“FIT & PROPER CRITERIA”: Impact on Scheme of Mergers & Demergers - MMJC

Introduction

Schemes of mergers, demergers, and various other arrangements (hereinafter “Corporate Restructuring”) involving listed entities have been seen increasing at a greater pace in recent times. Listed entities involved in the scheme of arrangement have to seek a No Objection letter from stock exchanges¹. Corporate Restructuring involving listed entities, SEBI Registered Intermediaries, and certain individuals forming part of these listed entities, must comply with and ensure the ‘fit and proper’ person criteria. During corporate restructuring, stock exchanges check this criterion on behalf of the Securities and Exchange Board of India (‘SEBI’). Fit and Proper person criteria seek to check if the entities involved in the corporate restructuring are morally and ethically sound.

Fit and Proper checks have always been crucial in the eyes of SEBI. It has always placed provisions for checking ‘Fit and Proper’ person criteria for intermediaries registered with it. SEBI periodically checks fit and proper person criteria in the case of registered intermediaries. Hon’ble National Company Law Tribunal also screens the cases of Corporate Restructuring on the grounds of “Fit & Proper”.

Considering this, it is vital to understand what can be considered fit and proper while undergoing any corporate restructuring and to establish a few precedents in this regard

Fit and Proper Person Criteria as is stated by SEBI in Schedule II of SEBI (Intermediaries) Regulations, 2008 is also applicable for Corporate Restructuring. The criteria are as follows:

(a) integrity, honesty, ethical behaviour, reputation, fairness and character of the person;

(b) the person not incurring any of the following disqualifications:

• criminal complaint or information under section 154 of the Code of Criminal Procedure, 1973 (2 of 1974) has been filed against such person by the Board and which is pending;
• A charge sheet has been filed against such person by any enforcement agency in matters concerning economic offences and is pending;
• an order of restraint, prohibition or debarment has been passed against such person by the Board or any other regulatory authority or enforcement agency in any matter concerning securities laws or financial markets, and such order is in force.
• the Board has initiated recovery proceedings against such person and are pending;
• an order of conviction has been passed against such person by a court for any offence involving moral turpitude;
• any winding up proceedings have been initiated or an order for winding up has been passed against such person;
• such person has been declared insolvent and not discharged;
• such person has been found to be of unsound mind by a court of competent jurisdiction, and the finding is in force;
• such person has been categorised as a wilful defaulter; (x) such person has been declared a fugitive economic offender; or
• any other disqualification as may be specified by the Board from time to time.

Schedule II of SEBI (Intermediaries) Regulations, 2008 gives that “Fit and Proper” criteria shall apply to the following persons

• the applicant or the intermediary
• the principal officer, the directors or managing partners, the compliance officer and the key management persons by whatever name called; and
• the promoters or persons holding controlling interest or persons exercising control over the applicant or intermediary, directly or indirectly. Provided that in case of an unlisted applicant or intermediary, any person holding twenty per cent or more voting rights, irrespective of whether they have controlling interest or exercise control, shall be required to fulfil the ‘fit and proper person’ criteria.
• Explanation– For the purpose of this sub-clause, the expressions “controlling interest” and “control” in the case of an applicant or intermediary shall be construed with reference to the respective regulations applicable to the applicant or intermediary.

Precedents – ascertainment of Fit & Proper criteria and rejection of schemes

Recently, in a few cases, it is seen that stock exchanges have been rejecting schemes on the grounds of listed Intermediaries, and individuals forming part of these listed Intermediaries have not complied with the criteria of “Fit & Proper”. A couple of schemes that were rejected based on ‘Fit & Proper’ person criteria are as follows:

• In the case of the Proposed Scheme of arrangement between Motilal Oswal Financial Services Limited (transferor or resulting Company) and Glide Tech Investment Advisory Private Limited (transferee Company) and Motilal Oswal Wealth Limited (Demerged Company) and their respective shareholders. It was seen that the Stock exchange had denied the NOC under Regulation 37 of SEBI LODR on the grounds that one of the directors was named in the Chargesheet filled by “The Economic Offence Wing, Mumbai in the matter of their investigations into irregularities at National Spot Exchange Limited which was disqualifying him under “Fit & Proper Criteria” of Schedule II of SEBI (Intermediaries) Regulations, 2008
• In the Case of Scheme of arrangement between IIFL Securities Limited and 5Paise Capital Limited and their respective shareholders and Creditors: In this case, the chargesheet by Economic Offence Wing [‘EOW’] questioned the “Fit & Proper” status of one of the directors of IIFL Securities Limited, and since the matter was sub-judice, SEBI/ Stock exchange was keen to understand the impact of penal action on the scheme of arrangement. In this case, the NOC was not issued, and Companies were asked to refile the scheme with additional information. Considering both the above cases, it indicates that SEBI/ Stock Exchanges are very clear that any non-compliance of the “Fit & Proper” Criteria under SEBI (Intermediaries) Regulations, 2008 may result in not entertaining any application of any scheme of merger, demerger or any other arrangements for Intermediary. Stock Exchanges may look into this Fit& Proper criterion during Corporate Restructuring because of the first and second proviso to clause 6 of Schedule II of SEBI (Intermediaries) Regulations, 2008.

NCLT & NCLAT Rejection due to Fit & Proper

In the matter of Hotel City Plaza Private limited v. Union of India in reference to the scheme of amalgamation, NCLT and NCLAT rejected the scheme on the grounds of violation of Sections 73 to 76A of the Companies Act, 2013, i.e. 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. Further, the Registrar of Companies had issued ‘Show Cause Notices’, and appellants had not responded. NCLAT, while passing the order, expressly stated as follows:

“Taking note of the surrounding facts and circumstances of the present case comes to an ‘inevitable’, ‘inescapable’ and ‘irresistible’ conclusion that the ‘Appellants’, had not made out a fit and proper case, for ‘Sanctioning the Scheme of Amalgamation’, in accordance with ‘Law’. Looking“

Considering the above case, the Hon’ble tribunals have clearly outlined that any non-compliance with the Companies Act, 2013, especially related to public deposits and the ignorance of show cause notices, is not a case of “Fit & Proper” for a scheme of merger.

Conclusion

The Conduct and actions of the Companies and the directors play an important role in demonstrating the “Fit & Proper” criteria before any corporate restructuring. Any violation of the criteria results in a loss of confidence by the regulator in the company and the intent of the transactions. Therefore, a pre- “Fit & Proper Criteria check” has become the unavoidable action point before any corporate restructuring.

This article has been published on Taxmann. The link for the same

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000024216/fit-proper-criteria-impact-on-scheme-of-mergers-demergers-experts-opinion