PART A: Introduction
Before the establishment of National Company Law Tribunals (“NCLTs”) under the Companies Act, 2013 (“2013 Act”), schemes of arrangement – being court approved arrangements or compromises between a company(ies) and its (their) creditors or members, fell within the purview of the High Courts under Sections 391-394 of the Companies Act, 1956 (“1956 Act”).
The NCLT and the National Company Law Appellate Tribunal (“NCLAT”) were constituted as specialized institutions to deal with corporate disputes and promote speedy disposal of matters pertaining to restructuring, rehabilitation and revival of companies. A notable trend that is emerging is that the various NCLTs are approaching company schemes somewhat differently from the High Courts under the erstwhile 1956 Act in certain cases and sometimes providing conflicting decisions. This has sometimes led to some transaction uncertainty as well as delay for clients choosing the NCLT route for transactions.
This article briefly examines some of these trends. To provide context, Part B of this article briefly sets out historically accepted and established principles relating to the role of courts while sanctioning schemes of arrangement, on the basis of which Part C then briefly analyses three sets of recent NCLT decisions which arguably deviate from these principles.
PART B: Role of courts in sanctioning schemes of arrangement
The following landmark judgments of the Supreme Court (“SC”) lay down principles relating to the role and level of intervention of courts while sanctioning schemes, and were relied on by the High Courts in India whilst considering schemes under the 1956 Act:
In Hindustan Lever Employees’ Union v. Hindustan Lever Limited and Ors.1 the SC held that, courts in sanctioning claims of mergers are not to ascertain mathematical accuracy if the determination satisfied the arithmetical test. It held that a company court does not exercise appellate jurisdiction and it’s not part of the judicial process to examine entrepreneurial activities. Section 394 casts an obligation on the court to be satisfied that the scheme was not contrary to public interest or unconscionable. The SC stated that the courts are required to examine a scheme for arrangement on the basis of the ‘prudent business management test’ and be satisfied that the scheme is not a device to evade law.
This was followed by the decision of the SC in Miheer H. Mafatlal v. Mafatlal Industries Limited2, where it held that, the court should not sit in judgment over the informed view of the concerned parties to the compromise as this would be in the realm of their corporate wisdom. It held that the court neither had the expertise nor the jurisdiction to delve into the commercial wisdom of creditors and members that have ratified a scheme by requisite majority and the jurisdiction of the court is peripheral and supervisory and not appellate. It held that the court cannot scrutinize a scheme with a view to find a better scheme that could have been adopted by the parties.
The SC identified the broad contours of the jurisdiction and role of courts while considering a scheme. These mainly comprised of monitoring compliance with requisite statutory procedures, ensuring that the scheme is just, fair and reasonable from the point of view of a prudent person taking a commercial decision, and ensuring that the scheme is not contrary to law or public policy.
Therefore, under the 1956 Act, courts adopted a non-interventionist approach while sanctioning schemes. The general market expectation was that the NCTLs would continue with this existing approach. However, aided by additional language in the 2013 Act, the NCLTs have in some cases been adopting what could be considered to be a more interventionist approach to schemes.
PART C: Recent NCLT Decisions
Ajanta Pharma3
In September 2018, the NCLT in Mumbai rejected a scheme of arrangement between Gabs Investment Private Limited (“GIPL”) and Ajanta Pharma Limited (“APL”) on account of objections raised by the income-tax authorities. The facts and a brief snapshot of the NCLT order are as follows:
- APL is a listed company and GIPL is an investment holding company. The promoters of APL owned and controlled GIPL, which in turn held 9.54% of the paid-up equity share capital of APL.
- The objective of the scheme was the extinction of the shareholding of the promoters in GIPL in exchange for the equity shares of APL. As a result, the promoters would hold the shares in APL directly rather than through GIPL. The scheme was approved by the members of both APL and GIPL with the requisite majority at their respective meetings
- Following receipt of the notice delivered in terms of Section 230(5) of the 2013 Act, the income-tax authorities raised objections on the ground that the scheme was structured to avoid tax.
Arguments of the income-tax authorities before the NCLT
The income-tax authorities argued that GIPL, being a separate legal entity, would have been subject to tax liability of INR 421.66 crores had the transaction been structured as a direct transfer of shares of APL from GIPL to the shareholders of GIPL. By way of the scheme, GIPL was instead transferring its shareholding in APL to its shareholders tax free, thereby causing a loss to the exchequer. They also argued that the amalgamation was an impermissible avoidance arrangement to avoid tax under the General Anti-Avoidance Rules (“GAAR”).
NCLT Order
The NCLT held that the scheme should comply with applicable laws and be in public interest for it to be approved. It noted that the companies had failed to satisfy it regarding compliance with the appropriate tax laws and ordered a resolution of the tax issues before sanctioning of the scheme.
