In closely held companies decisions regarding their success aren't always made with just the numbers involved; other factors contribute too. The long-term nature of the relationship between the owners and the business creates a duty of care that usually does not appear in any written contracts, but is nonetheless a significant part of the decision-making process. The laws governing similar business entities in the general market, do not govern every aspect of the relationships between family members or between family members and non-family members who help run the business. Therefore, although the initial arrangement may seem reasonable, problems can develop over time as the firm's management, control of the company, or change in the company's direction begin to be questioned by some or all of the family members.
There are many instances in which minority shareholders have been subjected to exclusion from the decision-making process; denied access to financial records; removed from an active role in the management of the company; and excluded from the family-oriented process, even if they were instrumental to the company and its success. The majority shareholders generally have a tendency to exercise their rights of control over minority shareholders in a way that is oppressive or prejudicial or contrary to the best interest of the company itself.
The Companies Act, 2013 recognizes this and provides minority shareholders with legal relief through provisions for oppression and mismanagement. Remedies for minority shareholders under Indian law are particularly applicable to closely-held businesses, where the line of demarcation between the ownership of the business and the management of the business is often blurry.
Understanding Oppression and Mismanagement
Sections 241 and 242 of the Companies Act, 2013 empower eligible shareholders to approach the National Company Law Tribunal (NCLT) where the affairs of a company are being conducted in a manner that is oppressive to any member or prejudicial to the public interest or the interests of the company.
Although the terms “oppression” and “mismanagement” are not exhaustively defined, judicial interpretation over the years has clarified their scope.
Oppression generally refers to behavior by a corporation typically involving actions that offend, exploit, or violate the rights of minority shareholders, including actions that intentionally deny minority shareholders the right to vote or participate in corporate governance.
On the other hand, mismanagement refers to how a corporation's business is managed; thus, examples of mismanagement can include: Financial irregularities, Misappropriation of corporate funds, Reckless business decisions, Lack of compliance with statutory requirements or Actions that may jeopardize the company's viability in the future.
The purpose of these two types of behavior is not only to punish those who have committed a wrongful act, but also to take steps to protect the business and ensure the rights of all stakeholders are respected.
Most of these disagreements arise not from unclear laws but rather because corporate governance in closely held entities tends to become more relaxed over time. Decisions are frequently made orally, documentation is often forgotten about and the nature of the roles within the company have advanced without having been created in a solid legal framework.
The Importance of Legitimate Expectation
The Doctrine of Legitimate Expectation is one of the most significant principles that Indian Courts have recognised in cases of oppression.
Shareholders in closely-held companies typically invest much more than monetary capital in the business. They often commit extensive time, effort and expertise to support the ongoing success of the company so that they have an expectation of sharing in management decisions. Therefore, sudden removal from participating in decision-making could result in oppression.
The Courts have also ruled that closely-held companies are often operated in a manner similar to partnerships, which means that equity will play a role in determining whether or not majority conduct is unjust.
For example, if an actively involved founder in the business for many years is suddenly removed from a company without being given transparency or justification as to the basis for the removal, the NCLT may determine if the conduct of the majority of shareholders is unfair or whether it violates the legitimate expectations of shareholders.
Eligibility to File an Oppression and Mismanagement Petition
Not every shareholder can automatically initiate proceedings under Sections 241 and 242.
Under Section 244 of the Companies Act, certain eligibility thresholds must ordinarily be met. In the case of a company having share capital, the application can generally be filed by:
Shareholders seeking relief for oppression and mismanagement under Section 241 must satisfy certain eligibility requirements before approaching the NCLT. In companies having share capital, the right to file such a petition is generally available to members holding at least one-tenth of the issued share capital or representing at least one-tenth of the total number of members.
In companies without share capital, the threshold extends to at least one-fifth of the total number of members. The provision also recognises joint shareholders as a single member for the purpose of calculating eligibility, and applicants must have paid all calls and sums due on their shares.
However, the NCLT also has the power to waive these requirements in appropriate cases. This becomes especially significant in private companies with a small shareholder structure where minority stakeholders may otherwise struggle to meet the threshold.
