India: Bombay High Court Holds That Reasons To Investigate Into The Affairs Of The Company By The Serious Fraud Investigation Office Have To Be Made Out Prima Facie

Laying down an important principle concerning the powers of the Serious Fraud Investigation Office (SFIO) in investigating the affairs of a company under the Companies Act, 2013, the Hon'ble Bombay High Court in the case of Parmeshwar Das Agarwal and Ors vs. Additional Director (Investigation) SFIO, Ministry of Corporate Affairs and Anr1 has held that reasons for investigating the affairs of a company have to be at least prima facie demonstrable where an order for investigation has been ordered by the Central Government. The Hon'ble Bombay High Court has further held that pending judicial resolution of the disputes between shareholders of the company, the Central Government cannot proceed to investigate into the affairs of the company, on the basis that it is in public interest.

Facts of the Case:

The petitioners (Majority Group) were shareholders of Singhal Enterprises Pvt Ltd (Company) holding more than 89% of the shares. The rest of the shares were held by the rival group (Rival Group), who belonged to the same family as the petitioners. The Company was in the business of manufacturing sponge iron and had 2 units. Pursuant to the Memorandum of Understanding (MOU) entered into by the members of the family, the shares held by the third faction (Third Group) of the family were sold to the Majority Group. Further, under the MOU, it was decided that one of the units of the Company would be demerged into another company which would be owned by the Rival Group. Accordingly, proceedings for demerger were filed before the Hon'ble Calcutta High Court. The said proceedings were opposed by the Third Group and were further followed up with a civil suit seeking revocation of the MOU. Interim applications were also filed in the civil suit. The interim applications were rejected. The appeal from the interim application was also rejected. Subsequently, the Hon'ble Calcutta High Court sanctioned the demerger. An intra court appeal was filed by the Third Group against the order permitting the demerger, which appeal is pending. The Rival Group filed an application withdrawing from the scheme. In the meanwhile, the first petitioner filed a civil suit seeking specific performance of the MOU.

As a result of the disputes between the two groups of shareholders, various compliances such as filing of annual accounts, holding of annual general meeting could not be met with. Notices were received by the petitioners from the Registrar of Companies (ROC) for non-compliance with statutory norms. The petitioners also filed proceedings under Section 633 of the Companies Act, 1956 seeking protection from prosecution by the ROC.

The Majority Group then instituted proceedings before the Company Law Board praying for directions for holding of annual general meetings. Pursuant to the orders of the Company Law Board, the annual general meetings were held but the annual accounts could not be approved. The Rival Group, in the meanwhile, approached the ROC alleging non-compliance in filing the annual accounts and returns. The Majority Group then received a show cause notice under Section 234 of the Companies Act, 1956 which was duly replied to stating that due to pending disputes between the shareholders, it could not file the various statutory documents. The ROC was apprised from time to time about the status of the pending disputes between the shareholders.

The Majority Group was then in receipt of summons from the SFIO which was issued on the basis of an order from the Central Government directing investigation into the affairs of the Company. The intent of the investigation was to direct the production of the books and papers relating to the Company and transactions with other concerns which were in the custody and power of the shareholders. The order of the Central Government was on the basis of a report from ROC, which was prepared pursuant to the letter from the Ministry of Corporate Affairs alleging lack of action and progress by ROC inspite of complaint from a Member of Parliament (MP) regarding the affairs of the Company. It was alleged by the Majority Group that the complaint from the MP was at the instance of the Rival Group. Neither was it in good faith nor in public interest.

Issue:

The writ petition filed before the Hon'ble Bombay High Court questioned the proceedings launched by the Central Government and sought a writ of certiorari for quashing the proceedings on the basis that the powers to direct investigation into the affairs of the Company vested in the Central Government were wrongly exercised at the behest of the Rival Group which was an unlawful exercise of power.

Analysis:

The Hon'ble Bombay High Court has applied the same test to interpret the provisions of Section 212 of the Companies Act, 2013 which have been applied for the purposes of interpreting Section 237 of Companies Act, 1956 by the Supreme Court in the case of Rohtas Industries2 and by the division bench of the Hon'ble Bombay High Court in the case of Hariganga Cements3 where investigation into the affairs of a company have been ordered by the Central Government. Section 212 of the Companies Act, 2013 permits the investigation into the affairs of a company on an order of the Central Government by the SFIO, while the erstwhile Section 237 of the Companies Act, 1956 permitted the investigation into the affairs of the company on an order of the Central Government by the inspectors appointed under that section. The earlier statute did not have any provisions for investigations by the SFIO. The Hon'ble Bombay High Court went on to hold that while it was the prerogative of the Central Government to form an opinion to investigate the affairs of the Company, the existence of circumstances which make it relevant to investigate should be made out prima facie. Vide this judgment, the Hon'ble Bombay High Court has also indicated that while forming its opinion for directing an investigation into the affairs of the Company, the Central Government cannot exercise the powers vested in it mechanically. The nature of the fraud which demands an investigation has to be of such magnitude and seriousness that it commands the requirement of an order from the Central Government for involvement of experts to investigate. While an order to direct an investigation into the affairs of a company may be based on subjective determination, however the circumstances for arriving at such subjective determination are required to be spelt out. The exercise of directing an investigation is a drastic power and should be exercised only when circumstances or material sufficient for exercise of such power exist. The decision, while passed under the new companies act legislation, draws heavily from the manner in which Companies Act, 1956 has been construed and interpreted by the courts in India.

Held:

The Hon'ble Bombay High Court has clarified that while proceeding on the basis that public interest demands for investigation into the affairs of a company, sufficient reasons are required to be shown and the investigation cannot proceed on the basis of allegations and counter allegations between two shareholders. The judgment lays down the test that would have to be followed by the Central Government while exercising its powers to investigate the affairs of a company. Additionally the judgment also clarifies that if disputes inter-se the members of a company are pending adjudication, the powers of the Central Government to investigate into the affairs of a company should not be exercised. It has been clarified by the Hon'ble Bombay High Court that while the decision taken by the Central Government directing an investigation into the affairs of a company may not be amenable to judicial review, the circumstances existing for coming to the decision would still be subject to judicial review.

KCO Comments:

The interpretation given by the Hon'ble Bombay High Court to the provisions of investigation by the Central Government under the Companies Act, 2013 has helped in clarifying the manner of applying the provisions under the new statute. Many a times, various regulatory and investigative powers under different statutes are misused at the behest of a disgruntled party. This judgment therefore will also be of assistance in situations where one group of shareholders is put to undue regulatory scrutiny at the behest of the rival group. Even though the legislature may have intended to keep the jurisdiction of the SFIO for investigating into the affairs of a company broad based, applying the principles of administrative law, the Hon'ble Bombay High Court has mandated the requirement of setting out reasons for exercise of such jurisdiction.

Footnotes

1. Writ Petition No. 2025 of 2016 decided on 5 October 2016

2. Rohtas Industries vs. S.D. Agarwal and Ors. (1969) 1 SCC 325

3. Hariganga Cements vs. The Company Law Board, Delhi 1987 MhLJ 775

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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