Analysis
In terms of the Income-Tax Act, 1961, a shareholder may, in a scheme of amalgamation, transfer shares of an amalgamating company in exchange of shares of the amalgamated company without the levy of capital gains tax.
The submissions of the parties to the court was that the scheme would permit a simplification of the holding structure, eliminate multiple levels of shareholding and bring in transparency. An overwhelming majority of the shareholders of the transferee company had voted in favour of the merger and save for the income tax authorities, other regulators had not found any objections to the scheme.
Notwithstanding these arguments, the scheme was disallowed. The previously understood position was that schemes could be disallowed on the basis of tax frauds. No such fraud was established in this case. Accordingly, the decision raises interesting questions in relation to the extent to which tax issues may affect the ability of parties to effectuate a court based arrangement in future. Clients should bear in mind and evaluate the possible consequences of any tax structuring envisaged under their scheme.
Wiki Kids4
In July 2017, the NCLT in Hyderabad rejected the scheme between Wiki Kids Limited (“Wiki Kids”) and Avantel Limited (“Avantel”), on account of the scheme benefitting only the common promoters of the parties (“NCLT Order”). The NCLT Order was upheld by the NCLAT. The facts and a brief snapshot of NCLT Order are set out below:
- (i) Wiki Kids, an unlisted company and Avantel, a listed company proposed a scheme before the Andhra Pradesh High Court (“APHC”), seeking directions regarding the meetings of the shareholders and creditors to approve the scheme. Wiki Kids (transferor company) was promoted by the promoters of Avantel (transferee company) which held 99.9% of the paid-up share capital of Wiki Kids.
- (ii) Pursuant to directions of the APHC, the scheme was approved by the shareholders of Wiki Kids. In the meantime, the case was transferred to the NCLT.
- (iii) The NCLT, upon perusing various documents, including the share exchange ratio and valuation report computed by an expert independent chartered accountant, observed that the objective of the scheme, which set out that the amalgamation would result in improved cash flows was not justified considering that Wiki Kids had not commenced operations and had no operating income. It observed that the scheme circulated to the shareholders and creditors neither provided necessary information nor disclosed the fact that the shares of Avantel were being allotted to the common promoters of the companies, which prevented them from taking an informed decision. The scheme was rejected for being beneficial to the promoters and no public interest was being served by the amalgamation as envisaged in the scheme. Aggrieved by the NCLT Order, the parties approached the NCLAT.
Arguments before the NCLAT
It was argued that all applicable legal requirements had been complied with and there were no objections from any concerned regulatory authorities. It was also argued that the NCLT Order was based on the numbers in the balance sheet of Wiki Kids and failed to consider the potential business model developed by it.
NCLAT Order
The NCLAT upheld the NCLT Order and held that a scheme should be in the interest of all shareholders and not only for a few. The NCLAT clarified that the NCLT comprises of both judicial and technical members and had enough expertise to examine a scheme to ensure that it is fair and just to all shareholders. The NCLAT agreed that while it may not be desirable for the NCLT to look into mathematical details, if the scheme appears to be unfairly beneficial to a particular class of persons, then the court should exercise its expertise and refuse to approve a scheme if, in its opinion, it doesn’t uphold public interest.
Analysis
The SC has previously held that the court should not ordinarily scrutinize the arithmetic accuracy or commercial viability of a scheme, if it is approved by the shareholders and creditors of a company. The valuation in this case was undertaken by an expert, and public shareholders of Avantel voted in favour of the scheme. There were no objections to the scheme. Regardless, the NCLT suo motu examined the financials of Wiki Kids in detail and disallowed the scheme on the basis that the valuation was not credible and the NCLAT upheld this approach. This appears to be an extension of the role envisaged by the Supreme Court for courts considering schemes and may pose challenges for restructuring exercises where a company does not have established cash flows or has one that is difficult to accurately value (as is the case with startups for example).
Conflicting Decisions on Appointed Date
The Appointed Date is the date from which assets and liabilities under the scheme transfer whereas the Effective Date is the date from which the scheme comes into effect. Thus, schemes come into effect on the Effective Date with effect from the Appointed Date.
Some companies have prescribed that the Appointed Date shall be the Effective Date of the scheme, whereas others have set out a fixed date as the Appointed Date for the scheme. Specifying that the Appointed Date shall be the Effective Date is particularly useful in cases where the Appointed Date is not intended to be a past historical date and the scheme involves a number of conditions precedent (particularly regulatory approvals that need to be obtained as a matter of law) and the timeline for satisfaction of these conditions precedent is not known in advance. Recently, the NCLT has sometimes taken the view that the Appointed Date should be a fixed “hard” date and a scheme which provides that the Appointed Date shall be the Effective Date is not legally tenable. The provision relied on is Section 232(6) of the 2013 Act, which provides for the first time that a scheme of arrangement should, “clearly indicate an appointed date from which it shall be effective and the scheme shall be deemed to be effective from such date and not at a date subsequent to the appointed date”.
