Rejection of Scheme By NCLT: Objection of Regional Director on grounds of non-compliance

Hotel City Plaza Private Ltd ( “Appellant 1” or Petitioner Company 1 or “Transferor Company”) Trivandrum Apollo Towers Private Ltd ( “Appellant 2” or Petitioner Company 2 or “Transferee Company”) have preferred appeal (Company Appeal (AT) (CH) No. 28 of 2021) before Hon’ble NCLAT Chennai Bench against order dated 05.02.2021 in TCAA/4/KOB/2019 & TCAA/5/KOB/2019 passed by Hon’ble NCLT Kochi Bench dismissing scheme of merger on basis of objection raised by Regional Director, Ministry Of Corporate Affairs.

Regional Director Objections

1. The Transferor Companies have violated Section 74(1)(b) of the or Companies Act, 2013 by retaining amounts of ₹17,50,000/- accepted from Sri Mohammed Kasim Varikkodan, a Director of the transferor company during the year 2014-15 and also ₹15,00,000/- from Sri Ibrahim Kutty, another Director of the transferor company during the year 2015-16.
2. In the Board report for 2014-15 and 2015-16 the Transferor company has not made disclosure regarding acceptance of deposits of the aforesaid two amounts from the said Directors violating the provisions of Section 73 of the Companies Act, 2013
3. They have violated the amended provisions of Sections 73 to 76A prohibiting the private limited companies from accepting or renewing any deposits from shareholders in excess of the aggregate of the paid-up capital, free reserves, and securities premium amount. However, the Transferor company have not disclosed in the Notes to the Financial Statements for the financial year coming after 1^st April 2014, the figure of such amount.
4. The said amount collected from the shareholders have been retained by the Transferor company without repaying them within a period of three years under Section 74 of the Act on the due dates as per the terms of acceptance, which is violation of Section 74(1)(b) of the Companies Act.
5. The transferor company accepted deposits from outside parties, which was not disclosed in the Balance Sheet as on 31.3.2016 but misleading facts were stated that it was received from parties stating it as Long-Term Borrowings. The amount outstanding unsecured loans/deposits is over Rs. 14 crores as compared to share capital of around Rs. 2.5 crores is in violation of Section 448 of the Companies Act which amounts to misleading disclosure;
6. Regional Director states that similar violations were committed by the Transferee Company also.

The petitioner companies filed a reply to the report of Regional Director stating these are not valid grounds for objecting proposed scheme.

Observation of Hon’ble NCLT while dismissing petition

• The decision Hon’ble NCLT Mumbai Bench in the case of UFO Moviez India Limited and another – C.P. (CAA) No./1920/MB/2018 in C.A. (CAA) No. 120 of 2018:-

“It is not that this Bench is against any business combinations, mergers or any proposition that would make the investors, promoters and shareholders more and more profitable. In fact, we welcome it. But at the same time, one must be humble and serious enough to abide by law and any proposition of business must be planned in such a manner that no law, logic and rights of any person are violated.”

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• Hon’ble NCLT Kochi Bench held that in present case, it is seen that both companies have violated the provisions of the Companies Act and the petitioners could not successfully controvert the objections raised by the Regional Director. They have not followed most of the provisions of the Companies Act, which are mandatory for continuance of a company honestly. They must be humble and serious enough to abide the law and any proposition of business must be planned in such a manner that no law, logic and rights of any person are violated. Hence this Tribunal is of the opinion that this is not a fit case to sanction the Scheme of Amalgamation.’’ and dismissed the petition.

Petitioner companies filed appeal with Hon’ble NCLAT, Chennai Bench on following grounds:

1. Petitioner companies states that prior to 15.9.2015, there was no requirement to disclose the details of the money accepted from the Directors in the Board’s report. However, they stated that an inadvertent omission occurred on the part of the company which resulted in the non-disclosure of the details of loans received from the Directors. However, it appears that companies have not provided any declaration in their reply to RD (Regional Director) Report that the said amount received in given out of Directors own funds and not out of borrowed funds.
2. The company has not accepted any deposits within the meaning of term as defined under Rule 2(1)(c) of the Companies (Acceptance of Deposits) Rules, 2014.
3. Tribunal had failed to appreciate, that the Scheme was Approved, by the Shareholders, Secured Creditors and Unsecured Creditors of both Companies.
4. Because there is an `allegation of commission of an offence,’ against the provisions of the Companies Act, 2013, the `Scheme of Arrangement’, is not to be `rejected’.

