy,
and observed :
Unless a majority in a company is acting oppressively towards the minority, this Court should not and will
not itself interfere with the exercise by the majority of its constitutional rights or embark upon an inquiry
into the respective merits of the views held or policies favoured by the majority and the minority. Nor will
this Court permit directors to exercise powers, which have been delegated to them by the company in
circumstances which put the directors in a fiduciary position when exercising those powers, in such a way
as to interfere with the exercise by the majority of its constitutional rights; and in a case of this kind also,
in my judgment, the court should not investigate the rival merits of the views or policies of the parties. (p.
268)
Applying this principle, it seems to us difficult to hold that by the issue of rights shares the Directors of
NIIL interfered in any manner with the legal rights of the majority. The majority had to disinvest or else to
submit to the issue of rights shares in order to comply with the statutory requirement of FERA arid the
Reserve Bank’s directives. Having chosen not to disinvest, an option which was open to them, they did not
any longer possess the legal right to insist that the Directors shall not issue the rights shares. What the
Directors did was clearly in the larger interests of the Company and in obedience to their duty to comply
with the law of the land. The fact that while discharging that duty they incidentally trenched upon the
interests of the majority cannot invalidate their action. The conversion of the existing majority into a
majority was a consequence of what the Directors were obliged lawfully to do. Such conversion was not
the motive force of their action.
- Before we leave this topic, we would like to mention that the mere circumstance that the Directors derive
benefit as shareholders by reason of the exercise of their fiduciary power to issue shares, will not vitiate the
exercise of that power. As observed by Gower in Principles of Modern Company Law, 4th edn., p. 578 :
As it was happily put in an Australian case they are ‘not required by the law to live in an unreal region of
detached altruism and to act in a vague mood of ideal abstraction from obvious facts which must be present
to the mind of any honest and intelligent man when he exercises his power as a director.
The Australian case referred to above by the learned author is Mills v. Mills which was specifically
approved by Lord Wilberforce in Howard Smith. In Manala Zaver too, Das J. stated at page 425 that the
true principle was laid down by the Judicial Committee of the Privy Council in Hirsche v. Sims [1894] A.C.
654, 660-661 , thus :
If the true effect of the whole evidence is, that the defendants truly and reasonably believed at the time that
what they did was for the interest of the company they are not chargeable with dolus malus or breach of
trust merely because in promoting the interest of the company they were also promoting their own, or
because the afterwards sold shares at prices which gave them large profits.
- Whether one looks at the matter from the point of view expressed by this Court in Nanala 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.
- We are therefore of the opinion that Devagnanam and his group acted in the best interests of NIIL in the
matter of the issue of rights shares and indeed, the Board of Directors followed in the meeting of the 6th
April a course which they had no option but to adopt and in doing which, they were solely actuated by the
consideration as to what was in the interest of the company. The shareholder-Directors who were interested
in the issue of rights shares neither participated in the discussion of that question nor voted upon it. The
two Directors who, forming the requisite quorum, resolved upon the issue of rights shares were Silverston
who, in our opinion, was a disinterested Director and Doraiswamy, who unquestionably was a disinterested
Director. The latter has been referred to in the company petition, Mackrael’s reply affidavit and in the
Holding Company’s Memorandum of Appeal in the High Court as “uninterested”, “disinterested” and
“independent”. At a crucial time when Devagnanam was proposing to dispose of his shares to Khaitan,
Sanders asked for Doraiswamy’s advice by his letter dated August 6, 1975 in which he expressed “complete
confidence” in Doraisway in the knowledge that the Holding Company could count on his guidance.
Disinvestment by the Holding Company, as one of the two courses which could be adopted for reducing
the non-resident interest in NIIL to 40% stood ruled out, on account of the rigid attitude of Coats who,
during the period between the Ketty meeting of October 20-21, 1976 and the Birmingham discussions of
March 29-31, 1977 clung to their self interest, regardless of the pressure of FERA, the directive of the
Reserve Bank of India and their transparent impact on the future of NIIL. Devagnanam and the disinterested
Directors, having acted out of legal compulsion precipitated by the obstructive attitude of Coats and their
action being in the larger interests of the company, it is impossible to hold that the resolution passed in the
meeting of April 6 for the issue of rights shares at par to the existing shareholders of NIIL constituted an
act of oppression against the Holding Company. That cannot, however, mark the end of the case because
2nd May has still to come and Shri Seervai’s argument is that the true question before the Court is whether
the offer of rights shares to all existing shareholders of NIIL but the issue of rights shares to existing Indian
shareholders only, constitutes oppression of the Holding Company.
- The purpose behind the planned delay in posting the letters of offer to Raeburn and to the Holding
Company, and in posting the notice of the Board’s meeting for May 2 to Sanders, was palpably to ensure
that no legal proceeding was taken to injunct the holding of the meeting. The object of withholding these
important documents, until it was quite late to act upon them, was to present to the Holding Company a fait
accompli in the shape of the Board’s decision for allotment of rights shares to the existing Indian
shareholders.
- The next question, and a very important one at that on which there is a sharp controversy between the
parties, is as to what is the consequence of the finding which we have recorded that the objection arising
out of the late position of the notice of the meeting for 2nd May goes to the root of the matter. The answer
to this question depends upon whether the Holding Company could have accepted the offer of the rights
shares and if, either for reasons of volition or of legal compulsion, it could not have accepted the offer,
whether it could have at least renounced its right under the offer to a resident Indian, other than the existing
Indian shareholders. The decision of this question depends upon the true construction of the provisions of
FERA and of Sections 43A and 81 of the Companies Act, 1956.
- The question immediately arises, which is of great practical importance in this case, as to whether
members of a Section 43A proviso company have a limited right of renunciation, under which they can
renounce the shares offered to them in favour of any other member or members of the company.
Consistently with the view which we have taken of Clause (c) of Section 81(1) our answer to this question
has to be in the negative. The right to renounce shares in favour of any other person, which is conferred by
Clause (c) has no application to a company like NIIL and therefore, its members cannot claim the right to
renounce shares offered to them in favour of any other member or members. The Articles of a company
may well provide for a right of transfer of shares by one member to another, but that right is very much
different from the right of renunciation, properly so called. In fact, learned Counsel for the Holding
Company has cited the decision in Re Pool Shipping Co. Ltd., in which it was held that the right of
renunciation is not the same as the right of transfer of shares.
The following proposition emerge out of the discussion of the provisions of FERA, Sections 43A and 81
of the Companies Act and of the articles of association of NIIL :
(1) The Holding Company had to part with 20% out of the 60% equity capital held by it in NIIL ;
(2) The offer of Rights Shares made to the Holding Company as a result of the decision taken by Board of
Directors in their meeting of April 6, 1977 could not have been accepted by the Holding Company ;
(3) The Holding Company had no right to renounce the Right Shares offered to it in favour of any other
person, member or non-member ; and
(4) Since the offer of Rights Shares could not have been either accepted or renounced by the Holding
Company, the former for one reason and the latter for another, the shares offered to it could, under Article
50 of the articles of association, be disposed of by the directors, consistently with the articles of NIIL,
particularly Article 11, in such manner as they thought most beneficial to the Company.
These proposition afford a complete answer to Shri Seervai’s contention that what truly constitutes
oppression of the Holding Company is not the issue of Rights Shares to the existing Indian shareholders
only but the offer of Rights Shares to all existing shareholders and the issue thereof to existing Indian
shareholders only.
The meeting of 2nd May, 1977 was unquestionably illegal for reasons already stated. It must follow that
the decision taken by the Board of Directors in that meeting could not, in the normal circumstances, create
mutual rights and obligations between the parties. But we will not treat that decision as non-est because a
point of preponderating importance is that the issue of Rights Shares to existing Indian shareholders only
and the non-allotment there of to the Holding Company did not cause any injury to the proprietary rights
of the Holding Company as shareholders, for the simple reason that they could not have possibly accepted
the offer of rights shares because of the provisions of FERA and the conditions imposed by the Reserve
Bank in its letter dated May 11, 1976, nor indeed could they have renounced the shares offered to them in
favour of any other person at all because Section 81(1)(c) has no application to companies like NIIL which
were once private companies but which become public companies by virtue of Section 43A and retain in
their articles the three matters referred to in Section 3(1)(iii) of the Act.
It was neither fair nor proper on the part of NIIL’s officers not to ensure the timely posting of the notice of
the meeting for 2nd May so as to enable Sanders to attend that meeting. But there the matter rests. Even if
Sanders were to attend the meeting, he could not have asked either that the Holding Company should be
allotted the rights shares or alternatively, that it should be allowed to “renounce” the shares in favour of any
other person, including the Manoharan group. The charge of oppression arising out of the central accusation
of non-allotment of the rights shares to the Holding Company must, therefore, fail.
We must mention that we have rejected the charge of oppression after applying to the conduct of
Devagnanam and his group the standard of probity and fairplay which is expected of partners in a business
venture. And this we have done without being influenced by the consideration pressed upon us by Shri
Nariman that Coats and NEWEY, who were two of the three main partners, were not of one mind and that
NEWEY never complained of oppression. They may or they may not. That is beside the point. Such
technicalities cannot be permitted to defeat the exercise of the equitable jurisdiction conferred by Section
397 of the Companies Act. Shri Seervai drew our attention to the decision in Blissett v. Daniel the facts of
which as they appear at pp 1036-37, bear, according to him, great resemblance to the facts before us. The
following observations in that case are of striking relevance ;
As has been well observed during the course of the argument, the view taken by this Court with regard to
morality of conduct amongst all parties-most especially amongst those who are bound by the ties of
partnership- is one of the highest degree. The standard by which parties are tried here, either as trustees or
as co-partners, or in various other relations which may be suggested, is a standard, I am thankful to say so,
far higher than the standard of the world ; and, tried by the standard, I hold it to be impossible to sanction
the removal of this gentleman under these circumstances. (p 1040)
Not only is the law on the side of Devagnanam but his conduct cannot be characterised as lacking in probity,
considering the extremely rigid attitude adopted by Coats. They drove him into a tight corner from which
the only escape was to allow the law to have its full play.
Even though the company petition fails and the appeals succeed on the finding that the Holding Company
has failed to make out a case of oppression, the court is not powerless to do substantial justice between the
parties and place them, as nearly as it may, in the same position in which they would have been, if the
meeting of 2nd May were held in accordance with Jaw. The notice of the meeting was received by Sanders
in U.K. on the 2nd May when everything was over, bar the post meeting recriminations which eventually
led to this expensive litigation. If the notice of the meeting had reached the Holding Company in time, it is
reasonable to suppose that they would have attended the meeting, since one of the items on the Agenda was
“Policy-(a) Indianisation, (b) allotment of shares”. Devagnanam and his group were always ready and
willing to buy the excess shares of the Holding Company at a fair price as clear from the correspondence
to which our attention has been drawn. In the affidavit dated May 25, 1977, Devagnanam stated
categorically that the Indian shareholders were always ready and willing to purchase one-third of the
shareholding of the non-resident shareholders, at a price to be fixed in accordance with the articles of
Association by the Reserve Bank of India. On May 27, he sent a cable, though ‘without prejudice’, offering
to pay premium if the Holding Company were to adopt disinvestment as a method of dilution of their
interest. In the Trial Court, counsel for the Indian shareholders to whom the rights shares were allotted
offered to pay premium on the 16,000 rights shares. The cable and the offer were mentioned before us by
Shri Nariman and were not disputed by Shri Seervai. There is no reason why we should not call upon the
Indian shareholders to do what they were always willing to do, namely, to pay to the Holding Company a
fair premium on the shares which were offered to it, which it could neither take nor renounce and which
were taken up by the Indian shareholders in the enforced absence of the Holding Company. The willingness
of the Indian shareholders to pay a premium on the excess holding or the rights shares is a factor which, to
some extent, has gone in their favour on the question of oppression. Having had the benefit of that stance,
they must now make it good. Besides, it is only meet and just that the Indian shareholders, who took the
rights shares at par when the value of those shares was much above par, should be asked to pay the
difference in order to nullify unjust unjustifiable enrichment at the cost of the Holding Company. We must
make it clear that we are not asking the Indian shareholders to pay the premium as a price of oppression.
We have rejected the plea of oppression and the course which we are now adopting is intended primarily
to set right the course of justice, in so far as we may.
Class Actions
Satyam
The need for a provision allowing for class action suits came out of a series of incidents involving Satyam
Computer Services Limited. Satyam Computer Services Limited (now merged with Tech Mahindra) was a
leading information, communications and technology (ICT) Company providing top-class business
consulting, information technology and communication services. A substantial portion of its clients were
based in the United States. It was listed on the Bombay Stock Exchange, the National Stock Exchange as
well as the New York Stock Exchange.
In December 2008, a meeting of the Satyam board was called to consider a proposal to acquire Maytas
Properties Limited and Maytas Infra Limited. It must be noted that this acquisition required a vote of
approval by majority, as it was a related party transaction. The promoter family owned more than 30%
shares in both the companies. Both Maytas firms were engaged in real estate, which was an unrelated
business area for Satyam. Further, this was a related party transaction as the Raju family owned shares in
excess of 30% in both the companies.
Although the independent directors did raise some objections during the course of the meeting, the
resolution was passed unanimously. However, the shareholders of Satyam did not accept this decision of
the board and the share prices of Satyam plunged immediately. Subsequently, a meeting of Board of
Directors was scheduled on January 10, 2009 to consider (i) strengthening the governance structure of the
Company, (ii) reviewing the Company’s strategic options to enhance shareholder value and (iii) addressing
issues arising out of possible dilution in the Promoters stake.
In the meantime however, on 7th January 2009 Mr. Ramalinga Raju, the then Chairman of the Company,
confessed to financial mismanagement and the ‘Maytas scheme’ to try and cover it up. While the Satyam
board had to withdraw its decision to acquire the Maytas’ firms, it later came to light that the Maytas
acquisitions were being carried out to manipulate past financial misrepresentation done by Satyam. For
years, Satyam had been inflating profits by showing fictitious assets. The share price of Satyam fell from
Rs 304.80 on the 31st of November 2008 to Rs 54.05 on the 31st of Jaunary 2009 resulting in a major loss
to shareholders wealth.
While the promoters, certain members of the board and other key managerial personnel were prosecuted
under the SEBI Act 1992, the SEBI (Prohibition of Fraud and Unfair Trade Practices) Regulations 2003
and the SEBI (Prohibition of Insider Trading) Regulations 1992, these prosecutions sought only to enforce
existing penal clauses within the gamut of securities regulation in India. There were no provisions to
compensate shareholders for their loss in shareholding value.
Seeking a redressal to this loss of shareholding value, a number of investors approached the National
Consumer Disputes Redressal Commission as well as the Supreme Court of India but their claims were
rejected for the absence of an extant law that allowed recovery of shareholding value in such cases. Indian
shareholders, along with Midas Touch, a consumer protection organization failed in their attempts to
recover monetary relief before the National Consumer Disputes Redressal Commission (NCDRC) which
rejected their claim, on the grounds that “We do not have the infrastructure to deal with such kind of petition
[…] CBI and CLB (are) already seized with the matter”. Even upon appeal, the Supreme Court of India
refused to overturn this outcome.
On the other hand, holders of American Depository Receipts (ADRs) listed on the NYSE were able to claim
$125 million from the company. In the case of In re Satyam Computer Services Ltd. Securities Litigation
a sum of $125 million was paid as settlement by Mahindra Satyam to United States investors who held
ADRs as a result of the erstwhile promoters of the company admitting to a fraud. Tech Mahindra, which
subsequently took over Satyam, was required to settle all pending litigations with several investors who
had claimed losses due to the shares of the firm plunging on the stock exchanges.
Additionally, there was a substantial failure on the part of Satyam’s auditors (Price Waterhouse Coopers
India) to detect the fraud and manipulation of financial accounts. Much like in the case of Enron and their
auditors Arthur Andersen, auditors would accept the claims of their clients at face value without minimal
checks due to immense competition between auditors to increase and retain market share and particularly,
with high income clients. Additionally, the fact that Satyam represented a significant revenue stream for
PWC India may have created powerful incentives for PWC India’s managers to give Satyam the accounting
treatment it wanted. There were fake customer identities, fake invoices which were created by the global
head of the internal audit to inflate the revenue amount. The fraud was also perpetrated by forging board
resolutions and by obtaining loans using illegal means for the company; it went to an extent that the cash
received from the American Depository Receipts were not even shown in the balance sheet. The most
troublesome aspect was that despite of being the auditors of Satyam from 2000 till 2009 (scam was exposed)
they overlooked without any test or verification the flagrant amount of $ 1.04 billion (claimed by Satyam
to be in its balance sheet in ‘non-interest bearing’ deposits). The fictitious sources of income created by
Satyam was never even detected as fraud by the auditors and this conduct of PWC has raised questions as
to whether it was complicit in this scam as Satyam paid it twice the amount than the other firms.
In spite of this, the auditors, expert advisors and other professionals engaged by Satyam were left largely
untouched as they could not be held liable or accountable for financial misstatements in the books of
accounts. Under the erstwhile Companies Act, 1956, auditors were engaged by companies and shareholders
had no privity with the auditors. Consequently, no claim could be raised by Indian shareholders against the
auditors of Satyam.
On the other hand, PWC was made a party to a class action suit by the ADR holders of Satyam. The
arguments raised by PWC included that the appropriate forum to file class action suit was India raising
much debate as to whether India was an appropriate forum for foreign investors. There has been support
for the argument that Order 1 Rule 8 of the Civil Procedure Code, 1908 which allows plaintiffs having
identical interests to file a single representative suit. Under this provision, the Court is required to ensure
that the interests of all class members is protected and the same review procedure that applies to individual
law suit is applied. Therefore, it may be argued that this rule is wide enough to encompass the class action
suit filed by the foreign investors of United States against Satyam.
While Indian shareholders and investors suffered due to lack of a provision on class action suits, the interests
of their counterparts in United States were safeguarded by a settlement of $125 million from Satyam and
$25.5 million from PwC. The disparity with which Indian and American security holders of Satyam were
dealt, renewed the interest of the Ministry of Corporate Affairs in class action suits. The inability of
shareholders and creditors to place liability upon the auditors also found its way into Section 245.
Section 245- Class Actions
(1) Such number of member or members, depositor or depositors or any class of them, as the case may
be, as are indicated in sub-section (2) may, if they are of the opinion that the management or conduct of the
affairs of the company are being conducted in a manner prejudicial to the interests of the company or its
members or depositors, file an application before the Tribunal on behalf of the members or depositors for
seeking all or any of the following orders, namely:—
(a) to restrain the company from committing an act which is ultra vires the articles or memorandum of
the company;
(b) to restrain the company from committing breach of any provision of the company’s memorandum
or articles;
(c) to declare a resolution altering the memorandum or articles of the company as void if the resolution
was passed by suppression of material facts or obtained by mis-statement to the members or depositors;
(d) to restrain the company and its directors from acting on such resolution;
(e) to restrain the company from doing an act which is contrary to the provisions of this Act or any
other law for the time being in force;
(f) to restrain the company from taking action contrary to any resolution passed by the members;
(g) to claim damages or compensation or demand any other suitable action from or against—
(i) the company or its directors for any fraudulent, unlawful or wrongful act or omission or conduct or
any likely act or omission or conduct on its or their part;
(ii) the auditor including audit firm of the company for any improper or misleading statement of
particulars made in his audit report or for any fraudulent, unlawful or wrongful act or conduct; or
(iii) any expert or advisor or consultant or any other person for any incorrect or misleading statement
made to the company or for any fraudulent, unlawful or wrongful act or conduct or any likely act or conduct
on his part;
(h) to seek any other remedy as the Tribunal may deem fit.
(2) Where the members or depositors seek any damages or compensation or demand any other suitable
action from or against an audit firm, the liability shall be of the firm as well as of each partner who was
involved in making any improper or misleading statement of particulars in the audit report or who acted in
a fraudulent, unlawful or wrongful manner.
(3) (i) The requisite number of members provided in sub-section (1) shall be as under:—
(a) in the case of a company having a share capital, not less than one hundred members of the company
or not less than such percentage of the total number of its members as may be prescribed, whichever is less,
or any member or members holding not less than such percentage of the issued share capital of the company
as may be prescribed, subject to the condition that the applicant or applicants has or have paid all calls and
other sums due on his or their shares;
(b) in the case of a company not having a share capital, not less than one-fifth of the total number of
its members.
(ii) The requisite number of depositors provided in sub-section (1) shall not be less than one hundred
depositors or not less than such percentage of the total number of depositors as may be prescribed,
whichever is less, or any depositor or depositors to whom the company owes such percentage of total
deposits of the company as may be prescribed.
(4) In considering an application under sub-section (1), the Tribunal shall take into account, in
particular—
(a) whether the member or depositor is acting in good faith in making the application for seeking an
order;
(b) any evidence before it as to the involvement of any person other than directors or officers of the
company on any of the matters provided in clauses (a) to (f) of subsection (1);
(c) whether the cause of action is one which the member or depositor could pursue in his own right
rather than through an order under this section;
(d) any evidence before it as to the views of the members or depositors of the company who have no
personal interest, direct or indirect, in the matter being proceeded under this section;
(e) where the cause of action is an act or omission that is yet to occur, whether the act or omission
could be, and in the circumstances would be likely to be—
(i) authorised by the company before it occurs; or
(ii) ratified by the company after it occurs;
(f) where the cause of action is an act or omission that has already occurred, whether the act or
omission could be, and in the circumstances would be likely to be, ratified by the company.
(5) If an application filed under sub-section (1) is admitted, then the Tribunal shall have regard to the
following, namely:—
(a) public notice shall be served on admission of the application to all the members or depositors of
the class in such manner as may be prescribed;
(b) all similar applications prevalent in any jurisdiction should be consolidated into a single application
and the class members or depositors should be allowed to choose the lead applicant and in the event the
members or depositors of the class are unable to come to a consensus, the Tribunal shall have the power to
appoint a lead applicant, who shall be in charge of the proceedings from the applicant’s side;
(c) two class action applications for the same cause of action shall not be allowed;
(d) the cost or expenses connected with the application for class action shall be defrayed by the
company or any other person responsible for any oppressive act.
(6) Any order passed by the Tribunal shall be binding on the company and all its members, depositors
and auditor including audit firm or expert or consultant or advisor or any other person associated with the
company.
(7) Any company which fails to comply with an order passed by the Tribunal under this section shall
be punishable with fine which shall not be less than five lakh rupees but which may extend to twenty-five
lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for
a term which may extend to three years and with fine which shall not be less than twenty-five thousand
rupees but which may extend to one lakh rupees.
(8) Where any application filed before the Tribunal is found to be frivolous or vexatious, it shall, for
reasons to be recorded in writing, reject the application and make an order that the applicant shall pay to
the opposite party such cost, not exceeding one lakh rupees, as may be specified in the order.
(9) Nothing contained in this section shall apply to a banking company.
(10) Subject to the compliance of this section, an application may be filed or any other action may be
taken under this section by any person, group of persons or any association of persons representing the
persons affected by any act or omission, specified in sub-section (1).
Powers of Investigation – SFIO
Section 211. Establishment of Serious Fraud Investigation Office.
(1) The Central Government shall, by notification, establish an office to be called the Serious Fraud
Investigation Office to investigate frauds relating to a company:
Provided that until the Serious Fraud Investigation Office is established under subsection (1), the Serious
Fraud Investigation Office set-up by the Central Government in terms of the Government of India
Resolution No. 45011/16/2003-Adm-I, dated the 2nd July, 2003 shall be deemed to be the Serious Fraud
Investigation Office for the purpose of this section.
(2) The Serious Fraud Investigation Office shall be headed by a Director and consist of such number of
experts from the following fields to be appointed by the Central Government from amongst persons of
ability, integrity and experience in,—
(i) banking;
(ii) corporate affairs;
(iii) taxation;
(iv) forensic audit;
(v) capital market;
(vi) information technology;
(vii) law; or
(viii) such other fields as may be prescribed.
(3) The Central Government shall, by notification, appoint a Director in the Serious Fraud Investigation
Office, who shall be an officer not below the rank of a Joint Secretary to the Government of India having
knowledge and experience in dealing with matters relating to corporate affairs.
(4) The Central Government may appoint such experts and other officers and employees in the Serious
Fraud Investigation Office as it considers necessary for the efficient discharge of its functions under this
Act.
(5) The terms and conditions of service of Director, experts, and other officers and employees of the Serious
Fraud Investigation Office shall be such as may be prescribed.
Section 212. Investigation into affairs of Company by Serious Fraud Investigation Office.
(1) Without prejudice to the provisions of section 210, where the Central Government is of the opinion, that
it is necessary to investigate into the affairs of a company by the Serious Fraud Investigation Office—
(a) on receipt of a report of the Registrar or inspector under section 208;
(b) on intimation of a special resolution passed by a company that its affairs are required to be investigated;
(c) in the public interest; or
(d) on request from any Department of the Central Government or a State Government, the Central
Government may, by order, assign the investigation into the affairs of the said company to the Serious
Fraud Investigation Office and its Director, may designate such number of inspectors, as he may consider
necessary for the purpose of such investigation.
(2) Where any case has been assigned by the Central Government to the Serious Fraud Investigation Office
for investigation under this Act, no other investigating agency of Central Government or any State
Government shall proceed with investigation in such case in respect of any offence under this Act and in
case any such investigation has already been initiated, it shall not be proceeded further with and the
concerned agency shall transfer the relevant documents and records in respect of such offences under this
Act to Serious Fraud Investigation Office.
(3) Where the investigation into the affairs of a company has been assigned by the Central Government to
Serious Fraud Investigation Office, it shall conduct the investigation in the manner and follow the procedure
provided in this Chapter; and submit its report to the Central Government within such period as may be
specified in the order.
(4) The Director, Serious Fraud Investigation Office shall cause the affairs of the company to be
investigated by an Investigating Officer who shall have the power of the inspector under section 217.
(5) The company and its officers and employees, who are or have been in employment of the company shall
be responsible to provide all information, explanation, documents and assistance to the Investigating Officer
as he may require for conduct of the investigation.
(6) Notwithstanding anything contained in the Code of Criminal Procedure, 1973, the offences covered
under sub-sections (5) and (6) of section 7, section 34, section 36, subsection (1) of section 38, sub-section
(5) of section 46, sub-section (7) of section 56, subsection (10) of section 66, sub-section (5) of section 140,
sub-section (4) of section 206, section 213, section 229, sub-section (1) of section 251, sub-section (3) of
section 339 and section 448 which attract the punishment for fraud provided in section 447 of this Act shall
be cognizable and no person accused of any offence under those sections shall be released on bail or on his
own bond unless—
(i) the Public Prosecutor has been given an opportunity to oppose the application for such release; and
(ii) where the Public Prosecutor opposes the application, the court is satisfied that there are reasonable
grounds for believing that he is not guilty of such offence and that he is not likely to commit any offence
while on bail:
Provided that a person, who, is under the age of sixteen years or is a woman or is sick or infirm, may be
released on bail, if the Special Court so directs:
Provided further that the Special Court shall not take cognizance of any offence referred to this sub-section
except upon a complaint in writing made by—
(i) the Director, Serious Fraud Investigation Office; or
(ii) any officer of the Central Government authorised, by a general or special order in writing in this behalf
by that Government.
(7) The limitation on granting of bail specified in sub-section (6) is in addition to the limitations under the
Code of Criminal Procedure, 1973 or any other law for the time being in force on granting of bail.
(8) If the Director, Additional Director or Assistant Director of Serious Fraud Investigation Office
authorised in this behalf by the Central Government by general or special order, has on the basis of material
in his possession reason to believe (the reason for such belief to be recorded in writing) that any person has
been guilty of any offence punishable under sections referred to in sub-section (6), he may arrest such
person and shall, as soon as may be, inform him of the grounds for such arrest.
(9) The Director, Additional Director or Assistant Director of Serious Fraud Investigation Office shall,
immediately after arrest of such person under sub-section (8), forward a copy of the order, along with the
material in his possession, referred to in that sub-section, to the Serious Fraud Investigation Office in a
sealed envelope, in such manner as may be prescribed and the Serious Fraud Investigation Office shall keep
such order and material for such period as may be prescribed.
(10) Every person arrested under sub-section (8) shall within twenty-four hours, be taken to a Judical
Magistrate or a Metropolitan Magistrate, as the case may be, having jurisdiction:
Provided that the period of twenty-four hours shall exclude the time necessary for the journey from the
place of arrest to the Magistrate's court.
(11) The Central Government if so directs, the Serious Fraud Investigation Office shall submit an interim
report to the Central Government.
(12) On completion of the investigation, the Serious Fraud Investigation Office shall submit the
investigation report to the Central Government.
(13) Notwithstanding anything contained in this Act or in any other law for the time being in force, a copy
of the investigation report may be obtained by any person concerned by making an application in this regard
to the court.
(14) On receipt of the investigation report, the Central Government may, after examination of the report
(and after taking such legal advice, as it may think fit), direct the Serious Fraud Investigation Office to
initiate prosecution against the company and its officers or employees, who are or have been in employment
of the company or any other person directly or indirectly connected with the affairs of the company.
(15) Notwithstanding anything contained in this Act or in any other law for the time being in force, the
investigation report filed with the Special Court for framing of charges shall be deemed to be a report filed
by a police officer under section 173 of the Code of Criminal Procedure, 1973.
(16) Notwithstanding anything contained in this Act, any investigation or other action taken or initiated by
Serious Fraud Investigation Office under the provisions of the Companies Act, 1956 shall continue to be
proceeded with under that Act as if this Act had not been passed.
(17) (a) In case Serious Fraud Investigation Office has been investigating any offence under this Act, any
other investigating agency, State Government, police authority, income-tax authorities having any
information or documents in respect of such offence shall provide all such information or documents
available with it to the Serious Fraud Investigation Office;
(b) The Serious Fraud Investigation Office shall share any information or documents available with it, with
any investigating agency, State Government, police authority or incometax authorities, which may be
relevant or useful for such investigating agency, State Government, police authority or income-tax
authorities in respect of any offence or matter being investigated or examined by it under any other law.
MODULE X - CORPORATE RESTRUCTURING

