In Re: Tri-sure India Ltd. Richard laurence parish (Jr.) and others

Bharucha, J.

(Dated December 8, 1980)

The petitioners were signatories of a prospectus which invited the public to subscribed for shares of Tri-Sure India Ltd. (now referred to as "Tri-Sure"). The prospectus contained mis-statements. The petition is filed under the provisions of s. 633 of the Companies Act, 1956, to relieve the petitioners of the liability under s. 633 of the Companies Act for making the mis-statements.

On 12th February, 1960, a company called the Indian Flange and Mfg. Co. Pvt. Ltd. was incorporated in West Bengal as a private limited company. Its shareholders were the nominees of American Flange and Mfg. Co Pvt. Ltd. (now referred to as "American Flange"). On 22nd April, 1960, Tri-Sure''s name was changed to Tri-Sure India Pvt. Ltd. On 17th June, 1960, Tri-Sure was authorised to issue 3,00,000 equity shares of Rs. 10 each on condition that within 24 months from its incorporation American Flange would sell 49% of its voting capital to Indian nationals at par. On 1st August, 1962, the registered office of Tri-Sure was moved from Calcutta to Bombay.

Tri-Sure manufactures flanges and bungs (barrel stoppers) at Mahul, Bombay.

On 7th March, 1963, Herbert Wheaton, the second petitioner, American Flange''s Vice-president, Operations, became a director of Tri-Sure. On 20th October, 1965, Charles Grundy, the fourth petitioner, was appointed a director of Tri-Sure. On 3rd May, 1968, Richard Parish, the first petitioner, American Flange''s President, was appointed a director of Tri-Sure. On 23rd November, 1971, Albert Parker was appointed a director of Tri-Sure. On 1st January, 1972, he was appointed and took charge as Tri-Sures'' whole-time director.

On 20th November, 1973, Tri-Sure authorised capital was increased and 2,53,336 fully paid-up equity shares were issued to and subscribed by American Flange and its nominee. On 25th July, 1974, Tri-Sure decided to dilute the holding of American Flange to 49% by a public issue of 2,63,680 equity shares of Rs. 10 each. On 30th July, 1974, Tri-Sure appointed the first National City Bank, the managers of the proposed issue. On 9th December, 1974, the Controller of Capital Issues consented to the proposed issue of 2,63,680 equity shares of Rs. 10 each for cash with a premium of Rs. 7.50 per share.

On 20th January, 1975, Hegde wrote to Parish at New York setting out the efforts that he had made in regard to Tri-Sure. He concluded by suggesting that he should be appointed the managing director of Tri-Sure. On 21st January, 1975, Hegde was appointed Tri-Sure''s managing director.

On 20th February, 1975, Tri-Sure became a public company by passing appropriate resolution.

Between 21st and 26th February, 1975, printers proof''s of the prospectus issued in regard to the public issue were considered at meetings in Bombay at which Parish, Grundy and Hegde were present. The evidence as to what transpired at these meetings is relevant to the determination of this petition and I will consider it in due course. On 26th February, 1975, at a meeting of Tri-Sure''s Board, the prospectus was signed. It was filed with the Registrar of Companies and issued.

The shares which were issued were fully subscribed and were allotted.

On 3rd October, 1975, Wheaton in the USA received a telephone call from an employee of Tri-Sure named Singaravelu. Singaravelu said that he had much to report about Tri-Sure and its accounts. Wheaton asked Singaravelu to contact Grundy. Singaravelu thereupon telephoned Grundy who was in Calcutta. Singaravelu met Grundy in Calcutta on the night of 4th October, 1975. Grundy has deposed that Singaravelu told him that at the end of August, 1975, the stocks produced by the Tri-Sure had been removed from Tri-Sure godown to avoid auditors'' inspection and had been secreted in outside warehouses. Singaravelu had the addresses of two such warehouses where some of the stocks lay. Grundy and Singaravelu thereupon spoke to Wheaton of this over the telephone.

On 6th October, 1975, Grundy spoke to Parish in the U.S.A. over the telephone and discussed what Singaravelu had disclosed. Parish suggested that a special investigative audit should be carried out by Ferguson & Company, Tri-Sure''s chartered accounts in Bombay. Parish said that Wheaton would be coming immediately to Bombay and that Fergusons'' investigation should not start till he arrived. Grundy got the requisite authority by telex from Parish and authorised Fergusons to carry out a special investigation audit of Tri-Sure.

On 1oth October, 1975, Wheaton came to Bombay. He has deposed that he was met at the airport by Grundy, Hegde and a representative of Fergusons. They went directly to Tri-Sure''s plant. Wheaton told Hegde that he had information that the goods which had been shown as shipped were secreted in outside warehouses and that Tri-sure''s account were in a mess. Hegde first said that this was because Tri-Sure''s own warehouses was full. This was discovered to be false. Wheaton asked Hegde to bring to his office Tri-sure''s production and sales manager and accountant and Hegde''s personal assistant so that Wheaton could confront them with his information. When they came, they first denied the correctness of it but then they admitted that there were goods in outside warehouses. Hegde state that there were orders for some of those goods and he would get orders for the rest. The accountant, Rammurthi, read out some in voices. In Wheaton''s words, "the invoice reading was an attempt to juggle". Wheaton, Hegde and the Ferguson man then proceeded to the outside warehouses and found in them goods which were shown as shipped in Tri-Sure''s books.

On 10th October, 1975, Fergusons commenced his resignation the Special investigative audit.

On 17th October, 1975, Hegde tendered his resignation as a director of Tri-Sure with immediate effect.

On 10th December, 1975, an inspector was appointed under the provisions of s. 209A of the Companies Act to inspect Tri-Sure''s books.

On 20th April, 1976, the special investigative audit report was made by Fergusons. It disclosed that there had been a wholesale fabrication and falsification of Tri-Sure''s books of account and records for the years ended 31st August, 1974, and 31st August, 1975.

On 28th April, 1976, Tri-Sure issued a notice convening its annual general meeting for the year ended 31st August, 1975. Along with the notice was enclosed a complete copy of the special investigative audit report. The directors'' report for the year ended 31st August, 1975, stated that this report disclosed that some of the statements in the prospectus were incorrect and could be justified. The directors offered to refund to all allottees of shares who claimed to have subscribed for the shares by reliance on the representations made in the prospectus all moneys paid towards allotment with interest at the rate 6% p.a. from the date of allotment. 595 members took advantage of the offer.

On 1st/2nd June, 1976, Tri-Sure''s books of account, records and files were seized by the I.T. authorities and not returned till about the end of 1977.

On 9th July, 1976, the inspector appointed under s. 209A of the Companies Act made his report. No copy of it was sent to Tri-Sure because it was confidential. The court has not had the benefit of seeing it.

On 10th September, 1976, on the requisition of American Flange, an extraordinary general meeting of Tri-Sure was convened and a special resolution was passed to the effect that the holders of equity shares who had subscribed to the fresh issue but had not taken advantage of the abovementioned offer should be returned the premium amount of Rs. 7.50 per share.

On 5th March, 1977, the Registrar of Companies wrote to Tri-Sure stating that the figures of sales for the year ended 31st August, 1974, as mentioned in the prospectus were not correct and that the statement therein under the heading "present activities", that 30% of the 1972-73 production of Tri-Sure had been exported was not based on correct data. The untrue statements in the prospectus, the Registrar stated, attracted the penal provisions of s. 62 and 63 of the Companies Act. On 25th April, 1977, the Tri-Sure''s advocates replied to the Registrar.

On 24th March, 1977, this court confirmed the reduction of Tri-Sure''s capital, as a result thereof the premium amount of Rs. 7.50 per share was returned to all allottees.

On 25th April, 1977, the petitioners filed this petition.

What precisely was done in regard to the production and sales of Tri-Sure''s products and the falsification and fabrication of its books, the fraud, as I shall briefly call it, has not been the subject of evidence before me. Wheaton obtained notarised statements from senior members of Tri-Sure''s staff. These are on record. The makers thereof were not subjected to cross-examination. I do not propose to rely upon those statements, except to note that one and all say that Hegde was the one who directed the fraud and compelled Tri-Sure''s staff to do his bidding. Criminal complaints filed against Hegde and some members of the staff filed by Tri-Sure and by the Registrar of Companies are, it must be noted, pending. Nothing that is said here should prejudice the parties to those proceedings.

The special investigative report made by Fergusons is also on record. Those who made the investigations and wrote the report have not been examined. A suit filed by Tri-Sure against Fergusons for defaults in carrying out the audits is pending; the parties to it must also not be prejudiced. I do not, therefore, propose to rely upon the report except to note that for a period of two accounting years, Tri-Sure''s books of account were false and fabricated as were all supporting documents.

