SEBI Denied Locus Over Scheme of Arrangement

It is a well-known fact that schemes of arrangement are a
popular method to implement mergers and corporate restructuring transactions in
India. While they involves an elaborate and cumbersome procedure and the
oversight of the court, parties enjoy tremendous flexibility in structuring
their transactions. More importantly, such a scheme is binding on the
dissenting minority. When this involves listed companies, it is obvious that
the Securities and Exchange Board of India (SEBI) as well as the stock
exchanges would take on an important role in determining the outcome of the
scheme, and particularly in ensuring that shareholder interest is not adversely
affected. However, the role of SEBI and the stock exchanges in such schemes has
been tenuous. Courts have kept them away from the purview of schemes of
arrangement that are essentially driven through the courts under the Companies
Act. While SEBI has sought to encroach upon the scheme territory through
amendments to the listing agreement introduced in 2003 and through two
circulars issued in 2013, the position remains unclear. Its attempt to
establish jurisdiction over a scheme of arrangement more recently resulted in a
lack of success before the Bombay High Court this month.
Before dealing with the recent ruling, a discussion of the
previous position would be in order. The question of SEBI’s jurisdiction over a
scheme of arrangement came up for the first time in Securities and Exchange
Board of India v. Sterlite Industries Ltd.
, (MANU/MH/0339/2002). When
SEBI appealed against a scheme of arrangement and reduction of capital, a
division bench of the Bombay High Court refused to recognise any power of SEBI
in representing itself before the court (a power that it sought to undertake
with a view to safeguarding the interest of the investors).
Deprived of any role in such schemes, SEBI followed a
somewhat unusual method to exert itself by imposing a role for the stock
exchanges in a scheme. It amended the listing
agreement in May 2003
, by which companies have been required to file any
scheme of arrangement with the stock exchanges at least one month before filing
it with any court or tribunal for approval.[1]
This is to ensure that stock exchanges have the opportunity to examine whether
the scheme violates any provisions of the securities laws or stock exchange
requirements. This power has indeed been exercised by the stock exchanges. For
example, in Re Elpro International Ltd. ([2009]
149 Comp. Cas. 646), although the Bombay Stock Exchange (BSE) did not approve a
scheme of reduction of capital when the parties filed with it, the Bombay High
Court sanctioned the scheme but with liberty to the stock exchanges to pursue
their rights under the listing agreement. Given BSE’s refusal to approve the
scheme, the company decided
not to pursue
the arrangement. In that sense, the amendment to the listing
agreement giving power to the stock exchanges has had an indirect deterrent
effect.
A decade after the introduction of clause 24(f) to the
listing agreement, SEBI issued two circulars (here
and here)
in 2013 not only strengthening the powers of the stock exchanges in evaluating
schemes of arrangement, but also in giving SEBI itself the opportunity to
review schemes. The downside of these additional powers (and that of clause
24(f) of the listing agreement is that they only enable SEBI and the stock
exchanges to provide comments on the scheme. If they decide not to approve the
scheme, the consequences thereof are unclear. If, for instance, a company
decides to proceed nevertheless and seek the approval of the court, at most
SEBI and the stock exchanges may make their representations before the court.
They appear to have no veto powers over the scheme.
It is in this regulatory backdrop that the Bombay High Court in
Securities and Exchange Board of India v. Ikisan Limited was required to consider
SEBI’s locus in seeking a review of a scheme of arrangement that was already
sanctioned by the court. This judgment 
by Justice S.J. Kathawalla issued on September 23, 2015 in Company Application No. 124 of 2013 in Company Scheme Petition No. 234 of 2011 is also accessible through the Bombay High Court website (http://bombayhighcourt.nic.in). .
Decision
The litigation relates to two related schemes of arrangement
filed by a group of companies. The first scheme, implemented in 2010, involved
an amalgamation of one company into another. The second, implemented in 2011,
and involving the previously amalgamated company and other companies related to
a complex restructuring. The details of the schemes are not only somewhat
complicated, but they are unnecessary for the present discussion.
