Tanya Mahajan and Tejas Venkatesh
(Final Year Students, Jindal Global Law School)
On 19 September 2024, a Kolkata bench of the National Company Law Tribunal (NCLT) rejected a petition made by Philips India Limited (Philips) to acquire its minority shareholding aggregating to 3.87% of their issued share capital (Petition). The plea was pursuant to requests made by public/retail shareholders, who had no avenue to liquidate their shares due to prior delisting. While the Tribunal's order (Order) underscores the importance of protecting minority shareholder rights in a predominantly promoter-controlled company like Philips, its characterization of the buyout as a buy-back under section 68 of the Companies Act, 2013 (Act), rather than as a capital reduction under section 66, stands in stark contrast to settled jurisprudence. In several cases, courts have allowed for selective reduction of share capital by extinguishment of rights of minority shareholders under section 66 of the Act. This article seeks to critically analyse the rulings of Indian courts by tracing the judicial development of the understanding of buy-back and capital reduction.
Order of the Tribunal
The Petition concerns a plea made by Philips, the Indian subsidiary of the group of companies held by Koninklijke Philips N. V. The Indian subsidiary is majorly promoter-held, with only 3.87% of its shares held by the public and an investor education protection fund. After the delisting of its shares in 2004, the retail shareholders were left with no avenues to liquidate their shareholding in the company. After several requests by inconvenienced shareholders, the company decided to buy-out these retail shareholders, by way of a selective reduction of share capital under section 66 of the Act.
To propose a “fair value” for their shares as consideration, Philips sanctioned a detailed valuation report from KPMG, which determined the fair value to be Rs. 740/- per equity share. In addition to the valuation, the Board proposed a premium of 24% on each share. Further, the proposed reduction was also approved by an overwhelming majority of 99.58% of the shareholders by way of a special resolution. However, the court also noted the allegations that merely 7 shareholders out of the 25,000 retail shareholders had written to the company requesting for a buy-out, and that an alternative “fair value” proposal was starkly higher at around Rs. 4,500/- per share.
The Tribunal noted that the objective of the capital reduction was to provide an exit opportunity to the public shareholders and save on administrative costs spent on sustaining the small proportion of minority shareholders. However, the NCLT concluded that neither of the opportunities fell within the ambit of section 66(a) which can be used to extinguish or reduce the liability of any of its shares in respect of the share capital not paid-up; or section 66(b) which can be used to cancel any paid-up share capital which is lost or is unrepresented by available assets; or (ii) pay off any paid-up share capital which is in excess of the wants of the company.
It further noted that, unlike section 66(6), which explicitly states that the provision does not apply to the buyback of securities under section 68, there was no equivalent provision under the previous section 100 of the Companies Act, 1956. As a result, in cases where share capital reduction is incidental to the primary goal of a buyback, the provisions of section 66 do not apply.
A Flawed Precedent?
Before analyzing the contents of this Order, it becomes important to understand what constitutes a Selective Reduction of Capital (SCR) and a Buy-Back of shares under the Act. Per section 66, a company is permitted to undertake a capital reduction “in any manner” subject to (i) A Special Resolution signifying shareholder consent; (ii) NCLT approval and; (iii) valuation as per the specified Accounting Standards. The phrase “in any manner,” implies that the company can undertake SCR, through which it can extinguish the shareholding of certain shareholders completely, while leaving others untouched. SCR has become a common means of “squeezing out” the minority shareholders, as it is less taxing procedurally when compared to section 236.
Although the process of SCR may appear similar to a Buy-Back under section 68, wherein a company repurchases the shares of minority shareholders and then cancels them, courts have recognized a distinction between the two, notably in Re: Reckitt Benckiser v. Unknown (Reckitt). The Court in Reckitt interpreted the phrase “notwithstanding anything contained in this Act” in line with previous precedents to hold that SCR and Buy-Back operate in different spheres, independent of each other. Moreover, there is no reason for a SCR to be proportionate to a Buy-Back as it can be done “in any manner”. With this clear distinction, it can be analysed how the recent NCLT Order completely ignores settled precedents.
