A recent decision of the Bombay High Court not only lays down and confirms important principles of law but also has implications for corporate governance and rights of shareholders (‘activists’ or otherwise). The decision has seen differing views and reactions. Some support it as laying down correctly the law. Others hold that a more purposeful view of the provisions could have been taken as they believe the conclusions drawn impact the spirit of good corporate governance. Be as it may be, these important legal conclusions of the court are valuable to review. This decision is in the matter of
Zee Entertainment Enterprises Ltd. vs. Invesco Developing Markets Fund ((2021) 131 Taxmann.com 321 (Bom.)).
This ruling is under appeal before the Division Bench of the Bombay High Court. Interestingly, parallel proceedings are also pending before the National Company Law Tribunal/National Company Law Appellate Tribunal for the same matter. Indeed, the core question of whether the NCLT has sole jurisdiction over such matters to the exclusion of the High Court is itself being pursued. Thus, we are likely to see further developments, including possibly a different view of the facts and/or law, in the matter.
SUMMARY OF CORE FACTS AND ISSUES
The core issue is whether shareholders have the unfettered right to call a general meeting and place resolutions for consideration by shareholders? Does the Board of Directors have any discretion or power to review and reject any of such resolutions or they are bound to call (or, in default, the shareholder group would itself call) such general meeting? Is the only thing the Board is expected to check is whether the procedural requirements of calling such general meetings are complied with? Or can the Board consider the merits of such resolutions in terms of their legality, whether such resolutions could result in violations of law by the company, etc.?
The matter concerned Zee Entertainment Enterprises Ltd. (ZEEL), a listed company. Two shareholders (‘the Shareholders’), holding, in the aggregate, 17.88% of the equity share capital of ZEEL, served a requisition under section 100 of the Companies Act, 2013 on ZEEL to convene an extraordinary general meeting (EGM) to consider primarily two categories of resolutions (aggregating to nine resolutions in all). The first three resolutions proposed the removal of three existing directors. The remaining six resolutions proposed the appointment of six specified individuals as independent directors. Two of the first three resolutions became redundant since two of the specified directors resigned voluntarily. Interestingly, the promoters of the company held only 3.99%.
The independent directors of ZEEL met and considered the matter. The Board of ZEEL considered various legal opinions and concluded that the notice of EGM was invalid and hence decided not to call the EGM. The reasons for holding that the notice was invalid were several and which were considered by the High Court. Since, under section 100, if the Board does not call the EGM, the Shareholders themselves could call it, ZEEL approached the High Court with three prayers. The first was to declare that the notice was illegal, ultra vires, invalid, bad in law and incapable of implementation. The second sought a declaration that the rejection by ZEEL to convene the EGM was valid in law. The third prayer sought an injunction against the Shareholders from holding the EGM themselves.
These prayers, including the grounds for rejection of such requisition, became the issues for consideration by the Court.
DOES THE HIGH COURT HAVE ANY JURISDICTION TO ENTERTAIN SUCH PETITIONS OR DOES THE NCLT HAVE SOLE JURISDICTION?
The Shareholders claimed that, in view of Section 430 of the Act, the High Court had no jurisdiction and the NCLT/NCLAT had sole jurisdiction over this matter. The Court rejected this contention stating that the relevant Rules that set out the provisions which NCLT has sole jurisdiction on does not include Section 100 and other relevant provisions. Thus, the Court concluded that it did have jurisdiction over such matters.
CAN SHAREHOLDERS PASS RESOLUTIONS WHICH HAVE LEGAL INFIRMITIES? CAN THE BOARD REJECT A REQUISITION ON SUCH GROUNDS?
This was the core and substantive issue before the Court. The Shareholders claimed that so long as the requirements of Section 100 are complied with, the Board was bound to call the EGM. Indeed, it was argued that Section 100 mandated the Board to do this by use of the word ‘shall’. The only principal substantive requirement the Board of Directors are required to check is whether the procedural requirements of Section 100 are complied with (e.g., the minimum percentage of shareholders specified (10%) have sought the holding of such EGM). This is the sole test that is relevant to decide whether the requisition is ‘valid’ (as specified in section 100(4)) or not. Effectively, the argument, as the Court highlighted, was that even if the resolutions could have resulted in ZEEL committing illegalities, the Board had no say and was bound to call the EGM.
