Companies Act, 2013
The Companies Act, 2013, (“the Act”) is gradually coming into force, with 98 sections duly notified and several set of draft rules circulated for feedback. The target for the Act to fully come into force by end of this financial year seems achievable. But how desirable is such speedy implementation? The common argument for quick implementation is that the new law has been in contemplation/consideration for too long and it is high time we have a modern law. The reality is that each successive version of the Bill has seen major changes/new provisions which, both in terms of drafting and implications, have been inadequately discussed. Worse, and that is one of the issues presented in this article, there are provisions that seem to overlap or are in conflict with other laws. In particular, for some reason, the lawmakers have sought to duplicate requirements that SEBI has already framed. These include provisions relating to Independent Directors, Audit Committee, bonus shares and many others. In subsequent issues, we will discuss such duplicate provisions. To begin with, the vexed topic of ‘Minority Squeeze-out’ is considered here.
What is buy-out vs. squeeze-out?
Simply described, minority Squeeze-out involves marginalising of and buying out of minority shareholders, often forced (hence the word “squeeze”) out of a lower value than fair value. As compared to buyouts which may be mandatory on the offers or but optional for the sellers, a squeeze-out gets greater publicity in case of listed companies though it is common in unlisted companies also. There was a time when companies sought to increase minority shareholding by issuing shares through a public issue. The process of listing ensured a higher issue price. Over a period, with increasing compliance and other requirements and depressed share prices, the status of listing can become burdensome. Worse, unscrupulous managements sometimes pursue acquisition of public (minority) shareholding at depressed value. Forced buybacks were thus seen in many companies (discussed earlier in this column) with minorities being bought off against their will and in many cases, at prices that were lower than fair value. The stratagem used was to carry this out through a court-approved scheme of arrangement/ reduction of capital where often the criteria for approval are different. The ignorant and scattered shareholders usually did not offer vigorous opposition. SEBI and stock exchanges took some belated inadequate action. Certain provisions such as requirement of pre-approval of schemes by stock exchanges were introduced. However, this was not enough and even circumvented.
Be as it may be, finally, the Act now makes certain specific provisions in relation to such minority squeeze-outs.
What do the new provisions in the Act provide?
Firstly, the new Act prohibits buyback of shares through schemes of reduction or arrangement. Thus, companies cannot buy back shares of shareholders through such schemes. Effectively, they will have to resort to the procedure for buyback of shares as prescribed in section 68 of the Act relating to ‘buyback of shares’. This means they will also have to follow the Rules that would be notified by the Central Government (for unlisted companies) and the Regulations as notified by SEBI (for listed companies). The provisions for buyback in the Act/ Rules/Regulations ensure that it cannot be forced upon unwilling shareholders. It is another issue that these provisions are not well drafted. Further, the provisions relating to buyback of shares suffer from several limitations, particularly the size of buyback. Hence, even genuine cases may face difficulties. Nevertheless, one abusive method will come to an end.
Secondly, there are two specific provisions that enable minority buy-outs. Essentially, they provide for purchase of shares of the minority shareholders when more than 90% of the shares are bought by a company or group. When minority shareholders are reduced to below 10%, they have minimal rights, except those provided generally by the Act or the articles of association. They have no powers to veto a general or special resolution. They also cannot file a petition complaining of oppression/mismanagement or initiate class action. The minority may thus want to have an opportunity provided by the majority shareholders to be bought out at a fair price, even if they did not avail of an earlier opportunity.
Sections 235 and 236 deal with such situations. While section 235 is a slightly modified version of the existing section 395 of the Companies Act, 1956, section 236, though overlapping to an extent, provides for a different situation and procedure.
Section 395, as may be recollected, provides for an opportunity and obligation both to an acquirer of 90% or more shares in a company to acquire the shares of the minority. The minority shareholders thus have a chance to exit the company.
Weak drafting
Section 235, however, continues the weak drafting of existing section 395 but with some modifications. It essentially provides that if a scheme or contract to acquire shares of a company is approved by more than 90% of shareholders (excluding shares held by acquirer company), then the shares of dissenting minorities may be acquired by the acquirer on the same terms. This section can be fairly dubbed as a squeeze-out provision since the acquirer can acquire the shares of the minority shareholders without the latter’s consent. The minority shareholders may, however, apply to the Tribunal and the Tribunal may give appropriate directions for relief. It appears that a window of negotiation for a higher price gets opened for the minority shareholders. The acquirer has the option, but not the obligation, to make such an offer to acquire shares of the minority shareholders. The minority shareholders, however, cannot force the acquirer to acquire their shares.
