This article has been written by Sanjay E.

Introduction

The 21st-century world is showing a trend of moving away from the utilitarian idea of the greater good and is focusing much more on the rights of an individual than the majority. Even though India is not a place where this trend is almost obsolete, eventually the inevitable succumbing to trade liberalization, which started in 1991, will happen if the country wants to stay in the trade business.  

Democracies are paving the way for the representation of minorities as well. The assurance that even the voices of the minorities are heard despite there being a majority against them is one of the biggest advantages of democracy. Almost all the exhaustive, voluminous and extensive legislations in the world like the UN Charter, American Constitution, or Indian Constitution guarantees certain rights to the minorities which cannot be taken away even if the majority desires to.

The plight of minority shareholders

Similarly, in the case of a company, there are majority and minority shareholders. However, when it comes to the jurisprudential history of companies in various countries, the rights of minority shareholders are negligible and their concerns are easily overridden by the majority. This plight of minority shareholders is generally not taken seriously by Indian or UK legal systems.

With help of relevant case laws, I would argue that the trepidations exhibited for the minority shareholders who are crammed in between these squeeze out transactions are diminutive in nature, which is probably due to a postulation that there are definite profits that would unquestionably ascend from these kinds of squeeze outs. Further, these profits are used to vindicate the instinctive cessation of the minority shareholders’ interests. This comes with a caveat of acknowledgement regarding the justification of squeeze outs being helpful in removing an abusive minority shareholder, who acts as a hurdle in the way of the company’s success. However, I would consider it as an exception which is not good enough to make a generalization out of.

Aftermath of a squeeze out merger on minority shareholders

In the aftermath of a squeeze out merger, the minority shareholders are the adversely affected ones. There are various instances in which minority shareholders are left with no other options but to give in for a ‘fair price’, which is very difficult to objectively calculate.

In this article, I would argue about the ways in which the rights of the minority shareholders can be protected and the necessity for protecting them. Even though it is most likely that there are appraisal rights guaranteed to the minority shareholders in all jurisdictions, it alone is not enough to conclusively establish that minority shareholders are immune from the abuse of majority shareholders.

I would be considering a few merger orders given out by certain prominent legal authorities in India to portray the scrape of minority shareholders in case of a merger. I would also refer to the jurisprudence of Delaware Courts in the US which have transgressed further than appraisal remedies to safeguard the minority shareholders by entitling them to equitable rights.    

Profit maximization as an argument against minority shareholders’ rights

The success of a company is generally looked at solely from an economic perspective. Profit maximization is the only purpose of a company because it is the shareholders’ revenue that is going to be ultimately considered as the aim. Even though the aim of profit maximization should be achieved, it cannot be done in a way that violates certain legislations. Just in the pretext of profit maximization, rules of the state cannot be flouted.

There are different constitutional provisions like the right against bonded labour or child labour guaranteed to Indian citizens. Labour laws including the Industrial Dispute Act ensure that workers are not being exploited just for the sake of profit maximization.

So, the aim of profit maximization cannot be an argument against minority shareholders’ rights. It is not just an economical issue, especially when the world is starting to consider indices like job satisfaction and happiness to determine the efficiency of work and quality of life. Since there are these factors that determine what is good for an individual, a utilitarian argument of the greater good for the company becomes redundant to the same extent where a societal norm is in practice against the Constitution. It is possible that it exists but it must be gradually thrown out. This is one of the principles which guide WSDEs and other cooperatives like Amul.

Whether statutory appraisal rights are fair especially after the costs of litigation which the minority shareholders should incur?

Section 236 of the Companies Act, 2013, which lays down the procedure to be followed for the purchase of minority shareholding, is also structured in a way that encourages squeeze out.^[1] It is obvious that the Companies Act does provide protection to minority shareholders.  

