ORDER
Vimla Yadav, Member
1. This is a reference to the Company Law Board (CLB) by the Union of India under Section 388B of the Companies Act, 1956 (hereinafter referred to as ‘the Act’) stating a case that in the opinion of the Union of India there are circumstances suggesting that the respondents namely, Shri Surinder Kumar Somani MD of M/s Kopran Limited, and other directors of the company namely, Shri Susheel G. Somani, Shri Rajendra Somani, Shri Sevantilal J. Parekh, Shri Sunil S, Paarekh, Dr. Suresh K. Parekh and Shri Humayun Dhanrajgir, in the conduct and management of the affairs of the company, M/s Kopran Limited (hereinafter referred to as ‘the company’), located at Parijat House, 1076, Dr. E. Moses Road, Worli, Mumbai-400018 are or have been in connection therewith guilty or fraud, misfeasance, persistent negligence or default in carrying out their obligations and functions under the law or breach of trust or that the business of the company is not or has not been conducted by the respondents in accordance with sound business principles or prudent commercial practices. This reference has now been made with a request that Company Law Board may inquire into the case and record a decision as to whether or not the respondents referred to above are fit and proper persons to hold the office of MD or Director(s) or any other office connected with the conduct and management of the company.
2. Such opinion is alleged to have been formed on the basis of an inspection of the books of accounts of the company in terms of Section 209A of the Act by the Central Government carried out on the basis of a preliminary report of the SEBI on the Stock Market Scam in 2001, on the main ground that the Company had loaned a sum of Rs. 78 crores to one M/s Classic Credit Limited, a group company of Shri Ketan Parekh, who was involved in the Stock Market Scam in 2001 and that in the process the company had lost 28 crores, exhibiting fraud, misfeasance, persistent negligence or default in carrying out the obligations and functions of MD/Directors under the law or breach of trust or that the business of the company is not or has not been conducted by the respondents in accordance with sound business principles or prudent commercial practices.
3. The case of the applicant in this reference, in short, is that the inspecting officer while carrying out inspection in terms of Section 209A of the Act had pointed out that the company had indulged itself in loaning of funds to the extent of Rs. 78 crores which is a huge sum considering the fact that it had not loaned such sum in its recent past, that too, to an investment in, viz., M/s Classic Credit Ltd. a company belonging to Ketan Parekh group, which was in the share market operations which is a high risk and volatile business. Inspite of the risk profile of the borrower, the directors of the company went ahead and loaned such a huge sum only on the strength of the balance sheet of M/s Classic Credit, without obtaining any security whatsoever and thus endangering the shareholders’ interest. The company had received back only Rs. 50 crores and is yet to receive the balance amount of Rs. 28 crores for which, even though it received a cheque from Classic Credit Ltd. the same has been dishonoured. The company is unlikely to receive this amount as the KP group of companies went broke due to stock market scam in 2001. The company raised a sum of Rs. 40 crores from the UTI by way of secured NCDs and the disbursement was unusually speedily completed on the day of sanction itself, i.e. on February 27,2001. Immediately, on the same day, this amount was parked with Classic Credit Ltd. giving rise to a reasonable presumption that Kopran acted as a front to Classic Credit in routing the funds from the UTI to Classic Credits. This amount was given without any security at a rate of 16 percent per annum. In addition, the company also diverted Rs. 38 crores from its internal resources and paid the same on February 27, 2001 to Classic Credit Ltd. The manner in which this amount of Rs. 78 crores was raised and transferred by the company to Classic Credit which is a company of Ketan Parekh in haste, clearly indicates that the lending was meant for some other purpose than being a genuine business transaction. The applicant emphasized that the company in its reply too has admitted that sum of Rs. 78 crores, in fact, was given on loan to M/s Classic Credit Ltd., a company under the control and management of Shri Ketan Parekh and that for lending the huge sum of Rs. 78 crores to Ketan Parekh entity called M/s Classic Credit Ltd., the company had diverted its own internal resources which otherwise would have been utilized for working capital thereby jeopardizing efficiency and literally handing over the company’s affairs on platter to Ketan Parekh entity by sinking the entire liquidity of the company. Further it was pointed out that the company has also admitted that no