Schemes of arrangement have been a useful method of implementing mergers and acquisitions in the Indian context. Historically under the Companies Act, 1956, schemes were supervised by the High Courts, but the Companies Act, 2013 conferred that jurisdiction upon the National Company Law Tribunal (NCLT). Under the regime set forth in the 1956 Act, the High Courts had adopted a largely non-interventionist approach relating to schemes and stepped in only in very specific circumstances. The Supreme Court developed important jurisprudence in Miheer H. Mafatlal v. Mafatlal Industries Limited, (1996) 87 Comp. Cas. 792 and Hindustan Lever Employees’ Union v. Hindustan Lever Limited, AIR 1995 SC 470.
Although that approach is largely expected to continue under the 2013 legislation, anecdotal experience has suggested a greater propensity on the part of the NCLT to intervene in schemes of arrangement, primarily on the ground of “public interest”. This approach initially found its way in the decision of the National Company Law Appellate Tribunal (NCLAT) in Wiki Kids Limited v. Regional Director (21 December 2017, as discussed here). More recently, the NCLT, Mumbai supplemented such a stance in the case of Gabs Investments Pvt. Limited and Ajanta Pharma Limited (30 August 2018), which has attracted intense debate (here and here). This post analyzes the NCLT decisions in Gabs/Ajanta, including its implications on scheme jurisprudence.
Facts and Ruling
The scheme of arrangement before the NCLT involves a proposed amalgamation of Gabs Investment Private Limited into Ajanta Pharma Limited. Gabs is an investment holding company of Ajanta’s promoters, the Agrawal family, and it holds 9.54% shares in the capital of Ajanta. Gabs is in turn held by members of the Agrawal family. The essence of the amalgamation is such that there will be a consequent transfer of the 9.54% shares of Ajanta held by Gabs to the promoters. In consideration for the transaction, Ajanta will issue an appropriate number of shares to Gabs’s shareholders. As a result, the promoters will hold the shares directly in Ajanta rather than through Gabs as an investment holding company. The rationale for the scheme included the fact that this will simplify the holding structure for the company.
The requisite majority of shareholders of both Gabs and Ajanta approved the scheme. In response to the notice of the petition, the Regional Director, Ministry of Corporate Affairs filed a report raising several points none of which the NCLT found to be insurmountable. It was the objections raised by the Income Tax Department (ITD) that caught the attention of, and ultimately found favour with, the NCLT. The essence of ITD’s objection was that if the transaction were to be structured as a transfer of the shares in Ajanta from Gabs to the shareholders of Gabs, there would have been a significant incidence of tax to the tune of INR 421.66 crores. By structuring the transaction as an amalgamation instead, the companies and their promoters effectively sought to avoid such a tax liability.
The NCLT noted that it can approve the scheme only if it complies with applicable laws and if the scheme is in “public interest”. Here, it found that the companies had failed to provide details regarding compliance with appropriate tax laws. It was necessary to resolve the tax issue before proceeding with the scheme. More importantly, the NCLT’s hesitation in blessing the transaction is evident from its concern that the scheme was benefiting the promoters rather than the company as a whole, including other shareholders as well. Although the company’s legal counsel placed several judgments that circumscribe the jurisdiction of the court or tribunal while considering a scheme of arrangement, the NCLT did not seem convinced and largely ignored those rulings. Instead, it placed substantial reliance on the NCLAT decision in Wiki Kids where too it was clarified that a scheme will not be approved if it is devised to benefit a few promoters rather than public interest. The NCLT also appeared perturbed that even though the transaction is likely to trigger the mandatory public offer requirements under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, the scheme made no provision for such an offer. For these reasons, the NCLT withheld sanction to the scheme.
The NCLT ruling raises a number of issues that merit discussion.
The first relates to the scope of the NCLT’s jurisdiction in reviewing schemes of arrangement. This has been a vexed area of the law, although in Miheer Mafatlalthe Supreme Court had clarified that the jurisdiction is “peripheral and supervisory and not appellate” primarily because the court or tribunal “has neither the expertise nor the jurisdiction to delve deep into the commercial wisdom exercised by the creditors and members of the company who have ratified the Scheme by the requisite majority”. At the same time, the court or tribunal ought to hear the various interested parties before arriving at a decision. While the 1956 Act was less clear about this and largely provided for a report by the Central Government, which exercises its power through the Regional Director, the 2013 Act (in section 230(5)) provides for a specific set of authorities to whom notice of the scheme must be provided. These include the Central Government, the Reserve Bank of India, the Securities and Exchange Board of India (SEBI), the Official Liquidator and the Competition Commission of India. This process has been sanctified in the legislation itself.
