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Cos Act Ep#10: Compromises, Arrangements & Amalgamations

Published on Sun, Jun 29,2014 | 23:20, Updated at Mon, Jul 07 at 22:22Source : CNBC-TV18 |   Watch Video :

As the Indian economy recovers, so will M&A activity. But will the Companies Act, 2013 prove to be a big hurdle to dealmaking? More disclosures, fast track mergers and for the first time ever, provisions for two-way cross border mergers – the new law ushers in big changes! In Episode 10 of this special series, CNBC-TV18’s Menaka Doshi spoke to Haigreve Khaitan of Khaitan & Co, Ashok Gupta, Aditya Birla Group, Amrish Shah, EY and Harish Hulyalkar, Citibank on whether the law makes M&A easier or more difficult to do.

Doshi: Today we focus on Chapter XV- Compromises, Arrangements and Amalgamations.

Be it a vanilla merger or an innovative scheme to write-off goodwill- Sections 391-394 of the Companies Act, 1956 permitted all that and more. They are still alive as Chapter XV and the corresponding Sections that is 230-234 of 2013 Act have yet to be notified but when they do come into force, Sections 230-234 will bring with them both restrictions and innovations. The first thing to know is that all schemes of compromise or arrangement now require more disclosures to the Tribunal including corporate debt restructuring.

Companies Act, 1956
Sections 391 - 394

Companies Act, 2013
Sections 230 - 234

Section 230 (2)(1)
Shall disclose to the Tribunal by affidavit
-all material facts relating to the company
-reduction of share capital of the company
-any scheme of corporate debt restructuring

Gupta: I don’t think there is a material change except that it is making more definitive.

Doshi: The new law also requires that any buyback of securities done via a scheme must comply with the requirements of the buyback Section i.e. Section 68- mainly the buyback must be 25 percent or less of the aggregate of paid-up capital and free reserves.

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

Section 68 (2)
No company shall purchase its own shares/securities unless
(c) the buy-back is twenty-five per cent. or less of the aggregate of paid-up capital and free reserves of the company

Shah: If you do a Tribunal process driven buyback or you do a non-tribunal process driven buyback through the market or even a direct tender, there is a 25 percent limit. So, now you cannot say that I will use a Tribunal route to go beyond 25 percent which used to be the case under the 1956 Act. So, that now has got synchronized.

Doshi: So you can’t do a buyback under a scheme and violate or ignore any of the limits set out in the buyback section, you have to honor those limits if you were to include a buyback in a scheme.

Shah: Yes. There is subtle difference as to why people may still do it under a Tribunal route and that’s a tax point because there could be a view that if I do a buyback under a Tribunal process, it may not fall under the new buyback taxation which came in the last Budget.

Khaitan: But having said that now you need to give notice to the Income Tax Department; so those creative schemes could have its own issues.

Doshi: Reduction of share capital under schemes. Is that unchanged?

Khaitan: What is clarified is that you can actually do a capital reduction and you don’t need to specifically follow another set of procedures for capital reduction. So, it can be part of the composite scheme. So, we used to do schemes but follow perhaps two procedures under some court procedures - the capital reduction procedure and the scheme procedure. Now you can do under one composite procedure which is a clarification; nothing really new but a good clarification.

Gupta: The whole idea is that earlier there was ambiguity whether the High Court can go beyond even the provisions of the law and now by capturing all those provisions here that High Court must ensure not only provisions relating to arrangement or compromise plus must also look at the relevant provisions which are applicable be it buyback or reduction of ….(Interrupted by Anchor)

Doshi: So you have to go back and make sure that it meets all the requirements in those Sections as well.

Gupta: Yes, to that extent it is good.

Under the Companies Act, 2013 in a scheme involving a merger or amalgamation the Tribunal has wide ranging powers including to provide for dissolution without winding up, exit for dissenting shareholders, share allotment to comply with FDI norms and most importantly for a transferee company to remain unlisted. Section 232 (3) (h) says, in the case of listed company being merged into an unlisted company, the resultant company may remain unlisted until listing. If shareholders of the listed company decide to opt out, then they must be compensated in the prescribed format.

Section 232 (3)
The Tribunal may provide for
- transfer of all or part of the transferor company
- continuation of legal cases by or against transferor company
- dissolution, without winding up, of transferor company
- exit for dissenting shareholders
- share allotment to foreign investors as per FDI norms

Section 232 (3) (h)
If a listed company is merged with an unlisted company

- resultant company (transferee) shall remain an unlisted company until it becomes a listed company

- if shareholders of transferor company decide to opt out of the transferee company, provision shall be made for payment of the value of shares held by them and other benefits in accordance with a pre-determined price formula or after a valuation is made

Hulyalkar: Earlier companies were trying merging a division into an unlisted company that was possible. In select cases we have seen that. Now there is an express provision that you can merge a listed company into an unlisted company and the transferee company will remain unlisted. So that’s a new express provision in the new Companies Act.

