Squeeze Outs: Analyzing the Cadbury Decision

[Professor Vikramaditya
and I have co-authored the following post]
In India, several transaction
structures are available for controlling shareholders to squeeze out minority
shareholders. These include the compulsory acquisition mechanism, scheme of
arrangement and reduction of capital. Out of these, the most commonly used
method is the reduction of capital. That is not at all surprising given that
the reduction method provides the most efficacious result for controllers,
while at the same time conferring the least protection to the minority.
Courts tend to approve proposals
for reduction of capital as long as the controllers are able to establish fair
process and fair price (determined in the manner discussed in this post).
Although minorities do have the power to challenge such proposals, they have
rarely been successful in seeking greater scrutiny. At most, they have been
able to persuade the court to order a reexamination of the price by appointing
a separate independent valuer. Even in those circumstances, disputes have not
been satisfactorily resolved, and valuations continue to be disputed.
This story played out most recently
in the decision of the Bombay High Court in Cadbury India Limited wherein the
court approved a squeeze out through a reduction of capital at a price
determined by an independent valuer appointed by the court. In doing so, the
court rejected the objections of the dissenting minorities. This case is
important for it analyzes the legal position regarding squeeze outs through
reductions of capital, and elaborately sets forth the principles upon which the
court would either interfere or refuse to do so. It also represents the
culmination of a bitterly fought squeeze out litigation lasting five years.
In this post, we analyze the Cadbury decision and explore its impact
on minority shareholders in squeeze outs through reduction of capital. Its fact
pattern is quite typical of squeeze outs effected via reduction of capital.
Cadbury: The Facts
Cadbury India was a public listed
company, being a subsidiary of Cadbury Plc, UK. As a result of several takeover
offers made by Cadbury Plc and buyback offers by Cadbury India, the public
shareholding of the company fell below the minimum required for continued
listing. Hence, the company was delisted from the stock exchanges. At a time
when the Cadbury Group held 97.583% of the equity share capital of Cadbury
India, with the remaining 2.417% held by the minorities, the company initiated
a capital reduction scheme to buy out the minorities. The price offered was
supported by the reports of two independent valuers, M/s. Bansi S. Mehta &
Co. and M/s. SSPA & Co., which both valued the shares of Cadbury India at
Rs. 1,340 per equity share. The special resolution required for such a
reduction scheme under the Companies Act, 1956 was duly passed, and the company
sought the sanction of the Bombay High Court to the same. It was then duly
subjected to challenge by the dissenting minorities.
The uniqueness of Cadbury lies in the fact that the court first
ordered the appointment of another valuer to conduct the valuation afresh
(albeit with the parties’ support) and then proceeded to announce a legal
standard that made it difficult for the minority to challenge this valuation. Although
the result appears somewhat curious, the High
Court’s order appointing the valuer
suggests it arose out of a compromise
whereby the company was keen to “cut short the controversy” so long the
independent valuation was to be treated as binding. However, the court retained
some leeway to interfere with such report in case of “any grave infirmity in
it”. Accordingly, Ernst & Young (E&Y), the court-appointed valuer,
returned an initial valuation of Rs. 1,743 per equity share, which was
subsequently revised upwards to Rs. 2,014.50 per equity share. This too was
challenged by the objecting minorities who demanded a price of at least Rs.
2,500 per share.
Decision of the Court
G.S. Patel, J engages in a detailed
analysis of the existing case law regarding the court’s jurisdiction in
overseeing a scheme of reduction of capital resulting in a squeeze out,
particularly on the question of valuation. He found:
4.7       Carefully read, these decisions seem to
me to suggest that before a Court can decline sanction to a scheme on account
of a valuation, an objector to the scheme must first show that the valuation is
ex-facie unreasonable, i.e., so
unreasonable that it cannot on the face of it be accepted; alternatively, that
it is discriminatory; or that it has not been approved by a sufficient majority
or at a minimum, that a substantial number or percentage voted against it at an
extraordinary general meeting. None of these are demonstrated in the present
case. …
On the question of whether there was
prejudice against a class of shareholders, the court found that an overwhelming
majority of the non-controlling shareholders voted in favour of the resolution.
Out of a total of 7,51,120 non-controller shares voted at the meeting, only
12,784 voted against the resolution, thereby indicating that a “majority of the
minority” (MoM) was in favour of the capital reduction. This appears to have
weighed heavily with the court, which observed that the “tyranny of the
majority” must be balanced with “the essential democratic discipline without
which the functioning of any company would degenerate into mere chaos and
anarchy” (at para. 5.25).
Nevertheless, the court exercised
its discretion in examining whether the scheme was fair, just and reasonable on
the lines enumerated by the Supreme Court in Miheer H. Mafatlal v. Mafatlal Industries Ltd., AIR 1997 SC 506.
The court’s conclusion on its oversight of valuation is quite categorical and
it refused to be drawn into a microscopic examination of the valuation reports
and the processes or methodologies followed. The court stated:
5.9       It is not possible for a Court to go into
the exercise of carrying out a valuation itself. That, as the Supreme Court
said in Miheer H. Mafatlal, is not
the Court’s remit. Courts do not have the expertise, the time or the means to
do this. I do not believe that they are expected to do it. What the Court’s
approach must be to examine whether or not a valuation report is demonstrated
to be so unjust, so unreasonable and so unfair that it could result and result
only in a manifest and demonstrable, inequity or injustice. This injustice must
be shown to apply to a class. This has not been done. It [is] always possible
that there may be two views on any approach to accounting and valuation. The
