Introduction

Commentators have always debated the wisdom of Section 66 of the Indian Companies Act.¹ This has made the question of squeezing out of minority shareholders a vexed question. The question is still prevalent today as laws in certain jurisdictions allow for the same to be carried out. This economic deal which is unfair in its root’s causes deprivation of the property rights to the minority shareholders. Though in India section 395 of the Companies Act² is the provision that deals with squeezing out, since it has its problems and legal complexities surrounding it, it is a rarely utilized provision.

However, majority shareholders who always run behind profit motive have devised their modes of utilizing Company law provisions in order to meet their objectives of squeezing out. This led to different modes of interpretation within Sections 391³ to 394⁴ of the Companies Act 2013. One of the interesting cases wherein this mode of procurement was highlighted was in the case of re Sterilite Industries Ltd. The factor that makes this offer special is its nature that silence from the minority shareholders on the procurement would mean that they have consented to the majority shareholders for the procurement. Though SEBI applied against⁵ this procurement the court stated that if the shareholders had entered into such an agreement, then SEBI cannot intervene in the process. Though this was not necessarily a squeeze out what turned out from the case was the difficulty of the shareholder to exercise the option to remain in the company if he wishes to do so.

This judgement had two serious impacts. The first one is that SEBI and other regulators understood their incapability in intervening in such procedures if the shareholders remained mute to it and secondly several companies understanding this loophole started exploiting it to provide an option to the company. In commercial terms too this seemed as a fair deal as all the amount concerning the reduction of the share capital came up on the company and not the shareholders hence it was a favorable scheme in all respects.

The analysis of the Court in the case of Sandvik Asia Limited⁶ seems problematic to the researcher. The court has stated that concerning section 100⁷ a company has the authority to reduce its share capital in any way as it wishes to do. In the case at hand there has not been any question as to the fairness of the special resolution that has been passed. No questions have also been stated concerning the Articles of Association as to whether the company is authorized to reduce its share capital. The non-promoters have also not stated that the amount that is offered is not fair. The only point of emphasis is that the special resolution that has been made in the case would wipe out the non-promoters and would be unfair and inequitable. Therefore, as long as no claim is raised stating the fairness of the amount it can be stated that whether a special resolution that has been made with no questions on revision of money can be stated as fair or not.

The judgement is a Pandora’s box with a lot of facets to it. If an unlisted company regardless of it being public or private brings forward such a regulation it can impact the rights of the shareholders immensely. Private equity holders who have limited shares in the company can be thrown out of the management at any time as they wish by passing resolutions. While courts have looked at only the fairness of the amount that has been offered to the shareholders, the core issue of concern in this case is whether a shareholder who has rights in a property be divested out of it just with the opinion of the majority.

While enacting the Companies Act 2013, the implicit assumption that they had was that reduction of capital is a procedure which would have impact across the board and why would a specific group need to give its permission again. However, the fact is there is an overwhelming power of the majority over the minority which will feel powerless and have no say in the matter.

The lack of interference on the part of Courts seems to be because of the fact that courts rely more on only the statutory interpretation and construction which makes them hesitant to be involved in the law-making or policy-making process. Courts do not intervene with the scheme unless there is an outright challenge that has been made towards it. An interesting facet of this judgement can also be seen in the Elpro case⁸. In this case, the court allowed for forced buyback of shares. Buyback of shares in the normal context should be voluntary and no shareholder is given the right to buy the shares back without a writing from the shareholder. However, buy back of shares is also a way of reduction of capital which facilitates the process of buying it back. In such a scenario what essentially happens is that even if the shareholders have voted against the resolution and no matter if they have even rejected the proposal in writing if the majority has approved the scheme, then the buying back is allowed by the Court. In this case too the voting will involve all of the shareholders of a company and the majority’s decision would prevail. The Court’s view on the matter still remained the same stating that the statutory minimum to be met by the company is 75% and as long as that target is met the Court cannot intervene with the decision. Though the Bombay Stock Exchange had raised concerns in the matter as the minority shareholders are being divested of their rights and the Promoters whose holding in the reduced capital would have increased would be selling it off in higher prices. The Court’s decision approving the scheme though looks legally perfect needs to have taken into account the issues that the minority shareholders are being subjected to.

