University of Petroleum and Energy Studies

College of legal studies

Academic year – 2018-2019

Under supervision of Ajit Kausal

Topic: Prevention of Mismanagement

Submitted by:
1.Name: Dibyanshu Singh
SAP ID: 500055203
ROLL NO.:R450216031
2. Name:Harsh Gop
SAP ID:500055224, ROLL NO.:R450216039
 ABSTRACT
Mismanagement is one of the old and major issue in the corporate world which create lot of dispute between
the shareholder’s and company the problem is big and remedy is been provided under companies act 2013
under section 398(1) as such the act dose not define the expression ‘mismanagement’ on the other hand
prevention of shareholder’s right majorly minorities unit need special attention in the case of
mismanagement as misconduct of majority shareholder’s or the directors can lead to big muddle to minority
unit.

This project is emphasised on prevention mechanism in the cases of mismanagement within company also
research on the major cases which provided the guidelines for prevention of mismanagement and most
important part under this is financial mismanagement which is an emerging problem should be prevented as
this project include the way to solve the financial mismanagement.

Keywords: mismanagement, companies act(2013), financial mismanagement.

 INTRODUCTION
Company is a legal entity holding a artificial personality in a broad sense is a group of persons
who have come together or who have contributed money for some common purpose and have
incorporated themselves into distinct legal entity. Company is the amalgamation of two distinct
words- “com" and “pain", the former meaning with/together and the later meaning “bread". To
govern the working company need effective and efficient management which help in the
promotion and smooth working and easy condition to shareholders company functions through
the decisions of the Board of Directors who are guided by the wishes of the majority subject to
welfare of the company. The general principle of company law is that every member holding
shares of a particular class will have equal rights to vote. It has therefore become a ‘Cardinal
Rule’ of Company Law that prima facie, a majority of members of a company are entitled to
exercise the powers of the company and generally control its affairs. Major problem in the
corporate world is ‘mismanagement’ this lead to internal instability and create a relation gap
between management and shareholder. Oppression and mismanagement are two big hurdles in
smooth function of company1

Corporate world continues to suffer from the much prevalent disputes between shareholders. It
definitely is not a phenomenon specific to India but is and has always been a universal problem.
Allegations by the minority shareholders against the majority reverberate in courtrooms
throughout the world. Indian law provides for various reliefs for oppression and mismanagement
but how effective they are is a point of debate. Although the concept of Minority shareholders
buying out the Majority shareholders is not too common but there are instances where the
minority shareholders buys shares of majority, thus oppressing the majority. The Supreme
Courts decision in the case Needle Industries (India) v. Needle Industries Newey (India) Holding
Ltd. is a landmark case on this subject and continues to be an authority on the subject. In this
case, the foreign majority alleged oppression by the Indian minority shareholders as the minority
appointed additional directors and issued further shares. The Company Law Board (“CLB”) and
the High Court held such acts of the minority shareholder as oppressive. In an appeal, however,
the Supreme Court observed that even if a case of oppression fails, the court has power to do
substantial justice in the matter and therefore on the facts and circumstance of the case, the
Supreme Court while rejecting the plea of oppression, directed the minority Indian shareholders
to purchase shares held by the majority foreign shareholders. In spite of the above judgment
Majority rule is the hallmark of democracy.

This equally applies to corporate democracy. In the case Yashovardhan Saboo v. Groz-Beckert
Saboo Ltd, the CLB went on to hold that even if a case of oppression is not established, to
provide a relief to do substantial justice between the parties, whose relationship has reached a
stage where reconciliation was difficult, it is the majority which has the right to purchase the
shares of the minority. It was also held that the majority should never be forced to sell its shares
to a minority. Sections 397 to 409 of the Companies Act, 1956 are specifically devoted to the
subject of prevention of oppression and mismanagement. But the term „oppression‟ is not

1
“Minority Shareholders Buying Out Majority Shareholders‟
by Mr. M.Rishi Kumar Dugar, Advocate, Madras High Court
defined under the Act. It has been understood as an act or omission on the part of the
management (which obviously implies majority,2 inasmuch as it is the majority which holds or
controls the management). It is needless to state here that though the ownership and management
are distinct in the eyes of law, in reality the majority ownership and management are synonym.

