Oppression of Minority Shareholders by Majority Shareholders

Submitted To Submitted byMr. Ajay Kant Chaturvedi Shobhit Tiwari

INDEX

Introduction Who comes under the term Minority? What is Oppression? Remedy Against Oppression(Laws) Conclusion Bibliography

Introduction :

Shareholders have ultimate control of a company. However the directors run the company's business and are responsible for its management. In general shareholders cannot interfere, although they can appoint and remove directors. Some constitutional matters, such as changes of the company's name, or to its Memorandum or Articles of Association, or to put it into liquidation (when solvent), require approval by special resolution, i.e. a 75% majority, which can therefore be blocked by shareholders with 25% or more.

The nascent debate on corporate governance in India has tended to draw heavily on the large Anglo-American literature on the subject. However, the governance issue in the US or the UK is essentially that of disciplining the management who have ceased to be effectively accountable to the owners. The primary problem in the Indian corporate sector is that of disciplining the dominant shareholder and protecting the minority shareholders.The corporate governance literature in the US/Canada and the UK focuses on the role of the Board as a bridge between the owners and the management. In an environment in which ownership and management have become widely separated, the owners are unable to exercise effective control over the management or the Board. The management becomes self perpetuating and the composition of the Board itself is largely influenced by the likes and dislikes of the Chief Executive Officer (CEO). Corporate governance reforms in these countries have focused on making the Board independent of the CEO. Many companies have set up a Nominations Committee of the Board to enable the Board to recruit independent and talented members.Turning to the Indian scene, a bird’s eye view reveals increasing concern about improving the performance of the Board. This is without a doubt a very imperative issue, but a close analysis of the ground reality would force one to conclude that the Board is not really central to the corporate governance malaise in India. As aforesaid, the central problem in Indian corporate governance is not a conflict between management and owners as described in the foregoing paragraph, but a conflict between the dominant shareholders and the minority shareholders. The Board cannot even in theory resolve this conflict, as it is composed of those very dominant shareholders upon whom this control needs to be exercised.This paper will highlight the legal framework on the subject of oppression of minority shareholders in India, by drawing a contrast with its compatriots in the UK and USA. Case laws on the subject shall be delved into in order to achieve a prognostic idea about the problem(s) that afflict the laws as they exist.

Who is Minority ?

“Minority”: In case of a company having share capital, not less than 100 members or not less than 1/10th of the total members, whichever is less or any member(s) holding not less than 1/10thof the issued share capital constitute “minority” for the purpose of consideration in this paper. In case of companies not having share capital, not less than 1/5th of the total members would have the right to apply.

Presently, 'minority shareholders' are not defined under any law, however, by virtue of Section 395 (Power to acquire shares of dissenting shareholders) and Section 399 (Right to apply for Oppression and Mismanagement) of CA 1956, minority shareholders have been set out as ten percent (10%) of shares or minimum hundred (100) shareholders, whichever is less, in companies with share capital; and one-fifth (1/5) of the total number of its members, in case of companies without share capital. In general terms, minority shareholding can be understood to mean holding such amount of shares which does not confer control over the company or render the shareholder with having a non-controlling interest in a company. CA 1956 provides for various provisions dealing with situations wherein rights of minority shareholders are affected and the same can be divided into two major heads, i.e., (a) oppression and mismanagement of the company; and (b) reconstruction and amalgamation of companies.

The Rule of Minority:

The principle of rule by majority has been applicable to the management of the affairs of the companies. The members pass resolutions on various subjects either by simple majority or by special majority. Once a resolution is passed by the requisite majority then it is binding on all the members of the company. On becoming a member, each person impliedly gives consent to the will of the majority. Thus, if the wrong is done to the company, it is the company which is the legal entity having its own personality and that can only institute a suit against the wrongdoer, and the shareholders individually do not have a right to do so.