It is enough to recite, briefly, what is stated in Tri-Sure''s complaint against Hegde and others in regard to the fraud. The sales figures for the year ended 31st August, 1974, were inflated by about Rs. 5,50,000 and for the year ended 31st August, 1975, by about Rs. 1,05,000. The way this was done is said to this : During the year 1973-74, in respect of oral or written orders received by Tri-Sure, which it was not possible to execute during that year, the sales department of Tri-sure was asked to raise invoices. The amounts thereof were entered in Tri-Sure''s books as if the sales had been completed. Even though deliveries had not been made, Tri-Sure accountant was asked to prepare false delivery challans. These invoices and challans were not parted with by Tri-Sure. When, in the next financial year, deliveries were made, as per the orders, fresh sets of invoices and challans were prepared and sent to the customers. Carbon copies of the first set of invoices were kept on the Tri-Sure''s records for inspection by the Tri-Sure''s auditors. Carbon copies of the second set of invoices and challans were destroyed. The amount of sales shown by the first type of invoices was shown in Tri-Sure''s books as debts due Tri-Sure. During the year ended 31st August, 1974, goods of the value of about Rs. 3,50,000 were shown sas sold though not even manufactured. For the year ended 31st August, 1975, the fraud was continued to be practised so that the manipulations of the previous year should not come to light. Since genuine orders could not now be anticipated in proportion to the inflation a larger quantity of goods was manufactured than was justified by the pending or expected orders. Books and records of Tri-Sure relating to stores were falsified. During the last days, August, 1975, stocks of finished goods lying with Tri-Sure were sent out for storage in outside godowns so that at the year end stock-taking, the auditors would not raise queries.

So much seems clear that production was shown of goods which had not been produced; and sales were shown of goods which did not exist; that the books and records of Tri-Sure were fabricated and falsified to show a false picture; and that this could not have been done without the complicity of much of Tri-Sure''s senior staff. That the figures of profit and sales in the prospectus are incorrect and that the statement in the prospectus that 30% of the production of Tri-Sure in 1072-73 was exported is incorrect is admitted.

The petition was first argued before me on the basis of affidavits. When I indicated to the petitioners'' counsel that I was not satisfied, the petitioners elected to lead evidence. The evidence of Wheaton, Grundy and Parish was led, in that order.

It is necessary first to construe s. 633 of the Companies Act as applicable to this case. It reads thus :

"633. power of court to grant relief in certain cases. - (1) If any proceeding for negligence, default, breach of duty, misfeasance or breach of trust against an officer of a company, it appears to the court, hearing the case that he is or may be reliable in respect of the negligence, default, breach of duty, misfeasance or breach of trust, but that he has acted honestly and reasonably,, and that having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused, the court may relieve him, either wholly or partly, from his liability on such terms as it may think fit :

Provided that in a criminal proceeding under this sub-section, the court shall have no power to grant relief from any civil liability which may attach to an officer in respect of such negligence, default, breach of duty, misfeasance or breach of trust.

(2) Where any such officer has reason to apprehend that any proceeding will or might be brought against him in respect of any negligence, default, breach of duty, misfeasance or breach of trust, he may apply to the High Court on such application shall have the same power to relieve him as it would have had if it had been a court before which a proceeding against that officer for negligence, default, breach of duty, misfeasance or breach of trust had been brought under sub-section (1).

(3) No court shall grant relief to any officer under sub-section (1) or sub-section (2) unless it has, by notice served in the manner specified by it, required the Registrar and such other person, if any, as it thinks necessary, to show cause why such relief should not be granted."

Section 633 confers upon the Court the somewhat exceptional power to excuse a petitioner from prosecution for and the liability of an act which has, under the Companies Act, penal consequences. The power must, in my view, be circumspectly exercised. Before excusing a petitioner the court must be reasonable satisfied that he has acted in doing the act, which has penal consequences under the Companies Act, honestly are reasonably, and that, having regard to all the circumstances of the case, including those connected with his appointment, he ought fairly to be excused. Section 633 does not contemplate adversary proceedings in the ordinary sense : a petition under s. 633 cannot be compromised nor can the court relieve the petitioner by an order made in invitum, for it has to be, as aforesaid, reasonably satisfied. The Registrar may, of course, state that no prospectus would be launched against the petitioner, in which case the petition would not survive. The relief under s. 633 is, as the use of the word "may" implies, discretionary, the discretion to be judicially exercised.

Mr Chagla for the petitioners referred to the judgment in Pyare Lal Bhargava Vs. State of Rajasthan, , and to the interpretation place therein on the word "appears" in s. 24 of the Evidence Act. The Supreme Court said that the appropriate meaning of the word "appears" was "seems" and it imported a lesser degree of probability than proof. Mr Chagla submitted, therefore, that under s. 633 something less than proof or satisfaction was required. The Supreme Court construed the word "appears" in the context of s. 24 of the Evidence Act whereunder a confession is to be treated as irrelevant if it appeared to court to have been caused by inducement, threat or promise. Even in that context the court said that the standard of a prudent man was not displaced and a court''s opinion based on pure surmise was not warranted. In my view, Mr. Chagla''s submission that something less than proof or satisfaction is required by s. 633 is not tenable. In the context of s. 633, the expression "appears to the court" must mean that the court is reasonably satisfied that the requirements of the section are met.

I turn to consider the authorities on s. 448 of the English Companies Act, 1948, and s. 372 of the English Companies Act, 1929, which are the sections therein equivalent to s. 633 In re Duomatic Ltd. [1969] 1 All ER 161 , Buckley J. said that s. 448 enable the court to grant relief where three circumstances are shown to exist. First of all, the position must be such that the person to be excused is shown to have acted honestly, Secondly, he must be shown to have acted reasonably. And, thirdly, it must be shown that, having regard to all the circumstances of the case, he ought fairly to be excused. The learned judge dealt with the question of reasonableness of action thus : He said that a man would be shown to have acted reasonably if he was acting in the way in which a man of affairs dealing with his own affairs with reasonable care and circumspection could reasonably be expected to act in such a case, for, such an imaginary character would take pains to find out all the relevant circumstances.

In re Barry and Staines'' Linoleum Ltd. [1934] 4 Comp Cas 196; [1934] 1 Ch. 227 , Court said that the jurisdiction ought to be exercised with great care.

In re Guit Edge Safety Glass Ltd. [1940] 10 Comp Cas 244; [1940] 1 Ch. 495 , Crossman J. said that what he had to consider in the case, having satisfied himself as to the first two conditions of the exercise of the jurisdiction, that is to say, honesty and reasonableness, was whether, having regard to all the circumstances of the case, including those connected with their appointment, the petitioners ought fairly to be excused for whatever their particular default is, negligence, default breach of duty or breach of trust. The petitioners in that case had ceased to be directors as a result of the reduction of the company''s capital. The shareholders of the company opposed the application and the court said that that was only one of the circumstances which it had to take into account. It held that the petitioners had no idea that they had ceased to be directors and that since no loss had been caused to the company, the petitioners should be excused.

There are also useful judgments on s. 633 itself. In Re: East India Hotels Ltd., there was a default in compliance with the Companies (Acceptance of Deposits) Rules, 1975. The company had asked for an exemption but the request was turned down. After some months, the company secured the excess deposits by creating a trust. In the meantime, the directors filed an application under s. 633. The Calcutta High Court held that since there had been no further violation the petitioners should not suffer the consequences of the default which had been committed but which they had made up.

In re Tolaram Jalan and In Re: Tolaram Jalan and Others, , the default of the petitioners was that the balance-sheet and the profit and loss account of the company of which they were directors had not been filed in time. It was urged that the omission was unreasonable inasmuch as accounts even for previous years had been delayed. The court held that that was an ommission with which the court was not concerned.

In Om Parkash Khaitan v. Shree Keshariya Investment Ltd. [1978] 48 Comp Cas 85 the Delhi High Court was concerned with a solicitor-director''s petition. He was also the company''s legal adviser. A number of defaults and breaches were committed by the company in relation to its obligations arising under the Essential Commodities Act, the Companies Act, the Sales Tax Act, the Employees'' Provident Funds Act and the Employees'' State Insurance Act. The petitioner apprehended penal consequences. It was held that it was necessary to make a distinction on between directors who were in effective control of the company''s management and affairs. The court held that since the object of s. 633 appeared to be to provide against undue hardship in deserving cases, it was proper to give relief from liability to persons, who, though were liable in law, ought to be excused rather than subjected to legal proceedings.

Bearing in mind these interpretations of s. 633, I propose to consider the first requisite of its application; in other words, have the petitioners acted honestly ?

Till 20th February, 1975, Tri-Sure was a private limited company. Its shares were fully owned by American Flange and its nominees. Wheaton had testified that by reason of the inflation of the figures of sales and profits for the years ended 31st August, 1974, and 31st August, 1975, Tri-Sure had paid, needlessly, Income Tax in the sum of Rs. 38 lakhs for the late year; whereas the total of the public issue was Rs. 46 lakhs. This suggests that the owners of Tri-Sure''s shares, represented on Tri-Sure''s board by the petitioners, lost rather than gained by the fraud.

