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This article is authored by Akash Krishnan, a student from ICFAI Law School, Hyderabad. It discusses in detail the changes in the procedure for sanctioning the schemes of mergers under the Companies Act 1956 and the Companies Act 2013 in light of a landmark judgment by the Supreme Court in this regard.

Introduction

India has been a commercial hub since time immemorial. However, the first Act that governed the functioning of a company in post-independent India was the Companies Act, 1956. This Act governed the Indian company law regime for over 50 years and was repealed in 2013 with the enactment of the Companies Act, 2013.

This article specifically focuses on the provisions of merger and amalgamation under the old and new company law regimes by critically analysing the observations of the Supreme Court in the case of Miheer H. Mafatlal vs. Mafatlal Industries Ltd (1996). Before moving on to the case, let us first try and understand the procedure for sanctioning a scheme of merger under the old company law regime.  

Procedural aspects of sanctioning the scheme of arrangement in the old regime

Companies Act, 1956

Sections 391, 392, 393 and 394 of the Companies Act 1956 deal with the procedure for sanctioning the scheme of merger and amalgamation. Let us understand this procedure in detail.

Memorandum of Association (MOA) and Board meetings

Both the companies who wish to merge or amalgamate with each other, i.e., the transferor and transferee companies should be empowered by the objects clause in their MOA to undertake such merger or amalgamation. However, this is not an absolute rule and even if the MOA does not inherently empower the merging entities, the companies are free to merge.

Once the merging entities have decided on the plan/scheme of merger, this scheme has to be approved in a joint meeting of the board members of both companies.

Valuation of shares and fairness of exchange ratio

The valuation of shares of both the merging entities has to be carried out by qualified chartered accountants. Once the valuation of shares is done, these chartered accountants will be responsible for determining the exchange ratio of these shares. This exchange ratio has to be accepted by 3/4th majority shareholders of both the merging entities. The exchange ratio is calculated through a combination of the yield method, asset value method and market value method.

The Court is not empowered to change or to issue directions to substitute the exchange ratio if the shareholders have accepted it. This is called the principle of non-interference and the same was laid down by the English Court in the landmark case of Foss vs. Harbottle (1843). The same was recognised and adopted by the Supreme Court in the case of Rajahmundry Electric Supply Co. vs. Nageshwar Rao (1956). However, the exchange ratio or valuation can be set aside by the Court on the ground of fraud.  

Filing of Petition with High Court and order of the High Court

Once the scheme of amalgamation has been approved by the board and the process of valuation of shares and preparation of exchange ratios has been completed, the next step is to file a petition in the High Court for the approval of the scheme of amalgamation. If both the companies are situated in the jurisdictions of different High Courts, then a separate petition has to be filed in each High Court. However, if both the companies are situated within the jurisdiction of the same High Court, a joint petition for the approval of the scheme can be filed.

The High Court after hearing the petition will pass the order convening a meeting of the shareholders and creditors of both the companies for the joint approval of the scheme.

Approval of the scheme

The shareholders and creditors of the company will meet on the predetermined date and vote on the scheme of the merger. The voting is conducted by a poll and a 3/4th majority is required for the adoption of the scheme of merger. Once the scheme has been adopted, it is binding on the dissenting minority as well.

Now that we have understood the procedure in detail, let us now look into the case at hand. 

Miheer H. Mafatlal vs. Mafatlal Industries Ltd

Brief Facts

  1. The transferee company, Mafatlal Industries Limited (MIL), was incorporated in 1913. The objects clause present in the MOA of MIL indicated that the company was incorporated for carrying out all kinds of businesses involving cotton spinning, wool, silk, jute etc. The authorised share capital of the respondent company was Rs. 100,00,00,000 divided into 30,05,500 equity shares of Rs. 100 each and 69,94,500 unclassified shares of Rs. 100 each.
  2. The transferor company, Mafatlal Fine Spinning and Manufacturing Company Limited (MFSL) was incorporated in 1931 and the objects clause of this company indicated that the company was incorporated for carrying out the business of manufacture and sale of textile piece goods and chemicals. The authorised share capital of the transferor-company was Rs. 30 crores divided into 30,00,000 ordinary shares of Rs. 100 each.
  3. Due to the limited financial resources that were available to both the companies, they had to let go of several business opportunities. In light of the same, the directors of MFSL proposed a merger with MIL and the same was accepted by the directors of MIL. A proposal for the merger was drafted and resolutions were passed for the formation of a detailed scheme of merger and the scheme of the merger was successfully formed thereafter.
  4. Since both the companies were not part of a common jurisdiction of a High Court, separate applications were filed by both companies for the approval of the scheme of merger. MFSL filed an application in the Bombay High Court and the Bombay High Court after considering the application, sanctioned the scheme. When the scheme was sanctioned by the Bombay High Court, the Court had directed MFSL to conduct a meeting of the equity shareholders for the approval of the scheme. When the meeting was conducted, the scheme was approved by an overwhelming majority. Over 5000 members voted in favour of the merger whereas only 143 members voted against it. The appellant participated in this meeting through a proxy.
  5. MFSL filed an application in the Gujarat High Court. However, before the scheme could be sanctioned by the Court, the appellant, a director of MFSL and a shareholder of MIL, filed an objection to the scheme of merger.  
  6. The Single Judge at the Bombay High Court after listening to the objection filed by the appellant ruled in favour of the merger. On an appeal to a Division Bench, the Court upheld the order of the Single Judge. In light of the same, the appellant had knocked on the doors of the Supreme Court through this appeal.

