Mergers and Acquisitions & Companies Act, 2013: Provision and Analysis

Mergers and Acquisitions & Companies Act, 2013: Provision and Analysis by Dr.Jinesh Panchali and Abhigya Jha Nomura Research Institute Financial Technologies India Pvt. Ltd. Page 1 of 19

Table of Contents I. Introduction... 3 II. The Changes in the Act... 4 1. Fast track mergers:... 4 2. Restriction of Multi-layer structures:... 5 3. Concept of Control:... 5 4. Private Placement for Private Companies:... 6 5. Differential voting rights:... 6 6. Restriction on insider trading:... 6 7. Cross Border Mergers:... 7 8. Restriction on buy backs:... 7 9. Mergers of listed companies with unlisted ones:... 7 10. Minority Squeeze Out:... 7 11. Entrenchment recognized:... 8 12. Prevention of Capital Reduction:... 8 13. Transfer of undertaking:... 8 14. Treasury shares:... 9 15. Loans to directors:... 9 16. Shareholders Protection:... 9 III. NCLT: Powers and Function...10 IV. Competition Commission and Restructuring: Overview...12 V. Conclusion:...13 ANNEXURE 1: Earlier Cases...14 Further Reference...16 Page 2 of 19

I. Introduction Mergers and acquisitions are an important aspect of corporate strategy. Worldwide mergers and acquisitions (M&A) have been accepted as a faster means to achieve various benefits such as efficiency, market power, diversification etc. the need in India for M&A arose in the post- liberalization period. In 2013, a new Companies Act was introduced which will make acquisitions and mergers much easier for the companies. Mergers defined simply are the combination of two or more separate entities into one single surviving entity. Even though mergers and amalgamation is often used interchangeably there is a fine difference between the both. Amalgamation usually means that two entities merger into a new one and a new entity is created all together. There are six types of mergers: 1. Horizontal mergers 2. Vertical mergers 3. Congeneric mergers 4. Conglomerate mergers 5. Cash mergers 6. Triangular mergers Acquisition on the other hand talks about the takeover of all the controlling shares or substantially all controlling shares of a company by another company. There are kinds of acquisitions: I. Friendly takeover II. Hostile takeover III. Leveraged buyouts IV. Bailout buyouts Other concepts with this are joint ventures, demergers and slump sale. Joint ventures are the coming together of two businesses to venture into a new business and this maybe for a limited period of time or not. Demergers is the opposite of mergers, where by one company splits into two or more to venture into specific fields making it a new entity. The shareholders of the old company will receive a part of the shares. Slump sale is a sale at a lump sum amount due to which each asset and liability is not given an individual amount. The advantage of this sale is that the liabilities are left behind and only the asset was passed forward to the company. The companies act, 2013 (herein after referred to as the Act) has brought about the much needed changes to the structure of Mergers and acquisitions in India. Page 3 of 19

II. The Changes in the Act Since the Act was brought in the Ministry of Corporate Affairs chose a scheduled notification of the same. Hence there are some parts of the Act that has been notified and certain that haven t been notified. Thus even though there are several changes in the field of M&A not all of them are in force right now. In this section we shall discuss all the aspects of the act, notified or not. 1. Fast track mergers: Fast track mergers and demergers have been introduced by the new Act. The concept of fast track and simplified method will be provided as an option to the following: 1.1 Merger of two or more specified small companies 1.2 Merger between a holding company and its wholly owned subsidiary 1.3 Any such class of companies specified under the 2013 Act. A small company is a private company that meets either of the following requirements: Its paid-up capital does not exceed INR5 million (or higher amount, as may be prescribed, and should not be more than INR 50 million). Its turnover (according to its last profit and loss account) does not exceed INR20 million (or a higher amount, as may be prescribed, which will not be more than INR200 million). Thus new act does away with the need to take permission from authorities for mergers in small enterprises, holding company and their wholly owned subsidiary. In this case the Central Government will approve the merger and there will not be any need to approach the NCLT. The scheme of being a fast track merger needs to be sent to the Registrar of Companies (RoC) and the Official Liquidator (OL) for their suggestion or objection within 30 days. Then this needs to be approved by: i. Shareholders holding 90% of the total number of shares at the general meeting ii. Majority creditors (representing 9/10th of value) in a meeting which is to take place within 21 days of the notice sent. There is no clarity on whether like the 1956 Act this will also have the present and voting as an essential criterion as it has not been specifically mentioned by the 2013 Act. Once this approval is however obtained then this has to be filed with the RoC, OL and the Central Government. This will be approved if the is no objections. If incase that is not the case then the Central Government may refer this to the NCLT to consider it for a normal merger process. The company hence may or may not be able to perform merger under the process of fast track merger. Both the companies must also file a declaration of solvency with the RoC. The one relaxation that has been provided is that in case of fast track mergers there is no need for the auditors to provide for the certificate of compliance with accounts Page 4 of 19