Procedure for merger
Under the provisions of the Indian Companies Act, 2013, it is possible to merge or amalgamate two
companies by way of a “compromise or arrangement between a company and its members”. It must be
ensured that the memorandum and articles of association of the companies proposed to be merged allow
the same. If not, the articles and memorandum of association of the companies must be amended to allow
a compromise or arrangement. The mechanism of a merger is vastly different from that of an acquisition.
In a merger, the assets and liabilities of one of the companies (the transferor company) are transferred to
the other (transferee) company and the shareholders of the transferor company are issued shares in the
transferee company. The transferor company ceases to exist.
The Companies Act empowers the Tribunal to pass an order to sanction a scheme of arrangement for the
merger of two companies. Much like the acquisition or investment agreement in case of an acquisition, the
‘scheme’ of merger is central in this case. A scheme of merger is prepared by the merging companies and
approved by their respective shareholders in a special resolution. The approved scheme is then submitted
to the Company Law Tribunal. Upon the issuance of an order by the Company Law Tribunal sanctioning
the scheme, the merger is effected.
A scheme of merger typically contains the following details of the companies to be merged:
(a) A description of the two companies and a break up of their respective shareholding patterns
(b) A rationale of the merger
(c) Description of the transfer of assets, liabilities, contracts, receivables, employees, permits, licenses
and legal proceedings, etc from the transferor company to the transferee company
(d) Number of shares to be issued to the shareholders of the transferor company. This is typically
expressed as a ratio to the number of shares held by the shareholders of the transferee company.
(e) A description of the accounting treatment of the merger and the increase in share capital of the
transferee company.
However, there are other considerations in cases where one or more of the companies to be merged are
listed on a stock exchange. In such cases, approval of the stock exchange and the Securities and Exchange
Board of India (SEBI) are also required in addition to the approvals from the shareholders and the Tribunal,
which is applicable in all cases. Further, in a recent circular, SEBI has mandated that in addition to the 75%
majority required for a special resolution, two-thirds of the public shareholding must also vote in favour of
the merger.
The following is a list of activities (in chronological order) that must be undertaken in order to effect a
merger for a listed company. In case of an unlisted company, no approval from the stock exchanges or SEBI
is required.
(a) Issue notice for board meeting to approve draft Scheme. 3 copies of such notice to be sent to stock
exchange(s) where the shares of the transferor company are listed (the “Stock Exchange”) simultaneously.
Fix a record date for determining the names of shareholders of the transferor company eligible for obtaining
the shares of the transferee company. Period of notice of board meeting to directors to be provided as per
articles.
(b) Hold board meeting to approve draft Scheme. Issue notice for board meeting for finalizing the
Share Exchange Ratio & Scheme of Amalgamation. The decision of the Board and and notice for the next
Board Meeting to be intimated to the Stock Exchange. The Board is required to in-principally approve the
Scheme and appoint a Chartered Accountant as Valuer for recommending the share-exchange ratio and
advocates for representing the matter on behalf of the Company before the Tribunal.
(c) Hold the Board Meeting to approve the draft Scheme and the Share Exchange Ratio. The decision
of the Board and the Share Exchange Ratio to be intimated to the Stock Exchange
(d) Apply to the Stock Exchange(s) where the Shares of the Company are listed as well as SEBI for
observations
(e) Upon receipt of observations from the Stock Exchange, apply to the Company Law Tribunal
seeking directions for holding meeting of shareholders and creditors. A copy of the application made to the
Company Law Tribunal must also be sent to the Regional Director appointed by the Central Government
(the “Regional Director”)
(f) The copy of the application sent to the Regional Director must be accompanied by a copy of the
Memorandum and Articles of Association of both companies as well as a copy of the latest audited balance
sheet of the transferee company
(g) Obtain order from the Company Law Tribunal convening the meeting of the meeting of
shareholders and creditors and for publishing advertisements for the same
(h) Publish advertisements with respect to shareholders’ meetings in accordance with the schedule
given by the Company Law Tribunal
(i) Send printed notices of court convened meetings to the shareholders & creditors in accordance with
the instruction of the Company Law Tribunal
(j) 3 copies of such notice to be sent to the Stock Exchanges. Such notices are required to be sent under
postal certification. Further, the pre and post-merger capital structure and shareholding pattern must be set
out in the explanatory statement accompanying the notice
(k) Prepare and file the affidavit for dispatch of notices and for publication of advertisements with the
Company Law Tribunal. Such affidavit must be accompanied by original proof of dispatch and original
proof of publication of advertisements
(l) Conduct the meetings of the shareholders and creditors in accordance with the instructions of the
Company Law Tribunal. The outcome of the meeting and the minutes of the meeting must be intimated to
the Stock Exchanges and the Securities Exchange Board of India.
(m) Please note that this resolution that. more than 75% of the total shareholding and more than two
thirds of the public shareholding in must vote in favour of the resolution. The result of the meeting may be
decided by voting in person or by proxy.
(n) Within 7 days of the shareholders and creditors meeting, file the chairman’s report with the
Company Law Tribunal.
(o) Within 7 days of the filing of the chairman’s report, file the company petition with the Company
Law Tribunal for approving the Scheme.
(p) File Form No. 23 with the Registrar of Companies within 30 days from the date of the meeting.
(q) Obtain an order of admission of petition from Company Law Tribunal.

