Law
No more ‘limited liability’
The government invokes Section 396 of the Companies Act in the
forced merger of nsel with 63 Moons Technologies
T
he recent Bombay High Court
order upholding the Ministry of
Corporate Affairs’ (mca) order to
forcibly amalgamate 63 Moons Tech-
nologies Limited (formerly known as
ftil) with its subsidiary, the National
Spot Exchange Limited (nsel), has
shaken the corporate fraternity. Cor-
porate and legal circles wonder how a
forced merger was used to lift the ‘cor-
porate veil’ and breach the concept of
‘limited liability’ between two private
companies.
There are apprehensions that this
move could erode the confidence of
doing business in India at a time when
the country is struggling to improve
its position in the World Bank’s Ease of
Doing Business Index. Not only that,
the order – that is being described
as  draconian – is also seen to be one
that could impact Foreign Direct
Investments (fdis) and Foreign Institu-
tional Investors’ (fii) investments.
“The government has set a danger-
ous precedent for corporate India, by
using Section 396, for the first time
since its introduction, to amalgamate
B u s i n e s s I n d i a u t h e m ag a z i n e o f t h e c o r p o r at e wo r l d
two companies which have no govern-
ment holding and which are in differ-
ent businesses,” argues Cyril Shroff,
managing partner, Cyril Amarchand
Mangaldas, advocates & solicitors. “The
20-odd cases for which it was invoked
earlier, pertained to government-held
undertakings in the same business.”
He points out that those amalgama-
tions were effected, for instance, in
cases, where the government took a
decision to ensure a co-ordination in
policy for the relevant industry sec-
tor and public sector undertakings
(psus) in India.  “Even then, the con-
sent of all shareholders and 90 per
cent of the creditors of the amalgam-
ating entities was required. By reading
Section 396 as permitting the govern-
ment to force through an amalgama-
tion of two entities, which object to
the amalgamation and on the basis
that the government believes that
a parent company is required to be
held responsible for acts/omissions of
its subsidiary, the section opens the
door to similar invocation as a means
to seeking recovery of a subsidiaries
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debts from its parent.  This cannot be
the purpose for which the section was
introduced – indeed it was introduced
as welfare legislation. In fact, such an
interpretation could render the objec-
tive of the Indian Bankruptcy Code
(ibc) also redundant,” Shroff adds.
“By forcing through the merger,
the government has taken away the
defence of the corporate veil and there-
fore the concept of limited liability,
from the parent company. This cannot
be a step in the right direction, as the
circumstances under which the cor-
porate veil can be lifted and the inde-
pendent corporate existence of each
company ignored, are well established,
including by the Supreme Court in the
very public Vodafone case. Further,
the conditions for lifting the corporate
veil are required to be proved in trial,
not through the executive action of
the government by ordering a compul-
sory amalgamation that then renders
nugatory one company’s defence.”
In the case of mca’s order for forced
merger of nsel with 63 Moons, the gov-
ernment has used it by conveniently
defining public interest, that too with-
out adjudication for sole purpose of
recovery of dues. There could be a
domino effect in the making (see box:
Domino effect triggered). Henceforth,
the government can use this section –
citing public interest – to recover dues
B u s i n e s s I n d i a u t h e m ag a z i n e o f t h e c o r p o r at e wo r l d
from companies with non-perform-
ing assets (npas), which sets a danger-
ous precedent, as banks laden with
huge npas will have to recover money
through this route, instead of rely-
ing on the ibc or the Securitisation &
Reconstruction of Financial Assets &
Enforcement of Security Interest (sar-
faesi) Act, 2002.
As it happens, the npas accumu-
lated by Indian lenders are higher than
those of banks in most major econo-
mies, including the US, the UK, China
and Japan. In fact, India ranks fifth out
of 39 major world economies plagued
by bad loans, according to a report by
Care Ratings. As on September 2017,
the npas of Indian banks stood at a
burgeoning R8.40 lakh crore.
