(Originally Published on Taxsutra: https://www.taxsutra.com/dt/experts-corner/conversion-equity-shares-preference-shares-nclts-broad-approach)
Introduction
Schemes of arrangement under section 230 – 232 of the Companies Act 2013 (and the corresponding provisions under section 391 of the Companies Act 1956) have been considered as fairly wide and what should really concern the Courts/NCLT is also whether it is prejudicial either to the shareholders or the creditors, or any particular class thereof. The broad approach should be (and generally has been) that the NCLT process should be an oversight, and what the scheme should be left to the company/shareholder and creditors, subject to the parameters of the Companies Act.
In the above context, an interesting Mumbai NCLT order dated Sep 20, 2021 has been pronounced in the case of Protans Supply Chain Management Pvt. Ltd. (‘Protans’), Ag-vet Generics Pvt. Ltd. (‘Ag-vet’) and Baaramati Agro Ltd. (‘BAL’) [LSI-754-NCLT-2021(MUM)], wherein Protan and Ag-vet would merge into BAL, and one of the dimensions of that merger was the conversion of the shares held by some shareholders of BAL from equity into preference shares. BAL had 21,675 shareholders holding equity shares of which 21,000 were shareholders holding some amount of equity shares and they were pressing for regular dividend and/or wanted their investment redeemed and, in this context, the scheme envisaged the conversion of equity shares held by such shareholders into non-cumulative optimal convertible redeemable preference shares (‘OCRPS’). The issue that was raised by the Regional Director (‘RD’) in his report was that such conversion was not permitted and was undesirable, and it is in this context that the NCLT had to deal with the RD’s observations and pronounce its order.
Relevant provisions of the Companies Act
The NCLT order has made references to several provisions of the Companies Act and hence the relevant provisions are sought to be outlined in the succeeding paragraphs. Section 230 of the Companies Act deals with power to make compromise or make arrangement with creditors and members and provides that where the compromise or arrangement is proposed between (a) a company and its creditors (b) a company and its members, the NCLT has the power to order a meeting of the creditors and members and sanction the scheme, subject to a majority of creditors or members representing at least 3/4th in value, approving the scheme at their respective meetings, unless of course, the meetings are dispensed with explanation to Section 230 reads as under:
For the purposes of this sub-section, arrangement includes a reorganisation of the company’s share capital by the consolidation of shares of different classes or by the division of shares into shares of different classes, or by both of those method.
Section 43 of the Companies Act provides that the share capital of a company can be either equity shares or preference shares. Section 61 of the Companies Act which deals with “power of company to alter its share capital” deals with reorganisation of share capital in the manner stated therein.
Contentions of the petitioner
The petitioner’s contentions were broadly that the section 230-232 are very wide and particularly, that the explanation to Section 230 provides that ‘arrangements’ includes a reorganisation of the company share capital by the consolidation of shares of different classes or division of shares into shares of different classes, and then read with Section 43 and 61 of the Companies Act outlined above, there is no bar to conversion of equity shares into preference shares under a scheme of arrangement.
The NCLT took cognisance of various judicial precedents including the following:
- The Supreme Court in SLP No. 984 of 2006 (Rajendra Prasad Gupta versus Prakash Chandra Mishra & Ors) held “Courts are not to act upon the principle that every procedure is to be taken as prohibited unless it is expressly provided for by the Code, but on the converse principle that every procedure is to be understood as permissible till it is shown to be prohibited by the law. As a matter of general principle, prohibition cannot be presumed”.
The word “arrangement” has not been defined under the Act; however, the term in itself carries a very wide import. The Division Bench of Punjab & Haryana High Court in the matter of Q. H. Talbros Ltd. observed inter-alia that a merger and a demerger are not the only components of a composite scheme of arrangement, and the legislature, therefore advisedly did not restrict scope of the term arrangement by defining it.
In the context of the above, the scheme was sanctioned.
Tax issues
Incidentally, it maybe mentioned that u/s 47(xb) of the Income Tax Act, a transfer by way of conversion of preference shares into equity shares is not considered a ‘transfer’, but the converse is not expressly provided for, and therefore, in the kind of situation before the NCLT, the tax issues which was the converse (i.e. equity into preference) could create a controversy. Section 47(vii) deals with amalgamation and exempts transfer in consideration of his shares in one company into the shares of another company in a scheme of amalgamation is exempt; however, in this case, the shareholders of BAL itself (i.e. the transferee company) are getting preference shares instead of equity and therefore, this re-organisation could still have a possibility of controversy in the context of the relevant provisions pointed out above.
Accounting issues
Although not directly relevant to the crux of this article, it may be noted that the scheme provides for accounting treatment in two different baskets; in so far as the assets and liabilities of the Transferor Company 1 (Protrans) are concerned, the scheme provides for accounting on a ‘common control’ basis, and in so far as Transferor Company 2 (Ag-vet Genetics) is concerned, it provides for fair value accounting. It seems that Transferor Company 1 may be a group company of the transferee, whereas that may not be so for Transferor Company 2.
Summing up
As mentioned at the beginning of this article, it is important to recognise that the term scheme of arrangement is very wide and the NCLT should normally permit a scheme to go ahead, especially since there is an inbuilt filter of approval of creditors and shareholders with a high threshold in terms of number and value. Re-organisation and restructuring is now becoming important and is an important part of Ease of Doing Business and one hopes and wishes that the NCLT recognises this critical aspect in sanctioning schemes and very importantly doing so, expeditiously so.