Balancing Power: Ensuring Fair Treatment of Minority Shareholders in Mergers and Acquisition

-by Hanshika Tiwari

Abstract

Companies are incorporated with the purpose of profits and expansions. Every company has a vision to gain more profit and increase its working, for which it uses different growth models, like organic growth (internal) and inorganic growth (external), mergers, acquisitions, strategic alliances, and joint ventures. These procedures require approvals and decision making through shareholders, who may agree at once or dissent; for that reason, the rule of majority prevails and the court of law shall not interfere unless exceptions are made. This paper aims to understand what the majority rule is and how it affects minority shareholders. Good corporate governance is essential for any corporate entity to carry on smoothly and without any turbulence. With the reports by experts and cases in the past, this has shown how, for the approval of all shareholders, the majority shareholders ploy them with different schemes and strategies. These schemes and strategies often result in the minority shareholders being marginalized and their interests not being adequately represented. This can lead to an imbalance of power within the company and create potential conflicts of interest. It is important for regulators and governing bodies to closely monitor and regulate the actions of majority shareholders to ensure fair treatment of all shareholders and uphold the principles of good corporate governance. Minority shareholders must also be vigilant and assertive in protecting their rights and interests within the company.

Keywords: Minority shareholders, oppression, shareholder rights, merger and acquisition.

Introduction

A company runs with the balance of rights of the shareholders, the shareholders are the ones who have the voting rights and make decisions for the company, they appoint directors as per the provisions for the smooth functioning of the company. The majority shareholders are ones who hold more than fifty per cent of the shares in the company. The rule of majority is an old principle that’s has been followed for almost seventy years now and it states that a simple majority of votes has be gain to pass any resolution, this affects minority shareholders in many ways, the rights being oppressed or there may exist mis-management, there are many manners to remove the minority shareholders from the company and take control.  Corporate democracy which includes shareholders democracy elucidates that the rule of majority shall prevail. For mergers and acquisitions, there are certain provisions that are to be followed, and for the same passing of resolutions and voting is a part, therefore, majority shareholders try to contrivance. In this paper, the author has researched the historical perspective, along with the statutory provisions and case laws.

Research Methodology 

Author has found a wealth of information on the topic, but is cautious about relying too heavily on secondary sources for this research paper. Planning to delve deeper into primary sources, such as official documents and reports by experts in the field, to ensure the accuracy and credibility of my findings. By combining both secondary and primary sources, there is hope to present a well-rounded and thorough analysis in a research paper. 

Method

Mergers and acquisitions are crucial for growth and expansion of corporate entities, buying and selling of companies, or company shares is done mostly in every business and to gain or raise more profits, the process of mergers requires a lot of time and governance. These include the transactions, the books of accounts, gaining rights and approvals, from the shareholders and from the tribunal. The process of merger in India is court driven or tribunal driven at present and therefore requires a much longer period of processing. The imperative requirement is the approval of shareholders for the merger and the votes in favour of it with the passing of the resolution. 

There are circumstances when the minority shareholders in a way or another are against the mergers or amalgamations of any of the interested companies and therefore, the majority shareholders tend to squeeze them out of the shareholding and retain those shares and set the approvals and gain profits. The process of merger and acquisition is crucial and this complex process underscores the well-known concept of “Corporate Democracy.” This concept embodies the philosophy that it is the majority’s prerogative to determine what is in the best interests of the company. The concept suggests the majority decides, and it is necessary as well, however the minority shareholders may dissent and their opinion has been considered as well.

Review of Literature 

The author has found to interest the book Minority Shareholders’ Remedies, and has looked at a few chapters of the book, along with the structural provisions of the Companies Act of 2013 and 1956. 

1. Historical perspective

Every law that existed in pre-independence India or post-independence has some or other relevance to English law, and so did the companies or corporate law during the colonial period with the English Companies Acts, which were later adopted by India or brought to India by the British. The Companies Act of 1956 was replaced by the Companies Act of 2013, which introduced significant changes to corporate governance and shareholder protection regulations. Based on the recommendations of the J.J. Irani Committee, the committee report highlighted the necessity for enhancing corporate governance, ensuring shareholder protection, and particularly safeguarding the rights of minority shareholders. With that, the chapter on prevention of oppression and mismanagement was brought.

