[Vasu Aggarwal is a student at National Law School of India University. He is grateful to Prof. Rahul Singh for inspiring him to write on this topic, and thankful to Prof. Rahul Singh and Prof. Umakanth Varottil for their comments on the earlier drafts of this post]
This post argues that courts have misinterpreted the scope of ex-ante sanction requirement for compromise and arrangement due to the lingering ghost of the Companies Act, 1956 (“CA1956”). It analyses the current jurisprudence from exclusive legal positivism.
From the perspective of exclusive legal positivism, Raaz and Marmor have argued that if the ‘source’ of the law is not correctly identified the law loses its authoritativeness. This is because laws are meant to provide the ‘source’ for resting the debate on inchoate ideas of fairness and, if the courts can re-initiate the debate on the idea of fairness by neglecting the ‘source’, the law loses its authority.
This post takes the example of two judgments in Jagatramka and Wiki Kids to show that the Indian courts have not correctly identified the requirements under section 230 of the Companies Act, 2013 (“CA2013”). Section 230 neither disqualifies the promoter to propose a scheme of arrangements, nor does it require the scheme of arrangement to fulfil “public interest” criteria. By importing these criteria, the courts have re-initiated the discussion on the requirements of section 230, and violated the ‘sources’ thesis.
‘Sources’ for Compromise and Arrangement
The ‘source’ for compromise and arrangement with shareholders and creditors is provided under section 230 of the Companies Act, 2013 (“CA2013”). The procedure for compromise and arrangement can be divided into three steps—(i) application, (ii) meetings and (iii) sanction. First, the company (or its creditors, shareholders or liquidator) may submit an application to the National Company Law Tribunal (“NCLT”) for a compromise or arrangement. The applicant shall disclose details such as material facts relating to the company, reduction of share capital or any scheme of debt restructuring. Second, the NCLT may order meetings of the creditors or members, or a class of creditors or members, as the case may be. The requisite majority of members or creditors or class of members or creditors in value must vote favorably. Third, the NCLT may also make ancillary orders (section 237(1) of the CA2013). Thereafter, upon sanction by the NCLT, the compromise or arrangement becomes binding. However, the NCLT may refuse sanction only in case of non-compliance with sections 232, 230(1) and 68 of the CA2013, and in absence of certificate by the auditor.
Before CA2013, the erstwhile CA1956 provided for a similar provision. While the scheme of the provision was also based on three steps, there is one important difference. At the third-stage (sanction), the tribunal had discretion to interfere the compromise or arrangement on grounds such as ‘‘public interest’ and ‘prejudicial to the interests of [company’s] members’. This means that not only did the numbers that consented to compromise or arrangement had the protection, but the numbers that did not consent had the protection too through the ‘prejudice’ ground. Apart from the ‘public interest’ ground to interfere with the compromise or arrangement, under CA1956 the tribunal had the residuary power to make ‘incidental, consequential and supplemental’ orders to ensure that compromise or arrangement is ‘full and effective’. Under CA2013, the NCLT has no such explicit residuary power. Although the notes on clauses are silent about the reason, the differences outlined above indicate that the legislature intended to take away entitlement from non-consenting members and restrict the power of the tribunal to interfere with compromise or arrangement. In other words, the legislature intended to give supremacy to the ‘commercial wisdom’ of the members or creditors, and restrict interference on grounds such as violation of ‘commercial morality’. However, the next part of this post argues that the judiciary has re-initiated this discussion and violated the ‘sources’ thesis.
Violation of ‘Sources’ Thesis
Judiciary at different levels—the NCLT, the National Company Law Appellate Tribunal (“NCLAT”) and the Supreme Court—have failed to recognize ‘sources’ and, consequently, change in legislative policy regarding compromise or arrangement under CA2013. While under the new policy, the tribunal has not been given the authority to interfere with ‘commercial wisdom’, it has consistently re-initiated the discussion on the idea of fairness and re-introduced grounds such as ‘public interest’ and ‘commercial morality’. In two cases, it is shown that courts have misinterpreted the scope of ex-ante sanction requirement for compromise or arrangement due to the lingering ghost of CA1956.
