October 16, 2021

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All you need to know about cross border demergers in India

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Thsi article has been written by Kumari Anju. It has been edited by Khushi Sharma (Trainee Associate, Blog iPleaders) and Vanshika Kapoor (Senior Managing Editor, Blog iPleaders).

Table of Contents

For most of the 20th century, the focus of businesses was the global economy. Now the scope of their deals and transactions has expanded from country-specific to international. Global mergers and acquisitions increasingly drive the face of mergers and acquisitions. Companies and corporations have a wide range of means for influencing these complex deals, including share purchases, sales of corporations, companies, etc. The large corporations are also exploring these opportunities for third-party acquisitions or mergers and reorganizations, as well as for corporate streamlining. The trend of Indian corporations participating in global deals for M&A, divestment, or in domestic restructuring is not new. We have also seen the rise of Indian businesses’ global involvement multiple fold. The regulatory structure of India has changed to accommodate business requirements and complex inbound and outbound transactions, integrating both imports and exports. An amendment was passed that allowed foreign companies to enter into Indian companies. Although foreign companies may merge with Indian ones under the Companies Act, outbound mergers are generally not allowed.

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In this article we are going to discuss the deal structuring process for the scheme of cross border demergers either in form of inbound or outbound in India works. The procedural aspect and legal aspect of cross border arrangements are important. With greater efficiency, restructure typically comes about as a result of a business analysis. If a particular segment of the business begins to decline, reallocating resources must occur to enable it to succeed. Sometimes a business may have grown beyond its abilities and needs to shift to the heart of what it is best at. Restructuring a company’s financial position may be necessary to remain profitable. Demergers are sometimes necessary to meet the constantly changing needs of industry competitors, survive a poor economic climate, or ensure the company can take advantage of new technology. 

This article discusses different aspects of cross border demergers including the need for outbound demergers, legal provisions, valuation aspects and tax implications, and accounting treatment pertaining to cross border demergers. Section 234 of the Act is considered a basic law relating to cross border arrangements including Rules 25A of Companies (CAA) Rules which contain a review of the applicable regulatory provisions. This article discusses concepts such as national companies incorporating in other countries, legal frameworks for national companies to consider when doing inbound and outbound demergers, and all of these concepts with the help of two case laws of inbound across border demerger where foreign company demerged to register under Indian Companies Act and become Resulting Indian Company.  The second case involves an outbound cross border demerger scheme where an Indian company arranged a spin-off to demerge itself into Resulting Foreign Company. To sum up, this article provides the broad idea in a generalized way to provide information of cross border structuring, issues regarding cross border deals and further developments in the saga of cross border demerger arrangements.

The restructuring of an enterprise is an opportunity to improve a company by the way of demergers. To execute both short term and long term objectives, businesses try to strengthen their position. Restructuring became a well-known practice in the corporate world from last decade. Large numbers of businesses worldwide have reorganized their divisions, restructured their assets, and streamlined their operations in an attempt to boost their performance. 

Planning and Strategy

A business is demerged to increase the efficiency of its operational and financial performance. To improve operational and financial efficiency, the company may propose demerging one or more units of the corporate debtor. In the event of demergers, consideration is offered to transferor shareholders in the form of equity shares based on their proportional participation in the equity exchange ratio by the transferee company, which is calculated based on the values assigned to the original company’s shares. What is left over from the use of the total cash flow is used to meet the operating and debt needs of the first entity, and then used to settle the debt of the second. If we talk about strategizing the cross border demerger arrangement, we first have to plan the cross border arrangement with proper intentions and objectives for this course of action to deal with the situation. Secondly, after planning the scheme guidelines the strategy of play also plays a very important role to maneuver with the intention of outwitting the competitor. Thirdly, maintaining a pattern of actions that scheme of going to act upon. Fourthly, it is imperative to strategize the environment and location of the Resulting Company or Transferee Company which seem most favorable to the demerger scheme. Lastly, it is important to know the perspective of the organization as well. All of these above mentioned strategies can be applied for creating an overall plan for accomplishing the objectives of the organization. Strategy is thus concerned with the relationship between an organization and its external environment, as well as the competition it faces.

