* THE HON’BLE SRI JUSTICE V.V.S.RAO + COMPANY PETITION No.79 OF 2009 % Dated 31.12.2009 # M/s.Aurobindo Pharma Limited. … Petitioner ! Counsel for Petitioner: Sri S.Ravi ^ Counsel for Respondent : Sri M.Anil Kumar (Counsel for Official Liquidator) <GIST: >HEAD NOTE: ? Cases referred 1. (1996) 87 Comp Cas 791 = AIR 1997 SC 506 2. 1995 Supp (1) SCC 499 = 1994 AIR SCW 4701 3. (1894) AC 399 (HL) 4. (1887) 12 AC 409 : (1886-1890) All ER 46 (HL)) 5. (2006) 5 SCC 638 6. (2005) 126 Comp Cas 647 (Bom) : (2004) 58 CLA 154 (Bom) 7. AIR 1953 SC 501 8. (1965) 55 ITR 35 (Mad) : AIR 1965 Mad 533 9. (1970) 2 SCC 4 : AIR 1970 SC 1530 THE HON’BLE SRI JUSTICE V.V.S.RAO COMPANY PETITION No.79 OF 2009 ORDER: This petition under Sections 391 to 393 read with Sections 100 to 103 of the Companies Act, 1956, and rule 79 of Companies (Court) Rules, 1959 (the Rules, for brevity) is filed by M/s.Aurobindo Pharma Limited (hereafter, Aurobindo) praying for sanction of Scheme of Arrangement between company and its shareholders. The Scheme of Arrangement concerns with two aspects, namely, (i) utilizing an amount of Rs.91 crores standing to the credit of ‘Capital Redemption Reserve’ (CRR) towards adjusting the expenses enumerated in clause 1.5 of the Scheme; and (ii) creation of ‘Reconstruction Reserve Account’ (RRA) by transferring/crediting an amount of Rs.90.30 million standing to the credit of ‘Capital Reserve’ and the benefits accruing from buy back of ‘Foreign Currency Convertible Bonds’ (FCCBs) and for utilizing ‘RRA’ for all or any of the expenses as enumerated in clause 1.5, which reads as under. 1.5 “Expenses” means and without limiting the generality of the foregoing, includes inter alia the following items accounted for in the financial statements of Aurobindo: 1.5.1 Amount to be written off towards obsolete or unrealizable assets, whether tangible or intangible or fixed or current; 1.5.2 Any unrealizable loans and/or advances, whether recoverable in cash or in kind, whether belonging to Aurobindo or its Subsidiaries and arising on preparation of stand alone and/or Consolidated Financial Statements of Aurobindo; 1.5.3 Interest and other financial charges receivable and outstanding for such period as may be determined by the Board on loans/advances made to subsidiaries; 1.5.4 Impairment, amortization and/or write off of goodwill; 1.5.5 Diminution in the value of investments in subsidiary companies and/or Joint Ventures of Aurobindo and/or any of its subsidiaries and consequent impairment of goodwill and accumulated losses of such subsidiaries on consolidation, in the financial Statements of Aurobindo; 1.5.6 Impairment/diminution/realisation losses, if any on investments other than as mentioned in clause 1.5.5 above, whether current or long term or quoted or unquoted, or trade or non-trade; 1.5.7 Such other expenses, cost, impairments, write off’s and diminution, as considered necessary by the Board from time to time; 1.5.8 For the purposes of this clause, if any issue/question arises with respect to identification and/or qualification of the nature and amount of the expenses, the decision/clarification of the Board shall be final. Background of the Scheme Aurobindo is a company registered under the Companies Act. Its authorized share capital is Rs.500 million consisting of 100 million equity shares of Rs.5/- each and one million preference shares of Rs.100/- each. 53,765,268 equity shares of Rs.5/- each have been issued, subscribed and paid up amounting to Rs.268.80 million. These shares are listed on National Stock Exchange Limited and Bombay Stock Exchange Limited. Aurobindo is in the business of manufacturing, marketing, chemicals, intermediaries, drugs, formulations, dyestuffs etc. The Board of Directors in their meeting held on 31.03.2009 allegedly passed resolution approving the Scheme of Arrangement between the company and its shareholders to utilise the amounts standing in the credit of CRR as on 31.03.2008 towards expenses of the company especially those expenses as enumerated in clause 1.5 of the Scheme and/or transferring the said amount as well as the benefits accruing from buyback of FCCBs to RRA towards adjusting expenses as referred to hereinabove. The details of these two aspects of the Scheme are as below. Aurobindo issued 12.5% redeemable non-convertible preference shares to an extent of Rs.50 lakhs (50,000 shares of Rs.100/- each) during the financial year 1997-1998 to Canara Bank. For the financial year 1998-1999, the company issued preference shares to an extent of Rs.4,50,00,000/- (4,50,000 preference shares of Rs.100/- each) on 17.11.1998 to SBI Capital Markets Limited, Mumbai; and preference shares to an extent of Rs.4,00,00,000 (4,00,000 preference shares of Rs.100/- each) to Global Trust Bank Limited, Mumbai on 24.11.1998. These are redeemable on 17.05.2000 and on 24.05.2000 respectively. The company purporting to comply with Section 80(1)(d) of the Companies Act credited out of its profit to CRR during the period commencing from financial years 1997-1998 to 2000-2001. The details of amounts credited to CRR from out of Profits is as follows. Sl.No. Financial Year ending in 31st March Amount credited (in 000s) 1. 