guarantee, security, or otherwise in any other form surety was taken from the Ketan Parekh entity. It was pointed out that without any previous knowledge, relation, association, as admitted by the company, lent more than ten times of its worth (net worth = share capital + reserve and surplus including accumulated profits -secured loans -accumulated losses) to absolutely unknown, unrelated person without any safety and security of return of principal amount and without any assessment of the worthiness of the Ketan Parekh entity. This goes to establish that management of the respondent has acted misfeancely with an intention to commit fraud on shareholders and its creditors in particular and public in general by lending this amount. It was argued that diversion of Rs. 38 crores from its internal sources (working capital funds) on 27.2.2001 to Classic Credit Limited is a grave mismanagement on the part of directors endangering the operation of the company. It is an imprudent act considering the fact that company is essentially a manufacturing company. It was pointed out that the fact that company received back Rs. 50 crores also does not mitigate the circumstances as it ultimately lost Rs. 28 crores, which is yet to be recovered from Classic Credit Limited and further that it has not filed any recovery suit against M/s Classic Credit Limited for recovery of the same and ever since this transaction the financial performance of the company has suffered. The act of management has made the company poorer by several crores and its effect is a continuous one which is reflected in the performance of the company till date. It was argued that the simple fact of treating an ICD as doubtful amount in the next financial year of its taking place is itself a crystal clear example of persisting mismanagement on the part of the directors. During all these three years the company has been incurring burden of increasing interest liability and is going towards bad to worse in a persistent manner. The counsel for the applicant further argued that there have been a number of irregularities in conducting the affairs of the company as is evident from the report of the Inspecting Officer. The company had violated the provisions of Sections 193, 224(8), 233(8), 257,205,270(3),209(1), 203(3), 209(3)(b), 211(3A) read with (3C), Part 1 of Schedule VI read with Section 1211 and 212. These violations would also indicate that all is not well with the present management. The company had made a public issue with a premium of Rs. 80 for a share of Rs. 10 but the present quoted price of the shares of the company is about Rs. 60. This is the only pharmaceutical company, the share price of which is quoted much lower than the issued price. This is also an indication that the affairs of the company are not being conducted in a sound manner. The petitioner further argued that the act of the management amounts to misfeasance relying on Canadian Land Reclaiming and colonizing Co. (Coventry and Dizon’s case), (1880) 14 Ch. D. (CA) “Misfeasance” according to James LJ mans “misfeasance in the nature of a breach of trust, that is to say, it refers to something which the officer of such company has done wrongly by misapplying or retaining in his own hands any moneys of the company or by which company’s property has been wasted or the company’s credit improperly pledged. It must be some act resulting in some actual loss to the company.” Further, relying on the decision in Alok Kumar Jain v. Union of India (1973) 43 Company Cases 68, 89 (Cal) the petitioner pointed out that the formation of the opinion by the Central Government is a subjective process and cannot be questioned or challenged by a party aggrieved by the action taken by the Central Government and that the only question that the Court can look into is the existence of materials to justify formation of such opinion. It was further reiterated by the counsel for the petitioner that the lending of such a huge amount of Rs. 78 crores with no past history without any mortgage, pledge or security to M/s Classic Credit Ltd, goes to prove that management of the company had played havoc with the affairs without ensuring the recovery of money and taking creditable security from M/s Classic Credit Ltd. This lending has jeopardized the affairs of the company. Had the management been prudent at the time of lending the money and secured the amount, it would not had to resort for the recovery as an unsecured creditor and the company would not had to suffer a loss for the incompetent, negligent and untrustworthy management. As the directors of the company stand in a fiduciary relationship, they act as principal and agent of the company and custodian of the interest of the shareholders and investors. With single act/transaction the management has been successful to put the life of company in danger and subject to huge losses. Hence, this petition under Section 388B of the Act.
