Wednesday, May 6, 2009

Squeezing Out Minority Shareholders: A Recent Judgment



The question of squeezing out minority shareholders (also known as freezeouts in some jurisdictions) is always a vexed question. This is because the law in certain circumstances allows minority shareholders to be forcibly bought out by the majority shareholders or the company such that they are forced out of the company. The controversy arises because this might amount to a deprivation of property rights of the minority shareholders.


In India, the only statutory provision that appears to deal with squeeze out of minority shareholders is Section 395 of the Companies Act. That, as we have seen earlier, is riddled with difficulties making it a rarely utilised legal provision.


Due to the inability of companies to effectively utilise Section 395, they and their advisors have resorted to other provisions in the Companies Act to achieve an outcome that mirrors a squeeze out. One of the notable efforts in this direction was undertaken by Sterlite Industries Limited a few years ago. The company proposed a scheme of arrangement under Section 391 to 394 of the Companies Act whereby it made an offer to the shareholders to buy back their shares. The peculiarity of the offer was that the shares of all shareholders would be bought back unless they specifically intimated the company otherwise in writing. In other words, silence of the shareholders amounted to consent of shareholders. This scheme was approved by the single judge of the Bombay High Court (In re Sterlite Industries Ltd., MANU/MH/0338/2002).


Subsequently, there was significant opposition to such a scheme. SEBI and the Central Government filed an appeal before the division bench of the Bombay High Court challenging the single judge’s order. The court in effect held that SEBI had no power to challenge such a scheme of arrangement. Further, the court held that there was nothing wrong in the scheme as proposed by Sterlite and that the scheme should stand
(Securities and Exchange Board of India v. Sterlite Industries Ltd., (MANU/MH/0339/2002). This was despite the fact that the scheme virtually required the shareholders to sell their shares in the absence of specific intimation provided in writing. Although this was not exactly a squeeze out, the difficulty of shareholders in exercising the option to remain in the company turned it almost into a non-option.


This ruling in favour of Sterlite led to two consequences. First, SEBI and the stock exchanges, realising their inability to intervene in such scheme of arrangement, introduced provisions in the listing agreement (sub-clauses (f), (g) and (h) of clause 24) that require listed companies to seek the prior approval of stock exchanges when they initiate schemes of arrangement. The stock exchanges (and indirectly SEBI) therefore obtain jurisdiction to determine whether such schemes are contrary to the listing guidelines as well as various regulations and guidelines issued by SEBI. Second, encouraged by the favourable ruling, several companies (particularly unlisted companies that are not covered by the new powers of SEBI described above) began initiating bolder schemes that effectively squeezed out minority shareholders without even providing any option to remain in the company (as Sterlite had provided).


In the next couple of years, several High Courts (Karnataka and Andhra Pradesh, just to name two) had approved schemes of arrangement involving reduction of capital whereby the company would reduce the share capital of all shareholders other than the promoters/ controlling shareholders. This is tantamount to a squeeze out. The majority shareholders benefited because they obtained the imprimatur of the court for such an arrangement. Further, in commercial terms, the majority shareholders did not incur any financial burden as the consideration for the reduction always came from the company (and not the shareholders).


This euphoria came to an abrupt end (at least partially) with a judgment of the single judge of the Bombay High Court in 2003 (Sandvik Asia Ltd., MANU/MH/0697/2003). The court held that such a proposal was highly inequitable, unjust and unfair because the promoter group (controlling shareholders) could virtually bulldoze minority shareholders. Hence, the company petition was dismissed. This created an element of disharmony among High Courts as some had already approved similar schemes. An appeal was filed by Sandvik Asia soon thereafter before a division bench of the Bombay High Court, and a decision was awaited by the corporate community with a sense of anticipation and hope that the issue would be put to rest.


