This article was written by Aashika Goyal and has been edited and published by Oishika Banerji (Team Lawsikho).
Table of Contents
Introduction
Mergers, acquisitions, and downsizing are concepts under corporate law that enable the company to increase its efficiency, economies of scale, and financial performance. These business practices are generally used to enhance the business model for rapid technological and management advancement of the company. Mergers refer to the practice where two or more companies enter into an arrangement to continue their business as a single entity, while acquisitions refer to the practice where one company takes over the business of another, which may include a subsidiary, its holding company, and an associate company. Downsizing, however, refers to the reduction or layoff of an inefficient workforce by employers, generally to survive harsh economic times. In this article, we will discuss these concepts in detail, including their impact, consequences, and legal compliances to be followed by the company. Mergers, acquisitions, and downsizing are all part of corporate restructuring.
Evolution of corporate restructuring
Before the Economic Reforms Policy of 1991, there was a regulated economy where the government interfered by its policies, rules, framework, etc. in every aspect of business. Earlier, the economy was centralised, and prices were not decided by market forces of supply and demand. The role of financial institutions in setting up the whole new trend of corporate restructuring has increased pursuant to the raid of DCM Ltd. and Escorts Ltd.
Post Industrial Policy 1991 Reforms, the economy was decentralised to ensure more investments from foreign companies, and globalisation resulted in an open competition regime for Indian markets. For instance, there were amendments made in the MRTP Act within all restrictive sections discouraging growth in the industrial sector. Environmental, technological, and capital market change enables the Indian and MNCs to restructure and reestablish their businesses to meet market synergies and compete in the market to ensure profitability and liquidity.
It is ideal to note that in today’s time, a restructuring wave is sweeping the corporate sector across the globe, thereby taking entities, both big and small, and also comprising old economy businesses as conglomerates alongside new economy companies. The infrastructure and service sectors are also very much involved in the same. Mergers, amalgamations, acquisitions, consolidation, and takeovers can be categorised as fundamental parts of the new economic paradigm. Taking note of such evolving times, one can be rest assured that corporate restructuring activities are expected to occur at a larger rate than ever before in the past, thereby placing India swiftly on the international market.
Change in trends of M&A
The concept of corporate restructuring offers various opportunities in the corporate world. Poor business and economic conditions, rapid technological advancement, and increasing competition enable various entities to undergo internal or external reconstruction. The main objectives are to enhance economies of scale, revive sick industrial units, reduce costs, and access advanced research and technology.
The concept evolved subsequently and is still in the process of undergoing changes in order to adapt itself to a dynamic environment. Change in various regulatory frameworks ensures the development and early success of corporations. The main regulatory mechanism has been altered to radically change the Indian takeover market such as SCRA and promulgation of new code i.e. SEBI Takeover Regulations, Finance Act, 1997 etc.
Further, owing to increasing digitisation and the post covid period, many companies tend to restructure their businesses for the purpose of acquiring advanced technology for innovations and to compete in the market efficiently by upskilling their existing and potential efficient workforce. It may also include removing inefficient permanent employees. An increase in digitisation enhances the focus on acquiring and adopting cybersecurity, cloud technologies, data driven information utilities, and AI mechanisms.
When would a company adopt any of these measures
Any company can adopt any of the corporate restructuring measures, depending on various circumstances and factors persisting in the market. It depends on company to company, and no single factor can be a reason for adopting these practices. It depends on multiple factors that determine the method of restructuring. In order to have an effective and successful restructuring of the company, the company takes into consideration a long term and medium term approach to business growth.
These factors or circumstances can depend on a business strategy, financial requirement, regulatory frameworks etc. With major layoffs, retrenchments, bankruptcy, and cash flow requirements, businesses need to cope with increasing competition. Other factors may include:
- Debt recovery;
- To redirect operational and day to day managerial activities;
- Arrange finance requirements to ensure profitable growth;
- Develop business competencies;
- Have better market share and Revive its position in market;
- To meet cash flow requirements;
- Obtain tax benefits;
- To meet CSR and changing regulatory frameworks;
- Diversification of business ideas; and
- To remove bankruptcy and insolvency.
