The reduction of share capital by limited companies is governed by section 66 of the Companies Act, 2013,1 which was previously covered under sections 100-105 of the Companies Act, 1956.2 This section authorizes the company to reduce its capital in ‘any manner’ the company deems fit, which implies that the company can carry out a selective reduction of capital, under which it can extinguish the shareholding of certain shareholders entirely while leaving others untouched.3 This has lead to the extensive usage of this provision by the promoters to compulsorily acquire the shares of the minority shareholders of the company. Such a situation, in which the controllers of a particular company forcibly acquire the shares of the minority shareholders4 by making use of various available methods such as reduction, compulsory acquisition and scheme of arrangement,5 is termed as a ‘Squeeze Out.’ It is a manifestation of the control of the majority shareholders (the promoters generally) over the company who use this provision to steamroll the minority.6 The reasons so as to why a promoter might choose to squeeze out the minority range from their desire to exercise greater control over the company to taking the advantage of easier compliance requirements.7 Even though the practice of squeezing out has always existed in the country, it has been categorically provided for by the 2013 act under section 236, which lists out instances in which the shares of the minority can be acquired by the majority.8
This paper aims to discuss the reduction of capital under section 66 in the context of its usage to squeeze out the minority shareholders. In its discussion regarding squeeze-outs, the scope of the paper is limited to the squeeze outs engineered by reduction of capital under section 66. It aims to understand the law governing squeeze outs in India by analyzing various judicial decisions on the issue and follows the Doctrinal approach. In the course of the paper I argue that the Indian courts have sanctioned the squeezing out of minorities via selective reduction of capital as long as the shareholders are being paid a fair price and have preferred to stick to the policy of non-intervention in the internal decisions of the company that are backed by the support of the majority. Part II of the paper briefly discusses the statutory provision governing squeeze-outs by reduction while also discussing the distinction between ‘reduction’ and buy-back using judicial precedents on the subject. Part III maps the evolution of case law regarding squeeze outs in India and also discusses the court’s approach towards contentions raised by the regulatory bodies and their role under the 2013 Act. Part IV contains the observation based on the analysis of the judgements with special focus on the status of the requirement of a Majority of Minority vote in case of squeeze-outs. Part V summarizes the discussion and concludes the paper.
Section 66 is the provision governing squeeze-outs via reduction of capital under the Companies Act, 2013, which has modified the earlier provisions and has inserted certain new compliances that are required to be fulfilled by the company. A pertinent change in this regard has been that the application for reduction is to be filed before the National Companies Law Tribunal (hereinafter ‘NCLT’) now instead of civil courts to ensure the speedy disposal of these applications.9 Various other changes that have been introduced include the requirement of the NCLT to serve a notice to the Central government, the Registrar and the Securities and Exchange Board of India (hereinafter ‘SEBI’) in case of listed companies, and a prohibition on reduction of capital in case the company is in arrears of payment of its debts.10
The procedure to reduce capital under section 66 requires three primary ingredients to be fulfilled by the company among others to materialize a squeeze-out. Firstly, the Articles of Association of the company must contain a provision authorizing reduction.11 Secondly, a special resolution must be passed by the shareholders confirming the reduction and thirdly, the company must ensure that none of the creditors have any objections regarding the proposed reduction and then take the approval of the NCLT.12 Further, the section requires the accounting treatment of the reduction to be in conformity with the accounting standards prescribed by the 2013 act.13 Reduction under section 66 is the most popular mode for effectuating a squeeze out as it has the least onerous procedural requirements as compared to the other two methods.14 It only requires a special resolution i.e. majority of 75% of the shareholders as opposed to the consent of 90% shareholders in the case of compulsory acquisition and 75% majority of each class of shareholders as in schemes of arrangement.15 Another advantage of utilizing section 66 to engineer a squeeze-out is that the corporate funds can be used to pay the shareholders and the controllers are saved from bearing any financial costs, while they end up becoming the owners of the company.16 Post the approval of the NCLT a certificate of reduction is issued by the Registrar of companies which acts as a conclusive proof of reduction, irrespective of the existence of any procedural irregularities during the reduction.17
THE BUY-BACK CONUNDRUM
The procedure of squeezing out under section 66 involves buying back the shares of the minority shareholders and then cancelling which leads to a consequential reduction of capital. This appears to be quite similar procedurally to a buyback of shares under section 68 (earlier section 77 of the companies act, 1956) of the Companies Act, 2013.18 An argument to that effect was raised by the petitioner in the case of In re: Reckitt Benckiser (India) Ltd19 where it was argued that since the reduction in the given case is essentially a buy back, the requirements of section 77 (Companies Act, 1956) should also be fulfilled and the company should be required to reduce its capital proportionately. However the court held that buy back and reduction operate in two entirely different fields, by placing reliance on Securities and Exchange Board of India v. Sterlite Industries.20 The court stated that by virtue of the wording of section 77 which states ‘notwithstanding anything contained in this act,’ buy back under section 77 and reduction under section 100 (Companies Act, 1956) are two separate provisions, independent to each other.21 Hence, there can be no requirement of the reduction under section 100 to be proportionate22 and it can be ‘in any manner’ (which includes a selective reduction) as provided under the section.23 Another distinction between the two includes that for a buy back there is no requirement of NCLT approval. However the distinction between the two is merely procedural in nature as both of them invariably lead to a reduction in capital.
