CHAPTER - 8 CORPORATE RESTRUCTURING AND REVIVAL OF...
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CHAPTER - 8
CORPORATE RESTRUCTURING AND REVIVAL OF SICK
COMPANIES
Corporate restructuring is an expression that connotes a restructuring process
undertaken by business enterprises for the purpose of bringing about a change for the
better and to make the businesses competitive. Restructuring is a method of changing the
organizational structure in order to achieve the strategic goals of the organization or to
sharpen the focus on achieving them. Corporate restructuring a comprehensive process by
which a company can consolidate its business operations and strengthen its position for
achieving its short-term and long-term corporate objectives – synergetic, dynamic and
continuing as a competitive and successful entity. In the words of Justice Dhananjaya Y.
Chandrachud, Corporate restructuring is one of the means that can be employed to meet
the challenges which confront business.
Corporate restructuring has become an imperative need in the wake of challenges
and opportunities made available to the economy. The emergence of World Trade
Organization, joint ventures and alliances between Indian and multinational companies,
approval to the new takeover code regulations and other factors have influenced the
corporate organizations in their decisions or moves towards joint ventures, mergers,
amalgamation and takeovers. Mergers are subject to approval by shareholders bodies of
both companies as well as judicial review.
In India, the process of economic liberalization and globalization ushered in the
early 1990‟s created a highly competitive business environment which motivated many
companies to restructure their corporate strategies. The restructuring process led to an
unprecedented rise in strategies like amalgamations, mergers including reverse mergers,
demergers, takeovers , reverse takeovers and other strategic alliances.
A business may grow over time as the utility of its products and services is
recognized. It may also grow through an inorganic process, symbolized by an
instantaneous expansion in work force, customers, infrastructure resources and thereby an
overall increase in the revenues and profits of the entity. Merger, amalgamations,
acquisitions, consolidation and takeovers are the expressions that have become common
to the corporate sector. Mergers and Acquisitions (M&A) serve as a vital instrument of
Corporate Governance to increase corporate efficiency. Mergers and acquisitions provide
the platform where corporate ethos, minority rights protection, cultural conditions,
regulatory environment and other contentious issues are tested over times. The economic
reforms have resulted in a radical change in the process of corporate control and other
forms of restructuring.
The procedure for putting through a merger and acquisition transaction under the
Act is very tedious and a lot of time is consumed in the completion of this process.
Sections 391 to 396 deal with the procedure, powers of the court and allied matters. The
basic difference between a court merger and an acquisition is that, in case of a merger,
the transferor company will be dissolved, whereas, in case of acquisition, the transferor
company continues to exist. A resolution to approve the scheme of arrangement has to be
passed by the shareholders in the general meetings. The shareholders have to vote on the
resolutions on the schemes of arrangement on the basis of the disclosures in the notice/
explanatory statement. Section 393 of the Act specifies the broad parameters of the
disclosures which should be made to the shareholders/ creditors for approving a statutory
scheme of arrangement.
The provisions of the Act, specifically sections 391 to 394, contain an elaborate
framework that enables companies to give effect to arrangements and compromises with
their shareholders and creditors. The expression „arrangement‟ has been interpreted to
include a wide range of transactions, such as mergers, demergers and other forms of
corporate restructuring (including debt restructuring). This framework has largely
functioned well and in fact, the above provisions have been extensively used by the
corporate sector in India, much more so than similar provisions contained in statutes in
other countries. The judiciary has also clearly laid out the parameters within which such
schemes of arrangement may be initiated, approved by shareholders and creditors and
then accorded the sanction of the court.
The Supreme Court has held 1 that the court has the necessary power to go into
all the incidental and ancillary questions in an effort to satisfy itself whether the scheme
has the approval of the requisite majority.
Never have the mergers and acquisitions been so popular from all angles – policy
considerations, businessmen‟s outlook and even consumers point of view. Courts too
have taken emphatic view towards mergers. The classic example is the remarks of
Supreme Court in the HLL – TOMCO merger case‟ where in the court had stated that in
this era of hyper competitive capitalism and technological change, industrialists have
realized that mergers/ acquisitions are perhaps the best route to reach a size comparable
to global companies so as to effectively compete with them. The harsh reality of
globalization has dawned that companies which cannot compete globally must sell out as
an inevitable alternative.
Public Sector Undertakings, private sector companies, as also family enterprises
are seeking recourse to restructuring on the assumption that it will put their enterprise to
the path of growth and success. They also believe that the challenge of internal and
external competition can be met only through restructuring the organization. Corporate
restructuring usually pays attention to the various criteria such as the objectives to be
achieved, the nature of the business i.e. trading, marketing, manufacturing or servicing,
territory of operations, the people to be organized in a network of relationship, the
product, process, technology to be adopted, the time dimension of operations and
activities, the extent of mechanization and automation, computerization, competitors,
customers, suppliers, contractors, collaborators, financial institutions and also the
stakeholders.
1 Miheer H. Mafatlal v. Mafatlal Industries (1996) 4 Comp LJ 585 (Guj)
A well thought process in depth, systematic and scientific study of restructuring
will take into account the different vital factors such as – the broad macro level
economic and financial indicators pointing the trend and direction of business and the
enterprise vis-à-vis the other entities engaged in similar or related activities; the
perceived impact or actual effect of merger, acquisition or a takeover of the enterprise,
the likely impact of the government policy on the present and future status of business
such as demolition of protective barriers, withdrawal of incentives, encouragement of
foreign capital inflow, investment and competition; perceived ability or inability of the
existing structure and its components to meet the requirements of the enterprise in the
near future; other stray signals or specific technology related changes or innovations or
break through which might render the extent structure inadequate, the likely intent of
business to expand by diversification, entering into collaboration or a joint venture for
increasing market share or for taking recourse to exports; a broad profile of the available
manpower resources and similar other factors.
Corporate restructuring being a matter of business convenience, the role of
legislation, executive and judiciary is that of a facilitator for restructuring on healthy
lines. The present stand of the Government is that monopoly is not necessarily bad
provided market dominance is not abused.
In India, the concept has caught like wild fire with a merger or two being reported
every second day and this time Indian Companies are out to make a global presence. The
Jamshedpur based steel giant, Tata Steel won the two-month long battle for Corus group
against Anglo-Dutch Steelmaker Cia Sidemrgica National (CSN) by offering $ 12.2
billion for the 20 million-tonne high grade steelmaker to become the fifth largest in the
world.
The going global is rapidly becoming Indian Company‟s mantra of choice. Indian
companies are now looking forward to drive costs lower, innovate speedily and increase
their International presence. Companies are discovering that a global presence can help
insulate them from the vagaries of domestic market and is one of the best ways to spread
the risks. Indian Corporate sector has witnessed several strategical acquisitions. Tata
Steel‟s acquisition of Corus Group, Mittal Steel‟s acquisition of Arcelor, Tata Motors
acquisition of Daewoo Commercial Vehicle Company, Tata Steel acquisition of
Singapore‟s Natsteel, Reliance‟s acquisition of Flag is the culmination of Indian
Companies efforts to establish a presence outside India. Not only this, to expand their
operations overseas, the Indian companies are acquiring their counterparts or are making
efforts towards efforts the end viz. the merger of Air India and Indian Airlines.
The corporate restructuring exercise generally involves the following techniques:
Joint Venture – Joint venture is a business enterprise for profit in which two or more
parties share responsibilities in an agreed upon manner by providing risk capital,
technology, patent/trademark/brand names and access to market. Joint ventures with
Multi National Corporations contribute to the expansion of production capacity, transfer
of technology and capital and above all, penetration into the global market.
Would a deadlock situation between partners under a joint venture be a justifiable
ground for passing an order of winding up of the joint venture company under the “just
and equitable clause” of section 433 (f) of the Act? The Delhi High Court held that it
would be justifiable in the facts of the case before it where the equal joint venture
partners had reached a deadlock; no further investments were being made in the company
and the disagreements on the management of the company had reached irreconcilable
hostility2.
Merger, Amalgamation and Takeover – Reconstruction of companies is crowded with
various hurdles which have to be crossed before an acquisition or a merger takes place.
Though such laws and regulations are in place to protect the interest of the shareholders
and creditors. However, for any merger or acquisition of any company, the report of the
auditor plays a very important role in the process. He initiates and concludes the
accounting process in the process of reconstruction of a company. The books of the target
2 Sangram Singh P. Gaekwad v. Shantadevi P. Gaekwad (D) (2005) 2 Comp LJ 385(SC)
company can also be inspected in order to protect the rights of the acquires company, so
as not to be defrauded later. The Official Liquidator had conducted an audit by
appointing auditors to look into the financial affairs including the balance sheet dated 30
June, 2006 of the Indian Charge Chrome Ltd3 and had categorically reported that the
audit did not reveal any information or indication that the affairs of the company had not
been conducted in a manner prejudicial to the interest of its members or the public.
The court allowing the application had opined that the thing which needs to look
into is firstly whether the accounts have been prepared according to the set standards of
accounting and secondly whether the scheme of reconstruction is reasonable, fair and
according to the law and in the interests of the secured creditors4. What is sine qua non
for the court to pass an order for sanction of scheme of amalgamation is primarily the
meeting of the creditors or the class of creditors or shareholders apart from being aware
of the financial position of the company5.
A merger involves the decision of two companies to combine and become one
entity; it can be seen as a decision made by two “equals” or little less than equals. Merger
and acquisition are manifestations of an inorganic growth process. While merger can be
defined to mean unification of two companies into a single entry, acquisitions are
situations where one entity buys out the other to combine the bought entity with itself. It
may be in the form of a purchase, where one business buys another or a management
buys out, where the management buys the business from its owners. A variety of reasons
such as growth, diversification, economies of scale, managerial effectiveness, utilization
of tax shields, lower financing costs, strategic benefit and so on are cited in support of
merger proposals. Domestic examples of some of the recent mergers are merger of
Reliance Petroleum Ltd with Reliance Industries Ltd and merger of JP Hotels Ltd with JP
Associates Ltd and examples of international mergers can be merger of American
3 In re: Indian Metals and Ferro Alloys Ltd; In re: Indian Charge Chrome Ltd (2009) 149
Comp Cas 362 (Orissa) 4 In Re Lord Chloro Alkalies Ltd (2009) 148 Comp Cas 873
5 In re Spartek Ceramics India Ltd (2006) 1 ALT 589
Automaker, Chrysler Corporation with German Automaker, Daimler Benz in 1998 to
form Daimler Chrysler.
Mergers and acquisitions are strategic decisions taken for maximization of a
company‟s growth by enhancing its production and marketing operations. They are being
used in a wide array of fields such as information technology, telecommunications and
business process outsourcing as well as in traditional businesses in order to gain strength,
expand the customer base, cut competitions or enter into a new market or enter into a new
market or product segment.
