Supreme Court: The Torchbearer Judgment
Citations: JT 1996 (8) 205
India has had a rich history as a prominent commercial centre throughout the ages. However, the Companies Act, 1956 was the first legislation to govern the operations of companies in post-independent India. This Act served as the foundation for the Indian company law regime for more than five decades until it was replaced by the Companies Act, 2013, which came into effect in 2013.
The focus is examining the provisions concerning mergers and amalgamations under the old and new company law regimes by critically analyzing the Supreme Court’s observations in the case of Miheer H. Mafatlal vs. Mafatlal Industries Ltd (1996). This case holds significance in understanding the legal framework surrounding mergers and amalgamations in India.
Before delving into the case details, it is essential to understand the procedural aspects involved in sanctioning a merger scheme under the old company law regime. This understanding will provide a context for comprehending the changes and developments introduced by the Companies Act, 2013 in relation to the process of approving merger schemes.
Procedural aspects of sanctioning the scheme of arrangement in the old regime
The procedure for approving a merger or amalgamation scheme is outlined in Sections 391, 392, 393, and 394 of the Companies Act, 1956. Now, let’s delve into the intricacies of this procedure.
Memorandum of Association (MOA) and Board Meetings
- The objects clause in their MOA should empower the transferor and transferee companies to undertake the merger or amalgamation.
- Approval of the scheme of the merger in a joint meeting of the board members of both companies.
Valuation of Shares and Fairness of Exchange Ratio
- Qualified chartered accountants conduct the valuation of shares of both merging entities.
- Chartered accountants determine the exchange ratio of shares, which needs acceptance by 3/4th majority shareholders of both companies.
- Exchange ratio calculation may involve yield, asset, and market value methods.
- The principle of non-interference applies, meaning the Court cannot change or substitute the exchange ratio if shareholders have accepted it, except in cases of fraud.
Filing of Petition with High Court and Order of the High Court
- File a petition in the High Court for approval of the scheme of amalgamation after board approval and valuation of shares.
- If the merging companies are under different High Courts, separate petitions are filed. A joint petition can be filed under the same High Court’s jurisdiction.
- The High Court hears the petition and passes an order to convene a meeting of shareholders and creditors for joint approval of the scheme.
Approval of the Scheme
- Shareholders and creditors meet on a predetermined date to vote on the merger scheme.
- Voting is conducted by a poll, requiring a 3/4th majority for the adoption of the scheme.
- Once the scheme is adopted, it becomes binding on the dissenting minority.
Miheer H. Mafatlal vs. Mafatlal Industries Ltd
- Mafatlal Industries Ltd (MIL), the transferee company, was incorporated in 1913 with a wide range of business activities involving cotton spinning, wool, silk, jute, etc. Its authorized share capital was Rs. 100,00,00,000.
- Mafatlal Fine Spinning and Manufacturing Company Limited (MFSL), the transferor company, was incorporated in 1931, specializing in manufacturing and selling textile piece goods and chemicals. Its authorized share capital was Rs. 30 crores.
- Limited financial resources led both companies to miss out on business opportunities, prompting the directors of MFSL to propose a merger with Mafatlal Industries Ltd, which MIL’s directors accepted.
- Resolutions were passed, and a detailed merger scheme was formulated and finalized.
- Since the companies were under different High Court jurisdictions, separate applications for the merger scheme’s approval were filed.
- MFSL applied to the Bombay High Court, which sanctioned the scheme and directed the company to conduct a meeting of equity shareholders for approval.
- The shareholder meeting resulted in overwhelming support for the merger, with over 5,000 members voting in favour and only 143 members opposing it. The appellant participated in the meeting through a proxy.
- MFSL also filed an application with the Gujarat High Court, but before the Court could sanction the scheme, the appellant, an MFSL director and a Mafatlal Industries Ltd shareholder, filed an objection to the merger.
- The Single Judge dismissed the objection at the Bombay High Court, and the Division Bench upheld the decision on appeal.
- Dissatisfied with the ruling, the appellant appealed to the Supreme Court.
Findings of the Supreme Court
Non-disclosure of material interests
The appellant in the Supreme Court case raised an argument regarding the failure to disclose vital interests during the shareholders’ meeting. This omission was seen as a violation of the prescribed procedure stated in Section 391(1)(a) of the Companies Act, 1956.
The appellant argued that the explanatory statement provided during the equity shareholders’ meeting failed to disclose the material interests of a Mafatlal Industries Ltd (MIL) director and the merger’s potential effects on those interests. Specifically, the material interest in question-related to a private dispute between the appellant and the director of Mafatlal Industries Ltd , which was being considered in the Bombay High Court. The appellant claimed the shares of the director based on a family settlement agreement, while the director had a different claim.
Based on these contentions, the appellant asserted that the lack of disclosure regarding these material interests prevented the equity shareholders from making an informed decision about the merger.
The Supreme Court analyzed the requirements for establishing a material interest of a director and its effects on the merger. It concluded that three essential conditions must be met: the director’s interest should be distinct from other voting members, the merger should have an impact on the material interest, and the effect of the merger on the director’s interest should differ from its effect on other members.
The Court determined that a private family dispute between the appellant and the director of Mafatlal Industries Limited (MIL) did not have a significant connection to the merger or affect the director’s interest in relation to the merger. Consequently, it was optional to disclose the details of the dispute in the explanatory statement.
