COURT ROOM EXERCISE 2

COMPANY LAW -I (U.G. SEMESTER V)

DATE OF APPEARANCE: 14/09/2022

1. Mr. Aragorn Arnor is an automotive engineer with 30 years’ experience in the field. After
having worked with several leading companies around the world, he decided to return to
Arendale during mid-2014 to pursue his entrepreneurial aspirations. Mr. Arnor was keen
to introduce a greener technology for the manufacture of automobile exhaust systems.
Certain corporations liked the idea being propounded by Mr. Arnor’s idea and agreed in-
principle to deploy the exhaust systems, subject to finalisation of the detailed terms and
conditions including price.
2. Mr. Arnor then had to build a corporate framework within which he could nurture his
business idea. He decided to partner with Motoparts (Arendale) Private Limited an
Arendalian business entity (hereinafter ‘Motoparts’), with an intent of seeking local
expertise and marketing network (especially for the aftermarket). Motoparts is a company
predominantly owned by Mr. Elrond Vilya (66%), with the remaining shareholding (34%)
spread across 50 other members of Mr. Vilya’s extended family. Motoparts has long been
in the business of sourcing and supplying automotive spare parts and servicing automobiles
at its various outlets in 15 cities across Arendale.
3. After several rounds of discussions between Mr. Arnor and Mr. Vilya, they came to an
agreement regarding the broad terms of their partnership. It was decided that the business
of manufacturing the exhaust systems will be carried out by a new company Exhaust
Systems (Arendale) Private Limited (with the corporate brand “Elfstone”) (hereinafter
‘Elfstone’). The company was incorporated with a paid-up share capital of ADR 10 crores
with Mr. Arnor and Mr. Vilya holding 50% shares each. Both of them also were the first
directors of the company.
4. Subsequently, after Mr. Vilya discussed the exhaust system proposal with his family
members, they all expressed great interest in participating in the new business, and hence
it was decided that Mr. Vilya will transfer his entire shareholding in Elfstone to Motoparts.
Mr. Arnor provided his concurrence, and the transfer of shares was given effect to on
December 7, 2014, such that Mr. Arnor and Motoparts became equal shareholders in
Elfstone. On the same day, the board of Elfstone appointed Mr. Arnor as its managing
director. With the corporate structure was in place, Mr. Arnor began expending his
resources to get the business off the ground. Upon finalising the business plan, he found
that he needed an additional financing of Rs. 5 crores to tide him through the initial
operative expenses such as leasing the land, building the factory and purchasing equipment.
5. Neither Mr. Arnor nor Motoparts possessed liquid funds to invest for the purpose. They
were not keen to raise money through equity instruments for the fear of dilution of the
current shareholding & possible control being exerted by the external shareholders. After a
few days of brainstorming, Mr. Arnor and Mr. Vilya decided to borrow the requisite
additional funds from Strider Valves GmbH (hereinafter ‘Strider’), a previous employer
of Mr. Arnor with whom he continued to enjoy excellent relations. Strider considered this
 to be a passive financial investment and was not interested in exercising any control over
Elfstone or its management.
6. The initial euphoria was short-lived as Strider’s lawyers advised their client against lending
to an Arendale company due to the extensive restrictions imposed under the Arendalian
regulatory framework on borrowings by the domestic companies from overseas lenders. As
an alternative though, they suggested Strider to invest through unsecured compulsorily
convertible debentures, which was subjected to relatively lesser regulations.
7. Although, uncomfortable with the idea, Mr. Arnor had to relent in order to protect the
Elfstone. During the drafting of the Debenture Subscription Agreement, Mr. Arnor argued
for the inclusion of certain mutually agreeable protective measures to ensure that the control
of Elfstone does not change upon the conversion of the debentures. Consequently, the
following clauses were included in the final Agreement:
a. On the fifth anniversary of this Agreement, each unsecured compulsorily
convertible debenture (“Debenture”) shall automatically, and without further act
or deed, be converted into one equity share of the Company.
b. The Debentures shall not be sold, mortgaged, secured, charged or in any way
disposed by the holder thereof without the prior written approval of all the
shareholders of the Company.
c. The shareholders of the Company shall have the option, exercisable by providing
a written notice of at least 30 days, to purchase the Debentures from the holder(s)
thereof in the same proportion as such shareholders hold shares in the Company.
Upon expiry of the notice period specified in the preceding sentence, the holder(s)
of the Debentures shall be obligated to transfer the Debentures to the shareholders
at a price that represents the aggregate of:
(i) the amount invested in the Debentures, and
(ii) a return of 10% of the amount invested in the Debentures.
d. The provisions of clauses (b) and (c) shall apply mutatis mutandis to the equity
shares arising out of conversion of the Debentures
8. Upon signing the subscription agreement, Elfstone issued 50 lakh convertible
debentures to Strider at a price of Rs. 10 per debenture. The proceeds for the issue were
utilised effectively by Elfstone, which was able to launch its new exhaust system
branded “Smartsys” by December 2015. The company broken even by mid-2017 and
was generating splendid profits thereafter. To further, the scope of the Company’s
business, Mr. Arnor, established a separate undertaking (may also be understood as a
division),1 for designing and producing exhaust systems for Formula 1 race cars. Mr.
Legolas Sindar, a race car designer (who was poached by Mr. Arnor from a leading car
manufacturer) was tasked with leading the division, the Formula 1 division (which was

