CORPORATE RECONSTRUCTION

Restructuring is the corporate management term for the act of reorganizing the legal,
ownership, operational, or other structures of a company for the purpose of making it more
profitable, or better organized for its present needs. Other reasons for restructuring include a
change of ownership or ownership structure, demerger, or a response to a crisis or major change
in the business such as bankruptcy, repositioning, or buyout. Restructuring may also be described
as corporate restructuring, debt restructuring and financial restructuring.

Executives involved in restructuring often hire financial and legal advisors to assist in the
transaction details and negotiation. It may also be done by a new CEO hired specifically to make
the difficult and controversial decisions required to save or reposition the company. It generally
involves financing debt, selling portions of the company to investors, and reorganizing or
reducing operations.

The basic nature of restructuring is a zero-sum game. Strategic restructuring reduces financial
losses, simultaneously reducing tensions between debt and equity holders to facilitate a prompt
resolution of a distressed situation.

Corporate debt restructuring is the reorganization of companies’ outstanding liabilities. It is

generally a mechanism used by companies which are facing difficulties in repaying their debts.
In the process of restructuring, the credit obligations are spread out over longer duration with
smaller payments. This allows company's ability to meet debt obligations. Also, as part of
process, some creditors may agree to exchange debt for some portion of equity. It is based on the
principle that restructuring facilities available to companies in a timely and transparent matter
goes a long way in ensuring their viability which is sometimes threatened by internal and
external factors. This process tries to resolve the difficulties faced by the corporate sector and
enables them to become viable again.

Steps:

 Ensure the company has enough liquidity to operate during implementation of a complete
restructuring
 Produce accurate working capital forecasts
 Provide open and clear lines of communication with creditors who mostly control the
company's ability to raise financing
 Update detailed business plan and considerations

Meaning and Need for Corporate Restructuring

Corporate restructuring is the process of redesigning one or more aspects of a company.
The process of reorganizing a company may be implemented due to a number of different
factors, such as positioning the company to be more competitive, survive a currently
adverse economic climate, or poise the corporation to move in an entirely new direction.
Here are some examples of why corporate restructuring may take place and what it can
mean for the company.

Restructuring a corporate entity is often a necessity when the company has grown to the
point that the original structure can no longer efficiently manage the output and general
interests of the company. For example, a corporate restructuring may call for spinning off
some departments into subsidiaries as a means of creating a more effective management
model as well as taking advantage of tax breaks that would allow the corporation to divert
more revenue to the production process. In this scenario, the restructuring is seen as a
positive sign of growth of the company and is often welcome by those who wish to see the
corporation gain a larger market share.

Corporate restructuring may also take place as a result of the acquisition of the company
by new owners. The acquisition may be in the form of a leveraged buyout, a hostile
takeover, or a merger of some type that keeps the company intact as a subsidiary of the
controlling corporation. When the restructuring is due to a hostile takeover, corporate
raiders often implement a dismantling of the company, selling off properties and other
assets in order to make a profit from the buyout. What remains after this restructuring may
be a smaller entity that can continue to function, albeit not at the level possible before the
takeover took place

In general, the idea of corporate restructuring is to allow the company to continue

functioning in some manner. Even when corporate raiders break up the company and leave
 behind a shell of the original structure, there is still usually a hope, what remains can
function well enough for a new buyer to purchase the diminished corporation and return it to
profitability.

Purpose of Corporate Restructuring

 To enhance the share holder value, The company should continuously evaluate its:

1. Portfolio of businesses,
2. Capital mix,
3. Ownership &
4. Asset arrangements to find opportunities to increase the share holder’s value.

 To focus on asset utilization and profitable investment opportunities.

 To reorganize or divest less profitable or loss making businesses/products.
 The company can also enhance value through capital Restructuring, it can innovate
securities that help to reduce cost of capital.

Characteristics of Corporate Restructuring

1. To improve the company’s Balance sheet, (by selling unprofitable division from its core
business).
2. To accomplish staff reduction ( by selling/closing of unprofitable portion).
3. Changes in corporate management.
4. Sale of underutilized assets, such as patents/brands.
5. Outsourcing of operations such as payroll and technical support to a more efficient 3rd
party.
6. Moving of operations such as manufacturing to lower-cost locations.
7. Reorganization of functions such as sales, marketing, & distribution.
8. Renegotiation of labor contracts to reduce overhead.
9. Refinancing of corporate debt to reduce interest payments.
10. A major public relations campaign to reposition the company with consumers.
Nature of Corporate Restructuring:

Corporate restructuring is about revisiting existing management practices of an enterprise and

altering them so as to attain greater adaptability and viability with reference to the current and
emerging environmental developments. It involves overhauling strategies, structures and
management processes in order to improve competitiveness and/or profitability.

Corporate restructuring, it must be noted, is a proactive and planned decision making exercise to
redefine the basic line of business and discover a common thread for the firm’s survival and
successful growth. It involves altering what it owes, refocusing itself at a point of time.

At times, restructuring may radically alter a firm’s product portfolio, capital structure, asset mix
and organization structure and culture so as to enhance value of the firm and attain competitive
edge on sustainable basis. Thus, kernel of corporate restructuring exercise is SWOT analysis.

Another salient feature of corporate restructuring is that it is an all permeating process involving
an analytical appraisal of the existing strategic policies and practices and wherever necessary
redesigning the strategies, the structure of the organization, up-gradation of its technology,
modernization of its plant and equipment, revamping financial structure, remodeling its human
relations ethos, revamping its marketing philosophy and repositioning the firm within the
corporate world. It also involves selection of the performance indices in context of which the
current and future effectiveness of the firm should be recorded.

In view of its pervasive nature, restructuring at any one level is inter-related with changes at
other levels and therefore, it is essential for the management to assess organization-wide
implications of any change which is going to be affected. The entire process is based on
wholistic approach.

Further, restructuring exercise is a continuing process which has to be done continuously so as to

cope with ever changing environmental developments, exploit emerging opportunities and
combat impending threats.
Restructuring process may take many forms including strategic alliances, mergers and
acquisitions, financial restructuring, company downsizing, product or process restructuring and
work reorganization. Post liberalization period has witnessed restructuring spree in India,
prominent being ICICI, IDBI, HLL, Aditya Birla Group, Ranbaxy, Sun Pharma, Lupin Agro,
SRF Finance, Jaiprakash Industries, Tata Group, Indian Oil Corporation, Sony Entertainment
Television (SET) India, ONGC, Steel Authority of India Ltd. Indian Tobacco Ltd., Coal India
Ltd, Blue Star, ICI India, etc.

Need & Scope of Corporate Restructuring

Objectives of the Corporate Restructuring

Corporate Restructuring is concerned about placing business activities of corporates as the whole
in order to accomplish certain prearranged objectives. The objectives encompass the following:

 Orderly redirection of the firm’s activities;

 Positioning extra cash flow from 1 business to finance profitable growth in another;
 Misusing inter-dependence amongst current or potential businesses within the corporate
portfolio; — risk reduction; and
 Development of core competencies.

The Scope of Corporate Restructuring

The scope of Corporate Restructuring encompasses:

1. Enhancing economy (cost reduction): The status allows it to leverage the same to its own
advantage by being able to raise larger funds at lower costs.
2. Improving efficiency (profitability): Reducing the cost of capital translates into profits.

Note: Corporate Restructuring aims at different things at different times for different companies
and the single common objective in every restructuring exercise is to eliminate the disadvantages
and combine the advantages.
Needs for Corporate Restructuring

The needs for undertaking Corporate Restructuring are as follows:

(i) To focus on basic strengths, operational synergy & other effective allocation of managerial
capabilities and infrastructure too.

(ii) Consolidation and economies of scale by expansion and diversion to exploit extended
domestic and global markets.

(iii) Revival and rehabilitation of a sick unit by adjusting losses of the sick unit with profits of a
healthy company.

(iv) Acquiring the constant supply of raw materials and access to scientific research and
technological developments.

(v) Capital restructuring by a suitable combination of loan and equity funds to decrease the cost
of servicing and improve return on capital employed.

(vi) Improve corporate performance to bring it on par with competitors by adopting the radical
changes brought out by information technology.

Important aspects to be considered while planning or implementing corporate

restructuring strategies

They are:

 Valuation & Funding

 Legal and procedural issues
 Taxation and Stamp duty aspects
 Accounting aspects
 Competition aspects etc.
 Human and Cultural synergies
Types of Corporate Restructuring Strategies

Various types of corporate restructuring strategies include 1. Merger 2. Demerger 3. Reverse

Mergers 4. Disinvestment 5. Takeovers 6. Joint venture 7. Strategic alliance 8. Franchising 9.
Slump Sale

1. Merger

The merger is the combination of two or more companies which can be merged together
either by way of amalgamation or absorption or by the formation of a new company. The
combining of two or more companies is generally by offering the stockholders of one
company securities to the acquiring company in exchange for the surrender of their stock.

Kinds of Merger:

Mergers may be –

 Horizontal Merger: It is a merger of two or more companies that compete in the same
industry. It is a merger with a direct competitor and hence expands the firm’s operations
in the same industry.
 Vertical Merger: It is a kind of merger that takes place on the combination of 2
companies that are operating in the same industry but at diverse stages of production or
distribution system. If any company takes over its supplier/producers of raw materials,
then it may result in backward integration. On other hands, forward integration also
results if a company agrees to take over the retailer or Customer Company.
 Congeneric Merger: It is the type of merger, where two companies are in the same or
related industries but do not offer the same products, but related products and may share
similar distribution channels, providing synergies for the merger.
 Conglomerate Merger: These mergers involve firms engaged in an unrelated type of
activities i.e. the business of two companies are not related to each other horizontally or
vertically. In a pure conglomerate, there aren’t any important common factors between
companies in production, marketing, research and development, and technology.
 Conglomerate mergers are the merger of various types of businesses under 1 flagship
company.

2. Demerger

The demerger is a type of corporate restructuring wherein an entity’s business actions are
separated into 1 or more mechanisms.

3. Reverse Merger

The reverse merger is the opportunity for the unlisted companies to become a public listed
company, without opting for Initial Public offer (IPO). In this process, the private company
acquires majority shares of the public company with its own name.

4. Disinvestment

It is the act of the organization or company or government for selling or liquidating an asset or
subsidiary, this is known as “divestiture”.

5. Takeover/Acquisition:

Takeover occurs when an acquirer takes over the control of the target company. It is also known
as an acquisition.

The Types of Takeover:

It may be a friendly or hostile takeover.

Friendly takeover: In this type, one company takes over the management of the target company
with the permission of the board.

Hostile takeover: In this type, one company takes over the management of the target company
without its knowledge and against the wish of their management.
6. Joint Venture (JV)

A joint venture is an entity formed by two or more companies to undertake financial act together.
The parties agree to contribute equity to form a new entity and share the revenues, expenses, and
control of the company. It may be a Project based joint venture or Functional based joint venture.

Project-based Joint venture: The joint venture entered into by the companies in order to achieve a
specific task is known as project-based JV.

Functional based Joint venture: The joint venture entered into by the companies in order to
achieve mutual benefit is known as functional based JV.

7. Strategic Alliance

Any agreement between two or more parties to collaborate with each other, in order to achieve
certain objectives while continuing to remain independent organizations is called a strategic
alliance.

8. Franchising

Franchising is to be defined as an arrangement wherein 1 party (franchiser) allows another party

(franchisee) the right to use its trade name along with definite business systems and procedure, to
produce and market the goods or services along with certain specifications. The franchise
generally pays a one-time franchise fee plus a % of sales revenue in terms of royalty and gains.

9. Slump sale

Slump sale means the transfer of 1 or more undertaking because of the sale for lump sum
consideration deprived of values being allocated to each and every individual assets and
liabilities in such sales.

FORMS OF CORPORATE RESTRUCTURING

Internal Restructuring i.e organic

Corporate restructuring occurs based on the needs of the company. Internal restructuring
typically occurs as a result of business analysis that shows a need for greater efficiency in the
way business departments communicate and complete tasks. Sometimes a particular segment of
the business will start to fail, and the company will need to reallocate resources in order to
support it. Sometimes a business may have expanded to much, and needs to refocus on its core
abilities. At other times a business may need to restructure its financial position in order to
continue making profits. Often, restructuring plans are necessary simply to meet the constantly
change demands of technology that competitors are embracing. Not all reasons for restructuring
are negative, and many benefit employees as well as executives in the company.

Financial Restructuring i.e non organic

Financial restructuring deals with all changes the businesses makes to its debts and equity,
including mergers, acquisitions, joint ventures and other deals. Generally these occur when a
company joins or is bought by another company. Ownerships of the company, or at least some
interest in the company, is transferred to another organization or group of investors. Actual
business practices may remain unchanged.

Technological Restructuring
Technological restructuring occurs when a new technology has been developed that changes the
way an industry operates. This type of restructuring usually affects employees, and tends to lead
to new training initiatives, along with some layoffs as the company improves efficiency. This
type of restructuring also involves alliances with third parties that have technical knowledge or
resources.

Restructuring Methods

Restructuring methods are typically divided into expansion, refocusing, corporate control, and
ownership structure. The last two, corporate control and ownership structure, apply mostly to
financial changes and affect ownership. Corporate control, for instance, is a method where the
company buys back enough shares to be able to make its own decisions again. Expansion occurs
with acquisition, mergers, or joint ventures. Refocusing can take many forms, including business
splits, sell offs of certain ventures, and general consolidation practices.

Corporate Growth can be Organic or Inorganic

A company is thought to be growing organically if the growth is through the internal sources
without any change in the corporate entity. Organic growth can be usually done through capital
restructuring or business restructuring. In Inorganic growth, the rate of growth of the business is
that by a collective increase in output and business reach by achieving or accomplishing almost
all the innovative businesses by way of mergers, acquisitions and take-overs and any other
corporate restructuring strategies that would create change in the corporate entity.

Why are inorganic growth strategies regarded as fast-track corporate restructuring strategies
for growth?

Inorganic growth strategies such as mergers, acquisitions, takeovers, and spin-offs are considered
as vital engines which give assistance to companies to enter into new markets, expand their
customer base and cut competition, consolidate and grow in size quickly, to employ new
technology with regard to products, people, and processes. Therefore, inorganic growth
strategies are observed as fast-track corporate restructuring strategies for the growth of the
business.

