Squeeze-out Mergers in India: How are they different from Global Standards?

[By Ajith N Kale & Rupa Veena S]

The authors are students of School of law, CHRIST (Deemed to be University), Bangalore.

 

Introduction

The common law rule of the majority, as laid down in the case of Foss v. Harbottle, has been widely followed in India. It empowers the majority shareholders to make decisions related to the management of affairs of the company which is not interfered with by courts generally. However, minority shareholders always have the right to approach the National Company Law Tribunal (“NCLT”),and courts in case of fraud, mismanagement, oppression or breach of charter documents by the majority shareholders. As per the freeze-out or squeeze-out provisions under the Companies Act, 2013 (“Act”) the majority shareholders can acquire the shares held by minority shareholders and, thereby, squeeze them out of the company, and resultantly can hold the entire shareholding in a company. In light of the same, this article focuses on the legal status of freeze-out mergers in India and further makes a comparative analysis with the laws of South Korea, the United Kingdom (UK), and Australia.

Legal status of freeze-out mergers in India

In early 2020, section 230 of the Act was amended to include sub-sections (11) and (12)(“2020 Amendment”). Moreover, Companies (Compromises, Arrangements, and Amalgamations) Amendment Rules, 2020 (“CAARules”) and the National Company Law Tribunal (Amendment) Rules, 2020(“NCLT Rules”) were also notified, which were collectively known as the “Takeover Notification” as the amendments primarily were in relation to the takeover of minority shareholding by the majority. Firstly, as per section 230(11) of the Act, any compromise or arrangement includes a takeover offer. Secondly, Rule 3(5) of the CAA Rules enables majority shareholders holding at least 75% of the equity shares carrying voting rights (including depository receipts with voting rights) to file an application with the NCLT to acquire the remaining minority shares subject to a fair price. Thirdly, NCLT Rules deal with procedures related to acquiring minority shares. If the NCLT approves the application, the majority shareholders can forcibly acquire the minority shares by creating an obligation on minority shareholders to sell their shares.

Section 235 of the Act allows the compulsory acquisition of shares held by dissenting shareholders if such an acquisition by a scheme or contract is approved by 90% of the shareholders within two months of notice to such dissenting shareholders unless NCLT has ordered otherwise on an application made by the dissenting shareholders.

Another option available for the acquirer to acquire the minority shares is stated under section 236. The said section allows majority shareholders holding at least 90% of the equity shares to acquire minority shares by virtue of an amalgamation, share exchange, conversion of securities or for any other reason by notifying the company about the same. However, the bare reading of the section does not expressly obligate the minority shareholders to sell their shares. Moreover, section 236(9) states that in the event of failure of acquisition of all of minority shares by the majority shareholders, the residual minority shareholders will still be regulated under the relevant provisions of the Act.

While also ensuring the right of acquisition to the majority shareholders, the amendments provide effective safeguards for the minority shareholders. As per section 230(12) of the Act, aggrieved minority shareholders of unlisted companies can approach the NCLT in case of grievances related to takeover offer. Additionally, the majority shareholders must compulsorily deposit at least 50% of the consideration of the takeover offer in a separate bank account.

In the case of S. Gopakumar Nair v. OBO Bettermann India Private Limited, the National Company Law Appellate Tribunal (“NCLAT”)held that the 90% majority shareholders can acquire the minority shares only if any of the events stated in section 236(1) that is “amalgamation, share exchange, conversion of securities or for any other reason” has taken place. As per the rule of ejusdem generis, NCLAT held that “for any other reason” includes only events that are like amalgamation, share exchange, or conversion of securities. It also differentiated between section 235 and section 236 by stating that on one hand section 235 provides for the acquisition of shares from dissenting shareholders, on the other, section 236 allows the acquisition of shares from assenting shareholders only if any of the events mentioned in section 236(1) are triggered. Arguably, Indian laws have tried to strike a balance between rights of the majority and the interests of the minority shareholders, however, to determine whether they are as per the global standards, laws of other nations may be compared.

