Introduction
In a recent case, the National Company Law Tribunal (“NCLT”) rejected a scheme of merger of three related entities on the ground that it was against public interest. Unlike the other cases of arrangements and schemes where the NCLT focused on the technical compliance of the provisions of the Companies Act, 2013 (“the Act”), in the instant case, the NCLT, in addition to analysing the scheme and verifying its satisfaction of the technical requirements, also went through the facts presented and the reports submitted by the Ministry of Corporate Affairs (“MCA”) and the Income Tax Department (“ITD”), who had carried out their separate investigations. The trend of recent decisions appears to show that the NCLT is not just mechanically sanctioning schemes of merger but is also going beyond the facts provided and reviewing them holistically.
Facts and findings
In the instant case, Hologram Holdings Private Limited, Swen Holdings Private Limited, and Sulphur Securities Private Limited (“Sulphur Securities”) had filed a scheme with the NCLT recommending their merger. With cross-holdings and a common address, the trio belonged to a group of companies that engaged in buying and selling of shares and claimed to provide financial services. The objective of the scheme of merger was stated to be consolidation of business to reduce overhead costs, consolidate managerial expertise of the companies and lend synergy to the group.
All the three companies had certain pending income tax demands against them. The ITD alleged that Sulphur Securities is a conduit paper company belonging to a certain SK Jain Group. The ITD also submitted that Sulphur Securities had only two major transactions with another company belonging to the SK Jain Group during the assessment year in question. The transactions involved sale and purchase of shares concerning other related companies that also belonged to the SK Jain Group and had the same set of directors and addresses.
Considering the above allegations, the NCLT issued directions to the MCA to carry out an investigation at the physical location of the company. Pursuant to the same, the MCA found out in its investigation that the registered office was in a dilapidated, unused shop full of dust and cobwebs. The display board also contained names of ten companies including the incorrectly-spelled Sulphur Securities.
It would be important to note that the NCLT has the power to either sanction or reject schemes of compromise, merger, or amalgamation under sections 230-232 of the Act. The NCLT is generally found to be focussed on the procedural aspects, ensuring that the statutory requirements are met, necessary approvals from shareholders and creditors are obtained, and legal provisions are not violated while sanctioning the schemes.
However, in the instant case, the NCLT decided to dig deeper to unearth the actual purpose and impact of the scheme. It went through the reports submitted by the MCA and the ITD as well as the audited financial statements including the notes appended thereto in order to understand the logic and rationale of the scheme. From the review of the financial statements, it observed that the revenue and expenses had phenomenally risen within one year without any credible source of investment or actual assets. It also observed that the difference between the expenses and revenue was disproportionate. Accordingly, the NCLT concluded that the transactions undertaken by Sulphur Securities were merely accommodation entries or paper transactions.
The NCLT further observed that the scheme’s objective of reducing costs was infructuous as the cost was already minimal as per the financial statements. The objective of attaining synergy was also flawed as the companies were already being controlled by a single group and transacting primarily among themselves. Basis these facts and representations provided by the companies, the NCLT concluded that the real objective of the merger was to legitimise the paper transactions of the three companies to artificially increase the share prices and use the merged company as a vehicle of tax evasion and money laundering.
Accordingly, the NCLT rejected the scheme of merger by holding that the merger scheme was against the interests of the broader public.
Key Takeaways
In pursuance of its broader duty to act in public interest, the NCLT in the present case evaluated whether the merger aligned with the stated objectives and assessed the true intent and purpose behind the transaction. This included detailed factual investigation of the facts and also a more informed analysis of the financial and strategic benefits proposed to be claimed by the applicant companies.
The recent decisions show that the NCLT is going beyond the procedural aspects and proactively scrutinising the schemes of reorganisations to ensure they don’t remain mere corporate restructuring exercises but serve a genuine business purpose without harming the interests of the society. It is not enough that the schemes comply with the statutory provisions and be fair to the stakeholders of these companies, they must also serve a business purpose or pursue an objective beneficial to the business environment or the general public and must be justified by the applicants on merits.
In light of the same, going forward it is important for applicants to define the objectives and explain the rationale of the proposed scheme in greater detail, highlighting the benefits and economies it seeks to achieve. The applications under sections 230-232 of the Act should no longer be designed to comply with the procedural aspects through a mere copy-and-paste template filing. The applicants must be ready with evidence to justify to the NCLT how the proposed scheme will help in achieving the stated objectives and how the merged entity shall be in the interest of general public.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
sr.patnaik@cyrilshroff.com
