Compromises and Arrangements

Who may apply, and for what: section 230(1)

Where a compromise or arrangement is proposed:

• (a) between a company and its creditors or any class of them; or
• (b) between a company and its members or any class of them,

the Tribunal may, on the application of the company, or of any creditor or member, or, where the company is being wound up, of the liquidator appointed under this Act or under the Insolvency and Bankruptcy Code, 2016, order a meeting of the creditors or class of creditors, or of the members or class of members, to be called, held and conducted in such manner as the Tribunal directs.

Note who may apply: the company, any creditor, any member, or the liquidator. It is not the company's application alone.

And note that the first order is only to call a meeting. Sanction comes later, under sub-section (6), and the two stages are commonly confused in answers.

What must be disclosed: section 230(2)

The applicant shall disclose to the Tribunal by affidavit:

• (a) all material facts relating to the company, such as its latest financial position, the latest auditor's report on its accounts, and the pendency of any investigation or proceedings against the company;
• (b) any reduction of share capital included in the scheme;
• (c) any scheme of corporate debt restructuring consented to by not less than seventy-five per cent of the secured creditors in value, including (i) a creditor's responsibility statement in the prescribed form; (ii) safeguards for the protection of other secured and unsecured creditors; (iii) a report by the auditor that the company's fund requirements after the restructuring conform to the liquidity test based on the Board's estimates; (iv) where the company proposes to adopt the Reserve Bank of India's corporate debt restructuring guidelines, a statement to that effect; and (v) a valuation report on the shares and on all the property and assets, tangible and intangible, movable and immovable, by a registered valuer.

Seventy-five per cent of the secured creditors in value is the figure to remember for a corporate debt restructuring, and it is different from the three-fourths in value of each class voting at the meeting under sub-section (6).

Notice of the meeting: section 230(3)

Notice of the meeting shall be sent individually, at the address registered with the company, to all the creditors or class of creditors, to all the members or class of members, and to the debenture-holders, accompanied by:

• a statement disclosing the details of the compromise or arrangement;
• a copy of the valuation report, if any; and
• an explanation of the scheme's effect on creditors, key managerial personnel, promoters and non-promoter members and the debenture-holders, and its effect on any material interests of the directors or the debenture trustees, with such other matters as may be prescribed.

The first proviso: publicity. The notice and documents shall also be placed on the company's website, and, in the case of a listed company, sent to the Securities and Exchange Board and the stock exchange for placing on their websites, and published in newspapers in the prescribed manner.

The second proviso: where the notice is also issued by advertisement, it shall indicate the time within which copies of the scheme may be had free of charge from the registered office.

Voting and objections: section 230(4)

The notice shall provide that the persons to whom it is sent may vote, themselves or through proxies or by postal ballot, on the adoption of the scheme within one month from the date of receipt of the notice.

The proviso is one of the most examinable sentences in the section. An objection to the compromise or arrangement may be made only by persons holding not less than ten per cent of the shareholding, or having outstanding debt amounting to not less than five per cent of the total outstanding debt as per the latest audited financial statement.

Two different thresholds, and they must not be mixed up: ten per cent of shareholding for a member, five per cent of total outstanding debt for a creditor.

The purpose is to stop a single small holder from obstructing a scheme that the great body of members and creditors want, while leaving a substantial minority its voice.

The regulators: section 230(5)

The notice and the prescribed documents shall also be sent to the Central Government, the income-tax authorities, the Reserve Bank of India, the Securities and Exchange Board, the Registrar, the respective stock exchanges, the Official Liquidator, the Competition Commission of India if necessary, and such other sectoral regulators or authorities likely to be affected, requiring that representations, if any, be made within thirty days from the date of receipt, failing which it shall be presumed that they have no representations to make.

Note the deeming. Silence for thirty days is consent, which is what makes the timetable workable.

