Shareholders’ Deadlock: Buy-Out as a Way Out

Reference Date \| Version	December 09, 2024 \| 1.0
Keywords	Buy-out, Deadlock, NCLT, Oppression, Mismanagement
Legislation(s)/Policies	Companies Act, 2013
Jurisdiction	India

Guidance from experienced corporate and commercial lawyers from the start of a business relationship can prove beneficial in more ways than one. Effective documentation is helpful because it sets the ground rules of the relationship in clear terms which encourages parties to work within the defined structure – whether working together in the joint venture or disengaging in case of a deadlock.

Introduction

A business partnership is as much about people as it is about the business. A thorough diligence exercise to evaluate various aspects including the business goals of the parties, working style and work culture compatibility is essential for a joint venture to succeed. Nevertheless, just like it is important to agree on business plans and fundraising plans for the joint venture, it is important to agree on a process for resolution of a deadlock situation. Exit from the joint venture can also be a solution to a deadlock, depending on the situation. Parties to a joint venture would find it fruitful to spend adequate time discussing various issues in respect of the joint venture including deadlock resolution. It is not the role of the courts to adjudicate on a deadlock. The decision of the National Company Law Tribunal, Mumbai (‘NCLT Mumbai’) in Mr. Hormouz Phiroze Aderianwalla & Anr. v. Del. Seatek India Pvt. Ltd. and Ors. (‘Hormouz Case’) is a case in point.

This article discusses the Hormouz Case with a view to explain the court’s perspective on the resolution of shareholders’ deadlock.

Facts of the case

The Petitioners i.e., Mr. Hormouz Phiroze Aderianwalla and Zinnia Hormouz Aderianwalla filed a company petition no. 199/2022 under Sections 241 and 242 of the Companies Act, 2013 (‘Act’), challenging various illegal acts of oppression and mismanagement malafide carried out by Respondent Nos. 2 and 3 i.e., Delzad Aspy Karani and Mymoona Delzad Karani in relation to the affairs of Respondent No.1 (‘Company’, being Del. Seatek India Pvt. Ltd. ). In the same matter, Respondent Nos. 2 and 3 in Company Petition No. 50/2023 also filed a cross-petition alleging that the affairs of the Company are being mismanaged by the Petitioners.

According to Section 241(1) of the Act, the member(s) of a company meeting the minimum shareholding criteria may make an application to the National Company Law Tribunal if;

The affairs of the company have been or are being conducted in a manner that is:

prejudicial to the public interest or
prejudicial or oppressive to such member or any other member or members or
prejudicial to the interests of the company;

material change has taken place in the management or control of the company, and that by reason of such change, it is likely that the affairs of the company will be conducted in a manner prejudicial to its interests or its members or any class of member. Changes by or in the interest of creditors are excluded.

Said Section 242(1) of the Act provides that if, on an application made under Section 241 , the National Company Law Tribunal is of the opinion that:

the company’s affairs have been or are being conducted in a manner prejudicial or oppressive to any member or members or prejudicial to the public interest or in a manner prejudicial to the interests of the company; and
to wind up the company would unfairly prejudice such member or members, but that otherwise the facts would justify the making of a winding-up order on the ground that it was just and equitable that the company should be wound up,

the National Company Law Tribunal may, with a view to bringing to an end the matters complained of, make such order as it thinks fit.

As per Section 242(2) of the Act, any such order may, among other things, provide for:

the regulation of the conduct of affairs of the company in future;
the purchase of shares or interests of any members of the company by other members thereof or by the company;
the termination, setting aside or modification, of any agreement, howsoever arrived at, between the company and the managing director, any other director or manager, upon such terms and conditions as may, in the opinion of the Tribunal, be just and equitable in the circumstances of the case;

In the case at hand, the Petitioners and the Respondents Nos. 2 and 3 held an equal stake, i.e., 50:50, in the Company.

The Petitioners among other things alleged that:

Respondents Nos. 2 and 3 have not participated in the affairs of the Company since the year 2016 while drawing disproportionate remuneration, prerequisites, allowances, dividends, profit share and other benefits out of the Company.
Respondents Nos. 2 and 3 created repeated roadblocks in the approval of an unsecured loan to the Company for financing the project subject to the creditor i.e. Mr. Chadha being appointed as independent director/observer in the Company.
Respondent No. 2 unilaterally and without consulting the Petitioners purported to inform Petitioner No. 1 that he had taken operational as well as financial matters of the Company under his sole control and that he had unilaterally and without any authorisation, made payments aggregating to the sum of Rs. 1,72,86,739 out of the Company, (which included a sum of Rs. 50,00,000/- to himself as remuneration and Rs. 45,00,000/- to Respondent No. 3 as remuneration).
Petitioner No. 1 requested a Board Meeting to discuss matters pertaining to the company’s statutory compliances, but Respondent No. 2 objected to it and sought various financial documents from the company’s consultants and employees. Respondent No. 2 informed the Petitioners that the said meeting could be conducted only after such documents were provided to him.
Respondents No. 2 and 3 disingenuously purported to forward to the directors of the Company and the Company Secretary, bogus, fraudulent, and illegal Minutes of a purported/said Meeting of the Board of Directors, purportedly held on 03.01.2022. The Petitioners were shocked to receive this communication since as highlighted above, no meeting of the Board of Directors of the Company took place on 03.01.2022. The proposed/said meeting was cancelled at the insistence of Respondent No. 2.