Last month (on April 4, 2009), a division bench of the Bombay High court overturned the single judge’s order and approved the scheme on appeal (Sandvik Asia Limited v. Bharat Kumar Padamsi, MANU/MH/0237/2009). The court sanctioned the scheme and held that there was nothing contrary to law in it. The court identified the issue as follows:


Perusal of Section 100 further shows that a company can reduce its share capital in any way. In the present case, it is nobody's case that the special resolution passed by the company is invalid or has not been passed by following the procedure laid down by the Companies Act. It is also nobody's case that in the Articles of Association of the Company there is no provision authorising the company to reduce its share capital. It is also nobody's case that the amount that is being offered to the non-promoters share holders is not just or fair. The only objection raised is that the scheme for the reduction of share capital proposed by the special resolution wipes out a class of share holders namely the non-promoter share holders and this, according to the objectors, is unfair and inequitable. The question, therefore, that is to be considered is whether the special resolution which proposes to wipe out a class of shareholders after paying them just compensation can be termed as unfair and inequitable.


The court considered the squeeze out question and held, after examining various Supreme Court decisions, that there is nothing invalid in that proposal.


In a Business Standard column, our guest contributor Somasekhar Sundaresan examines the implications of the judgment:


The judgement opens up several interesting possibilities and propositions in relation to shareholder rights in India. The company in question was not a listed company – it had already been delisted.


Listed companies would require stock exchange approval for reduction of capital under the listing agreement, and it is unlikely that stock exchanges would approve such a transaction. However, for an unlisted company, regardless of whether a company is a public company or a private company, shareholders rights can be impacted severely.


Private equity investors holding small stakes without serious rights could easily be thrown out by management using such resolutions. In family-run companies, a segment of the family that holds a minority stake could get thrown by the rest of the family. All that one would need is a special resolution.


The core business issue involved here is not about whether the price paid for the shares would be fair, but whether an owner of shares in India has a vested right to keep his property, or whether other shareholders can force him to divest his property.


While an appeal to the Supreme Court against this judgement is a certainty, for now, this position represents an established precedent.


Moving to the legal question, it is perhaps a daunting task to criticise the judgment on its merits. For example, the court held that there is nothing in the scheme that violates provisions of the Companies Act. That is certainly the case – the relevant sections set out the procedure for reduction of capital and that procedure was duly followed. The difficulties are compounded because that procedure does not cater to selective reduction of capital. The implicit assumption in the procedure seems to be that reduction of capital will be effected across the board, uniformly for all shareholders. Hence, there is no requirement to call for a separate meeting of minority shareholders who are being squeezed out. In practice, due to the overwhelming shareholder power of the majority, they are able to muster enough support to pass a special resolution for reduction of capital. The minority shareholders usually have no say whatsoever due to their minimal shareholdings, and are left powerless. What is missing in the statutory provisions is the need for a separate meeting of minority shareholders where the majority shareholder cannot participate (and hence influence the outcome).


There comes the next obvious question: if the statutory provisions are weak towards minority shareholders, why can the court not intervene in their favour as all schemes of reduction require sanction of the court? While fairly substantial powers are conferred on High Courts while approving schemes of reduction, they are usually exercised cautiously. The courts tend to rely on statutory interpretation and construction of the law and are hesitant (at least in the areas of corporate and commercial laws) to indulge in law-making or policy-making. Courts also normally assume the validity of schemes, unless they are challenged convincingly. This is at variance with practice followed in certain progressive jurisdictions such as Delaware where courts perform a more prominent role in the development of corporate law.


To conclude, unless there are statutory amendments, it appears be too optimistic to rely on courts to resolve such questions. A streamlining of statutory provisions involving various related aspects such as schemes of arrangement, reduction of capital, buyback and the option in Section 395 is necessary. While the Companies Bill, 2008 has taken some steps in that direction, it is far from the desirable.

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For a comprehensive discussion of the position regarding freezouts in Delaware law and the role of the courts, please see the article Fixing Freezeouts by Professor Guhan Subramanian of Harvard Law School.


My thanks are due to Somasekhar not only for highlighting the developments in the recent Sandvik Asia judgment in his Business Standard column but also for his analysis that triggered the chain of thought in this post.


