TMI Blog1981 (4) TMI 214X X X X Extracts X X X X X X X X Extracts X X X X ..... s consisting of 7,35,000 equity shares of Rs. 100 each. About 28% of the equity shares are held by the three financial institutions, namely, Unit Trust of India, General Insurance Company of India and the Life Insurance Corporation of India. From 1961, the petitioner-company commenced production of Viscose filament yarn and viscose staple fibre for which the petitioner-company installed plant, machinery and equipments imported by it from an Italian company, M/s. Italviscosa Easter Trading (to be referred to as "IET") under a collaboration agreement entered into between the petitioner-company and IET. The Govt. of Tamil Nadu originally invested by way of share capital a sum of Rs. 14 lakhs and has on the board of directors of the company one of its officers since then. From 1969 the petitioner commenced production of rayon grade wood pulp which is the basic raw material for viscose filament yarn and viscose staple fibre. This was also in collaboration with IET and the plant and machinery for the same were supplied by the said company. The process adopted by the petitioner-company for the manufacture of rayon grade wood pulp is said to be bisulphite process, which, it is claimed, i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enquiry as it deems fit to make, that it is necessary to make the appointment or appointments in order to prevent the affairs of the company being conducted either in a manner which is oppressive to any members of the company or in a manner which is prejudicial to the interests of the company or to public interest (the words "public interest" were added by the Companies (Amend.) Act, 1963). This power under section 408 is a peculiar feature of the company law in our country. Normally, the company being a body corporate is to be managed by a board of directors elected by its own shareholders. Provision for their removal and taking of action against them for failing in their duty are provided under the Act. There is no doubt that power is also given under sections 397 and 398 to the court to give relief in a case where 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 if the court is of the opinion that the company's affairs are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member. Evidently the powers that the court can exercise under section 397 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of law. Government will take great care to see that the section is not invoked lightly by disgruntled shareholders to satisfy their own private ends. ' Prejudice' to the interests of the company will be judged by the minimum standard of good management required of all companies." (Extract from the 4th Annual Report on the Working and Administration of the Companies Act, 1956 Year ended March 31, 1960)." The Company Law Board is constituted under section 10(E) of the Act to exercise and discharge such powers and functions as may be delegated by the Government. The CLB was constituted by a notification dated February 1, 1964. The Central Govt. in exercise of the powers conferred by clause ( a ) of sub-section (1) of section 637 read with sub-section (1) of section 10E of the Companies Act, 1956, by means of Notification No. GSR 443(E) dated October 18, 1972, has delegated to the CLB the powers and functions of the Central Govt. under section 408 of the Act. It may be noted that the board of directors of the petitioner-company consisted of 9 persons previous to the passing of the impugned order. It appears that the books of the petitioner company were inspected as they are liable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ong and detailed correspondence was exchanged between the petitioner and the CLB. There were a number of hearings also before the CLB with a view to clarify the various points raised with regard to the above five items. Ultimately, the impugned order dated February 18, 1980, was passed by respondent No. 5, the CLB, under section 408(1) by which it appointed two directors to the board of directors of the company for a period of 3 years. It is this order that is challenged in the present petition. We may note that the explanation of the petitioner-company with regard to item No. 2 has been found satisfactory. The impugned order, therefore, evidently rests on the assumption that the other four items stand proved as alleged. Now an exercise of the power under section 408 of the Act is circumscribed by the limitation mentioned in the section itself. The power under section 408 of the Act is not untrammelled and does not give absolute discretion to the Central Govt. to appoint directors only on its subjective opinion. The power under section 408 of the Act is dependent on the establishment, in an objective manner of the requisite conditions. The satisfaction of the Central Govt. cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... members or that the company was formed for any fraudulent or unlawful purpose, have held that, "if the existence of those conditions is challenged, the courts are entitled to examine whether those circumstances were existing when the order was made. In other words, the existence of the circumstances in question is open to judicial review though the opinion formed by the Government is not amenable to review by the courts" : (See Rohtas Industries Ltd. v. section D. Agarwal [1969] 39 Comp. Cas. 781,800; AIR 1969 SC 707). Therefore, simply because the exercise of power under section 401 depends upon the satisfaction of the Central Govt. it does not mean that its exercise cannot be subjected to judicial review and that the Government is the final arbiter of the conditions in which the power may be exercised. Reference may be made to Rampur Distillery and Chemical Co. Ltd. v. Company Law Board [1970] 2 SCR 177 at 186; [1970] 40 Comp. Cas. 916 ; AIR 1970 SC 1789. In