HC disapproves scheme of arrangement which was designed to avoid repayment of creditors

HIGH COURT OF ANDHRA PRADESH

Model Financial Corpn. Ltd.

versus

A.P. Mahesh Co-operative Urban Bank Ltd.

Ramesh Ranganathan, J.

C.P. Nos. 83 & 84 of 2002
C.A. Nos. 182 & 183 of 2002, 1218 of 2007 & 221 of 2009

NOVEMBER  2, 2012

JUDGMENT

1. C. P. No. 83 of 2012 is filed by Model Financial Corporation Ltd. (hereinafter called the “transferor company”), and C. P. No. 84 of 2012 is filed by M/s. Model Chit Corporation Ltd. (hereinafter called “the transferee company”), seeking sanction of this court, under sections 391 to 394 of the Companies Act, 1956 (“the Act”), to the proposed scheme of arrangement between both the companies and their respective shareholders and bondholders.

2. The transferor company was incorporated as a private limited company on April 20, 1987, under the name and style of “Model Housing and Finance P. Ltd”. The name of the company was, thereafter, changed to “Model Housing and Finance Ltd.”, and a fresh certificate of incorporation was issued on February 11, 1992. Subsequently the petitioner again changed its name to “Model Financial Corporation Ltd.”, and a fresh certificate of incorporation was issued by the Registrar of Companies, Andhra Pradesh on August 20, 1993. The registered office of the transferor company is situated at Hyderabad. Its authorised share capital is Rs. 15,00,00,000 divided into 1,00,00,000 equity shares of Rs. 10 each, and 50,00,000 preference shares of Rs. 10 each. The issued, subscribed and paid-up share capital of the transferor company, as at September 30, 2001, was Rs. 3,99,92,000 divided into 39,99,200 equity shares of Rs. 10 each fully paid-up. The main objects, for which the transferor company was incorporated, were to purchase, lease or otherwise acquire land, plots, construct and erect houses, buildings, flats on such land or plots, pull down old structures or acquire, rebuild, enlarge, improve, expand, alter existing houses, buildings and flats ; to act as contractors for the construction of buildings of all descriptions, roads, bridges, dams, etc. ; and to carry on and undertake the business of leasing and hire purchase, to finance lease operations of all kinds, purchasing, selling, hiring or letting on hire all kinds of plant and machinery, equipment and vehicles. For the financial year ending September 30, 2001, the transferor company suffered a loss before tax of Rs. 5,80,53,308 which, along with the accumulated losses of the previous years, was carried forward to the balance-sheet, as at September 30, 2001, as a loss of Rs. 6,10,47,079. The board of directors of the transferor company, in their meeting held on March 5, 2002, approved the scheme of arrangement.

3. The transferee company was incorporated on August 17, 1995. Its registered office is also situated at Hyderabad. The authorised share capital of the transferee company, as at March 31, 2001, was Rs. 5,00,00,000 divided into 50,00,000 equity shares of Rs. 10 each. Its issued, subscribed and paid-up share capital, as at March 31, 2001, was Rs. 86,20,900 divided into 8,62,090 equity shares of Rs. 10 each. The main objects, for which the transferee company was incorporated, were to organise, establish, support or aid in the organisation, establishment and support of chit series and, thereby, develop the habit of savings ; and to act as foreman for any of the chit fund series for the promotion of chits. For the financial year ending March 31, 2001, the transferee company made a profit, after tax of Rs. 1,69,04,473 which, along with the accumulated profits for the previous years and after appropriations, was carried forward to the balance-sheet, as at March 31, 2001, as a profit of Rs. 2,54,80,476. However, its subsidiaries, i.e., Model Chit Corporation (Karnataka) Ltd., suffered a loss of Rs. 7,59,643 for the financial year ending March 31, 2001, which, along with the accumulated losses of the previous years, was carried forward to the balance-sheet as at March 31, 2001, as a loss of Rs. 31,24,650. Likewise, another subsidiary, viz., Model Chit Corporation (Chennai) Ltd., made a profit after tax for the year ending March 31, 2001, of Rs. 2,83,312 which, after adjustment of its previous years accumulated losses of Rs. 18,57,502 was transferred to the balance-sheet, as at March 31, 2001, as a loss of Rs. 15,74,190. The board of directors of the transferee company, in their meeting held on March 5, 2002, approved the scheme of arrangement.

4. This court admitted both the company petitions on June 24, 2002 and, by order in C. A. No. 531 of 2002 dated July 11, 2002, granted stay of all proceedings, including filing of civil suits, for a period of eight weeks. The said interim order was extended until further orders on September 4, 2002. Thereafter, by order dated December 10, 2002, this court directed that the interim order, passed in C. A. No. 531 of 2002, be continued till the final disposal of C. P. Nos. 83 and 84 of 2002. This court, however, observed that the transferor should file an undertaking before this court that they would not dilute, or in any manner alter, the securities furnished in favour of the creditors. The secured creditors, i.e., A. P. Mahesh Co-operative Urban Bank Ltd., State Bank of Hyderabad, Lakshmi Vilas Bank Ltd., Andhra Pradesh Industrial Development Corporation (APIDC), etc., were permitted to come on record.

