Reconstruction and Amalgamation | Company Law - CLAT PG PDF Download

Introduction

A scheme of arrangement is a legal mechanism used in corporate restructuring, particularly in jurisdictions like Australia, Singapore, and the UK. It allows for various forms of debt and equity restructuring, such as converting debt into equity or altering share capital. The effectiveness of such schemes can depend on court approval or statutory provisions, leading to differences in judicial interpretation between countries.

Background

• The company aimed to avoid winding up by initiating a scheme where existing shareholdings would shift to a new company, inheriting the old company's assets, liabilities, and operations.
• This reconstruction scheme would result in the old company's shareholders owning 4% of the new company's shares.

Origin and Legal Principles

• Despite the historical roots of schemes of arrangement in the UK since the 1860s and shared legal foundations in Australia and Singapore, there is significant inconsistency in judicial interpretations regarding the nature of these schemes.

Court vs. Statutory Efficacy

• A key debate exists on whether a scheme of arrangement gains its effectiveness from a court order or from statutory provisions.
• Australian courts support the view that court orders are essential for a scheme's efficacy.
• In contrast, English courts argue that a scheme approved by the required majority of creditors is effective by statute, functioning as a statutory contract.

Diverse Applications of Arrangements

• Arrangements can cover a wide range of schemes, including:
• Debt-to-Equity Conversion: Transforming debt obligations into equity stakes.
• Debt Subordination: Reordering the priority of secured or unsecured debt claims.
• Secured to Unsecured Claim Conversion: Changing the status of claims from secured to unsecured and vice versa.
• Capital Adjustments: Altering share capital through increases or reductions.
• Corporate Restructuring and Amalgamation: Various forms of restructuring and merging entities.

Halsbury's Laws of England on Reconstruction and Amalgamation

• Reconstruction: A legal concept where an undertaking is transferred from one company to another, consisting of substantially the same shareholders, with the intention of continuing the business. It remains a reconstruction even if not all assets, shareholders, or liabilities are transferred.
• Amalgamation: The blending of two or more existing undertakings into one, where the shareholders of each merging company become the shareholders of the new entity. This can occur through the transfer of undertakings to a new company or to existing companies.

Mergers, Amalgamation, and Demergers under the Companies Act 1956

Governed by Sections 391 to 396

• Application to Court: Companies must apply to the court under Section 391 to seek approval for a proposed compromise or arrangement.
• Court Sanction: Section 391 empowers the court to sanction the proposed compromise or arrangement.
• Enforcement: Section 392 allows the High Court to enforce a compromise or arrangement ordered by the court.
• Compliance: Section 393 provides provisions for compliance with court directions.
• Supplementary Provisions: Sections 395, 396, and 396A relate to amalgamation, with Section 395 allowing amalgamation without court procedure.

Amendment in 2002

• The 2002 amendment to the Companies Act, 1956 empowered the National Company Law Tribunal (NCLT) to review and approve compromises or arrangements between a company and its creditors or members.
• Due to the non-formation of the NCLT,these powers remained with the High Courts, allowing parties to make applications to the High Courts for such approvals.

Reconstruction and Amalgamation through Voluntary Winding Up

Compromise and Arrangement

• A compromise is about settling a dispute, while an arrangement is broader and encompasses any lawful agreement related to the rights and obligations of the company, its shareholders, or creditors.

Section 494 of the Companies Act 1956

• This section empowers a company to reconstruct or amalgamate through voluntary liquidation, similar to Section 287 of the Companies Act 1948.
• In this process, the liquidator transfers the company's assets in exchange for shares or other securities of the transferee company.

Effect on Shareholders

• The resolution is considered valid, and the arrangement is binding on all shareholders.
• However, shareholders have the right to dissent from the sale or arrangement under certain circumstances.

Dissenting Shareholders

• Shareholders who wish to dissent must notify the liquidator in writing within seven days of the special resolution.
• Legal representatives of deceased shareholders also have the right to dissent.
• The liquidator can choose to waive the notice requirement.

Shareholders Refusing Shares

• Shareholders who neither agree nor challenge the scheme but refuse to accept shares in the transferee company (especially if they are not fully paid) will be deemed to have allowed the liquidator to sell the new shares and pay them the net proceeds.
• The liquidator will deduct the expenses incurred from the proceeds of the sale.
• If there are multiple such shareholders, the net proceeds will be distributed proportionately among them.

Effect on Creditors

Binding Nature of Arrangements

• The scheme implies that any arrangement under this section is binding on creditors, as indicated in subsection (5).
• Creditors can challenge the arrangement in court or tribunal within one year of the winding-up resolution.

Liquidator's Responsibilities

• An arrangement approved by a special resolution does not absolve the liquidator of their duties.
• It would be a serious neglect of duty for the liquidator to leave everything to the new company after dissolution.

Consent of the Shareholders

• The Companies Act, 1956, sets different requirements for decisions to be binding on a company, reflecting the importance of majority consent in certain cases while protecting minority rights in others.
• Sections 189 and 190 of the Act illustrate this by showing that some decisions require a simple majority, while others need a significantly greater majority, with at least three times the votes in favor compared to those against.
• Section 391, dealing with compromises and arrangements, stipulates that the consent of three-fourths in value of the affected persons is necessary for a decision to be binding on the rest.
• Chapter VI of the Act, covering sections 397 to 409, safeguards the rights of minority shareholders holding at least ten percent of the company.
• Section 395, positioned at the end of this spectrum, allows for the significant dilution of rights for a class of members constituting less than ten percent, a process sometimes viewed as 'expropriation'.
• The rationale behind the prescribed percentages in these provisions is questioned, with the idea that a small group should align with the overwhelming majority not being legally problematic.
• Historically, it has been argued that when nine-tenths of shareholders approve a scheme, it is presumed to be proper, and dissenting shareholders bear the burden of proving otherwise.
• Despite the compulsory nature of such sales or exchanges, it is suggested that courts should not be swayed by the label of 'expropriation' and should generally consider schemes endorsed by a large majority as fair.
• The principle behind Section 395 is that a company with 90 percent of shares under a scheme can compel the dissenting minority to part with their shares, while dissenting shareholders can also compel the company to acquire their shares on the same terms.