The provisions of the Companies Act, 1956, specifically sections 391 to 394, contain an elaborate framework that enable companies to give effect to arrangements and compromises with their shareholders and creditors. The expression “arrangement” has interpreted to include a wide range of transactions, such as mergers, demergers and other forms of corporate restructuring (including debt restructuring). This framework has largely functioned well, and in fact these provisions have been extensively used by the corporate sector in India, much more so than similar provisions contained in statutes in other countries. The judiciary has also clearly laid out the parameters within which such schemes of arrangement may be initiated, approved by shareholders and creditors and then accorded the sanction of the court. Miheer Mafatlal and Hindustan Lever are landmark decisions of the Supreme Court in that behalf.
The Companies Bill, 2011 seeks to make a number of changes to this framework that are likely to have an impact on mergers and acquisitions (M&A) transactions involving Indian companies. While some of the proposals are intended to make it easier for companies to implement schemes of arrangement, others impose checks and balance to prevent possible abuse of these provisions by companies. Ernst & Young has a nice comparison of the provisions in the Companies Act and the 2011 Bill on matters relating to M&A. In this post I propose to touch upon only some of the key issues.
Court/NCLT
Under the Companies Act, schemes of arrangement are to be approved by the High Court that has jurisdiction over the companies involved. While this ensures an oversight of the scheme and its fairness, there have been concerns regarding possible delays. For example, the average time taken for a scheme to be implemented from start to finish is no less than 6 months, and in several cases the schemes have taken a couple of years to be approved by the High Court. To that extent, the proposal to move the jurisdiction of the High Court in such matters to the National Company Law Tribunal (NCLT) is welcome as that would be a specialized body dealing only with cases under company and related laws thereby introducing elements of timeliness and efficiency. This is not a new proposal, but its introduction had been mired in litigation (R. Gandhi v. Union of India), and the provisions in the Bill appear to be a result of the resolution that emerged from the Supreme Court in the R. Gandhi case.
Objection to the scheme
Currently, any shareholder, creditor or other “interested person” may object to the scheme of arrangement before a court if such person’s interests are adversely affected under it. However, the Companies Bill, 2011 imposes some onerous requirements such that only persons holding at least 10% shares or at least 5% of the total debt outstanding in the company can object to the scheme. While it is understandable that there must be restrictions against frivolous litigation, the current provision operates against minority shareholders and creditors. One of the reasons that the scheme of arrangement route is adopted by companies is that, once approved, schemes can be implemented in a wide manner as it is binding on all affected parties. The binding nature of the scheme is premised on the fact that the court will adjudge on the interests of all parties that may be affected by the scheme. By substantially eroding the power of minority shareholders and creditors to object, that basic premise has been destroyed. This provision requires serious reconsideration.
It is a matter of some relief for minority shareholders, however, that schemes can provide for exit to dissenting shareholders. Even here, it appears that such exit options are available only if the NCLT specifically provides for that, and not automatically on the lines of appraisal rights that are available in similar circumstances in other jurisdictions (such as Delaware).
Accounting and Valuation
As schemes of arrangement tend to have significant implications on matters of accounting and valuation, specific provisions have been made in the Companies Bill. The scheme must comply with accounting standards. This is to ensure that schemes that primarily involve financial reengineering are not entertained by the courts. This concern of the regulators has already been addressed by incorporating such a requirement into the listing agreement, but now that has been provided for in the statute itself so as to apply even to unlisted companies.
The Bill also specifically provides that the report of an expert valuer has to be disclosed to the shareholders. This is significant because a substantial amount of litigation on schemes of arrangement relates to matters of valuation, and consequently the share exchange ratio. There is currently no requirement to obtain expert valuation, although it has now become a matter of practice for companies to obtain at least one, if not two, valuation reports before embarking on a scheme of arrangement so that the valuation can better withstand scrutiny of the court.
