Supreme Court Invalidates Compulsory Amalgamation under Section 396 of the Companies Act: 63 Moons Technologies Ltd. vs. Union of India (2019) INSC 441

Introduction

Date of the Judgment: 30 April 2019

Citation: (2019) INSC 441

Judges: R.F. Nariman, J. and Vineet Saran, J.

Can the government force a merger between two companies if it believes it’s in the public interest, even if one company is profitable and the other is struggling? The Supreme Court of India recently tackled this question, focusing on the legality of a compulsory amalgamation order under Section 396 of the Companies Act, 1956. The case involved 63 Moons Technologies Ltd. (formerly Financial Technologies India Ltd.) and its subsidiary, National Spot Exchange Ltd. (NSEL). The core issue was whether the government’s order to merge these two companies was valid, given the financial implications for 63 Moons Technologies and its shareholders.

The Supreme Court, in this judgment, examined the scope and applicability of Section 396 of the Companies Act, 1956, which allows the Central Government to order compulsory amalgamation of companies in the public interest. The court scrutinized whether the government’s order was valid, considering the financial implications for the transferor company and its shareholders, and whether all the conditions precedent for such an order were met.

Case Background

63 Moons Technologies Ltd. (FTIL) is a company that provides software for trading. It held a 99.99% share in its subsidiary, NSEL, which was set up to provide a platform for trading commodities. In 2007, NSEL received an exemption from certain regulations, allowing it to operate forward contracts of one-day duration. However, in 2013, a major crisis occurred when it was discovered that some traders on the NSEL platform had defaulted on payments amounting to approximately INR 5600 crore.

This payment crisis led to the closure of NSEL’s spot exchange operations. The Forward Markets Commission (FMC) recommended that the government verify the commodity stocks in NSEL’s warehouses and fix liability on FTIL, the parent company. Investigations revealed that NSEL was involved in “paired contracts,” which were essentially financing transactions rather than actual commodity sales, violating the terms of its exemption.

The Ministry of Finance, based on the findings of the FMC and a forensic audit report, proposed the amalgamation of FTIL and NSEL under Section 396 of the Companies Act. The Central Government issued a draft amalgamation order, which FTIL challenged in the Bombay High Court. The Bombay High Court dismissed the writ petition filed by FTIL, leading to the present appeal before the Supreme Court.

Timeline

Legal Framework

The case primarily revolves around Section 396 of the Companies Act, 1956, which empowers the Central Government to order compulsory amalgamation of companies in the public interest. This section is an exception to the usual procedures of voluntary amalgamation under Sections 394 and 395 of the same Act.

Section 396(1) states that where the Central Government is satisfied that it is essential in the public interest that two or more companies should amalgamate, it may provide for such amalgamation by order.

Section 396(3) mandates that every member or creditor of each company before the amalgamation shall have, as nearly as may be, the same interest in or rights against the company resulting from the amalgamation as he had in the original company. If the interest or rights are less, the member or creditor is entitled to compensation.

Section 396(4) outlines the procedural requirements for such an order, including sending a draft order to the companies, considering objections, and ensuring that compensation assessments are completed.

Article 31A of the Constitution of India protects laws providing for the amalgamation of two or more corporations in the public interest from being challenged on the grounds of Articles 14 (equality before law) and 19 (protection of certain rights).

Article 13(3) defines “law” to include any Ordinance, order, bye-law, rule, regulation, notification, custom, or usage having the force of law.

Arguments

Arguments by the Appellants (63 Moons Technologies Ltd. & Ors.):

• FTIL and NSEL are separate legal entities with distinct businesses and independent boards of directors. FTIL has not participated in NSEL’s profits, receiving only maintenance fees for technology services.

• A compulsory amalgamation order under Section 396 is invalid if its sole purpose is to impose NSEL’s unadjudicated liabilities on FTIL.

• The amalgamation order is based on an inconclusive forensic audit report by Grant Thornton, which stated that its findings were not verified and could be amended.

• The condition precedent for passing an amalgamation order is that compensation be assessed under Section 396(3) for both transferor and transferee companies, which was not done for FTIL and its shareholders.

• The amalgamation order interferes with the judicial process by ignoring decrees and arbitral awards obtained by NSEL against defaulters.

• The Central Government did not apply its mind to whether such an order was “essential” in the public interest. The public interest includes the interest of FTIL’s 63,000 shareholders, who would face a huge liability.

• The amalgamation order is arbitrary and violates Articles 14, 19, and 300A of the Constitution of India. It also violates the principle of proportionality.