4. The case of the respondents is that the action of the Union of India in initiating the present proceedings is wholly malafide. The petition is misconceived. It lacks merit and substance besides being liable to be rejected on preliminary objections challenging the maintainability of the reference on the grounds of the reference being barred by limitation (having been filed much after three years of knowledge – and hence barred by time as decided in Union of India v. R.C. Bhargava CP No. 63/1996) as well as on the principles of rest judicata, in as much as the earlier CP No. 9 of 2003, which had been admittedly filed on the same allegations and the same parties, had been dismissed by the Company Law Board vide a detailed order dated 15.6.2004 after examining all issues and pleas of the petitioner and recording a finding thereon It was further argued that the respondents, in terms of the CLB’s order dated 15.6.2004 in CP No. 9/2003 have already filed a suit for recovery against M/s Classic Credit Limited under Section 138 of the Negotiable Instruments Act in 2001 itself and that suit has been decreed also. It was pointed out that whatever was within the powers of the respondents has already been performed and hence no inaction can be imputed to the respondents. Further it was pointed out that the petitioners plea that an appeal has been filed in the Bombay High Court against CLB’s order dated 15.6.2004 in CP No. 9/2003 under lodging No. 7/2004 and the same is pending is misleading the Court as the appeal stands dismissed under Rule 986 vide Bombay High Court’s order dated 15.3.2005, It was further argued that the formation of the opinion may be a subjective process, but it is always open to the court, here the Company Law Board, being called upon to make an inquiry in a proceeding of reference under Section 388B and Chapter IVA of the Companies Act, 1956, to find out whether there are proper materials for the formation of such opinion, and also the manner and the method by which such an opinion has been formed. It was submitted that in making such inquiry under Chapter IVA of the Companies Act, the Company Law Board should make an independent assessment of the circumstances as alleged, and examine whether such circumstances suggest a case of fraud, misfeasance, negligence or that the acts complained of were done ignoring sound business principles or prudent commercial practices.
5. I have considered the pleadings and arguments of the counsels and also the written submissions filed by them, wherein they have also referred to some decided cases. This petition has been filed by the Central Government under Section 388B of the Act. The power of referring to the Company Law Board for enquiry into cases against managerial personnel is exercisable only by the Central Government as already pointed out in the case of Union of India v. Premier Automobiles Ltd. (2005) 128 Companies Act, 1956 cases 383 (CLB). In CP No. 65/2004 reference under Section 388B of the Act has been made for removal of Board of Directors of Kopran Limited, The procedure regarding Section 388B has been brought out in detail in Lok Sabha debates dated 28.11.1963 Vol XXII, pages 1996-1998 and 2000:
The procedure prescribed for effecting removal of such persons from positions of authority is that the Central Govt. when they come into possession of certain facts which indicate that any person concerned with the management of the affairs of a company has been guilty of misdemeanour or negligence or default in the earring out of his obligations and functions in other circumstances stated in Section 388B, would state the case against such a person and refer the same to the tribunal with the request that the tribunal may inquire into it and record their finding as to whether such is a fit and proper person to hold the managerial office in a company. The tribunal will thereupon hear the case after giving the opportunities to the persons involved and record their findings. After receipt of the tribunal’s findings to the effect that a person is not fit and proper, the Central Govt. will issue to that person a show cause notice asking him to show cause why he should not be removed from his position of authority. Naturally, on receipt of such notice a person may make a representation. But he shall not raise any matter before on appeal. Then follows action by Govt. after hearing the representation. The Central Govt. may pass orders removing such a person from office for a period of five years. If it finds that there is no case at all, the Govt. will have to follow other proceedings and go to a court, if need be, or not to follow anything at all, and drop the case.
