The Demerger the Minority Would Not Bless
Zenith Alloys Ltd (ZAL), listed on NSE and BSE, proposes a composite scheme under sections 230 to 232 of the Companies Act, 2013: demerger of its aluminium-rolling undertaking into Zenith Foils Ltd (ZFL), a wholly-owned subsidiary, with ZFL issuing one share for every four held in ZAL to ZAL's shareholders; merger of the promoter vehicle Zenith Holdings (61.4%) into ZAL; and reduction of ZAL's securities premium by Rs 210 crore. The appointed date is 1 April 2023, but the petition reaches the Ahmedabad NCLT only in February 2024, supported by a registered valuer's report dated December 2023. Two institutions holding 11.8% object: the rolling undertaking generated 54% of FY23 EBITDA, yet the share entitlement ratio implies only 38% of value; the promoter is simultaneously counterparty and majority voter; and the valuer benchmarked against three comparables, one of which is in CIRP. The audit committee 'noted' the report without recording an independent opinion. The Chairman wants sanction on the strength of 78% of votes cast in favour and asks you, as company secretary, whether the objectors can stall the scheme.
1. Do the objecting institutions form a separate class requiring a separate meeting under section 230? Set out the test the NCLT applies and what the company secretary should place before the Tribunal.
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Class membership is for the Tribunal to decide, not the board. Section 230(6) speaks of meetings of 'members or class of members', and the settled test, from Miheer H. Mafatlal v Mafatlal Industries onwards, is homogeneity of legal rights and of interest in the scheme, not the size of the holding.
On these facts the promoter group occupies a position different in kind: it is (i) the transferor of Zenith Holdings; (ii) the 61.4% voter whose votes alone can carry the three-fourths-in-value threshold; and (iii) the party whose share of the merged entity is fixed by the very valuation the public is challenging. The public shareholders, including the two institutions, are affected only as recipients of ZFL shares. That difference is sufficient to justify a separate meeting of shareholders other than the promoter group, with promoter votes excluded.
Practical steps the company secretary should take:
- Frame the class question in the application itself rather than waiting for the Tribunal to raise it; the chairman cannot unilaterally certify the class.
- Propose a public-shareholder meeting where the three-fourths-in-value test is applied to those votes alone.
- Ensure the notice carries the valuation report, the entitlement-ratio rationale, the audit committee's recommendation and the pre-scheme shareholding pattern.
- Record that any dispensation is sought on consent affidavits, not on assertion.
Misjudging class composition is the single most common ground on which sanctions are carried in appeal to the NCLAT under section 421.
2. If the Tribunal accepts the valuation objection, can it sanction the scheme with a corrected share entitlement ratio, or must it reject the scheme? Explain the scope of section 231 and the limits of commercial wisdom.
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Section 231(1) permits the Tribunal to sanction a scheme 'with such modifications as it may deem fit', but that is a corrective power, not a creative one. A modification may sever an illegality, correct a clerical or arithmetical error, or bring a clause into conformity with statute. It cannot re-open the bargain by substituting the Tribunal's own entitlement ratio, because the ratio is the commercial agreement of the demerged company, the resulting company and their shareholders.
The realistic outcomes are therefore three:
- Rejection with liberty to refile, where the valuation is unsupported and the defect cannot be cured on the existing record.
- Adjournment with directions: a fresh report from an independent registered valuer that confronts the 54%-versus-38% EBITDA mismatch, drops the comparable that is in CIRP, and applies a second method; the report then goes back to a reconvened meeting.
- Sanction with machinery modifications only (appointed date, premium adjustment, liability segregation) where the valuation objection has been answered on affidavit.
The Tribunal does not sit as a valuer and will not fix a ratio; it asks only whether the material before the shareholders was adequate and the scheme just and equitable. Advice to the board: pressing for sanction over an unexplained gap invites remand, and the time lost in remand normally exceeds the time taken to cure the report.
3. Identify the procedural and governance defects in the appointed date, the securities premium reduction and the audit committee process, and state how each should be cured before the final hearing.
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Appointed date. A retrospective date is permissible, but a ten-month gap between 1 April 2023 and the filing means the FY24 accounts must be recast and the profits of the rolling undertaking for the intervening period accounted for under section 232(3) and the scheme's own clauses. The Tribunal will ask who bore the risks and rewards in that window. Cure: either shift the appointed date to 1 April 2024, or file a restated working and an undertaking that no shareholder is prejudiced.
Premium reduction. A Rs 210 crore reduction of securities premium is a reduction of capital in substance. The scheme route does not dispense with creditor protection; the Tribunal will expect notice to the Registrar, the Income Tax Department and creditors, and confirmation that the reduction is not a device to write off a demerger loss against a non-distributable reserve. Cure: file the solvency certificate, the creditor consent position and the tax-neutrality confirmation under section 2(19AA).
Audit committee. A 25-minute meeting that merely 'notes' the report is indefensible. The committee should record the methodology, the comparables, the sensitivity of the ratio to WACC and terminal growth, and a reasoned recommendation, ideally supported by a second opinion.
Disclosure. Treat the scheme as unpublished price-sensitive information under the PIT Regulations and confirm the institutions were not given selective access to the valuation before it was filed.