The Effects of a Corporate Restructuring Strategy( also study from

pdf till page no. 18)

Companies occasionally encounter financial and operational difficulties that could lead to their
demise. One way corporations avoid a total shutdown is through a restructuring, which reduces
the level and severity of financial losses. A restructuring involves negotiating the different
positions taken by investors and owners who hold the equity and lenders and creditors who
control the debt. The final result generally provides a peaceful resolution to a stressed condition.

Restructuring Defined

A restructuring involves radically changing a company's organizational, financial and operating

structure to permanently and swiftly address serious financial and operational issues that could
lead to a corporation's shutdown or liquidation. With a restructuring, companies change
contractual relationships with debt holders and creditors, shareholders, employees and other
stakeholders. Restructuring essentially acts as an in-depth reorganization conducted for the
primary purpose of returning a corporation to profitability and productivity.

Financial Restructuring – Debt Swap

When corporations use a financial restructuring strategy, they change the company's capital
structure. They may replace debt with equity. When a company swaps out its debt, it eliminates
existing shareholders. In lieu of a liquidation or bankruptcy, the debt holders take over the
company's assets and obtain a claim on future earnings in the form of newly issued shares. Debt
holders often accept this arrangement when the elimination of the interest and principal
payments significantly strengthens the company's financial position. Shareholders typically
receive nothing.

Financial Restructuring – Debt Loading

Alternatively, a corporation may load the balance sheet with debt to finance the buyout of
existing shareholders. This debt loading strategy often is referred to as a leveraged buyout.
Companies use the debt loading strategy to enable one founder to buy out the shares of his co-
founders. The corporation repurchases and retires the shares and then uses its cash flow to pay
down the debt.

Organizational Restructuring

An organizational restructuring strategy involves redesigning operations and management

reporting structures to address and correct the operational issues that led to a company's
distressed position. A restructuring organization uses downsizing to eliminate costly overhead
and enable a company to return to profitability. Layoffs of nonessential personnel, process
redesign, location closures and renegotiation of existing contracts all result from this strategy. To
further reduce costs, corporations may restructure compensation and benefit packages for
employees who remain.

Portfolio Restructuring

A divestiture strategy is a type of portfolio restructuring strategy. Companies sell, shut down or
spin off unprofitable, money-losing divisions and subsidiaries or those that no longer fit its
strategy. Portfolio restructuring allows a corporation to refocus on its core activities and raise
much needed capital. It can use the proceeds of these transactions to strengthen its core business
or acquire other businesses that closely fit its strategy and contribute to a profitable bottom line.
What is Due Diligence in Corporate Law Matters?

Most people have heard the term “due diligence”, but few know what it actually means. In a
broad legal sense, due diligence refers to the level of care, judgment, or prudence of a person in a
particular circumstance. For example, the duty of a doctor to his or her patient. But what about in
specific terms? In this article, we discuss the question – “What is due diligence in corporate law
matters?”

Due Diligence in Corporate Law Matters

As alluded to before, many areas of the law consider due diligence the act of a person given a
certain circumstance or set of events. In corporate law, however, due diligence is more of a
process than an action or reaction. Due diligence in corporate law refers to the process of
investigating a corporation in advance of a sale, merger, or acquisition. This process includes
several steps, including gaining a full understanding of the company, such as the following
obligations:

 Debts
 Assets
 Pending or potential lawsuits
 Warranties
 Leases
 Long-term customer or vendor agreements
 Employment contracts
 Distribution agreements
 Compensation agreements

In short, due diligence is a thorough investigation into a company to determine whether a sale,
merger, or acquisition is the right choice.

When is Due Diligence Necessary?

In many ways, due diligence is part of many business strategies, even if they are not
comprehensive investigations. Due diligence is particularly important in cases of a merger or
acquisition to ensure that one or both parties are not entering into a contract under false or
unknowing means. Obtaining information can help the buyer or parties to a merger do the
following:

 Understand the business, it’s structure, and market

 Value the business, cash flow, balance sheets, and debts
 Draft documentation for the process, which can help negotiate terms and disclosure
agreements
 Identify obstacles to closing or completing contracts
 Avoid entering into a bad situation

Due diligence is often a lengthy process involving research and review. Many businesses and
individuals find it helpful to have an attorney work with them through this process. This can help
avoid pitfalls and ensure that the necessary information is available before getting into a contract.

Introduction

Due Diligence can be widely defined as a broad spectrum of investigative procedures in relation
to an acquisition of a company's shares or of assets in a commercial context, a joint venture
project, a financing transaction, the issue of securities and other general pre-contractual inquiries.

What do we mean by Due Diligence?

Due Diligence has become a sophisticated and intricate process requiring very special skills on
which the most delicate business decisions are founded. As defined above due diligence require a
whole lot of investigation into affairs and health of a company. In India there is as such no law or
case law on due diligence. Jurisprudence of Due Diligence is closely associated with concept of
Notice. A notice can be actual, constructive or imputed.

Section 3 of the Transfer of Property Act1 provides that "a person is said to have notice" of a fact
when they actually know that fact, or when, but for willful abstention from an inquiry or search
they ought to have made, or gross negligence, they would have known it.

Thus the statute casts a duty to find whether the fact presented is true or not and it presumes that
every prudent man before making investment in any form of property will find whether a clear
title to such property exists, or whether any debt or litigation is attached to it or whether it is in
any form going to prove not to be a wise decision.
Now in case of big companies and multinational corporations when one company buys or sell
any company or its assets the whole canvass is very big; lot of people, lot of documents, lot of
money is involved and it is here that need for due diligence arises.

Due Diligence is now finding deserved place in Indian Statues. Mandatory provisions have been
introduced for the conduct of due diligence under the Securities and Exchange Board of India
(Mutual Funds) Regulations 1996 and offshore offerings of securities by Indian companies
through American or global depository receipts (ADRs/GDRs).

Due Diligence is duty to take care. Many Indian statutes dealing with economic matters like S.
24 SCRA, 1956, s.53 MRTP, 1969, S.27 SEBI 1992, S.278B IT Act, 1961 contain a standard
section on offenses committed by companies.

These section has the following proviso:

"Provided that nothing contained in this sub-section shall render any such person liable
to punishment if he proves that the contravention took place without his knowledge or
that he exercised all due diligenceto prevent such contravention."

Due diligence implies a particular standard of care. In the Indian context, ordinarily there is
neither a positive statutory duty on the part of the buyer to exercise due diligence nor a criminal
liability for a failure to exercise due diligence.

Significance of due diligence

Due diligence is the process of obtaining sufficient reliable information about the business entity
to help to uncover any fact, circumstances or set of conditions that would have a reasonable
likelihood of influencing a business decision or the valuable making of an offer, of a
consideration and of a price to complete the transaction.

To exemplify how due diligence saved the world from big frauds and stripping share-holders of
their moneys, companies from their assets was evidenced in 1997 in Indonesia. This was the
biggest fraud in the history of mining. A small Canadian exploration firm, Bre-X Minerals Ltd.,
announced that it had made one of the world's largest gold discoveries in a remote part of
Indonesia2.

Tools of due diligence

Understanding importance of Due Diligence, the next question comes is how to go about it and
what are the tools for performing due diligence. Due the very complex nature of commercial
transactions both local and international no single analytical method can be prescribed as such.

One way of going about it is put a questionnaire to target company so as to check about its
general and financial health, risks involved in the business of company.
Another way is the representations and warranties that the seller can be asked to make in the
commercial contract.

The third method is to review, in an integrated manner, the financial analysis of the seller's
business with the analysis of the legal risks that are associated with the transaction.

Procedures regarding due diligence:

There are two ways of conducting due diligence

a. Presentation of predetermined data by the seller/target company in a ‘data room’;

b. Data provided in response to the acquirer’s questionnaire.

In Data Room method large amount of data is presented to interested parties to study and value it
and get due diligence conducted. Here mammoth data is provided. Data room method has been
successfully used for disinvestments by the tender route. By this process, the seller is able to
maintain ensure that all the bidders are treated fairly and that they are given access uniformly to
the same data or information. Hence, uniformly of the information and documents supplied to all
bidders is maintained.

Any discrimination in the supply of information or documents could vitiate the bidding process.
This applies more to disinvestments by the central or state government or government
companies, which can be subjected to judicial review under the provisions of the Constitution of
India.

In other method a questionnaire is put to target company and on that basis further one- to-one
negotiations are done.

Thereafter a Due diligence report is prepared by lawyers which can be effectively used to
negotiate the vexed question of the representations and warranties to be included in the sale and
purchase or financing agreement, the disclosures that inevitably qualify (some if not many of
them) and the amount, if any, to be set aside in escrow and on what conditions.

Managing the due diligence process

How do we actually go about due diligence? What kinds of people are involved in this procedure
what are the parameters? Let us examine each in some detail

1. Initial parameters – Management requires a preliminary evaluation of the areas of key

importance for the success of the transaction. This can be continuity of the targets, key
personnel, suppliers and customers after the acquisition.
2. Selecting due diligence teams – The core team for the conduct of the due diligence
should consist of:

 management representatives of the acquirer;

 legal counsel;
  valuation adviser;
 chartered accountants (CPA)/merchant bankers;
 technical consultants.

This stage will also involve the coordination plan among the team members, and allocating
responsibilities and functions. Usually, all external counsels are required to execute
confidentiality agreements before commencement of the assignment.

3. Preparing and executive preliminary investigation - The objective of the preliminary survey is
to identify deal-breaking issues upfront before money and other valuable resources are
committed to a detailed investigations. Some of the critical issues that may emerge during this
exercise are:

 concealment of facts and figures;

 insufficient internal controls;
 non-compliance of or adventurous interpretations of contracts, legal provisions,
accounting principles, policies or standards;
 employee retention and core management succession;
 contingent liabilities;
 statutory non-compliance;
 industrial sickness (erosion of net worth); and
 legal proceedings.

4. Detailed due diligence – The success of the investigation to make a well-informed decision
would lie in a well-planned, integrated and coordinated detailed enquiry procedures.

5.Certification of completeness of disclosures – The due diligence team should obtain a

declaration or certificate from the target company confirming the completeness of the disclosed
information and documents, and that no material data has been withheld by the target.

Contents of the due diligence report

The due diligence report ordinarily contains information pertaining to:

 company information;
 corporate capacity;
 directors, their interests and conflicts, if any;
 accounts;
 statutory compliance with the applicable regulations;
 personnel;
 compliance with the Industrial Disputes Act 1947, the Payment of Bonus Act 1965, the
Payment of Wages Act 1936, the Payment of Gratuity Act 1972, the Employees
Provident Funds and Miscellaneous Provisions Act 1952, the Employees State Insurance
Act 1948, and the Local Shops and Establishments Act; as well as with any industrial
settlement, award, judgment or order in any labour dispute or litigation; recognized trade
unions; retrenchments, lay-off and voluntary retirement schemes; and share options, share
 incentive, profit sharing or other incentive schemes for employees; pension, retirement,
provident fund, superannuation and gratuity schemes;
 share capital;
 shareholders;
 licenses, permits, approvals and specific statutory compliance;
 intellectual property rights – identifications of all patents, trade marks, copyrights,
industrial designs, all other forms of registered and unregistered intellectual proprietary
rights or other form of monopoly or property rights used or owned by the target company
and rights granted to third parties;
 industrial property – know-how, trade secrets;
 infringement of third-party rights;
 assets – immovable and movable property;
 exports and imports, compliance with laws;
 litigation – judicial, quasi-judicial, arbitral and other administrative proceedings;
 taxation issues – income tax, customs, excise and sales tax;
 insurance – quality of insurance cover;
 contractual liabilities and commitments; and
 Environment-related issues – compliance with law, social issues, and the rehabilitation of
people likely to be ousted by large natural resources projects, e.g. a reservoir for a
hydroelectric project.

Thus a due diligence report is a detailed one, elaborating on various aspects of company right
from its corporation to its labour problem, its history at share markets, to environmental issues to
taxation. It is indeed a grilling task for any lawyer of any stature.

Challenges in conducting due diligence

Like elsewhere due diligence does have hurdles, some of them are:

 insufficiency of basic data; this makes going tough

 road-blocks to obtaining or sharing proprietary information; and
 confidentiality/secrecy covenants may prevent disclosure of material documents.

Some of the minor issues include language barriers, traveling to remote locations, or people who
are not enthusiastic about or are unaware of the proposed transactions.

Professional project management of the due diligence process can however overcome these
problems.

Benefits of professional due diligence

The benefits of a professional due diligence exercise include:

 accuracy of warranties and representations;

 a ‘big picture’ of the vision of the target company and its future earnings;
 Complete analysis of the target company;
  identification of deal-breaking issues and formulating business solutions to resolve them;
and
 smooth transition of the merger.

How to get best result from due diligence exercise

There are certain steps that should be taken to ensure best results:

 clearly define the objective

 make firm and clear strategies;
 form groups of personnel for project management, data management, core due diligence
team and support team;
 lay down the terms of reference for each group and formulate procedures for a clear
allocation of responsibilities;
 observe an integrated approach for the due diligence process and rely on technical
consultants’ expertise wherever necessary;
 use appropriate technology for the collection, analysis, indexing and retrieval of data;
 store the data in electronic form which makes it portable, capable of being transferred to
and accessed from remote locations, and providing a single point access to the entire
transaction team;
 never hesitate to ask questions or seek clarifications;
 always insist on plant visits – the on-site conditions contain a wealth of information
which would be never be available on paper;
 due diligence should be continued until after the transaction is completed; and
 take media reports in stride, do not value them too much nor ignore them.

Due Diligence is order of the day and ensures free play. It helps avoid any pit falls, roadblocks,
displeasure in clenching deal successful and nasty surprises later on.