5. By order in C. P. Nos. 83 and 84 of 2002, dated June 25, 2003, this court rejected sanction of the proposed scheme of arrangement, and dismissed both the company petitions holding that the meetings of the secured creditors of the transferor company, and one of the secured creditors of the transferee company, were not held ; the Reserve Bank of India had cancelled the certificate of registration of the transferor company, and had prohibited them from carrying on the business of a non-banking financial institution ; the transferor company had been prohibited from accepting deposits and alienating its assets, with the exception that it was under an obligation to repay public deposits ; in view of the said prohibition the scheme of arrangement, which provided for assignment of book debts in favour of the transferee company, could not be legally permitted as it amounted to a transfer ; the main thrust of the scheme was assignment of book debts of the transferor in favour of the transferee in consideration whereof the transferee had agreed to settle the dues of the bondholders ; section 12 of the Chit Funds Act, 1982, prohibited chit fund companies from carrying on any business other than chit business unless necessary permission was obtained ; the dues of one of the secured creditors of the transferee, viz., Lakshmi Vilas Bank Ltd., had been adjusted, the transferee company had not adjusted its dues with another secured creditor, namely, IREDA, New Delhi ; no leave had been sought by the transferee company for not convening and holding meetings of the secured creditors ; and the existing scheme of arrangement could not be sanctioned by this court until the transferor company had obtained necessary permission from the State Government in view of the express bar in section 12 of the Chit Funds Act, 1982.

6. Aggrieved by the order passed by this court, in C. P. Nos. 83 and 84 of 2002 dated June 25, 2003, both the petitioner-companies preferred O. S. A. Nos. 69 and 71 of 2003 respectively. This court, by order in C. A. Nos. 1126 and 1405 of 2003 in O. S. A. No. 69 of 2003 dated December 24, 2003, modified the earlier order of stay granted on October 22, 2003 and observed that the proceedings pending before the Debts Recovery Tribunal initiated by the State Bank of Hyderabad, and other consortium banks/institutions, could go on in accordance with law ; and the decision, if any, rendered would be subject to further orders to be passed in the appeal ; the proceedings, if any, initiated by other creditors pending before whatever forum, including the Consumer Forum, could also go on, and the result thereof would be subject to the further orders passed in the appeal ; and the transferor company, its managing director and directors were restrained from alienating any of the properties which were the subject-matter of mortgage or guarantee in whatever form.

7. Both O. S. A. Nos. 69 and 71 of 2003 were allowed, by order dated January 30, 2006, by the Division Bench holding that the Chit Funds Act, 1982, did not apply to the State of Andhra Pradesh, as no notification had been issued by the Central Government under section 1(3) of the Chit Funds Act, 1982, with respect to the State of Andhra Pradesh. The order passed in C. P. Nos. 83 and 84 of 2002 dated June 25, 2003, was set aside, and the company petitions were remanded back for fresh hearing. The Division Bench also allowed an application filed by Ms. Leela Devi to be arrayed as a respondent in the company petitions. As a result of both the OSAs being allowed the interim order, passed in C. A. Nos. 1126 and 1405 of 2003 in O. S. A. No. 69 of 2003 dated December 24, 2003, ceased to remain in force (Mrs. KavitaTrehan v. Balsara Hygiene Products Ltd., AIR 1995 SC 441 and Spg. Corp. of India Ltd. v. Machado Bro, AIR 2004 SC 2093) ; and the earlier interim order, granting stay of all proceedings including filing of civil suits, passed in the company petitions stood revived.

8. Before sanctioning a scheme of arrangement, the court must be satisfied that the statutory provisions are complied with ; in case a meeting of the members, or a class of members or of the creditors or a class of creditors, is called for, the class is fairly well represented ; and the scheme of arrangement is such as a man of business would reasonably approve. It is the commercial wisdom of the parties to the scheme, who have taken an informed decision about the usefulness and propriety of the scheme supporting it by the requisite majority vote, that has to be kept in view by the court. The court would not act as a court of appeal and sit in judgment over the informed view of the parties to the compromise as it has neither the expertise nor the jurisdiction to delve deep into the commercial wisdom of the creditors and members of the company who had ratified the scheme by the requisite majority. The company court’s jurisdiction to that extent is peripheral and supervisory and not appellate. The supervisor cannot ever be treated as the author or the policy-maker. The propriety and the merits of the compromise or arrangement has to be judged, by the parties who as sui juris, with their eyes open and fully informed about the pros and cons of the scheme, arrive at their own reasoned judgment and agree to be bound by such a compromise or arrangement. The court cannot scrutinise the scheme to find out whether a better scheme could have been adopted by the parties (Miheer H. Mafatlal v. Mafatlal Industries Ltd. [1996] 10 SCL 70 (SC).

9. When a scheme of arrangement of a company is placed before the court for its sanction, the court should, in the first instance, direct holding of the meetings in the manner stipulated in section 391 of the Act. This court, by order in C. A. No. 182 of 2002 dated March 20, 2002, directed that the meeting of both the shareholders and the bondholders of the transferor company be convened and held on April 29, 2002 and appointed an advocate of this court as the chairman to convene and hold the meeting. By its order in C. A. No. 344 of 2002, this court appointed another advocate to convene and hold the meeting. The chairman of the meeting, in his report submitted to this court, stated that 190 shareholders and 1,831 bondholders had attended the meeting either personally or by proxy ; the managing director had shown a short multimedia presentation ; the representatives of the press and television had tried to enter the meeting hall, but were prevented from doing so ; the police were asked to be present to avoid any untoward incident during the course of the meeting ; the views expressed by some of the members, who were the shareholders of the company, had been noted ; the shareholders holding 2,09,37,400 shares had voted in favour of the proposed scheme of arrangement, and the shareholders holding 7,000 shares had voted against the scheme ; the total value of the valid bondholders, who voted for the proposed scheme, was Rs. 6,44,02,000 ; and the value of the bondholders, who voted against the scheme, was Rs. 32,66,000.