The majority, and the binding effect: section 230(6)

Where, at a meeting held in pursuance of sub-section (1), majority of persons representing three-fourths in value of the creditors, or class of creditors or members or class of members, as the case may be, voting in person or by proxy or by postal ballot, agree to any compromise or arrangement and if such compromise or arrangement is sanctioned by the Tribunal by an order, the same shall be binding on the company, all the creditors, or class of creditors or members or class of members, as the case may be, or, in case of a company being wound up, on the liquidator and the contributories of the company.

Take the majority apart, because it has three components.

A majority of persons. More than half of those voting, counted by head.

Representing three-fourths in value. Those persons must hold at least three-fourths of the value of the class voting.

Of those voting in person, by proxy or by postal ballot. Absentees are not counted either way.

And the sanction is separate from the vote. Even a unanimous meeting produces nothing until the Tribunal sanctions the scheme; and once it does, the scheme binds everybody in the class, including those who voted against and those who did not vote.

What the sanction order provides: section 230(7)

An order under sub-section (6) shall provide for all or any of:

• (a) where the scheme provides for the conversion of preference shares into equity shares, an option to the preference shareholders either to obtain arrears of dividend in cash or to accept equity shares equal to the value of the dividend payable;
• (b) the protection of any class of creditors;
• (c) where the scheme varies the shareholders' rights, effect being given to it under section 48;
• (d) where the creditors have agreed under sub-section (6), the abatement of proceedings pending before the Board for Industrial and Financial Reconstruction under the Sick Industrial Companies (Special Provisions) Act, 1985; and
• (e) such other matters, including an exit offer to dissenting shareholders, as the Tribunal thinks necessary to implement the scheme effectively.

The proviso: the auditor's certificate. No compromise or arrangement shall be sanctioned unless a certificate by the company's auditor has been filed with the Tribunal to the effect that the accounting treatment proposed in the scheme is in conformity with the accounting standards prescribed under section 133.

The rest of section 230

Section 230(8). The order shall be filed with the Registrar by the company within thirty days of receipt of the order.

Section 230(9): dispensing with a creditors' meeting. The Tribunal may dispense with calling a meeting of creditors or a class of creditors where creditors having at least ninety per cent in value agree and confirm the scheme by affidavit.

Note the two figures side by side. Three-fourths in value of those voting is needed to pass the scheme at a meeting; ninety per cent in value agreeing by affidavit lets the Tribunal dispense with the meeting altogether.

Section 230(10): buy-back. No compromise or arrangement in respect of any buy-back of securities shall be sanctioned unless the buy-back is in accordance with section 68.

Section 230(11) and (12): takeover offers. Any compromise or arrangement may include a takeover offer made in the prescribed manner; for listed companies the takeover offer shall be as per the regulations framed by the Securities and Exchange Board. An aggrieved party may apply to the Tribunal in respect of a takeover offer of a company other than a listed company, and the Tribunal may pass such order as it thinks fit.

The Explanation. For the removal of doubts, section 66 does not apply to a reduction of share capital effected in pursuance of an order under this section. So a scheme that reduces capital does not have to go through the separate reduction procedure.

Enforcing the scheme: section 231

Section 231(1). Where the Tribunal sanctions a scheme, it (a) shall have power to supervise its implementation; and (b) may, at the time of the order or at any time afterwards, give such directions or make such modifications as it considers necessary for the proper implementation of the scheme.

Section 231(2): the failed scheme. If the Tribunal is satisfied that the scheme cannot be implemented satisfactorily with or without modifications, and the company is unable to pay its debts as per the scheme, it may make an order for winding up the company, and that order shall be deemed to be an order made under section 273.

That is a striking provision. A petition that began as a rescue can end in a winding-up order without a fresh petition, because the Tribunal that sanctioned the scheme retains seisin of it.

Section 231(3). The section applies also to a company in respect of which a scheme was sanctioned before the commencement of this Act.

