Monday, December 5, 2011

The Proviso, Public Interest and Section 391


In Re Subhiksha Trading Services Ltd [161 CompCas 454], a single judge of the Madras High Court has considered a number of important questions relating to the role of the Company Court in sanctioning a scheme of arrangement or amalgamation under sections 391-4 of the Companies Act. Subhiksha Trading Services Ltd. [“STS”], the transferor company, was engaged in the business of trading in articles, operating retail stores etc. and sought the sanction of the Court to amalgamate with Blue Green Constructions and Investments Ltd. [“BGCI”], the transferee company. Of the many issues considered in the judgment, four* are especially important: (i) whether shareholders or creditors who consent to a scheme at a meeting are nevertheless entitled to raise an objection at the stage of sanction; (ii) the scope of the obligation of the transferor company to submit “latest” financial statements etc. under the proviso to section 391; (iii) whether it is open to a company in dire financial straits to apply for a scheme and (iv) role of the Company Court under section 391 and in particular the significance of public interest considerations.
As Ramasubramanian J. points out, the Petition, on the face of it, was perfectly consistent with section 391 and reasonable, for it was said that the amalgamation would permit economies of scale since both companies were engaged in the same line of business. At separate meetings ordered by the Court, the shareholders and secured creditors unanimously consented to the scheme. Neither the Regional Director nor the Official Liquidator raised any objection. Yet, the single judge permitted the secured creditors and members who had consented to resile from that position, and eventually dismissed the petition. It is submitted that the decision, which contains a valuable account of the law on these points, is correct.
The ground on which the secured creditors who had consented sought to nevertheless raise objections was that it had come to their attention that the transferor company’s financial position was beyond repair; that all of its shops had been closed and that it was effectively insolvent; that there were irregularities in the manner in which the promoters conducted the business etc. Since the creditors failed to establish misrepresentation or fraud, it became necessary to decide more generally whether it was open to them to withdraw consent. It was held that they can, because it is implicit in the judgment of the Supreme Court in Miheer Mafatlal that principles of contract law do not apply stricto sensu to a scheme. In particular, the Court reasoned that since it cannot sanction a scheme even if there is unanimity unless it is in the public interest and not manifestly unreasonable, a creditor is not foreclosed by his prior act of consent from raising issues that address these points:
… the grant of consent by itself, does not always ensure the seal of approval, since the Scheme has to pass through the other two check posts, before it is allowed to reach its destination. In The Calicut Bank Ltd. (in liquidation) v. Devani Ammal …, a Division Bench of this Court pointed out two things, viz., (i) that if there was misrepresentation, the consent given by the shareholders and the creditors, would be of no avail; and (ii) that if the company is hopelessly insolvent and the Scheme confers no apparent benefit on anyone, the Scheme cannot be accepted, even if the resolutions of shareholders and creditors had been passed after a disclosure of the true position. Therefore, the grant of consent by itself, would not ensure free passage through all check posts
Turning to consider the objections on the merits, the single judge examined the scope of the obligation on the company under the proviso to section 391 to disclose “all material factssuch as the latest financial position…and the like”. Since company petitions in High Courts routinely take two years or more to be allowed or dismissed, the question has arisen whether the obligation to furnish the latest financial position refers to the date of the application or the date of the final hearing. In Re Blue Star Ltd, the Bombay High Court endorsed the former view but the same Court in SBI v Alstom Power Boilers took the contrary view. Other High Courts took a middle path by holding that while the obligation of the company is to disclose financial statements as on the date of the petition, the Court is entitled to direct it to produce more recent statements at the time of final hearing (see Re Magnaquest Solutions Ltd). A reference to the Report of Daphtary-Sastri Committee, pursuant to which the proviso was inserted, made it clear, however, that the reference was to information available on the date of the petition. The single judge accepted this interpretation (¶117) but held that the Company Court is entitled to call for additional information should there be a material change in circumstances.
The Court further held that while the fact that a company is “hopelessly insolvent” is a relevant factor in judging the merits of a scheme, there is no bar on such a company preferring a scheme, because section 391 is not only intended not only to enable healthy companies to re-arrange their affairs, but also to help unhealthy and sick ones to recover and recoup”. If, however, the scheme would cause detriment to the shareholders or the creditors or the public on account of that financial position, the scheme will not be sanctioned.
On the role of the Company Court, Ramasubramanian J. held that a scheme contrary to public interest cannot be sanctioned even if it commands a majority (“I do not think that the role of the Company Court examining a Scheme is merely akin to the role of an Appeal Examiner in the Registry of a Court”). The judge referred with approval to the decision of the Bombay High Court in JS Davar v Marathe in which Chandrachud C.J. had held that sanction will not be given if the “arrangement cannot reasonably be supposed by sensible business people to be for the benefit of the class which they represent”. The Court concluded that the scheme in question was contrary to public interest because it represented an attempt by a failed company to raise funds from the public when every other avenue had failed, and by creating artificial contractual penalties should the scheme fail, in order to strengthen the case for allowing it. Despite, therefore, the consent of the authorities and the unanimity of the shareholders and creditors in the first instance, the scheme was rejected.

