MINORITY SHAREHOLDER RIGHTS – A CROSS- JURISPRUDENTIAL ANALYSIS
Author: Anjini Ganguly, IV year of B.A.,LL.B.(Hons.) from Jindal Global Law School
Co-author: Sonali Suresh, IV year of B.A.,LL.B.(Hons.) from Jindal Global Law School
Introduction
In Foss v. Harbottle,[1] the Majority Rule was laid down, according to which, if a wrong done by the company could be ratified by 50% of the shareholders, then the courts would not interfere. The underlying reasons for such a decision was firstly, to maintain corporate independence. More importantly, it was formulated to prevent a minority from proceeding against a matter which the majority had the power to decide at a general meeting.[2]
However, in Edwards v. Halliwell,[3] Justice Jenkins laid down certain exceptions to the aforementioned Rule. When the act of the directors is ultra vires the company's articles; or if an act requires a special majority but was ratified by a simple majority; or if an individual shareholder's personal rights have been violated, the rule can be ousted. Lastly, another exception occurs if those in control commit a 'fraud' against the minority. This implies that when the wrongdoers are in control of the company, they would not allow the company to sue and hence, the Foss v. Harbottle Rule is relaxed in order to let minority shareholders sue.
This paper will be exploring the last exception, while engaging in a cross jurisprudential analysis of oppression against minorities and minority squeeze-out. The aim of this paper is to assess the position of India with respect to other jurisdictions.
Definition and Legal Trajectory
Under s.994 of the (English) Companies Act 2006, a member is allowed to apply to court if the company's affairs are being conducted in a manner that is "unfairly prejudicial" to the interests of the shareholders. The Companies Act 1948 used the word "oppression"[4]; since it had been interpreted as an act that had to be ‘harsh’ and ‘wrongful,[5] it was considered to be too restrictive.[6] Thus, the word “unfairly prejudicial” was added to give the provision a wider scope and give minority shareholders more power to apply against any act that was detrimental to them.
The terms ‘oppression’ and ‘mismanagement’ do not appear to be defined anywhere in the (Indian) Companies Act of 2013. However, a general understanding of the terms can be drawn from s.397 and s.398 of the 1956 Act, according to which, any activity which results to be prejudicial to the interests of the company, its shareholders or the public would constitute as oppression/mismanagement. When the consistent majority disregards or ignores the decisions or interests of the minority shareholders of the company, and regularly and consonantly takes decisions that prove to be burdensome, wrongful, and also harmful to the minority shareholders, it can be said that the oppression of minorities has taken place.
Due to the majority rule and subsequent minority oppression, a US court laid down the standard of conduct between shareholders as the "duty of finest loyalty".[7] Furthermore, in Donahoe v. Rodd Electrotype Co.,[8] the court applied that same duty to close corporation shareholders as well. Additionally, minority shareholders can receive a fair market value of their shares from courts due to oppressive or fraudulent behaviour by controlling wrongdoers. [9]
Similar to Common law, the (Australian) Corporations Act of 2001 states the requirement of an Act to be ‘unfairly prejudicial’[10] or ‘unfairly discriminatory’[11] against the company’s shareholders for it to constitute as oppressive. The case of Ubertini v Saeco International Group Spa[12] reflected on one of the most important and landmark judgements with respect to Oppressive conduct, the UK case of Scottish Co-Operative Wholesale Soc Ltd. v Meyer.[13] It stated that there should be a lack of fair dealing and probity[14] for an act against a shareholder to be oppressive in nature. Similar to India, the case also stated that the act must in fact be ‘harsh’, ‘wrongful’, and ‘burdensome’, and that a mere dissatisfaction or disapproval of a shareholder would not be grounds for the aggrieved shareholder to avail remedies under the Act.[15]
In addition to ‘unfairly prejudicial’, the Canada Business Corporations Act further states the requirement of an act to be anything that ‘unfairly disregards’[16] the aggrieved party’s interests. Elder v Elder & Watson Ltd[17] the Act further clarified when courts can intervene, and thereby stated the minimum requirement of “a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely”.[18]
Threshold and Requirements
Under UK law, in Prudential Assurance Co Ltd v. Newman Industries Ltd.,[19] it was held that the claimant(s) had to establish that the company was being controlled by the majority shareholders to the detriment of the minority and the company. The UK position was initially that the plaintiffs would have to show that the wrongdoers had actual control of the company. This was, however, reversed in the above mentioned case,[20]where the court held that the exception would apply even if the directors did not have actual voting powers but nevertheless had control by abusing their position to influence the majority.
