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7 February, 2017
The provisions of the Companies Act, 2013 (‘CA 2013’) continue to be notified in a phased man- ner by the Government of India. Although the companies law in India underwent a complete overhaul and was replaced by CA 2013 with effect from April 1, 2014, some of the key areas re- lating to mergers, amalgamations, capital reduction and winding-up of companies continued to be governed by the Companies Act, 1956 (‘CA 1956’). On December 7, 2016 the Ministry of Corporate Affairs (‘MCA’) notified, with effect from December 15, 2016, various Sections un- der CA 2013 dealing with compromises, arrangements and amalgamations (Section 230 [except sub-section (11) and (12)]1, Sections 231 to 233 and Sections 235 to 240), winding-up2 and capital reduction (Section 66). Further, for effective implementation of these provisions, the MCA also notified the following:
- Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (‘NCLT Merger Rules’), prescribing the procedure to be followed for matters relating to compromises, arrangements and amalgamations, with effect from NCLT (Procedure for Reduction of Share Capital of Company) Rules, 2016 (‘NCLT Reduction Rules’), prescribing the procedure to be followed for matters relating to reduction of share capital, with effect from December 16, 2016;
- Companies (Transfer of Pending Proceedings) Rules, 2016 (‘Transfer Rules’) which mandated the transfer of all pending proceedings in relation to capital reduction, compromises, arrangements and amalgamations, under CA 1956 from the various High Courts to the National Company Law Tribunal (‘NCLT’), with effect from December 15, 2016; and
- Companies (Removal of Difficulties) Fourth Order, 2016 dated December 7, 2016, which clarifies that all proceedings relating to compromise, arrangements and reconstructions (which includes schemes of amalgamation, capital reduction and demergers) will be transferred from the respective High Courts to the applicable NCLT bench, except those reserved for orders which will continue to be dealt with in accordance with the provisions of CA 1956 and the Companies (Court) Rules, 1959 (‘Court Rules’), with effect from December 15, 2016.
We have set out below a brief analysis of the new provisions governing compromises, arrangements and amalgamations, and capital reduction, with a view to highlight some key points of difference from the provisions of CA 1956.
Forum
Previously, jurisdiction with regard to schemes of arrangements, compromises, amalgamations and capital reduction was conferred upon the respective High Courts and thereafter, appeals lay with the Supreme Court. The jurisdiction has now been conferred upon NCLT3 and appeals from the NCLT are to be preferred to the National Company Law Appellate Tribunal (‘NCLAT’), New Delhi, and further appeals from the NCLAT will lie with the Supreme Court.
Whilst the shift of jurisdiction to the NCLT will ensure that a specialized body deals with cases under company law and related matters thereby, in the long term, introducing elements, timeliness and efficiency; however, currently there is no clarity on the time that the NCLT will take to dispose off schemes and capital reduction matters. Given that the NCLT is a newly constituted body, it is expected that considerable time may be required for NCLT to achieve an op- timal level of operational functioning. Therefore, there is a likelihood of some amount of delay being faced, at least in a short term, with respect to approval of schemes and obtaining NCLT orders owing to the transfer of numerous pending schemes from the various High Courts to the benches of the NCLT.
Compromises, Arrangements and Amalgamations
A. Fast Track Mergers
Fast track merger is a new process introduced under CA 2013, and applicable to mergers between: (i) two or more “small” companies;4 or (ii) a holding company and its wholly owned subsidiary; or (iii) such other class or classes of companies as may be prescribed.5 This provides for a simpli- fied procedure in relation to such mergers, wherein the approval of the NCLT is not required, and the authority to sanction the same is vested with the relevant Regional Director (pursuant to the powers delegated by the Central Government). It is pertinent to note that companies continue to have the liberty to choose the normal merger process over the fast track process.
In such a merger, a notice has to be separately issued to the Registrar of Companies (‘RoC’) and the Official Liquidator (if applicable) and persons affected by the merger, and objections / suggestions received from such parties have to be placed before the members. The scheme is required to be approved by members holding at least 90% of the total number of shares at a general meeting and also by creditors representing 90% in value of the creditors or class of creditors of the respective companies. Once the scheme is so approved, another notice has to be given to the Central Government, RoC and Official Liquidator (if applicable). If the Central Government is of the opinion that the scheme is not in the public interest / creditors’ interest and objections / suggestions to the scheme have been received from the RoC or Official Liquidator, the Central Government may file an application before the NCLT requesting that the NCLT may consider the scheme for approval, instead of the fast track process.
