Case: J.S. Davar Vs. Shankar Vishnu Marathe

The facts leading to this appeal may be stated thus:(2) In 1964, a partnership firm by the name of "pioneer Dying House" was formed for the purpose of dyeing, printing and processing Calico cloth. It consisted of three partners D. B. Phatak, G. G. Ketkar and C. S. Phatak. On 1st of November , 1964, the firm was transformed into a Private Limited Company with an authorised capital of Rs. 5,00,000. D. B. Phatak was appointed a Managing Director of the company, while the two other partners, G. G. Ketkar and C. S. Phatkar were appointed Directors. On the 10th of November 1952, a petition for winding up of the company was filed by two creditors of the company, Harihar Ramkrishna Karandikar and Anandibai Karandikar. On the 2nd of February 1954, D. B. Phatak presented a scheme for reconstruction of the company, but the attempt to revive the company was given up as the scheme could not be worked out. On the 13th of August 1954, the learned District Judge, Poona, ordered the company to be wound up.(3) The company had constructed a building called pioneer House on the Laxmi Road,. Poona. D. B. Phatak, the Managing Director of the Company, made a claim that the building was of his private ownership and therefore, on the 6th of June 1955, the Official Liquidators filed Civil Suit No. 835 of 1955 against him and another person for a declaration that the building as well as the land under it were the ownership of the company. The trial Court held by is judgment, dated the 24th of July 1956, that the building belonged to the Company but the land under the building belonged to D. B. Phatak. The Official Liquidators did not challenge that part of the decree which was against the company but D. B. Phatak filed Appeal No. 537 of 1956 in the District Court, Poona, to challenge the correctness of the decision that the building belonged to the company. By his judgment, dated the 24th of April 1959, the learned ExtraAssistant Judge, Poona, dismissed the appeal and confirmed the decree of the trial Court. D. B. Phatak filed Second Appeal No. 925 of 1959 in this Court against the decree of the District Court, but that appeal was withdrawn during the hearing of this appeal.(4) On the 2nd of November 1957, that is after the trial Court delivered its judgment in Suit No. 835 of 1955, the Official Liquidators filed a misfeasance summons against D. B. Phatak and others on the basis of the finding recorded by the trial Court that the Managing Director was guilty of fraud. That finding formed theof the second appeal filed by the Managing Director in the High Court has as stated earlier, the appeal was withdrawn.(5) On the 12th of September 1964, that is more than ten years after the winding up order was passed, an application was filed in the District Court, Poona, by five persons propounding a scheme under section 158 of the Indian Companies Act, 1913, for the reconstruction of the company. Three of the five sponsors of the scheme are creditors of the company, while the two others Gopal Ganesh Ketkar and Achyut Dattatraya Phatak are the Directors of the company. Ketkar is a near relative of the Managing Director, while Achyut Dattatraya Phatak is the son of the Managing Director. Both of them are also said to be the creditors of the company.(6) Stated briefly, the following proposals are contained in the scheme. (A) That the leasehold rights in the vacant plot of about three acres at Yerandavana, belonging to the company be sold to two persons Lieutenant Colonel S. S. Pandit and K. D. Joshi for Rs. 1,85,000. (B) That the value of the shares held by the shareholders of the company be reduced from Rs. 1,. 47,000 to Rs. 14,700. (C) That the creditors of the company be paid a dividend ofpaise from out of the sale proceeds of the vacant plot and from the amount of the rent of the "pioneer House" (The Managing Director had agreed to sell the Pioneer House, Laxmi Road, Poona, to a company called Yeshwant Mutual Insurance Company, Limited, taking an earnest of Rs. 47,000. The Insurance Company was put in possession of the building by the Managing Director who treated the property as his own. The Insurance Company did not want the enforce its rights under the agreement of sale and it was willing to pay to the Official Liquidators the sum of Rs. 19,000 and old which was in its hands after the appropriation of Rs, 47,000 paid by its as earnest under the agreement of sale. The Official Liquidators had also in their hands a sum of about Rs. 24,000 from out of the rent of the "pioneer House". Thus the amount available for distribution amongst the creditors of the company was about Rs. 43,000 in addition to the sale proceeds of the vacant plot, amounting to Rupees 