Rule in Foss v. Harbottle

For over a century, the rule that was followed in England was that the courts were not justified in interfering with the matters of a company. This was first expounded by the court in Foss v Harbottle, in which the cardinal rule which was laid down is reproduced as below:

“On the first point it is only necessary to refer to the clauses of the Act to shew that, whilst the supreme governing body, the proprietors at a special general meeting assembled, retain the power of exercising the functions conferred upon them by the Act of Incorporation, it cannot be competent to individual corporators to sue in the manner proposed by the Plaintiffs on the present record. This in effect purports to be a suit by cestui que trusts complaining of a fraud committed or alleged to have been committed by persons in a fiduciary character. The complaint is that those trustees have sold lands to themselves, ostensibly for the benefit of the cestui que trusts. The proposition I have advanced is that, although the Act should prove to be voidable, the cestui que trusts may elect to confirm it. Now, who are the cestui que trusts in this case? The corporation, in a sense, is undoubtedly the cestui que trust; but the majority of the proprietors at a special general meeting assembled, independently of any general rules of law upon the subject, by the very terms of the incorporation in the present case, has power to bind the whole body, and every individual corporator must be taken to have come into the corporation upon the terms of being liable to be so bound. How then can this Court act in a suit constituted as this is, if it is to be assumed, for the purposes of the argument, that the powers of the body of the proprietors are still in existence, and may lawfully be exercised for a purpose like that I have suggested? Whilst the Court may be declaring the acts complained of to be void at the suit of the present Plaintiffs, who in fact may be the only proprietors who disapprove of them, the governing body of proprietors may defeat the decree by lawfully resolving upon the confirmation of the very acts which are the subject of the suit. The very fact that the governing body of proprietors assembled at the special general meeting may so bind even a reluctant minority is decisive to shew that the frame of this suit cannot be sustained whilst that body retains its functions…”In substance, the “majority rule principle” states that if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting then the court will not interfere, cadit quaestio.

This rule could be justified on two grounds – firstly that the corporation in itself constitutes a legal personality and therefore any injuries caused to the corporation by the majority shareholders should be remedied by the corporation itself and not any individual member. This is known as the ‘corporation principle’ – “the proper plaintiff in an action in respect of a wrong alleged to have done to a company or association of persons is prima facie the company or association itself.” Secondly there is a “partnership doctrine” which was held by the equity courts in the early 19thcentury that the affairs between one partner and another were out of bounds for the courts except in cases of dissolving the partnership.

The majority rule had certain exceptions to it, thus affording remedy to individual members in common law:

1. Where the act complained is illegal or ultra vires the company;

2. Where the act done by the majority inflicts fraud on the minority;

3. Where a resolution is passed by a simple majority for any act which specifically requires a resolution by special majority;

4. Infringement of individual rights of a member;

The rule in Foss is very notorious when it comes to the administration of justice and fairness. It allows the majority to perpetuate anything and everything on the minority shareholders in a company by virtue of its deceptive simplicity. The majority cannot complain about any wrong on the corporation itself or internal improprieties. Such a bottleneck approach is in absolute dissonance with the basic notion of shareholding i.e. every shareholder has an interest in the company by virtue of his share in the capital and it is the duty of the management to protect this interest.

What is Oppression ?

The definition of oppression in India has been adopted from the words of Lord Keith in Scottish Co-operative Ltd v Meyer, in Needle Industries (India) Ltd v Needle Industries Newey (India) Ltd and it runs as below:“Oppression under s 210 may take various forms. It suggests to my mind…a lack of probity and fair dealing in the affairs of the company to the prejudice of some portion of its members. The section confers a wider power on the Court to deal with such a situation in an equitable manner…”However, inefficient management would not fall into the category of oppression even if the impact thereof is oppressive upon some members.

