Gaya Sugar Mills Ltd. vs Nand Kishore Bajoria And Anr.

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 24 November, 1954

Coram: Mahajan, C.J.

In this matter the Supreme Court of India considered an appeal brought by the official liquidator of Gaya Sugar Mills Ltd., who had filed an application under Section 185 of the Indian Companies Act seeking a court order that required Nand Kishore Bajoria and Mahadeolal Jhunjhunwala to pay the sum of Rs 14,77,000 to the liquidator. The background facts, as set out by the Court, were that Gaya Sugar Mills Ltd. had been incorporated in 1934 with an authorized capital of Rs 7 lakhs consisting of 7,000 shares of Rs 100 each. In 1946 the company increased its authorized capital to Rs 1 crore, of which roughly Rs 65 lakhs had been subscribed by shareholders. To obtain the remaining funds the directors issued debentures valued at Rs 25 lakhs, each debenture carrying a face value of Rs 1,000. In addition, the authorized capital included, among other classes, 2,000 fully paid-up preference shares carrying a seven per cent dividend and 28,000 fully paid-up preference shares carrying a five per cent dividend, both classes having a face value of Rs 100 each. The aggregate amount raised through the issuance of the five per cent preference shares was approximately Rs 27 lakhs. The company had raised this capital in order to pursue an ambitious expansion plan, but unforeseen circumstances prevented the plan from being carried out, leading the company into severe financial distress that ultimately resulted in its winding up. On 24 October 1949 a director of the company, who also acted as the debenture trustee, Sohan Lal Jajodia, instituted a suit in the Calcutta High Court against the then managing director, Gursharan Lal, and other parties, seeking various reliefs relating to the management of the company. The parties to that suit reached an agreement on 1 January 1950. Under the terms of that agreement the parties prepared a scheme for the future operation of the business, which was to be sanctioned by the court, and pending such sanction they agreed to take certain steps for the repayment of the debenture holders and the preference-shareholders. The scheme was prepared pursuant to Section 153 of the Indian Companies Act and was embodied in a memorandum that contained a covenant whereby each signatory promised jointly and severally to take whatever steps were necessary to give effect to the scheme. The memorandum also provided that a new Board of Directors would be constituted, replacing the existing board of Gaya Sugar Mills Ltd. The parties asserted that it was in the best interests of the company and its shareholders that the existing debenture holders be fully paid off and that the company's capital be reduced, thereby setting the stage for the subsequent proceedings before the liquidator and the present application for payment against Mr Bajoria and Mr Jhunjhunwala.

In the scheme the parties agreed that the preference shareholders would be cancelled and paid off. The existing debentures were to be redeemed by cash payment, while the preference shareholders would receive a part cash payment and the balance in the form of five per cent taxable debentures having a face value of ten lakh rupees and five per cent tax-free cumulative redeemable preference shares having a face value of five lakh rupees. It was further provided that, if required, the ten-lakh-rupee debentures that were being redeemed could be retained alive for the purpose of being re-issued to the preference shareholders under the scheme.

The assets that related to the Warsaliganj scheme were to be handed over immediately to the trustees of the debentures, who were given full authority to manage, dispose of, and sell those assets. The proceeds from any such sale were to be applied first to the redemption of the debentures, and any surplus, if it existed, was to be transferred to the preference trustees named later for the purpose of redeeming the redeemable preference shares. Messrs Nand Kishore Bajoria and Mahadeolal were appointed as the trustees for this purpose and were thereafter referred to as the Preference Trustees.