The main points in regard to this consideration are that provision being introduced in law to deal swiftly and effectively with management of companies where the behaviour of the officers has been found to be not proper. Such persons, even if they have committed such anti social acts in respect of one company only under their management, will be debarred from being employed by other companies. The affected persons will be given an opportunity of a fair hearing before the tribunal. An aggrieved person will also have the right of appeal to High Court, and before removing a person from office, the Central Govt. will give him due notice to explain his position and make a representation.
This section gives vast powers to the Company Law Board and is applicable in any case;
(1) where -in the opinion of the Government there is fraud, misfeasance, persistent, negligence or default or breach of trust on the part of a person concerned in the conduct and management of a company’s affairs. The word ‘persistent’ was inserted before the word ‘negligence’ by the Select Committee, following the use of expression in the Jenkins Committee Report on Company Law Reform in the United Kingdom, where that committee laid stress on ‘persistent negligence or default; (2) where the conduct and management of the business of a company are not in accordance with sound business principles or prudent commercial practices; (3) where the company is conducted and managed in a manner injurious or damaging to the interests of the trade, industry, or business in which the company is engaged; (4) where the business is carried on fraudulently.
The concepts of ‘sound principles’ and ‘prudent commercial practices’ have been adopted in the wake of the Government resolution moved in Parliament in connection with the setting up of the Parliamentary Committee on Public Undertakings, which was required to examine and report whether the public undertakings were being managed in accordance with ‘sound business principles and ‘prudent commercial practices’. The idea of ‘sound business principles’ would seem to require not only the keeping of proper business accounts, presenting clear balance-sheets distinguishing between expenditure on capital account and on current account, making adequate allowance for depreciation, etc., in accordance with commonly accepted accounting principles and procedures, but also the adherence to a business code of conduct like integrity, fair dealings, efficient services and absence of bad faith and malpractices in the management of the business of the company, The expression ‘prudent commercial practices’ indicates the making of efforts to carry on the business in a manner conducive to efficiency, and good and harmonious relations and contact with the workers and other employees, shareholders, Government officers, etc., and being good and serviceable to members of the surrounding society. It also implies that the business is being carried on with cost consciousness and without waste and in a manner conducive to the benefit of all those interested in the enterprise. No case has been made out by the petitioner on these lines on merits.
6. Further the respondents’ first preliminary objection is on the question of limitation or delay. It was argued that the cause of action in the instant application arose long prior to the presentation of this reference by the Union of India, and as such the cause of action is barred by the laws of limitation. The act alleged pertains to the period 2000-2001 whereas the present reference has been filed much after 3 years of knowledge and hence barred interalia by limitation. Reliance was placed on the decision in Union of India v. R.C. Bhargava CP No. 63/1996. It was contended that the Limitation Act would apply and the CLB cannot go into the matter in respect of which the relief was barred after three years from approval of the cause of action as pleaded. It was pleaded that the Limitation Act is equally applicable to proceedings before the CLB being a quasi-judicial authority, which exercises the same powers and authority as used to be exercised by the High Court with regard to this provisions of law. The respondents have contended that there was no subsisting cause of action or legally conferrable right in 2004 when the present application was filed. The counsel for the Union of India, the applicant, has submitted that the Limitation Act is not applicable to proceedings under Section 388B of the Act before the Company Law Board, as the Company Law Board is not a Court. It was also argued that the Companies Act is a comprehensive legislation providing substantive law besides limitation and procedures. The counsel for the petitioner further submitted that if the Limitation Act is applied or delay and latches are being resorted to reject the application under Section 388B, it would then simply defeat the purpose of incorporating Section 388B in the Act, i.e. protection of public interest at large. I am inclined to agree with the counsel for the petitioner. Under the provisions of the Companies Act, the Company Law Board is a court in a restricted sense. Under Section 10(4C) of the Companies Act, the Company Law Board would have powers under the Code of Civil Procedure only in respect of the matters specified in Sub-sections (4C),(a) to (f), of Section 10E of the Act. The Company Law Board is a quasi-judicial authority to be guided by the principles of natural justice in the exercise of its powers and discharge of its functions under the Act and it shall act in its discretion. On the plea of application of the Limitation Act to the proceedings before the company Law Board it has been consistently held by the Company Law Board that the Limitation Act as applied by the civil court is not applicable to the proceedings before the Company Law Board, a quasi-judicial authority and not a court in the strict sense of the term. However, this does not preclude CLB from rejecting/dismissing petitions on account of delay/latches in appropriate cases. In the present case I have no hesitation in rejecting the respondents plea of action being barred by limitation. As regards respondents second preliminary objection that CP No. 65./2004 is admittedly based on same allegation and the parties being same as in an earlier CP No. 9/2003, the principles of rest judicata apply, it has been pointed out by the counsel for the applicant that though the basis of CP No. 9/2003 and CP No. 65/2004 is the same but the action and relief sought in CP No. 9/2003 and CP No. 65/2004 are different. CP 65/04 is under Section 388B of the Companies Act seeking removal of the Board of Directors of Kopran Limited whereas CP No. 9/2003 was under Sections 397,398, 401 and 408 of the Act. On facts of the case, I find that the principles of rest judicata do not apply.