Shareholder oppression occurs when the majority shareholders in a corporation take action that unfairly prejudices the minority. It most commonly occurs in close corporations, because the lack of a public market for shares leaves minority shareholders particularly vulnerable, since minority shareholders cannot escape mistreatment by selling their stock and exiting the corporation. The majority shareholders may harm the economic interests of the minority by refusing to declare dividends or attempting a squeeze out. The majority may physically lock the minority out of the corporate premises and even deny the minority the right to inspect corporate records and books, making it necessary for the minority to sue every time it wants to look at them.Democratic decisions are made in accordance with the majority decision and are deemed to be fair and justified while overshadowing the minority concerns. The corporate world has adopted this majority rule in decision making process and management of the companies. Statutory provisions in this regard have been provided under the Companies Act, 1956, which is being replaced by the Companies Act, 2013.

The term of Oppression under Companies Act, 1956:Oppression is the exercise of authority or power in a burdensome, cruel, or unjust manner. It can also be defined as an act or instance of oppressing, the state of being oppressed, and the feeling of being heavily burdened, mentally or physically, by troubles, adverse conditions, and anxiety. The term oppression explained in the case Scottish case of Elder v/s. Elder & Watson Ltd. which was cited in the case of Shanti Prasad Jain v/s. Kalinga Tubes by the Supreme Court-

The essence of the matter seems to be that the conduct complained of should, at the lowest, involve a visible departure from the standards of their dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to the company is entitled to rely.The most important element of oppression is that it should be a continuous act, which means that the act must be continued by the majority shareholder till date the petition is filed with the Tribunal.Section 397 of the Companies Act, 1956 says that when any affair of the company is being conducted to any member or members by the way of prejudice to public interest or oppressive then any one or more than one member have right to apply to the Tribunal by the virtue of Section 399 of the Companies Act, 1956.

The requisite number of members who must sign the application is given under Section 399 of the Companies Act, 1956.

1. In case of a company, having a share capital an application signed by at least one hundred members or by at least 1/10th of the total number of its members, whichever is lessORA valid application may be made by any member/ members holding not less than 1/10th of the issued share capital of the company

2. In case of a company, having not a share capital an application signed by at least 1/5th of the total number of members of the company.

If the calculation of requisite members as per (1) mentioned above, joint holders of the shares shall be counted as one member only.

Acts held as OppressionThe following are the few acts which are said to be as oppression through various judgments1. Not calling a general meeting and keeping shareholders in dark.2. Non-maintenance of statutory records and not conducting affairs of the company in accordance with the Companies Act.3. Depriving a member of the right to dividend.4. Refusal to register transmission under will.5. Issue of further shares benefiting a section of shareholders.6. Failure to distribute the amount of compensation received on nationalisation of business of company among members, where required to be so distributed.

Acts not held as OppressiveThe following are the few acts which are said not to be as oppression through various judgments

1. An unwise, inefficient or careless conduct of director.2. Non-holding of the meeting of the directors.3. Not declaring dividends when company is making losses4. Denial of inspection of books to a shareholder.5. Lack of details in notice of a meeting.6. Non-maintenance/Non-filing of records.7. Increasing the voting rights of the shares held by the management.

Remedy Against Oppression

CA 1956 provides for protection of the minority shareholders from oppression and mismanagement by the majority under Section 397 (Application to Company Law Board for relief in cases of oppression) and 398 (Application to Company Law Board for relief in cases of mismanagement). Oppression as per Section 397(1) of CA 1956 has been defined as 'when affairs of the company are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members' while the term mismanagement has been defined under Section 398 (1) as 'conducting the affairs of the company in a manner prejudicial to public interest or in a manner prejudicial to the interests of the company or there has been a material change in the management and control of the company, and by reason of such change it is likely that affairs of the company will be conducted in a manner prejudicial to public interest or interest of the company'. Right to apply to the Company Law Board in case of oppression and/or mismanagement is provided under Section 399 to the minority shareholders meeting the ten percent shareholding or hundred members or one-fifth members limit, as the case may be. However, the Central Government is also provided with the discretionary power to allow any number of shareholders and/or members to apply for relief under Section 397 and 398 in case the limit provided under Section 399 is not met.

