17 December 2021
Background
The law on minority squeeze-out has not been a glorious chapter in the history of India’s company law. The Parliament, as a matter of legislative policy, appears to be uncomfortable with enacting a law that forces minority shareholders to compulsory sell their shares. The government perceives it as a kind of ‘expropriation’. Hence, despite Dr. JJ Irani Committee’s specific recommendation, our Parliament has adopted a conservative approach while providing majority shareholders with the mechanism to ‘buyout’ the shares held by the minority shareholders. Even after the ‘right to property’ was abolished as a fundamental right under our Constitution, law makers seem uncomfortable in giving such right to majority shareholders, and half-hearted attempts have been made to provide majority shareholders with the ability to fully own a company.
In comparison, company laws of most developed countries provide a clear right to the majority shareholders with suitable safeguards, like Sections 979 and 983 of the English Companies Act, 2006. Indian Company Law is largely based on English Company Law, but we have departed from them in this one vital aspect.
Drawing on the legislative objectives, Section 395 of the Companies Act, 1956 (“1956 Act”), provided a transferee company with a limited mechanism for a minority squeeze-out, in situations where a scheme or contract involving a transfer of shares between two companies receives approval of at-least 90% of the shareholders, whose shares are being purchased.
Section 235 of the Companies Act, 2013 (“Act”) broadly corresponds to Section 395 of the 1956 Act. Section 235(1) provides for a compulsory acquisition of the shares held by the dissenting shareholders, in situations where a scheme or contract involving the transfer of shares or any class of shares in a company (i.e. the transferor company) to another company (i.e. the transferee company) has, within four months after making of an offer in that behalf by the transferee company, been approved by the holders of not less than nine-tenths (i.e. 90%) in value of the shares, whose transfer is involved. Once the approval is received from at-least 90% of the shareholders whose shares are being acquired, a company can issue notice to the dissenting shareholders, stating that it desires to acquire their shares. It is pertinent to note that in accordance with Sections 235(2) and 235(3) of the Act, the dissenting minority shareholders (whose shares are being compulsorily acquired) have a right to object to the acquisition, by approaching the NCLT.
In addition to the limited mechanism provided under Section 235, companies have also adopted other methods like selective capital reduction (in accordance with Section 66 of the Act), for a minority squeeze-out.
Listed companies have the additional option of undertaking a delisting of equity shares, in accordance with the SEBI (Delisting of Equity Shares) Regulation, 2021 (“Delisting Regulations”).
Along with Section 235, the Act has also added Section 236, which is a new provision dealing with “purchase of minority shareholding”.
Scheme of Section 236 of the Act
Section 236 of the 2013 Act partially mirrors the aborted provisions of Section 395A of the Companies (Amendment) Bill, 2003. The said Bill lapsed as the Parliament was dissolved for General Elections in 2004, and it never got re-introduced due to the change of the Government. Although the Companies (Amendment) Bill, 2003, had lapsed, the Irani Committee Report[1] had recommended that Section 395A may be considered as a basis for developing an appropriate legal framework for acquisition of minority shareholding.
Unfortunately, Section 236 is clumsily drafted, and it has resulted in many interpretative challenges for corporate lawyers. The rationale behind its introduction is also under-articulated in the Notes on Clauses to the Companies Bill, 2013.
Section 236(1) of the Act provides that in the event of an acquirer, or a person acting in concert with such acquirer, becomes a registered holder of 90% or more of the issued equity share capital of a company, or in the event of any person or group of persons becoming 90% majority or holding 90% of the issued equity share capital of a company, by virtue of an amalgamation, share exchange, conversion of securities or for any other reason, such acquirer, person or group of persons, as the case may be, shall notify the company of their intention to buy the remaining equity shares.
Section 236(2) provides that the acquirer/person/group of persons under Section 236(1) shall offer to the minority shareholders of the company for buying the equity shares held by such shareholders at a price determined on the basis of valuation by a registered valuer in accordance with such rules as may be prescribed.
Section 236(3) provides that without prejudice to the provisions of Sections 236(1) and 236(2), the minority shareholders of the company may offer to the majority shareholders to purchase the minority equity shareholding of the company at the price determined in accordance with such rules as may be prescribed under Section 236(2).
Sections 236(4) to 236(9) provide certain additional compliance requirements that must be fulfilled, once the majority shareholder(s) have exercised the rights conferred by Sections 236(1) and 236(2). Rule 27 of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, provides the method for arriving at the fair value of the shares, in case of both listed and unlisted companies.
It is also pertinent to note that for the purposes of Section 236(2), valuation should be undertaken by a registered valuer, in accordance with Section 247 of the Act, and the Companies (Registered Valuers and Valuation) Rules, 2017.
For evaluating the scope of Sections 236(1) and 236(2), it is instructive to refer to the decision of the NCLAT in S. Gopakumar Nair v. OBO Bettermann India Private Limited[2] (“OBO Bettermann”).
NCLAT’s interpretation of Sections 236(1) and 236(2)
In OBO Bettermann, the majority shareholders (who held 99.64% of the shareholding of the company) tried to compulsorily acquire the shares of the minority, by issuing notices under Section 236.