7. On examining the petition on merits I find that the applicant has not been able to substantiate its case as regards the requisite ingredients of Section 388B of the Act as detailed above. The reference under Section 388B of the Act has been made on the main ground that the company has loaned a sum of Rs. 78 crores to one M/s Classic Credit Limited a group company of Shri Ketan Parekh who was involved in the stock market scam in 2001 and that in the process the company has lost Rs. 28 crores, exhibiting mismanagement in the affairs of the company and that a single act is sufficiently capable of causing perpetual damage to the majority shareholders and amounted to a conduct effecting the revenues/profits/output/return to investors and it amounted to a conduct prejudicial to public interest. The counsel for the respondents has drawn my attention to the JPC report at para 11.6 notes that Department of Company Affairs had pointed out that the company had not violated the provisions of law relating to .transfer of this amount to Classic Credit. Therefore, the Board of Director cannot be accused of mismanagement for having taken a commercial decision just because a part of the amount loaned by the company bonafide, has not yet come back to the company. There are no allegations in the petition that any of the directors is guilty of misappropriation or siphoning off of funds. The allegations of the petitioner that the respondent directors are endangering the shareholders’ interest and that the directors had acted negligently are totally misplaced and wrong. The matter regarding loan of Rs. 78 crores to M/s Classic Credit Limited has also been examined in CP No. 9/2003 by this Board wherein it was held that “… as seen from the report of the JPC, the company had not violated any provisions of the Act in lending this amount to M/s Classic Credit. In the present petition also there is no allegation that the company had violated any of the provisions of the Act in lending this amount. From the explanation given by the respondents, I find that the petitioner is not justified in alleging that UTI hastily disbursed Rs. 40 crores to the company with the view to enable the company to lend this amount to M/s Kopran. I also find from the reply of the respondents, that before lending this amount the board of directors of the company had assessed the credit worthiness of M/s Classic Credit/Ketan Parekh the details of which have been indicated as a part of the arguments of counsel for the respondents. As a matter of fact, even in the petition, the allegation is that the company should not have gone only by the balance sheet of Kopran and that it should have taken adequate security. I do agree that when the amount was so large, the company should have asked for adequate security from M/s Classic Credit but the mere failure to do so cannot be in any way considered to be a willful act of mismanagement especially considering the fact that the company had received back Rs. 50 crores within a period of three days. According to the company, the bouncing of cheque for Rs. 20 crores was on account of detection of the stock market scam and consequent freezing of bank accounts of Classic Credit, while according to the petitioner, Classic Credit had gone broke and had no funds to meet this liability. In either event, even if the company had taken security, it might not have been able to enforce the same. Therefore, the only issue for consideration is whether the company could have at all parked funds raised for some specific purpose, with a third party. There are catena of judgments to the effect that a judicial forum cannot sit in judgment on business/commercial decisions which are within the ambit of the powers of the board of directors unless the power has been used for an ulterior motive or with an intent to defraud the company or to bestow an undue advantage to an outsider or in breach of the fiduciary duties of the directors. The admitted position in the present case is that, till the stock market scam came into light Ketan Parekh had a good reputation, on the basis of which the company had lent this amount. If it had been established that the board of directors, being aware that Classic Credit was availing of the loan to manipulate the stock market, then, the lending of money would have been not only be for a fraudulent purpose but also be against public interest. However, there is nothing on record to show or establish that in any of the reports of various agencies including JPC which probed