India: Binding Nature Of Scheme Of Arrangement Or Compromise

Last Updated: 16 January 2019
Article by Gaurav Tiwari

Introduction

Scheme of arrangement is a compromise or arrangement between the company and its creditors or between the company and its members.1 It includes the reorganisation of company's share capital by consolidation of shares of different classes or by division of shares into shares of different classes, or by both of those methods.2 It is taken as a form of financial and corporate restructuring including sale of assets or the business itself or amalgamation with another company.3 Moreover, 'Arrangement' means something analogous in some sense to a compromise.4 It also includes amalgamation which is blending of the two or more existing undertakings into one single undertaking, the shareholders of each blending companies becoming substantially the shareholders in the company which is to carry on the blended undertakings.5 It however has no precise legal meaning.6 But, arrangement as construed by courts, covers a broad array of transactions7 which are conducted according to a scheme, which is approved by a statutory majority be it the company and its members or the company and its creditors.

Is the scheme binding?

It is a clear position of law that a scheme once sanctioned comes to have a statutory force and has greater sanctity than a mere agreement between the parties affected by it.8

Once a scheme of compromise and arrangement is approved by statutory majority, it binds the dissenting minority. The company, its contributories and also the liquidator who is appointed in case the company is being wound up are bound by the terms of the scheme9. The reason being that once the scheme avails the sanction of the court, it binds the company and all its members, including those who voted against the scheme10.

The court always strives to maintain the sanctity of the scheme as it also reserves the power to stay proceedings at its discretion to allow time for a scheme of arrangement to be put into place. However, this jurisdiction to stay proceedings should only be exercised in exceptional circumstances.11 The court should also take into its purview general observations regarding a scheme as has been laid down in Re. CHPL Enterprises P. Ltd.(2000) 2 Comp. L.J. 218 (AP).12

How far can this scheme bind the parties and outsiders ?

However, an arrangement being made by a private party cannot therefore be used to bypass other statutes.13 This clearly means that the scheme has to be made in accordance with the law and not contrary to it. To overcome this problem, it was made necessary to get the sanction of the court to effectuate the scheme. However, this move does not exhaust the option of any of the affected party/parties to approach the court if the fact regarding its unlawfulness is discovered later on. Such party may also raise an objection if it was not given a reasonable opportunity to object before the court prior to court's sanction or during the course of hearing, provided the scheme suffered from no infirmity14.

The National Company Law Appellate Tribunal (NCLAT) for instance, has clarified that the National Company Law Tribunal (NCLT) is obligated to protect the public interest at large and may therefore reject the scheme of arrangement if it is not in public interest but limited to certain class of persons. This means that just because all the essentials of a valid scheme are fulfilled and no adverse observation is made by regulatory authorities, it shall not be construed to be in the public interest15. A scheme, even if it is in a nature of contract yet, after attaining statutory majority and the sanction of the court no longer remains just a contract. It attains the capacity to bind not just the parties to the scheme but also the outsiders.16 A third party is not permitted to file an objection to the scheme just because it affects some of his rights. Unless it is established that there is a violation of some substantive law, the scheme is rendered unaffected.17

For instance, in case where the scheme is objected to by a stranger who had a supply agreement with the transferor company claiming that the scheme was in breach of agreement with him, the court rejected his claim providing that he had no locus as he was neither a shareholder nor a creditor of the company. In case he suffers damages from the breach, such person is relegated to the appropriate forum to claim damages. The scheme therefore, was not disturbed as it was in public, shareholder and creditor interest accompanied by an all-round approval.18

Conclusion

We can therefore say that the scheme holds a position of sanctity once it receives the sanction of the court and cannot be disturbed unless there is a substantive law issue involved. The scheme shall also bind the outsider unless his substantial interests are at stake. It should not just be in the interest of creditors, members and the company itself, but it should also not be against public interest. There is no set formula to determine the all-round validity of the scheme but the court should with its iuris scientia, strike a balance between all the conflicting interests to uphold the scheme.

Footnotes

1 Advanced Law Lexicon, 5th Edn. Vol. 4 pg 4678

2 Section 230, The Companies Act, 2013

3 A. Ramaiya, A Guide to the Companies Act, 18th ed (Gurgaon: LexisNexis, 2015), at p. 3692

4 Re: Indian Petrochemicals . vs Unknown on 16 August, 2007 MANU/ GJ/7533/2007

5 Hal sbury Laws of England, 4th Edn. , Vol. 7, para 1539, p.855 cited in Singer India Ltd. v. Chander Mohan Chand, (2004) 7 SCC 1, 9, para 7

6 Saraswati Industrial Syndicate v. CIT, AIR 1991 SC 70, 72

7 Supra note 3

8 Srimathi Premila Devi v. People's Bank of Northern India Ltd. AIR 1938 PC 284

9 Navjivan Mills Ltd., In re (1972 42 Comp Cas 265(Guj)); Gupta(S.K.) v. K.P. Jain(1979) 49 Comm Cases 342, 350(SC)

10 ITW Signode India P. Ltd, Re [2004]121CompCas66(AP)

11 Bluecrest Mercantile BV v Vietnam Shipbuilding Industry Group. [2013] EWHC 1146 (Comm)

12 In para 45- The Court has also to satisfy itself that:

(1) Whether the provisions of the statute have been complied with;
(2) Whether the scheme is reasonable and practical or whether there is any reasonable objection to it;
(3) Whether the creditors acted honestly and in good faith and had sufficient information;
(4) Whether the Court ought in the public interest to override the decision of the creditors and shareholders

13 General Radio and Appliances Co. Ltd. & Ors. v. M.A. Khader(Dead) by Lrs. (17.04.1986) MANU/SC/0543/1986

14 Rasik S. Poladia v. Larsen & Toubro(2005) 2 Comp LJ 262(Bom)

15 Wiki Kids Ltd. & Anr. v. Regional Director & Ors. [2018]206CompCas147

16 Cape Plc, Re(2007) 2 BLCC 546

17 Essar Telecommunications Holdings P. Ltd. In re (2012) 106 CLA 95

18 Sequesnt Scientific Ltd., Re(2009) 151 Comm Cases 1)

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