‘Permissible unless prohibited’ is the position of the law – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/business-laws/permissible-unless-prohibited-is-the-position-of-the-law/article36813086.ece

National Company Law Tribunal allowing conversion of equity shares into preference shares is laudable

Paving way for corporates to give structured exit to its shareholders, the Mumbai Bench of the National Company Law Tribunal (NCLT/Tribunal), has recently sanctioned a scheme of amalgamation that involved conversion of equity shares into preference shares.

Notably, ‘preference shares’ carry preferential rights on the matters of payment of dividend and repayment of capital. Such shareholders are given priority or ‘preference’ in payment of dividend over equity shareholders. At the event of winding up too, preference shares are repaid before equity shares. On the other hand, equity shareholders, being the owners of a company, are entitled to dividend only after all liabilities of a company stand discharged.

In the instant case, the shareholders of the transferee company, holding a portion of equity shares had requested for regular dividends/ redemption of their investment as they were not interested in seeking control and management of the company. The transferee company expressed its inability to pass on such benefit and consequently proposed to convert Equity shares into 9 per cent non-cumulative optionally convertible preference shares.

ROC raised objections that the conversion of equity shares into preference shares was not permissible as per law as its value, terms and rights are different from equity shares. The company, however, contended that the conversion was not barred by the legal framework and in fact, such conversion amounts to ‘reorganisation of share capital’ permissible as per Companies Act in case of ‘compromise or arrangement’ of a company with its creditors and members. To substantiate its claim, the company relied on the verdict of the Supreme Court, wherein it was held that ‘every procedure is to be understood as permissible till it is shown to be prohibited by the law’. It was also highlighted by way of a High Court judgment that the very purpose of the scheme of reconstruction is to make available alterations in the structure of a company, to enable it to function. A scheme, therefore, which contains ultra vires provisions to Memorandum of Association (Such as alteration of rights of shareholders) can also be sanctioned.

No change

The Tribunal accepted the claims of the company and concluded that when shares of one class are converted to another, the value of paid-up share capital does not undergo any change. Plain re-classification of equity shares to preference shares and vice versa, has the effect of mere alternation of nomenclature of shares, without impacting the subscribed and paid-up share capital. It acknowledged that the prevailing law does not proscribe such a conversion.

The ruling will facilitate a flexible corporate restructuring for private companies and family settlements. Minority shareholders, not interested in the control and administration of a company will be able to secure a comfortable exit. The approval of the scheme permitting conversion would also help indebted companies, facing difficulties in paying-off debts taken from holding companies. In fact, share conversion route will also enable settlement with creditors, who hold equity shares of the company.

Notably, to protect the interests of dissenting minority shareholders, the Tribunal, while approving the scheme, has followed a judicious approach by seeking objections against the Scheme from the interested persons. Any interested person (including a minority shareholder) is at the liberty to apply to the Tribunal regarding this matter for any directions that may be necessary.

Another interesting point to note is that the Tribunal accepted the stance of the assessee, based on the pronouncement of the Division Bench of the Punjab and Haryana High Court, that the term ‘arrangement’ is of a wide amplitude and that a Scheme requires adherence to various legal provisions and enactments. The legislature, therefore, deliberately does not restrict the scope of the term ‘arrangement’ by defining it.

In fact, explanation to Section 230 of the Companies Act permits, by way of an inclusive definition that an ‘arrangement’ may be in the form of re-organisation of share capital’. Since the scope is not restricted, it would be against legislative intent to fetter the activities of a company and restrict the choice of the members/ creditors/ stakeholders.

Lenient approach

The flexible approach adopted by the NCLT, while sanctioning the Scheme of Arrangement/ Amalgamation between the companies concerned is praiseworthy. The Tribunal seems to have understood that the affairs of a company are often complex and involve numerous policy matters, financial aspects and legalities. Mindful of the fact that the purpose of reconstruction is to enable operations of the concerned entities by way of appropriate modifications, the Tribunal adopted a lenient approach.

Staying within the ambit of law and supporting judicial pronouncements, it has been clarified that a Scheme of Compromise or Arrangement may involve increase, consolidation, sub-division of shares or reduction of share-capital. Likewise, conversion of equity shares to preference cannot be disapproved.

(The author is Partner – M&A, Nangia Andersen LLP, a law firm)

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s