Recently, on June 15, 2023, the Supreme Court of India upheld the largely disproportionate allotment of shares in favour of one group of shareholders of a private limited company, thereby leading to a substantially increased shareholding percentage of such group over the other group of shareholders.

In the case of Hasmukhlal Madhavlal Patel and Ors. Vs. Ambika Food Products Private Limited and Ors.1, the Apex Court held that the increase in the appellant's shareholding from 30.8% to 63.58%, pursuant to an additional issue of shares, was the result of the other shareholder groups refusing to apply for additional shares, despite being given an opportunity and therefore, such additional issue of shares could not be characterised as oppressive.

Ambika Food Products Private Limited ("Company") is a private limited company. The authorised capital of the Company was Rs. 1 Crore. There are three shareholder groups, the H.M. Patel Group, which held 30.8% of the paid-up share capital, the Sheth Group which held 45% of the paid-up capital and lastly, the V.P. Patel Group with 24.2% of the paid-up share capital.

The authorized share capital of the Company was increased to Rs. 2 Crores and all the shareholders were given an equal opportunity to apply for shares in proportion to their existing shareholding (1:1). The shareholders also were given an option to apply for lower or higher number of shares. They could also exercise the choice to not apply for any shares at all. After the issue of additional shares, the H.M. Patel Group's shareholding increased to 63.58% and the shareholding of the V.P. Patel Group and the Sheth Group stood at 12.74% and 23.68% respectively. Both the groups filed petitions before the National Company Law Tribunal ("NCLT"), under Section 397 and 398 of the Companies Act, 1956, alleging mismanagement and oppression by the H.M. Patel Group and challenged their decision to increase the authorized share capital of the Company. The increase in the authorized share capital of the Company was upheld by the NCLT, however, it found that the distribution of shares was 'defective'. It was directed by the NCLT that the allotment of shares was to be made to all the existing shareholders of the Company, in proportion to their shareholding. The NCLT's decision was upheld by the National Company Law Appellate Tribunal ("NCLAT").

It was argued by the H.M. Patel Group that all shareholders in the Company were given an equal opportunity to apply for the additional shares in proportion to their existing shareholdings. It was highlighted that the Sheth Group and the V.P. Patel Group did not apply for the same. It was also pleaded that since the increase in authorized 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.

It was contended by the respondents that the Company is a closely held company and is more or less a quasi-partnership and it ran on trust. It was also stressed by the respondents that when allotment of shares is made by the board of directors, the question of allotment of shares, which are not taken up by the shareholders, must be taken up only after the shareholders, in the first place, decline the allotment.

The Supreme Court analysed the facts of the case as well as contention of the parties in detail and found that though no one from the Sheth Group and/or the V.P. Patel Group was present in the extraordinary general meeting of the Company, the shareholders were sent notices by registered post about the decision of the said meeting so they could exercise their right to subscribe to the additional capital.

The Supreme Court took note of the decision reported in Needle Industries (India) Ltd. and Ors. Vs. Needle Industries Newey (India) Holding Ltd. and Ors.2 wherein, it was stated that "the mere circumstance that the directors derive benefit as shareholders by reason of the exercise of their fiduciary power to issue shares, will not vitiate the exercise of that power".

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 Company consisted of four directors, two each belonging to the H.M. Patel Group and the V.P. Patel Group, respectively. It further reckoned that after the issue of the additional shares, the H.M. Patel 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 Court 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 Court said – 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 Court noted that if the shares are issued in the larger interest of the Company, the decision to issue shares cannot be struck down on the ground that it has incidentally benefitted the directors in their capacity as shareholders. In other words, if in the implementation of the decision taken primarily with a view to safeguard the interest of the Company, the H.M. Patel Group has made a gain, it cannot by itself render the decision vulnerable.

The Court also held that "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 Apex Court also added: "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 Supreme Court held that the H.M. Patel Group 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 H.M. Patel Group.

Footnotes

1. Civil Appeal No. 8194 of 2019 and 8195 of 2018

2. (1981) 3 SCC 333

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