Often times, minority shareholders in an unlisted company are in a position to block majority shareholders from passing resolutions or taking decisions that the majority shareholders may deem fit for the business and affairs of the company. Therefore, it becomes imperative for the majority shareholders to consolidate shareholding in the company to achieve better control over the business and affairs of such company without undue interference from the minority shareholders.

The Companies Act, 2013 ("Companies Act") has afforded to the majority shareholders of a company, various options to buy out, or squeeze-out, the minority in a reasonable manner.

This article explores various methods of minority squeeze-outs provided under the Companies Act vis-à-vis the novel method of minority squeeze-out that was notified by the Ministry of Corporate Affairs on 3 February 2020 as (a) Sections 230 (11) and 230 (12) of the Companies Act; (b) Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2020; and (c) the National Company Law Tribunal (Amendment) Rules, 2020, (collectively referred to as the "Takeover Rules"). Before the Takeover Rules were notified, popular methods considered by majority shareholders for minority squeeze-outs were (a) undertaking a reduction of share capital under Section 66 of the Companies Act; and (b) purchase of minority shareholding by a majority shareholder, or a person acting in concert with the majority shareholder, holding 90% or more of the share capital of the company, under Section 236 of the Companies Act.

Takeover Rules – Key Considerations

Minority Takeover Criteria

A member of an unlisted company, along with any other member, holding at least 75% of the shares in the company ("Majority Shareholders"), may make an application for arrangement ("Application"), for the purpose of a takeover offer and such Application may be filed for acquiring any part of the remaining shares in the company from the minority shareholders ("Minority Shareholders"). The Application shall be made before the relevant National Company Law Tribunal ("NCLT") for its approval. Creditors of the company need to consent to such an Application. If the Minority Shareholders do not approach the NCLT to redress their grievance with respect to the takeover offer and once the Application is approved by the NCLT, the order of the NCLT shall be final and binding on all the Minority Shareholders who would then be obligated to sell their shares in the company to the Majority Shareholders.

It is pertinent to note that the Takeover Rules clarify that 'shares' mean the equity shares of the company carrying voting rights and include any 'securities', like depository receipts, which entitles the holder thereof to exercise voting rights. Therefore, the Takeover Rules do not allow for the Majority Shareholders to make an Application for acquiring securities such as convertible debentures or warrants, which do not afford voting rights to Minority Shareholders.

Valuation of Shares

The Takeover Rules mandate that the shares proposed to be bought by the Majority Shareholders undergo a valuation by a registered valuer. Subsequently, a valuation report disclosing the details of the valuation shall be filed, along with the documents required to be filed for compromise and arrangement under Section 230 of the Companies Act before the NCLT. The registered valuer, while valuing the remaining shares, shall take into account (a) the highest price paid by any person or group of persons for acquisition of shares during the last 12 months; and (ii) valuation parameters including return on net worth, book value of shares, earning per share, price earning multiple vis-à-vis the industry average, and such other parameters as are customary for valuation of shares of such companies.

Courts in India have generally not questioned independent valuation reports to determine fair value in schemes of compromise or arrangement. The approach of courts is typically to examine whether a valuation report is seen to be so unjust and unreasonable that it would result in injustice or inequity. The Supreme Court in Ramesh B. Desai & Ors. v. Bipin Vadilal Mehta & Ors. held that once it is established that non-promoter shareholders are being paid fair value of their shares, and that at no point in time it is even suggested by them that the amount that is being paid is less, the court will not be justified in withholding its sanction to the resolution. In the case of Miheer H. Mafatlal v. Mafatlal Industries Ltd., the Supreme Court held that a Court has neither the expertise nor the jurisdiction to delve deep into the commercial wisdom exercised by the valuers. Consequently, the court's jurisdiction to that extent is peripheral and supervisory and not appellate. Court held that it is always possible that there may be two views on any approach to accounting and valuation. The fact that the objectors prefer one valuation over the other, does not render the valuation report incorrect.

Given the judicial precedence and the fact that the Takeover Rules now provide for relevant parameters to be considered for a fair valuation of shares, the NCLT will have little to no ground for rejecting an Application on the basis of a valuation report.

Deposit of Consideration

The Application shall also contain details of a bank account, to be opened separately by the Manjority Shareholders, wherein a sum of amount not less than 50% of the total consideration of the takeover offer shall be deposited. However, unlike Section 236 of the Companies Act, the Takeover Rules do not provide a timeline for disbursement of the consideration to the Minority Shareholders. This may cause a problem in a scenario where the Majority Shareholder is a non-resident that has made a takeover offer for the remaining shares of a resident or vice versa. The above-mentioned requirement of deposit of consideration seems impermissible under the framework of the extant Indian foreign exchange law and, therefore, will require approval of the Reserve Bank of India ("RBI") unless the relevant foreign exchange laws are amended / clarified.

Minority Grievance Redressal Mechanism

An aggrieved Minority Shareholder may make an application to the NCLT, under Section 230 (12) of the Companies Act, in the event of any grievances with respect to the takeover offer made by the Majority Shareholder. The NCLT may, on such an application, pass such order as it may deem fit. Such an application shall be filed in Form NCLT-1 along with documents mentioned in Annexure B of the National Company Law Tribunal Rules, 2016.

