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Gauhati High Court ruling in the ‘Shell Company’ matter

Finsec Law Advisors

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In its March 07, 2019 order in the matter of Assam Co. India Ltd. vs. Union of India, the Gauhati High Court held that branding a company as a shell company, without serving a notice or hearing, violates the principles of natural justice.

The origin of this matter dates back to June 09, 2017, when the Ministry of Corporate Affairs sent a letter to SEBI identifying 331 listed companies as “shell companies” (“MCA Letter”). In August 2017, SEBI forwarded that list of 331 listed companies to the stock exchanges to be shifted onto Stage VI of the Graded Surveillance Mechanism (GSM) and restrict the trading in securities of such companies by its directors and promoters. The petitioner in the current matter is one of the 331 listed companies mentioned in the MCA Letter.

GSM is a pre-emptive surveillance mechanism formed by SEBI to enhance market integrity and safeguard the interests of investors. While it contains six stages, Stage VI is the strictest of all wherein trading in securities is permitted only once a month under the trade-to-trade category. Further, buyers have to pay an additional surveillance deposit to the tune of 200% of the trade value.

Thereafter, SEBI’s communication was challenged by few of the companies, including the petitioner in this case, before the Securities Appellate Tribunal (“SAT”). SAT observed that the letter sent by MCA provided a list of “suspected shell companies” and opined that SEBI could not have presumed them to be shell companies without making an independent investigation of its own.

The petitioner is a company incorporated under the Companies Act, 1956, which is engaged in the business of cultivation and manufacturing of tea, and it vehemently denies that it is a shell company. Therefore, aggrieved by the MCA Letter, the petitioner filed a writ petition before the Gauhati High Court.

It is pertinent to note that no law in the country has defined or prescribed any criteria to identify “shell” companies. Furthermore, even if any company is a “shell company”, it is not implied anywhere that it can be penalized for being so. In the current case, the High Court has observed that the expression “shell company” in popular parlance refers to a tainted company, and thereby categorizing a company as such would carry adverse consequences.

In light of the above, while allowing the writ petition and setting aside the MCA Letter, the High Court has rightly observed that branding the petitioner as a shell company without even initiating any investigation or giving it an opportunity to be heard would be a gross violation of the principles of natural justice.