Computers Today, July 16-31, 2000; Managing IT; Plumping the Profit Lines

July 16-31, 2000 MANAGING IT

MERGERS AND ACQUISITIONS
Pumping the Profit Lines

Despite stock market jolts, the merger-and-acquisition frenzy continues unabated. Companies have to live up to hyperbolic expectations by boosting stock prices and keeping earnings high. But while the permutations seem infinite, deal-making is a legal exercise.

By Rodney D. Ryder

The rapid growth and capitalisation of infotech industry in India has seen the need for restructuring of commercial entities along more profitable lines. Mergers and acquisitions (M&A) is an important area of capital market activity within corporate structuring and has lately become one of the favoured routes for growth and consolidation.

The reasons to merge or acquire are varied, ranging from acquiring market share and restructuring corporate structure to meeting global competition. In recent years, India has seen a manifold growth in in M&A, largely encouraged by liberalisation measures, which have substantially relaxed restrictions on M&A transactions. There has been a marked shift in legislative policy towards facilitating commercial restructuring. We aim to provide a bird's-eye view of the substantive law and procedural requirements with regard to M&A in the Indian capital markets.

Merger Mania

Mergers can be classified into three categories: when two entities amalgamate and give birth to a new entity; when a relatively small and less profitable company merges with a big company; and when a relatively big and profitable company merges with a smaller company (sometimes even a loss-making company for that matter). Such a merger is known as a reserve merger.

As for the reason of merger, there can be many-diversification, growth, corporate control, synergy, cost advantages, market control or market share, breadth of product range, technological edge or control of research and development, globalisation, access to otherwise inaccessible source and markets, lower gestation period (such as in greenfield projects), managerial capability, or shareholder value, among others.

The usual form of consideration for a merger is exchange of shares of the acquiring firm with the shares of the target company. In acquisitions, the consideration may take the form of cash consideration or loan instruments such as debentures.

The regulatory regime governing M&A is complex and straddles several areas of law and accounting, not to mention business concerns. The restrictions on M&A transactions in India have been substantially relaxed with the liberalisation of the economy. Thus, the provisions concerning M&A under the Monopolies and Restrictive Trade Practice Act, 1969 (MRTP) and the restrictions under Foreign Exchange Regulation Act, 1973 (FERA) have been substantially removed.

In 1994, the law relating to acquisition of shares of quoted/listed companies was codified and the Securities and Exchange Board of India (SEBI) announced the Substantial Acquisition of Shares and Take Over Code (the 'code'). The code inter alia provides that if any one or more persons together acquire 10 per cent or more equity shares of a listed company, the acquirer shall make an offer to the remaining shareholders of the company to acquire their shares. The code also provides a detailed procedure to be followed and the price to be offered to the shareholders. The existing code is undergoing drastic changes and a new takeover code is expected to be notified soon.

MRTP Act, 1969: Certain Amendments in the MRTP Act were brought about in 1991. The government has removed restrictions on the size of assets; market shares and on the requirement of prior government approval for mergers that created entities that would violate prescribed limits. The Supreme Court, in a recent judgement, decided that "prior approval of the central government for sanctioning a scheme of amalgamation is not required in view of the deletion of the relevant provision of the MRTP Act and the MRTP Commission was justified in not passing an order restraining implementation of the scheme of amalgamation of two firms in the same field of consumer articles".

FERA, 1973: FERA is the primary Indian law which regulates dealings in foreign exchange. Although there are no provisions in the Act which deal directly with transactions relating to amalgamations, certain provisions of the Act become relevant when shares in Indian companies are allotted to non-residents, where the undertaking sought to be acquired is a company which is not incorporated under any law in India. Section 29 of FERA provides that no foreign company or foreign national can acquire any share of an Indian company except with prior approval of the Reserve Bank of India. The Act has been amended to facilitate transfer of shares between two non-residents and to allow Indian companies to set up subsidiaries and joint ventures abroad without the prior approval of the Reserve Bank of India.

Indian Companies Act, 1956: This has provisions specifically dealing with the amalgamation of a company or certain other entities with similar status. The most common form of merger involves an elaborate but time-bound procedure under sections 391 to 394 of the Act. An amalgamation is complete only after the court sanctions it and it takes effect after the order of the court is filed with the Registrar of Companies.

Acquisition by Purchase of Shares

Acquisition of shares means two categories: acquisition of shares of an unlisted or closely-held company; or acquisition of shares of a company listed or quoted on a stock exchange.