Organic vs. Inorganic Growth – Pros, Cons, and an Investor’s

Perspective

Every company loves to see growth – it’s a signifier of potential success and that things are
“working” within the organization. However, not all growth is created equal.
In general, growth is considered either organic or inorganic. Organic growth comes from
expanding your organization’s output and by engaging in internal activities that increase
revenue. Inorganic growth comes from mergers, acquisitions, and joint ventures.
What are the benefits of each type of growth, and what type of growth do most investors prefer
to see?
Pros of Organic Growth

Management knows the company inside and out. Since organic growth occurs in a relatively
tighter-knit organization, management knows the company strategies and operations more
intimately than an organization that has recently undergone a merger or acquisition. This means
the company is typically able to adapt to changes in the marketplace more quickly.
Less integration challenges and restructuring. During a merger or acquisition, there’s
typically restructuring of personnel and operations that occurs to manage the new volume of
business. This can often mean layoffs, changes in the leadership team, and overall figuring out
how to monitor more employees and assets. During organic growth, integration challenges or
management/personnel changes are typically more gradual, which can feel more comfortable and
natural for the internal culture.
Stay true to your dream. Without mergers or acquisitions, entrepreneurs have more control
over the direction the business is headed.
It’s more obviously sustainable. Sustainable growth is the ultimate goal of any company.
Without organic growth, there’s no investor interest, little possibility of becoming an acquisition
target, and virtually no chance that the company will become vibrant enough to sell. Bringing in
consistent or growing revenues is a sign that things are working within an organization and is an
important step in business success.
Cons of Organic Growth

Growth can be significantly slower. Since there’s no infusion of market, product, assets, or
resources, a company growing organically must do so at a sustainable pace. This means growth
can’t overshoot the personnel, support, and resources available.
May decrease your competitive edge. We all know that the best way to succeed in any industry
is to out-play your competitors. If your competitors are growing quickly or if your industry has
high M&A activity, then growing too slowly can mean you’ll be quickly overtaken by
competitors.
There is sometimes a glass ceiling. Businesses that rely on organic growth often find that they
lack the resources to continue to grow in a way that allows them to achieve their goals. As
business and customer needs grow, receivables and other cash-consuming items and resources
grow as well.
Competition drives the market. M&A activity is like dominoes—once companies in an
industry begin merging, it puts the heat on all the other companies to grow more quickly than is
organically possible, or they may be left behind. Competitor’s influx of resources and business
may allow them to lower prices or employ other tactics to steal market share, making it more
difficult for smaller companies in the industry to grow.

Pros of inorganic growth

Growth is much, much faster. According to Quickbooks, many business nearly double or triple
their client list with a business merger. Since this growth occurs through a transaction, this
inorganic growth is much faster than is possible for organic growth.
Gain an immediate increase in market share. One of the greatest benefits of a merger or
acquisition is the increase in market share. Through inorganic growth, you are gaining the
benefits of an entire company’s prior sales and relationships, which means you’re immediately
gaining markets and clients that you otherwise may not have had access to.
Increases knowledge and experience. By combining your company’s forces with those
resources of another company, you are gaining the knowledge and expertise of their key players.
This increased knowledge and experience means you have a stronger roundtable in making
strategic decisions moving forward.
Create a stronger line of credit. It can be easier to take on debt financing after a merger or
acquisition as some inorganic growth results in a stronger line of credit with the combined value
of the two businesses.
Gain a competitive edge in the market. Your newfound resources, assets, and market share,
means—if the implementation goes well—you will be a force to be reckoned with in your
industry. You’re setting a new pace for growth that can push you ahead of competitors and give
you a strategic advantage in pricing, purchasing, volume, and overall reach.

Cons of inorganic growth

Significant upfront cost. Funding a merger or acquisition usually means a sizable upfront cost.
If your company doesn’t have cash on hand, you’ll likely have to rely on taking on debt, which
can make the merger or acquisition less attractive to investors. If the integration doesn’t go well,
this could also mean a lot of debt that you’re suddenly unable to pay off.
Management challenges. The sudden growth from a merger or acquisition generates
complexities associated with properly scaling operations such as systems, sales, and support.
Without proper management of growth, a merger or acquisition’s roots won’t be able to take
hold and the integration will ultimately be unsuccessful.
Financial systems sustainment. There are plenty of operational aspects that an organization can
fumble through inorganic growth. Since finances support all company actions and is a key for all
future growth, not having systems in place that can sustain the new growth is a huge (and
unfortunately common) mistake.

Less control over the direction of the company. Combining forces with another organization
means you often have less control over the ongoing company vision. It can also mean you grow
in directions you didn’t necessarily anticipate.
Integration, restructuring, and culture differences. In the end, mergers or acquisitions rely on
the buy-in of both parties for a successful implementation. If cultures are too different or
operations don’t adapt to manage the influx of employees, resources, or sales, then the merger or
acquisition will likely become unsuccessful.
What do investors like to see?
As is commonly the case, it’s not as simple equation of growth equaling good and more growth
equaling better. If a company is showing slow (yet strong) organic growth, then that organization
may still be more attractive to a company that saw significant growth due to an acquisition,
especially if that company took on significant debt to acquire a company that had negative
growth.
A common misconception is that inorganic growth will repair the currently declining growth of a
company. It is typically more prudent to fix your company’s internal problems before taking on
more customers and business. Remember the phrase, “Can’t get out from under a sky that is
falling.” Your organization’s shortcomings and struggles will follow you regardless of growth,
so make sure you’re in a stable position to take on more weight.
The ultimate question an investor is answering is how strong is the company’s story, and do they
have the forecast, proof, and track record to back it up?
The key is formulating the best strategy for your organization and designing a strong business
case around that strategy.
Final thoughts
Whether you choose to grow your organization organically or inorganically, your greatest focus
should be on doing so in the most strategic way possible. Formulate the best strategy based on
your company’s current health, competition, industry trends, and financial capacity, then design
a strong business case around that strategy by projecting short- and long-term financial forecasts.
Having this level of detail for whichever strategy you commit to will give you a detailed
blueprint to make the most intelligent decisions to support and sustain growth.

MERGER AND AMALGMATION

The Companies Act, 2013 (2013 Act) has seen the light of day and replaced the 1956 Act with
some sweeping changes including those in relation tomergers and acquisitions (M&A).
The new Act has been lauded by corporate organizations for its business-friendly corporate
regulations, enhanced disclosure norms and providing protection to investors and minorities,
among other factors, thereby making M&A smooth and efficient. Its recognition of interse
shareholder rights takes the law one step forward to an investor-friendly regime. The 2013 Act
seeks to simplify the overall process of acquisitions, mergers and restructuring, facilitate
domestic and cross-border mergers and acquisitions, and thereby, make Indian firms relatively
more attractive to PE investors.
The term ‘merger’ is not defined under the Companies Act, 1956 (“CA 1956”), and under
Income Tax Act, 1961 (“ITA”). However, the Companies Act, 2013 (“CA 2013”) without
strictly defining the term explains the concept. A ‘merger’ is a combination of two or more
entities into one; the desired effect being not just the accumulation of assets and liabilities of the
distinct entities, but organization of such entity into one business.
On 7th November, 2016 Central Government issued a notification for enforcement of section
230-233, 235-240, 270-288 etc w.e.f. 15th December, 2016. But still rules were not available till
date for CAA.
MCA vide notification dated 14th Dec, 2016 has issued rules i.e. The Companies
(Compromises, Arrangements and Amalgamations) Rules, 2016. These rules will be
effective from 15th December, 2016. Consequently, w.e.f. 15.12.2016 all the matters relating to
Compromises, Arrangements, and Amalgamations (hereafter read as “CAA”) will be dealt as per
provisions of Companies Act, 2013 and The Companies (Compromises, Arrangements, and
Amalgamations) Rules, 2016.
Where a compromise or arrangement is proposed for the purposes of or in connection with
scheme for the reconstruction of any company or companies, or for the amalgamation of any two
or more companies, the petition shall pray for appropriate orders and directions under section
230 read with section 232 of the Act.
Section relating to Merger & Amalgamation Section 230 & 232.

In this article COMPROMISE & ARRANGEMENT (C&A) will be read in relation to Merger &
Amalgamation only.
In Case of application filing u/s 230 for Compromise & Arrangement in relation to
reconstruction of the Company or companies involving merger or the amalgamation of any two
or more companies should specify the purpose of the scheme.

Who can file the application for Merger & Amalgamation propose: Section 230(1)

[1]An application for Merger & Amalgamation can be file with Tribunal (NCLT). Both
the transferor and the transferee company shall make an application in the form of petition to the
Tribunal under section 230-232 of the Companies Act, 2013 for the puspose of sanctioning the
scheme of amalgamation.

Joint Application: Rule 3(2)

Where more than one company is involved in a scheme, such application may, at the discretion
of such companies, be filed as a joint-application.

However, where the registered office of the Companies are in different states, there will be two
Tribunals having the jurisdiction over those, companies, hence separate petition will have to be
filed.

Process
 It must be ensure that the companies under amalgamation should have the power in the object
clause of their Memorandum of Association to undergo amalgamation though the absence may
not be an impediment, but this will make matters smooth.
 A draft scheme of amalgamation shall be prepared for getting it approved in Board meeting of
each company.
1. Format of Application

Application to the tribunal for Merger & Amalgamation will be submitted in form no. NCLT-
1 along with following documents: Rule 3(1)

a) A notice of admission in Form No. NCLT-2

b) An affidavit in form no. NCLT-6

c) A copy of Scheme of C&A (Merger & Amalgmation)

d) A disclosure in form of affidavit including following points Section 230(2)

– All material facts relating to the company, such as

i. the latest financial position of the company,

ii. the latest auditor’s report on the accounts of the company and

iii. the pendency of any investigation or proceedings against the company

– Reduction of share capital of the company, if any, included in the compromise or arrangement

e) Any scheme of [3]Corporate Debt Restructuring consented to by not less than seventy five
per cent. of the secured creditors in value, including

i. A Creditor’s Responsibility statement in the form No. CAA-1.

ii. safeguards for the protection of other secured and unsecured creditors;

iii. report by the auditor that the fund requirements of the company after the corporate debt
restructuring as approved shall conform to the liquidity test based upon the estimates provided to
them by the Board;
iv. where the company proposes to adopt the corporate debt restructuring guidelines specified by
the Reserve Bank of India, a statement to that effect; and

v. a valuation report in respect of the shares and the property and all assets, tangible and
intangible, movable and immovable, of the company by a registered valuer.

f) The applicant shall also disclose to the Tribunal in the application, the basis on which each
class of members or creditors has been identified for the purposes of approval of the scheme.

2. Calling of Meeting by Tribunal:

Upon hearing of the application Tribunal shall, unless it thinks fit for any reason to dismiss the
application, give such directions / order as it may think necessary in respect meeting of the
creditors or class of creditors, or of the members or class of members, as the case may be, to be
called, held and conducted in such manner as prescribed in rule 5 of CAA Rules, 2016 as follow:

i. Fixing the time and place of the meeting or meetings;

ii. Appointing a Chairperson and scrutinizer for the meeting or meetings to be held, as the case
may be and fixing the terms of his appointment including remuneration;

iii. Fixing the quorum and the procedure to be followed at the meeting or meetings, including
voting in person or by proxy or by postal ballot or by voting through electronic means;

iv. Determining the values of the creditors or the members, or the creditors or members of any
class, as the case may be, whose meetings have to be held;

v. Notice to be given of the meeting or meetings and the advertisement of such notice.

vi. Notice to be given to sectoral regulators or authorities as required under sub-section (5) of
section 230;

vii. The time within which the chairperson of the meeting is required to report the result of the
meeting to the Tribunal; and

viii. Such other matters as the Tribunal may deem necessary.

3. Notice of Meeting: The Notice of the meeting pursuant to the order of tribunal to be give
in Form No. CAA-2. Rule 6
 Person entitled to receive the notice The notice shall be sent individually to each of the
Creditors or Members and the debenture-holders at the address registered with the
company. Section 230(3)

Person authorized to send the notice:

 Chairman of the Company, or

 If tribunal so direct- by the Company or its liquidator or by any other person
Modes of Sending of notice:

 By [4]Registered post, or by Speed post, orby courier, or

 By e-mail, or by hand delivery, or by any other mode as directed by the tribunal
Documents to be send along with notice: The notice of meeting send with (i) Copy of Scheme
of C&A and (ii) Following below mentioned details of C&A if not included in the said scheme:

a. Details of the order of the Tribunal directing the calling, convening and conducting of
the meeting:-

 Date of the Order;

 Date, time and venue of the meeting.
b. Details of the company including:

 Corporate Identification Number (CIN) or Global Location Number (GLN) of the company;
 Permanent Account Number (PAN);
 Name of the company;
 Date of incorporation;
 Type of the company (whether public or private or one person company);
 Registered office address and e-mail address;
 Summary of main object as per the memorandum of association; and main business carried on by
the company;
 Details of change of name, registered office and objects of the company during the last five
years;
 Name of the stock exchange (s) where securities of the company are listed, if applicable;
 Details of the capital structure of the company including authorised, issued, subscribed and paid
up share capital; and
 Names of the promoters and directors along with their addresses.
c. Relationship in case of Combined Application: if the scheme of compromise or
arrangement relates to more than one company, then the fact and details of any
relationship subsisting between such companies who are parties to such scheme of
compromise or arrangement, including holding, subsidiary or of associate companies.

d. Disclosure about effect of M&A on material [5]interests of directors, Key Managerial

Personnel (KMP) and debenture trustee

e. Details of Board Meeting:

 The date of the board meeting at which the scheme was approved by the board of directors
 The name of the directors who voted in favour of the resolution,
 The name of the directors who voted against the resolution and
 The name of the directors who did not vote or participate on such resolution
f. Explanatory Statement disclosing details of the scheme of compromise or arrangement
including:

 Parties involved in such compromise or arrangement;

 Appointed date, effective date, share exchange ratio (if applicable) and other considerations, if
any;
 Summary of valuation report (if applicable) including basis of valuation and fairness opinion of
the registered valuer, if any, and the declaration that the valuation report is available for
inspection at the registered office of the company;
 Details of capital or debt restructuring, if any;
 Rationale for the compromise or arrangement;
 Benefits of the compromise or arrangement as perceived by the Board of directors to the
company, members, creditors and others (as applicable);
 Amount due to unsecured creditors.
g. Disclosure about the effect of the Merger & Amalgamation (C&A) on: Section 230(3)

 Key Managerial Personnel;

 Directors;
 Promoters;
 Non-Promoter Members;
 Depositors;
 Creditors;
 Debenture holders;
 Deposit trustee and debenture trustee;
 Employees of the company:
 Share holders of the Company
h. A report adopted by the directors of the merging companies explaining effect of compromise
on each class of shareholders, key managerial personnel, promoters and non-promoter
shareholders laying out in particular the share exchange ratio, specifying any special valuation
difficulties;

i. Below Mentioned Details: Following below mentioned details

 Investigation or proceedings, if any, pending against the company under the Act.
 Details of approvals, sanctions or no-objection(s), if any, from regulatory or any other
governmental authorities required, received or pending for the proposed scheme of compromise
or arrangement
 A statement to the effect that the persons to whom the notice is sent may vote in the meeting
either in person or by proxies, or where applicable, by voting through electronic means
 A copy of the [6]valuation report, if any Section 230(3)


j. Details of avaibility of documents: Details of the availability of the following documents for
obtaining extract from or for making or obtaining copies of or for inspection by the members and
creditors, namely

 Latest audited financial statements of the company including consolidated financial statements;
 Copy of the order of Tribunal in pursuance of which the meeting is to be convened or has been
dispensed with;
 copy of scheme of Merger & Amalgamation ( C&A);
 Contracts or agreements material to the Merger & Amalgamation ( C&A);
 The certificate issued by Auditor of the company to the effect that the accounting treatment, if
any,
 Proposed in the scheme of Merger & Amalgamation ( C&A) is in conformity with the
Accounting Standards prescribed under Section 133 of the Companies Act, 2013; and
 Such other information or documents as the Board or Management believes necessary and
relevant for making decision for or against the scheme;
k. Some Other documents: Where an order has been made by the Tribunal under section 232(1),
merging companies or the companies in respect of which a division is proposed, shall also be
required to circulate the following:

 The draft of the proposed terms of the scheme drawn up and adopted by the directors of the
merging company;
 Confirmation that a copy of the draft scheme has been filed with the Registrar;
 The report of the expert with regard to valuation, if any;
[1] In the case of Kirloskar Electricals Co. Ltd., the Court held that various clauses of Section
394(1) of the Companies Act suggest that both the transferor and the transfer company shall
make an application to the Court and under section 391-394 of the Companies Act, 1956 for
sanction of the scheme of Compromise or arrangement involving amalgamation of the
Companies.