• The reasons given by the Bombay High Court for upholding the amalgamation order were not part of the draft order, thus violating the principles of natural justice.

• The High Court erred in ignoring the economic value of shares, holding that no compensation was needed for FTIL shareholders as the number of shares remained the same, despite their value becoming nil.

Arguments by the Respondents (Union of India & Ors.):

• FTIL held 99.9998% of NSEL’s shares, and NSEL was promoted by and is part of the FTIL group. NSEL’s board was under the control of FTIL.

• Shri Jignesh Shah was the common linchpin of both companies, holding 45% shares of FTIL and being the Chairman-cum-Managing Director, as well as Vice Chairman on the Board of NSEL.

• NSEL promoted “paired contracts” which were financing transactions, breaching the exemption granted to it under the FCRA.

• NSEL misrepresented that it dealt with commodities and spot delivery, while it was running a finance exchange with no commodities in stock.

• The amalgamation order was not just for repayment of debts but to instill confidence in commodity markets.

• The order was passed after hearing FTIL and NSEL, and is in the nature of delegated legislation, thus immune from challenge under Articles 14 and 19.

• The Central Government order does not direct any payment by the amalgamated company; it is to enable FTIL’s finances to be used for ongoing litigation.

• The economic value of shares is an uncertain phenomenon, and compensation under Section 396(3) need not be mathematically precise.

• The Central Government was satisfied on objective facts that it was essential in public interest to pass such order.

Sub-Submissions categorized by main submissions of all sides pertaining to the issue:

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues for consideration:

1. Whether the amalgamation order under Section 396 of the Companies Act, 1956, is valid when it does not adequately compensate the transferor company and its shareholders.
2. Whether the conditions precedent for passing an amalgamation order under Section 396 were met in the present case.
3. Whether the Central Government’s satisfaction that the amalgamation is essential in the public interest was based on relevant and objective facts.
4. Whether the amalgamation order is in violation of Article 14 of the Constitution of India.
5. Whether the amalgamation order is in violation of Article 19 of the Constitution of India.
6. Whether the amalgamation order is in violation of Article 300A of the Constitution of India.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues:

Authorities

The Supreme Court relied on the following authorities:

Judgment

The Supreme Court allowed the appeals filed by 63 Moons Technologies Ltd. and other appellants, setting aside the judgment of the Bombay High Court. The Court held that the amalgamation order under Section 396 of the Companies Act, 1956, was invalid.

The Court found that the amalgamation order did not adequately compensate the transferor company and its shareholders. The conditions precedent for passing such an order were not met. The Central Government did not apply its mind to whether such an order was “essential” in the public interest. The court also held that the amalgamation order was arbitrary, unreasonable, and violated Articles 14, 19, and 300A of the Constitution of India.

The Court emphasized that while Article 31A protects laws providing for amalgamation from challenge under Articles 14 and 19, it does not justify an irrational violation of these articles. The court also noted that the amalgamation order was more about recovering dues than serving the broader public interest. The Court also held that the reasons given by the Bombay High Court for upholding the amalgamation order were not part of the draft order, thus violating the principles of natural justice.

Implications

The Supreme Court’s judgment has significant implications for corporate law and the government’s power to order compulsory amalgamations. Here are the key takeaways:

• Limitations on Government Power: The judgment clarifies that the government’s power to order compulsory amalgamation under Section 396 of the Companies Act is not absolute. The government must ensure that all conditions precedent are met, including adequate compensation for the transferor company and its shareholders.

• Protection of Shareholder Rights: The judgment emphasizes the importance of protecting the rights of shareholders and creditors in compulsory amalgamation orders. The Court held that the economic value of shares cannot be ignored and that compensation must be assessed.

• Public Interest Requirement: The judgment clarifies that the public interest requirement for compulsory amalgamation must be genuine and not merely a pretext for recovering dues. The government must demonstrate that the amalgamation is essential for the broader public good.

• Judicial Review: The judgment reinforces the power of judicial review over government orders, especially when fundamental rights are involved. The Court can interfere when an order is found to be arbitrary, unreasonable, or violative of constitutional provisions.

• Procedural Due Process: The judgment highlights the importance of following procedural due process, including providing a fair hearing and ensuring that all reasons for the order are part of the draft order.

• Statutory Interpretation: The judgment provides important insights into the interpretation of Section 396 of the Companies Act, emphasizing the need to balance the public interest with the rights of stakeholders.

Flowchart of Compulsory Amalgamation Process under Section 396