Between consent and compulsion: Minority squeeze-out mechanisms

Traditionally, the principle of majority rule is often exercised for corporate decision-making, with control and governance largely resting in the hands of shareholders holding dominant shareholding. One may attribute this to the vicious corporate cycle, where most decisions for a company are influenced by the majority. To consolidate power and streamline control, majority shareholders adopt a mechanism widely known as 'squeeze-out', which is contractually designed to reduce the rights of the minority shareholders.

A squeeze-out enables the exit of minority shareholders. Statutorily, a squeeze-out may be implemented under the Companies Act, 2013 and Rules made thereunder by various methods like compulsory acquisition of shares by a company itself, through buy back of shares or reduction of share capital, as well as acquisitions undertaken directly by its majority shareholders; and contractually, through built-in provisions expressly incorporated in investment agreements.

This raises an important question as to whether it is advisable to be a minority shareholder, particularly in circumstances where there exists a significant risk of being compelled to exit either by the company or by its majority shareholders.

This article attempts to examine certain instances under which the minority shareholders, primarily in an unlisted public company or private company, may be compelled to exit through a squeeze-out.

Certain key instances where compulsory acquisition of shares of minority shareholders may result in a 'squeeze-out':

Drag along right: In some cases, closely held private companies allow the promoters holding the majority to have a right to drag out the minority shareholders through suitable provisions in the shareholders' agreements. Sometimes, investors holding minority shareholding contractually protect themselves through similar provisions if no exit is provided to them.

Reduction of share capital: The Companies Act [Section 66] provides a statutory procedure through which a company may reduce its capital. To undertake such a reduction, the company may elect ‘selective reduction of capital’, where the reduction applies only to certain shareholders. In executing such a selective reduction, the company must pass a special resolution and obtain approval of the National Company Law Tribunal (NCLT), based on which the minority shareholders may be required to offer their shares for capital reduction, resulting in the squeeze-out of their interest.

Scheme of compromise or arrangement: A company may consolidate or divide its share capital pursuant to a scheme of compromise or arrangement with its members [Section 230, Companies Act] if at least 75% of the members assent to such a scheme and the same is subsequently approved by the NCLT, then the company and the members will be bound by such arrangement, including the dissenting minority shareholders. This mechanism is often viewed as a comparatively straightforward method of effecting a squeeze-out where the approval of 75% of members is sufficient, subject to regulatory approval.

Acquisition of shares of dissenting shareholders: Where a scheme or contract involving the transfer of shares of the transferor company is approved by at least 90% of shareholders whose shares are involved in the transfer (excluding the shares already held by the transferee company), the transferee company may notify the dissenting shareholder of its desire to acquire the shares of the dissenting shareholders [Section 235, Companies Act]. However, the dissenting shareholders have a right to object to such an acquisition by approaching the NCLT. Interestingly, even if a dissenting shareholder has not objected to the transfer but fails to cooperate or execute the transfer form, the transfer process is not obstructed. As such, this facilitates compulsory acquisition of shares of such dissenting/minority shareholders.

Purchase of minority shareholding: Under the Companies Act [Section 236], where an acquirer or persons acting in concert ("PAC") or a person or group of persons holds 90% or more of the issued equity capital of a company - whether through amalgamation, share exchange, conversion of securities or otherwise, then such acquirer or PAC or group of persons is required to notify the company of their intention to purchase the remaining equity shares held by the minority shareholders. Correspondingly, minority shareholders may also initiate or offer their shares for purchase by the majority shareholders. If the minority shareholders fail to deliver the share certificates, such shares are deemed cancelled and replaced with new shares issued to the majority shareholders. Further, if the majority shareholders subsequently realise a higher price for the shares purchased from the minority shareholders without the minority shareholders’ knowledge, the majority shareholders are statutorily obligated to pay additional consideration to the minority shareholders on a pro rata basis.

Provisions more or less similar to Sections 235 and 236 of the Companies Act also exist under the United Kingdom’s Companies Act, 2006 ("UK Companies Act"), which provides for the rights of an offeror to squeeze-out minority shareholders (majority requiring sale of shares of minority) on account of a corporate takeover. While under the UK Companies Act[5], squeeze-out provisions extend to all categories of shares, including equity and preference shares, and permit the offeror to acquire a specific class of shares; in contrast, under Section 236 of the Companies Act, the right to compulsory acquisition is limited to equity shares, and not for preference shares.

Further, Section 981 of the UK Companies Act enables an offeror to acquire the remaining shares held by minority shareholders on the same terms listed in the takeover offer. As such, if the takeover offer provides shareholders with an option of electing the consideration – whether cash, shares or other securities, the same terms must be extended by the offeror to the minority shareholders as well, subject to the applicable statutory period. On the contrary, Section 236 of the Companies Act does not prescribe the modes of consideration and merely requires the price to be determined by a registered valuer.

Squeeze-out mechanisms are not anomalies within corporate law, but rather thoughtful tools embedded within both statutory frameworks and contractual arrangements, to facilitate consolidation of ownership, corporate restructuring and exit efficiency. Preventing a possible squeeze-out seems difficult given the statutory mechanisms available to the majority shareholders, barring some instances where minority shareholders have statutory protection. Such reliefs, while available to minority shareholders, are largely procedural. A carefully negotiated document with built-in clauses would add an additional layer of protection and significantly mitigate the adverse impact of a probable squeeze-out event.

About the authors: Prem Rajani is the Managing Partner of Rajani Associates. Pearl Boga is an Associate Partner, Karen Issac is a Principal Associate, and Kriti Bhatt is an Associate at the Firm.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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