(r) The Company Law Tribunal would order a copy of the petition to be served to the office of the
Regional Director and the Official Liquidator.
(s) Submit a Certified Copy of the Petition with the offices of the Regional Director, the Official
Liquidator and the Registrar of Companies.
(t) The Registrar of Companies shall submit its report to the Regional Director who will make a
separate study of the Scheme and file its report with the Registrar of Companies. The Registrar shall forward
the report to the government counsel.
(u) The Company Law Tribunal shall issue an order approving the Scheme.
(v) File the Company Law Tribunal order with Registrar of Companies in Form No. 21 along with the
payment of stamp duty, if applicable. The merger becomes effective once the Company Law Tribunal order
is filed with the Registrar of Companies.
(w) Within 30 days of obtaining a copy of the order. Annex a copy of the order to every copy of the
Memorandum of Association of the company issued after the certified true copy of the Company Law
Tribunal order has been filed with the Registrar of Companies.
(x) Proceed with implementation of the approved Scheme as per the directions of the court by issuing
suitable notices to shareholders, persons concerned and by allotting shares and taking over the business in
terms of the approved Scheme.
(y) The transferee company is required to file Form No. 2 and Form No. 3 with the Registrar of
Companies within 30 days of allotment.
MODULE XI - WINDING UP
Methods of winding-up
Section 270. Modes of winding up.
(1) The winding up of a company may be either—