1998 46.58 2. 1999 1,33,88.13 3. 2000 6,54,75.29 4. 2001 1,10,90.00 TOTAL 9,00,00.00 After transferring amounts to CRR in four financial years, Aurobindo redeemed preference shares allotted to Canara Bank on 20.12.2000. The shares allotted to SBI Capital Markets and Global Trust Bank were redeemed on 17.05.2000 and 25.05.2000 respectively. To that effect, the company also filed Form No.5 in accordance with Sections 95, 97, 97A(2) and 81(4) of the Companies Act with the Registrar of Companies (RoC). To meet financial requirements, Aurobindo issued FCCBs twice in 2005-2006 and 2006-2007. The first of these two issues is for 60 million US$ due on 2010 convertible into ordinary shares of Aurobindo. The second one was in two tranches. Tranch A is for US$ 150 million and tranch B is Rs.50,000,000/-. The first issue is redeemable on 11th August, 2010 and the second issue is redeemable on 11th August, 2010 and on 17th May 2011. Reserve Bank of India (RBI) issued policy directions vide A.P (Dir Series) Circular No.39, dated 08.12.2008 under Sections 10(4) and 11(1) of the Foreign Exchange Management Act, 1999 (FEMA) for buy back/pre payments of FCCBs at a discount of 15% or 25% as the case may be. The Companies were required to complete the buyback by 31st March, 2009. By yet another circular No.58, dated 13.03.2009, the time has been extended up to 31.12.2009 for the purpose of buyback at a discounted price. Statedly, RBI allowed buyback at a discounted price as market value of Indian Companies were downgraded due to global economic situation. Aurobindo availed opportunity and bought back FCCBs at a discount to face value in the open market and appears to have reaped considerable benefit by such buyback of FCCBs. As a part of Financial Restructuring Exercise (FRE), Aurobindo proposed to utilize capital reserve of Rs.90 million allegedly outstanding as on 31.03.2008 as well as the benefit arising from buyback of FCCBs on discount for the purpose of meeting expenses at the discretion of Board. Aurobindo moved an application before the High Court under Sections 391 to 393 read with Sections 100 to 103 of the Companies Act praying this Court to pass an order to convene the meeting of equity shareholders for the purpose of considering the scheme. The application being Company Application No.340 of 2009 was ordered and an advocate was appointed as Chairperson to convene the meeting of shareholders. Accordingly, meeting was convened on 21.05.2009 at the place designated by the Court. After doing so, Chairperson filed a report. The meeting was attended (out of 45,300) by 109 members (76 persons, 27 proxies and 6 corporate members). In the meeting held by chairperson, members representing 3,49,87,258 number of shares of Rs.5/- each, 94.50% (103 members) with Rs.3.28,68,148 (93.92%) voted in favour of resolutions which were considered. Aurobindo statedly has eight secured creditors, namely, Andhra Bank, Canara Bank, ICICI Bank, IDBI Bank, HDFC Bank, State Bank of Hyderabad, State Bank of India and Standard Chartered Bank. It appears all of them accorded consent for creation of RRA. Insofar as unsecured creditors are concerned, Aurobindo perceives that they will not be affected adversely with the proposed Scheme because post scheme assets will be sufficient to discharge the liabilities. Aurobindo also obtained no objection letters to the proposed Scheme from Bombay Stock Exchange and National Stock Exchange. Therefore, this application is filed under Sections 391 to 393 read with Sections 100 to 103 of the Companies Act. This Court ordered notice to Central Government while directing publication of notice of hearing in two newspapers. Aurobindo’s counsel took out notice and also served papers on Central Government i.e., Regional Director, Department of Company Affairs, Chennai. No objections have been received by the Court nor any person appeared when the matter was heard. The Registrar of Companies (RoC) purporting to act under authorization issued by Regional Director of Department of Corporate Affairs filed an affidavit stating that Central Government decided not to make any objection to the proposed Scheme. This Court heard learned counsel for Aurobindo on 07.07.2009 and 08.07.2009 and reserved the Orders. Again, the matter was directed to be listed ‘For Being Mentioned’ for certain clarifications on 20.07.2009 and 27.07.2009. The counsel reiterated the principles