The central challenge of corporate governance is to align the interests of ownership and management, and their role in ameliorating problems arising from conflicts of interest. Diffused ownership structures result in a management that is not held accountable for its actions, because small shareholders lack the incentives to act as watchdogs, creating principal-agent problems. On the other hand, large shareholders are in a better position to absorb the costs of monitoring and have the necessary voting power to influence corporate decision-making, but this, in turn, leads to principal-principal conflicts between majority and minority shareholders.
In the battle that played out before the NCLT in the Tata-Mistry case, the Pallonji family (owning 18 per cent of Tata Sons) put forward a case of principal-principal conflict, alleging oppression and mismanagement (Section 241 of the Companies Act, 2013) against Ratan Tata and the trustees of the Tata Trusts, among others, being collectively majority owners. Broadly speaking, the petitioners alleged that the stipulations in the Article of Association of Tata Sons (including the Trusts nominating 1/3rd of the Directors on the Board; decisions requiring an affirmative vote of a majority of Directors nominated by the Trust; and, the requirement that decisions on six specific aspects to be placed before the board) were being used by majority owners (Ratan Tata and Noshir Soonawala) as “shadow directors” to control, and force decisions at the board level that prejudiced the minority. To demonstrate this, various incidents were raked up, including the Corus acquisition and the AirAsia deal.
On July 9, with some rather florid prose, the NCLT dismissed the petition of the Pallonji family companies. Apart from dealing exhaustively with individual allegations and largely negating the contentions of the petitioners, it made important observations on corporate governance principles, adding to our country’s jurisprudence.
As the Tata group has evolved from a family-run business to what it is today, it has created a unique model of engaged ownership, where the Tata Trusts own 66 per cent stake in Tata Sons Ltd (an unlisted entity) which, in turn, holds significant shareholding (broadly over 20 per cent, in each case) in downstream listed operating companies, such as Tata Steel and Tata Motors. This allows professional management to run the operating companies, while allowing the Trusts to actively monitor the management and ensure that the operating companies adhere to the values and ethos associated with Tata name, with the Trusts essentially performing a stewardship function. Traditionally, the chairman of the Tata Trusts, Tata Sons and the operating companies was one and the same. This, incidentally, is a model followed the world over. The controlling stake in Maersk, for instance, is held by A P Moller Holding, which is wholly held by the A P Moller Foundation (the Maersk family foundation). Ane Maersk Mc-Kinney Uggla is currently the chairman of the foundation and the holding company, and is the vice-chairman on the board of Maersk itself, ensuring engaged ownership and a preservation of the group’s core values.
When Cyrus Mistry assumed the role of executive chairman of Tata Sons in 2012, and chairmanship of the operating companies, it was for the first time that the chairman of the Tata Trusts (Rata Tata) was different from the chairman of the Tata Sons and the operating companies. Mistry’s removal in 2016 was occasioned by the majority shareholder, i.e. Tata Trusts, losing confidence in him.
In its judgment, the NCLT identified the fact that a principal-agent dispute was being projected as a principal-principal conflict between majority and minority shareholders. The NCLT went to the extent of stating that the removal of Mistry occasioned “heartburn”, causing the petitioners to allege oppression and mismanagement as a device to project previous business decisions as acts of mismanagement. The NCLT concluded that Mr Mistry’s remedy lay in a civil court, and that “(h)is removal as executive chairman cannot become a ground to construe it as grievance of minority shareholder.”
The NCLT also held that corporate governance does not take precedence over corporate democracy, but is a part of corporate democracy. In other words, the influence of the majority shareholder on corporate decision-making cannot be overturned under the statute, unless the decisions under challenge are proved to be unfairly prejudicial to the complaining minority, in which case corporate governance principles are triggered to act as a check on the majority’s influence in corporate democracy. The NCLT, in refusing to interfere with the AoA, found nothing unusual in a majority shareholder taking an active role in decision-making through “majority rule”.
The first lesson from this saga, from a structuring standpoint, is that it may not make sense for holding companies and operating companies to have a different chairman from an upstream family trust which has a controlling stake. The second takeaway is that, in law, active stewardship of a controlling shareholder, as a part of corporate democracy, shall not tantamount to prejudicial meddling. Indeed, the NCLT has taken forward the views of the Supreme Court in the celebrated Kalinga Tubes decision of 1965, which held that oppression requires proof of “burdensome, harsh and wrongful” acts which impact the proprietary rights of the minority shareholders, and that mere loss of confidence between majority and minority is not sufficient.
Mukesh Butani is partner at BMR Legal; Karan Lahiri is a Supreme Court advocate. Views are personal.