Section 398 of the companies Act, 1956 is designed to primarily protect a company from being mismanaged and usurped by few at the helm to the detriment of the company’s interest and public interest.
Sec.398 of the companies Act, 1956 mandates a person holding 10% of the equity shares to file an application under sec.398(1)(a)& (b) if the affairs of the company are being conducted in a manner prejudicial to public interest or in a manner prejudicial to the interests of the company.
If the shareholder feels aggrieved by the way the affairs of the company are being carried out, he may well approach the Tribunal under section 398 of the companies Act, 1956 if he qualifies under section 399 of the Companies Act ( i.e. Holding not less than one- tenth of the issued share capital of the company).
In the case of ShriKishanKhariwalVs.The Ganganagar Industries Limited andOrs.(2004) 118 CC 626 (CLB) The company law board observed that “To maintain a petition under Section 397/398 the provisions of Section 399 have to be complied with. According to this Section, to maintain a petition under Section 397/398, the petitioners should hold either 10% or more shares of the subscribed capital or should constitute 10% or more of the total members in the company. In the present case, the petitioner has claimed that the shares held by him together with those of the members supporting him, account for 10.35% shares in the company and such the requirements of Section 399 are satisfied. This percentage is based on the share capital of the company before the issue of further shares impugned in the petition. This Board has always taken the view that if the shareholding of the petitioners is reduced below 10% on account of further issue of shares and if the issue of further shares is also challenged in the petition, then, the petition will not be dismissed as not maintainable in terms of Section 399. Instead, the allegation relating to the issue of further shares would be examined first as to whether the same is an oppressive act and if it is found to be so, then only other allegations in the petition would be examined. In the present case, the petitioner claims the support of those holding more than 10% shares and he has also impugned the further issue of shares, which has resulted in the holding of the petitioner and his supporters to around 1%. Therefore, this petition cannot be dismissed at the threshold before examining as to whether the issue of further shares could be considered to be an act of oppression against the petitioner and his supporters”.
M. MoorthyVs.Drivers and Conductors Bus Service P. Ltd(1991) 71 con cases 136, 148 (Mad)the Madras High court observed
“The language of sections 397 and 398 leaves no doubt as to the true intendment of the Legislature and it is transparent that the remedy provided by these sections is of a preventive nature so as to bring to an end oppression and mismanagement on the part of controlling shareholders and not to allow its continuance to the detriment of the aggrieved shareholders of the company. The remedy is not intended to enable the aggrieved shareholders to set at naught what has already been done by the controlling shareholders in the management of the affairs of the company.”
In this case the company sold its asset in gross neglect of the interest of the company, and the management of the company was indifferent to the affairs of the company after the sale of assets. Hence the court held it to be a case of mismanagement and passed orders under section 397 and 398 of the companies act.
The High court of Andhra Pradesh in the case of Sri Ramdas Motor Transport Ltd. and Ors.Vs.KaredlaSuryanarayana and Ors.ANDDevarapalli Surya Rao and Ors.Vs.SriRamdas Motor Transport Ltd. and Ors. 110CompCas193(AP) observed “relief under Section 398 of the Act can be obtained only if (1) the affairs of the company are being conducted in a manner prejudicial to public interest or the interests of the company, or (2) if there is a material change which has taken place in the management or control of the company in the manner set out in the said section, and that by reason of such change it is likely that the affairs of the company will be conducted in a manner prejudicial to public interest or in a manner prejudicial to the interests of the company.
But Section 397 of the Act comes into play when minority share-holders allege oppression by the majority shareholders and Section 398 of the Act comes into play when the affairs of the company are being conducted in a manner prejudicial to public interest and not in the interest of the company.
In the case of Akbarali A. Kalvert and Anr. Vs. Konkan Chemicals Pvt. Ltd. and Ors the company law board relied upon the observations made by the supreme court in the case of NanalalZaver v. Bombay Life Assurance Co. Ltd.  20 Comp Cas 179 that “It is well-established that directors of company are in a fiduciary position vis a vis the company and must exercise their power for the benefit of the company. If the power to issue further shares is exercised by the directors not for the benefit of the company but simply and solely for their personal aggrandizement and to the detriment of the company, the court will interfere and prevent the directors from doing so. The very basis of the court’s interference in such a case is the existence of the relationship of a trustee and of cestuique trust as between the directors and the company.”
A person to file an application u/s.398 should have a right to apply in virtue of sec.399.
The High court of Patna in the case of Bihar State Industrial Development Corporation Limited, a Government of Bihar Company and Magadh Spun Pipe Limited, a Joint Venture Company promoted by Bihar State Industrial Development Corporation LimitedVs.Company Law Board, Principal Bench and Ors observed
I. The object of prescribing a qualifying percentage of shares in petitioners and their supporters to file petitions under Sections 397 and 398 is clearly to ensure that frivolous litigation is not indulged in by persons who have no real stake in the company.
II. Moreover, I find that the Company Law Board has relied upon the judgment in SrikantDuttaNarasimha Raja Wadiyar’s case (supra) relied upon by the respondents under which if the person has been treated as a member of the company then the Company Court can exercise its jurisdiction in his favour. Even on this point treatment as a member of the company would be confined only to respondent Nos. 4 and 5, with respect to whom it was found that their names figure in the annual returns filed by the appellant company before the Registrar of Companies and further that they have been issued notices of two annual general meetings. There being no such finding with respect to respondent Nos. 2.and 3 and further there being a specific finding that the respondent Nos. 4 and 5 did not qualify as holding 1/10th share capital, this Court fails to understand as to how even by relying upon the said decision the Company Law Board could have arrived at a conclusion that the petitioners had succeeded in showing that they were holding 10% equity shares and entitled to maintain a petition under Section 398 before it.