fact that the objectors prefer one valuation or method, or prefer their own
valuation, is no answer. … [footnote omitted]
In doing so, the court has set a
high standard to be satisfied by the objecting shareholders to overturn a
valuation proposed by the company. Evidently, the objectors in Cadbury were not only in a miniscule minority of non-controlling
shareholders, but they were unable to discharge the burden of successfully
challenging the valuation. Given these circumstances, the court approved the
capital reduction at the price of Rs. 2,014.50, based on the revised E&Y
Helpfully, the court also laid down
certain “general principles of universal application in such matters”. Although
these are too many to discuss individually within the confines of this post,
they represent certain thumb rules for when and how courts must exercise their
discretion in reductions of capital, especially on matters of valuation.
Observations and Analysis
At one level, the Cadbury decision is consistent with the
prevalent legal position, which is represented by limited intervention of the
court in a capital reduction scheme that has received an overwhelming majority
of the shareholders, including an MoM vote. Similarly, courts are hesitant to
interfere in valuations proposed by the company except in extreme
circumstances. Nevertheless, this decision is crucial as it explicates the
legal position not only with reference to the specific facts of Cadbury but also with a view to enumerate
the legal principles in detail for reference in future cases as well. Given
that these are essentially matters of discretion to be exercised by courts
reviewing capital reduction schemes, Patel, J embarks on the process of
carefully setting out guidelines for the exercise of that discretion so as to
induce elements of transparency, certainty and clarity. In doing so, as
mentioned earlier, the court also sets a high threshold for objecting
shareholders to satisfy before reductions of capital are successfully
While it is difficult to disagree
with the court’s analysis and conclusions on the facts of the present case
where there was both an overwhelming MoM vote as well as three different
valuations that were adequately supported, we are concerned that the broader
ramifications of the ruling may confer inadequate protection to minorities in a
squeeze out. Hence, while the conclusion in Cadbury
is unassailable, the attenuation of the court’s jurisdiction in capital
reduction schemes resulting in squeeze outs is worrisome.
At the same time, it is somewhat
intriguing that Cadbury displays a
selective intervention by the court. While the court refused to provide a
higher price to the minority over the Rs. 2,014.50 per share recommended in the
E&Y report, that price itself was 50% above the Rs. 1,340 per share as
originally approved by the shareholders by special resolution. It appears that
the court was willing to make judgments about the valuation assumptions and
give effect to a compromise arrived at between the parties to abide by a
neutral court-appointed valuation. One wonders whether the stubbornness of the
minorities compelled the court to refrain from interfering with the revised
E&Y valuation.
must also be seen in the light of the broader issue concerning minority
protection in squeeze outs. In a working paper entitled “Regulating Squeeze
Outs in India: A Comparative Perspective”, we argue that the current state of
protection under Indian law for minorities in squeeze outs is fairly weak. This
is buttressed by comparisons with other jurisdictions such as the U.S., the
U.K., the European Union and Singapore where minorities are conferred much
superior protection. We briefly discuss below the inadequacies of the current
regime and some suggestions for reform:
1.         Independent
Board Approval
: In India, squeeze outs do not require the approval of
independent boards of directors. This could be useful as independent boards
carry the burden of examining whether transactions are carried out on an “arm’s
length” basis. Additionally, the increasingly stringent rules governing
related-party transactions under the new company law do not apply to squeeze
out transactions thereby denying that protection to minorities.
2.         MoM
: Although the court has used a MoM vote as one of the factors in
sanctioning capital reduction, we are not sanguine about whether such a voting
requirement would be effective in
protecting the minorities. For example, some of the larger minorities may
dictate the voting process and support a squeeze out even though it may not
benefit the minority shareholders as a whole.
3.         Regulatory
: Another option would be for
a regulator such as the Securities and Exchange Board of India (SEBI) to
exercise greater oversight on squeeze outs. However, under current law, once a company
is delisted  SEBI’s oversight powers are eliminated
and any squeeze out is outside of SEBI’s jurisdiction. One potential reform we
explore could be for SEBI’s supervisory and regulatory power to continue for a
specified period following a delisting so as to guard against any exploitative
squeeze outs.
Here, we identify only some of the
issues and suggest some of the reforms so as to provide a flavor for the types
of concerns and dynamics that emanate from squeeze outs.
While Cadbury undertakes the task of streamlining the court’s discretion
in squeeze outs through reduction of capital, in our view this solution is at
best temporary in nature. In any event, this ruling is subject to any appeal to
a higher court. Moving forward there is a need for greater certainty to be
introduced through legislative reform. Parliament has missed the opportunity to
clarify this area of the law in the Companies Act, 2013, and hence the
uncertainties are likely to continue in the new regime as well.

– Vikramaditya Khanna &
Umakanth Varottil

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.

1 comment

  • Acknowledging the necessity to protect the rights of minority shareholders so as highlighted in this post, there is a need to consider the greenmail strategies adopted by a few shareholders as well. On condition of anonymity, one director of a company had expressed to me about the problems faced from shareholders holding a minority stake and interfering with the decision making process of the Company. Considering the long term growth of the company, sometimes squeeze-outs becomes inevitable. Just because of that, dissident shareholders cannot keep on demanding. While determining exit price, striking a balance between these conflicting interests is the need of the day.

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