Mergers and amalgamations: section 232

Section 232(1): when the section applies. Where an application is made under section 230 and it is shown to the Tribunal:

• (a) that the compromise or arrangement is proposed for the purposes of, or in connection with, a scheme for the reconstruction of the company or companies involving merger or the amalgamation of any two or more companies; and
• (b) that under the scheme the whole or any part of the undertaking, property or liabilities of any company, the transferor company, is required to be transferred to another company, the transferee company, or is proposed to be divided among and transferred to two or more companies,

the Tribunal may order meetings to be called, held and conducted as it directs, and sub-sections (3) to (6) of section 230 apply mutatis mutandis.

Section 232(2): the five additional documents. The merging companies, or the companies in respect of which a division is proposed, shall also circulate for the meeting:

• (a) the draft of the proposed terms of the scheme drawn up and adopted by the directors;
• (b) confirmation that a copy of the draft scheme has been filed with the Registrar;
• (c) a report adopted by the directors explaining the effect of the compromise on each class of shareholders, key managerial personnel, promoters and non-promoter shareholders, laying out in particular the share exchange ratio and specifying any special valuation difficulties;
• (d) the report of the expert with regard to valuation, if any; and
• (e) a supplementary accounting statement where the last annual accounts of any merging company relate to a financial year ending more than six months before the first meeting summoned to approve the scheme.

The share exchange ratio is the heart of a merger, because it decides what each set of shareholders gets, and clause (c) makes the directors explain it.

Section 232(3): what the Tribunal's order may provide. After satisfying itself that the procedure has been complied with, the Tribunal may sanction the scheme and provide for:

• (a) the transfer of the whole or part of the undertaking, property or liabilities of the transferor company to the transferee company from a date determined by the parties, unless the Tribunal for reasons recorded in writing decides otherwise;
• (b) the allotment or appropriation by the transferee company of shares, debentures, policies or other like instruments; with a proviso that the transferee company shall not, as a result of the scheme, hold any shares in its own name or in the name of any trust, whether on its own behalf or on behalf of a subsidiary or associate, and any such shares shall be cancelled or extinguished;
• (c) the continuation by or against the transferee company of legal proceedings pending by or against the transferor company on the date of transfer;
• (d) the dissolution, without winding up, of any transferor company;
• (e) provision for persons who dissent from the scheme within the time and manner the Tribunal directs;
• (f) where share capital is held by a non-resident shareholder under foreign direct investment norms, the allotment of shares of the transferee company in the manner specified in the order;
• (g) the transfer of the employees of the transferor company to the transferee company;
• (h) where the transferor company is listed and the transferee company is unlisted, that (A) the transferee shall remain unlisted until it becomes a listed company, and (B) if shareholders of the transferor company opt out, provision shall be made for payment of the value of their shares and other benefits on a pre-determined price formula or after a valuation, provided that the amount shall not be less than what the Securities and Exchange Board has specified by regulations;
• (i) where the transferor company is dissolved, the set-off of the fee paid by it on its authorised capital against the fee payable by the transferee company on its authorised capital after the amalgamation; and
• (j) such incidental, consequential and supplemental matters as are necessary to carry the merger fully into effect.

The same auditor's certificate proviso applies: no scheme is sanctioned unless the auditor certifies that the accounting treatment conforms to the accounting standards under section 133.

Clause (d) is the practical point of the section. The transferor company is dissolved without winding up, so a merger does not require a liquidation.

Section 232(4): the transfer takes effect by the order. Where the order provides for the transfer of property or liabilities, by virtue of the order the property is transferred to and the liabilities become the liabilities of the transferee company, and any property may, if the order so directs, be freed from any charge, which ceases to have effect.

No conveyance is needed. The order itself passes the property, which is why a scheme can move thousands of assets at once.

Section 232(5). Every company in relation to which the order is made shall file a certified copy with the Registrar for registration within thirty days of receipt of the certified copy.

Section 232(6): the appointed date. The scheme shall clearly indicate an appointed date from which it shall be effective, and it shall be deemed to be effective from that date and not at a date subsequent to it.

