Amalgamation order held ultra vires Section 396 of the Companies Act, and violative of Article 14 of the Constitution of India – Supreme Court
ABCAUS Case Law Citation:
ABCAUS 2897 (2019) (04) SC
Important Case Laws Cited/relied upon by the parties
Prem Nath Raina v. State of Jammu & Kashmir and Ors., (1983) 4 SCC 616
Mohinder Singh Gill v. Chief Election Commissioner, (1978) 1 SCC 405
K.I. Shephard v. Union of India, (1987) 4 SCC 431
The instant judgment was delivered in a batch of appeals and writ petition raising questions as to the applicability and construction of Section 396 of the Companies Act, 1956, which deals with compulsory amalgamation of companies by a Central Government order when this becomes essential in the public interest.
The appellant was a 99.99% shareholder of the National Spot Exchange Ltd. (NSEL) and s a listed company with about 43% of the shareholding held by public. The appellant was a profitable company, having a positive net worth of over INR 2500 crore.
Economic Offence Wing (EOW) registered cases against Directors and key management personnel of the NSEL and the appellant, trading members of NSEL, and brokers of NSEL under various provisions of the Indian Penal Code and the Maharashtra Protection of Interest of Depositors Act, 1999 (MPID Act). Also, several suits were filed by the traders who allegedly to have been duped.
Based on a audit report of Grant Thornton report, the Forward Markets Commission (FMC) passed an order declaring that the appellant company was not “fit and proper” to hold equity in any commodity exchanges, and must dilute its shareholding.
Subsequently, the Department of Economic Affairs, wrote a letter to the Ministry of Corporate Affairs stating that the appellant and NSEL had fraudulent purpose of depriving investors of their money and the corporate veil be lifted to unearth the fraud.
It was therefore proposed to merge FTIL and NSEL under Section 396 of the Companies Act. Accordingly a draft order of amalgamation was made in accordance with Section 396(3) of the Companies Act, 1956 was circulated to the relevant stakeholders.
After statutory changes, SEBI was vested with the powers of the FMC which was to be governed by the Securities and Exchange Board of India Act, 1992 (SEBI Act).
Finally, a final amalgamation order was passed in terms of Section 396(3), thereby merging the appellant and NSEL, wherein all assets and liabilities of NSEL became assets and liabilities of the appellant.
The Hon’ble High Court by the impugned judgment dismissed the writ petition of the appellant.
Aggrieved the appellant approached the Hon’ble Supreme Court and argued that the impugned order was ultra vires Section 396.
The Hon’ble Supreme Court observed that any law providing for the amalgamation of two or more corporations in public interest is immune from challenge on grounds relatable to Article 14 or Article 19 of the Constitution of India.
The Hon’ble Supreme Court clarified that though there is no doubt whatsoever that Section 396 cannot be challenged on the ground of Article 14 or Article 19, given Article 31A of the Constitution of India. However, this does not mean that Section 396 must be construed in such a fashion that it would lead to arbitrary or unreasonable results.
The Hon’ble Supreme Court opined that the order passed under Section 396 is qua particular companies and does not lay down any general rule of conduct by itself, but in fact, follows the general rule of conduct laid down by Section 396. Thus, the Central Government order, made under Section 396, must conform to the fundamental rights guaranteed by Articles 14 and 19(1)(g) of the Constitution of India.
The Hon’ble Supreme Court observed that under section 396, first and foremost, the Central Government has to be “satisfied”, meaning thereby, that it must, on certain objective facts, come to a conclusion that amalgamation between two or more companies is necessary. This can only be done if the Central Government finds it “essential”, i.e., necessary to do so. Also, this can only be done in “public interest”.
The Hon’ble Supreme Court observed that the immediate reason for amalgamation, according to the FMC, and which was faithfully carried out by Government, was that NSEL, as a corporate entity, seemed financially and physically incapable of effecting any substantial recovery from defaulting members. This was the “emergency situation” according to the FMC, which should lead to an order of amalgamation of the holding and subsidiary companies so that the holding company’s financial resources could be used to pursue proceedings by which monies owed to the alleged duped investors/traders could be recovered.
However, it was noted that by the time the final order of amalgamation was passed, the final order itself suggested that the emergency situation had disappeared.
The Hon’ble Supreme Court opined that in the context of compulsory amalgamation of two or more companies, the expression “public interest” would mean the welfare of the public or the interest of society as a whole, as contrasted with the “selfish” interest of a group of private individuals.
The Hon’ble Supreme Court noted that in the amalgamation order all the expressions used in relation to “public interest” had relation only to the businesses of the two companies that were sought to be amalgamated. There was no interest of the general public as opposed to the businesses of the two companies that were referred to.
It was noted that the order showed that the sole object of the amalgamation was really to effect speedy recovery of dues of INR 5600 crore, which had been referred to in the letter of the FMC to the Secretary, Ministry of Corporate Affairs.
The Hon’ble Supreme Court opined that it is the Central Government that has to be “satisfied” that its order is in public interest and such “satisfaction” must, therefore, be of the Central Government itself and must, therefore, appear from the order itself.
The Hon’ble Supreme Court observed that the impugned Division Bench judgment had incorrectly held that the economic value of shares cannot be taken into account whereas from the Director’s Report and consolidated financial statements of NSEL, it was clear that the company may be exposed to liabilities in case of any adverse outcome in any of the proceedings that may be pending, as a result of which, it may have to pay back the whole or some part of the INR 5600 crore owed to the alleged investors/traders by the 24 defaulters who are members of NSEL. This would certainly impact the ‘economic value’ of shares held in appellant as this was one factor that would, post amalgamation, depressed the market value of shares held by such shareholder, and would also impact the dividend payable on such shares post amalgamation.
The Hon’ble Supreme Court noted that the assessment order did not provide any compensation to either the shareholders or creditors of the appellant for the economic loss caused by the amalgamation in breach of Section 396(3), therefore it was clear that an important condition precedent to the passing of the final amalgamation order was not met. On this ground also, therefore, the final amalgamation order was held to be ultra vires Section 396 of the Companies Act, and, being arbitrary and unreasonable, violative of Article 14 of the Constitution of India
The Hon’ble Supreme Court stated that even otherwise, this was a case where there was complete non-application of mind by the authority assessing compensation to the rights and interests which the shareholders and creditors of the appellant had and which were referred to in Section 396(3) of the Act. It was clear that Section 396(3) has not been followed either in letter or in spirit.
The Hon’ble Supreme Court have held that the amalgamation order was ultra vires Section 396 of the Companies Act, and violative of Article 14 of the Constitution of India The appeals were allowed and the impugned judgment of the High Court was set aside.