While certain High Courts allowed special dispensation to the parent entity from making separate filings in case of a wholly owned subsidiary–parent merger,6 there was no provision under CA 1956 that specifically envisaged such fast track process. The introduction of this fast track process under CA 2013 should provide a speedy alternative to disposal of merger schemes between certain companies.
B. Dispensation of Creditors’ and Members’ Meetings
Under CA 1956, while the High Courts had the power (on a discretionary basis) to permit a dis- pensation of a meeting of the creditors’, no express thresholds/limits were prescribed for the same. This resulted in different High Courts allowing such dispensation based on varying factors, with little uniformity. CA 2013 provides that dispensation from calling a meeting of creditors (or a class of creditors) will be permitted only if approval has been obtained from 90% of the creditors (by value) by way of an affidavit to the scheme of compromise / arrangement.7
CA 2013, therefore, appears to reduce the flexibility of the High Courts to dispense with creditors meetings by stipulating a fixed percentage of creditors who have to compulsorily pro- vide their consent to the scheme. Further, the requirement of an affidavit by 90% of creditors in value for dispensing a meeting is rigorous and consequently, it is likely that a meeting may, therefore, need to be called (where there is difficulty in procuring such an affidavit), which in the case of numerous lenders can be a cumbersome and time consuming process.
As regards dispensation of members’ meetings, CA 2013 does not contain an express provi- sion for dispensation (unlike in the case of CA 1956). However, under the NCLT Merger Rules, the NCLT has been granted the liberty to dispense with any procedure in pursuit of the object of the provisions for the implementation of the scheme, except on those matters which are specifically provided in CA 2013.8 Given that the NCLT Merger Rules have been enacted recently, there is as yet no precedent on the approach that may be taken by the NCLT in this regard.
C. Who can Raise an Objection
CA 1956 permitted any shareholder, creditor or other ‘interested person’ (without prescribing any minimum threshold) to object to a scheme of arrangement if such person’s interests were adversely affected under such scheme. Under CA 2013, only those persons (i) holding not less than 10% of the shareholding; or (ii) having outstanding debt amounting to not less than 5% of the total outstanding debt as per the latest audited financial statement, are entitled to raise objections.9
This should help address the issue of frivolous objections and harassment of companies which was prevalent under CA 1956.
D. Notice of Meeting
Under CA 1956, notice in relation to a proposed scheme of arrangements/ amalgamations was required to be submitted only to the creditors and shareholders (in case no dispensation was granted). Thereafter, the notice of the scheme was required to be served to the Central Government, the RoC and the Official Liquidator only as per the directions of the High Court, post admission of such scheme.
CA 2013 makes it mandatory for the notice and relevant documents to be submitted to the Central Government, income tax authorities, the Reserve Bank of India, RoC, stock exchanges (‘SE’), the Securities and Exchange Board of India (‘SEBI’), Official Liquidator, Competition Commission of India (‘CCI’) and any other sectoral regulators/ authorities likely to be affected (given how widely this has been worded, this could effectively require notices be sent to various regulators).10
The relevant regulators are required to revert within 30 days, failing which they will have deemed to have consented. While the time limit of 30 days has been imposed, it is not clear whether the timeline would be extended in the case of any further information/queries from such regulators, which is quite likely to be the case, therefore, resulting in a prolonged timeline. Further certain regulators such as the CCI, under their respective statutes, are permit- ted a longer time period than 30 days within which they are required to revert; as such it is not clear how the conflict will be treated.
CA 2013 effectively increases scrutiny of schemes by various regulatory authorities and this is ultimately likely to impact the timeline as well.
E. Offer to Purchase Minority Shareholding
This is a new provision introduced under CA 2013 pursuant to which: (i) the acquirer, or person acting in concert with the acquirer; or (ii) a person or a group of persons, who become reg- istered 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, may notify minority shareholders about their intention of buying out the remaining equity shares.11 In addition, minority shareholders are also entitled to offer their shares suo moto to such majority shareholders. This exit mechanism has been provided with the intention of reducing litigation with minority shareholders. It is not intended for the exit option to operate as a mandatory squeeze-out mechanism, instead simply an offer that can be made to minority shareholders, which they are not obliged to accept.
F. Merger of a Listed Company with an Unlisted Company
CA 1956 did not contain any specific provision governing the merger of a listed company with an unlisted one. It was generally assumed that shares issued pursuant to the merger of a listed company with an unlisted one (or pursuant to a reverse merger) would continue to be listed on the SEs where the transferor company was listed.
SEBI had previously eased listing requirements for listed companies proposing to merge with unlisted companies by granting them exemptions from complying with initial public of- fering (‘IPO’) requirements on a case-to-case basis.