While the process for consideration of various interests in the scheme is more elaborately set out in the 2013 Act as compared to its predecessor legislation, the NCLT simply exercised its discretion in response to the claims made by the ITD. Although the petitioner companies invited the NCLT’s attention to the scope of its jurisdiction as delineated in several decisions of courts, the NCLT refused to be drawn into a discussion of that jurisprudence, and went ahead to exercise its discretion nevertheless.
The NCLT placed substantial reliance on the fact that the scheme was in the interests of the promoters alone and not in public interest. The Supreme Court has considered the scope of “public interest” in a scheme in Hindustan Lever, where it held that the concept “cannot be put in a straight jacket” and that it “is a dynamic concept that keeps changing”. The Supreme Court provided an interpretation to the concept that rendered it wide amplitude, thereby giving the court or tribunal considerable discretion to examine schemes by wielding this significant tool. The inclusion of public interest analysis as an inherent part of the exercise of the NCLT’s jurisdiction while reviewing a scheme is beyond doubt. But, the manner of exercise of the power given its wide nature leaves much to be desired, as it causes considerable uncertainty to parties undertaking amalgamation and similar transactions.
Taxation Matters / GAAR
In this case, the only serious objection the NCLT received was from the ITD. The NCLT had the choice of either stalling the scheme or to approve the scheme subject to taxation to be determined by the ITD. The NCLT exercised the option of stalling the scheme because it found that the entire genesis of the rationale for the scheme lay in foreclosing the tax burden of the promoters and not for any broader purpose. Hence, it prevented the scheme from going through at all rather than to leave it to the tax authorities to pursue the parties for tax liabilities.
In adopting this approach, the NCLT is sending a clear message that merely because the option of amalgamation is available to the parties that they could legitimately undertake to mitigate tax obligations, the NCLT’s supervisory powers would enable it to go behind the motive of the parties to determine whether it should be allowed. The legitimacy of the transaction structure on a standalone basis cannot merit the NCLT sanction if the underlying motive is found to be questionable, a situation that ensued in this case. The impact of this decision from a practical perspective is that otherwise legitimate amalgamation transactions ought not to be driven by factors that involve mitigation of tax or stamp duty burdens.
On the taxation aspect, the NCLT also referred to matters pertaining to the general anti-avoidance rule (GAAR) without necessary delving into the details and procedures involved. As commentators have pointed out, the process for raising GAAR-related concerns appears not to have been followed
SEBI Takeover Regulations
Finally, the NCLT’s decision to reject the scheme was also premised on the fact that the transfer of the 9.54% shares of Ajanta from Gabs to its shareholders would trigger the mandatory open offer rules under the SEBI Takeover Regulations. As the promoter groups as a whole held more than 25% shares in Ajanta, they would be subject to the creeping acquisition rule that enables them to acquire no more than 5% shares per annum. This transfer would breach the limit. Since the scheme did not envisage an open offer to Ajanta’s shareholders, the NCLT found that the SEBI Takeover Regulations would not be complied with.
Here again, some questions remain. At the outset, it is not clear from the facts if SEBI or any other appropriate authorities had even raised the possibility of a breach of the SEBI Takeover Regulations. Second, the availability of possible exemptions from the mandatory open offer requirements receives no attention in the NCLT ruling. In such circumstances, assuming other requirements are satisfied, would it not be prudent for the NCLT to allow the scheme subject to compliance with the SEBI Takeover Regulation, a matter that is within the regulatory and enforcement domain of SEBI?
It is clear that the NCLT ought not to merely rubber-stamp schemes that have been approved by all shareholders. This is particularly so when objections are raised by concerned authorities such as the ITD. At the same time, the exercise of scheme jurisdiction by the NCLT (as supported by the NCLAT) has witnessed a gradual expansion of such jurisdiction. It is nobody’s case that matter such as public interest must be taken lightly, given that it has been ingrained into the scheme jurisprudence in India. The tribunal must, however, develop a cogent set of principles that underpin the exercise of the discretion so that it can promote greater certainty among parties engaging in transactions involving a scheme of arrangement.
– Umakanth Varottil