* Some of the other issues that are of importance are whether the court under section 391 is bound by the quorum requirement in the articles or in the Act in ordering a meeting; and the applicability of a provision in the Listing Agreement requiring fair valuation of shares.

4 comments:

vswami said...

"....It is submitted that the decision, which contains a valuable account of the law on these points, is correct."

THE JUDGMENT COMMENTED ON MAKES FOR A TRULY INTERESTING READING. IT DESERVES TO BE HEARTILY COMMENDED AS ONE OF THE VERY FEW OF ITS KIND LATELY REPORTED, THAT IS MARKED BY THE JUDICIAL WISDOM.THE PRACTICAL SIGNIFICANCE OR OTHERWISE OF THE CONCEPT OF 'MAJORITY', AND WHAT WEIGHTAGE COULD BE GIVEN THERETO IN ANY SUCH MATTER IN WHICH THE OVERRIDING CONSIDERATION MUST BE THE LARGER 'PUBLIC INTEREST' HAVE BEEN LUCIDLY DEALT WITH. THE COURT, IF CLOSELY LOOKED AT, SEEMS TO HAVE CHOSEN TO APPLY PRICIPLES OF NATURAL JUSTICE, AND GO BY THE 'SPIRIT' OF THE LAW, NOT BEING NECESSARILY BOGGED DOWN BY SIMPLY ITS 'LETTER.

(to be continued)

swami said...

@vswami
On the concept of ‘majority’, invariably misconstrued and followed blindly,also in our changed times, the words of deep wisdom, serving as a caution, uttered by a great thinker, late NA Palkhivala are noteworthy:

Anyone, if endowed with ability to think clearly, “will adopt an attitude of reserve towards ideologies that are popular and be critical of nostrums that are fashionable. It is true that in a democracy the majority view should prevail. But never make the mistake of thinking that the validity of a proposition or the correctness of a doctrine depends on the number of people who believe in it..... In the fields of.. economics, the soundness of an ideology is often in inverse proportion to the popular support it commands.”

“The voice of a small minority is today mistaken to be the voice of the majority, simply because it is loud and vociferous, while the still, small voice of reason is not heard.”

(Quotes from a couple of his memorable speeches; though delivered in different contexts, may be found to ring the bell / aptly fit in into any form or principle of ‘democracy’/ its derivatives, not necessarily in relation to a nation.)

Ajar Rab said...

Just a couple of doubts rather than comments:

In para 94 of the judgement, the court holds that "consequently, this objection cannot be sustained, in the absence of any of the shareholders raising it as a ground for going back on the consent given earlier"

1)does the court accept this as a valid ground for withdraw of consent,in cases shareholder raises such an objection?

2) if yes, what is the scope of the listing agreement applying to an amalgamation? Is a company bound to adhere to its provisions for the sanction of a scheme? Where do you derive such a position from?

3)How does one justify this as a valid ground for withdrawal of consents with reference to sections.391-394 as they have been held to to be complete code in itself?

Thanks

V. Niranjan said...

Thanks Ajar. Re (1), I think this objection has more to do with the merits of the scheme than consent. In fact, given the view the Court took on the role of consent, it is of limited significance because the court in any case independently examines the scheme. Re (2), whether a company is bound to adhere to such provisions or not, the fact that it has not done so may have a bearing on the court's analysis of the merits of the merger under section 391(2).
Re (3), the fact that section 391-4 is a complete code means only that certain restrictions found in other provisions of the Act may not apply to a scheme(for example reduction of capital, but even there see Bachawat J.'s classic analysis of what "complete code" really means in AIR 1960 Cal 637).