Arbitration of oppression and mismanagement disputes

Jun 10 2013, 20:25 IST
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SummaryAll hope is not lost for investors as the remedy is available despite there being an overarching arbitration clause

Debashish Sankhari & Satyajit Gupta

All hope is not lost for investors as the remedy is available despite there being an overarching arbitration clause

Can disputes of oppression and mismanagement in relation to the affairs of a company be adjudicated through arbitration? This would be an important question for many a financial investor (and even a long-term strategic investor) who has agreed to arbitration clauses in the investment/shareholder agreements, and which may also have been incorporated in the articles of association of the company. Such investors draw comfort from the knowledge that in the event of any unilateral move(s) by the promoters, which may prejudice the company or their investment(s), they would have the ability to challenge such act(s) by invoking their rights against ‘oppression and mismanagement’ under the provisions of Companies Act, 1956.

However, this notion has come under a cloud in various matters before the Company Law Board (CLB), the adjudicating authority for oppression and mismanagement disputes. Typically, in response to an allegation of oppression and mismanagement raised by a party, the counterparty raises the objection that given the existence of a valid and binding arbitration agreement between the parties, CLB is bound by law to refer the matter to arbitration. This argument is based on the provisions of the Arbitration and Conciliation Act, 1996 (Arbitration Act) that require a judicial authority to compulsorily refer the matter of dispute to arbitration upon application of a party made in accordance with the Arbitration Act.

As developed through judicial precedents, for a matter to be referred to arbitration, the following elements need to be satisfied: (1) there is an arbitration agreement (in writing), (2) a party to the agreement brings an action in court against the other party, (3) the subject matter of the action is the same as the subject matter of the arbitration agreement, and (4) the other party moves the court for referring the parties to arbitration before it submits its first statement on the substance of the dispute.

Where any one of the above conditions is not satisfied, the answer is simple. There can be no reference of the matter to arbitration. However, in a situation where all the above conditions are met (for example, the shareholders’ agreement, to which the company is also a party, is comprehensive and all the key governance and share transfer related provisions are incorporated in the Articles of Association of the company, which is normally done), the matter is trickier. Would it mean that the matter has to be mandatorily referred to arbitration as per the Arbitration Act? The dilemma exists because the rights against oppression and mismanagement are enshrined in and arise from the statute book, i.e. the Companies Act, 1956, itself. This, effectively, amounts to saying that because the requirements under the Arbitration Act are met, therefore, even claims for enforcing statutory rights must be referred to arbitration, as the provisions in the Arbitration Act are mandatory in nature.

The CLB has attempted to resolve the above dilemma by concluding that the test to determine as to whether the matter/ claim of oppression and mismanagement is to be relegated to arbitration is to examine as to whether the allegations of oppression/mismanagement can by adjudicated without reference to the terms of the arbitration agreement. In other words, the nature of the allegations should be such that if established, it could definitely be declared as an act of oppression/mismanagement. In such cases, the matter cannot be referred to arbitration. In coming to this conclusion, the CLB has also noted that to provide relief in circumstances of oppression/mismanagement it has wider powers (under Section 402 of the Companies Act) than an arbitral tribunal. Effectively, where the claims/allegations made are such that they indicate, on a preliminary basis, that oppression/mismanagement looks likely and needs to be taken up on further merits, then, given the wider powers of relief vested with the CLB, only the CLB can adjudicate the matter further on merits.

The above thought process of the CLB is in line with a recent decision of the Supreme Court, that deals, at a more fundamental level, with the kind of matter can be referred to arbitration, which is essentially a private dispute resolution mechanism.

In the matter of Booz Allen & Hamilton versus SBI Home Finance ((2011)5 SCC 532) the Supreme Court has examined in fair detail the issue of what kind of disputes are amenable to arbitration (and therefore must be referred to arbitration as per law) and kinds of disputes that cannot be referred to arbitration but need to be dealt with exclusively by courts of law or specific tribunals/authorities constituted for the said purpose. In determining this question the Supreme Court pointed out that usually actions in rem, i.e. actions pertaining to the rights of a person(s) against the world at large (for example, criminal offences, matrimonial disputes, insolvency/bankruptcy matters, eviction matters, etc) are considered to be non-arbitrable by their very nature as opposed to actions in personam, i.e. actions determining the rights and obligations of only the parties to the matter in question, which are considered amenable to arbitration. Only courts of law have the jurisdiction and powers to provide the appropriate relief in matters pertaining to actions in rem, e.g. winding up order can be issued by a court of competent jurisdiction only and not an arbitral tribunal. The Supreme Court has, however, clarified that this is not a rigid or inflexible rule. Disputes relating to sub-ordinate rights arising from rights in rem have always been considered to be arbitrable.

Given that the remedy against oppression and mismanagement is statutorily based on the provisions of the Companies Act and that the CLB has been vested with widespread powers (Section 402) including the ability to issue orders binding on third parties dealing with the company in question (for example, terminating, modifying or setting aside any agreement(s), unwinding any sale/ transfers which constitute a fraudulent preference, directing a shareholder to buy out other shareholder(s) etc), the response to the original question would be that where the allegations of oppression and mismanagement are such that, on a preliminary examination, oppression/mismanagement can be proven independent of the terms of the private agreement, then the matter would be taken up further on merits by the CLB, notwithstanding, any on-going arbitration proceedings. As such, all hope is not lost for investors who feel aggrieved by the unilateral moves of the promoters, as the remedy against oppression and mismanagement is available despite there being an overarching arbitration clause in the private agreement(s).

Debashish Sankhari is partner and Satyajit Gupta is senior associate with AZB & Partners, Delhi

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