Cross Border Demergers: Overview

Mandatory NCLT Approval: The hiving off running business into a separate entity in case of demergers can only be undertaken by prior approval of NCLT where all the employees of the company, assets of the company and all the liabilities related to the company got transferred to the Resulting company whether it is a foreign company or an Indian Company on a going concern basis. The transferee company is obliged to issue the shares of their company as a part of consideration whereas in the case of 

Additional requirements for the Listed Companies: All those listed companies who are involved in the scheme of demerger, have to comply with SEBI guidelines and LODR Regulation 37. In addition to that, they are obliged to take prior approval of all the stock exchanges in which the company is listed.

Employees and Licensing: The notice of demerger in a written form must be submitted to the employees and shareholders of the company. The employees must be informed of the form of demerger taking place in the company both in the case of Resulting Company and the Demerged Company. Whereas there is no requirement of license agreement as the scheme will include everything from Transferor to Transferee Company.

Assets and Liabilities: The cross border demerger where one or more undertakings of a company is transferred to another company overseas either to form a new company or to merge with the existing company. Such transfer of undertakings includes the transfer of all the assets and liabilities attached therewith.  All those liabilities which are apportioned to the undertaking is also be transferred to the resulting company and the losses will also be carried forward to the resulting company if the conditions of Section 72A (4) satisfied under Income Tax Act.

Capital Gains/Taxation Aspect: If a resulting company is a demerged company and capital assent transfer is taking place, then the company does not fall under Section 47 (vib) of the Income Tax Act. The tax concessions will be available in the cases there the company which is going to demerged satisfies two conditions which are, demerger took place as per conditions laid down in Section 2 (19AA) and the cases where an Indian Company is the final Resulting Company, that is, it is available for the Inbound cross border demergers where the resulting company is an Indian Company. 

In cases of outbound cross border demergers, no tax concessions are available to the company where the resulting company is a foreign company. The capital gains are also payable.

Additionally, the shares of the demerged company, as well as the shares of the resulting company, will be held by the shareholders of the demerged company. In the cases where the existing shareholders opt out for transfer of shared then the cost of those shares will be calculated as per Section 49 (2C), Section 49 (2D) and Section 2 (42A) of the Income Tax Act.

Stamp Duty and Consideration: Stamp Duty is based on state specific jurisdiction. The consideration can be paid by the issuance of shares to the shareholders or in the form of cash. The shares are basically issued to shareholders of the company which is going to demerged by the resulting company, if the company opts for issuance of shares, it would be the better option as they will get the benefit of tax concessions.

Due Diligence

Due diligence can be done both off-sight and on-sight where the former needs physical collection of facts whereas the latter is all about collection of facts by way of other means which can be online data available or by e-mails. For taking due diligence, it is important to go through basic principles of law which are undertaken by Tax Consultants, Human Resource, Intellectual Property Experts, Legal Experts and Auditing experts where each team has to submit their due diligence report to the company.

The book building process of valuation is a basic due diligence done by an independent registered valuer. The components of valuation include the basic reading of the balance sheet and profit and loss accounts. The valuation evaluation swings in both ways: one wants it to be high to get the most of it while the other wants it to be low to reduce the fees cost. Investors always ensure the projected target to get a proper valuation at the best price. The valuer gives the valuation report by evaluating all financial, technical as well as technical due diligence.

The collection of information of Target Company is divided into various sectors of laws:

Legal Due Diligence: The technical aspects are looked into by the target company which is undertaken by the Financial Experts.

Corporate Aspect: While going through the basic laws related to cross border demergers, the main objects of the scheme is finalized by going through standard chartered documents which includes the shareholders’ agreement, Memorandum of Association (MoA) of the company, certificate of incorporation and shareholding table of the company.  The components of MoA must include the main clause and secondary clauses in MoA such as object clause, Registered Office clause, Liability Clause, Capital Clause (must have enough head room, if not, you can ask to increase the capital), Promoter Clause and Name clause which is applicable to both companies which are incorporated before or after 2013.  After taking the MoA of the target company, the Articles of Association (AoA) also plays an important role. The financial experts must go through the restrictions on issuance of shares in the target company by going through the AoA; the company must do all the compliance checks before giving the shares to any other investors. Specifically ask for registers of the target company to check on the shareholding pattern of the company, members of the target company and the directors of the target company. If the register is maintained according to the specific format prescribed by the law or not. The main purpose due diligence serves is it helps in identifying the issues, flag it to the investors and identifying the attached compliances so that buyer can ask for those information which are missing and decide if the deal is favorable or not.

