Stringent Procedures for Schemes of Arrangement Involving Listed Companies

For the
last few years, there has been a perceptible concern on the part of the
Securities and Exchange Board of India (SEBI) that companies have been
utilizing the facility of schemes of arrangement available under Sections
391-394 of the Companies Act, 1956 to effect various types of transactions,
some of which may not be in the interest of minority shareholders. SEBI has
sought to introduce several protections in the form of additional oversight.
Its
first recent effort in this direction was to introduce clause 24(f) in the
listing agreement, which requires listed companies to file the draft schemes of
arrangement with the stock exchanges at least 30 days prior to initiating the
process with the court. Secondly, it introduced
clause 24(i) to constrain the use of innovative accounting treatments by
companies by requiring them to produce a certificate of a chartered accountant
that the scheme complies with the applicable accounting standards. Thirdly, as
regards reverse listings, where a listed company amalgamates or demerges into
an unlisted company which then becomes listed through this process, SEBI
required the parties to seek an exemption under rule 19(7) of the Securities
Contracts (Regulation) Rules, 1957 (SCRR).
It
appears that SEBI is not satisfied with the functioning of the current
framework and seeks to strengthen it further. It has voiced its immediate
concern on the third count above, which is that “in the recent past, SEBI has
received applications, seeking exemption, from certain entities containing, inter alia, (a) inadequate disclosures,
(b) convoluted schemes of arrangement, (c) exaggerated valuations, etc.” Although
the immediate trigger has been in the context of reverse listings (where SEBI’s
approval is expressly sought), it has acted to bring about reforms to the
entire range of schemes initiated by listed companies.
These
reforms have been brought about through SEBI’s circular
of February 4, 2013, the salient features of which are discussed below.
Role of the Stock Exchange
The
stock exchange will continue to play a significant role in scrutinizing such
schemes in ensuring that public investor interests are protected. For this
purpose, listed companies must file a copy of the scheme and other documents
with the stock exchange 30 days prior to initiation of the scheme process
before the court. One of the open issues in this scenario pertains to what
happens if the scheme is not approved by the stock exchange. In a technical
sense, the stock exchange can only raise objections or provide observations,
and does not have approval rights. In the past, stock exchanges have simply
refused to approve a scheme, and parties have nevertheless initiated the scheme
before the courts after the 30-day period. In one
case
, the court approved the scheme, subject to obtaining the approval of
the stock exchange, but it is possible that courts may nevertheless proceed to
grant sanctions to the scheme. This ambiguity has not been addressed in the new
circular.
Role of SEBI
One of
the significant changes brought about by the new circular is that SEBI now has
a direct role in scrutinizing schemes of arrangement. While the stock exchange
would provide its own comments, in doing so it has to aggregate SEBI’s comments
and views as well. While such an approach is helpful in egregious cases where
schemes have been drafted in a manner so as to benefit some parties and
(usually) to disadvantage of public minority shareholders, such an overarching
supervisory power to SEBI may give rise to significant practical issues. It is
not clear as to the extent to which SEBI can scrutinize the scheme. As far as
court supervision under Sections 391-394 of the Companies Act is concerned,
there is now a rich body of law that clearly scopes the role of the court. Unless
such a clear scope is available regarding the exercise of SEBI’s power, it
could leave a lot of uncertainty from a transactional perspective. Moreover,
there could be a timing issue as well. If both stock exchanges and SEBI have to
scrutinize and provide observations, this could be time-consuming, especially
if there is a lot of back and forth in terms of request for and exchange of
information between SEBI and the companies.
Transparency
The new
circular imposes requirements on listed companies to put out more information
regarding the transaction in the public domain, and also to submit additional
documents to the stock exchanges. These include details of valuation, fairness
opinion by merchant bankers and other financial and related information. This
is a welcome move. The downsides of complex and ingenious schemes can be
overcome by greater transparency. Better information rights would enable the
market to make their choices in an informed manner. If the informational
aspects are structured properly, and (even more) enforced strictly, that would
reduce the necessity for greater direct oversight of schemes by the regulators
as contemplated by other provisions in the circular.
Voting/ Majority
Schemes
of arrangement under section 391 of the Companies Act require the approval of
different classes of shareholders. This must be satisfied through a numerical
majority of shareholders represented by 75% in value of the shares, which is a
higher threshold than for other types of shareholder approvals. In case of
schemes of reduction of capital, no class meetings are required and a mere
special resolution would suffice.
The
circular now goes beyond the purview of the Companies Act, and requires that
schemes involving listed be considered sanctioned only “if the votes cast by
public shareholders in favor of the proposal amount to at least two times the
number of votes cast by public shareholders against it.” In other words, in
addition to the usual majority the scheme must also receive the approval of
2/3rds of the public shareholders. This is helpful in related-party
transactions where the controlling shareholders may have an interest in the
transaction. While this would certainly make the scheme procedure more
burdensome, there are some process-related issues to be ironed out. For
example, the circular is not clear whether such a 2/3rd requirement
applies to each class of shares.
Finally,
the new set of reforms would apply for all schemes that have not yet been filed
with the courts as of the date of the circular (February 4, 2013).

Given that the circular
makes the scheme process somewhat more onerous compared to the current situation,
it remains to be seen whether the scheme of arrangement as a route to achieve
M&A and restructuring transactions would lose favour with companies.
Currently, a scheme of arrangement is a fairly popular route in India compared
to other countries which have similar provisions, but that might very well
change, at least to some extent.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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