Amalgamation signifies the transfer of all or some of the assets and liabilities of
one or more existing business entities to another existing or new company. While a
merger is used for the fusion of two companies to achieve expansion and diversification,
amalgamation is an arrangement for bringing the assets of two companies under the
control of one company.
Thus, mergers and amalgamations may take two forms:-
Merger through Absorption – Absorption is a combination of two or more companies
into an „existing company‟. All companies except one lose their identity in such a merger.
For example, absorption of Tata Fertilisers Ltd (TFL) by Tata Chemicals Ltd(TCL).
TCL, an acquiring company, a buyer, survived after merger while TFL, an acquired
company, a seller, ceased to exist. TFL transferred its assets, liabilities and shares to
TCL.
Merger through Consolidation – A consolidation is a combination of two or more
companies into a „new company‟. In this form of merger, all companies are legally
dissolved and a new entity is created. Here, the acquired company transfers its assets,
liabilities and shares to the acquiring company for cash or exchange of shares. For
example, merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian
Software Company Ltd and Indian Reprographics Ltd into an entirely new company
called HCL Ltd.
Besides, there are three major types of mergers:-
Horizontal Merger – It is a combination of two or more firms in the same area of
business. It is a merger where the companies manufacturing similar kinds of commodities
or running similar type of business merge with each other. For example, combining of
two book publishers or two luggage manufacturing companies to gain dominant share.
Examples of this merger are merger of Lipton India and Brooke Bond, Bank of Mathura
with ICICI Bank, BSES Ltd with Orissa Power Supply Company, Associated Cement
Companies Ltd with Damodar Cement.
Vertical Merger – It is a combination of two or more firms involved in different types of
production or distribution of the same product or a merger between two companies
producing different goods or services. For example, joining of a TV manufacturing
(assembling) company and a TV marketing company or joining of a spinning company
and a weaving company.
Conglomerate Merger – It is a combination of firms engaged in unrelated lines of
business activity. For examples, merging of different businesses like manufacturing of
cement products, fertilizer products, electronic products, insurance investment and
advertising agencies. L&T and Voltas Ltd are examples.
Concentric Merger – It is a merger of firms which are similar type of business. For
example merger of cement business of L&T with the cement business of Kumar
Mangalam Birla group of Companies and merger of Shaw Wallace with United Spirits
Ltd or merger of Sahara Airlines with Jet Airways and merger of Deccan Air with King
Fisher Airlines.
The process of mergers and acquisition in India is court driven, long drawn and
hence problematic. The process may be initiated through common agreements between
the two parties but that is not sufficient to provide a legal cover to it. The sanction of the
High Court is required for bringing it into effect. The Companies Act, 1956 consolidates
provisions relating to mergers and acquisitions and other related issues of compromises,
arrangements and reconstruction. The Central Government has a role to play in this
process and it acts through an Official Liquidator (OL) or the Regional Director of the
Ministry of Company Affairs. The entire process has to be the satisfaction of the court.
This sometimes results in delays.
In case of a proposed scheme for amalgamation of company which is being
dissolved without winding up, the law requires a report form the OL or ROC that the
affairs of company have not been conducted in a manner prejudicial to the interest of its
members or to public interest. The Act also requires that no order for dissolution of any
transferor shall be made by the court unless the OL makes a report to the court that the
affairs of the company have not been conducted in a manner prejudicial to the interest of
its members or to public interest. The Committee felt that the above two requirements
under the present law can be recovered by issuing notices to ROC and OL respectively
who may file the report on the proposed merger before the court. Filing of the such report
may be time-bound, beyond which it may be presumed that ROC/OL concerned have no
comments to offer.
Single Window Concept
The law should provide a single forum which would approve the scheme of
mergers and acquisition in an effective time bound manner. In Company Law Bill, 2009,
„there are new provisions to provide for a single forum for approval of merger &
acquisitions along with a shorter merger process for holding & wholly owned subsidiary
companies or between two or more small companies.‟ The law should also provide for
mandatory intimation to regulators in respect of specified class of companies.
Court decisions on merger and amalgamation
There have been a number of situations, when the companies with similar
business have applied for amalgamation and the same have been sanctioned.
The transferor and transferee companies were carrying on business which was
more or less similar in nature6. The board of directors of the two companies felt that
amalgamation would be in the interest of both the companies. Members and Creditors of
the company had no objection. The OL and Regional Director okayed the merger. The
court granted sanction.
The decision is that there can be no objection to amalgamation of companies with
similar objects if those objects are such that they can be conveniently and advantageously
combined7. The scheme was approved because apart from this, there were no objections
as to fraud manipulation or evasion of Taxes.
Where the transferor and transferee companies were engaged in the same line of
business, their amalgamation was sanctioned because the scheme would enable both
companies to effect internal economy and optimize productivity8.
Similarity of objects and business not essential for amalgamation or mergers of
companies in the case9
, the scheme of amalgamation was opposed by the Regional
Director of the CLD on the ground that the claim that transferor and transferee companies
are engaged in same/ similar business has been found to be factually incorrect. Reliance
was placed on the Balance Sheet of the transferor company for the year ending
31.03.2003. The counsel for the petitioner in the reply affidavit stated that the transferor
and transferee companies are run by the same management. The counsel for the applicant
argued that for sanction of the scheme of amalgamation, it is not mandatory that the
objects of the two companies are pari materi or that the companies are involved in
similar businesses. He placed reliance on the decisions in the cases10
the court had held
that amalgamation u/s 394 of the Act is primarily an internal matter of the two companies
and requires approval of the shareholders secured and unsecured creditors of the
6 Cheminor Drugs Ltd (2001) 29 SCL 277 (AP)
7 Mcleod Russel (India) Ltd, Re (1997) 4 Comp. LJ 60 (Cal)
8 Debikay Sales (P) Ltd Re. (2000) CLC 757 (Del.).
9 Steel Kingdom Netcom Ltd. In re. (2004) 62 CLA 118 (Del)
10 W.A. Beardsell & Co. (P) Ltd. In re. (1968) 1 Comp. LJ (102) (Mad.) and Mcleod
Russel (I) Ltd. In re. (1997) 4 Comp. LJ 60 (Cal.)
companies seeking amalgamation, it is essentially an arrangement for mutual benefit in
creating a larger resource base and streamlining administration. The scope of interference
by the court is confined to considerations of legality and public interest only. Diversity of
objects of the two companies cannot in any case be a ground for declining sanction to the
proposed scheme of amalgamation.
When there is a merger of subsidiary company and also there is clubbing of
authorized share capital of the transferor and transferee company, there is no need to
follow the provision of Section 94 and 97 of the Companies Act, 1956. The Company
Court is duly empowered to sanction the same under Section 394.11
The Bombay High Court held that no additional fee is payable upon the merger of
the authorized capitals of the transferor and transferee companies12
.
The Bombay high Court in a matter of scheme of amalgamation, considered the
issue of devolution of interest of transferor on transferee13
. The concept of abatement is
not attached to a situation where, as a result of a scheme of amalgamation, the transferor
company ceased to exist and there was devolution of interest upon the transferee, the
transferee was entitled to be impleaded in the proceedings.
Scheme of amalgamation – Sanction of Court
The provisions of Rule 85 of the Company (Court) Rules, 1959 are not attracted
because there was no reduction of share capital being resorted to as a consequence of the
scheme. The scheme of amalgamation of the transferor company with the transferee
company has been approved by the shareholders and creditors of both the companies and
both the Official Liquidator and the Regional Director , Northern Region. Company Law
Board has not found any objection to the scheme of amalgamation being approved. The
scheme was sanctioned and the same shall be binding on all the shareholders and the
11
Kemira Laboratories Ltd, In re (2007) 140 Comp Cas 817 (AP) 12
You Telecom India Pvt. Ltd, In Re (2008) 141 Comp Cas 43 13
Delta Distilleries Ltd v. Shaw Wallacne and Co. Ltd (2009) 148 Comp Cas 809 (Bom)
creditors of the transferee company and all the assets, liabilities and reserves of the
transferor company shall vest in the transferee company14
.
Where the valuation of the assets of the transferor company is not made properly
and disinterestedly the court cannot sanction a scheme of amalgamation of two
companies15
.
The Supreme Court observed “Amalgamation or reconstruction has no precise
legal meaning16
. In amalgamation two or more companies are fused into one by merger
or by taking over by another when two companies are merged and are so joined as to
form a third company or more is absorbed into one or blended with another the
amalgamating company loses its identity.”
A scheme of amalgamation approved by the majority of the equity shareholders
and unanimously by the secured and unsecured creditors was sanctioned by the court in a
petition by the transferee company17
. The objections raised by the objector regarding
undue haste shown in moving the scheme and regarding the fairness of the reports
prepared by the two experts were rejected by the single judge also refused to consider the
objections received by post after conclusion of hearing of the petition (Reliance Inds. Ltd,
in re (2009) 151 Comp cases 124 (Bom). On appeal, the Division Bench held that in the
absence of any material contradicting the conclusions reached by the experts with
respect to valuation and fairness, it would be difficult to come to a finding that the
conclusions drawn by those experts were absurd. The methods employed by the valuers
were standard methods. The court could not go into the technical aspect regarding the
approach of the methods.
The court refused to give sanction to the scheme on the ground that the documents
filed by the petitioners were contrary to each other and the petitioners had withheld
14
Gulmohar Finance Ltd. (1998) 93 Comp case 544 15
Patiala Starch and Chemical Works Ltd. In re. AIR 1958 Punj 30 (1958) 28 Comp.
Cases 111: 60 Punj LR 89 16
Saraswathi Industrial Syndicate Ltd v. CIT (1991) 70 Comp. Cas 184 (SC) AIR 1991
SC 70 (1990) 3 Comp LJ 200 (SC) (1990) 186 ITR 278 (SC) 17
Anup Kumar Sheth v. Reliance Inds. Ltd (2010) 154 Comp. Case 278 (Bom)
material facts from the court and had filed documents to mislead the court. The court
clarified that the scheme of amalgamation could not be approved till the matter was
disposed by the CLB. 18
Scheme can be limited to sale of assets:
Whether such schemes could be sanctioned despite their being opposed to law and
whether such schemes can be resorted to only to restore the company to its original
business. The following questions arose19
in the context of the provisions of sections 391-
394 of the Act: (I) could a scheme for compromise or arrangement be limited to the sale
of assets of the company? (ii) Could the scheme not contemplate revival of the
company‟s main business? (iii) Could a scheme be sanctioned which only provided for
the revival of the company‟s corporate existence? The court answered all the above
questions in affirmative. Once the parameters under the sections as set out by the
Supreme Court were satisfied the court will have no further jurisdiction to sit over the
commercial wisdom of the scheme20
. The court further held that the company court in
sanctioning a scheme could revoke the order of winding up as held in the earlier cases21
.