When Singaravelu gave first indications of the fraud to Grundy, the petitioners acted very promptly to have the fraud fully investigated. Grundy immediately telephones Wheaton. Wheaton conferred with Parish. Parish conferred over the telephone with Grundy. Parish then sent a telex authorising Fergusons to undertake the special investigative audit, which commenced within 5 days of the disclosure by Singaravelu. Wheaton flew to Bombay, also within 5 days of Singaravelu''s disclosure, to catch the goods in the outside warehouses and confront the perpetrators of the fraud with that evidence. The promptitude with which the petitioners acted is indicative of their honesty.

When the special investigative audit report was received, the petitioners did not seek to conceal the disclosures. Rather they gave it full publicity by annexing a copy of it to the notice convening Tri-Sure''s next annual general meeting. An offer was made in the notice to those who had subscribed to the public issue that their shares would be taken back, if they so desired, and their full share value would be repaid with interest. About 600 shareholders took advantage of this offer. To those shareholders who did not take the advantage of this offer, at the instance of the petitioners, the premium amount of Rs. 7.50 was refunded. This also is an indication of the petitioners'' honesty.

Lastly, there is no evidence before me, nor have I reason to suspect, that the petitioners had participated in or had knowledge of the fraud.

On the material before me, therefore, I am reasonably satisfied that the petitioners acted honestly in signing the prospectus.

I now turn to the second requirement of s. 633 and ask; did the petitioners act reasonably ?

Until 20th February, 1975, the petitioners had been directors of Tri-Sure as a private limited company. Before I can decide whether the petitioners acted reasonably, when they signed the prospectus, on 26th February, 1976, I must be clear as to what was required of them as directors.

In re Denham & Co. [1884] 25 Ch.D. 752, it was held that it was sufficient if the directors appointed a person of good repute, competence and skill to audit the accounts and had no ground for suspecting that anything was wrong; also that directors were not bound to examine entries in any of the company''s books. Chitty J. held that the director before him was entitled to trust the auditors and that, since there was nothing which could have aroused the suspicion that the auditors were not doing their duties, the director was not guilty of such gross and wilful negligence as was equivalent to fraud, and was not liable.

In Dovey v. Cory [1901] AC 477, a director of a banking company relied on the judgment, information and advice of the chairman and general manager of the bank, by whose statements he was misled. It was held that, upon a true view of the facts before the court, he had not been negligent in the performance of his duties as a director. The argument was led by Halsbury L.C. to raise the serious question as to the responsibility of all persons holding position as directors, and how far they are called upon to distrust and be on their guard against the possibility of fraud being committed by their subordinates of every degree. He held in a celebrated sentence that "The business of life could not go on if people could not trust those who are put into a position of trust for the express purpose of attending of details of management." Lord Dovey said that a director was bound to give and exercise his judgment as a man of business on the matters which were brought before the board at the meetings which he attended and that he was entitled to rely upon the judgment, information and advice of the chairman and general manager, as to whose integrity, skill and competence he had no reason for suspicion.

In City Equitable Fire Insurance Co. Ltd., In re [1925] 1 Ch.D. 407. the directors were sought to be made liable for negligence. The court considered the duties of directors. It was said by Romer J. that in discharging the duties of his position a director must act honestly but he must also exercise some degree of skill and diligence. The care that he is bound to take is reasonable care to be measured by the care an ordinary man might be expected to take in the circumstances on his own behalf. The directors are not responsible for mere errors of judgment. They are not bound to give continuous attention to the affairs of the company. In respect of duties that, having regard to exigencies of business and the articles of association, may properly be left to some other official, a director is, in the absence of grounds for suspicion, justified in trusting that official to perform such duties honestly.

In Huckerby v. Elliott [1970] 1 All ER 189, the dictum of Romer J. in City Equitable Fire Insurance Company was applied. The court asked itself whether the appellant had any reason to distrust his co-director who was the company''s secretary and fully acquainted with its business. It found on the evidence produced that she had no reason to distrust him and could not be said to have neglected her duty.

In re Brazilian Rubber Plantations and Estates Ltd. [1911] 1 Ch.D. 425, Neville J. measured the reasonable care that a director must take in the despatch of a company''s business as being that care an ordinary man might be expected to take in the same circumstances on his own behalf.

In re Supreme Bank of India Ltd. [1964] 34 Comp Cas 34, the Mysore High Court held that it was a well established proposition of law that directors are entitled to rely upon the skill and integrity of the managing director or other principal officers of a company exercising supervisory functions provided that before appointing the managing director or officer they have been satisfied about the honesty and general competence of the appointee. If, however, circumstances come to their notice which raise reasonable doubt or suspicion about either the integrity or the competence of the person placed in charge of affairs, it is their plain duty to examine the position and take such steps as may be reasonable in the circumstances. If these are of such a character that no man with any degree of prudence acting on his own behalf would have omitted to take corrective action, it is not open to the directors to say that they continued to rely on the honesty and integrity of the managing director or other officer or to rely upon any principle of law in support of an argument that they have discharged the duty or responsibility which the law placed upon them.

In Official Liquidator, Supreme Bank Ltd. v. P. A. Tendolkar [1973] 43 Comp Cas 382, the Supreme Court held that it was a question of fact to be determined upon evidence in each case whether a director, alleged to be liable for misfeasance, had acted reasonably as well as honestly and with due diligence so that he could not be held liable for conniving at the fraud and misappropriation which had taken place. A director may be shown to be so place and to have been so closely and so long associated personally with the management of the company that he would be deemed to be not merely cognisant of but liable for fraud in the conduct of the business of the company even though no specific act of dishonesty was proved against him personally. He could not shut his eyes to what would be obvious to everyone who examined the affairs of the company even superficially.

Bearing these authorities in mind I proceed to discuss the petitioners'' contention that they acted reasonably.

The position of Hedge in Tri-Sure must first be examined. On 16th October, 1970, Hedge was appointed a consultant by Tri-Sure. He was not then concerned with the management of Tri-Sure. The day-to-day affairs of Tri-Sure were managed by American Operations Managers. On 6th January, 1972, Hedge was appointed a whole-time director. He was a required under cl. (1) of the agreement between him and the Tri-Sure to comply with the directions of the board. Subject thereto, without having substantial powers of management he had to attend to such aspects of the administration of Tri-Sure''s affairs as the board might allocate to him from time to time. Subject to such directions his duties included, inter alia, the administration of the affairs of the offence of Tri-Sure in accordance with sound business practice, under cl. 4 of the agreement, Hedge agreed to carry out faithfully and diligently such duties as the board might from time to time decide. Under cl. 7 of the agreement, Tri-Sure was entitled to terminate the agreement if Hegde disregarded or acted contrary to directions. On 24th February, 1973, the agreement to appoint Hegde as a whole-time director was renewed, in so far as his duties were concerned, the terms remained identical.

On 20th January, 1975, Hegde wrote a letter to Parish in which he said that he should be appointed the managing director of Tri-Sure. He claimed that this had been suggested by the authorities concerned with the conversion of the company into a public limited company. This is what he said :

"The crux of the matter is that unless we have our own know and trusted person holding the tile ''managing director'' which implies in effect effective control on behalf on the parent company, the public and financial institutions will try to impose their own nominee to full in such a position, as mentioned earlier."

On the very next day, 21st January, 1975, Hegde was appointed managing director of Tri-Sure. Under cl. (4) of his agreement, Hegde was required to exercise and perform such of the powers and duties of the board as the board would from time to time delegate to him subject to the board''s superintendence and control. Subject as aforesaid, he was entrusted with the management and business of Tri-Sure. Clause 10 of the agreement entitled Tri-Sure to terminate the agreement if Hegde disregarded or acted contrary to or failed to comply with the board''s directions.

Wheaton deposed that Hegde was appointed managing director pursuant to the letter written by him because he was considered to be a loyal employee and who knew the business of Tri-Sure well.

Parish deposed that when the management of Tri-Sure was to be nationalised, Wheaton and he discussed the matter and came to the conclusion that Hegde was the most outstanding and competent of Tri-Sure''s employees and they decided that he should be first appointed a director and then managing director. Parish deposed that Hegde was required to report America in advance when Tri-Sure''s policies or pricing required change and when senior staff were proposed to be appointed and he had been directed to consult Little & Co. in regard to legal matters. Apart from this, he said Hegde enjoyed autonomy in Tri-Sure''s management.

In cross-examination, Parish said that Hegde had appointed senior personnel despite the fact that he was not entitled to do so. Parish said that he was aware that Hegde had to act under the board''s supervision under the terms of his agreement with Tri-Sure. He said that effective supervision was not exercised over Hegde by Tri-Sure''s board. By his very nature Hegde would act independently and then come to the board and state what he had done. The board tried to curb Hegde''s initiative but found that Hegde was doing a good job. The board tried to keep Hegde within bounds. Wheaton and Parish had done this by writing letters to Hegde pointing out where he had exceeded his authority. They had also told him so, personally and over the telephone. Parish had occasions more than once to express displeasure to Hegde. The board had, however, found that Hegde was doing a good job. He was an Indian, he had initiative and, though he had inexperience of business matters, Parish felt that Tri-Sure needed him.