Minority Shareholders' Defence

To the extent possible, Minority Shareholders may also shield themselves from unfair takeover offers by ensuring an affirmative voting right / veto right be afforded to them in this respect, under a shareholders' agreement / articles of association of the company. Minority Shareholders may push for affirmative voting rights that give them the power to effectively veto further issuance of shares, reduction of share capital, any action taken by the majority shareholders pursuant to Section 230 (11) and Section 236 of the Companies Act. In the case of Mrs. Henriqueta Maria Julieta v. State of Goa, the Bombay High Court held that a right can be waived by the party for whose benefit certain requirements or considerations had been provided by a statute. Though there is an absolute bar for waiver of fundamental rights, there is no such bar for waiver of any statutory rights. Keeping this in mind, Minority Shareholders may also press for completely contracting out of Section 230 (11) of the Companies Act by getting the Majority Shareholders to waive this right under a shareholders' agreement.

Comparative Analysis with Existing Methods of Minority Squeeze-Outs under the Companies Act

Reduction of share capital

Section 66 of the Companies Act allows a company to reduce its share capital, subject to approval of shareholders by passing a special resolution and confirmation by the NCLT on an application by the company. Often times, Section 66 of the Companies Act is used by Majority Shareholders to squeeze-out the shareholding of the Minority Shareholders by cancellation of shares held by the minority shareholders and subsequently altering its memorandum of association. The NCLT approves such an application only if, inter alia, the company is not in arrears in repayment of any deposits accepted by it or any interest payable on such deposits. If the NCLT is appeased that the reduction of share capital is just and reasonable, the NCLT may approve the reduction on such terms and conditions as it may deem appropriate.

The process of selective reduction of capital may be challenged by the minority shareholders. However, Indian courts have frequently upheld selective reduction of capital. To determine whether a selective reduction of share capital is just and equitable, courts see whether the reason behind the selective reduction of share capital is bona fide and whether there has been a fair valuation of shares (as was held in Cadbury India Limited v. Samant Group & Ors. above). As long as the motive behind selective capital reduction is just and the minority shareholders are being paid fair value for their shares, the scheme for reduction of share capital is typically approved by the NCLT.

For a majority shareholder to squeeze-out the minority shareholder under Section 66 of the Companies Act, it needs the cooperation and support of the company. Section 66 puts the onus on the company to, inter alia, (a) make an application for reduction of share capital before the NCLT; (b) satisfy that the debt or claim of every creditor of the company has been discharged or determined or has been secured or her / his consent is obtained; and (c) publish the order approving the reduction of share capital by the NCLT. The burden to prove that the application for selective reduction of share capital is fair, rests on the company proposing the squeeze-out.

Contrary to this, the Takeover Rules provide a right to the Majority Shareholders to make an application of compromise or arrangement before the NCLT, under which the Majority Shareholders may use their own funds to squeeze-out the Minority Shareholders at a fair value of shares. In this novel method, the involvement of the company seems limited.

Purchase of minority shareholding

Under Section 236 of the Companies Act, an acquirer, or a person acting in concert with the acquirer, holding 90% or more of the issued equity share capital of a company, may notify the company of its intention to buy the remaining equity shares of the company. On the other hand, under Section 230 (11) of the Companies Act, the Majority Shareholders shall hold only 75% or more of the shareholding in the company to be able to make an Application before the NCLT for squeezing-out the Minority Shareholders.

Further, under Section 236 of the Companies Act, the entire amount of consideration equal to the value of the shares to be acquired by the majority shareholders shall be deposited in a separate bank account for 1 year, to be operated by the company, which shall be disbursed within 60 days. Contrarily, under Section 230 (11) of the Companies Act, only 50% of the total value of shares shall be put in an escrow account, however, no time for making disbursement is given under the Takeover Rules.

There is no prescribed timeline within which the offer, under Section 236 of the Companies Act, shall be accepted by the minority shareholders. Further, there is also no clarity on whether the minority shareholders are bound to accept this offer.

Conversely, under Section 230 (11), once NCLT approves the Application, the Minority Shareholders are bound to mandatorily sell their shareholding to the Majority Shareholders. Additionally, Section 236 of the Companies Act does not provide for a grievance redressal mechanism for protecting minority shareholders' rights, unlike Section 230 (12) of the Companies Act.

Conclusion

Irrespective of which method for minority squeeze-out is chosen, courts have always held that its doors remain open to see if the interests of the minority shareholders are adequately protected and that there is no unfairness involved. Each method has unique features different from one another; which method best fits the circumstance may have to be assessed based on the desired outcome. Legislature also provides various ways to approach courts in this respect, including on grounds of oppression and mismanagement. Having said that, the Takeover Rules do open a new option for corporate restructuring by introducing a novel method to completely squeeze-out minority shareholders with minimum dependencies while at the same time providing the dissenting Minority Shareholders an opportunity to raise their grievances.

Once the NCLT sanction is through, the Minority Shareholders are bound by the mechanism provided for under the Application and this mandatory nature of the squeeze-out makes it a feasible option for the Majority Shareholders to buy out the Minority Shareholders without requiring extensive participation by the company or the Minority Shareholders. As mentioned earlier, as a weighted factor, a just and fair valuation report which is based on the factors laid down in the Takeover Rules and which meets the test of judicial scrutiny, is a prerequisite to obtaining a sanction from the NCLT. Additionally, Majority Shareholders are required to deposit 50% of the total share consideration which is intended to protect the interests of the Minority Shareholders. Obtaining an approval from the NCLT on the Application is anticipated to be a prolonged process, however, this approval is necessary to help in ensuring that the interests of the Minority Shareholders are satisfactorily secured.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.