Section 236 is in many ways a variant of section 235 though with some important differences. Generally stated, it provides for an obligation for an acquirer/ persons acting in concert who have acquired 90% or more of the shares in a company to make an offer to the remaining shareholders. The offer has to be on the same terms and has to be valid for a prescribed period of time. Though the drafting is ambiguous at some places, it appears that the remaining shareholders are not under an obligation to sell their shares. Thus, it is not a squeeze-out. There is a provision that provides for negotiation by a specified section of the shareholders for a higher price. It is provided that in such a case, the higher price received by such shareholders will have to be distributed pro rata amongst the other shareholders who did not get such higher price. This is strange in one aspect. If a section of shareholders is given a higher price, the better course is to make the acquirer give such higher price to the other shareholders too.
Contrast with the SEBI Delisting Regulations Sections 235/236 apply to listed and unlisted companies. For listed companies, it is necessary to also consider the SEBI Regulations on delisting (SEBI (Delisting of equity shares) Regulations, 2009 or “the Regulations”). Simply put, the Regulations provide for procedure that Promoters/companies seeking to delist shares from stock exchanges need to follow. These Regulations are relevant in this context because the Promoters holding has to increase to at least 90% for delisting to be successful. The regulations also provide for the steps to be taken after the holding is increased to more than 90%. Some important steps relevant to the present context are as follows:
• The proposed delisting has to be approved by a special resolution. Such special resolution has to be by a postal ballot thus giving all shareholders a better opportunity to participate.
• Further, the resolution can be acted upon only if at least two-thirds of the non-Promoter share-holders approve delisting.
• The Promoters have to make an offer to acquire the shares of non-Promoters.
• A minimum benchmark offer price, based on recent prices and acquisitions by the Promoters, is fixed.
• The offer needs to result in such number of acceptances that would make the holding of the Promoters higher of two figures. The first figure is 90% of the equity share capital. The second is the existing holding plus 50% of the non-Promoters holding. Thus, if the Promoters held 75%, then they should get at least 15% acceptances. If they held, say, 85%, then they should get at least 7.50% acceptances. If this minimum figure is reached, then the Promoters are entitled to delist the shares.
• They are also required to make another offer and, in effect, keep it valid for the next one year, to acquire the remaining shares at the same price. The remaining shareholders have a right, but not an obligation, to offer their shares during this period. In other words, they may choose to remain shareholders, in the unlisted company.
If one compares these Regulations with section 235/236, clearly the Regulations give better protection to the minority shareholders, though they make it difficult for the Promoters to delist the company. The provisions of sections 235/236 and the Regulations are obviously not alternate to each other and both need to be complied with. Thus the stricter of the two provisions would apply. However, there may be a grey area as regards seemingly beneficial provisions. For example, if the provisions in the Act give a right to the acquirer to acquire the remaining shares, can the remaining shares be so acquired, though the Regulations do not provide such a right? One factor involved in interpreting this issue is whether a beneficial provision in the Regulations would override provisions in another enactment.
In any event, even for unlisted companies, section 235/236 are beneficial to those minorities who are reduced to such a number that their voice does not matter. The 90% majority acquirer also has an opportunity to acquire 100% control of the company so as to be able to run the company without any outside involvement. In the author’s opinion the provisions are worded in such a manner that the acquirer may escape from such obligation. Section 235 uses the term “transferee company” (including its nominees/subsidiaries) on whom such obligation is created. Thus, effectively, it will not apply if the acquirer is not a company or if the acquirer is more than one. This may even become a limitation on the acquirer if it seeks to acquire the shares in more than one entity. Section 236 is worded more broadly. However, several protections that are available in the regulations for listed companies are missing. Loose drafting is evident at several places.
Conclusion
To conclude, competition between two regulators to provide better protection to minority shareholders and generally other persons may seem commend-able. However, conflicting provisions may in the long run be counter productive and create hurdles for genuine transactions. Worse, unscrupulous companies may be found to resort to legislative arbitrage, seeking those provisions or methods that avoid both laws or use the ill-drafted one with lesser restrictions. The fact that the Act is carved in stone, in the sense of being very difficult to amend can only make matters more difficult. Ideally, SEBI, with its expertise, experience and resources, should be given a monopoly or at least a priority as far as listed companies are concerned.
