India: Rights Of A Co-Director To Challenge Sale Of Company Property

Last Updated: 20 November 2015
Article by Shujath Ahmed

In the corporate epoch that we live in, many business concerns are run by family owned companies, comprising of directors within the same family. Several times the affairs of such companies are managed by dominant members of the family, who in the position as directors run the company as though it were a soleproprietorship concern. Although the other directors have equal rights in the managerial affairs of the company, the practical position is that such directors are often oppressed by the dominant directors and have no substantial role to play in the affairs of company, resulting in mismanagement. The dominant directors taking advantage of such a situation often indulge in making personal gains that are not only detrimental to the interest of the company, but also affect the substantial interest of other directors and share holders. The company properties are also sold by such directors in an oppressive manner to make personal gains.

Now the question that arises for consideration is whether such oppressive acts of selling company property, that is detrimental to the interest of other directors/share holders, could be challenged?

Before answering the question in the affirmative, it is important to note that the role of a Director is akin to that of a trustee. A director has to run the affairs of the company in the best interest of the company. Equity prohibits a director from making any personal gains by his management, directly or indirectly. Directors are required to act on behalf of a company in a fiduciary capacity and their acts and deeds have to be exercised for the sole benefit of the company. Any sale of company property by a director who goes beyond his fiduciary capacity and sells company property to make personal gains at the cost of the company, is an act of oppression and the same could be challenged. Further in order to sell a company property there has to be a valid Board Resolution passed by the Board of Directors authorizing the sale of company property, giving justifiable reasons for the sale in the interest of the Company. In the absence of a valid Board Resolution, the sale transacted by some directors is void and is of no consequence.

It is important for directors to be acquainted with their rights and powers. It is the right of every director to participate in the meeting of the Board of Directors. Before passing any Resolution, the Board must call for a meeting and notice of such meeting has to be duly served on all the directors of the Company. It is relevant to note that Section 286 of the Companies Act, 1956, mandates that, "notice of every meeting of the Board of Directors of a company shall be given in writing to every director". Hence it is imperative on the part of the managing director to give notice of the meeting of the Board of Directors before passing any resolution. Without there being a valid notice of the meeting, duly served on all the directors, the validity of the resolution passed by the Board becomes voidable at the option of the aggrieved directors/shareholders.

Time and again Courts have held that 'Notice of Meeting' has to be given to all the directors. The Hon'ble Supreme Court in the case of Parmeshwari Prasad Gupta v. Union of India AIR 1973 SC 2389 has categorically held that "notice to all the directors of a meeting of the board of directors is essential for the validity of any resolution passed at the meeting. Where no notice is given to one of the directors of the company, the resolution passed at the meeting of the board of directors is invalid". Further the said principle has been reiterated by several Courts and the Division bench of the Hon'ble High Court of Kerala in the case of Dr. T.M. Paul Vs City Hospital [1999] 97 CompCas 216 (Ker), has gone a step ahead and held that non compliance of Section 286 amounts to fraud. "Section 286 requires notice of every meeting of Board of Directors of company to be given in writing to every Director - holding meeting and passing resolutions invalid for want of notice - adoption of resolutions without including them in agenda amounted to fraud".

Notice of meeting and the agenda of the same, has to be given as prescribed under Section 172 of the Companies Act. Further it is important to note that mere dispatch of notice as mandated under Section 286 does not amount to service of notice upon the directors. Even assuming the fact that notice was dispatched, the burden is heavy on the managing director to demonstrate that notice was duly acknowledged by the other directors. The Hon'ble Supreme Court in Parmeshwari Prasad Gupta (supra) has held that "leaving the notice in the residence of the director in his absence cannot be treated as proper notice". Further as held by the Division bench of Kerala High Court in Dr. T.M. Paul (supra), "adoption of resolutions without including them in agenda amounted to fraud". Hence it is imperative that notice of meeting, along with agenda of the meeting has to be duly served on all the directors before passing of a resolution and in the absence of the same, the resolution becomes voidable. Proceeding further it would be relevant to look into the Memorandum and Articles of Association of the company to ascertain the powers of the Board of Directors. Generally the Articles of Association regulate the powers of the Board of Directors. At this juncture it may be relevant to mention Sec 291 of Companies Act, which deals with The General Powers of the Board. The provisio to Sec 291 states that, "the Board shall not exercise any power which is required to be exercised in General Meeting as stipulated in the Memorandum or Articles of Association". Further the provisions of Sec 293 also lay down restrictions on power of the Board.

Section 293 states that, "the Board of Directors shall not, except in a general meeting, sell, lease or otherwise dispose of the whole or substantially the whole undertaking of the company". Sec 293 mandates that for sale of company undertaking, the prior consent in a general body meeting is mandatory and passing of an ordinary resolution in the general meeting is necessary. Although the word "undertaking" as laid down in this section does not necessarily include company property, the test to be applied would be to see whether the capital asset proposed to be disposed of constitutes substantially the bulk of the asset of the company, so as to constitute the integral part of the undertaking of the company.

Hence the Board of Directors do not have authority to pass a resolution for sale of company property without taking the consent of the general body as mandated under section 293(1)(a), for which it will have to be shown that the company property that has been sold falls within the meaning of the term "undertaking" as mentioned above.

Besides challenging the sale of company property on the grounds of insufficient notice of meeting and invalid board resolution, the other important aspect would be regarding the justifiable reasons for the sale of company property. As mentioned earlier, company property can be sold only in the interest of the company and for the benefit of the company. The need or benefit derived by the company has to be clearly stated before authorizing sale of company property. The sale of company property must be in the paramount interest of the company. In the absence of there being a valid reason for sale of company property, the sale transaction is liable to be set aside. The Hon'ble Company Law Board, Chennai in the case of P. Narayanasamy and Ors. Vs. Neela Spinning Mills P. Ltd. and Ors [2010] 1 CompLJ 424 (CLB), while dealing with a mortgage that was unnecessarily created by the Board has held that, "the need or the benefit derived by the company from and out of such borrowing is not established and lacks bona fides on the part of the respondents. The need for sale, adequacy of consideration or the valid authority for effecting sale of the properties is not borne out by any material. The benefit derived by the company has not been established by the respondents. The sale transactions which have come to the knowledge of the petitioners only after filing of the company petition, must be set aside, considering the paramount interest of the company".

Conclusion:

In the event of there being illegality in the sale of company property, the remedy available to the Directors/Share holders whose interest has been affected due to the oppressive act of the other directors in unilaterally selling the company property, is twofold, they can challenge the sale transaction by filing a comprehensive suit for declaration before the Civil Court to declare that the board resolution and the sale are illegal and seek for setting aside the illegal sale deed. Further the aggrieved parties could also approach the Company Law Board under the provisions of Section 397, 398 r/w 402 (f) on the grounds of mismanagement and oppression by the board of directors, provided the said application is made within three months from the date of sale.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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