During the early stages of a company’s life, Founders needing funds generally give away equity to multiple small investors – be it their wealthy neighbour, friends, or some angel investors. But, once the company and the business flourish, procuring funds becomes relatively easier. Often Founders may also wish to exit the business by sale of the entire business to a strategic or financial investor. However, such investors may only be interested in acquiring 100% of an operational company once the company has achieved certain size and scale. In such a situation, it would become difficult for Founders to negotiate a 100% acquisition with a potential buyer, with multiple minority shareholders in the picture. If all minority shareholders are on good terms with the Founder, it would be smooth sailing. But, this is rarely the case, since over the years shares of small investors may have been inherited by persons who were not original shareholders, the relations between Founders and minority investors may have soured etc. In such situations, Founders along with the potential acquirer need to be tactful in acquiring or managing the shares held by the ‘hostile’ minority shareholders.
So, how should a buyer deal with such hostile minority shareholders? The preferred and most efficient option would be for the selling Founders to invite the minority shareholders to sit across the table and strike an amicable deal. An alternative would be for the potential buyer to try and strike a workable solution with the minority shareholders. Taking aggressive steps or opting for legally questionable methods while dealing with such hostile shareholders may give rise to other problems for the buyer. While it is a risky proposition for a potential buyer to acquire a company with potentially hostile minority shareholders, business and strategic compulsions may sometimes override these commercially risky albeit manageable challenges. That said, if things cannot be worked out amicably, a potential buyer may need to evaluate other available options. In this article, we have taken a look at some statutory methods by which potential buyers could deal with the hostile minority shareholders, if amicable solutions cannot be worked out.
The new Companies Act, 2013 (Act) introduced a mechanism for squeezing out minority shareholders. Under the squeeze out mechanism, shareholder or a group of shareholders upon achieving the majority threshold, i.e., being holders of 90% shares may offer to buy out the shares held by minority shareholders, i.e., the remaining 10% shares of the company. The price offered to the minority shareholders has to be arrived at by a registered valuer and in line with the prescribed valuation rules. A squeeze out can be achieved very efficiently (in theory) since the acquiring shareholders can simply deliver the price for acquisition of minority shares with the company and it shall be the duty of the company to manage disbursement of payments to the minority shareholders. In case minority shareholders fail to surrender their share certificates to the company, the company has the option to cancel the existing share certificates and issue fresh certificates to the acquirer.
Another form of acquiring minority shares is by reduction of share capital which was also prevalent under the erstwhile Companies Act, 1956. Reduction of share capital can be achieved by extinguishing or reducing the liability in respect of unpaid share capital or by payment to any shareholders of any share capital (which the existing shareholder had already paid up). In order to carry out a reduction of share capital, the requisite majority of shareholders being present and voting, i.e. at least 75% of votes of shareholders in a meeting, need to approve the reduction indicating the class of shares (in the instant case, shares held by the minority shareholders) and the process of reduction to be adopted by the company. One of the key elements the company has to bear in mind is that it cannot reduce its share capital if creditors object to the scheme of reduction. The court is mandated to secure the debts or claims of creditors who do not consent to the proposed reduction. Although the compliance requirements appear to be manageable, reduction of share capital is a court driven process, i.e., the reduction can only be undertaken after securing a favourable order from the National Company Law Tribunal (NCLT). Once the shareholders pass a special resolution to effect the reduction in share capital, the company has to apply to NCLT in the prescribed manner and procure an order to carry out the reduction.
Another avenue opened up with the Ministry of Corporate Affairs having recently notified certain provisions under the new Act introducing takeover provisions for private companies. Under the takeover provisions, majority shareholders, i.e., shareholders holding 75% or more shares, can approve a scheme of takeover and make an application to the NCLT to take over any part of the remaining shares. The application filed with NCLT needs to be approved by the creditors as well. The price for acquiring such shares has to be arrived at by a registered valuer in line with the prescribed valuation rules. The acquiring shareholders need to deposit 50% of the acquisition amount of the takeover upfront in a separate bank account. Since this provision has been introduced recently, the implementation and modalities are yet to be tested in courts. While the takeover is also a court driven process, the fact that it enables 75% shareholders to take such a step is a welcome change for many companies.
The choice of one option over the other would be based on an assessment of the underlying facts and the key objective of any acquisition. Irrespective of the option, if any company / potential buyer intends to oust any minority shareholders, they should adhere to the due process of law and ensure that exiting shareholders are not treated ‘unfairly’.
To conclude; in any acquisition transaction, the primary option for exiting hostile minority shareholders should always be to have the selling Founders deliver the shares of the minority shareholders or to have a fair settlement with the minority shareholders. Exiting the hostile minority shareholders in an amicable manner may be a far better option, even if it means increasing the purchase cost by a certain value. The statutory options to forcibly squeeze out minority shareholders should only be used as a last resort measure. Attempting a forcible squeeze out may harden positions and involve litigation before courts in India. This is obviously not in anyone’s interest since judicial proceedings before Indian courts are plagued with delays. After having invested substantial amounts to acquire a company, a buyer must at all costs avoid getting dragged up in cumbersome litigations.
Ajay Joseph | Partner, Veyrah Law; Arun Mohanty | Principal Associate, Veyrah Law
Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.