Take Over Of Unlisted Companies– Problematic Areas Of CAA Rules 2016 Framed Under Sec 230 Companies Act 2013

THE NEW RULES INTRODUCED IN THE ACT

• With the insertion of a new , brief Rule under the Companies (Compromise Arrangements and Amalgamations) Rules 2016, in the Companies Act 2013, (the Act) the Ministry of Corporate Affairs has empowered the majority shareholders of a company ,at their choice, to get rid of the minority shareholders of the company by buying out the latter's holding – analogous to compulsory acquisition of land by the government.

  Let us go through the relevant provisions of the Act

  Section 230 of the Act , (which deals with provisions relating to compromise or arrangement ( Scheme) proposed between a company and its creditors or any class of them or between a company and its members or any class of them.) contains 12 sub-sections, of which the first 10 subsections ( 1 to 10 ) came into force from 15 December 2016 , while the following 2 sub-sections were notified on Feb 2 2020

  (11) Any compromise or arrangement may include takeover offer made in such manner as may be prescribed:

  Provided that in case of listed companies, takeover offer shall be as per the regulations framed by the Securities and Exchange Board.

  (12) An aggrieved party may make an application to the Tribunal in the event of any grievances with respect to the takeover offer of companies other than listed companies in such manner as may be prescribed and the Tribunal may, on application, pass such order as it may deem fit.
  
  

  Simultaneously the new Rule has been included in the CAA Rules 2016 by inserting sub rule 5 and 6 in Rule 3 which reads as follows

  "(5) A member of the company shall make an application for arrangement, for the purpose of takeover offer in terms of sub-section ( 11) of section 230, when such member along with any other member holds not less than three-fourths of the shares in the company, and such application has been filed for acquiring any part of the remaining shares of the company.

  Explanation I. - "shares" means the equity shares of the company carrying voting rights, and includes any securities, such as depository receipts, which entitles the holder thereof to exercise voting rights.

  Explanation II.-Nothing in this sub-rule shall apply to any transfer or transmission of shares through a contract, arrangement or succession, as the case may be, or any transfer made in pursuance of any statutory or regulatory requirement.

  (6) An application of arrangement for takeover offer shall contain:_

  (a) the report of a registered valuer disclosing the details of the valuation of the shares proposed to be acquired by the member after taking into account the following factors: -

  (i) the highest price paid by any person or group of persons for acquisition of shares during last twelve months.

  (ii) the fair price of shares of the company to be determined by the registered valuer after taking into account valuation parameters including return on net worth, book value of shares, earning per share, price earning multiple vis-d-vis the industry average, and such other parameters as are customary for valuation of shares of such companies.

  (b) details of a bank account, to be opened separately, by the member wherein a sum of amount not Iess than one-half of total consideration of the takeover offer is deposited

  EFFECT OF THE NEW RULES

  So ,with the above amendments, a shareholder or a group of shareholders holding not less than 75% of the paid up capital ( acquirer) and with the required resources to acquire the minority , can easily eject such minority with the official sanction of the NCLT .

  This has been made possible because all that is required for the acquirer is to move an application under Section 230 to the Jurisdictional Bench of the NCLT for its approval for the Scheme which would order meeting of creditors, /class of creditors/ members/class of members. If at the meeting so convened, majority of persons voting in person / through proxy / postal ballot representing three fourths in value of creditors/ members as the case may be, agree to the Scheme, the NCLT would by an order approve the Scheme .Once such order is issued ,it is binding on all the creditors and members of the company.

  With 75% holding, getting the required approval at the meeting is only a ritual for the acquirer. In Schemes like this , there is nothing for the creditors or the Regulators, who are likely to be affected by the Scheme to whom the Notice on the proposed Scheme is sent in terms of S 230 (5) of the Act to make representation to NCLT on the Scheme The Application of the Acquirer needs to only cover the proposal to acquire the stake of the minority and there is no need for it to furnish the benefits to the company that the takeover may bring in . And for the NCLT, it only has to satisfy itself that the prescribed conditions that the price offered for the acquisition is not less than the amount determined in terms of the Rule 3 (6) of the CAA Rules and 50% of the total consideration of the takeover offer is deposited in a bank account and nothing more. Thus, it is a cakewalk for the acquiring group. A Scheme for the majority group and by the Majority group!!!!

  PLIGHT OF THE MINORITY

  And the minority shareholders are bound by the Order of the Tribunal approving the takeover and they have no option but to accept the offer made to them- Compulsory acquisition

  The biggest drawback for the minority shareholders is- unlike in the case of SEBI (Substantial Acquisition and Takeover) Regulations, applicable to listed companies where the shareholders are NOT under compulsion to accept the offer of the Acquirer who makes Open Offer-here, the minority shareholders are bound by the NCLT order and exit the company. It is to be noted that SEBI only regulates the manner in which the acquisition of shares in a listed company can be made, whereas in the case of unlisted companies, the NCLT functions as the approving Authority for the takeover by an acquirer.