[2] In the case of Mohan Exports Ltd. V/s Tarun Overseas Pvt. Ltd., it was held that if both the
Companies are under the jurisdiction of the same High Court, Joint petition may be made.

[3] Scheme of Corporate Debt restructuring as referred in section 230(2)(c) means “a scheme
that restructures or varies the debt obligation of a company toward its creditors”.

[4] It is hereby clarified that the service of notice of meeting shall be deemed to have been
effected in case ofdelivery by post, at the expiration of forty eight hours after the letter
containing the same is posted

[5]Explanation – For the purposes of these rules it is clarified that-

(a) the term ‘interest’ extends beyond an interest in the shares of the company, and is with
reference to the proposed scheme of compromise or arrangement.

(b) the valuation report shall be made by a registered valuer, and till the registration of persons as
valuers is prescribed under section 247 of the Act, the valuation report shall be made by an
independent merchant banker who is registered with the Securities and Exchange Board or an
independent chartered accountant in practice having a minimum experience of ten years.

[6] the valuation report shall be made by a registered valuer, and till the registration of persons as
valuers is prescribed under section 247 of the Act, the valuation report shall be made by an
independent merchant banker who is registered with the Securities and Exchange Board or an
independent chartered accountant in practice having a minimum experience of ten years.

What are Mergers?

According to Prof. L.H.Haney, merger is, “a form of business organization which is established
by the outright purchase of the properties of constituents, organizations and the merging or
amalgamating of such properties into a single business unit”.

Examples of Mergers
 Acquisition of Modern Foods, Kissan, Tata Oil Mills Co., Ltd (TOMCO), Kwality Walls
etc., by Hindustan Level Limited(HLL).
 Acquisition of ANZ Grindlays Indian operations by Standard Chartered, Times Bank by
HDFC Bank, Bank of Madura by ICICI Bank,
 Acquisition of Voltas and Allwyn by Electrolux. Subsequently Electrolux’s – Indian
operations were acquired by Videocon International.
 Recent international mergers include – acquisition of Gillette by P&G, Betapharma by
Ranbaxy, IBM’s PC division by Lenovo, Compaq by Hewlett Packard(HP) etc.
What is Amalgamation?
In Amalgamation, two or more companies combine to create a new company. All the combining
companies lose their separate existence and entity. The new company takes over all existing
assets and liabilities of the companies amalgamated. The new company allots its shares to the
shareholders of the amalgamating companies.

Example of Amalgamation
For e.g. Arcelor, the world’s largest steel company (which has been since been acquired by
Mittal Steel) came into being as a result of amalgamation. French steel company Usinor
amalgamated with Aceralia of Spain and Arbed of Luxembourg in the year 2002 and the new
company formed out of this amalgamation was named as Arcelor.

Differences between Merger & Amalgamation

Though mergers and amalgamations are form of complete consolidation there are certain
differences between them. They are given in the following table:
 Points of
Acquisition Merger
distinction

Two or more independent units One unit acquires another. Generally the larger and financial stronger unit
1. Formation
combine together to form a new unit. takes over a smaller unit.

The acquirer retains the identity whereas the acquired company looses its
The combining units lose their identity. For e.g. when HDFC Bank acquired Times Bank, the acquirer (HDFC
2. Identity
individual identity. Bank) retained the identity whereas the acquired (Times Bank) lost its
identity.

Shareholders of all the combining

3. Shareholders of the acquired company become the share holders of the
units become shareholders in the
Shareholders acquiring company.
newly created enterprise.

Shares of the newly created entity is

Shares of the acquirer company is given to the shareholders of the acquired
4. Shares given to the shareholders of the
company.
combining units.

The initiative to amalgamate is

5. Initiative generally taken by the combining Initiative is generally taken by the acquirer.
units.

Forms of Merger

1. Merger through Absorption: When two or more entities are combined, into an existing
company, it is known as merger through absorption. In this type of merger, only one entity
survive after the merger, while the rest of all cease to exist as they lose their
identity. E.g. Tata Chemicals Limited (TCL) absorbed Tata Fertilizers Limited (TFL).

2. Merger through Consolidation: When two or more companies fuse to give birth to a new
company, it is known as merger through consolidation. This implies that all the companies to
the merger are dissolved, i.e. they lose their identity and a new company is
created. E.g. Consolidation of Hindustan Computers Limited, Indian Reprographics Limited,
Indian Software Company Limited Hindustan Instruments Limited, to form a new company HCL
Limited.

The common feature of the two forms of the merger is that the resulting or surviving company
acquires the ownership of other entities and unite their operations, with its own.

KINDS OF MERGER

5 Types of Company Mergers

There are five commonly-referred to types of business combinations known as mergers:

conglomerate merger, horizontal merger, market extension merger, vertical merger and product
extension merger. The term chosen to describe the merger depends on the economic function,
purpose of the business transaction and relationship between the merging companies.

Conglomerate

A merger between firms that are involved in totally unrelated business activities. There are two
types of conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with
nothing in common, while mixed conglomerate mergers involve firms that are looking for
product extensions or market extensions.

Example

A leading manufacturer of athletic shoes, merges with a soft drink firm. The resulting company
is faced with the same competition in each of its two markets after the merger as the individual
firms were before the merger. One example of a conglomerate merger was the merger between
the Walt Disney Company and the American Broadcasting Company.

Benefits of a Merger or Acquisition

Horizontal Merger

A merger occurring between companies in the same industry. Horizontal merger is a business
consolidation that occurs between firms who operate in the same space, often as competitors
offering the same good or service. Horizontal mergers are common in industries with fewer
firms, as competition tends to be higher and the synergies and potential gains in market share are
much greater for merging firms in such an industry.

Example

A merger between Coca-Cola and the Pepsi beverage division, for example, would be horizontal
in nature. The goal of a horizontal merger is to create a new, larger organization with more
market share. Because the merging companies' business operations may be very similar, there
may be opportunities to join certain operations, such as manufacturing, and reduce costs.

Market Extension Mergers

A market extension merger takes place between two companies that deal in the same products
but in separate markets. The main purpose of the market extension merger is to make sure that
the merging companies can get access to a bigger market and that ensures a bigger client base.

Example

A very good example of market extension merger is the acquisition of Eagle Bancshares Inc by
the RBC Centura. Eagle Bancshares is headquartered at Atlanta, Georgia and has 283 workers. It
has almost 90,000 accounts and looks after assets worth US $1.1 billion.

Eagle Bancshares also holds the Tucker Federal Bank, which is one of the ten biggest banks in
the metropolitan Atlanta region as far as deposit market share is concerned. One of the major
benefits of this acquisition is that this acquisition enables the RBC to go ahead with its growth
operations in the North American market.

With the help of this acquisition RBC has got a chance to deal in the financial market of Atlanta ,
which is among the leading upcoming financial markets in the USA. This move would allow
RBC to diversify its base of operations.

Product Extension Mergers

A product extension merger takes place between two business organizations that deal in products
that are related to each other and operate in the same market. The product extension merger
allows the merging companies to group together their products and get access to a bigger set of
consumers. This ensures that they earn higher profits.

Example

The acquisition of Mobilink Telecom Inc. by Broadcom is a proper example of product

extension merger. Broadcom deals in the manufacturing Bluetooth personal area network
hardware systems and chips for IEEE 802.11b wireless LAN.

Mobilink Telecom Inc. deals in the manufacturing of product designs meant for handsets that are
equipped with the Global System for Mobile Communications technology. It is also in the
process of being certified to produce wireless networking chips that have high speed and General
Packet Radio Service technology. It is expected that the products of Mobilink Telecom Inc.
would be complementing the wireless products of Broadcom.

Vertical Merger

A merger between two companies producing different goods or services for one specific finished
product. A vertical merger occurs when two or more firms, operating at different levels within an
industry's supply chain, merge operations. Most often the logic behind the merger is to increase
synergies created by merging firms that would be more efficient operating as one.

Example

A vertical merger joins two companies that may not compete with each other, but exist in the
same supply chain. An automobile company joining with a parts supplier would be an example
of a vertical merger. Such a deal would allow the automobile division to obtain better pricing on
parts and have better control over the manufacturing process. The parts division, in turn, would
be guaranteed a steady stream of business.

Synergy, the idea that the value and performance of two companies combined will be greater
than the sum of the separate individual parts is one of the reasons companies merger.

Types of Merger
1. Horizontal Merger: The merger is said to be horizontal when the companies that are
combined operate in the same industry or deal in similar lines of business. The market share
of the newly formed company is greater than the individual entities. It is aimed at reducing
competition, increasing market share, economies of scale and research and development.
2. Vertical Merger: Vertical merger takes place when companies are having ‘buyer-seller
relationship’, join to create a new company. It is an integration of two companies that are
working in the same industry, though at a different stage of production and distribution. It
can be upstream or downstream, i.e. where the business takes over its suppliers, then it is an
upstream merger while if the company extend to its distribution entities, the merger is termed as
downstream.
3. Conglomerate Merger: A type of business integration, in which the merging companies are
not related to each other, i.e. neither horizontally nor vertically. In a conglomerate merger, two
or more companies operating in different business lines combine under one flagship company.
This is further divided into, managerial conglomerate, financial conglomerate and concentric
conglomerate.
4. Co-generic Merger: Co-generic merger is when the companies undergoing merger operate in
the same or related industry. However, their product lines are different, as in they do not
offer same products but related one. The acquired and target company share similar distribution
channels.
5. Reverse Merger: A merger wherein a publicly listed company is taken over by a privately
held company and provides an opportunity, to the private company to go public, without going
through the complex and lengthy process of getting listed on the stock exchange. In this type of
amalgamation, the unlisted company acquires majority shares in the listed company.
 The decision of merger is taken with great planning and analysis considering all the positives and
negatives. The sole aim is to accelerate growth and build a good image in the market. It also
enhances company’s profitability through economies of scale, synergy, operating economies,
entry to new product lines, etc. Further, it removes financial constraints and also minimises
financial cost.

However, there are certain restrictions, like high employee turnover, culture conflicts, etc. which
might hit the efficiency and effectiveness.

What is Amalgamation?

Amalgamation is defined as the combination of one or more companies into a new entity. It
includes:

i. Two or more companies join to form a new company

ii. Absorption or blending of one by the other

Thereby, amalgamation includes absorption.

However, one should remember that Amalgamation as its name suggests, is nothing but two
companies becoming one. On the other hand, Absorption is the process in which the one
powerful company takes control over the weaker company.
Generally, Amalgamation is done between two or more companies engaged in the same line of
activity or has some synergy in their operations. Again the companies may also combine for
diversification of activities or for expansion of services
Transfer or Company means the company which is amalgamated into another company; while
Transfer Company means the company into which the transfer or company is amalgamated.

Existing companies A and B are wound up and a new company C is formed to take Amalgamation
over the businesses of A and B

Existing company A takes over the business of another existing company B which is Absorption
wound up
 A New Company X is formed to take over the business of an existing company Y External
which is wound up. reconstruction

How is Amalgamation different from a Merger?

Amalgamation is different from Merger because neither of the two companies under reference
exists as a legal entity. Through the process of amalgamation a completely new entity is formed
to have combined assets and liabilities of both the companies.

Types of Amalgamation

i. Amalgamation in the nature of merger:

In this type of amalgamation, not only is the pooling of assets and liabilities is done but also of
the shareholders’ interests and the businesses of these companies. In other words, all assets and
liabilities of the transferor company become that of the transfer company. In this case, the
business of the transfer or company is intended to be carried on after the amalgamation. There
are no adjustments intended to be made to the book values. The other conditions that need to be
fulfilled include that the shareholders of the vendor company holding atleast 90% face value of
equity shares become the shareholders’ of the vendee company.

ii. Amalgamation in the nature of purchase:

This method is considered when the conditions for the amalgamation in the nature of merger are
not satisfied. Through this method, one company is acquired by another, and thereby the
shareholders’ of the company which is acquired normally do not continue to have proportionate
share in the equity of the combined company or the business of the company which is acquired is
generally not intended to be continued.
If the purchase consideration exceeds the net assets value then the excess amount is recorded as
the goodwill, while if it is less than the net assets value it is recorded as the capital reserves.