Comparative jurisdictions

South Korea

Article 360-24 of the Korean Commercial Act, 2018 guarantees a majority shareholder holding at least 95% of the shares to buy out the shares held by minority shareholders. The minority shareholders must sell their shares within two months from the date of request. However, even after negotiation, if the minority shareholders are unsatisfied with the sale price, they can approach the court to determine a fair and reasonable sale price. This section can be compared to section 235 of the Act, wherein majority shareholders holding 90% of shares can acquire the shares held by dissenting shareholders within four months. Further, under Article 360-25, the minority shareholders have the right to sell their shares to the majority shareholder, and the court shall determine the sale price if the parties do not come to a consensus through negotiation. This is similar to section 236, wherein minority shareholders can sell their shares to the majority shareholder. However, while Korean law allows the minority shareholders to approach the court only to determine the reasonable sale price, Indian law empowers the minority shareholders to approach the NCLT in case of any grievances they face in relation to such an acquisition, in addition to making the submission of valuation report of the shares to NCLT mandatory. This indicates that the Indian laws emphasize more on minority shareholders’ protection than the Korean law. Furthermore, section 230 allows shareholders holding 75% of shares to acquire minority shares as opposed to the 95% threshold under Korean law. The majority threshold of 95% is not easily attainable compared to 75%. The lower qualifying threshold for the majority shareholders makes this right of acquisition of minority shares more accessible to a larger number of shareholders.

United Kingdom

According to sections 979 and section 983 of the English Companies Act, 2006, the acquirer may freeze-out the minority shareholders using structures similar to those followed in India, i.e., it enables the acquirer to purchase the remaining shares if they own at least 90% of the shares. Similarly, it also enables minority shareholders to “sell-out” their shares to an acquirer that owns at least 90% of the company. Minority shareholders have different legal rights under English law, as illustrated in the case of Hellenic and General Trust Ltd[1]. The court held that each shareholder should be regarded as a separate class because the acquirer’s approval derives itself from the minority group when addressing how “most of the minority” spearheaded the plan of action. In cases wherein freeze-outs have been implemented in a way that is detrimental to the interests of minority shareholders English courts have invalidated them. The notice that will be delivered to the minority shareholders specifies the outcomes and effects of the plan of action on them in accordance with English law.

Australia 

The Eggleston principles, which prioritise fairness, equality of opportunity, and the protection of minority shareholders over economic efficiency, form the foundation of Australia’s takeover procedure under the Corporations Act, 2001. If they consider a majority resolution to be against them, minority shareholders have the right to object to it in a general meeting. This prevents the application of rules like those in India where a “majority of the minority” voter may accept capital reductions despite being prejudiced against the interests of minority shareholders. This rule was observed in the case of Cadbury Ltd. vs. State of Maharashtra, wherein a special resolution for reduction of capital (99.96% Majority, 0.04% Minority) was passed and an independent valuation was ordered by High Court on objection by minority shareholders.

There are two fundamental techniques for freeze-out under the said Act, firstly, the mandatory acquisition of shares after a takeover offer. Secondly, a necessary approval obtained in different conditions. These schemes provide the minority shareholders the right to object to the acquisition of their shares. However, it should be highlighted that Australia’s takeover laws are among the most stringent across world economies. Therefore, directly implementing such laws in India will be challenging and inefficient.

Conclusion

Diverse strategies are used across the world to strike a balance between the issues of not safeguarding value-enhancing freeze-outs and those of protecting minorities. In India, we tend to be unenthusiastic about strategies that rely on a swift and dynamic judicial resolution to be effective. The authors contend that a combination of increased regulatory oversight and voting rights or other protections would be preferable in the Indian setting. Prior to the 2020 amendment to section 230 and the Takeover Notification, the qualifying threshold was 90% under section 236 for the acquisition of minority shares by the majority shareholder. However, post the Takeover Notification, 75% was set as the qualifying threshold under section 230. This ensures that more majority shareholders could exercise their right to acquisition of minority shares.

It is evident from a review of the minority squeeze-out provisions that the need to safeguard the interests of minority shareholders has been acknowledged. However, approaching NCLT for grievances is a time-consuming process, thus, the authors contend that the minority shareholders should be given the ability to challenge a resolution in a general meeting if it constitutes a fraud on them, or requiring a “majority of the minority” vote to effect a squeeze-out. As it is, the law provides a costly and ineffectual option for minority shareholders in the case of a “squeeze-out,” and as a result, it falls short of appropriately protecting such minority shareholders, especially when compared to other economies.

[1] Hellenic & General Trust Ltd [1976] 1 WLR 123

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