Tanvi Kini
Abstract
Squeeze outs demonstrate the power that majority shareholders in a company have to drive out the minority shareholders. It is a manifestation of the control of majority shareholders over the company. The minority shareholders are openly eliminated and are forced to accept the price determined by the majority for their shares. Although squeeze outs may enhance the value of the company at times, the interest of the minority shareholders is jeopardized. This open and legitimate method of forcefully removing shareholders from the company has posed several threats to minorities all around the world.
The Companies Act of 2013 which has provided for 4 methods of squeezing out, seems to be more defined and structured as opposed to the squeeze out provision(s) in the Companies Act of 1956. However, the questions that arise are, whether minority shareholders are adequately protected? What are the rights they exercise in a squeeze out process? Are the provisions of the 2013 Act really an improvement over the provisions of the 1956 Act? How different is the position in countries such as United Kingdom, United States, Australia and Canada?
The purpose of this article is first, to shed light on the squeeze out provision under the 1956 Act, second, to analyze the squeeze out provisions in the 2013 Act and third, to look into the position in foreign jurisdictions.
Introduction
A ‘squeeze out’, also known as a ‘freeze out’ or ‘minority buy out’, is a transaction wherein the majority or controlling shareholders buy out the minority shareholders, in an attempt to gain complete control over the company, resulting in the total exclusion of the latter from the company.
The term ‘squeeze out’ is defined by Black’s Law Dictionary1 as,
“an action taken in an attempt to eliminate or reduce minority interest in a corporation.”
For example, a Company ‘B’ has 55% shareholding in Target Company ‘A’. If company ‘B’ which aims at eliminating the minorities, purchases the remaining 45% shares and compensates the minority shareholders in cash, it may be said that the minority shareholders have been squeezed out of Company ‘A’.
The methods of squeeze out under the Companies Act,2013 (“2013 Act”) may be categorized as: (i) Compulsory Acquisition or Acquisition of shares of dissenting shareholders2, (ii) Purchase of Minority Shareholding3, (iii) Scheme of Arrangement4(Section 230 to 234) and (iv) Reduction of Capital5. These provisions are not only in the interest of the majority shareholders, but do also afford some amount of protection to minority shareholders.
Legal Position in India
Under Section 395 of the 1956 Act, an acquirer company may make an offer to the shareholders of a target company under a scheme or contract involving the transfer of shares of the target company. In the event that the shareholders holding value of 90% of shares in the target company accept the aforementioned offer, the acquirer company has the right to give a notice to the dissenting shareholders to acquire their shares.6 The acquirer company shall be entitled and bound to acquire the shares of the dissenting shareholders, unless they make an application, objecting to the buy-out, to the Court within one month from receiving the notice.7 Further, under Section 395, if the acquirer company or its subsidiary holds more than 10% of the value of the shares of the target company, the offer is only valid if it is approved by holders of 90% of the shares of the target company, not including the shares held by the acquired. Such approving shareholders should constitute not less than three-fourths in number of the holders of those shares. This provision safeguards the interests of the minority only to the extent that they may approach the Court, however, it is important to note that this provision does not contain any guidelines for the valuation of offer price.
According to Section 235 of the 2013 Act, which is the corresponding provision to Section 395 of the 1956 Act, the acquirer company makes an offer to acquire the shares of the target company under a scheme or contract, which is required to be accepted by not less than shareholders holding 90% in value of shares of the target company. The acquirer must then serve a notice to the dissenting shareholders, who may in turn approach the National Company Law Tribunal (“NCLT”) to seek appropriate remedy. The sum or consideration received for the shares in the target company must be disbursed within 60 days from the date of receipt of such sum by the transferor company. The 1956 Act does not prescribe any such time period.
As per Section 236 of the 2013 Act, an acquirer entity or a person acting in concert with such acquirer which holds at least 90% of the issued equity share capital by way of an amalgamation, share exchange, conversion of securities or any other reason, may notify the company of their intention to buy the remaining equity shares. Section 236(2) provides for a pre-determined exit price which is reached at by a registered valuer as per the prescribed rules. The minority shareholders may also offer to the majority shareholders to purchase the minority equity shareholdings under Section 236(3). Further, in the absence of a physical delivery of shares by the shareholders within the time specified by the company, the share certificates shall be deemed to be cancelled, and the transferor company shall be authorised to issue shares in lieu of the cancelled shares and complete the transfer. Furthermore, when the majority shareholder fails to acquire full purchase of the shares of the minority equity shareholders, the provisions of section 236 will still apply to the residual minorities, although the shares of the company of the residual equity shareholders have been delisted and the period of one year or the period specified in the SEBI regulations have lapsed.
