Skip to main content

Legal Capsule by Veyrah Law


HOSTILE MINORITY SHAREHOLDERS:
STATUTORY SQUEEZE-OUT; THE LAST RESORT?

During the early stages of a company’s life, Founders needing funds generally give away equity to multiple small investors – be it their wealthy neighbour, friends, or some angel investors. But, once the company and the business flourish, procuring funds becomes relatively easier. Often Founders may also wish to exit the business by sale of the entire business to a strategic or financial investor. However, such investors may only be interested in acquiring 100% of an operational company once the company has achieved certain size and scale. In such a situation, it would become difficult for Founders to negotiate a 100% acquisition with a potential buyer, with multiple minority shareholders in the picture. If all minority shareholders are on good terms with the Founder, it would be smooth sailing. But, this is rarely the case, since over the years shares of small investors may have been inherited by persons who were not original shareholders, the relations between Founders and minority investors may have soured etc. In such situations, Founders along with the potential acquirer need to be tactful in acquiring or managing the shares held by the ‘hostile’ minority shareholders.
So, how should a buyer deal with such hostile minority shareholders? The preferred and most efficient option would be for the selling Founders to invite the minority shareholders to sit across the table and strike an amicable deal. An alternative would be for the potential buyer to try and strike a workable solution with the minority shareholders. Taking aggressive steps or opting for legally questionable methods while dealing with such hostile shareholders may give rise to other problems for the buyer. While it is a risky proposition for a potential buyer to acquire a company with potentially hostile minority shareholders, business and strategic compulsions may sometimes override these commercially risky albeit manageable challenges. That said, if things cannot be worked out amicably, a potential buyer may need to evaluate other available options. In this article, we have taken a look at some statutory methods by which potential buyers could deal with the hostile minority shareholders, if amicable solutions cannot be worked out.

Possible Options
Forced Acquisition
The new Companies Act, 2013 (Act) introduced a mechanism for squeezing out minority shareholders. Under the squeeze out mechanism, shareholder or a group of shareholders upon achieving the majority threshold, i.e., being holders of 90% shares may offer to buy out the shares held by minority shareholders, i.e., the remaining 10% shares of the company. The price offered to the minority shareholders has to be arrived at by a registered valuer and in line with the prescribed valuation rules. A squeeze out can be achieved very efficiently (in theory) since the acquiring shareholders can simply deliver the price for acquisition of minority shares with the company and it shall be the duty of the company to manage disbursement of payments to the minority shareholders. In case minority shareholders fail to surrender their share certificates to the company, the company has the option to cancel the existing share certificates and issue fresh certificates to the acquirer.
Capital Reduction
Another form of acquiring minority shares is by reduction of share capital which was also prevalent under the erstwhile Companies Act, 1956. Reduction of share capital can be achieved by extinguishing or reducing the liability in respect of unpaid share capital or by payment to any shareholders of any share capital (which the existing shareholder had already paid up). In order to carry out a reduction of share capital, the requisite majority of shareholders being present and voting, i.e. at least 75% of votes of shareholders in a meeting, need to approve the reduction indicating the class of shares (in the instant case, shares held by the minority shareholders) and the process of reduction to be adopted by the company. One of the key elements the company has to bear in mind is that it cannot reduce its share capital if creditors object to the scheme of reduction. The court is mandated to secure the debts or claims of creditors who do not consent to the proposed reduction. Although the compliance requirements appear to be manageable, reduction of share capital is a court driven process, i.e., the reduction can only be undertaken after securing a favourable order from the National Company Law Tribunal (NCLT). Once the shareholders pass a special resolution to effect the reduction in share capital, the company has to apply to NCLT in the prescribed manner and procure an order to carry out the reduction.

Court Scheme
Another avenue opened up with the Ministry of Corporate Affairs having recently notified certain provisions under the new Act introducing takeover provisions for private companies. Under the takeover provisions, majority shareholders, i.e., shareholders holding 75% or more shares, can approve a scheme of takeover and make an application to the NCLT to take over any part of the remaining shares. The application filed with NCLT needs to be approved by the creditors as well. The price for acquiring such shares has to be arrived at by a registered valuer in line with the prescribed valuation rules. The acquiring shareholders need to deposit 50% of the acquisition amount of the takeover upfront in a separate bank account. Since this provision has been introduced recently, the implementation and modalities are yet to be tested in courts. While the takeover is also a court driven process, the fact that it enables 75% shareholders to take such a step is a welcome change for many companies.

Conclusion
The choice of one option over the other would be based on an assessment of the underlying facts and the key objective of any acquisition. Irrespective of the option, if any company / potential buyer intends to oust any minority shareholders, they should adhere to the due process of law and ensure that exiting shareholders are not treated ‘unfairly’. 
To conclude; in any acquisition transaction, the primary option for exiting hostile minority shareholders should always be to have the selling Founders deliver the shares of the minority shareholders or to have a fair settlement with the minority shareholders. Exiting the hostile minority shareholders in an amicable manner may be a far better option, even if it means increasing the purchase cost by a certain value. The statutory options to forcibly squeeze out minority shareholders should only be used as a last resort measure. Attempting a forcible squeeze out may harden positions and involve litigation before courts in India. This is obviously not in anyone’s interest since judicial proceedings before Indian courts are plagued with delays. After having invested substantial amounts to acquire a company, a buyer must at all costs avoid getting dragged up in cumbersome litigations.
Ajay Joseph | Partner, Veyrah Law; Arun Mohanty | Principal Associate, Veyrah Law
Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.

