Wednesday, December 9, 2009

Locus Standi for Oppression and Mismanagement: Dilution of Section 399(1)



Remedies for oppression and mismanagement under Section 397 and 398 of the Companies Act, 1956 provide for some relief to shareholders. However, in order to invoke the provisions of Sections 397/398, the petitioners must demonstrate their standing under Section 399. Section 399, which deals with the right to apply under Sections 397 and 398, says in the relevant part:


(1) The following members of a company shall have the right to apply under section 397 or 398:-
(a) in the case of a company having a share capital, not less than one hundred members of the company or not less than one-tenth of the total number of its members, whichever is less or any members or members holding not less than one-tenth of the issued share capital of the company, provided that the applicant or applicants have paid all calls and other sums due on 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.
(2) For the purposes of sub-section (1), where any share or shares are held by two or more persons jointly, they shall be counted only as one member.
(3) Where any members of a company are entitled to make an application in virtue of sub-section (1), any one or more of them having obtained the consent in writing of the rest, may make the application on behalf and for the benefit of all of them.


Sub-section (1) indicates (along with certain additional requirements) that it is only a ‘member’ who has the locus standi. Now, if questions of membership are disputed, it cannot be said that the petitioner has established that he is a member. Accordingly, where membership is disputed and objections as to standing are raised, a strict reading of the Section (which would cast the burden on the petitioners to show that membership requirements are fulfilled) would require that the petition be dismissed for lack of standing. Indeed, in as early as 1961, the Punjab High Court seems to have affirmed this proposition in Ved Prakash v. Iron Traders P. Ltd., [1961] 31 Comp Cas 122. The Court held that if the petitioners are not shown as members in the register of the company, whether rightly or wrongly, they must first have the register rectified under Section 111 before bringing a petition under Sections 397 and 398. However, subsequent cases appear to have taken a more lenient view towards the interpretation of Section 399(1).


The Company Law Board’s decision in C. Vasudevamurthy v. Associated Oxides, [2009] 150 Comp Cas 339, can serve as an illustration. In response to a petition filed under Section 397/398, the Respondents alleged that the Petitioners had transferred their shareholdings and were no longer shown on the register of members. Accordingly, it was argued that they would have no standing. The Petitioners claimed that the alleged documents showing the purported transfer were in fact forged. They said that rectifying the register u/s 111 was not a prerequisite and the Company Law Board itself had the powers to allow them to file the Petition.


The Board held that the petition was not barred. It stated, “The disputed question in respect of the transfer of shares involves substantial factual and controversial issues. The maintainability of the petition ultimately depends upon the validity or otherwise of the impugned transfer of shares and thereby if the petitioner succeeds in establishing the plea of forgery, he will qualify to pursue his complaint under Section 397/398 of the Act. Accordingly, the objection as to whether the petitioner is a shareholder of the company cannot be considered as a preliminary issue, but only at the time of disposing of the main petition on merits. It will not, therefore, be justifiable to decline the prayer at the threshold of the petition…”


Furthermore, it was held that the Board was empowered under Sections 397 and 398 read with Section 402 to consider the entire nature of the petition, “with a view to bringing to an end the acts complained of in the petition… despite non-invocation of the jurisdiction under Section 111 of the Act… substantial right of any aggrieved shareholder shall not be allowed to be defeated, on mere technicality of any omission which is procedural in nature…


While this decision may be hard to justify on a strict reading of the word “member”, there is considerable authority after Ved Prakash’s case which would appear to justify this stance of the Board. Indeed, after surveying the authorities on the point, the Madras High Court in SVT Spinning Mills v. M. Palaniswami, [2009] 151 Comp Cas 233 (Mad), has held that the word “member” in Section 399 must not be read in the strict technical sense but must be interpreted in light of the equitable considerations underlying the Board’s jurisdiction under Sections 397 and 398. This stance appears to go against the view of expressed in Gulabrai Naik v. Lakshmidas Patel, [1977] 47 Comp Cas 151 (Guj). There, it was held that where title to shares is in dispute, the appropriate remedy is to proceed for rectification; and only after that could a petition under Sections 397/398 be maintainable.


The case-law does seem to be inconsistent. Perhaps, the recent decisions can be read to mean that if complex questions of fact are involved, then the petition need not be thrown out at the threshold; and can be heard on the merits even if the petitioner has not established that he is a member. However, before relief is finally granted, the petitioner should be able to establish that he is a member. A lenient reading of Section 399(1) may well be indicative of the watering down of the locus requirements of Section 399 as a whole. The requirements of “consent in writing” as required by sub-section 399(3) have also been made less stringent. This follows from the decision of a two-Judge Bench of the Supreme Court in J.P. Srivastava v. Gwalior Sugar, [2004] 122 Comp Cas 696 (SC).


On the other hand, while J.P. Srivastava is useful in interpreting Section 399(3) liberally and can be read in support of the proposition that Section 399 is a directory provision and not a mandatory provision, it is not as helpful in the context of Section 399(1). In fact, the Court states specifically, “An equitable or beneficial interest in shares does not make the owner of the interest a member of the company. [See Howrah Trading Co. v. Commissioner of Income Tax, [1959] 36 ITR 215 (SC); Killick Nixon Ltd. v. Bank of India 1983 (2) Bom CR 631]…” The effect of this observation has not been considered either by the Company Law Board or by the Madras High Court.


The decision, and its implications on the requirements of Section 399(3), will be considered in a subsequent post.

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