Amendment in Takeover Offer Norms: A Formal Route to “Squeeze Out” Minority Shareholders

By Arushi Gupta, a Fifth-Year Student at DES Law COllege, Pune

On February 3rd, 2020  the Ministry of Corporate Affairs notified the coming into force of Sub-section (11) and (12) of Section 230 of the Companies Act, 2013 (‘Act’) which deals with the takeover offers in case of any restructuring of a company. The Ministry also notified the Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2020 (‘CAA Rules’), which added Sub-rule (5) and (6) to Rule 3 in the original rules of 2016, along with the National Company Law Tribunal (Amendment) Rules, 2020 (‘NCLT Rules’) adding Rule 80 A to the principal rules of 2016.

Section 230(11) of the Companies Act, 2013 deals with the takeover offers in case of unlisted companies. It is broad enough to include various types of restructuring like mergers, amalgamations, compromises, etc. Section 230(12) provides for the redressal of grievances concerning the takeover offers of companies other than a listed company, wherein the aggrieved party may make an application to the National Company Law Tribunal (‘NCLT’), which may pass an order as deemed fit. Rule 3(5) of the CAA Rules provides that a member of a company holding at least 75% of the shares along with any other member in the company shall make an application before the NCLT for an arrangement in terms of a takeover offer under Section 230(11) of the Act, acquiring remaining shares of the company. Furthermore, Sub-rule (6) of Rule 3 provides for a report of a registered valuer to be filed along with the application, disclosing the details of the value of the shares proposed to be acquired. Such valuation of the shares shall be made considering the following factors:

  1. The highest price offered for the acquisition of those shares during the last 12 months.
  2. The fair price must be determined by the registered valuer after considering parameters like return on net worth, the book value of shares, earning per share, price earning multiple vis-a-vis the industry average, etc.

Sub-rule (6) also stipulates that the member proposing the acquisition shall open a bank account and provide the details of the same in the report, wherein 50% of the consideration of the total takeover offer must be deposited. The NCLT Rules, 2020 provides for the form in which application for grievances can be made under Sub-Section (12) of Section 230 of the Act.

This article draws a detailed picture of how these norms can be utilized to force the exit of minority shareholders at a lower consideration, negatively impacting their interests.

Applicability

The newly notified Sub-section (11) of Section 230 of the Act applies to the takeover offer in the case of unlisted companies. The proviso to this sub-section specifies that the takeover offer in the case of listed companies is governed by the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 which require the acquirer to make an open offer to acquire such shares. Explanation 1 to Rule 3(5) of the CAA Rules defines “shares” as any equity shares which carry voting rights. Therefore, shares can include securities like depository receipts which entitle the holder to exercise voting rights. However, Explanation 2 to the same rule provides that these rules do not apply to the transfer of shares made through a contract, arrangement, or succession or in pursuance of any statutory or regulatory requirement. Hence, only voluntary arrangements, which are not predetermined come into the scope of the new rules.

An Overlap with Section 236 of the Act

Section 236(1) of the Act provides for the purchase of minority shareholdings under an amalgamation, share exchange, conversion of securities or for any other reason wherein a person who is a registered holder of 90% or more of the equity share capital of a company notifies the company of their intention to buy the remaining of the equity shares. This creates an overlap with Rule 3(5) of the CAA Rules, which provides for a scheme or arrangement in terms of takeover offer to acquire the remaining shares, enabling only 75% of the total shareholders to apply directly to the NCLT, without having to engage in procreated negotiations with the minority shareholders. This creates a confusion as to which provision would apply when it comes down to the purchase of minority shareholding. The direct approach to the NCLT with a takeover offer may eliminate the role of votes of or meetings with the minority shareholders in such arrangements, resulting in the “squeeze out” of such shareholders and sidelining their interests.

Furthermore, Section 236(9) of the Act provides that in case the majority equity shareholder fails to acquire any of the minority shareholders, then the provisions of Section 236 would still continue to apply to the residual shareholdings, which have not been acquired. This means that the provisions of Section 236 do not explicitly cast an obligation on the minority shareholders to sell their shares. However, the amended CAA Rules are silent upon the question of whether the minority shareholders would compulsorily have to give up their shares in a “compromise” or “arrangement” under Section 230 of the Act or not. This may affect the interests of the minority shareholders as they would have no inherent rights to retain their shares in the face of fair consideration. While some shareholders may be prepared to sell their shares for a lower consideration, others may prefer to hold. They may have a better grasp of the true value of their shares.

Valuation of Minority Shares

Considering the complexity and diversity of business carried out by the companies, the calculation of the fair value of minority shares as required under Sub-rule (6) of Rule 3 of the CAA Rules could be a subject of controversy. This may raise an issue for both the acquirer as well as the minority shareholders. This method of computation may be detrimental to the acquirer as the price offered to certain minuscule number of shares during the last 12 months may be higher than their original value. This would result in the acquirer having to pay more than what they were actual worth. On the other hand, there may be uncertainties while computation and some minority shareholders may be unrepresented, resulting in a financial loss to certain individuals.

Furthermore, the rules do not provide explicitly the minimum amount that a takeover offer should be, unlike the SEBI Takeover Regulations which clearly state the minimum price at which shares can be acquired under an open offer. This may cause the exploitation of these provisions to squeeze out minority shareholders at a lower price than their initial investment when the company is at a low value, even if it is transitionary.

Deposit of Funds

Unlike Section 236(4) of the Act, which stipulates that the majority shareholders shall deposit an amount equal to the value of the shares to be acquired by them, Sub-rule 6(6) of CAA Rules requires only 50% of the consideration to be deposited in the bank account. Section 236(4) of the Act also stipulates that such amount shall be dispersed within 60 days. However, the amended CAA Rules do not stipulate the time limit for the distribution of consideration to the minority shareholders. This may lead to frozen money in the bank account until the completion of compromise or arrangement, preventing the minority shareholders from quick exit thus, blocking them into the new structure.

Redressal of Grievance

Another anomaly that may be observed in the recent amendment is that there is no basis for the valuation of grievances by the NCLT provided in the grievance redressal mechanism under Section 230(12). In the case of Ramesh B. Desai v. Bipin Vadilal Mehta, the Supreme Court approved that the question of purchase of minority shareholdings is a domestic affair to be decided by the majority. The court also stated that in the absence of serious allegations regarding the bona fides of the proposed scheme, the courts are hesitant to interfere with the decisions of the majority, who the court believes are in the best position to know the interests of the company concerned. This puts an onus on the minority to prove that the offer is unjust and unreasonable, which is difficult for the minority shareholders.

Conclusion

The recent amendment is brought in to facilitate efficient and time-saving procedures to purchase the minority shares. However, there seems to be an inclination towards the benefit of the majority shareholders, at the expense of the interests of the minority shareholders. These regulations can be easily manipulated by the company management to pursue objectives that are different from enhancing shareholders’ value. Thus, there should be a system which maintains a balance between the right of majority as well as the minority shareholders.

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