Under Section 236, once the shares of the minority have been acquired, 75% of the minority shareholders may negotiate a higher price for the members and the additional compensation shall be shared with balance minority shareholders. On a thorough reading, several lapses in this provision unfold. There is no clarity as to whether minority shareholders are bound to accept the offer. If compulsory, there is no scope for opposition by the dissenting shareholders. There is no provision for holding a separate meeting of the minority shareholders to vote against the buy-out. Furthermore, there seems to be an overlap between Section 235 and Section 236.
Under Sections 230 to 234 of the 2013 Act, a scheme of arrangement may permit the acquirer to purchase shares held by the minority shareholders, thereby effecting a squeeze out. The company is required to make an application to High Court to convene meetings of the various classes of shareholders. The scheme is required to be approved by a majority in number representing 75% in value of each class of shareholders, present and voting, in each meeting of every class. On obtaining the approval of the shareholders, the company is required to approach the High Court for sanctioning of the scheme. The High Court on hearing representations made by interested parties, if satisfied, passes an order sanctioning the scheme. This form of squeeze out is more common than compulsory acquisition as it requires approval by 50% of the shareholders in number and 75% in value of shares, which is less onerous than the 90% required in the case of compulsory acquisition. The role of the Court and voting rights of the shareholders in a scheme of arrangement offer the minority a minimal standard of protection.
A company may, subject to confirmation by the NCLT and passing of special resolution by the shareholders, reduce the share capital by repurchasing some shares and consequently cancelling them under Section 66 of the 2013 Act. This is the most attractive and least onerous method of squeezing out minority shareholders because it requires a majority of 75% of votes by shareholders and not 75% of votes from each class as in the scheme of arrangement or consent of 90% of the shareholders as in compulsory acquisition.
Although Indian Courts have dealt with the issue of squeeze outs in limited cases, the following have left a significant mark. The Bombay High Court in In Re: Elpro International Ltd.,8 while dealing with a special resolution passed in favour of reduction of capital, held that a company can reduce the share capital of any shareholder in any way so long as the procedure is fair and gets the approval of the majority shareholders.
The legal position on squeezing out of minority shareholders through reduction of share capital was decided by the Bombay High Court in Sandvik Asia Limited v. Bharat Kumar Padamsi.9 The question before the court was whether a special resolution which proposed to wipe out a class of shareholders after paying them just compensation can be termed as unfair and inequitable? The Court held that,
“once it is established that non-promoter shareholders are being paid fair value of their shares, at no point of time it is even suggested by them that the amount that is being paid is any way less and that even overwhelming majority of the non-promoter shareholders having voted in favour of the resolution shows that the Court [lower] will not be justified in withholding its sanction to the resolution.”10
The abovementioned case laws lead us to the inference that minority shareholders can be squeezed out even without their consent.
Further, the Bombay High Court in the 2014 Cadbury India Limited, laid down the following guidelines to be pursued in matters of minority buy outs:
The Courts duty lies in ensuring that the scheme is not against the public interest, is fair and just and not unreasonable, does not unfairly discriminate against or prejudice a class of shareholders and draws a balance between the commercial wisdom of the shareholders expressed at properly convened meetings.
The term “prejudice” in relation to valuation of a scheme would mean something more than just receiving less than what a shareholder desires, being a concerted attempt to force a class of shareholders to divest themselves of their holdings at a rate far below what is reasonable, fair and just.
While there are several methods to squeeze out minority shareholders in India, the protection given to the same is lacking. Given this dearth, we examine the position in foreign jurisdictions, namely, United Kingdom, United States, Australia and Canada.
