Introduction
In order to protect minority, law has to provide certain ‘default rule’. These rules are incorporated as ‘oppression and mismanagement’ under Companies Act, 2013. This paper deals with nature of these rights in terms of fiduciary duty as a doctrinal justification for the same. However, the scope of this paper is limited only to ‘closely held corporation’. A closely held corporation is one in which public is not substantially interested and promoters have large shareholding.
In this regard, the ‘Tata-Mistry feud’ opens the debate regarding protection of the minority shareholders in India. This paper, in essence, is an attempt to extent fiduciary obligation beyond provisions of Companies Act, 2013. The fiduciary obligation is not strict one but encompasses duty of care and duty of loyalty so as to avoid minority using it as a tool of oppression.
Fiduciary Duty: Understanding its importance in Corporate Governance
Fiduciary relationship comes into picture when one party ventures to act on ‘behalf of another’ and while doing so exercises some amount of discretion. ‘On behalf of’ assumes that one is acting for the benefit of someone else. Moreover, fiduciary has the power to decide how to carry out the obligation i.e. it can exercise discretion.
The content of fiduciary obligation is – duty of loyalty and duty of care. These duties ensure that there is “no conflict of interest between stakeholders and their interests are aligned”. Such formulation encompasses ‘no profit’ rule by the fiduciary.
The bedrock of corporate governance is that board of directors owe fiduciary duty to the Company. In order to deal with agency problem, which is inherent in contract between board of directors and company, fiduciary duty has been introduced. It ensures that board of directors’ work for the benefit of the company i.e. exercise of discretion has to be in consonance with the interest of the company.
Protection of minority shareholder from oppression and mismanagement: Imposing Fiduciary Duty
Chapter XVI (§ 241-245) of the CA, 2013 incorporates provisions relating ‘oppression and mismanagement’. It was meant to protect the interest of the minority shareholders. Section 241 empowers members to apply to the NCLT in order to seek relief in circumstances when the affairs of the company are carried out in a way that is oppressive to any of them or other members, or “prejudicial to public interest”. § 244 lays down set of qualifications that needs to be fulfilled so as to entitle them to file a petition seeking relief provided by §241 of the act. § 244(1) provides that a petition would be maintainable only if any member is holding 10% or more of the ‘issued share capital’ or 100 or more members. Additionally, proviso to this section, empowers the NCLT to waive any of the requirements. The justification of having minimum requirement of 10% shareholding is to ensure that there is no frivolous litigation and proviso ensures that genuine claims do not remain unaddressed. § 242 describes the power of the tribunal – it can pass orders ranging from regulating the conduct of the company, purchase of shares, “recovery of undue gains”, removal of directors, imposing costs, etc. This enumeration of long list shows the intention of the law-makers to recognise the problem in close corporation. Hence, these provisions should be viewed in more general approach as ensuring that rights of minority shareholders is protected rather than as way of dissolution.
The Supreme Court has interpreted oppression to mean “wrongful, harsh, and burdensome”. In Scottish Co-operative Wholesale Society Ltd case, the HoL held that the corporation in essence was a partnership, “though not in law” and therefore, one should exercise utmost good faith among various constituents of the company. The scope of oppression also covers any conduct which is mala fide and act is advantageous to few shareholders, even though it might serve the purpose of the company in the long run. Moreover, it is possible that the act in question is permissible in law but it might be oppressive if it is harsh, wrong, burdensome, or mala-fide. Furthermore, what constitutes to be oppressive is a question of fact and; therefore, facts have to be analysed in light of settled principle with regard to oppression and there should be lack of probity, “conduct which is unfair”, “prejudice is caused to minority shareholder”. If by the act of the company or BoD, a member’s holding is reduced from majority to minority then such act would fall under oppression.
In cases of oppression, it is qualified by the “business judgment rule”. This is so because, traditionally, decisions of corporation are taken by the majority shareholders. Therefore, to maintain that standard, the threshold has been reduced. As per this rule, there is legal presumption that actions taken by the majority shareholders would be in the best interest of the company and there is no mala-fide intention. Therefore, for oppression, one has to prove that decision was not in the best interest of the company and had burdensome effect on the minority.
Oppression and Mismanagement: Its limitation
Even though this provision intents to protect the interest of the minority shareholder, there are certain limitations to it. The minimum requirement of having 10% shareholding has led to unfair treatment of the minority shareholders.