1
An ‘Undertaking’ is a business terminology, used to define any particular part of a larger group which, if
separated from such larger group, is still capable of operating independently.
 christened “Prancing Racers”) turned out to be a main source of revenue generation for
Elfstone.
9. However, by late 2018, the financial crisis had engulfed the globe and the automotive
sector too was badly affected. Strider sank deep into the red. It began liquidating its
assets so as to pay off its creditors. In the same vein, it wished to sell its convertible
debentures held in Elfstone. While it would have been most logical to attempt a sale of
the debentures to Elfstone’ existing shareholders, time was of the essence, and Strider
could not afford to initiate long-winding discussions with Mr. Arnor and Mr. Vilya.
Even if negotiations were to succeed, Strider feared that dealing with a complex
regulatory maze to go through with the sale would result in loss of precious time.
10. Strider’s misery was tempered by a windfall that emanated from unexpected quarters.
Eldamar Automobiles Limited, a Valinor based automobile company (hereinafter
‘Eldamar’ )offered to pay Strider 150% of the latter’s initial investment in order to
purchase the convertible debentures held in Elfstone. Unexpected this was because
Strider and Eldmar were caught in protracted litigation spanning 3 countries and several
years, that had soured the relationship between the two companies. Moreover, the cause
for such litigation can be pinpointed to none other than Mr. Arnor. Eldamar was Mr.
Arnor’s employer for 10 years before he decided to terminate that employment and join
Strider.
11. Since the two companies were intense competitors in the marketplace, Eldamar feared
that Mr. Arnor was likely to use his experience gained with it as also possible
proprietary information to its detriment in the course of employment with Strider. Soon
after Mr. Arnor’s departure from Eldamar, a few of its customers transitioned to Strider,
and it was a matter of great speculation that Mr. Arnor was the cause for that. The
parties were therefore embroiled in years of litigation over these matters in the Valinor
as well as Shire.
12. On October 16, 2018, Strider declared itself to be a trustee of the convertible debentures
held in Elfstone for the benefit of Eldamar. In consideration for such declaration of
trust, Eldamar paid Strider 150% of its initial investment to Elfstone. The parties
decided on such an arrangement as opposed to a direct sale because they did not desire
to invite the attention of Elfstone (and particularly Mr. Arnor) to the arrangement. They
were almost certain that if a direct transfer of shares was attempted, the board of
Elfstone would never approve such transfer. The declaration of trust was made by
Strider in writing, with such document expressly governed by the laws of Arendale.
This arrangement continued for several months, and interest payments received by
Strider from Elfstone were paid over to Eldamar under the trust arrangement.
13. Meanwhile, there were certain major structural changes happening at Elfstone.
Differences of opinion loomed large concerning the manner in which the Prancing
Horse’s business should be managed. While Mr. Legolas believed rapid expansion of
the business being the need of the hour, Mr. Arnor favoured a more conservative
approach. After prolonged discussions failed to provide any breakthrough, Mr. Legolas
 approached Mr. Arnor, with a proposal of buying out the entire undertaking of Prancing
Horse.
14. Although Mr. Arnor was initially reluctant, he however agreed to the proposal, as he
considered it to be a good riddance. Additionally, he felt, selling of Prancing Horse
would necessarily mean he did not have to deal with Mr. Legolas anymore, whom he
grown to dislike more with each passing day. After necessary discussions, it was
decided that Prancing Horse would be sold off for a nominal consideration, and be
thereafter incorporated as a wholly-owned subsidiary of Elfstone called under the name
Prancing Horse Systems Limited (hereinafter ‘Prancing Horse Systems’).
Furthermore, post incorporation, all shares would be transferred to Legolas Investment
Co. Pvt. Ltd. (hereinafter ‘Legolas Investment’), a personal investment company of
Mr. Legolas established in Arendale for the sole purpose of implementing the buyout
of Prancing Horse. The parties agreed upon a price of ADR 25 crores for transfer of
the shares.
15. The parties entered into the relevant legal agreements on February 9, 2009 to give effect
to the buyout of Prancing Horse. The transactions were completed within a period of
10 days thereafter. During the completion ceremony, when Mr. Arnor enquired with
Mr. Legolas as to how he managed to arrange funds to complete the acquisition, he was
