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FREEZE-OUT MERGERS IN THE INDIAN LANDSCAPE

INTRODUCTION

Freeze-out mergers more commonly known as minority squeeze-out mergers are an irresolute dilemma on whether the minority shareholders should alienate their shares on being outvoted by the majority shareholders in a body corporate setup. The Companies Act of 2013[1] is implicit in the aspect of Freeze-out mergers with a skewed mechanism being outlined in the legislation. Generally, Freeze-out implies the step taken by the majority shareholders buying off the stake of the minority shareholders who are dissenting in the decision-making process of the organization. The legislative policy enacted by the Parliament of India has adopted a conservative approach by not introducing the necessary recommendations suggested by the JJ Irani Committee report for developing an adequate regulatory framework for acquiring minority shareholding.

Legally speaking, the mandatory acquisition of equity shares gives ownership stake, held by minority shareholders in a company in exchange for a fair price value against the surrendered shares as determined in consonance with the CA, 2013.[2] Here comes the significance of introducing the phenomenon of minority shareholders of the company which denotes the shareholder group that holds a lesser number of equity shares of the company. The number of shares held by the minority shareholders is substantially lesser than the controlling shareholder i.e the majority group of the company.[3]

The concept of majority shareholding and controlling shareholder was a jurisprudence laid down by the Foss v. Harbottle[4] case wherein the decisions of the majority would prevail to ensure non-interference into the smooth functioning of the company except in cases of oppression, mismanagement, and fraud wherein the rights of the minority shareholders are violated. Hence, the concept of squeeze-out facilitates the company to ensure the internal operation systematically with no intrusion of dissenting members which can also be termed as annihilating undesirable shareholders from the organization. Though the majority’s will be prevailing prima facie is beneficial to the company’s health, the shareholders who are not holding a significant stake in the company are devoid of their rights.

THE CONCEPT OF FREEZE-OUT MERGERS AND LAWS GOVERNING

Minority shareholders of a company can be compelled by a majority shareholder to sell their equity shares in exchange for reasonable compensation i.e. fair price value under squeeze-out or freeze-out provisions. As per section 235 CA, 2013[5] minority shareholders’ shares may be acquired in a takeover by major shareholders who hold at least 90% of the stock in a particular company.[6] This section 235 of CA, 2013 runs concurrently with section 395 of the Companies Act, 1956, and an attempt was made to interpret section 395 to understand the 90% of the shareholding of the company to be consistent with the overriding majority shareholding concept.

The Delhi Court attempted to interpret a provision of the Companies Act, 1956, in AIG (Mauritius) LLC v. Tata Tele Ventures[7]. “Different and distinct people” would have to be included to meet the 90% threshold, according to the ruling. In the context of “closely-held private and unlisted companies,” this qualifying element presents particular difficulties because it was created to justify the conflicting minority shareholder interests.

It was noted in Sandvik Asia Limited v. Bharat Kumar Padamsi[8] that “once it is established that non-promoter shareholders are receiving fair value for their shares, at no point do they suggest that the amount being paid is less, and even the overwhelming majority of non-promoters shareholders receive less than their fair value.” Whether such an act of surrendering shares in exchange for a price would be unfair and inequitable was explored in this case. The Bombay High Court ruled that minority shareholders may be forced out of a company if, among other things, they have been allowed to be compensated at reasonable market value for their shares.

A minority squeeze-out can also be performed by aggregating shares generally known as consolidation of shares. Using this method, the company could consolidate the “nominal value of shares,” reducing the total number of shares while boosting each share’s nominal value.[9] Reverse stock splits are also commonly undertaken when share prices decline, to attract investors or avoid delisting. In a reverse stock split, a business replaces a specific number of shares with one whole share of stock to start the consolidation of its total number of shares. For instance, 100 units of stock are combined into one share in a one-for-100 reverse stock split.[10]

PRESERVING RIGHTS OF MINORITY SHAREHOLDERS

Squeeze-out operations involving minority shareholders must take fair valuation and pricing into consideration. Several variables must be taken into account when determining a reasonable price for shares, including earnings per share and return on net worth. Re: Cadbury India Limited[11] established certain principles that made it essential to evaluate share prices fairly based on prior share prices and offers. Minority shareholders lose their property as a result of minority squeeze-outs. Squeeze-outs were rendered legal under the law, thus legalizing property disposal. An offer should be presented by the acquiring party at a price determined by a registered valuer in the event of such a purchase.[12]

CONCLUSION

Since Section 236[13] does not impose a requirement that minority shareholders sell their shares at fair market value, it only offers a rudimentary remedy for a minority buyout and serves as a safety net for the minority to keep their ownership stake in the business. It is clear that minority shareholders in India are not entitled to adequate protection from such squeeze-out actions. In India, courts tend to attribute promoter bias by generally avoiding interfering in a company’s internal affairs, except in unusual circumstances, which makes them less likely to protect minority shareholders during squeeze-outs. Squeeze-outs provide cheap, ineffective, and inefficient recourse for minority shareholders. In India, the majority of minority votes are used for several purposes, including related-party transactions, compulsory acquisitions, and so forth, but not for squeeze-outs, which should be reconsidered to safeguard the minority shareholders.

Author(s) Name: Aathira Pillai (Maharashtra National Law University, Mumbai)

References:

[1] Hereinafter referred to as CA, 2013

[2] Bhandari R, “The Law on Minority Squeeze-out in India ”(The Law On Minority Squeeze-Out In India <https://www.mondaq.com/india/shareholders/1199734/the-law-on-minority-squeeze-out-in-india> accessed March 6, 2023

[3] “Minority shareholder.” https://dictionary.cambridge.org/ Dictionary, Cambridge <http://dictionary.cambridge.org/dictionary/english/minority-shareholder> accessed March 6, 2023

[4] [1843] 67 ER 189

[5] The Companies Act, 2013, s. 235

[6] “Mergers and Acquisitions – Nishith Desai” <https://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Mergers___Acquisitions_in_India.pdf> accessed March 7, 2023

[7] 2003 IIAD Delhi 672, 103 (2003) DLT 250

[8] Appeal No. 308 of 2004 in Company Petition No. 478 of 2003 in Company Application No. 290 of 2003, as decided on April 4, 2009

[9] The Companies Act, 2013, s. 61(1) (b), and Rule 71 of the National Company Law Tribunal (NCLT) Rules, 2016

[10] Neagu M, “Squeeze-Outs of Minority Shareholders: Methods and Pitfalls” (LexologyMay 7, 2018) <https://www.lexology.com/commentary/corporate-commercial/romania/schoenherr/squeeze-outs-of-minority-shareholders-methods-and-pitfalls#:~:text=In%20a%20reverse%20stock%20split,into%20one%20share%20of%20stock.>accessed March 7, 2023

[11] (2015) 125 CLA 77

[12] In accordance with the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016

[13] The Companies Act, 2013, s. 236