Kerala High Court
South India Paper Mills Pvt. Ltd. vs Sree Rama Vilasam Press & Publications ... on 23 June, 1980
JUDGMENT M.P. Menon, J.
1. This is an application by one of the creditors of the Sree Rama Vilasam Press and Publications (P.) Ltd., now in liquidation, for a declaration under Section 542(1) of the Companies Act, 1956, that its former directors and general manager are personally liable for payment of over Rs. 43,000 to the applicant. The company was ordered to be wound up in November, 1976, on a petition for winding up, filed in January, 1973. Provisional liquidator was appointed in November, 1975.
2. The allegations in the affidavit filed in support of the application are these. The applicant is a dealer in paper of various kinds, and was supplying paper to the company in liquidation for use in their printing and publishing business. The respondents were obtaining "credit purchases" from the applicant. The company had ceased to carry on business since 1970. Even after the commencement of the winding-up in January, 1973, the company continued to purchase paper on credit without disclosing the above state of affairs. Obtaining credit facilities after stoppage of business and even after commencement of winding-up, without informing the applicant of the true situation, amounted to misrepresentation and fraud. Supplies were obtained with intent to defraud. Over Rs. 43,000 are due to the applicant as per its accounts regularly kept in the course of business, and the respondents are personally liable for this debt of the company, under Section 542.
3. A representative of M/s. Paper Mart, Trichur, who are the agents of the applicant and through whom supplies were made to the company, has been examined as P.W. 1. P.W. 2 is a director of the applicant-company. Exhibits. A-1 to A-2 are the books of accounts and other connected documents. The respondents have adduced no evidence. Their case is that they had not perpetuated any fraud, and that they were not parties to any fraudulent trading. Some of them were not directors (or managers) during the relevant periods. They were not even aware that the transactions in question were being entered into by the company. The company was carrying on business till the provisional liquidator was appointed.
4. Section 542(1) provides that when it appears in the winding-up of a company that its business was being carried on with intent to defraud creditors or other persons or for any fraudulent purpose, all persons who were knowingly parties to such conduct be personally held liable, without any limitation of liability, for all the debts or other liabilities of the company. The liability is to be determined and imposed by the company court in proceedings initiated by the liquidator or a creditor or a contributory. What is to be proved in such proceedings is that the business was being carried on with a fraudulent intention or for a fraudulent purpose, and that the respondents were knowingly parties to it; and it has been held that where a company is seen to have carried on business and incurred debts at a time when, to the knowledge of the persons concerned, there was no reasonable prospect of the creditors ever receiving payment of those debts, an inference to defraud can be drawn [Maugham J. in Re William C. Leitch Bros. Ltd. [1932] 2 Ch 71 (Ch D)]. Since fraud is the basis for the liability, an element of dishonesty has to be established for obtaining relief under the section ; and dishonesty will not be inferred where the conduct of the persons concerned is susceptible of more than one explanation [see In re M. Kushler Ltd. [1943] Ch D 248 (CA) ]. Persons who are not actively in management cannot be parties to the carrying on of business with knowledge of an intent to defraud.
5. Normally, the directors of a company which has a legal personality of its own, do not owe any fiduciary or contractual duty to persons who deal with it; they are not liable to pay debts incurred by the company even at a time when they knew it to be insolvent. Section 542 is an exception to the above rule in that the protection afforded to the directors by the company's separate legal personality is taken away, the exception operating, however, in the limited sphere of fraud and that too, established after winding up. The exception, however, does not totally disregard the rule relating to corporate personality because the effect of an order by the court under Section 542 is not to make the directors and others personally liable to the creditor who has been defrauded. The amount determined is to be paid to the liquidator for being applied along with the other funds of the company, in paying all the creditors rateably. The creditors who move the court and obtain a favourable order have no preferential claim to the amounts involved. So, to state the law, is not to ignore the decision of the majority in Re Cyona Distributors Ltd. [1967] 1 All ER 281 (CA), where it was held that the court would have power to direct payment to the applicant himself, but only to recognise the dissent of Russel L.J. that the current of judicial opinion has always been that all such sums should go to the liquidator. The majority's observation was obiter as it was not a case where fraudulent trading was established; and the observations themselves only recognise a discretion in the court, and not any preferential right the applicant-creditor could seek to enforce.