flabbergasted with the response he received. Mr. Legolas stated that he had signed up
for part funding from certain international banks and the remaining from Strider. Jay
was unable to fathom how Strider could fund this acquisition since it was committed
to Elfstone. Jay decided to dig deeper, and found that Strider had provided financing to
Formstone Investment Limited to the extent of Rs. 10 crores in the form of subscription
to compulsorily convertible debentures of that company.
16. Post its 2018 slump, Strider’s fortunes had witnessed a quick reversal and it was again
flush with funds that enabled it to invest. On this occasion, Strider had taken an
additional step to protect its interests. In order secure the periodic returns (in the form
of interest) on the convertible debentures in Legolas Investment, it obtained a pledge
of the shares held by Legolas Investment in Prancing Horse Systems. Strider was also
keen on obtaining a guarantee from Prancing Horse Systems that would ensure
fulfilment of payment obligations under the debentures issued by Formstone
Investment to Strider.
17. Such a guarantee by Prancing Horse Systems was not possible as it was bound by a
negative covenant provided to other lenders of that company. Hence, it was decided
that Prancing Horse Systems would provide an undertaking to Strider stating that “it
shall make reasonable endeavours to ensure that sufficient funds are placed with
Formstone so as to enable it to comply with payments obligations under the secured
compulsorily convertible debentures issued to Strider”.
18. Mr. Arnor shaken at such revelations, further investigated the matter at Strider’s end.
He was distraught that Strider had betrayed him by investing indirectly in the Prancing
Horse business. An investment in Elfstone as well as Prancing Horse was sure to create
a conflict of interest. Although it was a tough nut to crack, Strider relented and then
 disclosed how it had got rid of its investment in Elfstone to Eldamar through the trust
arrangement, and therefore it did not foresee any conflict of interest.
19. The details of the new revelations were indeed a cause of serious agitation amongst
management of Elfstone and especially for Mr. Arnor. He rightfully assumed that
Eldamar had paid a high premium for the convertible debentures in Elfstone just so that
they could cause trouble in the company, hold Mr. Arnor’s back against the wall and
squeeze some payments out of him in the pending litigation with Eldamar. He also
discovered that Strider had struck a bargain in the trust arrangement that it would be
exonerated from any liability to Eldamar, which would focus its actions entirely upon
Jay. He then consulted his lawyers to determine the course of action.
20. Upon discussing the matter with Elfstone’s legal team and consequently acting upon
their advice, Mr. Arnor and Motoparts sent a joint notice to Strider requiring it to sell
the convertible debentures in Elfstone to its shareholders in accordance with clause (iii)
of the subscription agreement. Strider while rejecting the request stated that they were
merely a bare trustee of the convertible debentures, and they no longer held any other
interest so as to be able to sell the debentures to shareholders of Elfstone. It also stated
in its reply that in any event it was not obligated to sell the shares to Elfstone’
shareholders as such a commitment were “not worth the piece of paper on which it was
written”.
21. Thereafter, Mr. Arnor and Motoparts initiated legal action against Strider in the High
Court of Judicature at Mordor in order to obtain suitable remedies in respect of the
convertible debentures held by Strider in Elfstone. In addition, they also sought to
invalidate Strider’s financing of Legolas’ investment company that enabled the latter
to acquire shares in Prancing Horse, on the ground that the same violated various Indian
laws and regulations. Strider did not dispute the jurisdiction of the Indian courts, but
strongly resisted the merits of the plaintiffs’ case on all counts.
22. The High Court at Mordor rejected the claims of Mr. Arnor and Motoparts at the
original level as well as appellate level. As they preferred a further appeal, the Hon’ble
Supreme Court of Arendale has decided to hear the matter, and has granted leave for
the purpose.

Additional Information

1. The parties have provided an undertaking to the court that the debentures in Elfstone
will not be converted into equity shares, pending resolution of the dispute by the
Hon’ble Court, and that they would thereafter be converted subject to the outcome of
the Court’s decision.
2. The laws of Arendale are pari materia to the laws of India.
3. Case laws and authorities of India, UK and USA have persuasive value before the
Supreme Court of Arendale.