The Supreme Court and various tribunals have time and again clarified that waiver applications must be examined carefully, particularly where serious allegations of oppression or exclusion are raised.
Powers of the NCLT
The powers granted to the NCLT under Section 242 are broad and equitable in nature.
Unlike conventional civil litigation that may focus primarily on damages, oppression and mismanagement proceedings aim to bring an end to the unfair conduct and stabilise the affairs of the company.
Depending on the facts of the case, the NCLT may pass orders relating to the circumstances of disputes, the most practical solution becomes a structured exit for one set of shareholders through a valuation-based buyout.
Shareholder Agreements and Preventive Structuring
Most disputes between shareholders can be avoided through appropriate legal structuring.
Shareholders in closely held companies depend greatly on trust and personal connections with each other during the first stages of expanding their company. However, when a disagreement arises, there are no written contracts to reference, resulting in uncertainty and greater conflict.
Optimum written shareholder agreements play an important part in minimising future disputes. These agreements should address the following:
Establishing strong ways of governing is not a sign of distrust. They actually benefit the business itself as well as the relationship between the involved shareholders.
The Increasing Relevance of Corporate Governance in Private Companies
Corporate governance has become an issue for unlisted as well as listed companies. Investors, lenders, and business partners expect companies to be transparent about their operations, have a method of holding themselves accountable, and to document their decision-making.
This trend can be seen in the startup ecosystem and growth companies, where there are sometimes competing views on issues such as expansion, control of the company, and financial strategy between the founders and the investors.
As businesses grow, the informal structures that have worked well in the earlier days of the business typically cannot be maintained. Companies that do not adopt disciplined governance practices are at greater risk for disputes among employees; are at greater risk of scrutiny by regulators; and are at greater risk of experiencing instability in their operations.
From a legal perspective, maintaining accurate and complete board records, obtaining and documenting approval from shareholders for major transactions, submitting all required statutory filings in a timely fashion, and providing accurate financial statements in a transparent manner will all help to enhance the company's ability to resolve disputes if they arise in the future.
Balancing Majority Rule with Minority Protection
Company law indicates that a majority shareholder will typically have the ability to ensure control of a company and how it operates, but that the method exercised should not be detrimental to minority stakeholders.
The law is designed to create equilibrium between a company’s commercial independence and the equitable treatment of all shareholders.
As a rule of thumb, Courts and tribunals stay out of the routine business decision making process unless there is demonstrated unfairness, a lack of integrity or actions that harm either the company or its shareholders; being dissatisfied with one’s own management decisions will not necessarily be considered oppressive.
However, judicial intervention into how the majority shareholder's power is exercised (e.g. for self gain, by exclusion and/or to reduce the value of a minority shareholder's interest in the company) will normally occur.
The Need for Early Legal Intervention
Shareholders often fail to act timely on governance issues, which is among the most common mistakes made by shareholders.
Once followed, delays usually lead to legal disputes, with little or no communication between the parties to the dispute and no goodwill left among the parties. Evidence will have been destroyed or will become disputed, critical decisions will have been made and implemented, and irreparable damage may have occurred to the company's business operations.
Timely legal action can help determine the likelihood of successfully resolving the dispute, preserve evidence, determine the rights of the shareholders, and determine whether a negotiated settlement might be reached before the cost of the dispute escalates.
In numerous instances, securing advice from a lawyer in a timely manner can allow for avoiding lengthy litigation and protecting the business's long-term value.
Conclusion
Disputes that arise from oppression or mismanagement are disputes which often involve trust, control, expectations, and the future of the business as well as legal concepts.
There are laws in place that provide safeguards for minority shareholders from being excluded from a company or being treated unfairly by the company. These legal protections remind companies about the importance of good governance, transparency, and clearly defined shareholder rights in relation to creating long-term stability.
The optimal operation of private companies requires alignment of the legal framework to support growth and changes in the business over time. Proactive governance, and creating systems to prevent disputes can considerably decrease the chances of creating conflict between shareholders while continuing to protect the business and the relationships behind it.