Companies Act, 2013: Insight on Provisions relating to Corporate Restructuring

Brief Background

The long awaited Companies Bill, 2012, on receiving the assent of Honorable President of India on August 29, 2013, was notified in the Gazette of India on August 30, 2013 as the Companies Act, 2013 (18 of 2013) (‘new Act’). The new Act consisting of 470 sections divided into 29 chapters is aimed towards replacing the nearly 60 years old Companies Act, 1956 (‘old Act’). The Ministry of Corporate Affairs (‘MCA’) has released draft rules in 6 phases till now seeking suggestions from general public. The MCA has also notified 98 sections of the new Act to be effective September 12, 2013 and the corresponding sections of the old Act to cease to be in force from the same date. Among the host of changes brought about by the new Act, there are a number of provisions impacting corporate reorganisation and restructuring. In this article we have tried to analyse certain key provisions (including the relevant draft rules) relevant to the areas of corporate restructuring / reorganisation.

Key changes

  1. Notice to various regulators: The new Act requires that notice of meeting for approval of the scheme of compromise or arrangement be sent to various regulatory agencies (as below):
  2. The Central Government;
  3. Income-tax Authorities;
  4. Reserve Bank of India (‘RBI’);
  5. Securities Exchange Board of India (‘SEBI’);
  6. The Registrar;
  7. Respective Stock Exchanges;
  8. Official Liquidator;
  9. The Competition Commission of India, if necessary; and
  10. Other Sectoral regulators which could likely be affected by the scheme.

Representation, if any, by the above authorities will have to be made within a period of 30 days from receipt of notice. [S 230(5) of new Act]. Though the move to involve multiple parties in the approval process may have been initiated with the objective of imparting transparency, the same comes with its own perils like:

  • The process will tend to become cumbersome and slow down;
  • The various statutory authorities may use this platform to demand payment of all pending demands, including disputed dues;
  • The 30-day window may not be adequate or may conflict with provisions of other statues.

  1. Outbound mergers permitted: Under the old Act, only those scheme of arrangements viz. mergers or amalgamations were permitted in which the resultant entity was an Indian Company, i.e. a foreign company could merge into an Indian Company (‘inbound merger’) but not vice-versa.

The new Act, in case of an amalgamation, permits the resultant company to be a foreign company in notified jurisdictions. Thus, once effective, it would be possible for an Indian company to merge into a foreign company in notified jurisdictions (‘outbound merger’) with the prior approval of the RBI.

Payments for such schemes of amalgamation can be in the form of cash or of depository receipts or both.(S 234 of new Act) Pertinent to note the following observations in this regard:

  1. The provisions apply only in case of mergers and acquisitions and not in case of division or demergers.
  2. Presently, under the old Act, foreign companies from any jurisdiction can merge /amalgamate into an Indian Company. However, under the new Act, inbound mergers also seem to be restricted to notified jurisdictions. Notification of these jurisdictions is awaited.
  3. Some significant changes that would be required under the Foreign Exchange Management Act, 1999 (‘FEMA’) to facilitate a smoother implementation of the said provisions:
  • Allowing outbound mergers with entities in notified jurisdictions;
  • Restrictions on inbound mergers which are not from notified jurisdictions;
  • Share valuation methodology to be in line with the new Act;
  • Provision for specific approvals by the RBI/ Foreign Investment Promotion Board (‘FIPB’) in case of any cross border mergers.
  1. At present, schemes of mergers / amalgamations which satisfy specified conditions are income-tax neutral under the extant provisions of Income Tax Act, 1961. One of the essential conditions to be eligible for the said exemption is that the resultant entity should be an Indian Company. We hope that appropriate amendments to the Income Tax Act, 1961 will be notified soon to extent tax-neutrailty to outbound mergers where the resultant entity will be an overseas company.
  2. Demerger specifically defined in new Act – The draft Rules pertaining to Chapter XV on compromise, arrangements and amalgamations also define the term ‘demerger’. The definition of demerger has been retained to be synonymous with the definition under the Income-tax provisions. Though accounting treatment of demergers has also been defined to be similar to Income-tax provisions, any revaluation / write off of assets during the preceding two years need to be excluded from the value of assets and liabilities transferred (Draft Rule 15.31). Thus, due to the mismatch in the accounting treatment, the moot question which arises here is whether a demerger, which otherwise satisfies the other conditions to be tax exempt would continue to avail tax exemptions? Further, it is important to note here that while demerger has been specifically defined and dealt with in the draft rules, nothing in the Act or the Rules restrict ‘divisions’ which do not satisfy the prescribed conditions of being defined as a ‘demerger’. Thus, compromise or arrangements include any kind of division which is wider than ‘demerger’.
  3. Fast track mergers – The new Act permits options for mergers / amalgamations, divisions and demergers and other compromise and arrangements sans the court approval (S 233 of new Act) between: (a)Two or more small companies1