Contractual Aspect: Review all agreements for legality and verifiability of the company’s contracts. When it comes to business, the typical situation has the corporation has four relationships which are to financial creditors, distributors, suppliers, dealers, customers, clients, shareholders, contractors and competitors. Things that you should pay attention to are the obligation of business partners, loans, liens, guarantees, trust deeds, loan sales, redistribution pledges, sales contracts with restricted competition, and purchases of securities and mergers/acquisition and other agreements. 

Approval Aspect/Licensing:  While conducting research on the nature of operation in which Target Company works, to check upon regulatory licensing requirements. It is important to note if the target company has complied with registration with relevant authorities such as RBI, Ministry of Corporate Affairs, Environmental Clearance if necessary, Income Tax Authorities and compliance of Other Regulations are dune or not. Due diligence is conducted as per requirements of specific sectors, for instance, if a company is manufacturing plastic, it must comply with environmental criteria, maximum and minimum production criteria and other licensing aspects which are necessary and also check on the terms of the license. It basically includes identification of the relevant law, eligibility criteria, application requirement and nature of licenses required to be maintained along with the Insurance claims with respect to sellers’ business. 

Intellectual Property Due Diligence: It is to check whether the property, patent, business, trademarks are properly registered or not. Non-Disclosure Agreement is signed between buyer’s clients and the Buyers, any confidential information leakage will amount to insider trading it must also to look into consideration. The sale deed or transfer deed to acknowledge the flow of money and their transfer of shares must be checked as well as all the licenses and agreements in the matter of property. 

Litigation Aspects: The financial experts must go through all the litigation against the target company which is pending in the court of law. In addition to that, also look into the criminal charges against the directors, if any, and other litigation matters such as if any Tax is due in the company. 

Employment Compliances: The number of employees working in the target company, the wages of those employees, the sector they are involved into, minimum wages requirement and wages payable to them, all these aspects must be looked into. Additionally, check on whether the company is complying with Labor Laws which includes Provident Fund Act, Payment of Wages Act, Payment of Minimum Wages Act, Gratuity Act and all other corresponding acts. If in any case the Employees Provident Fund is applicable, the buyer must go through the contribution made by the company to its eligible employees along with whether these proper deductions are made or not. Keep check on the proper policy of other important labor laws such as POSH Act, Maternity Benefit Act, and Employees’ Compensation Act are there or not. The target company must have proper records and filings, here not only reading of legislation is important but reading of rules plays as important a role as legislation.

Financial Due Diligence: To examine the worth of the company or indebtedness of the company, the financial due diligence is important. It is to examine financial agreements, loan agreements, security agreements, pledge agreements and loan agreements of the target company. The financial due diligence answers the good fact record of the company by keeping check on loans taken by the target company, if the company is regular in making necessary payments, whether target company have good equity to debt ratio, what is the debt service ratio of the target company, what all securities are provided by the company, whether the target company have done proper documentation, filing done in different portals of Ministry of Corporate Affairs, SARFAESI and firms portal or not. After all taking due diligence of all these important financial and legal aspects the financial expert must point out key red flags issued and ask the target company to fix it if not then assets and investments can be at risk and can also lead to breaking of deal between buyer and seller. 

Operational Due Diligence: It looks into technical aspects of the business of target company where operational due diligence assists the company in analyzing functional and operational processes of target company, such as their manufacturing operations, what are the supply chain and distribution channels of the target company, procurement and supply of products, and other critical operations such as finance, accounting, and human resources. Since foreign companies do not have as much information about the Indian market, it can be difficult for them to identify their target; same is it with the Indian companies as well. There is a risk that targets do not give their employees or business partners any useful information, resulting in employees or customers not being ready to communicate to their suppliers, customers, and customers not having any contact with their networks, suppliers or personnel. Therefore, an overload of information sometimes results in insufficient assessment and inaccurate synergies.

