Minority Squeeze Out: In Re Cadbury India Ltd. (Part I)

In this tripartite blog series, the authors take a gestalt perspective to carefully analyse and examine the reduction of share capital proposed by Cadbury India Ltd. in 2009 which finally received the sanction of the court in 2014. This case has been analysed from the lens of minority squeeze-out and with the intention of examining the several available modes to facilitate such squeeze-outs. Such transactions have brought to the fore confusion surrounding the understanding of several provisions of Company law and their inter-relationship. Several conflicting judgments over a period of time being simultaneously accompanied by amendments to the statute have necessitated a thorough examination of the law in light of the Cadbury case.

Part I of the blog provides a proper understanding of minority squeeze outs to the readers, the various methods of minority-squeeze outs and their inter-relationship in light of the amendments to the Companies Act.

Part II of the blog lays down the details of deal and summarises the judgment of the court.

Part III of the blog critiques the reasoning of the judgment taking into account its context and examines the possible options of minority squeeze-outs that Cadbury India could have employed and their viability thereof.

There are four interlinked modes that could be used by a company to facilitate a minority squeeze out:

  • Buy-back of share,
  • Reduction of Share Capital;
  • Compulsory Acquisition and
  • Scheme of arrangement.

 (i) Buyback of Shares

A company limited by shares or limited by guarantee and having share capital does not have the power to buy its own shares unless the consequent reduction of share capital is effected under the provisions of this Act.[i] This is so since trafficking in own shares allows a company to artificially influence the price of the shares in the market in an unhealthy manner.[ii] However, Section 68 of the Act allows companies to buy its own shares out of:

  • its free reserves[iii]; or
  • the securities premium account; or
  • the proceeds of any shares, however, no buy-back shall be made out of the proceeds of an earlier issue of the same kind of shares. There are certain conditions that need to be satisfied for a company to be allowed to buy back its own shares:
  • the buy-back must be authorised by the Articles of Association,
  • a special resolution must be passed at a general meeting of the company authorising the buy-back,[iv]
  • the buy-back is 25% or less of the aggregate of paid-up capital and free reserves of the company,
  • the debt-equity ratio should not exceed 2:1;
  • all the shares must be fully paid up;
  • there should be a gap of one year between two buy-backs;
  • every buy-back must be concluded within one year from the date of passing of the special resolution;
  • the company must file a declaration of solvency signed by two directors, one of whom has to be a managing director before the Registrar and in case of public companies, before SEBI. It is important to note that the approval of the court/ tribunal is not required in case of a buy-back.

(ii) Reduction of share capital

Section 66 deals with reduction of capital. The need for reducing capital may arise in several situations, for example, trading losses, heavy capital expenses, and assets of reduced or doubtful value. Section 66 prescribes certain modes of reduction of share capital viz. extinguishing or reducing liability, cancelling any paid-up share capital and paying-off any paid-up share capital that is in excess of the demands of the company. However, these modes are merely illustrative and it was the policy of the Legislature to entrust the prescribed majority of the shareholders with the decision whether there should be a reduction of capital, and if so, how it should be carried into effect.[v] To that extent, a buy-back would also be one of these modes since it results in the reduction of share capital. The court does not see the motive behind the reduction of share capital, all it examines is whether the price is fair and equitable.[vi] Thus, it is evident from the judicial and the legislative approach that the reduction of share capital is a domestic affair of the company and no mode, motive, source or limit for such reduction is prescribed. However, the consent of the court/ tribunal is a sine qua non for the reduction. The court sits in a supervisory role to safeguard the interests of creditors and the minority.[vii]

The tribunal is required to send notice of the applications filed for the reduction of share capital to the Central Government, Registrar and SEBI (in case of listed companies). Their representations are to be taken into account by the court in giving its assent to the reduction. The erstwhile Companies Act was distinct from the current Act in terms of the procedure for a reduction since it allowed the court to dispense with the procedural requirements in light of special circumstances of cases.[viii]

(iii) Compulsory Acquisition

Compulsory Acquisition is covered by Section 235 of the Companies Act 2013. This section was brought about to protect the interests of the dissenting shareholders and to provide for a fair exit of such shareholders.[ix] This section states that an acquiring company (Transferee Company) may make an offer to the shareholders of the Transferor Company, in the form of a scheme or a contract to acquire shares of the company. If holders of 90% of the value of the shares (excluding shares directly or indirectly held by the Transferee Company) consent to such a contract within 4 months of the offer, the Transferee Company has the right to give notice to the dissenting shareholders to acquire their shares at any time within two months after the expiry of the four months. Under this section, the sanction of the court/ tribunal is not mandatory. The jurisdiction of the court is only triggered when the dissenting shareholders file an application objecting to the transfer. Where a scheme or contract is approved by 90% of the shareholders, the offer would be treated prima facie as a fair one and the onus to prove to the contrary lies upon the dissenting shareholders.[x] In these cases, the courts have interfered only in cases where the scheme is unfair.[xi] It has been stated that given the contractual nature of the agreement, the court would generally exercise restraint in intervening unless there is some fraud or prejudice to the public interest.[xii]

