Framework for Protection of Public Equity Shareholders in case of Listed Companies undergoing CIRP: A necessity or unnecessary interference by SEBI?
Arunima Sao & Vinit Bachwani
5th year, B.A. LL.B(Hons.), Hidayatullah National Law University
Introduction
In 2016, India made significant progress towards ensuring economic stability and growth by introducing a strong and contemporary insolvency framework known as the Insolvency and Bankruptcy Code, 2016. Therefore, SEBI should not interfere unnecessarily in case of a listed company undergoing CIRP under IBC in order to protect the interest of the public equity shareholders even though they are retail investors. The same may harm the objectives of IBC.
A significant issue throughout corporate restructuring history has been figuring out the right level of involvement for shareholders in the corporate insolvency process. There’s been a lot of disagreement over what kind of financial stake shareholders should have in the restructured company. This has led to clashes between shareholders and other groups like unsecured creditors, who also have claims on the company’s assets.
One of the main objectives of the Insolvency Law is to build strong credit infrastructure. Therefore, IBC needs to take steps to ensure that the rights of the creditors to get the repayment of their debt remains intact. The more there is a probability of getting back the payment by the company, the more individuals, banks, financial institutions will be willing to be ‘creditors’. We do no wrong to the existing equity shareholders of the company undergoing CIRP under IBC if we say that the ‘interests’ of the shareholders must be subservient to the rights of the creditors. The obvious reason behind saying so is that the equity shareholders of the company are liable for the default in repayment/payment of debt amount to the creditors. Now, the question arises whether shareholders and the company are one and the same because the debt was borrowed by the company’s name and not the shareholders? The equity shareholders are the principal and the company is the agent. Hence, shareholders, bound by the mutual agency principle, is liable for whatever default has been occurred due to the functioning of the company.
Equity Shareholders and their role in decision-making
Who are equity shareholders? Equity shareholders are the real owners of the company pursuant to Residual Equity Theory proposed by Prof. George Staubus. Even if the equity shareholders are the owners of the company, the entire equity shareholding is divided into two groups:
- Promoters Group
- Non-promoters Group, which is further divided into Retail Investors, HNI, Institutional Buyers.
The primary goal of investment by retail shareholders into equity is two-fold, receiving dividend and capital accretion. They are hardly bothered with the economic growth of the company in the long run as opposed to other equity investors.
Pragmatically, the right to vote granted to the shareholders under Section 47 of the Companies Act, 2013 often proves futile. Even though they possess the right, their influence is minimal, as illustrated by the scenario where a resolution requiring 75% of the votes can be passed with only a fraction of total votes if the majority shareholders favour it. This highlights the agency problem, where majority shareholders act as agents, leaving minority shareholders with little control or impact on crucial decisions. This power dynamic renders the voting rights of retail investors largely symbolic rather than substantive, especially in cases where their interests diverge from those of the controlling shareholders.
Sebi’s intention to protect Public Equity Shareholders
There are two significant cases where these questions came up. When DHFL was going through CIRP, the company’s paid-up share capital was entirely reduced at zero cost. Similarly, in the case of Jaypee Kensington Boulevard[1], the resolution plan included a complete reduction of paid-up share capital at a minimal cost, which was approved by the Supreme Court. This plight of shareholders made the SEBI disheartened.
Why do retail investors and minority shareholders suffer from company defaults caused by majority shareholders or promoters? Why aren’t they compensated for their losses, damaging investor confidence and discouraging investment from middle and working-class individuals?
To favour the shareholders belonging to the non-Promoters group in their pathetic situation, that is, when the company is going through CIRP, IBC already has a provision which allows such shareholders to propose a resolution plan. Section 29A of IBC does not prohibit non-defaulting shareholders to propose a resolution plan. Nonetheless, SEBI came up with the “Framework for protection of interest of public equity shareholders in case of listed companies undergoing CIRP under IBC, 2016” to strike a balance between encouraging investment and protecting creditors. Atmost, the investment, in accordance with this framework, by public equity shareholders may help lower down the financial burden placed on the Resolution Applicant.
To ensure that public equity shareholders can voice their opinions during the Corporate Insolvency Resolution Process (CIRP), SEBI, at maximum, could have granted the opportunity to appoint an authorized representative to sit on the Committee of Creditors (CoC) with absolutely no voting rights.
Analysis: Whether there is a need of such framework
Effect of Shareholders’ Right and Liability upon Creditors
The Bankruptcy Law Reforms Committee in its first report, observed,
“The limited liability company is a contract between equity and debt. As long as debt obligations are met, equity owners have complete control, and creditors have no say in how the business is run. When default takes place, control is supposed to transfer to the creditors; equity owners have no say.”
The limited liability feature of a corporate body implies that if a company fails, the shareholders are not personally liable for its debts beyond the amount they have invested. This could lead to a situation where the risk of business failure is transferred from shareholders to the creditors who lend money to the company. This might seem unfair because creditors could end up losing out without getting compensated. This, in turn, could make lenders hesitant to lend money to companies with limited liability, which could slow down economic activity. Hence, IBC, 2016, strives to build strong credit infrastructure by bestowing certain rights on creditors. If similar rights are conferred upon shareholders, that will amount to having fingers in every pie. In such situation, shareholders will have the best of both the worlds as in one hand, they would be protected from risking their personal assets by opting for limited liability feature and on the other hand, despite being the defaulter in case of default in payment of debt or business failure, having the right to be compensated similar to creditors.
