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This article is written by Sivagnana Selvi C who is  pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

Mergers mean when two companies join together and become a single entity. The idea behind the merger is to have an increased market share, greater efficiency, protect the industry from closing, diversification of risks and business, eliminate competition etc.  Demergers is opposite of the merger, it means splitting up of a company into multiple business entities. The demerges occur either to function independently or to be liquidated. The new companies need not has to be subsidiaries of the parent company after the demerger. The demerger is also called a form of corporate structuring, where companies can be split up for specialization and it allows the entities to expand. 

One of the major advantages of the demerger is, it provides various benefits for the shareholders to access better opportunities, and to participate in the decision-making process. The splitting up is also called as “spin-out”, “spin-off” or a “starburst”, which means the company divides into a separate entity by itself. After the company becomes independent the “spin-out” company gets the assets, intellectual properties, technologies etc. from the parent company. The shareholder of the parent company also gets shares in the new company, by the way of compensation for the equity in the original stocks and this makes mergers more attractive. Demergers can also be undertaken by the way of government intervention in the competition law aspect like through antitrust laws and de-cartelization.

Advantages of Demerger 

  1. Concentrate on Core Competency: Conglomerate companies which operate on various business operations and generally tend to lose their focus on the companies and in several cases they lose to their competitors. The present business environments seek for more specialization, demergers come handy. 
  2. Accountability: After demergers, each company would have its  own balance sheet and each company would have their own plans on business investment and raise funds on its  own account. As a result, the demerged company would be liable for its  own accounts.
  3. Increase in Capitalization: demergers create stock market value. Now the investors would see the operations of the firm that has been split off and there would be more supply of fund. 

STRENGTHS

WEAKNESS

  1. Unleashing the full strengths of the business by creating different businesses.
  2. It would increase the valuation of wealth of the shareholders.
  3. It would attract more investors.
  1. It would create unnecessary anxiety amongst the employees of the new department.
  2. There would be a delay in finalization of deals.
  3. When there is a sudden change in management or organization, would create gap and inefficiency amongst the workers of the organization.

OPPORTUNITIES

THREATS

  1. The restructuring would help to overcome short term constraints.
  2. Helps to focus on core business.
  3. Promotes independent collaboration and scope for expansion.
  1. Difficult to mobilize funds.
  2. Loss of synergy.
  3. Fear in the minds of investor about the resulting company.  

Reasons for Demergers 

Demergers are undertaken for two reasons. Firstly, for corporate restructuring and secondly to give effect to the family partition where family-controlled companies. In case of demerger as corporate restructuring, the undertaking is transferred from the transferor company to existing transferee company. But in case of family partition the undertaking is transferred to the newly incorporated company according to the family partition. 

What is Reconstruction? 

In the Companies Act, 1956 does not define the term ‘demerger’ but mentions as ‘reconstruction’. The difference between the two terms lies how it has been mentioned in the scheme of arrangement is actually to obtain the sanction of the Court.  The demergers actually form the part of scheme of arrangement. Further demergers would attract other provisions in the Companies Act, 1956. The Company has to pass a special resolution which has to be confirmed by the court by making an application by virtue of Section 101 of the Companies Act, 1956. According to the Act, the Articles of Association of the Companies shall have provision of reduction of its share capital and the memorandum of the company shall have provisions for demerger. Demergers which results in reduction of share capital would require the company to amend the Memorandum of Association.

How Demerger happens?

The process of Mergers and Acquisition are given under Section 232 of the Companies Act 2013, which also covers the concept of demerger.

Demerger can be affected by any of the following:

  1. By the virtue of agreement entered between promoters; or
  2. Scheme of Arrangement with the Court’s approval.
  3. Demerger and voluntary winding up.
  • Demerger by the way of agreement:

The agreement is entered between the promoters, resulting the principal company transfers its properties, liabilities and issues to the resultant company, immediately before demerger. 

