A Curious Case of ‘Public Interest’ in Indian Corporate Law

[Abhijeet Singh Rawaley is a Bar Council of India Trust Scholar and a III Year B.A., LL.B. (Hons.) Candidate at NALSAR, Hyderabad

With inputs from Shreenath A. Khemka, a King’s Law Scholar pursuing an LLM at the University of Cambridge]

This post comments on section 396 of the [Indian] Companies Act, 1956 (carried forward as section 237 in the Companies Act, 2013). The comment critiques the provision which empowers the Government of India to order compulsory amalgamation of two or more companies where it considers such an amalgamation to promote “public interest.”

An earlier post on the topic is available here]

The justifiable extent of governmental regulation (inter alia, on the touchstone of concepts such as “national interest,” “public interest”) in corporate activity engaged into by private actors has been a question of perennial asking. This substantively eternal dilemma resurfaced in an unprecedented form in a case decided by the Bombay High Court on 4 December 2017. The Court was adjudicating a writ petition instituted in 2014 by 63 Moons Technologies Limited against the Union of India (63 Moons) impugning the latter’s action under section 396 of the Companies Act, 1956 to order its compulsory amalgamation with its subsidiary company.

Section 396 is an extraordinaire provision which empowers the Government of India to order a “compulsory amalgamation” of two or more companies on the specific ground of promoting “public interest”. In its 222-pages long judgment, the Court upheld the compulsory amalgamation, making it possible for the government of the day to interfere and tamper with the definite and particular nature of corporate existence in order to give effect to the nebulous and malleable concept of public interest. However, the empowering colour of section 396 (carried forward as section 237 in the new Companies Act, 2013 with only “cosmetic changes”) is coupled with a countervailing obligatory bulwark of protecting shareholders’ rights through its sub-section 3, which mandates that the “interest” of each member of the amalgamating companies should remain the same in the resultant company. 63 Moons is a landmark decision in Indian corporate law because it represents the first-ever instance when the power under section 396 was exercised (and upheld) to amalgamate two non-government companies.

The case concerned amalgamation of a profit-making parent company (Financial Technologies (India) Limited (FTIL), which was later rechristened as 63 Moons Technologies Limited) with its loss-incurring subsidiary National Spot Exchange Limited (NSEL). Among a host of other issues relating to constitutional and administrative law raised by the petitioners, the principal issue related to whether the term “interest” in section 396(3) extended to cover the economic value of the shares held by the members of amalgamating companies. The Court held that it did not, as the shareholders do not have any interest in the property of the company. This issue has been dealt with by Mihir Naniwadekar here. This opinion piece seeks to critique section 396, much of which holds good in the context of section 237 in the Companies Act, 2013.

Firstly, the wording of section 396 is not very clear as to the specific form of ‘amalgamation’ that it contemplates. According to the Halsbury’s Laws of England, amalgamation is a form of corporate restructuring that entails “a blending of two or more existing undertakings into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the [new] company.” Such restructuring may be effected “either by the transfer of two or more undertakings to a new company, or by the transfer of one or more undertakings to an existing company”. Hence, it may happen that one of the amalgamating companies survives the restructuring and absorbs the other entity. However, another possibility is of two or more distinct companies coming together to form a new entity. Section 904 of the UK Companies Act, 2006 defines the former as a “merger by absorption”, and the latter as one occurring through the “formation of a new company”. Such ambiguity is also found in the way power is exercised by the Government in 63 Moons. While terms such as ‘transferor’ and ‘transferee’ companies cause no confusion since they pertain to “merger by absorption”, in 63 Moons it was the Government’s use of the term ‘resulting’ company which caused much confusion. However, this distinction between the two forms of amalgamation was neither raised by the petitioners nor considered by the Court. In our opinion, the distinction is relevant as in a merger by absorption, no new entity is created and hence the notional “interest” referred to in section 396 (3) stays static. However, in an amalgamation by forming a new company, it cannot be said that such “interest” remains the same.

Secondly, the sweeping and gaping scope of power vested in the government does not guarantee and assure sound corporate existence for ease in commerce and business. Section 396 and (now section 237 in the Companies Act, 2013) may be cited as a provision which surpasses the limits of mere regulation and assumes the character of intrusive governmental control on the very existence and structuring of corporates. The Expert Committee on Company Law headed by Dr. Jamshed J. Irani, in its report submitted in 2005 had recommended a legislative amendment of section 396. The Committee was of the considered view that “amalgamation should be allowed only through a process overseen by the [judicial] courts/ [quasi-judicial] tribunals”. Vesting of a power of such a great ambit reasonably carries a possibility of making its exercise one of political rather than judicial determination. Since the power to tamper with corporate entities has the character of affecting rights and obligations of the interested parties, its judicial exercise would go a long way to instill confidence and faith in the market. A two-step process in ordering such amalgamations is already under operation when it comes to the regulation of banking companies by the Reserve Bank of India under section 45 of the Banking Regulation Act, 1949 where the central bank’s power is limited to preparing a scheme only to be finally approved by the Central Government.

Thirdly, the use of the expression “public interest” is too wide an amplitude for a provision like section 396, the operation of which can have great civil consequences. As Justice Felix Frankfurter of the US Supreme Court once remarked, “the idea of public interest is a vague, impalpable, but all controlling consideration.” It is submitted that such broad conceptualization of a ground to ‘regulate’ companies is not in line with ensuring certainty and precision in legal standards.  Instead of public interest, the statute should instead provide for some definite standards providing a flavour for the exercise of power of the nature contained in section 396 (now section 237 in the new Act). Such grounds, it is submitted, may be similar to those which allow the lifting of corporate veil, viz. fraud, evasion of obligations etc.

Fourthly, 63 Moons informs us of the need for having greater safeguards for the members of the amalgamating companies. It is submitted that the expanse of the exercisable power under section 396 was never paid the due attention it deserved. This was an outcome of perhaps an unwritten policy of not applying it to any non-government company before 2014.  While it may be too farfetched and without much rational basis to do away with the government’s power to amalgamate (especially government-owned and controlled) companies in public interest, it is nonetheless essential to ensure protection of shareholders’ “interest” in a more robust and committed manner. Such protection, we contend, ought to extend to the economic/market value of their share. Reliance may be placed on Gower’s critique of a very formalist understanding of the nature of a ‘share’ limited to a legal denotation measured in relative figuration. The editors of his treatise on company law have called such limited understanding to be an “arbitrary and [an] illogical one”. Extending protection of interest to economic value of a share in absolute measurement would go a long way in instilling faith and confidence among investors in India. It is submitted with due respect that the level of protection as upheld by the High Court of Bombay falls extremely short of the reasonable standard of protecting private investors.

Therefore, the Bombay High Court’s judgment in 63 Moons strikes in the face and informs us of an until-recently unknown legal logic contained in section 396. Our hope in this post is to trigger a discussion on reforms that can be brought into the subject of compulsory amalgamation of companies under the fold of Indian corporate law.

​- Abhijeet Singh Rawaley, with inputs from Shreenath A. Khemka