Scheme contrary to statutory provisions – Can a scheme of arrangement whose terms
are contrary to any statutory provisions be permitted ? The Karnataka High Court
answered this in the affirmative22
.
A non-banking financial company formulated a scheme to repay the depositors
years after the maturity of the deposits and to utilise its statutory liquidity ratio (SLR) to
make these payments. Held that there was nothing in the provisions which prohibited the
court from according sanction even if the terms of the scheme were contrary to any
statutory provision applicable to the company. Reliance was on a recent judgement of the
248
Nu-line India P. Ltd., In re, (2010) 155 Comp cas 186 (HP) 19
Shree Niwas Girni Kamgar Kruti v. Rangnath Basudev Somani (2005) 6 CLJ 246
(Bom-DB) 20
Miheer H Mafatlal v. Mafatlal Industries Ltd (1996) 4 Comp LJ 124(SC) 21
Sudarshan Chits (I) Ltd v. Sukumaran Pillai (1984) 3 Comp LJ 40 (SC); Shankar Lal
Bansal, In re (2004) 118 Com Cases 602 (Raj). 22
Maharashtra Apex Corporation Ltd, In re (2005) 5 Comp LJ 78.
Supreme Court, where a similar argument that the delayed repayment of deposits under
the scheme would violate the law was not considered23
.
Power of Court to pass interlocutory orders before sanction – The Andhra Pradesh
High Court considered a scheme for amalgamation and arrangement of non-banking
financial companies which had outstanding payments on deposits accepted from the
public24
. Having regard to the powers of the company court to pass interlocutory orders
before and after the sanction of the scheme under section 392 including powers to order
winding up, appointment of a provisional liquidator or administrative, the court
concluded that a committee of administrators could be appointed to protect the assets of
the company pending consideration of the scheme. It is submitted that this decision
requires reconsideration since both section 392(1)(a) and (b) and section 394(1)(vi)
which empower the issuance of any incidental or supplemental orders by the court refer
to the exercise of such powers only at the time of or after the order sanctioning the
scheme. Two cases relied on by the court refer to the exercise of such powers only after
the sanction of the scheme25
.
Meeting of Creditors/Members mandatory –
The karnataka High Court held that an order for dispensation of the meeting of the
members or creditors under section 391(1) of the Act would be antithetical to the
provisions which is a provision for permission to hold a meeting. There is a definite
purpose and object to the law26
. That cannot be done away with by a process of
dispensation.
No adjudication at the stage of meeting –
23
Rahuta Union Co-operative Bank Ltd v. Union of India (2005) 5 Comp LJ 73 (SC) 24
Deepika Leasing and Finance Ltd, In re (2005) 3 Comp LJ 51 (AP) 25
S.K. Gupta v. K.P. Jain AIR 1979 SC 734; Mansukhlal v. M.V. Shah (1976) 46 Com
Cases 279 (Guj) 26
Ansys Software (P) Ltd, In re (2005) 1 CLJ 60 (Kant)
The Delhi High Court held that at the stage of directing meetings of creditors/ members
the court need not satisfy itself about all material facts relating to the company or take
account of its financial position27
.
Held that a scheme of amalgamation or compromise or merger was a commercial
document and once a finding was arrived at that, the legal requirements had been
complied with the company court had no jurisdiction to sit in appeal over the commercial
wisdom of the class of persons who had approved the scheme28
.
The Karnataka High Court in an application under section 391 of the Act, allowed
the applicants to convene a meeting of its equity shareholders to consider a scheme to
amalgamate the transferor companies with the applicant and for dispensation of the
meeting of the preference shareholders and creditors29
.
The equity shareholders had already given their consent to the proposed scheme30
.
The Official Liquidator and the regional director had not opposed the scheme. The
scheme of amalgamation was, therefore, sanctioned.
The Bombay High Court examined the jurisdiction of the company court31
. It held
that the company court had jurisdiction to pass appropriate orders or directions to
modify a scheme
only in the given facts and circumstances under sections 391 and 394 of the Act.
The court sanctioned the scheme of amalgamation when it found that the scheme
was in the interest of the companies, their members and creditors32
. However, where the
scheme was found against their interests, the court declined to give its approval.
27
Batliboi Ltd v. Mideast Integrated Steel Ltd (2005) 3 Comp LJ 75 (Del) 28
Modern Denim Ltd, In re (2009) 148 Comp Cas 873 (Raj), 29
Mysore Cements Ltd, In re (2009) 149 Comp Cas 50 (Karn) 30
Webneuron Services Ltd., In re (2009) 149 Comp Cas 61 (Del) 31
Reliance Natural Resources Ltd v. Reliance Industries Ltd., (2009) 149 Comp Cas 129
(Bom) 32
Surabhi Chemicals and Investments Ltd., In re (2009) 149 Comp Cas 278 (Guj)
The Gujarat High Court held that the scheme sought to transfer some of the assets
of one company to another company in the name of a scheme of demerger. The court
refused to sanction it on the grounds that section 391 of the Companies Act, 1956 does
not contemplate all kinds of schemes but only schemes that are either a compromise or an
arrangement with the creditors or members or any class of them. The onus to satisfy that
the scheme is one that can be sanctioned u/s 391 is upon the company33
. Contrary to this
judgement, the Delhi High Court has held that the expression „arrangement‟ under
section 391/394 of the Companies Act includes transfer of assets by a company without
consideration by way of a gift. The court took the view that here is no legal impediment
to a company transferring property by gift to another company34
.
Compromise or Arrangement – Share exchange ratio in amalgamation – whether
Central Government can raise objection
The Calcutta High Court reiterated the principles laid down in a number of cases
and held that that it was to be presumed that the shareholders of a company are prudent
businessmen. They had scrutinized the scheme in detail and were presumed to have
clearly understood what they had to give and what they would receive from the scheme
and how the scheme was likely to promote the business interests of the company and of
themselves. Therefore, the court should not ordinarily interfere with their decision. The
resolution adopting the scheme had been taken by such overwhelming majority of
shareholders of the transferee company and unanimously by shareholders of the
transferor company in their commercial wisdom. The objection of the Central
Government was overruled35
. By permitting the scheme, the court held that the scheme
was for the entire revival of the company sine it safeguards the interest of the workers
and the payment of all dues of the company. 36
The petitioner company sought the
33
Vodafone Essar Gujarat Ltd, In re (2011) 161 Comp. Cas. 144 34
Vodafone Essar Mobile Services Ltd, In re (2011) 163 Comp. Cas 169 35
Quippo Infrastructure Equipment Ltd & Srei Infrastructure Finance Ltd – In re (2011)
162 Comp. Cas 186 36
Thermopack Industries v. Ajay Electrical Industries Ltd (2010) 153 Comp Cas 470
(Del.)
sanction for a scheme of arrangement in which it was proposed to create developmental
plans for the improvement of its business. 37
Minority Interest
Protection of minority interest should be recognized under the law, only
shareholders/ creditors having significant stake at a level to be prescribed under the law
should have a right to object to any scheme of mergers. Where an act done by the
majority amounts to a fraud on the minority, an action can be brought by an individual
shareholder. This principle was laid down as an exception to the rule in Foss v. Harbottle
in a number of cases. On the same principle the majority shareholders are not allowed to
purchase the shares of a minority compulsorily 38
. Any resolution passed by the majority
to that effect is void39
.
Held, the plaintiff who were in minority in the defendant company carried on a
competing business. The validity of the resolution was challenged on the ground that it
was not for the benefit of the company as a whole. The court rejected the contention and
held that it was very much for the benefit of the company to get rid of the members who
were in competing business as such members have the unique opportunity of exploiting
the company‟s business secrets against it‟s very interest40
. The Court sought not to
interfere with decision of the majority in a general meeting if that decision is arrived at
fairly and honestly41
.
Amalgamation in Public Interest
Existing Section 396 empowers Central Government to order amalgamation of
two or more companies in public interest. It has been suggested that these provisions
37
Sasken Communication Technologies Ltd., In re, (2010) 155 Comp Cas 463 38
Cock v. Deeks (G.S.), (1916) 1 A.C. 554 39
Brown v. British Abrasive Wheel Company (1919) 1 Ch. 290 40
Sidebottom v. Kershaw Leese & Co., (1920) 1 Ch. 154 41
Re. Transval Gold Exploration and Land Co. Ltd (1885) 1 T.L.R. 604
should be reviewed and amalgamation should be allowed only through a process
overseen by the Courts/ Tribunals. If the object of the scheme is to prevent investigation
or there is failure in the management of affairs of the company or disregard of law or
withholding of material information from the meeting or the scheme is against public
policy, the court will not sanction the scheme42
However, in certain cases the court has
also held that where the scheme was approved by the majority and was not in violation of
public policy but the auditors report stated that the business of the company was
conducted in a manner prejudicial to the interest of the members of the company, the
court sanctioned the scheme for amalgamation.
Advantages of Mergers and Acquisitions
The merger wave across India‟s corporate sector tends to show that companies
want to avoid stiff and unequal competition. New business combinations are reshaping
India‟s largest industries and affecting not only dividend rates, business strategy and job
prospects but also the prices of necessities as competitors become fewer and more
powerful. The merger boom is more pronounced in such industries as dry cell batteries,
paints, toiletries, transport, banking and financial service, food, soft drinks, liquor and
entertainment. The most common advantages of mergers and acquisitions are as under: -
Accelerating a company‟s growth, particularly when its internal growth is constrained
due to paucity of resources. Internal growth requires that a company should develop
its operating facilities – manufacturing, research, marketing etc. But lack or
inadequacy of resources and time needed for internal development may constrain a
company‟s pace of growth. Hence, a company can acquire production facilities as
well as other resources from outside through mergers and acquisitions. Specially, for
entering in new products the company may lack technical skills and may require
special marketing skills and a wide distribution network to access different segments
of markets. The company can acquire company or companies with requisite
infrastructure and skills and grow quickly.
42
J.S. Davar v. Dr. S.V. Marathe, AIR 1967 Bom. 456 (DB)
Enhancing profitability because a combination of two or more companies may result
in more than average profitability due to cost reduction and efficient utilization of
resources.
Diversifying the risks of the company particularly when it acquires those businesses
whose income streams are not correlated. Diversification implies growth through the
combination of firms in unrelated businesses. It results in reduction of total risks
through substantial reduction of operations. The combination of management and
other systems strengthen the capacity of the combined firm to withstand the severity
of the unforeseen economic factors, which could otherwise endanger the survival of
the individual companies.
A merger may result in financial benefits for the firm in many ways i.e. (I) by
eliminating financial constraints (II) by enhancing debt capacity. This is because a
merger of two companies can bring stability of cash flows which in turn reduces the
risk of insolvency and enhances the capacity of the new entity to service a larger
amount of debt (III) by lowering the financial costs. This is because due to financial
stability, the merged firm is able to borrow at a lower rate of interest.