Treasury Shares
When there are mergers between companies that have cross-holdings of shares, e.g. between a parent and a subsidiary, the shares that one company holds in the other will typically be cancelled, and no further shares will be issued under the scheme. However, in the last few years, a practice had developed where shares were in fact issued under the scheme by the transferee company to a trust, to be held for its own benefit. The trust could further sell those shares and pay over proceeds to the beneficiary, being the company. The Companies Bill effectively sets at nought this practice, and requires any cross-held shares to be compulsorily cancelled. This provision appears to directly target the recent practice employed in some cases.
Cross-Border Mergers
Under the present dispensation, while foreign companies can be amalgamated into India companies, the reverse is not possible. This has also been accepted by the courts (see Andhra Pradesh High Court in Moschip Semiconductor). Under the Companies Bill, however, there is a proposal to allow cross-border mergers both ways. However, that is possibly only with companies in jurisdictions with which reciprocity has been established, as the Government may notify. This may provide additional stimulus for cross-border transactions.
Short-form Mergers
At present, all mergers, including those between group companies or between a parent and a subsidiary require compliance with the entire process of section 391 and 394, although in certain circumstances courts are willing to make some dispensations from procedural requirements. Under the Bill, certain mergers can follow an out-of-court approach, without requiring the approval of the court or NCLT. These are mergers between two or more small companies (as defined in the Bill) or between a parent and its wholly-owned subsidiary. In these types of mergers, there is greater emphasis on creditors’ interests: the companies must file a declaration of solvency and the scheme must be approved by at least 90% of the creditors or their classes. Although this simplifies the M&A regime to some extent, it may affect only a small number of transactions without much wider impact.
Reverse Mergers
The Companies Bill appears to plug possible loopholes that may allow backdoor listing of companies. A reverse merger of a listed company into an unlisted company may not automatically result in a listing of the resulting entity, unless it goes through the process of a listing through a public offering. Moreover, in case of such a reverse merger, the shareholders of the listed transferor company must be provided an exit at a fair value to compensate for the loss of liquidity.
Other matters
Some other specific issues where the Bill provides for a different treatment are:
The Companies Bill, 2011 seeks to make a number of changes to this framework that are likely to have an impact on mergers and acquisitions (M&A) transactions involving Indian companies. While some of the proposals are intended to make it easier for companies to implement schemes of arrangement, others impose checks and balance to prevent possible abuse of these provisions by companies. Ernst & Young has a nice comparison of the provisions in the Companies Act and the 2011 Bill on matters relating to M&A. In this post I propose to touch upon only some of the key issues.
Court/NCLT
Under the Companies Act, schemes of arrangement are to be approved by the High Court that has jurisdiction over the companies involved. While this ensures an oversight of the scheme and its fairness, there have been concerns regarding possible delays. For example, the average time taken for a scheme to be implemented from start to finish is no less than 6 months, and in several cases the schemes have taken a couple of years to be approved by the High Court. To that extent, the proposal to move the jurisdiction of the High Court in such matters to the National Company Law Tribunal (NCLT) is welcome as that would be a specialized body dealing only with cases under company and related laws thereby introducing elements of timeliness and efficiency. This is not a new proposal, but its introduction had been mired in litigation (R. Gandhi v. Union of India), and the provisions in the Bill appear to be a result of the resolution that emerged from the Supreme Court in the R. Gandhi case.
Objection to the scheme
Currently, any shareholder, creditor or other “interested person” may object to the scheme of arrangement before a court if such person’s interests are adversely affected under it. However, the Companies Bill, 2011 imposes some onerous requirements such that only persons holding at least 10% shares or at least 5% of the total debt outstanding in the company can object to the scheme. While it is understandable that there must be restrictions against frivolous litigation, the current provision operates against minority shareholders and creditors. One of the reasons that the scheme of arrangement route is adopted by companies is that, once approved, schemes can be implemented in a wide manner as it is binding on all affected parties. The binding nature of the scheme is premised on the fact that the court will adjudge on the interests of all parties that may be affected by the scheme. By substantially eroding the power of minority shareholders and creditors to object, that basic premise has been destroyed. This provision requires serious reconsideration.
