Mergers and De-Mergers in India 

Definition of merger and de-merger

A merger occurs when two or more companies combine to form a single, larger entity. This consolidation can help businesses gain a competitive edge, expand market reach, or access new technologies. Mergers can take several forms, such as horizontal (companies in the same industry), vertical (companies in the same supply chain), and conglomerate (companies from different sectors). Depending on the type of economic activity, mergers can be classified as below:

Contributing Advisor

Neeraj Khatri

Manager, Business Advisory Services

• Horizontal merger: Merger between companies dealing in the same nature of products.
• Vertical merger: Merger between companies dealing in the same nature of products but operating at different stages of production.
• Co-generic merger: Merger between companies serving the same set of customers.
• Conglomerate merger: Merger between two unrelated companies.
• Forward merger: Merger between a company and its customer.
• Reverse merger: Merger in which a business establishment chooses to merge or combine with its raw material suppliers.

On the other hand, a demerger involves the separation of a company into two or more distinct entities. This allows each new company to focus on its core operations, improving efficiency and strategic direction. Demergers are often executed through spin-offs, carve-outs, or divestitures.

Legal framework

Mergers and de-mergers in India are governed by several key legislations that ensure these transactions are carried out legally and transparently. The primary law in this context is the Companies Act, 2013, along with the involvement of various regulatory bodies and other relevant laws.

Companies Act, 2013

The Companies Act, 2013 is the cornerstone legislation for mergers and de-mergers in India. Sections 230-240 specifically outline the procedures and regulations for these corporate restructurings. These sections govern the approval process, which requires the involvement of shareholders, creditors, and regulatory authorities.

• Section 230-234: These provisions regulate the framework for mergers and demergers between companies. This includes the submission of a scheme of arrangement, which must be approved by both the National Company Law Tribunal (NCLT) and the stakeholders involved.
• Section 233: This section permits fast-track mergers for specific categories of companies, such as small companies and wholly owned subsidiaries.
• Section 234: It governs cross-border mergers and requires approval from the Reserve Bank of India (RBI) for transactions involving Indian and foreign companies.

In addition to the Companies Act, several other laws impact mergers and demergers in India.

• Income Tax Act, 1961: This Act determines the tax implications of mergers and demergers. Specific provisions allow for certain tax exemptions or concessions, making it a vital consideration for companies during these transactions.
• Stamp Duty Laws: Stamp duties are levied by state governments on various transfers of assets and properties, including those involved in mergers and demergers. The stamp duty varies across states and can significantly impact the cost of the transaction.
• Foreign Exchange Management Act (FEMA): For mergers or demergers involving foreign entities, FEMA governs the rules for foreign investments and transactions. The Reserve Bank of India (RBI) plays a key role in approving these deals, ensuring compliance with foreign exchange regulations.

Regulatory bodies

Several regulatory bodies oversee the approval and regulation of mergers and demergers in India, ensuring that the process complies with the legal framework.

• National Company Law Tribunal (NCLT): NCLT is the primary authority responsible for approving schemes of mergers and demergers. It ensures that the proposed transactions are in compliance with the Companies Act, 2013, and safeguard the interests of stakeholders, including shareholders and creditors.
• Competition Commission of India (CCI): Under the Competition Act, 2002, mergers and demergers must be reviewed by CCI if they meet certain thresholds. CCI evaluates the potential impact of these transactions on competition in the market, ensuring that no anti-competitive practices arise.
• Securities and Exchange Board of India (SEBI): SEBI oversees mergers and demergers involving publicly listed companies. Regulations such as the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, require transparency and the protection of minority shareholders during these transactions.

Procedure for Merger

Board approval

The merger process begins with securing approval from the boards of directors of the merging companies. The directors must thoroughly evaluate the merger proposal, considering its strategic, financial, and legal implications.

After reviewing, the board of each company must formally consent to the merger plan. This step is critical, as board approval demonstrates that both companies are aligned on the business and operational goals of the merger, thereby setting the stage for further procedures.

Shareholder approval

Once the board has approved the merger, the proposal must be presented to the shareholders of each company. As per Indian law, at least 75 percent of the shareholders present and voting at the meeting must approve the merger. Shareholders are given the opportunity to raise concerns or objections and are provided with all relevant documents to make an informed decision.

The proposal will not move forward without the requisite majority, making this step a vital part of the merger process.

NCLT Application

Following shareholder approval, an application must be filed with the National Company Law Tribunal (NCLT). The NCLT plays a pivotal role in reviewing and ratifying the merger scheme. It scrutinizes the terms of the merger to ensure compliance with legal and regulatory standards.

The tribunal also addresses any objections from stakeholders during hearings and decides whether the merger aligns with the interests of the company and its stakeholders. Once the NCLT is satisfied with the scheme, it grants approval, allowing the merger to proceed.

Regulatory Approvals

In addition to NCLT approval, mergers in India often require the consent of various regulatory bodies. For instance, approval from the Competition Commission of India (CCI) may be necessary to ensure the merger does not result in anti-competitive practices.

