This article is written by Vasundhara Gupta.

Introduction

On January 25, 2020, one of the top American multinational investment banking companies, Goldman Sachs, taking a hit at the lack of diversity in corporate boards, stated that they would not take a company public if it did not have at least one diverse member (not white, male or straight) on the Board. Asia, however, was excluded from this policy, the applicability of the same being limited to the USA and Europe. The aforementioned statement, coming from the biggest underwriter of IPOs in the United States, holds immense significance and raises the question as to the rationale and efficacy of having a diverse Board and how it impacts profitability and growth of the company.

The research methodology adopted by this paper seeks to trace the evaluation of the concept of small shareholders by looking at the litigation over the years and the statutory changes pertaining to them. Since the beginning, the majority rule has always prevailed over minorities in a company. The small shareholders have always been oppressed by the majority of shareholders. The origin of this majority rule in India was brought about by the leading English precedent Foss v. Harbottle in corporate law. In the case, the minority shareholders filed a case against the majority directors of the company claiming that the property of the company was squandered and misapplied and therefore the defendant should be held liable for the same. However, it was decided in the case that the plaintiffs were incompetent to file such a case as they were the small shareholders and the exclusive right to sue lied with the company or its representatives. Therefore, according to the decision of the court, the minority shareholders would be bound by the actions of the majority shareholders.

Through this article I have thrown light on the necessary shift required from the security offered to the majority directors which is biased, by the Foss v. Harbottle rule to finally recognize the importance of small shareholders in the BOD of a company.

Historical evolution 

It is evident in many cases that earlier the court accepted the majority rule and also the deviant acts of the majority directors were not penalised and made regular through resolution. For instance, in the case of Bhajekar v. Shinkar, the majority rule of the board of directors of a company passed a resolution through which certain people were appointed as ‘managing agents.’ In the general meeting, the company ‘confirmed the resolution’, however, some minority directors filed a suit against the majority directors claiming the resolution to be irregular. However, the court decided in the favour of the majority directors and held that the court would not interfere in the internal management of the company and it was the company’s right to approve any type of agreement even if it was deviant or irregular. 

Even, in the case of Rajahmundry Electric Supply Corp. Ltd. V. Nageshwar Rao, it was held that the courts would not interfere in the internal management of the company or the day to day operations of the directors if they acted within the limit of the articles of association proposed by the company. 

However, things changed eventually as the judiciary showed signs of deviation from the rigid majority rule so as to protect the interests of the minority shareholders. It tried to maintain a “balance between the minority and the majority shareholders of the company.”

Companies Act, 1956 provided a redressal mechanism for the protection of minority shareholders by introducing sections 397 to 409.

Therefore, in the case of Sri Ramdas Motor Transport Ltd. V. Tadi Adhinarayana Reddy and others, the court held that according to companies Act, 1956 section 397, any member of the company, including the minority shareholders, who complain that the affairs of the company are “irregular or prejudicial to the public interest or are oppressive to any member may apply to Company Law Board for an order.” The majority directors were however not deprived of their domestic rights due to minority activism. This judgment was also upheld in a similar case of Shanti Prasad Jain v. Kalinga Tubes Ltd.

Further, in the Companies Act, 2013 many favourable provisions were introduced in favour of the minority shareholders especially section 151 which allows the small shareholders to appoint a director which replaced section 252 of Companies Act, 1956. These provisions in the Companies Act gave rise to shareholder activism.

How far has it worked in India? 

Since the minority shareholders were never given any preference over majority shareholders what usually happened was that even if the acts of the majority directors were not acting in a way that would benefit the company, the small shareholders instead of raising their voice against the management, would “prefer to sell their shares.” However, with the introduction of certain sections in the companies act and the increase in the “institutional participation of the small shareholders in the Indian market”, it led to the rise of “shareholder activism” in the country. One of the recent cases of shareholder activism is, “when the small shareholders showed disagreement to the decision made by Ambuja Cements Ltd to buy majority shares in ACC Ltd. through a complicated deal.” “Life Insurance Corp. of India which held 5.57% of shares in the company, therefore considered to be the small shareholders, voted against the proposal.” It was the first time where the small shareholders were given preference over majority directors and the promoters were not given priority because of their higher shareholding. 

