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

Introduction

The Ministry of Corporate Affairs (MCA)’s 2017 notification on Section 234 of the Companies Act 2013 and insertion of Rule 25A in the Companies [Compromise, Arrangements, and Amalgamation] Rules 2016 (Companies Rule 2016), have consented to the cross border mergers and amalgamations in India. 

However, this notification and rule have not yet given clarity on the applicability and permissibility of cross border demergers transactions in India. It is still a contentious subject as in draft ‘FEMA Cross Border Merger Regulations 2018’, the legislative body has earlier incorporated the word “Demerger” and in the final regulation, it has deleted the word ‘Demerger’. Due to which it assumes that the omission of the word ‘demerger’ indicates that the legislative body is not intended to permit the cross border demerger transactions in India. 

This article delves into the understanding of the concept of ‘Outbound Cross Border Demergers’; its procedure as FEMA regulation prohibits Outbound Cross Border Demergers. We will also be discussing the decision of NCLT, Ahmedabad on the ‘Outbound Cross Border Mergers’ and ‘Outbound Cross Border Demergers’ an absurdity due to contradictory decisions by a similar bench.

Outbound cross border demergers

To understand what Outbound Cross Border Demerger is, let’s first understand what a demerger is.

A demerger is one of the restructuring strategies through which an existing company gets divided into two or more entities and gets registered separately to run the business and to function independently.

This arrangement is called as ‘Inbound Cross Border Demerger’, if the company is registered outside India and gets demerged and this demerged entity gets separately registered under the Indian Companies Act. 

The arrangement is called ‘Outbound Cross Border Demerger’ when the company registered under the Indian Companies Act gets demerged as a foreign company and the said demerged company gets registered separately outside the Indian jurisdiction.

To get clarity on the word ‘Demerger’ Indian courts have often taken the help of the provisions given under the Companies Act, FEMA Regulations, and Income Tax Act. For example, Corporate restructuring or scheme of arrangement (under Section 391 of the Companies act) with court approval under the Companies Act.  The word ‘Demerger’ is defined under Section 2 (19AA) of Income Tax Act 1961. It is neither defined under the Companies’ Act 1956 nor Companies Act 2013.  This definition is acknowledged in one of the judgments (Renuka Datla vs. Duphar Interfran Ltd.) and entered into Indian jurisprudence and under the Companies Act. 

Procedure

Primarily, the ‘Outbound Cross Border Demerger’ is not permitted in India. There is no defined procedure to carry out Outbound Cross Border Demerger. To understand the procedure of Outbound Cross Border Demerger’, let’s analyze the few sections of the Companies’ Act 2013 (Act). Section 230 of the Act is related to compromise and arrangement between companies and their creditors. Section 232 of the Act is related to compromise and arrangement whereby two or more companies are involved in connection with a merger, demerger, amalgamation, and reconstruction. Section 233 is related to fast track merger or amalgamations of the company. Section 233 (12) states that provision of Section 233 shall apply mutatis mutandis in respect of Scheme of arrangement or compromise of specified companies or transfer of companies under Section 232.  Section 234 of the Act says that provision of chapter XV of the Act unless provided in any other law shall apply mutatis mutandis to the scheme of merger and amalgamations between Indian companies and foreign companies. FEMA Cross Border Merger Regulation 2018 (FEMA Regulation 2018) permits inbound and outbound mergers with the prior approval of RBI. 

Considering the above briefing of the provisions for the outbound merger, if we consider extensively that the word ‘arrangement’ includes the word ‘merger’, to place the outbound demergers also require RBI approval. 

Based on the NCLT decision and interpretation of the two contradictory judgments of a similar court, the court will not approve the outbound cross border demergers. In such a case, this arrangement requires different colours to effectuate the transaction.

The company first demerge its intending business with other Indian Company and thereafter merge the same with a foreign company by following the procedure given hereunder: 

1. Prepare a scheme of arrangement as per Section 234.
2. Prior approval from Stock Exchange, Shareholders, and Creditors.
3. NOC from Registrar of Companies and Income Tax Authorities.
4. RBI Approval.
5. An application under Regulation 9 of the FEMA (Transfer/issue of Security by a Person Resident Outside India) Regulations, 2017 (FEMA Regulations 2017). 
6. Post-NCLT sanction of merger scheme merged the same with a foreign company.