Popular posts from this blog

VC Interview: Shailendra Singh of Sequoia Capital India

In a recent interview to Venture Intelligence, Shailendra Singh discussed some of the firm’s newer investments in the early stage segment including in the online payments space, the progress at a few existing portfolio companies and the active role the firm is playing in helping its portfolio companies scale and succeed in India and globally. Prior to joining the firm in 2006, Singh was a strategy consultant at Bain & Company in New York and before that, an entrepreneur in the digital media industry.

Venture Intelligence: How does Sequoia go about identifying potential early stage investments in India? Is there anything different you are doing today than, say, a couple of years back?

Shailendra Singh: There is a lot more focus on technology investing and early stage investing. In general, as you might remember a few years ago, we were doing primarily growth investing but in the past 18-odd months, we have had a very strong focus on early stage and that’s continuing. In terms of how…

Ambit tops League Table for Transaction Advisors to Private Equity deals in 2019

Ambit Corporate Finance topped theVenture Intelligence League Table for Transaction Advisor to Private Equity Transactions for the year 2019. Ambit advised PE deals worth $2.4 Billion (across 4 qualifying transactions) during the period. Citi ($1.1 Billion across 2 deals) and Avendus ($969 million across 12 deals) took the second and third spot. Edelweiss Financial Services ($758 million across 9 deals) and PwC ($708 million across 15 deals) completed the top five in 2019. 

The Venture Intelligence League Tables, the first such initiative exclusively tracking transactions involving India-based companies, are based on value of PE and M&A transactions advised by Financial and Legal Advisory firms.
Ambit Corporate Finance advised the $1.9 Billion buyout of Pipeline Infrastructure from Reliance Industriesby Brookfield Asset Management and the IFC and I Squared Capital-backedCube Highways' acquisition of Delhi-Agra Toll Road from Reliance Infrastructure (Reliance ADAG). Citi advise…

PE Investments down by 36% in Q1'20

Press Release
Private Equity-Venture Capital (PE-VC) firms invested $5.9 Billion (across 164 deals) during the quarter ended March 2020 - 36% lower than the $9.2 Billion (across 249 transactions) during the same period last year, according to data from Venture Intelligence, a research service focused on private company financials, transactions and their valuations. The Q1'20 investments were also 37% lower compared to the immediate previous quarter (which had witnessed $9.4 Billion being invested across 227 transactions). (Note: These figures include Venture Capital investments, but exclude PE investments in Real Estate).
The latest quarter witnessed 14 PE-VC investments worth $100 million or more, down from the 20 such transactions in the same period last year. The largest PE-VC investment announced during Q1’20 was the $567 million takeover of power generation company RattanIndia Power by Goldman Sachs and Varde Partners. The second largest investment was SoftBank Vision Fund…

Inventus, Sixth Sense, Blume & Norwest win Apex'20 Venture Capital Awards

Inventus Capital Partners, Sixth Sense Ventures, Blume Ventures and Norwest Venture Partners were voted the top Venture Capital investors in India during 2019. The Venture Intelligence “Awards for Private Equity Excellence” (APEX) is dedicated to celebrating the best that the Indian Private Equity & Venture Capital industry has to offer. Other 2019 winners in the VC segment included Axilor Ventures which was votedthe Accelerator of the Year for the second year running, 3one4 Capital (VC Fund Raise of the Year) and Innoven Capital (Venture Debt firm of the Year).
The APEX Awardees are selected based on both Self Nomination by the participating PE-VC firms as well as "crowd sourced" nominations and voting from the Limited Partner, PE-VC and advisory communities. (The main criteria are Exit Track Record, New Fund Raises & Follow-on Funding Rounds for Portfolio Companies).


"It is an honour to be recognised by entrepreneurs and investors as India's No 1 startup a…

PE investments in 2018 crosses $33-B to set new all-time high

Big Ticket investments in consumer apps Swiggy & Byju’s dominates year-end activity, even as investments in Core Sectors slow down
Private Equity (PE) investments in India rose to their highest ever figure of $33.1 billion in 2018 (across 720 transactions), according to data from Venture Intelligence (http://www.ventureintelligence.com), a research service focused on private company financials, transactions and their valuations. While PE investments have already surpassed the previous high - $24.3 Billion across 734 deals in 2017 - in the first nine months of 2018, the mega investments in Consumer Internet & Mobile startups such as Swiggy and Byjus towards the year-end, helped the 2018 total vault by 36% year-on-year. (Note: These figures include Venture Capital investments, but exclude PE investments in Real Estate.) The year witnessed 81 PE investments worth $100 million or more (accounting for 77% of the total investment value during the period), compared to 47 such transac…