[Shalin Ghosh is a 3rd year B.A., LL.B. (Hons.) student at Maharashtra National Law University, Mumbai]
Capital reduction is a common mode of financial restructuring for a company. It is a useful tool for companies to reduce accumulated losses and achieve an optimal capital structure. Organizationally, it is a popular route to provide an exit to minority or dissenting shareholders from a company to improve administrative efficiency.
In September, the National Company Law Tribunal (“NCLT”) Kolkata in the matter of Philips India Limited rejected a selective capital reduction scheme filed by the company for buying out nearly 4% shares held by minority shareholders. The NCLT’s order observed that section 66 of the Companies Act, 2013 (“CA, 13”) cannot be invoked for acquiring minority holding in a company through a reduction of capital as this objective does not fall within the scope of the provision.
This post argues that the NCLT’s findings are inconsistent with the established judicial position in India recognizing selective capital reduction while also resting on an incorrect understanding of the scheme of section 66 of the CA, 13. It also seeks to analyse the feasibility of effecting a minority squeeze-out via a secondary acquisition of shares under a scheme of arrangement under sections 230-232 of the CA, 13 as an alternative to the conventional route under section 66.
Background and Decision
The shareholding structure of Phillips India Limited indicated that its Dutch parent entity Koninklijke Philips N.V. (“KPNV”) held 96.13% of the company, with the remaining stake held by retail shareholders. The company had undergone a delisting in 2004 and, resultantly, its shares were not tradable on any stock exchange in India. There was a persisting demand from the company’s shareholders to provide them an exit as it was difficult for them to monetize their holdings due to lack of liquidity following the delisting.
Interestingly, this was the third time Philips tried to acquire the minority holdings in the company to vest its Dutch parent, KPNV, with complete control. The company tried to effect a squeeze-out in 2007 through a buyback under section 77A of the erstwhile Companies Act, 1956 (“CA, 56”) and later in 2018 where a capital reduction scheme filed under section 66 of the CA, 13 was voluntarily withdrawn by the company subsequent to its filing with the NCLT due to opposition by non-promoter shareholders. The present petition was filed by the company with the twin objectives of providing liquidity and exit to the minority shareholders and reducing administrative costs of servicing a number of public shareholders having a small stake.
The NCLT observed that a capital reduction scheme under section 66 can only be sanctioned if its objective falls under the specific scenarios envisaged by the provision. Therefore, a company can only reduce its share capital if it either wants to extinguish or reduce the liability on unpaid shares (provided under section 66(a)) or cancel any paid-up share capital which is lost or unrepresented by available assets (provided under section 66(b)). The NCLT rejected the company’s scheme as its cited objectives did not align with those spelt out under section 66. The bench also observed that, unlike section 66(6) of the CA, 13, which expressly renders section 66 inapplicable to a buyback under section 68, there was no similar provision which existed under section 100 of the CA, 56.
According to the NCLT, the main objective of the company’s selective capital reduction scheme was to execute a share buyback, with capital reduction being only an ancillary objective, thereby rendering section 66 inapplicable. While the capital reduction scheme was opposed by the minority shareholders mainly on the grounds of valuation mismatch, the NCLT declined to rule on this aspect due to the petition’s dismissal on the grounds mentioned earlier.
Analysis
The NCLT’s order ignores the settled jurisprudence recognizing selective capital reduction within the purview of Indian company law. The Bombay High Court in Elpro International Limited., In re held that selective capital reduction is permissible under Indian law and the classification of shareholders for effecting a capital reduction is not contrary to the provisions of section 101 of CA, 56. In this case, the petitioner company, which was listed on the Bombay Stock Exchange decided to extinguish and cancel around 9 lakh shares held by shareholders holding around 25% of the company’s issued and paid-up capital. The principle supporting selective capital reduction was reiterated once again by Bombay High Court in Sandvik Asia Limited v. Bharat Kumar Padamsi, where the Court ruled that a capital reduction scheme involving an acquisition of the minority holdings by the promoter group is valid provided the necessary procedural compliances under the CA, 56 are met.
