A typical “squeeze-out” refers to the mandatory sale of shares by minority shareholders, to the promoters or to the company. There are various reasons as to why a promoter or a company may wish to squeeze-out minority shareholders, ranging from exercising greater control over the company, to the company benefitting from an easier compliance regime. It could also be done to provide an exit opportunity to minority shareholders and enable them to liquidate their investments.
In India, a squeeze-out in its true sense can generally be effected only by virtue of: (i) promoters purchasing (or a company extinguishing, for cash) minority shareholding as a part of a scheme of arrangement under Sections 230-233 of the Companies Act, 2013 (Act); or (ii) a reduction of capital under Section 66 of the Act.
In India, the reduction of capital route has been overwhelmingly employed for a squeeze-out, where the shares of the company held by the minority shareholders are extinguished and fair value is paid for the said shares to such minority shareholders. The reason why this is used most frequently is because it is backed by ample judicial precedents and once it is approved by the requisite majority, it becomes binding on all the shareholders.
Of course, there are concerns about squeeze-outs, including the majority wielding its power unfairly to force the minority to divest its shareholding. However, when individual shareholder rights are pitted against shareholder democracy, the latter almost always prevails. For example, in India, proceedings pertaining to the oppression of minority shareholders or mismanagement can be initiated only if shareholders who move such proceedings are at least a hundred in number or hold at least 10% of the share capital.
The jurisprudence on squeezing out minority shareholders by carrying out a selective reduction of capital dates back to the 1894 decision of the House of Lords in British and American Trustee and Finance Corporation. In this case, the House of Lords approved a reduction of capital that was applied selectively to certain shareholders. It was observed that the (English) Companies Act, 1877 had not prohibited any method of effecting a reduction and that the requirement of a confirmation of reduction by the court was an adequate safeguard to protect the interests of the minority shareholders.
It appears that in India, utilising the capital reduction route to squeeze out the minority began fairly recently.
One of the first landmark cases was that of Reckitt Benckiser. After a series of open offers, Reckitt Benckiser (India) Limited (RBIL) was delisted and a reduction was proposed to return capital to: (i) all the remaining public shareholders (who continued to hold shares in RBIL); and (ii) to Lancaster (an affiliate of RBIL which had made the previous open offers, in respect of RBIL). The reduction was objected to by a shareholder group, amongst others, on the grounds that: (i) no necessity to reduce capital was made out; (ii) the reduction was discriminatory as it would extinguish the class of public shareholders; and (iii) there cannot be a forcible acquisition of shares as it would constitute as oppression of the minority shareholders. Ultimately, RBIL offered to let the objectors remain as shareholders and consequently, the Delhi High Court approved the capital reduction. However, the court laid down certain principles in relation to capital reductions and held that a selective reduction of capital is permissible but the court has to be satisfied that there is no unfair or inequitable transaction at play.
The Reckitt Benckiser judgment was followed by a number of judgments approving selective reductions of capital, including the judgments of the Bombay High Court in Elpro International Limited and Sandvik Asia Limited.
The jurisprudence on selective reduction of capital indicates that the most common ground for shareholder challenge to such reduction is the price offered by the company for extinguishment of shares. Accordingly, it is essential that the valuation give appropriate weightage to the relevant methodologies while arriving at the fair value. It is critical for the valuer to provide rationale in the valuation report, consider past buybacks, delisting, takeover offers and give proper context to the fair value arrived at, in relation to the reduction of capital. Valuers have often had to respond to pointed questions raised by shareholders.
While questions as to the fairness of promoters’ ability to drive out minority shareholders using a reduction of capital remain; the requirement of a court approval acts as a check against reductions that overreach or are unfair to minority shareholders. Accordingly, the onus lies on the company undertaking reduction to demonstrate that the reduction is fair to minority shareholders.
(The author is a Principal Associate at Khaitan & Co. Views are personal)