Cos Act Ep#11: Scheme Approval & Shareholder Buyouts!
Last week on Companies, Act! we examined the various schemes permitted under Chapter 15 – plain vanilla, CDR, buyback, merger of a listed company into an unlisted company, fast track mergers, de-mergers & cross-border mergers! This week we examine the various approvals a scheme needs and shareholder buyouts with Haigreve Khaitan of Khaitan & Co, Ashok Gupta of Aditya Birla Group, Amrish Shah of EY and Harish Hulyalkar of Citibank.
Just like the 1956 Act, the 2013 Act too require a scheme to be approved by a majority of creditors or members representing three-fourths in value. The 2013 Act sets two new standards for scheme sanction- that it must be in conformity with Accounting Standards as Security Exchange Board of India (SEBI) has already specified for listed companies and that notice must be given to the Government, Income Tax Department, RBI, SEBI, Stock Exchanges, Official Liquidator, CCI and all other concerned regulators. They have 30 days to make their representations.
Section 230 (6)
- Majority of creditors or members
- Representing three-fourths in value
Section 230 (7)
- Tribunal sanction of Compromise or arrangement
- Needs auditor certificate that Scheme is in conformity with Accounting Standards
SEBI Circular - April 2010
- Listed entities to submit auditor certificate for accounting treatment under Schemes of Arrangement
Section 230 (5)
- Notice to be sent to Government, Income Tax Department, RBI, SEBI, Registrar, Official Liquidator, CCI and such other sectoral regulators or authorities likely affected by the Scheme
- They can make representations within 30 days
Gupta: First of all it was not a requirement under the Companies Act earlier on.
Doshi: No, it wasn’t.
Gupta: Based on the experience, the Ministry of Corporate Affairs (MCA) has come out with the guidelines that you please give the notice to everybody. So, the new provision is aligned with the guidelines they have issued under the 1956 Act.
In Jan 2014 MCA issued circular that Regional Director shall invite specific comments from Tax Dept before filing response on Scheme (u/s 394A) to Court
Doshi: Especially because the Tax department was having a lot trouble with lot of these schemes.
Gupta: That is also in sectoral regulations because they have said- first merger will go through then you come to me. Now, hopefully, it will work very beautifully if no sectoral regulator will go back after the merger saying, no I want to look at it afresh. If they do that, than there is a problem because we’ll still be moving in circles. So, I am only hoping those regulators- whatever viewpoint they have on a given transaction- they will place before the Tribunal and after consideration of all those factors, the Tribunal will pass the final order. So, we have a certainty in terms of time and whether the transaction is going through or not, we have moved forward but if everybody is going to take a view I have file my limited objection for the merger, but I have to apply my law again when you come back to me after the merger has happened, then the problem is not solved; it is compounded.
Khaitan: There might be a jurisdictional issue as well there.
Khaitan: Let’s take a particular sectoral issue- this Tribunal may not be competent to rule on a regulatory issue. For example, let’s take a telecom license- now whether a telecom license is capable of transfer or not- if this Tribunal rules that yes, it is capable of transfer, but under the telecom regulatory or regulations, we have a different Tribunal who actually decides as to whether the telecom license is transferable or not…(Interrupted by Anchor)
Doshi: What would happen then?
Shah: I will just put it slightly differently. It is in the interest of the parties who are going through this process to get all their approvals absolutely necessary. Therefore most schemes and I would think when I say most, I would even go to the extent of saying 100 percent of the schemes, if they conditional upon the following approvals and if it is a telecom company they will talk about the telecom regulator’s approval as part of the scheme. So, even if the Tribunal clears it, the scheme is not through till you get the last of those approvals because it becomes effective only when you get the last of the approvals.
Khaitan: What this provision does is not a single window clearance under all laws possible because this Tribunal doesn’t have the jurisdiction to do that. But what it does is if there is any abuse where certain provisions are hidden and under the garb of a sanctioned scheme you then go to a telecom regulator to say the Court has sanctioned or Tribunal has sanctioned a scheme - so even though not allowed under your regulations, look at this Court order or Tribunal’s - order you are bound by it. And that was in one way being misused or abused.
