This article is written by Ipkshita Singh, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com.

Introduction

The inception of Indian markets being open to cross-border mergers was a stepping stone towards globalization of domestic business industries. The order of NCLT Ahmedabad in Sun Pharmaceuticals Industries Limited has changed the existing landscape of cross-border mergers. The company proposed restructuring by consolidating its overseas group companies and demerging its two undertakings into separate overseas companies. However, the NCLT held that cross demergers were found under the restructuring laws. This decision has posed an unanswered question before the legal fraternity- Whether outbound cross-border demergers are permissible under the Indian laws?

The legislative intent for the procedure of cross-border mergers could be found in the JJ Irani Committee Report of 2005 [1] which stated that the current regime of Company Law in India did not allow cross-border mergers. It suggested that in order to give effect to such transactions, international best practices must be adopted.

The legislature paved the way for cross-border mergers through Section 234 of the Companies Act, 2013 which provides for merger and amalgamation of a company with a foreign company. Additionally, Rule 25 A of Companies (Compromises, Arrangements and Amalgamations) Rules of 2016 further provides for mergers between a foreign company and an Indian company in detail.

The genesis of the law for demerger in India can be interpreted through Section 230(1) of the Companies Act, 2013 which defines any form of arrangement between creditors and the members as “inclusive” of a reorganisation of a company’s share capital through consolidation or division of shares, or both. 

The term “demerger” has not been defined in any of these above-mentioned provisions and no domestic law expressly permits an outbound cross-border “demerger”. The word “demerger” is defined only in Section 2 (19AA) of Income Tax Act of 1961. It states that demerger is a transfer of undertakings to any resultant company pursuant to a scheme of arrangement in accordance with the Companies Act with prior approval of Reserve Bank of India (RBI). 

Outbound Cross-Border Demergers

To understand the concept of outbound cross-border mergers it is imperative to understand the laws framed by the legislature. Section 234 of the Companies Act of 2013 states that any merger or amalgamation with a foreign company must be governed by rules framed by the Central Government, with prior approval of the RBI and Securities and Exchange Board of India (SEBI). 

The provisions of Section 234 came into effect through the Ministry of Corporate Affairs’ notification [2] in April 2017. Consequently, the draft regulations [3] on Foreign Exchange Management (Cross Border Merger) Regulations, 2017 released by RBI also provided the substantive and procedural guidelines for cross-border mergers between an Indian company and a foreign company. Regulation 2 (viii) of the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 [4] defines an outbound-merger as a merger between an Indian company and a foreign company, whereby the resultant company is a foreign company. Such mergers must be with host countries that fall within the purview of Annexure B to of Companies (Compromises, Arrangements and Amalgamations) Rules of 2016. The Annexure allows for cross-border mergers with foreign companies whose jurisdictions permit cross-border mergers.

Procedure relating to Outbound Cross-Border Demergers

The procedure regarding outbound cross-border mandate the following requirements as per the 2018 Regulations:

• A resident of India is permitted to acquire holdings of a foreign company pursuant to an outbound merger. 
• If a foreign company seeks to acquire assets of an Indian company, it must comply with the procedure laid down in the FEMA regulations and with the requirements of Section 394 of the Companies Act, 2013. 
• Any outstanding borrowings of the foreign company must be paid by the resultant foreign company.
• If any such cross-border transaction is barred by the FEMA laws, then the assets must be sold within two years from the date of sanctioning of the scheme. The proceeds must be repatriated outside India upon any sale and the proceeds may be used to repayment of any domestic liability in India. 
• Any valuation of such a scheme must be done as per Rule 25A of Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 [5] and Section 248 of the Companies Act of 2013 wherein such valuation is done as per arm’s length basis and internationally accepted standards. The valuers must be members of a recognised professional body in the jurisdiction of the transferee company.
• A certificate from the Managing Director/Whole-Time Director and Company Secretary (if available) of the companies must be submitted to the NCLT. 
• The draft scheme has to be submitted with a no-objection letter from relevant stock exchanges and SEBI.
• Prior approval of sectoral regulatory authorities such as SEBI and RBI.
• The scheme must satisfy the requirements of Sections 230 to 232 of the Companies Act.
• If the scheme meets the regulatory and statutory criteria under the FEMA laws, then such a cross-border merger is deemed to be approved by RBI.

NCLT’s order in Sun Pharmaceuticals Industries Limited

The issue regarding legal permissibility of outbound demerger arises due to the inconsistency between the scope of Section 234 and the definition of cross-border mergers as per the notified Foreign Exchange Management (Cross Border Merger) Regulations in March 2018. The definition provided in the 2018 Regulations define Cross Border Mergers as “any merger, amalgamation or arrangement between an Indian company and foreign company, in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 notified under the Companies Act, 2013.” The legislature dropped the word “demerger” while translating the draft regulations into a binding law. Whereas, Section 234 of the Companies Act provides only for “merger or amalgamation” of a foreign company.

Given the silent position of law, a question posed while deciding a cross-border merger scheme is whether the term “merger” in laws governing cross-border mergers includes the term demerger.

This inconsistency was the foundation of NCLT Ahmedabad’s order in Sun Pharmaceuticals Industries Limited [6]. In the proposed scheme for demerger, Sun Pharmaceuticals Industries was a listed public that submitted a draft scheme for demerging its two investment undertakings into two resultant wholly-owned subsidiaries. The resultant demerged entities were to be foreign companies, viz., Sun Pharma (Netherlands) B.V. and Sun Pharmaceuticals Holdings (U.S.A.) Inc. Despite prior approval from SEBI, RBI and Income Tax authorities, the scheme was rejected by the Regional Officer as he found legality of such an outbound demerger absent from the Indian restructuring laws.

