Company Law Board
Bhupinder Rai And Ors. vs S.M. Kannappa Automobiles Pvt. Ltd. And ... on 24 October, 1994
Equivalent citations: [1996]86COMPCAS18(CLB)
ORDER
1. Shri Bhupinder Rai and two others have filed this petition under Section 111 of the Companies Act, 1956 (hereinafter referred to as "the Act"), seeking rectification of the register of members of S. M. Kannappa Automobiles (P.) Limited. The facts as narrated by the petitioners are as follows.
2. The company is a private limited company incorporated in the year 1975, with an authorised capital of Rs. 10 lakhs and the paid-up capital of the company was Rs. 2,00,100 consisting of 2,001 shares of Rs. 100 each. Of this paid-up capital of the company, the petitioners' group held 1,000 shares. The sixth and seventh respondents' group held 1,000 shares and one share was held by Shri S. M. Kannappa who was the proprietor before the sole proprietorship was converted into a company. The one share held by Shri Kannappa was transferred to the first petitioner by the legal heirs of Shri Kannappa after his death in 1990. As the company refused to register the share in the name of petitioner No. 1, a petition under Section 155 of the Act was filed by the petitioner in the Karnataka High Court which is still pending. From the reply filed in these proceedings by the respondents, the petitioners came to know that the company had issued further 6,000 shares in the company at 3,000 shares each to respondents Nos. 6 and 7. In the present petition before us, this issue has been challenged and the petitioners have sought for removal of the names of these respondents from the register of members in respect of these 6,000 shares alleging that this allotment was made only with a view to increase the shareholding of respondents Nos. 6 and 7 so as to upset the equal holding of both the groups.
3. It is further stated in the petition that even though respondents Nos. 6 and 7 are not directors in the board yet respondents Nos. 2 to 5 who are directors and who owe allegiance to respondents Nos. 6 and 7, have, in violation of their fiduciary responsibilities, allotted these 6,000 shares to respondents Nos. 6 and 7. Such an allotment is against the basic understanding between the two groups that both the groups would hold an equal number of shares in the company. Therefore, it is alleged that allotment of shares to one group in exclusion of the other, is gross misuse of the fiduciary powers vested in the board of directors. It has been further stated in the petition, that the company had, by its letter dated December 7, 1987, offered rights shares in the ratio of 1 : 1 and on applying for 5,000 shares by remitting an amount of Rs. 50,000 by demand draft, petitioner No. 9 was informed that the board of the company had decided on March 31, 1988, to postpone the issue of rights shares and afterwards, in spite of reminders from the petitioners, the company had not informed anything about further issue of shares. However, before offering any shares to the petitioners, the company is purported to have issued 6,000 shares in 1990 to the respondents even without following procedure prescribed under Article 7 of the articles of association by which a special resolution is needed for increasing the share capital of the company for issuing new shares. Under these circumstances, they have sought for a declaration that the issue of 6,000 shares is void and illegal and, therefore, the register of members should be rectified by removing the names of respondents Nos. 6 and 7 in respect of these additional 6,000 shares.
4. Respondents Nos. 1 to 5 filed a reply raising preliminary objections . that the provisions of Section 111 are not applicable to private limited companies. Even otherwise the provisions of Section 111 are applicable only in the ease of transfer of shares and not allotment of shares. On the merits, the respondents have submitted that there are various litigations between the petitioners and the respondents and the instant petition is one among such litigations. They have denied various other allegations made in the petition and asserted that the allotment of 6,000 shares was rightly done as per the powers vested in the board of directors under its articles. There is no written or unwritten agreement between the petitioners and the respondents that their shareholding parity should always be maintained. Accordingly, they have sought for dismissal of the petition as mala fide and frivolous.
