The Switch of Seats between State and Corporates

[By Umang Agarwal & Anchal Bhatheja

The authors are students at the National Law School of India University, Bangalore. 

There has been an undesirable but convenient switch of roles of the government and corporates, which is reflected quite starkly in section 396 of the companies act 1956 (‘CA1956’) (which has now been replaced by section 237of companies Act 2013 (CA13)

On one hand, this provision empowers the government to take decisions regarding the restructuring of the companies in terms of being able to order an amalgamation in “public interest” which is a right that should technically vest with the board of directors (‘BOD’) and the shareholders of the company in the interest of corporate autonomy.

On the other hand, it mandates the companies to amalgamate in the public interest, when the state directs them to do so, even when the preamble vests responsibility furthering social justice and public interest with the state.

In this article, we aim to discuss the effect of this switch of roles. It is submitted that section 396 of CA56 and 237 of CA13 assail the very fundamental tenets of corporate law in various ways.

The macro-economic Challenge:

Richard Posner suggests that the wealth of the society maximizes when the resources vest in the hands of those who value them the most. Here, value alludes to both willingness and the ability to pay. However, sections 396 CA56 and 237 CA13 are counter-intuitive when viewed from a wealth maximization perspective.

S Balasubramanian, former chairperson of the Company Law Board suggests that the government often invokes section 396 of CA56 to salvage a company in distress. Even the 2016 amalgamation between FTIL and NSEL, which was eventually struck down by the SC in 63 Moons Technologies v UOI, was to salvage NSEL which was an electronic platform for buying and selling of goods and had run into losses and defaulted on payments to its 13000 investors amounting to nearly Rs. 5600 crores. The central government “jugaad” to resolve the problem was to amalgamate unhealthy NSEL with its healthy parent company FTIL so that the assets of the latter could be used to salvage the losses of the former.

Herein the idea was to revive a company, which might have the willingness to recover but not the ability to do so. This transfer of wealth would have eventually led to a net loss as two companies would have become unhealthy. But such outcomes are not desirable from an economic standpoint.

The motive of every business is to make profits. But every business has the inevitable downside of failing. If the online platform, NSEL was unable to avoid fraudulent transactions and ran into debt due to its mismanagement or inefficiency or in other words lost its “ability” to stay functional, it would be in the interest of wealth maximization to subject it to a resolution process or just dissolve it as per the IBC instead of affixing its liability on a healthy company.

The approach adopted by the central government is economically unsustainable. For instance, over 280 companies have been declared insolvent amidst the pandemic in India. If one were to replicate the FTIL-NSEL approach of merging an unhealthy company with a healthy one to save the former from dying down, for all these 280 companies, this would result in a net of 560 unhealthy companies and would render alternatives provided under the IBC useless.

The micro-economics challenge:

Further, the wording of section 396 CA56 and section 237 CA13 indicates a concern for “public interest”. However, as Milton Friedman puts it, the purpose of a business is only to increase its profits. In essence, the purpose of a corporate is to further the shareholders’ interest and nothing more than that. Corporates are business vehicles for profit maximization and re-structuring them to secure public interest is contradictory to the purpose of a corporate. The preamble of the Constitution puts the onus of being “socialist” and “welfarist” on the state and not on private entities. It is better to restrict the role of corporates in ensuring shareholders’ wealth maximization, instead of making them work towards “public interest”.

In this regard, it is pertinent to note that section 396 CA1956 and section 237 CA13 change the value of the shares and quite often to the detriment of the shareholders, especially when the amalgamation happens between a healthy and an unhealthy company. In such scenarios, the shareholders of the healthy company lose out as the value of the shares diminishes due to the increased liabilities of the company.

The financial value of shares is a great concern for the shareholders, as it decides the prospects of selling shares to get profits as well as the dividends, they eventually get on the shares they own. Therefore, the provision is economically unsustainable.

The Jurisprudential Challenge:

Furthermore, since the only purpose of a corporate is to further the shareholder’s interest, CA13 provides for a regime to ensure the efficacy of this idea. Towards this end, various provisions of CA13 like section 232 and 233 envisage the role of BOD in proposing a resolution for amalgamation. At a principal level, these provisions allude to the idea of liberalism where the BOD which is elected by the shareholders gets to decide the fate of the corporate and its formal structure. Sections 396 CA56 and 237 CA13 further a more paternalistic approach, wherein the state gets to decide what is best for the companies and the society at large.

In 63 Moons Technologies v UOI, the two companies were parent and subsidiary companies respectively. If they felt the need to amalgamate, CA13 gave them full autonomy to do so. And since the fundamental assumption of law and economics is that individuals and firms are rational and act in their best interest, they could have taken a decision regarding amalgamation on the basis of their own incentives and interests. Thus, there was no need for the intervention of the state to determine the companies’ best interests.


Considering the foregoing discussion, we submit that there is a case against section 396 CA56 and section 237 CA13 as it is counter-intuitive to the basic principles of law and economics and corporate jurisprudence.

Even if one were to ignore these fundamental challenges, the very scope and purport of “public interest” in the provision is extremely vague and can be characterized as a standard instead of being a rule. This enables the state to forcibly merge two corporates on the basis of its own subjective satisfaction, thereby eroding the principle of corporate autonomy. A market where corporates work towards public interest and state runs and re-structures corporates is undesirable. This switch of roles should thus be avoided and re-looking at section 237 CA13 would be the first step in that direction.


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