Critical Analysis of Selective Capital Reduction Framework in US

History of the Freezeouts

Until the 1920s minority shareholders had their property interest in the corporation which allowed them to hold out against controller shareholders who tried to freeze them out of the companies⁹. Florida was the first state to enact a cash-out merger statute in the mid-1920s.¹⁰ Later on, freezeouts became a common procedural implication in different parts of the world. This kind of freezeout where termed a merger freezeout wherein the controlling shareholder would establish a wholly owned corporation and the target board which includes the controlling shareholder, if approved the transaction becomes a valid transaction and the minority shareholders would be paid with cash in exchange.

When the procedure became extremely popular in companies, courts such as the Delaware courts stated that there must be judicial review of these processes to ensure that there is fairness to the procedural aspects dealing with minority shareholders.¹¹ This provision became a puppet in the hands of the majority shareholder to eliminate the powerless minority shareholder when the price of the shares increased in leaps and bounds.¹² Thus most of the major corporations came under the command of controlling shareholders who kept expanding their control at the same time absolving the liability of the company from being publicly held. Thus, the whole process emerged as a threat to public financing.¹³

When the whole problem was on rise the SEC promulgated the rule 13e-3 in 1979 to deal with the problem which stated that a controlling shareholder was supposed to make disclosures to the minority about the purpose¹⁴, the investment banker’s fairness of opinion¹⁵ and financial information such as current and historical market prices¹⁶ to ensure that the decision that has been arrived at an informed basis.

Procedural Protections

Weinberger v. UOP¹⁷: In this case, the court laid down the procedure for what would entail to be fair dealing. According to the court fair dealing is one in which details such as transaction timings, initiation timings, the method of structuring, negotiation and disclosure mechanisms are stated to the board of directors which later on receives approval. On the same hand fair pricing is the price at which the proposed merger would bring equitable economic and financial consideration to its shareholders. The point of interest of the researcher concerning this case is the area wherein the court has stated that though perfection may not be possible while dealing with the fairness of the value of a share, the result would have had an entirely different output if the decision had been left for an independent board of directors.

However, this view was retracted by the court in the case of Kahn v Lynch Communication System¹⁸ wherein the court stated that independent directors cannot be truly independent from the clutches of the controlling authority and the courts will have to make a scrutiny of the fairness procedure that has been entailed by the company. This put forward a Ceaser’s wife approach to the approval of the decisions made by the majority shareholder. This was further expounded in the Rosenblatt v Getty Oil Co.¹⁹ case wherein it was stated that the majority of the minority shareholders should also approve the deal followed by an approval from the SC about the fairness of the decision.

Tender-Offer Freezeouts

Tender offer freezeouts developed as a unique form of freezeouts wherein the controlling shareholder puts forwards an offer to the minority shareholders to acquire their shares. The same offer will be reevaluated by the Special Committee of the shareholders. The goal of the controlling shareholder in giving tender offer is to ensure that he meets the 90% threshold in buying the shares and if he is capable of meeting the requirement then a short-term merger would be formed which does not require the approval of other shareholders. The distinction between merger freezeouts and tender offer freezeouts is on the point that in tender offer freezeouts the company need not undergo the whole process of fairness review as stated in the merger freezeout. However, to further reduce an inequality that may arise the court stated three conditions:

(1) The offer must be subjected to non-alterable Majority of Minority condition

(2) A short from the merger can only be possible if the controller acquires 90 per cent of the shares

(3) The negotiations must be fair and not under coercion²⁰.

The aspects of judicial realism suggests that simple solution of applying entire fairness review may not adequately account for institutional realities and me introduce institutional costs that can outweigh the benefits of doctrinal convergence. If all the convergence transactions are analyzed by the courts, then there is a possibility that some value-enabled transactions may be deterred in the process. In the case of Siliconix²¹, it was stated by the court that there is no requirement for the Court’s interference in such transactions as they are just the sales that have been undertaken by individual shareholders and since it’s not a corporate decision affecting a lot of people there is no requirement for interference. However, a significant criticism that rose in this regard was that tender offer freezeouts can attain the character of hostile tender offers if not dealt with carefully.