Cross Border Demerger Strategy

The strategy is to be maintained for successful cross border demerger scheme which are listed here:

  • Scheme of Arrangement: Development of cross border demerger strategy and the expectations from the scheme. 
  • Search Criteria: After finalizing the cross border demerger strategy arrangement it is important to look into attached profit margins, geographical location of the company and customer base.
  • Potential Targets: Accordingly, the company which matches the criteria can go forward towards searching the potential demerger targets based on factors mentioned above.
  • Demerger Planning: Contact the target companies which meet the search criteria and form a cords border demerger planning.
  • Valuation: Conduct valuation of the company and ask them to provide the companies detail for the same. 
  • Negotiation: After conducting proper valuation, the buyer and seller must negotiate on the best price. The buyer always wants the price to be low and seller want the price to be high, in this case negotiation plays a very important role.
  • Due Diligence: It is for detailed examination of key strengths of the target company by analyzing their financial, operational and legal aspects.
  • Purchase or Sale contract: the contract can be formed either as asset purchase where the acquirer only purchases the assets of the target company but not become owner or share purchase where the acquirer becomes the owner of the target company.
  • Financing Strategy: the purchaser here figures out the different options available for finance for the process of Inbound Demerger to complete, for instance, bank loan, equity financing, leverage buy-outs etc. In case of outbound demerger, analysis of the best finance option available can be opted.
  • Closure of Deal
  • Filing of petition for approval of the scheme before NCLT 

Demergers Under Indian Law

A demerger is a legal restructuring in which a single firm gets divided into two or more separate corporations, legally distinct, organizations that are registered as distinct corporations. Companies Act of 1956 or Companies Act of 2013 do not clearly define the term demerger anywhere in the act. Before considering the legality of cross-border demergers, a baseline assessment of the current situation is required. In many cases, the Indian courts have resorted to Clause 1(b) of Section 232 of the Companies Act which basically allows for a demerger scheme to be submitted for approval, namely it permits a plan of arrangement to divide a single business among several companies.

Examining Cross-Border Demergers In India: Lack of Clarity

By making some changes in Companies (CAA) Rules in the 2017 notification of the Ministry of Corporate Affairs, the concept of cross border mergers emerged. Where the schemes of inbound or outbound cross border demergers were enabled and were permitted to have such arrangements between Indian and a foreign company by fulfilling recommendations made by J.J.Irani in Expert Committee on Company Law. It is good that they tried to consider the cross border issues related to merger but what about demergers taking place in India? It is possible where a foreign company demerged into a resulting Indian company and where an Indian company demerged into a resulting foreign company. The Section 394 applies to both mergers and demergers whereas there is only reference of “mergers and amalgamations” in Section 234 but no reference of demergers is there in the section. If we interpret Section 234 of 1956 Act, it leads to ban in demergers as whole, while the language of this new provisions works in such a straight manner that it permitted cross border mergers in both ways i.e., inbound and outbound, by inserting Rule 25A. In merger rules, the goal is to set forth clear the way for future cross-border deals. But the Act is unclear about whether it is legal for a foreign company to do business in India or not, basically there was no clear cut legislation as to legality of cross border inbound demergers or cross border outbound demergers.

Although the existing regulations fail to address demerger of an Indian company into foreign resulting company and vice versa, since the NCLT approved inbound cross border scheme of arrangement of an Indian company’s proposal by referring Section 232(1) of the Act and FEMA Regulation, the same tribunal later determined that an outbound cross border demerger scheme of arrangement to the same country was illegal on the grounds that outbound demergers are not permitted. These cases are discussed in detail in the following chapter. Due to conflicting instructions, it is unclear if cross-border demergers are permitted.

Legislative intention: An Analysis

If we look into 2018 Order of NCLT which appreciated FEMA Regulation, which governs the merger, demerger, or amalgamation of Indian companies. The order of NCLT acknowledges that if the legislature intended to prohibit cross border mergers, they would not have been explicitly addressed in the regulations at all. On the contrary to the 2018 order, the NCLT’s 2019 order completely disregards the theory of NCLT for legislative intention mentioned in 2017 FEMA Regulations in reaching its conclusion (these cases are discussed in detail in next sub-topic). 