MISMANAGMENT: a pivotal issue

The expression ‘mismanagement’ means the affairs of the company are being managed wrongly
or incompletely which lead to lot of diminish in company reputation and lack of internal
management acc. to the companies act mismanagement“u/s 398, Mismanagement is said to be
done if
the affairs of the company are being conducted in a manner prejudicial to the interests of the
company or a material change (not being a change brought about by, or in the interests of, any
creditors including debenture holders, or any class of shareholders, of the company) has taken
place in the management of control of the company, whether by an alteration in its Board of
directors, or if its managing agent or secretaries and treasurers, or in the constitution or control
of the firm or body corporate acting as its managing agent or secretaries and treasurers, or in the
ownership of the company's shares, or if it has no share capital, in its membership, or in any

2
(1965) 1 Comp. L.J. 193 (S.C.) atp. 211
 other manner whatsoever, and that by reason of such change, it is likely that the affairs of the
company will be conducted in a manner prejudicial to the interests of the company.” 3

Mismanagement is said to be done in this condition

(i) Absence of basic records.

(ii) Drawing considerable amounts for personal purposes.

(iii) Misuse and misapplication of companies’ finances.

(iv) Not filing documents with Registrar of Companies.

(v) Continuation in office by director beyond the term.

(vi) Directors not holding qualification shares.

(vii) Sale of assets at glaringly low price.

(viii) Neglecting the assets.

(ix) Sale by tender in collusion with the borrower company.

(x) Violations of provisions of law and of memorandum or articles of association.

(xi) Making of secret profits.

(xii) Siphoning of funds, etc.

Major cases in Indian:

1. Rajahmundry Electric Supply Co. v. Nageshwara Rao,

1956 AIR 213, 1955 SCR (2)1066
Similarly, in this case, the Honourable Supreme Court observed that, the courts will not in general
intervene, at the instance of shareholders in maters of internal administration, and will not interfere with the
management of the company by its directors so long as they are acting within the powers conferred on them
under the Articles of Association of the company. Moreover, if the directors are supported by the majority
shareholders in what they do, the minority shareholders can, in general do nothing about it.

One may notice that the aforesaid decisions are essentially a logical extension of the principle that a
company is a separate legal entity from the people who compose it. The rule, as applied to the companies,
however, appears a little more complicated. After all, the directors who have been fraudulent have injured
the company. The company is composed of members. Losses to the company affect all the members, not
simply the majority or minority or any particular member, yet the mere injury is not enough. The plaintiff
must show that the injury has been caused by a breach of duty to him. 4 Therefore minority shareholders,
under sec.398 of the Companies Act 156 have an option to approach the court only and if there has been a
blatant injury caused to the company and them by the fiduciary breach of duty by any of the directors or
majority shareholders by a particular act which cannot be ratified by the internal setup and mechanism of the
company by the Articles of Association of the company

3
AVTAR SINGH, COMPANY LAW, 509 (Eastern Book Company,15th ed.)
4
Edward v. Halliwell (1950) 2 All ER 1064
2.Harikumar Raja v. Soverign Dairies Industries Ltd.2001 106 CompCas 191 CLB In a significant
judgment the Madras High Court held that where a company committed large number of irregularities
including allotment of share against illusory consideration, accounts not audited since 1977, Annual General
Meeting not convened, annual returns not filed and prosecution launched against persons concerned in the
company for failure to comply with provision of the Companies Act, 5it appears to be a straight forward case
under sec397 and sec 398. It was held that not only the company was mismanaged; certain actions of the
company were prejudicial to the interests of the company and of the other shareholders. It was further held
that the scope of power of the court (now CLB) [19] is not subject to any limitation in the matters of under
sec 397 and sec 3986 and relief seeking members need not be sent elsewhere for getting the relie The all
pervasive powers in these matters include the power to alter Articles without a resolution of a company and
without being placed before the General Meeting and to order the rectification of the register of members
without recourse to laid down procedure.

LANDMARK CASE UNDER MISMANAGMENT

(foss vs harbotle,1843) :

The basic principle relating to the administration of the affairs of the company is that the Courts will not, in
general intervene at the instance of the shareholder in the matters of internal administration; and will not
interfere with the management of a company by its directors so long as they are acting within the powers
conferred on them under the Articles of the company. Nothing connected with the internal disputes between
the shareholders is to be made subject of an action by a shareholder. This rule was laid down as early as
1843 in the celebrated case of Foss v. Harbottle: In this case the action was by two shareholders in a
company against the directors charging them with concerting and effecting various fraudulent and illegal
transaction whereby the property of the company was misapplied and wasted, and praying that the defendant
might be decreed to make good to the company the losses. The action was rejected in respect of those
transaction which a majority of shareholder had the power to confirm. The Court held that the action could
not be brought by the minority shareholders. The wrong done to the company was one which could be
ratified by the majority of members. The company was the proper plaintiff for the wrong done to the
company, and the company can act only through its shareholders. The majority of the members should be
left to decide whether to commence proceedings against the director.