Doshi: What is the implication of this?

Hulyalkar: You can take listed company and put it into an unlisted company and the resultant company will not be listed. So, they probably wanted to avoid a situation where the unlisted company also automatically gets a listing through a merger process. The new amendment addresses that.
Doshi: Was it the case earlier that if you were merging a listed company into an unlisted company it would have automatically got listed?

Hulyalkar: Yes, under the Securities and Exchange Board of India (SEBI) rules you would have to provide liquidity to the share holders of the merging company. So, if the resultant company was unlisted that objective was not achieved. So now under the new Companies Act they have provided that if you do such a scheme where the resultant company is unlisted, you have to provide an exit opportunity to the shareholders who don’t want to be part of an unlisted company.

Doshi: How would that exit opportunity be given?

Hulyalkar: Essentially there will be valuation. They will have to be given either cash or some other form of consideration so that they do not end up holding an unlisted security in the new company.

Khaitan: Having said that the new Companies Act does provide that the SEBI regulation and the listing agreement don’t actually permit that. So, whenever you are dealing with a listed company as per current law you will have to go to the Exchanges and to SEBI. So if you maintain an unlisted company whether SEBI will at all approve that is in question and this is a way to probably achieve a back door delisting.

Doshi: Why would they not allow this?

Khaitan: While the Companies Act has put an enabling provision it is very doubtful that the SEBI and stock exchanges will allow this.

Doshi: Why would the Companies Act allow for this to happen because I am sure they can also see the implications of this being abused in some fashion?

Khaitan: It is more of an enabling provision. If our delisting provisions and the exit by merging listed to unlisted are synchronised together and the delisting can be achieved subject to certain conditions through a merger of listed with unlisted with the same sort of delisting parameters as SEBI prescribes, it can give you just one more re-structuring option as we go along. So it gives you more innovation and options for companies who might do a restructuring may do a merger and a delisting simultaneously. However this will all be subject to what SEBI and the Exchanges bring out as we go along.

In another first, the Companies Act 2013 makes an explicit provision for de-mergers?

Section 232
Explanation: a scheme involves a division, where under the scheme the undertaking, property and liabilities of the company in respect of which the compromise or arrangement is proposed are to be divided among and transferred to two or more companies each of which is either an existing company or a new company

Khaitan: Under the compromise and arrangement everything was covered and this has stemmed from the amendment to our tax laws where we now have a specific de-merger provision. So this is more clarificatory in nature to specifically allow and the controversy as to whether such schemes fall within compromise or arrangement there is no controversy left but it wasn’t again required. It’s just clarificatory.

Shah: If you look at the draft rules again, they have said that de-merger needs to be aligned with the tax definition. Therefore the question that will come is it the cart before the horse or the horse before the cart.

Doshi: Explain that?

Shah: Let’s look at it- a tax definition talks of an undertaking or a part of an undertaking to be falling within the definition of de-merger. Today if I want to just put one asset out the current Companies Act does allow it when I say current it is 1956. So, I can put one asset out, it will still fall as a compromise or an arrangement under 391-394. Going forward if this draft rule were to become rules I can’t put that asset out.

Doshi: Why?

Shah: Because I have to follow the tax definition and tax definition means it has to be an undertaking which means a business activity to say the least. Let us put it this way. There were companies which had land parcels and had business. So I had two choices, either to put the land parcel out under the company provisions or put the business out and depending on my situation I will decide which is better for me.

Doshi: Now you can only put the business out?

Shah: I can only put the business out.

Khaitan: Unless of course the land parcel itself is a business activity.

Doshi: I think he is talking about real estate as an asset.

Shah: So that is baffling to me that why would a Companies Act say that you have to follow the tax definition. If there are tax consequences of any restructuring, the tax people will take care of it in terms of the assessment and what they need to do.

Doshi: Was the tax treatment for de-merging simply an asset clear or was the tax treatment only clear when it came to de-merging and undertaking which is why maybe the IT department has prevailed on the MCA and said look, if you have a de-merger, it has to be aligned with what our available tax treatment is because we don't have a tax treatment available for just de-merging an asset.

Shah: I look at it slightly differently. Why should the tax department go and say don't do non-tax de-mergers because then they are losing the tax revenues.

Khaitan: I would add that we have a Companies Act which is now trying to address tax and stamp duty by virtue of a provision under the Companies Act. Stamp duty has its own provisions. They were spinning of parcels of land to avoid stamp duty. Now the Stamp Duty Act has been fixed in most States to deal with that situation. The tax law has been fixed to deal with that situation and you cannot have corporate law to check whether there is a tax abuse or a stamp duty abuse.