The outbound cross border demerger scheme did not have legislative approval, as Cross Border Merger Regulations does not include the term “demerger” deliberately. Finally, it was found that Section 234 did not include anything about compromise or an arrangement, whereas in Sections 230-232 of the Companies Act the term compromise and arrangement is mentioned clearly. Therefore, permissibility of outbound cross border demerger under the Companies Act was silent on this matter. Nothing new was added or subtracted from the law in this process, but only the definitions given in it were interpreted according to the Act’s language strictly. The clear legislative intention to interpret the law and apply it as it is, in the case of inbound cross border demerger, they took the case as ‘amalgamation’ of foreign company to Indian company rather than demerger of foreign company to resulting Indian company, whereas, in the case of outbound cross border demerger the court interpreted it as demerger of Indian company into foreign resulting company which cannot be verified under any law nether in cases of mergers nor in amalgamations.

Scheme of Arrangement

This scheme is basically a form of outbound cross border demerger can also be taken as cross border amalgamation scheme where the undertaking of Sun Pharma Global FZE (Transferor Company), here referred as Global FZE, which is a foreign company incorporated in United Arab Emirates demerge itself and merge to Indian company, Sun Pharmaceutical Industries Limited, here mentioned as SPIL (Transferee Company).

Transferor Company: The foreign transferor company Global FZE which is licensed under SAIF Zone in the UAE. Although this is an indirect wholly owned subsidiary of company SPIL which focuses on the manufacturing, development, transfer and trade of pharmaceutical formulations, it also participates in research of new drugs and similar other activities which are sold all over the USA and world market. Its immediate holding companies are Mauritius and Sun Pharma Holdings, whereas, SPIL is the ultimate holding company.

Transferee Company: The Indian transferee company SPIL, one of the world’s largest generic pharmaceuticals, is a public listed company established as per provisions of The Companies Act 1956. The business is in going concern basis whose equity shares are listed in BSE Limited and NSEI Limited who carry out business of pharmaceuticals and many types of drugs, in addition to the other activities, consists of developing, marketing, exporting, and distributing various generic formulations, as well as the production of pharmaceuticals.

Objective of Scheme of Arrangement

The demerger will enable the two organizations to integrate their business; compression of the activities by way of demerger will lead to synergies in operations, cutbacks in administration, management, and, eventually, an increase in the group’s growth and reputation. The SPIL and Global FZE, when combined, will provide greater efficiency for customers and ultimately benefiting patients. This will also enable the Transferor Company to better manage its customers in different therapeutic segments, regulatory, and pricing environments, all of which gives it an opportunity to grow its products and potentially expand globally as well as creating additional value for shareholders.

Accounting Treatment

It shall be done pursuant to the “Pooling of Interest Method” of Accounting in the books of SPIL which is a Transferee Company as per Appendix C of Indian Accounting Standards 103 notified under Companies Act and Companies (IAS) Rules duly certified by the Charted Accountant as per proviso of Section 230(7) of the Companies Act.

Consideration

The Global FZE Company is wholly owned by the transferee SPIL, since the Transferee Company holds all of the shares of the Transferor Company, the entire capital of the Transferor Company is held indirectly. Thus, following the completion of the Scheme, no shares of the SPIL was issued to the Global FZE. Following the conclusion of the implementation of the Plan, the Transferor’s entire share capital is extinguished and cancelled.

Valuation

There is no change to the shareholding pattern of the company which is to be demerged as per the scheme of arrangement, it is certified by a chartered accountant that there is no requirement of valuation in such cases. So there’s no valuation done in this scheme of arrangement.

Taxation Aspect

This scheme is a kind of cross border demerger of foreign companies into Resulting Indian Company as well as amalgamation that is taking place between the SPIL (Indian Company) and Global FZE (Foreign Company) after demerger. Therefore, the Income Tax Sections 47, Section 1(b), Section 2(19AA)  and other provisions will fall within the definition. If a foreign undertaking demerger itself into the resulting Indian Company, such transactions would be exempt from capital gains tax according to the Income Tax Act of 1961. 

Legal Compliances

Dissolution of Global FZE: Upon the implementation of the scheme, the Global FZE Company will commence liquidation proceedings under the SAIF Zone requirements and laws thereof.