governing the cases under the Companies Act which require sanction/approval of the Court like scheme of compromise/ arrangement or financial reconstruction or a scheme of amalgamation. Court’s power to sanction Scheme It is settled that in all such cases the Court does not exercise its appellate powers or review powers. It cannot sit in appeal over Scheme of Arrangement between the company, its members and creditors. Court in a way acts as a ‘Corporate Ombudsman’ to ensure that the Scheme of Arrangement/ compromise among the company, its members and creditors is fair and just and does not subvert public interest or breach law. In Miheer H. Mafatlal v Mafatlal Industries Limited[1], Supreme Court considered the scope of power vested in Court while dealing with ex parte applications and petitions under the Companies Act and Companies rules seeking sanction/approval of the Court for the Scheme of Arrangement. Referring to Hindustan Lever Employees’ Union v Hindustan Lever Limited[2], the following principles were laid down. 1. The sanctioning court has to see to it that all the requisite statutory procedure for supporting such a scheme has been complied with and that the requisite meetings as contemplated by section 391(1)(a) have been held. 2. That the scheme put up for sanction of the court is backed up by the requisite majority vote as required by section 391(2). 3. That the concerned meetings of the creditors or members or any class of them had the relevant material to enable the voters to arrive at an informed decision for approving the scheme in question. That the majority decision of the concerned class of voters is just and fair to the class as a whole so as to legitimately bind even the dissenting members of that class. 4. That all the necessary material indicated by section 391(1)(a) is placed before the voters at the concerned meetings as contemplated by section 391(1). 5. That all the requisite material contemplated by the proviso to sub- section (2) of section 391 of the Act is placed before the court by the concerned applicant seeking sanction for such a scheme and the court gets satisfied about the same. 6. That the proposed scheme of compromise and arrangement is not found to be violative of any provision of law and is not contrary to public policy. For ascertaining the real purpose underlying the scheme with a veil to be satisfied on this aspect. The court, if necessary, can pierce the view of apparent corporate purpose underlying the scheme and can judiciously X- ray the same. 7. That the company court has also to satisfy itself that members or class of members or creditors or class of creditors, as the case may be, were action bona fide and in good faith and were not coercing the minority in order to promote any interest adverse to that of the latter comprising the same class whom they purported to represent. 8. That the scheme as a whole is also found to be just, fair and reasonable from the point of view of the prudent men of business taking a commercial decision beneficial of the class represented by them for whom the scheme is meant. 9. Once the aforesaid broad parameters about the requirement of a scheme for getting sanction of the court are found to have been met, the court will have no further jurisdiction to sit in appeal over the commercial wisdom of the majority of the class of persons who with their open eyes have given their approval to the scheme even if in the view of the court there could be a better scheme for the company and its members or creditors for whom the scheme is framed. The court cannot refuse to sanction such a scheme on that ground as it would otherwise amount to the court exercising appellate jurisdiction over the scheme rather than its supervisory jurisdiction. (emphasis supplied) The question that often confronts the Court is whether it can decline approval/sanction to a Scheme of Arrangement, even when the majority of members approved the scheme in the Court convened meeting and all the creditors gave their consent for the scheme. There cannot be any doubt that even in such a case, the Court can refuse its approval if such scheme is found to contravene the law. The Court can reject sanction if the scheme is found to have been conceived with ulterior motive of playing fraud on public authorities. The Court can also withhold its imprimatur if it is found that in the long run such scheme is not in the interest of its members, creditors, employees and subverts public interest. Needless to mention that the Court can always throw out the scheme if it is intended to legitimize the lapses and illegalities that crept into the corporate governance for which persons at the helm of affairs of the company are alone responsible. Lastly if the Scheme of Arrangement is an inchoate transaction affecting