In the case of a closely-held (unlisted) company, the following provisions of the Companies Act have to be taken into account:

Under Sections 108A to 108I, the Central Government's approval is required before shares may be acquired beyond 10 per cent by an undertaking if it is the dominant undertaking as defined by the MRTP Act or will become the dominant undertaking after such an acquisition.

The term 'dominant undertaking' is defined in the MRTP Act as: "An undertaking which by itself or along with inter-connected undertakings produces, supplies, distributes or otherwise controls not less than one-fourth of the total goods that are produced, supplied or distributed in India or any substantial part thereof; an undertaking which provides or otherwise controls not less than one-fourth of any services that are rendered in India or any substantial part thereof."

Section 372 of the Companies Act limits the investment of one company in the shares of another and requires prior approval of the Central Government for any company to make an investment beyond 30 per cent of its paid-up share capital and free reserves. This is an important section for acquisition of shares since it limits inter-corporate investments, thereby restricting the ability of one company to acquire another in a hostile manner.

Section 395 facilitates the acquisition of 100 per cent of the shares of company and provides that if any scheme of acquisition is approved by shareholders holding 90 per cent or more shares, then the same may be imposed on the remaining shareholders of the company.

In the case of a listed company, the acquirer has to follow the procedure laid down under the Substantial Acquisition of Shares and Takeover Code and the Listing Agreement with stock exchanges. In particular, an acquirer must comply with clauses 40A and 40B of the listing Agreement which, among other things, require a purchaser acquiring shares of 20 per cent (or more), to make an offer to all the shareholders of the company to acquire their shares at a price at which the acquirer has already acquired or agreed to acquire shares of 10 per cent or more, or at a price which is the average of the high and low of the price quoted on the stock exchange during the preceding six months, whichever being higher.

SEBI's Shenanigans

It is expected that very soon the Securities and Exchange Borad of India, which rules on takeovers, is likely to have a substantial say in M&A, which, at present, is the sole preserve of the Companies Act and the courts.

The working group set up to draft a new Companies Bill has proposed the bringing of cases relating to company mergers and amalgamations within the ambit of the Company Law Board (CLB). This is a welcome proposal as it would not only reduce the number of pending cases but would also reduce costs of litigation as the process would be taken up by a single bench of the CLB.

The Indian Income Tax Act (ITA), 1961, contains elaborate provisions for corporate restructuring so that companies can focus better on core commercial activities. The comprehensive set of amendments to the Act aim at making such commercial re-organisations 'fully tax neutral'. The ITA refers to two types of mergers. The first type of merger as defined in Section 291B of the Act has to satisfy the following conditions:

All the property and liabilities of the amalgamating company or companies immediately before the amalgamation must become part of the amalgamated company by virtue of the amalgamation. Shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies must become shareholders of the amalgamated company by virtue of the amalgamation procedure.

It is not as if the amalgamation, which does not satisfy the above conditions, will not be recognised or that its legal effects will be ignored. Rather, the intention is to give special treatment and grant certain relief to an amalgamation satisfying the conditions under Section 2(1B). To amalgamations not covered under Section 2(1B), the relief would not be available and the transaction would have to be analysed individually and its implication determined accordingly.

It is also relevant to point out that the above conditions are for compliance with the Income Tax Act and the same is not necessary for compliance with the Indian Companies Act.

Sick Industrial Companies (Special Provisions) Act, 1985 (SICA): The SICA is a special statute to remove bottlenecks contained in various laws in the way of revival and rehabilitation of sick companies as well as to provide a single-window clearance to provisions of all such laws with respect to the revival of a sick unit. The Act provides for the revival of sick companies through a scheme, which may provide for amalgamation of the company with another company. The Board for Industrial and Financial Reconstruction (BIFR), which is the operational authority, has substantial powers to sanction such schemes prepared by an operating agency provided such amalgamations effectively revive the company.

A Major Business

Mergers and acquisitions are a common phenomenon in a competitive and free economy and as India integrates into the world economy, there will be several opportunities for M&A deals both inside and outside India. In the context of the liberalised environment, M&As are emerging as a major business for the financial community. There are a host of factors propelling the Indian corporate sector to move towards the M&A arena, including existence of several domestic players seeking to consolidate their business by acquiring firms in their core areas and shedding their non-core businesses. This trend is further supported by the presence of several foreign firms, which are looking to buy their way into the Indian market by acquiring existing plants and capacities.

Rodney D. Ryder, Rajinder Narain & Co., Solicitors and Advocates, Supreme Court of India. E-mail: mc@del2.vsnl.net.in

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