Additionally, more than 95% of the equity shareholders voted in favour of the scheme during the shareholder meeting. Only 8% of the votes were from individuals associated with a trust formed by the MIL director, while the majority of votes came from financial institutions and private entities. Therefore, regardless of the disclosure, it was evident that the equity shareholders made an informed decision to approve the scheme.
Drawing from these observations, the Supreme Court determined that the scheme’s approval by the equity shareholders remained valid despite the non-disclosure of the private dispute.
Absence of requisite majority
The appellant argued that the scheme needed to receive the required majority approval as specified in Section 391(2) of the Companies Act, 1956. The claim was grounded on the argument that the majority shareholders cast their votes collectively as a class rather than as individual members.
The Court, referring to the Hellenic and General Trust Limited case, determined that when approving a merger scheme, the Court should consider the bona fide actions of the majority acting as a class rather than as individual members. The Court rejected the appellant’s claim that the majority shareholders acted unfairly because they voted as a class. The Court also noted that the appellant, as a director of MFSL, had initially approved the merger and did not object to it when seeking approval from the Bombay High Court. Based on these factors, the Court concluded that the appellant’s contention was invalid, as his actions indicated approval of the merger, and the requisite majority had voted in favour of the scheme.
Suppression of minority interest
The appellant argued that the majority shareholders, as a class, had colluded to suppress the minority shareholders and that the voting was unfair. He claimed that the majority decision should not bind the dissenting shareholders.
The Court acknowledged that the merger aimed to strengthen the financial resources of the merged entity, facilitating the pursuit of new projects and the expansion of services, resulting in advantages for all shareholders involved. Therefore, the Court concluded that the voting process was fair and did not harm the interests of the minority shareholders. The Court emphasized that in order to establish suppression of the minority, it must be demonstrated that the majority’s actions were prejudicial to the minority’s interests. However, in this case, the interests of both majority and minority shareholders were aligned as the merged entity was expected to generate greater profits, eliminating any conflict or suppression of minority interests.
Sub-class of creditors
The appellant argued that he belonged to a unique minority class of equity shareholders due to a family arrangement dispute, entitling him to special voting rights. He further claimed that a separate meeting for his specific class of minority shareholders was not organized, rendering the voting process regarding the approval of the scheme incomplete.
The Court dismissed both arguments because the articles of association of the transferee company only acknowledged two classes of shareholders: equity and preference. Therefore, the appellant fell under the category of equity shareholders and not a separate or special class. Section 393(1) also stipulates that a meeting for that specific class must be convened if a merger scheme involves a particular class of members. In this case, the equity shareholders constituted the relevant class, and the meeting held complied with the legal requirements. No provision in the law recognized the right to hold a separate meeting for a sub-class of shareholders.
The appellant contended that the exchange ratio used in the merger was unfavourable to the shareholders of the transferee company and argued that it should have been determined by chartered accountants prior to filing the application for court sanction. The appellant claimed that the ratio of five shares of the transferor company for every two shares of the transferee company would result in significant losses for the transferee company’s shareholders. The appellant suggested that a ratio of six shares from the transferor company should be given in exchange for every two shares of the transferee company.
The Court observed that the valuation of shares in the merger was conducted using reliable methods and approved by the appellant at the initial stages. The Court held that it was not its duty to question or analyze the credibility of expert opinions regarding the exchange ratio. Additionally, the appellant should have provided an alternative opinion. Therefore, the Court concluded it would not interfere with the company’s internal affairs. Since the majority of shareholders accepted the offer, all shareholders would be bound by the decision.
Procedural Framework for Sanctioning Merger and Amalgamation Schemes under the Companies Act, 2013
Under the new regime of the Companies Act, 2013, the procedure for sanctioning a scheme of merger or amalgamation has been outlined in Sections 230, 231, and 232 of the Act. The key procedural aspects are as follows:
Meeting of Creditors and Members: When two companies propose a merger, an application must be filed with the National Company Law Tribunal (NCLT) to convene a meeting for voting on the scheme. The NCLT can order the meeting to be held after reviewing the application. For the scheme to be adopted, at least a 3/4th majority of the creditors and members present must vote in favour of it.
Sanctioning of the Scheme by NCLT: After the creditors and members have voted in favour of the scheme, it needs to be submitted to the NCLT for sanctioning. The NCLT reviews the scheme, considers the votes, and can pass an order sanctioning the scheme. During this process, the NCLT may also issue orders related to the transfer of liabilities, share allotment, provisions for dissenting shareholders, and other necessary directions for the effective implementation of the scheme.
Additionally, the NCLT has the power to provide supervision during the implementation process and can modify the scheme if needed to ensure its successful implementation.
These procedural aspects highlight the current framework under the Companies Act, 2013 for obtaining the necessary approvals and sanctioning of a merger or amalgamation scheme.
Miheer H. Mafatlal vs. Mafatlal Industries Ltd, In this case sheds light on significant aspects related to the approval of merger schemes, such as the non-recognition of sub-classes, the importance of material disclosures, and the prevention of minority suppression. Despite the changes in procedures for forming and approving schemes in the current regime, the fundamental principles established in this case remain relevant and applicable.