Limiting the severity of competition by increasing the company‟s market power
merger can increase the market share of the merged firm. This improves the
profitability of the firm due to economies of scale. The bargaining power of the firm
vis-à-vis labour, suppliers and buyers is also enhanced. The merged firm can exploit
technological breakthroughs against obsolescence and price wars.
Procedure for evaluating the decision for mergers –
The three steps are involved in the analysis of mergers and acquisitions: -
Planning – It will require the analysis of industry-specific and firm-specific
information. The acquiring firm should review its objectives of acquisition in the
context of its strengths and weaknesses and corporate goals. It will need industry data
on market growth, nature of competition, ease of entry, capital and labour intensity,
degree of regulation.
Search and screening – Search focuses on how and where to look for suitable
candidates for acquisition.
Financial Evaluation – It is needed to determine the earnings and cash flows, areas of
risk, the maximum price payable to the target company and the best way to finance
the merger.
A merger is said to be at a premium when the offer price is higher than the target
firm‟s pre-merger market value. The acquiring firm may have to pay premium as an
incentive to target firm‟s shareholders to induce them to sell their shares so that acquiring
firm is able to obtain the control of the target firm.
Regulation for Merger & Acquisitions
Mergers and acquisitions are regulated under various laws in India. The objective
of the laws is to make these deals transparent and protect the interest of all
shareholders.They are regulated through the provisions of :-
1. The Companies Act, 1956
The Act lays down the legal procedures for mergers or acquisitions;-
Permission for merger - Two or more companies can amalgamate only when the
amalgamation is permitted under their memorandum of association. In the absence of
these provisions in the memorandum of association, it is necessary to seek the
permission of the shareholders, Board of Directors and the Company Law Board
before affecting the merger.
Information to the Stock Exchange – The acquiring and the acquired companies
should inform the stock exchanges about the merger.
Approval of Board of Directors – The Board of Directors of the individual companies
should approve the draft proposal for amalgamation and authorize the management of
the companies to further pursue the matter.
Application in the High Court – An application for approving the draft amalgamation
proposal duly approved by the Board of Directors of the individual companies should
be made to the High Court.
Shareholders and Creditors Meetings – At least, 75% of shareholders and Creditors in
separate meeting, voting in person or by proxy, must accord their approval to the
scheme.
Sanction by the High Court – After the approval of the shareholders and creditors on
the petitions of the companies, the High Court will pass an order, sanctioning the
amalgamation scheme after it is satisfied that the scheme is fair and reasonable. The
date of the court‟s hearing will be published in two newspapers and also the regional
director of the Company Law Board will be intimated.
Filing of the Court Order – After the Court order, its certified true copies will be filed
with the Registrar of companies.
Transfer of assets and liabilities – The assets and liabilities of the acquired company
will be transferred to the acquiring company in accordance with the approved scheme
with effect from the specified date.
Payment by cash or securities – As per the proposal, the acquiring company will
exchange shares and debentures and cash for the share and debentures of the acquired
company.
2. The Competition Act, 2002
The Act regulates the various forms of business combinations through Competition
Commission of India. Under the Act, no person or enterprise shall enter into a
combination in the form of an acquisition, merger or amalgamation which causes or is
likely to an appreciable adverse effect on competition in the relevant market and such a
combination shall be void. Enterprises intending to enter into a combination may give
notice to the Commission but this notification is voluntary. The Commission while
regulating a „combination‟ shall consider the following factors:-
Actual and potential competition through imports
Extent of entry barriers into the market
Level of combination in the market
Degree of countervailing power in the market
Possibility of the combination to significantly and substantially increase prices or
profits
Availability of substitute before and after the combination
Extent of effective competition likely to sustain in a market
Market share of the parties to the combination individually and as a combination
Possibility of the combination to remove the vigorous and effective competitor or
competition in the market
Nature and extent of vertical integration in the market
Nature and extent of innovation
Whether the benefits of the combinations outweigh the adverse impact of the
combination
Thus the Competition Act does not seek to eliminate combinations and only aims to
eliminate their harmful effects.
The other regulations are provided in the The Foreign Exchange Management Act,
1999 and The Income Tax Act, 1961. The Securities and Exchange Board of India
(SEBI) has also issued guidelines to regulate mergers and acquisitions. The SEBI
(Substantial Acquisition of Shares and Take-over) Regulations, 1997 and its subsequent
amendments aim at making the take-over process transparent and also protect the
interests of minority shareholders.
Takeovers - Takeover implies acquisition of control which is already registered through
the purchase or exchange of shares. Takeovers usually take place when shares are
acquired or purchased from the shareholders of a company at a specified price to the
extent of at least controlling interest in order to gain control of that company. Takeover is
availed of as a business strategy to acquire control over the other company - either
directly or indirectly. When an acquisition is „forced‟ or „unwilling‟, it is called a
takeover and the management of the target company would oppose a move of being taken
over but when management of acquiring and target companies and willingly agree for the
takeover, it is called acquisition or friendly takeover.
Takeovers are taking place all over the world. Those companies whose shares are
underquoted on the stock market are under a constant threat of takeover. In fact every
company is vulnerable to a takeover threat. Takeover is a corporate device whereby one
company acquires control over another company usually by purchasing all or a majority
of its shares. Ordinarily, a larger company takes over a smaller company. It must be noted
that takeover of management is quite distinct from takeover of possession for the purpose
of sale of establishment. The takeover strategy has been conceived to improve corporate
value, achieve better productivity and profitability by making optimum use of the
available resources in the form of men, materials and machines.
Under the Monopolies and Restrictive Practices Act, takeover meant acquisition
of not less than 25 % of the voting power in a company. While in the Companies Act
(Section 372), a company‟s investment in the shares of another company in excess 10%
of the subscribed capital can result in takeovers. An acquisition or takeover does not
necessarily entail full legal control. A company can also have effective control over
another company by holding a minority ownership. But now MRTP Act has been
repealed and Competition Act, 2002 has come into force.
Regulation for Takeover
SEBI‟s Takeover Code for substantial acquisitions of shares in Listed companies
– In India take-overs are controlled. The first attempt at regulating takeovers was made in
a limited way by incorporating a clause in the listing agreement which provided for
making of public offer by any person to acquire 25% or more voting rights in a company.
This was later brought down to 10%.
On 4th
November 1994, SEBI announced a take-over code for the regulation of
substantial acquisition of shares, aimed at ensuring better transparency and minimizing
the occurrence of clandestine deals. Bhagwati Committee was set up in 1995 to review
these regulations . The SEBI Takeover Regulations, 1997 were based on the report of
Bhagwati Committee, 1997. The second amendment regulations were notified in 2002.
Regulations 23 of the SEBI Takeover Regulations 1997 deals with the general
obligations of the target company. The Bhagwati Committee desired that the regulations
should have definite provisions making it obligatory for the target company to transfer
the shares and allow changes in the Board of Directors once the acquires fulfills fulfill
their obligations under the regulations.
The take-over code covers three types of take-overs i.e. negotiated takeovers,
open market takeovers and bail-out takeovers.
The procedure for Merger and Takeover are as under:-
1. Accounting
All assets and liabilities of the “Transferor Company” before amalgamation should
become assets and liabilities of the “Transferee Company”
Shareholders holding not less than 90% of shares of the “Transferor Company”
should become the shareholders of the “Transferee Company”
The consideration payable to the shareholders of the “Transferor Company” should
be in the form of shares of the “Transferee Company” only
Business of the “Transferor Company” is intended to be carried on by the “Transferee
company”
The “Transferee Company” incorporates in its balance sheet the book values of assets
and liabilities of the “Transferor Company” without any adjustment except to the
extent needed to ensure uniformity of accounting policies.
The accounting treatment of an amalgamation in the books of the “Transferee
Company” is dependent on the nature of amalgamation.
2. Legal/Statutory Approvals
The process of mergers or amalgamations is governed by Sections 391 to 394 of the
Companies Act, 1956 and requires the following approvals:-
Shareholders Approval – The shareholders of the amalgamating and the amalgamated
companies are directed to hold meetings by the respective High Courts to consider the
scheme of amalgamation. The scheme is required to be approved by 75% of the
shareholders, present and voting and in terms of the voting power of the shares held,
in value terms.
Section 395 of the Companies Act stipulates that the shareholding of dissenting
shareholders can be purchased, provided 90% of the shareholders, in value terms, agree to
the scheme of amalgamation. In terms of Section 81(A) of the Companies Act, the
shareholders of the „amalgamated company‟ also are required to pass a special resolution for
issue of shares to the shareholders of the „amalgamated company”.
Creditors/Financial Institutions/Bank Approval – Approvals from these are required
for the scheme of amalgamation in terms of the agreement signed with them.
High Court Approvals – Approval of the High Courts of the States in which
registered offices of the amalgamating and the amalgamated companies are situated,
is required.
Reserve Bank of India Approval – In terms of section 19 of FERA, 1973, Reserve
Bank of India permission is required when the amalgamated company issues shares to
the nonresident shareholders of the amalgamating company or any cash option is
exercised.
3. Valuation
There are several approaches to valuation. The important ones are the discounted cash
flow approach, the comparable company approach and the adjusted book value approach.
Non- compliance of SEBI takeover regulations –
In a case under section 111A, a rectification was sought of the register of
members of the company on the ground that the share acquisition violated regulation 7(1)
of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. The
Company Law Board (CLB) held that where the respondents, when acquiring the shares
of the company in concert, had failed to disclose their acquisition beyond 5% within four
days of such acquisition as required by regulation 7 (1), such acquisition would be
invalid43
. Accordingly, it directed rectification of the register of members of the company
by removing the names of the respondents in respect of the shares acquired beyond 5%.
This principle was also applied in rejecting a petition filed by the same respondents under
sections 397 and 398 of the Act. The CLB disregarded the acquisition above 5% while
computing the qualification in shareholding of 10% as required by section 399 of the Act.
43
Aska Investments P. Ltd v. Grob Tea Co. Ltd (2005) 126 Comp Cases 603 (CLB)
While doing so, the CLB relied on its earlier ruling, where it had held that such
acquisition, without the preemptory disclosure, would be invalid44
. Since then, however,
there have been rulings by the Andhra Pradesh High Court45
and the Calcutta High
Court46
and the Securities Appellate Tribunal47
to the effect that the consequence of such
acquisition will render the respondents liable to penalties under regulation 45. Although
these judgements have not ruled that such acquisitions will be invalid, the acquisition of
shares in violation of SEBI regulations would be invalid under section 23 of the Contract
Act, 1872. But the CLB disregarded the plea of the respondents that proceedings by the
SEBI were also underway on the same issue, which could result in multiple and possibly
conflicting orders on same issue. Where proceedings with regard to such acquisition are
pending before the SEBI, the CLB ought to have awaited the outcome of these
proceedings.