5. We heard the case on a number of days and finally on June 24, 1994. Shri A. K. Mylsamy, advocate, appeared for the petitioners and Shri S. Sreenivasan, practising company secretary for respondents Nos. 1 to 5 and Shri C. Harikrishnan, advocate, for respondents Nos. 6 and 7. Learned counsel for the petitioner reiterating the submissions made in the petition stated that the preliminary objection relating to maintainability of the petition no longer survives in view of the decision of the Company Law Board in Jitendra Nath Saha v. Shyamal Mondal [1993] 1 CLJ 76 ; [1995] 82 Comp Cas 688 in which the Board has held that the provisions of Section 111 are applicable to private limited companies. He further submitted that the shareholding of the petitioners and the respondents' group was always equal, each holding 1,000 shares. Even though originally 500 shares each were held by Shri Om Parkash Narang, Shri M.L. Manchanda, Shri Vijay Kumar Narang (second petitioner) and Shri Bhupinder.Rai (first petitioner), there were inter se transfers in the family and presently the petitioners' group held 1,000 shares and other group (respondents Nos. 6 and 7) held 1,000 shares. The petitioners came to know of the allotment of 6,000 shares only from the reply filed by the respondents to the petition under Section 155 of the Act in the Karnataka High Court against refusal of registration of transfer of one share held by Shri Kannappa. Thereafter, the petitioners took inspection of the records with the Registrar of Companies, Karnataka, and came to know that the impugned shares were allotted at the board meeting stated to have been held on September 24, 1990. This was obviously done only after petitioner No. 1 purchased one share held by Shri Kannappa and lodged transfer documents with the company. According to the information of the petitioners, no cash was paid for these shares and respondents Nos. 3 to 5 who were the directors of the company and who were in one way or the other connected with respondents Nos. 6 and 7, by misusing the fiduciary authority vested in them, allotted the impugned shares with the mala fide intention of reducing the holding of the petitioners' group to a minority position. He further drew our attention to the letter of the company dated December 7, 1987, offering 500 shares in the ratio of 1 : 1 to the first petitioner for which he also remitted a sum of Rs. 50,000 to substantiate his argument that even the company intended to maintain parity in the shareholding. However, the company postponed the allotment and instead of offering shares later in the same ratio to all shareholders, allotted the impugned shares to respondents Nos. 6 and 7 completely excluding the petitioners' group. He also drew our attention to the provisions of Article 7 of the articles of association of the company and stated that no special resolution as stipulated in the articles was passed for issuing new shares. He also refuted the submissions made by the company that the company was in need of funds and it also requested the petitioners to contribute towards the cash requirement of the company. Shri Mylsamy stated that the petitioner did not receive any communication from the company seeking any loan from the petitioners. He also questioned the statement of the company that the allotment was made by converting the loan given by respondents Nos. 6 and 7 into equity shares. He further stated that there is nothing in the resolution passed on September 24, 1990, to indicate the purpose for which the allotment was made. According to him, in earlier allotments made by the company on June 15, 1981, and August 17, 1981, while converting the loan into share capital, the shareholding parity was maintained. He further alleged that the company has not produced any evidence regarding the. payment received towards these shares and as such an adverse inference should be drawn against the company. For this proposition he relied on Gopal Krishnaji Ketkar v. Mohamed Haji Latif, AIR 1968 SC 1413. He summed up his argument stating that the allotment is irregular, illegal and mala fide done only with a view to reduce the position of the petitioner to a minority and as such the prayer for rectification of register of members in respect of these shares be granted.
6. Shri S. Sreenivasan, appearing on behalf of respondents Nos. 1 to 5, questioned the claim of the petitioners that there were identifiable groups in the company and the shareholding parity is to be maintained. There is neither any written agreement between the shareholders nor any terms to that effect incorporated in the articles of association of the company. No shareholder of the company is on the board and only professional directors are managing the company and as far as they are concerned, in the absence of any terms in the articles of association, even assuming that there are agreements between the shareholders, they are not binding on the company and the board of directors could not take cognizance of those agreements. As regards violation of the provisions of Article 7 of the articles of association, he submitted that special resolution as stipulated in Article 7 would be needed only if new shares are created by increasing the authorised capital but does not apply in the case of increasing the subscribed capital within the existing authorised capital. Issue of shares within the existing authorised capital is at the discretion of the board of directors as provided in article 6 and exercising this power, the directors who are not shareholders, allotted the shares in favour of respondents Nos. 6 and 7, by conversion of loan given by respondents Nos. 6. and 7 to the company. This was done only in the best interest of the company and, therefore, the allegation that there was no receipt of money from respondents Nos. 6 and 7 against the allotment is not well-founded. He also refuted the allegation that respondents Nos. 2 to, 5 have acted as stooges of respondents Nos. 6 and 7. Even though the respondent directors have some connection with respondents Nos. 6 and 7, yet whatever they did was in the interest of the company. He also made a statement that ' these directors are prepared to resign from the board of directors if so directed by us in the interest and welfare of the company as they do not want to be parties in a fight among the shareholders.
