Company Law Board
Andhra Pradesh State Civil Supply ... vs Delta Oils And Fats Ltd. And Ors. on 19 March, 1997
Equivalent citations: [1999]96COMPCAS303(CLB)
ORDER
1. This is a petition under Section 235(2) of the Companies Act, 1956 (hereinafter called "the Act"), filed by the A. P. State Civil Supplies Corporation Ltd. which is fully owned by the Government of Andhra Pradesh. The respondents in this case are Delta Oils and Fats Limited, Tadepallygudam, West Godavari District (AP), (a joint venture between the petitioner and three other private entrepreneurs) and its former managing director and two other directors. The petitioner has prayed for an order for investigation into the affairs of the respondent-company during the period when respondent No. 2 J. Ramachandra Rao was the managing director of the company.
2. The company, incorporated on February 18, 1982, was a joint venture between the A. P. State Civil Supplies Corporation and J. Ramachandra Rao, respondent No. 2 herein, and three others who were the co-promoters. The petitioner-corporation contributed Rs. 25 lakhs, being 50 per cent. of the share capital of the respondent-company and the private co-promoters contributed the balance 50 per cent. In addition, the petitioner-corporation also provided a bridge loan of Rs. 10 lakhs. As per the joint venture agreement, the petitioner-corporation had the right to appoint its nominee director as the chairman and Ramarhandra Rao was designated as managing director. The company was under the direct management and supervision of Ramachandra Rao as its managing director till he was removed by the majority decision of the shareholders at an extraordinary general meeting in 1992.
3. It is the contention of the petitioner, that, till 1988, the unit was making good progress and there were no cash losses. In the year 1989, there was glaring and prominently noticeable mismanagement by Ramachandra Rao. Therefore, the board of directors decided to conduct a management audit to examine the correctness of the heavy losses, reported for the first time in the history of the company. The management audit brought out the following irregularities :
(i) No production registers of the company were maintained from April to August, 1990, with the result the discrepancy if any between physical verification and production register could not be ascertained.
(ii) An amount of Rs. 74,295 had been debited/transferred from sundry debtors to transportation charges. These amounts were transferred from the opening balances. It was reported that these amounts were paid towards transportation charges by various parties in earlier years, but without any proof.
(iii) During the year 1989-90 there was a shortage of 123.719 MT of oil based on the purchased quantity and the normal yield rate based on which the purchase price was fixed. The total value of the shortage was Rs. 18,33,886.
(iv) In the case of rice bran oil, as per the production records and sales records, there should be a closing stock of 69.315 MT, but the same was shown as 124.155 MT. The value of the excess stock was Rs. 8.51 lakhs.
(v) There was excess transportation charges on purchases paid to the extent of Rs. 62,000 which has not been explained.
(vi) Rice bran purchases from Srinivasa Trading Company, a firm stated to be belonging to the brother-in-law of the managing director, had been at a rate higher than the purchases made from other concerns by about Rs. 5 to 10 per quintal. The total purchases amounted to 4,154.877 tonnes. The estimated excess payment is about Rs. 2.07 lakhs. It is stated that this supplier has been carrying on the business from the factory premises of the company as the bills do not show any address but only indicate telephone numbers which belong to the respondent-company. The respondent-company had been bearing transportation charges of the supplier. Though the directors were interested in these transactions, no disclosure was made as required under Sections 297 to 302 of the Companies Act. The company also preferred to purchase the material through this intermediary rather than directly from the mills.
(vii) Inflation of transportation charges on account of purchases from Srinivasa Trading Company amounted to Rs. 3,45,196.
(viii) Apprehension of misappropriation in transport charges of coal from Singareni Collieries as they are not reconciled with the way bills and weighment slips.
(ix) During the year an amount of Rs. 1,77,650 was paid to parties on account of failure to deliver oil as per the contract. This payment is despite the company having sufficient stock throughout the year.
(x) The company did not have any policy on sales like calling for tenders or getting quotations for selling or fixing the sales prices. The sales were made at the discretion of the managing director and there was no counter check on the selling prices. Moreover, the entire sales were made for cash and the prices ranged widely from Rs. 900 per MT onwards. In addition, there were discrepancies in the quantitative figures of stock as they had not been agreed/tallied between production records and sales invoices/sales register. Whereas the production records showed the production during the year as 1660.971 MT, on a comparison of closing and stocks with the sales invoices and opening stocks a production of 1,715,811 MT emerged. A discrepancy of 54.840 MT in production is unexplained.
(xi) During the year, the company paid conveyance charges of Rs. 54,750 to the managing director for using his car for which no approval was taken from the board. In addition, the company paid the die-sel charges on the car for the entire period.