10. On the question whether, in a scheme of arrangement between the company and its members and a class of its creditors (bondholders) a meeting of the other classes of creditors (both secured and unsecured), must be held, it is necessary to note that section 391(1) enables the court, on the application of a company or a creditor or a member of the company, to order a meeting of the creditors/or the members “as the case may be” to be held and conducted in such manner as the court directs. Under section 391(2), if a majority representing three-fourths in value of the creditors or members agree, in the meeting, to approve the compromise or arrangement, the scheme, on its sanction by the court, would be binding on all the creditors/members “as the case may be”, and also on the company. The expression “as the case may be” finds place both in sub-sections (1) and (2) of section 391. If the words “as the case may be” in section 391(1) is construed as requiring the court to order the meeting of only the members, in a scheme of arrangement between the company and its members, and only a meeting of a class of creditors in a scheme of arrangement between the company and such class of creditors, should the expression “as the case may be” in section 391(2) not be read as to bind only the members where a meeting of the members is held, and such creditors where a meeting of a class of creditors is held ? The safeguard in the provision, of three-fourths the members or creditors in value voting in the meeting to approve the scheme, is that the wishes of a majority of the class should prevail, and the dissenting minority of one-fourth or less of the class should not be permitted to derail the scheme of arrangement unless, of course, the court, on examining the scheme, finds that the objection of the minority is justified. If no meeting of the creditors is required to be held, in a scheme of arrangement between the company and its members, then, in the absence of ascertaining whether three-fourths in value of the creditors approve the scheme or not, would the court be justified in statutorily imposing such a scheme of arrangement on the creditors, even though their consent has not been obtained or their wishes ascertained ? If it were held that not holding the meeting, and ascertaining the wishes of the creditors, would result in the scheme of arrangement not to bind them, would the very purpose of the scheme being sanctioned by the court not be defeated, and approval of the scheme not be an exercise in futility ? If, on the other hand, the view, that a meeting of the creditors/members must necessarily be held in all cases, irrespective of whether the scheme of arrangement is between the company and its members or the creditors, is accepted would that not render the words “as the case may be” in section 391(1) mere surplusage ?

11. One view expressed by courts is that the creditors are not entitled, as of right, to participate in the process of consideration of sanction of the scheme, as the Act does not contain a specific provision for notice being given to the creditors at any stage either prior to the making of the order or subsequent thereto, except in so far as the creditors may have notice of it by public advertisement (Union of India v. Asia Udyog P. Ltd. ) [1974] 44 Comp. Cas. 359 (Delhi), and that the Legislature has cast a duty on the court to ascertain whether the scheme affects the interests of the creditors to such an extent that holding of their meeting is essential and, if the court is of the view that the interests of the creditors would be adversely affected, it could refuse to sanction the scheme unless their consent has been obtained (Ansal Properties and Industries Ltd., In re [1978] 48 Comp. Cas. 184 (Delhi)).

12. Another facet of this view is that, under section 391 of the Act, a compromise or arrangement is either between a company and its creditors or between a company and its members. In case of an arrangement between the company and its members, the arrangement is the result of an agreement between the company and its members and there is, therefore, no provision for the participation of persons other than the members of the company to vote on an arrangement proposed between a company and its members (Nava Bharat Ferro Alloys Ltd., In re [1997] 14 SCL 267 (AP) ; Mafatlal Industries Ltd., In re [1995] 84 Comp Cas 230 (Guj) ; Coimbatore Cotton Mills Ltd. & Lakshmi Mills Co. Ltd.,In re [1980] 50 Comp Cas 623 (Mad) and Telesound India Ltd., In re [1983] 53 Comp Cas 926 (Delhi)).

13. Yet another view is that section 391(1) gives a discretion to the court to convene a meeting of the creditors or any class of them ; the court would exercise the discretion by convening a meeting of creditors, if the creditors are likely to be adversely affected by an arrangement between the company and its members ; attending the meeting and voting are steps of participation in the process of consideration of the scheme ; if the creditors have no right of hearing at the time of hearing of the petition under section 391, the only way of ascertaining whether the creditors are affected or not would be through the wishes of the creditors expressed by them in a meeting which the court is entitled to convene under sub-section (1) of section 391 ; and, therefore, the court would exercise discretion as a matter of course to convene a meeting of the creditors of the company under sub-section (1) of section 391 unless the court is, prima facie, satisfied that the interests of the creditors are not likely to be adversely affected by the scheme (ICICI Bank Ltd., In re [2002] 104 Bom. LR 399).

14. In cases where the scheme of arrangement involves the company and one class of creditors, the wishes of the other classes of creditors, more particularly public sector/scheduled banks, must be ascertained as the scheme may adversely affect their interests. In the present case both the transferor and the transferee companies have neither convened a meeting of their secured creditors (other than bondholders) nor was their no objection/consent obtained for the proposed scheme of arrangement. Company Application No. 794 of 2002 was filed by the State Bank of Hyderabad wherein, while referring to the dues of the transferor company, to the consortium banks, it is stated that they were opposing the scheme of arrangement. Reference is made to the fact that the computation statement for Rs. 50 lakhs was erroneous ; the pre-closed contracts included in the stock statement was for Rs. 8.53 lakhs ; the expired hire purchase agreements shown in the stock statement was for Rs. 3.72 lakhs ; there were discrepancies in the documents, such as non-availability of insurance, non-registration of charges, and non-filing of Form Nos. 8 and 13 with the Registrar of Companies ; and the company was due Rs. 272.63 lakhs to the State Bank of Hyderabad as on September 26, 2002. While Sri V. S. Raju, learned counsel for the petitioners, would submit that the dues of the State Bank of Hyderabad were subsequently repaid, no document has been placed before this court in proof thereof. The affidavit filed by the State Bank of Hyderabad, in C. A. No. 794 of 2002, details the dues to various secured creditors of the transferor company as on September 26, 2002 :

15. In the counter affidavit dated July 18, 2007, filed on behalf of APIDC, it is stated that APIDC had invested Rs. 30,00,000 for purchase of 2,00,000 equity shares of Rs. 10 each at a premium of Rs. 5 per share ; in addition, they had sanctioned the transferor company, on January 18, 1997, a bill rediscounting facility of Rs. 100 lakhs for a period of 12 months, which was later reduced to Rs. 55,00,000 ; and, as security for these dues, the transferor had offered its property, situated at Model House, Panjagutta, Hyderabad, as a collateral. The said affidavit narrates in detail the several attempts made by APIDC to recover their dues by offering a one-time settlement, but to no avail ; proceedings were initiated, under section 29 of the State Financial Corporations Act, 1951 and the property offered as collateral security was seized, though it was not in a functional state ; the representatives of the transferor had appeared at the scene, and had carried away all furniture and files ; and no records were available in the said building. While denying the allegation that it was only because of the seizure that the transferor had been rendered dysfunctional, APIDC would submit that the transferor was carrying on its business from another premises in the same complex.