According to Upendra Baxi, litigation expenses borne by the dissenting shareholders are clearly not worth the compensation they are receiving for giving up the shares.^[2] The price of the appraisal litigation as compared to the likely profits along with the uncertainty involved, without any doubt, apprehends most of the minority shareholders from pursuing an appraisal remedy. Especially for a small shareholder, the cost of litigation overshadows the possible benefits of the ‘fair price’.^[3] 

Calculation of fair price

Moreover, in the calculation of a fair price for settlement, an objective estimation seems impossible. A fair price is not adequate in protecting the minority shareholders because the exercise of this remedy happens only if the value paid as compensation is discriminating and exceptionally insufficient. It was Justice Katju in one of his statements in open court opined that this ex-post remedy is almost like a charity given by the majority after a request from the courts.^[4] It is only compensation and not protection for minority shareholders.

Deficiencies in the appraisal statutes

Due to the severe deficiencies accompanying the appraisal statutes, the constraint on alternate remedies reduces the security available for the minority shareholders. There is absolutely no other statute to protect these persecuted minority shareholders except the evolutionary jurisprudence of interpretation in case of judicial activism. This appraisal remedy is continuously used as an excuse by the legislature for not making statutes that protect the dissenting shareholders at the time of a merger. Even from an economic perspective, there are not enough statutes to ensure the protection of minority shareholders during a merger.

The Companies Act, 2013

As I mentioned in one of the earlier paragraphs, the world is vastly moving away from utilitarianism. The majority need not always be right as history has shown us from Galileo to Steve Jobs and that’s the precise reason why the world is focusing more on individual rights rather than a greater good for the greatest number. However, in the Companies Act, 2013, there are statutory provisions for the governing majority shareholders to easily enforce a squeeze out on the minority shareholders who are helpless to do anything about it. It is an agreeable proposition that a few of those minority shareholders are content with the fair price. However, for some others, shares are invaluable. There are many cases in which minority shareholders are emotionally attached to the company and we should recognize the grave injustice in squeezing them out of their own company just because they are minority or dissenting shareholders.^[5] 

It’s undeniable that minority shareholders have some remedies as protective techniques against tyrannical majority oppression. The Companies Act, 2013 provides for corroboration by an independent expert regarding the appraisals put forth by the merging companies. The shareholders have the right to approach the appropriate court of law for a suitable remedy and there are appraisal rights that enables the exit of a minority shareholder which is set according to some unwritten agreements.

Even though on paper it may seem like every statute is for the protection of minority shareholders, an analysis of the jurisprudence of civil courts suggests that 92% of the petitions for injunction given by the minority shareholders are rejected even before going into an extensive hearing of the case.^[6] Most of these suits are rejected within 2-3 hearings. This means that courts are also taking a pro majority stance when it comes to this. I am not forgetting that judges are bound by statutes but not even going into the merits of the case and rejecting the majority of suits just based on the majority’s opinion cannot be construed as a fair trial.

Case laws

A possible solution to this is an analysis of the ‘Business Purpose’ doctrine, as held in Singer v Magnavox^[7], applied by Delaware Court for reaching an idealistic goal of ‘Entire Fairness’ in Weinberger v UOP.^[8] The farsightedness in judicial activism of the Delaware Court is incredible in protecting the various rights of minority shareholders.

In the Singer case, the claim of the appellant was that the only purpose of the upcoming merger was the squeezing out of minority shareholders. After looking into the details of the case, the court found out that the appellant’s claim was true and subsequently held that a business purpose is mandatory to withstand a merger.

However, this holding was later on critiqued and questioned by the US Supreme Court because this was against the idea of a liberal trade system that the constitution guarantees.^[9] So, the same court, in the Weinberger case, modified the ‘Business Purpose’ doctrine to accommodate fair dealing along with the fair price to establish the ‘Entire Fairness’ doctrine.

The case established the need for substantive and procedural fairness. So, the court started appointing amicus curiae for investigating the allegations and were especially asked to scrutinize the actions of directors and majority shareholders. The larger minorities were also consulted while making a detailed report which has to be submitted to the judge within 90 days. Generally, in the situations where the amicus curiae wants to prove that majority shareholders’ decision to squeeze out was unfair and just for the sole purpose of squeezing out, the burden of proof is with the minority shareholder.

However, in case of a non-arm’s length transaction where the shareholders have an existing relationship with each other, it has to be ensured that both parties in the deal are acting in their own self-interest and are not subject to any pressure or duress from the other party. Here, the burden of proof is on the majority shareholders to prove the fairness of it.