(xii) It is further stated in the petition that though the managing director has given explanation on the points raised in the management audit report, the board was not satisfied with the explanations given. The State Bank of India, after inspecting the factory gave a legal notice to the company to regularise the bank account. The board also convened an extraordinary general meeting in August, 1992, in which the shareholders unanimously voted for the removal of the managing director. The company's statutory auditors also remarked adversely regarding the performance of the company during the year.
(xiii} The State Bank of India report also brought out various irregularities in the conduct of the affairs of the company especially relating to diversion of stock from the company which according to statement of stock as on May 1, 1991, was of the value of Rs. 73.56 lakhs while as per the statement given to the bank as on May 25, 1991, the value was only of Rs. 18.03 lakhs.
4. Therefore, according to the petitioner, there is prima facie evidence that respondent No. 2, the former managing director had acted dishonestly and mismanaged the joint venture by committing irregularities and malpractices justifying an order of investigation by the Company Law Board. Only an order of such investigation would bring out as to how the company which had built up reserves in the last 8 to 9 years, had not only eroded the funds but posted a loss year during 1991.
5. Respondent No. 2 originally filed a reply for himself and also on behalf of respondents Nos. 3 and 4. Later, on taking inspection of various documents as ordered by us, he filed a detailed additional reply. He has stated in his reply that he could not take complete inspection of all the documents as many documents were not produced and some of those produced were incomplete as the same had been eaten by white ants. Therefore, according to him, even in his detailed reply, he has not been able to, in the absence of full records, cover all the points with documentary evidence to counter the allegations and on the basis of the existing documents made available to him, he has filed the reply.
6. A sum-up of his reply is as follows :
The cause of action for the petitioner to move the petition is the report of the management auditor dated October 16, 1990. However, on explanations given by respondent No. 2, to the same management auditor the latter revised his report on December 31, 1990. In the original management audit report, as against a loss of Rs. 6.8 lakhs as shown in the annual accounts, the same was revised to a profit of Rs. 12.26 lakhs. However, in the revised management audit report, as against Rs. 12.26 lakhs profit arrived at as per the first management audit report, the same auditor, after considering the explanation given by respondent No. 2, computed the loss at Rs. 2.93 lakhs. Even for this figure, respondent No. 2 had advanced his reservation. The petitioner had completely suppressed the second management audit report and as a matter of fact the annual accounts for 1989-90 had been unanimously approved taking into consideration the second management audit report. Therefore, having adopted this report unanimously in the board in which the representative of the petitioner was also present, they cannot raise any allegation in the petition now, especially when even the general body had approved the annual accounts. The reason for the company going into the red in the year 1989-90 was on account of shortage of raw materials resulting in lower capacity utilisation. Even after taking over the company after resignation of respondent No. 2 and the voluntary resignation of respondents Nos. 3 and 4, the petitioner has not been able to run the company and decided to lease out the unit. However, they did not accept the lease at Rs. 19 lakhs per annum offered as amount to run the company and now the company is closed. Respondent No. 2 offered to purchase the shares of the company held by the petitioner at Rs. 102 against book value of Rs. 40 and the petitioner has also not refunded a sum of Rs. 3.06 lakhs given by respondent No. 2 as advance for purchase of the unit under Section 29 of the State Financial Corporations Act, 1951, on January 29, 1993, and even though public auction was held on February 20, 1993, the petitioner-corporation has put its poke effort. Respondent No. 2 filed a writ petition in the High Court of Hyderabad to confirm the offer of the highest bidder and even though the Divisional Bench directed the company to decide on this matter within a month, the petitioner-corporation has not taken any action in this matter. Thus, the petitioner-corporation has not bothered the either accept the offer of respondent No, 2 to purchase the shares or run the unit or auction the same. Thus, the petitioner-corporation is responsible for making the company a sick unit.
7. On the various allegations, the reply of respondent No. 2 is as follows :
(i) Transportation charges of Rs. 74,293 for the normal course of business, the company used to advance transportation charges to the transporters which was to be later reimbursed by the customers. In some cases, since the customers had not refunded the amount, the same has been transferred from sundry debtors to transportation charges. Compared to the amount of Rs. 3.24 crores turnover in the year 1989-90, a sum of Rs. 74,293 is a negligible amount and does not reflect any mismanagement.
(ii) Purchase of bran from Srinivasa Trading Company : It is the usual practice that no rice mill bears the transportation charges from the mill/to the factory. Therefore, the transportation charges paid was in accordance with the trade practice. No favour by higher price was shown to this firm and there was no need for disclosure under Section 299 since at the relevant time the company was a private company.
