IndiaCorpLaw

Bombay High Court on Enforcing Articles and Board Nomination Rights

The last few years have witnessed a
dispute between two families that relate to the right to nominate directors to
the board of Yes Bank. Earlier this week, the Bombay High Court issued its
judgment in Madhu
Kapur & Ors. v. Rana Kapoor & Ors.
, which seeks to resolve the
dispute – at least temporarily – and in the process clarifies some areas of
corporate law and contract law. In this post, I discuss the Court’s ruling on
some key issues and their broader implications.

Facts

Although voluminous records and
submissions were placed before the Court, the essential facts relevant to the
key questions are indeed straightforward. The dispute relates to the right to
nominate directors to the board of Yes Bank, one India’s leading private sector
banks. The Reserve Bank of India (RBI) granted a banking licence to the
promoters of Yes Bank in 2002. The original promoters of Yes Bank are Ashok
Kapur and Rana Kapoor, two individuals related to each other by marriage. They
invited subscription by Rabobank. Accordingly, Yes Bank was established with a
51% shareholding collectively by Ashok Kapur and Rana Kapoor (by themselves,
through their family members and investment entities), and with a 49%
shareholding by Rabobank. In terms of management, Ashok Kapur was the chairman
of Yes Bank, while Rana Kapoor was the managing director. Yes Bank also
completed its initial public offering in 2004.

Tragedy befell in November 2008 –
which triggered the present dispute – when Mr. Ashok Kapur became victim to the
terrorist attacks on Mumbai. After his death, Ashok Kapur’s shares in Yes Bank
were transmitted to his wife Madhu Kapur and to their children Shagun Kapur and
Gaurav Kapur. From that time, Ashok Kapur’s heirs, who are the plaintiffs in
this suit, have been seeking nominations on the board of Yes Bank, including
the nomination of Shagun Kapur. While Rana Kapoor is alleged to have made
initial assurances to accommodate the plaintiffs’ request, he has thereafter
steadfastly denied the availability of any such rights to the plaintiffs. By
way of this suit, the plaintiffs have sought to enforce their rights in the
articles of association of Yes Bank to nominate directors, including
themselves, and also to challenge the appointment of certain existing directors
of the bank, both whole-time and independent.

Articles of Association

Since the plaintiffs rely on their
rights in the articles of association of Yes Bank, their terms are vital and
hence discussed here. The articles confer special rights on the founder
shareholders. Most importantly, article 110(b) provides that so long as the
Indian Partners hold 10% shares in the company, they “have the right to recommend
the appointment of three directors collectively referred to as the ‘IP
Representative Directors’”. In addition, article 110(c) provides that Rabobank
and the Indian Partners may recommend the names of Independent Directors to the
nominations committee of Yes Bank. There is a different mechanism for
appointing the first independent directors, which is not of immediate concern.
By way of an amendment, article 127A was inserted to provide that subject to a
recommendation made by the Promoters (an expression that has not been
specifically defined), the board shall also appoint whole time directors.
Finally, article 127 provides that the Indian Partners shall have the right to
recommend the name of the chairman as well as the CEO/managing director, with
the first occupants of these positions being Ashok Kapur and Rana Kapoor
respectively. In all, the Indian Partners have rights to recommend the names of
the chairman, CEO/managing directors, the IP Representative Directors, whole
time directors and independent directors, thereby conferring upon their
extensive rights over the constitution of the board of Yes Bank.

Even more crucial to the
determination of the dispute at hand is the definition of the expression
“Indian Partners”, which has been used in the relevant provisions discussed
above. The expression has been defined to refer collectively to Ashok Kapur and
Rana Kapoor, and individually to each of them. Furthermore, each of Ashok Kapur
and Rana Kapoor has been defined individually “unless it be repugnant to the
context, [to] mean and [include] his successors, legal representatives and
assigns”. It is the interpretation of these provisions of the articles,
especially the definitions, which strike at the heart of the dispute.

Issues and Decision

In his detailed judgment, Justice
G.S. Patel sets out various issues for consideration and rules on those issues.
Here, I summarise the key rulings and reasoning, and also analyse some of the
key legal issues.

