In contentious corporate litigation, much depends on interim measures. A victory at the interim stage becomes a turning point for most parties. This is particularly true for shareholder disputes, which become a battle to retain the company’s control. A favorable interim relief becomes the ultimate bargaining chip, giving parties an upper hand while negotiating their demands.

Shareholder disputes are litigated in India in the form of “oppression and mismanagement” actions under section 241-242 of the Companies Act, 2013 (“Act”). Section 241 allows shareholders to approach the National Company Law Tribunal (“NCLT”) if they believe that a company’s affairs are mismanaged or being conducted in a manner which is prejudicial or oppressive to the company or its shareholders.

The NCLT exercises wide powers under section 242(4) and is empowered to pass “any interim order which it thinks fit for regulating the conduct of the company’s affairs upon such terms and conditions as appear to it to be just and equitable”. Such wide powers equip the NCLT to effectively deal with shareholder disputes, which are mostly complex and multifaceted. Concerns, however, arise when the NCLT appears to over-step the Act’s mandate and starts encroaching on the rights of third parties which have no connection with the dispute.

In this post, we discuss the scope of the NCLT’s powers under section 242(4), the range of interim reliefs that may be granted and instances, if any, of the NCLT encroaching upon third party rights by stepping beyond the realm of the Act.

Scope of Section 242(4) of the Act

Section 242(4) empowers the NCLT to pass such interim orders as it deems fit for regulating the conduct of the company’s affairs. Rule 11 of the National Company Law Tribunal Rules, 2016 further grants the NCLT inherent powers to make such orders as may be necessary for meeting the ends of justice or preventing abuse of process.

A joint reading of section 242(4) and rule 11 bestows the NCLT with enough flexibility to pass interim orders, addressing the peculiar facts of each case, to effectively insulate companies from adverse consequences of a shareholder dispute. The only guardrail imposed is that terms and conditions of any such order must be just and equitable. The Supreme Court in Cascade Energy Pte v. Archer Power Systems Private Ltd has clarified that “just and equitable” is associated with the terms and conditions of the interim order and not the reasons for passing such order.

Section 242(4) is in line with the powers granted to the Company Law Boards (“CLB”) to pass interim orders under section 403 of the erstwhile Companies Act, 1956. Courts have recognised that under section 403 the CLB was free to pass orders, provided they were in the interest of proper conduct of the company’s affairs [Ashok Manufacturing (P) Ltd. v. Atul Nath]. The Delhi High Court has even held that this power was incidental to powers under section 402 of the 1956 legislation [Sanjay Gambhir v. D.D. Industries Ltd], which has been aptly described as an innovation in company administration [Richardson and Cruddas Ltd., Life Insurance Corporation of India, In re v. Haridas Mundera]. In this regard, courts had opined that the only limitation which could be impliedly read on the power under section 402 was that there must be a nexus between the order passed and object sought to be achieved by section 397-398 of the Companies Act, 1956 (akin to section 241 of the Act) [Bennet Coleman v. Union of India].

Nature of Interim Reliefs Granted

Since its establishment, the NCLT has effectively exercised its powers under section 242(4) to protect companies during the pendency of proceedings. It has been granting interim relief depending on the nature of complaint, reliefs claimed and level of threat  the company is under. Interim reliefs have ranged from ordering forensic audits [Dr. Dipen Kailashchandra Agrawal v. Nag Vidarbha Chamber Of Commerce], freezing directors’ bank accounts [Union of India v. IL&FS], and restraining  respondents from participating in day to day management and affairs, including operating the company’s bank account [R. Semalaiappan v. R.S. Mills (P) Ltd.].

In extreme cases, the NCLT has suspended the board of directors and reconstituted a new board, as seen in the Infrastructure Leasing and Financial Services Limited (“IL&FS”) case. Similarly, the National Company Law Appellate Tribunal (“NCLAT”) had suspended Delhi Gymkhana’s General Committee and appointed an administrator during the pendency of proceedings [Union of India v. Delhi Gymkhana Club Limited].

At first blush, these interim measures may appear severe. However, given the grave allegations of mismanagement, replacing the then-existing management was a logical and necessary direction to protect the company. In any event, the Act under section 242(2) empowers the NCLT to remove and appoint new directors as a final relief.

Concerns arise, however, when the NCLT steps beyond the realm of the Act and encroaches upon rights of entities who are not even parties to the dispute before it. Such parties then become causalities in a fight to which they are not even a party, and thereby suffer consequences without being given a hearing. The NCLAT’s interim order dated October 15, 2018 in Union of India v. IL&FS  is a case in point, which was passed “taking into consideration the nature of the case, larger public interest and economy of the nation and interest of the Company and 348 group companies”.

Under this order, the NCLAT restrained (a) institution or continuation of proceedings by any party against IL&FS and its group companies before any court, tribunal /authority; (b) any action to foreclose, recover or enforce any security interest created over said companies’ assets; and (c) any banks/financial institutions from exercising the right to set off or lien against any amounts lying with any creditor against dues whether principal or interest or otherwise against the balance lying in any bank accounts and deposits, of IL&FS and 348 group companies (“Order”).

Interestingly, the Order is in the nature of a moratorium envisaged under the Insolvency and Bankruptcy Code, 2016 (“Code”). Unlike the Code, the Act does not contemplate imposition of any such moratorium, that too, without the consent of third parties involved. In fact, the Act under section 242(2)(f) (dealing with final reliefs which may be granted by the NCLT), has a contrary provision. It mandates securing consent of concerned third parties prior to passing any order terminating, setting aside or modifying any agreement between the company and such party.

Given this mandatory consent requirement at the final stage, it may not be possible for NCLT to ignore this requirement at the interim stage. Undisputedly, no such consent was taken prior to passing the Order. Instead, the NCLAT justified the Order by observing that while power of moratorium under section 14 of the Code cannot be exercised under the Act, it could be exercised under section 242(4). The Order had a far-reaching impact on several third parties, particularly financial institutions, which had advanced loans to IL&FS and/or its subsidiaries.

One such institution was HDFC. Pursuant to the Order, IL&FS disputed HDFC’s right over receivables deposited in an escrow account in relation to a loan transaction. IL&FS had assigned to HDFC the right to collect certain rent amounts, which were receivables to be deposited in the escrow account. The matter went upto the Supreme Court. After considering the parties arguments, the Supreme Court finally clarified that IL&FS had assigned to HDFC the right to receive the rentals from the property in question. Such a right would not be impacted by the Order [IL&FS v. HDFC Bank Ltd].

Till date, several such cases have emerged wherein third parties have become casualties of the Order. Thus, it may be argued that in its endeavor to protect the interests of IL&FS and its subsidiaries, the NCLAT encroached upon and jeopardized the rights of several third parties.

While considerable leeway has been given to tribunals under section 242(4), this power ought to be exercised with necessary checks and balances. The intent of section 242(4) is to the protect the company’s interest during the pendency of the proceedings. However, such powers cannot have an overarching effect of interfering with rights of third parties, in a manner which is contrary to the Act. This is particularly relevant in cases wherein interest of third parties who have no connection with the complaint raised under section 241 (example HDFC) are sacrificed.

Conclusion

The significance of the NCLT’s power under section 242(4) cannot be undermined, as it has proved to be an effective tool in the past few years. However, one must be mindful that unfettered and unchecked exercise of such power can have far reaching consequences, including on third party rights. The Order is a case in point, wherein the NCLAT, by borrowing and implementing aspects of the Code, encroached on rights of several third parties. It is only hoped that going forward the NCLT and the NCLAT are more conscious of third party interests while exercising its powers and acts as per the Act’s statutory mandate.