TMI Blog1925 (3) TMI 2X X X X Extracts X X X X X X X X Extracts X X X X ..... he latter claim was withdrawn in the course of the proceedings on the ground, as we understood it, that it was included in the mis-statements contained in the accounts in the Company's books and if it really represented a sum of money which had disappeared, it was for the purposes of this section included in and therefore overlapped the dividends which have been alleged to have bean improperly paid. With regard to the second item, namely the loss which the Company incurred through the failure of certain of the Directors to obtain adequate security over the grain, we have come to the conclusion that although some of the Directors cannot be acquitted of the charge of negligence in respect of this matter, and although as will appear hereafter we are of opinion that the circumstances connected with this transaction were such as to put them on enquiry and to arouse their suspicion as to the way in which the business of the Bank was being carried on, on the other hand, the evidence which the Liquidator has been able to lay before us falls short of satisfying us that any amount of grain which the Annapurna Company had control of free from encumbrance, and which it could have, by prope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der Section 281 whether in regard to each of these Directors who took part in such breach of trust, ha has acted not only honestly, but also reasonably so as to show that he ought fairly to be excused for such breach of trust. 2. The story of the case is a painful and pathetic one. The Union Bank was established in 1905 with a nominal capital of ₹ 20,000 which was subsequently increased, and in a modest way appears to have done in its early stages, fairly satisfactory business and slowly to have earned a reputation and the confidence, at any rats, of the Bengali community, which is a very large one in Allahabad. The founder and moving spirit, and, as it is now shown, the master of its destinies was one Kedar Nath Mitra, himself a Bengali, a man no doubt of ability in whom everybody who knew him believed and in whose honesty his colleagues, friends, and persons associated with him in business placed confidence. The task of the Liquidator in this case, and the task of the Court, and the burden of meeting the charge thrown upon the Directors, have not been rendered less onerous by the mysterious disappearance of this man. The company winding up, a Judge of this Court issued a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of such a business and the hops of its success must, depend in the long run, as a matter of daily consideration by those responsible for its conduct, upon the solvency of the debtors to whom the money is lent, and the adequacy of the security which they are prepared to give. A bank of this kind, or a money lender who contented himself with lending money at random without regard to the solvency of the customers and without requiring either adequate or any security at all, would merely be rushing to his own ruin, and it cannot be disputed in considering the conduct of this particular Bank that if it was to make any profit at all, its debtors ought to be responsible persons who ware able to keep up their payments of interest, or who, if they got into arrears, had provided security adequate to enable the Bank to recoup its original loan with a reasonable profit by way of interest thereon. The Memorandum of Association describes the objects as including every description of banking, trading and mercantile speculation, and to any body acquainted with this class of business in India, it is common knowledge that banking business of this kind is largely done by the deposit of ornaments, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... may happen such as a sudden theft or a dishonest Manager surreptitiously and suddenly removing a large quantity of such securities the charge against them substantially is that they carried on unprofitable business and allowed Kedar Nath Mitra to make loans of large sums to worthless insolvent debtors. If the Directors had troubled to enquire into even their names, they would have known at once that many were unable to pay and that large sums were issued by way of loans without any security whatever. So that at any time during the years in respect of which these Directors are charged with neglect of their duty, a comparison of the paper statements of securities in possession of the Bank with the actual ornaments at that time in existence within the four walls of the Bank's premises, would have shown that the Bank was unsecured and on the road to ruin. The relevant articles to which' our attention has also been drawn are Article 81 dealing with payments of dividends Article 88 dealing with the keeping of accounts and of the monies received and Article 73 dealing with the relation of the Manager of the Directors and the superintendence and control which they undertook to exer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the resolution and so rob the Company. The Directors are not charged in regard to this matter, but an inspection of the balance-sheets from year to year shows, when the statements in them are compared with the state of things disclosed when the Company came to grief, a startling contrast and a state of things, the knowledge of which could not have been withheld from any Director who took the least trouble to acquaint himself with the affairs of the Bank. The Company were paying and advertising themselves as paying to depositors 61/4% interest on fixed deposits for 12 months, 51/2% on 9 months deposit, 41/2% on 6 months and no less than 61/4% on the Family Endowment Fund, They were at the same time paying to their share-holders dividends varying in the years with which we have to deal between 9% and 7i% on paid-up capital of about ₹ 64,000. They were advertising on the front page of their balance-sheet a yearly increasing working capital which amounted in the last year to ₹ 2,18,743. That sum represented the total of the paid-up capital to which I have just referred and of the amounts of deposits and Endowment Fund which the public and their customers had