The Central Government recently notified Sections 230(11) and 230(12) of the Companies Act, 2013 (“Act”), which deal with takeover offers in unlisted companies. Section 230 of the Act provides for arrangements between a company and its creditors or members or any class of them, specifying the procedure to be followed to make such a compromise or arrangement. The newly-notified Section 230(11) states that in the case of unlisted companies any compromise or arrangement may include a takeover offer made in the prescribed manner, while Section 230(12) permits a party aggrieved by the takeover offer to make an application, bringing its grievance before the National Company Law Tribunal (“NCLT”). The Ministry of Corporate Affairs has also amended the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (“CAA Rules”) and the NCLT Rules, 2016, corresponding to the above provisions. Sub-rules 5 and 6 have been added to Rule 3 of the CAA Rules, and Rule 80A has been inserted in the NCLT Rules, detailing the manner in which the applications may be made under Sections 230(11) and 230(12), respectively. However, these rules are not applicable to any transfer or transmission of shares through a contract, arrangement or succession, as the case may be, or any transfer made in pursuance of any statutory or regulatory requirement.
In effect, these provisions allow majority shareholders, holding 3/4th of the shares, in a company to make a takeover offer to acquire any part of the remaining shares, by way of an application before the NCLT. For this purpose, shares have been defined to mean equity shares or securities such as depository receipts, which entitle the holder thereof to exercise voting rights. This can be read to mean that these provisions bring within their fold every equity instrument as long as the said instrument contains concomitant voting rights. The application with the takeover offer is required to contain the report of a registered valuer disclosing the details of the valuation of the shares proposed to be acquired as well as details of a bank account, to be opened separately by the offeror, wherein a sum of not less than 50% of the total consideration of the takeover offer is deposited. The valuation report must take into account the highest price paid by any person or group of persons for acquisition of shares during the last 12 months and the fair price of shares of the company, determined after taking into account valuation parameters including return on net worth, book value of shares, earning per share, price earning multiple vis-a-vis the industry average, and such other parameters as are customary for valuation of shares of such companies. Additionally, the amendments to the NCLT Rules provide the manner in which a minority shareholder (or any other party) aggrieved by the above offer may make an application bringing his grievance before the NCLT under Section 230(12) of the Act.
A formal route for minority squeeze outs?
The above provisions are likely to serve as another avenue for majority shareholders to squeeze out minority shareholders from a company. Presently, this is ordinarily accomplished by way of selective reduction of share capital under Section 66 of the Act. In fact, the newly introduced takeover rules appear to be in consonance with the jurisprudence that has sprung up regarding the squeeze out of minority shareholders through such selective reduction. For instance, the framework set in place by the above provisions does not envisage any inherent right of minority shareholders to retain their shares in the face of fair consideration being offered to them. This is in line with the ruling of the Hon’ble Bombay High Court in Sandvik Asia Limited v. Bharat Kumar Padamsi, where the Division Bench held that “once it is established that non-promoter shareholders are being paid fair value of their shares…and that even overwhelming majority of the non-promoters shareholders having voted in favour of the resolution shows that the court will not be justified in withholding its sanction to the resolution.”
The focus on fair valuation and securing the consideration amount is also in keeping with existing jurisprudence on minority squeeze outs. In a landmark judgment in Cadbury India Limited, the Bombay High Court set out the principles a court should take into account while determining if selective reduction of share capital is fair, and the new framework appears to have taken these principles into account. The Cadbury principles emphasise the importance of ensuring fair valuation, including by reference to the rate at which past offers were effected, as provided for in the present rules with the requirement to provide in the application the highest price at which shares had been acquired in the past 12 months.
The framework provided by the newly introduced provisions is minimal. The emphasis is evidently primarily on the aspect of valuation. The provisions lend some guidance on specific factors and parameters that the valuation report must take into account to arrive at the fair price of shares, namely (i) the highest price paid by any person or group of persons for acquisition of shares during the last 12 months; (ii) return on net worth, (iii) book value of shares, (iv) earnings per share, (v) price earning multiple vis-a-vis the industry average, and (vi) such other parameters as are customary for valuation of shares of companies. Whilst the provisions employ a degree of detail and specificity on the criteria a valuation report ought to meet, considering the diversity and complexities of the nature of businesses carried out by companies today, the question of what constitutes fair valuation of a company’s shares may prove to be a vexed one and a field for controversy before the NCLT. The approach that the NCLT will adopt in scrutinising such applications remains to be seen. However, there is judicial precedent available in this regard for the NCLT’s benefit in the form of the Cadbury judgment. The Cadbury judgment sets a high standard to dismiss a valuation report or conclude that minority shareholders have been discriminated against or prejudiced – it states, “Prejudice” here must mean something more than just receiving less than what a particular shareholder may desire. It means a concerted attempt to force a class of shareholders to divest themselves of their holdings at a rate far below what is reasonable, fair and just. Prejudice in this context must connote a form of discrimination, a stratagem by which an entire class is forced to accept something that is inherently unjust.
As such, according to the principles laid out in this case, for a court to decline sanction to a scheme on account of a valuation, an objector to the scheme must first show that the valuation is ex facie unreasonable, i.e., so unreasonable that it cannot on the face of it be accepted. To upset a valuation, a wrong approach must be demonstrated clearly and unequivocally, and the result must be plainly invidious. A plausible rationale provided by a valuer cannot readily be discarded merely because an objector has a different point of view. On a fair reading from a reasonable person’s perspective, and without requiring any microscopic scrutiny, the valuation must be so egregiously wrong that the judicial conscience will not permit it.
Grievances of aggrieved shareholders
Insofar as a minority perspective is concerned, the protections offered in the takeover rules to minority shareholders remain largely in terms of ensuring that a fair value is offered to them for their shares and that the consideration amount is secured. This is done by an onerous condition requiring deposit of 50% of the consideration in a bank account, as well as by detailing the factors to be taken into account in the valuation report. Interestingly, while schemes under Section 230(1) of the Act as well as the Cadbury principles both take into account the views and vote of affected/ minority shareholders on the resolution, the takeover rules do not make reference to any such vote or meeting or minority shareholders.
Further, while aggrieved shareholders may place their grievance before the NCLT, neither Section 230(12) nor the amended NCLT Rules provide any guidelines in terms of the factors to be taken into account by the NCLT while considering such an application, which as stated above focuses almost exclusively on valuation. This may permit opportunistic majority behavior and place minority shareholders at a disadvantageous position, for instance, if the takeover offer is made shortly before the company enters into a profitable transaction. The provision may also be utilised to squeeze out minorities at a lower price than their initial investment, at a time when the company is lowly valued, even if that period is transitory. In such instances, it remains to be seen whether the NCLT will consider prospective valuation / profitability of the company as well. While the Cadbury principles took a clear view that the role of the court in such circumstances was merely peripheral and supervisory, not appellate, the level of scrutiny that will be exercised by the NCLT will largely determine the degree of protection to be offered to minority shareholders in such applications.