Section 234 of the Companies Act broadly states that the provisions of Chapter XV (Compromises, Arrangements and Amalgamations) shall apply mutatis mutandis to cross border inbound or outbound mergers. The MCA, vide its Notification dated April 13, 2017, has also amended the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (Merger Rules) to insert Rule 25-A (Rule 25-A) dealing with cross-border mergers. Rule 25-A lays down the scope of the application of Section 234.
The conditions for cross border mergers under Section 234 of the Companies Act are as follows: (i) requirement of prior approval from the Reserve Bank of India (RBI); (ii) valuation of the surviving entity to be submitted to the RBI, which report must be prepared per internationally accepted principles on accounting and valuation prepared by a valuer who is a member of a recognized professional body in its jurisdiction; (iii) provisions of Sections 230-232 to be followed for cross border mergers (thus requiring approval of the NCLT, approvals from shareholders, approvals from creditors (if any), approvals from Securities and Exchange Board of India (SEBI) (for listed companies), sectoral regulators and the income tax authorities); (iv) the scheme of merger may provide for payment of consideration to the shareholders of the merging company in the form of cash or depository receipts or partly in cash and partly in depository receipts; and (v) the foreign company should be incorporated in a permitted jurisdiction, which restriction only applies in case of outbound mergers (i.e. where the surviving transferee company is a foreign company).
Clarity has been provided to the term ‘permitted jurisdictions’ listed under Annexure B to the Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2017, (Annexure B) which shall mean a jurisdiction where the surviving entity is located being one (i) whose securities market regulator is a signatory to the International Organization of Securities Commission's Multilateral Memorandum of Understanding (Appendix A signatories) or a signatory to a bilateral Memorandum of Understanding with SEBI or (ii) whose Central Bank is a member of the Bank of International Settlements (BIS); AND (iii) a jurisdiction that has not been identified in the public statement of Financial Action Task Force (FATF) as: a jurisdiction having strategic ‘Anti-Money Laundering or Combating the Financing of Terrorism’ deficiencies to which counter measures apply; or a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the FATF to address the deficiencies.
The scope of Rule 25-A does not provide for fast track mergers under Section 233 available to domestic mergers, therefore all cross-border mergers are required to undergo the entire process as laid down under Sections 230-232 of the Companies Act.
To harmonize the scope of cross-border mergers with exchange control laws in India, RBI has released (as on April 26, 2017) the Draft Foreign Exchange Management (Cross Border Merger) Regulations, 2017 (Draft Regulations) for public consultation, that prescribes certain guidelines to be followed in case of both inbound as well as outbound mergers. The Draft Regulations state that:
In case of inbound mergers where the resultant company is an Indian company: (i) The issue and/or transfer of securities to a person resident outside India by the resultant company shall be in accordance with Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000; (ii) The existing borrowing(s) of the foreign company obtained from overseas sources shall conform to the foreign borrowing norms laid down by RBI; and (iii) The holding of assets outside India by the resultant company because of the merger or the subsequent transfer of assets shall adhere to the Foreign Exchange Management Act, 1999 or rules or regulations framed thereunder (FEMA).
In case of outbound mergers where the resultant company is a foreign company: (i) The acquisition and holding of securities in the resultant company by an Indian resident shall be in accordance with Foreign Exchange Management (Transfer or issue of Foreign Security) Regulations, 2000 or the provisions of the Liberalized Remittance Scheme, as applicable; (ii) The outstanding or impending borrowings shall be repaid by the resultant company as per the scheme sanctioned by NCLT; and (iii) The resultant company can acquire, hold any assets in India or transfer any such assets, as per the permissible limits prescribed under FEMA.
Irrespective of the transaction being an inbound or outbound merger, if such assets or securities held by the resultant company is in contravention of the provisions of FEMA, the resultant company would be required to sell the said assets/securities within 180 days from the sanction of the merger scheme and the sale proceeds to be repatriated to India or outside India, as the case may be.
Although the Draft Regulations are at the stage of public consultation, permitting a resultant company to acquire assets (which it is otherwise not permitted to acquire under foreign exchange laws) pursuant to sanction of a Scheme of cross-border merger, only to require such entity to subsequently divest such assets within 180 days from sanction of the Scheme, may entail unattractive tax and stamp duty implications. As violation of FEMA may entail penalty of up to three times the amounts involved, the feasibility of having a blanket 180-day period for divestment of such prohibited assets also needs to be examined.
To bring parity with Section 248 of the Companies Act, valuation of the merging entities is proposed to be done as per internationally accepted pricing methodology on arm’s length basis, which shall be duly certified by an authorized Chartered Accountant/public accountant/merchant banker. All transactions arising due to cross border mergers are proposed to be reported to RBI as required under FEMA. Further, any transaction undertaken in accordance with Draft Regulation shall be deemed to be approved by RBI as required under Rule 25-A.
One important issue in the Draft Regulations is the explanation provided to the definition of “foreign company” which states that foreign company should mean those incorporated in jurisdictions at Annexure B. The term ‘foreign company’ under the Draft Regulations is used for both inbound and outbound mergers, making applicable the restrictions of permitted jurisdictions under Annexure B to even inbound mergers, in contradiction to what is stated under Rule 25-A.
Although notification of Section 234 is intended to enable cross-border mergers, a host of related concerns remain unaddressed, especially where the surviving transferee entity is a foreign company that acquires and holds business interests and assets in India of an erstwhile Indian transferor entity. Extensive amendments by the legislature and various regulators including by the Insurance Regulatory and Development Authority, the RBI, tax authorities, to name a few, are also required on numerous jurisdictional issues involved in cross-border mergers such as matters concerning recovery of taxes under the Income Tax Act, 1961, social welfare liabilities for employees, and litigations that would be inherited by surviving company, especially in outbound mergers. To protect the interests of various stakeholders involved and effectively operationalize Section 234, this legislative and regulatory void needs to be addressed in parallel. In the absence of such exhaustive legislative and regulatory changes, liberalization of the cross-border merger regime envisioned by Section 234 is not practically workable.