entrusted to th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lated liability of principal and interest due to the Union Bank from the Tata Industrial Bank. At the time when these entries were made and the Tata Industrial Bank, was being treated as a debtor of the Union-Bank, the Tata Industrial Bank it is not too much to say, was known by name throughout India as a substantial and as far as the public knew a very flourishing concern in Bombay bearing the name of a distinguished and successful man of business in Bombay. It is not disputed that the notion of the Tata Industrial Bank coming to Allahabad to borrow money from the Union Bank, was ridiculous upon the face of it, and would be bound to arouse the suspicion of any body. The account of the Tata Industrial Bank showed that they had borrowed from time to time not very large sums, ₹ 1,500 or 2,000 or perhaps even more and that they had agreed to pay for the advantage a high rate of interest. Of course they never paid a pice, because they had never borrowed the money. But the account, if looked at, shows on the face of it that they were in default and although there were cash entries suggesting that they had made payments which took the original date of the loan out of the mischief o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at some subsequent date, and the money was paid to Kedar Nath Mitra's agent in Bombay. That investment of the Union Bank authorised by the Directors apparently went straight into the pocket of Kedar Nath Mitra, and no one appeared to take any trouble to ascertain where the shares were, nor was the investment specially referred to in the subsequent balance-sheet. But one would have thought that a transactions out of the ordinary course of the Bank's business of that kind placed upon the Directors the business duty to see that it was carried out and if, as I have already pointed out, the name of the Bank had bean searched for in the books of the Company, the state of this fictitious account would have been discovered. It is true to say and we accept the view that if the Directors had discovered the truth or anything like it, they would have immediately put down their foot and brought it to an end. The same observation, as has been made about the Tata Bank, may be made about the series of family loans which at the date of the liquidation were outstanding against Kedar Nath Mitra's family. These loans included a deceased brother, a penniless brother, who has admitted in thi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest which had not been paid or, in other words, that according to sound banking business, it is legitimate in the case of a good debtor to; treat as profit earned that which has accrued due although it has not been paid, and Mr. Govia said that he would not be surprised if he found that Banks were in the habit of doing that. But of course a Bank can only justify doing that, and the Directors can only justify a payment out of profits, which means realised profits. If they have satisfied themselves that the debtor, whose particular liability for interest has fallen due but has not been paid is a man whose liability is as good as cash, and if in a succeeding year he again does not pay, it is their duty to write that off as a loss in the following year's profits and loss account until the sum is realised. That is to say that which is a legitimate risk for a business man to take in a sound business concern, can only be justified where the Directors have taken reasonable care to satisfy themselves that the debtor is a solvent person, and that though he is temporarily in arrears, the liability is a good one, and it seems to ms that where it is shown afterwards' that, the debt was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8377; 4,000 per annum, and in spite of that a dividend was declared of ₹ 4,464. Ha further stated that a study of the books shows that in order to justify on the face of the books the payment of these dividends, the interest which they were earning was roughly speaking 1/5th of the outstanding principal, or, in other words, 20 par cant on the outstanding loans, and ha also showed that a careful examination of the books by the Auditor or any Director, who was desirous of checking the monthly statements or the yearly balance-sheet, would have shown, for example, that whereas in the year 1919 ₹ 11,862 was due as interest, only ₹ 5,000 was realised, in 1920 where ₹ 13,034 was due by way of interest, only ₹ 3,964 was realized in 1921, whereas ₹ 13,638 was due by way of interest, only ₹ 5,256 was realised. It seems to me that all this, which appears from a cursory examination of the book3, throws upon the Directors, the defendants to this charge, the onus of showing that they acted reasonably and had real grounds such as would operate upon the minds of business men for believing that these false balance-sheets and false statements that had been p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was appointed and a resolution was passed distinctly prohibiting any further business with this company without further security, bat as the result of this, little or nothing was done. It looks from the Liquidator's report on page 9 as though in spite of the resolution that no further business should be transacted, further business was transacted. It is true that interest would be accumulating upon this account automatically. There is no evidence before us as to how the amount was accumulating. The Annapurna Company is hopelessly insolvent is in liquidation, and its books of account are said to be in a state of utter disorder, but between 1915 and 1917 the amount (increased by 4,000 and between 1917 and 1919 it increased by ₹ 8,400. A committee was appointed containing several persons besides Directors, and in the result the Bank was supposed to have secured possession and control of the Annapurna grain as a preliminary step to a complete mortgage. Ultimately in 1923, 8 years after the resolution of the shareholders, a mortgage-deed was brought into existence. It probably surprised nobody that by that time there was no grain. Where the grain went to-which so much trouble ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ght