This article is written by Rajeev Awasthi, pursuing a Diploma in M&A, Institutional Finance and Investment laws (PE and VC transactions) from LawSikho.

Introduction

The Indian tax and regulatory framework provide different routes to carry out M&A transactions in India. The Companies Act of 1956 provided the concept of mergers and acquisitions. The merger and acquisition channel is undertaken when two or more profit entities combine their assets and liabilities into a new entity or into one of the existing entities either to support the business, to make the business more profit yielding, acquisition of technologies, access to more diversified sectors or global markets etc. The provisions relating to merger and amalgamation are detailed in sections 391 to 396A in Chapter V of Part VI of the Act. The sections 390 to 394 of the Companies Act 1956, deals with the schemes of arrangement or compromise between an entity, its creditors and/or its shareholders.

It is to be noted that under the Companies Act 2013, provisions have been made to have a single forum in the form of National Companies Law Tribunal (“NCLT”) to approve of all merger, acquisition and de-merger schemes. The NCLT is yet to be set-up and until it is formed such power to approve schemes lies with the High Courts.

According to the report published in Grant Thornton’s Annual DealTracker, the Indian private equity and venture capital. According to the report in the first half of 2018, there were more than 600 deals worth more than $75 bn, double the half-yearly revenue compared to the same period last year. The dealmakers recorded over 200 M&A transactions valued at over $65 bn, which is double growth compared to the same period last year. The telecom sector led the M&A activity: The Bharti-Indus merger ($14.6 bn) and the Reliance Jio-RCom merger ($3.8 bn). This was followed by the E-commerce sector which saw the Walmart-Flipkart deal ($16 bn).

Applicable Laws

The governing laws depend on the parties involved in the transaction. If both the acquirer and acquiree are located in India, they will be governed by Indian Law. However, in case one party is located offshore, the parties can mutually agree to a jurisdiction offshore.

For an acquisition finance transaction involving a non-resident party, the most important legal rules are the:

• Foreign Exchange Management Act 1999 and its related rules and regulations.
• Foreign investment policy of the Government of India notified through various press notes.

For listed companies, the applicable laws are the:

• Securities and Exchange Board of India Act 1992 (SEBI Act) and its related rules, regulations and guidelines.
• SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code).
• SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 (ICDR Regulations).
• SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR Regulations).
• Indian Contract Act, 1872.

For acquisitions financed through debt, the applicable laws include the:

• Transfer of Property Act 1882.
• Securitization and Reconstruction of Financial Assets and Enforcement of Security Act 2002 (SARFAESI Act).
• Recovery of Debts due to Banks and Financial Institutions Act 1993.
• Old Companies Act.

• Income Tax Act 1961.

Different types of creditors defined under the Insolvency and Bankruptcy Code, 2016

The Insolvency and Bankruptcy Code is aimed at protecting the interests of small investors and makes the process of doing business a cumbersome-less process. The introduction of IBC has not only made the distinction between different types of investors clearer but also simplified the process of resolution and liquidation of corporate debtors.

A ‘creditor’ is a person to whom debt is owed. A debt is a liability or obligation in respect of a claim, due from any person.

The IBC has coined the concept of ‘Financial Creditor’ and ‘Operational Creditor’ that is distinct from the Companies Act of 2013 which did not classify the term ‘Creditor’ in detail.

The section 5(7) of IBC, defines a ‘Financial Creditor’ as “a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred”. The financial debt has been classified under section 5(8) of IBC as a debt along with interest if any which is disbursed against the consideration for time value of money.

The section 5(20) of IBC, defines an ‘Operational Creditor’ as any person to whom an operational debt is owed which has been legally assigned or transferred. The Operation debt is defined as a debt in respect of the provision of goods and services. The expression includes all the trade creditors whom the corporate debtor contracts as part of its operations and services.

Step by Step Process

1. A meeting of creditors and members is called by making an application with the NCLT. Along with the below set of information:

• • latest financial position of company
  • auditor’s report of the company
  • any pending investigation or enquiry against the company
  • Not less than 3/4th of the creditors should provide consent to the corporate debt restructuring.

2. Once the NCLT calls a meeting of the creditors and shareholders, a notice has to be dispatched to the registered address of the creditors and shareholders individually with

• • Details of compromise or scheme of arrangements statement.
  • Valuation Report copy.
  • Effect of such scheme on creditors, shareholders etc.

