India: Determination Of Classes Of Shareholders And Creditors In A Scheme Of Arrangement Under Sec.391- 394 Of The Companies Act, 1956

The court has to classify creditors or members if there are such classes and before sanctioning the scheme, to see that their respective interest are taken care of.1

The scheme of arrangement is a procedure under section 391-3942 of the companies act 1956 for obtaining court approval for compromise or arrangement between a company and its members and creditors. Essentially, a scheme can be used to bind a majority of creditors or members, as the court can sanction a scheme once it has been approved by a majority in number representing 75%3 in value of the class of creditors or members in question. There are complex technical issues which arise on scheme. One in particular is the question of Why creditors/ members should be put in different classes for the purpose of voting on the scheme.

MEANING OF THE WORD 'CLASS' UNDER SECTION 391-3944 OF THE COMPANIES ACT 1956 ?5

If the share of the company are classified into different kinds, such as equity, preference, deferred, promoters' non-voting, etc., they are said to be divided into different classes. Classification of share is based on the rights attached to the shares and to ascertain the rights reference must be made to the articles of association of the company. Likewise if there are various classes of creditors such as secured creditors, debenture holders, unsecured creditors, etc, the scheme has to be approved by the special majority of each class of creditors at their separate meetings. Therefore the group styled as a class should, ordinarily, be homogeneous and must have commonality of interest and the compromise offered to them must be identical.

WHAT CONSTITUTE CLASS? DETERMINATION OF CLASS/ CLASSES OF MEMBERS AND/ OR CREDITORS

The creditors composing the different classes must have different interests. When one finds a different state of facts existing among different creditors which may differently affect their minds and their judgment, they must be divided into different classes, 'class' must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest 6

In order to constitute a class, members belonging to the class must form a homogeneous group with commonality of interest. If people with heterogeneous interest are combined in a class, naturally the majority having common interest may ride roughshod over the minority representing a distinct interest.7

THE UK SUPREME COURT IN THE CASE OF

  • Nordic Bank plc v. International Harvester8 Australia Ltd laid down "what constitute Class"9 - The court does not itself consider at this point what class of creditors or members should be made parties to the scheme. The court said that it should be left for the company to decide in accordance with what the scheme purports to achieve. In this case rights of ordinary shareholders are to be altered, but those of preference shares are not touched, a meeting of ordinary shareholders will be necessary but not of preference shareholders. If there are different groups within the class of interest of which are different from the rest of the class, or which are to be treated differently under the scheme, such group must be treated as separate class for the purpose of the scheme.
  • Tritonia ltd., Re10 - In this case court held that when the company has decided what classes are necessary parties to the scheme, it may happen that one class will consist of a small number of persons who will all be willing to be bound by the scheme in that case it is not the possible to hold a meeting of that class, but to make the class a party to the scheme and to obtain the consent of all its members to be bound. It is however, necessary for at least one class meeting to be held in order to give the court jurisdiction under the section.

In The Case Before The Indian Supreme Court

  • Miheer H. Mafatlal v. Mafatlal Industries Ltd.11 Supreme court concluded that: It is obvious that unless a separate and different type of scheme of compromise is offered to sub – class of the class of creditors or shareholders otherwise equally circumscribed by the class, no separate meeting of such sub class of the main class of members or creditors is required to be convened. On the facts of the present meeting of dissenting minority equity shareholders represented by him.

WHAT SHOULD BE THE BASIS OF GROUPING THE MEMBERS OR CREDITORS?

A group of persons would constitute one class when it is shown that they have conveyed all interest and their claims are capable of being ascertained by any common system of valuation. The group styled as a class should ordinarily be

  • Homogeneous
  • Commonality of interest
  • Compromise offered to them must be identical.

This will provide a rational indicia for determining the peripheral boundaries of classification. In the authoritative case of Sovereign Assurance Vs Dodd12 a case concerning a scheme of arrangement, Bowen LJ said:

"It seems plain that we must give such a meaning to the term class as will prevent the section being so worked as to result in confiscation and injustice, and that it must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest."