The Court held that the action could not be brought by the minority shareholders. The wrong done to the
company was one which could be ratified by the majority members. The company was the proper plaintiff
for the wrongs done to the company, and the company can act only through its majority shareholders. The
majority of the members should be left to decide whether to commence proceedings against the directors or
not.7

5
PENNINGTON, COMPANY LAW,734 (5th ed.)

6
A.K MAJUMDAR & DR. G.K. KAPOOR, COMPANY LAW AND PRACTICE, 935 (Taxmann Publications, 17th ed.)
7
foss vs harbotle,1843)
Rules laid down under (foss vs harbotle):

Majority rule:

The old common law position was based on the principle of the ‘Majority Rule' laid down in Foss v
Harbottle(1843). The majority rule stands for the proposition that the decisions and choices of the majority
will always prevail over those of the minorities. In practice, the greater the amount of shareholding of an
individual member, the greater rights and powers accrued to that individual member within the company.
Thus it appears that a substantial amount of power has been placed in the hands of the majority shareholders
and that by virtue of the majority rule, the minority shareholders are required to accept the decisions made
by the majority shareholders. In such circumstances, the minority shareholder cannot ask for court
intervention because Foss v Harbottle does not cater for minority members who complain of a wrong done
to the company provided that the majority shareholders do not wish to take any action against the wrong
committed. As a general principle laid down in Foss v Harbottle, where it is alleged that a wrong has been
done to the company then proper claimant in such an action is the company itself and where the company is
competent to settle the alleged wrong itself or, the company is competent to ratify or condone an irregularity
by its own internal procedure, then no individual member may bring action.

Minority rule:

A strict application of the general principle laid down in Foss v Harbottle appears to be harsh and unjust
with regard to minority shareholders, as although a substantive right has been accrued to them, still they are
barred from obtaining justice under the rule and have to submit to the wrongs done by the majority because
at the end of the day it is the majority of the members that control the company and the minority members
have no say due to their small strength of number. However, in order to mitigate this harshness, four
exceptions to the general principle have been laid down:

The first exception is where the alleged act is ultra vires or illegal. The cases of Taylor v National Union of
Mineworkers (the support of an unlawful strike) and Smith v Croft no.2 (a transaction violating the financial
assistance or capital maintenance provisions of the Companies Acts) show that a member may by virtue of
his right, sue against a threatened lawful act (as in Simpson v Westminster Palace Hotel Co) and may set
aside an unlawful act by bringing a derivative action.

The second exception concerns a situation where the alleged matter was such that could only have been
validly done or sanctioned,in violation of a requirement in the articles, by some special majority of
members. An example of this is Edwards v Halliwell. It was stated in this case that the alleged act could
have been done only by a two-thirds majority and not by a simple majority and thus the rule in Foss v
Harbottle could not be relied upon as the members were suing in their own right only to protect their own
rights in their capacity as members and were not infact suing in the right of the union because here the
wrong has not been done against the union(in which case, the union would solely have been able to bring a
cause of action). Instead, here the defendants had by breaching the rules of the union by which they are
bound, had invaded the personal and individual rights of the minority.

The third exception relates to an alleged act which has caused the invasion of the claimant's personal and
individual rights in his capacity as a member. An example of this is Edwards v Halliwell (above).

Last but not the least, the fourth exception deals with a situation where a ‘fraud on the minority' has been
committed by the majority who themselves control the company. There are various examples of fraud on the
minority. Menier v Hooper's Telegraph Works(1874) is an example of misappropriation of corporate assets.
In this case, where Menier a minority shareholder complained that there were self-interested transactions
between a majority member and the company, the court held that a minority shareholder's action was
properly bought in these circumstances. An example of abuse of power or discrimination is the case of
Estmanco (Kilner House) Ltd v Greater London Council(1982), where Templeman J stated that under this
exception, a minority can bring a claim even in the absence of a complaint of fraud and that in the absence
of any remedy, an individual member may bring a claim where the powers are used intentionally or
unintentionally, fraudulently or negligently, by the directors in a way which proves beneficial to them and
disadvantageous to the individuals. Thus, the court held that stultification of the purpose for which the
company was formed, against the wishes of the minority shareholders, may constitue ‘fraud on minority.' An
example of a case involving negligence in a situation where the result is a personal advantage to the
wrongdoer is Daniels v Daniels (1978), where three minority shareholders claimed that mr. & mrs.Daniels
(two directors and majority shareholders) had acted negligently in making the company sell land to
Mrs.Daniels at a very low price although it was worth a lot more money, it was held that the plaintiffs had
the right to sue in such circumstances. In contrast, where a minority shareholder claimed that the directors
had acted negligently in selling an asbestos mine to another company at a fraction of its true value in
Pavlides v Jensen (1956), it was held that as no fraud or personal advantage was evident from the facts of
the case it appeared that the minority shareholder had no right to sue in such circumstances.

