Thursday 22 August 2013

Impact of Companies Bill on M&A Transactions

Introduction


India Inc’s long wait for a new company law seems to be finally getting over. The Companies Bill, 2012 (“the Bill”) has been passed by the Rajya Sabha on August 8, 2013. It now needs presidential assent and notification in the Official Gazette to replace the existing Companies Act, 1956 (“the Act”).



It is pertinent to note that most of the provisions of the Bill are subject to rules, which are yet to be formalized – going by the current press release, it appears that MCA expects all rules regarding the Bill to be in place by March 31, 2014, after taking into account the suggestions from stakeholders.


The Bill contains some far-reaching changes which will impact the management and administration of companies, shareholder’s rights, director’s responsibilities, maintenance of accounts and audit of companies and other provisions relating to mergers, acquisitions, winding up of companies.


In this edition of BMR Edge on the Bill (our second such alert), we have focused on the key aspects that impact the M&A landscape. Please ‘click here’ for our earlier editions of BMR Edge, covering the overall impact of the Bill vis a vis the Act.


A. Migrating to the Bill


On enactment and notification of the Bill, the Act (except for certain specified provisions) shall stand repealed.


• Any action (including issuance of any rule, notification, order, notice, resolutions passed, instruments executed, etc) under the Act including those taken by any authority will continue to be valid and in force so long as the same is not inconsistent with the provisions of the Bill.


Any principle or rule of law, form or course of pleading, practice or procedure etc shall not be affected.


Key takeaways:


Steps and procedures undertaken for ongoing transactions appears to be grandfathered; however, depending on the approval stage of the transaction when the Bill is legally enacted, issues could arise which, while permissible under the Act, are inconsistent with the provisions of the Bill.


For example, consider a clause in an ongoing scheme of merger which envisages creation of treasury stock – would this need to be deleted and the swap ratio to be reworked, if the Bill becomes effective prior to the final sanction of the scheme by the court? If yes, would it also require a duplication of corporate approvals for the revised scheme?


Another example is the circulation of a postal ballot notice for an ordinary resolution in the event of a proposed sale of an undertaking by a company in accordance with the Act. If the Bill becomes effective prior to the completion of the postal ballot process, would the company be required to obtain a special resolution as envisaged by the Bill by repeating the postal ballot process?


Re-enactment of any law normally gives rise to transitioning and grand fathering issues. Similarly, repealing of the Act on the date the Bill becomes effective would give rise to the above and various other issues, which will need to be clarified/ resolved. One option is to specify a transition date (say, April 1 2014) on which all existing or ongoing procedures will remain valid and be executed under the Act; further, any transaction that is commenced after such date will be required to follow the provisions of the Bill. If such a date is notified well in advance, it will enable corporates and regulators to plan their activities and hopefully avoid controversies and wasteful litigation.


B. Transition of powers


The Bill envisages that all powers and functions of the Company Law Board, Company Court and those of BIFR under the Sick Industrial Companies Act would henceforth be exercised by the National Company Law Tribunal (‘the Tribunal’). Such a provision is contained in the Act too, though the Government did not setup the Tribunals as required owing to litigation and other factors.


The Bill therefore provides that until the Government notifies a date for transfer of all matters, proceedings or cases to the Tribunal, the provisions of Act in regard to the jurisdiction, powers, authority and function of the current Company Law Board and the Company Court shall continue to apply.


Key takeaways:


The creation of a single forum which is dedicated to corporate matters is a welcome move, and removes the problem of multiple regulators. However, given that its an unprecedented exercise, careful planning and clear rules will be required to ensure that transition to a new regulator will happen without trouble. In particular, migration of existing proceedings (at various fora) needs to be managed carefully. Given that execution of schemes of restructuring under the Act is a time consuming exercise, it remains to be seen whether the new Tribunal will help accelerate matters.


C. Amendments impacting mergers/ demergers and other arrangements


1. Enhanced scrutiny and procedural requirements


With a view to enabling greater scrutiny of the schemes by the concerned regulators and protecting shareholder rights, the Bill provides for the following:


Notice of meeting for the scheme should be sent to the Central Government (i.e the Regional Director, Department of Company Affairs (‘DCA’), Registrar of Companies (‘ROC’) Official Liquidator (‘OL’), Income-tax authorities, RBI, SEBI, Competition Commission of India (‘CCI’) and other sectoral regulators for their comments/ suggestions/ objections within 30 days – in case no representation is made within 30 days, it will be presumed that they have approved the scheme.


The swap ratio for scheme will be undertaken by a registered valuer and a copy of the valuation report should be provided to all the shareholders and creditors.


The meeting of creditors can be dispensed with if creditors holding 90% or more value of total debt of the company approve the scheme by way of an affidavit.


Shareholders would have the option to vote for the scheme through postal ballot, in addition to voting physically at a meeting.


Companies will have to obtain statutory auditor’s certificate to the effect that the accounting treatment in the scheme is compliant with Accounting Standards (listed companies are in any case required to provide this certificate under the Listing Agreement).