The concept of the rule of majority, as established in the case of Foss v. Harbottle, dictates that the court should refrain from intervening in company affairs and stakeholder matters if the issue at hand can be resolved through majority ratification in a general meeting. This rule has enduring significance as it empowers the company and its members to rectify mistakes independently, thereby fostering a sense of accountability and autonomy within the corporate structure. This rule underscores the principle of equality among shareholders, ensuring that each shareholder holds equal rights within the company, and emphasizes the significance of considering their opinions in decision-making processes. In cases where disagreements persist among shareholders, the requirement of a two-thirds majority for decision-making takes precedence, ensuring a balanced resolution of conflicting interests.

2. Foss v. Harbottle

In 1843, the Victoria Park Company faced a dispute. Minority shareholders, Richard Foss and Edward Starkie Turton, accused the company directors of financial misconduct. They alleged misuse of company assets and improper mortgages, leading to significant losses. Taking matters into their own hands, Foss and Turton sued the directors to hold them accountable.

The central question revolved around whether individual shareholders could take legal action for wrongs committed against the company itself. This case would establish a landmark principle in company law.

The court dismissed the claim brought by Foss and Turton. They established the principle that a company is a distinct legal entity from its shareholders. This principle, known as the separate legal personality doctrine, meant that the company, not individual shareholders, had the legal standing to sue. The court reasoned that only the company, acting through its proper representatives, could initiate legal proceedings.

The court’s decision rested on two key points. Firstly, they emphasized the “majority rule” that governs companies. Shareholders vote on matters affecting the company, and the majority vote decides the course of action. Individual shareholders cannot use lawsuits to undermine this principle. Secondly, the court argued that allowing individual shareholder lawsuits would create chaos with the potential for a “multiplicity of suits.” Imagine a scenario where every shareholder could sue directors or officers perceived to have wronged the company. This, the court reasoned, would lead to an unwieldy legal situation.

The Foss v. Harbottle the decision established a foundational principle in company law – the “proper plaintiff rule.” This rule dictates that only the company itself, and not individual shareholders, can bring lawsuits for wrongs done to the company. This principle has been highly influential in common law jurisdictions around the world, shaping the landscape of corporate governance.

Despite its widespread acceptance, the Foss v. Harbottle the rule has faced criticism. Some argue that it can leave minority shareholders vulnerable, particularly in situations where the majority shareholders collude with the directors or where the company itself is unwilling to pursue legal action. In recognition of these concerns, exceptions to the rule have been developed over time. These exceptions, known as derivative actions, allow minority shareholders to sue on behalf of the company under specific circumstances, such as fraud on the minority or instances where the company is controlled by the wrongdoers. These developments strive to strike a balance between protecting the interests of the majority and ensuring recourse for wronged minority shareholders.

1.  Exceptions to the rule of majority

Courts may intervene in the following circumstances:

• Ultra Vires Acts: When the majority attempts an illegal or unauthorized action (ultra vires), a minority shareholder can seek a court order or injunction.
• Fraud on the Minority: If the majority engages in fraudulent conduct against the minority, the minority can initiate legal action. The court will determine the validity of such claims if the concept of “minority fraud” is unclear.
• Wrongdoer Control: When a wrongdoer controls the company, the minority can file a “derivative action” alleging fraudulent misrepresentation. As established in Glass v. Atkins (1967)courts will protect the minority’s right to sue in such situations.
• Special Majority Requirement Breach: If a decision requiring a special majority vote is passed with a simple majority, a minority shareholder can challenge it.
• Duty Breaches: When the majority and directors neglect their fiduciary duties, the minority shareholder can sue.
• Oppression and Mismanagement: The minority can take action to prevent oppressive or mismanaged practices by the majority. Oppression has not been defined under any statute, although in the case of Scottish Coop. Wholesale Society Ltd. v. Meyer, it was held by the court of law that if the members or any stakeholder of the company lacks probity towards the other stakeholder or has been involved in unfair dealings of company affairs to prejudice some members of the company or the public interest or even the company goal, it is oppression.

3. Key statutory provisions

To protect the minority groups in a company, there have been provisions under the companies act, 2013 and before that in the 1956 act as well it was framed the substantial provisions relating to oppression and mis-management.