Stock Exchange Approvals: The SPIL duly communicated the scheme with explanatory statement to the SEBI and other stock exchanges which includes NSEI Limited and BSE Limited and obtained approval from the same.

Consent Affidavit: As per the directions of NCLT the transferee company hold separate meeting of unsecured creditors of the company and for equity shareholders of the company with the scheme of arrangement and copy of explanatory statement as well as other regulatory disclosure requirements. The transferee company sent notice to the unsecured creditors and equity shareholders of their company and held the meeting individually as per the order of tribunal along with explanatory statements and copy of scheme of arrangement. As per the provisions of Companies Act, 2013 read with Companies (CAA) Rules and other applicable rules it is mandatory to have approval of majority of shareholders and unsecured creditors. 

Publication: There was publication of meetings held for the unsecured creditors and equity shareholders of Transferee Company in ‘Financial Express’ English newspaper and local Guajarati newspaper as per NCLT orders.

Approval of Scheme by Equity Shareholders and Unsecured Creditors: By e-voting, where the transferor company got 98.45 percent of approval from equity shareholders in number and 99.99 percent approval in aggregate value and also approved by unsecured creditors unanimously who were present in the meeting.  

Notice to Statutory Authorities: The transferee company duly served notice of scheme of inbound cross border arrangement to various statutory authorities which includes, Central Government, Income Tax Authorities, Security exchange board of India (SEBI), Registrar of companies, Reserve Bank of India, Bombay stock exchange and National Stock Exchange of India. Along with scheme of arrangement they also provide them with explanatory statements, mandatory disclosures and other required documents. 

RBI Approval: As this scheme includes cross border demerger arrangement, the prior approval of Reserve Bank of India is mandatory before filing the application to NCLT which is duly done by the transferee company. In the FEMA notification issued by the RBI, the transferee company complies with it and sought deemed approval as per the notification of RBI.

NCLT Observations and Decision

The tribunal approved the scheme on the basis that the documents were duly produced with the conditions that the transferee company is abide by Income Tax Act and all the tax implication if any, it must accept all the liabilities, comply with pricing guidelines as per FEMA Regulation 2017, compliance with transfer of WOS (wholly owned subsidiary) as per ODI Regulation. In addition, the Resultant Company is obliged to comply with ODI Regulations for prescribed transfer of shares to the overseas WOS while merging to Indian Company.  

The Scheme was approved on the basis of applicability and compliance of Section 230-232 of the Act which is considered to have the same nomenclature as to what we call “merger and amalgamation”. If we look into Section 232(b) it clearly says that the whole or any part of the Transferor Company’s undertaking can be transferred to the Transferee Company, this implies that we can also apply demerger and other amalgamation schemes which involve transfer of an undertaking from one company to another. Additionally, Section 234(1) can also be applied to schemes which involve mergers and amalgamations. This is also supported in Rule 9 of FEMA Regulation 2017 which is quite obvious in the fact that there is clear intention of consideration of demergers as well otherwise it would not have been provided in Regulations anyway.

Scheme of Arrangement

The demerged company Sun Pharma filed a petition under Section 230 to Section 232 of Companies Act, 2013 read with Section 234 of Companies Act, 2013 seeking for the sanction of the scheme of cross border demerger arrangement. This is a scheme of spin-off involving demerger of two undertakings of the Sun Pharma India into undertaking of two oversea companies one of them was situated in Netherlands called Sun Pharma B.V. (resulting company 1) and the other one was situated in the USA named Sun Pharmaceuticals Holdings USA Inc. (resulting company 2) in the form of Resulting Companies. 

The Demerged Company: The Company is per the provisions in the Act having registered office in India. The business is a going concern with running business activities which is mandatory for process of demerger to take place. The Sun Pharmaceutical Industries Limited is involved in manufacture of various drugs and their marketing and sale including sale of formulas of drugs and many other pharmaceutical products for their development and for trading purposes, they also export these drugs and formulas. The equity shares of the company are listed under stock exchanges in India on National Stock Exchange India Limited and Bombay Stock Exchange.