It is noteworthy that even where an individual member has the right to bring a claim on behalf of the
company under one of the exceptions to the general principle, he may still be prevented from bringing a
claim where the wrongdoer has a sufficient level of control over the company and is opposed to the
litigation. In Smith v Croft no.2(1988), where the minority shareholders claimed for the recovery of sums
given away in transactions which were both in breach of the statutory prohibition on financial assistance and
ultra vires, it was held that as it appeared to be a prima facie case of ultra vires and illegality, thus the
plaintiffs had the right to bring a derivative action, provided that majority shareholders had no objection to
the continuation of the action.

What the law needs to do is strike a balance. It can neither give more support to the majority (as the minority
will then be prejudiced) and nor to the minority (who would then object on every action, resulting in the
floodgates argument). However, it seems quite evident from these four exceptions and the various case law
flowing as a result of them that under common law minority shareholders have been given protection to
quite an extent and the law seems to have provided some remedies to meet those cases in which majority
power has been abused.8

8
Foss vs harbotle( 1843)
 FINANCIAL MISMANAGMENT
One of the burring issue in the company is ‘financial mismanagement’ internal fraud committed by
employees of nonprofit organizations is, unfortunately, a more common occurrence than one might realize.
Embezzlement happens most frequently to not for profit organizations that have not taken active steps to
prevent it. In addition, once any type of fraud or financial mismanagement is detected, many nonprofits do
not handle the information properly or understand their responsibility; specifically, whether it is best to
address the situation internally or report the fraud to the authorities.

One of the way to come over the evil of ‘financial mismanagment’ is Association of Certified Fraud
Examiners (“ACFE”), a nonprofit organization that conducts anti-fraud research and provides analysis of the
costs, methodologies and the perpetrators of fraud within U.S. organizations, has found that the typical
organization loses 5 percent of its annual revenue to fraud — translating to a total fraud loss in this country
of more than $2.9 trillion every year.2 Fraud tends to be carried on for an average of 18 months before
being detected. And occupational fraud is much more likely to be detected by a tip from an employee than
by any other means. Organizations that lack anti-fraud controls are the most vulnerable to being victimized
by fraud. In order to encourage whistleblowing, it is critical for organizations to have procedures and
policies in place that enable employees to anonymously provide information to the board that can help in the
detection of fraud.

The ACFE has identified three primary categories of occupational fraud used by individuals to defraud their
organizations asset misappropriations, by far the most frequent and least costly form of occupational fraud,
are schemes in which the perpetrator steals or misuses an organization’s resources (embezzlement by
stealing cash receipts, falsifying expense reports, and forging corporate checks) corruption schemes, which
involve an insider’s use of his or her influence in business transactions in a way that violates his or her duty
of loyalty for the purpose of obtaining a private benefit (e.g., bribery, extortion, interested party transactions,
conflicts of interest); and financial statement fraud schemes, which are those involving the intentional
misstatement or omission of information in the organization’s financial reports.9

Section 398 - Remedy and Prevention of Mismanagement

The true test of corporate administration is the way in which the majority tends to minority interests . All
shareholders similarly add to the inner voice of the body corporate . Be that as it may, the corporate majority
rule government is figured with the quantity of offers and not with the quantity of people included . Along
these lines, there is a sure power on the holders of a majority of offers and a plausibility that this power

9
PENNINGTON, COMPANY LAW,734 (5th ed.)
(1985) 1 All ER 65 CA
might be mishandled. Different methodologies have been taken to check this abuse by courts and lawmaking
bodies.

Area 398 accommodates help in instances of mismanagement. For an appeal to under this arrangement to
succeed, it must be set up that the issues of the company are being led in a way prejudicial to the interests of
the company or public interest everywhere, or that, by reason of any adjustment in the administration or
control of the company, it is likely that the issues of the company will be led in that way. The target behind
this is to manage the cost of assurance to those whose voices are brought down by the rate holding of a
company and to who's disadvantage any demonstration did to be subjected to judicial supervision.