3. Voting by Polls or through electronics means: At least 3/4th of the creditors and shareholders’ present in the meeting and voting should approve of the scheme. After which the auditor of the company has to file a certificate with NCLT confirming the accounting treatment in accordance with Sec. 133 of Companies Act, 2013.
4. Under section 230(9) of Companies Act, 2013 NCLT has the power to call off the meeting with creditors, if 90% of these crediotrs approve of the scheme by way of affidavit.

Inter-creditor Agreements

1. These are governed by the Indian law and the borrower is not included.
2. This arrangement provides for the rights and arrangements of various classes of creditors.
3. The agreement lays out the ranking and the sharing of proceeds between various lender groups, voting by lenders, waivers and decisions including decisions in relation to defaults.
4. All payments made by borrower and shared amongst the class of creditors in a pro-rata basis.

Role of creditors and shareholders under Merger Provision

1. The companies involved in the merger make an application before the Company Court which is a specific bench of the High Court and which has jurisdiction over the company to call meeting of its respective shareholders and/or creditors.
2. A meeting of the creditors/ shareholders of the merging entities is held.
3. If more than 3/4th of the creditors and shareholders’ present and voting in this meeting are in favor of the merger, and if such merger is sanctioned by the Court then it becomes binding on all the creditors or shareholders of the company.

Schemes of Compromise or Arrangement under The Companies Act, 1956 (Sec. 390-394)

1. The creditors are divided into appropriate classes to achieve at settlement and each classes consent to scheme is obtained.
2. The scheme must be approved by majority in number and 75 per cent in value of creditors in each class present and voting at the meeting.
3. After approval from each class of creditor, the Court must approve of the scheme.
4. It is a time consuming process as the court has to hear all the objecting creditors.

Corporate Debt Restructuring Governed By The Reserve Bank Of India

1. This scheme applies to companies which have obtained financing from several banks and have outstanding debts of more than Rs. 100 million (US$ 2 million).
2. The re-structuring can be carried out by creditors within 90 days (and extended up to 180- days) of submitting the matter to the restructuring process.
3. It becomes binding on all creditors if 75 per cent of the lenders by value and 60 per cent by numbers agree to the scheme.
4. The CDR guidelines additionally offer exit options to any creditor who does not agree to the restructuring. A dissenting creditor has the provision to sell his/ her stake to any majority creditor at a price to be agreed, or to any other lender who agrees to be bound by the terms of the restructuring. This system is purely contractual and operates on the basis of a creditor-debtor agreement and inter-creditor agreements.

Provisions provided to Creditors under the Bankruptcy Code vs. SARFAESI Act

1. Under the Bankruptcy Code, 75% of the Creditors must approve of a sale of business while, under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 60% of the secured creditor’s approval is required.
2. Secured and Unsecured Creditors are not distinguished under the Bankruptcy code on voting rights in the committee

Existing Powers of Creditors and Proposals

The Companies Act of 2013 empowers the Creditors to approve any scheme of merger or amalgamation if a specific threshold is met, which is 3/4th of the aggregate creditors of the target company. The Act does not distinguish between unsecured and secured or financial and operational creditors.