Legal Position in Foreign Jurisdictions
In English Law, under the Companies Act, 2006, the acquirer may squeeze out the minority shareholders using methods very similar to those used in India i.e. compulsory acquisition, scheme of arrangement and reduction of capital. While the thresholds and procedures are similar in both Indian and English laws, the judicial interpretation and rights afforded to minority shareholders are different. For instance, in Hellenic and General Trust Ltd.,11 the Court, while discussing the “majority of the minority” rule in a scheme of arrangement, held that a subsidiary of the acquirer had a distinct interest from the minorities and hence each must constitute a separate class. Such a view has not been taken in India yet. English courts have invalidated squeeze outs where they have been carried out in a manner that harms minorities’ interests. Further, under the scheme in English law, the notice that is to be sent to the minority shareholders explains the consequences and effect of the scheme of arrangement on the minority shareholders.12
In the United States, it is the Delaware State laws (which are highly relied on for mergers) which provide squeeze out methods:13 (1) long-form merger, wherein the acquirer is unable to purchase at least 90% or more of the targets shares and thereby calls for a special meeting to obtain the requisite shareholder’s votes and (2) short form merger, wherein the acquirer is able to purchase at least 90% of the targets shares and obtaining the votes of the target’s shareholders is not required. Minority shareholders have two remedies against squeeze out: (1) Appraisal Rights and (2) Fiduciary Duty Class Actions. The appraisal rights under state corporate law statutes entitle dissenting shareholders in a squeeze out merger to compel the acquirer to pay them a court-determined fair value for their shares. Further, the Delaware Fiduciary Duty Class Action (FDCA) has evolved over the years. The FDCA is available regardless of the transactional structure or consideration used and places the burden to show that the transaction is entirely fair, on the acquirer.
In Canada, under the Canada Business Corporations Act (“CBCA”), squeeze outs may be effected by (i) compulsory acquisition or (ii) shareholder-appr oved transaction (which is generally an amalgamation squeeze out). Under the CBCA, the threshold for minority buy out is 90% of the shares of the target company, however, the minority shareholders have the right to demand for payment of fair value when they believe that the consideration being offered does not represent fair value of target company’s shares. This fair value is determined by the Court.14 To implement an amalgamation, squeeze out, a meeting of the shareholders of the target company must be held and at least 66 2/3% of the shares of the target company voting at the meeting must approve the amalgamation. The unique right of demanding payment of fair value by the minority shareholders is exercisable in the amalgamation method as well.
In Australia, under the Corporations Act, 2001 there are two methods of squeeze out: (1) compulsory acquisition following a takeover bid or (2) compulsory acquisition in other circumstances. In both these methods, the minority shareholders have the right to object to the acquisition of their securities by signing an objection form (which accompanies the notice served to them) and return it to the shareholders (90%) who approved the acquisition. The 90% shareholders lodge the objection with the Australian Securities & Investments Commission (“ASIC”) along with a list of shareholders who objected.15 Once the minority objection is cleared, the compulsory acquisition proceeds provided that the shareholders in each class who have objected to the acquisition together hold less than 10% of the shares or the Court has approved the acquisition on the basis of fair value for the securities offered.
Conclusion
To summarize, the key problem globally, is the inadequate protection of minority shareholder interest. While in the above mentioned foreign jurisdictions, the protection afforded to minority shareholders are still insufficient, they are certainly more well defined than the current position in India. It is important for minorities to understand the implications of the squeeze out provisions in the 2013 Act and be aware of the rights that they have as owners of the company i.e. the right to vote, fair valuation, and oversight of the Court. There is an urgent need to establish a balance between the interests of minority and majority.
1 Blacks Law Dictionary, The Law Dictionary (2nd Ed.), available at: https://thelawdic tionary.org/sque eze-out/
2 Section 235 of the Companies Act, 2013.
3 Section 236 of the Companies Act, 2013.
4 Section 230 to 234 of the Companies Act, 2013.
5 Section 66 of the Companies Act, 2013.
6 Section 395(1) of the Companies Act, 2013.
7 Ibid.
8 [2008] 86 SCL 47 (Bom).
9 (2009) 3 BomCR 57.
10 Sandvik Asia Limited v. Bharat Kumar Padamsi, (2009) 3 BomCR 57.
11 [1976] 1 WLR 123
12 IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, United Kingdom. (2016).
13 IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, United States of America (2016).
14 Christopher C. Nicholls, Lock-ups, Squeeze-outs, and Canadian Takeover Bid Law: A Curious Interplay of Public and Private Interests, MCGill Law Journal, 2006.
15 IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, Australia (2016)