However, compared to other countries in the world, shareholder activism has been low in India. One of the major reasons for this is the “complex structure of the Indian market.” “In the west, the markets are dominated by institutional investors whereas in the Indian companies it is difficult for small and minority shareholders to contest management decisions since it has large promoter shareholding and therefore they have not much say in the day to the day decision-making process of the company.” Therefore, the implementation of section 151 of companies act, 2013 has been of limited success especially in India. 

Also, it can be seen that the new section 151 of Companies Act, 2013 has limited its scope because it is applicable only on listed companies and not on private companies and unlisted public companies. However, earlier under the Companies Act, 1956 small shareholders provision was applicable on non-listed companies as well, companies which had “paid-up capital of five crore rupees or more and having one thousand or more small shareholders.” The purpose of this was to safeguard the rights of the minority shareholders by having them on the company’s BOD but it lost its relevance because of its optional nature. 

Thus, the dominance of majority directors dampens the effects of shareholder activism in the Indian companies. The institutions and the legal redressal mechanism are not effective in providing timely and cost-effective litigation strategies to the small shareholders to counter managements when they act against their interest. 

There are only a few ways by which they can make the board of directors of the company more accountable, that is through approaching SEBI as it is responsible “to protect the interests of the investors” or by approaching the National Company Law Tribunal (NCLT).

Do small shareholders seek a seat on a company’s board nowadays? 

Although, section 151 of Companies Act, 2013 has been introduced in favour of the minority shareholders, specifically to recognise their worth in the company’s board however nowadays no company wants to indulge in giving a seat to the small shareholders of the company. Their main reason for doing so is to separate ownership from control. Even after SEBI made it clear that there must be independent directors on the board of a company, the listed companies do not want to include small shareholders in their board. This can be seen in the case of Alembic Limited were a set of small shareholders of the company, employees of a company named Unifi, wanted to seek a seat in the board of the company, making their ownership of shares in the company passive.

They moved their application under section 151 of the companies Act to appoint a small shareholder director, representing the interests of the shareholders who are not holding shares of nominal value not more than Rs. 20,000. However, the company rejected their application stating that they had nexus and direct conflict. The main contention raised by Alembic Ltd. was that the small shareholder chosen by the company had close nexus with Unifi since he was an employee there, for being a director on their board. However, they don’t take into consideration the important steps to protect the interests of the shareholders. Thus, the right given to them under section 151 of the companies act stands emasculated since the board of a company can step in and reject the proposal at its own discretion.

Efficacy of having small shareholders in the board of directors

With the appointment of small shareholder directors, the shareholders can finally assert their power as “the owners of the company to increase its efficiency.” Having some control on the board will not only influence the behaviour of the company but also cover a broad spectrum of activities. It will further help in the governance of the company, ensure fair treatment of all shareholders and will also increase the value of the company over time. As a result, it will benefit the company by improving the legal environment, shareholder democracy and increasing shareholder participation. Another reason why the potential need of small shareholder participation is required in the board of directors is that if the majority directors do not act in company’s interest then as owners of the company the shareholders can raise their voice against it through the director appointed by them under section 151 of the companies Act, 2013. 

Conclusion 

With no seat given to the small shareholders in the board by any company when proposed by them, section 151 of Companies Act, 2013 stands emasculated. Having small shareholders on the board is very effective for the company since they are the investors of the company and therefore they have all the more reason to work for the welfare of the company. Moreover, having shareholders on the board will give rise to shareholder participation since more people will be willing to invest in a company where they have ownership and control, both simultaneously. Therefore, it won’t be harmful to the company to have both ownership and control lying with the same body rather it would prove effective since the shareholders have put everything at stake would have a proper incentive to work for the benefit of the company. 

Bibliography

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