Companies Bills provisions affecting M&A
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Companies Bills provisions affecting M&A

Bar & Bench

By Lalit Kumar

JSA Partner, Lalit Kumar discusses some of the proposed amendments to the Companies Bill.

Last month the investors’ community was relieved, at least for a year, when the General Anti Avoidance Rule (GAAR) was deferred for a year although at the same time the whip of the retrospective amendments made to the income tax laws was hard to bear. Whether it was a good or a bad move in the income tax laws is a matter of debate but at least there cannot be any compliant about stagnancy in that space of law unlike in the case of the new company law. It seems that nothing is moving ahead with the yet another refined version of the company law which will replace the Companies Act, 1956 and which was introduced in the Parliament in December, 2011. The news is that it is likely that the Companies Bill, 2011 (“Companies Bill”) will be introduced in the monsoon session of the Parliament. The Companies Bill has proposed a lot of provisions, which can define and change the way merger and acquisition activities take place. However those can be only effective once the new law comes into force and till then one has to wait.

This column discusses some of such important proposed amendments.

Private company which is a subsidiary of a public company can retain its basic characteristics

Clause 2(71) of the Companies Bill defines a public company to mean:

  • a company which is not a private company;
  • and has a minimum paid-up share capital of Rs. 5 lakhs or such higher amount as may be prescribed.

A proviso is proposed to be inserted to the above definition of public company. The said proviso states that a subsidiary of a public company shall be deemed to be a public company even where such a subsidiary company continues to be a private company in its articles of association. The proviso means that a private company which is a subsidiary of a public company will be deemed to be a public company although it can retain the basic characteristics of a private company in its articles of association. This proviso is a slight departure from the existing provisions in this regard provided under Section 3(1)(iv) of the Companies Act, 1956 wherein it is provided that a private company which is a subsidiary of a public company will mean a public company. Consequently, such companies cannot provide for the basic characteristics of a private company in their articles. Interestingly, the addition of the proposed proviso appears to bring back to life a similar provision which was provided in Section 43A of the Companies Act, 1956 which was deleted in year 2000. Before deletion, Section 43A dealt with the concept of deemed public company wherein a private company under certain circumstances was treated as a public company. The deleted provision of Section 43A provided that even after the private company became a public company by virtue of the provisions of Section 43A, its articles of association could still include the provisions relating to the basic features of a private company and could have the number of its members may be less than seven. Therefore, it appears that once the Companies Bill comes into force a private company which is subsidiary of a public company can retain the provisions in relation to restriction on transfer of shares, number of members, etc. This will have the effect of over ruling the decision of the Bombay High Court in re: Jer Rutton Kavasmanek wherein it was held that a private company which is a subsidiary of a public company cannot retain any basic characteristics of a private company in its articles.

Shareholders of public company can enter into contractual obligations to restrict the transferability of shares

Under the existing Companies Act, 1956, it is provided in Section 111A that shares or debentures and any interest therein in a public company shall be freely transferable. A similar provision exists in Clause 58 of the Companies Bill wherein it is also provided that securities or other interest of any member in a public company shall be freely transferable. However, interestingly, a proviso has been inserted in Clause 58, the equivalent of which is not there in the existing Section 111A of the Companies Act, 1956. The proviso states that any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract. It appears that the amendment is proposed to provide for the decision of the Bombay High Court in the case of Messers Holdings Limited wherein it was held that shareholders of a public company are free to contract regarding the manner in which the shares can be transferred and it would be binding on them and they will be liable for any breach in respect of that. Before the decision in Messers Holdings Limited any contract restricting the free transferability between the shareholders of a public company was not enforceable in view of the fact that the shares of a public company are freely transferable and therefore shareholders of such company could not have entered into contract which restricts its free transferability. The proposed change will ensure that even in cases of public companies, the contracting shareholders are free to provide restrictions on the transferability of shares and such a contract will be binding on them even if it is not binding on the public company.

Rights issues provisions will apply to a private company

The existing Section 81 of the Companies Act, 1956 is not applicable in case of a private company. Consequently, if a private company has to allot shares on a preferential basis, it does not need approval of the shareholders by way of a special resolution. However, the proposed Clause 62 of the Companies Bill does not grant any such exemption to a private company. Therefore, even in case of a private company a special resolution of shareholders will be required in case it proposes to issue shares on a preferential basis. It appears that the proposed amendment has been made in light of the Supreme Court decision in Dale & Carrington Investments (P). Ltd. Vs. P.K. Prathapan wherein it was held that the principles relating to Section 81 of the Companies Act, 1956 will also apply to a private company.

Clear definition of the terms “undertaking” and “substantially the whole of the undertaking”. 

