Duomatic Principle: Neither Mere Substantial Compliance nor a Normative Right

[Sahil Aggarwal is a 4th year B.A., LL.B. (Hons.) student at National Academy of Legal Research and Studies (NALSAR), in Hyderabad and Akshat Baghmar is a 5th year B.A., LL.B. (Hons.) student at Maharashtra National Law University, Aurangabad]

In its recent judgment in Mahima Datla v. Dr. Renuka Datla (2022), the Supreme Court reaffirmed the application of the ‘Duomatic’ principle in Indian jurisprudence. The relevant facts of the suit involve the letter of resignation submitted by Mr. G.V. Rao, one of the directors of the company, which was later withdrawn in one of the company’s board meetings. As such, there was no protest by Dr. Renuka Datla to such withdrawal and Mr. Rao continued to participate and vote in subsequent meetings. However, one of the subsidiary issues brought forth before the Supreme Court in the appeal was whether the issue of resignation of a director had lapsed in view of no-objection from Dr. Datla. The Court simply relied upon the Duomatic principle to settle the issue and held that “…the thrust of the Duomatic Principle is that strict adherence to a statutory requirement may be dispensed with if it is demonstrated otherwise on facts, if the same is consented by all members.” Since there was no evidence of any protest on part of Dr. Datla to the participation and voting of the director in question in the subsequent meetings of the board, it was deemed that the said resignation was clearly not accepted.

Although this is not the first time that Indian courts have applied the Duomatic principle in order to settle the issues brought before it, the pronouncement of this principle without any inhibitions can attract serious repercussions in future. In this post, we shall consider how various Indian courts have applied this principle to distinct factual scenarios and identify the adverse possibilities that could result from the lack of clarity on the requirements of the Duomatic principle.

Duomatic Principle in India

The Supreme Court in Mahima Datla indeed referred to the case from which the principle takes its name, that is, In Re: Duomatic Ltd., [1969] 2 Ch. 365, and it noted that “anything the members of a company can do by formal resolution in a general meeting, they can also do informally if all of them assent to it.” Effectively, this principle overrides the terms of the articles of association which provide the specific procedure for the mode of consent in relation to the subject matter involved. However, the Supreme Court, while referring to Bowthorpe Holdings Ltd. v. Hills (2002) cautioned that such a principle is only applicable in those cases where a bonafide and intra vires transaction has been undertaken through Duomatic means. It is notable that, in this formulation, there is no guidance as to the other legal pre-requisites (other than the requirement of consent of all members) for invocation and application of such principle. On the other hand, a review of previous judgments of courts where the Duomatic principle has been utilized further compounds this issue.

Equivalency between Substantial Compliance and the Duomatic Principle

Interestingly, in cases like Brilliant Bio Pharma Limited v. Brilliant Industries Limited  (2013) and Mazda Theatres Pvt. Ltd. v. New Bank of India Ltd. (1975), the Telangana High Court and the Delhi High Court respectively made reference to the Duomatic principle in correspondence to the notion of ‘substantial compliance’. The Telangana High Court specifically observed:

 “The thrust of the Duomatic Principle is that strict adherence to a statutory requirement may be dispensed with if it is demonstrated on facts that the substance of such requirement has been accomplished or fulfilled indirectly.” [emphasis added]

However, this equivalency drawn by the Court between the doctrine of substantial compliance and the Duomatic principle presents a potential for precarious application of the principle for many reasons.

It is important to note here that the doctrine of substantial compliance has always been understood as a defence for the party which had diverted from the formal compliance of the rules, but still managed to accomplish the underlying purpose for them. In reference to ‘doctrine of substantial compliance’, the Supreme Court in Commissioner of Central Excise, New Delhi v. M/s Hari Chand Shri Gopal, (2010) drew a distinction between mandatory and directory rules, and noted that where the rules are “directory” or “non-essential” for the orderly operation of business, such rules can be complied with substantially, if not strictly. However, in reference to the Duomatic principle, the issue which arises is whether the court must analyse such procedural formalities against the touchstone of mandatory or directory requirements for consent which can be easily dispensed with or not.

In this context, this equivalency presents a potential for two postulations with reference to the application of the Duomatic principle. One is, as some academicians such as J. C. Hardman have suggested:

Rules should be default and waivable by those who they are designed to protect. Any protections designed for third parties should, however, either be mandatory rules or only waivable by those third parties.

He further argues that the application of Duomatic principle must be made normative in the sense that wherever the shareholders feel that only their own interests are involved in a decision, such decisions can be taken without adhering to any formality of general meetings. This practice has been favoured as it reduces the agency costs for the decisions made by them. However, such a postulation invites serious criticisms.