On the other hand, CA 2013 provides for provisions relating to oppression and mismanagement under Sections 241-246. Section 241 provides that an application for relief can be made to the Tribunal in case of oppression and mismanagement. Section 244(1) provides for the right to apply to Tribunal under Section 241, wherein the minority limit is same as that mentioned in CA 1956. Under CA 2013, the Tribunal may also waive any or all of the requirements of Section 244(1) and allow any number of shareholders and/or members to apply for relief. This is a huge departure from the provisions of CA 1956 as the discretion which was provided to the Central Government to allow any number of shareholders to be considered as minority is, under the new CA 2013 been given to the Tribunal and therefore is more likely to be exercised

Old Companies Act(1956)

The primary provision in the Companies Act 1956 was S. 397, which was as mentioned earlier, modeled in the likeliness of S. 210 of the English Companies Act 1948. The section is as produced below:“397. Application to Company Law Board for relief in cases of oppression.

(1) Any members of a company who complain that the affairs of the company are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members (including any one or more of themselves) may apply to the Company Law Board for an order under this section, provided such members have a right so to apply in virtue of section 399.

(2) If, on any application under sub- section (1), the Company Law Board is of opinion-

(a) that the company’ s affairs  are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members; and(b) that to wind up the company would unfairly prejudice such member or members, but that otherwise the facts would justify the making of a winding- up order on the ground that it was just and equitable that the company should be wound up; the Company Law Board may with a view to bringing to an end the matters complained of, make such order as it thinks fit.”

The section prescribes criteria for maintainability of application for relief in cases of oppression. The impugned act should be prejudicial to the interest of the company or oppressive upon a member or group of members; or the act may be prejudicial to general “public interest”. It is also the burden of the applicant to satisfy before the Board that winding up the company would “unfairly prejudice” him or the class he is representing; but otherwise the facts prima facie would justify that the company be wound up on just and equitable grounds. The right to apply is given to members as specified in the definition of “minority”. Both conditions under this section should subsist in order to entail relief from the Board. Where there are no allegations to support a winding up, a petition u/s 397 cannot be entertained.

In Killick Nixon Ltd v Bank of India, it was held that no personal prejudice need be caused to the applicant. The cause of action is that

the affairs of the company were conducted in a manner which was prejudicial and oppressive to the interests of the members or the public interest. Thus, oppression of other members can also be a locus standi for filing a petition under this section.

The expression “public interest” renders a wide ambit to this section. An action for oppression, thus, could be justified even when a member or group of members is not affected at all by the impugned acts of the majority but the brunt thereof is suffered by some third party. In cases of companies the concept of public interest takes it out of the conventional sphere of merely being a going concern in which only shareholders are interested. The stakeholder theory is endorsed by emphasizing upon the idea that a company works for the public good and welfare of the society at large, and anyone who is reasonably connected to the company and impacted by its actions can be said to have a “stake” in its actions.

In Shant Prasad Jain v Kalinga Tubes Ltd, the Supreme Court has thus expressed the position on the requirements demanded by s 397:

“It is not enough to show that there must be a just and equitable cause for winding up the company though that must be shown as a 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 part of a consecutive story… There must be continuous acts on the part of the majority shareholders, continuing upto 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 and 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 atleast an element of lack of probity and fair dealing to a member in the matter of his proprietary rights as a shareholder.”

Thus in substance, an application for oppression is not very easy to maintain for the applicant before a court in India. This ratio of the Supreme Court has enlarged the onus lying upon the applicant in such cases. The requirement of continuous acts is one which has been inserted into the gamut of s 397 by virtue of this case law. Thus an

unwise, inefficient or careless conduct of a Director or the Board of Directors cannot give rise to a claim for relief u/s 397. However, if circumstances indicate that even though an oppressive act is not per se continuous its effect is, the courts can interfere. The requirement that the act must prejudice the member(s) in the capacity of members is also strictly enforced, unlike the English counterpart in s 994 CA 2006.