1,85,000.) (D) That the Company will issue debentures of the value of Rs. 2,02,500 to the depositors and other creditors of the company in partial satisfaction of the amount due to them. The debentures would be repayable at the end to ten years and the interest at 7 1/2 per cent per annum could, at the option of the Company, be capitalised during the first three years. (E) That the creditors should forgopaise in a rupee in consideration of the interest paid by the company on the debentures. (F) That D. B. Phatak , the Managing Director of the Company, will transfer the land under the building called "pioneer House", Laxmi Road, Poona, to the company for a consideration of Rs. 47,000 which was already received by him from the Yeshwant Mutual Insurance Company Limited under an agreement of sale. (G) That the company should take over the personal debts of D. B. Phatak amounting by adjustment to Rs. 1,57,000. A sum of Rupees 70,000 in cash was to be paid to the personal creditors of D. B. Phatak. in partial satisfaction of the balance of Rs. 87,000, debentures of the value of Rs. 30,000 repayable within ten years and bearing interest at 7 1/2 per cent per annum were to be issued to those creditors. In respect of the amount of Rs. 57,000 which would still remain payable to Phataks personal creditors, the company was to execute a mortgage in their favour for a period of five years bearing interest at 6 per cent per annum.(7) On the 23rd of October 1964, the Official Liquidators filed their reply exhibit 389 to the proposed scheme. They protested against some of the proposals contained in the scheme as for example the proposal that the vacant plot at Yerandavana be sold by private treaty and contended that if all the assets of the company were sold, it would be possible to pay the creditors and the depositors, fully. In the last paragraph of their reply, however, the Official Liquidators stated that they would abide by the orders of the Court and their attitude was that they would neither oppose the scheme nor give their consent to it.(8) On the same day that the Official Liquidators filed their reply, the learned District Judge directed that a meeting of theshareholders and the creditors of thecompany be held under the Chairmanship of an Advocate called V. R. Phadke for ascertaining their wishes. The Chairman was directed by the District Judge to put before the meeting the views of the Liquidators. A separate meeting was directed to be held of the shareholders and the creditors of a company called the Maharashtra Textiles Limited to which the Pioneer Dying House Limited owed a debt of Rs. 1,20,000. The Maharashtra Textiles Limited were themselves in liquidation and Mr. J. S. Davar, who is one of the Official Liquidators of the Pioneer Dying House Limited, was appointed a Liquidator of the Maharashtra Textiles Limited also.(9) The meetings of theshareholders and the creditors of thePioneer Dying House Limited were held on the afternoon of the 13th of December 1964. The report exhibit 398, dated the 19th of January 1965, submitted by the Chairman, V. R. Phadke, to the District Court shows that all the nine shareholders of the Pioneer Dying House Limited consented to the scheme. The meeting of the depositors and the creditors, which was held separately from the meeting of the shareholders, was attended by 124 persons representing claims of the value of Rs. 4,38,004. 36 creditors appeared personally and 88 appeared through proxies 7 creditors representing claims of the value of Rs. 43, 345 opposed the scheme whereas others holding a total claim of Rs, 3,31,399 consented to the scheme. On the material date, the company held deposits of the value of Rupees 5,00,000 and the other debts amounted to Rs. 2,50,000.(10) The meetings of theshareholders and the creditors of theMaharashtra Textiles Limited which was the largest single creditor of the Pioneer Dying House Limited, were held separately on the 19th of January 1965. The report of the Chairman at exhibit 248 shows that all the shareholders gave their consent to the scheme. In the meeting of the creditors, 13 creditors attended personally and 23 by proxies 35 creditors consented to the scheme, whereas on creditor opposed the scheme.(11) The learned District Judge, Poona, has sanctioned the scheme by his judgment, dated the 29th July 1965. He observes that more than 75 per cent of the creditors and depositors of the company had consented to the scheme, that the bona fides of the sponsers of the scheme and of those creditors and depositors who consented to it were not disputed and that the scheme was conceived in the larger interest of the company. Being aggrieved by the judgment, the Official Liquidators have filed this appeal.

