This article is written by Abhijit Kirtunia, pursuing the Diploma Programme in M&A, Institutional Finance and Investment Laws (including PE and VC transactions) from LawSikho.

Background

Non-Banking Financial Companies are companies which are registered under companies act 1956 or 2013 and are engaged in the business of extending loans or advances. They also provide asset financing support, purchase share by putting in investment or buy debentures or other marketable securities like leasing hire purchase, insurance business.

They also provide loans for working capital and also give credit facilities and provide investment in various properties they are useful in trading money market instruments.

No NBFC can do business without obtaining a certificate from RBI. It should be registered under companies act 1956/13 and must have a net owned fund of not less than 20 million rupees for a systemically important one. Whereas for non-deposit taking NBFCs who do not accept or hold public deposit RBI mandates a net owned fund of 5 billion or more as per their latest audited balance sheet.

Merger of NBFCs

The merger is a combination of two entities which form into a new company or either into one entity. Merger is part of corporate strategy decisions wherein two entities or two NBFCs merge into one in order to enhance the financial and operational strength of both organizations. The acquiring company can take the majority of equity shares of target companies or the other acquired company may surrender majority of shares to the acquiring company.

As per RBI only the NBFCs can undertake NBFC takeover which have got registered under companies act 2013.

Advantages and disadvantages of mergers 

Pros: It helps in providing economics of scale, helps in the growth and competes with government and multinational banks so that they can later apply for bank licenses. NBFC merger helps to avoid the cost and time as may be required to start NBFC Company on its own. They may also provide tax benefits. They also help in providing adequate ammunition to compete with banks they help in increasing the market share, increasing the goodwill and reducing their non-performing assets.

Cons: There are operational challenges due to large scale of NBFC businesses. They may create distress among employees because of merger in the organization there is always a risk of operational matters and management issues cannot be ignored.

Types of mergers

There are two ways of acquiring a target company one is friendly takeover this is based on mutual consent from both acquire and target companies. Here the acquiring company simply offers the target company for being acquired and the latter willing to accept the offer.

Hostile takeover: Here the acquired company tries to purchase Target Company secretly However this type of NBFC to take a takeover happens when the board of directors of the company show resistance to accept the offer of the takeover.

Precaution before merger

NBFC takeover is an important way of enlarging business. It is perfect to get through for those companies who fail to register NBFCs, however precaution needs to be exercised before embarking on takeovers.

Due diligence is very important so as to conduct extensive research into the background of target companies. It is important to verify before purchasing a company by making a checklist of various aspects which needs a thorough analysis for further alignment with the key goals for this takeover and contemplate whether this new target company will help in fulfilling those objectives.

it is important to evaluate the financial position of company which the acquiring firm wants to acquire and needs to carefully assess and estimate the maximum amount of payment which would be required for takeover as per the cash flows and finalize the best mode of payment as the company will reject the offer below market value so it is better to evaluate the right pricing before offering the deal.

Key steps in the merger process

• First sign the MoU and get approval from the board of directors.

• The merger procedure of NBFC is triggered when both parties sign the MoU. It defines that both companies are ready for the takeover agreement. The Directors of the acquiring company and Target Company come together and sign them. This MoU shall include content around the needs and responsibilities of all companies and when the MoU gets approved, the acquiring company pays the token amount to the target company so as to confirm the beginning of transaction.

• Consent from the bank for the proposed merger is taken next.
• Prepare KYC documents for directors in companies.
• Prepare the business plan.
• Seek RBI approval (3-4 months)

• A company requires RBI approval if there is a change in management after the acquisition e.g. if there is any variance in the shareholding of an NBFC that turns more than 26% (after acquisition) of the paid-up equity capital.
• if the NBFC takeover tends to change management of about 30% of the number of directors.
• RBI approval not required if the shareholding change is due to some buyback offer or rotation of directors.

Documents to be submitted to RBI:

1. All the information of the Proposed shareholders/ directors.
2. Information about the sources of funds.
3. Bankers’ Report for proposed shareholders/directors.
4. A declaration for non-association of a company with any other entity that has denied a Certificate of Registration by RBI.
5. A declaration and affidavit of non-criminal background.
6. Financial record of last three years.

• Once RBI approval is received;

• Call upon a board meeting to discuss matters related to public notice, date, time of EGM.
• Publish a public notice in 2 languages (English is must) after 30days of RBI approval and invite any objection to said arrangement. The following needs to be completed before takeover.

1. Obtain NOC from creditors.
2. Enter into a formal agreement for  purchase share/ transfer of management/ transfer of shares/ or such interest for NBFC Takeover.
3. Transfer of Assets – they are in compliance to signed agreements.
4. Valuation of company as per rules prescribed by RBI ( discounted cash flow method).
5. Notice to the regional office of RBI.

• After 30 days of signing of formal agreement, publish a second public notice in 2 languages (English is must), the public notice must capture

1. Intention to sell or transfer control/ ownership;
2. All the relevant particulars of the transferee; and
3. Reasons for NBFC takeover agreements or the transfer of control/ownership.

• Final Step NCLT Approval (2-3 months)– File an application to NCLT under section 230-233 of company act in 2013 seeking approval for scheme of merger or amalgamation. Following documents need to be provided to NCLT for approval:

• Application with NCLT for convening the general meeting.
• Tribunal will pass an order to conduct a general meeting of shareholders (List of shareholders to be provided).
• Shareholder meetings will be conducted by The company for approval of the merger scheme.
• Certified copy of latest audited balance sheet and profit and loss statement. 
• Approval from SEBI, in case of a listed company.
• Prepare the scheme of merger with an explanatory statement.
• Creditors list with their outstanding dues.
• Official liquidator report.
• Intimation to the regional director.
• Get a valuation report.
• Details of legal proceeding by or against the company.

NCLT may look at the application with following observations:

1. They can do cross questioning on the material statements of the bank latest financial position auditor report and any such observation. 
2. The member or creditor or any class of them are fairly represented by those who attended the meeting.
3. The scheme should be in public interest if feasible.
4. The scheme is in the interest of the company also and its members and creditors.

Conclusion 

Mergers and takeovers are on the rise and are an important source of driving growth in an exponential manner. It has become one of the important sources of business expansion in the short run. NBFC takeover proves to be a ray of hope for all those companies who fail to register an NBFC of their own.

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