Compulsory Amalgamation: the Bombay High Court on the FTIL-NSEL case

In 63 Moons Technologies Ltd. v. Union of India (and connected petitions), the Bombay High Court considered important questions of law going to the heart of Indian corporate law. The case involved a challenge to an order of the Central Government under s. 396 of the Companies Act, 1956. Purporting to act under s. 396, the Central Government had amalgamated the National Spot Exchange Ltd. (“NSEL”) and 63 Moons Technologies Ltd., previously known as Financial Technologies (India) Ltd. (“FTIL”). The constitutional validity of s. 396 itself was not challenged (para 165 – all para references in this post refer to paragraph numbers of the judgment), but orders made under the section were challenged on several grounds. These grounds included the alleged failure of natural justice, the alleged lack of power to compulsorily amalgamate a loss making wholly owned subsidiary (NSEL) with its profit-making parent (FTIL), considerations of public interest and proportionality etc. This post will look at the Court’s consideration of the issue of whether loss-making subsidiaries can be compulsorily amalgamated with their profit-making parent companies under s. 396.

The petitioners contended (para 14-15) that s. 396 cannot be read so as to permit the Central Government to compulsorily amalgamate a ‘healthy’ company with an ‘unhealthy’ company. The Petitioners contended:

… [Section 396(3)] mandates the retention of shareholders and creditors interest in or rights against the resultant company as held in or against the original companies…

the Central Government has misconstrued the scope of the expression ‘interests of member’ in Section 396 so as to altogether exclude the economic value of the shareholding. They submit that the expression, in the context of listed companies like FTIL would include the entire package of rights and interests associated with such shares. They submit that the compulsory amalgamation of FTIL having net worth of Rs.2800 crores with NSEL having putative liabilities of Rs.5600 crores is bound to drastically reduce the book value of FTIL’s shares. The resultant company will never be in a position to compensate shareholders of FTIL for such losses. Therefore, the only reasonable construction of Section 396 is to permit compulsory amalgamation of two or more healthy companies…”

The Court noted (paras 158-164) the legislative history of the provision, and also the provisions of Article 31A of the Constitution of India, 1950 (which ‘immunised’ the section itself from a constitutional challenge under Articles 14/19). The legislative history indicated that “the legal provision in Section 396 to provide for amalgamation of two or more companies in public interest was regarded as a social welfare or essential welfare legislation…” This provided the background for the Court to consider s. 396(3) of the Companies Act, 1956. Section 396(3) reads thus:

Every member or creditor (including a debenture holder) of each of the companies before the amalgamation shall have, as nearly as may be, the same interest in or rights against the company resulting from the amalgamation as he had in the company of which he was originally a member or creditor…

The question was: how does one assessee whether the shareholders have “as nearly as may be, the same interest…” The Petitioners’ contention was that the ‘interest’ of a shareholder in a company includes the entire package of rights associated with shares (and not just the formal shareholding itself): this would include, among other things, the economic value of the shareholding also. That was the real “interest” which must be protected.

In its consideration of the question, the Court relied on classic principles of separate personality: curiously, the case illustrates that applying those classic principles in fact negated the protection which shareholders typically would enjoy due to separate personality. In other words, principles flowing from the separate legal personality were applied effectively to deny the benefits of that separate personality. The Court held (para 170) that “interest” cannot include the economic value of the shareholding. The Court then (para 171 onwards) reflected on the nature of a ‘share’, and held (para 179) after citing prior judgments of the Supreme Court including Chiranjit Lal Chowdhuri, Bacha F. Guzdar, etc.:

The shareholder undoubtedly has an interest in or rights against the company of which he is the shareholder. His interest is represented by the share he holds. The share is a moveable property which can be sold or transferred by the shareholder. The shareholder is entitled to the income arising from the shares in the form of dividends. The shareholder has a right to vote at the election of the Director and thereby take part in the management of the companies affairs. He has right to apply for appropriate relief in case of oppression or mismanagement.  He has a right to institute a petition for winding up a company which may result in the distribution of net assets amongst the shareholders. The shareholder has no right in the property of the company which is a juristic person entirely distinct from its shareholders. The property of the company is not the property of the shareholders. A shareholder has merely an interest in the company arising out of the article of association measured by a sum of money for purpose of liability and by a share, for the profit…

And further (paras 186-187):

… the shareholding of the shareholders  of FTIL in the resultant company is the same as their shareholding in the original company, it cannot be said that  the interest of the shareholders in or their rights against the resultant company stand diminished.  It is not possible to accept the construction suggested by the petitioners expressed by them.  The amalgamation does not impair the interest of the shareholders in or the right against the resultant company to receive dividends or receive a share in the surplus on winding up. The petitioners were unable to  point out any provision in the Companies Act or any precedent  which entitles a shareholder to any specific quantum of dividend or surplus  on winding up…

Section 396, neither makes any reference to the market value or the economic value of the shares when it comes to the determination of the interests of a shareholder in or rights of a shareholder against a company.  The provision also suggests no statutory prohibition to the amalgamation of a wholly owned loss making subsidiary with its profit making holding company, provided of course, the test of public interest is satisfied.   If, as suggested by the petitioners, Section 396 were to contemplate only the amalgamation of two or more healthy companies, the legislature, could have said so in clear terms.  Further, if this is what was in contemplation, then, there was perhaps no necessity for the immunity in Article 31A(1)(c) of the Constitution to  any law providing for amalgamation of two or more companies in public interest. Therefore, it is not possible to rewrite the provision in Section 396 so as to restrict its scope to the compulsory amalgamation of two or more healthy companies  as is suggested by the petitioners…

It is interesting to see that the Court relies on Article 31A: the Court’s point seems to be that if the Petitioners’ are correct, then the provision would not offend against Articles 14 and 19. Therefore, the immunity granted would be meaningless. On the other hand, one could argue that the existence of the immunity should not have a bearing on the correct interpretation of the statute: one cannot presume that merely because there is immunity, the law must necessarily be construed in the most expansive manner. The principles of corporate personality invoked by the Court are certainly well established. There is no real doubt over the proposition that a shareholder does not own the property of the company.

But, with respect, it seems that the Court’s reasoning does not squarely address the argument of the Petitioners. All words are always used in a certain context; so too, the word “interest” can have different shades of meaning depending on the context involved. One hint that “interest” as used in a section was not used as a formal construct is that the section talks of the interest of members and also of creditors. So too, the interest must be “as nearly as may be” the same. These are contextual hints which suggest that “interest” in the section refers to the economic interest rather than just the formal legal rights of shareholders. If one is not considering economic aspects, then what does it mean to speak of creditors’ interests? Does not the flexibility inherent in the formulation leave open assessments of economic circumstances? Merely saying that shareholders have no title to the property of the company, and that shareholders and the company are different entities, does not address this aspect. To meet the Petitioner’s arguments, it may be necessarily to consider the context and rationale of s. 396 in more detail, rather than stopping the analysis with a recitation of the law on corporate personality. As things stand, on the reasoning adopted by the Court, the principles of corporate personality can be used to effectively negate the economic value of shareholders through the mechanism of amalgamating their health company with an unhealthy subsidiary. The Court does provide one hint of taking the context into account when it says (para 191), “The circumstance that Section 396 is a social welfare or essential welfare legislation is also not an irrelevant circumstance, in this context…” That is the real proposition which must be tested: what does it mean to say that s. 396 is a “social welfare or essential welfare legislation”, and exactly what bearing that has on understanding what ‘interest’ is sought to be protected by the section. We will look at these arguments further in a subsequent post.