7. Shri Harikrishnan, counsel for respondents Nos. 6 and 7, supplementing and supporting the submissions made by Shri Sreenivasan, questioned the very basis of the arguments relating to maintenance of parity between the group especially when there is no concept of groups that could be even presumed if one looks at the relationship between the petitioners and respondents Nos. 6 and 7. The relationship between the parties is such that the so-called groupisim could have been never thought of when the company was incorporated, he submitted. If there was an any understanding regarding parity, he further questioned, as to how petitioner No. i could have attempted to corner the share of Shri Kannappa. He also drew our attention to the extracts of the ledger produced by the company from which it was evident that the amount standing to the credit of respondents Nos. 6 and 7 was set off by issue of the impugned shares to respondents Nos. 6 and 7. He was of the view that the provisions of Section 111 do hot apply to allotment of shares but it relates only to cases of transfer of shares. However, he stated that in view of the Company Law Board decision in Jitendra Nath Saha v. Shyamal Mondal [1395] 1 CLJ 76 ; [1995] 82 Comp Cas 688 that even allotment in a private limited company could be agitated in a petition under Section 111(4), the, attack on allotment is possible only in two contingencies. One is that the allotment is illegal and the other is that the allotment is mala fide. The former relates to procedural defect or lack of authority while the latter relates to state of mind. Only cases relating to the first category can be entertained in a proceeding under Section 111(4) and the latter only in proceedings under Section 397/398. The company has established, he argued, that there was neither any procedural defect nor did the board of directors lack authority in issue of the impugned shares. Under the circumstances, according to him, the petition does not merit any consideration and should be dismissed.
8. We have considered the pleadings and arguments. The prayer sought by the petitioner is that the resolution passed on September 24, 1990, allotting 6,000 shares in favour of respondents Nos. 6 and 7, be declared void, illegal and inoperative and consequently the register of members of the company should be rectified by deleting the names of these respondents in respect of these shares.
9. The prayer is based on three premises. One is that this allotment is against the promoters' agreement of maintaining parity between the two groups. Secondly, it was done with mala fide intention to reduce the petitioners to a minority and, thirdly, the allotment violates the provisions of Article 7 of the articles of association of the company according to which Special resolution should have been passed for issue of new shares. Therefore, the issues that arise for our consideration are :
(a) Whether the allotment is in contravention of agreement between the promoters.
(b) Whether the allotment violates the provisions of Article 7.
(c) Whether mala fides are established.
(d) Whether the relief sought by the petitioners be granted.
Before we proceed to answer these issues, it is necessary to clarify, in view of the preliminary objection that a private company is not subject to the provisions of Section 111, we decided to proceed with the case on the basis of the Company Law Board decision in Jitendra Nath Saha v. Shyamal Mondal [19931 1 CLJ 76 ; [1995] 82 Comp Cas 688 in which it was held that the provisions of Section 111 are applicable to private limited companies also.
10. In regard to the issue of maintaining parity of shareholding between the two alleged groups, we are, for the following reasons, of the view that the petitioners have not been able to establish any such agreement which has binding force on the company. It is admitted in the petition itself at paragraph 6 that the petitioners and the sixth and seventh respondents are related. Originally, there were five shareholders, namely, Sarvshri M. L. Manchanda, O.P. Narang, Vijay Kumar Narang, Bhupinder Rai and S. M. Kannappa. While Shri Kannappa held only one share, all others held 500 shares each. The sixth and seventh respondents acquired their shares by transfer from their fathers, Shri M. L. Manchanda and Shri O. P. Narang, respectively. In other words, out of the five original promoters among whom the agreement of maintaining parity is alleged to have been agreed upon, only petitioners Nos. 1 and 2 are in a position to assert now on such agreement. There is nothing in the articles incorporating any such terms or any written document produced before us in this regard. Their idea of maintaining parity also falls when we look at the attempt of the petitioner to acquire one share of Shri Kannappa, the acquisition of which would definitely affect the so called parity. Another important point raised by counsel for respondents Nos. 6 and 7, Shri Harikrishnan, which impressed us was the relationship among the parties and how in such a situation any group concept would have been visualised at the time of incorporation of the company.
