Miscellany

Mismanagement in Companies & Oppression to Minority Shareholders

Md. Nazrul Islam Khan
There subsist two basic collective organs in the management of the company namely members and board of directors. The board is responsible to perform their fiduciary duties within the ambit of Article of Association of the company. In General Meeting, on the other hand, the members participate in decision making and in case of poll they are entitled to vote in proportion to their respective shares. Any agenda proposed at a General Meeting is decided by the majority vote and democratic values suggest that there is nothing to complain for the members who did not concur with the majority’s view. Complication may arise if the decision taken by the majority is ultra vires to the Articles of Association or constitutes prejudice to the minority shareholders or causes mismanagement in the company.
Section 233 of the Companies Act, 1994 provides for protection of minority shareholders. The court may pass necessary order as it thinks fit safeguarding interest of members if –(a) the affairs of the company are being conducted or the powers of the directors are being exercised in a manner prejudicial to its member; (b) the company is acting or is likely to act in a manner which discriminated or is likely to discriminate the interest of any member; and (c) a resolution of the members has been passed or is likely to be passed which discriminates or is likely to discriminate the interest of one or more of the members. The petition shall require to be preferred by the members holding not less than one-tenth of the shares issued and in case of a company not having a share capital by not less than one-fifth in number of the total members. Before passing any order the court shall require to satisfy itself that the interest of the applicant(s) has been or is being or is likely to be prejudicially affected.
Allotment of shares to gain control of the company, transfer in violation of pre-emptive right, refusal to register transfer of shares, manipulation of accounts, breach of Articles of Association etc. are instances of prejudicial acts to the members. Prejudicial acts are not necessarily to be illegal and even an act which is legal may be treated as prejudicial to members. A prejudicial or oppressive act may be tested in the light of the principle laid down by Lord Cooper: “a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely, rather than mere legality or illegality of the act” (Elder vs. Elder & Watson, 1952 SC 49). Bhagwati, J. rightly observed: “It may be that a resolution may be passed by the directors which are perfectly legal in the sense that it does not contravene any provision of law, and it yet may be oppressive to the minority shareholders or prejudicial to the interests of the company” [(1964) 34 Com Cas 777 (Guj)].
In an allegation of oppression or prejudicial act the members may invoke the doctrine of ‘legitimate expectation’ in some limited cases. The question of legitimate expectation would arise only if a person who has been exercising / enjoying legitimate rights and suddenly finds himself deprived of the same. Once a person abandoned his rights and legitimate expectation for years, he cannot revive the said expectation… [(2007) 140 Com Cas 18 (CLB)]. There would be no presumption as to legitimate expectation unless there is some document promising it or the facts and circumstances strongly indicating its existence, such as the way the company has been managed for considerably long time (‘Compendium of Key Issues under Corporate Law’ by Dr. K.R. Chandratre, Vol. 2, Ch. 55-58).
Any decision for allotment of shares should be bona fide and the meeting of the board of directors should be convened by sufficient notice.
When the company is not able to adduce any proof to show that the company offered proportionate shares to the petitioners and other shareholders while allotting new shares to the respondents, that constitutes an act of oppression and is bad in law because any allotment without offering shares to the existing members and without following due procedure is oppressive since the shareholding of the existing members will dilute and their rights will be prejudiced. [(2010) 99 CLA 407 (CLB)].
When the articles of a private company provide that any new shares to be issued shall be offered to the existing shareholders in proportion to their existing holding and the directors issue new shares only to one of the shareholders and as a result of such an issue a majority shareholders is converted into a minority one, it may be regarded as the exercise of the power by the directors in bad faith…It may also be regarded as the case of ‘oppression’ of the shareholder whose majority has been converted into a minority. (‘Compendium of Key Issues under Corporate Law’ by Dr. K.R. Chandratre, Vol. 2, Ch. 55-64).
In exercise of fiduciary duty the directors are authorized to raise capital by issuing new shares for the benefit or in the interest of the company. When the company is in no need of further capital, directors are not entitled to use their power of issuing shares merely for the purpose of maintaining their control, or the control of themselves and their friends, over the affairs of the company. [(1950) 20 Com Cas 179 (SC)]. The defense of ‘for the benefit or in the interest of the company’ is hardly accepted by court as in most cases it is found flimsy and taken in an attempt to take shelter behind to overshadow the reality.
In determining ‘prejudice’ David Richards, J. observed: Prejudice will certainly encompass damage to the financial position of a member. The prejudice may be damage to the value of his shares but may also extend to other financial damage which in the circumstances of the case is bound up with his position as a member. So, for example, removal from participation in the management of a company and the resulting loss of income or profits from the company in the form of remuneration will constitute prejudice in those cases where the members have rights recognized in equity if not at law, to participate in that way. Similarly, damage to the financial position of a member in relation to a debt due to him from the company can in appropriate circumstances amount to prejudice. The prejudice must be to the petitioner in his capacity as a member but this is not to be strictly confined to damage to the value of his shareholding. Moreover, prejudice need not be financial in character. A disregard of the rights of a member as such, without any financial consequences, may amount to prejudice.
The courts are usually reluctant to interfere with a business decision made by a company’s board of director or its majority shareholders except where there is ulterior motive or a conflict of interest.
In Re Little Olympian Each-Ways Ltd (No. 3)[1995] 1 BCLC 636 the company’s assets had been sold by directors at a substantial undervalue, some £ 2 million, to another company which was also controlled by them. The court did not hesitate in finding such conduct of the company’s affairs to be prejudicial to the petitioner’s interests. It was also held that an order could be made against the second company requiring it to buy out the petitioner’s shares at a price which reflected their value before the wrongful sale.
Infringement of fiduciary duties of directors often cause prejudice to the members and persistent prejudicial acts inevitably lead a company to a severe deadlock in its management. Causing barrier in the voting right of members, misapplication of company’s assets, earning secret profits, allotment of shares for an improper purpose, diversion of corporate opportunity etc. prejudicially affect the rights of the members. In extreme circumstances the court may hold that failure to pay dividend or payment of excessive remuneration to directors amounts to prejudicial conduct. In Re a Company (No 004415 of 1996) [1997] 1 BCLC 479 it was observed that where remuneration and dividend levels cannot be justified by ‘objective commercial criteria’ it would seem to follow that the affairs of the company have been managed in a way unfairly prejudicial to the interests of the shareholders who are not directors.
The Court shall, on receipt of an application under section 233 (1) send a copy thereof to the Board and fix a date for hearing the application. If after hearing the parties present on the date so fixed, the Court is of opinion that the interest of the applicant or applicants has been or is being or is likely to be prejudicially affected for reasons specified in the application, it may make such order as prayed for or such other order as it deems fit including a direction-(a) to cancel or modify any resolution or transaction ; or (b) to regulate the conduct of the company’s affairs in future in such manner as is specified therein; (c) to amend any provision of the memorandum and articles of the company.
It is not unusual that directors may try to create monopoly in the management of the company and we have found that that articles of some companies provide for prior recommendation by an existing director to be eligible to contest in the election for the office of director. Such provision in large listed companies may be prejudicial to their members.
Mismanagement or oppression to minority shareholders is a threat to the sound functioning of a company and the feelings of injustice compel the members to bring their disputes to the court repeatedly. Even the objectives behind its incorporation may be frustrated. It may bestow an opportunity to outsiders to take over its management forcefully.
[Md. Nazrul Islam Khan is an Advocate of the Supreme Court of Bangladesh who can be reached at nikhan.law.ru@gmail.com]

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