(iv) Scheme of Arrangement

Scheme of arrangement is covered by Section 230 of the Companies Act 2013 which corresponds to Section 391 of the Companies Act, 1956. This section provides powers to the Tribunal to make an order on the application of the company or any creditor or member to hold a meeting for the proposed compromise or arrangement between the company, its members and the creditors. A notice of the meeting called in pursuance of the order of the Tribunal shall be sent to all members and creditors.[xiii] Section 230(6) states that a scheme or arrangement would be binding on the members and the company if it receives assent of more than 3/4th of the members present and voting and is sanctioned by the court. The court has to find out whether the scheme is fair, just and reasonable and is not contrary to the provisions of law and does not violate public policy.[xiv]

INTER-RELATIONSHIP OF THE METHODS

The distinction between buy-back, reduction of share capital and scheme of arrangement under 1956 was best summed by SEBI v. Sterlite Industries (India) Ltd.[xv] wherein the court stated that Section 77A starts with a non-obstante clause which shows that it is an enabling provision that allows companies to buy-back its own shares without having to approach the court for its sanction, as is required by Section 391 and Section 100-104. The court further stated that prior to the introduction of Section 77A the companies were bound by the procedure under Section 391 and Sections 100-104. However, the introduction of the Section provided an alternative mechanism for the Companies subject to limitations of source and the quantum of buy-back as laid down in the Section itself.[xvi]

This distinction between buy-back and reduction of share capital seemed apt in the context of the 1956 but has been significantly altered following the Companies Act 2013. Section 66(6) states that nothing in this section shall apply to buy-back of its own securities by a company under Section 68. There was no similar provision in the 1956 Act. The text of Section 68 is unequivocal to the extent that it deals with buy-backs only up to a certain limit and from certain sources. Therefore buy-backs satisfying the conditions laid down within the Section would be covered by Section 68 and would not require the court’s sanction. Any buy-back not falling within Section 68 would fall under Section 66. This is so because there is no restriction on any mode under Section 66. Buy-back as a mode is not excluded by Section 66. The Section only excludes buy-backs under Section 68. Thus, insofar as a buy-back does not fall under Section 68 it should fall under Section 66. An alternative understanding would imply that buy-backs beyond the limits prescribed under Section 68 cannot be undertaken.

This alternative argument is buttressed by the fact even Section 230(10) of the 2013 Act states that no compromise or arrangement with respect to a buy-back of securities shall be sanctioned by the Tribunal unless the provisions of Section 68 are complied with.

On the other hand, the Explanation to Section 230 states that the provisions of Section 66 shall not apply to a reduction of share capital done under a scheme of arrangement that has been approved by the court. Compulsory Acquisition lies on an entirely different footing and is distinct from the other three methods.

[i] § 67, Companies Act 2013.

[ii] Trevor v. Whitworth, 1887 (12) AC 409.

[iii] Defined under § 2(43) of the Companies Act, 2013 as reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend.

[iv] This condition can be dispensed with and a resolution by the Board of Directors would suffice if the buyback is less than 10% or less of the total paid-up equity capital and free reserves of the company.

[v] British and American Trustee and Finance Corporation v. Couper, 1894 AC 399; Chetan v. Rockwool India Ltd., (2010) 155 Com Cases 605 (AP).

[vi] In re: Organon (India) Ltd., (2010) 157 Com Cases 287 (Bom).

[vii] Hindustan Commercial Banks Ltd. v. Hindustan General Electric Corporation, (1960) 30 Com Cases 367.

[viii] See § 101(3), Companies Act 1956.

[ix] GUIDE TO THE COMPANIES ACT, A Ramaiya, 18 ed., Vol. 2 at 3921.

[x] Government Telephones Board Ltd. v. Hormusji Maneckji Seervai, (1943) 13 Com Cases 249.

[xi] In re: Hoare & Co. Ltd., (1933) 150 LT 374.

[xii] GUIDE TO THE COMPANIES ACT, A Ramaiya, 18 ed., Vol. 2 at 3932.

[xiii] Section 230(3), Companies Act 2013.

[xiv] Miheer H. Mafatlal vs. Mafatlal Industries Ltd., AIR 1997 SC 506.

[xv] (2003) 113 Comp Cas 273 (Bom).

[xvi] Ibid


ABOUT THE AUTHORS

Harshit Sharma

Harshit

Harshit Sharma is a B.A., LL.B. (Criminal Law Hons.) graduate from National Law University, Jodhpur and an LLM (Criminal Law) from Mahatma Jyoti Rao Phoole University, Jaipur. He has qualified NTA NET (December 2019) and can be reached at harshitsharmanluj@gmail.com.

Rishav Dixit

Rishabh

Rishav Dixit is a B.A., LL.B (Business Law Hons.) graduate from National Law University, Jodhpur (Batch of 2019). Presently he is working as an Associate for Cyril Amarchand and Mangaldas.

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