Findings of the Supreme Court

Non-disclosure of material interests

The contention of the appellant

  1. The first contention raised by the appellant was that the statutory procedure for the approval of the scheme in the meeting of shareholders as prescribed under Section 391(1)(a) of the Companies Act, 1956 was not followed.
  2. To support this contention, he relied on the explanatory statement that was placed for consideration in the meeting of equity shareholders. He contended that the explanatory statement failed to disclose the material interests of the director of MIL and the effects of the merger on the material interest.
  3. The material interest as contended by the appellant was a private dispute between the appellant and the director of MIL that was under consideration in the Bombay High Court. In that case, the appellant was claiming the shares of the director of MIL by relying on a family settlement agreement and the director was claiming otherwise.
  4. In light of these contentions, he claimed that the equity shareholders could not make an informed decision due to the non-disclosure of material interests.

Observations of the Court

  1. The Court interpreted Section 393(1) and held that there were 3 essential requirements for the establishment of a material interest of the director and the effects of the merger on the material interest. These essentials have been enumerated below:
  • The director’s interest must be different from the interests of the other voting members in the meeting.
  • The merger should have an effect on the material interest.
  • The effect of the merger on the interests of the director should be different from the effect of the merger on the interests of the voting members.  
  1. In light of the same, the Court held that a private family dispute between the appellant and the director of MIL had no substantial connection with the merger nor had an effect on the interest of the director w.r.t the merger. Thus, it was not mandatory to disclose the details of the dispute in the explanatory statement.
  2. Further, from the total number of equity shareholders who voted in the meeting, over 95% voted in the favour of the scheme. Out of this 95%, only 8% votes came from the individuals who were part of a trust formed by the director of MIL. The rest of the votes had come from financial institutions and other private entities. Thus, irrespective of the disclosures, the intent of the equity shareholders to approve the scheme was clear and since the disclosure was not mandatory, it cannot be deemed that the equity shareholders did not make an informed choice.   

Absence of requisite majority

The contention of the appellant

The appellant contended that the scheme was not approved by a requisite majority as prescribed under Section 391(2) of the Companies Act, 1956. To support this contention, he relied on the fact that the majority shareholders had acted as a class and not as individual members while casting the vote.

Observations of the Court

  1. The Court relying on the English case of Hellenic and General Trust Limited (1976) concluded that while sanctioning a scheme of merger, the Court has to look into the bonafide actions of the majority acting as a class and not as individual members. Just because the appellant was part of a different class of shareholdings, it cannot be deemed that the majority had acted unfairly against him.
  2. The Court further noted that before the applications for sanctioning of the scheme were filed in the respective Courts, the directors of both the companies had agreed to the scheme of merger. The appellant was the director of MFSL and had given his approval to the scheme at that time. Also, he did not object to the scheme when the sanction was sought from the Bombay High Court by MFSL.
  3. In light of the same, the Court concluded that the actions of the appellant indicated that he was in approval of the merger and because the requisite majority had voted in favour of the scheme, this contention was invalid.

Suppression of minority interest

The contention of the appellant

The appellant contended that the class of equity shareholders had acted in concert and the actual intent behind the majority decision was to suppress the minority shareholders. He, therefore, claimed that the voting was unfair and the minority/dissenting shareholders will not be bound by it.

Observations of the Court

  1. The Court noted that the object of the merger was to increase the financial resources of the merged entity so that they could take up new projects and expand the scope of their services and thus the merged entity would bring more profits to all the shareholders. In light of the same, the Court held that the voting was neither unfair nor prejudicial to the interests of the minority shareholders.  
  2. To support this conclusion, the Court stated that in order to prove suppression of a minority, it has to be proved that the majority has acted in a manner that is prejudicial to the interests of the minority. But in this case, the interests of the majority and the minority were aligned because the resultant entity was going to generate more profits than the individual companies and thus, there was no question of differing interests or suppression of the interests of the minority.

