TAKEOVER NOTIFICATION, 2020: FILLING THE GAPS IN THE LAW ON MINORITY SQUEEZE OUTS IN INDIA
This post has been authored by Harsh Dhiraj Singh, a third year student at National Law University, Jodhpur.
The ‘Takeover Notification’ (hereinafter ‘Notification’) notified by the Ministry of Corporate Affairs has introduced sub-sections (11) and (12) of Section 230 in the Companies Act, 2013.[i] The Notification has limited applicability over minority squeeze outs in unlisted companies. The issues surrounding pricing and valuation, regulatory supervision and minority voting rights have been unequivocally answered by this Notification. This article attempts to refute the arguments of deprivation of property to the minority and the minority’s right to consultation whilst analysing the various provisions of the Notification.
Major Changes under the Takeover Notification, 2020
The changes notified under the Notification are summarised as below:
i. The Notification allows the holders of 75% securities (including depository receipts) of an unlisted company to acquire the shares of the minority, pursuant to a takeover application approved by the court.
ii. The takeover application submitted to the National Company Law Tribunal (NCLT) should include the details of the valuation of the shares, after considering:
a. The maximum price paid by any person or group of persons for the acquisition of these shares in the preceding 12 months; and
b. The Return on Net Worth, Earnings per Share, book value of shares, industry average and other like factors that are customary to valuation of such shares.
iii. The acquirer is required to deposit a sum equivalent to at least 50% of the takeover offer in a different bank account.
The Justification for Minority Squeeze-Outs
It has been time and again highlighted that the greed and lust for power of the majority are the guiding force behind minority squeeze outs.[ii] However, there are rational economic consideration behind such acquisitions. The idea behind not prohibiting such minority acquisitions has largely been the concepts of efficient management and value-enhancing transactions.[iii] The idea of benefitting from the synergic effect is a tempting one for the majority shareholders. If the company sheds off its minority shareholders then the regulatory disclosures to SEBI are considerably reduced and so are the costs attached to such disclosures. Additionally, the costs attached to distribution of dividends, possible challenges to investment plans and legal actions are other such leverages that such an acquisition helps to discard.[iv]
The majority shareholders often benefit from such compulsory acquisitions because of the reduced scope for ‘free-riders’ to the minority shareholders which create an economic cost for the company.[v] Free riders are those benefits that a minority shareholder expects to earn by letting go such tender offer in anticipation of a rise in market price of shares. Therefore, a compulsory acquisition or minority squeeze out helps a company to increase its wealth by reducing economic costs.
Arguments against Minority Squeeze Outs : Deprivation of Property and the Right to Consultation
Minority squeeze outs have been opposed on the grounds of legal fairness. Minority shareholders assert that buying out minority shares deprives them of their property and leads to dispossession of property under law. They argue that such deprivation can only be done for public or general interest, and subjecting their free riders to a management problem is no justification for a compulsory acquisition. It is followed by an attempt to highlight that it is only the idea of convenience and flexibility that drives the law on minority squeeze outs, rather than the principle of equal and fair representation. This argument leads to the long drawn criticism of the Foss v. Harbottle[vi] majority rule and requirement for carving out the much needed right to consultation for the minorities. Therefore, in a gist, these arguments in toto challenge the very base of this concept of squeeze outs, rather than bringing any change to the existing laws. However, the Notification has fairly attempted to crease out these inconsistencies and resolve the issues of fairness in terms of pricing and valuation, as well as, voting and consultations.
Creasing out the Issues under the Takeover Notification, 2020 : An Analysis
As discussed above, the central theme of opposing minority squeeze outs has been the fairness in terms of price and the process.[vii] Earlier methods had lacunae that were intended to be resolved through the Notification. This section would analyse the Notification in terms of the impact it had on the following:
i. Valuation and Pricing
ii. Minority Rights
A. Instilling fairness in valuation and pricing
The minority shareholders challenge the subjectivity inherent in the process of pricing and valuation of shares. The different methods of squeeze outs have different ways of valuation, however, one thing that runs common is the alleged unfairness in the process. For example, if the squeeze outs is made through a scheme of arrangement or reduction of capital, then, the valuation reports holds a significant value. In Hindustan Lever Employees’ Union v. Hindustan Lever Ltd.,[viii] the Supreme Court took a defensive stand by holding that if the majority of the shareholders agree to a particular method of valuation, it cannot be challenged only on the ground that there exists a different method which leads to a better valuation. Courts usually abstain themselves from piercing the veil and interfering in the valuation process, unless the process itself suffers from any illegality.[ix] Hence, it is clear that the problem stems from the subjectivity of the process; unlike the objectivity and control over prices in the delisting process, where the reverse book building process is followed. The idea of control leads to the problem of choice. These processes lack an option for choice to the minority shareholders.[x]
This problem of choice can be assessed depending upon the exercise of control and effectiveness in a management practice.[xi] Instilling objectivity into this process of pricing and valuation by identifying parameters on the grounds of control and effectiveness can solve this difficulty faced by the minority shareholders. This is because the principle of shareholders’ wealth maximization is indispensable to the principle of corporate governance, and only these two factors can bring objectivity into this valuation and pricing methods.[xii]
The Takeover Notification has made considerable efforts to reduce the subjectivity. The factors like Return on Net Worth, Earnings per Share, industry average etc. have a common thread linking them to the principles of efficient management. Hence, it brings into context all such customary practices and factors that drive the efficiency of a company and introduces objectivity in the management process. However, the applicability of these methods will be refined and better explained through judgements and observations by courts.