Grundy deposed that he had expressed to the American directors views against the appointment of Hegde as a whole-time director. He had done so because he had thought that better people would be available to run the business and that somebody with wider experience would be better suited.

It is noteworthy that by the time Hegde was invested with the powers of managing director, the fraud had already been in operation for two years or so and that, during these two years or so, Hegde had, under the terms of his agreement with Tri-Sure, no substantial powers of management but was subject to the directions of the board. Suffice it to say that his appointment as managing director would appear to have been made only on superficial appearances.

Wheaton deposed that he was concerned principally with production and engineering and that Parish was concerned with finance but they discussed all matters that pertained generally to the business.

Grundy deposed that the form of control to which Hegde was subject was that he was acquired to prepared statements about Tri-Sure''s progress and send copies thereof to the American directors and, often, to him. At the board''s meetings, particularly when one of the American directors was present, Hegde would report new developments and policies and there would be discussed.

Parish deposed that American Flange received from its subsidiaries and affiliates, including Tri-Sure, monthly balance-sheets, cash flow statements and report written by sub-managers from time to time. These statements, balance-sheets and reports were Xeroxed and distributed within American Flange. Parish himself received these and glanced at them to from in impression how the business in these subsidiaries was going. Detailed study was left to the departmental heads concerned and they were expected to bring to Parish''s notice what was considered relevant : financial difficulties, borrowings, anything which was out of the ordinary. Parish said this is what in fact happened.

The correspondence, statements and the reports sent by Tri-Sure to the American directors had been disclosed. The correspondence and reports pertain mainly to finance, plant and labour. The correspondence shows that the Tri-Sure was encountering financial stringency. In a letter of 20th June, 1973, by Yien, American Flange''s Financial Controller, to Hegde, Yien recorded that Tri-Sure''s explanation for shortage of funds was an was an unusual stockpiling of raw material but, after review of concerned financial statements, he saw no increase in Tri-Sure''s inventory. On 7th August, 1973, Parish wrote to Hegde that Rs. 15 lakhs available for bill market use had best be restricted to 120 days as a precautionary measure and that any extensions, such as the 60 days that Hegde had requested, taking it to the limit of 180 days permitted under the bank agreements should be treated as a red flat warning to Hegde and the board of director of Tri-Sure and that Tri-Sure were dangerously close to a serious financial problem. On 8th August, 1973, Yien called upon Rammurthi, the chief accountant of Tri-Sure, to explain why, all of a sudden, the bill acceptance had to be extended to the full 180 days limit and why additional funds were required. On 10th August, 1973, Hegde wrote to Parish to say that it was prudent to assume that all the sales collections of a month would be fully recovered during the course of the third month only and that, after it a careful examination of the financial position, Hegde felt that Tri-Sure required to have all the present bills extended to the maximum limit of 180 days. On 30th April, 1974, Rammurthi wrote to Yien that it was Tri-Sure''s practice to sen out advance pro forma invoices for expected deliveries at the time shipments were scheduled to take place. On 30th May, 1974, Parish sent a telex message to Hegde, Rammurthi and Grundy through Little and Co. to ask that Tri-Sure should not issue further pro forma invoices until they were in a position to deliver the goods and that Tri-Sure was only authorised cash against document and that the abuse of this authority was regarded as a very serious matter. The telex required that proper accounting of funds received against pro forma invoices should be sent to Parish so that the Tri-Sure''s true obligations would be known. On 7th June, 1974, Hegde wrote to Parish that payments against bills were inordinately delayed and it was for this reason that payments from major customers were collected against pro forma invoices prior to actual delivery. Hegde assured Parish that this would not be repeated in future and that Tri-Sure would collect cash from customers only when in a position to despatch goods right from the shelf. On 17th June, 1974, Yien wrote to Rammurthi recording that he and Parish were waiting to receive an accounting on the pro forma invoices and advance receipts. He said that this was a form of borrowing and borrowing should have full authorisation from the board and the board should be consulted for it. On 5th July, 1974, the background of the pro forma invoices was sought to be explained on the accounting had been sent. There is one further letter which may be noted here. On 8th November, 1974, Rammurthi wrote to Yien. He said that payments by the director general of supply and disposals had been held up and Tri-Sure was rather worried that, in the event this payment was not expedited, it would be hard put to find Rs. 20 lakhs as temporary accommodation from bank sources; he asked that he be allowed to approach the Bank of India for this facility.

Parish deposed that between June, 1974, and August, 1975, he did not get regularly in New York monthly returns of Tri-Sure''s production and quarterly returns of stocks. These, he said, were statements required by the Government and copies were endorsed to New York. He admitted that, prior to this, New York had been getting copies of these statements regularly. He said that he did not consider the reports in the form in which they were relevant and that no explanation was sought as to why copies of these reports stopped coming to New York. An affidavit made by Parish in these proceedings needs to be referred to in this connection. The affidavit is dated 30th November, 1977. In para. 2(5)D of the affidavit, Parish states that there were instances where consultation or communication with the American Flange were matters of required procedure but such procedure was not consistently followed by Hegde. Tri-Sure, he adds, was registered with the directorate general of technical development, Government of India, and, in this connection, Tri-Sure had been sending to the New Delhi monthly returns of production of flanges, bungs, etc., and quarterly returns of stocks of scarce categories of steel and flange steel. Copies of the returns when sent were also endorsed to American Flange. The returns continued to be submitted by Hedge until the production return for May, 1974, which was dated 14th August, 1974. There after, there was a gap and neither the Director-General nor American Flange received copies of such returns until that dated 29th December, 1975, for the period January-August, 1975, which was sent by the man who succeeded Hegde. Parish states that it was obvious that the reason why such reports were stopped was that, at that point, the records of Tri-Sure were being falsified on instructions by Hegde. 67. Tri-Sure''s sales figures were regularly sent to New York. They tell an interesting story. For the months ended September-October, 1973, sales are shown at Rs. 1,18,534 and Rs. 1,88,646 respectively. For the month of June, 1974, sales are shown to have risen to Rs. 25,19,766, almost 12 times the figure for October, 1973. For July, 1974, the figure is shown as Rs. 31,97,477, an increase of over Rs. 6 lakhs over the previous month. The aggregate of the sales between September, 1973, and July, 1974, are shown at Rs. 1,44,79,910. The prospectus shows sales up to August, 1974, at about Rs. 1,85,03,000; that is, that in the month of August, 1974, there were sales of about Rs. 41 lakhs. Parish deposed that when he received the sales figures for the year ended August, 1974, he was stunned that the sales had been so large, but he did not imagine that the sales had been inflated. Parish had made a statement to the inspector appointed under the provisions of section 209A of the Companies Act. In that statement he said that they in New York were stunned to see the figures of sales for the year ended 31st August, 1975, but after receiving the auditors'' report, Parish did not see any reason to question their authenticity.

Parish (and Grundy) deposed that he arrived in Bombay on 16th February, 1975, in connection with the prospectus. He was authorised to come by the Board of American Flange and was accompanied by American Flange''s Counsel on Corporate Affairs, Drabek, and its Vice-president, Financial and Planning, Yien. What is stated to have happed thereafter needs to be examined carefully, the statements and affidavits in the chronological order of their filing and the testimony in the order in which it was presented.

On 25th April, 1977, a reply was sent by the petitioners'' advocates to the Registrar of Companies, in response to his letter dated 5th March, 1977. In that letter, it was said that the petitioners had relied on information supplied by Hegde that 30% of Tri-Sure''s production for the year ended 31st August, 1973, had been exported. It was said that Hedge wanted the prospectus to mention that the company expected to export 30% of its production and this statement was included in the first proof of the prospectus but was subsequently deleted. Some of the petitioners had questioned Hegde on the statement that 30% of the production for 1972-73 had been exported before the prospectus was signed. On the basis of information and statements supplied by Hegde the petitioners had reasonable ground to believe and did believe that the statement was true.

Next in order of chronology is the petition. In para. 15 it is stated that the information relating to the exports of the Tri-Sure was supplied by Hegde and was, in fact, approved by him and the petitioners had reasonable ground to believe and did in fact believe that the statement that approximately 30% of Tri-Sure''s production during 1972-73 was exported was true. Again, in para. 24, it is stated that the petitioners had relied upon the information supplied by Hegde with regard to exports of Tri-Sure before signing the prospectus and that, at the time when the prospectus was drafted, it was Hegde who was insisting on the inclusion of a statement regarding Tri-Sure''s exports and he wanted to include a statement that Tri-Sure expected to export at least 30% of its production.

