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SEBI & Schemes: Debatable Caution, Doubtful Precision

Published on Mon, Feb 11,2013 | 17:00, Updated at Mon, Feb 11 at 20:22Source : 

By: Nitin Potdar, Partner M&A, JSA

In a recent development, SEBI has decided to scrutinize all Schemes of Amalgamation/ Merger/ Reconstruction/ Reduction of Capital prior to filing u/s 391, 392 and 101 of the Companies Act, 1956.  The said motive is to ensure adequate disclosures, weed out convoluted schemes as also arrest exaggerated valuations by public listed companies.  SEBI’s noble intentions notwithstanding, this unwarranted scrutiny itself calls for a serious scrutiny to foresee the likely consequences.

But before that, let’s take a cursory look at the guidelines as laid down in great detail in SEBI’s Circular dated February 4, 2012 addressed to all listed companies desirous of submitting draft Schemes to Stock Exchange (‘SE’). SE needs to forward the draft scheme (so received from companies) to SEBI within 3 days. Further, the SE is required to issue its ‘Objection/ No-Objection’ letter on the draft Scheme within 30 days. SEBI would then, within 30 days, endeavour to provide its comments to SE on the draft Scheme.  It’s prudent to note that the response time frames for both SE and SEBI are subject to companies providing all clarification to SE/SEBI. Which means the time frame is conditional, there’s nothing binding about it, and in no time days could become months!  Also SEBI’s “endeavour” is only an endeavour at best; it implies no compulsion to respond.  

Coming back to the guidelines, based on SEBI’s comments if and when received, SE would have to issue an Observation Letter to the listed company which the latter needs to include in the notice sent to the shareholders seeking approval of the Scheme as also bring it to the notice of the High Court at the time of seeking approval. The listed company also needs to publish, on its website, all documents submitted to SE including draft Scheme, Valuation Report/ Audit Committee Recommendation and Merchant Banker’s Fairness Opinion and the said Observation Letter. This public disclosure is to enable concerned persons to file complaints/ comments to SEBI if any.  SEBI would then forward these complaints/ comments to SE for necessary action and resolution by the listed company.  In that case, the listed company has to submit a ‘Complaints Report’ prior to SE issuing the Observation Letter.

Now, in such cases, it’s apparent that SE won’t be able to issue its Observation letter within 30 days. And what if the complaint simply cannot be resolved in good time?  Quite obviously, the scheme will only get stuck in the elongated loop of the procedure u/s 391, of seeking directions from the High Court to convene Shareholder and Creditors meetings by issuing public notices…so on and so forth.  

Most important, as per the new Circular SEBI wants special resolution to be passed through postal ballot and e-voting following disclosures of all material facts in the explanatory statement, whereas u/s 391 requires approval from the shareholders or creditors, who are physically present and voted by majority in number representing three fourths in value.  Shareholders’ approval through postal ballot is clearly in conflict with The Companies (Court) Rules, 1959 (“Rules”), which require shareholder consent by poll, and meeting outcome reported in the prescribed form. 

If you think you can proceed to implement the Scheme after getting the High Court clearance, hang on! Para 5.16 of the SEBI’s New Circular requires you to find out whether votes cast by public shareholders in favour of the proposed Scheme are at least two times the number of votes cast by public shareholders against it.   And only if public shareholders have so voted in favour, can the listed company proceed to implement the Scheme.  

Else, the entire herculean exercise of SE and SEBI’s pre-scrutiny/ SE’s No Objection Letter / Observation Letter/ Complaint Report/  Public Notices/ High Court proceedings stands nullified in one ruthless stroke.
In my opinion, this is against the basic principles of majority rule; in fact, SEBI’s provision has may be unknowingly converted minority into majority!   Exception to the majority rule laid down by Foss V. Harbottle is available to minority shareholders if there is a ‘fraud played on minority’.   With respect to SEBI, Clause 5.16 which gives public shareholders the right to veto any Scheme proceeds on the assumption that every Scheme proposed by listed companies is a fraud on minority, and hence needs protection. Henceforth, majority shareholders will have little say or control whatsoever over any Scheme of Restructuring. They would be at the mercy of the minority public shareholders, who may not even continue to hold their miniscule shares after having voted against the Scheme.  One can only imagine the potential abuse by the concerned company’s competitors that could follow as a result.