(a) by the Tribunal; or
(b) voluntary.
(2) Notwithstanding anything contained in any other Act, the provisions of this Act with respect to winding
up shall apply to the winding up of a company in any of the modes specified under sub-section (1).
Compulsory winding-up
Section 271. Circumstances in which company may be wound up by Tribunal.
(1) A company may, on a petition under section 272, be wound up by the Tribunal,—
(a) if the company is unable to pay its debts;
(b) if the company has, by special resolution, resolved that the company be wound up by the Tribunal;
(c) if the company has acted against the interests of the sovereignty and integrity of India, the security of
the State, friendly relations with foreign States, public order, decency or morality;
(d) if the Tribunal has ordered the winding up of the company under Chapter XIX;
(e) if on an application made by the Registrar or any other person authorised by the Central Government
by notification under this Act, the Tribunal is of the opinion that the affairs of the company have been
conducted in a fraudulent manner or the company was formed for fraudulent and unlawful purpose or the
persons concerned in the formation or management of its affairs have been guilty of fraud, misfeasance or
misconduct in connection therewith and that it is proper that the company be wound up;
(f) if the company has made a default in filing with the Registrar its financial statements or annual returns
for immediately preceding five consecutive financial years; or
(g) if the Tribunal is of the opinion that it is just and equitable that the company should be wound up.
(2) A company shall be deemed to be unable to pay its debts,—
(a) if a creditor, by assignment or otherwise, to whom the company is indebted for an amount exceeding
one lakh rupees then due, has served on the company, by causing it to be delivered at its registered office,
by registered post or otherwise, a demand requiring the company to pay the amount so due and the company
has failed to pay the sum within twenty-one days after the receipt of such demand or to provide adequate
security or re-structure or compound the debt to the reasonable satisfaction of the creditor;
(b) if any execution or other process issued on a decree or order of any court or tribunal in favour of a
creditor of the company is returned unsatisfied in whole or in part; or
(c) if it is proved to the satisfaction of the Tribunal that the company is unable to pay its debts, and, in
determining whether a company is unable to pay its debts, the Tribunal shall take into account the contingent
and prospective liabilities of the company.
Who can commence the compulsory winding-up proceedings and when?
Section 272. Petition for winding up.
(1) Subject to the provisions of this section, a petition to the Tribunal for the winding up of a company shall
be presented by—
(a) the company;
(b) any creditor or creditors, including any contingent or prospective creditor or creditors;
(c) any contributory or contributories;
(d) all or any of the persons specified in clauses (a), (b) and (c) together;
(e) the Registrar;
(f) any person authorised by the Central Government in that behalf; or
(g) in a case falling under clause (c) of sub-section (1) of section 271, by the Central Government or a State
Government.
(2) A secured creditor, the holder of any debentures, whether or not any trustee or trustees have been
appointed in respect of such and other like debentures, and the trustee for the holders of debentures shall be
deemed to be creditors within the meaning of clause (b) of sub-section (1).
(3) A contributory shall be entitled to present a petition for the winding up of a company, notwithstanding
that he may be the holder of fully paid-up shares, or that the company may have no assets at all or may have
no surplus assets left for distribution among the shareholders after the satisfaction of its liabilities, and
shares in respect of which he is a contributory or some of them were either originally allotted to him or
have been held by him, and registered in his name, for at least six months during the eighteen months
immediately before the commencement of the winding up or have devolved on him through the death of a
former holder.
(4) The Registrar shall be entitled to present a petition for winding up under subsection (1) on any of the
grounds specified in sub-section (1) of section 271, except on the grounds specified in clause (b), clause (d)
or clause (g) of that sub-section:
Provided that the Registrar shall not present a petition on the ground that the company is unable to pay its
debts unless it appears to him either from the financial condition of the company as disclosed in its balance
sheet or from the report of an inspector appointed under section 210 that the company is unable to pay its
debts:
Provided further that the Registrar shall obtain the previous sanction of the Central Government to the
presentation of a petition:
Provided also that the Central Government shall not accord its sanction unless the company has been given
a reasonable opportunity of making representations.
(5) A petition presented by the company for winding up before the Tribunal shall be admitted only if
accompanied by a statement of affairs in such form and in such manner as may be prescribed.
(6) Before a petition for winding up of a company presented by a contingent or prospective creditor is
admitted, the leave of the Tribunal shall be obtained for the admission of the petition and such leave shall
not be granted, unless in the opinion of the Tribunal there is a prima facie case for the winding up of the
company and until such security for costs has been given as the Tribunal thinks reasonable.
(7) A copy of the petition made under this section shall also be filed with the Registrar and the Registrar
shall, without prejudice to any other provisions, submit his views to the Tribunal within sixty days of receipt
of such petition.
Winding up as a Debt Recovery Mechanism
Harinagar Sugar Mills v M. W. Pradhan , Court Receiver, High Court, Bombay [1966] 36 Comp Cas 426
The appellant company purchased a farm from a joint Hindu family for Rs. 40 lacs out of which Rs. 25 lacs
remained to be paid. The Income-tax Officer served a notice under s. 46 of the Indian Income-tax Act, 1922
on the company asking it not to pay the said amount of Rs. 251/- to the joint family but towards income-
tax payable by the said family.
Thereafter one of the members of the joint family filed a suit for the partition of the family assets and at his
request the court appointed a Receiver. The Receiver by notice under s. 434 of the Companies Act asked
the company to pay Rs. 25 lacs towards income-tax to the Additional Collector and when it did not do so
he sought permission from the Court under O.XL r. 1 (d) of the Code of Civil Procedure to file a petition
for winding up against the company,, which. was allowed. The Company's appeal to the Division Bench of
the High Court failed and it appealed to this Court by special leave. The Court had to consider (i) whether
the court could under O.XL r. 1 (d) of the Code authorize the Receiver to file a winding-up petition against
the company, (ii) whether a receiver was a 'creditor' within the meaning of s. 439(1) of the Indian
Companies Act, (iii) whether in asking the company to pay the sum in question to the Additional Collector
the Receiver contravened s. 434, (iv) whether in not making the payment the company 'neglected to pay its
debt' and (v) whether there was a bonafide dispute as to the liability of the company to pay the debt.
HELD:
(i) Assuming that a petition for winding up of- a company was not a suit within the meaning of O.XL r. 1
(d) of the Code, the other powers mentioned therein were comprehensive enough to enable the Receiver to
take necessary proceedings to realise the property of and debts due to the joint family. A winding up petition
is-one of the modes of realising debts form a company, and the Respondent therefore had power to file such
a petition.
The Court appointed the respondent as the Court Receiver on October 20, 1961, of the properties belonging
to the joint family in the suit.
The material part of the order reads :
IT IS FURTHER ORDERED that the Court Receiver be and is hereby appointed' Recevier of the properties
belonging to the joint family in suit and all the books of accounts papers and vouchers with all necessary
powers under Order XL Rule 1 of the Code of Civil Procedure including power to vote and or exercise all
the property rights in respect of shares belonging to the joint family in the several joint stock companies
mentioned in the plaint including power to file suit.
Under this order, all the necessary powers under O.XL, r. 1, of the Code of Civil Procedure were conferred
upon the Receiver, including the right to file suits. Assuming that a petition for winding up of a company
is not a suit within the meaning of O.XL, r. 1(d) of the said Code, the other powers mentioned therein are
comprehensive enough to enable the Receiver to take necessary proceedings to realise the property of and
debts due to the joint family. Can it be said that the petition filed by the Receiver for winding up of the
Company is not a mode of realisation of the debt due to the joint family from the Company ? In Palmer's
Company Precedents, Part 11, 1960 Edn., at p. 25, the following passage appears "A winding up petition is
a perfectly proper remedy for enforcing payment of a just debt. It is the mode of execution which the Court
gives to a creditor against a company unable to pay its debts."
This view is supported by the decisions in Bowes v. Hope Life Insurance and Guarantee Co.(1), Re General
Company for Promotion of Land Credit(2) and Re National Permanent Building Society(3). It is true that
"a winding up order is not a normal alternative in the case of a company to the ordinary procedure for the
realisation of the debts due to it"; but nonetheless it is a form of equitable execution. Propriety does not
affect the power but only its exercise. If so, it follows that in terms of cl. (d) of r. 1 of O.XL of the Code of
Civil Procedure, a Receiver can file a petition for winding up of a company for the realisation of the
properties, movable and immovable, including debts, of which he was appointed the Receiver. In this view,
the respondent had power to file the petition in the Court for winding up of the Company.
That apart, under O.XL, r. 1(d), of the Code of Civil Procedure the Court can also confer on the Receiver
such of those powers as the Court thinks fit. It is implicit in this apparently wide power that it shall be
confined to the scope of the Receiver's administration of the estate. If, for the proper and effective
management of the estate of which the Receiver has been appointed the Court thinks fit that it shall confer
power on the said Receiver to take steps for winding up of the debtor-company, it must be conceded that
the Court will have power to give necessary directions to the Receiver in that regard. On November 22,
1963, the Receiver obtained the directions of the Court empowering him to file the winding-up petition
against the Company. But, it is contended that the learned Judge made that order without prejudice to the
contentions of the members of the joint family and that one of the contentions was that a petition for the
winding up of the Company was not maintainable at the instance of the Receiver. This reservation, no
doubt, entitles the appellant to raise the plea of the maintainability of the petition by the Receiver for
winding up of the Company, But it does not bear on the question of authorization obtained by the Receiver
to file the said petition. The question of the maintainability of the petition will be dealt with by us at a later
stage of the judgment. In this view also the Receiver had the power to file the petition before the Court for.
winding up of the Company. There are, therefore, no merits in the first contention.
(ii) The Receiver was a 'creditor' within the meaning of s. 4396(1) (b) of the Indian Companies Act.
(iii) By asking the company to pay the sum in question to the Addition Collector the requirements of s. 434
were not contravened.
(iv) By not paying the amount in question to the Additional Collector the company clearly neglected to pay
the amount within the meaning of s. 434 of the Indian Income-tax Act.
(v) On the facts of the case them was no bona fide dispute as to the liability of the company to the joint
family so as to render the winding up petition an abuse of the process of the Court.
Smt. Nagaveni Bhat v. Canara Leasing Ltd ILR 2001 KAR 5569
1. This O.S.A. is filed against the order of the learned Company Judge, dated 25-8-2000 passed in Co. P.
No. 5 of 1996 whereby the learned Single Judge declined to issue a direction for winding up of the company.
2. According to the learned Counsel for appellants, the respective appellants deposited amounts in the
company on various dates between 1989 and 1991 for specified periods. But the amounts so deposited were
not repaid on respective maturity dates. The appellants issued notice and claimed interest at 14% per annum
on the maturity value. It is alleged that as no reply was received, the company is deemed to have been
unable to pay its debt and therefore the appellants filed this petition under Section 433 of the Companies
Act for winding up. Pending company petition, the entire amount along with interest was paid. The learned
Single Judge on consideration of the case-law has not interfered and observed that the petitioners will be
free to sort out their grievance before the Civil Court by filing civil suits in accordance with law.
3. The grievance of the petitioners is that the learned Single Judge has erred in not allowing the petition and
directing the winding up of the company on its failure to pay interest on delayed payment when there was
no dispute regarding the liability for the payment of the principal amount. The learned Counsel relied on
the decision of Madras High Court in Rashi Leathers (Private) Limited v Super Fine Skin Traders , and also
the ruling of Delhi High Court in Devendra Kumar Jain v Polar Forgings and Tools Limited2, and another
verdict of Punjab and Haryana High Court in Stephen Chemicals (Private) Limited v In-nosearch Limited.
4. On the other hand, learned Counsel for the company submits that as per the terms of the contract, the
principal amount as well as interest on the maturity value has been paid and therefore merely on the ground
of delayed payment the appellants are not entitled to seek winding up and to determine the interest amount.
The order of the learned Single Judge cannot be interfered with and the appellants are not entitled to get
interest on the delayed payment in the garb of this winding up petition and the cases relied upon are not
helpful. The learned Counsel also submits that after maturity date without renewal or a fresh cause of action
the appellants cannot claim any interest on delayed payment and interest so claimed is disputed. He also
relied on the decision in Greenhills Exports (Private) Limited, Mangalore and Others v Coffee Board,
Bangalore1, wherein it was held that unless interest portion is determined by a competent Court, the winding
up cannot be ordered on the basis of mere pleadings. As such winding up cannot be ordered and interest
cannot be determined.
5. In the rejoinder the learned Counsel for the appellants submits that the decision relied upon by the learned
Counsel for the company is of no avail as it pertains to the claim for damages and not to the claim for
interest.
6. We have heard the learned Counsel for the appellants and the learned Counsel for the respondents and
perused the material on record and also the case-laws.
7. Under the Companies Act a special jurisdiction has been created for winding up which is entirely for a
different purpose. That if admitted debt is not paid after expiry of the statutory notice and company is unable
to pay the debt, winding up order can be passed. In other words, if any admitted debt is due, the provisions
of Section 433 can be invoked, but the debt should be bona fide and whether it is bona fide depends upon
the circumstances of each case. Whether the dispute is raised to avoid payment of debt and not based on
substantial ground cannot be considered. It is also seen that it is not the legislative intention that Company
Court should be converted itself into an ordinary Civil Court and proceed to hold a trial at the instance of
individual creditor.
8. In the instant case as facts culled out, the entire principal amount along with interest due till the maturity
date has been paid. As such the cause of action, if any, for winding up ceases to exist, as only those
circumstances have to be seen which existed on the date of the petition. Therefore, no direction can be
issued as prayed for. In our opinion, once the cause of action to seek winding up does not subsist, Section
433(e) cannot be invoked for awarding interest on the delayed payment which is also disputed in the facts
of this case.
9. So far as the cases relied upon are concerned, in Devendra Kumar Jain's case, supra, because of the fact
that the interest was not calculated, it was observed that the letter constituted a valid demand for interest at
18% per annum and the Company Judge has power to determine the interest and direct to pay interest at
12% per annum, failing which the company would be liable to be wound up. This is not helpful in the facts
of the present case. In Stephen Chemicals Limited's case, supra, wherein the observation of the learned
Single Judge that when a winding up petition has been filed on the ground that it is unable to repay its debt
and the company admits its liability and in fact pays it up, the Company Judge is the appropriate forum for
determining as to whether the creditor is entitled to interest on the amount in question or not, has not been
interfered by the Division Bench on the ground that Punjab and Haryana High Court Rules do not provide
for a company appeal and the point in issue regarding delayed payment was not there. As such this decision
is also not helpful in the facts of the given case as stated. Lastly, in the case of Rashi Leathers (Private)
Limited, supra, it is held that the liability to pay interest was never in dispute. It was also observed that in
all its replies to the respondent's letters claiming principal and interest, the appellant had been assuring that
it would settle the claim, but never disputed its liability to pay interest and therefore the Company Judge
was right in holding that the liability of the appellant to pay interest is a matter which could be gone into in
the winding up the petition. This ruling is also not helpful in the facts of this case as stated above. The
ground urged for winding up on the delayed payment cannot be gone into nor this Court can determine the
same invoking the provisions of Section 433(e) of the Companies Act.
10. In view of what has been discussed above and under the circumstances, we find no error, or illegality
in the order of the learned Single Judge so as to call for any interference. Appeal is dismissed.
Substratum of the Company