(Update: I would also like to draw readers’ attention to another decision of the Bombay High Court in connection with a forced reduction of capital involving a listed company. In Elpro International Limited (MANU/MH/1414/2007), the court approved a scheme of forced reduction despite the objections of the Bombay Stock Exchange under clause 24(f) of the listing agreement. This approach seems consistent with that adopted by the division bench of the Bombay High Court in the Sandvik Asia case.


Mr. Jayant Thakur has previously posted on this Blog an insightful analysis of the Elpro decision and has also written about anomalies regarding forced buybacks in a Rediff column, both of which have enormous relevance to the present discussion.)

(Update - May 14, 2009 - Deepaloke Chatterjee, a law student who has just completed the 4th year at NUJS, Kolkata sends us these additional case references that may be relevant to the discussion:

- Cosmosteel, MANU/SC/0048/1977;
- In Re Siel, MANU/DE/9436/2007;
- In Re Indian National Press, MANU/MP/0068/1986;
- In Re Pmp Auto Industries, MANU/MH/0112/1991)


3 comments:

Adit C. said...

"In the next couple of years, several High Courts (Karnataka and Andhra Pradesh, just to name two) had approved schemes of arrangement involving reduction of capital whereby the company would reduce the share capital of all shareholders other than the minority shareholders. This is tantamount to a squeeze out."

Kindly explain how the same amounts to a squeeze out. Is there some mistake - 'the company would reduce the share capital of all shareholders other than the minority shareholders'. Shouldn't this be promoter shareholders?
Thank you.

Umakanth Varottil said...

Adit, thanks for your comment. Yes, there is a typographical error. It should read "reduction of capital whereby the company would reduce the share capital of all shareholders other than the promoters/ controlling shareholders". It has been corrected in the post.

Abhyudaya Agarwal, 3rd Year, NUJS said...

I think there are some facts which are observed from the Sandvik case :
It concerned only a S.100 reduction without S. 391 scheme (as evident from the DB judgment; I don't think the Single Judge has not made n observation on this). The single judge had called a class meeting purely under a S.100 scheme.
Also, one of the reasons the Court cited while appoving the scheme was also because it said that an overwhelming majority of the minority approved the reduction- (the minority in consideration comprised the 5 % non-promoter group) and over 99 % of the total votes polled were in favour of the buyback.
Further, I wanted to bring to light the Bom HC (Single Judge) case of In Re Hoganas India Ltd. (2009) 88 CLA 174 (Bom.) delivered on 21st August 2008 which was passed before Sandvik (DB), at the time when the Single Judge's Judgment carried the day. The reduction plan there had one difference that S. 391 was involved there, unlike Sandvik. Nevertheless, the Court refused to call a separate meeting of the promoter's subsidiary in that case.
Briefly, facts were that there was company Hoganas India Ltd. which was delisted from the stock exchange. A scheme to buy all its shares except promoter shares of 96.15% held by Hoganas AB Sweden (its holding company) was proposed. An additional 1.82 % of the shares were held by the subsidiary of Hoganas AB Sweden, and remaining 2.01 % by other shareholders. A meeting for approval was called of the Hoganas' subsidiary only and the other shareholders (not Hoganas AB Sweden) .
It was interesting to see how the Court distinguished Hoganas from Sandvik (Single Judge), without going into the difference between S.391 + S.100 scheme versus an only S.100 proposal. The question requiring determination was what constitutes a class, and from that it would be determinable whether a class meeting was required. The Court held, following established precedents such as Miheer Mafatlal's case (SC) that a class would not merely be a separately identifiable group (promoter versus non-promoter, etc.) but would be a group to whom different terms were being offered under the scheme. Now, It held that in this case the shareholders had commonality of interest, with identical terms being offered to them (because even the shares of the subsidiary of Hoganas amounting to 1.82 % were being bought; those of the holding amounting to 96 % were safe, and the holding company was not called for that reason).

Abhyudaya Agarwal
3rd Year,
NUJS, Kolkata