List of documents required 

The procedure for Outbound Cross Border Demergers are permitted in India vide ordinance No 1182; 13th April 2017 and amendment to Companies Compromises, Arrangement & Amalgamations Rule, 2016. The list of documents required for Outbound Cross Border Demerger are as under:

1. Valuation of Company by professional of the recognized body; and as per internationally accepted accounting and valuation principles and declaration of such valuation to RBI before getting its approval.
2. Approval of Board of Directors for such Scheme for amalgamations before getting RBI approval.
3. Prior approval of RBI.
4. Statutory notice to Central Government, Registrar of Companies, Income Tax Authorities, SEBI, RBI, and other Sectoral authorities if any, as required to get the NCLT order.
5. Scheme approval by majority members/creditors to get   NCLT order.
6. NCLT Order.
7. Name approval of foreign Company.
8. Bank account details; GST details; EPFP & ESIC details.
9. Apostille (Notarised Copy) of resolution (having details of authorized representative and Number of subscription shares) of foreign Company.
10. Apostille (Notarised Copy) of ID Proof of authorized representative.
11. Apostille (Notarised Copy) of the charter of Foreign Company.
12. Name, address, and ID proof of one Indian Resident Director.
13. Apostille from Country of origin (Notarised Copy) of ID Proof of Director/subscriber and proof of the digital signature of such Director/subscriber.
14. Declaration related PAN Card.
15. Branch office in India, proof of office address, copy of utility bills, and NOC of property Owner.

The entire process needs to be completed within a period of two (2) years.

Discussion on the NCLT Ahmedabad order in case of Sun Pharma

NCLT has passed two judgments in 2018 and 2019, both are related to Sun Pharmaceutical Industries Limited (Sun Pharma) and contentious to each other. Let’s discuss this one by one. 

• In 2018, the NCLT bench passed an order and permitted an application placed under Section 234(1) of the Act for Inbound Cross Border Demerger. NCLT says that thorough reading of Section 232 (10 (b) of the Act suggests demerger as it states transfer of part undertaking is allowed and thus it is a transaction of the demerger.

The order says that provision of chapter XV of the Act deals with the arrangement, compromise, and amalgamations and shall apply to its mutatis mutandis unless otherwise provided. Further, it says that the word ‘arrangements’ includes demerger. Thus Inbound Cross Border Demerger was permissible under the Act. The order has also given a reference to Section 9 of the FEMA Regulation 2017 whereby the tribunal may permit the issuance of capital instruments to the shareholders of the existing company post scheme of merger/demerger, in case shareholders residing outside India. And the Scheme for inbound Cross Border Demerged was allowed.

• Contrary to the above in 2019, the NCLT bench at Ahmedabad, against a similar entity has given a contrary view. NCLT held that Outbound Cross Border Demergers are not permitted in India.

Facts of the case – 

• Sun Pharma placed an application whereby it intended to transfer its two undertakings to the wholly-owned subsidiaries incorporated in the USA and Netherlands. 
• NCLT rejected the petition on the ground that outbound cross border demergers are prohibited in India. The reason is that there is no word ‘demerger’ in the provision given under Section 234 of the Act; Rule 25 A of the Companies Rule 2016 is silent on demerger; FEMA Regulation, first included the word ‘demerger’ in the draft and afterwards omitted in the final regulation reveals the intention of the RBI and legislation to omit from its scope the cross-border demergers.
• In the above case, NCLT has strictly followed the rule of interpretation, that statute must be read strictly. NCLT has taken a narrow interpretation of the provision of the Act and FEMA regulations and with a restrictive view have rejected the petition placed for outbound cross-border demerger. However, in the earlier order of 2018, NCLT allowed Inbound cross-border demerger without restricting the inland development and have taken its broader view to cover demergers under the word ‘arrangement’. Thus till the appellate body either amend the Companies Act to permit the cross-border demergers, interested companies shall have to resort to alternative methods of restructuring.

Conclusion

The above-restricted view of NCLT in the 2019 order has limited the progressive scope of the provision given under Section 234 of the Act which covers the cross border transactions. The two contradictory views by a similar bench against the identical scheme placed by a similar entity has opened a room for discussion as it hampers the progress of the cross border transactions. 

The Companies Act 2013 neither permitted nor prohibits cross border demergers. It can be interpreted with the help of FEMA Regulations 2017 and 2018. NCLT Ahmedabad bench’s decision is not bound on all NCLT benches. With a border view, the other benches can set a precedent. NCLT Ahmedabad bench erred in rejecting the petition for outbound cross-border demerger on the ground of lack of legislative intention to incorporate the word ‘demerger’ in the regulations.

NCLT Ahmedabad bench instead overlooks the law, with its border view can extend the scope of the provisions. NCLT followed part of the Rule of Interpretation to read the statute strictly and failed to follow that in case of any absurdity, NCLT may interpret in its true sense. His narrow view has created regulatory uncertainty. It is also required to be seen whether another bench of NCLT will take a different view.  till that company could demerge its business into another Indian Company and merge the same with foreign companies under the purview of Section 234 of the Act. The transactions related to Inbound Cross Border Demerger and the Outbound Cross Border Demerger are similar and have to be treated at par. It helps to widen the scope of mergers and acquisitions. 

Given the above, this dilemma can be resolved either by the necessary interpretation by the legislative body or final decision of the Appellate Tribunal in this regard.  The amendment is required in the regulatory framework. Till the issue of Outbound Cross Border Demerger gets eventuality, the alternative method of restructuring such as hiving off through slump sale, share acquisitions, cross-border arrangements through merger may be explored by the companies.

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