The landmark common law case which sanctioned the selective reduction of capital and has been used extensively by the Indian courts in cases regarding squeeze-outs is British and American Trustee and Finance Corporation Ltd and Reduced v. John Couper.24 In this case the House of Lords held that the question of reduction of share capital is a domestic concern of the company, and since the act did not specify the manner in which the reduction of capital has to be carried out, the intention of the legislature was to let the majority of shareholders determine the question of whether there will be a reduction and if so the manner in which it will be materialized.25 This judgement was confirmed by the Supreme Court as an authority on the issue of reduction of capital in the 2006 case of Ramesh B. Desai v. Bipin Vadilal Mehta.26
In the recent years there have been a number of decisions of the Bombay High Court on the question of selective reduction of capital by which the controllers have squeezed the minorities out. One of the first cases on the issue was Reckitt Benckiser (India) Ltd. v. Unknown27 (hereinafter ‘Reckitt’) which was a petition seeking the court’s approval regarding the reduction of capital under section 100 of the Companies Act, 1956. A shareholder challenged the scheme of reduction in the given case by claiming that the proposed reduction is “discriminatory, unfair and mala fide and to extinguish the class of public shareholders.”28 The court observed that to decide the question of a proposed reduction being unfair or discriminatory, two factors are to be considered, which are the motive of the company behind the given extinguishment and the fairness of valuation of the shares.29 However the company agreed to let the petitioner retain his shares.30 The court delineated certain principles which govern squeeze outs in this case which were summarized by Justice Chandrachud in the case of In Re: Elpro International 31 (hereinafter ‘Elpro’) and have been followed by the courts consistently in the latter cases as well. These principles are :32
A defining judgement on the issue of squeeze outs post Reckitt was Sandvik Asia v. Bharat Kumar Padamsi33 (hereinafter ‘Sandvik’) in which it was argued that a scheme that wipes out an entire class of shareholders of a public company such that only the promoters are left as the shareholders is contradictory to the legislative intent and public policy. A single judge bench of the Bombay High Court accepted the argument of the petitioners and held that there must be a separate meeting of the non-promoter shareholders on the question of reduction to ensure that the minorities have a say in the decision.34 Additionally the shareholders in the given case were not given an option to retain their shares, which the court found to be unfair as it amounts to the minority shareholders being forced to give up their shares at a price determined by the majority.35 This decision was later appealed and the division bench of the High Court reversed the earlier decision. The court opined that since a reduction can be done in any manner under the act, the proposed reduction in the given case was permissible.36 Additionally, a fair price was being paid to the shareholders in lieu of the shares and the resolution to reduce the share capital was supported by an ‘overwhelming majority of non-promoter shareholders’ and hence it cannot be disallowed.37
In the case of In Re Organon (India) Limited38 the court held that for the valuation to be fair it has to be carried out by an independent body and should be in accordance with law. In the given case only one shareholder holding capital equivalent to less than 0.002% (80 shares) of the total capital objected to the reduction.39 The court applied the principles laid down in Sandvik and held that since an overwhelming majority of non-promoter shareholders have voted in favour of the reduction and there is no patent unfairness in the valuation of the shares and the scheme of reduction is valid.40
An interesting judgement on this issue was given by Andhra Pradesh High Court in the case of Chetan G Cholera v. Rockwool (India) Limited41 wherein the court approved the reduction on facts of the case but made certain observations regarding the preservation of the rights of the minority. The court remarked that in line with the preamble of the constitution and the Directive Principles of the State Policy which promote the establishment of a socialist state, the court may reject the scheme of reduction formulated by the promoters with the intention of amassing all the profits themselves and for denying the small investors their rights.42 The court also observed that in such cases mere compliance with all the required statutory provisions will not suffice and the court will scrutinize, taking into account all these surrounding factors (including National Interest) as well.43 The observations made by the court in this can be considered as an aberration from the settled principles which the courts have followed previously. The court did not lay down any clear standards for its intervention to protect the interests of minority shareholders and convoluted the issue further. However, the arguments made by the petitioner on the basis of observations made by court in this case have been rejected by the court in the 2011 case of In re: Reckitt Benckiser Ltd44 (hereinafter ‘Benckiser’) where the court held that these observations were in the nature of obiter dicta and consequently are not of binding nature. In this case it was argued by the company that according to the principle of the promoters being ‘first in and last out’ the promoters are to be the holders of the shares till the very end and therefore the reduction was done only with respect to the non-promoter shareholders in the given situation.45 The court accepted this argument and sanctioned the reduction of capital limited to non-promoter shareholders in the case.46