Why Amalgamate?

a. To acquire cash resources

b. Eliminate competition
c. Tax savings
d. Economies of large scale operations
e. Increase shareholders value
f. To reduce the degree of risk by diversification
g. Managerial effectiveness
h. To achieve growth and gain financially

Procedure for Amalgamation

1. The terms of amalgamation are finalized by the board of directors of the amalgamating
companies.
2. A scheme of amalgamation is prepared and submitted for approval to the respective High Court.
3. Approval of the shareholders’ of the constituent companies is obtained followed by approval of
SEBI.
4. A new company is formed and shares are issued to the shareholders’ of the transferor company.
5. The transferor company is then liquidated and all the assets and liabilities are taken over by the
transferee company.

Advantages of Amalgamation

 Competition between the companies gets eliminated

 R&D facilities are increased
 Operating cost can be reduced
 Stability in the prices of the goods is maintained

Disadvantages of Amalgamation

 Amalgamation may lead to elimination of healthy competition

 Reduction of employees may take place
 There could be additional debt to pay
 Business combination could lead to monopoly in the market, which is not always positive
 The goodwill and identity of the old company is lost

Recently announced Amalgamation

One of the recent amalgamations announced on the corporate front is of PVR Ltd. Multiplex
operator PVR Ltd has approved an amalgamation scheme between Bijli Holdings Pvt Ltd and
itself to simplify PVR’s shareholding structure. As per the management, the purpose of the
amalgamation is to simplify the shareholding structure of PVR and reduction of shareholding
tiers. It also envisages demonstrating Bijli Holdings’ direct engagement with PVR. After the
amalgamation, individual promoters will directly hold shares in PVR and there will be no change
in the total promoters’ shareholding of PVR.

Other examples of Amalgamations

1. Maruti Motors operating in India and Suzuki based in Japan amalgamated to form a new
company called Maruti Suzuki (India) Limited.
2. Gujarat Gas Ltd (GGL) is an amalgamation of Gujarat Gas Company Ltd (GGCL) and GSPC
Gas.
3. Satyam Computers and Tech Mahindra Ltd
4. Tata Sons and the AIA group of Hongkong amalgamated to form Tata AIG Life Insurance.

HUMAN RESOURCE: KEY FACTOR

It is reported that one of the main reasons for failure of a merger or acquisition is based on
Human Resources neglect. People issues have been the most sensitive but often ignored issues in
a merger and acquisition. When a decision is taken to merge or acquire, a company analyses the
feasibility on the business, financial and legal fronts, but fails to recognize the importance
attached to the human resources of the organizations involved. Companies which have failed to
recognize the importance of human resources in their organizations and their role in the success
of integration have failed to reach success. While it is true that some of these failures can be
largely attributed to financial and market factors, many studies are pointing to the neglect of
human resources issues as the main reason for M&A failures. PricewaterhouseCoopers global
study concluded that lack of attention to people and related organizational aspects contribute
significantly to disappointing post-merger results. Organizations must realize that people have
the capability to make or break the successful union of the two organizations involved.

Cartwright and Cooper (2000) acknowledged that the leading roles of modern human resources
functions are to be actively engaged in the organization and perform as a business partner and
advisor on business-related issues. Employees do not participate enough in the integration
process of a merger. If a merger is to reach its full success potential, they need to be informed
and involved more actively throughout all the stages of the merger process.

Human resource professionals are key in pre-merger discussions and the strategic planning phase
of mergers and acquisitions early as to allow them assess to the corporate cultures of the two
organizations (Anderson, 1999). Being involved in the pre-merger stage allows HR to identify
areas of divergence which could hinder the integration process. They can play a vital role in
addressing any communication issues, employees concerns, compensation policies, skill sets,
downsizing issues and company goals that need to be assessed.

STRATEGIES FOR MANAGING HUMAN RESOURCE IN M&A

I. Communication

During mergers and acquisitions, employees are often kept in the dark about the sale of the
corporation. They often hear about the acquisition through the press or through the corporate
grapevine. This can lead to a distorted or misrepresented picture of the acquisition's ramifications
and to counterproductive activities by employees, who may be anxious about possible job losses.
Therefore, Communication is of utmost importance in every stage of a merger or acquisition
process, and is the key to its success.

It is very important for management to communicate clearly and regularly to all employees the
implications of the merger, including the planned changes to working practices and
organizational processes. Management should share as much information as it can with
employees before, during, and after the acquisition. To be effective, the communication process
has to be carried out in such a way as to avoid confusion and mixed messages. The
communication process should also encourage two-way feedback between management and
employees to make employees feel that they are contributing to the solution. By involving people
at all levels of the organization, the merging companies are encouraging widespread acceptance
of the merger process and reducing feelings of insecurity.

II. Retaining Key People

The retention of a talented workforce, which is often a major reason behind the decision to
merge, should take priority during the merger process, and management needs to adopt
measures to improve the retention rate of the best people in the merging companies. Truthful and
thorough communication with employees can play a significant part in management's retention
strategy. If the communication process is performed effectively, it can reduce employees' sense
of insecurity and give them a better picture of what the future holds for them.

Pay and reward strategies can also play an important role in management's retention strategy but
they need to be addressed early on in the merger process and should not only focus on senior
executive pay, but also on the remuneration of employees at all levels of the organization.

III. Try to Establish a Common Culture

Successfully integrating the two cultures of the merging companies is an essential step towards
achieving a successful partnership. Both organizations, the acquiring and the acquired, will have
unique and beneficial cultural elements. Rather than imposing one organization's cultural
elements on the other, 'the best of both companies can be integrated into a common culture for
the new organization' (Hunsaker and Coombs 1988, 62). This can create a win-win situation for
both organizations, since it will result in a corporate culture with which both sides can identify.

Defining and promoting the new corporate culture will enable employees to work together
toward achieving the business goals of the new organization. Conducting a cultural audit is a
useful way of obtaining useful information about the two companies' differing cultures and helps
to evaluate differences and similarities in work standards and practices. That information can
raise awareness of potential difficulties and issues in the merging process, and allows the
merging company to take steps to minimise culture clashes by building an effective
communication structure.

IV. Training and Development

Training and development should be provided to senior and middle management and should
focus on all aspects of the merger process. Training should focus on the implications of the
merger for the company, its effects on employees at all levels of the organization and its impact
on working practices and organizational structures. Training should also educate managers on
what each stage of the merger process entails for them and for the company as a whole. Such
interventions will facilitate more effective leadership on the part of managers, who will have a
better understanding of the key issues that arise during the course of a merger.
V. Try to Eliminate the Them-Us Syndrome

Acquiring organizations should try to eradicate any arrogance on the part of their personnel to
ensure that acquired employees do not feel inferior and 'conquered.' A post-acquisition
atmosphere fostering mutual respect among management groups will facilitate a better
understanding of the others' perspective and make a smoother transition.

VI. Provide Individual Counseling

Individual counselling on personal adjustment and stress coping strategies can assist the
employees to 'solve the problems associated with merger stress; recommend, demonstrate and
initiate coping with merger stress strategies; or improve the employee's mastery'. In addition, a
counsellor can unveil new career paths and job opportunities within the newly acquired
organization, which can provide incentives for employees to remain with the organization.

ECONOMIC ASPECTS

The merger and acquisition (M&A) activities have grown significantly around the world over the
last two decades, the amount and volume of mergers and acquisitions is reaching a record
braking levels. Major factors underlying this process are attributed to emergence of
globalization, low cost funding and current financial turmoil, hence the need to create large
entities to be able to compete for seeking out growth and profits. Mergers and acquisitions are a
topic of great debate in today’s business world. Some proponents argue that mergers increase
efficiency whereas opponents argue that they decrease consumer welfare by monopoly power.
The motives of merger and acquisition are ultimately related to a common objective: maximizing
profit or returns for shareholders. They have been playing an important role in the external
growth of a number of leading companies the world over. In the wake of economic reforms,
Indian industries have also started restructuring their operations around their core business
activities through acquisition and takeovers because of their increasing exposure to competition
both domestically and internationally.

In the turbulent global economy, mergers and acquisitions of industries takes place to protect
Indian businesses. Such mergers and acquisitions are taking place in Heavy Industries and in
major service industries. In fact, acquisitions during a recession actually can create greater value
and impact for three reasons. First, the “entry price”—the cost to gain access to the stream of
cash flows, market segment, capability and synergies from the acquired business—is often much
lower, as companies’ market capitalizations have dropped around the globe to levels around 40 –
70 percent below where they were just a year ago. Second, due to the lower values, organizations
are able to go after targets that were formerly out of reach. Third, companies that have relied on
debt and equity financing or have less favorable financial positions typically must sit on the
sidelines, meaning far less competition for an acquisition, and, thus, fewer companies bidding up
the price.

SECURITIES

The term ‘Securities’ under Section 2(81) of the Companies Act, 2013 has been defined to mean
‘securities’ as defined in Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA).

Under section 2(h) of SCRA, the term ‘securities’ include the following:

 Shares, scrips, stocks, bonds, debentures, debenture stocks etc. in or of any incorporated
company or another body corporate.
 Derivatives.
 Units issued by any Collective Investment Scheme to the investors in such scheme.
 Security receipt as defined in Section 2(zg) of the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002.
 Units or any other such instruments issued to the investors under any Mutual fund scheme.
 Government Securities
 Such other instruments, rights or interest therein shall be declared by the government to be
securities be declared by the government to be securities.

The SCRA recognises securities issued by a body corporate as well as the government. A company
may also issue its securities at a higher price than their normal value if the market already exists.
Stock exchanges are authorised under Section 9(m) of SCRA to make provisions in their bye-laws to
list securities on the stock exchange.

Listing means including any security for the purpose of trading in a recognised stock exchange, i.e.
admission of securities of any incorporated company, Central and State Governments, Quasi
Governmental and other financial institutions/corporations, municipalities, electricity, housing boards,
etc.

In Sahara India Real Estate v. Securities & Exchange Board Of India, one of the issues of the case
was whether the hybrid Optionally Fully Convertible Debentures of the company fall within the
definition of "securities" within the meaning of Companies Act, SEBI Act and SCRA so as to vest
SEBI with the jurisdiction to investigate and adjudicate. It was held that although the OFCDs issued
by the two companies are in the nature of ‘hybrid’ instruments, it does not cease to be a "Security"
within the meaning of Companies Act, SEBI Act and SCRA. It says although the definition of
"Securities" under section 2(h) of SCRA does not contain the term "hybrid instruments", the definition
provided in the Act is an inclusive one and covers all "Marketable securities".
Sub-section 84 of Sectopm 2 of the Companies Act 2013, defines “Shares” as, “Share” means a
share in the share capital of a company including stocks. Shares are considered as a type of
security. Securities is defined in the Sub-section 80 of Section 2 of the said Act, which refers to
the definition of the securities as defined in clause (h) of section 2 of the Securities Contracts
Act, 1956.

According to Section 44 of the said Act, the shares of any member in a company shall be
movable property. It is considered to be transferable in the manner provided by the articles of the
company. 1

According to Section 45 of the said Act, it mandates on all companies having a share capital to
ensure that the shares of the company shall be distinguished by a distinctive number. This
requirement does not apply where a share is held by a person whose name is entered as holder of
beneficial interest in the records of depository. 2

Allotment of Securities

Offers for shares are basically made when application forms are supplied by the company. It is
considered an allotment when an application is accepted. It is considered as an appropriation out
of the previously un-appropriated capital of a company. Consequently where forfeited shares are
re-issued, it is not the same thing as an allotment.3

For an allotment to be considered valid it shall comply with the requirements of the and
principles of the law of contract that is regarding acceptance of offers.

Statutory Restrictions on Allotment

1. Minimum subscription and application money

According to Section 49 of Companies Act, 2013 the first requisite of a valid allotment is that of
minimum subscription. In the given prospectus of the company the amount of minimum
subscription shall be stated when shares are offered to the public. No shares shall be allotted
unless a specified amount has been subscribed and the application money, which shall not be less
than the appeal that was held to be successful, the decision of stock exchange was set aside and
the listing would be granted. The allotment would be saved.4

2. Over-subscribed Prospectus

An allotment is valid when the permission of a stock exchange has been granted and the
prospectus being considered as over-subscribed portion of the money received shall be sent back
to the applicants within the given time frame.

PRINCIPLES OF ALLOTMENT OF SHARES

1. Allotment of shares by proper authority

Allotment is generally made by a resolution that consists of the Board of directors. But where the
articles so provided, an allotment made by secretaries and treasures was held to be regular.

2. Within the reasonable time

Allotment is basically made within a reasonable or specified period of time otherwise the
application shall lapse. The specified time frame of six months between application and
allotment is held to be not reasonable.

3. Shall be communicated

It is primary that there must be communication of the allotment to the applicant. Posting of a
properly addressed and stamped letter of allotment is considered as a sufficient communication
even if the letter were to be delayed or lost.5

4. Absolute and unconditional

As per the terms and conditions of the applicant the allotment must be absolute and
unconditional. Thus where a person applied for 400 shares on the condition that he would be
appointed cashier of a new branch of the company, the Bombay High Court held that he was not
bound by any allotment unless he was so appointed. 6

Global Depository Receipt

As given under Section 41 of the Companies Act 2013, a company may pass a resolution in its
general meeting authoritising it to issue depository receipts in any foreign country in such
manner and subject to such conditions as prescribed by the company.7

Private Placement

According to Section 42 of Companies Act 2013, a company may make a private placement
through issue of offer letters for private placement. Provisions of Section 42 become applicable
to such placement. Provisions of Section 42 become applicable to such placement. The offer of
securities or invitation to subscribe for securities can be made to a number of persons but not
exceeding 50 or such higher number as may be prescribed. This number is not to include
qualified institutional buyers and employees of the company being offered securities under a
scheme of employees stock option as per the provisions of Section 62(1)(b). This can be done in
one financial year and on such conditions as may be prescribed which is to include the form and
manner of private placement.8

The first Explanation to sub-section (2) provides that an offer of private placement to more than
the prescribed number is deemed to be an offer to the public and is governed by the provisions of
(Ss. 23-41) relating to public issues. This will be so whether the company intends to go in for
enlistment or not in or outside India.

The Second Explanation to Sub-Section (2) states that for the purposes of this sub-section, the
expression used in it will have the following meaning –

“A qualified institutional buyer” means one as defined in SEBI (Issue of Capital and Disclosure
Requirements) Regulations 2009 as amended from time to time.
According to [Section 42(3)] no fresh offer or invitation is to be made by the company unless
allotments under any earlier offer have been completed or that offer has been withdrawn or
abandoned.