Broadly speaking, a group of persons would constitute one class when it is shown that they have conveyed all interest and their claims are capable of being ascertained by any common system of valuation. The group styled as a class should ordinarily be homogeneous and must have commonality of interest and the compromise offered to them must be identical.13

So the conclusion can be drawn that if the members and creditors of the company have Divergent interests then they cannot be clubbed together into one class

CLASSIFICATION OF CREDITORS

Creditors can be divided into three categories of preferential creditors, secured creditors and unsecured creditors. All Unsecured preferential creditors can be treated as one class, and if, as will frequently be the case, all preferential creditor shall are to be paid in full, they will be single class whether or not some are secured and some are unsecured. Similarly all unsecured creditors will normally form a single class, except where some of them are to be treated in a manner different from the rest and have different interests which might conflict. In such a case fresh classes will be carved out.

  • Thus in the case of the insurance company the insured person whose policy have matured form a different class of creditors from those whose policies have not matured.14
  • Similarly where subordinate creditors have an interest in the company which could be affected in a way which is different from the effect upon other creditors, then they would constitute a separate class.15
  • In the case before the supreme court, Mihir H. Mafatlal v Mafatlal Industries Ltd.,16, One of the objection was that a sub- class meeting of members was not called. The Supreme court found no basis for classification of members into different classes. The court said: "On the express language of section 391(1) it became clear that where the compromise and arrangement is proposed between a company and its members or any class of them a meeting of such members or class of them has to be convened. This clearly presupposes that if the scheme is offered to any sub-class of member which has a separate interest and a separate scheme to consider, no question of holding a separate meeting of such a sub-class would at all survive." "consequently when one and the same scheme is offered to entire class of equity shareholders for their consideration and when commercial interest of the applicant so far as the scheme is concerned is in common with other equity shareholders, he would have a common cause with them either to accept or to reject the scheme from commercial point of view. There was no occasion for convening a separate class meeting of the minority equity shareholders represented by the appellant and his group as tried to be suggested. It is also to be kept in view that it is not the case of appellant that any different terms of compromise were offered to persons holding equity shares who were covered by the family arrangement of 1979 or otherwise. In fact the entire proposal of the scheme of arrangement was one affecting equally and in the like manner all the existing shareholder of the like company."
  • In the case of premier motors (p) ltd. v Ashok tendon17 it was held that Unsecured creditor will form a single class.
  • Creditors with competing rights – Creditors with competing rights should be treated as different classes. Such scheme should be approved by separate class meetings accordingly. This having not been done, the scheme was not sanctioned.18
  • Creditors meeting not necessary where scheme is only between members – in the case of ICICI Ltd. Re,19 - the transferor company prepared a scheme of merger with its subsidiary company. It sought a direction for convening the meeting of its equity shareholders no direction was sought for convening the meeting of its creditors. The applicant gave an undertaking to the court that if any objection was raised by any creditor at the time of hearing of petition, it would raise no objection and that the notice of hearing would be given in newspapers. The court said that though the court is bound to call a meeting of creditors where the proposed arrangement is only between members, and the creditors are not likely to be adversely affected.
  • In the case of In re, British and Commonwealth Holdings Ltd.20 The administrators of the company wishes to propose a scheme to dispose of assets not required for the purpose of administration. These assets would suffice to pay off the preferred creditors and to provide a dividend for the unsecured creditors. There was however a number of subordinate creditors who would receive nothing under the proposed scheme and wished to oppose it. It was held by the court that on true construction of the rights the subordinate creditors had no interest in the assets subject to the scheme and directed the administrators to apply to the court for the meeting of the creditors to be convened on the footing that the subordinate creditors would not be entitled to receive notice of the meeting or to vote at it. It was also suggested that if the subordinate creditors had had an interest in the assets which was different to those of the other creditors they would have constituted a separate class.21

SHOULD PERSONS WITH DIVERGENT INTERESTS BE ALLOWED TO VOTE AS MEMBERS OF THE SAME CLASS?

For the purpose of ascertaining whether the Scheme has been approved by the necessary 75% majority, if their votes are only to be discounted or disregarded by the Court when considering whether to sanction it? There seem to be three reasons.

  • The first is the impracticality in many cases of constituting classes based on similarity of interest as distinct from similarity of rights. Re Alabama, New Orleans, Texas and Pacific Junction Railway Co.22 is an example of this; Re BTR plc23is another.
  • A second is that the risk of empowering the majority to oppress the minority to which Bowen LJ referred in Sovereign Life Assurance Co. v. Dodd is not the only danger. It must be balanced against the opposite risk of enabling a small minority to thwart the wishes of the majority. Fragmenting creditors into different classes gives each class the power to veto the Scheme and would deprive a beneficent procedure of much of its value. The former danger is averted by requiring those whose rights are so dissimilar that they cannot consult together with a view to their common interest to have their own separate meetings; the latter by requiring those whose rights are sufficiently similar that they can properly consult together to do so.
  • The third reason is that this is mandated by the rationale which underlies the calling of separate meetings. A company can be regarded as entering into separate but linked arrangements with groups whose members have different rights or who are to receive different treatment. It cannot sensibly be regarded as entering into a separate arrangement with every person or group of persons with his or their own private motives or extraneous interests to consider.