The NCLT’s order also stands in complete contrast to the position taken by recent orders of the NCLT in the capital reduction schemes of Reliance Retail and Wipro Enterprises Limited. The NCLT Mumbai, in the Reliance Retail case involving opposition from minority shareholders over valuation concerns, sanctioned a capital reduction scheme undertaken to provide greater liquidity to the exiting shareholders and achieve operational efficiency by being a wholly owned subsidiary of its parent company. The NCLT Bengaluru, in the case involving Wipro Enterprises Limited, approved a selective capital reduction scheme whose was aimed to provide an exit to certain non-promoter shareholders. The NCLT ruled that Wipro had complied with the conditions under section 66, with the approval order drawing on earlier rulings on section 100 of the CA, 56.
The NCLT’s restrictive approach in limiting the intent of a capital reduction scheme only to the scenarios provided under section 66 also runs counter to the text of the provision. Section 66 states that a company can reduce its share capital “in any manner” subject to the conditions specified under the provision. This has been repeatedly interpretatedto mean that companies enjoy complete discretion to undertake capital reduction, irrespective of whether the mode of reduction is explicitly mentioned in the relevant provision. The Delhi High Court in Reckitt Benckiser held that capital reduction is a purely domestic concern of a company where the majority’s decision to reduce the company’s capital in any manner deemed fit based on commercial considerations must prevail. Therefore, specific scenarios spelt out by the provision, which were strictly relied on by the bench, are merely indicative and not exhaustive. The NCLT’s reliance on section 66(6) to conclude that section 66 is inapplicable to a buyback of securities under section 68 also appears to be a misplaced interpretation of the provision. Section 66(6) merely clarifies that a company effecting a buyback need not obtain an NCLT approval to sanction the scheme as envisaged under section 66. However, section 66(6) cannot be interpreted to mean that selective capital reduction cannot be used when its effect is similar to a buyback.
With the NCLT order restricting the use of capital reduction under section 66 to execute a minority-squeeze-out, can a company alternatively consider a secondary acquisition of shares under a scheme of arrangement via section 230-232 to facilitate the same outcome? Section 230(11) of the CA, 13 provides that a takeover offer may be made by the majority shareholder(s) facilitating minority squeeze-outs by allowing the promoter group to acquire the remaining shares of the company held by public shareholders at a price determined by a registered valuer. Earlier this year, the NCLT Chennai in the matter of India Forge & Drop Stampings Limited approved a scheme of arrangement involving a secondary acquisition of shares under sections 230-232 by the promoter group. This was undertaken at a price ascertained by an independent valuer with a view to provide an exit to the public shareholders of a formerly public entity.
While this might suggest the availability of an alternative strategy to acquire minority holding, it is pertinent to note that both section 230(11) and the NCLT Chennai order dwell on the possibility of a minority squeeze-out occurring in context of a company implementing a debt restructuring option like a scheme of arrangement. Therefore, it is questionable whether section 230(11) can provide an alternative route to companies (like Philips in the present case) deciding to undertake a capital reduction solely to provide an exit opportunity to minority shareholders without it being concomitant with a compromise or arrangement.
This point becomes increasingly relevant due to a decision of NCLT Delhi In Re: Aviat Networks (India) Private Limited where a company was prohibited from effecting a capital reduction scheme via section 230-232, bypassing the route under section 66. It was observed that since section 230 of a CA, 13 is a complete code, it can have a reduction of share capital only as a consequence of a compromise or arrangement between a company and its creditors or members. In the absence of such a scheme, the compliance envisaged under section 66 cannot be avoided and must be strictly complied with. The bench added that the placement of the provisions under two distinctly different chapters is indicative of the legislative intent in demarcating “reduction of capital” and “compromise and arrangement”. While this decision was rendered in context of a company deciding to write-off accumulated losses and return capital via a scheme of arrangement, it nonetheless raises questions about the validity of undertaking a capital reduction scheme under section 230(11) that is not collateral to a compromise or arrangement.
Conclusion
The NCLT Kolkata’s order in the Philips case takes an unduly narrow view of section 66 while also ignoring the settled principles on selective capital reduction. The alternative route of effecting a capital reduction under section 230(11) to solely provide minority shareholders an exit does not seem to have a generic application, further limiting the avenues for unlisted companies to improve the liquidity of their shares and alter their shareholding patterns to achieve greater efficiency. It is imperative that the order is set aside on appeal and the jurisprudential clarity on the matter is restored.
– Shalin Ghosh