Subsequently, SEBI issued guidelines stating that in case of reverse merger, i.e., a scheme involving merger of a listed company into an unlist- ed company, the unlisted company would be able to apply for a specific exemption for listing its shares without complying with the SEBI prescribed IPO requirements only upon such reverse merger scheme having obtained the approval of the Court. CA 2013 provides that such reverse merger will not ipso facto make the unlisted company listed. It will continue to be unlisted until the applicable listing regulations and SEBI guidelines in relation to allotment of shares to public shareholders are complied with.12 Therefore, the changes under CA 2013 are in line with the SEBI requirements and will encourage companies to explore this option as an alternative to the SEBI (Delisting of Equity Shares) Regulations, 2009.
Further, CA 2013 sets out formal guidelines and permits the transferee company to remain unlisted, provided the shareholders of the merged listed company are given an exit opportunity by making payment amounting to the value of the shares and other benefits, in accordance with a pre-determined price formula or after a valuation report is produced (which should not be less than the value prescribed by SEBI regulations).
G. Cross Border Mergers13
Under CA 1956, mergers were permitted only where the transferor was a foreign company and the transferee/resultant company was an Indian company, i.e., only inbound mergers were permitted. CA 2013 now proposes to permit both inbound and outbound mergers, with outbound mergers to be permitted only in relation to those jurisdictions as notified by the Central Gov- ernment from time to time (which have not yet been notified).
It should be noted that this provision appears to apply only to mergers and acquisitions and not in cases of division or demergers.
Appropriate changes would need to be made to the relevant foreign exchange regulations as well as in relation to the Income-tax Act, 1961 (to extend tax-neutrality to outbound mergers).
H. Buy Back
Under CA 1956, in case of a Court approved buy-back of shares, multiple buy-backs were per- missible within a period of one year and the same did not need to comply with the various other restrictions applicable to buy-backs (if so permitted by the Court).
Under CA 2013, a gap of one year is mandatorily required to be maintained between any two buy-backs. Further, buy-backs are also restricted in case a company has defaulted in mak- ing repayments of public deposits / term loan / interest thereon, redemption of debentures / preference shares and payment of dividends, and three years have not passed since remedy of the same. Now, even a buy-back through the Court approved process is required to comply with these buy-back conditions specified in CA 2013 (including the prescribed limits and the cooling period of one year) and, therefore, the flexibility under CA 1956 has been withdrawn.14
I. Scheme involving Reduction of Share Capital
There was no express provision under CA 1956 granting exemption from complying with the procedure prescribed under Sections 100 to 103 of CA 1956 if a composite scheme of arrange- ment involving reduction of share capital was approved by the High Court. An express proviso in this regard has been included in CA 2013.15J. Additional Compliances with respect to Notice of Meeting & Voting by Postal Ballot CA 2013 increases various disclosure requirements. Pursuant to the NCLT Merger Rules, various disclosures are required to be made in the notice of merger sent to the creditors and mem- bers, to the extent not already disclosed in the scheme, which include, inter alia, information on the order passed by the NCLT, the relationship between the companies who are parties to the scheme, the date of board meeting for approval of the scheme and directors who voted for / against the scheme and those who abstained from voting.
An explanatory statement is also required to be provided along with the notice of the meeting disclosing, inter alia, information on details of the scheme, the parties involved, the share exchange ratio, rationale of the scheme and a summary of the valuation report. Further, mandatory disclosures are to be made about the effect of compromise / arrangement on the material interests of creditors, directors, employees, key managerial personnel, promoters, non-promoter members, depositors, debenture holders, deposit trustees and debenture trustees. Under CA 2013, the members and creditors are entitled to obtain, inter alia, extracts of the latest audited financial statements, order of tribunal for dispensation of the meeting, copy of the scheme, material contracts and auditor’s certificate (ensuring compliance with accounting standards).
Voting by postal ballot process and e-voting has also been introduced to enhance disclo- sure requirements and ensure maximum participation of the shareholders. Therefore, it is evi- dent that by making information more accessible, CA 2013 increases scrutiny by the members and creditors of the company.
K. Valuation Certificate
Notice to shareholders/creditors is now necessarily required to be accompanied by a valuation report from a registered valuer (which was previously only required for listed companies, and there too the same was only provided for inspection) to enable ready access to the shareholders and creditors.16 This change under CA 2013 is significant because a substantial amount of litigation on schemes of arrangement (as seen under CA 1956 regime) related to matters of valuation, and consequently the share exchange ratio.
L. AccountingTreatment
Under CA 2013, no scheme can be sanctioned unless the auditor’s certificate is filed with NCLT stating that the accounting treatment, if any, proposed in the scheme is in conformity with the accounting standards prescribed under Section 133 of CA 2013, applicable for both listed and unlisted companies.17 Previously, schemes often provided for accounting treatment that would deviate from the prescribed accounting standards, which will, therefore, no longer be possible.