In the past, the rbi and government
had red-flagged this and offered solu-
tions, including the ibc, to contain the
situation. ibc, which came into effect
in December 2016, was expected to
be a game changer by allowing faster
resolution of bad loans. However, the
Centre’s new mantra of invoking sec-
tion 396 in the nsel-63 Moons case
has opened a Pandora’s box and, now,
the government would be duty-bound
to prefer Section 396 over both ibc and
Domino effect triggered?
T he Bombay High Court has recently
issued notice to the mca to consider
the forced merger of bank loan defaulting
companies with their group companies
and holding companies under Section
396. mca has been told to respond by 21
February 2018.
A Public Interest Litigation (pil) was
filed on 24 January 2018 by Yuvraj Pote
before a two-judge bench seeking to
consider the merger of bank loan default-
ing companies with their parent/group
companies. The High Court took cogni-
zance of the bank npa issue in the back-
drop of its recent order on Section 396
and issued notice to the mca in order to
facilitate recoveries of bank loans from all
bank loan defaulting companies. With
this, the corporate veil will now be lifted
without running a trial.
Among the bank loan defaulting
companies are:
u Kingfisher Airlines to be merged with
Shroff: dangerous precedent
sarfaesi as an easier and all-pervading
recovery tool.
Now, the mca can choose to merge
a defaulting company with its healthy
sibling and utilise its assets to pay off
debts of the defaulting company. This
would turn out to be a more preferred
United Breweries, United Spirits and
Mangalore Chemicals & Fertilizers
u Lavasa Corporation to be merged
with Hindustan Construction Co
u Essar Steel to be merged with Essar
Ports, Essar Shipping and Essar Agro;
u gmr Chhattisgarh Energy to be
merged with gmr Infrastructure
u gvk Gautami Power to be merged
with gvk Power & Infrastructure and
gvk Energy
u Jaypee Infratech to be merged with
Jaiprakash Associates and Jaypee
Infra Ventures
u Coastal Gujarat Power to be merged
with Tata Power Co and Tata Sons;
u Indian subsidiaries of Videocon
Industries to be merged with its
holding company
Effectively, the government can now
invoke Section 396 to merge bank loan
defaulting companies with their group
companies, thereby passing on the bur-
den to the group companies.
u 75 u
f e b rua ry 1 2 -2 5, 2 018
Law
Paanse: order should be reviewed
and convenient route as under ibc,
Debts Recovery Tribunal (drt) and
National Company Law Tribunal
(nclt) proceedings, banks have to take
substantial haircut, resulting in loss of
public money.
Against the concept
Many lawyers opine that that the pre-
cedence set by the government in the
nsel-63 Moons  merger case to facili-
tate recovery will result in damaging
the concept of an independent limited
liability corporate entity. In order to
recover default money and protect pub-
lic interest, the government has force-
merged two private corporate entities
for the first time, grossly undermined
the shareholders’ rights and brushed
aside shareholders’ resolution. In such a
scenario, investors (both domestic and
foreign) would be wary of investing in
any company that has subsidiaries, lest
it is saddled with its ailing sibling with
unlimited risk of liability.
“The forced amalgamation of nsel
with 63 Moons and the supersession
of 63 Moons board will have a delete-
rious effect on investments into India
and the Indian economy as a whole,
as follows: the sustained endeavours
to attract foreign investments into
India by the multiple action plans of
the Central government under the
dynamic stewardship of Modi (a name
which is now becoming synonymous
Law
with the ‘Mission Of Developing India’
may not yield the desired results as
the forced amalgamation would erode
confidence of the investors’ commu-
nity. At the same time, the mca’s pro-
posal to supersede the board is most
likely to create chaos and confusion in
India’s corporate landscape and would
open a virtual floodgate of unneces-
sary and time consuming litigation
that would be difficult, nay impossi-
ble, to breach,” says Apurva Agarwal,
founder, Universal Legal.
