Takeover norms for unlisted companies, Logical or Arbitrary

The Takeover Provisions are silent on several aspects, primary being, whether it is obligatory on the part of the minority to tender their shares pursuant to the takeover offer as long as the fair price has been offered...

Corporate India, where majority of companies are promoter driven, is in the mood of merriment ever since the Ministry of Corporate Affairs of India ("MCA") has enforced the provisions of sub-section (11) and (12) of Section 230 of the Companies Act, 2013 ("Act") with alongside enforcement of the Companies (Compromises, Arrangement and Amalgamations) Amendment Rules, 2020 ("Arrangement Rules") and the National  Company Law Tribunal (Amendment) Rules, 2020, to operationalize the takeover of unlisted companies (collectively referred as "Takeover Provisions"). The reason for such merriment is obvious, as the Takeover Provisions seem to provide the majority shareholders an avenue to gain complete control over the target company by ousting the minority shareholders through implementation of a scheme of takeover. However, upon having a closer look, one may effortlessly recognize that the Takeover Provisions are vastly ambiguous, and a lot has been left to be tested and evolved through jurisprudential developments.

Takeover as arrangement – Does it have a binding effect above all?

The Takeover Provisions have been brought within the realm of Section 230 of the Act, which regulates schemes of compromise or arrangement between:

• a company and its members or any class of them;
• a company and its creditors or any class of them.

The criteria prescribed under the Arrangement Rules for making a takeover offer as arrangement reads as under:

"A member of the company shall¹ make an application for arrangement, for the purpose of takeover offer in terms of sub-section (11) of section 230, when such member along with any other member holds not less than three-fourths of the shares in the company, and such application has been filed for acquiring any part of the remaining shares of the company."

A plain reading of the above criteria would reveal that only certain qualified member (i.e.  member(s) holding at least three-fourth shares of the company) may make an application for arrangement contemplating acquisition of any part of the remaining shares of the company. However, given that the Section 230 allows a scheme of arrangement between the company and its members and not between members inter-se, it would be logical to infer that the target company would be a party to the scheme and act as an applicant (on behalf of the majority shareholder making application) seeking approval to the takeover scheme.

In case of unlisted companies, minority shareholders (particularly if they are strategic investors) generally hold rights on matters that affect their shareholding/voting rights in the company, through underlying shareholders' agreement. Any direct application made by majority shareholders to take over the shares of minority may result in breach of such rights of the minority. Thus, making a company party to the takeover albeit through the route of scheme of arrangement seems potent, as, the scheme once approved by the National Company Law Tribunal ("Tribunal") has a binding effect on all members (including minority). Having said that, it remains open to question, whether the minority shareholders may halt the scheme of takeover claiming it to be prejudicial to their rights as contractually agreed with the company under the shareholders' agreement or on grounds that it is 'ultra-vires' of the Articles of Association, where such contractual rights have been replicated in articles of the company.

Hostile takeover made easy?

Transfer or transmission of shares undertaken through a contract, arrangement or succession, or made in pursuance of any statutory or regulatory requirement have been excluded from the ambit of Takeover Provisions. Due to such exclusion, it may be fair to state that the Takeover Provisions have been enforced with an intent to regulate 'hostile takeover' of unlisted companies i.e. when 'friendly takeover' via transfer of shares through private arrangement or contract is not workable as per mutually agreed terms and conditions. However, despite of enforcement of the Takeover Provisions, such proposed hostile takeover may not easily sail-through, given that the Takeover Provisions do not provide any specific exemption from Section 230 (4) of the Act which entitles member(s) jointly holding at least 10% shareholding in the company to raise objection to compromise or arrangement before the Tribunal. In the absence of such exemption, a scheme involving takeover is likely to be objected by the same class of members, who in the first place, wouldn't have agreed for friendly transfer of their shares through private contract. As a result, the schemes for takeover may result in unscrupulous litigations.

Objective of takeover undermined?

A primary objective for takeover is to gain control over the target company by purchasing shares which contains voting rights. However, the Takeover Provisions seem to undermine the said objective as they impose a pre-condition that the applicant should be holding at-least three fourth shares of the company. An applicant who is holding three-fourth shares of the company, would already be in control of the company, as such applicant would be in a position to effortlessly approve or reject both ordinary and special resolution proposed to be passed in the company. The limited benefit that Takeover Provisions offer is that upon purchase of the remaining one-fourth shares, the risk of minority seeking reliefs on the ground oppression and mismanagement is avoided. However, as discussed above, any scheme for takeover offer may itself be objected by members holding 10% shareholding in the company under Section 230(4) of the Act, thereby making aforesaid resulting benefit a 'too far away' thought.

Narrow meaning to the term 'shares'

As per an explanation included under the Arrangement Rules, the term 'shares' have been defined as "equity shares of the company carrying voting rights, and includes any securities, such as depository receipts, which entitles the holder thereof to exercise voting rights". A plain reading of the said definition suggests that the takeover offer may be made for acquiring only such securities that contain voting rights on the date of making takeover application and not convertible securities that offer voting rights at future date upon conversion.

Due to such a narrow definition, the option of takeover may not prove to be much attractive in case of companies where the number and amount of convertible securities outweighs the shares / securities carrying voting rights. In such companies, the control acquired through takeover would be temporary as the same would get diluted upon conversion of the convertible securities.

Aggrieved party, undefined

Section 230 (12) of the Act allows any 'aggrieved party' to make an application to the Tribunal in the event of grievances with respect to the takeover offer. Unlike Section 230(4), which prescribes minimum shareholding requirement for raising objections, Section 230(12) does not provide any such minimum threshold for raising grievances. This would make schemes of takeover prone to the same challenge that various schemes of arrangement (under the erstwhile Section 391-394 of the Companies Act, 1956) used to face where a member / creditor / or any other person having miniscule interest was in a position to object to a scheme. 

Lastly, as 'aggrieved party' is undefined, it may be perceived that the route of making application under Section 230(12) is open even for majority shareholder(s) who have made takeover offer, where such offer is not being accepted by minority, despite it being fair in terms of the price being offered.

Conclusion:

The Takeover Provisions, undoubtedly, empower the majority shareholder(s) to squeeze out the minority. However, similar to already existing methods for minority squeeze as available under Section 235 and 236 of the Act, the Takeover Provisions are silent on several aspects, primary being, whether it is obligatory on the part of minority to tender their shares pursuant to takeover offer as long as the fair price has been offered. Further, in the absence of any specific guidance to the meaning of the term "aggrieved party', line of objections, including frivolous objections made with intent to stall or defer the takeover proposal, may be witnessed. It would also be equally challenging for the Tribunal to strike a balance between safeguarding the interest of the minority versus ensuring that the rule of the majority prevails.