Reasoning: (22) On a review of these authorities and from the provisions in section 153 (2) of the Indian Companies Act, 1913, it seems to us clear that the consent of the majority of creditors or shareholders to a scheme does not conclude the issue whether the scheme should be sanctioned. The jurisdiction of the Court which is called upon to sanction a scheme transcends the mere consideration that a majority of those affected by the scheme is willing to submit to the scheme. The creditors of a company may agree to accept a fraction of the amount due to them from the company and yet, on considerations of more lasting importance, like public or commercial morality, the Court refuse to accept the verdict of the majority. It may also refuse to accept the scheme on the ground that it is not reasonable or that it is not feasible or that there is no chance that it will yield to a smooth and satisfactory execution. By reasonable is generally meant that the arrangement cannot reasonably be supposed by sensible business people to be for the benefit of the class which they represent. The Court will also not sanction the scheme if the facts which would have influenced decision of the majority were not known or disclosed to the majority, or if the sponsors of the scheme have misrepresented the true position of the company. Finally, if the acceptance of the scheme would lead to the stifling of an inquiry into the conduct of the delinquent directors, the Court would be slow to give its sanction to the scheme. Considerations such as those mentioned above must be taken into account by a Court before a scheme is sanctioned but in the very nature of things, it is not possible to enumerate exhaustively the circumstances which a Court is entitled to take into consideration.(23) In our opinion, therefore there is no substance in the submission of Mr. Mistry that he decision of the majority must necessarily lead to the inference that the scheme is for the benefit of that class which was represented in the statutory meeting. It is undoubtedly true that the verdict of the majority must be given due weight, because implicit in that verdict is the inference that those whose interests are likely to be affected by the scheme are willing to submit to it. As we have, however, stated earlier, the view of the majority is but one element in the case, though a very important one, which must be taken into account in sanctioning the scheme. The view of the majority is not decisive.(24) We must now turn to the more important clauses of the scheme in order to show why the scheme cannot be sanctioned. A scheme of reconstruction of a company which is ordered to be wound up must postulate that on some reasonable hypothesis it is possible to revive the business of the company. The assets of this Company are so meagre and its liabilities so large that it is in a state of hopeless insolvency, From that state it would, in our opinion, be impossible to resuscitatestatement prepared by Mr. Mistry as reflecting the position of the company under the scheme is open to certain objections, but even assuming that it truly reflects the financial position of the company, it is clear that the company is wholly insolvent. According to the statement submitted by Mr. Mistry, the company will have assets of the value of Rs. 6,73,000 and liabilities amounting to Rs. 7,24,500, under the scheme. It is difficult to see how the company is going to function without any running capital and without any liquid assets. We must also mention that the liabilities shown in the statements tendered before us by Mr. Mistry ignore many other liabilities which the company shall have to meet. For example, the arrears of tax have been shown in the statement at Rs. 32,000 when, in fact, the company will have to pay a much larger amount under that head. If the building on the Laxmi Road belongs to the company, and that is the decision in the suit filed by the Liquidators against the Managing Directors, the company will have to payon the monthly rent received during the course of the last many years. The Managing Director had made an unfounded claim that the building belonged to him and the rent was not taxed in his hands, because it is said that his income was less than the minimum taxable.(25) The total debts of the company can be taken roughly at Rs. 7,44,000. if the personal debts of the Managing Director amounting to Rs. 1,57,000 which under the scheme are passed on to the company are added to it, the total liability of the company would come to Rs. 9,01,000. About Rs, 1,20,000 were paid by the Liquidators as interim dividend and, therefore, a sum of Rs. 7,81,000 is still due from the company by way of debts.(26) As against these debts, the assets of the company consist of a vacant plot of three acres which under the scheme is to be sold for Rs. 1,85,000, another plot of three acres which yields a monthly rent of Rs. 2,100, a building on the Laxmi Road which yields an income of Rs. 1,300 per month and about Rs. 43,000 which are lying to the credit of the company as rent of the building on the Laxmi Road.(27) Under clause (f) of the scheme, Rs. 1,87,000 would have to be paid to the creditors in partial satisfaction of their dues at 25 paise in rupee. Thetherefore of the three acres of land at Yerandavana shall have been used for the purpose of paying debts partially. Under clause (g) of the scheme debentures of the value of Rs. 2,02,500 bearing interest at 7 1/2 per cent per annum are to be issued in favour of the creditors. The interest on the debentures alone would come to Rs. 16,000 per annum. Under clause (i) (a) of the scheme, a cash amount of Rupees 70,000 is required to be paid to thesecured creditors of the Managing Director. The sum of Rs. 43,000 which is lying to the credit of the company as rent of the Laxmi Road property can be used to meet this liability but a balance of Rs. 27,000 will still remain outstanding against the company.