[Arjim Jain and Shruti Asati are 4th Year B.A., LL.B. (Hons.) students at National Law University, Odisha]
In a ruling in July, the National Company Law Tribunal (‘NCLT/Tribunal’) rejected a proposed merger scheme involving three interconnected entities, citing concerns that the scheme was not in the public interest. Unlike other cases where the NCLT typically focused on ensuring compliance with the technical provisions of the Companies Act, 2013 (‘the Act’), this case marked a notable shift in approach. Beyond verifying technical compliance, the NCLT undertook a comprehensive examination of the scheme by considering the factual details presented, along with reports from the Ministry of Corporate Affairs (‘MCA’) and the Income Tax Department (‘ITD’), both of which had conducted their own investigations. This case underscores a growing trend where the NCLT is no longer simply approving merger schemes based on technicalities alone. Instead, it is taking a more holistic approach, carefully scrutinizing the underlying facts and implications of such schemes to ensure they align with broader public interests.
Factual Background
In the instant case, Hologram Holdings Private Limited, Swen Holdings Private Limited (‘Transferor Companies’) and Sulphur Securities Private Limited (‘Sulphur Securities/ Transferee Company’) had filed a scheme with the NCLT recommending their merger under sections 230-232 of the Act. The three companies involved in the case primarily engage in financial transactions such as buying, selling, and transferring shares and bonds. They provide investment and financial planning services, as well as handling investor grievances. Their transactions are mostly internal, with little creation of tangible assets.
The ITD filed a report concerning the Transferee Company, highlighting a pending tax demand of ₹481.09 crores for the Assessment Year (‘AY’) 2012-13 under section 147 of the Income Tax Act, 1961 (‘IT Act, 1961’), along with additional penalties. The department reopened the case, alleging that Transferee Company is a conduit paper company linked to the SK Jain Group, involved in suspicious financial activities, including rotating over ₹500 crores in a single month in 2012. Investigations revealed irregularities, such as shared addresses with other companies in the SK Jain Group and the absence of records at the registered addresses. The company also failed to file its Income Tax Return for FY 2012-13, making it difficult to reconcile its transactions. Additionally, the ITD filed a report on one of the Transferor Company, Hologram Holdings Pvt. Ltd., indicating an outstanding tax demand of ₹3.98 crores for AY 2012-13 under section 147 of the IT Act, 1961.
In light of the aforementioned allegations, the NCLT directed the MCA to conduct an investigation at the company’s physical premises. The Registrar of Companies (‘RoC’) conducted a physical verification of Sulphur Securities’ registered office and corporate office as directed by the Tribunal. The verification revealed that the registered office was a shop with a closed shutter, no display board, and appeared unused for a long period. Upon inspection, a display board inside the shop listed several companies, including Sulphur Securities, but with an incorrect spelling. The company’s corporate office in Delhi was also inspected, where the RoC official met a company director and reviewed records.
The Official Liquidator also filed a report noting the incorporation details, capital structure, and financial highlights of all the Companies. The report also included extracts from the Statutory Auditors’ reports on the financial statements. It was noted that the Transferor Companies would wind up without undergoing the formal winding-up process. No adverse observations were found in the Official Liquidator’s report.
Analysis by the Tribunal
The Tribunal’s analysis of the case revealed several concerns, especially regarding the financial activities and legitimacy of the companies involved. The ITD had flagged significant pending tax demands against the Transferor and Transferee Companies, particularly for the AY 2012-13. The ITD also raised suspicions that the Transferee Company might be a shell company, existing only on paper without actual business operations.
When examining the financial transactions of the companies, the Tribunal noted that they were part of a group with shared ownership and addresses. Their main business activities involved buying, selling, and transferring shares and other financial instruments. However, many of these transactions appeared to be internal, taking place only between companies within the group, without resulting in any tangible assets. This raised doubts about the legitimacy of the financial activities, as many seemed to exist only on paper.
The Tribunal scrutinized the financial statements of the Transferee Company and found that it reported substantial revenue for the financial year 2023-24, mainly from long-term capital gains. However, these gains were largely from transactions involving unlisted shares, which was suspicious. The company’s investments were mostly in other group companies located at the same addresses, indicating a lack of genuine diversification. Despite an increase in office expenses, these were still minimal compared to the revenue generated, suggesting that the company’s operations might be largely speculative or paper-based.