Cross Border Mergers & Acquisition
The rise of Globalization has exponentially increased the market border M&A.
This rapid increase has taken many M&A firms by surprise because the majority of them
never had to consider acquiring the capabilities or skills required to effectively handle
this kind of transaction. There are also new forces in play that make cross-border
expansion more feasible and capable of creating value. For example, international
deregulation is removing old barriers. Institutional investors are taking a more global
perspective. Customer profiles across markets are becoming more homogeneous. More
generally, the newly created firm will share features of the corporate governance systems
of the two merging firms. Therefore;
Cross-border mergers provide a natural experiment to analyze the effects of changes-
both improvements and deterioration, in corporate governance on firm value.
FDI plays an important role with the cross mergers and takeovers as they are followed
by sequential investment by foreign acquirer sometimes large especially in special
circumstances such as that of privatization.
44
Bombay Dyeing & Mfg. V. Arun Kumar Bajoria (2001) 4 Comp LJ 115 45
Karamsad Investments Ltd v. Nile (2002) 108 Comp Cases 58 46
Arun Kumar Bajoria v. SEBI (W.P. 331/01 – unreported) 47
Mega Resources Ltd v. SEBI (2002) 3 CLJ 179
Cross border M&A can be followed by newer and better technology especially when
acquired firms are reconstructed to increase the efficiency of their operations.
Cross border M&A leads to employment opportunity over time when the sequential
investments take place and if the linkages of the acquired firm are retained or
strengthened.
Divestment Strategy – Divestment strategy also known as divestiture strategy, involves
selling off or shedding business units or product divisions or segments of business
operations to redeploy the resources so released for other purposes. While selling off a
business segment or product division is one of the common forms of divestment, it may
also include selling off or giving up control over a subsidiary or a demerger whereby the
wholly owned subsidiaries may be floated off as independently quoted companies.
Retrenchment Strategy – A strategy option which involves reduction of any existing
product or service line is known as retrenchment strategy. When a firm suffers from poor
performance in terms of lower earnings and profits, it may be required to shut down units
of activity or segments which continue to be a drain on total performance.
A Mixed or Combination Strategy – The main purpose of such a strategy is
optimization of the enterprise profitability and minimizing losses.
Financial Restructuring – This exercise involves reaching an appropriate mix of debt
and equity ensuring a competitive cost structure and optimizing return on investment.
Demerger and Spinoffs
Companies have to downsize or contract their operations in certain circumstances
such as when a division of the company is performing poorly or simply because it no
longer fits into the company‟s plans or to give effect to rationalization or specialization in
the manufacturing process. This may also be necessary to undo a previous merger or
acquisition which proved unsuccessful. This type of restructuring can take various forms
such as demerger or spin off, split off, etc. Large entities sometimes hinder
entrepreneurial initiative, sideline core activities, reduce accountability and promote
investment in non-core activities. There is an increasing realization among companies
that demerger may allow them to strengthen their core competence and realize the true
value of their business.
Typically, in these demergers, stand-alone, non-synergistic business, forming part
of an existing company, are hived off as new firms that are then listed. Their shares are
distributed to the shareholders of the „parent‟ company. As far as the shareholders are
concerned, their interests are fully protected as they now collectively own exactly the
same businesses as before except that the ownership is through separate shareholdings.
“A scheme of demerger is in effect a corporate partition of a company into two
undertakings, thereby retaining one undertaking with it and by transferring the other
undertaking to the resulting company. It is a scheme of business reorganization.”48
The Calcutta High Court dealt with the issue of merger. The scheme was
approved by the requisite majority of the equity shareholders of the two companies at
their respective meetings held at Calcutta. An application was filed by the shareholders
who had objected the sanction of a scheme of arrangement by demerger as it was unfair.
Court rejected the application for sanction of arrangement and demerger.‟
Recently one Landmark judgement is there. A scheme of arrangement
proposed by the appellant company was not sanctioned by the single judge on the ground
that it was in violation of the statutory provisions and prejudicial to the shareholders as
well as the secured creditors of the company49
.
A scheme related to demerger was challenged on the ground that incorporation of
the resultant company after the appointed date could be a reason for rejecting sanction of
the scheme.
48
Justice N.V. Balasubramaniam J in Lucas TVS Ltd. In Re. CP No. 588 and 589 of 2000
(Mad- Unreported) 49
G.V. Films Ltd., in re. (2009) 150 Comp. Case 415 (Mad.)
The logic of a demerger to unlock value for shareholders, stems from a variety of
reasons, such as sharper focus and managerial attention to individual businesses avoiding
cross-subsidization and sub-optimal resource allocation by the management, enhancing
investor interest by generating greater following by security analysts and permitting
portfolio diversification by the investors themselves. The spinoff or the demerger route is
anti-thesis to the process of mergers. The corporate restructuring process can assume
several forms – demergers, spinoffs and equity carve-outs as under:
Demerger involves the effective splitting up of one organization into two or more
parts which may take the form of two or more roughly equal entities.
• Spin-off involves the separation of a company as a subsidiary from the parent by
transfer of operating assets without a substantial change in the constitution of equity
ownership. The equity ownership does not undergo a major change as the subsidiary
company issues equity shares to the parent in lieu of assets transferred to it.
• Equity Carve-out is a variant of spinoff. A company spun off as a wholly-owned
subsidiary comes out with an initial public offering (IPO) for the part of the shares of the
subsidiary. On the completion of the IPO, the shares are traded independently from that
of the parent.
One of the issue50
was whether in a scheme of demerger, incorporation of the
resultant company after the appointed date could be a reason for rejecting sanction to the
scheme. Answering that question in the negative, the Delhi High Court held that the
appointed date is only to identify and the value of assets to be transferred to the resultant
company and hence the fact that the resultant company was incorporated after the
appointed date was not material, the scheme would be effective only on the effective
date.
Short-form Mergers – At present, all mergers, including those between group
companies or between a parent and a subsidiary requires compliance with the entire
process of section 391 and 394, although in certain circumstances courts are willing to
make some dispensations from procedural requirements. Under the new Companies Bill,
50
Alchemist Ltd & Alchemist Foods Ltd – In re (2010) 160 Comp. Cas. 496 (Delhi)
2011, certain mergers can follow an out-of-court approach, without requiring the
approval of the court or NCLT. These are mergers between two or more small companies
or between a parent and its wholly-owned subsidiary. In these types of mergers, there is
greater emphasis on interests of creditors that is the companies must file a declaration of
solvency and the scheme must be approved by at least 90% of the creditors or their
classes. Although this simplifies the M&A regime to some extent, it may only a small
number of transactions without much wider impact.
The provisions that enabled fast-track implementation of merger of small
companies with minimum compliances have been modified slightly. As per the Bill, a
notice has to be issued to the Registrar of Companies (RoC) and official liquidator (OL)
first and objections/ suggestions have to be placed before the members in the general
meeting. Once the scheme is approved by members and creditors, a notice would have to
be given to the central government, the RoC & OL. If the Central Government has any
objections, it may file an application with the tribunal and seek its approval.
Reverse Merger – The companies Bill, 2011, has provided an exit option at a fair value
to compensate for the loss of liquidity for minority shareholders of a listed company in a
reverse merger. The law in force at present does not provide for this. A reverse merger is
a transaction where a listed company is merged with an unlisted one.
In section 45 (h)(B) the Bill states – “If shareholders of the transferor company
decide to opt out of the transferee company, provision shall be made for payment of the
value of shares held by them and other benefits, in accordance with a pre-determined
price formulan or after a valuation is made.”
Other Matters – Some other specific issues where the Bill provides for a different
treatment are:
Notice of the scheme must be provided to various government authorities such as the
Income Tax Department, SEBI, RBI, Competition Commission, OL such that all of
their concerns can be heard by the NCLT before sanctioning the scheme. Although
these authorities can object before a court even at present, there is no such notice
requirement.
The requirement of majority of shareholders or creditors is 75% in value. The existing
additional requirement of obtaining a majority in number of the shareholders or
creditors has been done away with.
Permits the clubbing of authorized capital and claim of set off by transferee company,
of fees, if any, paid by the transferor company on its authorized capital.
Notice of the shareholders meeting and relevant documents will also be required to be
submitted to the Central Government, Income-Tax authorities, RBI, SEBI, Stock
exchanges (in case of listed companies), Registrar, OL, Competition Commission of
India and any other regulator or authorities likely to be affected.
The four pillars holding the foundation of the Bill are accountability, procedural
simplification, disclosure and unification across various regulatory authorities. The
simple process of submitting documents before the court registrar is now a multi-party
affair with a series of documents. Corporates will now necessarily have to deal with
multiple authorities like income tax, RBI, SEBI, Central Government and the
Competition Commission of India as opposed to single-window clearance.
Onerous disclosures such as details of valuation report, statement giving effect of
the restructuring on promoters, auditors certificate, which was earlier mandated by SEBI
for listed companies, stating compliance with accounting standards are required to be
given. The attempt to get a larger number of regulatory authorities – in particular, the
income tax authorities involved from the preliminary stages – could be another indicator
of the legislative desire to provide greater certainty to companies in an M&A process, at
an earlier stage of transaction. The Bill is set to curb the number of holding companies to
two. While there may be an aim to achieve transparency, the move may hinder genuine
need for Indian multi-layered structures. On the other hand, outbound acquisition of
(foreign) multi-layered structure may still allowed in certain situations.
Diversification – Identifying and developing core competencies has become the key
strategy for building up corporate strength and adding to the intrinsic worth of the
company. In fact, expanding and consolidating the base of the company is necessary to
withstand the onslaught of MNCs. However, in all such strategies, the core strengths of
the company can hardly be ignored.
Divestment – The basic objective underlying a divestment strategy is to prevent any
particular unit or segment of business being a drag on the total profitability of the
enterprise, particularly when opportunities of alternative investments exist. Divestment
may be preferred as a deliberate strategic decision for the following reasons:
• To sustain and develop a favourable competitive position in a product-market,
the firm may be required to deploy resources – financial, technical or managerial – which
are lacking. In that situation, the appropriate strategy should be to divest and withdraw
from the particular segment for better utilization of the available resources in some other
product-market.
• Sometimes after the acquisition of a business it may be found that some parts of
the acquired business are not as desirable as others. The unwanted operations may be
justifiably disposed off to recover a part of the acquisition cost.
• If the profitability or growth performance of any unit of business or subsidiary,
which held promises earlier, prove to be unsatisfactory due to unexpected emergence of
strong competitors, rise in costs or a fall in demand.
• The scale of operation of some units, both in relation to the total operations of the
firm and relative to the respective markets, may be a small part of the enterprise
activities and yet involve disproportionately large management efforts.
• For a multi-product, multi-divisional firm, divestment of some of the traditional
activities may be desirable as part of product portfolio strategy.