Personal
or Proprietary Rights?

The core legal question relates to
whether the bundle of rights conferred in the articles of association are
rights personal to Ashok Kapur and Rana Kapoor as individuals, or whether they
flow to their successors. If the rights are found to be personal, the
plaintiffs cannot avail of those rights. If proprietary, they can exercise
them.

From a substantive perspective,
Justice Patel has approaches the question by examining the legal nature of the
articles of association of a company. Given that they are nothing but a contractual
arrangement between the parties, he proceeds to interpret the articles on
similar lines as interpreting a contract. He finds no difficulty from the plain
language of the articles that the rights in the articles are expressly
available to “successors, legal representatives and assigns”. Moreover, the
bundle of rights granted by the articles to the Indian Partners can be
exercised by the individual specified or the successors, with the only
exception being the appointment of the two individuals as chairman and
CEO/managing director respectively. In interpreting the articles as a contract,
Justice Patel pays regard to surrounding circumstances such as the conduct of
the parties whereby Rana Kapoor had initially never denied the existence of the
right of the plaintiffs. In essence, the Court came to the conclusion that the
rights in the articles are not personal to Ashok Kapur and Rana Kapoor and that
they can be exercised by their successors, thereby indicating the proprietary
nature of those rights.

Manner
of Exercise of Rights

The next question relates to the
precise manner in which the Indian Parties can exercise the rights in the
articles. More precisely, it relates to whether they can be exercised jointly
or individually. Here, the Court was emphatic in its conclusion that the right
can only be exercised jointly. Justice Patel observes (at para 8.44):

This takes us
immediately to the second question: how is that right to be exercised? I
believe this question more or less answers itself. The right in Articles
110(b), 127(b) and 127A(a) must be exercised jointly or not at all. Nothing in
either of those Articles lends itself to an understanding that each Indian
Partner was entitled to exercise that right unilaterally, i.e., to the
exclusion of the other. In fact, this follows directly from my conclusion that
the right was not personal to the two individuals in question but accrued and
accrues also to their successors. The words in the clauses do not employ the
disjunctive at any stage. Nothing suggests that Ashok Kapur and Rana Kapoor each were entitled to a separate exercise of the right.

In buttressing this point further,
Justice Patel envisages a scenario where Ashok Kapur may have survived. Even
then, he concludes, the core of the matter would lie in how any disagreement
between him and Rana Kapoor would be resolved. They were entitled to exercise
the right jointly and not individually, and the fact that the rights have now flown
to the successors ought not to make a difference. Hence, the right can only be
exercised jointly by Ashok Kapur’s successors and Rana Kapoor, and never
singly.

Director
Nominations

The relevant articles permit the
Indian Parties to “recommend” individuals for appointment as directors. The
Court was concerned with the precise remit of this right, and whether it amount
to making a mere suggestion as to individuals who may be considered for
appointment by the company, or whether they amount to nomination of those
individuals. It concludes that if the right were merely one of making
suggestions, it was available in any event and need not have been contained in
the articles. Hence, this can only be a right to nominate. Of course, in the
end the nominees must be appointed in the manner prescribed by law, which
includes obtaining the approval of the shareholders and the requisite clearance
from the RBI as required for banking companies.

One legal question that arose is
whether by considering the nominations of the Indian Parties, the board of Yes
Bank is fettering its discretion that thereby amounts to a breach of the
directors’ fiduciary duties. The Court concludes there is no such fetter on
discretion since the actions of the board are subject to the articles.
Attention was drawn to section 179(1) of the Companies Act, 2013 that deals
with the allocation of powers between the board and the shareholders, which
makes the power of the board subject to the articles. In any event, the board
was not required to accept all nominations, particularly if the candidates were
found not to be qualified or suitable for the director post. Moreover, the
Court reemphasized the role of nominee directors whereby their allegiance is
primarily to the company and not to the shareholder that nominated them.