16. Sri P. V. Ravinder Kumar, learned counsel for APIDC, would submit that a sum of Rs. 1.55 crores was due to APIDC from the transferor company towards the bill discounting facility ; and Rs. 7.63 crores towards share capital. Learned counsel would submit that APIDC is not willing to give its consent to the proposed scheme of arrangement, as the scheme is prejudicial to its interests ; if a meeting of the secured creditors of the transferor company had been called for, APIDC would have opposed the scheme of arrangement ; and, in view of the interim stay granted by this court in the company petitions, APIDC has not been able to recover their entire dues for the past more than a decade.

17. In their affidavit, filed in support of C. A. Nos. 933 and 934 of 2002, A. P. Mahesh Co-operative Urban Bank Ltd., would submit that the transferor was due and payable Rs. 67,81,000 as on the date of filing of C. A. No. 182 of 2002, along with interest thereon ; arbitration proceedings have already been initiated against the transferor before the Registrar of Co-operative Societies ; and an order of attachment before judgment was passed therein.

18. Sri V. S. Raju, learned counsel for the petitioners, does not dispute that the amounts due to A. P. Mahesh Co-operative Bank have not been paid or that arbitration proceedings are still pending. Learned counsel would submit that a substantial portion, of the principal due to the bondholders, has been repaid. In this context it is necessary to note that this court, by its proceedings dated February 23, 2012, acceded to the request of Sri V. S. Raju, learned counsel for the petitioners, for grant of a week’s time to file a statement giving details of the amounts paid by the petitioners to the chit subscribers. Thereafter, the matter underwent several adjournments, despite which no affidavit, furnishing details of the amounts, if any, paid either to the bondholders or the other secured or unsecured creditors of either of the two companies, has been filed.

19. As is evident from the earlier order passed by the learned single judge, in C. P. Nos. 83 and 84 of 2002, even the transferee company did not obtain the no objection/consent of IREDA, New Delhi, to the proposed scheme of arrangement though the transferee owed them Rs. 3,69,12,000 as at March 31, 2001. It does not also appear that the transferee had obtained the no objection/consent of their creditors to the proposed scheme of arrangement, i.e., creditors who had advanced term loans, overdrafts and loans under hire-purchase agreements to the transferee company. Failure of both the transferor and transferee companies either to obtain the consent or to convene and hold a meeting of such secured creditors is a factor which should weigh with this court in deciding whether or not to accord its sanction to the scheme of arrangement. The interests of the creditors, more particularly the secured creditors, viz., public sector banks/financial institutions would, undoubtedly, be adversely affected by the scheme as the scheme involves payment of a portion of the dues of another class of creditors, i.e., the bondholders, without providing for any mode of payment of the dues of the other classes of creditors. As the secured and unsecured creditors of both the transferor and transferee companies, other than the bondholders, have not given their consent, the proposed scheme of arrangement does not merit sanction by this court.

20. Under the proviso to section 391(2), no order sanctioning any compromise or arrangement shall be made unless the court is satisfied that the company has disclosed to the court, by affidavit or otherwise, all material facts relating to the company, such as the latest financial position of the company, the latest auditor’s report on the accounts of the company, the pendency of any investigation proceedings in relation to the company under sections 235 to 251, and the like. In every case the court needs to know at least the general purpose of what is proposed under the scheme. Since many applications are unopposed, and the company court hears only from the applicant-company, it would be undesirable to dilute in any way the applicant’s duty of full and frank disclosure to the court (Buckley on the Companies Acts (14th edition, 1981, Butterworths), Volume 1, page 180). The proviso appended to sub-section (2) of section 391 is mandatory in nature. It is incumbent upon the court to satisfy itself about the financial soundness of the company before it puts its seal of imprimatur on the scheme of arrangement (Maneckchowk& Ahmedabad Manufacturing Co. Ltd.,In re [1970] 40 Comp Cas 819 (Guj), Premier Motors P. Ltd. v. Ashok Tandon[1971] 41 Comp Cas 656 (All), Navjivan Mills Co. Ltd., In re [1972] 42 Comp Cas 265 (Guj), Bhagwan Singh and Sons P. Ltd. v. Kalawati[1986] 60 Comp Cas 94 (Delhi), Bharat Synthetics Ltd. v. Bank of India [1995] 82 Comp Cas 437 (Bom), Aradhana Beverages & Foods Co. Ltd., In re [1998] 16 SCL 681 (Delhi), KEC International Ltd. v. Kamani Employees Union [2002] 109 Comp Cas 659 (Bom) and Deepika Chit Fund (P.) Ltd.,In re [2004] 56 SCL 566 (AP).

21. Both the company petitions were filed on June 13, 2002 and it is asserted therein that no investigations or proceedings are pending under sections 235, 237 or other provisions of the Act or under any Act against the transferor or the transferee companies. The balance-sheets of the transferor dated September 30, 2001 and that of the transferee dated March 31, 2001, were filed along with the company petitions. Though both the company petitions have been pending on the file of this court for the past more than a decade, none of the subsequent balance-sheets of either the transferor or the transferee companies have been placed before this court. The requirement of both the companies placing their latest financial position, and the latest auditor’s reports on the accounts of their companies, as stipulated under the proviso to section 391(2), is not satisfied.

