Deal Talk
October 07, 2024
NCLT “Squeezes In” Philips for “Squeeze Out” of
Minority Shareholders!
A. Introduction
The Kolkata Bench of
the National Company Law Tribunal (‘NCLT’)
passed an order on September 19, 2024, dismissing
the application filed by Philips India Limited
(‘Philips’) for
a capital reduction under Section 66 of the
Companies Act, 2013 (‘CA 2013’).1 The two majority shareholders
of Philips – Koninklijke Philips N.V.
and Philips Radio B.V. (‘Majority
Shareholders’) collectively held
approximately 96.13% shareholding, and the remaining
public shareholders held approximately 3.87%
shareholding out of which 0.71% is held by the
Investor Education Protection Fund (collectively,
the ‘Public Shareholding’). Philips got delisted
from the Bombay Stock Exchange on February 16,
2004, where it provided an exit option to its
existing shareholders at INR 105 per share within
one year from the date of delisting. The Public
Shareholding is held by the shareholders who
remained with Philips even post the delisting
offer. The current application
was filed by Philips for a capital reduction
under Section 66 of the CA 2013 to cancel and
extinguish 3.87% of the share capital of Philips
other than from the Majority Shareholder. In this edition of
the Deal Talk, members of our M&A Team:
Anurag Shah, Parina Muchhala, Nishchal Joshipura
and Viral Mehta discuss the reasons because
of which NCLT dismissed the petition by Philips
and breakdown the key takeaways from this order.
B. Reason
for the capital reduction and the proposal
According to Philips,
the minority shareholders (that continued even
after the delisting in 2004) who have continued
to hold the Public Shareholding are holding
illiquid asset and have not been able to monetize
their shareholding in Philips. They had received
multiple requests from the minority shareholders
in relation to their distress due to non-liquidity
of their Public Shareholding. Therefore, to help
the minority shareholders and provide them with
liquidity, Philips was undertaking the capital
reduction at a premium to the fair value. As
per the valuation report (and a fairness report),
the board of Philips determined the fair value
of the shares as INR 740 per equity share and
the capital reduction being proposed at a 24%
premium to the fair value of the shares (i.e.
INR 915 per share). The valuation methodology
used for the valuation report approved by the
board of Philips was the ‘Discounted Cash
Flow’ methodology (‘DCF’).
Shareholders representing 99.58% of Philips
approved the capital reduction, post which the
application was filed with the NCLT for approval. Certain minority shareholders
of Philips filed an objection with NCLT, Kolkata
against the capital reduction scheme filed by
Philips under Section 66 of CA 2013.
C. Arguments
by minority shareholders and Philips’ responses:
D. NCLT’s
Order
The NCLT noted that
Section 66 can be invoked for capital reduction
in the following cases:
extinguish
or reduce the liability on any of its shares in
respect of the
share
capital not paid-up; either with
or without extinguishing or reducing liability on
any of its shares cancel any paid-up
share
capital which is lost or is unrepresented by available
assets; and either with or without extinguishing
or reducing liability on any of its shares pay off
any paid-up
share
capital which is in excess of the wants of the company,
alter its memorandum by reducing the amount of its
share capital and of its shares accordingly.
As per NCLT, the proposed
squeeze out of the minority shareholders did
not fall under any of the aforementioned (a),
(b) or (c) cases. The rationale provided by
Philips for the capital reduction was: (i) providing
liquidity to the minority shareholders holding
Public Shareholding and (ii) saving administrative
cost that being incurred due to such high number
of minority shareholders. NCLT was of the view
that neither of the two formed valid reasons
for invoking Section 66. Additionally, the NCLT
also held that Section 66 specifically bars
the application of this section on buy-back
of its own securities by a company. However,
in this case, Philips was in essence buying
back the shares from the minority shareholders
and incidentally reducing the share capital. With respect to the
arguments on valuation method, NCLT was of the
view that: (a) the valuation procured by the
minority shareholders on Comparable Companies
methodology did not specify the companies to
which Philips was being compared, and (b) the
model of Philips is unique due to the cost-plus
mark-up model, and the Comparable Companies
methodology might thus not be the most suitable
methodology for valuation. NCLT was of the view
that the DCF methodology was better suited for
valuation, given that Philips had fewer physical
assets and was being run as a going concern. However, NCLT did note
that the valuation determined by the valuer
of Philips through the DCF methodology had a
huge gap when compared to the valuation determined
by the valuer of the minority shareholders through
the same method. Nevertheless, it did not get
into the merits of the same, given that it dismissed
the application due to non-invoication under
Section 66 of the CA 2013.
E. DCF methodology
v. Comparable Companies methodology
As noted above, one
of the key arguments presented before the NCLT
was whether the right methodology for valuation
was the DCF methodology or the Comparable Companies
methodology. Choosing the right
valuation methodology for a company is pertinent
not only from a CA 2013 perspective, but also
from a foreign exchange and tax perspective.
