This article has been written by Neha Mallik, studying at Vivekananda Institute of Professional Studies, affiliated to Guru Gobind Singh Indraprastha University. This article talks about cross border demergers and addresses the question of whether cross border demergers are permitted with special reference to the order passed by National Company Law Tribunal in Sun Pharmaceutical Case. 

Introduction

Globalization has led to significant changes in the world economy. Today business deals and transactions are not restricted to the physical boundary but have reached the length and breadth of the world. Globalization and invasion of technology have changed the modus operandi of doing business and brought various amendments in the regulatory framework. Now businesses have widened from being country-specific to involving multiple jurisdiction to keep pace with recent developments.

With the incessant technological development and cut-throat competition to stand out in the market, the trend for mergers and acquisitions has become a global scenario. It provides greater access and scope to the companies in the international market. It also offers a wide range of support concerning financial and technological access. Cross-border mergers and acquisitions and amalgamations are allowed by the Companies Act, 2013, but laws on cross border demergers are still incoherent in India. In this article, we would study about Cross Border demergers and the challenges faced by Indian companies for having such transactions. We would also have a critical analysis of the recent case involving cross border demergers. Before diving deep into cross border demerger, we have to understand what is merger and acquisition and its legal and regulatory framework. 

General Concept of Mergers and Acquisitions

Merger and acquisition is a corporate strategy used for corporate restructuring, reorganization and realignment of businesses to raise capital. Though industries always say mergers and acquisitions together, both the terms are different. A merger is typically a marriage, wherein two or more companies combine together with the intention of drawing up synergies or perhaps tapping some advantages that they individually could not achieve, and they come together to form the same entity. For example.: JP Morgan has been merged with Chase to form JP Morgan Chase & Co. When it comes to acquisition, it is when one company acquires a stake, whether its a majority stake or minority stake or a complete takeover in the target company. E.g., Alibaba has acquired a small stake in Snapdeal.

Types of Mergers & Acquisitions 

The transaction involving M&A can be both domestic and cross border. Merger and acquisition taking place with the companies registered in the same country are called domestic M&A, on the other hand, cross border M&A takes place wherein a company registered in one country takes control over the assets and management of another company in another country. The domestic M&A is a simple process, but cross border M&A is a bit complex transaction as it involves many challenges in terms of legal or political frameworks and the social relationships between the countries. 

In a developing country like India, cross border M&A is considered as a corporate tool to raise Foreign Direct Investment (FDI) in the economy. Cross border M&A leads to numerous benefits not only to the company but to the country as well. Some of the reasons for cross border M&A include consumer coverage, access to the international market, optimum utilization of resources, financial and technological assistance and a lot more. It has been witnessed in the recent past that India is actively participating in cross border transactions for acquisitions and corporate restructuring. There is a constant amendment in the Indian regulatory framework to keep pace with the dynamics in the business world. 

Section 230-240 of the Companies Act, 2013, deals with the M&A involving inbound and outbound arrangements. Earlier, the Companies Act, 2013, only permitted the inbound merger, which means that only the foreign company is allowed to get merged with an Indian company and not vice versa. But with the amendment, Section 234 of the Act read with 25A, and Annexure B provides for both Inbound and outbound mergers but with the prior approval of Reserve Bank of India. Surprisingly, the Companies Act, 2013 talks about mergers, acquisitions, compromises and arrangements, but there is no mention of demergers. Let’s understand what cross border demerger is.

Cross Border Demerger under Indian Law

The term ‘demerger’ means to get separate. In the demerger of companies, there is a separation of a company or entity into two or more distinct companies or entities. The current Act only limits its scope to mergers involving the inbound and outbound transactions, but there is no mention of ‘demerger’ anywhere in the Act. 

Now the question arises here is whether cross border demerger is permitted or not? To address this question first, we need to analyze the provisions given in the Companies Act, 2013 relating to compromise, arrangements and amalgamation.

• Section 230 of the Act specifies the compromises and arrangements with creditors and members. 
• Further, Section 231 talks about the enforcement of compromises and arrangements ordered by the Tribunal. 
• Coming to Section 232, it talks about mergers and amalgamation of companies.
• Fast Track mergers of specified companies come under Section 233. Whereas sub-Section 12 of Section 233 specifically states that provision given in Section 233 would mutatis mutandis applied to specific companies.
• Moreover, Section 234 deals with mergers and amalgamations of Indian companies with foreign companies.

Furthermore, the exchange control regulation, i.e. Foreign Exchange Management Act,  1999, permits inbound and outbound mergers. It is interesting to note that the draft of cross border merger regulations had included the term “demerger,” but there is no mention of the same in the final version of the regulation. 

If we interpret the provision given under Section 230, the word ‘compromise’ can be inferred as demerger. Still, there remains an iota of doubt that cross border demerger involving outbound and inbound demergers are permitted.

Inbound Cross Border Demerger

The merger wherein a company demerges into an Indian company which means that the resulting companies would be registered under The Companies Act, 2013, is called Inbound cross border demerger.

Outbound Cross Border Demerger

It occurs when a company registered in India demerges into a foreign company that would be registered outside India. In other words, the resulting companies would be foreign companies registered outside the jurisdiction of India.