6. It will be useful to compare the provisions of Section 542 with those of Sections 543 and 531. Section 543 empowers the court to assess damages against delinquent directors and others who occupy a fiduciary position in relation to a company. They are expected to act at all times in the interests of the company, eschewing fraud, underhand dealings and motives of personal aggrandisement. They also owe a duty of care. If they are found to be in breach of the duties attached to their special position, they are liable in damages under Section 543, and the court can order them to make good the loss sustained by the company as a result of their conduct. Misfeasance proceedings under the section lies for breach of any duty, even if it does not amount to a perpetration of fraud. The thrust of Section 531, on the other hand, is against " fraudulent preference ", i.e., parting with the assets of the company in favour of a few creditors with a view to defeating the others. The court is given power under this section to invalidate such transfers made on the eve of winding-up. The three sections are thus part of a scheme for reducing the liabilities of the company, recovering its assets and recouping its losses, if the conditions prescribed by them are found to exist on an examination of its affairs, after winding-up. While Section 542 seeks to relieve the company of the liabilities incurred by fraudulent trading making those responsible for the fraud personally answerable, the purpose of Section 531 is to recover assets which should have belonged to the company but for fraudulent preference. Fraud is a common ingredient for both, whereas the proceedings under Section 543 are designed to recoup losses sustained by a breach of duty which may fall short of fraud.
7. Exhibits A-1 to A-4 are pages of the ledgers the applicant was maintaining, in regard to the supplies made to the company. At the beginning of 1972, the balance due from the company in liquidation was Rs. 9,062. Goods worth Rs. 37,727 were supplied during 1972 in four consignments, against which the company paid only Rs. 18,800 in six instalments. The debit balance carried over to 1973 was Rs. 27,989. During 1973, paper was supplied on two occasions for a total value of Rs. 9,496 and the company paid Rs. 15,486, thereby reducing the debit carried on to the next year to Rs. 21,999. During 1974, there was only one sale for Rs. 33,115 against a total payment of Rs. 21,000; inclusive of a debit of Rs. 7,760.90 towards excise duty, the balance due from the company at the end of the year was thus Rs. 41,877.90. No supply was made in 1975 ; but the company paid Rs. 7,760.90 due towards excise duty during that year. The letters, Exs. A-5 to A-7, deal with the submission of C Forms for purposes of sales tax, and Ex. A-8 is a letter to the applicant from Sree Rama Vilas forwarding a demand draft and cheque, and requesting for a resumption of supplies. Exhibits A-9 and A-10 reveal that two cheques issued to the applicant in 1972 were dishonoured. Exhibits A-11, A-12, A-13 and A-15 show that the company was unable to clear the documents under which two consignments of papers were supplied in June and August, 1972, and that the applicant had to request their agents at Trichur to collect the amounts. Exhibit A-14 is a letter dated October 10, 1972, from the company acknowledging receipt of Ex. A-12 consignment and stating that the goods were being kept in their godown and that the key had been handed over to the paper mart. By Ex. A-16 dated February 15, 1973, the company made an urgent request for supply of paper as there was a danger of its contract with the KSRTC being cancelled ; and by Ex. A-17 dated July 9, 1973, the applicant was assured that the said contract was being continued opening up the possibility of cash purchases thereafter and progressive liquidation of prior liabilities. Rupees 11,000 were sent under Ex. A-18 dated January 5, 1974, along with a request for 40 reams of paper. Exhibits A-19, A-20 and A-21 only serve to show that supplies were being maintained in 1974 also.
8. The documents discussed above do not by themselves establish or even vaguely indicate that there was any attempt by the company to defraud the applicant, or to indulge in fraudulent trading ; they suggest, at best, that credit sales were being continued as of old in spite of the financial difficulties of the purchasers brought to light by the dishonouring of the cheques, their failure to clear some of the documents, and the admissions in their own letters. P.W. 1 would say that the applicant was having dealings with the company for at least 15 years and that he knew that the company was in difficulties during 1972 and 1973 ; if this was so, the entire documentary evidence discloses nothing but an anxiety on the part of the applicant to help the company in spite Of its difficulties which were apparently considered temporary. It is also interesting to notice that though the amount due on balance of accounts is specified as Rs. 41,874.90 in the applicant's affidavit, the amount disclosed by Ex. A-4 as on December 31, 1975, is only Rs. 34,114.