Intersection between IBC and Legal Framework Governing Companies
Furthermore, on one hand, the law is so committed to the objective of IBC, the reorganization of the insolvent company and building of strong credit infrastructure that
- Section 30(2) of the IBC mandates a significantly lower voting threshold of 66% of financial creditors (by value), which increases the likelihood that an acquisition will be approved through the CIRP process as opposed to Section 230 of the Companies Act 2013 which calls for a 75% approval of creditors.
- The law provides an exemption to the acquirer from giving an open offer to the existing shareholders on the occasion of the acquisition of substantial shares which is compulsory in accordance with the Takeover Code, 2011.
- The acquisition process is further aligned with the Companies Act, 2013 through an Explanation to section 30(2)(e) of the IBC. This explanation stipulates that if any shareholder approval is required under the Companies Act 2013 or any other applicable law for implementing the resolution plan, such approval will be considered as granted. With no added costs to the acquirer, this clause guarantees that acquisitions made through CIRP adhere to current companies law.
The above points show that to streamline the process of CIRP, the provisions of companies law and SEBI Regulations such as SEBI(Substantial Acquisition of Shares and Takeovers) Regulations are presumed to be followed once the provisions of IBC are followed.
Effect of ‘Framework for protection of interest of Public Equity Shareholders’
On the other hand, according to a consultation paper released by SEBI, it is proposing to offer 25% of shares to existing public shareholders at the same price at which the resolution applicant is supposed to buy, thereby,
- burdening the acquirer to follow LODR and ICDR regulations,
- such above-mentioned burden may be one of the reasons for prospective applicants for not coming up with resolution plans,
- since the public equity shareholders may have shareholding more than 10% of the shares, giving them the right to file an application for prevention of mismanagement and oppression under Section 241 of Companies Act, 2013, which may unnecessarily create nuisance,
- giving consideration to public equity shareholders at the cost of haircut taken by creditors.
The above-mentioned points show why and how it is unjustified to come up with such framework.
Other Relevant Arguments
The supporters of the given framework may argue that financial creditors managed to recover at least 100% of their claims in 56 instances out of the 517 companies resolved through resolution plans until June 30, 2022. Consequently, it is plausible that certain businesses among these may still possess equity holding substantial value. Should the resolution plan lead to the complete elimination of this remaining equity value, the acquirer would unjustly derive benefit at the expense of the shareholders.
But what about the other way round? If the resolution applicant, being a company with goodwill in the market, proposing a plan to merge the insolvent company with its own, the insolvent company which is of absolutely no value and has zero equity value, if gets a value after merging, because of merging, because of the goodwill of the resolution applicant, in such case why would the public equity shareholders get the equity shares at the same price at which the resolution applicant is acquiring. Isn’t it unjust enrichment by the shareholders?
This may discourage the resolution applicants to come up with resolution plans. This discouragement cannot be afforded by IBC as its one of the major objectives is to reorganize the company. Hence, the proposal by SEBI is too much to accept keeping in mind the objective to be achieved by IBC.
Conclusion
The author’s contention is not that the Indian government and regulators should stop taking steps to maintain the nation as ‘social welfare state’ just because India, practically, is moving towards being a capitalist state as only handful of corporate groups are running the economy of the country. Rather, the contention is that handholding of minority shareholders/retail investors is good as the SEBI’s main objective is investor protection but SEBI must not protect their stake by compromising the rights of other such as creditors and burdening the other stakeholders.
In this circumstance, if one is to safeguard minority/retail investors, will SEBI persist in providing protection even amidst future situations similar to that of the Adani-Hindenburg incident? In Adani-Hindenburg case, the financial statements were out by Hindenburg which was already in the public platform but still the stock crashed and loss happened to retail investors. Why did this happen? Because of Adani’s fault or Hindenburg’s fault? Neither of them. But because of financial illiteracy and unawareness by the shareholders.
Suggestion – We do get that the pampered baby of SEBI, which is, minority public shareholders/retail investors, is affected when the company goes through CIRP or liquidation, but SEBI cannot take such an extreme step to protect them for the loss they signed up for while subscribing equity shares. We do agree with the fact that financial illiteracy is one of the major factors eating up their money and hence, SEBI, must come up with investor education programmes, not only on-paper but rather focus on wide implementation of such programme.
Bibliography
2. Insolvency and Bankruptcy Code, 2016
3. Sebi (Substantial Acquisition of Shares and Takeover) Regulations, 2011
4. Sebi (Listing Obligations and Disclosure Requirements) Regulations, 2015
5. Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2018
6. Treatment of Public Equity Shareholders under IBC – By Adv. Abhishek Arya and CS Gagan Bajaj
7. https://indiacorplaw.in/2023/05/shareholder-protection-under-ibc-a-myth-or-a-possibility.html
References:
[1] Jaypee Kensington Boulevard Apartments Welfare Association v. NBCC (India) Ltd., (2022) 1 SCC 401