Objection to the scheme can be raised by shareholders holding at least 10% stake or creditors holding at least 5% of total outstanding debt as per the latest audited financial statements.


In the course of any arrangement, transferee companies are prohibited from holding any shares in its own name or in the name of any trust whether on its own behalf or on behalf of its subsidiary/ associate companies.


Key takeaways:


The above provisions should result in greater transparency and reduce the scope for unconventional/ ambiguous practices, particularly where valuation and accounting considerations are involved.


Under the Act, notices of the scheme are required to be sent to the DCA, RoC and the OL. Imposition of the time limit of 30 days may actually help to improve their response rate, although the possibility of these authorities approaching the Tribunal for additional time cannot be ruled out. In case of listed companies, notices of the schemes are required to be sent to SEBI prior to the schemes being filed with the Tribunal. Similarly, notices are also required to be sent to CCI in case the merger/ demerger transaction meets the specified thresholds. However, the impact of notifying other regulators (RBI, Income-tax authorities) both on timelines as well as execution needs to be seen.


• Minimum thresholds of 10%/ 5% for shareholders and creditors intending to object to schemes appears high. Particularly in case of listed companies, minority needs to commit substantial efforts in pooling stake if they have to raise valid objections, unless a large institutional shareholder takes up the cause. Of course, the flip side is that this will eliminate frivolous objections by shareholders with negligible stake (which happens in many schemes) thereby avoiding unnecessary delays.


Prohibition on companies holding shares in their own names or in the name of any trust is intended to stop companies from creating treasury stock in the guise of a merger or demerger. Historically, such blocks of shareholding have been used as an avenue to control voting rights or in other cases, to manage profitability and cash flows. This change is also in line with the Act which prohibits a company from owning its own shares. It is interesting to see whether the Bill will permit creation of treasury stock held by trusts on behalf of shareholders (and not on behalf of the company or its subsidiary/ associate). A related concern is how treasury stock holdings already created under the Act will be treated in future ie whether they can continue as such or do they need to be unwound.


2. Relaxation for small companies


The Bill provides that the following transactions may be undertaken without the approval of Tribunal:


Merger between small companies (based on prescribed capital/ turnover); or


Merger between holding company and its 100% subsidiary; or


Merger between other class or classes of companies as may be prescribed.


Approval process: As a process, the scheme approved by the Board of Directors of the companies is to be sent to the RoC and the OL inviting their suggestions/ objections within 30 days. The scheme is then considered in the meeting of shareholders and creditors along with suggestions/ objections – the scheme should be approved by the shareholders (holding 90% of total number of shares) and creditors (majority in number representing 9/10th in value). Once the scheme is approved by the shareholders and creditors, the same is filed with the OL, RoC and the Central Government (ie the DCA) – if the OL or the RoC have no further objections, the scheme is registered by the DCA.


Such scheme may be referred to Tribunal in case the RoC or the OL or the DCA have any objection to the scheme – in such a case, the Tribunal can either direct the scheme to be considered under the normal merger route or it may confirm the scheme by passing an order.


Key takeaways:


A welcome step that would result in reduction in administrative burden, timelines and costs for smaller companies that fall within the threshold limits.


Merger of a listed company and its 100% subsidiary would still require approval of SEBI and the stock exchanges under the Listing Agreement.


3. Merger of Indian company into foreign company


Presently, while foreign companies are allowed to merge into Indian companies, the reverse is not possible. The Bill now provides for the merger of an Indian company into a foreign company located in certain jurisdictions (to be notified). The consideration for merger, which would also be subject to approval of RBI, can either be in cash or Depository Receipts (“DR”) or partly in cash and partly in DR.


Key takeaways:


A far reaching change that would facilitate cross border transactions with greater flexibility. For example, dual listing could be made possible. Readers may recall that one of the concerns in the Airtel/ MTN deal was the absence of a provision in the Act which would have enabled cross border merger followed by dual listing (this would require a change in securities laws) in both countries.


Indian companies could also utilize this route to restructure their shareholding, whereby they migrate ownership to an international holding structure which increases access to foreign markets (and possible exit to financial investors). However, the extent to which this provision would actually play out would depend on which jurisdictions are actually permitted for such cross border mergers.


Tax laws will need to be amended to make such transactions tax-protected in the same way as domestic mergers. Similarly, foreign exchange laws need to be amended to facilitate such mergers and one has to see what the RBI approval process practically entails.


4. Exit to shareholders


On merger of a listed company into an unlisted company, the unlisted company can remain unlisted provided shareholders of the merging listed company are given an exit opportunity. Technically, such a transaction is possible even under the Act (recent precedents include Wipro Ltd. and Sundaram Clayton Ltd).


Key takeaways:


A specific provision in the Bill would encourage companies to explore this option as an alternative or in addition to the Delisting Guidelines. It will be interesting to see what stand SEBI and stock exchanges take when schemes are presented to them for their approval.