First, such a presumptive strategy would undermine the purpose of general meetings, which is to enable debate and discussion among the members of the company. It affords the shareholders an opportunity to consider the insights of other shareholders. Second, the application of the Duomatic principle presumes that the relevant constituents (for instance, shareholders) is a homogenous class whose interests would always align directly. However, this is not the case normally, since a minority shareholder may have a different interest as against a controlling shareholder. Third, though a prima facie or substantial fulfilment of the purpose of procedural requirements can be achieved by the company instead, it would be burdensome for the courts to later consider each and every case with their distinct facts and decide on the merits whether such compliance was justified or necessary.

Brilliant Bio is one example where the High Court allowed the reduction of capital and where the Duomatic Principle was not invoked as a proper defence to estop the members of the company to go back on their previous decision[1] but as an argument for substitution of general meeting, since ‘substance compliance’ had been achieved. In such application of the principle, we strongly see the prospect for the aforementioned proposition of normative application of Duomatic principle by the companies for avoiding formalities.

Duomatic Principle: The Conundrum of a Good Reason

In complete contrast to the above, the court in the case of In re Barry Artist ltd. [1985] 1 WLR 1305, which had a similar factual scenario as Brilliant Bio, was critical of such approach but, as the company had presented a good reason for having the reduction confirmed before the end of the term, it allowed the said reduction only with the observation that in future no such order will be given in a similar case. This case exemplifies the second postulation with reference to the application of Duomatic principle and it says that the proposition of normative application of Duomatic principle must be conditioned on the presence of good reason for opting an informal procedure. An Indian example for such postulation would be the case of Dr. Jayanta Kumar v. Astha Nursing Home Private Limited (2016), wherein the Calcutta High Court held that with regards to the dispensation of the statutory requirement through Duomatic principle, though there was the assent of all the shareholders of the company, the parties must also be able to demonstrate that the decision was ‘for the benefit of the company’.

However, this idea of a good reason is vague to an extent and may also invite certain criticisms. For instance, consider the observations in the cases of Duomatic and In Re George Newman & Co. [1895] 1 Ch. 674. In both cases, a challenge was instituted against certain payments made to Directors and Chairman of the companies while they were on the verge of liquidation. In Duomatic, while laying down the principle, the Court decided to overlook the fact that no formal decision-making was carried out to back such payments in context of weakening financial position of the company. In the Newman case, in contrast, the Court observed that it was a mere speculation that a general meeting would have sanctioned the said payment without any discussion on the status of the company.   

Presume that, in a similar situation, a substantial quantum of payment is given to the director for a good reason (perhaps, a medical expenditure which has been accorded through a directory rule in articles) by the shareholders of a financially distressed company without holding the general meeting. In this situation, there is indubitably a need to reach a decision in favour of the company keeping in mind the financial status as well as the good reason to grant payment to the director. The question therefore is: in the absence of a mandatory rule, to what extent can such a power of shareholders to avoid formal decision making be condoned by the courts? This shows that even where there is a directory rule to conduct a general meeting, sometimes the presence of good reason must be balanced out with the circumstances of the company and the rules cannot be avoided normatively. It is submitted that such evaluation of the Duomatic principle does not find a place in Indian jurisprudence as of yet and thus leaves space for abuse by the decision-makers of the company, since there is no restriction as such on companies to opt for normative application of Duomatic principle.  

Conclusion

In a nutshell, there is no doubt that the Duomatic principle has utility in cases where it is invoked for the purpose of estopping the members of the company from deviating from their previous decisions. Mahima Datla is a brilliant example for this; however, previous application of the Duomatic principle in India makes it susceptible for the members of a company to reduce the Duomatic principle to mere substantial compliance. This is because, first, the Duomatic principle can possibly be utilized by third parties to estop members for overturning their previous decisions. Second, if we consider that the Duomatic principle can be made applicable in terms of substantial compliance, it leaves space for the companies to adopt the Duomatic principle in normative practice which invites serious concerns. Third, even if we consider that the criterion utilized for doctrine of substantial compliance (i.e. mandatory or directory rules) still holds relevance for the critical application of Duomatic principle, a justifiable application of Duomatic principle would demand that even a directory formal procedure must not be relinquished without any good reason (like, for the benefit of the company). In that sense, therefore, there is a legitimate requirement for solidifying the requirements for application of Duomatic principle. Notwithstanding this, the Mahima Datla judgment is a welcome pronouncement of the Supreme Court through which the Duomatic principle will definitely find increased application in the coming future.

Sahil Aggarwal & Akshat Baghmar

[1] Sarah Worthington & Paul Davies. Gower & Davies: The Principles of Modern Company Law. Sweet & Maxwell, 2012, p. 443.

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