• Divestment strategy may also be unavoidable in the face of financial crisis
involving liquidity problems which may even threaten the survival of the firm as a
whole.
Compared with acquisitions and mergers, divestment may be a rather infrequent
event. Divestment is an irreversible decision in so far as the divesting firm is concerned.
Divestment, to be effective, should be carried out in a manner and at a time so as to
ensure that replacement investment is worthwhile.
Winding Up of Companies
The Indian economy on the other hand is left to bear huge costs because of delays
in winding up. The delays reflect lack of appreciation on the part of law and legal
administration to preserve the value of the assets of a company that is being wound up
and also the failure to realize the fact that the worst affected parties are workers and
secured creditors. The group, therefore, emphasizes that the winding up procedures must
radically expedite the sale of assets, by sale of assets first as quickly as possible and
adjudicate and distribute later. The group for the purpose of evolving a new and strictly
time-bound approach has recommended the following measures:
• High Courts will have exclusive jurisdiction in the matter of liquidation of a
company.
• Encouragement of voluntary winding up which is generally a more cost and
time-efficient manner of liquidation.
• Distinct separation of the two aspects of liquidation i.e. Asset sale and
Distribution of the proceeds.
• Clarity in winding up order – which should coherently describe the steps that
have to be taken along with time-frames for each action.
• Clear enunciation of the manner which the act shall catalyse rapid, transparent,
market-determined sale of assets which would not only allow for their profitable re-use
but also increase the pool for distribution to claimants including workers.
• Well-defined and non-subjective norms to ascertain whether a company‟s assets
should be sold in totality as a going concern or in parts as individual asset sale.
• Permitting professionals such as chartered accountants, lawyers or company
secretaries to be empanelled by the High Court as liquidators who may be selected as
Official Liquidator (Section 300). Corporate bodies comprising these professionals may
also be appointed as company liquidators. The company liquidator has to submit the
valuation report to the court within a period of 60 days from the date of taking
possession.
The basic guideline has been that the assets of a company being wound up should
be sold within a period of six months of the winding up order. This is sought to be
implemented by a clear time-bound schedule to complete various processes prior to sale
and by making most of the procedures to run concurrent rather than sequential. The
group has also recommended that the High Court should distinguish between asset sale
on the one hand and misfeasance and malfeasance on the other. An application for
misfeasance or malfeasance against the directors, officers or the liquidator has to be
made within a period of two years from the date of order of winding up. At present the
time allowed in this regard is five years. If a director makes a wrong declaration of
solvency, then he could be punished with imprisonment upto a period of one year or fine
up to Rs 50,000 or both.
In 2005, there are few important judgements the court considered the rights of a
secured creditor in the context of the debtor company being in liquidation. The Supreme
Court clarified that the Obiter in paragraph 76 of its earlier judgement to the effect that
workmen‟s dues would have priority over the dues of the secured and unsecured creditors
was unnecessary51
. In this judgement the court also held that the provisions of sections
446 ipso facto did not confer any power on the company court to pass any interlocutory
orders52
and that any such exercise of inherent power in passing interlocutory orders
would have to be exercised in consideration of the factors set out in the Morgan Stanley
case53
. Although power of the court to order for the winding up of the company is
discretionary, it has to take into consideration „public interest‟ involved in such cases. 54
The court held that default in furnishing of specified information was purely a question of
fact and winding up of such petitions could be resolved only by a civil court. 55
Commencement of Winding up – The Madras High Court Administrator, held that where
a company is ordered to be wound up, winding up will be deemed to commence from the
date on which the first winding up petition is filed against the company, even though the
order of winding up is not passed in that petition56
.
Corporate Debt Restructuring
51
Andhra Bank v. Official Liquidator (2005) 4 Comp LJ 33(SC) 52
Allahabad Bank v. Canara Bank (2000) 2 Comp LJ 170 (SC) 53
Morgan Stanley Mutual Fund v. Kartick Das (1994) 3 Comp LJ 27 (SC). 54
HMT Ltd v. N.T. Ramatulla Khan and Associates (2010) 155 Comp cas 169 (Kar.) 55
ICICI Bank Ltd v. Saura Chemicals Ltd (2010) 153 Comp Cas 429 (P&H) 56
MCC Finance Ltd v. Ramesh Gandhi (2005) 127 Com Cases 85 (Mad)
CDR is a non-statutory method, taken up voluntarily by companies to ensure their
viability and resolve their unmet financial obligations. The CDR framework aims at
preserving the viable entities, outside the purview of BIFR, DRT and other legal
proceedings affected by internal and external factors. It also aims at minimizing the
losses to the creditors and other stakeholders in coordinated and transparent fashion.
The Reserve Bank of India has specific tools for fast track debt restructuring
known as the CDR Mechanism (Corporate Debt Restructuring Mechanism). It is often
seen that sometimes even though 75% of the secured creditors consent to the debt
restructuring and make significant sacrifices, minority secured creditors or unsecured
creditors put a spoke through the wheel. As a result, such schemes that would otherwise
enable the return of the corporate to viable operation, get delayed.
As in the case of contractual mergers or schemes of arrangement, the Committee
recommends that if the petitioning creditors or petitioning company is prima facie able to
prove that 75% of the secured creditors who have consented to the CDR Mechanism have
made sacrifices to restructure the company then, notwithstanding the minority dissent,
such as a scheme should be sanctioned on filing.
Appropriate remedies for misstatement and the ability to revoke such an order
with punishment for any misstatement would be an adequate safeguard for false
misstatement. The unsecured creditors are subsequent in the queue and without the
consent of the secured creditors and their debt restructuring; they would have no hope to
receive dues. However, to safeguard their interests and to ensure the continuity of the
company‟s functioning, the scheme must satisfy a minimum liquidity test and should
have provisions for a security pool either made available by the secured creditors as cash
availability or by the promoter to progress the scheme of restructuring.
Since its inception almost a decade back, this sort of mechanism has seen
widespread participation from all quarters of industry and especially from giant
companies such as Kingfisher, Wockhardt, Vishal Retail, Subhiksha, Jindal Steel, Easar
Steel etc. This sort of fast track restructuring is believed to go an long way especially in
the light of the ongoing global economic crisis.
Such schemes must contain safeguards against fraudulent preference and must
have a creditors responsibility statement, similar to a directors responsibility statement,
appended to it. The Court/National Law Tribunal could regulate withdrawal from the
security pool provided for by the liquidity test.
The Committee recommended that the need to file a separate scheme for
reduction of capital simultaneously the scheme for merger and acquisition should be
avoided. The provisions relating to obtaining consent from unsecured creditors should be
done away with. To ensure continuity of the existence of transferee Company/resulting
Company, the Committee felt the need to mandate requirement of a satisfactory liquidity
test and prescribed debt equity norms. The creditors consent may be necessary only in
case of companies not meeting the liquidity test.
According to new Companies Bill, 2011 the application for the scheme of
compromise or arrangement in case of a company under CDR, must disclose safeguard
for the unsecured creditors. It is also said that perhaps the non-participation of various
lenders, India as well as foreign has weakened the CDR mechanism. The case of
Kingfisher, Vishal Retail and Wockhardt have shown very little progress in terms of
revival of the company and recovery by banks. It also shows the inherent tensions and
limitations of the CDR mechanism. It might also help in reducing the pendency of cases
and in expediting recovery of comparatively higher amounts within the existing
framework.
SECTION B - REVIVAL OF SICK COMPANIES
There is one standard joke that there are many financially sick companies but no
financially sick promoters. The problem of industrial sickness is nothing peculiar to our
country or any developing country. In the Indian scenario, it is not possible to shut down
the sick units, as it will lead to substantial national block capital to go waste and create
more unemployment. As sickness is prevailing in country‟s industrial climate, the
Government of India appointed the Tiwari Committee to examine the matter and
recommend suitable remedies. Based on it, a special legislation was enacted, namely the
Sick Industrial Companies (Special Provisions) Act 1985 (1 of 1986) (hereinafter referred
as the “the SICA”).
The main objective of the SICA was to determine the sickness and expedite the
revival of potentially viable units i.e. sick industrial company or closure of unviable units.
It was expected that by revival, idle investments in sick units will become productive and
closure would release the locked up investment in unviable units released for productive
use elsewhere. The SICA applied to companies both in public and private sectors owning
industrial undertaking.
The Central Government had amended the Companies Act, 1956 through the
Companies (Second Amendment) Act, 2002 by inserting Part VI A comprising of
sections 424A to 424L dealing with revival and rehabilitation of sick industrial
companies. Subsequently, the Sick Industrial Companies (Special Provisions) Repeal
Act, 2003 was enacted to repeal the SICA.
The main object of the 2002 Act, was constitution of the National Company
Appellate Tribunal (NCLT). However, the constitutionality of the tribunal was
challenged in various courts and recently in a case the apex court has held that the issues
with regard to the constitution of the tribunal and the areas of their jurisdiction need to be
given a fresh look and the matter deserves to be heard by a Constitution Bench57
. The
matter has been decided upholding the validity of the NCLT. The main issue is not
whether the judicial functions can be transferred to the tribunals, the issue is whether the
judicial functions can be transferred to the tribunals manned by persons who are suitable
or qualified or competent to discharge such judicial powers or whose independence is
suspected. The Supreme Court has answered this issue in partly positive and partly
negative terms. It has upheld the decision of the High Court that the creation of the
57
Union of India v. R. Gandhi (2007) 137 Comp Cas 689; 76 SCL 350
National Company Law Tribunal and National Company Law Appellate Tribunal and
vesting in them, the powers and jurisdiction exercised by the High Court in regard to
company law matters, are not unconstitutional.58
In this case, decided by the constitution
bench, the Supreme Court addressed important issues pertaining not only to company law
but also to constitutional law. 59
As the NCLT takes over the functions of High Court, the members should as
nearly as possible have the same position and status as high court judges. Only officers
who are holding the ranks of Secretaries or Additional Secretaries alone can be
considered for appointment as technical members of the NCLT.
With the proposition of setting up a NCLT by Companies Amendment Act, 2002,
Views started pouring in both supporting and opposing the move. While, on the one
hand, there was hope that this will pave way to a more effective mechanism in solving
the corporate disputes and also reduction of the huge backlog pending in the various
judicial bodies (like CLB, BIFR & AAIFR), High Courts and Supreme Court.
The power of the High Court to interfere with CLB‟s power was examined. The
court held that the CLB cannot grant interim reliefs pertaining to matters which were not
a subject matter of a petition. CLB did not have the power to extend time given by the
High Court for granting of reliefs. 60
In V.L. Sridharan v. Econo Valves P. Ltd., 61
deviating from Andhra Pradesh
High Court‟s 62
view, the Madras High Court held that the Act empowers the CLB to
decide about the competence of the person to file petition under section 397/398 of the
Act.