(28) Under clause (i) (b) of the scheme, debentures of the value of Rs. 30,000 bearing interest at 7 1/2 per cent per annum are to be issued in favour of the personal creditors of the Managing Director. The interest on these debentures will come to Rs. 2,250 per year. Under the same clause a mortgage is to be created in favour of some of the creditors of the Managing Director, in the sum of Rupees 57,000, with the interest at 6 per cent per annum. The interest on the mortgage will come to Rs. 3,420 per year.(29) The first question which one might consider is from where will the company pay even the interest to the secured creditors. The interest payable to the two classes of debenture holders and the mortgages comes to Rs. 21,670 per year. The only source of income to the company today is the rent of Rs. 2,100 per month from the three acres of plot which is in the possession of two companies called the Bajaj Electrical Limited and the Hunar Caustics Limited and the rent of Rs. 1,300 per month from the Pioneer House at Laxmi Road, Poona. Excluding four moths rent for taxes, repairs and out goings the company will receive a sum of Rs, 27,200 per year by way of rent. The best part of this amount shall have to be utilised for paying the interest on the debentures and the mortgages, with the result that the company will not be left with any capital to carry on its business. It is urged by Mr. Mistry that under the scheme, the company would issue fresh shares for subscription by the public and the public may come forth to buy the shares. This possibility seems to us for too optimistic. A company which has gone in liquidation, which for over ten years is unable to meet its obligations and whose affairs are in such fresh capital. The possibility, therefore, that the company may be able to raise capital for its business must be excluded. Therefore, if the scheme is accepted, all that can happen is that the evil day will be postponed. We see no justification for prolonging the agonies of the creditors any more. It seems to us certain that even if the scheme is accepted, the company will have to face a fresh challenge to its solvency within a short time.(30) The second reason why the scheme cannot be sanctioned is that its object appears to us to be to cover the deeds of delinquent directors. In Civil Suit. No. 835 of 1955 which was filed by the Official Liquidators against the Managing Director and another person for a declaration that the building called pioneer House on the Laxmi Road, Poona, is of the ownership of the company, the trial Court held that the Managing Director had made a false claim to the building, that he had manipulated accounts to suit his convenience and that he had not acted in the best interests of the company. The decree of the trial Court was confirmed in appeal by theJudge, Poona, who also held that the Managing Director was guilty of fraud. The Managing Director had filed an appeal in this Court from the judgment of the learnedJudge, being Second Appeal No. 925 of 1959, but that appeal was withdrawn during the hearing of this appeal. We explained to the learned counsel appearing for the Managing Director that the withdrawal of the appeal will not efface the finding of fraud, but counsel stated that he was conscious of that position but had advised his client that it was not in his interest to prosecute the appeal. If the scheme is sanctioned, the winding up order will stand set aside, the liquidators will be discharged, there will be none to prosecute the misfeasance summons against the erring directors and the assets of the company will once again fall into he hands of persons whose rectitude is under a cloud. That cannot be permitted under the cloak of a scheme of reconstruction.(31) The third reason why the scheme cannot be sanctioned is that it provides by clause (i) (a) that the personal debts of the Managing Director, amounting to Rs. 1,57,000, should be taken over by the company. It seems to us utterly unreasonable that the company should undertake to discharge the personal liabilities of the Managing Director. While justifying this provision, the scheme resorts to some mathematics and a little logic both of which are fictitious. In fact, the adoption of such a provision by the creditors shows that they gave their consent to the scheme without appreciating its real implications. In the language of the decision in the Alabama case, this part of the arrangement is not such as men of business would reasonably approve.(32) We would like to draw attention to a few other provisions of the scheme which appear to us unreasonable and impractical. Under clause (d) of the scheme, the vacant plot at Yerandavana measuring about three acres is required to be sold by private treaty for a sum of Rs. 1,85,000. We see no reason why the property should be sold privately. Public offers have never been invited for the sale of this property and not even a formal valuation of the property has been made. The decision, therefore, that the property should be sold at Rs. 1,85,000 strikes us as arbitrary and unreasonable. The location of the property, its extent and its potentialities indicate that the property is capable of fetching a much higher price.