Earlier this year in April, the Ministry of Corporate Affairs (the "MCA") by way of notification effective from April 13, 20171 notified Section 234 of the Companies Act, 2013 (the "Act") along with the Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2017 (the "Rules") to operationalize Section 234 of the Act (the "MCA Notification").
Section 234 of the Act broadly applies to schemes of mergers and amalgamations between Indian companies and foreign companies incorporated in foreign jurisdictions notified by the Central Government. It provides for mergers and amalgamations subject to prior approval from the Reserve Bank of India (the "RBI") and the Central Government is empowered to make rules, in consultation with the RBI, in relation to the merger and amalgamation provisions under Section 234.
Pursuant to the MCA notification, the RBI released a draft of the Foreign Exchange Management (Cross Border Merger) Regulations, 20172 under the Foreign Exchange Management Act, 1999 to make provisions for mergers, demergers, amalgamations and arrangements between Indian companies and foreign companies (the "Cross Border Regulations"). The proposed Cross Border Regulations were open for public comments until mid May.
This article highlights the provisions of the MCA Notification and the Cross Border Regulations and considers whether the new regime will be an attractive structuring option for inbound and outbound mergers and acquisitions.
Earlier under the Companies, Act, 1956, Sections 391 to 394 only permitted inbound mergers (where the resultant company was an Indian company) to ensure that the resultant merged company that continued after the merger was an Indian company, which was governed by Indian law and regulations. Basically, the Companies Act, 1956 did not permit outbound mergers, where the resultant company was a foreign company. Section 234 of the Act changed that.
3. KEY DEVELOPMENTS
The MCA Notification has essentially expanded the scope of cross border mergers and amalgamations by permitting outbound mergers or amalgamations of an Indian Company with a foreign company subject to compliance with certain conditions contained therein. The key conditions specified in the MCA Notification are set out below.
3.1 Permitted Jurisdictions for Outbound Merger
Indian companies are permitted to merge with foreign companies incorporated in certain jurisdictions specified in the Rules. Generally, these include jurisdictions: (i) whose securities regulator is a member of the International Organization of Securities Commission's Multilateral Memorandum of Understanding (or a signatory to bilateral Memorandum of Understanding with Securities Exchange of India); or (ii) whose central bank is a member of the Bank for International Settlements (BIS); and (iii) identified in the public statement of the Financial Action Task Force as regards certain specified matters.
A valuer (who must be a member of a recognized professional body in the outbound jurisdiction) must conduct the valuation of the merged entity. Further, such valuation must be in accordance with internationally accepted principals on accounting and valuation and a declaration to this effect is required to be attached with the application made to the RBI seeking approval form the merger.
3.3 Prior Approval from the RBI
The National Company Law Tribunal will consider the merger application to give effect to the merger only after the company concerned has obtained an approval from the RBI and complied with the provisions of Sections 230 to 232 of the Act and the Rules.
Sections 230 to 232 of the Act sets out the procedural requirements which need to be complied with by the merged entity before a scheme of merger is sanctioned by the National Company Law Tribunal such as the manner of calling a meeting of the creditors, members or debenture holders of the merged entity to obtain their vote to the adoption of the scheme of merger, the details of the information needed to be made available to creditors, members and debenture holders of the merged entity and various governmental authorities such as the RBI, the Securities Exchange Board of India, the Competition Commission of India and such other regulators that may be applicable for making an informed decision in relation to the proposed scheme of merger.
4. THE CROSS BORDER REGULATIONS
In order to operationalize Section 234 of the Act, the RBI issued a draft of the Cross Border Regulations in order to make provisions for the acquisition or transfer of any security or asset or debt by an Indian resident or non-resident in a cross border merger, demerger, amalgamation, or rearrangement. The Cross Border Regulations stipulate conditions that should be adhered to by companies involved in a scheme of merger, demerger, amalgamation, or rearrangement and we set out those conditions below.
4.1 Inbound Mergers
In the context of inbound mergers, the Cross Border Regulations stipulate the following.
(a) Any issue or transfer of security to a non-resident by the resultant Indian Company shall be in accordance with the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000.
(b) Any borrowing of the transferor foreign company which becomes the borrowing of the resultant Indian company (or any borrowing entering into the books of resultant Indian company) arising must conform to the external commercial borrowing norms or trade credit norms (or other foreign borrowing norms), laid down under Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 or the Foreign Exchange Management (Guarantee) Regulations, 2000, as may be applicable.
(c)The resultant Indian company may acquire and hold any asset outside India, which an Indian company is permitted to acquire under the provisions of the Foreign Exchange Management Act, 1999 and rules or regulations framed thereunder.
(d) If any asset or security is not permitted to be acquired or held by the resultant Indian company, the resultant Indian Company shall sell such asset or security within a period of 180 days from the date of sanction of the scheme of cross border merger and the sale proceeds shall be repatriated to India immediately through banking channels.
4.2 Outbound mergers
In the context of outbound mergers, the Cross Border Regulations stipulate the following.