2. Restriction of Multi-layer structures: The new regulations also prevent companies from investing in multi-layer companies. They prevent two layers of investment companies. Investment companies are usually defined as an enterprise with the principle function of acquisition of shares, stocks, debentures or other securities. Thus by the 1956 Act: And by the new law The law does not affect the following: 2.1 Company from acquiring another enterprise and if it is allowed to have investment subsidiaries beyond two layers according to the laws of that particular country. 2.2 A subsidiary company which has investment subsidiaries to meet statutory requirements. There is no definition provided of the principle business of an investment company. There is no clarity on the fact that whether this will also be needed to be complied by the old existing structures. This could affect a lot of genuine multi corporate structures and become a deterrent to Mergers and acquisitions. 3. Concept of Control: The new Act has provided for a broader meaning of control. Since it ambiguous on what is the scope of this definition, it might create some problems. Similar definition to the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011, the scope of this may be applied to the new Companies Act maybe applied. The New Act defines Control as: shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner Again in this a problem area as this is also not clear. In the case of Subhkam Ventures, Securities Appellate Tribunal (SAT) had decided that affirmative voting rights granted to investors would Page 5 of 19

not amount to control. The Supreme Court stated that this judgment would not hold precedent value as Subhkam Ventures v. SEBI, did not appoint its Directors on the Board and left most of it investments. This will also lead to problems in agreements with unlisted companies in regards to the shareholders agreements as there is no clarity on what really constitutes control. In the shareholders agreement certain rights are giving and accordingly the Articles of Associations are amended. Investors by this get certain rights which provide them a degree of control over the management. 4. Private Placement for Private Companies: The 2013 Act also introduces the concept of private placement for private companies. If the provisions stated in the Act are not satisfied then this will be deemed a public offer. Private placement of securities can be made to a maximum of 50 persons, except if a higher number has been prescribed for that financial year. Qualified Institutional buyers, under the SEBI s Issue of Capital and Disclosure Requirement and employees under Employee s Stock Option Scheme have been not included while calculating the maximum limit. The securities through private placement must be allotted within 60 days, failing which the subscribers need to be repaid. Companies generating funds in this manner are not allowed to release any public advertisement or use any media, marketing or distributing channels or agents to inform the public about these offers. The new Act also states that without the allotment of previous offer or invitation, a new invitation or offer cannot be issued. 5. Differential voting rights: A company is allowed to issue DVR shares (not exceeding 25% of its share capital), only if it has been profitable for three years preceding the year in which it has decided to issue DVR shares, and it has not defaulted in filing its annual accounts and returns for the period. Also, the articles of a company should allow the issue of DVR shares or the company must have obtained the shareholders approval for the same in a general meeting by passing a special resolution (by postal ballot in the case of listed companies) for the issue of such shares. Under the 1956 Act, it was permitted to a private company to issue such shares provided there were no a subsidiary of a public company. The New Act has now applied this to the private company, without the mention of the validity or enforceability of share under the 1956 act which were made without any such regulations. 6. Restriction on insider trading: Section 195 of the new act not only solidifies what is stated in SEBI s Prohibition of Insider Trading Regulations, 1992, but also extends it to unlisted companies. According to the clause, no director or key managerial personnel of a company should engage in insider trading, e.g., subscribing, buying, selling or dealing in securities, if such a person is reasonably expected to have access to Page 6 of 19

