Approval of Schemes of Listed Companies: Independent Directors, Not a Sign-Post but a Check-Post

The securities market regulator, SEBI, has recently issued a Circular (No. SEBI/HO/CFD/DIL1/CIR/P/2020/215 dated November 3, 2020) (Circular) introducing a series of changes in the approval mechanism of schemes of arrangement /amalgamation /merger /reconstruction /reduction of capital etc. (Scheme) involving listed companies.  As per the new Circular,  for stock exchanges to refer draft Schemes to SEBI, they need to be fully convinced that the listed entity is in compliance with SEBI Act, 1992, rules, regulations and circulars issued thereunder.  

Another critical change introduced by SEBI is the approval required from the independent directors to the Scheme. A committee of independent directors will need to provide a report (ID Report) recommending the draft Scheme, taking into consideration, inter alia, that the Scheme is not detrimental to the shareholders of the listed entity.  

In addition to the ID Report, the audit committee report is now required to comment on certain aspects of the Scheme, such as: (a) need for the merger/demerger/amalgamation/arrangement, (b) rationale of the Scheme, (c) synergies of business of the entities involved in the Scheme, (d) impact of the Scheme on the shareholders, and (e) cost-benefit analysis of the Scheme. Notably, the independent directors form the majority of the audit committee of listed companies, hence, both the aforementioned changes, are directed to require the independent directors to be careful before they give their approval to the Schemes.   

Are independent directors equipped enough to play the role of a check-post? 

Schedule IV of the Companies Act, 2013 (Companies Act) provides a comprehensive set of code of conduct for independent directors. The ID Report seems an extension of those roles and responsibilities.   The Companies Act and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) have already incorporated various roles and responsibilities for the independent directors.  

However, this circular provides more granularity to the role. Specifically, Schedule IV, Clause II, para 5 and 6 of Companies Act provide that the independent directors shall: 

• safeguard the interests of all stakeholders, particularly the minority shareholders; 
• balance the conflicting interest of the stakeholders;  
• By requiring the independent directors to certify “inter alia ” that the draft scheme is not detrimental to the shareholders of the listed entity, essentially the Regulator is providing direction to the duties cast upon the IDs.

The job asked to be played by the independent directors is not an easy one as it is akin to one of the roles that the National Company Law Tribunal (NCLT) plays while granting its approval to the Schemes. It is settled law that the courts/tribunals have to examine the genuineness and bona fides of the Schemes, and one of the tests is whether the Scheme is detrimental to the interests of the creditors or members or public interest.  

The recommendations provided in the ID report will be submitted to stock exchanges on the basis of which it will give its no-objection, hence, the ID Report is now an important piece of document for any Scheme. Therefore, the independent directors will need to be careful on this additional role, and doing this just due to the fact that the Scheme will ultimately require the approval of the NCLT, may not be the right approach. The Companies Act and LODR Regulations, both provide that if the independent directors do not act diligently, they can be held liable for the acts / omissions. Couple this with the newly introduced class action that can be initiated by minority shareholders against the company, and its management including directors, the independent directors are surely in for a rough ride.   

As the independent directors are not involved in the day to day affairs and management of the companies, they may not have all the information and material to arrive at conclusion for the ID Report. This will make them rely upon the management’s presentation of the facts and circumstances, however, that does not appear to be the idea of the ID Report. Hence, first and foremost, independent directors will need to ensure that they have access to all the information relating to the Scheme proposed by the listed company and the necessary views on the basis of such information. This will not only require them to be sure of Schedule IV compliances but also use it to their advantage. Schedule IV inter alia provides a role on the independent directors to seek appropriate clarification or amplification of information from the company and, where necessary, take and follow appropriate professional advice and opinion of outside experts at the expense of the company. Hence, this can be effectively utilized by the independent directors, where they are not satisfied with the information provided to them by the management, and hence, they can reach out to external consultants, law firms, valuers, to protect the interest of the stakeholders and give proper recommendations. It is imperative to note that the circular issued by SEBI uses the term “inter alia” when it talks about the ID Report. Accordingly, the interest of the shareholders is only one of the many aspects that will need to be considered by the committee. Similarly, the points to be specifically addressed in the audit committee report will also require the independent directors to objectively assess the Scheme and its impact on the stakeholders.    

Further, the deliberations amongst the independent directors with the proper set of information will be critical for granting their nod in the form of the ID Report. In this context, it is not clear, if the ID Report can have certain qualifications or it has to be an absolute recommendation. It is also not clear whether the discussions/ proceedings of the committee meeting need to be recorded in the form of minutes. This may become important especially where there exists a difference of opinion amongst the independent directors on a particular Scheme, and dissenting independent director(s) may not be fine with the Scheme. Recording of concerns may act as a shield for independent directors where questions, if any, are raised by authorities on the ID Report. 

How will the listed companies be impacted by SEBI’s new rule? 

The Companies Act does not mandate the formation of a committee of the independent directors and merely requires that a separate meeting of independent directors be held at least once in a financial year. In the absence of any governing rules on the formation of such committees, the listed companies may face certain questions on the implementation front. Such questions could be whether the committee is required to be constituted by a listed entity only for the consideration of the draft Scheme /will such committee continue to exist till the Scheme has been approved by the stock exchanges or till the approval of the NCLT is obtained, or till the time the Scheme is implemented in full. Another question that may arise is whether a unanimous approval of all the members of the committee will be required to approve the draft Scheme or approval of majority of members of the independent directors’ committee would suffice? What will be the quorum requirements, recording requirements, and other procedural aspects, will be various issues which the listed company will need to resolve, considering that now the ID Report will be one of the documents that the stock exchanges will rely on, for granting of the no-objection letter.  

Conclusion 

SEBI’s move is guided by the principles to ensure that the stakeholder’s interests are protected by the listed companies, especially by the independent directors, who are already liable to bring an element of objectivity to the board processes. One of the major reasons why companies choose the Scheme’s route is its binding nature as against a private contractual arrangement. The Companies Act itself provides that once a Scheme is approved by the NCLT, it shall be binding on the company, creditors, members, liquidator, and the contributories of the company. While the benefits of a Scheme are immense, at the same time, the Scheme has to be genuine, bona fide and reasonable. This is where SEBI has introduced the changes to require the independent directors to not just act as a sign-post but act as a check-post to scrutinize the scheme and make its objective recommendations on the Scheme and live true to their role as per the law.

Note: The article has been authored by Sujjain Talwar (Partner), Manendra Singh (Associate Partner), Tanvi Goyal (Associate Manager)