All moneys payable towards subscription have to be paid through cheque or demand draft or
other banking channels and not cash.

As per Section 42(5) Securities have to be allotted within 60 days of receipt of application
money failing which the application money would have to be refunded within 15 days or else 12
per cent interest would become chargeable. The money received on application is to be kept in a
separate bank account in a scheduled bank and is to be utilized only for adjustment against
allotment of securities or refund as given under Section 42(6).

Offers can be made only to persons whose names are recorded by the company prior to the offer.
They should receive the offer by name. A complete record of such offers has to be kept by the
company in a prescribed manner. A complete information about an offer has to be filed with the
Registrar within a period of 30 days of circulation of the relevant private placement offer letter.
As given under Section 42(7) a company offering securities under this section is not to release
any public advertisements or utilize any media, marketing distributing channels or agents to
inform the public about the offer.

Section 42(8) explains that after making allotments, the company shall file with the Registrar a
return of allotment in the prescribed by the company which consist of the complete list of all the
security holders along with their full names, addresses, number of securities allotted and also
any other information.

Consequences for the default

Section 42(10) provides an explanation stating that any contravention of the section would make
the company, its promoters and directors liable to a penalty which may extend to the amount
involved in the offer, or two crore rupees whichever is higher. The company shall then be in a
position to refund the money to subscribers within a specified time frame of 30 days of the order
imposing the penalty.

Private Placement of securities under Companies Act 2013

A private placement is a capital raising event that involves the sale of securities to a relatively
small number of select investors.
A private placement is different from a public issue in which securities are made available for
sale on the open market to any type of investor.
As per the definition under Explanation II to Sub Section 1 of Section 42 of the Companies Act,
2013 Private Placement means any offer of securities or invitation to subscribe securities to a
select group of persons by a Company ( other than by way of public offer) through issue of a
private placement offer letter and which satisfies the conditions specified in this section.
Private Placement is governed by Section 42 of the Companies Act, 2013. As per Section 42 of
the Companies Act, 2013 the maximum number of persons to which allotment can be done in a
year shall not exceed 200( Excluding Qualified Institutional Buyers and Employees who have
been given securities under ESOP Scheme) in a financial year. If the same exceeds the
prescribed limit then in will be deemed to be a public issue and the Company has to follow
the procedure of Public issue. As per the present scenario, if a Company, listed or unlisted,
makes an offer of Securities to more than 200 persons during a year, whether it receives money
or not, to any person whether in India or abroad and intends to get its Securities listed on a
recognized stock exchange whether in India or abroad, shall be deemed to be a Public issue and
the Company has to Comply with the provisions of Public issue.
Procedure
1. Company planning to make Private Placement has to first pass a special resolution in the
general meeting of the Company.
However, in case of Non Convertible Debentures(NCD) it will be sufficient if the Company
passes a special resolution once in a year for all the Private Placements to be made by the for the
NCD during the year.[Rule 14(2)].
2. Next, the Company has to issue a Private Placement letter of offer to the Identified persons by
the Board to whom the allotment is to be made. [ Companies Amendment Act, 2017].
However, it is to be noted that the Private Placement letter of offer shall not contain Right to
Renunciation.[ Companies Amendment Act, 2017].
The Company also has to keep the records of the same and file the details with the ROC within
30 days from the date of issue of Private Placement letter of offer.[Rule 14(3)].
3. Once the Company receives the allotment money, the Company shall allot the Securities
within 60 days and if it fails to do so then refund the money within the next 15 days. If the
Company fails to do so then interest @12% will be charged from the expiry of 60th day.
4. The Company has to file return of allotment within 15 days of allotment in Form PAS-3
.Companycannot utilize the Application money until it has filed Return of allotment with
the ROC[ Companies Amendment Act, 2017].
Following points are to be noted
1. The Application money to be received shall be either through Cheque, Demand Draft or other
banking channels except cash. [Section 42(5)]
2. The minimum application size shall not be less than Rupees Twenty Thousand per person.
3. Private Placement shall not be done unless any previous offer or invitation has been completed
or withdrawn or abandoned by the Company. [Section 42(3)].
4. The Company shall not advertise about the Private Placement to the public.
5. If a Company makes contravenes the provisions of this Section, then the Company, Promoters
and its Directors shall be liable for a penalty which may extend to the amount involved in the
contravention or rupees two crores, whichever is higher. Further the Company also has to refund
all monies to subscribers within 30 days of the order.
6. Restriction of 200 is for each kind of a Security [explanation to Rule 14(2)(b)].

Cases
inefficient or careless conduct of a director in the performance of his duties cannot
give rise to a claim for relief under s.397. The person complaining of oppression must
show that he has been constrained to submit to conduct which lacks in probity,
conduct which is unfair to him and which causes prejudice to him in the exercise of
his legal and proprietary rights as a shareholder.--- Needle Industries
case, S.P.Jainv. Kalinga Tubes, Scottish co-operative case, Elder v. Elder and
Watson.
In Shanti Prasad Jan v. Kalinga Tubes Ltd., there had been two groups of shareholders led by P
and L, in the respondent company incorporated in Orissa in 1950. In 1954, an agreement was
entered in to between the appellant s, and P and L, by which S was allotted shares equal to those
held by P and L, and the 3 groups were to have equal measure in the capital and control of the
company. The company was not a party to this agreement and no change was ever made in the
articles thereofto confirm to the agreement, although the company was converted into a public
company with the consent ofthe 3 groups 1957. In 1958, the P and L groups outvoted S in a
general meeting in passing a resolution that 39,000 new shares be allotted not to existing
shareholders but to outsiders. In 1960, a notice of a general meeting was issued for raising the
capital and issuing additional equity shares to outsiders only. S filed an application under ss. 397,
398, 402 and 403 of the Companies Act, 1956 alleging oppression at the hands of the P and L
groups who wanted to exclude S and his minority group completely from all control in the
company by acquiring 75% voting control therein in breach of the said agreement of 1954. He
also alleged mismanagement in the company, and a lack of confidence by his group in the
conduct of the company’s affairs by P and L groups resulting from a lack of probity in their
conduct. The application was heard in the first instance by Justice Barman who held that the way
in which the P and L groups had acted in the matter ofthe issue of new shares was oppressive of
the minority shareholder represented by S and the subsequent conduct ofthe 2 groups amounted
to continuing and continuous processes of oppression of the minority shareholders and also
amounted to mismanagement \ likely to be prejudicial to the interests of the company. He held
that in view of the oppression, there was just and equitable cause for winding up the company
but that winding up would be prejudicial to the interests of the company. He therefore allowed
the petition and granted relief u/s 397 and 398 to restore equal shareholdings and control ofthe 3
groups in the light ofthe said agreement. This was followed by 14 appeals to the Division Bench
of the Orissa High Court by the company and the various shareholders. The Division Bench274
came to the conclusion that the agreement of 1954 was not binding on the public company which
came into existence in 1957 whatever might have been the position under the agreement when it
was a private company. It was held that no case had been made out for oppression u/s 397 or
mismanagement u/s 398, and so the appeals were allowed, the application of the appellant was
dismissed, and the order ofjustice barman u/s 397 and 398 was set aside. The reasons given for
holding that S had failed to make out a case u/s 397 were:
“The ... argument that the status quo conceived in the terms ofthe oral agreement should be
exercise ofjurisdiction under S. 397. Nondistribution of one-tkird shares to.the petitioner in
proportion to the existing shareholdings had undoubtedly led to lack of confidence and private
animosity between the majority group and the minority group in the matter ofpoPce and
administration of the company. But the Directors of the company concerned with the
management of the affairs cannot be charged with fraud, misfeasance or misconduct towards any
parts ofits members. It cannot be said that the Director controlling the Company have abused
their powers resulting in injury to the rights ofthe minorities unless it is assumed that the
minorities are entitled as ofright to proportionate one-third distribution of the newly issued
shares.
Finally, the appellan; obtained leave to appeal to the Supreme Court which upheld the decision
of the Division Bench of the High Court and dismissed the appeal, holding that it is not enough
to show that there isjust and equitable cause for winding up the company, though that must be
shown as preliminary to the application u/s 397. It must further be shown that the conduct of the
majority shareholders was oppressive to the minority as members and this requires that events
have to be considered not in isolation but as a part of a consecutive story. There must be
continuous acts on the part ofthe majority shareholders, continuing up to the date of the petition,
showing that the affairs-, of the company were being conducted in a manner oppressive to some
part of the members. The conduct must be burdensome, harsh and wrongful and mere lack of
confidence between the majority shareholders would not be enough unless the lack of confidence
springs from oppression of a minority by a majority in the management of the company’s affairs
and such oppression must involve at least an element of lack of probity or fair dealing to a
member in the matter of his proprietary rights as a shareholder. As such it was held that the case
of oppression based on the agreement of 1954 must fail because the agreement was not binding
even on the private company, and much less on the public company when it came into existence
in 1957. It was also held that no case was made out to show mismanagement u/s 398 of the Act.
The main reason supporting the \ decision of the Supreme Court, that the allotment of new shares
to outsides only cannot be said to be oppressive ofthe appellant and his group, is seen in the
following passage:
 “It also appears that the Patnaik group was afraid at the time when the new shares were being
issued that as they had no money the appellant group would take up the entire new issue and
would thus obtain majority control ofthe company. This they wanted to avoid and that is why the
new issue was resolved in general meeting to be issued to others and not to the. existing
shareholders. This was the reason why new-shares were not issue to the existing shareholders it
can hardly be said that the action of the majority shareholders in passing the resolution which
they did on 29th march, 1958, was oppressive to the minority shareholders. ”
From the foregoing judgement ofthe Supreme Court, it is clear that it adopted a very legalistic
and mechanical view of the provisions of section 397 as was latter taken in England u/s 210 of
the Companies Act, 1948 in Re Five Minute car-Wash Service277 and Re Jermyn Street Turkish
Baths Ltd.278 The Supreme Court in this case relied on Elder v. Elder and Watson279, Scottish
Cooperative Wholesale Society Ltd. In formulating and laying down the ingredients ofthe nature
ard meaning of “oppression” u/s 397 ofthe Companies Act, 1956.

Minority Shareholders

Ownership of shares grants equitable interest in the company to shareholders however, they do
not right to manage the affairs of the company directly but they do so indirectly by way of
electing directors. The categories of shareholders include majority shareholders, small
shareholders, who hold shares of value of shares held is less than INR 20,000.00 and minority
shareholders. Out of these, Minority Shareholders are those equity holders who do not have
voting control. However, law protects the rights of a Minority Shareholders substantially if they
are subject to oppression and mismanagement. They can take recourse to legal remedy under
section 235 (Investigation of the affairs of the Company) and section 237 (Investigation of the
affairs of the Company in other cases) and 397 (Application to Company Law Board in respect
of Oppression) and 398 (Application to Company Law Board in respect of Mismanagement) read
with section 399 (which provides right to apply under section 397 and 398) where they can
approach the Company Law Board, if companies take recourse to oppression and
mismanagement. Chapter XVI of the New Companies Act, 2013 deals with the similar
provisions. The shareholders activism is key to good corporate governance and therefore the
article reflects upon minority shareholders in wake of recent news of their role in Maruti Suzuki
voting over a proposal to understand the Corporate law in India on subject.

Generally speaking Shareholders have following rights:

 (a) Right to receive income in the form of dividends, issue of shares or bonus shares;

(b) Right to vote in meeting/attend meetings either personally or through proxies;

(c) Right to demand a poll for voting on any resolution, which can be detrimental to their
interest;

(d) Right to receive statutory reports of the company;

(e) Right to apply for investigation for affairs of the company

Conclusions

Corporate governance cannot be synonymous with the role of dominant shareholders alone. But
role of minority shareholders in its fullest needs to be yet realized as yet because Independent
directors or auditors neither protect the minority shareholders nor their value is appreciated.
Activism can be achieved by direct dialogue with management, Board, writing open letters or by
way of shareholder’s proposals. Electronic voting is one such measure which enables minority
shareholders in far flung areas to have say in shareholder’s resolution (Section 108 of the New
Companies Act), related party transactions are required to approved by Minority Shareholders
(Section 188 of the New Companies Act). Section 245 of the Companies Act, 2013 allows you
to bring in class action suits against the company and auditors by Minority Shareholders. The
new Companies Act allows any number of minority shareholders to file proceedings against the
company under section 241 of the Act. It is interesting to note that what constitutes minority in
this regard is left to the discretion of the tribunal. Earlier this decision was left to the central
Government. So, the new law has brought in many changes and recent developments in Siemens,
United Spirits and Tata Motors too have witnessed terrain of shareholders activism but the same
has long way to go before bring ground level changes in corporate governance.

OPPRESSION & MISMANAGEMENT

Section 397

This section gives the provision to apply to Tribunal (substituted for ‘Company Law Board’ by the
Companies Second Amendment Act, 2002) for relief in cases of oppression.

Subsection (1) of section 397 states that any members of a company who complain that the affairs
of the company are being conducted in a manner prejudicial to public interest or in a manner
oppressive to any member or members (including anyone or more of themselves) may apply to the
Tribunal for an order under this section, provided such members have a right so to apply under
section 399.

Subsection (2) of section 397 has 2 clauses:

Clause (a) of subsection (2) states that if, on any application under subsection (1), the Tribunal is
of the opinion that the company’s affair are being conducted in a manner prejudicial to public
interest or in a manner oppressive to any member or members, the Tribunal may, with a view to
bringing to an end the matters complained of, make such order as it thinks fit.

Clause (b) of subsection (2) says that if, on any application under subsection (1), the Tribunal is of
opinion that to wind-up the company would unfairly prejudice such member or members, but that
otherwise the facts would justify the making of a winding-up order on the ground that it was just
and equitable that the company should be wound-up, then the Tribunal may with a view to
bringing to an end the matters complained of, make such order as it thinks fit.

The key terms in subsection (1)

I. prejudicial to public interest,

II. oppressive to any member/members

I. prejudicial to public interest:

The words “in a manner prejudicial to public interest” were inserted in section 397 and also in
section 398 and section 408, by the Companies Amendment Act of 1963.The insertion of these
words provides for the court or the Central Government to have jurisdiction to interfere in cases
where even though there may be no prejudice to any shareholders but yet may be prejudicial to
public interest.