The most recent judgement on this subject was given by the Bombay High Court in the case of In Re: Cadbury India Limited47 (hereinafter ‘Cadbury’) which reiterated the previously established legal position and dealt primarily with the question of valuation of shares. Here the company passed a resolution to reduce its share capital which was supported by 99.96% of the shareholders. One of the minority shareholders challenged the reduction and to determine the correct and fair price of the shares the court itself appointed an independent valuer. Three principles of general applicability in which must govern the discretion of courts in the matters of reduction of capital were laid down in the case.48 Firstly the court must ensure that the scheme is not against public interest, Secondly, the reduction must be just, fair and reasonable and lastly, it should not prejudice a particular class of shareholders.49
REGULATORY BODIES AND SQUEEZE OUTS
Regulatory bodies such as the Securities Exchange Board of India and the Stock exchanges have in pursuance of their objective of protecting the interests of shareholders raised objections regarding certain exploitative, majoritarian schemes of companies before the court. In Securities & Exchange Board of India v. Sterlite Industries50 SEBI brought a petition before the Bombay High Court in which they claimed that a buyback of its shares by the company at market price can only be done under section 77 of the Companies Act, 1956 and not under section 100-104 which cover reduction of capital. The company is obligated to comply with the procedural requirements of section 77 while engineering this reduction as in it its essence is a buy-back. Further, the silence of the shareholder was being treated as their consent to transfer their shares in the given case which should not be allowed, and there must be requirement of a positive assent.51 The court here on the outset held that SEBI had no locus to challenge the scheme of reduction before the court.52 As long as no shareholders objected to the given arrangement SEBI could not ask the court to disallow the reduction which had the support of the majority.53 This decision though, has been rendered invalid post the 2013 amendment, as now the SEBI can present its objections, if any before the NCLT regarding a scheme of reduction as per the section 66(2) of the amended act.54
Similarly in the Elpro case the Bombay Stock Exchange (‘BSE’) argued that the scheme of reduction regarded silence as consent to sell the shares which shouldn’t be permitted and the assent of the shareholders must be required.55 The court approved the scheme but allowed the BSE to take action under the listing agreement if they found a violation of securities laws.56 The BSE withheld its approval and ultimately Elpro could not move forward with its scheme of reduction.57 The above cases illustrate that the SEBI and stock exchanges can play the role of effective regulatory bodies in cases of forced squeeze-outs. The 2013 act has, by allowing the SEBI to file objections before the court in matters pertaining to reduction58 has further strengthened their role. However, the supervisory role of regulatory bodies such as SEBI can only be exercised with respect to the listed companies and it has been observed that squeeze-outs are often materialized post delisting the company, in which case SEBI ceases to have a say over these transactions.59
On analyzing the cases on the issue of squeezing out by selective reduction of capital, it can be seen that the courts have limited their intervention in these cases to the extent of ensuring that the shareholders get a fair price for their shares at the time of acquisition by the company. They have followed a policy of non-interference in the domestic matters of the company, and as long as the resolutions have had the support of the majority they have abstained from invalidating the reduction, by citing the non-expertise of the court regarding commercial matters as well as the legislative intention of providing discretion to the companies on their internal matters as the reason. The approach followed by the courts seems to be favouring the promoters over the minority shareholders as the burden of proof on the objecting shareholders have been made increasingly onerous by the courts over the time. In the Indian setup, where a lot of companies are family run, there might arise a situation in which the sect of the family with majority shareholding might be in a position to extract the shareholding of the other sect of the family with a minority stake.60
Another common characteristic in all the above cases regarding a squeeze out via section 66 is the fact that the majority of minority (hereinafter ‘MoM’) has supported the reduction in all these instances. The courts have also laid down the support of ‘overwhelming majority of the minority (non-promoter) shareholders’ as being one of the factors for approving selective reduction of capital which wipes out the minority shareholding. Therefore even though the statute allows for the company to selectively reduce its share capital without any requirement of the approval of the MoM, there hasn’t been an instance so far in which they have opposed the proposed reduction. So can this be understood to mean that in case the MoM does not vote in favour of the proposal they can be allowed to retain their shares in the company? Does the court have the authority to disallow a reduction on this ground when the statute does not prohibit selective reduction?
