In a very welcome move, the Ministry of Corporate Affairs ('MCA') has issued a circular on August 21, 2019 ('Circular') clarifying that Section 232(6) of the Companies Act, 2013 ('Act') allows companies, that are party to schemes of mergers/ de-mergers, to choose an 'appointed date' which could either be a specific calendar date or a date that is linked to occurrence of agreed events such as the receipt of required approvals and the fulfilment of agreed conditions precedent that are relevant to the scheme, which is referred to in most schemes as the 'effective date'. If the event-based date (effective date) occurs after the filing of the sanctioned scheme with the relevant Registrar of Companies ('RoC'), then there is a requirement to intimate the RoC within 30 days from the scheme becoming effective. The Circular also clarifies that if the appointed date is a retrospective date going back more than one year from the filing date, justification for choosing such a date should be provided in the scheme, and such date should not be against public interest.
The Circular should put to rest unnecessary confusion caused by certain orders of the National Company Law Tribunal ('NCLT') benches (predominantly the Mumbai bench of NCLT ('NCLT Mumbai')) based on observations of the Regional Directors ('RD') who, in a significant deviation from past practice, started taking the view that Section 232(6) of the Act requires that the 'appointed date' be a specified calendar date. In effect, RDs were rejecting the time-tested and sensible construct that the contemplated appointed date is to be a date linked with the scheme becoming effective upon satisfaction of the agreed conditions and receipt of required approvals, including NCLT's sanction. NCLT Mumbai has further amplified the confusion and controversy by even rejecting the specified calendar date furnished by the parties and holding that the appointed date should be the 'valuation date', i.e., the date of the valuation of the companies based on which the merger consideration was determined. Before setting out the serious legal, accounting and commercial implications that arise due to such inconsistent approach and interpretation, please see below a brief description of the controversy.
The Confusion and the Controversy
Despite there being several precedents of sanctioned mergers/ de-mergers by various NCLTs (NCLT Mumbai included) and Company Courts under the erstwhile Companies Act, 1956, on September 5, 2018, in the Scheme of Arrangement between East West Pipeline Limited and Pipeline Infrastructure Private Limited ('Pipeline Case'), NCLT Mumbai directed that the appointed date should be the date on which the valuation was undertaken for the demerged business (i.e., July 1, 2018), based on which the parties were directed to amend the scheme to stipulate July 1, 2018 as the appointed date. NCLT Mumbai sanctioned the scheme on December 21, 2018. Effectively, the appointed date in this case ended up being a retrospective date. Since this order, NCLT Mumbai has been pushing parties to a merger/ de-merger to submit a specific calendar date as the appointed date. In some cases, this ended up being prospective, whereas in others, the date was retrospective. Further, the approach followed by NCLT Mumbai was not consistent either. While in many cases, NCLT Mumbai required parties to submit a specified calendar date before it sanctioned the scheme, equally there is precedent of NCLT Mumbai sanctioning the scheme subject to the parties submitting the specific calendar date subsequently.
While the controversy so far had been more a matter of the parties submitting a calendar date of their choice, in Scheme of Demerger amongst Century Textiles and Industries Limited and UltraTech Cement Limited, NCLT Mumbai, while sanctioning the scheme by its order dated July 3, 2019, rejected the appointed date of April 1, 2019 chosen by the parties, stating that the said date is arbitrary and without proper justification and instead directed that May 20, 2018, which was the date of the valuation report and fairness opinion, be treated as the appointed date.
It is pertinent to note that neither the Company Courts (under the Companies Act, 1956) nor any of the NCLT benches prior to the Pipeline Case interpreted Section 232(6) to rule out an 'event based' appointed date. Prior to the Pipeline Case, the Company Courts and NCLT benches across India respected corporate democracy and did not interfere with the choice of appointed date as long as it was approved by the shareholders in accordance with law and there was a proper rationale for the same. Several NCLT benches in India continue to respect this position even after the Pipeline Case. This approach has several substantive legal, commercial and accounting implications, none of which, based on a review of the orders of the NCLT and the deliberations recorded in them, seem to have been placed before the NCLT in response to the RDs' objection, for NCLT's consideration.
Implications of Not Allowing Appointed Date to be an Event-Based Date Linked to Effectiveness of the Scheme
Insisting that a calendar date be given as an appointed date (contrary to the commercial agreement between the parties to the scheme), when effectiveness of the scheme is dependent on conditions precedent, including applicable corporate, regulatory and NCLT approvals, creates significant issues for the parties to the scheme. This becomes more problematic when listed companies are involved and where the agreed scheme which links appointed date to effective date has been approved by the Securities and Exchange Board of India ('SEBI') prior to its filing with the NCLT. Listed companies have to make periodic disclosures of their financials including their profits and losses, which, in turn, may be the subject matter of inclusion on a consolidation prior to the effective date, in their respective holding or parent companies.
The implications are substantive concerning the interim period falling between the calendar date insisted upon by the NCLT and the date on which the scheme will become effective (i.e., after NCLT sanction and filing with the RoC) ('Interim Period'), such as: (i) the transferor company will effectively be deemed to be carrying on its business for and on behalf of the transferee company during the Interim Period and the profits/ losses of the Interim Period will belong to the transferee company, contrary to the agreement between the parties; (ii) the board of directors of the transferor company would not be allowed to deal with the profits of the transferor company during the Interim Period, which could be against the commercial understanding of the parties. A practical outcome of this would be the inability of the transferor company to declare dividends to its shareholders during the Interim Period; (iii) the taxes paid by the transferor company pertaining to the Interim Period would be deemed to have been paid by the transferor company on behalf of the transferee company; (iv) inter-se transactions between the transferor company and the transferee company during the Interim Period would need to be reversed upon the scheme becoming effective; (v) the financial statements and the books of accounts of the transferee company would, upon the scheme becoming effective, need to incorporate all transactions of the transferor entity, its assets, liabilities and profits/ losses with effect from the such calendar date i.e., even for the period before the effectiveness of the scheme, contrary to the agreement amongst those involved with the scheme; and (vi) where the order of the NCLT is not issued before the close of the accounting years of the parties or is delayed beyond the relevant regulatory filing dates such as quarterly results and the like, complexities will arise in relation to accounting treatment during the Interim Period, including how any resultant profit or loss should be accounted for.
As an example, when profits are held to be held to the account of the transferee company from the specified date, the question arises whether the profits of the transferor company from the specified calendar date till the effective date can be consolidated by the parent of the transferor company. Insisting on the appointed date being the valuation date may have even more serious consequences. The valuation date, in case of listed companies, may be a date before the scheme is approved by the board of directors and a few months before the scheme is even filed with the NCLT, where filing itself is subject to receipt of SEBI and stock exchange approvals.
While on the one hand there are several significant unanticipated issues from the imposition of an artificial appointed date in the scheme there was no public purpose whatsoever being served by insisting on a specific calendar date to be the appointed date in a scheme. It is, therefore, a relief that the MCA has intervened and its responsiveness in addressing issues such as these must be appreciated.
Date: August 28, 2019
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