Valuation reports: Holy Grail or Pandora’s box?

The law relating to valuation reports in the context of corporate restructuring is fairly settled. Two landmark judgments of the Supreme Court, in the Hindustan Lever case (1995) and the Miheer Mafatlal case (1996), have stood the test of time, laying down the principle that once the court finds that a scheme has met the broad parameters of the requirements for getting court sanction, the court has no further jurisdiction to sit in appeal over the commercial wisdom of the majority of the class of persons who have given their approval. The court has neither the expertise nor the jurisdiction to delve into the commercial wisdom exercised by persons who have ratified the scheme with the requisite majority. Therefore the court, in the absence of strong grounds, cannot be entitled to set up its own view of fairness.

The application of the above ruling in cases relating to selective reduction of capital is examined below.

Popular method

In the absence of statutory compulsory squeeze-out mechanisms, a selective reduction of the capital held by minority shareholders has become a preferred form of squeeze-out that is being adopted by promoter shareholders. Courts have held that this does not amount to a forcible acquisition or elimination of the public shareholders. Several judgments state that so long as the minority shareholders are paid “fair value” and the selective reduction is approved by the requisite majority of shareholders, courts are not justified in withholding their sanction to the resolution on selective reduction.

In cases such as Elpro International (Bombay High Court, 2007), Sumitra Pharmaceuticals (Andhra Pradesh High Court, 1996), Reckitt Benckiser (Delhi High Court, 2011), etc., the courts have relied on the Supreme Court ruling and refused to interfere with the valuation report as the objectors could not prove any grave irregularity, fraud or prejudice.

Bombay High Court in the cases of Organon (India) Limited (2010), and Cadbury India Limited (2014) appears to have deviated in this regard.

Cadbury India case

Consequent to a delisting, Cadbury India filed for a selective reduction of capital of the minorities. Based on two independent valuation reports, ₹1,340 (US$22) per share was offered to the minorities. Due to opposition by some of the public shareholders, Cadbury India volunteered to do a fresh valuation and asked for an “assurance” that it would be treated as the final valuation. The objectors granted the assurance with a caveat by the court that if the court found any “grave infirmity” it would be free to interfere.

The fresh valuation – based on the comparable companies multiples method of valuation – was ₹1,743 per share. The court then “directed” the valuer to update its report taking into account the discounted cash flow (DCF) method, without giving reasons for this request. The valuer submitted a revised report which brought the valuation to ₹2,014 per share.

The objectors, all but two of whom remained (it was nearly four years since the original petition was filed), then demanded ₹2,500 per share. The court upheld the revised valuation of the court-appointed valuer, giving lengthy reasons for its view that it could not interfere unless the valuation was ex facie unreasonable.

Despite the court’s order stating that it would interfere with the valuation of the court-appointed valuer only if there was a grave infirmity, the court had deemed it fit to dictate the method of valuation (DCF as opposed to comparable companies) and get the report revised. It is not clear whether the order for revision was pursuant to mutual consent of the parties or was initiated by the court. In either case, it goes contrary to the Supreme Court ruling that these technical matters are best left to the experts.

Conclusions

The above cases on selective reduction lead to three observations.

Firstly, after having obtained shareholder approval by the requisite majority based on an independent valuation which is fair, companies have deemed it fit to engage with the objectors, revalue the shares and voluntarily offer a higher price in order to reduce the number of objectors and receive sanction of the court (as in the cases of Reckitt Benckiser and Cadbury India).

Secondly, though there is no legal requirement, the fact that a majority of the minority have voted in favour of the resolution seems to be an important consideration for all of the high courts whilst granting approval.

Lastly, though the Supreme Court has stated that the court will not sit in judgment over the commercial wisdom of stakeholders, some high courts have deemed it appropriate to examine valuation reports in detail and go beyond a mere “absurdity”/“perverse” check. By doing so they have diverged from the Supreme Court ruling, even though they claimed to wholly rely on it.

Akila Agrawal is a partner at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the author and do not reflect the position of the firm.