The Companies Act of 2013 establishes substantive rights for minority shareholders. Section 236 The Act addresses the purchase of minority shareholdings. Additionally, Schedule IV The Act outlines the code for independent directors. Under Part II of Schedule IV, it is stipulated that independent directors must safeguard the interests of all stakeholders, particularly minority shareholders. Justice Sinha of the Calcutta High Court, in Kanika Mukherjee v. Rameshwar Dayal Dubey, noted that the principles enshrined in sections of the Companies Act aimed at preventing oppression and mismanagement serve as an exception to the rule established in Foss v. Harbottle, which upholds the sanctity of majority rule. Chapter XVI (Prevention of Oppression and Mismanagement) of the Companies Act, 2013, encompassing sections 241 to 246, protects the position of minority shareholders by expanding the scope of the fiduciary responsibilities of majority shareholders. It ensures that minority shareholders are not unfairly prejudiced or oppressed by the decisions and actions of the majority.

1. Application to the Tribunal for Relief in Cases of Oppression, etc.

Section 241 allows any member of a company who believes that the affairs of the company are being conducted in a manner prejudicial to the public interest or in a way oppressive to any member(s) to apply to the Tribunal for relief. This provision aims to address grievances related to unfair treatment of minority shareholders and ensure that the company’s operations do not harm its stakeholders.

2. Powers of the Tribunal

Section 242 grants the Tribunal broad powers to order appropriate relief if it finds that the company’s affairs have been conducted oppressively or prejudicially. The Tribunal may, among other things, regulate the conduct of the company’s affairs in the future, appoint or remove directors, or restrict the transfer of shares. This section empowers the Tribunal to take the necessary actions to rectify oppressive practices and mismanagement.

3. Consequences of Termination or Modification of Certain Agreements

Section 243 addresses the consequences of the termination or modification of agreements with the company. It provides that if the Tribunal orders the termination or modification of any agreement between the company and its directors, managing directors, or other officers, the concerned individuals will not be eligible to hold office in the company or its subsidiaries for five years unless the Tribunal directs otherwise.

4. Right to Apply under Section 241

Section 244 specifies the eligibility criteria for applying to the tribunal under Section 241. It requires that the application be made by at least 100 members, or by members holding at least one-tenth of the total voting power, or by any member(s) authorised by the Central Government. This section ensures that only a significant portion of the company’s membership can bring forth a complaint, preventing frivolous applications.

5. Class Action

Section 245 introduces the concept of class action suits, enabling members, depositors, or any class of them to seek relief on behalf of all members or depositors. This provision allows for collective action against the company, its directors, auditors, or experts for any fraudulent or wrongful act, misstatement, or omission. It aims to enhance the accountability of those in charge of the company and protect the interests of members and depositors.

6. Application of Certain Provisions to Proceedings under Section 241 or Section 245

Section 246 states that certain provisions of the Code of Civil Procedure, 1908, and the Limitation Act, 1963, shall apply to proceedings under Sections 241 and 245. This section ensures that the procedural aspects of civil litigation are followed in cases of oppression and mismanagement, providing a structured legal process for such disputes.

In summary, Chapter XVI of the Companies Act, 2013, provides a robust legal framework for minority shareholders to address grievances related to oppression and mismanagement. By empowering the Tribunal to intervene and offering mechanisms for collective redress, this chapter seeks to ensure fair and equitable management practices within companies.

4. The Companies Act, 2013: Bolstering Minority Shareholder Protections

The Companies Act of 2013 serves as a vital safeguard for minority shareholders, addressing historical concerns about their vulnerability within a company structure. Here’s a breakdown of key provisions that empower minority shareholders:

1. Representation in Leadership: Minority shareholders are no longer passive bystanders in company leadership selection. Section 163 mandates the use of proportional representation methods, like cumulative voting, during director appointments. This ensures their voices are heard and reflected in the company’s decision-making body.
2. Enhanced Transparency: Gone are the days of information asymmetry. Section 132 compels companies to provide clear and accurate disclosures to all shareholders, regardless of their holding size. This transparency fosters trust and empowers minority shareholders to make informed decisions about their investments.
3. Safeguarding Minority Rights at Meetings: Minority shareholders are not relegated to the sidelines during company meetings. Section 111 guarantees their right to attend general meetings and actively participate. They can raise concerns, ask questions, and engage in discussions that shape the company’s direction.
4. Proportionate Voting Rights: Voting power is no longer solely concentrated in the hands of majority shareholders. Section 47 establishes a fair system where voting rights are directly proportional to shareholding. This ensures minority shareholders have a measured influence on company decisions that impact their investment. Additionally, Section 48 dictates that variations in shareholder rights require specific majority approval, preventing unilateral changes that could disadvantage minority interests.
5. Dedicated Representation for Small Shareholders: Recognising the unique challenges faced by smaller investors, Section 151 empowers listed companies to have a director specifically elected by small shareholders. This dedicated representative serves as a vital link, ensuring the concerns and perspectives of this crucial investor group are brought to the forefront.
6. Protection from Oppressive Practices: The Act doesn’t tolerate unfair treatment of minority shareholders. Sections 241-246 empower them to seek legal recourse against oppressive or mismanaged practices by the majority. This allows them to challenge decisions that unfairly disadvantage their investment and restore balance within the company structure.
7. Access to Information: Minority shareholders are not kept in the dark. Section 132 grants them the right to access price-sensitive information and company records. This empowers them to stay informed about the company’s financial health, upcoming developments, and potential risks associated with their investment.

By implementing these comprehensive provisions, the Companies Act of 2013 creates a more equitable playing field for minority shareholders. They are no longer voiceless entities but active participants with the tools and legal framework to protect their interests and ensure a fair return on their investment.

5. Case laws
   1. On understanding the judicial principles of mergers, a landmark case of Miheer H. Mafatlal v. Mafatlal Industries Ltd., the supreme court has laid few points that are to be taken into consideration:

• That the class was fairly represented by those who attended the meeting and that the statutory majority are acting bona fide;
• That the arrangement is such as a ‘man of business’ would reasonably approve;
• There should not be any lack of good faith on the part of the majority;
• Scheme not contrary to public interest or any other;
• Prudential Business Management Test.

Nevertheless, there is a lack in understanding the term ‘fairness’ which takes understanding from its different circumstances.

2.  Needle Industries (India) v. Needle Industries Newey (India) Holding Ltd.

The foreign majority alleged oppression by the Indian minority shareholders, who had appointed additional directors and issued further shares. The Company Law Board (CLB) and the High Court found these actions by the minority shareholders to be oppressive. However, the Supreme Court observed that even if a claim of oppression fails, the court has the authority to administer substantial justice. Based on the specific facts and circumstances of the case, the Supreme Court, while rejecting the plea of oppression, directed the minority Indian shareholders to purchase the shares held by the majority foreign shareholders.

3.  Sandvik Asia Ltd. v. Commissioner of Income Tax

The minority shareholders’ counsel presented a compelling argument. They acknowledged the majority’s right to reduce capital but emphasised the need for a fair and equitable approach. The proposed plan, however, offered no meaningful options for the minority. Presented with a fixed date and a take-it-or-leave-it offer—accept the proposed amount or exit the company—the minority shareholders were essentially forced out. The court recognised this as profoundly unfair, highlighting the lack of any genuine choice presented to the minority. The decision underscores the principle that majority shareholders cannot simply steamroll the interests of the minority in such a manner. The minority shareholders were left without any recourse or protection, ultimately leading to a significant loss of their investments.

Suggestions

The most crucial steps are to be taken by the companies to avoid corporate governance failures and promote fairness, transparency and accountability towards the stakeholders as well as in public interest. This may help in suppressing the minorities and in growth, and to avoid the heavy burden of litigation. The courts or even tribunals shall always provide a fair chance to the companies to ratify on their own and when the companies lack, the courts or tribunals shall guide them with the laws prevailing and expertise as well.

Conclusion

To promote corporate democracy the companies, have to give chance to all the shareholders in decision making to grow the company, the decisions are show to have reflection of corporate governance of the company and it is important that the company does not fails its mergers and acquisitions due to differences in the opinions of the shareholders, the decision of majority is followed however, the company directors cannot disregard the minorities rights and opinions.  Therefore, there shall be balance between majority shareholder and minority shareholder opinion and shall be regarded.