The record indicated that when the second scheme was pending
before the Bombay High Court, SEBI received a complaint from a shareholder
regarding some deficiencies in the nature of the scheme. SEBI forwarded the
complaint to BSE, but no action was taken. It is also the case that the BSE did
not raise any objections when the scheme was filed with it pursuant to clause
24(f) of the listing agreement. In the meanwhile, the Bombay High Court
provided its sanction to the scheme, which was duly implemented. It was only
subsequently that SEBI approached the Bombay High Court for a review of the
scheme on account of various deficiencies, and on the ground that the scheme
therefore did not comply with the relevant legal requirements for sanction.
Although the judgment of the court refers to the various details of the scheme,
this post is limited to the discussion pertaining to SEBI locus standi in seeking a review of a scheme under sections 391 to
394 of the Companies Act, 1956.
For the major part, the Bombay High Court relied on its
previous division bench judgment in Sterlite
Industries
(discussed above). As decided in that case, SEBI did not have
the locus standi to challenge a scheme under the Companies Act. Although the Sterlite Industries decision went on
appeal to the Supreme Court, it refused to interfere in the matter and left the
substantive issues open. Accordingly, in this case the court found no reason to
doubt the binding nature of Sterlite
Industries
. Although SEBI sought to exercise its wide scope of powers that
were recognised by the Supreme Court in Sahara
India Real Estate Corporation Ltd. v. SEBI
((2013) 1 SCC 1), it was not
found to have overruled the decision in Sterlite
Industries
.
The court also found that there was substantial delay in
SEBI’s action in bringing the application for review. Although the scheme was
sanctioned in 2011 and further complaints from shareholders followed soon
thereafter, SEBI acted only in 2013. In any event, given the grave nature of
the allegations brought by SEBI, the court decided to delve into the merits of
the case. But, here too, the court did not find reason to overturn its earlier
order sanctioning the scheme. Hence, SEBI’s application was dismissed.
Implications
This effort represents another instance in SEBI’s continued
efforts to seek meaningful intervention in schemes of arrangement, but without
success. It continues to bear the adverse consequences of the ruling in Sterlite Industries. Unless a different
outcome ensues from the Supreme Court, significant change is unlikely. The
unintended consequences of this approach is that it provides parties with the
option of embarking upon a scheme of arrangement in order to sidestep SEBI’s
oversight, potentially leading to a regulatory arbitrage. As I have previously
mentioned, schemes of arrangement do provide sufficient flexibilities to
parties to undertake various types of restructuring transactions that may not
necessarily be in the interests of the minority shareholders. This may deprive
such shareholders of regulatory supervision.
At the same time, it is not all gloom and doom for the
regulator and the minority shareholders. The present case arose in 2011, i.e.
prior to SEBI’s issuance of circulars in 2013 granting it (and the stock
exchanges) greater oversight over schemes of arrangements. Cases subsequent to
the issue of the circulars would be subject to a more stringent regime,
although this remains untested.
More importantly, this case as well as Sterlite Industries hinge on the timing of SEBI’s intervention. In
both those cases, SEBI stirred into action after the court had already
sanctioned the scheme. It either exercised the powers of appeal or review.
Conversely, if SEBI had approached the court during the hearing stage (and
prior to the sanction of the scheme), the outcome may have been different. It
may not be possible in such a situation for the court to refuse to hear SEBI’s
objections to the scheme.
Going forward, the situation is clearer. Under the Companies
Act, 2013, the notice of the scheme is required to be sent by the company to
various authorities, including SEBI (section 230(5)), who are entitled to make
representations before the court. Hence, SEBI’s right of audience before the
court is explicit. Of course, this provision is yet to come into force, due to
which SEBI will be compelled to navigate through the current system in the near
future. The bottom-line from SEBI’s perspective appears to be: raise objections
to the scheme before the court sanctions it, or never.



[1]
Listing Agreement, clause 24(f).

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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