Doshi: It was happening?
Khaitan: It was happening and for tax is a perfect example where schemes provided for just about anything and then you went to the tax authorities and said look at my scheme, it has Court authority; so you can’t question it. So that abuse will stop but I don’t think this will be single window clearance.
Gupta: No, it is not but it facilitated the task of getting subsequent approval faster. That is the point we are looking forward to.
Doshi: I have a question- it may seem slightly naïve- but from what I have understood of how currently the court system works on schemes is that they don’t really question your schemes beyond a point. If you have the requisite shareholder approval, Courts are supposed to allow for this scheme. They are not supposed to impose their commercial wisdom or their regulatory wisdom on your scheme. So I am just curious as to how Tribunals, which will be a slightly different body than our current Court system, are going to be able to deal with this given that they now will have to address objections being raised by specific regulators in their forum- not in a separate forum, it is not the Telecom Regulatory Authority of India (TRAI) raising it at the TRAI level or the Telecom Disputes Settlement and Appellate Tribunal (TDSAT) level. If the TRAI now sends a representation to the Tribunal saying look this is my problem with the scheme, what is the Tribunal going to say- tell the company that go sort it out with TRAI, get a no-objection certificate only then will I pass the scheme?
Khaitan: No, the way it should really work and which will be the objective is that unless the Tribunal sees fraud or a violation of law, it should not sanction a scheme- even if it is another law, not just the Companies Act. Other than that, the Tribunal should sanction schemes and leave it to those regulators even if they have objected here to decide whether or not… (Interrupted)
Doshi: But then what is the purpose of this Section.
Khaitan: The purpose is that the Tribunal gets the notice.
Shah: As he said if there is a violation of law and somebody says this violates over this regulation, then the tribunal will take notice of it.
Khaitan: Whether it is a bona fide scheme at all, whether the Tribunal should at all sanction this scheme or it should sanction the scheme and let the regulator decide the sectoral regulation- that is the purpose
I suppose that is good news for the tax department. Now onto treasury stock or rather the ban on it. The 1956 Act disallowed a company from holding its own shares but companies circumvented this by holding shares via trusts. The 2013 Act disallows a company from holding any shares in its own name or in the name of any trust. This casts a cloud on existing treasury stock and future scheme structures.
NO TREASURY STOCK
1956 Act: Section 77 (1)
No company shall have power to buy its own shares…
2013 Act: Section 232 (3)
Transferee company shall not hold any shares in its own name or in the name of any trust…
Khaitan: Yes, one more option of structuring or the fact that companies could hold through treasury their own shares will go away but if it is known in advance and that is the law, it again gives you notice and advance that this is not going to be allowed and you plan. So yes, shares will be cancelled or they will be transferred out as part of the scheme and there could be several options.
Doshi: So you don’t see this serving as a big hurdle in being able to design schemes?
Khaitan: I don’t think so. Yes, some options are closed but in one way again one bad apple and our legislators are compelled to legislate and stop many other good schemes providing for the same thing.
Doshi: So illustration of one option that goes away from the table in a scheme because of this no treasury stock?
Khaitan: Let us take the example of a company and a subsidiary merging- so you have to cancel the shares or make sure you divest the shares as part of the scheme or prior to the scheme rather than keep your shares and therefore keep controlling interest, keep a low promoter interest, keep it through the company and the two combined can keep you comfortable throughout life.
Hulyalkar: That seems to be the intent that they don’t want promoters to have additional voting rights through treasury shares.
Doshi: Which was the reason why the earlier Act also did not allow for this and people were using trust structures. But trust structures were also being abused in some fashion or the other.
Hulyalkar: So they could have addressed that by saying that make these shares non-voting or have some restrictions.
Doshi: Then somebody would have found another way through this.