Where the government or sharehold-
ers have used Section 396 in accordance
with the law, in case of the consensual
merger of two government companies,
approval of 100 per cent shareholders
and 90 per cent creditors and employees
was required for the merger, as was the
standard requisite. Compared to this,
the government, while force-merging
two completely distinct and dissenting
private sector companies (nsel and 63
Moons), has brushed aside sharehold-
ers’ resolutions. The mca had brushed
aside the objections raised by majority
of stakeholders calling them ‘orches-
trated’, and issued the final order on 12
February 2016 thereby merging the two
entities. Unfortunately, even the Hon-
ourable Bombay High Court upheld
the same.
Disastrous consequences
“The government has taken a dan-
gerous and unwelcome step, which
destroys the very essence of the lim-
ited liability concept under Company
Law,” observes Vineet Naik, senior
advocate, Bombay High Court. “It is a
trite law that a holding company can-
not be visited for the misdoings of
its subsidiary. If this is permitted, it
will lead to disastrous consequences,
wherein a perfectly sound company
can be destroyed by foisting liabilities
of its subsidiary completely to the det-
riment of its shareholders. The scheme
under 396 doesn’t even provide for
some sort of hearing of its stakehold-
ers and supervision by courts unlike
the usual provisions or amalgamation
and mergers (a&m). What constitutes
public interest is a vexed issue and can
have the potential of being misused.”
Naik feels this could never have been
the legislative intent behind 396. “Pre-
viously, when this power was used, it
was only with respect to psus and not
B u s i n e s s I n d i a u t h e m ag a z i n e o f t h e c o r p o r at e wo r l d
Agarwal: eroding confidence
private corporations,” he adds.
Laywers also believe that this order
does not meet the test of proportion-
ality, as it failed to balance the inter-
ests of the majority of stakeholders
vis-à-vis the interests of ‘investors’
whose genuineness is yet under scru-
tiny by investigating agencies. From
the shareholder’s perspective, it could
eventually affect the ‘economic’ inter-
ests of the 63 Moons shareholders
as the entire net worth of 63 Moons
would get wiped out, if nsel were to be
held liable for the putative liability of
R5,600 crore.
Strangely, in this, nsel has been
termed as an exchange that is on a par
with the likes of bse, nse and mcx, and
it has been felt necessary to restore pub-
lic confidence by merging an exchange
(nsel) with a technology company (63
Moons) – and that too, when the mar-
ket regulator declared 63 Moons as ‘not
fit & proper’. This apart, some lawyers
have also observed that the government
has deviated from its earlier stand that
the nsel crisis was a private dispute and
did not constitute any systemic risk,
thus ruling out any executive interven-
tion. What then prompted such draco-
nian action is being discussed among
these legal brains.
“The real objective  should be on
survival and revival of business rather
than emphasis and focus on  speedy
recovery of debts by banks and
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Naik: unwelcome step
financial institutions. The coercive
and forceful measures adopted by the
lending institutions for recoveries do
not constitute an actual solution. From
the available data, it is clear that the
lending institutions have succeeded to
recover only 13 per cent of bad debts
by adopting such methods. In the pro-
cess, total productive assets have been
found to be diminishing,  becoming
non-productive and finally ending up
in scrap, grossly affecting the gdp of
the country. In case of forceful merg-
ers under Section 396, total injustice
will be caused to the shareholders and
creditors. Therefore, the order of High
Court should be reviewed,” argues
Vishwas Paanse, founder, npa Con-
sultants, Mumbai, which has been
restructuring the npas of mid-cap and
sme companies.
While 63 Moons will be moving
the Apex court against the order, if
the outcome allows unhindered rein
over corporate sector to the executive
machinery, it may well dampen cor-
porate confidence and investor senti-
ment, both locally and globally. At a
time when our political leadership is
doing its best to project India as an
emerging economic superpower, gov-
erned by the rule of law, can it let a
Damocles’ sword hang over its engine
of growth?
u LANCELOT J OSEPH
lancelot.joseph@businessindiagroup.com