Section 232(7): annual compliance statement. Every such company shall, until the completion of the scheme, file a statement every year with the Registrar, in the prescribed form and time, duly certified by a chartered accountant, a cost accountant or a company secretary in practice, indicating whether the scheme is being complied with in accordance with the Tribunal's orders.

Section 232(8): the penalty for failing to file under sub-section (5). The company and every officer in default are liable to a penalty of twenty thousand rupees, and for a continuing failure a further one thousand rupees for each day after the first, subject to a maximum of three lakh rupees.

The Explanation defines the vocabulary of mergers, and it should be quoted, not paraphrased, in an answer on kinds of merger.

• A merger by absorption: the undertaking, property and liabilities of one or more companies are transferred to another existing company.
• A merger by formation of a new company: the undertaking, property and liabilities of two or more companies are transferred to a new company, whether or not a public company.
• Merging companies means, in a merger by absorption, the transferor and transferee companies, and in a merger by formation of a new company, the transferor companies.
• A division: the undertaking, property and liabilities of the company are divided among and transferred to two or more companies, each either existing or new.
• Property includes assets, rights and interests of every description, and liabilities include debts and obligations of every description.

A worked example

Ulhasnagar Papers Limited owes forty crore rupees to two hundred creditors and has fallen behind. It proposes a scheme under which unsecured creditors take sixty paise in the rupee in cash and equity shares for the balance, and preference shares are converted into equity.

The application. The company, or any creditor or member, may apply to the Tribunal to order meetings: section 230(1). The scheme is an arrangement with creditors under clause (a) and with members under clause (b), and, converting preference shares, it is also a reorganisation of share capital within the Explanation.

The affidavit. The applicant must disclose all material facts: the latest financial position, the latest auditor's report, and any pending investigation or proceedings; the reduction of capital the scheme involves; and, this being a corporate debt restructuring, the consent of not less than seventy-five per cent of the secured creditors in value, with the creditor's responsibility statement, the safeguards for other creditors, the auditor's liquidity report, a statement if the Reserve Bank's guidelines are adopted, and a registered valuer's report on the shares and all the assets: section 230(2).

The notices. Individual notice goes to every creditor, member and debenture-holder at the registered address, with the statement of the scheme, the valuation report and the explanation of its effect on creditors, key managerial personnel, promoters, non-promoter members and debenture-holders, and on the material interests of the directors and debenture trustees; the documents go on the company's website; and copies go to the Central Government, income-tax authorities, Reserve Bank, Securities and Exchange Board, Registrar, stock exchanges, Official Liquidator and, if necessary, the Competition Commission of India, which have thirty days to make representations, failing which they are presumed to have none: section 230(3) and (5).

Voting. Those noticed may vote in person, by proxy or by postal ballot within one month of receipt: section 230(4).

A small objector. A member holding three per cent and a creditor owed two per cent of the total outstanding debt wish to object. Neither may. An objection may be made only by a member holding not less than ten per cent of the shareholding or a creditor with not less than five per cent of the total outstanding debt as per the latest audited financial statement.

The result. At the creditors' meeting, one hundred and twenty of the two hundred creditors vote, and those voting in favour are seventy in number holding thirty-one crore rupees of the forty crore voting value. Are both tests satisfied? Seventy of one hundred and twenty is a majority in number; thirty-one of forty crore is seventy-seven and a half per cent, which is more than three-fourths in value. Both are satisfied, so the meeting has agreed.

Had ninety of the creditors voted in favour but holding only twenty-eight crore, that is seventy per cent in value, the scheme would have failed, though a clear majority in number supported it. That is the trap the two-limb test sets.

Sanction. Even so, the scheme takes effect only when the Tribunal sanctions it, and the Tribunal will not sanction it unless the auditor's certificate that the accounting treatment conforms to the standards under section 133 has been filed. On sanction it binds the company and all the creditors and members of the class, including the objectors. The order provides an option to preference shareholders to take arrears of dividend in cash or equity of equal value, protection for a class of creditors, effect to the variation of shareholders' rights under section 48, and an exit offer to dissenting shareholders: section 230(7). A certified copy goes to the Registrar within thirty days: section 230(8). And because the reduction of capital is effected by the order, section 66 does not apply.

