In a far-reaching decision, a division bench of the Bombay High Court has endorsed a special resolution of a company to reduce the share capital of a company on the basis of the identity of the person holding the shares. Majority shareholders can now throw out minority shareholders by effect a reduction of the capital held by minority shareholders alone.
Normally a reduction of capital is effected uniformly across all shareholders – not in a manner that picks and chooses specific shareholders who would cease to be shareholders. Since the proposed resolution sought to throw out minority shareholders alone as a consequence of the proposed reduction, a single judge had ruled that the proposal was inequitable. The division bench dealt with an appeal against the judgement of the single judge.
The provisions of Sections 100 to 105 of the Companies Act, 1956 (“the Act”) deal with reduction of capital. If a company’s Articles of Association permit reduction, the company could pass a special resolution (75 per cent vote by shareholders present and voting at a general meeting) approving reduction of capital, and then seek a court’s approval to effect the reduction.
The law entitles creditors to object to the proposal under certain conditions – logical, because shareholders normally stand last in queue when a company is wound up, and a reduction puts them ahead of the creditors.
There are other provisions in the Act based on which a shareholder could be taken out of a company. The provisions Sections 391-394 of the Act entail propounding of a scheme of arrangement or compromise whereby rights and obligations of shareholders and creditors could be altered, adjusted and modified in an extraordinary or unusual manner. Such sche-mes of arrangement too are subject to sanction of the high court, and once approved would bind the world at large including those dissenting to the scheme. Section 395 expressly deals with having to buy out dissenting minority shareholders who do not agree to a scheme approved by the majority.
However, in the instant case, the company’s proposal to reduce capital was in effect a proposal to squeeze-out the shareholders other than the promoters and divest them of shareholding.
The promoters were able to comfortably pass the special resolution. In lieu of the reduction, such shareholders would of course be paid money in terms of a fair value to be computed, but these shareholders would lose their right to hold shares although they were not willing sellers.
The division bench has ruled that the “special resolution which proposes to wipe out a class of shareholders after paying them just compensation” is not unfair or inequitable.
“In our opinion, once it is established that non-promoter shareholders are being paid fair value of their shares, at no point of time it is even suggested by them that the amount that is being paid is any way less,” the court observed. That an overwhelming majority of the non-promoter shareholders voted in favour of the resolution too weighed with the court, which held that “the court will not be justified in withholding its sanction to the resolution.”
The judgement opens up several interesting possibilities and propositions in relation to shareholder rights in India. The company in question was not a listed company – it had already been delisted.
Listed companies would require stock exchange approval for reduction of capital under the listing agreement, and it is unlikely that stock exchanges would approve such a transaction. However, for an unlisted company, regardless of whether a company is a public company or a private company, shareholders rights can be impacted severely.
Private equity investors holding small stakes without serious rights could easily be thrown out by management using such resolutions. In family-run companies, a segment of the family that holds a minority stake could get thrown by the rest of the family. All that one would need is a special resolution.
The core business issue involved here is not about whe-ther the price paid for the shares would be fair, but whether an owner of shares in India has a vested right to keep his property, or whether other shareholders can force him to divest his property.
While an appeal to the Supreme Court against this judgement is a certainty, for now, this position represents an established precedent. (The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)