It can be argued that the Delaware court has started to open a new page in the jurisprudence of fiduciary duty when they held in Brinckerhoff v. Enbridge Energy Company that majority shareholders are in a position of a fiduciary just like directors.^[10] The court held that upon a purposive interpretation of the term fiduciary duty, it seemed like a duty of loyalty which arises when a person is in the place to influence the decision of others and these people have placed faith in that person to make decisions for them.

Trust and fiduciary duty

Generally, in the company laws of various jurisdictions, directors are construed to owe a fiduciary duty to the company. When we analyze the inter shareholders conflict, majority shareholders have better bargaining power. Most of the time, minority shareholders have to place their trust in the majority shareholders’ decisions which can be classified into a fiduciary relationship.

Even though the court agreed that there is no comparison between the duties of a director to that of majority shareholders, the existence of a trustee beneficiary relationship can be figured out in the case of shareholders. Trust is a big factor in a fiduciary as it is supposed to act for the beneficiary and not herself. So there should be disclosure on everything which may have a bearing on the fiduciary. Thus, the court explained the fiduciary duties of the majority like acting bonafide in the interests of the minority shareholders as well because they are a part of the company.

Misusing the proper purpose doctrine

This comes with the duty to disclose while exercising the proper purpose doctrine. Proper purpose doctrine is also misused by the majority especially in a squeeze out merger. So, the relationship between majority and minority shareholders empowers the fiduciary to make decisions that can be detrimental to the beneficiary which can make it vulnerable for the minority shareholder.

Here, the obligation is on the majority shareholders to disclose all the relevant facts, especially during mergers. Obviously, the failure in doing so amounts to a breach of contract in the form of a breach of trust. The controlling shareholders which form the majority are under a fiduciary duty towards the non-controlling shareholders which form the minority. This is still a setup that is nowhere mentioned in Indian statutes or does not form a part of judicial activism.

Conclusion and suggestions

The urge to figure out a balance between a democratic setup of the company laws against the profit maximization has vastly become construed as a tyranny of majority versus the tyranny of the minority. If we analyze historical events, it may seem like the tyranny of the majority is much more dangerous than the tyranny of the minority.

However, the question of making majority expendables for the minority still remains intact. In the case of the companies, the question of placing minority rights above the needs of the majority will be catastrophic. Ensuring adequate protection to the minorities and keeping in mind the interests of the majority is a herculean task but it is possible.

The necessity of figuring out a balance is important because shares are given different values by different shareholders. We should not be perplexed by this idea because India as a country is filled with emotionally driven people who may not come out as the most rational beings. There can be ego issues or other emotional attachment or any other reason which may not be adequately compensated by the concept of a fair price. However, this element of subjectivity is totally ignored by Indian laws or judgments and there is no explicit provision for the protection of minority shareholders.            

It is surprising to know that so far there have been no hard cases in front of the constitutional courts of the country regarding this issue and there are no explicit statutes to protect the minority shareholders. In all the jurisdictions around the world, except for the Delaware court, even the socialist regimes or the so-called welfare states are generally silent about the rights of minority shareholders during a merger. Except for instances like the Mondragon model of WSDEs, where there exists a freedom to raise their opinions as shareholders and contribute in decision making, there are no rights guaranteed to the minority shareholders.^[11] 

Ensuring a fair chance for the minority shareholders can be done keeping in mind the ultimate aim of sustaining the company. For example, ex-ante rights can be guaranteed by amendments to freeze certain statutes by restricting majority powers. The onus of proving the fairness of a merger should be on the controlling shareholders which form the majority. It is also surprising that any case based on violation of Article 19(1)(g) has not been heard by the apex court of the country.

Due to the fact that the idea of independent directors or majority of minority shareholders’ approval has so far not been able to solve the skirmish between them, a statute is a necessity for the protection of minority shareholders. The idea of fiduciary duty of obligation and loyalty as explained by Delaware court could also be easily involved as an amendment in the Companies Act, 2013. The civil remedy in the form of compensation is not enough. We must also not forget that despite the right to property not being a fundamental right anymore after the 44th amendment, one cannot deprive a person of her property without a chance to protect it.          

References