(iii) Freight charges paid for coal : The company decided to use bamboo dust instead of coal as the former was cheaper and it was a management decision taken in the interest of the company and cannot form an allegation for investigation.
(iv) As far as other allegations like shortage of oil excess of stock and loss in contract for supply of oil are concerned, the respondent has stated that since these allegations have arisen out of the first management audit report, and as these issues have been dropped by the auditor himself, in his second report the respondent has nothing to offer as explanation.
(v) The loss of Rs. 47 lakhs incurred during the year 1990-91 was due to factors beyond the control of the company like shortage of raw material and acute shortage of power in Andhra during this year and is not on account of any mismanagement on the part of respondent No. 2 and as a matter of fact these issues were discussed in the meeting of the board of directors as well as the general body meeting before the accounts for the year were adopted.
(vi) As regards the allegation relating to the report of State Bank of India, it has already filed a civil suit O. S. No. 105 of 1993 and the trial is yet to commence.
8. To sum up, the respondent has submitted that under the chairmanship of the petitioner-corporation, accounts for 1990-91 had been approved and it has not made out a prima facie case for moving the Company Law Board for an order under Section 235(2) and has sought for dismissal of the petition.
9. The matter was heard on January 21, 1997. Anil Kumar (Vidya Sagar), advocate for the petitioner, reiterated the allegations made in the petition. According to him, a very profitable company had been brought to the stage of being closed solely due to the mismanagement by respondent No. 2. He stated that the allegations made in the petition provide prima facie evidence to show that there have been diversion of funds and misappropriation. The extent of diversion of funds and misappropriation can be found out only when a thorough investigation is conducted under an order by the Company Law Board and not by any enquiry by the present management. As such, he prayed that an order of investigation under Section 235(b) be ordered.
10. V.S. Raju, advocate for respondents Nos. 2 to 4 stated that the entire allegation is based on management audit report of which three major allegations have already been dropped in the second management audit report. This fact had not been disclosed by the petitioner. The company was under the control and management of respondent No. 2 over a long period during which the company did well but due to the circumstances beyond the control of the company, it incurred a loss of Rs. 47 lakhs in 1989-90. The representatives of the petitioner who were on the board of directors were aware of the situation. Even after the management audit report was submitted, the annual accounts for 1989-90 and 1990-91 were unanimously approved. When the petitioner-company decided to remove respondent No. 2 from the position of managing director, he, along with respondents Nos. 3 and 4 resigned even from the directorship. His aim was to somehow revive the company and therefore, he made an offer to purchase the shares held by the petitioner-corporation, but the same was not accepted and even the efforts to get the unit auctioned had failed. In other words, according to Raju, the petitioner-corporation was never interested in reviving the unit in which it had substantial stake.
11. On the maintainability of the petition, Raju argued to state, that, the allegation in the petition, after taking into consideration the explanation given by the respondent in his reply, would not make out a case for ordering an investigation. Citing a similar issue that arose in Professional Grade Components Limited, In re [1995] 5 CLJ 514 (CLB) in which the Company Law Board held that adverse comment by the auditor in a special audit report involving irregularities during the tenure of a person as managing director does not call for an order of investigation. He also relied on Delhi Flour Mills Co. Ltd., In re : S.L. Verma v. Delhi Flour Mills Co. Ltd. [1975] 45 Comp Cas 33 (Delhi) in which the Delhi High Court held that unless there is material to show that the fall in profits was due to mismanagement and that there was something which was not apparently visible to the naked eye, an order of investigation cannot be made. In the present case, Raju argued to state that the report of the management auditor is available with the company and the petitioner-corporation being in charge of the company, could initiate whatever action it wants to, against respondent No. 2 even without any investigation.