into the stock market scam, there is any observation that the company had the knowledge that Ketan Parekh was manipulating the stock market and by lending this amount, the company had abetted him in doing so. None of these reports mentions that the company had any dealings with Ketan Parekh or his companies other than the solitary instance impugned in the petition. In the absence of any ulterior motive of any nature established against the board of directors, it could, at the best be held, that the board was guilty of commercial misjudgment or had taken an unwise decision, as the amount of Rs. 28 crores is still to be realized back. It has been held that commercial misjudgments will not amount to oppression even if they have adverse effect on the price of the share of the company (Rutherford, In re(1994) BCC 876). The Supreme Court has observed, in the celebrated Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd. (1981) 51 Comp Cas 743 (SC) that unwise, inefficient or careless conduct of a director cannot give rise to a claim under Section 397 unless the conduct is one which lacks probity or a conduct which is unfair. Further, the company has already taken appropriate steps for recovering the money by invoking the provisions of Section 138 of the Negotiable Instruments Act and also have been periodically obtaining acknowledgement of debt from M/s Classic Credit. There is no allegation in the petition, which could be considered as an act of oppression to attract the provisions of Section 397. Only during arguments it was submitted that the fall in the market price of the shares would indicate that the affairs of the company are being carried on in a manner oppressive to the shareholders and it would also indicate mismanagement in the affairs of the company. This argument is far fetched. Fluctuations in the stock market depend on various factors, and just because the price of the shares of a company falls, it does not necessarily mean that the affairs of the company are carried on in an oppressive manner. In paragraph 6 of the Inspection Report, the Inspecting Officer has dealt with the Financial Position and Working Results for three years and he had opined that the “working results appear to be satisfactory.”
8. As regards the allegation that there have been a number of irregularities in conducting the affairs of the company and the violations under various sections of the Act indicate that all is not well with the present management, the requirements of all these sections in respect of which the petition has alleged violation are procedural, which cannot lead to a conclusion that such violations are prejudicial to the interest of the company or public interest.
9. The petitioner failed to make a case under Section 397 of the Act in CP No. 9/2003. On the same facts, the ingredients of Section 388B have not been substantiated. There is not sufficient and proper material for this Board to hold that the loan to M/s Classic Credit Limited was an act clearly suggesting that the respondents in the conduct and management of the affairs of the company are guilty of fraud, misfeasance, persistent negligence and further that the respondents have not conducted the affairs of the company in accordance with sound business principles and prudent commercial practices. In lending the amount of Rs. 78 crores, the act of the Board could at best be declared as an action of commercial mismanagement or an unwise decision. It is not the petitioner’s case that this decision of the Board of Directors was not within the legitimate powers of the Board or that the Board had violated any provision of law. I find that the petitioner has not established that by the single act of lending money and violating the provisions of certain Sections of the Act in the year 2000-2001 the company is being managed in a manner prejudicial to the interest of the company or to the public interest and that it amounts to fraud misfeasance, persistent negligence and further that the respondents have not conducted the affairs of the company in accordance with sound business principles and prudent commercial practices warranting removal of the MD and directors of the company. On the facts of the case, the MD and the directors of the company cannot be held to be unfit and improper persons to hold the office of MD/Directors or any other connected with the conduct and management of the company.
10. In view of the aforesaid, this reference is hereby dismissed. I do not, however, propose to make any order as to cost.