If the creditors were nearly unanimous. Had creditors holding ninety per cent in value agreed and confirmed by affidavit, the Tribunal could have dispensed with the creditors' meeting altogether: section 230(9).

Afterwards. The Tribunal supervises the implementation and may give directions or modify the scheme as necessary: section 231(1). If, two years later, the scheme cannot be implemented satisfactorily even with modifications and the company cannot pay its debts under it, the Tribunal may order the company to be wound up, and that order is deemed to be made under section 273: section 231(2).

A merger instead. Suppose the rescue takes the form of a merger with Kalyan Paper Mills Limited, the whole undertaking of Ulhasnagar Papers passing to it. Section 232 applies. The merging companies must also circulate the draft terms adopted by the directors, confirmation that the draft was filed with the Registrar, the directors' report explaining the effect on each class and stating the share exchange ratio and any special valuation difficulties, the expert's valuation report, and, the last annual accounts being more than six months old, a supplementary accounting statement: section 232(2).

The order. It transfers the undertaking, property and liabilities from the appointed date; provides for allotment of Kalyan's shares to Ulhasnagar's members, cancelling any shares Kalyan would otherwise hold in itself; continues the pending litigation against Kalyan; dissolves Ulhasnagar Papers without winding up; provides for dissentients; transfers the employees; and sets off the fee paid on Ulhasnagar's authorised capital against Kalyan's: section 232(3). The property passes by virtue of the order, freed from any charge the order so directs: section 232(4).

If Ulhasnagar were listed and Kalyan unlisted, Kalyan would remain unlisted until it became listed, and Ulhasnagar's shareholders opting out would be paid the value of their shares on a pre-determined formula or a valuation, not less than what the Securities and Exchange Board has specified: section 232(3)(h).

Compliance. A certified copy goes to the Registrar within thirty days, and until the scheme is complete an annual statement certified by a chartered accountant, cost accountant or company secretary in practice must be filed: section 232(5) and (7). Failure to file the certified copy costs the company and every officer in default twenty thousand rupees, with one thousand rupees a day thereafter, up to three lakh rupees: section 232(8).

Distinctions that carry marks

What this does NOT mean

It does not mean a bare three-fourths in value is enough. A majority of persons representing three-fourths in value of those voting is required, and both limbs must be satisfied in each class.

It does not mean an approved scheme takes effect. It takes effect only when the Tribunal sanctions it, and not before the auditor's certificate under section 133 is filed.

It does not mean every dissatisfied member may object. Only a member holding ten per cent of the shareholding or a creditor holding five per cent of the total outstanding debt.

It does not mean a creditors' meeting is always necessary. The Tribunal may dispense with it where creditors holding ninety per cent in value agree and confirm by affidavit.

It does not mean a reduction of capital under a scheme needs the section 66 procedure. The Explanation to section 230 says section 66 does not apply.

It does not mean a merger requires the transferor to be wound up. Section 232(3)(d) provides for dissolution without winding up.

It does not mean the scheme may choose a later effective date. Under section 232(6) it is deemed effective from the appointed date and not at a date subsequent to it.