The shares held by the company in Ryam Sugar Company Ltd, together with the lands known as Chakand and Gaya, and the unrealised dividend due on the Ryam shares as well as the commission arising from the sale of Ryam sugar for the 1948-49 season, were to be vested in the Preference Trustees. The trustees were empowered to realise the dividend and commission, to sell the Ryam Sugar shares, and to sell the Chakand and Gaya lands. The net sale price of the Ryam Sugar shares was fixed at twenty-five rupees per share. Regarding the Chakand and Gaya lands, if the total sale proceeds exceeded one lakh rupees the excess was to be handed over to the company; if the proceeds were less than one lakh, the shortfall was to be made up by the company. In the same way, if the amount realised from the unrealised dividend and commission exceeded sixty-five thousand rupees the surplus was to be transferred to the company, and if it was less than that amount the deficiency was to be covered by the company.

The proceeds obtained from the sale of the aforementioned properties were to be paid to the preference shareholders. In addition to any cash payment, the preference shareholders were to receive the five per cent taxable debentures of ten lakh rupees face value and the five per cent tax-free cumulative redeemable preference shares of five lakh rupees as full satisfaction of their capital dues and any arrears of interest. The general meeting of shareholders that had been called by certain shareholders acting as requisitionists was to be abandoned, and a fresh meeting of the shareholders was to be convened in Calcutta because that location was considered convenient for the shareholders generally. The scheme also provided that steps would be taken, as necessary, for the sanction of the court and for the approval of the shareholders to implement the arrangements described above.

In accordance with the agreement dated 1-1-1950, the Board of Directors of Gaya Sugar Mills Ltd. passed a resolution on 9-1-1950 that incorporated the terms of that agreement. The resolution stipulated that, pending the court’s sanction and the approval of the shareholders for a reduction of capital and the redemption of preference shares, the shares held by the company in Ryam Sugar Co. Ltd. would be sold. The proceeds from the sale of those shares together with the proceeds from the sale of the Chakand and Gaya lands, including the structures situated thereon, were to be placed in the possession of Messrs Nand Kishore Bajoria and Mahadeolal Jhunjhunwala, who were designated as the “preference trustees.” These trustees were to hold the assets on trust, sell the lands and structures, and retain the sale proceeds of Ryam Sugar Co. Ltd. In addition, an amount of Rs 7,000 out of the proceeds from the land and structure sales was to be earmarked for distribution among the preference shareholders in the event that the court sanctioned the redemption of capital. However, the intended meeting of the creditors required by the agreement never took place, nor was any court sanction obtained for the reduction of capital. Consequently, the proposed scheme was never put into effect. Despite this, the two individuals styled as preference trustees were handed the Ryam Sugar Mills shares, which they subsequently sold for Rs 11,30,400. This sum, as admitted, remains in the possession of the trustees.

On 16-4-1951, certain debenture holders and other creditors filed a winding-up application against Gaya Sugar Mills Ltd., leading to a winding-up order on 14-11-1951 and the appointment of an official liquidator on 1-2-1952. Soon after his appointment, the official liquidator filed an application that gave rise to the present appeal, seeking an order for the recovery of Rs 14,77,000 from the two trustees on the ground that the amount was held by them on behalf of the company. The trustees acknowledged that they possessed Rs 11,39,400, not the full Rs 14,77,000 claimed by the liquidator, and argued that the sum was held in trust for the redemption of the preference shares, rendering the company not entitled to it. They further contended that the amount could not be recovered in a summary proceeding under Section 185 of the Indian Companies Act because the term “trustee” in that provision did not encompass a “constructive trustee.” The trustees maintained that, under the terms of the 1-1-1950 agreement, they were acting as trustees for the benefit of the preference shareholders. The application was heard by Judge Imam J., who held that Gaya Sugar Mills Ltd. was entitled to the Rs 11,39,400 and that the preference trustees held the money in trust for the company’s benefit. The trustees subsequently filed an appeal under the Letters Patent against this decision, while the official liquidator also filed a response.

The High Court appeal bench considered the cross-objections that related to dividends and commission. The bench held that the agreement dated 1-1-1950 was illegal because the company did not possess the statutory power to purchase its own shares by diverting its capital, nor could it reduce its share capital in the manner proposed in that agreement. The bench further held that the term “trustee” in Section 185 of the Companies Act referred only to an express trustee and did not extend to a constructive trustee. Consequently, the official liquidator could not recover the disputed sum under the provisions of Section 185. As a result, the High Court set aside the earlier order that had directed the respondents to pay the appellant a sum of Rs 11,39,400, and it dismissed the cross-objections.