B. Shaping Minority Rights: The Procedural Clarity
It has been discussed above that minorities have been deprived of their right to consultation under the existing methods of squeeze outs and at the most they can only demand re-examination of the process.[xiii] The assurance of minority rights has been compromised in the background of wealth maximisation. However, it can be said that the new requirement of depositing 50% of the tender offer in a separate bank account can be the very first step towards assuring minority shareholders that the process is firm and loyal to the principles of fairness and transparency. This ensures that the minority has a right to inspect and demand re-examination by the court. This gives the minority a choice a priori, an option to choose their buying out process on a certain price and valuation parameters. If nothing else, then this step itself has a potential of introducing minorities to a hoard of solutions to the existing problems of oversight by courts, regulatory supervision and compliance check.[xiv]
Minority Squeeze outs have been balanced in different manners in different jurisdictions. In spite of such differences, the principles of control, effective management, wealth maximization etc. are common to all such practices and methods. Takeover Notification has managed to strike a balance between these above-mentioned principles and rights of the minorities in terms of fairness, consultation and inspection. The two major changes introduced by the Notification have instilled confidence and clarity to the process of squeezing out minorities, by introducing procedural safeguards. It can be confidently asserted that the majority rule in Foss v. Harbottle has been refined and adjusted according to the issues and rights involved in this battle for procedural fairness.
[i] Ministry of Corporate Affairs, Notification, (March 23, 2020; 11 am), http://www.mca.gov.in/Ministry/pdf/Rules1_04022020.pdf. [ii] Hyeok-Joon Rho, New Squeeze-out devices as a part of Corporate Law reform in Korea: What type of device is required for a developing economy?, 29 Boston University International Law Journal 51, 51--53 (2011). [iii] F.H. Easterbrook & D.R. Fischel, Corporate Control Transactions, 91 YALE L.J. 698, 700 (1982). [iv] Supra note 2, at 52. [v] Sanford J. Grossman & Oliver D. Hart, Takeover Bids, the Free-rider Problem, and the Theory of the Corporation, 11 Bell J. Of Econ. 42, 43 (1980). [vi] Foss v. Harbottle, (1843) 67 ER 189. See also, V. Khanna & U. Varotill, Regulating Squeeze Outs in India: A Comparative Perspective, NUS Working Law Working Paper Series, (July, 2014). [vii] Id. at 17. [viii] Hindustan Lever Employees’ Union v. Hindustan Lever Ltd., AIR 1995 SC 470. [ix] In Re Organon, (2010) 101 SCL 270 (Bom.). [x] See Securities Exchange Board of India v. Sterlite Industries, 2003 113 Comp Cases 273; Sadvik Asia Limited v. Bharat Kumar Padamsi, 2009 (4) Bom LR 1421. [xi] A.W.A. Boot, J.R. Macey & A. Schmeits, Towards a new theory of Corporate Governance: Objectivity versus Proximity, (March 23, 2020), https://pdfs.semanticscholar.org/686b/7db8137cd02b740bbaa3dcb46b5b330428bc.pdf. [xii] Zubair Ahmed Khan & Irem Hussanie, Shareholders Wealth Maximisation: Objective of Financial Management Revisited, International Journal of Enhanced Research in Management & Computer Applications, 7 (2018). [xiii] Anup Koushik Karavadi, Squeeze out Clause- A Perspective, Lakshmiri, https://www.lakshmisri.com/insights/articles/squeeze-out-clause-a-perspective/#. [xiv] Supra note 6.