future, the Court can always refuse sanction. In British and American Trustee and Finance Corporation v John Couper[3], the importance and sanctity of curial sanction to a Scheme of Arrangement was explained by House of Lords in a case wherein the Scheme of Arrangement envisaged reduction of capital by paying off the shares of one group of members was approved observing as under. I do not see any danger in the conclusion that the Court has power to confirm such a scheme as that now in question, or any reason to doubt that this was the intention of the Legislature. The interests of creditors are not involved, and I think it was the policy of the Legislature to entrust the prescribed majority of the shareholders with the decision whether there should be a reduction of capital, and if so, how it should be carried into effect. The interests of the dissenting minority of the shareholders (if there be such) are properly safeguarded by this: that the decision of the majority can only prevail if it be confirmed by the Court. Thus, the law providing for Court sanction for Scheme is a safeguard against ultra vires corporate excesses and is intended to subserve public interest. Of late, the corporate world derives abundant sustained strength by State support which comes by way of direct/indirect financial participation, subsidized infrastructural facilities, continuous flow of supplies of human resources and sovereign guarantees where international finances are involved. Therefore, even though the Court ought to view the Scheme of Arrangement submitted for approval with deference to the wishes of proposers and members, nevertheless the Court should be cautious not to be swayed by approval of imposing majority. All decisions of majority at all times cannot be presumed to be legal or legitimate, and corporate leadership cannot always be presumed to be correct in absolute terms. The Court when called upon to examine a scheme for the purpose of according sanction, must therefore keep in view not only the subject matter before it but also look to effect of its decision on the future corporate arrangements. Reduction of Share Capital vis-à-vis Capital Reduction Reserve Capital includes ‘share capital’ which may again compromise equity share capital and preference share capital (Sections 85 and 86 of Companies Act). In addition to this, the reserve account created by the company from out of its profits earned also forms part of capital. A perusal of the provisions in Part IV Schedule I and Schedule VI would show that the capital of the company consists of mainly shareholders’ funds which include capital, reserves and surplus. When the share capital together with reserves/surplus is found to be in excess of requirements of the company, it would certainly be an unwise business proposition to carry on business with such surplus capital. Therefore, the company, if its Memorandum and Articles so authorize, can reduce its share capital. Companies Act primarily recognises three modes of reduction of share capital. Regulation 46 of the Regulations for management of a company limited by shares (Table A Schedule I) provides that a company may by special resolution reduce in any manner (i) its share capital; (ii) any capital redemption reserve account; or (iii) any share premium account. Section 100(1) indicates three ways of reducing its share capital. These are (i) by extinguishing or reducing liability in respect of unpaid share capital; (ii) by cancelling paid up share capital which is lost or unrepresented by available assets; or (iii) by paying off any paid up share capital which is in excess of wants of the company. Needless to mention that any resolution of the company to reduce share capital in any of the three ways needs confirmation of the Court which is required to follow the procedure contemplated in Sections 100 to 104 of the Companies Act and Rules 46 to 65 of the Companies (Court) Rules. In addition to the reduction of share capital as contemplated by Section 100 of the Companies Act, the company can also reduce its share capital in other two ways. Until recently, law barred a company from purchasing its own shares. Section 77 of the Companies Act prohibits a company to buy its own shares unless consequent reduction of capital is effected and sanctioned in pursuance of Sections 100 to 104 of the Companies Act. By Companies (Amendment) Act, 1999, with effect from 31.10.1998, Parliament inserted Sections 77A, 77AA and 77B. Under Section 77A, which is an exception to Section 77, a company may purchase or buyback its own shares out of its free reserves or securities premium account or proceeds of any shares or any other specified securities not exceeding 25% or total paid up equity capital in a financial year. It is now well accepted that the