In the case of Sovereign life assurance co. vs Dodd24 the often cited test of a class is that "it must be confined to those persons whose rights are not so dissimilar as to make it impossible for them to consult together with a view to their common interest." The emphasis here is on rights, which are not dissimilar, and the rights in question must surely be rights against the company in respect to the shares or debts in question. Extraneous interests should surely be disregarded.25

So we conclude that the test is based on similarity or dissimilarity of legal rights against the company, not on similarity or dissimilarity of interests not derived from such legal rights. The fact that individuals may hold divergent views based on their private interests not derived from their legal rights against the company is not a ground for calling separate meetings.

CONCLUSION

By studying the cases of various jurisdiction, it can be concluded that the basis for the determination of classes of members and shareholders for the purpose of sanctioning scheme of arrangement is: that the classes shall be grouped on the basis of commonality of interest and the class formed must be homogenous group.

It is the responsibility of the company putting forward the Scheme to decide whether to summon a single meeting or more than one meeting. If the meeting or meetings are improperly constituted, objection should be taken on the application for sanction and the company bears the risk that the application will be dismissed.

Persons whose rights are so dissimilar that they cannot sensibly consult together with a view to their common interest must be given separate meetings. Persons whose rights are sufficiently similar that they can consult together with a view to their common interest should be summoned to a single meeting.

The question is whether the rights which are to be released or varied under the Scheme or the new rights which the Scheme gives in their place are so different that the Scheme must be treated as a compromise or arrangement with more than one class.

The Court has no jurisdiction to sanction a Scheme which does not have the approval of the requisite majority of creditors voting at meetings properly constituted in accordance with these principles. Even if it has jurisdiction to sanction a Scheme, however, the Court is not bound to do so.

The Court will decline to sanction a Scheme unless it is satisfied, not only that the meetings were properly constituted and that the proposals were approved by the requisite majorities, but that the result of each meeting fairly reflected the views of the creditors concerned. To this end it may discount or disregard altogether the votes of those who, though entitled to vote at a meeting as a member of the class concerned, have such personal or special interests in supporting the proposals that their views cannot be regarded as fairly representative of the class in question.

Footnotes

1 Bhagwanti v New India Ltd (1950) 20 com cases 68: AIR 1950 EP 111

2 391. Power to compromise or make arrangements with creditors and members(1) Where a compromise or arrangement is proposed-(a) between a company and its creditors or any class of them; or(b) between a company and its members or any class of them,

3 If a majority in number representing three-fourths in value of the creditors, or class of creditors, or members, or class of members as the case may be, present and voting either in person or, where proxies are allowed

4 391. Power to compromise or make arrangements with creditors and members(1) Where a compromise or arrangement is proposed-(a) between a company and its creditors or any class of them; or(b) between a company and its members or any class of them,

5 A group of persons would constitute one class when it is shown that they have convened all interest and their claims are capable of being ascertained by any common system of valuation.

6 Sovereign Life Assurance Co. v. Dodd [1892] 2 QB 573 ,

7 ibid

8 (1983) 2 VR 298 at 303

9 Palmer's Company Law, 24th Edition

10 1948 SLT notes 5

11 (1996) 87 comp cas 792 at 834

12 [1892] 2 QB 573

13 (2001) BCLC 755

14 Sovereign Life assurance co vs dodd (1892) 2 qb 573 (CA)

15 Re British and commonwealth holdings plc. (No. 3), (1992) BCLC 322

16 (1996) 87 Com Cases 792 at 833 (SC)

17 (1971) 41 Com Cases 656 (All)

18 Hawk Insurance Co. Ltd. Re, (2001) 2 BCLC 480

19 (2002) 36 SCL 682 (Bom)

20 (no 3), 1992 BCLC 322

21 PALMER'S COMPANY LAW, para 12.018A (25th Edn, 1992)

22 [1891] 1 Ch 213 CA

23 [1999] 2 BCLC 675

24 (1892) 2 QB 573

25 Rosen v. Bruyns, N.O., 1973 (1) S.A. 815 (T), 820

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