The Resulting Company 1: The Sun Pharma B.V. company established in the Netherlands is an unlisted company who holds strategic investments of the company and undertakes financial activities overseas. It is a wholly owned subsidiary of the demerged company, i.e., the SPIL. 

The Resulting Company 2: The Sun Pharmaceuticals Holdings USA Inc is established in the United States of America which is an indirect wholly owned subsidiary of the demerged company, i.e., the SPIL and also carries on financial activities and holds strategic investments as well. 

Objective of Scheme of Arrangement

By virtue of this scheme, the company can strengthen the portfolio of the SPIL and its investments while gaining synergy benefits out of this outbound cross border demerger scheme of arrangement. It can also improve risks and policies of the company, can deal with regulatory challenges more efficiently, and can also consolidate the operational resources, management recourses and financial resources overseas. The proposed arrangement also enables both demerged and resulting companies to focus on the competitive strength of both companies as well as increase their goodwill and reputation. It focuses on long term growth, creation of more value to the shareholders and consolidation. The spin-off of the undertakings of SPIL aims to independent growth of the companies and reorganization of present arrangement for better utilization of control, management and cash flows and get benefited in a group level.  

Accounting Treatment

In the books of demerged company SPIL will be accounted as per Section 133 of the Act in accordance with Accounting Standards which are read with relevant rules. In the books of Sun Pharmaceutical Industries Limited the book value of the undertaking is to be added to the book value of the resulting company.

In the books of Resulting Company 1 of Netherlands which is the Sun Pharma B.V shall record the investments as per the applicable accounting standard under laws of its country Netherlands.

In the books of Resulting Company 2 of USA which is Sun Pharmaceuticals Holdings USA Inc. shall record the investments as per the applicable accounting standard under laws of its country USA.

Consideration

There was no consideration paid by the companies as both the transferee companies of Netherlands and USA is wholly owned subsidiaries of SPIL. As the SPIL Company will ultimately control the undertaking which is spun-off shall not involve any transfer of assets as well as consideration as per the scheme.

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Valuation

There is no change to the shareholding pattern of the company which is to be demerged as per the scheme of arrangement, it is certified by a chartered accountant that there is no requirement of valuation in such cases. So there’s no valuation done in this scheme of arrangement.

Legal Compliances

Observation Letter: The Demerged Company, SPIL, is public listed company which is listed under Bombay Stock Exchange and NSE India Limited. The company duly notified the stock exchanges and took prior approval from both Bombay Stock Exchange Limited and National Stock Exchange Limited. It turned out that both that both Stock exchanges did not find any adverse observation out of the arrangement of outbound cross border demerger. 

RBI Approval: The SPI Company followed the terms of the Section 234 requirements of the Companies Law, 2013 as scheme envisages overseas arrangements. Additionally, they also comply with FEMA (Cross Border Arrangement) Regulations, 2018 issued by notification of Reserve Bank of India guidelines. The director of the company and the company secretary also placed the Compliance certificate for the same before court of law which was considered to be deemed approval as per notification of Reserve Bank of India given in Rule 9 of the said Act. 

Consent Affidavit: The transferee company sent notice to the unsecured creditors and equity shareholders of their company and held the meeting individually as per the order of tribunal along with explanatory statements and copy of scheme of arrangement. As per the provisions of Companies Act, 2013 read with Companies (CAA) Rules and other applicable rules it is mandatory to have approval of majority of shareholders and unsecured creditors. 

Publication: There was publication of meetings held for the unsecured creditors and equity shareholders of Transferee Company in ‘Financial Express’ English newspaper and local Guajarati newspaper as per NCLT orders.

Approval of Scheme by Equity Shareholders and Unsecured Creditors: By e-voting, where the transferor company got 99.97 percent of approval from equity shareholders in aggregate value and also approved by unsecured creditors unanimously who were present in meeting.  

Notice to Statutory Authorities: The demerged company duly served notice of scheme of arrangement to various statutory authorities which includes, Central Government, Income Tax Authorities, Security exchange board of India (SEBI), Registrar of companies, Reserve Bank of India, Bombay stock exchange and National Stock Exchange of India. Along with scheme of arrangement they also provide them with explanatory statements, mandatory disclosures and other required documents. 