  • Demerger under Scheme of Arrangement:

The scheme of arrangement is based on the powers conferred to a company in its Memorandum. The same procedure of acquisition can be followed for the demerger. The Scheme requires approval by Tribunal. The Scheme of arrangement is a vital document in the process of demerger, it binds all the stakeholders of the company. 

The Supreme Court in Miheer H. Mafatlal v. Mafatlal Industries Ltd, the Court laid down the following principles:

  1. The Statutory provisions should be complied with.
  2. The class who attended the meeting must fairly represent all the stakeholders and they should act in the bona fide manner.
  3. The arrangement should reasonable.
  4. The Scheme should not be contrary to public interest or any other law.

Application in Tribunal

A demerger can be completed by the process of making an application to the Tribunal and by orders issued by the Judge. The application must be filled in the prescribed format along with:

  1. Affidavit of the Promoters;
  2. MOU and AOA;
  3. List of Shareholders and Creditors;
  4. Board Resolution approving the Scheme;
  5. Scheme of Arrangement; and 
  6. Draft notice of the meeting.

For this purpose a notice should be sent to the inter.

Relevant Indian Laws

The word ‘demerger’ has not been mentioned in the Companies Act, 2012. But an explanation to Sec 230(1) of the Act gives arrangement for the recognition of the company’s share capital by:

  • Consolidation of shares of different classes;
  • Division of the shares of different classes; or both

The term ‘demerger’ has been defined under Section 2(19AA) of the Income Tax Act, 1961. In the Companies Act demerger can be understood in terms of transfer according to scheme of arrangement given under sections 391 to 394 of the Companies Act 1956:

  • By the virtue of demerger, all the property of the undertaking would be transferred by the demerged company, becomes the property of the resultant company.
  • By the way of demerger, all the liabilities of the undertaking would be transferred to the resultant company.
  • After demerger the properties and liabilities of the undertaking would be transferred to the demerged company.
  •  The resultant company would issue shares to its shareholder on proportionate basis.
  • Shareholders having not less than 3/4th in value of the shares in demerged company, becomes the shareholder of the demerged company, by the way of demerged.

Case study: Wipro Demerger

Wipro is one of the largest IT services in India has approved the demerger o non-IT business. After the announcement of the demerger, shares of the company’s share soared 4 per cent and traded in the first 50 share Nifty benchmark. In Wipro’s demerger 3 units would be hived off – Wipro Consumer Care and Lighting, Wipro Infrastructure Engineering and Medical Diagnostic Product and Service business. These companies would be a separate unlisted company called Wipro Enterprises. WIPRO would still contribute 86 per cent of revenue and still remains a publicly listed company. The shareholders have three options:

  1. Receive a share of Wipro Enterprises for 5 shares of Wipro Ltd;
  2. The shareholders can redeem one preference share in Wipro Enterprises at seven percent for five shares of Wipro Ltd.
  3. Lastly, the shareholder shall exchange one share of Wipro Ltd held by the founder for every 1.65 shares in Wipro Enterprises. 

The USB has predicted that most of the institutional shareholders would prefer for the third option. The Chief Financial Officer of Wipro Mr. Suresh Senapaty expected to increase in profits due to the separation of non- IT businesses. Now the demerger would helps to concentrate on IT business which would help to accelerate investment and capitalization.

Conclusion 

Demerger would enable companies to strengthen their shareholders value and it also increase investment and focus more on core business. The relevant provisions of demergers are the Companies Act, Income Tax Act, SEBI, Stamp duties. The demerger should have a clear motive and it should keep the welfare of the shareholders in mind. Demergers have been proved successful in many cases and many stakeholders have benefited. Example Reliance Industries Ltd’s demerger in August 2005. Shareholders of the reliance industries benefited in many ways like, now the shareholders of the company directly participate in the affairs of the company and unlock great value and the shareholders would also receive separate shares in the new entities. 


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