ZEEL countered this by pointing several issues in the resolutions which made them illegal to be proceeded with and would also mean committing illegalities by ZEEL if such resolutions were passed. The appointment of six independent directors could possibly exceed the limit of 12 directors on the Board. ZEEL operated in areas that were regulated by Ministry of Information and Broadcasting (‘MIB’). Any change in the Board required prior approval of the MIB. The resolutions, however, proposed the appointment first and made it subject to approval, meaning the approval, if received, would be a post-facto approval. Thus, the removal or appointment of directors would mean violation of the MIB rules for which the company would suffer.
Appointment of independent directors could be made, in law, only by following a specified procedure. The Nomination and Remuneration Committee is required to review the merits of the proposed independent directors and recommend them to the Board. The Board thereafter, at their discretion, appoints such directors and this appointment has to be then approved by the shareholders. Thus, it was a three-step process mandated by law. ZEEL contended that the requisition sought to bypass the first two steps and, thus, again, the company would be held to commit violation if it allowed the resolutions. Indeed, it was contended, the shareholders could only ‘approve’ an appointment already made and not directly appoint an independent director itself.
ZEEL even questioned whether the directors proposed for appointment by certain substantial shareholders could be held to be ‘independent’, despite their respective merits and qualifications. In the ordinary course, nominee directors are by definition, not independent directors.
Thus, ZEEL contended on these and other grounds that if the EGM was allowed to be proceeded with and the resolutions passed, ZEEL would be committing several violations of law.
The High Court, in the very eloquently written judgment, held that the Board could not proceed with a requisition that would, if implemented, result in the company committing violations of law. Citing early precedents from the UK (where the law had thereafter changed, but the rulings still had merit) and also elsewhere, as well as decisions of Indian courts, the Court held that the Board was not bound to convene an EGM if the resolutions resulted in the company committing illegalities. Particularly for listed companies (and ZEEL was a listed company), there were certain specified requirements to be followed for the appointment of independent directors, and these could not be bypassed. The prior approval of the MIB for changes in the Board was required while the resolutions proposed that it could be obtained later on.
An issue arose whether the Board of Directors could consider extreme situations and possibilities to decide whether the resolutions may end up in the company committing illegalities. The Court held that the Board could and cited the philosopher Karl Popper and held that the test of illegality was to be checked from every angle, even extreme ones. It observed, ‘Any hypothesis has to be tested, repeatedly, for failure; including testing at the margins or extremities. It is no use saying that a hypothesis fits a median situation. The question is whether the hypothesis survives a test or collision against a polarity? If it does, then it is sound; if not, it must fail throughout and considered unsound’. To demonstrate this, the Court asked the counsel for the Shareholders whether a resolution proposing that the company engage in gambling business (illegal in India) could be allowed? The counsel replied that this was an extreme or outlandish proposition. The Hon’ble Court held that even such extreme tests were necessary to test the proposition raised. If the argument of the Shareholders was accepted, even a ‘madcap resolution’ would end up being allowed.
The Court also made another important point. It observed that even the Board of Directors itself could not propose such resolutions in the manner in which they were proposed as there would be violations of law. The shareholders are not on any higher pedestal, and the same criteria are applied. Had the Board proposed such resolution, could a shareholder object before a court against such proposals and seek injunctions? The Court answered in the affirmative.
Thus, the Court affirmed the decision of the Board of ZEEL to reject the requisition and granted the injunctions prayed. The EGM was directed not to be held by the Board or by the requisitioning shareholders.
IMPLICATIONS ON RIGHTS OF SHAREHOLDERS AND ON CORPORATE GOVERNANCE GENERALLY
With due respect, some aspects are worthy of consideration and debate. Concerns have been raised whether the court ruling would disempower shareholders and put brakes on even healthy shareholder activism. It could, it is argued, excessively empower an existing board having support of a small minority of shareholders and exclude the majority shareholders from exercising their rights. In particular, the issue raised was whether the process of screening prospective directors through the Nomination and Remuneration Committee was for the benefit of shareholders or could be used to supplant and exclude them? Indeed, this would mean that the shareholders could not even appoint directly those board members who would form this Committee. These, it is respectfully submitted, are valid points but it is also respectfully submitted that the answer lies in an amendment of the law, which, perhaps in hindsight, does seem to have lacuna which the present decision has thrown up.
In any case, it is respectfully submitted, that the Hon’ble Court is right in holding that the Board could not allow resolutions to be passed and implemented resulting in the company violating legal requirements. As the Court pithily observed, ‘Sometimes, it happens that a company must be saved from its own shareholders, however well-intentioned’.