22. Section 393(1)(a) stipulates that, where a meeting of the creditors or any class of creditors, or of members or any class of members, is called for under section 391, with every notice calling the meeting, which is sent to a creditor or member, there shall be sent also a statement setting forth the terms of the compromise or arrangement and explaining its effect. The requirement under section 393(1)(a) is to state and explain the effect, and not the details or particulars of the consequence or result. The basis of working, on which a certain consequence or result would flow from the scheme, is not required to be stated. It is only the resultant effect of the scheme which is required to be stated (Jitendra R. Sukhadia v. Alembic Chemical Works Co. Ltd. [1988] 64 Comp Cas 206 (Guj)). Section 393 is mandatory in terms. The statement, in strict conformity with section 393(1), must be annexed to the notice convening the meeting, and sent to the members or creditors (Navjivan Mills Co. Ltd., In re [1972] 42 Comp Cas 265 (Guj)). The court, before approving a scheme of arrangement, must be satisfied that the body of persons, entitled to vote at the scheme meeting, has been properly informed by an explanatory statement which is required to be sent to all persons entitled to vote, setting out the matters which they should take into account when considering how to cast their votes (M. B. Group plc, In re [1989] BCLC 672). All relevant facts must be properly set out in the explanatory memorandum before the scheme meeting ; and all known and relevant circumstances, being both accurate and kept up to date, should be disclosed (Jessel Trust Ltd., In re [1985] BCLC 119 and M.B. Groupplc, (supra).

23. The transferor company was required, under section 393(1)(a), not only to set forth the terms and conditions of the scheme of arrangement, but also to explain its effect. A copy of the scheme was required to be enclosed to the notice sent to each bondholder before the meeting was held. Sri V.S. Raju, learned counsel for the petitioners, would submit, across the bar, that the transferor company had issued bonds of Rs. 1,000 each for periods ranging from 12 to 18 months carrying interest at the rate of 15 per cent. per annum. As shall be explained in detail hereinafter, the scheme of arrangement, for which sanction is sought from this court, provides, among others, for the transfer of bonds and shares of the transferor company to the transferee. In effect, repayment of the bonds, of the bondholders of the transferor, is required to be made by the transferee in the manner prescribed by clauses 7 to 9 of the scheme of arrangement.

24. The manner of repayment of each bond of Rs. 1,000 is :

(a)          shares in the transferee company for Rs. 125 would be allotted towards 50 per cent. of each bond, i.e., for an extent of Rs. 500 of each bond of Rs. 1,000 (clause 7.1 of the scheme) ;

(b)          as a consequence thereof, each bondholder is required to forego Rs. 375 for each bond of Rs. 1,000 ; and

(c)          the remaining 50 per cent. of each bond of Rs. 1,000, i.e., Rs. 500 is to be repaid in the following manner :

(i)           50 per cent. thereof, i.e., Rs. 250 for each bond of Rs. 1,000 is to be redeemed in cash by the transferee company within thirty days after the transfer date or the effective date whichever is later (clause 8) ; and

(ii)          the remaining balance of Rs. 250 on each bond of Rs. 1,000 is to be repaid and redeemed after the transfer date, after conversion into equity shares as per clause 7 of the scheme, and part-redemption as per clause 8 of the scheme by September 30, 2003 (clause 9).

25. As the scheme defines “transfer date” to mean September 30, 2002 and the “effective date” to mean the date on which the certified copy of the order of this court, sanctioning the scheme of arrangement, is filed with the Registrar of Companies, sections 7 to 9 of the scheme, when read together, required the transferee to issue shares of Rs. 125 and pay Rs. 500 in cash, for each bond of Rs. 1,000 latest by September 30, 2003. Though the bond agreement required the transferor to pay interest at 15 per cent.per annum to each bondholder, the said interest stood frozen as on September 30, 2002, in terms of clause 1.4 of the scheme. The scheme not only requires each bondholder to forego Rs. 375 but also to forego interest at 15 per cent. per annum after September 30, 2002, on each bond of Rs. 1,000. The petitioners could not have been unaware that delay in sanction of the scheme would render the date, stipulated in clause 9 of the scheme, i.e., “September 30, 2003” redundant. The effect of the scheme was not explained to the bondholders, nor were they made aware that delay in obtaining sanction of this court, to the scheme of arrangement, could result in their payment, of either the share component of Rs. 125 per bond of Rs. 1,000 or the cash component thereof of Rs. 500 being delayed far beyond September 30, 2003 (i.e., the date stipulated in clause 9 of the scheme). Full and frank disclosure of the effect of the scheme, in the explanatory memorandum enclosed to the notice sent to each bondholder, is an essential prerequisite for this court to hold that the convened meeting of the bondholders is valid. The very purpose of requiring the effect of the scheme of arrangement to be explained, in the explanatory memorandum, before the scheme meeting is held, is to ensure that the body of persons, entitled to vote at the scheme meeting, have been properly informed of all necessary facts which they should take into account when considering how to cast their votes whether in favour of or against the scheme of arrangement. It is evident that failure of the petitioners, to explain the effect of the scheme to the bondholders, has resulted in their exercising their vote without comprehending the effect and purport of the scheme in its entirety. In failing to explain the effect of the scheme to the shareholders and bondholders, the petitioners have violated the mandatory requirements of section 393(1)(a) of the Act. The bondholders of the transferor company have also been misled into believing that they would be paid one-fourth of the bond amount, i.e., Rs. 250 per bond of Rs. 1,000 latest by September 30, 2003. The subsequent events show that the transferor never had any intention of adhering to this time frame. As the mandatory provisions of section 393(1)(a) of the Companies Act are not satisfied, this court must refuse to accord sanction to the proposed scheme of arrangement on this ground also.