The meaning of ‘public interest’ is an elusive abstraction, meaning general social welfare
or ‘regard for social good’ and implying ‘interest of the general public in matters where
regard for the social good is of the first moment’. In State of Bihar v. Kameshwar
Singh,1952(sc) it was observed that the expression is not capable of precise definition and has not
a rigid meaning, and is elastic and takes its colour from the statutein which it occurs, the
concept varying with the time and state of society and its needs. The expression cannot be
considered in vacuo but must be decided on the facts and circumstances.

In N.R.Murty v. Industrial Development Corporation of Orissa, it was observed that the

concept of “public interest” takes the company outside the conventional sphere of being a
concern in which the shareholders alone are interested. It emphasizes the idea of the company
functioning for the public good.

However, it is important to note that it is difficult to sustain an application under section 397on the
ground of being prejudicial to public interest as the condition in clause(b)of subsection(2) cannot
be satisfied in such case, as conducting the affairs of a company in a manner prejudicial to public
interest cannot be a just and equitable ground for ordering the winding up of the company,
unless it should be considered illegal or opposed to public policy.

Clause(h) to section 433 provides for winding up if the company has acted against the interests of
the sovereignty and integrity of India, the security of the state, friendly relations with foreign
states, public order, decency or morality.

It has been held that proceedings by a company against a government company for recovery of
huge amounts due from it have been held to be enforcement of contractual rights and not an act
against public interest-Maharashtra Power Development Corporation Limited v. Dabhal Power
Company. In the same case, the Bombay high court, on appeal, observed that to invoke section 397
proof has to be established that the affairs of a company are being conducted in a manner
prejudicial to public interest or in a manner oppressive to the complainant.

According to the dictionary meaning, oppression is any act exercised in a

manner burdensome, harsh and wrongful. Oppression under section 210(the corresponding
section of the English Companies Act of 1948)[sections 459-461 of the Act of 1985]may take
various forms.In Elder v. Elder and Watson Limited(1952) Scottish cases,it was observed that
oppression implies a lack of probity and fair dealing in the affairs of a company to the prejudice of
some portion of its members.

II The term ‘oppression’ is not specifically defined in the Companies Act. Its interpretation may
be extracted from the judicial pronouncements of case-laws.

In Scottish Corporation case, it was held that Oppression may result from not acting as much as
by acting. It means that oppression may arise from doing a particular act and also from avoiding to
do certain act which should have been done.

However, inefficient management will not amount to oppression though it may amount to
mismanagement under section 398. Nor will oppression not relating to the company’s affairs but
directed towards a third person come under this section ---Kanika Mukherji v. Rameshwar
Dayal Dubey

Where a majority of members exercise their rights as shareholders in the conduct of the
company’s affairs, the fact that there is oppression , lapse or impropriety on the part of an officer
not pertaining to or unconnected with the exercise of voting rights by a majority of shareholders,
will not justify invocation of jurisdiction under section 397.---Chaturgun Ram Maurya v. U.P.
Builders(p) Ltd.

Oppression may take different forms and need not necessarily be for obtaining pecuniary benefit.
It may be due to a desire to obtain power and control, or be merely vindictive.—In Re,
H.R.Harmer Ltd..

Where no pvt. Agreement or understanding among members of a pvt.company as to appointment

of directors is provable, the fact that the majority shareholders appointed all directors does not
amount to oppression.---V.M.Rao v. Rajeshwari.

Unwise, inefficient or careless conduct of a director in the performance of his duties cannot give
rise to a claim for relief under s.397. The person complaining of oppression must show that he has
been constrained to submit to conduct which lacks in probity, conduct which is unfair to him and
which causes prejudice to him in the exercise of his legal and proprietary rights as a shareholder.---
Needle Industries case, S.P.Jainv. Kalinga Tubes, Scottish co-operative case, Elder v. Elder
and Watson.

The Court starts with the presumption that the directors are acting in the best interest of the
company. The court cannot adjudicate upon the wisdom of the Board of Directors if they decide to
terminate a distribution agreement.The burden lies on those to prove the fact who allege that
powers have been exercised in personal interest, or not in the interest of the company or with a
view to injuring the interest of the complaining shareholders.—M.L.Thukral v. Krone
Communications Ltd.

Decisions relating to the operation of company’s bank accounts are a part of the managerial
powers of the directors .The mere fact that a director is not being associated with operation of the
company’s banking accounts does not constitute oppression and mismanagement---Sudha
M.Singh v. Eagle P.Ltd

An isolated and single act of ouster from directorship would not entitle the aggrieved person to
ask for company’s winding up by way of relief against oppression invoking clause (b) of sub-
section (2) of s.397 as there is appropriate remedy for it by way of company suit—Bagree Cereals
Pvt.Ltd v. Hanuman Prasad Bagri.

It has also been held that merely because the majority are carrying on a competing business does
not necessarily mean that the minority are being oppressed in relation to their own company,
unless the majority are diverting corporate opportunities away from the company or are using the
company’s facilities for the purposes of their competing business without proper payment. In many
instances, it may be desirable to prevent the majority from competing and to cause them to devote
substantially all of their time to the affairs of the company by—

1) restrictive covenants,
2) confidentiality undertaking,
3) service agreements
4) express contractual undertakings in a shareholders’ agreement

These provisions become particularly important where the company is a quasi-partnership and it is
intended that all the participants including the majority should work in the business.

The scope and meaning of the expression ‘oppressive’ with reference to the corresponding section
of the English Act(s.210) are explained by Jenkins, L.J., in H.R.Harmer Ltd---

1)The person permitted to apply to the court under section 210 is ‘any members of the
company’ and he must show that the affairs of the company are being conducted in a manner
oppressive to some part of the members (including himself). This indicates that the oppression
complained of must be complained of by a member of the company and must be oppression of
some part of the members, in their or his capacity as members or member of the company as such.

2) The section does not purport to apply to every case in which the facts would justify the
making up of a winding_up order under the just and equitable rule, but only to those cases of
that character which have in them the requisite element of oppression.

3)The ‘affairs of the company are being conducted’ suggests prima facie a continuing process and
is wide enough to cover oppression by anyone who is taking part in the conduct of the affairs of
the company, whether de facto or de jure.

4) The section gives no guidance as to the meaning of the word ‘oppressive’, although it does
indicate that the victim or victims of the oppressive conduct must be a member or members of the
company as such. Primafacie, therefore, the word ‘oppressive’ must be given its ordinary sense
and the question must be whether in that sense the conduct complained of is oppressive to a
member or members as such.

Another important aspect of sub-section (1) of s.397 is that the act of oppression should be of
continuous nature. The term ‘are being conducted’ are used in the section and this implies an
action which is still continuing. Mere isolated acts do not amount to oppression. It was held in
Shanti Prasad Jain v. Kalinga Tubes Ltd. that there must be continuous acts on the part of the
majority shareholders, continuing upto the date of petition, showing that the affairs of the company
are being conducted in a manner oppressive to some part of the members.

Some other instances which have been held to be act of oppression are —

1) Clandestine loans to directors

2) Secret profits
3) Issue of further shares for the purposes of converting a majority into a minority
4) Increasing capital without need and denying shareholders the oppurtunity to elect directors
constitute act of oppression.

The case of Needle Industries was distinguished in Kamal K.Dutta v. Ruby General Hospitals Ltd.
because in that case the Board’s decision was in overall and larger interests of the company and the
circumstances were such that even if adequate notice was given to the foreign corporate member it
could not have taken advantage of the further issue of capital.

The fact that, by issue of shares, the directors incidentally acquire or maintain control over the
company does not amount by itself to an abuse of their fiduciary power. What would be considered
objectionable would be use of such powers merely for an extraneous purpose like maintenance or
acquisition of control over the affairs of the company.

A mere apprehension that the minority shareholders will be oppressed in future is not sufficient to
invoke this section --- Krishna Prasad v. Andhra Bank Ltd.

Depending upon the facts and circumstances, single act can also amount to oppression. For
instance, a majority shareholder gets reduced to the position of minority by allotting the new issue
of shares wholly to the minority group. The circumstances were such that if the aggrieved majority
shareholder was called upon to dispose of his stake in the company to the other group, he would
not be able to get adequate compensation because the business which he had built in the name of
the company was of great value to him. The Court held it to be an act of oppression.

In Ramashankar Prasad v. Sindri Iron Foundry (P) Ltd it was held that a position under s.397
would be maintainable even if the oppression was of a short duration and of a singular conduct if
its effects persisted indefinitely.

It is well-settled that the directors could not utilise the fiduciary powers over the shares purely for
the purpose of destroying an existing majority or creating a new majority. If the power to issue
further shares was exercised by the directors, not for the benefit of the company, but simply and
solely for the purpose of consolidating and improving their voting power to the exclusion of the
existing majority shareholders, such use of the power could not be allowed, it being a power of
fiduciary nature delegated by the company to the Board of Directors to be used for the benefit of
the company.

Where the increase of capital and its allotment was necessitated by the Supreme Court’s directions,
there could be no complaint.

However, in Suryakant Gupta v. Rajaram Corn Products (Punjab) Ltd. it was held that allotment to
one group to the exclusion of the other group was held to be justified because of the company’s
need for funds and the assurances given to the Tribunal that the original shareholding percentage to
the petitioner group in the company would be restored.

The remedy under s.397 is an alternative to winding up. The interests of the company are
paramount in moulding the relief. Where each side is equally strong, and one is unable to oppress
the other, there may be a deadlock but not oppression. It is not a case for winding up.

Where there is loss of substratum of the company’s business, it was held to be fit case for ordering
winding-up. The phenomenon of continuous losses cannot be regarded by itself as oppression to
any shareholder. Some other instances which make up for winding-up order are--- loss of mutual
trust, misuse and siphoning of funds provided that such allegation is supported by a statement of
particulars, manipulation of accounts in a pvt. Company so as to be unable to pay its debts and
capital being wiped out because of losses.

In a two-members two-directors company,with one of them as managing director, the other being
the minority shareholder-director, the latter can file a petition in his capacity as a minority
shareholder for prevention of oppression and mismanagement. However, he would be estopped
from raising any such decision for proof of his suffering in which he participated as a director at
the meetings of the board.

In case of a charitable company, no personal interest of members and directors is involved. They
have only right and duty to see that the objects of the company are carried out. Thus, even if there
is allegation that the funds have been misappropriated by the management, the remedy would lie
elsewhere and not by way of prevention of oppression.

With respect to sub-section (2) of s.397, both conditions in clauses (a) and (b) must exist before the
Tribunal can entertain an application. Where there is no allegation to support a winding-up, the
petition cannot be entertained. Clause (b) of sub-section (2) implies that though it is necessary that
facts should justify winding-up, instead of winding-up, an alternative relief is provided if the facts
are such that the winding-up would unfairly prejudice the interest of the complaining members.
The words ‘in a manner which is unfairly prejudicial’… connote that there must be harm or
prejudice and that such harm must be unfair harm. It plainly implies that there may be harm which
is not unfair, and harm, to be within the section, must be alleged to b unfair to the interest of some
part of the members.

It is important to point out that in certain instances petitions are motivated and amounts to abuse of
process of the court and are not contemplated by this section. For example, if the object of the
petition is to recover money from the controlling shareholders; if the petition aims at redressal of
any personal grievance of a member, and so on.

Burden of proof--

Burden lies on the petitioner to prove his allegations. Where the allegations were not substantiated
with cogent evidence, nor a case of winding-up was made out, which is a prerequisite for relief, the
petition was dismissed.

A petition may be allowed to me amended for the purpose of including any other relief which was
not included earlier. Events occurring subsequent to the filing of the petition can be brought on
record by the process of an amendment of the petition ---Jer Rutton v. Gharda Chemicals
Ltd.(2000)
With respect to the question of composite petition under s.397,398 and 433(f), the Supreme Court
had observed in Shanti Prasad Jain v. Kalinga Tubes that it is maintainable.

Sections 397 and 408 do not confer exclusive jurisdiction on the Tribunal to grant relief against
oppression and mismanagement. Suits by minority shareholders against oppression and
mismanagement is a time honoured exception to the majority rule established in Foss v. Harbottle.
A petition lies against the person who is in effective control of the company though he may not be
a majority shareholder.

Right of Central Government—

Central Government has a right to apply, under section 399(4), suo moto or at the instance of the
shareholder or shareholders or any other person, irrespective of the conditions required by sub-
section(1) of section 399. Explaining the position and involvement of the Central Government in
petitions for oppression and mismanagement the Delhi High Court observed in Sakthi Trading Ltd.
v. Union of India—

The reading of the sections 397 to 409 makes it clear that no action can be taken by the Tribunal
under section 397 or 398 without giving adequate opportunity to the Central Government to make
submissions before the Tribunal. The powers of the Tribunal under s.397 or 398 read with s.402
are of the widest amplitude.

In Hungerford Investment Trust Ltd. v. Turner Morrison and Co. Ltd. the Court observed that
powers under section 397 and section 398 confers upon the Court discretion of wide nature, so it
must be exercised with care and not so as to substitute management by the Tribunal for the existing
management for every difference of opinion between the shareholders.

According to the Delhi High Court, in exercising its jurisdiction, the Tribunal will be guided by
three important considerations---

1) the need to maintain democratic rights of the majority of members to manage the affairs within
the limits laid down by the constitutional documents of the company;
2) need to protect the minority from any possible onslaught by the majority so that their vital
interests are safeguarded;

3) the Tribunal should limit its interference to the actual needs of the occasion so as to make sure
that useful social services being provided by the company are not jeopardized. Moreover, the
procedure established for the protection of minorities should not be permitted to be misused for
exploitative purposes.

Where the membership of any person making the application is disputed, the application cannot be
admitted unless the applicant is prima facie entitled to membership or his right to membership is
indisputable or unchallengeable. --- Gulabrai Kalidas Naik v. Lakshmi Patel.

Good faith and conduct of petitioner are other important considerations. The right to petition is a
product of equity and, therefore, there must not be such conduct as would disqualify the plaintiff
from proceeding against the company. For instance, if he participates in the wrong complained of
by him, he would be disqualified from applying for relief. It has been held by Supreme Court in
Needle Industries (India) Ltd. case that the court’s power to exercise jurisdiction under section 397
or 398 cannot be defeated by mere technicalities. The petitioner cannot succeed merely by showing
that a ground for relief exists. His good faith is a necessary aspect of the jurisdiction and it can be
gauged not only by looking at his conduct in a proceeding under this section but also in parallel
proceedings in Civil Courts and in other civil litigations.

