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MCA Opens a New Way Out for an Old Problem – Squeezing Out the Minority Shareholders from a Company

The Ministry of Corporate Affairs, Government of India (“MCA”) vide its Notification dated February 3, 2020, has brought into effect the eagerly anticipated sub-sections (11) and (12) of the Section 230 of the Companies Act, 2013 (“CA2013”). These provisions facilitate the takeover of the company/squeezing out the minority shareholders under a scheme of compromise/arrangement. While the remaining provisions of Section 230 of the CA2013, and for that matter the whole Chapter XV of the CA2013 relating to compromise, arrangements and amalgamations, were brought into effect in the year 2016, it has taken the MCA well over 3 (three) years to notify these key provisions.

Simultaneously with the commencement of Section 230 (11) and (12) of CA2013, the MCA has also notified the consequential revisions to the National Company Law Tribunal Rules, 2016 and the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (“Rules”), laying down the procedural aspect for utilisation of this route by the majority shareholders.

In terms of the Rules, in order to take benefit of these provisions the shareholder of a company must hold at least 3/4th (three fourth) of the shares (i.e., equity shares carrying voting rights, and includes any securities, such as depository receipts, which entitles the holder thereof to exercise voting rights) of the company. In case of takeover offers pertaining to listed companies, then in terms of the section  the same shall be as per the regulations framed by the Securities and Exchange Board.

In addition to the other information/documents required to be filed for compromises, arrangements and amalgamations, the application to the National Company Law Tribunal (“NCLT”) is required to enclose the report of registered valuer taking into consideration:

(a)      the highest price paid by any person or group of persons for acquisition of shares of the company during last 12 (twelve) months; and

(b)      the return on net worth, book value of shares, earning per share, price earning multiple vis-a-vis the industry average, and such other parameters as are customary for valuation of shares of such companies.

Additionally, at the time of making the application, the shareholder proposing the takeover is also required to deposit a sum of at least 50% (fifty percent) of the takeover offer in a separate bank account to be disclosed to the NCLT.

It is pertinent to mention here that while there are other ways that were already available under the CA2013 to achieve the exit of the minority shareholders, including: (i) selective reduction of share capital (under Section 66 of the CA2013); (ii) consolidation of share capital (under Section 61 of the CA2013); and (iii) exit of minority shareholders (under Section 236 of the CA2013), this is certainly a welcome addition to the array. All of these options have their own peculiarities (including in relation to timelines, income tax and stamp duty implications) and as is always the case, which attire fits best would need to be evaluated based on the subject as well as the occasion.

For a quick overview of the factors to be considered in making the choice between the methods, we provide here a few examples. Except selective reduction of share capital and this new addition, the other two pre-existing methods stated above cannot be undertaken simultaneously with compromises, arrangements and amalgamations and need to be undertaken separately. Further, while the outlay of funds would be by the company in case of selective reduction of share capital, the same would be from the majority shareholder in the case of consolidation of share capital, exit of minority shareholders under Section 236 of the CA2013 as well as under this newly introduced route.

Interestingly, with the imminent abolition of dividend distribution tax in terms of the Finance Bill, 2020, the new approach may be more beneficial to the minority shareholders in comparison to a selective reduction. This stems from the fact that distributions (from the accumulated profits of the company) at the time of reduction of share capital are considered dividend under the Income Tax Act, 1961. These amounts till now were taxable at approximately 15% in the hands of the company at the time of distribution, but under the Finance Bill, 2020 the entire amount received would now be added to the total income and taxable based on the applicable tax slabs of the shareholders. On the other hand, under this route of exit provided under Section 230 of the CA2013, the amount received in the hands of the minority shareholders would be chargeable under the head ‘capital gains’ and depending on the period of holding would be taxed as long term or short term capital gain. This may be more beneficial to the minority shareholder (at least for the taxpayers falling in the high-income tax slabs).

Another key aspect that needs to be considered in view of this introduction, is that now minority investors in companies need to protect themselves against this squeeze out by way of protective covenants in the shareholders agreement/ charter documents of the company, as this method can be used for forced exits of such minority investors. At the end of the day, this option opens more avenues for corporate restructuring. As to the question, whether the juice is worth the squeeze, could only be answered keeping in view the circumstances and the desired objective. But it certainly is a laudable development opening more doors than before.

If you have questions or would like additional information on the material covered herein, please contact:

Abhijeet Das, Partner

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