Rights of Minority Shareholders - Safeguarding Minority Interests in Business

Rights of Minority Shareholders - Safeguarding Minority Interests in Business. Rights of Minority Shareholders - Here's how to safeguard minority interests in your business
Minority shareholders often find themselves at crossroads when it comes to major business decisions. Their shares may be diluted without their consent, or the majority shareholders may be engaged in fraudulent practices within the company. A company may not appropriately provide for protecting minority interests and thus fall short of adequate corporate governance standards. In this post, Compliance Calendar demystifies several legal aspects of rights of minority shareholders, including circumstances justifying approaching the NCLT. In the second part of this post, we discuss best practices that your business can incorporate for protecting minority shareholders in the current corporate environment.
Who is a minority shareholder?
While there is no precise definition of a minority shareholder in the Companies Act, it is reckoned with reference to certain principles in the substantive act. For instance, shareholders having one-tenth of issued share capital can approach the National Company Law Tribunal for a case of oppression.
A case for Oppression under the Companies Act, 2013
Oppression, in the corporate sense, includes acts that may be prejudicial to the minority shareholders. In this case, shareholders can directly approach the NCLT. Examples of oppression include an issue made for the sole purpose of diluting minority shareholding, or a preferential allotment to one section of the shareholders at a steep discount.
Chapter XVI of the Companies Act, titled Prevention of Oppression and Mismanagement provides the statutory framework for protection of minority shareholders against oppression and mismanagement. Section 241 provides for approaching the Tribunal for relief in cases of oppression.
Landmark cases where minority shareholders proved acts of oppression

A single act may be deemed oppressive - In Bhagirath Aagarwala v. Tara Properties P Ltd. (2002) 111 Comp Cas 597, it was held that a single act of issuing additional shares at a meeting without complying with legal requirements and made to a single member without a simultaneous offer to others on a pro rata basis – was considered to be an act of oppression.

Creating a new majority - In Uma Pathak v. Eurasian Choice International P. Ltd (2004) 122 Com Cases 922 : 2004 CLC 1324 (CLB), it was held that a further issue of capital made for creating a new majority, through which existing majority is reduced to minority position. This is a breach of fiduciary duty and constitutes an act of oppression. The CLB ordered cancellation of the allotment. There was an increase of capital and issue of shares solely with a view to gain control of the company.

Change in shareholding to the detriment of one group - Where the purpose of new allotment is for upsetting existing shareholding to the detriment of one group, the allotment is held to be oppressive. S Varadarajan v. Udhayam Leasings and Investments (2005) 125 Com Cases 853,

Increase in share capital without a bona fide need - It was held that a sudden increase in share capital without adequate need can also constitute oppression (Peerson Education Inc v. Prentice Hall of India P. Ltd (2007)

What qualifies as “Mismanagement” under the Companies Act
Sometimes, minority shareholders may be privy to information about a section of majority that may be diverting company funds, engaging in fraudulent transactions with related parties etc.
To address such situations, the Section 241(1)(a) of the Companies Act, 2013 defines the term ‘mismanagement’ as gross mismanagement of a company’s affairs and acts that are prejudicial to its interest. Gross negligence in managing the affairs and inaction, are also valid grounds to prove mismanagement.
Mismanagement may include acts such as diversion of public money for unknown/ unwanted purposes, affecting grossly the financial state of the company. (K.R.S. Mani & Ors. v. Anugraha Jewellers Limited & Ors., (2000) 100 Comp Cas 665 (CLB)
Some instances held as “mismanagement” are:

Absence of basic records of the company;

Failure to hold general meetings for adoption of accounts;

Failure to finalize/get the accounts audited; and

Failure to file documents with the Registrar of Companies.