It is a matter of some relief for minority shareholders, however, that schemes can provide for exit to dissenting shareholders. Even here, it appears that such exit options are available only if the NCLT specifically provides for that, and not automatically on the lines of appraisal rights that are available in similar circumstances in other jurisdictions (such as Delaware).
Accounting and Valuation
As schemes of arrangement tend to have significant implications on matters of accounting and valuation, specific provisions have been made in the Companies Bill. The scheme must comply with accounting standards. This is to ensure that schemes that primarily involve financial reengineering are not entertained by the courts. This concern of the regulators has already been addressed by incorporating such a requirement into the listing agreement, but now that has been provided for in the statute itself so as to apply even to unlisted companies.
The Bill also specifically provides that the report of an expert valuer has to be disclosed to the shareholders. This is significant because a substantial amount of litigation on schemes of arrangement relates to matters of valuation, and consequently the share exchange ratio. There is currently no requirement to obtain expert valuation, although it has now become a matter of practice for companies to obtain at least one, if not two, valuation reports before embarking on a scheme of arrangement so that the valuation can better withstand scrutiny of the court.
Treasury Shares
When there are mergers between companies that have cross-holdings of shares, e.g. between a parent and a subsidiary, the shares that one company holds in the other will typically be cancelled, and no further shares will be issued under the scheme. However, in the last few years, a practice had developed where shares were in fact issued under the scheme by the transferee company to a trust, to be held for its own benefit. The trust could further sell those shares and pay over proceeds to the beneficiary, being the company. The Companies Bill effectively sets at nought this practice, and requires any cross-held shares to be compulsorily cancelled. This provision appears to directly target the recent practice employed in some cases.
Cross-Border Mergers
Under the present dispensation, while foreign companies can be amalgamated into India companies, the reverse is not possible. This has also been accepted by the courts (see Andhra Pradesh High Court in Moschip Semiconductor). Under the Companies Bill, however, there is a proposal to allow cross-border mergers both ways. However, that is possibly only with companies in jurisdictions with which reciprocity has been established, as the Government may notify. This may provide additional stimulus for cross-border transactions.
Short-form Mergers
At present, all mergers, including those between group companies or between a parent and a subsidiary require compliance with the entire process of section 391 and 394, although in certain circumstances courts are willing to make some dispensations from procedural requirements. Under the Bill, certain mergers can follow an out-of-court approach, without requiring the approval of the court or NCLT. These are mergers between two or more small companies (as defined in the Bill) or between a parent and its wholly-owned subsidiary. In these types of mergers, there is greater emphasis on creditors’ interests: the companies must file a declaration of solvency and the scheme must be approved by at least 90% of the creditors or their classes. Although this simplifies the M&A regime to some extent, it may affect only a small number of transactions without much wider impact.
Reverse Mergers
The Companies Bill appears to plug possible loopholes that may allow backdoor listing of companies. A reverse merger of a listed company into an unlisted company may not automatically result in a listing of the resulting entity, unless it goes through the process of a listing through a public offering. Moreover, in case of such a reverse merger, the shareholders of the listed transferor company must be provided an exit at a fair value to compensate for the loss of liquidity.
Other matters
Some other specific issues where the Bill provides for a different treatment are:
- Notice of the scheme must be provided to various government authorities such as the Income Tax Department, SEBI, RBI, Competition Commission, Official Liquidator such that all of their concerns can be heard by the NCLT before sanctioning the scheme. Although these authorities can object before a court even at present, there is no such notice requirement.
- The requirement of majority of shareholders or creditors is 75% in value. The existing additional requirement of obtaining a majority in number of the shareholders or creditors has been done away with.