any non-public, price-sensitive information in respect of the securities of a company or its procurement processes, or communicate, directly or indirectly, any nonpublic price-sensitive information to any person. 7. Cross Border Mergers: Global integration and cross-border mergers are now permitted. The foreign company must be based in a notified area. This gives Indian companies to restructure the shareholdings and shift its ownership to international holding companies, thus giving it more access to the international market. The 1956 Act allowed only the possibility of inbound merger (i.e. a foreign company with Indian company). The 2013 Act on the other hand proposes way for both, inbound and outbound mergers. An Indian company can now merger with a foreign company despite its place of business is India or in a certified jurisdiction subject to the approvals of NCLT and RBI. The clause of certified jurisdiction might restrict a lot of movement in both outbound and inbound that currently is allowed in any jurisdiction which allows this kind of merger. 8. Restriction on buy backs: The number of buy backs per financial year has been restricted by the new Act. The cooling period between two buy backs is one year even if it is a shareholder approved buy back. Even a buy back under a scheme will have to compliant with the conditions given. If a company has defaulted in repaying deposits, redeeming preference shares or debentures, paying dividend etc. then the company is prohibited from buy back for a period of three years after the default is completely paid up. 9. Mergers of listed companies with unlisted ones: The 2013 Act has set out a formal code for the merger of a listed with an unlisted company. It gives the transferee company the option to be unlisted and merger with a listed company, the only condition being that they should provide for an exit opportunity to the shareholders of the listed company. Thus the act allows merger of a listed with an unlisted company with the option of keeping the unlisted company unlisted, provided that the shareholders of the merging listed company are offered an exit opportunity. Unlisted authorities are also brought into the area of regulatory authorities whereby the NCLT without looking into the certificate sanctioned by auditor that the accounting treatment is correct cannot sanction a scheme. 10. Minority Squeeze Out: The 2013 Act also provides for accesses to an acquirer, PAC (Person in Concert), or a person or a group of persons becoming registered shareholders of 90% or more of the issued equity share capital of the target company (listed or unlisted) by virtue of amalgamation, share exchange, conversion, securities or for any other reason to notify the minority shareholders about the Page 7 of 19

buying out of the remaining equity shares. Minority shareholders can also suo moto offer their shares to majority shareholders. The Act hence recognizes minority squeeze out as a legal option. 11. Entrenchment recognized: Entrenchment has been recognized in this new Act as a part of the Articles of Association thus making the investor have a greater say in enforcing rights in certain matters. While this was present as a norm in most shareholders agreement the 1956 Act was silent on it thus creating an ambiguity. In the new Act, the provision for entrenchment ascertains that the rights that were contractually available to the shareholders would be available in a more binding manner once incorporated in the Articles of Association. The 2013 Act also provided for the issue related to restrictive rights of parties in relation to transfer of securities of a company. It has stated that any contract or arrangement between any two or more parties or persons in relation to securities of a company then that shall be enforced as a contract. The law has provided for legality of shareholders agreement related to transfer of shares. The private equity investors shall be able to now enforce certain strict clauses in their agreements with the promoters. 12. Prevention of Capital Reduction: The 2013 Act also prevents companies or organizations from capital reduction if there has been a default in payment or irregularity in payment of deposit from public or interest on such deposits. The procedure for capital reduction includes sending an application to NCLT (which receives applications from companies undertaking capital reduction) who are required to forward it to the Central Government (CG), the Registrar, SEBI (in cases of listed companies) and creditors. The NCLT has to then give an assent within a period of three months after reviewing the representation of the company. The company is supposed to submit a certificate from the auditor stating that the accounting treatment for such reduction is in conformity with the specified Accounting Standards. Also the company is supposed to publish the order of the NCLT sanctioning capital reduction scheme. 13. Transfer of undertaking: Under the 1956 Act an ordinary resolution was enough to lease/ sell the entire or a substantial part of the undertaking. There was always an ambiguity in the terms: undertaking and substantial the whole of the undertaking. In the 2013 Act, there has been a clear definition of the terms undertaking and substantially whole of the undertaking there by eliminating the ambiguity that was present. Also now the sale or transfer of the whole of an undertaking or substantially most of it by a company will require a special resolution over an ordinary one like in the older law., irrespective of the fact that if it is a private or a public company. Page 8 of 19

