[Priyanshu and Chirag are students at National Law University, Jodhpur.]
Reduction of share capital, as the term suggests, pertains to the decision of a company to reduce the equity shareholding either selectively or equally through share cancellations, or repurchases/buybacks. The said reduction can be done for reasons such as restructuring the capital, or to reduce the payment of dividends, or to remedy the balance sheets. However, in ‘selective’ reduction of shares, there is differential treatment with some shareholders; which sometimes can amount to extinguishing some of the shareholders’ shares. In other words, minority shareholders can be discriminated against and their shares can be acquired, without consent, by the majority shareholders/controllers at a price they deem fit. This is also known as a ‘squeeze-out’, albeit selective reduction of shares is only one of the means for achieving this. In fact, such a squeeze-out was the central plot of the movie The Social Network, where Mark Zuckerberg removed his co-founder from Facebook (now rebranded as ‘Meta’) by significantly diluting his shares through selective share reduction. This raises concerns of corporate governance as the controllers can, essentially, drive out minority shareholders if they deem it essential without prior appraisal or consent.
In this article, the authors begin with explaining the statutory scheme and jurisprudence of selective reduction of shares under the Indian law. Later, they argue that the decision making vis-à-vis reduction of shares, whether selective or not, must not be regulated as it affects the autonomy of the controller/majority shareholders to take independent business decisions. The authors further argue that, alternatively, there is a mechanism of oppression and mismanagement that can be used to deal with such cases. Hence, the authors propose that the scope of judicial review for reduction of shares should be limited.
Statutory Scheme
Selective reduction of shares stems from Section 66 of the Companies Act 2013 (CA 2013). This provision must be read with the procedural requirements laid down in the National Company Law Tribunal (Procedure for Reduction of Share Capital of Company) Rules 2016. According to Section 66 of the CA 2013, there are, inter alia, five primary requirements that must be met in order to implement a selective reduction of shares:
The shareholders must pass a Special Resolution (i.e., the vote of at least 75% shareholders) in favour of such reduction of shares;
The company’s Articles of Association (AOA) must authorise such action;
None of the company’s creditors should have an issue with this decision;
The company must successfully seek the approval of the National Company Law Tribunal (NCLT) for the same.
Reduction of shares cannot be carried out if “if the company is in arrears in the repayment of any deposits accepted by it.”
Special attention must be paid to the language of Section 66(1) of the CA 2013 when it states that “a company [...] having a share capital may, by a special resolution, reduce the share capital in any manner.” A textual interpretation of this provision prima facie indicates that companies have the autonomy to carry out reduction of shares in whatever manner they deem fit for the purposes of carrying out their commercial activities. This level of autonomy seems to stem from the phrase “in any manner.” In this regard, the legislature has not specifically carved out any criteria, or legal thresholds. However, as explained in the next part, the courts have not done justice to the level of autonomy that has been given to companies by the legislature.
Is the Scope of Judicial Scrutiny Justified?
More often than not, the decisions to be taken in a company in India are put to vote where the opinion of the majority is chosen per se. Here, despite clear statutory demarcations, the Indian courts have raised certain guidelines for objection where the company will not be allowed to move ahead with capital reduction. A landmark common law case, British and American Trustee and Finance Corporation Ltd. and Reduced v. John Couper, has stated that the issue of reduction of shares is a domestic concern, i.e., it is an internal matter of a company. However, the Indian judiciary does not seem to have followed this line of thought. For instance, in Reckitt Benckiser v. Unknown, the Supreme Court of India (SC) stated that “in order to determine whether a proposed selective reduction is unfair or discriminatory, two factors must be duly considered — a) The motive of the company behind the given extinguishment; and b) The fairness of the valuation of the shares.” Introducing aspects such as motive and fairness does not seem aligned with the legislative intent of the provision as derived from the textual interpretation of “in any manner” in Section 66 of the CA Act 2013.
Dissecting the first factor; the court reasoned that it was the responsibility of the court to protect the interest of the minority of the shareholders which are dissenting per se [Re. Denver Hotel Co.]. Thus, it was considered that it was the policy of the legislature that the majority should provide a justification for capital reduction and the manner in which it shall be carried out.