Sub-class of creditors

The contention of the appellant

  1. The appellant contended that he belonged to a different class of equity shareholders, i.e., by virtue of the family arrangement that was in dispute, he belonged to a special minority class of equity shareholders and thus, he had special rights of voting.
  2. He further contended that the meeting that was convened was of equity shareholders only and a separate meeting for his class of special minority shareholders was not convened. Thus, the voting regarding the approval of the scheme was still incomplete.

Observations of the Court

  1. The Court rejected both these contentions on the ground that the articles of association of the transferee company only recognises two classes of shareholders, i.e., equity shareholders and preference shareholders. It did not recognise any separate/special class of shareholders. Thus, the appellant would come under the same class of shareholders, i.e., equity shareholders.
  2. According to Section 393(1), if a scheme of a merger has been proposed between a company and any class of its members, a meeting of such a class of members has to be convened. In this case, the class of members involved is the equity shareholders and thus the meeting convened was in accordance with the provisions of law. There was no provision in the law that recognised the right to hold a special meeting for a sub-class.

Exchange ratio

The contention of the appellant

  1. The appellant contended that the exchange ratio should be prepared by the chartered accountants before an application for sanction is filed to the High Court. However, in this case, even though the exchange ratio was determined before, it was unfavourable to the shareholders of the transferee company because for every two shares of the transferee company, five shares of the transferor company were being issued.
  2. The appellant contended that applying this exchange ratio will cause significant loss to the shareholders of the transferee company and at least 6 shares of the transferor company should be exchanged for every 2 shares of the transferee company.

Observations of the Court

  1. The Court noted that the valuation of shares is based on 4 factors, i.e., capital cover, yield, earning capacity of the company and marketability. The chartered accountancy firm involved had used several reliable methods to determine the value of the shares like earnings per share method, break value method, market value method etc. The Court further noted that the appellant had approved this exchange ratio at the initial states itself.
  2. The Court on the basis of the aforesaid details held that it is not the duty of a Court of appeal to question or analyse the credibility of such expert opinions. Moreover, the appellant had failed to provide an alternative opinion in this regard. Therefore, the Court held that it will not interfere within these internal affairs of the company and because the offer was accepted by the statutorily recognised majority, the shareholders will be bound by the same.  

Now that we have understood the principles laid down in this case, let us look into how the law regarding the sanctioning of the scheme of a merger has changed under the new regime. 

Procedural aspects of sanctioning the scheme of arrangement in the new regime

Companies Act, 2013

Sections 230, 231 and 232 of the Companies Act 2013 deal with the procedure for sanctioning the scheme of merger and amalgamation. Let us understand this procedure in detail.

Meeting of the creditors and members

  1. When two companies come together and propose a scheme of merger, an application to convene a meeting regarding the same has to be filed with the National Company Law Tribunal (NCLT). The NCLT after going through the application may pass an order for convening a meeting to vote on the scheme of merger.
  2. In the meeting, at least 3/4th majority of the creditors/members should vote in the favour of the scheme for its adoption.

Sanctioning of the scheme by NCLT

  1. Once the creditors/members vote in favour of the adoption of the scheme, the scheme has to be submitted to the NCLT for its sanction. The NCLT after considering the scheme and the votes may pass an order sanctioning the scheme.
  2. While sanctioning the scheme, the NCLT can also pass orders w.r.t transferring of liabilities, allotment of shares, provisions for dissenting shareholders etc.
  3. The NCLT also has the power to pass directions w.r.t supervision of the implementation process or pass orders w.r.t any modifications that have to be made in the scheme for its better implementation.

Conclusion

This case brings to light several important aspects of the sanctioning of the scheme of merger. This includes the inapplicability of sub-classes, material disclosures, suppression of minorities etc. In the modern regime, even though the procedures for the formation and sanctioning of the schemes have changed, the core principles remain the same and thus the principles laid down, in this case, are even applicable in this modern regime.  

References

  1. https://taxguru.in/company-law/mergers-amalgamations-companies-act-1956.html 
  2. https://taxguru.in/company-law/merger-amalgamation-companies-act-2013.html 
  3. https://blog.ipleaders.in/procedure-for-compromises-arrangements-and-amalgamation-under-the-companies-act/ 
  4. https://d1.manupatra.in/ShowPDF.asp?flname=Miheer_H_Mafatlal_vs_Mafatlal_Industries_Ltd_110910421s970844COM556440.pdf 
  5. In Re Hellenic & General Trust Ltd [1976] 1 WLR 123 

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