If SEBI’s provision is only to (a) ensure adequate disclosures, (b) avoid convoluted schemes of arrangement and (c) stop exaggerated valuations it has clearly gone overboard by outlining a process that threatens the basic rule of majority and prima facie appears to be in serious conflict with the provisions of the Companies Act and the Court Rules.

Having said that, let’s examine how SEBI could have mitigated the said concerns without violating the provisions of Companies Act and the Court Rules.

To ensure adequate disclosures, SEBI could have directed listed companies to compulsorily publish on its website all documents in connection with the Scheme including valuation report/ fairness opinion and audit committee recommendations.  It could also have directed companies to include a summary of the Scheme in layman’s language along with the notice to shareholders explaining scheme implications in simple terms.  Rather than direct SE to write an Observation Letter, SEBI could have asked for a smart summary of draft Scheme in simple language. This would have ensured adequate disclosures besides helping shareholders understand the so called ‘convoluted schemes’. In fact, SEBI and SEs together should stress on proactive measures by listed companies in educating shareholders towards making informed decisions.

SEBI has been rightly raising concern over the valuation exercises adopted by listed companies in the wake of umpteen grossly unfair valuations in the past. However, today valuations are done by independent chartered accountants and mandatorily backed by a fairness opinion from category I merchant banker besides the Audit Committee recommendation. If SEBI feels the need for more checks over and above the three-layered scrutiny, it could either come up with its own valuation norms or constitute a home panel of independent chartered accountants for valuation akin to what the High Court liquidator follows. And the listed companies could be mandatorily made to seek confirmation from these independent valuers on the proposed valuation, which could even be submitted to the High Court at the time of hearing.

Given the fact that valuation is devoid of mathematical accuracy, it would invariably remain a matter of subjective opinion and hence debatable, if not controversial. It would not be out of place to cite a Supreme Court observation here, whilst deciding the merger of TOMCO with HLL reported in (1994) 4 Company LJ 267 (Para 3):

 “the jurisdiction of the Court in sanctioning any merger is not to ascertain with mathematical accuracy whether the valuation satisfies the arithmetical test.  It is not required to interfere only because the figure arrived at by the valuer was not better as it would have been if another method would have been adopted.  The Court’s obligation is to be satisfied that valuation was in accordance with law and it was carried out by an independent body.” 

Most importantly the Court observed, “…….certainly it is not part of the judicial process to examine entrepreneurial activities to ferret out flaws.  The Court is least equipped for such oversights.  Nor, indeed it is a function of the judges in our constitutional scheme.   We do not think that the internal management, business activity or institutional operation of public bodies can be subjected to inspection by the Court.  To do so, is incompetent and improper and, therefore, out of bounds.”  

The cause and conviction of independent valuation, and most importantly, the role of agencies like High Court, SE or SEBI could not have been expressed better.

As far as complaints/ suggestions from shareholders are concerned, today any aggrieved person, including shareholders and employees, is free to file his/her objection before the High Court examining the Scheme with the guarantee of a full hearing right up to the Supreme Court.  It would have been more prudent for SEBI and/or SE to collect all these complaints/ suggestions and file a detailed affidavit through SE to the High Court with their views/ comments, and directing the listed company to comply with/or satisfy the complainant under direct High Court supervision.   This would have given a fair chance to all parties to represent as well as defend their positions.

In the pursuit to avoid ‘convoluted schemes’ by listed companies, SEBI has ended up proposing an even more ‘convoluted process’ which would only lead to colossal waste of time, money and effort. Indian corporations, in today’s globalized economy, deserve a more enabling statutory environment to help them restructure processes and polices aimed at productivity and sustainability. It is truly unfortunate that, in the two decades of liberalization, we have been busy creating new factories of red-tape, totally oblivious of the need of the hour.

(Views expressed by the author are his personal.)


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