Selective reduction of share capital to squeeze out the minority shareholders has been repeatedly resorted to by companies, especially those left with a residual group after a successful delisting process.
The jurisprudence on this has fossilised to the extent that the majority can decide when and how to carry this out, with very limited scope for the affected shareholders to agitate this before the courts. The courts have receded in their role and merely look at the correctness of the process followed.
Little would have one thought that the minimal juristic safeguards that the minority enjoys can be further worsened or weakened. But never underestimate the courts!
Bharti Telecom Ltd (BTL) was listed on the bourses till the dawn of the millennium, when it managed a successful delisting. Over time, BTL emerged as a pure holding entity, its main asset being the investment in Bharti Airtel Ltd.
Like in most delisting, there remained a clutch of dogged and determined members who refused to be offloaded, about 5,000 at last count. And BTL was not wanting in its efforts to rid the company of this sticky lot.
The company put through a capital reduction scheme under Section 66 of the Companies Act, 2013, during the financial year (FY)19-20. A section of the shareholders challenged this and took the matter to the national company law tribunal (NCLT) and, later on, appealed to the national company law appellate tribunal (NCLAT). With the successive failures, they petitioned the Supreme Court.
The main pleas before the court were-
1. There was a fundamental flaw in the process as the notice to the meeting for capital reduction did not include the share valuation report, based on which the capital reduction was carried out;
2. The valuer, Ernst & Young Merchant Banking Services Pvt Ltd, was not independent as its sister firm was the internal auditor of BTL;
3. The substratum of the share valuation was incorrect; and,
4. The discount in the valuation for lack of marketability of the shares (DOLM) was unwarranted.
The Court rejected the argument that not annexing the valuation report to the notice was fatal to the proceedings. It held that the process of capital reduction required only the requisite shareholders’ approval. Following this the tribunal (NCLT) should approve the minute.
The Court firmly held that, unlike certain other provisions like an amalgamation or other forms of arrangement under Sections 230-232, making a valuation report a mandatory annexure to the notice convening the meetings, Section 66 did not mandate the same. The company making available the report at its registered office for perusal was sufficient compliance.
To add insult to the injury, the Court opined that even a valuation exercise was not necessary to carry out a capital reduction.
In the words of the court- “Reduction of share capital can be achieved by a special resolution and confirmation by the Tribunal, without a report of valuation from an approved/registered valuer and hence, it does not fall within the ambit of a relevant material; without the full and complete disclosure of which the reduction of capital cannot be acted upon. However, it is pertinent to notice that the company despite any legal requirement had adopted a valuation exercise……….”
The most contentious issue in any capital reduction has been the valuation. The Court’s view that a valuation is not required will have a far-reaching implication.
There may be a lateral way to look at this finding of the Court, but that may be too late in the day. The need for a valuation arises only if the capital reduction is selective and discriminates against a section of the shareholders for differential treatment.
When it applies to all the shareholders, there is no need for a valuation. This provision was conceived to carry out capital reduction across all shareholders equitably and not use it as a vehicle to treat a section of them in a discriminatory manner. Courts in the UK and here have, over time, allowed this to be used indiscriminately to eliminate the minority.
Once the barrier of valuation is removed, the exercise can become very easy and equally quite arbitrary. There is a vibrant market to trade in unlisted stocks, similar to BTL. Such traders should beware of the risk of an easy squeeze out of the minority with little safeguards!
The decision also hammered another nail into the coffin. A longer one this time!
The valuation matrix of BTL by Ernst & Young Merchant Banking P Ltd is set out in the table on the right. A careful scrutiny of the numbers would show that the starting point is the value of the shares held by BTL in BAL, which is highly liquid and traded.
A subsequent step bungs the spanner of a big discount for the illiquidity of BTL shares!
The Court rejected the argument that the underlying value cannot be discounted, as potentially the BAL shares can be sold and the BTL shares will capture its full value.
More importantly, the shareholders argued that in a case where they are being squeezed out compulsorily there is no question of any discount for lack of marketability.
They cited international literature and court decisions from outside to explain that the DLOM is not applicable in all situations. It may apply only where a willing buyer and a willing seller contract.
Very strangely, the bench distinguished one of the cases of the Singapore Court, by a highly convoluted view that in the other case the section affected was a larger minority, whereas in BTL it was a much smaller minority!
“The illustrative reference to minority with a 33% shareholding in an oppressive setting also is distinguishable from the instant case, which deals with a far lesser minority and in the Indian setting.”
Other reasons like misconstruing the audit certificate issued by the statutory auditor in such cases as an approval for the valuation, and the reliance on the valuation guidelines issued by the ICAI (Institute of Chartered Accountants of India), in supporting the conclusion, are not elaborated here as they constitute a lesser evil as compared to the main reason to endorse the validity of DLOM in this case.
Liquidity discount was very much a feature of it. The current view of the court will make matters worse for any minority group placed similarly for a reasonable exit valuation!
(
Ranganathan V is a CA and CS. He has over 45 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as a senior advisor post-retirement, handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)