(33) Under the earlier part of clause (i) (a) of the scheme, the Managing Director agrees to transfer the land under the building pioneer House, to the Company for a consideration of Rs. 47,000. It is difficult to appreciate that men of business knowing their interest would agree to such a provision. The Managing Director had made a false claim to the building which belongs to the company. He agreed to sell the building to Yeshwant Mutual Insurance Co. Ltd. , and took an earnest of Rs. 47,000 from them. He put the Insurance Company in possession and during the course of the last few years that Company has recovered by way of rent an amount larger than the one which it had paid by way of earnest. The Insurance Company has been taken over by the Life Insurance Corporation of India which has very properly taken the view that it will not enforce the agreement of sale. It is content that the amount paid by way of earnest has already been recovered in the shape of rent. It would be clear from these facts that the Managing Director has wrongly appropriated to himself the sum of Rupees 47,000. It, therefore, seems to us strange that he should be said to have transferred the land to the company for a consideration of Rupees 47,000. The company today is in possession of the building as well as the land and whatever may be the complications arising out of the duel ownership of the building and the land, the company could not be dispossessed, save through a proper action.(34) Finally, as we have stated earlier, the object of a scheme of reconstruction must be to enable the company to tide over a temporary difficulty andits business. This company has not only large liabilities and meagre assets but as matters stand today it has neither a place to carry on its business nor the equipment with which to conduct it. The company owns six acres of land, three acres from out of which are to be sold under the scheme. The remaining three acres are in the possession of the Bajaj Electricals Limited and the Lunar Caustics Limited. The building on the Laxmi Road is mostly in the possession of tenants and, besides, the company will not be able to do its business in the building. That is about the place of business. As regards the machinery and equipment, the entire machinery which belonged to the company and with which it used to conduct its business has been sold by the liquidators for Rs. 1,20,000 It is from this amount that the liquidators had paid an interim dividend of 19 paise to the creditors. If the company has to start its business afresh, it will have to find a place first which in Poona is neither easy nor cheap to obtain and it will then have to buy the equipment and the machinery for which a considerable amount would have to be expended.(35) Mr. Mistry says that the business of dyeing and printing cloth which the company used to do does not require a large capital or an expensive machinery. It is not possible to agree with this submission. Theof the company at exhibit 85 would show that in 1950 it had stock in hand worth about Rs. 92,000 and in 1951, thewas worth about Rs. 61,000. Dyes and Chemicals in the respective years were of the value of Rs. 52,000 and Rs. 40,000. As stated earlier, the company has hardly any means to pay the interest on the outstanding debts. It seems to us impossible that it will be able to raise any amount for the purchase of the equipment and the machinery needed for its business. The scheme is so unrealistic and impractical that it does not even attempt to visualise where and with what equipment the company will do its business.(36) We will only cite one more reason why the scheme should not be sanctioned. That reason is by no means the least important After the trial Court decided Suit No. 835 of 1955 in respect of the building at Laxmi Road, the Official Liquidators filed a misfeasance summons on the 2nd November 1957 against the Managing Director and three other directors of the company. The misfeasance summons was stayed during the pendency of the second appeal filed by the Managing Director in this Court. The fact that the misfeasance proceedings were taken against the directors of the company is not shown to have been disclosed to the shareholders and creditors of the company. While considering the scheme, its was highly relevant whether the conduct of the Managing Director and the other directors was such that the fate of the company could be put in their hands. If the creditors were told that a Court of law had held that the Managing Director was guilty of fraud as against the company and if they were further told that misfeasance proceedings were taken against the Directors, their decision on the approval of the scheme could have been easilyquestion, in out opinion, is not who is to blame for the nondisclosure of such an important fact, but the question is whether material facts were before the shareholders and creditors who had met to consider the scheme. We are not surprised that the sponsors of the scheme did not disclose to the meeting that misfeasance proceedings were pending, because two of the sponsors of the scheme. Gopal Ganesh Ketkar and Achyut Dattarya Phatak figure as delinquent directors in those proceedings. The Managing Director of the company against whom also misfeasance proceedings are taken is the father of Achyut Dattatraya Phatak. It seems to us clear that if the creditors and shareholders were apprised that misfeasance proceedings were taken against the Directors of the company, they would not have approved the scheme under which the affairs of the company are once again relegated into the hands of the