Wednesday, September 1, 2010

Andhra Pradesh High Court on Reduction of Capital: More Uncertainty?

In an earlier post, I had highlighted some observations of the Bombay High Court in Re Organon, and had commented on whether the decision of the Single Judge in that case stood easily along with the observations of a Division Bench in Sandvik. The decision in Sandvik can perhaps be read to mean that when an overwhelming majority of non-promoter shareholders votes in favour of the scheme, then the presumption of fairness is even further strengthened. This does not mean that the presumption of fairness is rebutted by there being no overwhelming majority of non-promoter shareholders. Consequently, the observation in Re Organon that Courts “cannot withhold sanction to the special resolution for reduction of capital, unless there is some patent unfairness regarding the fair value of the shares or there is lack of an overwhelming majority of non-promoter shareholders who vote in favour of the resolution…” should not be taken to imply that this is being read in as a requirement. Hopefully, this aspect will be clarified in subsequent decisions. In another development in this area of law, the Andhra Pradesh High Court also seems to have adopted a ‘minority friendly’ view in Chetan G. Cholera v. Rockwool (India) Limited, [2010] 102 SCL 93 (AP):

In modern times, entities incorporated offshore with transborder operations and global dealings with sole aim of accumulating profits for the benefit of the promoter groups mainly are coming into existence in plenty. In the case of Rockwool one shareholder AIM with more than 90% controls and manages the company. AIM is not a company incorporated in India and it is a company incorporated in Mauritius and its holding company is Dubai based… A foreign company therefore to obtain total control and management of a company, which was initially promoted by Indians, can successfully use the present procedure. In other words, a company that achieved high growth and high net-worth and in a position to share its profits among all the small investors can go into the hands of few individuals or a group helping them to amass wealth. Is it in tune with the Indian Constitutional values so loudly proclaimed in Preamble and Parts III & IV of Constitution of India

... it would not be sufficient for Court only to adhere procedural and substantive aspects of a scheme of arrangement or compromise. The scrutiny must be beyond the provisions of the corporate law. State cannot ignore the preamble of the Constitution, which assures to secure a Socialist State to citizens, benefits under Articles 38 and 39 and other directive principles. The Court must not lose sight of the fact that Regulatory Bodies have been established under the Acts of Parliament like SEBI to safeguard the interests of the investors. All companies offering shares to public are required to allot required quantity to retail investors. In addition to this, retail investors are provided investor friendly methods, procedures and safeguards for buying and selling securities and prevent fraud by overenthusiastic corporate brokers. All this would be rendered illusory if promoters - with a view to bypass small investors; come forward with petition to reduce share capital. In every case, it cannot be assumed that majority shareholders protect and safeguard class rights. The majority shareholders if they belong to one group or family can never be interested in safeguarding and protecting the class rights of minority. In such cases, all aspects of the matter have to be gone into. Complying with Delisting Regulations, Buyback Regulations and other Regulations of SEBI as well as provisions of Companies Act may not by themselves be sufficient to grant approval to special resolution for reduction of share capital. When such special resolution is engineered by the promoter group controlling majority shareholders and it is found that such reduction is intended only to deny rights of minority shareholders or small investors, the Court can even pass orders rejecting confirmation of the minute and/ or modifying the scheme of arrangement for reduction of the capital, in such a manner that small investors derive the benefit expecting which they invested their money in the company.”

On the facts of the case, as in Organon, the scheme was approved. But observations such as these – besides being incorrect – are only likely to increase uncertainty in this area of law. It is hard to understand exactly what was ‘so loudly proclaimed’ in the Preamble and in Parts III and IV of the Constitution that motivated these observations. The relevance of the reference to ‘foreign companies’ and ‘transborder operations’ is also doubtful. Further, how can adhering to both 'procedural and substantive' considerations ever not be sufficient? When will it be said that the promoter has ‘engineered’ the reduction to ‘deny rights’ to small investors? When will one determine whether small investors have received the benefit ‘expecting which they invested their money’? One would think that shareholders – whether majority or minority – would rather have some certainty in the law. With respect, one can only hope that we can see some concrete legal tests being developed in this regard, rather than the broad generalizations made by the Andhra Pradesh High Court.


Vijay said...

The judgment is unclear on what needs to be done to ensure that interest of minority is protected. The minority shareholders are not promoters of the Company nor are responsible for the management of the Company. This judgement also goes on to say that the Court can interfere in the business decisions that are taken by Board of Directors based on their professional wisdom. Squeeze out is permitted under the Companies Act by scheme of arrangement and therefore it does not use any words of limitation while defining arrangement under Section 391. If there is oppression or mismanagement, option has been given to shareholder under Section 397/398. If he does not fulfill the requisite voting power to file petition, he can still obtain approval of Central Government and file a petition for oppression or mismanagement. The Court in a Scheme of Arrangement has to only see if the scheme is fair and is not to suit particular shareholder/class of shareholder's interests or for collateral purposes and the valuation arrived at is in accordance with the guidelines and is fair. In my humble submission the Court cannot act as an appellate authority and do fact finding in the Scheme. It can only satisfy itself of fairness and not try to find out if shareholders lose money in the bargain. Since equity is an instrument involving risk, the holders of it must be aware of the loss they can incur. Minority should not dictate terms and command management of the Company. It is like tail wagging the Dog.

Anonymous said...

Can the shareholder though not eligible to file a suit under section 399, file a Special Leave Petition in the Supreme Court?