The Tribunal concluded that the financial transactions seemed to be accommodation entries, i.e., fake transactions intended to deceive within a group of companies controlled by a single individual. The significant increase in profits, especially from long-term capital gains, was not backed by credible investments or real assets, indicating possible manipulation.
The companies involved in the proposed merger argued that it would help streamline business operations, reduce costs, and create synergy within the group. However, the Tribunal found these claims to be unsubstantiated. The companies’ operational costs were already minimal and, since most transactions were internal, the merger would not bring any real operational benefits.
In its conclusion, the Tribunal emphasized its duty to act in the public interest, noting that similar schemes in the past had been closely scrutinized. The proposed merger seemed designed to benefit a small group of promoters or shareholders, likely allowing them to avoid tax liabilities, rather than serving any broader public or shareholder interest. The Tribunal found the scheme to be unfair, unreasonable, and not in the public interest. It appeared to be a way to legitimize paper transactions, artificially inflate share values, and possibly facilitate money laundering. Consequently, the Tribunal dismissed the petition for amalgamation.
Analysis Of The Order & Case Comment
Firstly, the NCLT shifted its approach in this case by not just verifying compliance with the Act, but also examining whether the proposed merger aligned with the companies’ stated objectives and served the public interest. This marks a departure from its usual focus on procedural compliance.
Secondly, the NCLT’s decision was based on detailed investigations by the MCA and ITD, which raised concerns about the companies legitimacy, including significant tax demands and suspicions of tax evasion. The Tribunal’s close analysis of their financials revealed that most revenue came from suspicious long-term capital gains on unlisted shares and internal transactions lacking real business activity. This thorough investigation underscores the Tribunal’s increasing focus on preventing the misuse of mergers for illicit financial activities, ensuring that corporate actions genuinely serve public and legal interests.
Thirdly, the NCLT emphasized its duty to act in the public interest, which it considered paramount in its assessment of the proposed merger. The Tribunal’s analysis reflected a growing trend where it scrutinizes the real purpose behind corporate restructuring schemes, ensuring that they are not used as tools for evading taxes or facilitating illicit activities. This focus on public interest demonstrates the Tribunal’s commitment to safeguarding the integrity of the business environment and protecting societal interests. The Tribunal’s refusal to sanction the scheme follows the precedent set in Wiki Kids Limited v. Regional Director, where the National Company Law Appellate Tribunal denied approval to an amalgamation scheme deemed to benefit only the promoters without serving any public interest.
Fourthly, although the Supreme Court in Miheer H. Mafatlal v. Mafatlal Industries Limited established that courts, including tribunals, should respect the commercial wisdom behind mergers, the NCLT has shown it will intervene when a merger conflicts with public policy. In light of this evolving approach, applicants must now provide detailed, well-supported justifications for how their proposed mergers serve both business objectives and public welfare, going beyond mere procedural compliance.
Lastly, in light of the NCLT’s evolving approach, it is now more important than ever for applicants to clearly define the objectives and rationale of any proposed merger in greater detail. It is no longer sufficient for companies to merely comply with procedural requirements or submit copy-and-paste template filings under sections 230-232 of the Act. Applicants must be ready to provide robust evidence demonstrating how the proposed scheme will achieve its stated objectives, benefit the business environment, and serve the general public interest. This requires a well-considered strategy that goes beyond mere formalities, ensuring that the proposed merger is justified on its merits and contributes positively to the broader economy and society.
Conclusion
The ruling by the NCLT serves as a pivotal moment in the landscape of corporate restructuring in India, signaling a shift towards more rigorous scrutiny of merger schemes. By prioritizing public interest and thoroughly examining the underlying facts and financial activities of the companies involved, the Tribunal has made it clear that mere procedural compliance is no longer sufficient. Companies must now ensure that their proposed mergers genuinely align with their stated objectives and contribute to the broader business environment and public welfare. The NCLT’s approach underscores its role as a gatekeeper, ensuring that corporate transactions are not used to facilitate tax evasion, money laundering, or other illicit activities. This ruling sets a precedent for future cases, where the focus will be on the real benefits and public interest served by such schemes. As a result, companies must approach merger proposals with greater transparency and accountability, providing clear, evidence-based justifications to the Tribunal. In doing so, they will not only comply with legal requirements but also contribute to a more robust and trustworthy corporate governance framework in India.
– Arjim Jain & Shruti Asati