Also referred to catena of Judgements in support, few of them are listed below: –

1. Hon’ble Calcutta High Court in the case of Mankam Investments Ltd. Re. 3 (1995) 4 Comp LJ 330 (Cal): – “It is a matter for the shareholders to consider commercially whether amalgamation or merger is beneficial or not. The court is not concerned with the commercial decision of the shareholders until and unless the court feels that the proposed merger is manifestly unfair or is being proposed unfairly and/or to defraud the other shareholders.
2. Hon’ble NCLAT in the matter of Mel Windmills Pvt. Ltd. v. Mineral Enterprises Limited & Anr. with Mel Properties Pvt. Ltd. v. Mineral Enterprises Limited & Anr. (vide dated 27.05.2019), reported in (2019) SCC Online NCLAT 900: – The Pending issues could not be construed as an impediment in sanctioning the proposed scheme of demerger.
3. Hon’ble Gujarat High Court in case of “Core Health Care Limited Vs. Nirma Limited.: – The scheme can always be sanctioned subject to and without prejudice to the liability, if any, in the civil and criminal proceedings in respect of the past transactions.

Reply by Respondent: –

1. On verification, it was found that all the six Directors, were appointed on dates before giving Loans to the Transferor Company;
2. Transferor Company had manipulated the records, to reflect that the `Sum’ received from these 63 persons as amount received from the `Members’, with a view to `escape’, from the `breach of the ingredients of Section 58A of the Companies Act, 1956;
3. Provisions of companies act states that any sum received from the Directors, will be exempted, only if a Declaration, is furnished by such Director, to the company that the amounts, so given were not borrowed, from Third Parties (others) and that such Disclosure, along with the details of money so collected was made in the Board’s Report. But a glance of the Board’s Report for the year 2014-15 and 2015-16, shows that such a Disclosure, was not made;
4. Balance Sheet from 2013-14, that it was mentioned that the Transferor Company, claimed to have accepted Unsecured Loans, from Outsiders, but now, it is claiming that these were all received from Members.
5. Also, Transferor company has filed DPT-3 Return, wherein, it was observed that the Transferor Company, had not submitted the required information, especially, in respect of the `Deposits’ received and retained’, by the Transferor company from the Shareholders, from 01.4.2014 to 31.03.2019, and thereby, there was a `violation’ of `Section 74 of the Companies Act, read with Companies (Acceptance of Deposits) Rules, 2014, as amended;

Hon’ble NCLAT upheld order of Hon’ble NCLT on following grounds: –

1. Although on behalf of the Companies, it is projected before this Tribunal, that the sanctioning of the arrangement, mentioned in the Scheme, will be for the `advantage and benefit of the Companies, its Shareholders, and the Creditors coupled with the fact that no investigation proceedings were instituted or pending, in terms of the relevant provisions of the Companies Act, etc., This Tribunal, on a consideration of the submissions made on behalf of the `Respondent’ / `Union of India’ (Regional Director, Southern Region Ministry of Corporate Affairs, Chennai), pertinently points out that the Companies had not adhered to, the utmost provisions of the Companies Act, 2013, which creates an unfavourable circumstance, to and in favour of the Companies;
2. If a Transaction, is entered into mainly with a view to circumvent, supplant, evade, or avoid the Rules of the Game or any Law in Force, and evade Tax Liability, a Tribunal / Court of Law, cannot and will not approve, any Compromise / Arrangement. Moreover, if the Arrangement, is an inequitable and unfair one, the `Scheme,’ cannot be given a `Green Signal, for an Approval, sought for in the matter, by the Party / Parties, concerned;
3. Disclosure, in respect of any proceedings, pertaining to a Company, which have an impact or material effect on the decision, is to be made, apart from the Disclosure, to be made, in respect of any `pending investigation.’ In fact, the proceedings, ought to be in the character or leading to an investigation, which has a crucial bearing in the subject matter in issue.
4. In the light of the `violations,’ committed by the Companies, under the Companies Act, keeping in mind that both the Companies had not `given replies,’ to the `Show Cause Notices,’ issued by the `Registrar of Companies,’ Ernakulam, Kerala
5. There is a clear cut `violation’ of Section 73 of the Companies Act, 2013, regarding the Prohibition on acceptance of deposits from public, for acceptance of deposits, from the Directors of the Transferor Company in respect of the years 2014-15 and 2015-16.
6. The Companies had not made out a fit and proper case, for `Sanctioning the Scheme of Amalgamation,’ in accordance with Law.

NCLAT after examining all the facts and submissions upheld the decision of Hon’ble NCLT rejecting the scheme.

Conclusion: –

From the facts, it looks like the companies involved in the scheme did not observe the provisions of The Companies Act and Rules there under. Based on that, the Hon’ble NCLT rejected the scheme and Hon’ble NCLAT upheld the decision of Hon’ble NCLT. Hon’ble NCLAT felt that it does not seem the companies and the management had discipline to comply with the provisions of the law. It seems that we are increasingly seeing cases/schemes rejected by the NCLT based on objections by various other government authorities. A similar case of rejection we covered last month where the Hon’ble NCLT rejected the scheme based on objections by the Income Tax department.

Hon’ble NCLT is monitoring the scheme on grounds of objections raised due to non-compliances of various laws. This might force applicant companies to take this as an indication of becoming more compliant before entering a restructuring exercise and waste time and resources of all involved.