In Parish''s affidavit dated 30th November, 1977, it is stated (in para. 5) that when he was in Bombay during February, 1975, the subject of exports came up and Hegde said that the subject of exports should be included in the prospectus. Parish pressed Hegde to be certain not to overstate the figures as he was concerned that the shareholders might be misled as to what to expect in future. Parish pointed out to Hegde that a certain American Flange licensee of some 47 years had historically supplied all of the market to which the Tri-Sure was exporting. Parish asked Hegde to go back to his staff and review the matter, which Parish was advised; he did and later Hegde and Rammurthi confirmed the export figures not only to Parish but also to Grundy and Drabek some days prior to the signing of the prospectus. Again (in para. 35 of the affidavit) Parish says that he questioned Hegde at the meeting of 1975 about the export of 30% of the 1972-73 production because he thought that it was too high a figure. Similar questions were asked of Hegde in Parish''s presence at some of these meetings by Yien, Drabek and Grundy. Parish states that it would be accordingly apparent that he and his co-petitioners had made prolonged enquiries directed, as usual, to Hegde. In the same paragraph Parish says that during the preparation of the prospectus, during his stay in India in February, 1975, he distinctly detected "a great reluctance and hesitance" on the part of Hegde to verify information and data contained int he prospectus with those involved in its preparation and he recalled several instances where Hegde deliberately absented himself from some of the many meetings held in connection with its preparation.

I now turn to the evidence regarding the discussion of the export figures at the meetings of February, 1975. Wheaton was not present. He has deposed that he saw the prospectus in its final form when Parish brought it back to New York. In it Wheaton saw that 30% of the 1972-73 production was shown to have been exported. He said he asked Parish about this and Parish replied that he had taken up the point with Hegde and what he had been shown indicated that the statement was correct.

Grundy deposed that because Hegde said that Tri-Sure had export orders in hand, it was stated in the first draft of the prospectus that Tri-Sure would export 30% of its production. Hegde commented on the phenomenal exports that Tri-Sure had already made and which it had expected to make and referred to certificates of merit obtained by Tri-Sure on this account. The discussion took place, Grundy said, on 15th or 16th February, 1975, or thereabouts. The first printer''s proof of the prospectus was prepared immediately after this discussion. In the second printer''s proof, delivered on 22nd February, 1975, the statement that Tri-Sure expected to export 30% of its production did not appear because Grundy had advised that a statement which was not factual should not be made. There was a discussion about the statement that in 1972-73, Tri-Sure had exported 30% of its production. Question were asked of Hegde by Parish, Drabek and Grundy. Export orders were mentioned by Hegde and by heads of the departments, who were present, in support of the statement and Grundy was satisfied. This aspect was reverted to in Grundy''s cross-examination. In regard to the statement about 30% exports of the 1972-73 production there was, Grundy deposed, a discussion at an earlier meeting between Hegde, Parish and Yien. He said he had made a mistake in this connection in mentioning Drabek in his examination-in-chief.

Parish deposed that he came to Bombay on 16th February, 1975. He was accompanied by Drabek and Yien at the suggestion of American Flange''s board. He had no previous experience of the issuance of a prospectus and Drabek and Yien were to aid him. On 18th February, 1975, Parish and Yien went to Fergusons to meet the senior partner, Alpaiwalla. Parish said he suggested to Alpaiwalla that Fergusons should undertake an audit for the six months that had passed since the last audit. Alpaiwalla assured Parish that it was not necessary. It was suggested that an inventory should be taken. Alpaiwalla said that too was not necessary. He said that he and Ferguson''s staff had intimate knowledge and confidence in Tri-Sure''s employees and that Parish and Yien should share that confidence. . Parish deposed that between the first and second printing of the draft prospectus there was a discussion about export prospectus. Hegde wanted a statement in the prospectus about the future prospectus. Grundy and Parish wanted the prospectus to be confined to matters of fact. In the first draft, there was a statement about the exports made by Tri-Sure during 1972-73. Parish deposed that he had asked Yien, Rammurthi and Hegde to look into export figures and state whether they were correct. They subsequently stated, in the presence of Grundy and Drabek, that the figures were correct and there was no reason for Parish to doubt the statement.

Parish deposed that the figures of accounts in the prospectus were incorporated from a statement of the accounts for 5 years certified by Fergusons.

In cross-examination, Parish deposed that when he signed the prospectus he was shown by Rammurthi in Yien''s presence a working out of the figures of production and export for the year ended August, 1973, on the basis of which he believed that Tri-Sure had exported 30% of its production during that year. Parish said that he had been sensitive about the export figures of Tri-Sure which was a new entrant in the market particularly in the Middle East. Being sensitive about exports, Parish and Grundy were reluctant to incorporate into the prospectus anything which was not factual. Parish said he was satisfied with the figure of 30% export only after being shown the worked out statement by Rammurthi. He deposed that he had stated at the meetings in regard to export figures for 1972-73, that Tri-Sure had no reason to and should not exaggerate. Later, parish deposed that when the first saw 30% of the production for the year 1972-73 had been shown as exported he felt that it was a large amount and asked that he figures be shown to him. He said that "they" (presumably including Yien) came back with the statement which showed that 30% had been exported. Yien, he said, had satisfied himself of the correctness of the figure.

In cross-examination Parish averred that he had not discovered at the meetings held in February, 1975, any hesitation or reluctance on Hegde''s part to give information. After being shown his statement in the affidavit (referred to above), he said that the statement was correct and his answer in evidence was not he went on to say that Hegde had deliberately absented himself from some of the meetings in connection with the prospectus. After the recess, Parish tried to explain away the hesitation to which he had referred in the affidavit by saying that Hegde had seemed to suggest that somebody else to produce the documents required in connection with the proceedings and not be.

I cannot accept Parish''s statement that Yien was asked to go to Tri-Sure''s Office and work out the figures and that Yien had said that he had satisfied himself or that "they" (if he meant to include Yien) had come back with a statement which showed that 30% of the 1972-73 production had been exported. I cannot do so because : (a) It has never been so stated, or even indicated, in any prior statement, affidavit or testimony. (b) Yien has not been examined to corroborate Parish''s statement. (c) As Wheaton has testified, the books of Tri-Sure showed that less than 30% of its production in 1972-73 had been exported. If Yien had checked the books he would have discovered that the figure of 30% was not correct.

I also cannot accept Parishs'' gloss over the statement in his affidavit and in his testimony that Hegde was reluctant and hesitant to provide information. The phraseology employed in the affidavit is clear : was reluctant and hesitant, to "follow through and verify the information and data contained in the statements in the prospectus."

During the course of his cross-examination, I asked Parish a question. The question and Parish''s answer are reproduced :

"Q. On your own admission you were dealing with a man who, despite your rebukes, insisted on acting on his own initiative; you were stunned by the sales figures for the year ended August, 1974; you were surprised that as much as 30% of the company''s production for 1972-73, should have been exported. Did all this not suggest to you that an enquiry into the books and records of the company was necessary which by-passed Hegde ?

A : In February, 1975, when I saw Alpaiwalla he told me that 32% of the company''s debtors had acknowledge their debt to the company. He said that this was very unusual particularly when the debtors were mostly governmental agencies. For the prior year he said that the percentage had been 13% which was nearer the norm. Also, till time the exposure was made I felt that Hegde and Rammurthi were honest men. My father had carried the same impression of Hegde. In February, 1975, receivables had aged 3 months."

The answer, it will be noted, as far from satisfactory.

The factors I now set forth should have aroused the suspicion or doubt in Parish''s mind that all may not be well in Tri-Sure, notwithstanding the rosy picture painted by Hegde and the audited accounts.

(a) Tri-Sure''s perennial money problems.

(b) Accounting asked for by New York in regard to moneys received on pro forma invoices, that is, by way of price for goods yet unmanufactured and undelivered not sent despite reminder.

(c) Progressive and the phenomenal increases shown in sales from June, 1974, onwards, month by month, the effect of which was, in Parish''s wirds, to stun him.

(d) Copies of production returns from June, 1974, on wards not sent to New York.

(e) Hegde insisted on going his own way, contrary to established practice and procedures, despite rebukes from Parish and Wheaton and disagreement with Grundy.

(f) Parish''s view that Tri-Sure''s board had not exercised effective supervision over Hegde.

(g) Hegde had been reluctant and hesitant to supply information and verify data at the meetings in February, 1975, and had absented himself from some of them.

(h) Parish found the statement that 30% of the production for 1972-73 had been exported difficult to accept in view of the fact that an American Flange subsidiary was the traditional supplier to the market at which Tri-Sure exported were aimed.

In the circumstances, Parish should not have accepted at face value the figures of exports in 1972-73 provided by Hegde and Rammurthi, Parish should have done whatever he considered reasonable to determine, independently of Hegde, Rammurthi, et al, whether there was not something about Tri-Sure''s affairs which these men were trying to conceal; he did not. Parish could have communicated and discussed the aforesaid factors, or even some of them, with Grundy; he did not. Parish could have communicated the aforesaid factors, or even some of them, to Alpaiwalla of Fergusons asked for advice or insisted on an audit or some other means of investigation; he did not.

