Scheme Of Arrangement: SEBI Scrutiny

In India, schemes of arrangement are like Swiss knives. Companies have used them to do just about everything. Increase promoter shareholding, hide promoter liabilities and even set off goodwill impairment against balance sheet reserves. Recently minority investors have protested amalgamations by Escorts, Siemens and Indiabulls, the merger of Sesa Goa with Sterlite, a restructuring by Elecon Engineering. And they’ve lost. Because the promoters’ votes ensure the scheme goes through. Well; not any more. A new SEBI circular issued this week puts in safeguards pertaining to valuation and voting and requires all schemes to be approved by SEBI. But could this put SEBI in direct conflict with company law? Payaswini Upadhyay finds out.

In May last year, Escorts proposed a merger of its 3 subsidiaries with itself. A complicated cross-ownership amalgamation and merger proposal resulted in increase of promoter’s voting control from 31.7 percent to 41.1 percent. The voting control of other shareholders feel proportionately when the proposal got the majority approval in the Court. And why just Escorts, concerns raised by minority shareholders and advisory firms in the restructuring by Elecon, amalgamation of Siemens Power Engineering with Siemens, and Indiabulls Power with Indiabulls Infrastructure met with the same fate. These and many more schemes of arrangements have been ratified by Courts under Section 391-394 of the Companies Act. But now, SEBI wants to scrutinize all schemes of arrangement before companies approach the High Courts. This week, the market regulator laid down new guidelines for listed companies that will require them to submit their schemes of arrangement to the exchanges. The exchanges will then submit the scheme to SEBI which will examine the scheme for adequate disclosures, convoluted structures, and exaggerated valuations Shishir Vayttaden
Partner, Luthra & Luthra
"Typical forms of abusive restructuring would involve promoter companies merging into a listed company at a skewed swap ratio which allows the promoter to enhance its shareholding in the listed company to the detriment of the public shareholders. Sometimes objections are raised by public shareholders when the merger or the demerger is into an unlisted company which doesn’t list. I remember some time ago there was a lot of brouhaha in the papers about Wipro demerging a division and not listing that resultant company- I don’t know if it eventually did- but at that time there was a lot of objection from public shareholders. Frequently there are merger schemes that involve promoter liabilities being rolled into the listed company – that’s the very convenient way for a promoter to borrow on the strength of the listed company’s balance sheet. So the forms of abuse the merger and demerger procedures can be put to is bounded only by human imagination but we all know there were abusive practices in this area." Nitin Potdar
Partner- M&A, JSA
"Whenever a scheme comes up for final hearing, Regional Director, Department of Company Affairs, and Liquidator gets a notice of the scheme. Let it be mandatory for a notice to be sent to SEBI also. The scrutiny which SEBI is going to do of each and every scheme – let them do the scrutiny and come up to the High Court and let that objection be made to the Court itself. So Courts will, once and for all decide whether there is a need to modify the scheme." Sanjay Rathi
Head- Legal & Corporate Governance
Pantaloon Retail
“The scheme of arrangements, so far, were being done directly without SEBI's intervention. Stock Exchanges were directly giving approvals to companies and there were certain instances where new companies were being created by virtue of this schemes of arrangement which were approaching SEBI for listing without using the IPO route. By this new Circular, SEBI would have the advantage to review all such companies in advance and they would be able to control any new entry into the market where the minority interests are not protected.” Rule 19(2)(b), SCRR lays down listing requirements
Rule 19(7), SCRR allows SEBI to grant exemption from any or all listing requirements
 
