Valuation as a tool for sustenance of public interest under the Companies Act, 2013
The Companies Act, 2013 has ushered in a significantly focused valuation regime by creating a new class of professionals and provision of independent valuation for critical actions under the Act. All this is stemming from the core intention of using valuation as a tool in sustenance of public interest under the Companies Act, 2013 as detailed in this article.
Background
There is no single, universally accepted legal definition of “public interest” in legal jurisprudence. However, the term is generally understood to refer to matters that affect the well-being of the community as a whole, rather than the interest of specific individuals or groups. Public interests may include issues such as civil rights, civil liberties, environmental protection, consumer protection, and economic justice.
Some examples of public interests that have been recognized by the courts include:
- Protecting the environment from pollution
- Access to quality education and healthcare for all citizens
- Rights of marginalized groups and minorities
- Preventing corruption and abuse of power by government officials
Black’s Law Dictionary (6th Edition) defined Public Interest 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 localities, which may be affected by the matters in question. Interest shared by citizens generally in affairs of local, state or national government....”.
In the intricate world of legal jurisprudence, the term “public interest” carries a profound significance. While there isn’t a universally accepted legal definition, it is generally understood to encompass issues that affect the well-being and welfare of the broader community rather than the interests of specific individuals or groups. Public interest encompasses a wide spectrum, including civil rights, environmental protection, consumer welfare, economic justice, and much more.
In the context of Indian jurisprudence, the concept of public interest plays a pivotal role and has been explicitly recognized in the Companies Act, 2013. However, its scope extends beyond mere stakeholder protection and fairness; it encompasses the larger interests of society as a whole.
This article delves deep into the pivotal role of valuation in safeguarding public interest under the ambit of the Companies Act, 2013. It explores the historical evolution, legislative developments, and practical implications of valuation as a tool for upholding the greater good.
Historical Evolution of Public Interest
The notion of public interest in legal jurisprudence has evolved over centuries. It has been a dynamic and adaptable concept, reflecting the changing needs and values of society. The roots of public interest can be traced back to ancient legal traditions, where rulers and governments were expected to govern for the welfare of the entire community.
Over time, the concept of public interest found its place in modern legal systems. Notably, in the United States, the term “public interest” gained prominence in the early 20th century with the establishment of regulatory bodies like the Interstate Commerce Commission, which aimed to protect the interests of the public against powerful corporations.
In India, public interest has been a cornerstone of jurisprudence, emphasizing the need to balance individual rights with the collective good. It has found expression in various laws and regulations, with the Companies Act, 2013, being a significant milestone in this journey.
The Companies Act, 2013: A Paradigm Shift:
The enactment of the Companies Act, 2013, marked a significant paradigm shift in India’s corporate governance landscape. It introduced a comprehensive framework that not only focused on stakeholder protection and fairness but also embraced the broader concept of public interest.
One of the most notable aspects of the Companies Act, 2013, is the pivotal role assigned to valuation as a tool for upholding public interest. This emphasis on valuation stems from the recommendations of the Expert Committee on Company Law, chaired by Shri J.J. Irani, which recognized the need for transparency, fairness, and accountability in corporate transactions.
Earlier to this Committee, there was a Committee (called the Shroff Committee) appointed by the then Department of Companies Affairs that came out with a Report on guidelines on the valuation of corporate assets and shares. The J J Irani Committee also took note of the recommendations arising from this report.
Specifically, the J J Irani Committee Report brought out the need for a law for restructuring and liquidation that prescribes a flexible but transparent system for the disposal of assets efficiently and at maximum value.
In respect of valuation, the Committee report recommended various measures, specifically including:
- When a company opts to delist from the stock exchanges, it must offer a buyback within three years, and for this purpose, appropriate valuation rules are to be prescribed.
- In the case of allotment of shares for noncash consideration, the law should provide for an independent valuation.
- In respect of mergers where shares are proposed to be allotted against takeover of the assets and liabilities, also in the interest of protection of interests, there must be a valuation which is mandated.
- The issue on a preferential basis by a public unlisted company also has a mandatory requirement of independent valuation to form the basis for the proposed issue. In this connection, the report brought out the fact that the SEBI has already framed regulations for preferential issues to be made in respect of listed companies and the need for having some framework in respect of unlisted public companies too.
- In respect of buy out by 90% holder of the minority stake provided under the Act it should also be at the fair value as determined by an independent valuation.
- Wherever a company is mandated to have an Audit Committee, then all valuations would necessarily be referred to the board through the Audit Committee only to ensure that there are enhanced governance requirements in respect of such valuation matters.
Further, in a Chapter specifically focussed on minority interests, a whole sub-section had been included to deal with “fair valuation as a means of safeguarding minority interests”. This specified that there must be a recognition of independent valuation conducted on recognized valuation principles as a means of safeguarding minority interests.
