Jayant M Thakur: A question of choice

Forcible buyback of shares by companies is contrary to shareholders' interests

Consider this: you are living in a housing society and the society writes to you "" unless you specifically write otherwise "" that your flat will be bought out by the society at a price determined at its whim.

And further, even the choice of rejecting such an "offer" is not with you and your flat is bought out even if you don't wish to sell it. Sounds straight out of a Kafka or Orwell novel?

I'm sure your sentiment would not change a bit if the asset was shares instead of a flat. But this is what, in one way or another, is being proposed by some companies. In some cases, though inherently unfair, it was found to be within the law. Recently, though, one court has thrown out such a proposal.

Let us consider the issue first. By a 1998 amendment to the Companies Act, 1956, buyback of its own shares by a company is allowed (Section 77A).

Details for a buyback under Section 77A were laid down by the Securities and Exchange Board of India (Sebi). Many companies made offers to their shareholders and bought back the shares offered.

However, even before 1998, buyback was possible either as reduction of capital (Section 100) or a scheme of arrangement (Section 391), both with the court's approval.

The framework for buyback under Section 77A involves making an offer at a specified price to all the shareholders to buy a limited quantity of shares. Those who find the price attractive would accept in writing sending their shares along with the letter.

A couple of years ago, a scheme (not under Section 77A) was introduced by a company whereby letters were sent to all its shareholders but with a special provision.

The scheme provided that unless the shareholders rejected the offer specifically they would be deemed to have accepted it. Thus, if, for instance, you missed reading the notice or forgot to send a letter of rejection, you will find a cheque in the mail soon thereafter and your shares bought and cancelled.

Many find this objectionable. Sebi even made a belated and feeble attempt to litigate the matter, but it was rejected by the court.

This precedent was followed by many companies and, in some cases, strange reasons were given "" such as the increasing costs of shareholder servicing and so on.

Such schemes were initiated through the approval of the court (they cannot be devised under Section 77A, which specifically prohibits this); due applications were made and they were accepted by the court.

While legally these proposals could not be faulted, their unfairness was obvious. Many shareholders will typically not even glance at the opaque legal notices sent in obscure technical language, and even if they do, it may be beyond their competence to understand them.

But surely shareholders are entitled to believe that without their consent their shares will not be bought over "" and that, too, at a price that is neither transparent nor assuredly fair.

While debate on the issue is still on, some companies recently went a step further. They proposed that the shares of minority shareholders will simply be bought back at a price determined by the company "" with the shareholder having no say in the matter at all.

To add the proverbial insult to the injury, a token letter was sent to the shareholders asking them to accept the offer. However, this is an empty formality.

Even if the shareholder does not accept the offer, his shares will still be bought back. The viewpoint of the judiciary is seen in two recent decisions of the high court, one taking a diametrically opposite view of the other. These are outlined below.

The Bombay High Court considered such a buyback proposal (Sandvik Asia Ltd, in re (2004) 121 Comp. Cas. 58 (Bom.)). In this case, the parent foreign company held 95.54 per cent of the share capital. A scheme of reduction of capital was proposed under which the 4.46 per cent shares held by the public would be bought back at Rs 850 a share.

It was claimed by the company that 99.50 per cent of the shareholders approved the scheme at the meeting but the court noted that 95.54 per cent of the shares were held by the promoters themselves who were, in any case, not selling their shares.

It held that when there were two distinct groups, "the meeting ought to have been convened separately for the non-promoters group, otherwise the meeting would be rather absurd and would result in injustice".

It also noted the submission of the minority shareholders that the share price had seen levels of Rs 1,650, Rs 3,050 and even Rs 6,850 in the past as against the offer price of Rs 850.

More importantly, the court accepted the unfairness of the scheme by accepting the submissions of the minority shareholders. It endorsed their submissions that "the proposal had no option and in any event the proposal was highly inequitable, unjust and unfair, in the sense that the minority shareholders will have to leave the company.

Therefore, the promoters group would virtually bulldoze the minority shareholders and purchase their shares at the price dictated by them, which is totally unfair and unjust".

The court dismissed and rejected the scheme and the proposal before it and even awarded costs to the minority shareholders who had objected to the scheme.

The decision is praiseworthy. However, one wonders whether there is still more that needs to be done in terms of either amendment to the law or even further proactive action by courts.

This is because some other company could still claim that the current case is one extreme of the issue and one could still have buyback schemes having a negative option as discussed earlier. Another important issue is the meaninglessness of general meetings in India. Even if, as the court suggested, separate meetings of shareholders are held, how many can or will attend them?

First, it is submitted that negative option buyback should be specifically banned. It is also suggested, therefore, that in such cases, approval should be taken from the outside shareholders through the "postal ballot route" where all shareholders have a meaningful say.

Coming to the other decision, the Andhra Pradesh High Court has a view opposite to that in Sandvik's case, though based on almost identical facts.

Here, too, there was a buyback scheme where shares held by the shareholders were to be bought back even if they expressly disagreed. There were two aspects that were different from Sandvik's case. First, this was a buyback scheme under Section 391.

Second, the scheme applied only to those shareholders who had, in all, shares with face value of less than Rs 20,000, though, of course, they had practically no individual or separate say in the matter.

However, clearly, the central issue remained the same and that is whether shares of a certain section of shareholders can be bought back without a choice to them, at a price fixed by the company.

The Andhra Pradesh High Court held, in substance, that such schemes were internal matters of the company and if shareholders approve it in meetings, the court will normally not interfere. The Bombay High Court decision has rightly said that this should not be permitted.

The Bombay High Court's view is preferable when it says that in such cases, the promoters and the minority shareholders are not at par, and hence, the promoters' decision cannot be imposed on the latter.

This unjust situation for small shareholders arises, however, also because of the shortcomings in the law and instead of the judiciary needing to tackle it, the law should be amended to prevent such acts in the future.

Sebi for one could, and in my view, it is within its powers to prevent such buyback attempts by companies. For instance, Sebi has required that in case of preferential allotment, further issue of shares should be made at a minimum price and, otherwise, placed many other restrictions.

Buyback of shares is the reverse of making a fresh issue of shares and control in deserving cases can and should be made.

To conclude, a shareholder enters a company by choice and mutual agreement and should be entitled to exit only by choice. Forcible buyback of shares at a non-transparent price would be expropriation and should be prevented.

(The writer is a Mumbai-based chartered accountant. His email id is mthakur@yahoo.com)