Companies Act - Decision To Allot Additional Shares Cannot Be Set Aside Merely Because Promoters Have Also Benefited: Supreme Court

The Supreme Court has upheld the largely disproportionate allotment of rights share in favour of one group of shareholders of a private limited company, substantially increasing its shareholding percentage in the company over other group of shareholders.

The bench comprising Justices K.M. Joseph and B.V. Nagarathna found that the increase in the appellant- H.M. Patel Group’s shareholding from 30.80% to 63.58% of the paid-up share capital of the private company, was the result of the other shareholder-group’s refusal to apply for the additional shares, despite being given the opportunity. Thus, the allotment of fresh shares could not be characterised as oppressive, the court ruled.

The court held that after the Board of Directors had resolved to allot additional shares to the existing shareholders in the ratio of 1:1, while also giving them the option to apply for more or lesser number of shares than they were entitled to, the members of the H.M. Patel Group had applied for a greater number of shares. The shareholders constituting the other shareholders’ group, however, did not apply for the same.

The court thus ruled that there was no defect in the allotment of additional shares after the authorized share capital of the company was increased by a resolution passed in the Extraordinary General Meeting of the shareholders. The top court thus set aside the order of the National Company Law Appellate Tribunal (NCLAT) where it had ruled that the distribution of the additional shares was ‘defective’. The Tribunal had directed the allotment of additional shares to all the existing shareholders of the company in proportion to their shareholding.

The Apex Court noted that the members of the H.M. Patel Group were members of the Board of Directors at the time the decision to increase the authorized share capital and issue fresh shares was taken. It held that though Section 81(3) of Companies Act, 1956 expressly exempts a private limited company from the purview of Section 81, which deals with further issue of capital; however, notwithstanding the same, the conduct of the Directors is to be judged on a higher yardstick.

The court, however, remarked that the fact that the Directors may also benefit from a decision taken primarily with the intention to promote the interest of the Company, cannot vitiate the decision. Thus, even though the Directors who constituted the said shareholders’ group, benefited and made a gain from the implementation of a decision taken primarily with a view to safeguard the interest of the Company, it cannot by itself render the decision vulnerable to attack.

Facts of the Case:

The respondent-company, Ambika Food Products Pvt Ltd, is a closely held private limited company which is controlled by three groups of shareholders, who all hold varying percentage of shares in the said company.

The H.M. Patel Group, the Sheth Group, and the V.P. Patel Group held 30.80, 45, and 24.20 percentage of the paid-up share capital in the company, respectively.

Consequently, the authorised capital of the company was increased from Rs 1 Crore to 2 Crore. After the issue of additional shares, the H.M. Patel Group’s shareholding increased to 63.58% of the paid-up share capital. The shareholding of the V.P. Patel Group and the Sheth Group stood at 12.74% and 23.68% percentage, respectively, of the paid-up share capital.

The V.P. Patel Group and the Sheth Group filed petitions under Sections 397 and 398 of the Companies Act, 1956 before the National Company Law Tribunal (NCLT), alleging mismanagement and oppression by the H.M. Patel Group, and challenged the latter’s decision to increase the authorised share capital of the company.

The NCLT upheld the increase in the authorised share capital of the company, holding that the same was valid and binding on all the shareholders. The Tribunal, however, found that the distribution of the shares was ‘defective’. Thus, it directed that the allotment of shares in respect of the increased share capital, was to be made to all the existing shareholders of the company, in proportion to their shareholding.

The same was upheld by the NCLAT in appeal. Against this, the H.M. Patel Group (the appellants) filed an appeal before the Supreme Court.

The H.M. Patel Group argued before the top court that all the shareholders were given an equal opportunity to apply for the additional shares in proportion to their existing shareholdings; further, they could also apply for a lesser or a greater number of shares.

The H.M. Patel Group pointed out that the Sheth group and the V.P. Patel Group did not apply for the same. It pleaded that since the increase in the capital was not found to be illegal or malafide by the NCLT and the NCLAT, the actual allotment of shares could not be held to be defective.

Analysis of the Supreme Court:

Referring to the facts of the case, the Supreme Court observed that in response to a proposal for a term-loan made by the appellant-group in 2009, the Bank of Baroda advised the respondent-company to increase the Share Capital to a minimum level of Rs. 2 Crore.

The court referred to the Minutes of the Extraordinary General Meeting of shareholders held in 2010, where the decision to increase the authorised share capital of the company to Rs.2 crores was taken. The Board, thereafter, resolved to allot additional shares in the ratio of 1:1 to the existing shareholders who applied for the same. A shareholder was also given the option to apply for more or lesser number of shares than he was entitled to.

The bench found that though no one from the Sheth Group or the V.P. Patel Group was present in the Extraordinary General Meeting, the shareholders were sent Notices by Registered Post about the decision of the said Meeting so that they could take steps to subscribe to the additional capital sought to be raised.

Other Shareholders’ Group Had Knowledge Of The Proposal To Increase The Share Capital:

In the petitions filed before the NCLT, the Supreme Court noted that the Tribunal had found that the ‘V.P. Patel Group’ shareholders were having knowledge of the proposal to increase the share capital. The Sheth Group also, with knowledge, did not chose to participate in the Board Meeting and the Extraordinary General Body Meeting.