The central issue that required determination on appeal was whether the High Court possessed jurisdiction, under the facts of this case, to compel the two respondents to remit the amount of Rs 11,39,400 to the official liquidator pursuant to Section 185 of the Indian Companies Act. The answer to this issue depended upon the construction of the aforementioned agreement and upon the nature of the relationship that the agreement created between the company and the two respondents. This analysis had to be undertaken in light of the directors’ resolutions up to the point at which the court sanctioned the scheme, and considering that the proposal to reduce share capital had been accepted only after all formalities prescribed by the Companies Act had been completed.

Section 185 of the Indian Companies Act provides: “The Court may at any time after making a winding-up order, require any contributory for the time being settled on the list of contributories and any trustee, receiver, banker, agent or officer of the company to pay, deliver, surrender or transfer forthwith, or within such time as the court directs, to the official liquidator any money, property or documents in his hands to which the company is ‘prima facie’ entitled.”

This provision is intended as a summary remedy designed to facilitate a speedy winding-up of a company’s affairs. For the provision to be invoked, the person against whom the order is made must be a contributory, trustee, receiver, banker, agent or officer of the company and must be in possession of money, property or documents that the company is prima facie entitled to. The court, acting as the company judge, concluded that the two respondents were trustees who possessed the sum of money to which the company was prima facie entitled. It was held that they held this money for the benefit of the author of the trust, namely Gaya Sugar Mills Ltd.

The appeal bench, however, expressed the view that although the official liquidator might have a claim to the money, that claim could not be enforced through the summary procedure laid down in Section 185. Accordingly, the bench held that the court lacked jurisdiction to pass an order under that section to compel the respondents to return the sum to the official liquidator.

It was observed that an order under Section 185 could not be granted because the term “trustee” in that provision did not extend to a “constructive trustee”. Before the Appeal Bench, a submission was made that the two respondents might be regarded as agents of the company until the proposed scheme was completed. The learned judges rejected that submission, stating that the two respondents acted in their own right and not as agents of the company with respect to the property in question. They further held that the money was being held for an unlawful purpose; consequently, a principal-agent relationship could not arise when the purpose itself was illegal. The present judgment concluded that the Appeal Bench’s view could not be upheld and that its decision must be set aside. The reversal was based on the fact that, until the scheme received formal approval by the shareholders, the creditors, and the court, and until the share capital was reduced, the preference shareholders could not acquire any rights under the scheme nor become beneficiaries of the proceeds from the sale of the shares of Ryam Sugar Company Ltd. Until that formal approval occurred, the ownership of the shares clearly remained with Gaya Sugar Mills Ltd., and the proceeds from their sale continued to be the property of the Mills. The agreement provided that a new meeting of the shareholders would be convened in Calcutta to consider the scheme and that steps would be taken for court sanction and shareholder approval as required for implementation. In this context, the covenants and directions contained in the agreement were merely proposals; until they were implemented, neither the preference shareholders obtained any rights under those proposals, nor did the so-called preference trustees acquire ownership of Ryam Sugar Company Ltd.’s shares or the immovable property that was proposed to be transferred to them and which they were authorised to sell. In other words, the agreement dated 1-1-1950 remained in an inchoate form and never became operative. Accordingly, the two respondents, Messrs Nand Kishore Bajoria and Mahadeolal, never assumed the role of trustees for the preference shareholders as envisaged in the proposed scheme. Gaya Sugar Mills Ltd. therefore continued to be the legal owner of the shares, the sale proceeds, and the immovable properties.