Since the exit to shareholders will happen by way of cash, there would be income tax implications for the shareholders since transactions involving cash consideration do not enjoy tax neutrality.


5. Minority buy out


The Bill provides that where a person or group of persons become shareholders with 90% or more stake in a target company (listed or unlisted), then such person/ group shall compulsorily notify the target company of their intention to acquire the balance stake held by the minority shareholders. The price mechanism for such deal is yet to be formalized; however the same needs to be carried out by a registered valuer.


Key takeaways:


Exit opportunity for the minority shareholders at a fairly determined price.


Again, a provision which would enable promoters or other acquirers to delist the company in the event the target is a listed company. In unlisted companies too, the provision would allow consolidation of shareholding without any significant or long drawn litigation.


D. Other M&A related provisions


1. Sale of an ‘Undertaking’


Transaction will be subject to special resolution (as opposed to an ordinary resolution under the Act) and applicable to both private and public companies.


‘Undertaking’ defined as one:


- in which investment of the company is >20% of its net worth as per the audited balance sheet of the preceding financial year; or


- which generates 20% of the total income of the company during the previous financial year.


‘Substantially the whole of the undertaking’ is defined as 20% or more of the value of the Undertaking as per the audited balance sheet of the preceding financial year.


Key takeaways:


Process to sell an Undertaking is made more stringent - provision to apply to both private and public companies and it now requires ¾ majority of shareholders.


2. Buy back


Bill specifically provides for a minimum gap of one year between two buybacks.


Buyback is not possible in case of following defaults, unless the defaults have been remedied and three years have passed:


- Repayment of deposit/ interest payable;


- Redemption of debentures or preference shares;


- Payment of dividend; or


- Repayment of any term loan or interest.


Key takeaways:


Provision is beneficial for the investor community since a company which has defaulted on repayment of public deposits is restricted from distributing dividends or undertaking buybacks, thereby ensuring that shareholders cannot extract cash while public investors suffer.


On the flip side, this provision is retrograde in its thinking because it restricts the ability of companies to distribute surplus cash to its shareholders frequently.


3. Capital reduction


Capital reduction is not permitted if company has not repaid deposits or interest payable.


Notice of proposed capital reduction to be sent to DCA, RoC, SEBI and creditors; representations, if any, to be made within 3 months.


Statutory auditor’s certificate required for confirming accounting treatment is in accordance with Indian GAAP.


Key takeaways:


Overall timelines will increase due to notice required to be sent to DCA and other authorities (presently not required) and the 3 months notice period.


There have been instances where even profitable companies have utilized share premium account to write off capital expenditure and assets which have lost value and thereby protected their revenue reserves. Needs to be seen how auditors will grant certificates in such cases, though Indian GAAP is silent on ability to make such set offs.


Creates additional pressure on public companies to settle any outstanding public deposits.


4. Provision for sick companies


Any company can be declared as a sick company (need not be an 'industrial undertaking’ as is presently the case under the Act).


Criterion of erosion of 50% net worth for declaring a company sick is dispensed with – the revised criterion is ‘inability to pay 50% the outstanding secured debt’ within 30 days of service of notice by the secured lenders.


The scheme of revival and rehabilitation should be approved by both secured creditors (holding 75% value) and unsecured creditors (holding 25% value) – if not approved, Tribunal can order winding up of the company.


Key takeaways:


A rational move to correlate ‘sickness’ with a company’s inability to pay its debts rather than with erosion of net worth which is more governed by accounting considerations.


Many large companies in the services sector such as hospitality, ITES etc have negative net worth and/ or are unable to pay their debts. However, these companies are not covered within the ambit of provisions governing sick companies, by virtue of an anomaly in the Act, which is now removed.


An area of concern could be the exclusion of unsecured creditors from the definition of ‘inability to pay’.


5. Miscellaneous


In addition to the right to appoint majority directors, paid-up capital (ie equity capital + preference capital) is to be considered for determining the holding-subsidiary relationship. This stand is in conflict with the consolidation principles under the Accounting Standards, which are based on voting power or composition of Board of Directors.


The Bill prohibits multi-layered investment structure wherein investment is not permitted through more than 2 layers of investment companies. However, overseas multi-layered structure is permitted. The provision has been introduced to bring transparency in the transactions. However, it would be interesting to see the impact on the existing multi-layered structures and in case of merger of a company having an existing multi-layered structure into another company.


The Bill provides that Articles of a company may contain entrenchment provisions, whereby the specified provisions of the Articles can be altered if more restrictive conditions as compared to those applicable in case of special resolution have been met - This would provide an additional layer of protection for investors with respect to voting and other commercial terms agreed.


Any contract or arrangement between two or more persons in respect of transfer of securities of a public company shall be enforceable - Important amendment to bring some clarity to the entire debate on transfer restrictions in public companies. This was becoming a concern area, with various judicial precedents upholding different principles.

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