Reduction of Share Capital
A. Notice to Creditors
Under CA 1956, notice to creditors was required to be sent only where the reduction of share capital involved either: (i) diminution of liability in respect of unpaid share capital; (ii) payment to any shareholder of any paid up share capital; or (iii) in any other case, if directed by the High Court.
Under CA 2013, notice to creditors is required to be sent in all cases of reduction of share capital. Also, the objections, if any by the creditors, are required to be filed with NCLT within three months from the date of publication of notice with a copy served on the company.18 NCLT may dispense with the requirement of giving notice to creditors or publication of such notice as mentioned above if it is satisfied that the debt or claim of every creditor has been discharged or determined or has been secured or his consent is obtained.19 If no representation is received from the creditors it will be presumed that they have no objection to the reduction.
B. Notice to RoC, Central Government, SEBI (for Listed Companies)
This requirement has been added under CA 2013 by which NCLT is required to give notice of every application made to it to: (i) Central Government; (ii) RoC; (iii) SEBI (in case of listed companies); and take into consideration the representations made to it by the aforementioned entities within period of three months from the date of receipt of notice of such objection. If no representation is received by any of the above persons, within the prescribed period, then it will be presumed that none of the above persons have any objection for capital reduction.20
C. No Arrears in Repayment of any Deposits Before Undertaking Reduction
This condition has been newly introduced under CA 2013 as there was no such pre-condition for undertaking reduction in share capital under CA 1956. As a result of this development, any company, in arrears in repayment of any of its deposits or interests thereon, either before or after the commencement of CA 2013, will not be entitled to undertake reduction.21
D. Accounting Treatment
Similar to the schemes of arrangements, no scheme of capital reduction can be sanctioned unless the auditor’s certificate is filed with NCLT stating that the accounting treatment, if any, proposed in the scheme is in conformity with the accounting standards prescribed under Section 133 of CA 2013 (applicable for both listed and unlisted companies).22
Conclusion
As evident from the above, CA 2013 read with the NCLT Merger Rules and the NCLT Reduction Rules envisage various noteworthy changes which, in some cases, simplify the arduous require- ments and procedural loop holes in CA 1956 read with the erstwhile Companies (Court) Rules, 1959. These changes streamline the compromise and arrangement procedures with an intention of making it smoother and more transparent by guaranteeing a system of checks and balances thereby, protecting the interest of the stakeholders, while simultaneously avoiding frivolous objections.
However, the exact time frame of the entire arrangement process is still unknown and more clarity will be obtained once it is tested over the course of time.
1 These provisions deal with a compromise / amalgamation of a listed company coupled with a takeover.
2 Please refer to our January 2017 Special Edition on the Insolvency and the Bankruptcy Code which discusses the
provisions relating to insolvency, liquidation and bankruptcy process that have been recently notified by the MCA.
3 11 benches of the NCLT have currently been constituted and been made operational in India.
4 A ‘small company’ has been defined under CA 2013 to mean a company (other than a public company), with (i) paid-up capital not exceeding ¤50 lakhs (approximately US$ 73,500) or such higher amount as may be prescribed not being more than ¤5 crores (approximately US$ 735,000); and (ii) turnover not exceeding ¤2 crores (approxi- mately US$ 294,000) or such higher amount as may be prescribed not being more than ¤20 crores (US$ 2.9 million).
5 Introduced under Section 233 of CA 2013.
6 Mahaamba Investments Limited v. IDI Limited [2001] 105 CompCas 16 (Bom).
7 Section 230(9) of CA 2013.
8 Rule 24 of NCLT Merger Rules.
9 Proviso to Section 230(4) of CA 2013.
10 Section 230(5) of CA 2013.
11 Section 236 of CA 2013.
12 Section 232(3)(h) of CA 2013.
13 Section 234 of CA 2013 which deals with cross-border mergers has not yet been notified.
14 Section 230(10) of CA 2013.
15 Explanation to Section 230(12) of CA 2013.
16 Sections 230(2)(v) and 230(3) of CA 2013.
17 Proviso to Section 230(7) of CA 2013.
18 Section 66(2) of CA 2013.
19 Rule 3(6) of NCLT Reduction Rules.
20 Section 66(3) of CA 2013.
21 Proviso to Section 66(1) of CA 2013.
22 Proviso to Section 66(3) of CA 2013.
For further information, please contact:
Zia Mody, Partner, AZB & Partners
zia.mody@azbpartners.com