Effective Date as the Appointed Date
In SCIL Ventures Limited and M/s Securities Research & Analysis Private Limited5, the NCLT in Mumbai accepted that the scheme was subject to requisite approvals and the date on which all such approvals are obtained and the order of the NCLT filed with the Registrar of Companies, would be the Effective Date as defined in the scheme and that further, the scheme would be effective from the Appointed Date, as mentioned in the scheme.
In Vodafone Mobile Services Limited, Vodafone India Limited and Idea Cellular Limited6 before the NCLT in Mumbai, the implementation of the scheme was conditional upon the approval by the Department of Telecommunication (“DoT”), which could be obtained only upon sanction of the scheme by the NCLT. It was accepted that the Appointed Date and the Effective Date were prospective in nature, as also the provisions of the scheme which linked the Appointed Date to the Effective Date. The NCLT stated that while a scheme may be sanctioned, the Appointed Date of the amalgamation/merger may be delayed till pre-conditions are fulfilled.
In In Re: UltraTech Cement Limited7 before the NCLT in Mumbai, the explanation that the Appointed Date in the scheme was defined as “shall be the Effective Date” and the Effective Date was defined as the date on which the scheme would become effective in accordance with its terms, was accepted. Therefore, the Appointed Date and the Effective Date would be the same date in accordance with the 2013 Act.
Appointed Date being a Fixed Date
In East West Pipeline Limited and Pipeline Infrastructure Private Limited,8 the NCLT in Mumbai passed an order requiring a fixed Appointed Date for the scheme. The order states that, “when it has been specified as ‘date’, it has to be conceived as calendar ‘date’, and it shall not be conceived as contingent upon approval of scheme by NCLT”. It held that the reason for having an identifiable date is that all financial implications of the scheme including the consideration payable thereunder, would be on the basis of a valuation conducted as of the Appointed Date.
In Tata Teleservices (Maharashtra) Limited9 before the NCLT in Mumbai, the scheme was conditional upon the approval of the DoT and permission was sought to approach the tribunal with a fixed Appointed Date upon obtaining approval of the DoT. The NCLT sanctioned the scheme with an undertaking that the tribunal would be approached within three months of obtaining the approval of the DoT, with a fixed Appointed Date.
These cases are illustrative but show the conflicting decisions of the NCLT on this question. Under the supervisory jurisdiction of the High Courts under the 1956 Act, it was understood that the Appointed Date could be linked to the Effective Date. In our view, the better interpretation is that Section 232(6) of the 2013 Act does not require an actual date to be provided as the Appointed Date so long as the Appointed Date is capable of determination under the scheme. The decisions in East West Pipeline and Tata Teleservices can lead to significant challenges for transaction structuring – particularly where regulatory approvals with unclear timelines are involved and even more so where the valuation date for the transfer of assets and liabilities under the scheme is linked to the Appointed Date.
Conclusion
The judgments identified above indicate that the involvement of the NCLTs whilst dealing with schemes has in some cases been more intrusive than the earlier approach adopted by the High Courts pursuant to the position laid down by the Supreme Court. Grounds for disallowal of schemes could range from tax objections to questions of valuation which courts did not previously enter into in such detail, even where shareholders approve the transaction with the requisite majority or where regulators do not object to the scheme. The confusion around Appointed Dates also poses practical challenges in structuring a transaction and achieving closure. Clients should be aware of these recent trends in order to make an informed choice to opt for a court based arrangement for their transaction and to structure it appropriately.
Footnotes
3 CSP No. 995/2017 and CSP No. 996/2017 in CSA No. 791 and 792/2017.
4 Company Appeal (AT) No. 285/2017
5 TCSP No. 158/230-232/NCLT/MB/MAH/2017, TCSP No. 159/230-232/NCLT/MB/MAH/2017, TCSP No. 160/230-232/NCLT/MB/MAH/2017.
6 CSP No. 1012/2017 & CSA No. 829/2017.
7 TCSP No. 338/2017 in CSP No. 881/2016 and Company Summons for Direction No. 772/2016.
8 CSA 719/2018.
9 C.P. (C.A.A)/3596/230-232/NCLT/MB/MAH/2018.
About the authors
Akshay Chudasama
Mr. Akshay Chudasama is the Managing Partner of Shardul Amarchand Mangaldas & Company in Mumbai. Akshay has advised on various marquee transactions, been described as a “cross border M&A specialist” and consistently been listed as a “highly recommended”/“leading individual” in the Corporate/M&A/Real Estate/Telecom/Media & IT categories by Asia Pacific Legal 500, PLC’s Which Lawyer? Merger & Acquisition Guide and Chambers & Partners.
Arka Banerjee
Mr. Arka Banerjee is a corporate partner at Shardul Amarchand Mangaldas & Company in Mumbai and focuses on mergers and acquisitions, private equity transactions, joint ventures, restructurings and general corporate matters.