Shareholder ratification cannot cure company's funds diversion: Supreme Court

The Supreme Court on Tuesday held that shareholder ratification cannot legitimise violations of securities laws and a company cannot escape liability for diversion of funds merely because its shareholders subsequently approved the conduct [SEBI Vs Terrascope Ventures Ltd]..A Bench of Justices JB Pardiwala and KV Viswanathan made the observations while restoring the penalties imposed by the Securities and Exchange Board of India (SEBI) on Terrascope Ventures Limited and its directors for violating the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations (PFUTP Regulations).The judgment was delivered on an appeal filed by SEBI against a ruling of the Securities Appellate Tribunal (SAT) which had granted relief to the company..The Court rejected the core reasoning of SAT that a subsequent special resolution passed by shareholders validating the utilisation of funds would cure the initial deviation.It held that while ratification may operate in the realm of private corporate acts, it cannot be invoked to defeat statutory obligations or regulatory breaches.“By a private resolution, a liability which is crystallised cannot be wiped off,” the Court observed, emphasising that securities regulations are designed to protect a wider class of stakeholders..Terrascope Ventures Limited (formerly Moryo Industries Limited) raised funds in 2012 through a preferential allotment of shares, after informing shareholders that the proceeds would be used for specific purposes such as capital expenditure, working capital, marketing and overseas expansion.However, the company utilised the funds to purchase shares of other companies and to extend loans and advances—purposes not disclosed in the notice of the Extraordinary General Meeting (EOGM).SEBI initiated proceedings and found that the company had deviated from the stated objects of the issue and failed to disclose such variation as required under the listing agreement. It held this conduct to be fraudulent and imposed penalties on the company and its directors.On appeal, SAT set aside SEBI’s order, holding that a subsequent special resolution passed by shareholders in 2017 ratified the utilisation of funds and cured any defect..The Supreme Court squarely rejected this approach, holding that a private resolution of shareholders cannot extinguish liabilities arising from statutory violations.The Court reasoned that allowing such ratification would effectively permit companies to bypass regulatory safeguards through internal approvals, thereby undermining the statutory scheme.It emphasised that SEBI regulations are framed to protect not just shareholders, but a wider universe of stakeholders including existing investors, potential investors and the market at large. Hence, compliance obligations cannot be diluted by subsequent consent of shareholders alone..Expanding on this principle, the Court held that the doctrine of ratification, well recognised in private law, has limited application where public law and regulatory obligations are involved.It drew a parallel with waiver, observing that just as rights grounded in public policy cannot be waived, illegal acts contrary to statutory provisions cannot be ratified.“There cannot be a ratification of illegality,” the Court underlined..The Bench cautioned that treating such violations as capable of ratification would seriously jeopardise public interest since securities regulations are designed to ensure transparency, fairness and investor confidence in the market..Securities law violations cannot be viewed solely through the prism of shareholder consent, the Bench said..On merits, the Court held that diversion of funds from disclosed objects constituted a clear violation of Regulations 3 and 4 of the PFUTP Regulations.It emphasised that disclosures regarding the objects of a preferential issue are central to investor decision-making.“The investors and all other stakeholders adjust their affairs based on the disclosures made,” the Court noted..In view of these findings, the Court set aside the SAT order and restored the penalties imposed by SEBI’s adjudicating officer on Terrascope. .Follow Bar and Bench channel on WhatsAppDownload the Bar and Bench Mobile app for instant access to the latest legal news.