Priyanshu Agrawal and Vaishnavi Vyas, NMIMS KPM School of Law, Mumbai
In India, squeeze-outs have become an area of increasing interest and scrutiny. The extant legal framework provides for several methods through which squeeze-outs can be effected in Indian companies. On February 03, 2020, a newly notified provision, Section 230(11) of the Companies Act, 2013 (the “Act”) has been introduced to enable minority squeeze-outs in unlisted companies. The new rule enables a majority shareholder holding more than 75% of the stake in a company to make a takeover offer to acquire the minority stake. However, the amendment is a half-baked remedy and provides minimal protection to the minority shareholders. Having said that, the new rules do not envisage any clarity on the existing provisions but merely are an additional tool reflecting hostile takeover in unlisted companies.
Regulatory Framework on “Squeeze-outs” in India
Primarily, section 235 of the Act facilitates the majority with an option to buy out minority shareholders through a scheme. The provision enables an acquirer company to dislodge minorities following a takeover offer. The provision does not mandate prior approval of the court for the implementation of the scheme. However, the dissenting shareholders within one month from the date of the notice can approach NCLT to seek appropriate measures. Nonetheless, based on the practice followed by NCLT it is unlikely that it will alter the terms of the scheme. Hence, a transferee company by virtue of section 235 could forcefully exit the minority against its wishes.
Further, section 236 of the Act states than any individual(s), acquirer, or a person acting in concert with such acquirer having 90% or more of the share capital (“purchaser”), through an amalgamation, conversion of security, share exchange, or for any other reason, must notify the company of its intention to purchase the remaining equity shares and subsequently offer to purchase shares of the minority shareholders at a price determined based on a valuation by a registered independent valuer.
Nonetheless, section 236 lacks clarity on whether the minority shareholders are obligated to accept the exit offer or have the power to dissent, as in several cases the section is interpreted as compulsory acquisition. Further, there is no clarity on the time limit within which the minority shareholders are to give away their shares to the majority shareholders. Additionally, the provision only authorises the acquisition of equity share capital but not preference share capital of a company. The appointment and scrutiny of the registered valuer are not succinctly dealt with under the extant provision, and therefore, the majority shareholder may appoint a biased independent valuer. Practically, this would hamper the rights of minority shareholders and they would be left with no resort.
Furthermore, minority squeeze out is also accomplished by way of reduction of share capital under Section 66 of the Act. The extant law attempts to extinguish the share capital of the select minority, subject to the passing of a special resolution and subsequent approval by NCLT. This method is attractive as it merely requires a majority vote of 75% of the shareholders, unlike a scheme of arrangement or consent of 90% majority as in the case of compulsory acquisition.
Takeover Notification: A new route to squeeze out minority?
The Ministry of Corporate Affairs (“MCA”) has recently added a new method of minority squeeze out that would apply to unlisted companies. In lieu of the same, section 230(11) and 230(12) have now been made effective from February 3, 2020. In order to operationalize the extant provisions, the MCA subsequently notified Rule 3(5) of the Companies (Compromise, Arrangement and Amalgamations) Rules, 2016 (“Takeover Rules”) detailing how the application may be made u/s 230(11) and 230(12) respectively.
At the behest of the Takeover Rules, any shareholder who has an individual or collective shareholding of 75% in a company, is entitled to squeeze out the minority by making a takeover offer and presenting an application before the NCLT. In order to make an application under the takeover rules, the proposed shares to be acquired need to be valued by a registered valuer along with a report disclosing details of shares, opening of bank account, wherein not less than 50% of the total consideration of the takeover offer is deposited. The new framework emphasises primarily on parameters to be taken into consideration by the valuer while arriving at a fair value of shares. Apart from the book value of shares, net worth, and industry average, the valuer must take into account the highest price paid by a person or group of persons for the acquisition of shares in the preceding 12 months. Whilst this amendment is perceived to be a positive step for business entities, it is a missed opportunity for the minority shareholders who could be forced to involuntarily exit the company.
Moreover, the newly added provision provides a remedy for a minority shareholder to make an application before NCLT u/s 230(12) r/w with rule 3(5) of the Takeover Rules, if they are aggrieved by the offer. However, the provision is discretionary in nature and the aggrieved party can approach NCLT if the valuation report is unfair. Though section 230(12) allows the minority shareholder to move an application against the takeover offer, the focus of fair valuation in the new takeover rule flow from In Re: Cadbury India Limited judgment passed by the Bombay High Court. The principles laid down in the latter judgment have given due importance to fair valuation while scrutinizing the application. The takeover rule expressly reflects majority supremacy in matters of control of a company and is an added weapon in the hands of the majority.
Analysing the Dilemma over Multiplicity of Exit Options
The newly notified takeover rule is nothing but a collocation of exit options enacted by the legislature. A better way to introduce the progressive changes intended by the MCA could have been to add them as a proviso to the existing section. Practically, that would have clarified the conundrum over multiple exit options.
Section 230(11) is redundant in terms of protecting the interests of minority shareholders. Notably, the dissenting shareholders can approach NCLT based on the valuation report, it is highly unlikely that NCLT will give a favourable order as its role is restricted to determine ‘reasonableness’ of the valuation report. It does not get into the technicalities and calculations of the valuation report. The judicial trend in this regard has been weaved in a way where the courts refused to look into the application unless there are inherent defects in the valuation report. In Sandwick Asia Limited v.Bharat Kumari Padamsi, the Bombay High Court refused to withhold the resolution of share capital reduction as the overwhelming majority shareholders voted in favour of the scheme. Similar reasoning was provided in Re Organon (India) Ltd. v. Unknown and Wartsila India Ltd. v. Janak Mathurdas. Hence, even though the literal interpretation of section 230(12) provides for a broader remedy to minority shareholders, the existing judicial framework is quite restrictive. Apart from the valuation of share value, neither Section 230(12) nor the NCLT rules provide for factors to be taken into account while deciding upon such an application. Therefore, clarity in this regard is essential. Moreover, in the In Re: Cadbury India Limited, the Bombay High Court has set high standards for dismissing the valuation report. The principles lay down that only when an objector is able to show that the valuation is ex facie unreasonable and unequivocal, the court should allow the application. It is well stated that the role of NCLT is supervisory and it cannot evaluate the scheme in terms of judicial scrutiny.
Nonetheless, it is worth questioning the legislative intent of including the proviso to Section 230, as the general schemes u/s 230(1) gives due importance to voting rights of minority shareholders and their views on the resolution. Conversely, Section 230(11) is silent on voting, meetings, and minority shareholders. Secondly, although the pricing norms seem justified, the same can be deliberately evaded as analysed by the industry experts. The provision is a blessing in disguise for the majority shareholders who can squeeze out the minority at a low price by doing valuation at the distressing times when the company is lowly valued. Therefore, it is imperative to balance such a draconian provision that allows opportunistic behaviour by putting minorities at a disadvantageous position. Interestingly, the registered valuer is appointed by passing an ordinary resolution and it is highly probable that the share valuation report could be biased towards the interests of majority shareholders. Neither the law nor the precedents make any reference on evaluating the independence of the registered valuers. All the exit options seem to overlap with each other, thereby resulting in uncertainties around existing law on the minority. Hence, it is prudent for the legislature to simplify the crowded regime over squeezing out by making one clear provision on all possible situations.