that case the court was construing the power given to the Central Govt. under section 326(2)( b ), which imposes a duty on the Central Govt. not to accord its approval to appointment or reappointment of a proposed man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is why Mr. Diwan, the learned counsel for the petitioner, took us through the material on record and urged that that this was a case of total non-application of mind by the CLB and of a total absence of any material and there was no material on the basis on which the CLB has taken the impugned decision and the satisfaction of the Central Govt. was, therefore, arrived at on the foundation of non-existing material, and the satisfaction was, therefore, illusory because it had proceeded on an erroneous view of the scope and limitation of section 408 of the Act. It will be helpful to deal with each item to see whether the satisfaction of the Central Govt. is based on relevant material, because once that conclusion is reached the order of the Central Govt. will be immune from challenge. Now the substance of the first charge is that the petitioner-company placed an order with M/s. Air Control and Chemical Engineering Company (ACCEL) for purchase of machinery worth Rs. 4.51 crores. The irregularity pointed out by the CLB by its letter of November 28, 1978, suggested that the orders were placed with ACCEL because Mr. Venkataswamy Naidu, the managing director of the petitioner-company, is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... value of Rs. 3.65 crores, the company negotiated with ACCEL for the supply of proprietary items and placed orders with ACCEL for the aggregate value of Rs. 4.61 crores (including 10 lakhs non-proprietary). The petitioner-company pointed out that the machinery and equipment for expansion had to be such as could be integrated with the existing plan and it was natural for the company to look for the specifications of IET. This 4.51 crores was said to include, ( a ) know-how; ( b ) equipment design and detailed drawings ; ( c ) services of foreign specialist engineers and technicians specially recruited for the manufacture of proprietary equipment with performance guarantee. The petitioner pointed out that the assessment of the CLB that Dasturs had evaluated the proprietary machines at Rs. 3.44 crores was against the record as the Dasturs while evaluating the items had excluded the value of items mentioned above, i.e ., know-how, equipment, design and detailed drawings, etc . They sentito the Central Govt. a re-evaluation done by Dasturs, who certified the value of these extra items at Rs. 61 lakhs as per their letter of November 7, 1978. It is important to note that Dasturs even ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by its letter of November 24, 1979, asked for some more details and asked whether any negotiations took place with the foreign suppliers and also any negotiations with ACCEL before finalising the deal. The petitioner-company on December 7, 1979, sent the details of the specifications and also pointed out that as the items were specifically designed to fit into the existing plant they could not possibly be manufactured or be available from any indigenous source since the know-how and engineering details were exclusively the property of IET and agreed to be furnished only to ACCEL in India, by virtue of the collaboration agreement. A reference to the impugned order will show that the CLB has held that the placing of these orders with the ACCEL cannot be considered proper and that the company did not follow the proper procedure in regard to the placing of order on ACCEL. Now this conclusion is based on the fact that though the company had been issued a licence for Rs. 3.65 crores in June, 1974, against Rs. 7 crores applied for, it did not care to make local enquiries whether any other manufacturer could meet its requirement. The CLB found the conduct of the petitioner-company, in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... against public interest. Now, it would be certainly against public interest if the motivation of entering into agreement with ACCEL was shown to be as was the original suggestion that Naidu and Dr. Rossi had any financial or personal interest in placing this order. This allegation has been specifically denied. As a matter of fact it has been put on record that Naidu held only 50 equity shares jointly with EID Parry and Dr. C. Rossi holds 80 equity shares of Rs. 100 each in ACCEL. There was thus no personal motivation by those on the board to enter into such a deal. There is also no evidence at all to show that the averment of the petitioner-company that it was not possible for it to get the supply of the equipment from the indigenous local market was factually incorrect. There is not even a whiff of suggestion that any other indigenous manufacturer could have supplied equipments and that it would have cost the petitioner-company less than the order which it placed with ACCEL. The more serious infirmity is the assumption by the CLB that even the valuation done by Dastur Co. showed an overpayment of Rs. 50 lakhs. It is apparent that the CLB had relied on the earlier evaluation of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... B's order nor is there any challenge to the basis which has been adopted by Dasturs for making the evaluation. Evaluation is a matter for experts and if an expert has given his opinion as to the manner in which he has evaluated the amount, unless, therefore, that basis was demolished by either questioning him or by producing some other valuer to indicate that the valuation basis adopted by Dasturs was totally undependable there would be no evidence or material on the basis of which the CLB could have come to the conclusion that the price paid was in excess of the actual value, which, if correct, may prima facie raise a presumption that such an order