- An Indian resident may acquire or hold securities of the resultant foreign company in accordance with the Foreign Exchange Management (Transfer or issue of Foreign Security) Regulations, 2000 or the provisions of the Liberalized Remittance Scheme, as applicable.
- The resultant foreign company shall be liable to repay outstanding borrowings as per the scheme sanctioned by the National Company Law Tribunal pursuant to the terms of the Companies (Compromises, Arrangement or Amalgamation) Rules, 2016.
- The resultant foreign company may acquire and hold any asset in India, which a foreign company is permitted to acquire under the provisions of the Foreign Exchange Management Act, 1999, and rules or regulations framed thereunder.
- Where the asset or security is not permitted to be acquired or held by the resultant foreign company, the resultant foreign company shall sell such asset or security within a period of 180 days from the date of sanction of the scheme of cross border merger and the sale proceeds shall be repatriated outside India immediately through banking channels.
4.3 Reporting requirements
Cross border merger transactions are required to be reported to the RBI in the same manner required under the Foreign Exchange Management Act, 1999, rules or regulations (including the filing of Form FC-TRS, Form FC-GPR and Form ECB). The Indian company and the foreign company involved in the cross border merger are also required to provide reports as may be prescribed by the RBI.
4.4 Deemed approval
The Cross Border Regulations further stipulate that any transactions taken in accordance with these regulations, be deemed to be approved by the RBI as required under the MCA Notification.
The MCA Notification has, on the face of it, liberalized cross border mergers and amalgamations, providing structural flexibility for overseas corporate transactions. While in principle, it's a welcome move, whether corporates will take advantage of the option remains to be seen. Successful cross border mergers generally require a degree of regulatory harmonization or convergence between jurisdictions and given existing exchange control, asset holding restrictions and tax treatment, a foreign company choosing to merge with an Indian company to create a resulting Indian entity seems to be an unlikely proposition.
While on the face of it, an outbound merger may be an attractive strategy for a foreign corporate to essentially acquire Indian assets, it is clear that it the resultant entity will not be permitted to own assets that the Foreign Exchange Management Act, 1999 would otherwise prevent. The discharge of the existing indebtedness of the merged Indian entity will also be required.
Significantly, the new regime does not seem to permit a de-merger of an Indian entity with a foreign entity, effectively preventing the foreign entity from picking and choosing business divisions to merge with. Further, it remains to be seen to what extent seeking prior approval from the RBI, will slow down the process for cross border mergers in practice, though we do note that pursuant to the MCA Notification, consent from various government regulators is time bound and requires them to provide their representations within 30 (thirty) days of receipt of the notice of the proposed merger from the Indian company, failing which it shall be deemed that they have no objection to the proposed merger scheme.
Notably, the new regime does not appear to extend the benefit of fast track mergers between holding and wholly owned subsidiaries to cross border mergers, (without approval of the National Company Law Tribunal under section 233 of the Act), making it mandatory for all cross border mergers to file an application with the National Company Law Tribunal.
Although the changes are welcome (notwithstanding the complexity of working out a cross border merger), when we look at the global business environment, it's quite rare for corporates in different jurisdictions to merge operating companies, simply because the resultant restructuring necessary is often disproportionate to the business aim. When such global mergers do occur, it's often done through merging offshore holding companies for the purpose of unlocking value through debt and equity listings, essentially leaving operating subsidiaries in different jurisdictions untouched. Generally, the only thing that's different after such a merger is the identity of the ultimate holding company of the merged groups.
The MCA Notification, while permitting outbound and inbound mergers in principle, is effectively stating that foreign companies merging with Indian companies will become subject to Indian regulations, with all the additional regulatory restrictions that come with that prospect. This will inevitably lead to complicated restructuring, to ensure, amongst other things that foreign debt and asset holdings are in compliance with Indian regulations.
From the perspective of a foreign company, it is therefore, difficult to see a compelling business driver to choose the merger route, rather than incorporating an Indian subsidiary and acquiring the Indian target by way of share or asset acquisition? However, if the foreign company is looking to integrate the entire business of the Indian company into a foreign company, a merger route could be a viable option, but that will only be the case where there is a rare perfect fit in business synergies between the two entities.
That aside, in an outbound merger, the complexity of tax treatment of the resultant foreign entity, issuing shares to resident shareholders will need to be considered. Currently, the tax regime in India does not extend the tax neutral treatment of inbound mergers to outbound mergers making it an unattractive option and in our view, an asset sale might be a preferable mode of acquisition if the business objective is to take over key assets of the Indian company which fit into the business strategy of the foreign company, bypassing the complexity of taking on other liabilities and restructuring necessary under a full blown merger. That aside, logistically an asset sale is not an easy process in itself, due to the necessity to individually transfer particular assets, pay stamp duty and procure approvals from particular governmental authorities, third party vendors and other counterparties.
So will the operationalization of Section 234 of the Act trigger a flood of cross-border mergers? It remains to be seen, though so far, a simple Google search on the subject yields no results. In our view, cultural and regulatory differences between jurisdictions make the integration of operations between Indian and foreign companies particularly difficult: mergers assume a common cultural platform and employee culture that is difficult to engineer.
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