Effect of merger, acquisition and downsizing on a company
Corporate restructuring altogether can affect a company’s revival or provide a different business strategy. Many companies undergo pivots to gain position in a market, as in the case of OYO Rooms. Merging a company with another or acquiring another company can provide a competitive advantage.
A company would have efficient management and a defined business structure that enhances the growth and viability of the business. Downsizing proves to be a necessary step when a company has been functioning improperly and needs to change its administrative structure.
Mergers, acquisitions, and downsizing may prove to be of strategic importance and may lead to the dissolution of the company. Hence, it is necessary to take into account all necessary measures, due diligence before entering into any transaction, and compliances to have a positive effect on the company.
Legal requirements of corporate restructuring
Mergers, acquisitions, and downsizing play an important role in the development and growth of the company, and there are various laws to govern their functioning. Various statutes, regulations, rules, orders, notification governs them and different sectoral regulators are involved in implementing these schemes such as RBI, SEBI, CCI, RoC, Central Government, etc.
Corporate restructuring under the Companies Act, 2013
The Companies Act, 2013, provides enabling provisions relating to compromise, arrangements, and amalgamations under Sections 230-240 of the Act. Mergers, acquisitions, or downsizing are part of an arrangement or a compromise of a company for ensuring growth of the company or for reasons to meet the synergies of the economy at that time. Section 232 of the Act provides for a procedure to be followed when a compromise or arrangement is made in connection with a scheme of merger or amalgamation. The Companies Act, 2013, under Section 233, provides for certain companies, such as small companies, their holding companies, and subsidiary companies, to follow a fast track mode of merger or amalgamation at their discretion. The Central Government has the discretion to approve these companies adoption of fast track methods and may also impose certain conditions on them. For any scheme of arrangement with creditors or members, the company had to follow the procedure as per Sections 230-232.
All about corporate restructuring under the Competition Act, 2002
The economic aspects of mergers and combinations are provided under the Competition Act, 2002. This Act provides for the establishment of the commission to regulate the market by protecting the economy from practices that would have an appreciable adverse effect on competition. Merger and acquisition is termed as a combination under the Competition Act. The regulation of combinations is elucidated under Section 6 of the Act. This act made it mandatory to submit a notice to the commission of the proposed combination within 30 days of getting approval from the Board of Directors.
The Competition Commission of India has been empowered under Section 29 to investigate whether disclosure made to it under Section 6 is correct or whether such a proposed combination would have an adverse effect on competition. In case, CCI has prima facie reasons to believe that such a transaction will likely have an impact on the competition, it can issue a show cause notice to the parties as to why an investigation shall not be followed against them. After receipt of the reply, CCI may call for the report of the DG within 7 days. Even after inviting suggestions and objections from the public, if the commission believes that the proposed combination will have an appreciable adverse impact on competition, it may suggest some modifications, and such a combination will be allowed only if these modifications are accepted by the parties or if some amendments are accepted by the CCI as proposed by the parties.
Any failure to provide such notice or declaration will result in a penalty being imposed under Section 43A of the Act against such person, association of persons, enterprise, or association of enterprises.
An insight to corporate restructuring through the lenses of Insolvency and Bankruptcy Code, 2016
Insolvency is a situation where the assets of the company are not sufficient to pay off the liabilities. IBC provides for a framework and procedures to be followed by the creditors or corporate debtor to resolve the debts and liabilities and revive the position of the company. Chapter II of the Code mentions the provisions related to the Corporate Insolvency Resolution Process (CIRP) that can be initiated by a financial creditor, operational creditor, or corporate debtor itself. In case of failure of CIRP, debtors will undergo a liquidation process, and assets are realised and distributed by the liquidator.
This Code provides for reconstruction mechanisms and not only debt recovery mechanisms as under the Sick Industrial Companies Act, 1985 (that has now been repealed). Mergers, acquisitions, or downsizing are used to revive the business of the company, and an application needs to be filed before NCLT.