9. The oral evidence of P.W. 1 and P.W. 2 does not also, in my view, improve matters. One attempt made by P.W. 1 to suggest anything near fraud was to state that the directors of the company had not informed the applicant about the pendency of the winding up petition (from January 1, 1973) and that had this been done, no supplies would have thereafter been made. P.W. 2 was more explicit when he stated :
" (Q). Could you please explain what is the fraud or misrepresentation prepetuated by respondents 2 to 13 as referred to in paragraph (10) of the said affidavit (A). By that all that we meant was that in spite of the pendency of liquidation proceedings, they had not informed us about it and continued to get paper from us on credit basis. We had not asked them whether liquidation proceedings were pending. Really they have not made any statement at all, but what they have done is to suppress."
10. This is a far cry from the " false representations " or the " false pretence " alleged in the affidavit, and I have not been referred to any authority to hold that the carrying on of business after the presentation of a winding-up petition, without disclosing the pendency of the proceedings, should by itself be presumed to be fraudulent. Mr. Vyasan Potti argued that where such presentation is actually followed by a winding-up order, even if it be nearly four years later as in this case, the effect of it is to hold that the company was unable to pay its debts at the time the petition was presented, and that the directors should be presumed to know even at that time that there was no reasonable prospect of repayment. A proposition so wide has not received judicial recognition so far. A company may actually be insolvent at a given time; but its directors may bona fide hold a different view. Even in a case where they are aware of the true position, they may still think that all was not lost and that they would be able to stem the rot by further borrowings and improving the business. In re F.L.E. Holdings Ltd. [1967] 1 WLR 1409 ; [1968] 38 Comp Cas 214 (Ch D) is a case in point. Mr. Brown who was in de facto control of the company had borrowed some amounts from a bank in July, 1965, by deposit of title deeds. But the mortgage was not registered. By September, 1965, two other creditors had obtained decrees against the company and it was fairly clear that it had become insolvent. Thereafter, he gave a legal mortgage to the bank by registering the charge and this transaction was attacked as a fraudulent preference. Pennycuick J. held that there was no fraud at all because Mr. Brown had faint hopes that by keeping good faith with the bank he could get further advances from it to revive the company. As already seen from Exs. A-1 and A-2, the company was indebted to the applicant to the tune of Rs. 28,000 even before winding up had commenced in January, 1973. During the year 1973, the company purchased paper worth Rs. 9,496 but paid Rs. 15,486 to the applicant. That is, during the first year after the commencement of winding-up, it paid not only the full value of its purchases, but something more. Exhibit A-4 indicates that paper was supplied to the company only once during 1974, i.e., in the month of June ; and by that time the outstandings had been brought down to around Rs. 11,000. No supply was made at all in 1975, but still the company paid Rs. 7,760 during that year. These facts do not fit in with a presumption that the directors of the company were aware, at the time the purchases were made, that there was no reasonable prospect of repayment at all. The inference referred to by Maugham J.
in William C. Leitch Bros.' case [1932] 2 Ch 71 (Ch D) is one to be drawn when knowledge on the part of the directors is shown to exist; it is not an inference to be drawn about such knowledge itself.
11. P.W. 1 stated in his evidence that some of the goods supplied on credit were being kept in the premises of Sree Rama Vilasam at Trivandrum under lock and key and that " though the key was with us, they opened the room where these goods were kept and used the goods without our consent".
12. But he added in cross-examination :
" We had opened the room and supplied the paper to R-1's account even from the last consignment. I cannot say what part of it was so handed over. Acknowledgment must have been obtained for the paper given. We had not issued any notice to the company about the alleged breaking open of the room there. Our manager went there and the directors promised to pay, though not in writing."
13. P. W. 1 did not say who broke open the premises or when. He could not also say what quantity of paper was unauthorisedly taken away. Assuming that his evidence is sufficient to hold that such an incident had taken place, that again cannot amount to a carrying on of business with the intent to defraud. The applicant's case in the affidavit was that the company was not doing any business after 1970 and that without disclosing this, it continued to obtain supplies of paper. In the course of their evidence, however, both P. W. 1 and P. W. 2 gave up this case and attempted to set up a different one. And the short answer to this, if it requires answering, is that the incident complained of is not a trading, fraudulent or otherwise.
14. There is thus no merit in this application and it is dismissed. Parties will suffer their own costs.