The existing Section 293 of the Companies Act, 1956 provides provisions relating to sale, lease or disposal of whole or substantially the whole of the undertaking. However, the said section does not clearly define the meaning of the terms “undertaking” or “substantially the whole of the undertaking”. In the absence of any clarity of the meaning of these terms, one has to determine with respect to the facts and circumstances in a given case and certain judicial precedents some of which provide that an undertaking has to be a going concern and a unit closed for long cannot qualify as an undertaking. Generally, an undertaking is understood to mean a complete business division of a company capable to be identified as a separate business unit within a company. However, Clause 180 of the Companies Bill clearly defines the meaning of the terms “undertaking” and “substantially the whole of the undertaking”. The term “undertaking” has been defined to mean an undertaking in which the investment of the company exceeds 20% of its net worth as per the audited balance sheet of the preceding financial year or an undertaking which generates 20% of the total income of the company during the previous financial year. Similarly, the expression “substantially the whole of the undertaking” in any financial year shall mean 20% or more of the value of the undertaking as per the audited balance sheet of the preceding financial year.

Investments limited upto through two layers of investment companies

Section 372A of the Companies Act, 1956 which deals with inter-corporate loans and investment does not limit the layers of companies through which the investment can be made. However, Clause 186 of the Companies Act, 1956 provides that a company will not be permitted to make investment through more than two layers of investment companies. In this regard, ‘investment company’ has been defined to mean a company whose principal business is the acquisition of shares, debentures or other securities. However, a relief from this restriction has been provided in the following cases:

  • in case a company acquires any other company incorporated in a country outside India if such other company has investment subsidiaries beyond two layers as per the laws of such country;
  • a subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force.

Further, separately it is provided in Clause 2 (87) of the Companies Bill that such class of classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.

Inter-corporate investments exemption to private companies and between holding-wholly owned subsidiary will stand withdrawn

Presently, under Section 372A of the Companies Act, 1956 a private company is exempted from the applicability of the provisions of Section 372A of the Companies Act, 1956 relating to inter-corporate loan, guarantee and investments. Further, Section 372A exempts from the provisions of the said section from any transaction of loan made by a holding company to its wholly-owned subsidiary, any guarantee given or any security provided by a holding company in respect of loan made to its wholly-owned subsidiary and to any acquisition of securities by a holding company of its wholly-owned subsidiary. Clause 186 of the Companies Bill now proposes to withdraw the said exemption in case of a private company and transactions between a holding company and its wholly-owned subsidiary. 

Detailed disclosure / information provided with respect to scheme of arrangement and process made time bound

The Companies Bill now proposes and requires companies proposing the scheme of arrangement to provide more information to the stakeholders about the financial position, pending investigations and proceedings, details of valuation, explanation of the effect on the creditors, managerial personnel, promoters and non-promoter members and the debenture-holders and the effect of the arrangement on any material interests of the directors of the company.

Further, the Companies Bill proposes to make the process of scheme of arrangement time bound and provides that simultaneously with taking approvals of stakeholders like the creditors, shareholders, debenture holders, etc., representation will also be taken from statutory authorities such as income-tax authorities, RBI, SEBI, Registrar of Companies, stock exchanges, official liquidator, CCI and such other sector regulators which are likely to be affected by the arrangement. 

Merger of listed company with unlisted company

The Companies Bill specifically provides for provisions relating to a merger of a listed company with an unlisted company and gives power to the National Company Law Tribunal to order exit of the dissenting shareholders of the transferor listed company in case they opt out of the unlisted transferee company with payment of the value of shares held by them and other benefits in accordance with a pre-determined price formula or after a valuation has been made.

Cross Border Merger permitted

Presently, under the Companies Act, 1956 an Indian company is not permitted to merge with a foreign company, however, the vice versa is allowed i.e. a foreign company can merge into an Indian company. Clause 234 of the Companies Bill now proposes to allow the merger of an Indian company with a foreign company provided permission of Reserve Bank of India is sought and the merger takes place with companies incorporated in countries notified by the Central Government. It is not clear from the provisions of Clause 234 if demergers are also permitted, though it appears that demerger of a unit of an Indian company into a foreign company is not permitted.

Short Form Merger

In order to save time and process for small companies and for internal restructuring, the Companies Bill proposes to allow merger among “small companies” or between “holding-wholly owned subsidiary” without seeking the approval of National Company Law Tribunal. In such cases only the approval of Central Government will be sufficient provided the Registrar of Companies and Official Liquidator do not raise any objection to such merger schemes. Small company means a private company whose paid-up capital does not exceed Rs. 5 million or such higher amount as may be prescribed which shall not be more than Rs. 50 million or the turnover of which as per its last profit and loss account does not exceed Rs. 20 million or more or such higher amount as may be prescribed which shall not be more than Rs. 200 million.

Offer of sale concept by certain members introduced

Clause 28 of the Companies Bill has introduced a new concept regarding offer of sale by certain member or members of the company in consultation with the board of directors of the company to offer part of their holding of shares to the public through the prospectus and such members shall reimburse the company all expenses incurred by the company for such offer of sale.

Differential voting rights shares preserved

The Companies Bill proposes to retain the differential voting rights shares as provided in Section 86 of the Companies Act, 1956. In certain merger and acquisition transactions, such differential voting rights shares are issued and used to achieve certain objectives proposed in a structure of a transaction and therefore the Companies Bill provision to retain such kinds of shares will be welcomed.

It is certain that once the Companies Bill is passed and the above provisions come into force, there will be a lot of activities and thoughts around structuring M & A deals from new perspectives.

Lalit Kumar is a Partner with J.Sagar Associates. The views expressed are personal.

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