14. Treasury shares: The 2013 Act prevents a transferee company from holding its shares in its own name or in a trust. In a case where such an act takes place the merger must be necessarily cancelled between the companies involved. In the past often Promoters have followed the practice of transferring the shares of their subsidiary companies to trusts and issuing shares of holding companies pursuant to the mergers of wholly owned or partially owned subsidiaries with holding companies, instead of canceling such shares. In cases like Escorts, Mahindra & Mahindra and Jaiprakash Associates, the court has dealt with these issues. 15. Loans to directors: In the light of the misuse of the loans granted under the 1956 Act, the 2013 Act has withdrawn all the exemptions provided to private companies.thus making it impossible for the directors to push the money for their personal use. The new act has also been worded in a manner so as to cover the subsidiaries in this as well. 16. Shareholders Protection: The new act ascertains that now the investor will have a greater say in the shareholders agreement. It provides for a legality of inter-se agreements related to transfer of shares. They will now be able enforce strict terms of conditions on the promoters of the company. Drag along and tag along clauses can now be mentioned in the agreement. The Act has clearly stated that any contract or arrangement between two or more parties in respect to transfer of securities will be treated like a contract. SEBI and RBI have also made amendments to enable and be in sync with these rights. The new Act also provides for the concept of class action which entitles the stakeholders to seek compensation from the company, and also its directors, auditors, and expert advisors for any wrongful conduct. Page 9 of 19

III. NCLT: Powers and Function NCLT or National Company Law Tribunal is a tribunal that has been established under the Companies Act, 2013 under Section 419 to Section 434. The birth of NCLT took place in the 124 th report of the Law Commission Report and the amendment of 2002 in the older act. This was brought into force so as to reduce the burden of the high court. The amendment was challenged on grounds of being unconstitutional. It was brought in to replace Company law board, BIFR, Appellate Authority for Industrial and Technical members. Hence independent tribunals were to be set up so as to provide specialized focus on these cases. This has also been brought into force so that there is faster disposal of cases. As already provided in the companies act, 2013 the tribunal and even the appellate court (NCLAT) has to dispose off the cases within three months of filing. The reason for this delay must be recorded and the president or chairperson may extend it for another 90 days and not more. After going to NCLT and NCLAT if the person still wants to further appeal he can go to the Supreme Court within 60 days from date of receipt from the NCLAT. This shall not be bound by the procedures as laid down in the CPC, 1908 but by natural justice. The Tribunal and the Appellate Tribunal have been given the powers that as of a civil court under the Code of Civil Procedure, 1908 when a suit on any of the following matters is present in the tribunal: a) summoning and enforcing the attendance of any person and examining him on oath b) requiring the discovery and production of documents c) receiving evidence of affidavits d) requisitioning any public record or document or a copy of such record or document e) issuing commissions for the examination of witness or documents f) setting aside any order of dismissal of any representation for default or any order passed by it ex parte; and g) any other prescribed matter Any order by the tribunal or appellate tribunal is to be treat like the order in the court where a trial is pending. The Tribunal or Appellate Tribunals may send its order for execution to the court within the local limits of jurisdiction: a) The registered office of the company is situated; or b) The person concerned voluntarily resides or carries on business or personally works for gain. Any proceeding in the tribunal or the appellate tribunal is to be treated as judicial proceeding within the meaning of Sections 193, 196 and 228 of Indian penal Code. The tribunal and appellate tribunal shall be treated as a civil court for the purposes of Section 195 and Chapter XXVI of the Code of Criminal Procedure Code, 1973. Page 10 of 19