The appointment of such independent valuers was to be by the Board of Directors / Audit Committee as the case may be and the shareholders will have the right to approach the court/tribunal where they perceive the process to be unfair. In such cases, the tribunal should also have the power to appoint a valuer.
The report also emphasized the need for independent registered valuers, benchmarking of valuation techniques, development of valuation standards, and peer review mechanisms for the valuers.
The report further, under the Chapter on restructuring and liquidation has a separate section dealing with the valuation of debtor estate and in this section again had recommended the need to have independent valuation experts.
Legislative developments in the past that contributed towards focus on valuation
The Shroff Committee formation itself was preceded by certain key happenings, which had indications of public concern concerning valuation-related issues and implications on shareholder value.
The Sterlite Industries scheme where reduction of capital was undertaken without going through the requirements of Section 77A of the Companies Act, 1956, and the Godrej Industries scheme for reduction of capital are worth noting. In Godrej Industries matter, the consumer redressal forum held that the scheme has been approved and the option to hold or sell the share was also communicated to the shareholders hence the scheme, which also results in the reduction and purchase of shares is valid.
In the Sterlite Industries case, the company had undertaken a scheme under the Companies Act, 1956 provisions, and this led to a reduction in capital also. SEBI had approached the High Court against this and it was held that SEBI had no locus standi in a scheme under the provisions of law and when a scheme is considered, specific provisions in the act relating to buy back of shares are also not necessarily to be considered. Even the Supreme Court declined to intervene in this matter.
However, these have also been addressed in the 2013 Act, where it is now included in the Act that notice is to be given to SEBI who would have the right to make representations to the NCLT in the matter.
Larsen and Toubro’s buyback scheme was rejected by SEBI – L&T considered the standalone financial statement to determine the debt–equity ratio post buy-back to meet the requirements that it does not fall below 2:1, while SEBI considered the position as per consolidated financial statements.
These developments significantly contributed to the need for and a focus on evaluating guidelines for the valuation of corporate assets and shares.
The provisions that have been included in the Companies Act, 2013 are not only to protect minority interests but also to ensure that the interests of all stakeholders are appropriately taken care of and the common interests are addressed.
Specific provisions in the Companies Act, 2013
The Companies Act, 2013 and the rules thereunder provide for the concept of an independent registered valuer who is to be appointed by the Audit Committee or in its absence the Board of Directors, which should also approve the terms and conditions of such appointment and impose responsibilities on such valuer to make an impartial, true and fair valuation of assets that are being valued; exercise due diligence and care; make the valuation by the prescribed rules; not to undertake valuation of assets in which he has a direct or indirect interest or becomes interested at any time during or after the valuation of that asset.
The Companies Act, 2013, and the rules thereunder have enabled a separate class of professionals, namely, the Registered Valuers, who are independent professionals with the required qualification, experience, character, and accreditation. The Registered Valuers are required to have complete independence from the company/asset they are to value and by introducing this requirement for various valuations expected under the Companies Act, 2013, significant emphasis has been placed on protecting public interest in respect of such transactions through the use of valuation as a tool.
The issue on a preferential basis
Whenever a company proposes to issue additional shares other than by way of rights issue or ESOP, the price of such shares is to be determined by the valuation report of an independent Valuer.
Here, it can be seen that the emphasis is on “price” and “determined by” and the logical interpretation is that the pricing need not be exactly as per the valuation report and could be above such valuation too.
The essence of having this requirement enshrined in this section is to ensure that preferential issues, which change the shareholding pattern are done at a price that is at least at the valuation carried out by an independent valuer.
Here it is not only the minority shareholders’ interests (or the other shareholders who are not enjoying the preferential allotment) being protected but also it ensures that the interests of other stakeholders such as income tax authorities (who may have concerns on change of wealth amongst the members) are addressed.
Noncash transactions with Directors and their connected persons
Companies Act also requires members’ approval for noncash transactions between the director(s) and their connected persons and the company in the purchase or sale of assets. In such cases, the notice to be sent to the members must include along with the details of the transactions, the valuation of the assets involved in the arrangement by a Registered Valuer.
This ensures that the members who have to decide concerning such noncash transactions are provided with appropriate information for an informed decision.
It is pertinent to note in this regard that as the emphasis is on an informed decision, the provisions do not provide for a blanket prohibition in transacting at a value different from the asset valuation computed by the registered valuer but ensure that the registered valuers’ valuation is available for the shareholders when they embark to decide on the matter.
Where in general, any shares are proposed to be issued for consideration other than cash, there is a need to have a valuation report along with the justification for the proposed allotment on consideration other than cash.
Compromise and arrangements
In respect of compromise and arrangements amongst shareholders/creditors, there is a requirement that the company / or the applicant to the Tribunal submits a valuation report in respect of the shares and the property and all assets, tangible and intangible, movable and immovable, of the company. Further, when a meeting is proposed to be called for this purpose, the notice should be accompanied by a copy of the valuation report.