Prejudicial Acts
Newly introduced in the 2013 Act, members also have recourse against affairs of a company being conducted in a manner prejudicial to their interest. The term ‘prejudicial to the interest of its members or any class of members’ being a novel concept has not yet been fully interpreted by Indian Courts in the corporate context.
In R.N. Jalan v Deccan Enterprises Pvt. Ltd, (1992) 75 Comp Cas 417, (paragraph 26), the single act of issuing additional shares for the sole purpose of altering the shareholding pattern in certain shareholders’ favor and subsequent changes to the board of directors, was held to prejudicially affect the interests of the petitioning shareholders by the Andhra Pradesh High Court. In this case, noting that the company was profitable (and so it would be inappropriate to order it to be wound up), the Court appointed an interim administrator/ special officer to take charge and conduct the affairs of the company in supersession of the Board of Directors, in order to remedy the prejudice caused.
Related Party Transactions - Remedies for minority shareholders
A related party transaction can be considered abusive when the dominant shareholders expropriate the minority shareholders by selling assets at a reduced price, giving loans without security, borrowing at higher interest rate than the market rate, repayment of loans of controlling shareholders, etc.
Section 188 of the Companies Act, 2013 as well as Rules issued by SEBI for listed companies after the enactment of SEBI (Listing Obligations Disclosure Requirements) prohibit related party transactions.
Section 2(76) of the new Companies Act, 2013 incorporates a wider definition of related parties including Key Managerial Personnel, holding company, subsidiary company, associate company.
How can minority shareholders approach the NCLT?
Minority shareholders meeting the requisite numerical threshold can approach the NCLT with a petition.
Numerical threshold for approaching NCLT
Under Section 244 of the Companies Act, 2013, the minimum numerical threshold for maintainability of an action for oppression/ mismanagement/ prejudicial acts before the NCLT, is either :

members holding at least 10% of the “issued share capital of the company”, or

1/10th of its total number of members, whichever is less; or,

where the company does not have a share capital, not less than 1/5th of the total number of its members

Waiver of Minimum Threshold : However, this threshold was waived in the Tata sons case (Cyrus Investments Pvt. Ltd. v. Tata Sons Ltd. SCC OnLine NCLAT 261), where NCLAT ruled that minority group could maintain the action, notwithstanding that the number of members fell short of the 10% threshold, if exceptional circumstances were made out (which it ruled, were made out in that case), it could grant a ‘waiver’, and proceed with the application.
What reliefs can possibly be granted to minority shareholders by the NCLT?
Under Section 242, the Tribunal may, on being convinced of the acts of the company being oppressive against the minority shareholders usually orders one or more of the following reliefs;

Ordering purchase of shares or interests of any members of the company by other members thereof or by the company;

A reduction of share capital;

Placing restrictions on the transfer or allotment of the shares of the company

Termination, setting aside or modification, of any agreements between the company and the managing director, any other director or manager, upon such terms and conditions as may, in the opinion of the Tribunal, be just and equitable in the circumstances of the case;

It may also set aside any transfer, delivery of goods, payment, execution or other act relating to property made or done by or against the company within three months before the date of the application under this section, which would, if made or done by or against an individual, be deemed in his insolvency to be a fraudulent preference;

Remove the managing director, manager or any of the directors of the company;

Order recovery of undue gains made by any managing director, manager or director during the period of his appointment

Appoint directors, who report to the Tribunal

Impose costs as may be deemed fit by the Tribunal;

The NCLT may also appoint administrator(s), or a special officer or committee of advisors to take charge of the company. In Sanjiv Jain v. Satya Prakash & Bros P Ltd. 2010, 95 CLA 316 (CLB), CLB passed an order directing refund of investment of the amount of shares (from date of investment till date of payment) with reasonable interest of 18%. In another case, Gurmit Singh vs. Polymer Papers, the majority was ordered to exit the company, and to protect the interest of the company, the minority was deemed to run the company, and were directed to buy out the majority.
Filing a suit for class action
A case for class action may be filed by shareholders in specific scenarios of where acts that are fraudulent, illegal or harmful to the company are being committed. These could be:

Restraining the company from committing an act which is ultra vires the articles or memorandum of the company;

To declare a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained by mis-statement to the members or depositors;