Quick revision

• 230(1): on the application of the company, any creditor or member, or the liquidator, the Tribunal may order meetings of creditors or members or any class; arrangement includes a reorganisation of share capital by consolidation or division of shares of different classes.
• 230(2): disclose by affidavit all material facts, the latest financial position and auditor's report, any pending investigation, any reduction of capital, and any corporate debt restructuring consented to by seventy-five per cent of secured creditors in value, with the creditor's responsibility statement, safeguards, auditor's liquidity report, any Reserve Bank guidelines statement, and a registered valuer's report.
• 230(3) to (5): individual notice to creditors, members and debenture-holders, with the statement, valuation report and explanation of effects; publication on the website, and for a listed company to SEBI and the stock exchange and in newspapers; voting in person, by proxy or by postal ballot within one month; objections only by a ten per cent shareholder or a creditor with five per cent of outstanding debt; notice to the regulators, whose silence for thirty days is deemed to be no representation.
• 230(6): a majority of persons representing three-fourths in value of the class voting must agree, and the Tribunal must sanction; then the scheme binds the company, the whole class, and in a winding up the liquidator and contributories.
• 230(7) to (12): the order may provide for the preference shareholders' option, protection of creditors, variation of rights under section 48, abatement of BIFR proceedings, and an exit offer to dissentients, and requires the auditor's certificate under section 133; filing with the Registrar in thirty days; dispensing with the creditors' meeting on ninety per cent in value by affidavit; buy-back only under section 68; takeover offers included, per SEBI regulations for listed companies, with an aggrieved party's application for unlisted ones; and section 66 does not apply to a reduction under the order.
• 231: the Tribunal supervises implementation and may direct or modify; if the scheme cannot be implemented and the company cannot pay its debts under it, the Tribunal may wind the company up, the order being deemed one under section 273.
• 232(1) and (2): applies where the scheme is for a reconstruction, merger or amalgamation with a transfer of undertaking, property or liabilities, sections 230(3) to (6) applying mutatis mutandis; the merging companies circulate the draft terms, confirmation of filing with the Registrar, the directors' report with the share exchange ratio, the expert's valuation report, and a supplementary accounting statement where the accounts are more than six months old.
• 232(3) to (8): the order may transfer the undertaking from the date the parties determine, provide for allotment with the transferee holding no shares in itself, continue pending proceedings, dissolve the transferor without winding up, provide for dissentients, deal with non-resident holdings, transfer the employees, protect opting-out shareholders of a listed transferor merging into an unlisted transferee at not less than the SEBI-specified amount, set off the fee on authorised capital, and settle incidental matters; the auditor's certificate is again a condition; property passes by virtue of the order, freed of charges if so directed; a certified copy to the Registrar in thirty days; an appointed date from which the scheme is effective and not later; an annual compliance statement certified by a chartered accountant, cost accountant or company secretary in practice; and failure to file costs twenty thousand rupees plus one thousand a day, up to three lakh rupees.

Test yourself

1. What majority is required to approve a compromise or arrangement? A majority of persons representing three-fourths in value of the creditors, or class of creditors, or members, or class of members, voting in person or by proxy or by postal ballot: section 230(6). Both limbs, a majority in number and three-fourths in value, must be satisfied, and the scheme must then be sanctioned by the Tribunal.

2. Who may object to a scheme? Only persons holding not less than ten per cent of the shareholding, or having outstanding debt amounting to not less than five per cent of the total outstanding debt as per the latest audited financial statement: proviso to section 230(4).

3. When may the Tribunal dispense with a creditors' meeting? Where creditors or a class of creditors having at least ninety per cent in value agree and confirm the scheme by way of affidavit: section 230(9).

4. What happens if a sanctioned scheme cannot be implemented? If the Tribunal is satisfied that it cannot be implemented satisfactorily with or without modifications and the company is unable to pay its debts as per the scheme, it may order the company to be wound up, and such an order is deemed to be an order under section 273: section 231(2).

5. Distinguish a merger by absorption from a merger by formation of a new company. In a merger by absorption, the undertaking, property and liabilities of one or more companies are transferred to another existing company; in a merger by formation of a new company, those of two or more companies are transferred to a new company, whether or not a public company: Explanation (i) to section 232.

6. How does property pass under a scheme of merger? By virtue of the Tribunal's order itself: where the order provides for the transfer of property or liabilities, the property is transferred to, and the liabilities become the liabilities of, the transferee company, and any property may, if the order so directs, be freed from any charge, which ceases to have effect: section 232(4).