The proposed conversion of Tata Sons Limited from a public limited company to a private limited company has reignited the corporate governance issues that the Tata Group has faced over the last year or so. Menaka Doshi has an interesting piece (and an accompanying interview with two corporate lawyers) in BloombergQuint that sets out some of the background to why Tata Sons proposes (and that too now) to proceed with the conversion. My goal in this post is to outline an obscure common law rule that might in the end be determinative of the validity of Tata Sons’ actions.
In a nutshell, the situation is that Tata Sons has convened an extraordinary general meeting (“EGM”) of shareholders’ to approve alterations to its articles of association, which include conversion of the company to private one. Seemingly, this move is to ensure that there is no risk as to the enforceability of transfer restrictions within the articles of the company. Moreover, as a private limited company, it will enjoy greater flexibility in carrying out various actions without the approval of the shareholders, and it will also not be subject to relatively onerous transparency requirements. Given the history of the corporate battle within the Tata Group, it is reasonable to assume that this effort is being undertaken to minimize the power that the Mistry Group can exercise as shareholders of Tata Sons.
To give effect to the conversion, the first step is for the company to obtain a special resolution (i.e., 75% majority) of its shareholders at an EGM. This is a foregone conclusion given that the Mistry Group holds only about 18% shares in Tata Sons, thereby not possessing sufficient shares to exercise a veto over the conversion.
However, since the alteration of the articles involves conversion of Tata Sons into a private company, section 14 of the Companies Act, 2013 (the “Act”) requires that such conversion shall not take effect unless it has been approved by the National Company Law Tribunal (“NCLT”). The Act itself does not specify the scope of the NCLT’s jurisdiction when it considers an application to approve such a conversion. However, the National Company Law Tribunal Rules, 2016 (the “NCLT Rules”) prescribe the procedure to be followed when a company seeks to convert from a public to a private company. Of relevance is Rule 68(7), which provides that the NCLT may disallow the conversion if the same “would not be in the interest of the company or is being made with a view to contravene or to avoid complying with the provisions of the Act”. In the present case, there has been no allegation on whether the alteration of Tata Sons’ articles is intended to contravene the companies’ legislation; hence, it boils down to whether the alteration is “in the interest of the company”. This raises some fundamental questions of corporate law that might be worth exploring.
At the outset, it is clear that the power to alter the articles (including conversion to a private company) is vested with the shareholders to be exercised in general meeting. Under general principles of company law, this power can be exercised by the shareholders in any manner as they may deem fit, including in their own interests. This principle emanates from the fact that shares represent property rights, and that voting rights are but one facet of those property rights. However, under the Act read with the NCLT Rules as outlined above, there is indeed an exception created when the shareholder body exercises its power to alter the articles to convert to a private company. Here, the shareholders are not entitled to act in their own interest, but rather in the interest of the company. In other words, the shareholders must put the interests of the company ahead of their own interest while altering the articles. This, albeit indirectly, has the effect of treating a shareholder as a fiduciary, something that is antithetical to general corporate law principles.[1] To that extent, the role of the shareholders in the context of the alteration of the articles can be said to be an exception.
What does it mean to say that the alteration of the articles of association of a company that results in its conversion to a private company “is in the interest of the company”? Here, one may have to resort to principles of common law, which provide that any alteration of the articles of association of the company ought to be “bona fide for the benefit of the company as a whole”.[2] This test was laid down in Allen v. Gold Reef of West Africa Ltd.[3] Supplementing the stipulation in the NCLT Rules regarding the scope of the NCLT’s jurisdiction in considering a petition for conversion to a private company, the common law rules seek to expand or elaborate the considerations that the NCLT should account for before approving a conversion.
Hence, in the case of Tata Sons, the issue will ultimately boil down to whether the conversion to a private company is for the benefit of the company as a whole, or is it only for the majority shareholders (which thereby operates as a disadvantage to the minority shareholders, viz. the Mistry Group). The onus though is on the challengers to show that the alteration is not for the benefit of the company,[4] due to which there is a sort of presumption of validity. This will effective impose a burden on the Mistry Group to demonstrate that the proposed alteration of Tata Sons’ articles and the consequent conversion to a private company is not in the interests of the company. The NCLT would have to decide the question after weighing all the relevant factors, including the motivations behind such alteration and conversion.
That leads to the question regarding the legal remedies available to the minority shareholders of Tata Sons. Rule 68(6) of the NCLT Rules recognizes that “any person whose interest is likely to be affected” may file an objection, which the NCLT will then have to consider. In the past, the Mistry family has not enjoyed success in exercising remedies before the NCLT as it has failed to cross the threshold of 10% of the issued share capital of the company as required under section 244 of the Act for bringing an oppression action. This time, however, the scenario might be different. There is no minimum holding prescribed for a shareholder (who is presumably a “person whose interest is likely to be affected”) in filing an objection before the NCLT when it considers a petition for alteration of the articles involving a conversion to a private company. In that light, the battle, if any, may have to be found on the merits before the NCLT and not rejected on grounding of locus standi.
In case the alteration of the articles of association of the Tata Sons are approved at the EGM, as it likely will, then the focus may shift to the NCLT where the above issues of corporate law may be called into question.
[1] For an understanding of the conceptual differences between the positions of shareholders and directors under Indian law, see Rolta India Ltd. v. Venire Industries Ltd., [2000] 100 Comp. Cas. 19 (Bombay High Court), at paragraphs 22-23.
[2] Note that the common law principle applies for any kind of alteration, and not merely to one that involves conversion of a public company into a private company.
[3] (1900) 1 Ch 656. For this test, see also Greenhalgh v. Arderne Cinemas, (1950) 2 All ER 1120 (CA); Shuttleworth v. Cox Bros. & Co., (Maidenhead) Ltd., (1927) 2 KB 9.
[4] Peter’s American Delicacy Co Ltd v Heath (1939) 61 CLR 457.