Hulyalkar: Yeah, but it does take away the flexibility.
Shah: No, once you have non-voting then what can you do.
Doshi: No, but before we get to that, what flexibility does it take away for you to ask therefore that why couldn’t they have made this non-voting?
Hulyalkar: It is one way of capital management. Companies can use those block of shares to raise capital at short notice and a very short timeframe.
Doshi: Could it not then lead to instances of insider trading of any sorts?
Shah: I have a different perspective on the insider trading because if you see any scheme and any treasury stock through the trust, the beneficiary is the merging company. So what insider trading are we talking about because it is the company which is making the money which belongs to all the shareholders; it is not belonging to a promoter shareholder or anybody else. The abuse is not on the cash flow side, the abuse is on the voting right side if at all, and that is what they needed to plug.
To my mind, this takes out a lot of flexibility. If let’s say, I am a company which is buying shares of another company with similar business - let’s say just taking example at Rs 500 crore. So I become wholly owned subsidiary when I buy those shares. I want to now get the synergies of the two businesses- so I want to put it in one company because then it helps me to get the synergies. My accounting standards prohibit me to do a fair value accounting when I am merging a subsidiary into myself. I have to do book value accounting. When I am buying shares I have recorded it Rs 500 crore. Let’s say the net asset value of that company – it’s book value is Rs 200 crore. I have a huge goodwill of Rs 300 crore in my balance sheet and my accounting standard further requires me to write it off over a period five year period or maybe a ten year period depending if I can convince the auditors. A Rs 60 crore hit or a Rs 30 crore hit is not something that I would want to do. So, either if they want to stop this, they should have also allowed the accounting standards to change that I can do fair value accounting in such scenarios. It is just going half way and then hitting me. To my mind it takes way lot of flexibility and I will think when I am doing an acquisition that if I have to take all the synergy benefits is there a hit on me or not; that is very important.
Gupta: The implication of this and whether it is going to impact the business operation like Amrish is saying has not been evaluated completely. World over this is being encouraged. It reduces costs by the way of raising capital from the market. You have a stock, you give it to them- so it has a number of advantages. So if you can plug the loopholes it gives humongous amount of flexibility to the businesses.
Special shareholder exits, high governance standards and majority of minority voting in related party transactions- in many places, the 2013 Act bats for minority shareholders but Chapter XV has thrown up a surprise. Earlier any shareholder could object to a scheme in a court. Now he will need at least 10 percent to do so. Rarely does even a large investor like LIC own that much stock in a company.
HIGH OBJECTION THRESHOLD
Section 230 (3)
Any objection to the compromise or arrangement shall be made only by persons holding not less than ten per cent. of the shareholding or having outstanding debt amounting to not less than five per cent. of the total outstanding debt as per the latest audited financial statement.
Doshi: It seems very unfair but Mr Gupta I am sure companies are celebrating because all those holds ups in schemes will go away.
Gupta: You need to strike a balance from abuse to proper use.
Doshi: Yes and this is gone to another extreme, you would agree?
Gupta: I won’t say that.
Shah: If you look at the erstwhile provisions- if a minority wanted to object under 397, which was minority objection provision, it was a 10 percent requirement, they have just maintained that.
Doshi: But there is so much mismanagement in operations.
Shah: So same thing here.
Doshi: If you want to accuse the company or its management of mismanagement in operation, I can understand you need that high threshold. I can’t understand if you are a dissenting shareholder, then why you need such a high threshold to dissent.
Shah: Because people were coming and putting roadblocks to the schemes.
Khaitan: If you are selling a business, you need a special resolution. If you have mismanagement, there is 10 percent threshold. For schemes, what is so special that you need to have anything more liberal given all of the abuse? I had a case where there was a shareholder holding one share and that one share that held up a public company merger for one year.
Shah: And that must be brought after the board meeting for the merger.