(b)Holding and wholly owned subsidiary company

(c)Other class of companies as may be prescribed Such scheme can be approved by the Central Government after the fulfilment of the following primary conditions:

  • Approval from atleast 90% of the shareholders (number of shares) and atleast 90% of the creditors (value);
  • No objection from the Registrar and Official Liquidator. Further, there seems to be no requirement to send notices to various regulators or provide valuation report also. This provision would help cut costs, simplify procedures and save time involved. 1 Small company means a company, other than a public company,-
  • paid-up share capital of which does not exceed fifty lakh rupees (or suchhigher amount as may be prescribed which shall not be more than five crorerupees); or
  • (ii) turnover of which as per its last profit and loss account does notexceed two crore rupees (or such higher amount as may be prescribed which shallnot be more than twenty crore rupees): Provided that nothing in this clause shall apply to—

(A) a holding company or a subsidiary company;

(B) a company registered under section 8 (formed with charitable objects); or

(C) a company or body corporate governed by any special Act;

  1. Minority buy-out – Where a person or a group of persons become the registered shareholders of 90% or more of the issued equity share capital, such person (or group of persons) are required to notify the company of intentions to buy the remaining share capital. Such shares would be offered for sale at a pre-determined price computed as per prescribed valuation. Minority shareholders also have the option to offer their shares suo moto. Thus, the new Act allows companies to delist its shares and become private companies without long drawn litigation.

  1. Buy-back – Under the old Act, in case of buy-back (other than Board approved, i.e. general Meeting approved / court approved), multiple buy backs within a period of one year was possible. The new Act restricts two consecutive buy-back offers within a period of one year. Further, buy-back is also restricted in case the company has defaulted in making repayments of public deposits / term loan / interest thereon, redemption of debentures / preference shares, payment of dividends. (S 68 and 70). Buy back will not be permitted till 3 years after the default has been remedied. There was no such restriction on buy back in the old Act. Thus, the new Act restricts making payouts to shareholders before repayment of third party dues. Buy-back through the court approved process also needs to comply with all the buy-back conditions (including the prescribed limits and the cooling period of one year).

  1. Multi-layered structures prohibited – The new Act prohibits investments beyond two layers of ‘investment companies’2 except:

(a) If required by law; or

(b) If an overseas company is acquired and such company has investment subsidiaries beyond two layers as per the laws of that country. This provision is aimed at preventing misuse of subsidiaries embedded in various layers as a tax avoidance tool. However, it results in restricting the flexibility in sectors such as infrastructure where SPV structures are required for project bidding, implementation and fund-raising. Also, it will be in order to introduce some grandfathering rules in respect of existing multi layered structures.

  1. Others- Certain other changes worth noting include:

(a) approval of scheme by postal ballot thereby involving wider participation;

(b) restriction of right to object to a scheme to persons

(i) holding atleast 10% of shareholding; or

(ii) having debt atleast 5% of the total debt as per latest audited financials thereby protecting against mala fide and frivolous objections;

(c) abolishing the practice of companies holding their own shares through a trust; 2 Investment company means a company whose principal business is of acquisition of shares/debentures/ other securities

(d) mandatory inclusion of the valuation report to the notice of the meeting for approval of the scheme;

(e) certificate from the statutory auditor that the accounting treatment of the proposed scheme is in consonance with the prescribed accounting standards.