was prejudicial to the interest of the company and to the public interest. We are prepared to accept that if it could have been so shown, a prima facie case of acting prejudicially to the interest of the company and to the public interest could have been raised and the CLB's decision could not have been reviewed by this court sitting under article 226 of the Constitution. Bat here is a case of total absence of any material. No suggestion is given that any of the board members or anybody else has personally benefited from such a deal. No ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , while the advance was paid by the petitioner-company even before the prospects were issued by the SAE. In considering this allegation the explanation given by the petitioners in their letter of October 29,1979, seems to have been completely ignored by the CLB. In the explanation the petitioner-company had stated, and this fact had not been denied in the counter-affidavit, that originally SAE in 1974 was almost a foreign owned shareholding company and at that time its capital was Rs. 5 lakhs though the annual turnover was over Rs. 3 to 4 crores. The SAE had adequate financial capital resources on account of their resources for working capital being duly guaranteed by their foreign principals through their bankers. With the coming into force of the Foreign Exchange Regulation Act, 1973, the SAE was required to dilute its non-resident holding, and, therefore, the SAE proposed to increase its share capital to an extent whereby the non-resident shareholding would be not more than 40%. Initially SAE proposed to increase its capital and allot the shares in the increased capital only to the petitioner-company and Parry Ltd. and their existing non-resident shareholders. SAE had no intenti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... advanced it was expected that the petitioner-company would be amongst the two big shareholders, but because the Government later on took the decision to throw open the equity participation to the public, allotment could not be made before certain necessary formalities were completed. For these delays occassioned by the public authorities the petitioner could not be held responsible. The petitioner-company had within a month or two got approval at the general meeting. It applied under section 372(4) in August, 1974. It had, therefore, done all that it had to. Further steps were not in its control. It is curious that the CLB has conveniently ignored the vital fact that it took almost three years to approve the application for investment made by the petitioner-company. It may be that the application was made to the CLB on August 10, 1974, after the said amount had been advanced by July, 1974, for the purchase of shares to SAE. But it is undisputable that the CLB approved an investment up to Rs. 12 lakhs for which the Controller of Capital Issues had also given his sanction. This is proof enough of the soundness of the investment. In business matters the board of directors had evidentl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ary 18, 1980. During the course of hearing an order passed by the Govt. of India on May 20, 1980, has been produced before us which shows that the Central Govt. had approved the reimbursement of Rs. 1,09,565*32 towards medical expenses to Shri Devarajulu. The said document has been marked as 'X' and is being placed on record. This post facto approval justifies the stand of the petitioner which was explained by its reply of December 29, 1978. It was explained that on account of an emergency that required a heart surgery to be done on Shri Devarajulu in the USA he was allowed to draw by way of perquisites the said sum of Rs. 1,47,283.23 subject to the condition that if such drawing in excess of his permitted remuneration was not approved by the board, the company and the Central Govt., the same would be held by him in trust for the company and would be refunded to the company as per the requirements of section 309 of the Act. It is also explained that Shri Devarajulu was one of the promoters of the company and had been associated with the company since its inception and it was in the interest of the company that to meet the emergency this amount should be sanctioned. In this connec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a Rayon Corporation Ltd. during the year 1976, ( c ) a sum of Rs. 2.20 lakhs is also said to have been paid to Shri K. B. Venugopal of Bangalore for sale of Anhydrous Sodium Sulphate to M/s. Mysore Paper Mills Ltd. during the year 1977. These transactions have been held to be not prudent on the part of the company. One fault mentioned is that as Dr. Rossi was a common director of National Rayon Corporation and Baroda Rayon Corporation as well as of the petitioner-company there was no necessity for introducing the intermediary for selling the goods. We can only marvel at the logic which seems to think that for such like transactions the director can act as intermediary. Dr. Rossi holds 50 shares in the National Rayon Corporation and 134 shares in the Baroda Rayon Corporation. It is not as if he controls the National Rayon Corporation and Baroda Rayon Corporation. Actually utilising the services of a director for sale of goods to the other company might even have been objectionable as raising a conflict of interest. Even the CLB, having made this point, realised the unreality of this assumption and was quick to resile from it by conceding that it is not the function of the common dir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gainst the rate of Rs. 661 per ton of the sales made to other parties. The CLB, however, wrongly worked out the average of the sales to the Mysore Papers at Rs. 540 per ton and found the commission paid to Venugopal as abnormally high compared to the price obtained from sales to others. The correct figure works out to