New Companies Act(2013)

Ss. 241 and 242 are the relevant provisions that give the power to an individual member or a group of members to apply for relief in case of oppressive practices. The major portion of these sections is similar to that of S. 397 and 402 of the Companies Act 1956.

The only difference is that of S. 241 (1) (b), which provides an additional ground for filing application for oppression:

(b) the material change, not being a change brought about by, or in the interests of, any creditors, including debenture holders or any class of shareholders of the company, has taken place in the management or control of the company, whether by an alteration in the Board of Directors, or manager, or in the ownership of the company’s shares, or if it has no share capital, in its membership, or in any other manner whatsoever, and that by reason of such change, it is likely that the affairs of the company will be conducted in a manner prejudicial  to its interests or its members or any class of members

Thus this clause allows the minority a pre-emptive remedy, i.e. they can prevent any change in the original composition and structure of the company if there is reason to believe that such change will lead to an injury to their interests. Also, the term “fraud” has been specifically defined to include any act, omission, concealment of any fact or abuse of position committed with intent to deceive, to gain undue advantage from, or to injure the interests of the company or its shareholders or its creditors or any other person.

Conclusion

Indian law provides for the empowerment of every shareholder of the company, including the minority shareholders. The minority shareholders were specifically granted powers under the Companies Act 1956 to challenge the decisions of majority shareholders and also to convey their opinion on the management and working of the company.

Apart from the deadlock or risks of litigation created by the minority block, there can be cases where the majority wants to do away with the minority shareholders in entirety in order to obtain an administrative stronghold. Thus the concept of minority “squeeze outs”, which are well recognized in the legal frameworks of many jurisdictions, becomes relevant.

A squeeze out refers to a device by which the controlling block effectively acquires the shares held by the minority shareholders in a company. S. 395 of the 1956 Act directly deals with this concept. It provides for compulsory acquisition of shares by the majority shareholders in certain circumstances. The shareholders who dissented from this acquisition had the right to file their objections before the Court. Unless the court orders otherwise, the acquirer will be entitled to acquire the shares of the transferor company (including the minority). However, no corresponding rules were framed and thus wide discretionary powers fell into the lap of the Courts. Further, the section did not contain any guidelines for valuation of shares for purposes of the acquisition offer.

236 of the Companies Act 2013 is the concurrent provision for purchase of minority shareholding. In the event of an acquirer, or a person acting in concert with such acquirer, becoming registered holder of 90% or more of the issued equity share capital of the company, or in the event of any person or group of persons becoming 90% majority or holding 90% of the issued equity share capital of a company, by virtue of an amalgamation, share exchange, conversion of securities or for any other reason, such entity shall notify the company of their intention to buy the remaining equity shares.

Sub-section (2) provides for the pricing mechanism of the shares so acquired, at a price determined by a registered valuer. The transferor-company shall act as a transfer agent for receiving and paying the

price to the minority shareholders. It is also pertinent to note that in this case the wheels of transfer are set into motion only once the shares have been acquired, whereas in the old Act the mere approval of the scheme by 9/10th of the shareholders of the company allowed the transferee company could serve notice to the dissenting shareholders for compulsory acquisition of their shares.

In order to ensure fairness to the minority shareholders, the provision of a ‘registered valuer’ is given for valuation of the shares. This guarantees that the minority shareholders are not squeezed out of the company without being given fair value of their shares.

Thus the new Companies Act 2013 in many ways ensures that the rights of the minority shareholders are protected in every possible manner. The stake held by them in a company is not in any manner subservient to the majority and it is the duty of the law to protect their interests from any odious activity of the latter.

Bibliography Primary Sources

Taxmann Publication Pvt Ltd The Institute of Company Secretaries of India Company Law

Secondary Sources

http://www.legalservicesindia.com/article/article/minority-rights-on-oppression-and-mismanagement-under-companies-act-1956-and-companies-bill-2011-1534-1.html

http://www.indialawjournal.org/archives/volume6/issue-2/article5.html http://www.lawctopus.com/academike/oppression-mismanagement-

corporate-law/