Minority interest that seems to be the overriding concern of SEBI…which is why the new guidelines provide for an independent valuation by the exchanges and SEBI. Companies will have to first get their scheme vetted by an Independent Chartered Accountant. The Audit Committee will be required to place this before the Board and submit it to the exchange. The exchanges will then forward this scheme to SEBI. And simultaneously – both the exchange and SEBI- will examine the scheme and issue observation letters. And it’s not for nothing that SEBI wants to scrutinize schemes for fair valuation. Take for instance the Akzo Nobel amalgamation last year with its three unlisted group entities. At that time, proxy advisory firm- InGovern had raised concerns on grounds of lack of financials of unlisted entities, nebulous valuations presented to investors, one-off write-offs and unsecured loans. 23% of the company’s public shareholders opposed the proposal for these reasons but a majority vote of 76% sailed it through. Shishir Vayttaden
Partner, Luthra & Luthra
 “I think what SEBI is now trying to do is to let the High Court have the benefit of a specialist scrutiny of the scheme. So what SEBI is saying in this Circular is that every merger involving a listed company will now have to present to the High Court all the comments that the Stock Exchanges and SEBI provide on the scheme. Also, it provides for broader dissemination of the scheme, the observation letter from the Stock Exchange which will include comments from SEBI- this will entail as if all public shareholder groups getting an opportunity to weigh in on the scheme. In the end analysis, I think the power to approve the scheme continues to rest where it was before the Circular which is the High Courts.” Nitin Potdar
Partner- M&A, JSA
"After having three layers of scrutiny- independent Chartered Accountant, fairness opinion, then Audit Committee report, thereafter I need to go to the Stock Exchange and SEBI and justify my valuations-what for? I must say this that the SC, time and again, and all High Courts – SC has said that we will not go into the merits of the valuation; we are not equipped to do so. We will leave this in the realms of a commercial decision by shareholders. So even if SEBI comes tomorrow with a valuation and recommends it to the High Courts, the Court is not going to interfere in that valuation." SC In TOMCO Case, 1994
“We do not think that the internal management, business activity or institutional operation of public bodies can be subjected to inspection by the Court. To do so, is incompetent and improper and, therefore, out of bounds.” And that would be the true test of this new framework- the consideration that Courts give to SEBI’s observations without which this entire effort would be futile. If history is anything to go by, SEBI has had little luck on that front. In 2002, the Bombay HC ratified a reduction of capital scheme of Sterlite despite the regulator’s intervention and argument that the scheme forces the minority out of the company. The court ruled that SEBI had no power to challenge the scheme of arrangement. Perhaps, this could be the reason why SEBI, in its new framework, has added a requirement that could very well stall schemes.  As per the new guidelines, any scheme of arrangement by a listed company would be approved only if the number of public shareholders voting in favor of the resolution is twice the number opposing it. This when the Companies Act requires only a numerical majority of shareholders represented by 75% in value of the shares. Question is can SEBI impose an additional condition for listed companies for schemes of arrangement when none was envisaged by the parliament under Companies Act. Nitin Potdar
Partner- M&A, JSA
"After the scheme has been sanctioned and passed, one has to look at the voting pattern. From the public shareholders, we will have to find out how many have voted against. And you will need to have twice the number – amongst the public shareholders- who have voted in favor of the scheme. So what are you saying- you’re saying ignore the majority, and now lets go to this public shareholders and find out whether they are in agreement or not. You are converting minority into a majority decision. You’re subjecting the majority decision, the statutory requirement of the Companies Act to this verification. Now is this something which is permissible. You are telling the majority that you may have raised this company over five generations, slogged for it etc but now this public shareholding will decide whether you can restructure or not. SEBI will have to take a relook at it because this is against the fundamentals of Company Law." Shishir Vayttaden
Partner, Luthra & Luthra
"In other areas like, say the buyback of securities- that’s another area where the Companies Act has a robust framework and SEBI’s regulations supplement that framework. The respect in which the jurisprudence of buyback differs from the Circular is that provisions relating to mergers don’t give SEBI any powers to notify any regualtions to supplement that framework whereas most of these other areas where SEBI has supplemented the Companies Act, it would derive its power to do that from the Companies Act itself." Most lawyers I spoke to conceded that there has been considerable abuse of schemes of arrangement by promoters to the detriment of minority shareholders. And so it’s no ones case that SEBI should not protect the interest of the minority. The additional concern, besides the ones raised by the experts in this story, is that the circular does not distinguish mergers that have a potential of abuse from the ones that don’t- for instance, merger of a wholly owned subsidiary into the parent listed company which has little or no effect on public shareholders. Secondly, if companies go ahead with their schemes without meeting the new voting requirements, can and will SEBI take punitive action against them- experts told me to wait for the jurisprudence to evolve on this. But most importantly the success of this brave attempt by SEBI will depend upon how much importance courts give to SEBI's opinion. In Mumbai, Payaswini Upadhyay