to say, I should come without hesitation independently of any authority cited to us, to these definite conclusions. This company made no profit whatever from and including 1915; every rupee distributed by way of dividend was part of its capital; all the dividends for the year 1915 onwards were paid out of capital. I am satisfied of that as a fact that although the Directors honestly did what they did trusting in Kedar Nath, the duty imposed upon them by the Articles was such-giving due weight to everything which they have said-as to place the onus upon them of showing that they acted reasonably. I, therefore, hold that they are prima facie liable under Section 235, and that they hare failed to discharge the onus which the law imposes upon them by Section 281. Out of respect, however, to the learned arguments addressed to us on behalf of the defendants, and recognizing that the principle underlying the administration of these sections must be governed by the authorities upon the question in England, which of course I am prepared in every way to follow as far as I can where they apply to the particular case before the Court, I propose to deal shortly with the cases upon the subje ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pply a particular Article, but in asking myself the somewhat difficult question what the Legislature had in view when it enacted Sub-section 3 to Section 235, I cannot shut my eyes to the fact that if they intended that the liability of a Director for breach of trust and misapplication of funds should be barred, either from the point of view of tort after two years, or from the point of view of breach of contract after 3 years, they might just as well not have enacted Section 235 at all. I do not hesitate to say that after an experience of 9 years in this Court of winding up business, such a provision would render in India Section 235 almost a nullity. This much is clear, that the Legislature distinctly retained from segregating the various claims which can be made under Section 235, and applying to them the appropriate Article in the-Schedule. It may be said that they threw that extremely delicate and difficult task upon the Judges instead of discharging it themselves, but giving the best-effect I can to the apparent intention disclosed by the language used, I am of opinion that it is only a statutory bar to the right of the Liquidator to make his application against a defaulting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al, and never attempted in any report or balance sheet to distinguish realized profits from the estimated profits which they thus purported to divide, or to ascertain out of what fund the dividends were actually paid. It has been argued that this was done bona fide, and that where directors in good faith have made an error in the computation on which their balance sheets are founded, the Court will not lightly visit them with the consequences of a, bona fide mistake, I confess I hardly know what is meant by bona fides in such an argument. I inquired whether there was any evidence that the Directors bad considered the meaning of the Articles or had taken any advice upon them. There is no suggestion that they ever did so. There is nothing obscure or difficult in the construction) and it seems to me incredible that any man of business could suppose that this course of proceeding was a division of realized profits. 7. That case was followed by Mr. Justice Stirling in the case of Leeds Estate, Building and Investment Co. v. Shepherd (1887) 56 Ch. 787. With regard to the liability of an auditor he held: that it was the duty of the auditor in auditing the accounts of the compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (3) they were content throughout to act on the statements of Crab-tree without inquiry or verification of any kind other than the imperfect audit of the accounts by Looking. Those accounts and balance sheets did not truly represent the state of the Company's affairs; and that being so, I think that according to what is laid down in Rance's case (1878) 10 Ch. Div. 118 the onus is laid upon them to show that the dividends they paid were paid out of profits. This upon the evidence before me they fail to do. 9. Finally it seems to me that the principle laid down In re Sharpe, In re Bennett, Masonic and General Life Assurance Co. v. Sharpe (1882) 1 Ch. Dev. 154 governs this case. We were, on behalf of the defendants, strongly pressed by the decisions in the cases of Kingston Cotton Mill Co. (No. 2) (1896) 1 Ch. Dev. 331, and Dovey v. John Cory (1901) A.C. 477. I do not propose to discuss the Kingston Cotton Mill Co. (1896) 1 Ch. Div. 331 at length. I think it may be said to represent the high water-mark of the immunity from legal liability of the ornamental and do-nothing Company Director. It seems to me that there is a broad distinction between the circumstances oft hat c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h officers when there was no reason for doubting their fidelity, and that such attempts had not been successful, and it was further said in the course of that passage that it was sufficient to refer to the case of Dovey v. Cory (1901) A.C. 477. Paying all the respect which is due to any dictum in an opinion of their Lordships of the Privy Council, I can only say that if it is to be taken as a historical statement of fact, it cannot be accepted as accurate. In fact in that particular case, no negligence was found against the Directors. An appeal was brought against the decision of the Court below, but so little headway did it make on the facts that the respondent's Counsel was not called upon, and the judgment does not profess to discuss the oases. I have already pointed out that the study of the case Dovey v. Cory (1901) A.C. 477 does not quite bear out the statement male with regard to it in Sir Arthur Wilson's opinion, and I hold myself not to be hound by that dictum if it is to be taken as laying down the law that where-ever director honestly trusts a fraudulent Manager, he is free from all liability. Finally I prefer to base myself upon what was said by Lord Lindley in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of his