Though this seems like an unfair transaction economists such as Adam Pritchard²² state that such legal transactions that transfer one-time wealth are a common practice in corporate law and the market will eventually find a new balance addressing fairness for the future as the prices will adjust to itself ensuring that market efficiency is maintained and there is fairness for the minority shareholders.

When both methods are analyzed, each has its pros and cons. As far as the merger freezeouts are concerned efficient transactions can get to a halt here because the Special Committee will have an overpowering power over the transactions that are to happen. While if the Tender Offer freezeouts are concerned, the Special Committee does not even have a role to play and it depends on the decision formed as part of the negotiation. The negotiation can also turn out not to be fair as the controlling shareholder will only provide a bit above the market price and knock minority shareholders out of the game. Since there is no fair value review in the tender freeze-out process the stock value can be manipulated by the controller owner and this can be used to buy back the shares from the minority shareholders. Further on if the market price is the only determinant factor that dictates the freezeout price then the minority shareholders themselves may view their shares as being worthless. This may cause the shareholders not to get fair value and further on the share price of the shares in the company would go down on a downward spiral.²³

Judicial Decisions on Selective Capital Reduction in India

As far as the Indian Courts are concerned the view that has been taken up is that reduction of capital by a company is a purely domestic affair as long as the shareholders can receive a fair price. This leaves unanswered the major research interest of this paper with regard to the rights of the minority shareholder. The question that remains is whether an uncontested price would serve as the whip to divest the rights of minority shareholders of their rightful holdings.

Reduction of share capital generally happens when a company decides to reduce the amount that makes up its share capital. The method that is used to reduce the share capital can be different which includes reducing the share that needs to be issued, reducing the nominal value of each share, or reducing the amount that needs to be paid up for each share. The reasons why a company needs to reduce its share capital may be varied. This can include creating distributable reserves to pay back the dividend or buy back the shares or in order to redeem its own shares. It can also be for reducing or eliminating the accumulated losses to make distributable profits in the future or to return the surplus capital that has been accumulated to its shareholders or in order to distribute the non-cash assets to the shareholders.

In a recent case it has been stated by Justice Venugopal that Reduction of Capital is a domestic affair and it does not require the tribunal to get involved in the matter. This has been the reiteration of a landmark case that happened in Britain termed as British and American Trustee and Finance Corporation Ltd and reduced v. John Couper in which the court has stated a similar ratio stating that reduction of capital is a domestic concern and tribunal should not intervene. The Supreme Court had taken the same case as the precedent in the case of Ramesh Desai v Bipin Vadilal Mehta.

The earlier provisions that dealt with the reduction of share capital were Sections 100-105 of the Companies Act. Later on, after amendment Section 66 of the Companies Act deals with Capital Reduction mechanism.

Reformation of Section 66

A possible amendment that can be brought into Section 66 of the Indian Companies Act of 2013 is a two-stage approval which involves approval from the target board and secondly approval from the target shareholders.²⁴ As evident from the cases that has been analyzed in Part 2 of the paper courts as of now Courts employ business judgement review which means that unless there is a clear evidence of wrongdoing courts are not supposed to interfere with the activities of the business. This review procedure can be made more effective by adding blanket of protection which is an entire fairness review wherein a stricter procedure is adopted whereby courts closely examine whether a deal was fair to minority shareholders in both the price and the process. While indulging in this process courts would require the approval of both an independent board which is disinterested in the review process and the approval by the disinterested shareholders.²⁵ To ensure that a deal has only minimal to null court scrutiny it must be ensured that there has been SC approval and it has met the criteria of majority of the minority condition. If both the conditions are missing then it would imply that an entire fairness review should be adopted in place.

The immediate after-effect of inculcating such a reform in place would be that the controlling shareholders would also state in their Memorandum of Association what needs to be the procedure to meet the MOM condition. This would act as an additional layer of protection for the minority shareholders. Further on, if a fairness question still arises the burden would be on the company to prove that the negotiations and the procedural framework were dealt in a reasonable and fair manner.

The benefits of the approach would be that when the Special Committee has higher bargaining power, the controlling owners of the company would not act unfairly and there would not be any non-public information that is held back which could potentially cause a disadvantage to the minority shareholder. A special Committee being a corporate committee having economic motives is less likely to hinder the economic transactions that would bring profit to the company.