companies decision to purchase or buyback its own shares from out of free reserves or share premium account is “an indirect method of reducing capital of the company” (See Traver v Witworth[4] and Ramesh B.Desai v Bipin Wadilal Mehta[5]). In addition to reduction of capital by buyback of shares, law also contemplates yet another method of reduction of share capital. This is by way of a deemed provision, which creates a fiction as if it amounts to reduction of share capital. Here it is necessary to refer to power of the company to issue redeemable preference shares and method of redeeming such preference shares. For ready reference, Section 80 of the Companies Act to the extent relevant (omitting sub-section (2) (4) 5A and 6), is extracted below. 80. Power to issue redeemable Preference Shares (1) Subject to the provisions of this section, a company limited by shares may, if so authorized by its articles, issue preference shares which are, or at the option of the company are to be liable, to be redeemed: Provided that- (a) no such shares shall be redeemed except out of profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of the redemption; (b) no such shares shall be redeemed unless they are fully paid; (c) the premium, if any, payable on redemption shall have been provided for out of the profits of the company or out of the company’s security premium account, before the shares are redeemed; (d) where any such shares are redeemed otherwise than out of the proceeds of a fresh issue, there shall, out of profits which would otherwise have been available for dividend, be transferred to a reserve fund, to be called the capital redemption reserve account, a sum equal to the nominal amount of the shares redeemed; and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the capital redemption reserve account were paid-up share capital of the company. (3) The redemption of preference shares under this section by a company shall not be taken as reducing the amount of its authorized share capital. (5) The capital redemption reserve account may, notwithstanding anything in this section, be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares. The provision deals with power of a company to issue and redeem preferential shares. Unless and until the Articles of Association of a company permit to do so, preferential shares cannot be issued. Even if the preferential shares are issued, they have to be redeemed within a stipulated period. There cannot be any doubt that the amount, which the company gets by issue of preferential shares forms part of the capital of a company. It is very interesting as to how the law enables redemption of preference shares. The proviso to sub-section (1) of Section 80 of the Companies Act contemplates the redemption of fully paid preference shares in two ways, namely, (i) from out of the proceeds of fresh issue of shares made for the purpose of redemption; and (ii) from out of distributable profits. Sub-section (3) of section 80 of the Companies Act is to the effect that redemption of preference shares shall not amount to reducing the amount of its authorized share capital. So to say, if fresh issue of shares is made even if such proceeds of fresh issue of shares are utilized for redemption of preference shares, it shall not be treated as reducing the authorized share capital. However, if the company redeems fully paid up preference shares from out of the profits, it is required to follow the procedure applicable for reduction of share capital. Section 80(1) read with its proviso, especially clauses (a) and (d) thereof is to the effect that when shares are redeemed out of distributable profits, the company is required to follow two things, namely, (i) to create and transfer to (from out of profits) capital redemption reserve (CRR) and (ii) to do so, follow the provisions of the Companies Act relating to reduction of share capital. It may look little odd that when the proceeds of fresh issue of shares are utilized for redemption of preference shares, provisions relating to reduction of share capital are not applied but when distributable profits are utilized for reduction of the preference shares, the provisions relating to reduction of share capital are applied. The intention of legislature appears to be the following. When the preference shares are to be redeemed from out of the fresh issue of share capital, the company is required to issue such fresh issue of shares specifically mentioning the purpose of such fresh issue, namely, redemption of preference share capital. However, when the profits are earned and for the purpose of compliance with the statute, portion of the profits are transferred to general reserve or statutory reserve, as the case may be, no reduction of capital is involved. The profits are ordinarily