The next issue for consideration was the true nature of the relationship between the company and the two respondents prior to the sanction of the scheme. While awaiting court sanction, the company passed a resolution directing that the shares be sold and that the sale proceeds be placed in the possession of the two respondents for distribution among the preference shareholders in the event that a reduction of capital was sanctioned by the court. The judgment held that there was no doubt that, under the circumstances that arose, the two individuals functioned as agents of the company. Their role was to sell the shares and retain the proceeds until the scheme was either sanctioned or not. They could not be trustees under an unfinished document; therefore, the only relationship that could be recognised between them and the company was that of principal and agent, appointed for a specific purpose and to address a particular eventuality. This principal-agent relationship need not have been expressly created; it could be implied by law from the situation that had arisen due to the scheme not being implemented. Thus, the relationship was necessarily implied by the facts of the case.

In this case the Court held that the two respondents functioned as agents of the company for the purpose of selling the shares and for retaining the sale-proceeds until the proposed scheme received sanction, and that, if the scheme failed to receive sanction, they continued to act as agents of the company by holding the proceeds in custody. The Court explained that the respondents could not be regarded as trustees under the incomplete document dated 1-1-1950, and therefore the only relationship that could exist between them and the company was that of principal and agent appointed for a specific purpose and to address a particular eventuality. The Court further observed that a principal-agent relationship does not always require an express agreement; it may arise by implication of law when the circumstances of a case impose such a relationship. In the present circumstances, the Court found that the relationship was clearly implied by the fact that the scheme was never implemented, and that the exigencies of the case necessarily gave rise to an implied agency.

The Court noted that the shares were sold pursuant to a resolution of the Board of Directors of the company, and that the Board had fixed the price at which the shares were to be sold. The transfer deeds were executed by the company on behalf of the persons in whose names the shares were nominally held. The two respondents were therefore merely custodians of the amount until the anticipated event occurred. Because that event did not materialise, the property never vested in them as trustees for distribution among the preference shareholders. Instead, the Court held that they remained simple agents of the company, holding the money for the company pending sanction of the scheme. Consequently, the money belonged to the company and was in the hands of its agents, making the official liquidator entitled to its return under Section 185 of the Indian Companies Act. Since no obligation attached to the ownership of the money before the scheme was sanctioned, no trust—express or constructive—was created, and the Court concluded that the lower courts erred in deciding the matter on the basis of any trust.

The Court criticised the Appeal Bench of the High Court for concluding that no principal-agent relationship existed between the company and the two respondents under the 1-1-1950 agreement, on the ground that the respondents had acted “in their own right” in effecting the sale. The Court stated that this interpretation was plainly erroneous because the respondents possessed no independent right in the shares or the money; any right they claimed arose only from the contemplated trusteeship under the agreement that never came into force. Accordingly, they could not lawfully act in their own right in selling the shares of Ryam Sugar Co. Ltd. or in retaining the sale proceeds. The Court also expressed inability to follow the reasoning of the Appeal Bench that the scheme outlined in the agreement was unlawful, and indicated that it was compelled to observe the foregoing analysis.

In this matter, the Court observed that both the learned Single Judge and the Appeal Bench of the High Court had completely failed to recognise that no legal right could be vested in either the preference shareholders or the individuals described as trustees. This was because the instrument upon which they based their conclusions contained only proposals, was of an inchoate nature, and never reached the stage of completion or operation. The Court concluded that the reliance on such an incomplete and non-operative document was the essential reason for the error that had infiltrated the earlier decisions.

Accordingly, for the reasons articulated above, the Court allowed the appeal. It set aside the judgment of the Appeal Bench and reinstated the order originally made by the Single Judge. That order required the two respondents to return the amount of Rs 11,39,400 to the Official Liquidator of Gaya Sugar Mills Ltd, which was then in liquidation. The Court further noted that the appellant had not pressed the issues of dividend or the commission that had been raised in the cross-objections before the lower court during these summary proceedings. Consequently, the Court directed that the Official Liquidator would be entitled to recover his costs from the two respondents.