Over time, the principle of ‘majority of the minority shareholders’ arose, where the courts stated that the reduction of shares will not be interfered unless minority shareholders support such a decision [Sandvik Asia Limited v. Bharat Kumar Padamsi; Organon (India) Limited v. Unknown]. This is akin to giving the minority shareholders a veto power over the decision making of the controllers, thereby seriously impacting the decision-making autonomy of the controllers/majority shareholders.
Furthermore, the courts have also gone into the question of whether the valuation of the minority’s shareholding was ‘fair’ or not. In Re: Cadbury India Limited, the court appointed an independent valuer to check and/or establish a fair price. Issues have also arisen contending “oppressive” valuation of minorities’ shareholding in such arrangements [Bharti Telecom Limited v. Registrar Of Companies]. With this decision, it can be observed how erroneous this approach is as, in the absence of any express thresholds, the courts are delving into the ‘fairness’ of valuation, which is a highly subjective exercise. Additionally, these tribunals (both company law boards and NCLTs) have ignored the SC decision of Hindustan Lever Employees’ Union v. Hindustan Lever Limited, where the apex court stated that “[a] company court . . . is not required to interfere only because the figure arrived at by the valuer was not as better as it would have been if another method would have been adopted.”
Recently, the National Company Law Appellate Tribunal (NCLAT) has provided conflicting decisions on this topic. In Devinder Parkash Kalra v. Syngenta, the NCLAT ordered a fresh valuation as the “the minority shareholders had the right to expect best price for the shares they were being asked to forego.” However, the reason behind ordering a fresh valuation was a three-year delay and a corresponding change in the financial position of the company. Unlike the previous instances, this decision seems to be on a better footing as there was a valid rationale behind it and the same was not carried out to determine a ‘fair’ valuation. In another recent decision of Economy Hotels v. Registrar of Companies, the NCLAT categorically stated that a “‘[r]eduction of Capital’ is a ‘Domestic Affair’ of a particular company in which, ordinarily, a Tribunal will not interfere because of the reason that it is a ‘majority decision’ which prevails.” This decision seems to respect the internal workings of a company, especially vis-à-vis autonomy of the controllers to take independent business decisions.
The Way Forward
As the previous parts of this article indicate, in the context of reduction of shares, the authors support the position that the independent business decision-making authority of the controllers should not be interfered with, or should only be interfered with to a very limited extent. A brief analogy can be drawn with the workings of the Committee of Creditors (CoC) under the Insolvency and Bankruptcy Code 2016. In this regard, the author has previously argued that the “commercial wisdom” of the CoC must be respected vis-à-vis Corporate Insolvency Resolution Process and should not be subjected to unnecessary checks as suggested by the Insolvency and Bankruptcy Board of India. Similarly, except for the procedural checks provided by the provision, the courts should not interfere with the controllers’ commercial decision-making, especially in the context of ‘fair’ valuation.
Alternatively, minority shareholders can rather choose the route of Section 244 of the CA 2013. A company can be held liable for its oppressive or prejudicial acts. Oppression means lack of probity and fair dealing in the affairs of the company, prejudicing some members [Rajahmundary Electric Supply v. A Nageshwara Rao]. To constitute oppression, there must be a wrongful act, the conduct of which is mala fide and against good conduct [Shri V.S. Krishnan v. Westfort Hi-Tech Hospital]. Thus, if the controllers take the decision of conducting share reduction with a mala fide intention of removing a minority shareholder(s), or if the controllers set an unfair price ultimately prejudicing the minority shareholders, they can file a suit of oppression against the controllers.
This approach ensures that the controllers are in a position to take commercial business decisions in the context of share reductions without being affected, or interfered, by courts vis-à-vis treatment of minority shareholders. At the same time, the minority shareholders have an avenue for filing a suit against the company in case the controllers act, for instance, in a mala fide manner. This two-pronged approach effectively balances the two sides of the same coin: commercial decision-making autonomy and corporate governance.