The underlying objective of constituting the tribunals is speedy justice by
avoiding a multiplicity of authorities and consolidating the jurisdiction and powers of the
CLB, BIFR/AAIFR and High courts. On the other side some viewed it as a threat to the
separation of powers, independence of judiciary and dilution of justice system. The five
58
2010(3) CTC 517 59
(2010) 100 SCL 142 291
Shree Ram Urban Infrastructure Ltd v. R.K. Dhall (2010) 153 Comp Cas 150 (Bom.)
61
(2010) 158 Comp Cas 505 62
B. Subha Reddy V. S.S. Organics Ltd (2009) 151 Comp cas 190
judges constitutional bench of the Supreme Court has upheld the legality of the
Companies (Second Amendment) Act, 2002 providing for the establishment of the NCLT
and NCLAT. The judgment paves the way to make the NCLT and NCLAT functional for
revival/ rehabilitation of sick industrial units, mergers/ amalgamations, reduction of
capital insolvency, winding up and liquidation of companies in a time bound manner63
.
The recent landmark judgment64
rested it all. It upheld the constitutionality of the said
amendment allowing the creation of NCLT and its appellate authority through mandating
certain changes in the structure and composition before the amendment becomes
operational.
It was also clarified that the tribunal was an alternate judicial forum and requires
least interference of the executive in its functioning. In this landmark judgment, the court
upheld the legislative competence of the Parliament to set up the NCLT and directed the
Parliament to modify the law relating to appointment of members to the tribunal.
Company law matters are considered to be technical in nature and require expert
knowledge to resolve it. Although the court gave green signal for the establishment of
tribunals for handling company law matters, the actual functioning of the tribunal would
depend on the proposed amendments in the Act.
Before the constitution of the tribunal, the Board for Industrial and Financial
Reconstruction (BIFR) and the Appellate Authority for Industrial and Financial
Reconstruction (AAIFR) continues to function in dealing with the sick industrial
companies. The SICA, 1985 was also amended by inserting two provisos in section 15
which restrain certain companies from making a reference to the BIFR and in certain
cases empower the creditors to move against the company whose reference is already
registered with the BIFR. With the establishment of BIFR, medium and large-scale
companies whose net worth has been eroded by 50 percent or more are obliged to report
this fact to the Board. The BIFR has been given wide-ranging powers in respect of
approval of rehabilitation packages and revival as well as change of management or
63
UOI v. R.Gandhi (2010) 96 CLA 222 (SC) 64
Union of India v. R. Gandhi, President, Madras Bar Association & Madras Bar
Association v. Union of India (UOI) (2010) 2 Comp LJ 577 (SC)
amalgamations with any other company or sale or lease of a part or whole of the
industrial undertaking or even winding up of the company. BIFR appoints an operating
agency which may be a public financial institution (IDBI, IFCI, ICICI or IRBI) or a
leading commercial bank to prepare a rehabilitation plan. SICA has hardly satisfied the
banks and financial institutions for recovery of dues. BIFR has been called the „Bureau of
Industrial Funeral Rites„. It is high time that we scrap the entire system.
BIFR deals with medium and large-scale sick industrial companies while for
sick companies in the small-sector, separate facilities are available. State Finance
Corporations and commercial banks will be asked to devise a scheme for the
rehabilitation of sick units in the small-scale sector and the assistance given by them for
the revival of such units will e eligible for refinancing by the Industrial Reconstruction
Bank of India (IRBI). IRBI is a principal reconstruction agency which provides
assistance for reconstruction and rehabilitation of sick industrial units.
The judicial nature of the BIFR proceedings makes it obligatory for the
parties to attend the hearing when notified to do so. It is also open to BIFR to specify any
one bank or financial institution as operating agency by a general or special order.
However, BIFR was not armed with powers to dispense with the consent to state
government and its agencies of banks and FIs. This seriously affected speedy
implementation of the sanctioned schemes. While the BIFR mechanism represents a very
important step towards tackling industrial sickness, its effectiveness has been marred by
many limitations- time-consuming, dilatory and frustrating procedures; the exercise
mainly being considered a financial exercise; marketing strategies and technological
improvements which are the two most critical ingredients of rehabilitation plans often
short-changed; concerned parties left to feel that they are not getting a fair treatment etc.
The operating agency has not always been efficient and the management too not very
obliging. Under the existing regulatory framework managements lacked the freedom and
flexibility. Therefore, basic changes are called for regulatory framework.
Directions were issued to the BIFR to examine the proposal of the existing
management for infusion of funds through a strategic investor. The petitioner in a writ
petition contended that the strategic investor was only infusing the funds and there was
no transfer of the management. The Delhi High Court held that there was no participation
by the strategic investor for transfer of shares and the change of management was only a
wrong presumption. 65
BIFR YEAR WISE PERFORMANCE AS ON 30.09.2010
Year Total Cases
Registered
during the
Year
Cases Disposed off during the year
Cases under
Revival
Cases
Revived
Winding up
Recommended
Dismissed
1987 311 0 0 0 8
1988 298 0 1 12 29
1989 202 0 1 31 77
1990 151 1 3 42 45
1991 155 1 5 47 27
1992 177 3 7 30 43
1993 152 3 13 63 59
1994 193 2 38 77 48
1995 115 6 25 61 29
1996 97 6 92 83 25
1997 233 2 34 81 21
1998 370 5 21 49 36
1999 413 4 11 61 72
2000 429 8 37 142 156
2001 463 10 47 113 126
2002 559 21 34 107 212
2003 430 8 42 99 190
2004 399 6 29 50 70
2005 180 17 71 19 180
Year Total Cases
Registered
during the
Year
Cases Disposed off during the year
Cases under
Revival
Cases
Revived
Winding up
Recommended
Dismissed
65
Raam Tyres Ltd v. Appellate Authority for Industrial and Financial reconstruction
(2010) 155 Comp Case 80 (Del.)
2006 118 63 91 22 296
2007 79 66 81 19 205
2008 57 80 64 13 130
2009 64 192 82 19 125
2010 43 690 70 22 118
TOTAL 5687 1199 899 1262 2327
Causes of Sickness
Some industries are born sick and some industries become sick due to a number
of causes and it varies from case to case. In India , the causes of sickness are classified as
under :
A. Internal Causes - These factors are within the internal control of management as
1. Planning which includes
(i) Technical viability i.e. inadequate technical know-how, locational disadvantage,
outdated production process
(ii) Economic viability i.e. high cost of inputs, uneconomic size of project, under
estimation of financial requirements, unduly large investment in fixed assets,
over-estimation of demand.
2. Implementation i.e. cost over-runs resulting from delays in getting licenses/sanctions
and mobilization of finance.
3. Production which includes Production management i.e. inappropriate product mix,
poor quality control, high cost of production, lack of adequate time and adequate
modernisation, high wastage, poor capacity utilisation. Labour management i.e.
excessive high wage structure, inefficient handling of labour problems, excessive
manpower, lack of skilled staff.
External Causes –
Infrastructural bottlenecks i.e. Non-availability/irregular supply of critical raw
materials or other inputs, chronic power shortage, transport bottlenecks.
Government control, policies etc. i.e. Government price controls, fiscal duties,
abrupt changes in Government policies, procedural delays on the part of the
financial/ licensing/other controlling or regulating authorities. Those are banks, RBI,
financial institutions, Government Departments, licensing authorities, MRTP Board
Financial Institution Related Factors i.e. delay in providing finance, inadequate
working and/or long-term capital, inexpert assessment of the client‟s finance
proposal.
The government can take some effective steps particularly towards mitigating the
ineffective management of the units. It should not hesitate to penalize the management
that are found to have willfully turned the units sick. Apex financial institutions such as
IDBI, IFCI, ICICI and nationalised commercial banks are also in a better position to
prevent industrial sickness. The financial institutions can prevent sickness by undertaking
a continuous monitoring which usually takes the form of periodic financial reports, desk
officer for client unit, institutional nominee on the board, periodic inspections etc.
Careful project appraisal is also required coupled with careful scrutiny of technology,
plant size, choice of location, quality of management etc. There may be incentive
schemes for units which remain healthy, in the form of interest relief and in other cases,
imposition of penal interest for avoidable project cost escalation, false sale or profit
projections.
Government accepted the recommendations of the Tiwari Committee with some
modifications and the Sick Industrial Companies (Special Provisions) Act, 1985 was
enacted. But there are some problems relating to SICA:-
1. Procedural Delay – There is some procedural and legal delay in proceedings before
BIFR as it takes one year to determine whether a company is sick and further one
year to formulate revival package. Consideration of the same also takes time by the
banks and FIs. By the time decisions are taken and communicated, it has lost its
viability resulting in failure of revival schemes even after sanction.
2. Lack of timely commencement of proceedings – Under the existing law, a
company can approach the BIFR for adopting steps for its revival, on erosion of its
entire net worth. The erosion of the entire net worth is too late a stage to attempt
restructuring as by the time the net worth is eroded the company is too sick to be
revived.
3. Misuse of protection against recovery proceedings – Under the SICA, an
automatic stay operates against all kind of recovery proceedings against all the
creditors once the reference filed by the company is registered. Erring debtors have
misused the SICA to seek protection and moratorium from the recovery proceedings
. The provisions for suspension of legal proceedings are misused.
4. Lacks of extra territorial jurisdiction – Insolvency laws do not have any extra-
territorial jurisdiction, nor do they recognise the jurisdiction of foreign courts in respect
of branches of foreign banks operating in India. If a foreign company is taken into
liquidation outside India, its Indian business will be treated as a separate matter and will
not be automatically affected unless an application is filed before an insolvency court for
winding up of its branches in India.
BIFR is unsuccessful to serve the purpose with which they are set up. Over-
riding effect of SICA –
The Supreme Court in a case considered the question as to whether the company
court can sanction a scheme of arrangement in relation to Pharmaceuticals Products of
India Ltd under sections 391-394 of the Companies Act, 1956 where proceedings were
pending before the AAIFR in relation to PPIL66
.
During the pendency of proceedings before the AAIFR, PPIL also filed a scheme
of arrangement between some of its creditors and PPIL before the company court. The
company court approved this scheme. The Supreme Court in an appeal filed by Tata
Motors Ltd, inter alia, against the sanctioning of the scheme, followed an earlier
judgement of the Supreme Court, wherein it was held that the Sick Industrial Companies
(Special Provisions) Act, 1985 (SICA) is a special statute and a complete code in itself67
.
The jurisdiction of the company court would arise only when the BIFR or AAIFR,
recommends winding up of the company after arriving at the conclusion that the
company cannot be revived.