The Respondents among other things alleged that:

In or around August 2021, during one of the visits to Ahmedabad, the Respondents learnt that the Company does not have 4 but 5 Directors. Upon further inquiry and upon inspecting the government records, the Respondents were surprised to learn that a 5th director i.e. Mr. Rajiv Chadha was inducted to the board of directors of the Company for providing a loan in favour of the Company. Such an appointment was illegal as it was done without obtaining the Respondents’ consent.
Petitioner No. 1 was siphoning off the funds from the Company to entities controlled by the Petitioners.
Petitioner No. 2 had given directions to write off an investment from the books of the Company, without consulting or discussing the same with the Respondents. The said investment was made by using the funds of Seatek (Abu Dhabi), amounting to INR 5.48 crores.
Petitioner No. 1 addressed emails to Respondents alleging that they did not purportedly contribute anything towards the Company, and further, the Petitioners suggested that both parties i.e. the Petitioners and the Respondents should part ways.

Findings and Directions of the NCLT Mumbai

The NCLT Mumbai noted in its findings that:

The Petitioner group and the Respondent group held shares in equal proportion – 50:50, and both the groups filed separate company petitions alleging illegal operations and mismanagement of the affairs of the Company by the other group.
Both parties had agreed to nominate one valuer each for valuation of shares of the Company,
The Respondents had contested the valuation report filed by the Petitioners, but they failed to place on record their own independent valuation report. The Respondents also did not cooperate with the Petitioners to get valuation report by mutual consent. The NCLT, Mumbai had earlier dismissed the application filed by the Respondents challenging the valuation report vide order dated 16.05.2024, stating that:“this bench is not inclined to interfere into the valuation report submitted by the valuer. Moreover, the bench is of the opinion that valuation report is a technical document and this bench does not have the expertise to decide on the correctness or otherwise of such a report.”
Both the parties also did not follow through with any other mode of resolution or settlement and therefore, the only way out is the buy-out/sell-out preposition based on the valuation report shared by the Petitioners.
There was an absolute deadlock in the functioning of the Company which was adversely impacting even the statutory compliances and it was constrained to rely on the valuation report tendered by the Petitioner herein owing to the non- availability of the valuation report of the Respondent.

The NCLT Mumbai stated that, “in cases of equal shareholding and director representation among shareholders, where a deadlock arises in the day-to-day management of the company, it is a well-establishment principle that such deadlocks should be resolved by one group purchasing the shares of the other. “

On the issue of valuation, it was observed that while the Respondents had contested the valuation report filed by the Petitioners, they failed to place on record their own independent valuation report. Further, the Respondents also did not cooperate with the Petitioners to get a valuation report by mutual consent. Thus, the NCLT was constrained to fall back on the valuation report placed on record by the Petitioners.

Both the parties also did not follow through with any other mode of resolution or settlement therefore, the only way out is the buy-out/sell-out preposition based on the valuation report shared by the Petitioners.

The Petitioners and Respondents are 50:50 shareholders of the Company. Accordingly, the value per equity share of the Company as on 31.12.2022 is INR 26,179. Hence, this Bench is of the considered view that, the Petitioners be directed to purchase the shareholding of Respondent Nos. 2 and 3 in the Company within six months, accordingly the Respondents shall exit the Company.

It deems appropriate to clarify that, the said direction of buying out the shareholding of the Respondents is passed keeping in view of the deadlock in the company and considering the fact that the warring factions can no longer do business together. The said direction is passed in the interest of the Company alone without delving into the allegations of Oppression levied by both sides.

Viewpoint

The NCLT Mumbai adopted a pragmatic approach to address the dispute among the parties. Each party had its own reasons for calling out the actions of the other party as acts of oppression and mismanagement.

The dispute was between two member groups with 50:50 shareholding. Thus, even if an act of ‘Oppression’ by either party had been established, the fundamental issue would remain the same – i.e., the parties could not do business together. Unlike a situation where the member(s) holding a minority may be subject to act(s) of oppression or mismanagement and seek legal recourse to curb the menace caused by those in control.

It would seem only appropriate that if two groups can no longer do business together, they must part. Therefore, the buyout of one party by the other would serve the best interest of the Company.

However, the company law provisions, do enable even a member holding 50% of the share capital to make an application in respect of ‘Oppression and Mismanagement’. Deadlock among the shareholders may also arise on account of ‘Oppression and Mismanagement’. Arguably, a deadlock between the shareholders may or may not be independent of the issue of ‘oppression and mismanagement’- the issue merits independent examination.

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