Gupta: I will get in another perspective just to say that it is not unfair to minority. For instance, number one, in your schemes and Haigreve has touched upon it, it is not within the related party transaction, the management is expected to know that is largely in the interest of the company and shareholders, majority of them will get it approved in the general meeting and therefore for someone to come - unless it is a very serious objection and impacted significantly- then why should one be heard because you are taking 90 percent --- (Interrupted by Guest)
Khaitan: And related party can’t vote. Let’s also look at the fact that where there is abuse, it has been checked already by Securities and Exchange Board of India (SEBI).
Shah: There are enough counter balances and it is balanced. If you see the voting pattern that happens in a Tribunal meeting, it is not only by value but it is also majority in numbers- the promoter will not have that majority number in that sense, he will have value but not majority in numbers.
By the way section 230 (7) (e) empowers a Tribunal to order that shareholders dissenting to a scheme should be provided an exit.
EXIT FOR DISSENTING SHAREHOLDERS
Section 230 (7) (e)
Tribunal can provide for exit offer to dissenting shareholders
Gupta: This is directly linked to the previous point that you have that why 10 percent? This is an option. Tribunal will say okay I am not hearing you but I may provide for exit.
Doshi: How is this exit going to work?
Khaitan: Let’s take 1 percent shareholder or a nominal shareholder who doesn’t have the right to stop the scheme but who is dissenting and says that if this scheme is implemented or this restructuring is done, I don’t want to continue as a shareholder and let’s also assume that there is no market for the shares- so he can come to the Tribunal and say why don’t you provide for my exit, do a fair valuation, I am not sure that I will get a value outside of this scheme or if I remain and give me an exit. Even under 1956 Act, this was always there, power was there but it is now in the Statute.
Now for the squeeze out that isn’t really a squeeze out. Section 235 of the 2013 Act- similar to Section 395 in 1956 Act- gives companies the power to acquire shares of dissenting shareholders. That’s if the scheme has received approval from shareholders holding 90 percent of the shares but Section 236 is a new provision - it provides for an acquirer with 90 percent shareholding to offer to buyout the minority but it does not explicitly compel the minority to sell, falling short of a true and proper squeeze out provision.
Doshi: Can you explain what the provisions are sort of implied? Because Section 235 is very confusing.
NOT QUITE A SQUEEZE OUT!
- Where a Scheme involving a transfer of shares
- Is approved by shareholders holding not less than 90%
- Transferee company may give notice to dissenting shareholder that it desires to acquire his shares
If acquirer owns 90% or more shares
- He shall notify intention to buy remaining shares
- Price to be determined on basis of valuation by registered valuer
Minority may offer to majority to purchase the minority equity shareholding
Khaitan: Section 235 is really what was under Section 395, 1956 Act- it hasn’t really been used but its just enabling provision where a scheme can also provide for buyout of shareholders. It hasn’t been used, how it will be used, what was the intent and there seem to be more drafting errors as to what the intent is.
Doshi: Not used very often in the earlier avatar?
Khaitan: Not used very often in the earlier avatar.
Doshi: Why is that so?
Khaitan: Because there was no clarity as to how and when it ought to be used - whether it was a squeeze out, whether it was a buyout provision, whether it was dissenting shareholders because of the lack of clarity and that still prevails.
Gupta: The ecosystem of the country did not allow delisting even though there is enabling provision under the Companies Act and SEBI regulations for listed companies. However, these provisions are similar to many developed countries where once you get to 90 percent, you want you can squeeze out minority 10 percent.
Khaitan: I wouldn’t agree that we have that. Even when we come to Section 236, I don’t think it is a squeeze-out provision. I think a lot of noise has been made that the new Act now gives us a squeeze-out right but in fact there is no squeeze-out right at all. What I think it does is that the minority who is stuck in that 10 percent can have the right for exit.
Doshi: So that is still Section 236 and that is still easier to understand. What are the mechanics of Section 235? If nine tenths of them approve you can buyout their shares- is that what this means?
Khaitan: Not on a compulsory basis, that seems to be still lacking under the Section.