The Tribunal and appeal board both have the same jurisdiction as the High Court in case of any contempt that maybe committed, as given under the Contempt of Court Act, 1971. It may also delegate its power to an authorized person to inquire into a matter of the Tribunal or Appellate board and then report back to them. The Tribunal may in order to take into custody or under its control all property, books of account or other documents request in writing the Chief Metropolitan Magistrate, Chief Judicial Magistrate or District Collector within whose jurisdiction any such property, books of account or other documents of a company are situate or found to take possession thereof. The magistrate or collector shall- a. Take possession of such property, books of account or other documents; and b. Cause the same to be entrusted to the Tribunal or other person authorized by it. The Magistrate or Collector may take steps and use force as may be necessary. No such act shall be called in question on any court or before any authority on any ground whatsoever. Page 11 of 19

IV. Competition Commission and Restructuring: Overview In 2009, the Competition Act was notified which dealt with anti-competition agreements and abuse of dominant position amongst other things. In 2011, the combination provisions were notified. With the enforcement of the combination provisions and the notification of the Combination Regulations, all mergers, amalgamations and/or acquisitions falling within the thresholds indicated in section 5 of the Competition Act will require prior approval of the CCI. Following provisions of the Competition Act, 2002 deals with mergers of the company:- 1. Section 5 deals with Combinations which is defined by reference to assets and turnover: a. exclusively in India and b. in India and outside India. 2. Section 6 states that, no person or enterprise will enter into a combination which may affect or is likely to affect the Indian market in an adverse manner and any such a combination shall be held void. All types of intra-group combinations, mergers, demergers, reorganizations and other similar transactions should be specifically exempted from the notification procedure and appropriate clauses should be incorporated in sub-regulation 5(2) of the Regulations. These transactions do not have any competitive impact on the market for assessment under the Competition Act, Section 6. The Indian Law states that a maximum of 210 days is provided for determination of combination, which includes mergers, amalgamations, acquisitions and similar actions. This however is not the compulsory waiting period for those who file with the Competition Board as the law provides that depending on which is earlier, 210 days or the order of the board, will be the maximum waiting period. The internal time limits within the overall gap of 210 days are proposed to be built in the regulations that the Commission will be drafting, so that the over whelming proportion of mergers would receive approval within a much shorter period. Page 12 of 19

V. Conclusion: The new Companies Act seems to be opening up a lot of new and simpler methods and mechanisms for mergers and acquisitions in India. It aims to make the process smooth and transparent. This Act is also expected to look into the rights of the shareholders and give a new dimension to corporate restructuring. The Act also has aligned itself with the already prevailing acts such as Income Tax Act and other similar provisions. The phased implementation has created a certain amount of problems for the Companies. The Act does not talk about any transitional provision whilst the notification is being given to the act. There is also no mention of what is supposed to done with the acts of the company which have been expressly disallowed or changed in the new act. The new act also requires or acts to be updated so as to keep it fully functional and make sure that all provisions are being implemented to their fullest extent. The full impact of the act, even though it has it has introduced certain very forward looking and simple provision, will be clear only with time. The Act has codified certain acts that were in practice present by not by the law. It is step forward to looking at a more transparent and accountable Indian market. Page 13 of 19