1. A creditor with an outstanding debt of at least 5% of the total outstanding debt of the amalgamating company can object to the merger scheme before the National Company Law Tribunal. During mergers, the amalgamating company should ensure that it passes all its assets and liabilities to the merged company which in this case should be inclusive of trade dues to the operational creditors.
   1. Reliance Communications and Aircel Limited merger (role of creditors with less than 5%debts): According to a report from Debtwire, a plea was filed with the appellate tribunal by a group of small creditors to block the scheme of arrangement for the merger of Reliance Communications’ wireless business with Aircel Limited. In this case the NCLT’s order dated August 14, 2017 was challenged with NCLAT. The filing with NCLAT was against NCLT’s decision of upholding the appeal on the grounds that the appeal was made by a consortium of 14 creditors including the appellant Thomas Cook (India) Ltd. Who combined had less than 5% claims against either of the companies objecting from the proposed merger. To arrive at its decision NCLT cited Section 230 of Companies Act, 2013 (discussed above: minimum threshold of creditors against a debtor should be 5% to object of a scheme of arrangements). The conflict in judgment provided by NCLT and decision of creditors to move to NCLAT occurred that the creditors were of the view that the consortium of 14 creditors believed that the 5% threshold should not be applicable to the creditors as Section 230 covers the procedures for scheme meeting for shareholders and creditors. However, the NCLT hearing was based on the citation that the scheme was already approved by the shareholders of the two companies and thus the 5% threshold would be applicable. It can be noted here that if NCLAT also objects to the plea of the consortium of creditors, they can still move up to Supreme Court to challenge the scheme of merger.  (Read full case filing to NCLT here.) The appeal was later withdrawn (see NCLAT’s principal bench’s order here). However, this case was important study since, it shows that no matter what size of creditors, it can be ugly if such consortium of creditors are permitted to object from such schemes.
2. The Insolvency and Bankruptcy Code of 2016, empowers the operational trade creditors with a minimum payment amount default of Rs. 1 lakh to initiate the corporate insolvency process against a merging corporate debtor. However, if the debtor disputes this by filing an arbitration reference the claims of operational creditors under the code become pointless.
   • The NCLT currently lacks sufficient powers to examine whether the disputed debts by the corporate debtor is genuine. The operational creditor becomes ineligible to pursue an insolvency resolution process due to such disputed debt claims raised by the corporate debtor.
3. Under the current scheme the operational creditors are provided no representation in the committee of creditors which approves the insolvency scheme of the corporate debtor. To protect the interests of operational creditors as a separate class it becomes important to provide them sufficient representation based on certain thresholds.
4. Citing the Mobilox Innovations Private Limited v. Kirusa Software Private Limited resolved by the Supreme Courts orders, in case the unsecured operational trade creditors are able to prove a default in the payment of trade dues, they may choose to file a civil suit under the Code of Civil Procedure to recover such dues. However, such a process is time-consuming and tedious.
5. In case the operational trade creditor is able to prove that corporate debtor has prevented distribution among creditors by means of a criminal breach of trust or dishonest or fraudulent removal or concealment of property. In such situations, the operational creditor can initiate criminal action seeking arrest of key managerial personnel of corporate debtor.
6. There have also been cases where clarity has been brought out whom to classify as a Financial Creditor. In the Nikhil Mehta & Sons (HUF) & Ors. v. M/s AMR Infrastructures Ltd. (NCLT Delhi) case, the NCLAT overturned the decision of NCLT and ruled that the even the buyer of Real Estate under an ‘Assured return’ plan will be classified as a ‘Financial Creditor’ for the purpose of Insolvency and Bankruptcy Code. Such class of Financial Creditors would, therefore, be eligible to initiate corporate insolvency process against the corporate debtor, which in this case was the AMR Infrastructures Ltd., in lieu of non-payments of Assured returns and non-delivery of the residential unit. The NCLT’s reason for overturning the appeal was the citation of the fact that the agreement between the builder and appellant was ‘pure and simple agreement of sale and purchase of a piece of property and has not acquired the status of a financial debt as the transaction does not have consideration for the time value of money. The NCLT held, that disbursal of monies ‘against the consideration for the time value of money’ which is a pre-requisite for the debt to qualify as a ‘financial debt.

Conclusion

To conclude the government needs to set up a mechanism to provide more transparency to the merger and amalgamation process and more law enforcement to the sector to save creditors and class of creditors from raising genuine claims which we have discussed above. Additionally, the Companies Act or Bankruptcy Code should add legal provisions to check if a corporate debtor is obligated to settle all the dues to the unsecured trade creditors before undertaking any scheme of restructuring or amalgamation.

The different reforms of the government, such as GST, IBC, RERA and Housing for All, had a visible positive effect in the first half of 2018. That said, it would take a while to see the full benefits of these reforms. The expectation is also to see a near-term return from the Housing for All scheme and PSU bank recapitalization (which would support credit growth) along with NPA resolutions. The IBC amendments recently passed by the Parliament as many distressed assets come up for sale at attractive valuations will also further support M&A. This is especially true for capital-intensive sectors such as real estate, infrastructure, power and cement. A good capital market and strong regulatory reforms, including the insolvency law, are signs of depth and maturity, and this makes the Indian market more attractive.

Disclaimer: “The views presented by the author are his personal views and do not in any way represent the views of the organization he is associated with.”

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