Madhusudan Gordhandas & Co. v. Madhu Woollen Industries Pvt. Ltd. (1972) 42 Comp. Cas. 125
The appellants filed a petition for winding up of the respondent company, on the grounds : (1) that the
company was unable to pay the debts due to the appellants, (2) that the company showed their indebtedness
in their books of account for a much smaller amount, (3) that the company was indebted to other creditors,
(4) that the company was effecting an unauthorised sale of its machinery, and (5) that the company had
incurred losses and stopped functioning, and therefore the substratum of the company disappeared and there
was no possibility of the company doing any business at profit.
The High Court dismissed the petition.
Dismissing the appeal to this Court,
HELD : The rules for winding up on a creditor's petition are if there is a bona fide dispute about a debt and
the defence is a substantial one, the court would not' order winding up. The defence of the company should
be in good faith and one of substance. if the defence is likely to succeed on a point of law and the company
adduced prima facie proof of the facts on which the defence depends, no order of winding up would be
made by the Court. Further under s. 557 of the Companies Act, 1956, in all matters relating to winding up
of a company the court may ascertain the wishes of the creditors. If, for some good reason the creditors
object to a winding up order, the court, in its discretion, may refuse to pass such an order. Also, the winding
up order will not be made on a creditor's petition if it would not benefit the creditor or the company's
creditors generally.
(1) In the present case, the claims of the appellants were disputed both in fact and in law. The company had
given prima facie evidence that the appellants were not entitled to any claim. The company had also raised
the defence of lack of privity and of limitation.
(2) One of the claims of the appellants was proved by the company to be unmeritorious and 'false, and as
regards the admitted debt the company had stated that there was a settlement between the company and the
appellants that the appellants would receive a lesser amount and that the company would pay it off out of
the proceeds of sale of the company's properties.
(3) The creditors of the company for the sum of Rs. 7,50,000 supported the company and resisted the
appellants' application for winding up.
(4) The cumulative evidence in support of the case of the company is that the appellants consented to any
approved of the sale of the machinery. As shareholders, they had expressly written that they had no
objection to the sale of the machinery and the letter was issued in order to enable the company to hold an
extraordinary general meeting on the subject. The company passed a resolution authorising the sale. The
appellants themselves were parties to the proposed sale and wanted to buy the machinery. Where the
shareholders had approved of the sale it could not be said that the transaction was unauthorised or
improvident.
(5) In determining whether or not the substratum of the company had gone, the objects of the company and
the case of the company on that question would have to be looked into. In the present case, the company
alleged that with the proceeds of sale the Company intend to enter into some other profitable business. such
as export business which was within its objects. The mere fact that it had suffered trading losses will not
destroy its substratum unless there is no reasonable prospect of it ever making a profit in the future. A court
would not draw such an inference normally.
One of its largest creditors, who opposed the winding up petition would help it in the export business. The
company had not abandoned the objects of its business. Therefore, on the facts and circumstances of the
present case it could not be held that the substratum of the company had gone.
Nor could it be held that the company was unable to meet the outstandings of any of its admitted
creditors.The company had deposited money in court as per the directions of the Court and had not ceased
carrying on its business.
(6) On the facts of the case it is apparent that the appellants had presented the petition with improper motives
and not for any legitimate purpose. The appellants were its directors, had full knowledge of the company's
affairs and never made demands 'for their alleged debts. They sold their shares, went out of management of
the company and just when the sale of the machinery was going to be effected presented the petition for
winding up.
Voluntary winding-up
Section 304. Circumstances in which company may be wound up voluntarily.
A company may be wound up voluntarily,—