While s.241 of the 2013 Act states when someone can apply for relief, s.244 states who has the right to apply for the same. In companies that have a share capital, s.244(1)(a) states that a minimum of 100 people or 1/10th of total members of the company(whichever is lesser), or members of the company who have a share value which is equal to at least 1/10th of the total share capital of the company, have the right to apply to the tribunal for relief. In cases where a company does not have a share capital, a minimum of 1/5th of the total members of the company have the right to apply for the same.[21] The provision also prescribes the condition of a written consent of others that is to be acquired before applying under s.241. Furthermore, in case a party results to be aggrieved by the decision of the tribunal, s.421 allows them to appeal the decision.
Under the English Act of 1948, only minority shareholders could apply to court since the heading clearly used the word “minorities”. This, however, was removed in the 2006 Act under s.994. In contrast, s.244 of the Indian Act states that at least 1/10th of the total members or 100 (whichever is lesser) can apply to the NCLT against oppression and mismanagement, implying that there is a lower limit but not upper limit. Thus, majority members also have the right to apply under Indian law.
In the United States, although each state has its own corporate code, the Model Business Corporation Act is often used to assess the behaviour of the majority. Similar to the UK, minorities can seek action if the directors or the majority engage in acts that are illegal, fraudulent, oppressive or unfairly prejudicial to them.[22]
While the Indian and British Law focus on the minimum requirement, Australian law under s.234 has no mention of any such rule. It allows any member who has had an act or omission committed against them or any other member of the company; or any member having been removed from the register of members as a consequence of selective reduction; or a person no longer a member of the company; or a person to whom shares have been transmitted via will or operation of law; or any member the Australian Securities and Investments Commission (SIAC) deems fit, to apply for an order under s.232.[23]
Canadian law has laid down the test of reasonable expectation to assess oppressive conduct. In Naneff v Concrete Holdings Ltd.,[24] the court held that merely looking at the technicality of the relationship between the principals involved in a case of oppression is redundant. It was held that, a proper examination of the ‘expectations’ and ‘obligations’, the ‘real rights’ must be conducted by the Courts to fairly arrive at a decision while deciding on the remedy for oppression.[25] This test was put in place to distinguish the real expectations that a shareholder would have from their company, from their individual expectation that is not provided in the company’s corporate constitution.[26]
Minority Squeeze-Out
The new method of minority squeeze-out introduced by the Ministry of Corporate Affairs under s.230(11) of the 2013 Act, allows shareholders holding at least 75% of the Company’s securities to submit a takeover offer (following the application of compromise or arrangement under s.230) to the National Company law Tribunal (NCLT) in order to acquire the remaining shares. This offer must complement a report stating the exact details of the valuation of securities/shares that the majority seek to acquire. This offer must also warrant the fair payment to the minority shareholders being squeezed out, which must be calculated by taking into consideration the highest price paid by a person/group of people in the preceding 12 months of the acquisition; and must also take into consideration earning per share, net worth, book value, et cetera.[27] Furthermore, a minimum of 50% of the consideration from the takeover offer must be deposited by the majority (acquiring) shareholders, in a separate bank account.[28]This takeover notification can only be accessed by unlisted companies, and must also be approved by all the creditors of the particular company. Upon the approval by the tribunal, the minority shareholders would be bound by this order, and thereby would need to sell their shares as required.
S.230(12) of the Act, however, allows the minority shareholders disquieted by such a takeover notification to submit an application of their grievances along with documents supporting their arguments in front of the NCLT; the tribunal will thereby make its decision based on the merits of the arguments so presented.
Another method of minority squeeze out is prescribed under s.66 of the Companies Act, 2013, allowing the majority shareholders via a special resolution and the approval of the NCLT to selectively reduce the share capital of the company. This includes cancelling the shares owned by the minority shareholders and thereby altering the MoA to reduce the share capital mentioned. Upon NCLT’s satisfaction that the request for the share capital’s reduction is in fact fair and equitable, it can issue an order for such a reduction (provided that the company is not in any arrears for the repayment of its deposits).
