M J Antony: A rule by majority

OUT OF COURT

Recognising the challenges faced by the corporate sector in the global market, it was given parliamentary and executive support in recent times. There are laws to keep a company from becoming insolvent and even to revive sick ones.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act is a recent example of government support. The judiciary is also giving a helping hand through the interpretation of economic and corporate laws, as seen in last month's judgement of the Supreme Court in Administrator of UTI vs Garware Polyester Ltd.

Garware, which manufactures polyester films, used to export half its production to the US, Europe and other countries. The company then went in for massive expansion. Its scheme was financed by obtaining loans from various financial institutions and issuance of debentures.

However, the anti-dumping policies of European countries and other factors adversely affected the scheme and the company suffered losses. It approached IDBI with a request for a restructuring package to clear its liabilities. The Unit Trust of India (UTI) and other debenture holders met and a common subscription agreement was entered into between them.

The company then filed an application in the Bombay High Court under Section 391 of the Companies Act. This provision deals with the power of the court to compromise or make arrangements with creditors and members. When such a proposal is mooted, the court may call a meeting of the creditors.

If a majority in number representing three-fourths in value of the creditors agree to any compromise or arrangement, the compromise or arrangement shall, if sanctioned by the court, be binding on all the creditors. All debenture holders sanctioned the restructuring package in this case except UTI.

UTI opposed the scheme stating that it was unfair, unreasonable and unjust, which no prudent businessman would accept. Moreover, it claimed that it was different from others who supported the scheme, such as IDBI, LIC and GIC, as they were financial institutions whereas UTI was an investing company.

Garware argued that UTI did not have the power to frustrate the scheme which was beneficial to the debenture holders. The common subscription agreement did not confer absolute power on any debenture holder.

According to the principle of corporate democracy, the majority view should prevail in these matters. Moreover, UTI had contributed only 10 per cent of the total amount lent by the debenture holders and no one of them could claim preferential rights.

The Supreme Court accepted the latter view. It said that the underlying idea of the agreement was that the majority principle would be accepted by all.

"It does not provide for unanimity; or any veto power in favour of one debenture holder so as to scuttle the decision of the majority," the judgement emphasised.

The Supreme Court recommended a liberal interpretation of the terms of the agreement. A literal reading of a commercial document would amount to misreading it. In this case, the parties to the agreement were all commercial concerns. Each party would try to protect its interest when advancing loans or making investment. They might have also weighed the risks involved in the scheme.

In the present case, the reversal in the fortunes of the company was due to external factors, like dumping of the product by Korea and Indonesia in Europe and the levy of anti-dumping duties by European countries. Moreover, the restructuring package was evolved by IDBI, which was the largest lender and the trustee.

In two earlier cases, the Supreme Court has asserted that such a scheme should be given effect to if it is fair, just and reasonable, and not contrary to public policy ( Miheer Mafatlal vs Mafatlal Industries, 1997).

In JK (Bombay) Ltd vs New Kaiser-i-Hind (1969), it had ruled that such a scheme is binding even on creditors and shareholders who dissented. Therefore, the court took a pragmatic view of the problem in the Garware case. It could be a precedent for helping companies to tide over tough times.