Section 398

This section provides for application to Company Law Board/Tribunal for relief in cases of
mismanagement. Unlike section 397, this section has no counterpart in the English act. It was
recommended by the Company Law Committee to provide relief against mismanagement which
cannot otherwise be suitably dealt with under any other provision of the Act. In order to grant
relief under this section, it is not necessary for the Court that there are facts to justify the making
up of a winding-up order. It is enough if the affairs of the company are conducted in a manner
prejudicial to the interests of the company or to the public interest.

Section 398 has two facets. The first is the positive acts done by the management which result in
prejudice being caused to the company; secondly, even where no action at all is taken by the
management, such non-action results in prejudice being caused to the company. The non-conduct
may arise for a variety of reasons including serious disputes amongst the Board of directors of the
company which results in a complete deadlock or stalemate. In cases falling under section
398(1)(b), action can be taken to prevent even likelihood of injury in future either to the interest of
the company or to public interest.

When a party is charged with acts of mismanagement, misappropriation or improper conduct, full
particulars of the acts complained of must be set out in the pleading and unless so set out, such
charges should be ignored and no reliance should be placed on them. Applying this legal
requirement to petitions under sections 397-398 in Clive Mills Company Ltd., Re, the court said –
It is not only in the case of fraud, but in case of all other allegations relating to mismanagement,
misappropriation or other improper conduct with which a party is charged in applications under
sections 397 and 398 of the Act, full particulars must be set out in order to enable the party
charged to understand what he is charged with, and also to enable him to answer such charges.

The Tribunal is not concerned with past management except where the past ‘projects itself as a
continuous wrong that pervades the conduct of the company’s affairs’. The powers under this
section cannot be exercised against a person who has ceased to be a director at the date of the
petition for compensation of tortuous acts committed in the past, even if the acts complained of
constitute misfeance under section 543.

INSTANCES OF MISMANAGEMENT

1.Conduct of affairs to the company’s prejudice—Conditions that prevent the proper

functioning of the company, according to the provisions of the Indian Companies Act, the
uncertainty as to the de jure character of the Board and difficulty of having the state of affairs
rectified in the usual way, the patent fact that the company was being run by the Board in their
own interest overriding the wishes and interest of the majority of shareholders which inevitably
involved the company in costly litigations where facts from which the court could include that the
affairs of the company were being conducted in the interest of a group and certainly not in the
interest of the company. These acts would bring the case within section 398 of the Companies Act.

2. Continuation in office after expiry of term and infighting amongst directors---Where the
Managing Directors of a company continued in office after their terms had expired, without a
meeting being held to re-appoint them prior to making a fresh application to the Central
Government under s.269, the continuation in office under these conditions was held to be
mismanagement within the purview of this section and s.397.It was so held in Sishu Ranjan Dutta
v. Bhola Nath Paper House Ltd. .So also infighting among the directors resulting in serious
prejudice to the company constitutes mismanagement under s.398.

3. Preventing directors from functioning—Where a set of properly appointed directors were not
permitted to join or function as director, the court said that the complaint of such appointees could
be regarded as a symptom of mismanagement and entertained a petition under section 398 for
providing appropriate relief.—Ador-Samia Ltd. v. Indocan Engineering Systems Ltd(1999).

4. Absence of records and losses:-Where the directors were not taking any interest in the affairs
of the company, the management failed in protecting the company’s records causing prejudice to
the company and the business was also seriously prejudiced because of the infighting among the
directors and the company had started incurring losses, the court held that this was a fit case for
orders under s.398.

5. Sale of assets at low price and without compliance with the Act—In Malayalam Plantations
(India) Ltd.Re one of the estates of a tea and rubber plantations company was sold by the director
at a low price to another tea plantation company without complying with the requirements of
s.293(1) which demands approval by shareholder and without giving adequate notice under section
173 and relevant information giving delivery of possession before general body meeting and
accepting consideration in instalment. It was held to be mismanagement.

Similarly, in another case it was held that sale of the company’s assets was in gross neglect of the
interest of the company and the management was different to the affairs of the company after the
sale of assets, grant of relief under sections 397 and 398 was held to be proper.

6. Company doomed to trade unprofitably--- There can be no doubt that if the directors of a
company continue to trade when the company is making losses and when it should have been
apparent that there was no real prospect that the company would return to profitability, the court
may draw inference that the directors’ decision was improperly influenced by their desire to
continue in office and in control of the company and to draw remuneration and other benefits for
themselves and others connected with them.

7. Violation of statutory provisions and those of articles---Transferring shares without first

offering them to the existing members in accordance with their rights under the articles, holding
meetings without sending notice to members; issue of shares for a consideration other than cash
not represented by corresponding assets and burdening the company with additional rental by
shifting the company’s office have been held to be acts constituting mismanagement of affairs so
as to attract the preventive jurisdiction of the Tribunal under s.398.

8. Misuse of funds---Where a company of four brothers was provided with funds by a bank for its
business and three of the four brothers started using the money in breach of the agreement between
them for the use of that money, it was held that the fourth brother had legitimate ground for
making a complaint of financial management under s.398. It was so held in Narain Das v. Bristol
Grill (P) Ltd. (1997).

9. Affairs of subsidiary---A probe into the affairs of a company so as to find out the existence of
mismanagement would include an enquiry in the affairs of the company’s subsidiaries.

Some instances of cases not involving mismanagement:

1 Bonafide decisions consistent with the company’s memorandum and articles are not to be
equated with mismanagement even if they turn out to be wrong in the circumstances or they cause
temporary losses.

2. The change in the control and management of the company and the appointment of new
directors as a result thereof cannot be questioned under this section, and the court will not interfere
with the affairs of a company in a case where the act complained of is not ultra-vires the company.
The section is only concerned with acts prejudicial to the interests of a company, whether caused
by conduct lawful or unlawful.

3. Allegations of financial excesses and irregularities which were not substantiated by evidence
were not regarded as sufficient either for an order of investigation or for any relief against
mismanagement—Picksonic Electronics P.Ltd. v. Indira Singh (1998)

4. A bonafide shifting of the registered office of a company, causing no loss to the company, has
been held to be as not amounting to mismanagement.--- Bagree Cereals P.Ltd. v. Hanuman Prasad
Bagri (2001)

5. Removal of existing directors from office and appointment of new directors, which was valid,
cannot be challenged in a position under section 398. To amount to a case of mismanagement, it
must be shown that the removal had prejudicially affected the company’s interest or the public
interest.

Miheer H Mafatlal Vs Mafatlal Industries Limited – Case study

A Scheme of Amalgamation of M/s. Mafatlal Industries Limited [MIL] being the Transferee
Company and Mafatlal Fine Spinning and Manufacturing Company Limited [MFL] being the
Transferor Company was proposed The Learned Single Judge of Gujarat High Court had
sanctioned the said scheme in Company Petition No. 22 of 1994. Appeal was filed against the
impugned Judgment before the Division Bench of High Court of Gujarat in Appeal No. 16 of
1994 and the said Appeal was also dismissed. Aggrieved by the Judgment of the Division Bench,
the Appellant filed an Appeal by Special Leave before the Supreme Court.

Background Facts of the case:

1. Transferor Company: [MFL]: MFL was incorporated on 20th April 1931 under the Baroda
State Companies Act and had been carrying on the business of manufacture and sale of textile
piece goods and chemicals. Its registered office was situated at Mafatlal Centre, Nariman Point,
Bombay. It was engaged in the manufacture and sale of textiles and fluorine based chemicals.

2. Transferee Company: [MIL]: MIL was incorporated on 20th January 1913 under the name
‘The New Shorrock Spinning & Manufacturing Co. Limited’ and its name was subsequently
changed to ‘Mafatlal Industries Limited’ as per the fresh Certificates of Incorporation dated 24th
January 1974. Its registered office was situated at Ahmedabad, Gujarat. The objects of MIL
includes carrying on all or any of the businesses such as cotton spinners and doublers, wool, silk
flax, jute and hemp spinners and doublers etc,.

3. Appellant: 1/5 The appellant who has objected to the amalgamation before the High Court of
Gujarat is one of the directors of MFL.

4. Amalgamation: Meeting of shareholders of the Company were convened and the Scheme was
approved by the overwhelming majority of shareholders.

Grounds of appeal: The following four important considerations were raised by the Appellant
in the present case.

1. Non -Disclosure of Interest of Directors:MIL while placing the scheme before the equity
shareholders meeting did not disclose the interest of the directors, namely, Shri Arvind Mafatlal
and Shri Hrishikesh Mafatlal in the explanatory statement supporting the Scheme and hence the
shareholders were misled and could not come to an informed decision.

2. The Scheme is unfair to the minority shareholders

3. The appellant represented a distinct class of equity shareholdersso far as the respondent
transferee -company is concerned and consequently separate meeting so far as his group is
concerned should have been convened by the Company Court.

4. :As it provides under the Scheme that two equity shares of the transferee company will be
allotted against five equity shares of the transferor- company at their respective face value of Rs.
100/- per share

Points of Law discussed:

Scope and Ambit of Jurisdiction of Company Court:

Broad principles concerned with the Jurisdiction of the Company Court were laid down. While
considering and sanctioning the scheme of Amalgamation, the Court has to see,
1. That the requisite statutory procedurefor supporting such a scheme has been complied with
and that the requisite meetingas contemplated by Section 391(1) (a) have been held.

2. That the scheme is backed up by the requisite majority voteas required by Section 391(2).

3. That the concerned meetings of the creditors or members or any class of them had the
relevant material to enable the voters to arrive at an informed decisionfor approving the scheme
in question.

4. That all the necessary material indicated by Section 393(1) (a) is placed before the votersat the
concerned meetings.

5. That all the requisite material contemplated by Section 391(2)of the Act is placed before the
Court by the Applicant 2/5

6. That the proposed scheme of compromise and arrangement is not found to be violative of any
provision of law and is not contrary to public policy

7. That the Company Court has also to satisfy itself that members or class of members or
creditors or class of creditors as the case may be, were acting bona fide and in good faith and
were not coercing the minorityin order to promote any interest adverse to that of the latter
comprising of the same class whom they purported to represent.

8. That the scheme as a whole is also found to be just, fair and reasonable from the point of view
of prudent menof business taking a commercial decision beneficial to the class represented by
them for whom the scheme is meant.

Once the aforesaid broad parameters about the requirements of a scheme for getting sanction of
the Court are found to have been met, the Court will have no further jurisdiction to sit in appeal
over

Concept of commercial wisdom: Jurisdiction of Company Court:

The question whether the Company Court has jurisdiction like an appellate authority to minutely
scrutinize the scheme and to arrive at an independent conclusion whether the scheme should be
permitted to go through or not when the same is approved by majority of the creditors or
members of the company was answered by the Court in negative.

The following lines are quoted in this regard:

“It is the commercial wisdom of the parties to the scheme who have taken an informed decision
about the usefulness and propriety of the scheme by supporting it by the requisite majority vote
that has to be kept in view by the Court. The Court certainly would not act as a court of appeal
and sit in judgment over the informed view of the concerned parties to the compromise as the
same would be in the realm of corporate and commercial wisdom of the concerned parties. The
Court has neither the expertise nor the jurisdiction to delve deep into the commercial wisdom
exercised by the creditors and members of the company who have ratified the Scheme by the
requisite majority. Consequently the Company Court’s jurisdiction to that extent is peripheral
and supervisory and not appellate. The Court acts like an umpire in a game of cricket who has to
see that both the teams play their according to the rules and do not overstep the limits. But
subject to that how best the game is to be played is left to the players and not to the umpire.”

On issues raised:

1. On Non – Disclosure of interest of a director: 3/5 This issue was dismissed and
the following observations were made in this regard.

“If the special interest which the director has is in any way likely to be affected by
the Scheme and if non-disclosure of such an interest is likely to affect the voting
pattern of the class of creditors or shareholders who are called upon to vote on the
scheme, then only such special interest of the director is required to be
communicated to the voters as per Section 393(1) (a).”

Consequently the interest of Arvind Mafatlal in the share-holding or likely future

impact thereon by the litigation was de hors the Scheme in question and was not
required to be placed before the voters. Therefore the same is not valid ground of
objection.
2. On the Scheme being unfair and unreasonable. The Supreme Court declared
that the Scheme of Compromise and Arrangement is neither unfair nor
unreasonable to the minority shareholders represented by the appellant as the
scheme was approved by the overwhelming majority of the shareholders of the
Company and it is not proved that the interest of the minority is prejudiced by the
scheme. It was stated that the financial institutions and statutory corporations held
substantive percentage of shares in respondent-company. This class of
shareholders who are naturally well informed about the business requirements and
economic needs and the requirements of corporate finance wholly approved the
Scheme if it was contrary to the interest of shareholders as class. The following
lines are quoted in this regard:

“It could not be said that the majority shareholders had sacrificed the class interest
of appellant minority shareholders when they voted with overwhelming majority
in favour of the Scheme.”

3. On Appellant’s plea to be treated as a separate class of shareholders:

Quoting Palmer in this Treatise Company Law 24th Edition, it was held that
unless a separate and different type of Scheme of Compromise is offered to a sub-
class of a class of creditors or shareholders no separate meeting of such sub-class
of the main class of members or creditors is required to be convened

4. On Valuation of shares: In this regard, reference was made to a decision of

the Gujarat High Court in Kamala Sugar Mills Limited [55 Company Cases
P.308] which dealt with an identical objection about the exchange ratio adopted in
4/5 the Scheme.

“Once the exchange ratio of the shares of the transferee-company to be allotted to

the shareholders of the transferor-company has been worked out by a recognized
firm of chartered accountants who are experts in the field of valuation and if no
mistake can be pointed out in the said valuation, it is not for the court to substitute
its exchange ratio, especially when the same has been accepted without demur by
the overwhelming majority of the shareholders of the two companies or to say
that the shareholders in their collective wisdom should not have accepted the said
exchange ratio on the ground that it will be determined to their interest.”
Therefore share exchange ratio fixed by experts who are certified professionals
will not be disturbed unless the same is contrary to the provisions of law