66
Tata Motors Ltd v. Pharmaceuticals Products Of India Ltd (PPIL) (2008) 144 Comp
Cas 178 67
NGEF Ltd. v. Chandra Developers P. Ltd (2005) 127 Comp Cas 822; (2005) 8 SCC
219
Legal process under the Companies Act
1. Reference to the Tribunal – When an industrial company has become a sick
industrial company, the board of directors of such company shall make a reference to
the tribunal, prepare a scheme of its revival and rehabilitation and submit the same to
the tribunal along with an prescribed application. Government company may with
the prior approval of the Central Government or a State Government, as the case
may be, make a reference to the tribunal.
SICA Section 22,16 - Jurisdiction of Civil Court – Ouster of Money suit filed against
company for its neglect to pay price of articles supplied – Company had become sick
industry – Reference to BIFR pending since prior to institution of civil suit – suit was
filed without prior consent of Board – Receipt of a reference must be held to be starting
period for proceeding with enquiry in terms of section – 16 of SICA – Civil Court had no
jurisdiction to entertain suit68
.
The Calcutta and Madras High Courts, have held that a reference under section
15 of the SICA will continue to remain pending even though a company has been
declared to be a sick industrial company by the BIFR and financial institutions can
initiate measures under the SARFAESI Act even when a scheme for rehabilitation is
under way69
.
While such measures under the SARFAESI Act, if permitted, may enable
financial institutions to recover public money, it could have bad consequences for
companies being rehabilitated under such schemes, especially if the secured creditors of
such companies have difference of opinion. If such measures are allowed under the
68
AIR 2009 SC 1947 (from Karnataka) Dr. Mukundakam Sharma, JJ Civil Appeal No.
3603 of 2009 (arising out of SLP No. 15301 of 2008) dated 15.05.2009 M.D. Bhoruka
Textiles Ltd v. M/s Kashmiri Rice industries. 69
Imperial Tubes P. Ltd v. Board for Industrial and Financial Reconstruction and
Golden Weaving Mills P. Ltd. v. Tamil Nadu Industrial Investment Corporation Ltd
(2010) 159 Comp Cas 596 (2007) 138 Comp Cas 336
SARFAESI Act, the spirit of the SICA, the revival and rehabilitation of the sick industrial
companies, may be defeated. A reference under sub-section (1) or sub-section (3) shall be
made to the tribunal within a 180 days from the date on which the board of directors of
the company or the Central Government or the RBI or a State Government or a public
financial institution or a state level institution or a scheduled bank, as the case may be
come to know, of the relevant facts giving rise to causes of such reference or within 60
days of final adoption of accounts, whichever is earlier. The tribunal may on receipt of a
reference under sub-section (1) pass an order as to whether a company in respect of
which a reference has been made has become a sick industrial company and such order
shall be final.
1. Inquiry – The tribunal may make such inquiry as it may deem fit for determining
whether any industrial company has become a sick industrial company either upon
receipt of a reference with respect to such company under section 424A.
2. Suitable order by Tribunal – If after making an inquiry under section 424B, the
tribunal is satisfied that a company has become a sick industrial company, the tribunal
shall after considering all the relevant facts and circumstances of the case, by an order
in writing, whether it is practicable for the company to make its net worth exceed the
accumulated losses or make the repayment of its debts referred to in clause (b) of sub-
section (2) of section 424A within a reasonable time.
3. Preparation of sanction – Where an order is made under sub-section (3) of section
424C in relation to any sick industrial company, the operating agency specified in the
order shall prepare as expeditiously as possible and ordinarily within a period of 60
days from the date of such order, having regard to the guidelines framed by the
Reserve Bank of India in this behalf, a scheme with respect to such company
providing for any one or more of the following measures, namely
(i) the financial reconstruction of such industrial company
(ii) the proper management of such industrial company by change in or
takeover of the management of such industrial company
(iii) the amalgamation of –(a) such industrial company with any other
company (b) any other company with such industrial company.
Provided that the tribunal may extend the said period of 60 days to 90 days for
reasons to be recorded in writing for such extension.
4. Rehabilitation – A fresh procedure for revival & rehabilitation of sick companies
has been provided under the proposed Act. After the determination of a sick
company, an application made on interim administrator is appointed to convene a
meeting of creditors and in absence of a draft scheme of revival, the interim
administrator takes over the management of the company to protect and preserve the
assets of the sick company and for its proper management. Interim administrator
would appoint a Committee of Directors. Either a company administrator may be
appointed on the basis of interim administrator‟s report or a winding up can be
initiated.
Whether the scheme relates to preventive, ameliorative, remedial and other
measures with respect to the sick industrial company, the scheme may provide for
financial assistance by way of loans, advances or guarantees or reliefs or concessions or
sacrifices from the Central Government, a State Government, any scheduled bank or
other bank, a public financial institution or State level institution or any institution or
other authority to the sick industrial company.
The Rajasthan High Court acknowledged the board of industrial and financial
reconstruction (BIFR) as an expert body to deal with rehabilitation of the sick company70
.
The court held that it couldn‟t interfere if the BIFR had not given any green signal for the
revival of the sick unit. It also held that the jurisdiction of the company court in this
matter was not appellate but restricted to that of overseeing that the meetings were
properly held and the voting was properly exercised.
The Bombay High Court held that there was no inconsistency between the
provisions of sections 15 to 19 of the Sick Industrial Companies (Special Provisions) Act
where a registered sick company can be provided with a package for rehabilitation to
70
Modern Syntex Ltd, In re, (2009) 148 Comp Cas 843 (Raj)
make the company viable and sections 391 to 394 of the Companies Act71
. The latter
provisions similarly provide for rearrangement of the company‟s business by way of
granting amalgamation, demerger and/ or by sanctioning of a scheme of compromise
which also has the very same purpose and object of reviving the company.
Scheme enforceable only when company complies with its obligations – A company
was under a scheme of rehabilitation formulated by the BIFR. It sought the withdrawal of
the winding up proceedings by the creditors as provided under the scheme. The company
relied on the provisions of section 18(8) of the Sick Industrial Companies (Special
Provisions) Act that made the scheme of rehabilitation binding on the sick industrial
company, its shareholders, creditors, guarantors and employees. The court, however,
refused the application on the ground that the company had breached the terms of the
scheme, which stipulated payments to the creditors concerned. Thus, it could not
implement the provisions of the scheme until its obligations were performed72
.
Expeditious disposal of assets - Now the OL shall dispose of all the assets & collect the
amount payable to the company from the debtors and contributories within 60 days of his
appointment. Final report has to be made by the OL to the tribunal.
The Madhya Pradesh High Court stated that it was the duty rather than legal
obligation of the BIFR to ensure expeditious disposal of the reference (registered one
way or the other at an early date) so that both the creditors and the company should know
their fate to recover the outstanding dues in accordance with law in the event of winding
up of the company73
.
5. Winding up – Where the tribunal, after making inquiry under section 424B and after
consideration of all the relevant facts and circumstances and after giving an
71
National Organic Chemical Industries Ltd v. NOCIL Employees Union (2005) 126
Comp cases 922 (Bom) 72
Mafatlal Industries Ltd v. S. A. Chemicals, (2005) 6 Comp LJ 293 (Guj) 73
Laxmichand Daya Bhavi Exports Co. v. Prestige Foods Ltd (2009) 149 Comp Cas 235
(MP)
opportunity of being heard to all the concerned parties, is of the opinion that the sick
industrial company is not likely to make its net worth exceed the accumulated losses
within a reasonable time while meeting all its financial obligations and that the
company as a result thereof is not likely to become viable in future and that it is just
and equitable that the company should be wound up, it may record its findings and
order winding up of the company.
BIFR controls properties until winding up
The Supreme Court considered the interesting issue of the respective jurisdiction
of the BIFR and the company courts where the petition for winding up of the company is
on a reference by the BIFR/ AAIFR74
. The issue arose on account of the sale of the
company‟s assets under the superintendence of the company court, prior to the winding
up. The court held that the BIFR and the company court do not have concurrent
jurisdiction over the company. Till the company remains sick, having regard to the
provisions of section 20(4) of the Sick Industrial Companies (Special Provisions) Act,
1985, the BIFR alone would have jurisdiction as regards the sale of the assets of the
company, until an order of winding up is passed. This conclusion was arrived at on the
ground that the provisions of the Sick Industrial Companies (Special Provisions) Act
prevailed over the provisions of the Companies Act.
It is submitted that the issue could have been resolved by reference to the powers
of the company court in the course of hearing a petition for winding up under the
Companies Act itself. The companies Act does not vest in the company court the
properties of company until either an order for winding up or for the appointment of a
provisional Liquidator is passed.
74
NGEF v. Chandra Developers (P) Ltd., (2005) 6 Comp LJ 203 (SC)
Section 22 does not mean proceedings filed are not pending
A company was registered before the BIFR as a sick industrial company75
. The
court held that the notice to be given in an application for stay of proceedings under
section 391(6) to creditors who had filed winding up proceedings would not be affected
by section 22 of the Sick Industrial Companies (Special Provisions) Act. The expression
“pending” in rule 71 of the Companies (Court) Rules, 1959 was to be given a liberal
interpretation and suspension of proceedings under section 22 of the Sick Industrial
Companies (Special Provisions) Act would not mean that the winding up proceedings
were not pending in the court.
Role of Official Liquidator in winding up proceedings
The Supreme Court gave due importance to the role of official liquidator in winding
up proceedings and virtually laid down that without the notice of the official liquidator no
action for recovery of debt can be initiated by any tribunal or court76
. The company was
ordered to be wound up and the OL was directed to take charge of the assets of the
company-in-liquidation by the High Court of Bombay. The OL applied for directions to
the company court and sought permission to get the property valued by a valuer from the
panel of valuers of the OL and to sell the properties are public auction.
The issue before the Supreme Court was whether the OL representing a ranked
secured creditor working under the control of the company court could be kept out of the
process of recovery of debt recovery tribunal?
The court observed that the conflict, if any, is in the view that the debt recovery tribunal could sell the properties of the company in terms of the Recovery of Debts Act.
The question was whether the liability with respect to money due from a company in
liquidation towards could be fastened on an independent corporation77
. On review the
application and appeal, the Supreme Court held that under section 446 of the Companies
75
Sharp Industries Ltd., In re. (2005) 3 Comp LJ 221 (Bom) 76
Rajasthan Financial Corporation & Another v. Official Liquidator & Another 77
Punjab State Industrial Development Ltd v. PNFC Karamchari Sangh (2006) 4 SCC
367
Act, the powers of the company judge under liquidation might be wide but that did not
empower him to pass an order making a distinct and separate corporation, a third party,
liable for the liabilities of the company in liquidations.
Financial Restructuring
Cash crunch is an inescapable problem. The preparation of cash flow projections
would highlight „how much‟ cash and when it is required. Cash generating and
conserving, leading to positive cash flow, is the focal point during survival stage. The
implementation of a nursing programme does not mean merely pumping in of additional
funds but more particularly cooperation from all parties concerned viz., the bankers,
creditors, the government, workers, management and financial institutions.