The case of Cadbury India Limited,[29] also famously known as Cadbury Principles, laid down some principles of valuation. It stated that, for a court to reject the request of capital reduction, the objecting party must prove the erroneous and unreasonable nature of the valuation so proposed.[30]
Another method provided for under s.236 of the Act is the purchase of minority shareholding. Under this provision, a registered shareholder holding a minimum of 90% of equity shares has the power to acquire the remaining shares by a way of notifying/informing the company.[31] The price at which the majority shareholders seek to acquire the minority shareholding must be contemplated via valuation (as mentioned above).[32]
In the United Kingdom, similar to s.236 of the Indian Act, the threshold for minority squeeze-out is the same, where the acquirer can compulsorily acquire shares only after owning 90% of the company.[33] While Indian courts have been flexible in allowing minority squeeze-out through other methods,[34] courts in the UK have taken up a more interventionist role.[35] In In Re Bugle Press Ltd,[36]the court declared a squeeze-out to be invalid when the acquirer found insidious ways to avoid the statutory requirements. Under a scheme of arrangement, the UK provides protection to minorities, where they can constitute as a separate class who can raise grievances. Whereas in India, a shareholder has to own at least 10% to raise objections. In the UK, the Majority of Minority Rule is based on the classes of directors. In Hellenic and General Trust Ltd, it was held that if the acquirer and the minorities had different interests, they had to constitute a separate class.
Likewise, under Canadian law, s.194 states the requirement of approval (by ordinary resolution) of shareholders of each class who may be affected by a squeeze out. However, this trajectory has not been seen in India till date.[37] The Corporations Act of 2001 in Australia provides for 2 methods of minority squeeze out – i) compulsory acquisition pursuant to a takeover bid; ii) compulsory acquisition following other circumstances.[38] The threshold for both the methods herein is 90%, similar to s.236 of the Indian Act.[39] Minority shareholders can object to the acquisition of their shares and upon the clearance of such an objection, if each class of minority that objected to the compulsory acquisition collectively held only 10% of shares at the most, the company may proceed with the compulsory acquisition.[40]
Redressal: Derivative Suits
The term 'derivative suit' emerged in the U.S, following the 1856 case of Dodge v. Woolsey,[41] where the court held that a derivative action was the "principal weapon of minority shareholders to curb abuses by the majority wrongdoers." To bring about such an action, the claimant would first have to exhaust their corporate remedies and then request for action to the Board of Directors. If not accepted, the shareholders could file a derivative suit. [42]
According to the Federal Rules of Civil Procedure, the plaintiff would have to show that directors had refused to pursue the claim or that the directors were under the influence of the wrongdoers.[43] Some states in the US, also laid down statutes that would require a plaintiff shareholder to give security for reasonable expenses if their shareholding was less than 5%.[44] Although derivative suits have been abused, according to Justice Rifkind, the evolution of such action has helped in "protecting corporate ownership as against corporate management".[45]In the English case of Heyting v. Dupont, the court opined that unless the facts highlighted one of the exceptions to the majority rule, the court would have no jurisdiction to hear the case.
S.241 of the 2013 Act allows members to challenge actions that are prejudicial or oppressive to the company. However, since the section does not allow a single shareholder to seek redressal, it is not wide enough to account for derivative suits. [46]
Analysis And Conclusion
India would benefit by factoring in Canada’s test of reasonable expectation instead of the current threshold regarding who can apply against oppressive conduct. This test would allow courts to fairly provide remedies for the aggrieved minority. Therefore, rather than looking at the minimum requirement, where shareholders have to hold at least 1/10th of a company’s shares, if the Courts look at which shareholder is deserving of the remedy, it could prove to be more efficient.
Moreover, under the scheme of arrangement, this minimum 10% requirement may result in excluding the minorities not holding at least 10% securities from redressal against their squeeze-out. Therefore, adopting the UK's mechanism to allow the interested minorities to form a separate class and therefore raise grievances would be beneficial to the Indian corporate legal system. Additionally, following the US Courts, who have emphasized on the importance of loyalty from majority shareholders,[47] the Indian position should move towards imposing majority shareholders with a duty of loyalty towards minority shareholders.
Although not intended for minority squeeze-outs, it has been seen that schemes of arrangement and reduction of capital are more commonly used in India.[48] Since the protection available for them is minimal, the majority are placed at an advantage, while leaving minority shareholders vulnerable. Thus, the NCLT should have an interventionist role like the English judiciary[49]while considering such squeeze-outs. Additionally, if Section 236, which was specifically enacted for minority squeeze-out, is used more often, minority shareholders would have a better mechanism for redressal.