ANNEXURE 1: Earlier Cases In this section we shall look at some earlier cases that have been taken up by the courts of India. 1. Miheer H. Mafatlal v. Mafatlal Industries Ltd.: Facts: The transferor company and transferee company had an agreement passed the resolutions of amalgamation. The appellant was a director of the company himself. In the meeting of equity shareholders convened pursuant to the order of the High Court, overwhelming majority of the equity sha reholders of the respondent transferee company approved the Scheme. Issues: The issue that was brought up was that whether the amalgamation was against the minority shareholders of the company. It was also unfair to the equity shareholders as the exchange ratio of equity shares of the transferor and transferee companies was ex facie unreasonable and unfair to the shareholders of the transferee-company. Decision: The petition was dismissed on the grounds that the arrangement was neither unfair nor unreasonable to the equity shareholders. Once the transfer ratio has been fixed by no mistakes can be pointed out as to unfairness of the scheme, that too when it has been passed by such big majority of shareholders.th e court also held that if there was no special scheme of compromises that had been offered to the different class of shareholders there wasn t any need to convey a meeting for them. 2. Hindustan Lever s Employees Union v Hindustan Lever Ltd.: Facts: In 1994, Hindustan Lever Ltd (HLL) made an amalgamation by the order of the Company Court with Tata Oils Mills Company, ltd (TOMCO). This amalgamation took place despite the fact that neither of the companies ware financially insolvent or sick and was initially challenged by minority shareholders. This appeal was brought in by the employee union of both TOMCO and HLL. Issues: The employee union of HLL made the objection in court as to the future of the employees of HLL and speculated retrenchment as well. Held: The court held that any amalgamation that is made is supposed to take into account the employees of the company. It is supposed to ascertain that the service conditions are continuous and unaffected. Service conditions are not to affect just due to the merger taking place. The merger with TOMCO would definitely help HLL to grow and prosper. The court found no reason to doubt the judgment of the company court. It held that the merger had not been planned as a scheme for a device of retrenchment. Page 14 of 19

3. Marshall Sons & Co. (India) Ltd. V. Income Tax Officer: Facts: A subsidiary company was merged with its appellant holding company which passed a resolution with respect to (w.r.t) to the amalgamation with effect from 1.1.1982. Both the companies got the approval of the high court of Madras and Calcutta where there respected registered offices were located. This took over two years two years to be sanctioned. The Registrar of Companies in Madras struck off the name of the subsidiary company in the year 1986. Issues: The Income Tax Department by a notice on 25.11.1984 to file tax returns for the assessment years of 1984-85 and 1985-86. The subsidiary company stated that by the resolution passed by the company, it had undergone an amalgamation with effect from 1.1.1982. The High Court stated that the amalgamation comes into effect only after the High Court approves the amalgamation scheme and not on any other date earlier than that. Held: The Supreme Court allowing the appeal held that every scheme has to necessarily provide a date of amalgamation from which the amalgamation is to be effective. The Court can provide for a date of amalgamation after that which is not the case. Here in this case, the date has not been provided by the Court and hence the amalgamation date will be held as the one that has been given by the Scheme. As the transferee and Transferor Company must carry on the business as per usual while the amalgamation is pending hence the subsidiary company will be presumed to carry on business for the holding company as an agent for the same. Page 15 of 19

Further Reference 1. Mergers and Acquisitions in the new era of the Companies Act, 2013 http://www.ey.com/publication/vwluassets/assocham_white_paper_companies_act/ $File/Assocham_White_paper_Companies_Act.pdf 2. Mergers, amalgamation and Reconstruction 3. Companies Act, 2013: Key highlights & Analysis 4. Merger and Acquisition- Transformed rules of the game http://www.ey.com/in/en/issues/governance-and-reporting/ey-compass-on- Companies-Act-2013/EY-cfo-companies-act-2013-mergers-amalgamation-andreconstruction https://www.pwc.in/en_in/in/assets/pdfs/publications/2013/companies-act-2013-keyhighlights-and-analysis.pdf http://www.lexology.com/library/detail.aspx?g=e55e05ba-1363-4300-a981-64c6fafe186a 5. Changing contours of mergers and acquisitions under Companies Act, 2013 6. http://cn.lakshmisri.com/news-and- Publications/Publications/Articles/Corporate/Changing-contours-of-mergers-andacquisitions-under-Companies-Act-2013 Page 16 of 19

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