One of the prime objections of the Regional Officer was that Section 234 of the Companies Act only referred to mergers and amalgamations, and not demergers. Per contra, the company rebutted this objection stating that such an interpretation of law would be contrary to the NCLT’s previous decision in 2018 [7] that allowed for inbound demergers under the same provision. Therefore, no differentiation could be drawn between an inbound demergers and outbound demergers and both ought to be treated at an equal footing.

The NCLT did not sanction the scheme in the latter case citing lack of legislative will through deliberate omission of the term “demerger” from the 2018 Cross-Border Merger Regulations under FEMA. Additionally, the adjudicating authority also held that there was no mention of compromise or arrangement under Section 234, unlike Sections 230 to 232. Thus, both the provisions as well as the rules of Companies Act were silent on permissibility of an outbound cross-border demerger. The NCLT refrained from “adding or subtracting” anything in the existing law and chose to interpret the provisions of the Act strictly.

Conclusion

Outbound demergers were expressly allowed under Section 394 of the 1956 Act, but transferee company was not permitted to be a foreign company. However, this is not the case with the Companies Act of 2013. In fact, the legislature itself omitted the term from the nomenclature of Section 234 and the FEMA Cross Border Merger Regulations of 2018. Therefore, NCLT being an adjudicating authority, ought to sanction a scheme of arrangement as per the law of the land. NCLT, is a quasi-judicial body, that is incapable of interpreting laws in a manner that defeats the legislative intent. 

The argument that NCLT could not have deviated from its previous decision in the related case cannot be sustained. The previous decision interpreted Section 234 to include a scheme for demerger. However, there is a need for a reasonable classification to be drawn between an inbound cross-border demerger and an outbound cross-border demerger. An inbound cross border demerger is expressly allowed by Rule 9 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 [8]. Further, there is no evidence of lack of legislative intent for an inbound cross-border demerger.

Even if a broad interpretation were to be given to the provisions of the Companies Act, there is no clarity of procedure as to how the resultant foreign company must bridge the gap between domestic law and the law of permitted jurisdictions. Cross-border mergers are defined [9] either on the basis of the “structure” or the “effect” of the merger. Given that an outbound cross-border demerger would involve a foreign entity as well as a resultant foreign company, it can be ascertained that such a demerger would affect markets of multiple jurisdictions. This creates room for inconsistency in regulatory requirements of each jurisdiction.

Additionally, inbound mergers may be exempted from the capital gains tax under Section 47 of the Income Tax Act. However, there exists no such clarity regarding taxation of an outbound demerger company or guidelines for avoiding Double Taxation of such transactions. If outbound mergers are also to be considered tax-neutral, such intent must be reflected through legal provisions, or legislative guidelines. 

The anomaly still awaits a clarification from the Ministry. Due to the aforementioned reasons and ambiguities surrounding an outbound cross-border demerger, outbound demergers may not be the best type of restructuring under the governance of Indian laws. Unlike the outbound demergers, inbound cross-merger serve better purposes given that there is tax exemption and it fosters a convenient compliance mechanism under the domestic jurisdiction.

However, if an entity does wish to move forward with an outbound demerger scheme, the legislative procedure must be followed and the lacuna may be argued differently and decided by the NCLT on a case to case basis. 

References

1. Expert Committee on Company Law, Report on Company Law (May 31, 2015), http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf. 
2. Ministry of Corporate Affairs, Notification on enforcement of Section 234 of the Companies Act 2013, 2553 GI/2017 (April 13, 2017), http://www.mca.gov.in/Ministry/pdf/section234Notification_14042017.pdf.
3. Reserve Bank of India, Foreign Exchange Management (Cross Border Merger) Regulations 2017, (April, 2017), https://rbidocs.rbi.org.in/rdocs/Content/PDFs/CBMD08484A86A9AE4780A2D825C5D85184B3.PDF.
4. Reserve Bank of India, Foreign Exchange Management (Cross Border Merger) Regulations 2018, FEMA.389/2018 (March 20, 2018),

https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11235&Mode=(). 

5. Ministry of Corporate Affairs, Rule 25A of Companies (Compromises, Arrangements and Amalgamations) Rules 2016, https://www.mca.gov.in/Ministry/pdf/compromisesrules2016_15122016.pdf. 
6. Sun Pharmaceuticals Limited (“NCLT’s decision in 2019”), CP (CAA) 79 of 2019 in CA (CAA) No. 38/NCLT/AHM/2019, 

https://nclt.gov.in/sites/default/files/Jan-final-orders-pdf/FINAL%20Sun%20Pharmaceutical%20Industries%20Ltd%20Vs%20–.pdf.

7. Sun Pharmaceuticals Limited (“NCLT’s decision in 2018”), CP (CAA) 19/230-232/2018 in CA (CAA) No. 18/NCLT/AHM/2018,

https://nclt.gov.in/sites/default/files/final-orders-pdf/Final%20Sun%20Pharmaceutical%20Industries%20Ltd%20Vs%20–.pdf. 

8. Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, Rule 9, https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11161&Mode=0#:~:text=(9)%20A%20person%20resident%20outside,as%20specified%20in%20Schedule%209.
9. Organisation on Economic Co-operation and Development, Cross-Border Merger Control: Challenges for Developing and Emerging Economies, http://www.oecd.org/competition/mergers/50114086.

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