Lastly, although derivative suits have been allowed in India,[50]there is no statutory provision for the same. Consequently, the application is limited, and courts have to refer to other common law jurisdictions.[51] As India's corporate structure shifts towards having a more dispersed shareholding, clarity regarding derivative suits would be ideal to crystallize the rights of minority shareholders.[52]
[1] (1843) 67 ER 189 [2]K. W. Wedderburn, Shareholders' Rights and the Rule in Foss v. Harbottle, 15 CAMBRIDGE L.J. 194, 201 (1957). https://heinonline-org.opj.remotlog.com/HOL/P?h=hein.journals/camblj1957&i=206 [Last Accessed 27th January 2022] [3] (1950) 2 All ER 1064 [4]Companies Act 1948, S. 210 [5]Scottish Co-operative Wholesale Society v. Meyer [1959] AC 324 [6]In Re Saul D Harrison plc [1995] 1 BCLC 14 [7]Meinhard v. Salmon 164 N.E. 545 (N.Y. 1928) [8] 328 N.E.2d 505 (Mass. 1975) [9]Sandra L. Miller, Minority Shareholder Oppression in the Private Company in the European Community: A Comparative Analysis of the German, United Kingdom, and French Close Corporation Problem, 30(2) Cornell International Law Journal, 381,388 (1997) https://core.ac.uk/download/pdf/80563243.pdf [Last Accessed 27th January 2022] [10] Corporations Act 2001 (Cth), s 233 [11]Id. [12] [2014] VSC 47 [13] [1959] AC 324 [14]Id. [15]Id. [16] Canada Business Corporations Act 1985, s 241 [17] [1952] AC 49 [18]Id. [19] (1982) Ch 204 [20]Prudential Assurance Co Ltd v. Newman Industries Ltd(1982) Ch 204 [21] Companies Act 2013, s 244(1)(b) [22]Model Business Corporation Act 1996, s. 14, extracted from Sandra L. Miller, supra note 9, at 388 [23] Corporations Act 2001 (Cth), s 234 [24][1995] OJ No 1377 (QL) [25]Id. [26]Id. [27]Companies (Compromises, Arrangements and Amalgamations) Rules 2016, Rule 6 [28]Id. [29] In Re: Cadbury India Ltd v. State 2015 (125) CLA 77 Bom [30]Id. [31] Companies Act 2013, s 236 [32]Supra note 27 [33] Companies Act 2006, S. 979 [34] Scheme of Arrangement under Section 230 and Reduction in Capital under Section 66 [35]Vikramaditya Khanna and UmakanthVarottil, Regulating Squeeze-Outs in India: A Comparative Perspective, 63(4) The American Journal of Comparative Law, 1009, 1042 (2015) https://www.jstor.org/stable/26425447[Last Accessed 27th January 2022] [36] [1960] 3 All E.R. 791 [37]Vikramaditya Khanna and UmakanthVarottil, supra note 35, at 1041 [38]IBA Corporate and M&A Committee 2014, Squeeze-Out Guide, Australia (2016) [39]Id. [40]Id. [41] (1856) 59 U.S. (18 How.) 331. [42] Anoop Singh, The Protection for Oppressed Minority Shareholders under Companies Act of UK and India A Comparative Study of Judicial Approach, Maharshi Dayanand University: Department of Law, p. 167 (2008) https://shodhganga.inflibnet.ac.in/handle/10603/129446 [Last Accessed 27th January 2022] [43] Federal Rules of Civil Procedure (United States), Rule 23.1 [44] Anoop Singh, supra note 42, at 169 [45]Brendle v. Smith, 46 Fed. Supp. 522, 525 (D.C.N.Y.), extracted from Anoop Singh, supra note 42, at 170 down when a derivative action can be sought); Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd (1981) 3 SCC 333 (The court laid down exceptions to filing derivative action suits) [46] Anoop Singh, supra note 42, at 177 [46]Roopam Dadhich and Sankalp Jain, Contextualizing Derivative Suits in India, The Competition & Commercial Law Review (Jan 2 2021) https://www.tcclr.com/post/contextualising-derivative-action-suits-in-india [Last Accessed 27th January 2022]Anoop Singh, supra note 42, at 177 [47]In Re Wheelbrator Technologies, Inc 663 A.2d 1194 (Del. Ch. 1995) [48]Vikramaditya Khanna and UmakanthVarottil, supra note 35, at 1050 [49]Vikramaditya Khanna and UmakanthVarottil, supra note 35, at 1042 [50]Satya Charan Law v. Rameshwar Prasad Bajoria (1949) SCC OnLine FC 35 (The court laid down when a derivative action can be sought); Needle Industries (India) Ltd. v. Needle Industries Newey (India) Holding Ltd (1981) 3 SCC 333 (The court laid down exceptions to filing derivative action suits) [51] Anoop Singh, supra note 42, at 177 [52]Roopam Dadhich and Sankalp Jain, Contextualizing Derivative Suits in India, The Competition & Commercial Law Review (Jan 2 2021) https://www.tcclr.com/post/contextualising-derivative-action-suits-in-india [Last Accessed 27th January 2022]