What I have just said holds as well regarding the incorrect figures of profits and sales, in the prospectus as it does regarding the incorrect statement about exports in 1972-73. Directors are entitled to rely upon the audited books of account, but not when they have reason to suspect or doubt that the books may not have been kept so as to reflect the company''s true position. I have no doubt that a reasonable man dealing with his own investment when acquainted with the factors which I have mentioned or even some of them, would have suspected that Tri-Sure''s books might not reflect the true positions and that the figures provided by Hegde and other Tri-Sure''s employees might not be correct. A reasonably man would not have signed the prospectus on the say-so of Hegde and Rammurthi and other Tri-Sure''s employee''s or upon the basis of the of the books maintained by them. This is not, as I look at it, a view borne out of hind-sight or a view no businessman would take, as Mr, Chagla submitted. To adopt the language of the Mysore High Court in the Supreme Bank of India''s case [1964] 34 Comp Cas 34, circumstances came to Parish''s notice which should have raised reasonable doubt or suspicion about the integrity of Hedge. It becomes then Parish''s plain duty to examine the position and take such steps as were reasonable in the circumstances. These circumstances were of such a characters, so plain, so manifest and so simple of appreciation that no man with a degree of prudence on his own behalf, would have omitted to, at least, look into the matter.

Mr. Chagla submitted that s. 633 took into account cases of negligence. It does. There may be cases where negligent conduct may yet be held to be reasonable. This is not one of them.

On the material before me, I am not reasonably satisfied that Parish acted reasonably.

I turn now to consider whether Wheaton can be said to have acted reasonably. He had almost the same grounds for suspicion as Parish before Parish came to Bombay in February. 1975, but did not hearken to them. Mr. Chagla urged that it was permissible for him to sign the prospectus by proxy. It is; but, it is not permissible thereby to shift or evade the responsibility of ascertaining the truth of the contents of the prospectus. I am not, on the material before me, reasonably satisfied that Wheaton acted reasonably.

Parish deposed that Parker had been practising as a patent counsel and had now retired. He had not been well enough to come to India in February, 1975, and was still in ill-health. Parker had filed an affidavit the proceedings in which he has set out matters which make it clear that he was appointed a director of Tri-Sure by reason of his special expertise as a lawyer. He could not have had knowledge of any of the factors that should have raised suspicion and doubt; certainly, there is no evidence that they or any of them were communicated to him. It is reasonable that he should expect that Parish and Yien, who were men of ascertain the truth of the contents of the prospectus before it was signed. On the material before me, I am reasonably satisfied that Parker acted reasonably.

Grundy deposed that in 1962-63 Parish''s father had asked him whether he would act for Tri-Sure; he had replied that his firm would. Parish Senior had asked whether the firm would provide two directors and had replied in the affirmative, provided that there was a businessman on the board who was based in India. Since that time, Grundt''s firm of Little and Co, and for a short while Grundy personally, have acted as Tri-Sure''s legal advisers.

Grundy deposed that a draft of the prospectus was sent to him for legal advice. At the meetings of February, 1975, his participation had been confined to legal matters. In cross-examination, Grundy said that Hegde''s instructions were that he (Grundy) should send copies of all matters which had legal implications. He could not recall any occasion on which Hegde had discussed with him a purely business matter with on legal implications.

On the record before me it is clear that Grundy was what is called a solicitor-director. As the Delhi High Court held in the case of Om Parkash Khaitan [1978] 48 Comp Cas 85, a distinction has to be made between directors who are on the board purely by virtue of their technical skill and those who are in effective control of the management and affairs of the company. It would be unreasonable, as that court said, to fasten liability on independent directors for defaults and breaches of the company where such directors appointed by virtue of their special skill or exercise but did not participate in the management.

It is reasonable that Grundy should have expected Parish and Yien to ascertain the truth of the contents of the prospectus before it was signed. There is no evidence that any of the grounds of suspicion and doubt were known to Grundy or communicated to him. On the material before me, I am reasonably satisfied that Grundy acted reasonably.

In so far as Parker and Grundy are concerned, it now becomes necessary to decide whether having regard to all the circumstances of the case, including those connected with their appointment, they ought fairly to be excused. As I have pointed out, the action of offering to take back from allottees the shares of the company and to refund to them the share value with interest and the action of refunding to shareholders who did not take advantage of the aforesaid offer the premium amount of Rs. 7 50 per share shows that there can have been no loss by reason of the misstatements in the prospectus. There is no reason that I can see why, then, Parker and Grundy should not fairly be excused from the prosecution and its consequences.

In the circumstances, I would extend the protection of s. 633 to Parker and Grundy.

I wish to make it very clear that this judgment does not indicate, and should not be read to indicate that a prosecution should be launched - or should not be launched - against Parish and Wheaton. If a prosecution is launched the court hearing it should decide it, on the record before it and independently of this judgment. It will be open to Parish and Wheaton - if it is permissible in law-to plead s. 633 again before the court hearing the prospection and the court will decide upon this plea against having regard only to the material before it.

I wish to record my appreciation of the fairness with which counsel for the petitioners and for the Registrar of Companies have brought to my attention the relevant portions of a voluminous record and the apposite law.

In the result, the third and the fourth petitioners are relieved of all liability under s. 633 of the Companies Act in regard to the misstatements in the prospectus dated 23rd February, 1975. In so far as the first and the second petitioners are concerned, the petition is dismissed. The petitioners shall pay to the Registrar of Companies the costs of the petition quantified at Rs. 4,000.

On Mr. Chagla''s application I direct that no prosecution shall, in any event, be filed against the 1st and 2nd petitioners until after 12th January, 1981.

JUDGMENT

Deshpande C.J.

(dated March 3, 1981)

This is an appeal against the judgment of Bharucha J. dated 8th December, 1980, in Company Petition No. 308 of 1977. (On appeal)

The four directors of a company named Tri-Sure India Ltd. (herein-after referred to as "the company") filed the above petition for relief under s. 633 of the Companies Act, 1956 (hereinafter referred to as "the Act").

They, with some other directors of the company, are the signatories to a prospectus dated 26th February, 1975. The company itself was originally registered in West Bengal as a private limited company on 12th February, 1960. Its shareholders were the nominees of the American Flange and manufacturing Co. P. Ltd. registered in America. The company decided to make it a public limited company and invite applications for additional share capital. On 20th February, 1975, the company became a public company by passing an appropriate resolution. A few days before the same, one Hegde was appointed a managing director of the company on 21st January, 1975. He had already been a whole-time director of the company from 1972 itself. Three of the petitioning directors are admittedly Americans and they reside in America. The fourth petitioning director, Charles Grundy, is a citizen of U.K., but resides in India is a partner of the solicitors'' firm, Little and Co. in Bombay.

The said prospectus admittedly contained two incorrect statements : (1) that during the year 1972-73, 30% of the products of the company were exported, and (2) that the figures of the sales and profits of the company indicated by reference to the year ending on 31st August, 1974, were highly inflated. The Registrar of Companies issued a show-cause notice on 5th March, 1977, calling upon the petitioning directors and other directors to explain why they should not be prosecuted for offences under s. 62 and 63 of the Act for issuing a prospectus containing untrue statements with regard to the affairs of the company. The present petition was filed by the four directors mentioned above in this court on 25th April, 1977, for relief under s. 633 of the Act relieving them from the proposed prosecution on the ground that they had acted throughout the transaction honestly and reasonably.

At the trial three of the four petitioning directors examined themselves on oath, when the learned trial judge indicated that affidavit evidence filed in support of the petition was not enough to enable him to adjudicate the points that arose in the petition. The Registrar of Companies did not think it necessary to examine any witnesses in support of the show-cause notice. Statement of the witnesses examined by one of the petitioning directors, Wheaton, are placed on record, in addition to certain other documents, though no attempt has been made to prove these by examining the authors thereof. By his impugned order dated 8th December, 1980, the learned judge held that all the four petitioning directors acted honestly. He, however, held that of the four directors, Parker and Grundy alone can be said to have acted reasonably. He was, however, not satisfied on the material placed before him that the two appellants, viz., Parish and Wheaton, had acted reasonably. Consistent with this finding, the learned judge relieved Parker and Grundy, petitioners Nos. 3 and 4, of all liability under s. 633 of the Act in regard to said prospectus. The learned judge, however, declined to so relieve the present appellants. Hence this appeal.