11. The relationship between the parties is that the first petitioner is the brother-in-law of the seventh respondent and the third petitioner is the uncle of the seventh respondent and petitioner No. 2 is the son of the third petitioner. The sixth respondent is the son of one of the original promoters, namely, Shri M. L. Manchanda, who was the uncle of another promoter, Shri O. P. Narang. In other words, the petitioners and the sixth and seventh respondents are so closely related in such a way that the petitioners being in one group and the sixth and seventh respondents being in another group for the purpose of maintaining parity of shareholding is not very convincing. If the statement of the petitioners was that each of the four original promoters other than Shri Kannappa was to always maintain parity in shareholding, then it would have had some merit but not the so called group parity.
12. Normally, a company is different from its promoters. Any agreement between the promoters concerning the company should have been incorporated in the articles of association for having a binding on the company towards such agreement. This is an established principle of law as was upheld by the Supreme Court in V.B. Rangaraj v. V. B. Gopalahrishnan [1992] 73 Comp Cas 201 ; [1992] 1 Comp LJ 11. However, Jitendra Nath Soha v. Shyamal Mondal [1993] 1 CLJ 76 ; [1995] 82 Comp Cas 688 on which reliance was placed by the petitioners, the Company Law Board took into consideration that even though the terms of the promoters agreement were not incorporated in the articles, the company had acted on various terms in the agreement between the promoters and, therefore, we held that even though the agreement was not incorporated in the articles, the same was binding on the company. But, in the present case, other than the oral submissions by the petitioner regarding the purported agreement, in the absence of anything in the articles of association, no material was placed before us regarding the alleged agreement. To substantiate the existence of an agreement, the petitioners relied on the letter of the company dated December 7, 1987, offering 500 shares to the first petitioner in the ratio of 1 : 1 as he had already held 500 equity shares in the company. As per that letter, the petitioner could also apply for additional shares if he desired so. However, the company, after some time, returned the amount of Rs. 50,000 remitted by the petitioner for 500 shares offered with the indication that the rights issue had been postponed and fresh offer, if any, would be made as and when resolved by the company. Therefore, according to the petitioner, the offer of rights at 1 : 1 itself is an admission on the part of the company that the shareholding parity is to be maintained. We are of the view, that, such rights offer itself cannot be so construed, in the absence of any other material, specially when the same is not incorporated in the articles of association, to establish the alleged agreement between the promoters.
13. Now, that we have held that there is no agreement regarding maintenance of parity in the shareholding, which is binding upon the company, the issue that arises is whether the board of directors has infringed the provisions of the articles of association of the company in allotment of the impugned shares in favour of respondents Nos. 6 and 7. Articles 6 and 7 are relevant in regard to further issue of shares. According to article 6 "The shares of the company shall be under the control of directors who may issue and allot them at such time or times in such manner in all respects as the directors may think fit". Article 7 reads "the company may, by a special resolution, passed in a general meeting increase the capital of the company .by issue of new shares or such other amounts and value and under such conditions as may be specified in such a resolution or reduce the capital or consolidate or sub-divide shares or may otherwise amend the memorandum and articles of association in accordance with the provisions of the Act."