A major principle identifying with majority lead and shareholder security was gotten Foss v. Harbottle ,
which discussed judicial non-obstruction. Courts decline to interfere in the administration of the company at
the occasion of a minority of its individuals who are disappointed with the lead of the company's
undertakings by its top managerial staff, or by or under the course of the individuals from the company who
control a majority of the votes which might be thrown at its general gatherings. Exemptions to this manage
were all the while advanced, inter alia, on grounds of misrepresentation on minority, ultra vires activity, and
control in the hands of miscreants and oppression and mismanagement . Some of these special cases are not
intelligently deducible from the principle, and are either the aftereffect of recorded mishap or of a cognizant
want by the courts to prohibit the manage when it works unjustifiably. One of the special cases, which have
been statutorily perceived in India, is an activity on the grounds of oppression and mismanagement.
Consequently, it can be positively said that this special case has turned into a run the show. It is the
depiction of the decide and its temperament that is the extent of the words underneath. What we have seen is
a halfway unrest in judicial attitudes.10

It must be established for a very successful petition under Section 398 that the affairs of the company are
being to be conducted in a manner prejudicial to the interest of the company or public interest, or that, by the
reason of any change in the management or control of the company, it is very likely that the affairs will be
conducted in such a manner. Relief against mismanagement runs in favour of the company and not to any
particular member or members . It is not a necessary for the court to find cause for winding up in order
granting relief. Section 398 enables the court to take into important consideration outside interests that are
affected by corporate operations. There must be present and continuous mismanagement.

Some of the instances, which have been held to be mismanagement;

 Absence of basic records.

 Drawing considerable amounts for personal purposes.
 Misuse and misapplication of companies’ finances.
 Not filing documents with Registrar of Companies.
 Continuation in office by director beyond the term.
 Directors not holding qualification shares.
 Sale of assets at glaringly low price.
 Neglecting the assets.
 Sale by tender in collusion with the borrower company.
 Violations of provisions of law and of memorandum or articles of association.
 Making of secret profits.
 Siphoning of funds, etc.

10
https://www.lawteacher.net/free-law-essays/business-law/relief-and-prevention-of-mismanagement-business-law-essay.php
 Conclusion

In modern law, giving the courts major power by statute to control exercise of discretion by the persons or
institutions on grounds of “unfairness" is very hardly novel. Yet such open-ended legislations, which in
effect involves a large sharing of the legislative functions between the Parliament and the courts, always
present the courts that with the challenge of how to develop on a case-by-case basis the criteria by which the
very imprecise concept of fairness can be given operational contents. Even if courts did not have the
discretion in cases of unfair prejudice,in oppression and mismanagement, considering the equity foundations
of court, the law would not remain as far it is now.

Though by law majority rule always prevails, yet there are many safeguards to protect the interests of
minority shareholders. As per sec.398, sec. 397 and sec. 399 of the Companies Act, 1956 and other judicial
decisions, minority can file a petition to the Company Law Board praying relief against oppression and
mismanagement. Shareholders have the major opportunity to present their case to the regulators that is
(SEBI) to obtain redress for their rights. Disclosure by the Board of their material pecuniary interest,
relationship, arrangement via the company/firm they represent should be disclosed in advance prior to their
appointment in the company.11

11
Company Law: by Alan Dignam (Author), John Lowry (Author)
To encourage shareholders interest in the general gatherings, on select things of business, the arrangement of
postal poll has been as of now set up. Outside Institutional Investors do have an evenhanded treatment in the
arrangement choices of the administration and notice of the gatherings ought to be sent to them. The
arrangement of corporate administration in India provides for more noteworthy straightforwardness, better
and opportune money related detailing. Monetary Disclosures have been widened with selection of
Accounting Standards and keeping in mind the end goal to reinforce the arrangement of review, more duties
have been added to the examiner who needs to stay autonomous over the span of his task and the Companies
Act, 1956 do accommodates de-connecting of connection of reviewer versus of his auditee company.
Individuals from the sanctioned bookkeeping calling need to watch the Code of Conduct and Ethics of the
Institute while practicing their work.

The SEBI is currently thinking about a proposition to bring a framework show for rating of corporate
administration. Thus usage as opposed to authorizing is of considerably more real significance in the extent
of corporate administration and in the field of reasonability of rights managed their insurance is important.
The minority and in addition the larger part bunches in assortment of cases should be managed insurance for
their rights and hence such arrangements against oppression and mismanagement of the prevailing
controlling gathering in legitimized.12

12
https://www.lawteacher.net/free-law-essays/business-law/relief-and-prevention-of-mismanagement-business-law-essay.php