Terminating Select Shareholders' Tenancy! Managing a Minority Squeeze-out
One of the activities that has not been formally labelled as an adventure sport is investing in the shares of unlisted companies.
There has been a major mushrooming of brokers and portals dealing in this space and the fancy has caught on with many sections of investors viewing this as an investment in a new asset class.
There is no restriction or legal impediment to trade in these shares and the fact that all these shares are in demat form has aided the flexibility and ease in such trades.
Except in the case of shares of the National Stock Exchange Ltd (NSE), where diligence and due acceptance of the investor is a prerequisite, in all other cases these shares are transferred in the same manner as a listed one.
Reliance Retail Ventures Ltd, the holding company of Reliance group’s retail venture, has been one of the most actively traded stocks in the unlisted space. 
The company has recently announced its intent to reduce its share capital and cancel the shares held by all the non-promoter shareholders and pay a consideration of Rs1,362 per share.
There has been much grievance bubbling in the social and mainstream media about this step and about the hardship to many investors who have bought the shares at a much steeper price, even up to Rs3,000 per share.
The facts, as gathered from the media reports, are that only 0.09% of the total issued equity shares are held by the retail (non-promoter) investors amounting to 78.65 lakh shares.
The company has obtained a valuation report from Ernst & Young and BDO Valuation Advisory LLP who have, respectively, valued each share at Rs884 and Rs849. The proposed price at which the capital reduction is planned is Rs1,362 per share.
The question most asked is whether a company can unilaterally take such a decision and the unfairness in the treatment of the minority shareholders.
There are two aspects to addressing this question. The first is whether the identified minority shareholders alone can be squeezed out. The second is the fairness of the price paid.
Dealing with the second aspect first, the subject of valuation falls squarely within the domain of experts in the subject. The process of capital reduction is primarily scrutinised by the national company law tribunal (NCLT) only for ascertaining if the legal mandate has been observed by the company.
This forum—and the high courts earlier—have distanced themselves from the aspect of scrutinising the valuation, holding it to be an exercise to be carried out by experts in the field. Having regard to this position, companies that seek to effect capital reduction make sure that a proper valuation report supports the price fixed.
In this instance as well, the company has obtained two valuation reports which almost converge on the value. The company has, in fact, proposed a significant premium to the value suggested by the two experts and moving NCLT on this point may be futile.
The primary question is the selective process of reducing only the non-promoter shareholders. The predominant view prevailing on the matter is that decisions like capital reduction are the domestic concern of a company and its members and the decision of the majority shareholders cannot be interfered with by a court unless there is patent perversity in the same.
Many of the aspects of the majority vs minority tussle came up before the Supreme Court in the Cyrus Mistry and Tata group dispute and the court affirmed the above-stated proposition of the rule of the majority.
In the context of the selective capital reduction to squeeze out the minority holders, there have been repeated affirmation of this principle, and the scrutiny of the court or NCLT has been limited to ensuring observance of the due procedure under the law.
The courts, typically, look at the extent of dissent for such proposals to see if it is widespread among the affected shareholders.
Though the law allows voting by all the shareholders, including the promoter/majority, to pass a special resolution, the courts have also used an informal yardstick to see if there is any oppression and assessed the matter by looking at whether the majority in number among the affected shareholders approved the reduction.  
If a majority of the affected shareholders does not dissent to the proposal and only a small fraction object, then the objections are ignored if the other parameters are met.
A subtle difference between most past cases and the present one which merits a mention here, though that may have no bearing on the legal position. Almost all the past precedents (though not all) arise from cases where the companies concerned were listed entities at some stage and went through a delisting process as per the Securities and Exchange Board of India (SEBI) rules and were still left with a group of shareholders who did not participate in the delisting initiative.
The reverse book-building process for delisting is a robust benchmark for price discovery and, if the same or a higher price is adopted in the process of capital reduction subsequently, the level of dissent would be quite minimal. 
In this case, the company was never listed and did not have any independent price discovery. However, they have two reports of reputed valuers and hence the challenge to the valuation should be academic only.
Another point to look at is that, in the context of a company that was once listed and post-delisting effects a squeeze-out, the leftover shareholders may have greater legitimacy to protest a squeeze-out as they had originally got in through the market when the company was listed. In an unlisted company, such logic will be missing to lend legitimacy to the dissent.
Even assuming theoretically that the NCLT allows the dissenting holders to continue, they would be worse off as the unofficial trading will offer no better price than Rs1,362 and, worse still, that all the trading may cease with the discovery that minority holders in an unlisted company have little leeway legally.
Imagine if the company calls off the entire process on the grounds that it doesn’t wish to upset the loyal shareholders of the company!
Should this company list, within a short time of say two to three years and at a price much higher than Rs1,362, then a governance question may arise whether those investors who are squeezed out now should be  duly compensated!
The step by Reliance group may have the effect of slowing down or even closing down the market for unlisted shares. 
The prices in the unlisted space may fall quite drastically and those with a stronger gut or greater trust in their horoscope may indulge in bargain-hunting and bottom-fishing!
(Ranganathan V is a CA and CS. He has over 43 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as senior advisor post-retirement handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies).
7 months ago
As usual, a well drafted and informative article by Ranga
Kamal Garg
7 months ago
The point here is that market price is a culmination of various and many complex issues including market frenzy, price manipulation, etc for a particular and so on. Whereas a Company cannot buy back at a market price and would insist on buying-back only at a fair value arrived at by independent valuers.
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