Before we deal with the points that really arise is the present appeal, it will be convenient to take a resume of the circumstances that ultimately led to the show-cause notice dated 5th March, 1977, and the filing of the present petition on 25th April, 1977. Even before respondent No. 1 came to know about the said inaccuracies in the prospectus, the petitioning directors had already started moving in the matter, as soon as they learnt that the figures as to sales were inflated and the stock of the products manufactured at the factory of the company with a view to prevent its detection by the auditors of the company and other directors of the company. On 3rd October, 1975, Wheaton received a telephone call from an employee of the company, Singaravelu, indicating that the accounts of the company were not true. Singaravelu was directed by Wheaton to contract Grundy. There was a meeting between Singaravelu Grundy on 4th October, 1975, at Calcutta. In the process of further discussions, Grundy appears to have learnt from Singaravelu that at the end of August, 1975, the stocks manufactured by the company were removed from the company''s godown to avoid inspection and were secreted in outside warehouses. On Parish being apprised of such diversion of goods from the company''s godown on 6th October, 1975, Parish suggested that a special investigative audit should be carried out by the companys'' chartered accountants, Ferguson and Co. Wheaton also appears to have decided to come down to Bombay from America. On getting an authority from the chairman, Parish, by a telex message, to Grundy authorised Ferguson & Co. to carry out such a special investigative audit. Wheaton arrived in Bombay on 10th October, 1975. Wheaton appears to have discovered many more irregularities and the result was that Hegde tendered his resignation on 17th October, 1975. On 10th December, 1975, an inspector also was appointed under s. 209A of the Act to inspect of the company''s books.

Ferguson & Co. submitted their special investigative audit report on 20th April, 1976. The said report disclosed that "there has been whole-sale fabrication and falsification on Tri-Sure''s books of account and records of the years ended 31st August, 1974, and 31st August, 1975."

The annual general meeting of the company for the year ending on 31st August, 1975, was convened by a notice dated 28th April, 1976. The special investigative audit report prepared by Ferguson & Co. was enclosed along with the notice of the meeting. The report enclosed with the notice disclosed that some of the statements in the prospectus were incorrect and could not be justified. The directors offered to refund share moneys with interest at 6% per annum from the date of allotment to all the allottees of shares who claimed to have subscribed to the prospectus. About 600 allottees appear to have taken advantage of this offer.

On 2nd June, 1976, the I.T. authorities seized the accounts books, records and files of the company and the said records were in their possession till the end of 1977. The inspector also submitted his report on 8th July, 1976, under s. 209A of the Act. The report being confidential was not sent to the company and was not available to the learned trial judge. On 10th September, 1976, at an extraordinary general meeting of the company, a special resolution was passed. In terms of the said resolution, holders of equity shares who had subscribed to the fresh issue were made entitled to get back the premium of Rs. 7.50 per share. There is no dispute about these facts. It is sufficient to notice even at this stage that the directors in right earnest in putting the house of the company in order as soon as they came to know about the manipulation of the accounts from Singaravelu on 3rd October, 1975. They also earnestly tried to compensate the shareholders who can be said to have been misled and put to some loss because of the misrepresentations and incorrect statements which had crept into the prospectus dated 26th February, 1975. It is not clear from the records as to when precisely the Registrar of Companies learnt about these manipulations of accounts and inaccuracies contained in the prospectus. It is, however, not in dispute that the petitioning directors started corrective process even before the Registrar had even come to know about these irregularities. Decision by the Registrar to take action obviously is long after the initiation of the corrective process commenced by the petitioners.

It is also worthwhile taking notice of the fact that of the four petitioning directors, three including the appellants are the residents of America. The Act itself makes a distinction between the obligations of the whole-time director and the other directors who are expected to look after the affairs of the company only through the eyes and ears of executive officers appointed on the spot, and it is the whole-time director such as the managing director, who is expected to be in charge of the day to day affairs of the company, and who has better opportunities to detect the irregularities and correct them in good time. It is not even suggested that the petitioning directors or any one of them has been at any time party to the conspiracy of manipulation of accounts or deliberate and intentional mis-statements in the prospectus. Their liability for such inaccurate statements in the prospectus springs from the provision of s. 63 of the Act. Sub-section (1) of s. 63 of the Act reads as follows :

"(1) Where a prospectus issued after the commencement of this Act includes any untrue statement, every person who authorised the issue of the prospectus shall be punishable which imprisonment for a term which may extend to two years or with fine which may extend to five thousand rupees or with both, unless he proves either that the statement was immaterial or that he had reasonable ground to believe, and did, up to the time of the issue of the prospectus believe, that the statement was true."

Sub-section (2) is not relevant to the points that arise in the present case. That the prospectus does include "untrue" statements in regard to the two matters specified earlier is not in dispute. Under the latter part of sub-s. (1) of s. 63 of the Act, it is open for the person authorising the issue of the prospectus, such as the present directors, to prove that "he had reasonable ground to believe, and did, up to the time of the issue of the prospectus believe, that the statement was true."

It is true that the occasion for such person to prove the reasonableness of his plea can arise only when he is prosecuted for an offence under s. 63 of the Act. There is, however, no reason why the Registrar should not take this into account, if in fact any such reasonable ground for such belief is found by him to exist on the plea of such statement being believed to have been true, even though ultimately the statement turns out to be untrue. He has a duty to find if it is necessary, expedient and proper to prosecute any one at all. This apart, s. 633 of the said Act expressly authorises the court, before which the proceedings, for negligence, default, breach of duty, misfeasance or breach of trust, are initiated against an officer to relieve him either wholly or partly from his liability on such terms and conditions as it may think fit. Sub-section (2) authorises the High Court to give to the officer identical relief when such an officer has reason to apprehend initiation of such proceeding against him. In other words, apart from the right of such person to prove, reasonable ground of his belief in the statement which subsequently turns out to be untrue on prosecution being initiated, such an officer can also persuade the court to relieve him of his criminal liability under s. 633 of the Act on proof of his honest and reasonableness and all other circumstances of the case.

The learned trial judge has found that even the appellant-directors had acted honestly in this matter. Mr. Dhanuka, the learned advocate appearing for respondent No. 1, was fair enough not to challenge this finding of the learned trial judge before us. As stated earlier, there is nothing on record to suggest any dishonesty on the part of any one of these directors excepting in the case of the managing director, Hegde, who is alleged to have been responsible for all these mis-statements and the inflation of the accounts. We may hasten to add that even his such alleged part is not subject matter of this case and anything that we may observe in regard to his role cannot prejudice or otherwise affect his defence against such possible charges against him. The learned trial judge declined to relieve the present appellants only on the ground that they have not proved that they had acted reasonably in the matter of signing the said prospectus.

The learn trial judge has relied on factors (a) to (h) (p. 440 of the paper book, part I) which, according to the learned judge, should have aroused the suspicion of the appellant-directors, suggesting that all was not well in the company notwithstanding the rosy picture painted by Hegde and the audited accounts. We have given our anxious consideration to these factors. Mr. Chagla, the learned advocate for the appellants, contends that none of these factors was enough by itself or collectively to justify any suspicion or doubt in the mind of the chairman, Parish, against Hegde or any officer of the company, and the directors must be held to have acted reasonably while appending their signatures to the prospectus by relying on the managing director, Hegde, and other executive officers of the company who were instrumental in drafting the same. We find much substance in the contention of Mr. Chagla. To begin, with, we are unable to see how the company''s perennial money problems should have aroused the suspicion of the company''s directors. In any business concern, money problems are bound to be there even when it flourishes. That money problem continued from year to year by itself cannot justify any suspicion against the whole-time managing director or against the officers of the company.

It is true that the American directors through their local officers had called upon the managing director, Hegde, to submit accounts of the moneys received on pro forma invoice and it appears that such accounts were not sent by Hegde or other officers of the company in spite of demands from them. It is not in dispute that the device of a pro forma invoice is resorted to in cases where the company requires money and invoices are issued for the goods which are yet to be manufactured. Such invoices reflect the orders placed for production. The purchasers are required to advance purchase price of the goods when the invoices are issued. It appears from the evidence of the directors of the company that they did not approve of this method of raising money. The chairman, Parish, from America had directed the managing director, Hegde, to discontinue the said practice at once. Hegde''s letter informing about discontinuation appears to have satisfied the chairman. The last such letter was written by Hegde on 7th June, 1974. Admittedly, the chairman, Parish, as also the financial adviser of the American Flange, Mr. Yien, had called upon Hegde to give an account of the moneys that were collected against the pro forma invoices, which were treated by Yien as borrowings. It also appears from the record that notwithstanding such demands for the statements of account, Hegde did not send the same. This correspondence seems to have been carried on between May & August, 1974. The company''s officers themselves did not appears to have pursued the point further. Reasonable inference from this conduct of the directors and Yien would be that notwithstanding their objection to borrow moneys by taking advances against the goods still not produced, they did not themselves think this irregularity to be of any serious character. That the same appears to us to be grave at this late stage when inflated figures are proved to have played a havoc by itself cannot justify any conclusion that non-accounting of the moneys received against pro forma invoices could have appeared to be equally grave at the time when Hegde did not send the accounts thereafter, in spite of demand from Yien and the chairman, parish.