12. We have considered the pleadings and arguments of counsel. The company was incorporated in the year 1982 and as per the own version of the petitioner, respondent No. 2 was the managing director right from the beginning till his removal. The alleged acts of mismanagement/misappropriation as averred in the petition relate only to the years 1989-90, 1990-91 that too when the company which had built up reserves over a period, showed a loss of Rs. 6.8 lakhs as per books of account, in 1989-90 and Rs. 47 lakhs in 1990-91. This prompted the petitioner-corporation to order a management audit, as per which, as against the loss of Rs. 6.8 lakhs shown in the books of account, the profit was computed at Rs. 12.26 lakhs. Later on, the same management auditor revised this report on the basis of various explanations given by respondent No. 2 and revised the final figure of loss as Rs. 2.93 lakhs. As against the eight major observations of alleged financial impropriety committed by respondent No. 2 as noted in the first management audit report, the second audit report released respondent No. 2 of three of the alleged acts of financial impropriety. Thus, the balance of five allegations relating to financial impropriety were left intact except that the amounts in respect of two of such irregularities were substantially reduced, viz., in respect of inflated payment for purchase from Srinivasa Trading Company and inflated payment of transportation charges for purchase of bran from the same trading company. The respondent in its reply had averred that these payments were purely in the normal course of business and at normal rates and that no mala fides can be attributed in respect of these dealings. In the rejoinder by the petitioner-corporation, it is averred that these financial mismanagement/ misappropriation by respondent No. 2 had resulted in a heavy withdrawal of over Rs. 67 lakhs from the State Bank by respondent No. 2 and that when he was removed as managing director, there was nothing left in the kitty of the company. We find from the rejoinder, that the petitioner-corporation has not countered any of the explanations given in the reply by respondent No. 2 in regard to the alleged prevailing market practices, which according to him, had been followed all through by the company. This becomes more relevant in view of the chairmanship of the company having been with the petitioner. The petitioner-corporation has also not countered the statement of respondent No. 2 that in view of the company being a private limited company at the relevant time, there was no need for him to disclose his interest as per Sections 299(iii) and 302 of the Companies Act.
13. Admittedly, the present management of the company is controlled by the petitioner-corporation. They have also conducted a management audit and the areas of the alleged financial impropriety have already been made available by the management auditor. Respondent No. 2 has categorically stated in his reply that the year 1990-91 had been a bad year due to nonavailability of raw material as well as power shortage in the State of Andhra Pradesh. The petitioner-corporation should have commented on these explanations inasmuch as in its own admission, the petitioner-corporation has stated that the company had been doing well in earlier years and had also built up sufficient reserves. A comparative statement of the performance of similarly placed companies during the relevant period vis-a-vis the respondent-company would have enabled us to form a prima facie opinion as to whether there has been mismanagement in the company which would call for a thorough investigation. Unfortunately, no such information has been made available to us, to enable us to form an opinion that the company has incurred huge losses or that there had been heavy withdrawals from the bank, without justification or that there had been financial misappropriation of funds which cannot be found without an investigation. More details should have been furnished in the petition on the basis of the accounts of various years. This had also not been done. If the petitioner-corporation, which is now controlling the company is not convinced of the explanations given by respondent No. 2 on the report of the management auditor, it could, on its own initiate criminal/civil action against respondent No. 2. A similar matter was considered by the Company Law Board in Professional Grade Components Limited, In re [1995] 5 CLJ 514 (CLB) and the Company Law Board held that no case has been made out for investigation of the affairs of the company in terms of Section 235 of the Act. The Company Law Board also held in Hotel Shweta Private Ltd.'s case [1995] 4 Comp LJ 540, a petition under Section 235 that "an order of investigation is not an end by itself, but only a means to find out the full facts of the acts complained. It is nothing, but an exploratory measure to be proved or disproved with reference to facts later on ascertained." Our view is also supported by Delhi Flour Mills Co. Ltd., In re : S.L. Verma v. Delhi Flour Mills Co. Ltd. [1975] 45 Comp Cas 33 (Delhi) decided by the Delhi High Court in which the allegations were that there was a fall in the profits of the company, certain relatives of the managing director were appointed as senior executives in the company, and that the company had borrowed large sums of money for depositing in firms in which the relatives of the managing director were the major shareholders. It was held by the Delhi High Court that the purpose of Section 237 (in the present case Section 235) was not to order investigation into the economic working of the company, unless there was material to show that the fall in profits was due to illegal action. It further held that the object of investigation is to discover something which is not apparent and that where the petition discloses merely facts which are apparent from the records of the company, the investigation will not be ordered unless at least prima facie evidence is produced concerning the circumstances which will lead to the conclusion that an investigation is necessary.
14. As we have pointed out earlier, the main reason for the petitioner-corporation seeking an investigation is on the basis of findings of the management auditor and auditor of the company. Other than the observation of these auditors, the petitioner-corporation, which is today controlling the board of directors of the respondent-company has not substantiated the alleged irregularities either by comparison with the earlier years or with similarly placed companies.
15. A mere statement of facts based on the auditor's report without any corroborative evidence will not assist us in framing the requisite opinion. The material placed before us should be such as to satisfy ourselves that a deeper probe is necessary. Therefore, on the premise that on the basis of the material placed before us, we are unable to form an opinion that the affairs of the company should be investigated, we dismiss this petition.