(a) if the company in general meeting passes a resolution requiring the company to be wound up voluntarily
as a result of the expiry of the period for its duration, if any, fixed by its articles or on the occurrence of any
event in respect of which the articles provide that the company should be dissolved; or
(b) if the company passes a special resolution that the company be wound up voluntarily.
Section 305. Declaration of solvency in case of proposal to wind up voluntarily.
(1) Where it is proposed to wind up a company voluntarily, its director or directors, or in case the company
has more than two directors, the majority of its directors, shall, at a meeting of the Board, make a declaration
verified by an affidavit to the effect that they have made a full inquiry into the affairs of the company and
they have formed an opinion that the company has no debt or whether it will be able to pay its debts in full
from the proceeds of assets sold in voluntary winding up.
(2) A declaration made under sub-section (1) shall have no effect for the purposes of this Act, unless—
(a) it is made within five weeks immediately preceding the date of the passing of the resolution for winding
up the company and it is delivered to the Registrar for registration before that date;
(b) it contains a declaration that the company is not being wound up to defraud any person or persons;
(c) it is accompanied by a copy of the report of the auditors of the company prepared in accordance with
the provisions of this Act, on the profit and loss account of the company for the period commencing from
the date up to which the last such account was prepared and ending with the latest practicable date
immediately before the making of the declaration and the balance sheet of the company made out as on that
date which would also contain a statement of the assets and liabilities of the company on that date; and
(d) where there are any assets of the company, it is accompanied by a report of the valuation of the assets
of the company prepared by a registered valuer.
(3) Where the company is wound up in pursuance of a resolution passed within a period of five weeks after
the making of the declaration, but its debts are not paid or provided for in full, it shall be presumed, until
the contrary is shown, that the director or directors did not have reasonable grounds for his or their opinion
under sub-section (1).
(4) Any director of a company making a declaration under this section without having reasonable grounds
for the opinion that the company will be able to pay its debts in full from the proceeds of assets sold in
voluntary winding up shall be punishable with imprisonment for a term which shall not be less than three
years but which may extend to five years or with fine which shall not be less than fifty thousand rupees but
which may extend to three lakh rupees, or with both.
Section 306. Meeting of creditors.
(1) The company shall along with the calling of meeting of the company at which the resolution for the
voluntary winding up is to be proposed, cause a meeting of its creditors either on the same day or on the
next day and shall cause a notice of such meeting to be sent by registered post to the creditors with the
notice of the meeting of the company under section 304.
(2) The Board of Directors of the company shall—
(a) cause to be presented a full statement of the position of the affairs of the company together with a list
of creditors of the company, if any, copy of declaration under section 305 and the estimated amount of the
claims before such meeting; and
(b) appoint one of the directors to preside at the meeting.
(3) Where two-thirds in value of creditors of the company are of the opinion that—
(a) it is in the interest of all parties that the company be wound up voluntarily, the company shall be wound
up voluntarily; or
(b) the company may not be able to pay for its debts in full from the proceeds of assets sold in voluntary
winding up and pass a resolution that it shall be in the interest of all parties if the company is wound up by
the Tribunal in accordance with the provisions of Part I of this Chapter, the company shall within fourteen
days thereafter file an application before the Tribunal.
(4) The notice of any resolution passed at a meeting of creditors in pursuance of this section shall be given
by the company to the Registrar within ten days of the passing thereof.
which shall not be less than fifty thousand rupees but which may extend to two lakh rupees and the director
of the company who is in default shall be punishable with imprisonment for a term which may extend to
six months or with fine which shall not be less than fifty thousand rupees but which may extend to two lakh
rupees, or with both.
Section 307. Publication of resolution to wind up voluntarily
(1) Where a company has passed a resolution for voluntary winding up and a resolution under sub-section
(3) of section 306 is passed, it shall within fourteen days of the passing of the resolution give notice of the
resolution by advertisement in the Official Gazette and also in a newspaper which is in circulation in the
district where the registered office or the principal office of the company is situate.
(2) If a company contravenes the provisions of sub-section (1), the company and every officer of the
company who is in default shall be punishable with fine which may extend to five thousand rupees for every
day during which such default continues.
Ranking of claims
Section 324. Debts of all descriptions to be admitted to proof.