Here again, it can be seen that the parties who are to participate in a meeting to decide on a compromise/arrangement are provided with a copy of the valuation report for them to make an informed decision, and also the tribunal is placed with a copy of the valuation report for the tribunal to consider it on merits along with all the other facts and circumstances in approving the scheme.
This also enables any aggrieved party to raise a dispute before the Tribunal based on such valuation report placed before the tribunal.
Mergers and Amalgamations
The directors of the merging companies have to share a report with the members explaining inter-alia, the share exchange ratio, and any special valuation difficulties. Along with this, the valuation report is also to be shared.
A clear reading of the provisions will indicate that it is for the Board to explain the share exchange ratio and even any valuation difficulties it faces. The valuation report is only to accompany the notice for members to understand the valuation by an independent valuer in the context of the proposed scheme. Essentially, it is left to the members to make an informed decision and the exchange need not be precisely at the ratio prescribed in the valuation report. The members and the Tribunal (in case of any disputes by shareholders) can evaluate the rationale presented for the deviation from the valuation report, if any.
Acquisition of minority shareholding
When acquirers have obtained 90% shareholding, they could notify the company of their intention to buy out the balance shares and such offer to minority shareholders must be based on a price determined based on a valuation report.
In contrast to the provisions for schemes or mergers, in this case, again, as in the case of preferential issue, the focus is on “price” and “determined based on”. Essentially, this is to protect the minority interest from being offered a price that is below the fair value as determined by the independent valuer. Thus, the pricing in this case should be at or above the valuation determined by the independent valuer.
Sweat Equity
Sweat equity is another area where shares are allotted to specific individuals (many times to people who are in control of the company) and for consideration other than cash.
The Companies Act 2013 and the rules thereunder require that such sweat equity shares are valued at a price determined by a registered valuer, as the fair price giving justification for such valuation. Further it also requires that the valuation of intellectual property rights or know-how or value additions for such sweat equity be also valued by the registered valuer.
Thus, in this scenario also it can be seen that there is a specific emphasis on “price” to be determined by a registered valuer.
Loan to employees or trust for purchase of shares
The Companies Act 2013 specifies that in case of any loan by the company for the purchase of its shares by employees or a trust for the benefit of employees, in case of unlisted shares, such shares shall be purchased at a valuation made by the registered valuer.
This is again an area where there is a need to ensure fair pricing is involved, as the cash is provided by the company to buy its shares.
Buy-back of shares
A buy-back scheme is where there is no explicitly stated requirement for a valuation report in the Companies Act, 2013. However, the explanatory statement to be shared with members for approval of the scheme is to contain the basis for arriving at the buyback price. Given this requirement, it may be appropriate to consider having a valuation report done to justify the basis for the purchase to be effected.
Thus, in this way, the need for a valuation report to justify the price, when the transaction could lead to a change in shareholding or have an implication for the minority shareholders has been addressed.
Transactions for which valuation is not mandated under the Companies Act, 2013
Rights issue
The rationale for having a valuation report for the preferential issue because it leads to a change in shareholding structure is exactly the rationale, on the contrary, for rights issue, which is offered on a pari passu basis to all shareholders is not covered by a mandatory valuation requirement. However, an opportunity to understand the fair value to the existing shareholders may go a long way in terms of informed decisions to participate in such rights issues.
ESOP issue
The Companies Act, 2013 gives freedom of pricing for the issue of shares on an Employee Stock Option Scheme as the intent of such schemes itself is to provide an incentive to the employees.
Bonus Issue
Bonus issue leads to capitalization of reserves of the company and is given pari passu to the existing shareholders. Accordingly, this also does not have any impact on the shareholding ratio or does not lead to any change of wealth inter-se shareholders and hence, there is no pricing mechanism through a valuation process prescribed.
Conclusion
The Companies Act, 2013, stands as a cornerstone in India’s corporate governance framework, emphasizing the role of valuation in safeguarding public interest. Valuation, as a tool, ensures transparency, fairness, and accountability in corporate transactions, protecting the rights and interests of all stakeholders.
In summary, the Act’s provisions go beyond the protection of minority shareholders; they reflect a holistic approach to consider the interests of all stakeholders. Valuation is not just a mechanism; it is a cornerstone in preserving public interest within the corporate sphere.
References
- Report of the Expert Committee on Company Law released in 2005
- Shroff Committee Report on guidelines on valuation of corporate assets and shares
- Securities and Exchange Board of India v. Sterlite Industries Ltd., (MANU/MH/0339/2002)
- Ritu Bhargava vs Godrej Industries Ltd & Ors on 23 January 2014 before the National Consumer Disputes Redressal Forum
- https://regtechtimes.com/why-was-larsen-and-toubro-buyback-rejected-by-sebi/