To restrain the company and its directors from acting on such resolution;

To restrain the company from doing an act which is contrary to the provisions of this Act or any other law for the time being in force;

To restrain the company from taking action contrary to any resolution passed by the members;

To claim damages or compensation or demand any other suitable action from or against—

the company or its directors for any fraudulent, unlawful or wrongful act or omission or conduct or any likely act or omission or conduct on its or their part;

the auditor/audit firm of the company for any improper or misleading statement of particulars made in his audit report or for any fraudulent, unlawful or wrongful act or conduct; or

any expert/advisor/consultant/any other person for any incorrect or misleading statement made to the company or for fraudulent, unlawful or wrongful act or conduct or any likely act or conduct on his part;

Numerical threshold for class action - In case of company having a share capital, not less than 100 members of the company or not less than such percentage of the total number of its members as may be prescribed, whichever is less, and in case of company not having share capital, one fifth of total number of members.
Fraud - Seeking inspection of books through an order by the Central Government
If the Central Government is satisfied that the circumstances warrant, it may direct the Registrar, or an Inspector appointed for the purpose to conduct an inquiry under Section 210 of the Companies Act. Where the business of a company has been or is being carried on for a fraudulent or unlawful purpose, every officer of the company who is in default shall be punishable for fraud in the manner provided in Section 447.
Moreover, under Section 212, an investigation into the affairs of the company by Serious Fraud Investigation Office can also be ordered.
Protecting Minority Interests - Ideal practices for a business
Drafting a Shareholders Agreement
A shareholders' agreement (SHA) is essentially a contract between some or all shareholders in a company, which confers rights and imposes obligations over and above those provided by the company law (under its Memorandum and Articles). The essential purpose of SHA is to make provisions for proper and effective internal management of the company. It can visualize the best interest of the company on diverse issues and can also find different ways not only for the best interest of the shareholders, but also for the company as a whole.
SHAs regulate the ownership and voting rights of shares in the company including matters such as restriction of transfer of shares i.e. right of first refusal (RoFR), right of first offer (RoFO), drag-along rights (DARs) and tag-along rights (TARs), pre-emption rights, call options, put options, subscription options, etc. or granting securities interest over shares, provision for minority protection, lockdown or for the interest of the shareholders and the company.
Appointing a Small Shareholders Director
Section 151 of the Companies Act requires that a listed company may have one director elected by such small shareholders in such a manner and with such terms and conditions as prescribed. Small shareholders’ means a shareholder holding shares of nominal value of not more than 20,000 or such other sum as may be prescribed.
Exit option to minority shareholders based on fair valuation of shares
In several landmark cases, the courts have time and again held that minority shareholders are entitled to a set of protective rights. These protective rights include a larger subset of rights, such as participation rights during change in control.
In the leading case of Vodafone International vs. Union of India, it was held that minority shareholders also have the right to exit. These exit rights are part of the protective rights available to the minority shareholders.
The 2013 Act lays down the process of buying out minority shareholders in certain situations. A regular buy-back from existing shareholders can be done by complying with conditions under Section 68 of the Companies Act. More specifically, a majority shareholder, who holds at least 90% of the equity shareholding of a company, has the right to notify its intention to buy-out the minority shareholders. The minority shareholders may sell their shares to the majority shareholder at a price to be determined as per draft rules prescribed under the 2013 Act.
Moreover, as per SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘Takeover Regulations, 2011’), an acquirer who gains ‘control’ over a company, is mandatorily required to give an option to the minority shareholders to sell their shares to the acquirer, as an exit option. This helps to protect the interests of the minority shareholders for the non-consensual actions of the majority shareholders.
For the latest updates on compliances applicable for your business, consult the legal resources available on our website at Compliance Calendar. Having advised several niche
clients in drafting shareholders agreements and best practices for corporate governance, our in-house legal professionals ensure that you have the most up-to-date advice on aspects relating to minority shareholders within your company.

Rights of Minority Shareholders - Safeguarding Minority Interests in Business

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