liability as Auditor to be disposed of. In my opinion Mr. De was guilty of signing a false statement of a balance-sheet as Auditor. Unless auditors are to be held strictly to their legal liability, however honest they may be, the object of the Legislature in requiring a certificate from them is absolutely defeated. I acquit Mr. De of any conscious dishonesty. I am not satisfied that he deliberately left the Board in order to become an Auditor. I believe he is both in the ordinary way, and so far as the conduct of this business was concerned, a perfectly honest man. But, on the other hand, I hold that he was utterly reckless and indifferent in his conduct as an Auditor. He had been in the employment of the Government in the Accountant General's Office and was a certified Government Auditor. He was trusted to discharge his duty having regard to the experience which he had derived from his previous service, and in my opinion, he allowed Kedar Nath to throw dust in his eyes and to deceive him in the most obvious manner. Mr. De says that if he had examined the books and asked for an explanation about the Tata Industrial Bank's liability, he would have discovered in two ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t they do show, but also for the purpose of satisfying himself that they show the true financial position of the Company. 15. As Auditor, therefore, Mr. De must be declared to be liable for the last two years' dividends, namely 1922 and 1923. In this respect Mr. De is jointly and severally liable in each year with the Directors whom we hold responsible for that year. Mukerji, J. 16. After the very exhaustive judgment which has been just delivered by my learned brother, I would hardly consider it necessary for me to say anything by way of addition. But having regard to the importance of this case to the community, which has been hard hit by the failure of the bank, I think I may as well state, very briefly, the reasons which have induced me to agree with the judgment of my brother. 17. The liquidator has called upon the Auditor and the late Directors of the Union Bank to make good a large sum of ₹ 1,41,000 and odd on the ground that, between themselves, they have allowed so much money of the Company to be misspent. The application is one under Section 235 of the Indian Companies Act, 1913. 18. Two questions have been raised by way of defence on behalf of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of breach of confidence may be called into question by the liquidator. The only check to be applied is that afforded by Section 281 of the Companies Act. If an act has been done honestly and reasonably, nobody need be liable. Further, if Article 36 applied, a fraudulent Director has only to keep the shareholders and others in ignorance of their mischievous acts for two years, and he would be immune. It is clear, therefore, that we cannot be guided by sheer considerations of policy in choosing what Article to apply. 21. It was argued by Mr. Banerji, the learned Counsel for the Directors, that if Article 35 did not apply, Article 115 would. He argued that if it was a matter of contract then Article 115 ought to apply. But if Article 115 applied, in this particular case Article 116 would apply as the Articles of Association have been registered under the law. Registration with the Registrar of Companies is as much a registration within the Article 116 as registration under Acts 16 of 1908. This was held in Ripon Press and Sugar Mill Co. Ltd. v. Nama Venkatarama Chetty (1918) 42 Mad. 33. However, I agree with my learned brother that Article 115 or Article 116 has no application. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he superintendence, orders and control of the Directors. The Directors were even given power to dismiss the manager. If after all this power and if after the clear provision that it was for the Directors to manage the business of the Company, the Directors submitted their judgment to the disposal of the manager, it can hardly be said that these gentlemen acted reasonably. His Lordship here discussed facts and proceeded: The facts noted above will clearly show that none of the gentlemen who figure as the Directors took any genuine interest whatsoever in the affairs of the Company. They may have acted under the direction of Kedar Nath and with blind faith in him, but it can never be said that they exercised any discretion whatsover, much less to say that they acted reasonably. 25. I agree, therefore, in holding that the several Directors are responsible for having paid out, out of the capital, dividend during the several years in suit. 26. Coming to the case of Mr. De, the Auditor, I agree with my learned brother that although no dishonesty can be imputed to him in the sense that he misappropriated any money of the Company, he really shut his eyes and passed any accounts, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2,00,000 were fully secured. Before he certified to the fact, he ought to have satisfied himself that there was something on which he could base his certificate although it may not have been his duty to count the security and to assess the market value of several articles. If a bank possesses mortgage-deeds as security, I suppose, it would be the duty of the auditor to examine the deeds Similarly it would be the duty of the auditor to satisfy himself that there really was in the possession of the bank the security, so as to justify him in saying that the loans advanced were fully secured. 30. We find that by resolution dated the 4th of June, 1916, Mr. De, as one of the Directors authorised the manager to raise a loan of ₹ 15,000 by pledging the ornaments in the custody of the bank. To be accurate, he ought to have examined whether the security which was in the possession of the bank was still in its possession or had been pawned away in order to rajas money. This was. an important fact which the share-holders and the public had a right to know and this fact wall concealed. As a matter of fact, as already stated, the liquidator found no ornaments or only just a few and of n ..... X X X X Extracts X X X X X X X X Extracts X X X X
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