14. According to the petitioners, the allotment of 6,000 shares to respondents Nos. 6 and 7 literally means increasing the capital of the company and as such the allotment should have been authorised by a special resolution. However, without such a resolution the board had allotted these 6,000 shares which is against the provisions of Article 7 and as such not valid. We are in full agreement with the submission of counsel for the respondents that Article 7 relates to increase of share capital by issue of new shares. It is an admitted position that the authorised capital of the company is Rs. 10 lakhs divided into 10,000 equity shares of Rs. 100 each out of which only 8,001 shares have been issued. In other words, out of the existing authorised capital, before allotment of the impugned 6,000 shares, 7,999 shares were still unsubscribed and the impugned 6,000 shares formed part of the above 7,999 unsubscribed portion of the authorised capital. The wording of Article 7 clearly indicates that it covers only alteration in the share capital of the company. The term "increase the capital of the company by issue of new shares" should actually mean that the company simply takes power to issue new shares in excess of its former nominal capital. In the present case, what the company has done is to issue shares out of the unsubscribed portion of the existing authorised capital which is not covered by Article 7. As per article 6, the board of directors have powers to issue and allot shares as they deem fit and there is no pre-emptive right to the existing shareholders to claim as a matter of right allotment of shares. Therefore, we are unable to agree with the contention of the petitioner that the board of directors have infringed the provisions of the articles of the company in alloting the impugned shares.
15. The petitioners contended that no consideration was received in respect of the impugned shares and as such the allotment of shares is not valid. The company has produced documentary proof to show that the shares were issued against loans taken by the company from the allottees and as such the contention of the petitioners in this regard has no basis.
16. The next argument advanced by the petitioner was that issue of the impugned shares was with the mala fide intention of reducing the petitioners' shareholding to the advantage of the respondents. In this regard, we are in full agreement with the submission of Shri Harikrishnan that matters relating to allotment of shares can be agitated in a petition under Section 111(4) only when it is either in violation of the provisions of articles or where the board of directors have exceeded their authority as then only the entry of a name in the register of members would be wrong and would merit rectification. Therefore, in a petition under Section 111 the scope of which is limited, the question of mala fides and bona fides of any allotment cannot be either agitated or enquired into. If the petitioners are aggrieved that the allotment of the impugned shares was for a purpose other than for the benefit of the company, they have to invoke the relevant, provisions of the Companies Act and not Section 111(4) which is limited to rectification, of the register of members wherever the board of directors have entered or removed the name of any one without any sufficient cause.
17. This decision of ours may look as if we are disapproving the decision in Jitendra Nath Saha v. Shyamal Mondal [1993] 1 CLJ 76 ; [1995] 82 Comp Cas 688 in which, both of us, as members of that Bench decided that in a petition under Section 111(4), the Company Law Board is competent to consider all relevant facts and circumstances and see whether the principles of justice and equity and fair play are observed in allotment of shares, While ordinarily we would not have looked into the allegation of mala fides in allotment of shares under Section 111, in Jitendra Nath Saha v. Shyamal Mondal [1993] 1 CL] 76 ; [1995] 82 Comp Cas 688 we found that even though the terms of the promoters' agreement had not been incorporated in the articles of the company, the company had acted in terms of the said agreement and there was also enough material available in the records of the company evidencing such promoters' agreement, relating to shareholding. Therefore, we entertained that petition as we felt that the action of the board of directors in allotting shares was in contravention of an agreement binding on the company having the same force as if incorporated in the articles and while doing so looked into, inter alia, the motive behind infringing the provisions of the promoters' agreement. But, in the present case, the petitioners have not been able to establish the existence of any agreement regarding parity of shareholding and, therefore, the basis on which we entertained the petition in Jitendra Nath Saha v. Shyamal Mondal [1993] 1 CLJ 76 ; [1995] 82 Comp Cas 688 is found absent in the present case.
18. The relief sought for in the petition is that the names of respondents Nos. 6 and 7 should be removed from the register of members, declaring the issue of the impugned shares as void and illegal. The effect of relief, if granted, would be that there will be reduction of capital and we do not have any such powers under Section 111 to order reduction of share capital. Therefore, even the relief sought by the petitioner in the petition is beyond the scope of the section and the powers of the Company Law Board.
19. Therefore, considering the facts and circumstances of the case, we are of the view that the petitioners have not made out'a case for any relief under Section 111 and as such we dismiss this petition. Interim orders passed are vacated.
20. Before parting with the case, we record herein that counsel for the respondents made a statement at the Bar that the company would be prepared to allot to the petitioners all the shares which still remain unallotted out of the present authorised capital of the company of Rs. 10 lakhs, if they apply for the same.
21. There will be no order as to costs.