The first landmark case sanctioning SCR was the case of Ramesh B. Desai v. Bipin Vadilal Mehta. The Court in this case reiterated the stance in common law judgements and declared that the reduction of share capital is a domestic concern. Since the Act permits reduction to be undertaken “in any manner,” the legislative intent of the section was to give full control to the shareholders to carry out reduction, in whatever manner they deemed fit. This reflects the primacy given to corporate democracy and autonomy in capital management.
In Reckitt, the Bombay High Court noticed a similar fact pattern to the Petition. A shareholder challenged the SCR scheme, claiming it was “discriminatory, unfair, and intended to eliminate public shareholders.” The Court noted that two material factors must be considered in determining whether the SCR is unfair or discriminatory: (1) The Company's motive for the reduction; and (2) The fairness of the share valuation. The principles laid down in Reckitt were summarised and built upon by the Supreme Court within In Re: Elpro International. These principles are:
1. Reduction of share capital is a domestic concern.
2. If majority shareholders pass a Special Resolution to reduce share capital, they also have the authority to decide how the reduction will be carried out.
3. A company can implement a SCR within the same class of shares by either reducing shares proportionately or extinguishing certain shareholders' shares entirely, leaving others unaffected.
4. The court's role is to ensure that the reduction is fair and equitable, and that all creditors have had the opportunity to object, been paid, secured, or have given their consent.
If all of these principles are met, SCR is generally permitted by courts. Another landmark case is that of Sandvik Asia v. Bharat Kumar Padamsi, wherein a reduction scheme that removed an entire class of shareholders was challenged on grounds of public policy. The High Court concluded that since the Act allows for capital reduction to be carried out “in any manner”, the proposed reduction in this case was permissible. Additionally, the shareholders were to receive a fair price for their shares, and the resolution to reduce the share capital was supported by an overwhelming majority of non-promoter shareholders.
Thus, on a base analysis of landmark precedents, it is seen that courts have limited intervention in rejecting schemes of SCR when all the above-mentioned principles are met and have generally upheld corporate democracy in such matters, allowing SCRs to proceed as long as they have majority support. Lack of expertise in commercial matters along with the legislative intent to grant companies discretion in section 66 are cited by the courts for their non-intervening stance.
Courts have only intervened in SCR schemes where the valuation of shares is patently unfair or discriminatory. This is evident from Re: Cadbury India, where the SCR was challenged based on its share valuation. The Court appointed an independent valuer to determine a fair price for the shares and established principles that should guide its discretion in capital reduction matters. As the issue of “fair valuation” has been raised in the present case, if the Petition were dismissed on valuation grounds, it would align with prior precedents, provided the valuation is deemed unfair. However, the tribunal dismissed the case without requesting an independent valuation or examining its merits.
The Tribunal's approach to confining SCR schemes strictly within the parameters of sections 66(a) and 66(b) overlooks the foundational aspect of the provision, which allows for reduction to be undertaken “in any manner.” This broad interpretation has historically been recognized to provide maximum leeway to companies in executing capital reduction, regardless of whether the chosen method is explicitly enumerated within the statutory provisions. Moreover, the Bench's reliance on section 66(6) to support its conclusion that section 66 is inapplicable to a buyback under section 68 reflects a misunderstanding of the provision. While a SCR scheme can produce effects like those of a Buy-Back, they follow different procedures, as discussed above. Further, a Buy-Back does not require NCLT approval as is mandated in a SCR. This understanding does not align with prevailing judicial trends, that favor a flexible interpretation of capital reduction provisions, allowing companies to utilize SCR methods that can effectively achieve their goals while safeguarding shareholder rights. The insistence on rigid categorization not only undermines the legislative intent but also sets a problematic precedent that could hinder companies from utilizing valid mechanisms for capital restructuring.
Conclusion
The Order raises important concerns about capital reduction schemes, especially distinguishing between selective reductions and buybacks. The Appellate Tribunal must adopt a flexible approach aligned with judicial precedents to help companies navigate restructuring. Addressing these nuances will protect shareholder rights and promote corporate growth and stability.
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