26. A reading of section 394A of the Act shows that the scheme of arrangement would not be sanctioned unless the court has considered the representation of the Central Government. In the counter affidavit, filed on behalf of the Central Government by the Registrar of Companies, reference is made to the contents of the scheme, and it is contended that assignment of the book debts of the transferor in favour of the transferee, and the proposal of the transferee to settle the dues of the bondholders of the transferor, were outside the purview of the business of the transferee and the transferor companies, and against the provisions contained in clause 12 of the Chit Funds Act, 1982. In view of the order of the Division Bench, in O. S. A. Nos. 69 and 71 of 2003 dated January 30, 2006, referred to hereinabove, this objection of the Central Government may not survive.

27. The court, before whom the scheme is placed, is not expected to put its seal of approval on the scheme merely because the majority of the shareholders have voted in favour of the scheme. Since the scheme, which gets sanctioned by the court, would also bind the dissenting minority shareholders or creditors, the court is obliged to examine the scheme in its proper perspective together with its various manifestations and ramifications to find out whether the scheme is fair, just and reasonable to the concerned members, and is not contrary to any law or public policy. The expression “public policy” though incapable of precise definition, connotes some matter which concerns the public good and the public interest (Sesa Industries Ltd. v. Krishna H. Bajaj [2011] 9 taxmann.com 218 Hindustan Lever Employees’ Union v. Hindustan Lever Ltd. [1995] 83 Comp. Cas. 30 (SC) and Central Inland Water Transport Corpn. Ltd. v. BrojoNathGanguly[1986] 60 Comp. Cas. 797 (SC). Before according its sanction to a scheme, the court has to see that the statutory majority has acted bona fide and in good faith and are not coercing the minority in order to promote any interest adverse to that of the latter comprising the same class whom they purport to represent ; and the scheme, as a whole, is just, fair and reasonable from the point of view of a prudent and reasonable businessman taking a commercial decision (Sesa Industries Ltd. (supra).

28. Is the scheme of arrangement, in the present case, in public interest ? The court cannot abdicate its duty simply because the statutory majority has approved it and there is no opposition to the scheme in court. It must scrutinise the scheme to find out whether it is an arrangement which can, by reasonable people conversant with the subject, be regarded as beneficial to those who are likely to be affected by it. In pursuit of such an enquiry the court is not tied down by any rigid principles or strait-jacket formulae. No enumeration contained in judicial decisions of the factors which can be taken into account, howsoever precise, can be treated as exhaustive so as to limit the scope of the inquiry which, having regard to varying circumstances, might differ from case to case. The burden lies on the petitioner-company to show that the scheme is fair, reasonable, workable and is such that a man of business would reasonably approve. The court would, of course, take into account the fact that it has been approved by a big majority vote, but it would not shirk its duty to scrutinise the scheme (Bank of Baroda Ltd. v. Mahindra Ugine Steel Co. Ltd. [1976] 46 Comp Cas 227 (Guj)). When it exercises the power, conferred on it by section 391(2), to sanction the scheme of compromise or arrangement, the court, by its act, is imposing the scheme on the dissenting members of that class. Before taking such an action, it would be open to the court to examine the scheme before imposing it on the unwilling/dissenting members of the class. Even if all the statutory formalities are duly carried out, the court has still the discretion either to sanction or refuse to sanction the scheme (Bank of Baroda Ltd. (supra) and Bengal Hotels (P.) Ltd., In re [1977] 47 Comp Cas 597 (Guj)).

29. The arrangement must fulfil some felt need, some purpose, some object and that must have some co-relation with public interest. The court is charged with a duty to ascertain whether its affairs have been carried on not only in a manner not prejudicial to its members but also that it is not against public interest. The expression “public interest” must take its colour and content from the context in which it is used (Union of India v. Ambalal Sarabhai Enterprises Ltd. [1984] 55 Comp Cas 623 (Guj)). The Indian law, a departure from the English law, enjoins a duty on the court to examine objectively whether the arrangement is, or is not, violative of public interest. What would be in public interest cannot be put in a strait-jacket. It is a dynamic concept which keeps on changing. It has been explained in Black’s Law Dictionary as :

“Something in which the public, the community at large, has some pecuniary interest, or some interest by which their legal rights or liabilities are affected. It does not mean anything so narrow as mere curiosity, or as the interests of the particular locality which may be affected by the matters in question. Interest shared by citizens generally in affairs of local State or National Government.”

30. It is an expression of wide amplitude. A scheme, valid and good, may yet be bad if it is against public interest. The basic principle of the satisfaction, that the scheme is not contrary to public interest, is none other than the broad and general principles inherent in any compromise or settlement entered into between the parties that it should not be unfair or contrary to public policy or unconscionable. The courts have evolved the principle of “prudent business management test” or that the scheme should not be a device to evade the law (Hindustan Lever Employees’ Union (supra). No court of law would ever countenance any scheme of compromise or arrangement if it finds that it is an illegal scheme or is otherwise unfair or unjust to the class of shareholders or creditors for whom it is meant. The fairness of the scheme, qua the disputing minority shareholders or creditors, also has to be kept in view by the High Court while putting its seal of approval on the scheme.

31. The High Court should examine whether the proposed scheme of compromise and arrangement is violative of any provision of law and is not contrary to public policy. For ascertaining the real purpose underlying the scheme with a view to be satisfied on this aspect, the court, if necessary, can pierce the veil of apparent corporate purpose underlying the scheme and can judiciously x-ray the same. The High Court must also ensure that the scheme as a whole is also just, fair and reasonable from the point of view of prudent men of business taking a commercial decision beneficial to the class represented by them for whom the scheme is meant (Miheer H. Mafatlal (supra)).