Similarly, if the companies involved are publicly listed, the Securities and Exchange Board of India (SEBI) will need to approve the merger to protect shareholder interests. Depending on the industries involved, additional approvals may be required from sector-specific regulators.

Implementation

Once all necessary approvals are secured, the merger enters the implementation phase. This involves transferring assets, liabilities, and obligations from one entity to the other in accordance with the terms of the merger scheme. The merged entity must also integrate operations and resources effectively.

Furthermore, any changes to corporate records, such as the issuance of new shares or modifications to company documents, must be completed. The goal of this stage is to ensure a seamless transition and alignment of both companies into a single, cohesive entity.

Procedure for De-Merger

A de-merger enables a company to separate one or more business units or divisions into a new entity, allowing each unit to be valued independently. This process helps in realizing the true potential and market worth of individual operations that may have been undervalued or overlooked within a larger corporate structure. Here’s how value is unlocked:

• When business units are split into independent entities, each division undergoes a specific valuation based on its assets, earnings, and future growth potential.
• Investors may find a newly de-merged entity more appealing, especially when it offers focused business operations with clearer objectives and fewer distractions from unrelated divisions.
• The parent company and the de-merged entity can now concentrate on their respective core strengths, leading to better strategic direction and resource allocation, ultimately improving operational efficiency.

Regulatory requirements

A de-merger in India is subject to stringent regulatory oversight to ensure fairness, protect shareholders, and maintain market stability. The following key regulatory steps must be followed:

• NCLT approval: The process begins with submitting a de-merger proposal to the National Company Law Tribunal (NCLT). The NCLT reviews the proposed scheme of de-merger, assesses its impact on stakeholders (including creditors and shareholders), and ensures that the transaction complies with the law. NCLT approval is mandatory for the de-merger to proceed.
• Board approval: The de-merger process begins with approval from the board of directors of the de-merging company. The board reviews and approves the proposed scheme of de-merger, laying down the specific terms, conditions, and objectives of the separation.
• Shareholder and creditor approval: After the NCLT reviews the scheme, meetings of shareholders and creditors must be convened. At these meetings, the proposed de-merger is presented, and approvals are sought. The approval must be by a majority representing three-fourths in value of the shareholders or creditors present and voting.
• Competition Commission of India (CCI): If the de-merger could potentially affect competition in the market, an application must be submitted to the CCI. The CCI examines whether the transaction would create a monopoly or restrict fair competition. If the transaction poses risks to market dynamics, the CCI may impose conditions or reject the proposal.
• Securities and Exchange Board of India (SEBI): If the de-merging company is publicly listed, approval from SEBI is required. SEBI ensures that the transaction is transparent, fair, and in compliance with securities laws, protecting the interests of minority shareholders. Listed companies must disclose all relevant information about the de-merger to the stock exchanges to maintain transparency.
• Other regulatory filings: Depending on the industry, other regulatory bodies may need to be involved. For instance, companies in the banking, insurance, or telecom sectors may need to seek additional approvals from sector-specific regulators.
• Post-de-merger formalities: Once approvals from NCLT, CCI, and SEBI are obtained, the de-merger is formalized. The next steps include updating corporate records, transferring assets and liabilities to the new entity, issuing new shares to the shareholders of the de-merged company, and notifying all stakeholders (including creditors, employees, and shareholders) about the changes.

Due diligence in mergers & de-mergers

Legal due diligence

Legal due diligence involves an in-depth review of the target company’s legal framework, ensuring compliance with laws, protecting intellectual property, and identifying any potential liabilities.

• The first step is to assess the target company’s legal structure by examining its foundational documents, such as articles of association, shareholder agreements, and board minutes.
• Scrutinizing the target company’s contracts, licenses, and agreements is crucial to identifying potential legal obligations or hidden liabilities. These could range from supplier contracts to employee agreements.
• Intellectual Property (IP) assessment including patents, trademarks, copyrights, and designs, involves evaluating the validity, enforceability, and ownership of the target company’s IP portfolio to safeguard against potential IP infringement or disputes that could affect the value of the transaction.
• A comprehensive review of any past, pending, or potential litigation is also conducted. Legal disputes, whether they are commercial, employment-related, or regulatory, can create significant liabilities for the acquiring company or complicate a de-merger.

Financial and operational due diligence

In addition to legal due diligence, financial and operational due involves a detailed review of the target company’s financial statements, including balance sheets, income statements, and cash flow reports.

The financial due diligence process also examines whether the company’s financial records are in line with applicable accounting standards. Beyond the numbers, operational due diligence examines key areas such as supply chain efficiency, production capabilities, customer relationships, and technological infrastructure.

A key goal of financial and operational due diligence is to identify any red flags that could lead to post-transaction challenges. This includes analyzing the company's debts, assessing the reliability of its income streams, and evaluating whether it has the capacity to meet future obligations. Additionally, examining ongoing projects and future growth potential can highlight opportunities and risks that could affect the value of the transaction.