Filing of Petition: The demerged company published the notice of petition ten days before hearing in local newspaper and in English newspaper. Additionally, the demerged company also served notice to Income Tax Department, Registrar of Companies and the Central Government with the help of Regional Director.

NCLT Observation and Decision

Due to the scope of the 2018 changes to the Foreign Management (Foreign Exchange) Mergers Notification Act, it is no longer clear whether or not outbound mergers are permitted. Cross Border Mergers are defined in the 2018 Regulations as “any merger, amalgamation, or arrangement between an Indian company and a foreign company, in accordance with the Companies (Compromises, Arrangements, and Amalgamation) Rules, 2016, as amended by the Companies Act, 2013.” While translating the draught regulations into a binding law, the legislature omitted the term demerger. Whereas, Section 234 of the Companies Act provides only for a foreign company’s merger or amalgamation. And, finally, when faced with the problem of determining the appropriate laws to govern a cross-border demerger, the question becomes: Does cross border merger laws include cross border demerger? 

This level of inconsistency formed the basis of the NCLT’s decision in Sun Pharmaceuticals scheme of outbound cross border Demerger, in which Sun Pharmaceuticals, a public company which is listed under stock exchange, submitted a proposal for demerging two associated undertakings into two resulting companies which is situated overseas will be called resulted foreign companies. Despite RBI, SEBI, and the Indian Income Tax Authority having previously granted approval, the plan was scrapped because they were unable to find proof of the lawfulness of such an outbound cross border demerger arrangement scheme. 

As court ruled out Section 234 of the Act only speaks of mergers and amalgamation, but not of demergers. In contrast to this, the demerged company disagreed with this argument, asserting that a different interpretation of law was given in 2018 when the NCLT ruled in favor of the inbound cross border demerger scheme. Because of this, there can be no differentiation between an inbound cross border demerger and an outbound cross border demerger, and therefore they must be treated the same.

The outbound cross border demerger scheme did not have legislative approval as Cross Border Merger Regulations does not include the term “demerger” in the deliberately. Finally, the deciding authority found that Section 234 did not include anything about compromise or an arrangement, whereas in Sections 230-232 of the Companies Act the term compromise and arrangement is mentioned clearly. Therefore, permissibility of outbound cross border demerger under the Companies Act was silent on this matter. Nothing new was added or subtracted from the law in this process, but only the definitions given in it were interpreted according to the Act’s language strictly. 

It could be a smart business strategy for Indian companies to utilize cross border demergers to implement consolidation and restructuring to generate value. There is no mention of cross border demergers in the Act which means it neither permits cross border demerger scheme nor prohibits the same. If we talk about legislative intention, FEMA Regulations be it Cross Border Merger Regulations or Regulation for issue of security by person outside India, it is considered to be supportive to cross border transactions in India. It appears to run counter to the intent of the Act as interpreted by the Tribunal in its 2019 order in case of Sun Pharma. It appears the petitioner’s proposal was rejected on the grounds of legislative intent. The reasoning that the tribunal relies on is incontrovertible, but adopting a narrow approach is unfair and has produced legal uncertainty for corporations. 

While interpreting Clause 1(b) of Section 232 we can find out that it permits the cross border arrangements in India which is read with Section 234 where the demerger concept can only be decided by the proper legislative action by higher authorities to make a precedent of the judgment by clarifying the ongoing cross border demerger issues and clashing of ideas and judgments in NCLT decisions. We can even say that the decisions made by NCLT has ignited the hitherto debate of cross border demergers which were not in recognized until now. 

But on other hand the NCLT has chosen a notably regressive position on this issue, and these conflicting decisions might contribute to several irresolvable ambiguities under the Act when it comes to interpretation of cross border demergers in the line of arrangements and amalgamations. On the other hand, it seems that companies have no option but to approach other means of corporate reconstruction as per my interpretation it was unnecessary in the part of court to give separate interpretation to the cross border demergers where inbound is permitted whereas outbound demergers were rejected. There is no guarantee that a new bench of the NCLT will take a different view in light of the corporate separation allowed under Section 234, given the firm could subsequently spin-off into an Indian company an then they can simply merger that demerged Indian company with another Foreign company under this section which would be permissible as per the reasoning given by the NCLT while interpreting cross border demergers.


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