an average price (Rs 800 160) of Rs. 640 per ton. It is also relevant that prior to the present transaction the petitioner-company had never sold Sodium Sulphate to the Mysore Paper Mills Ltd. Considering that a bulk quantity of 900 tons was sold to one party, namely, the Mysore Paper Mills, the difference of Rs. 21 (in sales to others) can hardly be said to be such as to invite action under section 408. How much discount should have been given for a bulk sale could be a matter of difference of opinion. It is possible to argue plausibly that the price fetched could have been something more but unless the finding was supported further by the fact that the utilisation of Shri Venugopal's service was for a collateral purpose, a normal business transaction bona fide could not form the basis for taking action under section 408 of the Act. It is not disputed in the impugned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there was some contravention of some provisions of the Act (even when the bona fide was not challenged and (even when no personal gain was being made by the management) it was sufficient by itself to establish that the said actions were prejudicial to the interest of the company. This is not the position in law. Such an argument raised before Bhagwati J. (as his Lordship then was) was rejected in Sheth Mohanlal Ganpatatram v. Shri Sayaji Judilee Cotton and Jute Mills Co. Ltd. [1964] 34 Comp. Cas. 777 ; AIR 1965 Guj. 96 at 103 when he said (p. 831): "A resolution may be passed by the board of directors which may in the passing contravene a provision of law, but it may be very much in the interest of the company and of the shareholders. Such a resolution may be attacked as invalid in a suit or other appropriate proceeding, but not being oppressive to the minority shareholders or prejudicial to the interests of the company, it cannot be challenged in a petition under section 397 or section 398. I do not subscribe to the proposition that every action of the directors which is in contravention of a provision of law must necessarily be prejudicial to the interests of the company. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herefore, acted in the absence of any relevant material and the impugned order by which it has appointed the directors on the board of the petitioner-company, therefore, has been passed without satisfying the condition precedent as laid down by the statute and being, therefore, in excess of jurisdiction cannot be upheld and is hereby quashed. Internal management of the company should normally be left in the hands of the members. Of course if the management misuses its dominant position inasmuch as it oppresses the minority or conducts the affairs of the company in a manner which is prejudicial to its interest or public interests, the exercise of the power by the CLB would not only be permissible but would also be a duty. However, in the matter of exercise of these extraordinary powers, it would be apt to remember the observations of the high-powered expert committee for reviewing the working of the Companies Act, 1956, and MRTP Act, 1969, which submitted its report in August, 1978, and said in para. 2.3 : "While the right of Government to regulate private management in the sphere of managerial appointment, and remuneration, inter-corporate investment, etc ., might be sometimes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions should be re-oriented in a manner that there is an effective participation of a nature which encourages and achieves industrial growth and, at the same time, ensures confidence in the general public with the role played by the financial institutions. The role of financial institutions is not to be looked upon merely as an investor or a financing agency but more as a developmental agency.......For this purpose, the financial institutions must play a more participative and purposeful role in the development of various sectors of the economy, and the Government should lay down clearly well-defined policy on this aspect." We may also note that Mr. Dewan had sought to challenge the constitutionality of section 408 of the Act, more especially after its amendment by the Companies (Amendment) Act, 1974, by which in place of the original provision which permitted the Government to appoint not more than two persons on the board of a company, the law has been amended and now there is no limit to the number to be appointed on the board of directors so that, technically speaking, the majority of the directors on the board can consist of Government directors. He wanted to urge that this p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8 of the Act. We do realise that this power may sometimes be passed for extraneous reasons. But nevertheless we feel that subject to certain safeguards the retention of this power in the Act is necessary and salutary. We may in this connection refer to the observations of the high-powered expert committee which while noticing the power to prevent oppression and mismanagement conferred on the courts under sections 397 to 407 and the powers conferred on the Central Govt. under section 408 and 409 stated as under : "This distinction is, in our opinion, necessary to be maintained. But we consider that the overriding power in cases of alleged oppression and mismanagement should be that of the court and would accordingly recommend that all final orders passed by the Central Government under section 408 and/or section 409 should be revisable in appeal by the High Court. We are at the same time conscious of the fact that the emergent powers under section 408 are on occasions necessary and unless shown to be exercised mala fide are really in the interest of the shareholders." As a result, the writ petition is allowed and an appropriate writ is issued quashing the impugned order No. 4/ ..... 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