Doshi: Let us be fair. This is in the draft rules to point out.

Khaitan: But many of the draft rules, I have to say, have become final.

Doshi: And some have not and some final rules have also not been final. Even those have been now amended after being notified.

Gupta: Possible explanation for its inclusion could be, normally arrangement and compromise would be more of a business transaction and not a property or a standalone property because there are many different provisions. That is the power of the CEO and the board of directors to sell off the assets of the company under different provisions of the Act. So if it is only a property and nothing to do with the business arrangement ….(Interrupted by Anchor)

Doshi: The Scheme provision was being misused?

Gupta: Yes, it is an arrangement in the overall scheme of things.

Khaitan: I would say that this does limit, if the rules were to come out, many restructuring possibilities. Let us take an example of an asset which is not a business and I need to restructure just to take that asset out while I am doing three other de-mergers as part of the same scheme. I need to just take out one property. I can do it under a composite scheme; I can de-merge two businesses, merge one business take out a land parcel which has a separate tax treatment but I don’t need to follow yet another procedure for sale of an undertaking or for sale of a land and do it as part of composite scheme. All the approvals my tax, CCI, shareholders, creditors all are satisfied. So, the single window sort of clearance scheme which we now have under the 1956 Act in one way will go away.  

Doshi: That is if the Draft Rules become final.

Shah: Commercially you may need to do everything at the same time. So, if it was under one scheme as Haigreve was saying it would all happen at the same time. So, you are taking away that flexibility.  

Hulyalkarr: It could also be if it is not done for shares but done for cash. So, if you are doing a de-merger for cash like Amrish said you may end up paying tax and you maybe okay with that.  

Doshi: I started by asking whether this was an enabling provision- clearly it doesn’t sound very enabling. All of you sound unhappy with it?

Shah: Since we are on de-merger there is one more thing in the Draft Rules and again the definition is not exactly in sync with the tax definition because if we read that definition, the tax definition says that all revaluations that you do will be ignored when you look at book values. Here they say revaluation only in the last two years will be ignored. It doesn’t synchronise with the tax definition of de-merger. Either the revaluation is completely ignored – you can’t have two year window for the revaluation to be ignored for the Companies Act definition.

Doshi: That is if the Draft Rules become the final rules. Since we are still on grey man’s land on that – maybe they will listen to you and maybe this will all change before it gets finalized.

Shah: A lot of representations have been made so hopefully we will see better things on this one.

Doshi: What clearly does seem to be helpful on the face of it is the explicit provision for not having to go to the Tribunal when it comes to the merger of two small companies or the merger of a wholly owned subsidiary into a parent. That shortens the process, makes it easier and more hassle free for companies and I suppose that can only be good, right?

Khaitan: That is right.

The most important new feature in Chapter XV is the provision for not just inbound cross-border mergers but outbound ones as well. The 1956 Act permitted foreign companies to merge with Indian companies but Section 234 of the new law also permits an Indian company to merge into a foreign company and it allows the use of depositary receipts as payments to the shareholders of the Indian company. There is just one hitch- such inbound and outbound mergers can only take place with companies in countries as notified by the government.

1956 Act
Permitted a foreign company to merge with into an India company

2013 Act
Allows a foreign company to merge into an India company and vice versa

Section 234 (1)
A foreign company may merge into an Indian company or vice versa
Need prior RBI approval
Payment of consideration can be cash or Depository Receipts
Government to notify list of countries

Shah: For inbound there should be no restriction on jurisdiction because if you look at the entire tenet of the Act, it has been more transparent, more disclosure and all of that. Now if I have a BVI company or I have a Mauritius company which is merging into an Indian company, the disclosure is only going to enhance, it can’t go away. If they have to look at this jurisdiction it should only be for outbound mergers; inbound should be as free as it is today because that will allow the full flexibility.

Doshi: I don’t know whether the wording of this Section seems to indicate that the list will apply only to outbound and not to inbound; it seems to imply a common list for both.

Khaitan: While notifying they could actually make a distinction.

Doshi: In many other instances Rules have amended the Act. Some of the interesting things here are that you could use even Indian Depository Receipts (IDRs) to pay for such an outbound merger of sorts?

Gupta: It is bound to happen otherwise how to take care without IDR.

Doshi: There is only one IDR in this country it is not like too many people benefit from this but just the fact that it will make IDRs that much more appealing?

Gupta: Absolutely.

Doshi: You see this as a big move?

Gupta: It is a big move depending on how many countries that you are going to notify, whether it is attractive for people to have the outbound merger happening.

Doshi: I suspect the only countries that they may not include in the list as Harish Hulyalkar pointed out were some of the tax haven countries?