32. Clause 1.4 of the scheme of arrangement defines “bonds” to mean the secured bonds issued by the transferor company and assigned under this scheme to the transferee company and remaining to be redeemed inclusive of interest accrued thereon but not paid as on September 30, 2002. Clause 1.6 of the scheme defines “transfer date” to mean September 30, 2002, i.e., the date of assignment and vesting of the shares and bonds in the transferee company, pursuant to the scheme, as per the orders of the High Court of Andhra Pradesh. Clause 1.7 defines “effective date” to mean the date on which a certified copy of the order of the High Court of Andhra Pradesh is filed with the Registrar of Companies, Andhra Pradesh, Hyderabad, under section 391(2) of the Companies Act, from which date the scheme is to come into effect. Clause 1.8 defines “record date” to mean the date, after the transfer date, fixed by the board of directors of the transferee company as the date on which the bondholders shall be eligible to be allotted equity shares of the transferee company, pursuant to the scheme. Clause 1.10 defines “assigned book debts” to mean the book debts comprising hire purchase lease rentals, and other debts, due and outstanding and/or payable as per the due dates specified in the respective contracts entered into by the transferor company with its borrowers amounting to Rs. 2,260.62 lakhs ; and assigned by the transferor, under the deed of assignment dated March 5, 2002, in favour of the transferee along with all rights, powers, interest, charges, privileges, etc. Clause 3 relates to assignment and, under clause 3.1 thereunder, with effect from the transfer date and in consideration of the dues payable by the transferee to the transferor on the assigned book debts and the obligations undertaken to be performed thereunder by the transferee company, the bonds and shares in the books of the transferor shall stand assigned to and vested in the transferee, along with all rights, privileges and interests thereto. Clause 3.2 stipulates that the assigned book debts shall be deemed to be assigned and vested in the transferee company as on the date of their assignment with effect from September 29, 2001, by the transferor. Clause 3.3 stipulates that, until and up to the transfer date, all dues, including interest at the contracted rate in respect of the secured bonds of the transferor company, shall be accrued and not paid for by the transferor company, and the same shall stand assigned and vested in the transferee company as on September 30, 2002, pursuant to the scheme.

33. Clause 7 of the scheme of arrangement relates to issue of shares by the transferee company and, under clause 7.1 thereof, with effect from the transfer date of the effective date, whichever is later, 50 per cent. of the value of the bonds for every Rs. 40 thereof shall stand converted, subject to deduction of income-tax at source if any, into one equity share of the face value of Rs. 10 each of the transferee company at the fair value of Rs. 40 per equity share as per the valuation determined by Deioitte Haskins and Sells, chartered accountants ; the bondholders, as on the record date, shall, subject to provisions of the scheme, be issued and allotted appropriate number of equity shares of the transferee company of the face value of Rs. 10 each in the share capital of the transferee company, which shall be credited as fully paid-up. What clause 7.1 of the scheme stipulates is that 50 per cent. of the value of the bonds, i.e., for Rs. 500 shall be converted into one-fourth of its value, i.e., shares for a value of Rs. 125 in the transferee which, in effect, would require each bondholder to forego Rs. 375 towards the principal amount due to them under each bond of Rs. 1,000. Even these equity shares are to be issued by the transferee company, in terms of clause 7.1 of the scheme, only with effect from the transfer date or the effective date whichever is later. While the transfer date has been stipulated, in clause 1.6 of the scheme, as September 30, 2002, the effective date is defined, under clause 1.7, to mean the date on which the certified copy of the order of this court, sanctioning the scheme of arrangement, is filed with the Registrar of Companies. As the effective date has not as yet arrived, the transferee company was neither obligated to nor has it issued even these equity shares worth Rs. 125 for each Rs. 500 of the bond of Rs. 1,000 each held by the bondholders of the transferor company. Clauses 7.1 and 1.8 of the scheme leave it to the unfettered discretion of the board of directors of the transferee company to fix the date on which the bondholders of the transferor are eligible to be allotted equity shares of the transferee company. The net result is that the bondholders of the transferor company have not received a single share, in terms of clause 7.1 of the scheme, till date. The other sub-clauses, of clause 7 of the scheme, relate to allotment of shares to the promoters, and need no reference in the present proceedings.

34. Clauses 8 to 11 of the scheme are, however, relevant. Clause 8 stipulates that the transferee company shall, within thirty days after the transfer date or the effective date whichever is later, effect redemption up to an extent of 50 per cent. of the amount of the bonds, in cash, held by bondholders after conversion in part into equity shares pursuant to the scheme, to those bondholders whose names appear in the register of bondholders on the date to be announced/notified for this purpose by the board of the transferee company. What clause 8, in effect, stipulates is that 50 per cent. of Rs. 500 (which is the remaining part of the amount due under each bond, after the adjustments effected in terms of clause 7.1), i.e., Rs. 250 for each bond of Rs. 1,000 shall be paid in cash after conversion of the other part of Rs. 500 of each bond of Rs. 1,000 into equity shares of Rs. 125 in the transferee company. As noted hereinabove, clause 7.1 has not been complied with till date, and 50 per cent. of each bond of Rs. 1,000 has not as yet been converted as equity shares for Rs. 125 in the transferee company. It is only after the conversion, in accordance with clause 7.1, does clause 8 require the transferee to redeem 50 per cent. of the remaining amount, i.e., Rs. 250 towards each bond of Rs. 1,000 in cash.

