Reduction of share capital under section 100 of the Companies Act, 1956, is used by companies to extinguish the shares of a group of shareholders. While the procedural requirements of undertaking a selective reduction of share capital are settled, the courts continue to differ on what constitutes a fair and equitable scheme of reduction. As such, the discretion available to courts while judging if the valuation of shares is fair and equitable is of particular interest.
What the courts look for
Indian courts have concluded that the pre-determinants for sanctioning such a scheme are: statutory provisions have been complied with; class of persons who attended the meeting was fairly represented; statutory majority acted in a bona fide manner; and a reasonable man may approve of the arrangements made.
It is well settled that no scheme of reduction “ought to be confirmed unless the court be satisfied that it will not work unjustly or inequitably” as held by the House of Lords in British and American Trustee and Finance Corporation v Couper. However, both the courts and the statutes are silent on what the just and equitable price should be.
So, while companies proposing to reduce share capital submit valuations that support the price they intend to pay, the courts get involved in determining the fairness of their valuations.
This continues to be a controversial issue, especially in schemes under section 100, as minority shareholders are always looking to maximize their investments. The scope for questioning valuations is greater as the Ministry of Company Affairs does not have a specific valuation methodology for schemes of reduction. This gives valuers the freedom to adopt any mechanisms they deem fit.
Juxtapose this to a situation where the shareholders in the scheme of reduction are persons not resident in India. As required by the Reserve Bank of India such reductions will need to be carried out at a price no more than the fair value arrived at through the discounted free cash flow method.
The issue of valuation is more acute for unlisted public or privately held companies than for listed companies, as for the latter the market price on and before the date of valuation would provide guidance.
The method adopted for valuations undertaken for the former can become a bone of contention and the courts may take it upon themselves to examine how it was done. The question is: where the valuation is undertaken by an independent valuer and the share price appears to have been arrived at fairly, how far should courts go in questioning the valuation?
Conventional role of courts
It is an established principle that the courts can examine a valuation if it is fundamentally wrong or if the valuer has made a mistake. While considering challenges to a valuation the courts generally ascertain if the valuer has included any irrelevant material or omitted any relevant material.
The Supreme Court in Hindustan Lever Employees Union v Hindustan Lever Limited clarified that the courts may examine valuation principles if they are prima facie arbitrary and unjust. The court further emphasized that the test of a fair valuation should not be whether the offer is fair to a particular shareholder, but whether it was approved by an overwhelming majority of shareholders.
On the flipside, it is arguable that section 100 does not prescribe limits to the court’s power to confirm a scheme of reduction. Does this necessarily mean that when courts sit in judgment over valuations under section 100, they can overstep well established principles of law and maybe even ask for a fresh valuation?
If the majority shareholders (including non-promoter shareholders) approve a scheme of reduction and decide the manner in which the shareholding is to be reduced, the decision of the majority should prevail. Unless there are vitiating factors in valuation reports, the court should not ordinarily suspect its correctness or judge commercial decisions made by majority shareholders.
Recently Bombay High Court in Wartsila India v Janak Mathuradas held that the role of the courts in approving a scheme is limited to ensuring that the scheme is not unfair or unjust.
The courts do not have the expertise or jurisdiction to delve into the commercial wisdom exercised by a company’s members or its creditors who ratify a scheme with the requisite majority. Despite such judgments the issue of judicial discretion in this matter is far from settled.
Anuj Prasad is a partner at Amarchand & Mangaldas & Suresh A Shroff & Co, where Anu Susan Abraham and Priyanka Sant are associates. The views expressed in this article are those of the authors and do not reflect the official policy or position of Amarchand Mangaldas.
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