The Supreme Court recently set aside order of compulsory and forced merger between 63 Moons Technologies Ltd (Formerly known as Financial Technologies India Ltd FTIL) and its subsidiary National Spot Exchange of India Ltd (NSEL). It was the first time in history that Govt. invoked Section 396, for non-government companies, which provides merger in the public interest. The Apex court ruling discusses constitutional principles and nuances of corporate laws to come to a finding that merger order was not in ‘public interest’.
Background of the Case
FTIL is a listed company holding 99.99% shareholding of the NSEL. NSEL provided an electronic platform for trading of commodities between buyers and sellers. In July 2013, 13,000 persons who traded on the platform of NSEL claimed to have been duped by other trading members, who defaulted in payment of obligations amounting to approximately Rs.5600 crore! The transactions on the NSEL were to result in actual deliveries of commodities but it was found that there were no commodities or there were inadequate commodities in the warehouses of NSEL for affecting such deliveries. As a result, over 13,000 investors, with claims of over Rs. 5600 crores, neither received the commodities nor the amounts due to them from the defaulters or from the settlement guarantee fund created by NSEL. Reacting to this crisis, Forward Market Commission (FMC) ordered Forensic Audit, Inspection of books of accounts etc. of NSEL and suggested merger between NSEL and its holding company i.e FTIL so that FTIL resources can be used to pay off liabilities of NSEL.
Section 396 of the Companies Act, 1956
Section 396 empowers the Government to order compulsory amalgamation of two or more companies where it is satisfied that it is essential in the ‘public interest’ to do so. The Bombay High Court and the Supreme Court in particular analyzed in great detail as to whether it was ‘essential’ and in the ‘public interest’ to merge the two companies.
Findings of the Bombay High Court
The Petitioner contended that the shareholders or creditors of FTIL were deprived of opportunity of appeal under Section 396(3A) and therefore there is a breach of procedure prescribed in Section 396(4). Accordingly, the impugned order is ultra virus. They also contended that the merger between a loss making wholly owned subsidiary (NSEL) with its profit making holding company (FTIL) would lead to the diminution of economic value of shares. But the Bombay H.C rejected both the arguments and held that if the C.G by consolidating the businesses of NSEL and FTIL aims to restore confidence in commodity exchanges, the High Court see no reason to upset such a decision or hold that such a decision is not in public interest. Bombay H.C concluded that the action by the C.G was in furtherance of the legitimate aim, namely, ‘public interest’ and the means adopted by the C.G are quite suited to achieve public interest.
Findings of the Supreme Court
However, when the order of the Bombay High Court was considered by the Hon’ble Supreme Court, it viewed it differently. The Supreme Court findings qua 396 were as follows:
The ‘Corporate Veil’, is the basic doctrine of corporate law. A classic judgment decided by UK court in late 18s in Salomon V.S A Salomon & Co Ltd held that a company is a separate legal entity distinct from its members. This case held its importance till date and almost every country following this ‘Separate Legal Entity distinct from its Members’ principle including India. Although, this corporate veil may be lifted but only where a company has been constituted with the sole intention of acting as a façade to perpetrate a fraud.
The judgment of Supreme Court has far-reaching implications. If Section 396 is permitted to be used in this case, it would circumvent the long established legal fiction and permit a claimant to seek recovery of dues from the members of the holding company. It is difficult to see how such action could be said to be ‘essential’ or in ‘public interest’ when it is tantamount to bringing down two entities instead of liquidating one which has no hope of restructuring or survival.
In a capitalist economy, the principles of limited liability of corporate entity separate from the holding company constitute the very foundation of corporate growth. The shareholders and creditors of a listed holding company cannot be mulcted to satisfy debts of a subsidiary company.