The NCLAT held that Section 236 can be invoked by the majority shareholder(s) only if either of the ‘events’ specified under Section 236(1) have taken place – which implies that the majority shareholder should hold or acquire a minimum of 90% of the shareholding “by virtue of an amalgamation, share exchange, conversion of securities or for any other reason”. It was held that the words “for any other reason” should be read ejusdem generis with the preceding words and would only include ‘events’ that are similar to an amalgamation, share exchange and conversion of securities.
The NCLAT had also observed that while Section 235 deals with the acquisition of shares from dissenting shareholders in certain specified situations, Section 236 deals with the acquisition of shares from assenting shareholders, if either of the ‘events’ specified in Section 236(1) have taken place.
Whether Section 236(3) is independent from Sections 236(1) and 236(2)?
The king-puzzle of the Act is in the form of Section 236(3), which provides that without prejudice to the provisions of Sections 236(1) and 236(2), the minority shareholders of the company may offer to the majority shareholders to purchase the minority equity shareholding of the company at the price determined in accordance with the rules prescribed under Section 236(2).
While Sections 236(1) and 236(2) [which deal with the majority shareholders’ right to buyout the minority], use the word “shall”, Section 236(3) uses the word “may”. This indicates that a person who becomes a 90% majority shareholder [by virtue of an amalgamation, share exchange, conversion of securities or for any other reason] has an obligation to make an ‘offer’ to purchase the shares of the minority. However, there is no corresponding obligation on the minority shareholders to compulsorily sell their shares to the majority.
This is also supported by Section 236(9) of the Act, which provides that when a majority equity shareholder “fails to acquire full purchase of the shares of the minority equity shareholders”, then Section 236 shall continue to apply to the residual minority equity shareholders.
Further, given that Section 236(3) begins with the words “without prejudice to”, at a prima facie level, one could argue that Section 236(3) is an independent provision, that confers an independent right to the minority shareholders to sell their shares to the majority. If one were to take such a view, it would tantamount to the minority shareholders in Indian companies having a perpetual ‘put option’ on the majority shareholder, without have any such right under a contract. One could even argue that since Section 236(3) is an independent provision, the “minority” does not mean shareholders holding 10% or less, but would cover a situation where a minority shareholder holding 49% shares can exercise a ‘put option’ on the majority shareholder holding 51%.
However, such an interpretation would militate against the objective of Section 236, which is captured in the Report of the Parliamentary Standing Committee on Finance, which examined the Companies Bill, 2011 (“PSC Report”). The PSC Report notes the MCA’s view that Section 236(2) and 236(3) are different, but “interlinked” provisions, and the valuation requirements prescribed under Section 236(2) are also application for Section 236(3).[3]
Moreover, it is pertinent to note that Section 236(3) only uses the words “without prejudice to”, and does not use the words “notwithstanding anything contained in sub-sections (1) and (2)”. This indicates that Section 236(3) has a close correlation with Sections 236(1) and 236(2), and does not confer any separate statutory ‘put option’ right to the minority shareholder, that is independent of any Shareholders’ Agreement executed between the parties.
In this context, indicative guidance can also be taken from the decision of the Supreme Court in A.P. State Financial Corporation. v. Gar Re-Rolling Mills[4], where it was observed that the use the words “without prejudice to” in a statute implies that the applicability of the other provisions is not excluded, and this expression should not be used to make the other provisions redundant.
The wording of the provision and the legislative objective suggests that Section 236(3) is closely connected with the preceding provisions, and the minority shareholder can make a binding offer to sell his shares only when the pre-conditions prescribed under Sections 236(1) and 236(2) are satisfied.
Concluding Thoughts
As Section 236 does not make it mandatory for the minority shareholders to sell their shares at fair value, Section 236 only provides a half-baked remedy for a minority buyout. Keeping in mind the recommendations made in the Irani Committee Report, the wording of Section 236 could have expressly stated that the minority shareholders have a corresponding obligation to sell their shares to the majority at fair value, once the conditions prescribed under Section 236 are satisfied.
As the Act still does not confer an effective remedy for buying out the minority, majority shareholders are forced to resort to other methods such as selective capital reduction. Listed companies have the additional option of undertaking a delisting of equity shares in accordance with the Delisting Regulations, where the ‘reverse book building process’ poses many practical challenges to do a successful delisting. And even after the completion of the delisting process, a large number of small shareholders, who did not participate for any reason, continue to hold insignificant number of shares, resulting in avoidable compliance burden on such companies.
It is time for our law makers to provide a clear legal architecture for minority squeeze-outs in India (with adequate safeguards to protect the minority) in the next round of amendments to the 2013 Act.
For further information, please contact:
Bharat Vasani, Partner, Cyril Amarchand Mangaldas
bharat.vasani@cyrilshroff.com
[1] Report of the Expert Committee on Company Law, chaired by Dr. Jamshed J. Irani, submitted to the MCA on May 31, 2005.
[2] 2019 SCC OnLine NCLAT 402
[3] 57th Report of the Parliamentary Standing Committee on Finance, The Companies Bill, 2011, 15th Lok Sabha, at Pg. 73.
[4] (1994) 2 SCC 647