  Section 230 (12) says the aggrieved party may apply to the NCLT in the event of any grievance with respect to takeover offer. Now, when the only requirement for the Acquirer to satisfy the Tribunal is on the acquisition price and the deposit of the prescribed percentage of the price with a bank, on what grounds an aggrieved shareholder may approach the Tribunal? For, the provisions do not prescribe any circumstances/ situations in a company when the Acquirer may "exercise the power to buy out the minority?" . The Acquirer who has the required resources decides to eject the minority and the NCLT gives the seal of its approval for the takeover. That's all

  FAVOURABLE TERMS FOR THE ACQUIRER

  Let us consider the provisions on the stipulation for deposit of the purchase consideration for the takeover, by the Acquirer in terms of the new Rules. Rule 3) (6) (b) requires application to NCLT to contain details of the bank account to be opened separately, by the member where the 50% of the purchase consideration for the takeover offer is deposited. What a poor drafting? From the wording it appears that at the time of moving the NCLT the amount is not kept in the separate account with a bank . There are no terms on how the account will be operated , is it an Escrow account, when the remaining 50% of the amount will be deposited, what will be last date by which the offer will close and the period within which the purchase amount will be released by the Acquirer.

  Compare this with the provisions contained in the other sections of the Act which deal with acquisition of shares in a company in certain circumstances, as given below

  Section	subject	Terms of deposit	Percentage of the purchase consideration
  235	Power of transferee company to acquire shares of shareholders of transferor company dissenting from Scheme or contract approved by majority	Amount to be paid by transferee company to the Transferor company's separate bank account	100% of the purchase consideration
  236	Purchase of minority shareholding by Acquirer holding 90% or more of the issued capital of a company	Amount to be deposited by Acquirer to a Separate account to be operated by the company	100% of the purchase consideration

  ( only the terms of deposit to be made by Acquirer in brief are listed above . The details of the contents of the Sections are not detailed here)

  One wonders as to the need for the Acquisition of the minority in terms of Section 230 (11) to be shown concessions and favours as if such acquisition is of national priority ?

  LEGAL VALIDITY OF THE NEW RULES

  The most important question to be addressed is the validity of the new Rules now inserted in the CAA Rules 2016 . If one studies carefully the "acquisition" described in the Rules , it would be noted that the transaction is between two groups of shareholders in a company – viz., majority and minority groups of the same company.

  Now we may consider the provisions of Section 230(1) which reads as follows:

  " Power to Compromise or Make Arrangements with Creditors and Members.

  230. (1) Where a compromise or arrangement is proposed—
  (a) between a company and its creditors or any class of them; or
  (b) between a company and its members or any class of them,

  the Tribunal may, on the application of the company or of any creditor or member of the company, or in the case of a company which is being wound up, of the liquidator, appointed under this Act or under the Insolvency and Bankruptcy Code, 2016, as the case may be, order a meeting of the creditors or class of creditors, or of the members or class of members, as the case may be, to be called, held and conducted in such manner as the Tribunal directs.

  Explanation.—For the purposes of this sub-section, arrangement includes a reorganisation of the company's share capital by the consolidation of shares of different classes or by the division of shares into shares of different classes, or by both of those methods."

  So, essentially what is contemplated under S 230 is any arrangement between :

  • a company on the one hand and or its creditors or any class of them on the other OR
  • a company on the one hand and its member or any class of them

  However, the acquisition contemplated under Rule 3 ( 5) of the CAA Rules being a transaction between two groups of shareholders of a company and the company is not a party cannot be considered as an arrangement or compromise within the meaning of S 230

  Even the explanation to S 230(1) of the Act refers to a situation where the share capital of the company undergoes a change ( reorganisation of capital) and therefore is eligible to be classified as an arrangement or compromise.

  It is worth mentioning here that Section 235 of the Act covers an acquisition as a consequence of a Scheme under S 230 ; and S 236 of the Act which permits acquisition of shares by an Acquirer holding not less than 90% of the issued capital of a company to buy out the remaining shareholding, is outside the scope of s 230 of the Act

  The Takeover introduced under the new Rules is analogous to acquisition under S 236 of the Act

  Then what could be the effect of S 230 (11) that refers to takeover of a company.? It should mean a takeover as a part of an arrangement or compromise covered under Sec 230 (1) of the Act. In other words, there cannot be an arrangement or compromise for acquisition of shares by the majority shareholder of the minority shareholder in a company (as contemplated under new Rules) as a standalone Scheme/ arrangement / compromise

  CONCLUSION

  In this case, the rule that Rules must be subordinate to the provisions of the relevant Act, has been breached and therefore the new Rules should be deleted , before any aggrieved person raises the question of its legal validity before a court of law. But that means a Takeover under the Rules should be initiated and then an aggrieved shareholder challenges its validity . When will such event take place? It  remains to be seen.

  (The author is a practising Company Secretary based in Chennai. Views are personal)