The above judgment goes on to show that the courts are wary of accepting applications u/s. 398 if the petitioner does not meets the requirements prescribed under Section. 399.
Power of the Tribunal under section 398 of the companies act
Section 398 invests the tribunal with some very extensive powers to pass such orders as it may think fit in the circumstances to bring an end to the agony of the shareholders and set the mischief committed by the management at rest to ensure smooth functioning of the company in the interest of the company and public.
The courts have by virtue of section 398 been playing a pro- active role, and they still continue to do so, whenever they sense a whiff of mismanagement in a company.
A clutch of decisions by various courts and tribunal reaffirm and reiterate the point that the court would intervene and take stock of the situation and pass such orders as it deems appropriate in the given circumstances, if it proved to its satisfaction that the alleged acts of mismanagement have been and are being committed which seriously affects the health of the company and public interest.
A case to hold water, will have to be corroborated with sufficient evidence in the backdrop of allegations made against the company under section 398, that would make out a case for proceeding against the management of the company.
A glimpse at section 235 of companies act:
Section 235 of companies act is another section that deserves a mention when there occurs mismanagement in the company’s affairs.
A shareholder who feels the affairs of the company are being mismanaged ,and it would only be fair to invoke a probe into the affairs of the company to make things transparent, shall make an application under section 235(2) (a).
Section 235(2) (a) reads as follows;
“Where, in the case of a company having share capital, an application has been received from not less than two hundred members or from members holding not less than one-tenth of the total voting power therein”, the tribunal may, after giving the parties an opportunity of being heard ,by order declare that the affairs of the company ought to be investigated by an inspector or inspectors, and on such a declaration being made, the central govt. shall appoint one or more competent persons as inspectors to investigate the affairs of the company and to report thereon in such manner as the central govt. may direct.
A shareholder holding one- tenth of voting rights shall by virtue of section 235 invoke a probe into the affairs of the company.
A application to sustain under section 235(2)(a) should corroborate the allegations made in the application with sufficient evidence, as would satisfy the court to direct an inquiry into the affairs of the company.
Applications under this section would not be entertained if the allegations made in the application are vague and uncertain.
It becomes extremely pertinent to place on record a case law that buttresses the above mentioned point.
In the case of Mohta Bros. (P.)Ltd. and Ors.Vs.Calcutta Landing and Shipping Co. Ltd. and Ors40CompCas119(Cal), 73CWN425the high court ofCalcutta observed “Full particulars must be given by a petitioner in an application under Sections 397 and 398 of the Act of acts of mismanagement and oppression. Vague and uncertain allegations of mismanagement and oppression, although they may constitute grounds for suspicion, do not entitle a petitioner to ask the court to embark upon an investigation into the affairs of the company, in the hope that in consequence of such investigation, something will turn up which will enable the court to grant relief to the petitioner. It is true that it may not always be possible for one or a group of shareholders to furnish particulars of acts of mismanagement, fraud, oppression, misappropriation or other improper acts, but such inability on the part of shareholders, who have no access to the books of the company, is by no means a ground for directing an investigation into the affairs of the company or for giving any other relief to a petitioner. The petitioner must set out the facts which constitute acts of mismanagement, misappropriation, fraud or oppression and prove, prima facie, at any rate, that on those facts an investigation is called for. If a petitioner fails to set out the facts and produce satisfactory proof in support of those facts no order for investigation into the affairs of the company can be made, nor can any relief be granted to the petitioner. A shareholder has no right of access to the books of the company, but denial of access to such books is not an act of oppression as has been held by this court in a Bench decision, Rajya Lakshmi (Lalita) v. Indian Motor Co. Ltd. MANU/WB/0037/1962 : AIR1962Cal127 If a petitioner cannot make out a case of mismanagement and oppression, because he was unable to collect materials for the purpose, it is not for the court to direct the directors of the company to offer inspection of the company’s books and accounts to enable a petitioner to collect materials for the petition under Sections 397 and 398 of the Act, or to direct investigation into the company’s affairs and accounts by an independent person to bring out materials for further orders against the company, its directors or shareholders”.
To sustain an application under section.398 should have conclusive evidence as to the allegations they make. The person complaining of mismanagement should glean the necessary evidence in support of his allegations made under section 398.
In Re: Bengal Luxmi Cotton Mills Ltd. 35CompCas187(Cal), 69CWN137,the high court of Calcutta observed “In an application under Section 397 and Section 398, the petitioner may rely upon, and indeed he should rely upon, supporting affidavits from persons having personal knowledge of the allegations of oppression, mismanagement, misconduct or other act prejudicial to the interest of the company, if the petitioner has no personal knowledge himself. Failure or omission to secure affidavits of persons having personal knowledge of the charges made, if the petitioner has no personal knowledge of the same, may prove fatal to the petition itself as was held in In re Clive Mills Co. Ltd., ”
Thus, to put things in perspective an application under section 398 should allege that the affairs of the company are being conducted in a manner prejudicial to public interest or in a manner prejudicial to the interests of the company as opposed to alleging that the affairs of the company are being conducted in a manner prejudicial to interest of a few shareholders. An application under section 398 would sustain the scrutiny of the court only if the application alleges that the mismanagement is of such a nature as would have an adverse impact upon the health of the company.