Corporate restructuring under the Income Tax Act, 1961
As per the Income Tax Act, 1961, merger and acquisition are referred to as “amalgamation,” and merging companies are termed “amalgamating companies.” Tax benefits and exemptions differ from the structure of amalgamation. Amalgamation must be confirmed with certain conditions in order for it to be considered tax neutral along with fulfilling requirements under the Companies Act, 2013.
A merger will be considered an amalgamation for the purpose of the Income Tax Act, 1961, when:
- All the properties and liabilities of an amalgamating company becomes property and liability of an amalgamated company.
- Shareholders holding at least 3/4th in value of shares in amalgamating company became the shareholders of amalgamated company.
Amalgamating company gets an exemption from capital gains tax under section 47 when capital assets of a amalgamating company is transferred to amalgamated company, the capital gain will b exempted from tax or when one foreign company is amalgamated with other foreign company having shares of Indian Company, such gain will not be taxable if not taxable under provisions of foreign company, required that 25% of shareholders of amalgamating company continues to remain shareholders in amalgamated company.
Any expenditure on scientific research by the amalgamating company being transferred to an amalgamated Indian company will be allowed to be carried forward and set off. If such an asset has been sold by the amalgamated company, the cost of the asset will be considered business income, and any price above the cost will be taxable as a capital gain. For example, if an asset costing 10 lakh is sold for 15 lakh, the amount above the cost price, i.e., 5 lakh, will be taxable as a capital gain.
SEBI Regulations and corporate restructuring: an insight
Mergers and acquisitions of any listed company are governed by various regulations incorporated by SEBI, which include the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Regulations); SEBI (Issuance of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations); and SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR Regulations).
All the regulations to be read, along with the SEBI Act of 2015, must be followed and complied with in order to have a valid and enforceable acquisition or merger of companies.
Effect of cross-border transactions on India
Corporate restructuring can also be done outside India, and it may involve foreign companies. Globalisation has increased avenues for foreign and Indian companies to direct or control the management of other companies. This results in opening the market up to two jurisdictions and helps each company revive or reconstruct itself. Cross-border transactions can be of two types i.e. Indian companies acquiring or merging with foreign companies, and vice-versa. It has been governed by Section 234 of the Companies Act 2013 and various other statutes.
Increasing cross border transactions enhances Indian presence in foreign markets, which results in higher growth, diversification, technological advancement, etc. in the Indian economy. This has also allowed small companies to compete with foreign and advanced companies. These transactions, along with various regulatory approvals, enhance the growth and liquidity of the economy as a whole.
Conclusion
Mergers, acquisitions, and downsizing are some of the methods of corporate restructuring. These types form a major part of the development and growth of Indian markets and require various regulatory approvals for their efficient functioning. Mergers and acquisitions involve external restructuring, but downsizing is generally an internal restructuring mechanism that involves the removal of inefficient employees or workers from the company. A company adopts these measures depending on various factors, such as company profile, development stage of a company, its life cycle, management, its objects and motives, etc. That differs from company to company. To make the most of the corporate restructuring, it is essential for every company to function as per the regulatory frameworks and get appropriate and timely approvals according to various statutes applicable to their industry. Companies should always take recourse to some professional help to comply with every regulation to prevent itself from hefty penalties applicable to them for any contravention of the law.
References
- https://www.scconline.com/blog/post/2022/09/17/key-ma-trends-digital-transformation/
- https://taxguru.in/corporate-law/corporate-restructuring-india.html#:~:text=In%20earlier%20years%2C%20India%20was,policies%20and%20rigid%20regulatory%20framework.
- https://www.icsi.edu/docs/webmodules/Publications/3.%20Corporate%20Restructuring,%20Valuatuion%20and%20Insolvency.pdf
- https://journals.sagepub.com/doi/pdf/10.1177/0256090919970301
- https://www.taxmanagementindia.com/visitor/detail_manual.asp?ID=588
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