Background
A scheme of arrangement is an oft used mechanism for company restructuring, which may take the form of a ‘merger’, a ‘demerger’ or even a ‘compromise’ with creditors. Sections 391-394 of the Companies Act, 1956 (“1956 Act”), read with the Companies (Court) Rules, 1959, were the relevant statutory framework governing this.
Broadly, the approval process for a scheme is two staged:
- First motion: getting approvals of shareholders, creditors, etc., through affidavits and/ or at meetings convened pursuant to court directions.
- Second motion: the company court considering the scheme on merits, together with the observations/ objections by statutory authorities and the public at large.
Therefore, objections to the scheme at the first motion stage, were largely dismissed.
The Hon’ble Supreme Court’s Judgement in Rainbow Denim Ltd. v. Rama Petrochemicals Ltd.[1] (“Rainbow Denim”) seemingly cast in stone the proposition that objections to the scheme cannot be considered at the first motion stage by observing that:
“The appropriate time for the Company Judge to consider the scheme is subsequent to approval thereof by the shareholders and creditors of the appellant Company.”
The Companies Act, 2013 (“2013 Act”), retains the two-step process for approval of a scheme. The analogous provisions to Sections 391-394 (of the 1956 Act) are Sections 230-232 of the 2013 Act.
The Rainbow Denim position seemingly held the field even under the 2013 Act, as it appears from the Hon’ble NCLAT’s judgement in MEL Windmills Pvt. Ltd. Vs. Mineral Enterprises Limited And Anr. [2] (“MEL Windmills”),wherein it was observed that:
“The Tribunal, at the very threshold stage, was not required to venture into the merits of the proposed scheme of demerger which had to be examined only, after, obtaining the consent of creditors/members with requisite majority”
However, recent judgements from different benches of the National Company Law Tribunal (“NCLT”) are signalling a thaw in this position.
In this article, we explore these nascent winds of change.
Chinks in the rainbow: NCLT’s departure from the earlier position
By an order dated January 24, 2024, in SRS Private Investments Powai Limited v Supreme Housing and Hospitality Private Limited,[3] (“SRS Pvt Ltd”), the Hon’ble NCLT Mumbai Bench, Court III, rejected a scheme at the stage of first motion, for being contrary to public interest and for proposed violation of a stay order on dealing with certain properties. Specific reliance on Rainbow Denim and MEL Windmills was considered and rejected. The tribunal held it was incorrect to argue that:
“this Tribunal cannot even prima facie consider the proposed Scheme, without going into merits of the Scheme, or consider the surrounding circumstances to the proposed Scheme”
The NCLT Mumbai also placed reliance on Rule 5 of the Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016 (“CAA Rules”), which empowers the Tribunal to dismiss a first motion petition “for any reason it thinks fit”.
By an order dated April 18, 2024, in Ayushi Credit and capital services Ltd[4] (“Ayushi Credit”), the Hon’ble NCLT Delhi Bench, Court II, dismissed a scheme of arrangement at the first motion stage. The NCLT noted how the scheme involved companies that were involved in perpetrating financial scams. The judgements in Rainbow Denim and MEL Windmills were once again distinguished.
Most importantly, in Ayushi Credit, the NCLT noted that, “the provisions of the Companies Act, 1956 and Companies Act, 2013, though largely similar, still have certain subtle differences, particularly with respect to a Compromise or Arrangement.”
Thereafter, upon a comparison of the powers of the company courts (in terms of Rule 67 to 69 of the Companies (Court) Rules, 1959) and those under the CAA Rules, with specific reference to Rule 5, held that:
“we note that the latter clearly provides that the Tribunal shall issue necessary directions ‘unless it thinks fit for any reason to dismiss the application’. Such a mandate was not clearly stated in the relevant rules in the Companies (Court) Rules, 1959 (extracted above). Thus, we are of the view that the rules under the Companies Act, 2013 provides that this Tribunal dismiss the application in the first motion stage, if a case backed by sufficient evidence is made out before the Tribunal to that effect.”
By an order dated July 19, 2024, in Mist Direct[5], the Hon’ble NCLT Delhi Bench, Court VI, rejected a scheme proposed by a company with its creditors, who were allottees in a real estate project. The NCLT noted that material disclosures at the first motion stage were not made and relevant facts were concealed. The NCLAT judgement in MEL Windmills was distinguished by holding that:
“The very purpose of taking permission from this Tribunal for convening a meeting is to ensure that the scheme is not prejudicial to the interests of any class of stakeholders involved and that all classes of stakeholders who will be affected by the Scheme have been made to participate in its approval. Most importantly, all relevant material facts, any pending investigations or proceedings, and the effect of these on the Scheme are disclosed to all those stakeholders who will decide regarding approval of the scheme.”
ANALYSIS & THE ROAD AHEAD
In Miheer H. Mafatlal v. Mafatlal Industries Ltd.[6],the Hon’ble Supreme Court has held that a company court is not a mere rubber stamp to approve a scheme. It needs to consider the interest of all stakeholders and the public at large.
However, at the stage of first motion, the courts were slow to dismiss a petition. Thus, meetings were directed at the first motion stage, and only at the stage of the second motion did the courts consider a scheme on merits.
This position largely remains unchanged even under proceedings under the 2013 Act. However, the biggest difference between the 1956 Act and the framework of the 2013 Act is Rule 5 of the CAA Rules. Such a provision, conferring the tribunal/ company court with the power to dismiss the first motion petition ‘for any reason’ was not there earlier.
Resultantly, there is now perhaps greater scrutiny of the bonafides of the scheme, the facts and circumstances surrounding the scheme and other aspects, such as investigations/ proceedings. Further, the Tribunal (NCLT) being conferred with the power to dismiss a petition at the threshold, is more mindful of whether compliances of the first motion have been fulfilled. This would include presenting all material particulars, including the latest, true and accurate financial position of the applicant company(ies). Notably, such objections, even if raised at the first motion, would not be objections relating to the merit of the scheme. Rather, they pertain to the surrounding circumstances, and whether the mandatory disclosures (as set out in the 2013 Act and CAA Rules) have been made.
Even so, the position in Rainbow Denim has not been irrevocably altered. It is unlikely that the NCLT will entertain objections to the merits of the scheme at the first motion. Equally, applicants seeking sanction of a scheme can perhaps no longer blindly rely on the Rainbow Denim position to seek directions for meetings, without showing that requisite disclosures for the first motion are made and/ or that the scheme is not manifestly against public interest.
A scheme lacking material disclosures for the first motion stage or a scheme starkly prejudicial to the public or based on concealment or fraud can be dismissed at the threshold. It would be no defence to say that such an objection cannot be taken at the first motion.
The road ahead may see applicants not take sanction of a first motion as a fait accompli and be more careful about ensuring disclosures. Any shortcomings in this regard and/ or relevant surrounding circumstances can be raised at the first motion stage, leaving the merits for later. This perhaps balances the need of the scheme to proceed ahead, at least at the first stage (approvals of shareholders and creditors), without diluting the standards necessary for the first motion to pass. That being said, the Rainbow positionmight now shine brighter.
For further information, please contact:
Kapil Arora, Partner, Cyril Amarchand Mangaldas
kapil.arora@cyrilshroff.com
[1] (2002) 10 SCC 498
[2] Company Appeal (AT) No. 04 of 2019
[3] Intervention No. 13 of 2023 in CA (CAA) No. 233/2023
[4] CA(CAA) 78/ND/2022
[5] CA(CAA) 10/ND/2024
[6] (1997) 1 SCC 579