It is not equivocal if the demerger involving inbound and outbound transactions are absolutely disallowed. In the recent order, the National Company Law Tribunal (NCLT) in the Ahmedabad bench addressed the query. Let us critically analyze the facts and the order passed by the NCLT. 

Sun Pharmaceuticals Case: Analysis

The National Company Law Tribunal passed an order on 19 December 2019, where it rejected an application made by Sun Pharmaceutical Industries for demerging of its two investment undertakings into two wholly-owned subsidiary companies, one registered in the Netherlands and the other in the United States of America. 

The above order is contradictory to the earlier order passed by the same bench on 31 October 2018. NCLT Ahmedabad had approved the application made before it by Sun Pharma involving inbound demerger. The NCLT allowed the demerger of the specified undertaking of Sun Pharma Global FZE Incorporated under the United Arab Emirates with Sun Pharma registered in India. Let us analyze the two orders with respect to Section 234 of Companies Act, 2013.

Inbound Demerger Order

In the Inbound Demerger Order, as expressed over, the NCLT needed to choose whether the demerger and transfer of Sun Pharma Global FZE, (which is a wholly-owned subsidiary of Sun Pharma) to Sun Pharmaceutical Industries Limited, could be allowed under Section 230 and 232 read with Section 234 of the Act. While settling on the issue, the NCLT needed to assess the complaint raised by the Regional Director that the provision in Section 234 of the Act just alludes to cross-border mergers and amalgamations and doesn’t refer to demergers. 

Nonetheless, the NCLT saw that the passable exchange of part of the undertaking under Section 232(1)(b) of the Act suggests a demerger because if we thoroughly read the provision, then we can observe that it states that transfer of part of undertaking is allowed, which is a transaction of demerger. Further, it noticed that Section 234(1) of the Act affirms that the given section shall be applied mutatis mutandis (to make necessary modifications without affecting the existing law) to the transaction of merger and amalgamation. Besides, the same transaction is allowed by the way that Rule 9 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, that gives the provision for demerger of Indian organizations.

Outbound Demerger Order

While accepting the inbound demerger, presently, the enquiry emerged before NCLT, whether a demerger of two Indian undertakings into two overseas resulting companies, viz, Sun Pharma Netherlands and Sun Pharmaceutical USA, can be allowed under Section 230 and 232 read with Section 234 of the Act. It is imperative to note that both companies are wholly owned subsidiaries of Sun Pharmaceutical. 

According to the observation by NCLT, Section 234 of the Act includes words like merger and amalgamation. Unlike Section 230 and Section 232, there is no mention of ‘compromise’ and ‘arrangement’ in Section 234. The close and conjoint reading of this provision infers that any compromise or arrangement like a transaction involving demerger with a foreign company is not permitted by the Companies Act 2013. Additionally, rule 25A of the FEMA cross border regulation does not allow the transactions of demergers. 

Eventually, the NCLT construed that cross border demerger is strictly prohibited by FEMA Cross Border Regulation and the Companies Act, 2013. Given the fact that the draft regulation initially included the term demerger, it was concluded by the NCLT that had the cross border demerger been intended to be allowed; it would not be excluded from the final Cross Border Regulations. Hence NCLT rejected the application.

Criticism of the Sun Pharma Orders passed by Tribunal

• The conjoint reading of both the orders specifies that there are certain inconsistencies in judicial reasoning. Having said that, it is important to mention here that in the outbound demerger order, NCLT rejected the application only because Section 234 of the Act is silent on outbound demergers. 
• Secondly, earlier there was a prohibition on outbound merger or demerger as the companies involving such transactions were to necessarily be an Indian Company. However, such restriction was removed by the amendment in Section 234 of the Act. Now the transferee company should not be an Indian company. Further, It can be concluded from the above that removal of the prohibition has allowed cross border merger and demergers involving inbound and outbound transactions. Furthermore, the order of the NCLT has relied upon the deletion of the term ‘demerger’ from the final version of the Cross border Regulation. According to NCLT, such removal is deliberate, and the legislative intent is to disallow the inbound demergers. The order fails to effectively recognize that the expression demerger is included within the purview of cross border mergers.
• Thirdly there is a lack of logical clarity in both the orders. The inbound demerger is allowed, whereas the outbound demerger is not permitted. This is the breach of the legal continuum as both the transactions are of similar nature. 

Recommendation

• The Companies Act, 2013, has consistently been amended to keep pace with the dynamics of the business world. There is a lack of clarity in the provisions relating to cross border demergers.
• According to the rule of interpretation, the statute must be read literally. Still, if there is any absurdity or lack of clarity, the Court can make its purposive interpretation of the statute.
• In this case, the rationale behind the order is incomprehensible, which needs to be precise.
• The cross border transaction involving outbound and inbound transactions should be treated at par with each other to give more scope to mergers and acquisitions. 

Closing Remarks

It seems that the Tribunal had taken a narrow interpretation of the provisions relating to cross border demergers. Consequently, the progressive nature of the amendment in the provisions relating to cross border transactions gets hindered if the cross border mergers are prohibited. There is a need for comprehensive interpretations of existing laws to cater to the development of the economy. Till that time the companies have to take resort to the alternative methods of restructuring.

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