Specifically for tax purposes, in case of related
party transactions, we have seen many tax litigations
due to the taxpayers not using the appropriate
valuation methodology which eventually leads
to the tax authorities taking a position that
the determined valuation was incorrect. There are multiple
valuation methodologies such as the DCF method,
Comparable Company method, Net Asset method
and the Earnings Capacity method. Let’s
understand the difference between the methodologies
that were discussed by NCLT in the Philips order –
DCF methodology and the Comparable Company methodology:
F. Analysis
of the NCLT Order
Jurisprudence
on the scope and interpretation of Section 66
While the order of
the NCLT is in the interest of the minority
shareholders, it opens up a pandora’s
box of questions in relation to capital reduction
under Section 66 of the CA 2013. The position taken
by NCLT that Section 66 can only be invoked
in cases as mentioned in (a), (b) and (c) of
Section 66 (1) does not take into account the
fact that the text of Section 66 (1) of CA 2013,
also allows for the reduction of share capital
“in any manner”
and in particular by the methods prescribed
under Section 66 (1) (a), (b) and (c). There
have been multiple precedents where Section
66 has been invoked for reasons other than as
mentioned in Section 66 (1) (a), (b) and (c).
Additionally, there have been a plethora of
precedents where Section 66 has been invoked
specifically for minority squeeze-outs. Let’s explore
few of these precedents:
Based on the precedents
mentioned above, a few key points to note which
were not considered by the NCLT in its order
were as follows: (i) Section 66 can be invoked
for capital reduction in instances
other
than the indicative methods
specified in Section 66 (1) (a), (b) and (c);
(ii) Squeeze out of minority shareholders is
a valid reason for invoking capital reduction
as long as the price being paid to the minority
shareholders is fair; (iii) courts have limited
reasons due to which it can interfere in a capital
reduction, which inter alia includes:
(a) whether the capital reduction is discriminatory
towards any shareholder, and (b) if the price
determined is a fair price. Interestingly, in
the present case, NCLT did not get into the
merits of valuation issue and pre-maturely disposed
off the petition. Additionally, the NCLT’s
observation with respect to the capital reduction
by Philips essentially being a buyback is also
open to challenge, given that it did not consider
the fact that the restriction under Section
66 (6) is only with the intent to ensure that
the provisions of the capital reduction procedure
are not applied to a buyback of securities occurring
under Section 68 of CA 2013. Buyback is an entirely
different process as compared to capital reduction,
because: (a) Section 66 allows for selective
capital reduction whereas Section 68 allows
for buy-back of securities from existing shareholders
only on a proportionate basis; and (b) in case
of a buy-back, the shareholders have a right
to tender their shares for buy-back. Therefore,
NCLT’s intent to equate a minority squeeze
out with a buyback followed with capital reduction
is not aligned with the spirit of both these
sections.
Is
Section 236 a valid and available recourse for minority
squeeze out?
Interestingly, Section
236 of the CA 2013 introduces an intriguing
mechanism for majority shareholders to acquire
minority holdings in a company. Unlike Section
66, which facilitates a minority squeeze-out
through a capital reduction, Section 236 offers
a direct approach for majority shareholders
to buy out the remaining shares from the minority. Despite its potential,
Section 236 remains relatively underutilized,
partly due to its complex drafting and interpretation.
According to Section 236(1), any acquirer (or
an entity acting in concert with them), who
holds 90% or more of the company’s equity,
must notify the company of their intention to
purchase the outstanding shares. However, Section 236(3)
adds a twist: while majority shareholders are
obliged to extend an offer to minority shareholders,
the latter are not required to sell their shares
to the majority shareholder. This creates a
dynamic interplay where minority shareholders
can choose whether or not to accept the offer,
adding a layer of negotiation and strategy to
the squeeze-out process and making it a less
preferred route for the majority shareholder
seeking to consolidate shareholding in the company.
G. Concluding Thoughts
To summarize our thoughts: (a) Section 236 provides
for minority squeeze out by the majority shareholders,
however, the drafting of the section provides the
minority shareholders with the option of not tendering
their shares; (b) Section 68 provides for buyback
of securities, however the same needs to be done
on proportionate basis and therefore cannot be a
selective minority squeeze-out; and (c) Capital
reduction under Section 66 can be invoked for reasons
more than just items mentioned in (a), (b) and (c)
of Section 66 (1), with a minority squeeze-out by
the company being just one of the reasons.
Authors:
Anurag Shah,
Parina Muchhala,
Nishchal Joshipura and
Viral Mehta
You can
direct your queries or comments to the relevant member.
1CP/312(KB)2023.
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