Apt example of this is – ‘Tata-Mistry Feud’ Mistry was removed from Tata Sons as chairman. Inter alia various issues one of them was on maintainability of petition with respect to ‘oppression and mismanagement’ filed by the Mistry group. Mistry group owed 18.34% of the equity shares in the Tata Sons; therefore, they contended that their petition was maintainable. However, Respondent argued that equity and preference share both needs to be taken together, and petitioner held only 2.17% of the total shareholding. High Court had already taken a view on that point. It had held that wider interpretation has to be taken as legislatures meant both equity and preference shareholders and this has been reaffirmed by the Supreme Court. Being bound by the precedent, NCLT ruled that the petition filed by the Mistry was not maintainable as the minimum requirement of 10% has not been fulfilled. ‘Any class of members’ was interpreted to mean all class of shares that a company can issue. This kind of approach makes it difficult for any minority shareholder to succeed. In spite of having legitimate ground of oppression, mere technical niceties prohibited Mistry to maintain his application. Such approach shows that law has not been able to protect the interest of the minority shareholders. There is need for developing alternate approach to deal with this problem, which is not based on oppression but on fiduciary relationship.
Prof. Umakanth argues that large number of companies, in India, are promoters driven but majority shareholders are not subject to any kind of fiduciary duties. On the other hand, in USA, close corporation are rare even then laws protect minority shareholder. In this regards, he cites Lynch Communication Systems Inc. This problem calls for alternate way to protect the interest of the minority shareholders.
Alternate approach to protect the minority shareholders
Given the inherent fault in ‘oppression and mismanagement’ provisions in CA, there is need for alternate mechanism to protect the minority. This can be done by finding fiduciary obligation apart from oppression related provisions.
In Donahue case, the SC of Massachusetts observed that controlling shareholders owe fiduciary duty similar to partnership and described this duty as “utmost good faith and loyalty”. However, this case did not lay down the standard that has to be satisfied by the majority shareholders. It was reiterated in other cases as well, where holding shareholders as partners on fact but not in law. The rationale for coming to this conclusion was that there was ‘concentration of power’ in the hands of the controlling shareholders, who could take decision that might be pre-judicial to the interest of the minority shareholders. Later on, courts developed ‘business judgment rule’, which has already been discussed. This was done to ensure that company can carry out its business in accordance with its objects. In USA, particularly in Delaware and California, controlling shareholders owe fiduciary duty to the minority shareholders.
In this model, duty of care involves restricting majority from actions that are too risky; duty of loyalty, on the other hand, ensures that majority shareholder do not act in manner that is more advantageous to them. Moreover, these duties are present in their weak form rather than strong form so as to ensure that minority do not become hindrance to the working of company. In order words, if majority shareholders act in a way that is not in the best interest of the company but in their personal interest then it would be deemed that there was breach of fiduciary duty.
We can see development in India as is evident from the observation of the SEBI in Jilla Grahak Suraksha Mandal case where it was looking into the allotment practice of “warrants to promoters”. Where petitioners argued that SEBI should take steps to prohibit promoters from voting in the GA; to that SEBI responded by stating that they will take not of the same and initiate a consultative process. Allotment of share warrants to promoters at the low price leads to serious loss to company and to minority shareholders. Such view shows willingness of the SEBI to introduce fiduciary obligation apart from oppression and mismanagement provisions.
In light of this, there is immediate need to recognise fiduciary obligation apart from ‘oppression and mismanagement’ related provisions. This development will help in building confidence viz-viz investors. In this model, fiduciary duty acts as an analytical and normative framework, where position of controlling shareholder is such that it might cause detriment to the interest of the minority. Hence, fiduciary obligation ensures that there is some kind of deterrence upon those controlling the assets of the company. However, the possible argument against this is that it can be used as weapon by the minority in interfering in the daily affairs of the company. Such argument is untenable as it is ‘not a coercive tool’ but rather protective one, which requires same amount of loyalty. Hence, there is corporate cohesion between majority and minority; a recognition of harmonious interplay between two groups. This model has found application in number of cases. In Kemp & Beatley case, it was observed that minority shareholder cannot act in a manner so as to cause prejudice to interest of the company or its dissolution.
Conclusion
The ‘Tata-Mistry Fed’ has opened the debate about the feasibility of ‘oppressions and mismanagement’ provisions. In order to deal with this, I suggest alternative approach to protect the interest of the minority. This model is based on common law and is similar to that of applied in USA. In this, there is no relationship of agency between majority and minority but having regard to position of the majority and their capability to cause prejudice to minority – fiduciary duty is imposed. We see recognition of this model in observation made by SEBI in Jilla Grahak Suraksha Mandal case. But, the possibility of minority using this as tool to oppress majority cannot be left out. To deal with this, I suggest reciprocal fiduciary obligation upon minority shareholders. In this way, we will be able to balance the interest of majority and minority shareholder. Such analysis is possible due to flexibility offered by the fiduciary duty without compromising with its normative character. For better understanding, courts have often relied upon partnership to draw an analogy. But the same does not take away the corporate existence, which is embedded in law. This approach is better over others as it takes into account all contingency that might arise in dealing with each other.
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