Individual
Directorships

Based on the conclusions arrived at
on the principal issues, the Court then goes on to consider whether
appointments already made to the Yes Bank board in alleged violation of the
nomination procedure set out in the articles are valid. While the Court
considers each director’s case separately, here I discuss some of the
principles emanating from that in a consolidated fashion. The first issue
pertained to the reappointment of Rana Kapoor as managing director. While the
plaintiffs made a number of arguments alleging the invalidity of his
appointment, including on account of non-compliance with the provisions of the
Companies Act, 2013 pertaining to related party transactions, the court refused
to entertain those objections at this stage.

In respect of certain other directors
who were treated as IP Representative Directors, where there was a unilateral
nomination by Rana Kapoor under the articles, the Court invalidated their
appointment. With respect to certain independent directors, at an annual
general meeting they were ‘treated’ as independent and as not being liable to
rotational retirement. The Court concluded that as a matter of law these
directors ought to have been appointed by a shareholders’ resolution by virtue
of section 152(2) of the Companies Act, 2013, and their placement on the board
was carried out in a manner unknown to law. Similarly, it was found that
certain whole-time directors were yet to be approved by the shareholders.

Finally, and most importantly, the
board considered the nomination of Shagun Kapur as a director. This was found
not to comply with the “joint” nomination requirement under the articles as
earlier enunciated by the Court. Furthermore, the Court refused to be drawn
into a discussion of the actions of the nomination committee in rejecting her
candidature or in evaluating her credentials on the merit. Rightfully, the
Court declined to sit in judgment over such matters, as they are not within its
purview. Consequently, the court concluded that the plaintiffs are not entitled
to a reserved seat on Yes Bank’s board.

Broader Implications

The dispute between the parties is
replete with a number of legal issues, which are of importance. While the
issues were rather straightforward, the detailed facts, background and
documentary evidence made its resolution rather complex. In all, the Court
applied legal principles and techniques of contractual interpretation to
resolve the dispute at hand. In that sense, the Court’s effort was to apply the
law to the facts of the case at hand, which it did so in an astute manner, but
it is hard to say that the legal issues themselves were controversial enough
for the Court push the boundaries of the law by laying down new principles.

In terms of broader implications,
the dispute at the outset and the judgment underscore the importance of the
articles of association of a company, particularly when there are special
provisions among identified shareholders, as was the case here. It is usually
not the case that sufficient attention is paid to detailed drafting of the
articles, but this dispute would caution against that approach. In this
particular case, however, there is no indication of inadvertence in drafting
the articles, in as much as the Court observes (in para 8.27) that the articles
are cautiously worded and that parties must have intended what they meant.

Continuing with the articles, one
issue that has not found mention is a principle that emanates from common law that
prescribes the type of rights that are enforceable when found in the articles
of association. Known as the qua member
rule, it prescribes that a shareholder can only enforce “membership” rights and
not other rights that are contained in the articles. English cases have sought
to elaborate on this rule,[1]
although none have actually attempted to define a membership right. Although
this approach of constricting the enforceable rights in the articles has
attracted its own share of criticism,[2]
the courts have not rejected it. On a wider plane, membership rights will
include the right to receive dividends (when declared), the right to attend and
vote at shareholders’ meetings and similar rights that are intrinsically
associated with being a shareholder of a company. Whether the right to nominate
directors is a membership right is a questionable proposition.

In terms of the final outcome, it
is a pyrrhic victory of sorts for both sides. While the Court has confirmed the
availability of the basket of rights in the articles to the plaintiffs, they
cannot exercise that unilaterally. They will necessary have to exercise it
jointly with Rana Kapoor. In that sense, the judgment has not resolved the
dispute, and the impasse would continue. What it has achieved is to clarify the
relative legal rights of the parties, which would provide a platform on which
the parties may take further efforts to break the deadlock. As the Court has
observed, an ultimate breakthrough can be achieved only when the articles are
amended to untangle the situation.



[1] Rayfield v Hands [1960] Ch 1; Eley v Positive Government Security Life Assurance Co Ltd (1876) 1
Ex D 88 (CA); Hickman v Kent or Romney Marsh Sheepbreeders
Association
[1915] 1 Ch 881.

[2] See, RR Drury, “The Relative Nature of a Shareholder’s Right to
Enforce the Company Contract” (1986) 45 Cambridge
Law Journal
219-246.