As indicated earlier, it is not suggested that Yien and the other directors of the company did not act throughout honestly. If such an honest director did not feel it necessary to pursue this point any further, it cannot be said to be an unreasonable act on his part. It rather shows that the irregularity did not appear to them to be so grave to justify any immediate action. We will presently refers to the implications of the directors having appointed Hegde as the managing director of the company on 21st January, 1975. Suffice it to notice at this stage itself that such appointment of Hegde as the managing director about five to six months after the detection of the irregularities and the failure of Hegde to send to accounts as demanded clearly indicate the degree of irregularities involved both in taking advances against pro forma invoices and not sending the accounts for the benefit of the directors. To our mind, the conclusion is irresistible that this irregularity was not treated as of any consequences whatsoever. This alone can explain the inaction of the directors to take immediate drastic action. It is difficult for us to take subsequent events into account and judge, what appeared to every one as an insignificant act before 3rd October, 1975, to be an act of unreasonableness.

The third circumstance relied on by the learned trial judge is with regard to the phenomenal increase shown in the sales from June, 1974, onwards month by month. It is true that in his evidence, the chairman, Parish claims to have been stunned by looking at the sale figures of progressive and phenomenal increase. It is, however, not possible to isolate him impression of being stunned from what he has said immediately thereafter. He has stated in his evidence more than once that the explanations given to him were quite satisfactory and he did not find anything objectionable whatsoever, after he found that the balance-sheets pertaining thereto were duly audited by the auditors of the company. It is against worthwhile to note that though sale statements were sent month to month, the evidence is not clear as to how many days after a particular month statements were received in New York and how many days thereafter they were proceeded and placed for the perusal of the directors. It is also not clear as to with what degree of carefulness such statements were examined or required to be examined by the directors personally in the ordinary course. The directors are under no obligation to go through the account books themselves carefully and even for that matter to examine the sale statistics merely because such statements happen to have been received in their offices. Mr. Dhanuka did not draw our attention to any provision in the Act or any authority to suggest that the directors were under an obligation to examine the statements of accounts without any rhyme or reason. We have already indicated how the exact sale figures, howsoever, inflated they may appear to be, by themselves, cannot be sufficient to arouse any suspicion in the mind of the directors. There is nothing to suggest that Hegde''s integrity was ever in doubt or whatever rebukes or remarks are claimed to have been passed by the directors against him appear to have been due to his overacting. Overacting or indulging in schemes which did not appear to be sound, would be irregular. This by itself, in our opinion, cannot justify any suspicion in the mind of the directors for doubting the correctness of the figures purported to have been made in the account books.

The fourth circumstance relied on by the learned trial judge is the failure of the Bombay office to send production returns from June, 1974, onwards. It appears that such monthly production returns were sent by the company to the Govt. of India. The record before us does not indicate as to what was the source of the obligation of the company to send such returns. It is, however, obvious that the obligation to send returns to the Government must arise due to the arrangement between the company and Govt. of India. Copies thereof appears to have been sent by the company to the American directors. Its failure to send such copies and not of the statements, that appears to have weighed with the learned trial judge. It is not suggested that sending of such copies was obligatory on the part of Hegde under any arrangement arrived at between the managing director, on the one hand, and the board of directors, on the other.

It is true that the directors in America appear to have noticed this failure on the part of Hegde to send such production returns to New York. Though the Indian directors appear to have attributed their ignorance about the company''s affairs due to such failure on the part of Hegde, in their statements and affidavits made by them after the fraud was detected, there is nothing on the record to suggest that any one of the directors had any occasion to take a very serious view of the failure of Hegde to send such return to them. Apart from the absence of anything on record, failure to send such return was never considered to be important by the directors themselves. Failure may assume some importance now that some fraud and falsification of accounts has been discovered. We are, however, unable to see how this failure by itself could have been sufficient to arouse any suspicion of the American directors against the way in which the accounts were maintained by Hegde in the company. A lot of prejudice appears to have been caused in this case while judging the honestly and reasonableness of the petitioning directors by taking into account the events which have been subsequently discovered. This approach, mind, is not correct and is likely to result in miscarriage of justice.

Our attention is not drawn to any provision of the articles of association of the company or to any agreement between the managing director or the board of directors to suggest that the managing director or the officers of the company were under any obligation to send such production returns for enabling the directors in America to know the working of their company in Bombay.

The fifth circumstance relied on by the learned trial judge is that Hegde insisted on going his own way. This is based on the evidence of the directors suggesting that Hegde used to do what he liked in Bombay regarding the affairs of the company. Now, the anxiety to act without consulting the directors by itself cannot be a ground for suspecting his honesty and integrity. The details elicited on this point in the cross-examination of the three petitioning directors do not justify any conclusion that Hegde was abusing his position as the managing director by acting in his own way. The petitioning directors, at any rate, did not appears to have suspected even though they were displeased with the manner in which he was acting on the work of the company. We are also unable to find any justification for describing the exchange of thoughts between Hegde on the one side, and the American directors on the other, as rebukes and dis-agreements.

It is true that in his evidence the chairman, Parish, admitted that the board did not exercise effective supervision over Hegde. The question at issue while considering the directors'' liability under s. 633 of the Act is not whether the board had exercised effective supervision over Hegde or not. The only question is whether the directors were carrying on their statutory obligations or were they required to do more than that they were doing. Mr. Dhanuka was unable to tell us how this supposedly lack of supervision had anything to do with the detection of inflated sales figures or mis-statements in the prospectus as to the percentage of exports. These two things could not have been ascertained by the directors correctly except by examining the account books themselves. If the information given to them by the managing director turned out to be incorrect and inaccurate, the same cannot be attributed to the supposed ineffective supervision by the board of directors.

It is true that the directors'' evidence suggests if Hegde was reluctant to give any information and verify the data contained in the prospectus from other sources, when questions were asked at the meeting held in February, 1975, in which the prospectus appears to have been signed by the directors. The chairman, Parish, suggested that Hegde even absented himself from the meetings on some occasions. The true effect of these supposed acts of Hegde shall have to be determined not by discussing what was discovered subsequently, but what was known to the directors at the time when the prospectus was signed by them on 26th February, 1975. It is in this context that the evidence of the petitioning director appears to be of much significance. Notwithstanding the rebukes alleged to have been hurled at him by the directors from time to time and notwithstanding the supposed disagreement between Grundy and Hegde and notwithstanding the dislike of some of the directors for Hegde, the latter was unanimously elected as the managing director of the company on 21st January, 1975. Such appointment of Hegde as the managing director reflects the degree of faith that the directors chose to put in him. Such confidence could not have been put in by the directors in spite of his having committed so many faults had these faults been of any serious nature. He had gained such confidence due to his continued working as a whole-time director from 1st January, 1972. The admissions made by the directors with regard to the conduct of Hegde have got to be tested by reference to the confidence which they found it possible to repose in him just one month earlier. This confidence is eloquent enough to suggest that the stories about disagreements and is rebukes were of superficial nature, and nothing appears to have been done by Hegde to justify any suspicion on his conduct. Even his reluctance not to supply any information or absenting himself from some of the meetings by themselves cannot detract from the degree of confidence that appears to have been reposed by the directors in him which is reflected in his appointment as the managing director unanimously on 21st January. 1975.

It is true that the chairman, Parish, has admitted in his evidence that he found it difficult to believe that exports could have been 30% of the production during the year 1972-73. He does not appear to have made some enquiry to allay his doubts. It cannot, however, be fore gotten that Hegde was a co-signatory along with all the directors to the prospectus. His becoming a co-signatory could easily furnish an assurance to the other directors that to the knowledge of Hegde the statements made in the prospectus were true. The fact that Hegde was as much liable to be prosecuted as the other directors in the event any of the statements turned out to be untrue also could have created confidence in the truthfulness of these statements. Having regard to all the facts and circumstances of the case as that had existed to the knowledge of the directors on 26th February, 1975, we are unable to hold that the directors acted unreasonably. If they found Hegde to be trustworthy to be appointed as a whole-time director on 21st January, 1975, certainly they could not have found anything suspicion when he himself became a signatory to be prospectus and when the board of directors had chosen him unanimously.

The degree of care and vigilance that is required to be exercised by the directors in a limited company is now a matter of settled law, The learned trial judge himself has referred to a judgment of the House of Lords in the case of Dovey v. Cory [1901] AC 477. The said ratio was followed by Romer J. in the case of In re City Equitable Fire Insurance Co. Ltd. [1925] 1 Ch.D. 407 . These observations have been followed by all the Indian court still this day. If the conduct of the appellants is judged by all the tests laid down by Lord Halsbury and Romer J. in these cases, they, in our opinion, are entitled to be relieved of their liability under s. 633 of the Act.

We accordingly set aside the judgment of the learned trial judge to the extent to which it applies to the appellant and allow the appeal as also their application for relief under s. 633 of the Act against any liability under s. 633 thereof. The appellants to pay to respondent No. 1 the cost of this appeal quantified at Rs. 2,000. The order of the trial court as to the costs of the Registrar of Companies in the petition will remain.

Mr. Chagla states that the notarised statements of the officers of the company are marked Ex.B in the present proceedings. He requests for the return thereof. The same may be returned to the appellants on their furnishing copies thereof for the record of the court and on their undertaking to produce the original thereof in the event they are called upon to do so.