Conclusion and Suggestions

The researcher through this project had tried to critically analyse the provisions regarding capital reduction in the Companies Act, 2013 with respect to the rights of the minority shareholder. By analysing various judicial precedents, it has become evident that the rights of minority shareholders are getting negatively impacted by the provisions in the Companies Act, 2013 with respect to capital reduction. This is because the court has laid down that silence from minority shareholders can be treated as consent and had overpowered the company by stating that the company can reduce its share capital in any way as it deems fit clearly highlighting that an upper hand has been given to the rights of the majority shareholder over minority shareholder.

Since there exists judicial non-intervention in this arena it becomes crucial to bring an amendment in the legislation wherein a special resolution needs to be passed by an independent board whenever capital reduction is proposed which should be followed by the resolution getting passed by the majority of minority shareholders which would ensure that their interests are protected. As far as the appointment of the Independent Board is concerned, the UK Corporate Governance Code²⁶ can be taken into consideration wherein the companies are required to appoint independent non-executive directors tied up with the recommendation that at least half of the board should be independent. The code also highlights the importance of such a board in cases of audit, remuneration and nomination committees. The Article of Association of the company should also explicitly state the procedure by which this approval would be acquired from majority of minority shareholders, thereby establishing explicit consent of the minority shareholders to the process of capital reduction which would be carried out. In case the above procedural requirements are not met then the capital reduction process should undergo an entire fairness review by the court covering both substantial and procedural aspects of the transaction with respect to the prices and the process.

Endnotes

1. Indian Companies Act, 2013, Sec. 66.
2. Indian Companies Act, 1956, Sec. 395.
3. Indian Companies Act, 1956, Sec. 391.
4. Indian Companies Act, 1956, Sec. 394.
5. Securities and Exchange Board of India v. Sterlite Industries Ltd., (MANU/MH/0339/2002).
6. Sandvik Asia Ltd. v. Bharat Kumar Padamsi, 2009 92 SCL 272.
7. Indian Companies Act, 1956, Sec. 100.
8. Re: Elpro International Ltd., 2008 (86) SCL 47 (Bom).
9. Elliott J. Weiss, The Law of Take Out Mergers: A Historical Perspective, 56 N.Y.U. L. Rev. 624, 627–29 (1981).
10. Ibid. at 632.
11. Sterling v. Mayflower Hotel Corp., 93 A.2d 107 (Del. 1952); Gottlieb v. Heyden Chem. Corp., 91 A.2d 57 (Del. 1952).
12. Lynch v. Vickers Energy Corp., 351 A.2d 570, 573 (Del. Ch. 1976).
13. Arthur M. Borden, Going Private – Old Tort, New Tort or No Tort?, 49 N.Y.U. L. Rev. 987, 987 (1974).
14. SEC Schedule 13e-3, Item 7, 17 C.F.R. § 240.13e-100 (2005).
15. Regulation M-A § 1015, 17 C.F.R. § 229.1015 (2005).
16. Regulation M-A § 1014, 17 C.F.R. § 229.1014 (2005).
17. Weinberger v. UOP, Inc., 426 A.2d 1333 (Del. Ch. 1981).
18. Kahn v. Lynch Commc’n Sys., Civ. A. No. 8748, 1993 WL 290193.
19. Kahn v. Lynch Communication System, 493 A.2d 929 (Del. 1985).
20. In re Pure Resources, Inc., Shareholders Litigation, 28 Del. J. Corp. L. 645, 668–69 (2003).
21. In re Siliconix Inc. Shareholders Litig., No. Civ. A. 18700, 2001 WL 716787, at *6 (Del. Ch. June 19, 2001).
22. A.C. Pritchard, Tender Offers by Controlling Shareholders: The Specter of Coercion and Fair Price, 1 Berkeley Bus. L.J. 83, 101 (2004).
23. Paul G. Mahoney, Concentrated Corporate Ownership, supra note 145, at 259, 260.
24. Del. Code Ann. tit. 8, § 251 (2001).
25. American General Corp. v. Texas Air Corp., Nos. Civ. A. 8390 et al., 1987 WL 6337 (Del. Ch. Feb. 5, 1987).
26. UK Corporate Governance Code, Provision 11, 2024.