In every winding up (subject, in the case of insolvent companies, to the application in accordance with the
provisions of this Act or of the law of insolvency), all debts payable on a contingency, and all claims against
the company, present or future, certain or contingent, ascertained or sounding only in damages, shall be
admissible to proof against the company, a just estimate being made, so far as possible, of the value of such
debts or claims as may be subject to any contingency, or may sound only in damages, or for some other
reason may not bear a certain value.
Section 325. Application of insolvency rules in winding up of insolvent companies
(1) In the winding up of an insolvent company, the same rules shall prevail and be observed with regard
to—
(a) debts provable;
(b) the valuation of annuities and future and contingent liabilities; and
(c) the respective rights of secured and unsecured creditors,
as are in force for the time being under the law of insolvency with respect to the estates of persons adjudged
insolvent:
Provided that the security of every secured creditor shall be deemed to be subject to a pari passu charge in
favour of the workmen to the extent of the workmen’s portion therein, and, where a secured creditor, instead
of relinquishing his security and proving his debts, opts to realise his security,—
(i) the liquidator shall be entitled to represent the workmen and enforce such charge;
(ii) any amount realised by the liquidator by way of enforcement of such charge shall be applied rateably
for the discharge of workmen’s dues; and
(iii) so much of the debts due to such secured creditor as could not be realised by him or the amount of the
workmen’s portion in his security, whichever is less, shall rank pari passu with the workmen’s dues for the
purposes of section 326.
(2) All persons under sub-section (1) shall be entitled to prove and receive dividends out of the assets of
the company under winding up, and make such claims against the company as they respectively are entitled
to make by virtue of this section:
Provided that if a secured creditor, instead of relinquishing his security and proving his debts, proceeds to
realise his security, he shall be liable to pay his portion of the expenses incurred by the liquidator, including
a provisional liquidator, if any, for the preservation of the security before its realisation by the secured
creditor.
Explanation.—For the purposes of this sub-section, the portion of expenses incurred by the liquidator for
the preservation of a security which the secured creditor shall be liable to pay shall be the whole of the
expenses less an amount which bears to such expenses the same proportion as the workmen’s portion in
relation to the security bears to the value of the security.
(3) For the purposes of this section, section 326 and section 327,—
(a) “workmen’’, in relation to a company, means the employees of the company, being workmen within the
meaning of clause (s) of section 2 of the Industrial Disputes Act, 1947;
(b) “workmen’s dues’’, in relation to a company, means the aggregate of the following sums due from the
company to its workmen, namely:—
(i) all wages or salary including wages payable for time or piece work and salary earned wholly or in part
by way of commission of any workman in respect of services rendered to the company and any
compensation payable to any workman under any of the provisions of the Industrial Disputes Act, 1947;
(ii) all accrued holiday remuneration becoming payable to any workman or, in the case of his death, to any
other person in his right on the termination of his employment before or by the effect of the winding up
order or resolution;
(iii) unless the company is being wound up voluntarily merely for the purposes of reconstruction or
amalgamation with another company or unless the company has, at the commencement of the winding up,
under such a contract with insurers as is mentioned in section 14 of the Workmen’s Compensation Act,
1923, rights capable of being transferred to and vested in the workmen, all amount due in respect of any
compensation or liability for compensation under the said Act in respect of the death or disablement of any
workman of the company;
(iv) all sums due to any workman from the provident fund, the pension fund, the gratuity fund or any other
fund for the welfare of the workmen, maintained by the company;
(c) “workmen’s portion’’, in relation to the security of any secured creditor of a company, means the amount
which bears to the value of the security the same proportion as the amount of the workmen’s dues bears to
the aggregate of the amount of workmen’s dues and the amount of the debts due to the secured creditors.
Illustration
The value of the security of a secured creditor of a company is Rs. 1,00,000. The total amount of the
workmen’s dues is Rs. 1,00,000. The amount of the debts due from the company to its secured creditors is
Rs. 3,00,000. The aggregate of the amount of workmen’s dues and the amount of debts due to secured
creditors is Rs. 4,00,000. The workmen’s portion of the security is, therefore, one-fourth of the value of the
security, that is Rs. 25,000.
Section 326. Overriding preferential payments
(1) Notwithstanding anything contained in this Act or any other law for the time being in force, in the
winding up of a company,—
(a) workmen’s dues; and
(b) debts due to secured creditors to the extent such debts rank under clause
(iii) of the proviso to sub-section (1) of section 325 pari passu with such dues, shall be paid in priority to
all other debts:
Provided that in case of the winding up of a company, the sums towards wages or salary referred to in sub-
clause (i) of clause (b) of sub-section (3) of section 325, which are payable for a period of two years
preceding the winding up order or such other period as may be prescribed, shall be paid in priority to all
other debts (including debts due to secured creditors), within a period of thirty days of sale of assets and
shall be subject to such charge over the security of secured creditors as may be prescribed.
(2) The debts payable under the proviso to sub-section (1) shall be paid in full before any payment is made
to secured creditors and thereafter debts payable under that sub-section shall be paid in full, unless the assets
are insufficient to meet them, in which case they shall abate in equal proportions.
Section 327. Preferential payments
(1) In a winding up, subject to the provisions of section 326, there shall be paid in priority to all other
debts,—
(a) all revenues, taxes, cesses and rates due from the company to the Central Government or a State
Government or to a local authority at the relevant date, and having become due and payable within the
twelve months immediately before that date;
(b) all wages or salary including wages payable for time or piece work and salary earned wholly or in part
by way of commission of any employee in respect of services rendered to the company and due for a period
not exceeding four months within the twelve months immediately before the relevant date, subject to the
condition that the amount payable under this clause to any workman shall not exceed such amount as may
be notified;
(c) all accrued holiday remuneration becoming payable to any employee, or in the case of his death, to any
other person claiming under him, on the termination of his employment before, or by the winding up order,
or, as the case may be, the dissolution of the company;
(d) unless the company is being wound up voluntarily merely for the purposes of reconstruction or
amalgamation with another company, all amount due in respect of contributions payable during the period
of twelve months immediately before the relevant date by the company as the employer of persons under
the Employees’ State Insurance Act, 1948 or any other law for the time being in force;
(e) unless the company has, at the commencement of winding up, under such a contract with any insurer as
is mentioned in section 14 of the Workmen’s Compensation Act, 1923, rights capable of being transferred
to and vested in the workmen, all amount due in respect of any compensation or liability for compensation
under the said Act in respect of the death or disablement of any employee of the company:
Provided that where any compensation under the said Act is a weekly payment, the amount payable under
this clause shall be taken to be the amount of the lump sum for which such weekly payment could, if
redeemable, be redeemed, if the employer has made an application under that Act;
(f) all sums due to any employee from the provident fund, the pension fund, the gratuity fund or any other
fund for the welfare of the employees, maintained by the company; and
(g) the expenses of any investigation held in pursuance of sections 213 and 216, in so far as they are payable
by the company.
(2) Where any payment has been made to any employee of a company on account of wages or salary or
accrued holiday remuneration, himself or, in the case of his death, to any other person claiming through
him, out of money advanced by some person for that purpose, the person by whom the money was advanced
shall, in a winding up, have a right of priority in respect of the money so advanced and paid-up to the
amount by which the sum in respect of which the employee or other person in his right would have been
entitled to priority in the winding up has been reduced by reason of the payment having been made.
(3) The debts enumerated in this section shall—
(a) rank equally among themselves and be paid in full, unless the assets are insufficient to meet them, in
which case they shall abate in equal proportions; and
(b) so far as the assets of the company available for payment to general creditors are insufficient to meet
them, have priority over the claims of holders of debentures under any floating charge created by the
company, and be paid accordingly out of any property comprised in or subject to that charge.
(4) Subject to the retention of such sums as may be necessary for the costs and expenses of the winding up,
the debts under this section shall be discharged forthwith so far as the assets are sufficient to meet them,
and in the case of the debts to which priority is given under clause (d) of sub-section (1), formal proof
thereof shall not be required except in so far as may be otherwise prescribed.
(5) In the event of a landlord or other person distraining or having distrained on any goods or effects of the
company within three months immediately before the date of a winding up order, the debts to which priority
is given under this section shall be a first charge on the goods or effects so distrained on or the proceeds of
the sale thereof:
Provided that, in respect of any money paid under any such charge, the landlord or other person shall have
the same rights of priority as the person to whom the payment is made.
(6) Any remuneration in respect of a period of holiday or of absence from work on medical grounds through
sickness or other good cause shall be deemed to be wages in respect of services rendered to the company
during that period.
(a) the expression “accrued holiday remuneration” includes, in relation to any person, all sums which, by
virtue either of his contract of employment or of any enactment including any order made or direction given
thereunder, are payable on account of the remuneration which would, in the ordinary course, have become
payable to him in respect of a period of holiday, had his employment with the company continued until he
became entitled to be allowed the holiday;
(b) the expression “employee” does not include a workman; and
(c) the expression “relevant date” means—
(i) in the case of a company being wound up by the Tribunal, the date of appointment or first appointment
of a provisional liquidator, or if no such appointment was made, the date of the winding up order, unless,
in either case, the company had commenced to be wound up voluntarily before that date; and
(ii) in any other case, the date of the passing of the resolution for the voluntary winding up of the company.
*****