It further noted that there was a concurrent finding by the NCLT and NCLAT that the decision taken by the appellant-group to increase the authorised share capital, cannot be treated as an act of mismanagement or oppression of the rights of the V.P. Patel Group and the Sheth Group.

The court added: “We can find that the case of the V.P. Patel Group and the Sheth Group based on there being mismanagement and oppression by the appellants, has otherwise been rejected. The complaint that the appellants acted in an oppressive manner or mismanaged the Company, when it decided to increase the authorised capital, has also been rejected.”

Allotment of Additional Shares in the interest of the Company, cannot be set aside merely because Directors benefited from the same:

The court took note that at the time the decision to increase the authorized share capital and issue fresh shares was taken, the Board of Directors of the respondent-company consisted of four directors, two each belonging to the appellant-group, i.e., the H.M. Patel Group, and the V.P. Patel Group, respectively. It further reckoned that after the issue of the additional shares, the appellant-group became majority shareholders in the company.

While considering the question whether oppression had been occasioned by the manner in which the allotment of the additional shares was done, the bench referred to Section 81(3) of the Companies Act, 1956.

The court observed that Section 81, which deals with further issue of capital, provides in sub-section (3) that a private limited company is exempted from the purview of Section 81. Notwithstanding the same, the court said that the conduct of the Directors is to be judged on a higher yardstick.

“The question would, in the ultimate analysis, trickle down to, whether the Directors acted in the best interest of the Company or were they motivated to consolidate their power in the Company or maintain the power in the Company. Did the Directors act bonafide in that, when a decision was taken to increase the Authorised Share Capital, they were driven by the intention to side-line the other stakeholders in the Company?” the bench said.

The court concluded that the fact that the Directors may also benefit from a decision taken primarily with the intention to promote the interest of the Company, cannot vitiate the decision.

“In other words, if in the implementation of the decision taken primarily with a view to safeguard the interest of the Company, the appellants have made a gain, it cannot by itself render the decision vulnerable,” the court remarked.

Appellants Did Not Act In A Defective Or Unfair Manner In Allotment Of Further Shares:

Perusing the facts of the case, the court found that after the Board had resolved to allot additional shares, the shareholders from the V.P. Patel Group and the Sheth Group, admittedly, did not apply for the same. The members of the appellant-Group, on the other hand, applied for the shares.

It further noted that the wife of the first appellant, Hasmukhlal Madhavlal Patel, belonging to the appellant-Group, had 20 shares and she had been allotted 96000 shares; even though, she was entitled to only 20 shares if the rights issue was limited to a 1:1 ratio. However, since, as per the application form, a shareholder could apply for a larger number of shares than he was entitled for, the members of the appellant-Group applied for a greater number of shares. Consequently, the wife of the first appellant came to be allotted a seemingly disproportionate number of shares, the court observed.

“If the shareholders belonging to the V.P. Patel Group and the Sheth Group had also applied for a larger number of shares than what they held and there was any discrimination or rejection of their application seeking greater number of shares, then, there would have been, indeed, an occasion to find that an act of oppression had been perpetuated,” the court said, adding: “In the absence of any application by members of the V.P. Patel Group and the Sheth Group for shares in any number, we are unable to perceive or characterise the act as oppressive.”

While holding that the allotment of additional shares was made only to the existing shareholders, the court said, “This is a case where the terms were applied equally to all the existing shareholders. The change in shareholding, in that the appellants shareholding grew from 30.80% to 63.58% is the result of the respondent’s refusal to apply despite being given the opportunity.”

“On the whole, in the facts, the appellants cannot be described as having acted in a defective or in an unfair manner, in the matter of allotment of further shares particularly when the contention of the respondents about the bona fides of the decision to increase the authorised capital has been found in favour of the appellants,” the Supreme Court ruled.

The court thus set aside the direction of the NCLAT to allot the additional shares as specified by it in its impugned order.

Case Title: Hasmukhlal Madhavlal Patel and Anr. vs Ambika Food Products Pvt Ltd. and Ors.

Citation : 2023 LiveLaw (SC) 490

Counsel for the Appellants: Ms. Meenakshi Arora, Sr. Adv., Mr. Mohit D. Ram, AOR, Mr. Rajul Shrivastav, Adv., Ms. Monisha Handa, Adv., Mr. Anubhav Sharma, Adv.

Counsel for the Respondents: Mr. Ritin Rai, Sr. Adv., Mr. S. S. Shroff, AOR, Mr. Malak Manish Bhatt, AOR, Ms. Tanishka Khatana, Adv., Mr. Siddharth, AOR

Companies Act, 1956: Section 81-The Supreme Court has upheld the largely disproportionate allotment of rights share in favour of one group of shareholders of a private limited company, substantially increasing its shareholding percentage in the company over other group of shareholders.

The court held that though Section 81(3) of Companies Act, 1956 expressly exempts a private limited company from the purview of Section 81, which deals with further issue of capital; however, notwithstanding the same, the conduct of the Directors is to be judged on a higher yardstick.

The court, however, remarked that the fact that the Directors may also benefit from a decision taken primarily with the intention to promote the interest of the Company, cannot vitiate the decision. Thus, even though the Directors who constituted the said shareholders’ group, benefited and made a gain from the implementation of a decision taken primarily with a view to safeguard the interest of the Company, it cannot by itself render the decision vulnerable to attack.

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