SC: Promoters’ Benefit Doesn’t Invalidate Decision To Allot Additional Shares Under Companies Act

The Supreme Court has upheld the allocation of additional shares in a private limited company, which resulted in a significant increase in the shareholding percentage of one group of shareholders over another.

Justices K.M. Joseph and B.V. Nagarathna determined that the disproportionate increase in the shareholding of the H.M. Patel Group was due to the other group of shareholders declining to apply for the additional shares despite being given the opportunity. Therefore, the court concluded that the allocation of fresh shares could not be deemed oppressive.

The court explained that the Board of Directors had resolved to allocate additional shares to existing shareholders in a 1:1 ratio, with the option to apply for more or fewer shares than entitled. The H.M. Patel Group applied for a larger number of shares, while the other group of shareholders did not apply.

Consequently, the court ruled that there was no defect in the allotment of additional shares, as it was carried out after the authorized share capital of the company had been increased through a resolution passed in an Extraordinary General Meeting. The Supreme Court set aside the order of the National Company Law Appellate Tribunal (NCLAT), which had deemed the distribution of additional shares as “defective” and directed their allocation to all existing shareholders in proportion to their shareholding.

The Supreme Court observed that the members of the H.M. Patel Group, who were also directors of the company, were involved in the decision to increase the authorized share capital and issue fresh shares. Although Section 81(3) of the Companies Act, 1956 excludes private limited companies from the application of Section 81, which pertains to further issuance of capital, the court emphasized that the directors’ conduct should be evaluated to a higher standard.

However, the court stated that the mere fact that directors may benefit from a decision primarily aimed at promoting the company’s interests does not invalidate the decision. Therefore, even if the directors who constituted the concerned shareholders’ group derived benefits and gains from the implementation of a decision taken to protect the company’s interests, it does not make the decision susceptible to attack.

In the case, Ambika Food Products Pvt Ltd, a closely held private limited company, had three groups of shareholders: H.M. Patel Group, Sheth Group, and V.P. Patel Group, with varying percentages of shareholding.

The company’s authorized capital was increased from Rs 1 crore to 2 crores, resulting in the H.M. Patel Group’s shareholding rising to 63.58% of the paid-up share capital. The V.P. Patel Group and the Sheth Group held 12.74% and 23.68% of the paid-up share capital, respectively.

The V.P. Patel Group and the Sheth Group filed petitions alleging mismanagement and oppression by the H.M. Patel Group, challenging the increase in authorized share capital. The National Company Law Tribunal (NCLT) upheld the increase in authorized capital but found the distribution of shares to be “defective.” The NCLAT also upheld this decision, directing the allotment of shares to all existing shareholders in proportion to their shareholding.

The H.M. Patel Group appealed to the Supreme Court, arguing that all shareholders were given an equal opportunity to apply for additional shares based on their existing holdings, but the Sheth Group and V.P. Patel Group did not apply. They contended that since the increase in capital was deemed legal and not malicious by the NCLT and NCLAT, the actual allotment of shares could not be considered defective.

The Supreme Court analyzed the case and noted that the Bank of Baroda had advised the respondent-company to increase its share capital to a minimum of Rs. 2 crore in response to a term-loan proposal made by the appellant-group in 2009.

The court referred to the minutes of the Extraordinary General Meeting of shareholders in 2010, where the decision to increase the authorized share capital to Rs. 2 crores was made. It was observed that the Board further resolved to allot additional shares to the existing shareholders in a 1:1 ratio, allowing them the option to apply for more or fewer shares than they were entitled to.

Although no representatives from the Sheth Group or the V.P. Patel Group were present at the meeting, the court found that these shareholders were sent notices via registered post, informing them of the decision and giving them the opportunity to subscribe to the additional capital being raised.

The Supreme Court observed that the NCLT had found that the shareholders of the “V.P. Patel Group” were aware of the proposal to increase the share capital. Additionally, the Sheth Group, also having knowledge of the proposal, chose not to participate in the Board Meeting and the Extraordinary General Body Meeting.

The court further noted that both the NCLT and the NCLAT had concurred that the decision made by the appellant-group to increase the authorized share capital could not be considered as an act of mismanagement or oppression against the rights of the V.P. Patel Group and the Sheth Group.

The court stated, “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.”

The Supreme Court took into account that at the time of the decision to increase the authorized share capital and issue new shares, the Board of Directors of the respondent-company included two directors from the appellant-group (H.M. Patel Group) and two directors from the V.P. Patel Group. It also acknowledged that after the additional shares were issued, the appellant-group became the majority shareholders in the company.

In analyzing whether oppression occurred due to the manner in which the additional shares were allotted, the court referred to Section 81(3) of the Companies Act, 1956. This section exempts private limited companies from the provisions of Section 81, which deals with the further issue of capital. However, the court stated that the conduct of the directors should be evaluated with a higher standard.

The court raised questions regarding whether the directors acted in the best interest of the company or if their actions were motivated by consolidating their power or sidelining other stakeholders. It emphasized that if the directors acted in good faith and the decision was made to safeguard the company’s interests, any benefit they derived from the decision would not render it invalid.

The court remarked that “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.”

Upon reviewing the facts of the case, the Supreme Court found that the shareholders from the V.P. Patel Group and the Sheth Group did not apply for additional shares, whereas the members of the appellant-Group did apply for them. The court also noted that the wife of the first appellant, belonging to the appellant-Group, received a seemingly disproportionate number of shares.

The court took note of the fact that the wife of the first appellant, who belonged to the appellant-Group, had initially held 20 shares but was allotted 96,000 shares. This allotment appeared disproportionate as she was entitled to only 20 shares based on a 1:1 ratio for the rights issue. However, the court explained that shareholders had the option to apply for a larger number of shares than they were entitled to according to the application form. Therefore, the members of the appellant-Group applied for a greater number of shares, resulting in the seemingly disproportionate allotment to the wife of the first appellant.

“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.”

The court emphasized that the allotment of additional shares was carried out exclusively for the existing shareholders, applying the terms equally to all. It stated “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.”

Considering the overall circumstances, the court concluded “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.”

Therefore, the Supreme Court overturned the NCLAT’s directive to allot the additional shares as specified in its order.