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CASES AND MATERIALS ON COMPANY LAW

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MODULE V – MANAGEMENT AND CORPORATE GOVERNANCE ......................................... 104

Section 129. Financial statement. ................................................................................................ 192

Section 272. Petition for winding up. .......................................................................................... 294

MODULE I - INTRODUCTION TO THE CORPORATE FORM

Principles of Corporate Law

What is Corporate Law?

1.2 What is a Corporation?

1.2.1 Legal personality

1.2.2 Limited liability

1.2.3 Transferable shares

1.2.4 Delegated management with a board structure

1.2.5 Investor ownership

1.3 What Does Corporate Law Include?

1.3.1 Secondary and partial corporations forms

1.3.2 Additional sources of corporate law

1.3.3 Non-corporate law constraints

1.4 What is the Goal of Corporate Law?

Meaning of the word ‘Company’

Tennant v. Stanley [In re Stanley] (1906) 1 Ch. 131 –

Independent Legal Entity

Corporate Personality in India

Salomon v. Salomon & Co. Ltd.

Lifting the Corporate Veil

Holding and Subsidiary Companies

Salomon v. Salomon [1897] A.C. 22

In Re: The Kondoli Tea Co. Ltd. (1886) ILR 13 Cal. 43

Lifting of the corporate veil

In re Dishaw Maneckjee Petit AIR 1972 Bom 371

Macaura v. Northern Assurance Company (1925) AC 619

Prest v Petrodel Resources Limited [2013] UKSC 34

Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613

State of Rajasthan v. Gotan Lime Stone Khanji Udyog Pvt. Ltd.

Fundamental rights of a company

R.C. Cooper v. Union of India 1970 AIR SC 564

National Company Law Tribunal and Appellate Tribunal

MODULE II - TYPES OF BUSINESS ORGANISATIONS

Ownership Individual Partners Partners Individual 2 to 7 shareholders Shareholders in

Liability Unlimited Unlimited- Each Limited to the Limited to Limited to Limited to

Formation Minimal Optional Compulsory Considerable Considerable Considerable

Profits Individual Partners Partners Individual Shareholders Shareholders

MODULE III - INCORPORATION AND FORMATION OF COMPANIES

4. (1) The memorandum of a company shall state—

Doctrine of constructive notice, ultra vires and indoor management

Royal British Bank v. Turquand (1856) 6 E&B 327

Ashbury Rly. Carriage & Iron Company v. Riche (1875) LR 7 HL 653

Lakshmanaswami Mudaliar v. L.I.C. AIR 1963 SC 1185

Modifications to the articles and memorandum of association

Conflict between a shareholders agreement and AoA

Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613

MODULE IV - SHARE CAPITAL AND SHAREHOLDERS

Kelner v. Baxter, (1866) LR 2 CP 174

Specific Relief Act

Types of share capital

43. Kinds of share capital-

Explanation.—For the purposes of this section,—

Who is a shareholder; who is a promoter?

Section 2(55) “member”, in relation to a company, means—

Section 2(69) “promoter” means a person—

Section 96. Annual general meeting.

Section 100. Calling of extraordinary general meeting

Pre-requisites of a valid meeting