Gupta: Just to give an example for an MNC who has setup a wholly owned company or subsidiary company which are listed by the way, and if you allow that merger to happen, it is quite possible all of them will get merged with the holding company and this will remain a branch. All I am saying is it has huge implications. It is not merely notification of countries, but it has implication on wide variety of activities. For instance equal wages you get in the foreign country you must pay here, same country we are a branch we are no longer a company. Can you sue a foreign company, because you are not under an independent company - it is a branch, so it has number of applications in terms of outbound and inbound and therefore the government is grappling with it. So have a comprehensive notification, to avoid any possible misuse whether tax, labour laws, contracts, commercial agreements, foreign exchange.

Shah: Clearly you will not see major outbound mergers till the tax law changes.

Doshi: Why?

Shah: Let's say this was already notified- an Indian company merging into a foreign company and you getting shares of the foreign company as a shareholder- that is not a tax neutral merger, because only when you get a shares of an Indian company…(Interrupted by Anchor)

Doshi: If it was a cash consideration?

Shah: Cash is separate; then maybe SEBI will not permit it because you are not allowing the flexibility to the shareholders. I am just taking an example- you will get the shares of the parent company whichever it is. So anyway you can trade because Foreign Exchange Management Act (FEMA) rules do permit for you to hold shares of foreign companies. Second FEMA rules have to change as Ashok Gupta just pointed on the branch. Branch - the type activities that a branch can do is very limited. It is not like what you can do as a subsidiary or as a company which is incorporated in India. So, again those restrictions are there, that is very important. The third is IDR will not come into play because even if it is an Indian security, again tax needs to change to say that if an IDR issued on merger it is tax neutral for the Indian shareholders. Today only when shares are issued in lieu of shares it is tax neutral.

Doshi: It can happen?

Shah: When we raised it with the last Finance Minister (FM) or the previous FM, he was very clear that he would push this once Rajya Sabha cleared it but obviously the time was too short for him thereafter. So I am hoping at least the tax part will get cleared- that was the commitment and I don’t think it should change - that’s my point of view on this. So maybe it will change because otherwise you will have a Companies Act and a provision which is very good, which is forward looking but cannot be implemented practically.

Doshi: So we need the tax department to come onboard, we need RBI to come onboard and we need SEBI to come onboard?
Hulyankar: Absolutely.

Khaitan: One very big issue is going to be valuation because look it in another way- it is Indian assets being transferred abroad and we are all aware about the controversies around Discounted Cash Flow (DCF), Return on equity (ROE) - Indian shares being transferred. So here we may not be dealing with Indian shares but then we are dealing with Indian businesses and assets. So when RBI comes into the picture we really need a fix there on valuation.

Doshi: But even RBI is coming around now to the view that we don’t want to prescribe to you a valuation method, we are willing to treat you like adults and we are all waiting for the final provisions on that.

Khaitan: If they really come around to that and they also provide for that here then one big hurdle would be crossed.

Doshi: Are you not excited by this- I thought all of you would be beaming with 234 but all you all have done is raise how this will not work?

Gupta: This is cautious optimism. For instance even valuation- two sets of accounting. We have not yet adopted the International Financial Reporting Standards (IFRS). Now those accounts- foreign jurisdiction would be following another IFRS system we don’t have. I would say there is no clarity in terms of whether the conversion to bring both the accounts at the same level is going to impact Indian shareholders or not.

Hulyalkar: The IDR plus this Section can actually be quite helpful for inbound Mergers and acquisitions (M&As).

Doshi: I thought so as well- that was the feedback that I got except that has been slammed here.

Hulyalkar: Because if you merge an Indian company into a foreign company, it is not practical for Indian public shareholders to get securities of an overseas company, have broking accounts, how do you track it, how do you sell it? Maybe an IDR then becomes a solution because today you are not seeing, like you said, companies come forward and tap the Indian capital markets just on a standalone basis and have IDRs but maybe an IDR in the pretext of an M&A could actually be much more positive.

Doshi: I will admit that even the tax treatment of IDR is currently awaiting clarity. We have only one IDR in the country but let us assume that since this Act is now here for at least the better part of our lives, that this will when put into force six months or a year down the line be a big change for how Indian M&A is done.

Shah: Just one more aspect which they have missed out and which they should cover which today is permitted for inbound is that this provision only talks of merger and it doesn’t talk of de-merger. If you see all the other provisions they have said the same provisions will apply to de-merger- whether it is the fast track merger, whether it is the normal mergers- this is the only provision in which de-merger is not covered. I have seen cases today where inbound de-mergers have happened. Going forward they will stop.

Khaitan: Again the question would be really was it all intentional or was this all hurried drafting issues.

Doshi: So why would they take away the ability to de-merge if they had been allowing this earlier.

Khaitan: Exactly.


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