It is a well-known fact that schemes of arrangement are a popular method to implement mergers and corporate restructuring transactions in India. While they involves an elaborate and cumbersome procedure and the oversight of the court, parties enjoy tremendous flexibility in structuring their transactions. More importantly, such a scheme is binding on the dissenting minority. When this involves listed companies, it is obvious that the Securities and Exchange Board of India (SEBI) as well as the stock exchanges would take on an important role in determining the outcome of the scheme, and particularly in ensuring that shareholder interest is not adversely affected. However, the role of SEBI and the stock exchanges in such schemes has been tenuous. Courts have kept them away from the purview of schemes of arrangement that are essentially driven through the courts under the Companies Act. While SEBI has sought to encroach upon the scheme territory through amendments to the listing agreement introduced in 2003 and through two circulars issued in 2013, the position remains unclear. Its attempt to establish jurisdiction over a scheme of arrangement more recently resulted in a lack of success before the Bombay High Court this month.
Before dealing with the recent ruling, a discussion of the previous position would be in order. The question of SEBI’s jurisdiction over a scheme of arrangement came up for the first time in Securities and Exchange Board of India v. Sterlite Industries Ltd., (MANU/MH/0339/2002). When SEBI appealed against a scheme of arrangement and reduction of capital, a division bench of the Bombay High Court refused to recognise any power of SEBI in representing itself before the court (a power that it sought to undertake with a view to safeguarding the interest of the investors).
Deprived of any role in such schemes, SEBI followed a somewhat unusual method to exert itself by imposing a role for the stock exchanges in a scheme. It amended the listing agreement in May 2003, by which companies have been required to file any scheme of arrangement with the stock exchanges at least one month before filing it with any court or tribunal for approval. This is to ensure that stock exchanges have the opportunity to examine whether the scheme violates any provisions of the securities laws or stock exchange requirements. This power has indeed been exercised by the stock exchanges. For example, in Re Elpro International Ltd. ( 149 Comp. Cas. 646), although the Bombay Stock Exchange (BSE) did not approve a scheme of reduction of capital when the parties filed with it, the Bombay High Court sanctioned the scheme but with liberty to the stock exchanges to pursue their rights under the listing agreement. Given BSE’s refusal to approve the scheme, the company decided not to pursue the arrangement. In that sense, the amendment to the listing agreement giving power to the stock exchanges has had an indirect deterrent effect.
A decade after the introduction of clause 24(f) to the listing agreement, SEBI issued two circulars (here and here) in 2013 not only strengthening the powers of the stock exchanges in evaluating schemes of arrangement, but also in giving SEBI itself the opportunity to review schemes. The downside of these additional powers (and that of clause 24(f) of the listing agreement is that they only enable SEBI and the stock exchanges to provide comments on the scheme. If they decide not to approve the scheme, the consequences thereof are unclear. If, for instance, a company decides to proceed nevertheless and seek the approval of the court, at most SEBI and the stock exchanges may make their representations before the court. They appear to have no veto powers over the scheme.
It is in this regulatory backdrop that the Bombay High Court in Securities and Exchange Board of India v. Ikisan Limited was required to consider SEBI’s locus in seeking a review of a scheme of arrangement that was already sanctioned by the court. This judgment by Justice S.J. Kathawalla issued on September 23, 2015 in Company Application No. 124 of 2013 in Company Scheme Petition No. 234 of 2011 is also accessible through the Bombay High Court website (http://bombayhighcourt.nic.in). .
The litigation relates to two related schemes of arrangement filed by a group of companies. The first scheme, implemented in 2010, involved an amalgamation of one company into another. The second, implemented in 2011, and involving the previously amalgamated company and other companies related to a complex restructuring. The details of the schemes are not only somewhat complicated, but they are unnecessary for the present discussion.
The record indicated that when the second scheme was pending before the Bombay High Court, SEBI received a complaint from a shareholder regarding some deficiencies in the nature of the scheme. SEBI forwarded the complaint to BSE, but no action was taken. It is also the case that the BSE did not raise any objections when the scheme was filed with it pursuant to clause 24(f) of the listing agreement. In the meanwhile, the Bombay High Court provided its sanction to the scheme, which was duly implemented. It was only subsequently that SEBI approached the Bombay High Court for a review of the scheme on account of various deficiencies, and on the ground that the scheme therefore did not comply with the relevant legal requirements for sanction. Although the judgment of the court refers to the various details of the scheme, this post is limited to the discussion pertaining to SEBI locus standi in seeking a review of a scheme under sections 391 to 394 of the Companies Act, 1956.
For the major part, the Bombay High Court relied on its previous division bench judgment in Sterlite Industries (discussed above). As decided in that case, SEBI did not have the locus standi to challenge a scheme under the Companies Act. Although the Sterlite Industries decision went on appeal to the Supreme Court, it refused to interfere in the matter and left the substantive issues open. Accordingly, in this case the court found no reason to doubt the binding nature of Sterlite Industries. Although SEBI sought to exercise its wide scope of powers that were recognised by the Supreme Court in Sahara India Real Estate Corporation Ltd. v. SEBI ((2013) 1 SCC 1), it was not found to have overruled the decision in Sterlite Industries.
The court also found that there was substantial delay in SEBI’s action in bringing the application for review. Although the scheme was sanctioned in 2011 and further complaints from shareholders followed soon thereafter, SEBI acted only in 2013. In any event, given the grave nature of the allegations brought by SEBI, the court decided to delve into the merits of the case. But, here too, the court did not find reason to overturn its earlier order sanctioning the scheme. Hence, SEBI’s application was dismissed.
This effort represents another instance in SEBI’s continued efforts to seek meaningful intervention in schemes of arrangement, but without success. It continues to bear the adverse consequences of the ruling in Sterlite Industries. Unless a different outcome ensues from the Supreme Court, significant change is unlikely. The unintended consequences of this approach is that it provides parties with the option of embarking upon a scheme of arrangement in order to sidestep SEBI’s oversight, potentially leading to a regulatory arbitrage. As I have previously mentioned, schemes of arrangement do provide sufficient flexibilities to parties to undertake various types of restructuring transactions that may not necessarily be in the interests of the minority shareholders. This may deprive such shareholders of regulatory supervision.
At the same time, it is not all gloom and doom for the regulator and the minority shareholders. The present case arose in 2011, i.e. prior to SEBI’s issuance of circulars in 2013 granting it (and the stock exchanges) greater oversight over schemes of arrangements. Cases subsequent to the issue of the circulars would be subject to a more stringent regime, although this remains untested.
More importantly, this case as well as Sterlite Industries hinge on the timing of SEBI’s intervention. In both those cases, SEBI stirred into action after the court had already sanctioned the scheme. It either exercised the powers of appeal or review. Conversely, if SEBI had approached the court during the hearing stage (and prior to the sanction of the scheme), the outcome may have been different. It may not be possible in such a situation for the court to refuse to hear SEBI’s objections to the scheme.
Going forward, the situation is clearer. Under the Companies Act, 2013, the notice of the scheme is required to be sent by the company to various authorities, including SEBI (section 230(5)), who are entitled to make representations before the court. Hence, SEBI’s right of audience before the court is explicit. Of course, this provision is yet to come into force, due to which SEBI will be compelled to navigate through the current system in the near future. The bottom-line from SEBI’s perspective appears to be: raise objections to the scheme before the court sanctions it, or never.