Oppression and Mismanagement | Company Law - CLAT PG PDF Download

Shareholders and Creditors

Shareholders and creditors are the two groups that have invested their money in corporate bodies. However, not all shareholders have controlling power in the company. Shareholders are divided into two groups:

• Majority Shareholders: Those who hold enough shares to have controlling power.
• Minority Shareholders: Those who have invested in the company but do not hold enough shares to control it. Their interests may be neglected because they lack controlling power.

Foss v. Harbottle Rule

The rule of Foss v. Harbottle, established in 1843, states that:

• Courts generally do not intervene in matters of internal administration at the request of shareholders.
• Courts will not interfere with the management of a company by its directors as long as they act within the powers granted to them by the company's articles.

Exceptions to Foss v. Harbottle

The court has provided exceptions to the rule, one of which is  "oppression and mismanagement." These exceptions allow for court intervention in certain situations, such as:

• Act is Ultra vires: If the actions of the management go beyond their legal authority.
• Fraud on minority: When the majority shareholders commit fraud against the minority shareholders.
• Acts requiring special majority: Certain actions that require a special majority vote.
• Wrongdoers in control: When those in control of the company are the wrongdoers.
• Oppression and mismanagement: Instances where the minority shareholders are oppressed or mismanagement is evident.

Oppression and Mismanagement

Oppression and mismanagement refer to situations where the interests of minority shareholders are harmed or where the management of the company is grossly negligent.

Oppression is explained as a visible departure from fair dealing standards and a violation of fairplay conditions that every shareholder expects when entrusting their money to the company.

Mismanagement is the act of majority shareholders grossly mishandling the affairs of the company. An example of mismanagement is seen in the case of Rajahmundry Electric Supply Corporation v. Nageshwara Rao. In this case, shareholders filed a petition against the company due to mismanagement by the directors. The court found evidence of mismanagement, including:

• The Vice Chairman's gross mismanagement of company affairs and personal withdrawals.
• Large amounts owed to the Government for electricity supply charges.
• Machinery in disrepair.
• Weak directorate.
• Dominance of a local junta.

Remedies Under Section 241 of the Companies Act, 2013

Section 241 of the Companies Act, 2013 allows any member of a company who believes there is oppression or mismanagement to apply to the Tribunal. Additionally, the Central Government can also apply to the Tribunal if it believes the company's affairs are being conducted in a way that is harmful to the public interest.

Key Provisions of Section 241

• Any member of a company can complain to the Tribunal if:
  • The company's affairs are being conducted in a way that is harmful to public interest or oppressive to any member.
  • There has been a significant change in the management or control of the company that could harm the company's interests or its members.
• The Central Government can also apply to the Tribunal if it believes the company's affairs are harmful to the public interest.

Personal Action

• In this type of action, shareholders assert their individual rights as outlined in the company's constitution, specifically the Memorandum of Association and Articles of Association.
• However, under Indian Companies Law, there is no statutory provision for personal actions by shareholders aggrieved by acts of oppression or mismanagement.

Derivative Action

• Derivative action is a legal mechanism that allows shareholders to take legal action on behalf of the company against a third party, typically when the company itself is unable or unwilling to do so.
• While there is no specific statutory provision for derivative action in Indian companies law, Indian courts recognize this doctrine.
• A shareholder can initiate a derivative action if they believe that a wrong has been committed against the company by those in control of it. This action is based on the shareholder's corporate right to sue on behalf of the company.

Key Aspects of Derivative Action

• Derivative action is not about enforcing personal rights of shareholders; it focuses on the rights and liabilities of the company.
• The action is brought by a shareholder on behalf of the company, seeking relief for the company's benefit.
• The company, despite being the defendant, is represented by the shareholder initiating the action.
• All other shareholders are bound by the outcome of the action, as it is a representative action.

Instances for Derivative Claims

Derivative claims can be brought by shareholders in specific situations:

• Ultra Vires: Shareholders can take action against the company and its directors for matters that are beyond the powers outlined in the Memorandum or Articles of Association. For instance, if directors approve actions that contradict the company's objectives.
• Fraud on Minority: Directors and the company may be liable if the actions of the majority shareholders constitute a "fraud on minority." This occurs when the majority shareholders' actions unfairly discriminate against minority shareholders. For example, if a special resolution is passed that disadvantages minority shareholders for the benefit of majority shareholders.

Required Resolution

Certain actions of a company can only be approved by passing a special resolution at a general meeting of shareholders. If the majority tries to bypass this legal requirement by passing only an ordinary resolution, or fails to pass the special resolution as required by law, any member or members can take legal action to restrain the majority.

To Safeguard Interests of the Company

For example, if the Directors have clearly wronged the company, but the majority shareholders, controlled by these Directors, refuse to allow action against them, any member or members can initiate a derivative action to protect the company's interests.

Individual Membership Rights

Generally, personal rights cannot be enforced through derivative actions. However, exceptions exist, particularly when rights are granted to shareholders by the Companies Act or the Articles of Association. These are known as "individual membership rights." Examples include the right to vote, the right to have one's vote recorded, and the right to be nominated as a Director during elections at general meetings.

Prevention of Oppression and Mis-management

A representative action can be taken to prevent oppression and mismanagement. This occurs when the majority acts in a way that oppresses the minority or when the company's affairs are conducted in a manner harmful to public interests, oppressive to certain members, or detrimental to the company's interests, such as significant changes in management or control. Since these actions benefit the company, they are considered a form of derivative action under Indian company law as per the Companies Act.

Approach to NCLT for Relief

Section 244 of the Companies Act, 2013 grants the right to apply to the National Company Law Tribunal (NCLT) for relief. According to Section 244(1), the following members of a company have the right to apply under section 241:

• In the case of a company with share capital, either:
• Not less than one hundred members or not less than one-tenth of the total number of members, whichever is less; or
• Any member or members holding not less than one-tenth of the issued share capital, provided they have paid all calls and other sums due on their shares.
• In the case of a company without share capital, not less than one-fifth of the total number of members.

The Tribunal may waive any of the requirements in clauses (a) or (b) to allow members to apply under section 241.

The power to waive the requirements of section 244 is significant and was utilized by the NCLAT in the case of Cyrus Mistry's application for oppression and mismanagement.