35. Clause 9 of the scheme of arrangement, in effect, provides for the repayment of Rs. 250 per bond of Rs. 1,000 to each bondholder by September 30, 2003, the bondholders of the transferor company approved the scheme of arrangement, in their meeting held on April 29, 2002, evidently on the premise that they would at least be repaid Rs. 250 in cash for each bond of Rs. 1,000 in terms of clause 9 of the scheme, latest by September 30, 2003. While fairly stating that the transferee company has not repaid this sum of Rs. 250 in cash to each bondholder by September 30, 2003, Sri V. S. Raju, learned counsel for the petitioners, would submit that, since clause 9 requires the balance amount of Rs. 250 to be paid in cash only after the transfer date and that too after conversion into equity shares as per clause 7 and part redemption as per clause 8, the stipulated date in clause 9, i.e., “September 30, 2003” loses significance, and it is only after clauses 7 and 8 are complied with, does clause 9 require the transferee to repay Rs. 250 in cash, for each bond of Rs. 1,000 to each bondholder, and not by September 30, 2003. The ambiguous language of clause 9 of the scheme has enabled the transferee company to misconstrue the conditions stipulated thereunder as requiring compliance only after clauses 7 and 8 of the scheme are complied with, and not by September 30, 2003.

36. Both the transferor and the transferee have, in effect, misused the provisions of the Companies Act governing sanction of a scheme of arrangement, and have avoided making payment to the bondholders either in cash or in the form of shares in terms of clauses 7.1, 8 and 9 of the scheme of arrangement. Pendency of these two company petitions, on the file of this court for more than a decade, has enabled the transferee company not only to avoid paying interest, but even the principal amount due to the bondholders of the transferor company.

37. Clause 10 of the scheme requires the transferee company, within 30 days after the transfer date or the effective date whichever is later, to create appropriate security in favour of the bondholders so that the existing level of security to the bondholders shall remain undiluted. As the effective date has not as yet arrived, and would come into force only after the scheme of arrangement is sanctioned by this court, the transferee company is not obligated, even in terms of clause 10 of the scheme, to create appropriate security in favour of the bondholders. Clause 11 stipulates that the equity shares to be allotted to the bondholders, and to the promoters, as per clause 7 of the scheme along with the existing equity shares of the transferee company shall be listed on the Stock Exchange at Hyderabad, Andhra Pradesh. The Stock Exchange at Hyderabad has, during the pendency of these company petitions on the file of this court, ceased to function, and no longer exists.

38. It is evident from the clauses referred to hereinabove, and from what has been narrated in this order earlier, that the bondholders were deliberately misled to believe that they would receive at least Rs. 250 in cash for each bond of Rs. 1,000, i.e., at least one-fourth of their principal latest by September 30, 2003. It is also clear that this scheme of arrangement was formulated by the petitioners only to avoid discharging the legitimate dues of the bondholders, even the principal amount due to them ; as also the legitimate dues of the other secured and unsecured creditors of both the companies. Proceeding on the premise that a majority of the shareholders/bondholders have approved the scheme (even if it be on a misunderstanding of its effect), this court is still not obligated to sanction the scheme; if it is satisfied that the scheme, as proposed, is against public interest. The scheme, as proposed in these company petitions, is but a ruse to avoid repayment of the dues of the creditors of both the petitioner-companies, and was filed only to obtain an order of stay from this court under section 391(6) of the Act. The petitioners have chosen not to pay their secured and unsecured creditors, and their bondholders, even the principal due to them for the past more than a decade as the interim order of this court protected them from being proceeded against/prosecuted in a competent court. I am satisfied that the scheme, as proposed by the petitioners, is against public interest.

39. The proposed scheme requires all bondholders (even those who voted against the scheme), to forego Rs. 375 ; receive Rs. 500 in cash, i.e., Rs. 250 at two different stages Rs. 125 in the form of shares of the transferee for each bond of Rs. 1,000 ; and to forego the prescribed rate of interest of 15 per cent. per annum, on each bond of Rs. 1,000 after September 30, 2002. It cannot, therefore, be said to be fair, just and reasonable to the concerned bondholders. As the scheme affects the interests of the other secured creditors also, failure to obtain their consent would render the scheme illegal and against public interest. The petitioners have not been able to discharge the burden of showing that the scheme is such that a man of business would reasonably approve or is one which can, by reasonable people conversant with the subject, be regarded as beneficial to those who are likely to be affected by it. Even from the point of view of a prudent and reasonable businessman, taking a commercial decision, the scheme, when, read as a whole, is not just, fair or reasonable. I see no reason, therefore, to sanction the scheme of arrangement which is the subject-matter of these two company petitions.

40. The petitioners, by procrastinating for the past several years, have also abused the process of court. I consider it appropriate, therefore, to dismiss the company petition with exemplary costs of Rs. 2,00,000 (rupees two lakhs only). Such costs of Rs. 2 lakhs should, rightfully have been paid to the bondholders/secured creditors of both the petitioner-companies as it is they, who have suffered for the last more than a decade, after the company petitions were filed, and are still to be paid even their principal in its entirety, let alone being paid interest thereon. It is, however, brought to my notice that there are a large number of secured creditors and bondholders, and it would be almost impossible to divide the costs, and search and pay the said costs to them. This difficulty notwithstanding, exemplary costs need to be imposed on the petitioners as it is only then would it deter unscrupulous litigants, such as the petitioners herein, from abusing the process of court. The petitioner shall therefore pay costs of Rs. 2,00,000 (rupees two lakhs only) to the Legal Services Authority, Andhra Pradesh High Court, Hyderabad within four weeks from today. Needless to state that the interim orders granted by this court, during the pendency of the company petitions, stand automatically vacated, and it is open to the secured and unsecured creditors, and the bondholders, of both the transferor and transferee companies to initiate/continue any proceedings which they may have initiated for recovery of their legitimate dues.

41. Company Petitions Nos. 83 and 84 of 2002 are, accordingly, dismissed with costs as mentioned hereinabove, and Company Applications Nos.1218 of 2007 and 221 of 2009 are disposed of accordingly.

NF