Some scholars have argued that the favourable vote of the MoM operates only to strengthen the presumption of fairness of a scheme of reduction and even in the absence of a MoM vote the reduction can be approved by the court, and it shouldn’t be read in as a mandatory requirement.61 The rejection of the requirement of the MoM vote by the court can also be inferred from the repeated rejection of the court to the demand of treating the minority shareholders as a different class altogether and holding separate class meetings for them to decide the matters concerning reduction.62
While this can be a way to look at it, the absence of a MoM vote can also lead to objections from the SEBI against the company, and in light of the Rockwool judgement it might be argued that the courts might in certain instances also be inclined towards disallowing the reduction to safeguard the minority interest. The requirement of the consideration of ‘public interest’ as laid down in Cadbury also comes into play here, which can be used to contend that if an overwhelming majority of the minority has opposed the forced squeeze-out then would be against public interest to let the company to steamroll them. Various scholars have also suggested the usage of the MoM vote to determine the reduction of capital in cases of minority squeeze-outs which would safeguard their interests and would prevent the forcible acquisition of their shares by the promoters.63 Hence, the decision of the court can go either way, and there is a need of judicial clarification on this issue which has not been provided so far.
In my opinion, in order to balance the interests of the company on one hand and to safeguard the minorities on the other, there should be two votes on the issue of reduction of capital. One on the question of whether to reduce the capital or not which should be decided by a special resolution and another in which the manner in which the reduction will be engineered should be put to vote, i.e. whether the shares of all shareholders are to reduced proportionately or a selective reduction which extinguishes the shares of certain members entirely is to be done. On the second question a Majority of Minority should be required to vote in favour of the manner of reduction of capital for it to be valid.
It has also been suggested that in order to protect the interests of minority shareholders there should also be a requirement of the approval of the squeeze-out by Independent Directors whose decision cannot be influenced by the promoters/controllers of the company.64 This will act as an additional safeguard to ensure that the interests of the minority shareholders are not being manipulated for the benefit of the controllers.
The most feasible method to engineer a squeeze-out in India is via the reduction of share capital under section 66, as has also been illustrated by numerous cases in the recent past. The legal position on the issue is fairly settled, and the courts have had a limited intervention on the issue of squeezing out by way of selective reduction, as long as it has been backed by the support of the majority and the shareholders have been offered a fair price. The statutory provisions as well as the judicial inclination has been to regard the issue of squeezing out as matter as a domestic concern of the company, but there exists a grey area regarding the status of the Majority of Minority vote in this context. It is unclear so as to what will be the court’s approach in case the MoM refuses to support the scheme of reduction, with indications in the recent past of the court giving due consideration to public interest as well as the interests of the minority. The regulatory bodies such as SEBI have an important role to play here as well. As has been pointed out by Mr. Somasekhar Sundaresan, that the issue here is not just of the payment of a fair amount to the shareholders whose shares are being acquired coercively by the company, but is that whether he has a right to hold his shares of which he is a lawful owner, or can he be compelled to divest his property by the promoters.65 Hence, it is required on the part of the courts that due consideration is given to the interests of the minority shareholders while ensuring that they do not encroach upon the domestic matters of the companies, a careful balance must be struck between the two.