Doshi: Even Section 236 says that – it is not on a compulsory basis.
Khaitan: Yes but it compels the majority having reached 90 to give an exit to the minority.
Doshi: But it doesn’t compel the minority to submit its shares. So you could reach 98 and you still have 2 percent shareholders floating around in the system somewhere.
Gupta: But then there is no liquidity unless you really want to create nuisance.
Doshi: The point is if it doesn’t compel the minority to submit their shares once the majority has acquired 90 percent, then this is not really squeeze out, is it?
Hulyalkar: It extends the provision of the delisting guidelines to even private companies. Under the delisting guidelines we have to provide a one year window after delisting to the shareholders who are left behind, they can tender their shares at the same price. So, now they are effectively extending that to even other situations where you reach 90 percent.
Khaitan: To be honest, the present provisions are worse than the provisions today. Today’s Section 391, 394, 395 have in a way been used for squeeze out and there are several judgments where courts have held that how you can do a squeeze out. Let say, with majority not voting, promoter not voting, interested parties or the parties which are being dealt with differently not voting but today with Section 235 & 236, the question will be whether a scheme of compromise can actually do a squeeze out or not because given this ambiguity, are we worse off or better off.
Doshi: The earlier squeeze out I have seen is selective reduction of capital- that’s seems to be the most effective squeeze out that people have deployed in this country.
Shah: Many of those schemes in the creativity are less likely to survive once this new Act comes.
Doshi: So there is no complete squeeze out, it’s a partial squeeze-out but it doesn’t seem to bother all of you that much. It would have been nice if it was complete squeeze out.
Doshi: We come now to the wrap up question. Are we better off or worse off?
Shah: The critical thing for us is to see how the Tribunal pans out on all of this and why I am saying this is because if you look at 1956 Act and court order and if you look at implementing the scheme thereafter, there used to be a lot of ease, So when I say ease, let’s say I go to the water department to change my water connection, it ill be very easy if it was a court order, I don’t know if the same efficacy will lie with the Tribunal order.
Doshi: So, whether it will carry the some weight or not.
Shah: Tribunal order is a Tribunal order at the end of the day and they have to provide for something which would have given it a sort of court sanction like we have in the arbitration decrees which ultimately goes to the court for its final sanction. I think that too would have helped in the practical implementation of all these schemes and that is going to be the critical element.
Second important thing is that whether the Tribunal order can now look at retrospective appointed dates which were used to incorporate restructuring- that is going to be a question because courts had an inherent power to do anything that they want; whether a tribunal will have that, it is going to be a question. The jury is still not out on this whether they have or not. These are the two things that I see as things that they need to work on and change it.
Hulyalkar: I think it is a forward looking Act. I don’t think people are going to be materially worse off. If you look at cross-border mergers, you look at fast track mergers the last Act had a life of 57 years and you can call it enabling provision today but when you think of it, maybe 10 years down the line when indeed Indian M&A is more aligned with global M&A, I think we have created something that can facilitate it.
Doshi: So, you are delighted with all the enabling that this Act has laid out?
Hulyalkar: I don’t see as being at least worse off.
Doshi: What a relief, at least we are not worse off!
Gupta: It has a lot of positives. For instance for industry as a whole uniformity, standardisation, tribunal would know what the powers they have. I think a lot of haziness is cleared but of course the time, emotional issue of tribunal versus High Court will remain.
Doshi: If you had the power to decide whether M&A continues under the jurisdiction of the earlier Act which is Section 391-394 or it has to now exist under Section 230-236- what would you decide?
Khaitan: Under the existing 1956 Act- I would decide that and I think that we didn’t deserve an Act in today’s day and age with so many inconsistencies, errors. As professionals in the community, all our time is going in interpreting what these inconsistencies are, what the power is, we didn’t deserve this. Corporate India has been crying about squeeze-out and the government says I have given a squeeze out provision and what comes is an exit provision; that’s very disappointing.