In Arun Kumar Jagatramka v. Jindal Steel and Power Ltd., the Supreme Court was concerned with the question whether a promoter can propose a scheme of debt restructuring under section 230-232 of the CA2013. The Court held that a promoter is ineligible to propose a compromise or arrangement on largely two grounds—legislative history of compromise and arrangement provisions and its interplay with the Insolvency and Bankruptcy Code, 2013 (“IBC”). It may be argued that reliance on these two grounds was in furtherance of “purposive” interpretation. This post argues that both these grounds are erroneous in determining the purpose of S.230.
Firstly, as described above, the legislative policy of compromise and arrangement provisions has undergone major changes. From an earlier intrusive power held by the tribunal, it was restricted to technical grounds. Therefore, reliance on legislative history and precedents under the CA1956 is erroneous. Secondly, the IBC is a different mode for insolvency resolution than compromise or arrangement under CA2013. This has previously been argued by Varottil where he describes a compromise and arrangement as a middle-path on a continuum between too-loose informal workouts and a too-cumbersome IBC procedure. In fact, the Supreme Court relies on Varottil for the benefits of compromise and arrangement as a mode for debt restructuring, but entirely ignores his larger argument about difference between compromise and arrangement on the one hand and the IBC regime on the other as two independent modes, with the potential to serve different purpose and potential to be activated in different situations. Therefore, the interplay between the IBC and compromise and arrangement as a ground to hold the promoter ineligible is erroneous. The Supreme Court also considered the possible agency costs—despite their own wrong, the promoters may be able to retain their control. The Court also held that it would be against ‘commercial morality’ even though the creditors and members have been given freedom to apply their ‘commercial wisdom’.
Had the Supreme Court followed the ‘sources’ thesis, the decision would have likely been different. Under section 230 of the CA2013, there is no bar on the promoter engaging in a scheme of compromise or arrangement. In fact, section 230 expressly states that ‘member’ may apply for compromise or arrangement. A ‘promoter’ is a member, and thus, has been given an express opportunity to propose a compromise or arrangement. Thus, Jagatramka should have been allowed to propose compromise or arrangement. Therefore, the SC has re-initiated the debate between ‘commercial morality’ and ‘commercial wisdom’ based on the lingering ghost of CA1956, which was settled in the favor of the former by the legislature under the CA2013.
In Wiki Kids, the NCLAT was concerned with a decision of the NCLT where it had held that since the merger was benefiting only the promoters, it could not be sanctioned it on ‘public interest’ grounds. The NCLAT upheld the NCLT’s decision that the merger was not in public interest and, thus, refused sanction. The NCLAT observed that the “[NCLT] has a duty to act in public interest”. The NCLAT relied on precedents such as Miheer Mafatlal and Hindustan Lever to introduce ‘public interest’ and ‘commercial morality’ in the gamut of sanction by the tribunal. However, the NCLAT failed realize that these precedents were interpreting the erstwhile CA1956 which had an express requirement of ‘public interest’ being fulfilled under section 394 of that legislation.
Had the NCLAT followed the sources thesis, the decision would have been different. As described above, ‘public interest’ is not a ground for rejection of sanction. In fact, entitlements from non-consenting shareholders have been taken away under CA2013. Thus, the merger should have received sanction, as it had complied with statutory requirements. In the absence of the ‘public interest’ ground in section 230, the NCLAT re-initiated the debate on the ‘public interest’ ground, which was settled by the legislature, and that too against the ground.
The question of determining entitlements and scope of judicial review lies entirely with the legislature as ‘sourced’ in the Constitution. The legislature has settled the debate on fairness regarding the procedure for compromise and arrangements by not entitling the non-consenting members and not allowing interference by tribunal with ‘commercial wisdom’. Moreover, no ‘source’ empowers the judiciary to re-initiate the discussion. Therefore, for the law retain its authoritativeness, the judiciary must not re-initiate this discussion, and rely on the statute, as it is.
– Vasu Aggarwal