A chaotic situation in cross-border demergers

In December 2019, the National Company Law Tribunal (NCLT) in the matter of Sun Pharmaceutical Industries held that the Companies Act, 2013 (act), read with the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (regulations), do not permit cross-border demergers.

Sun Pharma wished to restructure by consolidating the holding structure of its overseas group companies and demerging two vertical units into separate overseas companies situated in the Netherlands and the US. In accordance with sections 230-232 of the act, which detail the procedure for undertaking any scheme of merger or amalgamation, the company sought approval from its shareholders, creditors and statutory authorities such as the Registrar of Companies, the Reserve Bank of India (RBI), the Securities and Exchange Board of India and the income tax authorities.

No observations were received from any statutory authority apart from the registrar, who argued that section 234 refers only to cross-border mergers and amalgamations and does not cover demergers. Sun Pharma replied that section 234 applied to a scheme of amalgamation whether by way of merger or demerger. The RBI had indicated that they were not inclined to vet the proposed scheme on an individual basis and the NCLT considered this to be a deemed approval as all conditions under the regulations were satisfied.

However, the NCLT, in reviewing the provisions relating to cross-border mergers, contrasted sections 230 and 232, which relates only to mergers and amalgamations of Indian companies, with section 234, which relates to cross-border mergers. It held that the words “compromise and arrangement” in the former sections could be construed as including demergers, but that the same construction could not be placed in the specific language of section 234. On the basis of this interpretation, the NCLT held that cross-border demergers are not permitted under the act.

The NCLT also examined the position of demergers under the regulations and observed that, while the draft regulations specifically included the word “demergers” in the definition of cross-border merger, the notified regulations defined cross-border merger to mean “any merger, amalgamation or arrangement between an Indian company and a foreign company”. The word “demerger” had been omitted. The NCLT relied upon such exclusion to support its decision that the intention of the legislature was to exclude cross-border demergers. On the strict interpretation of the act and regulations, the NCLT held that cross-border demergers were not permitted. It used the cardinal rule of interpretation that statutory expressions should be interpreted in their primary and objective sense. While the NCLT may be correct in its construction, it does not appear to have considered legislative policy and intentions with regard to section 234 or the regulations.

The Companies Act, 1956, did not allow the merger of an Indian company with a foreign one. However, the report of the Expert Committee on Company Law of 2005 recognized the importance of mergers and amalgamations in the corporate world and recommended sweeping changes in relation to such cross-border transactions, and accorded demergers the same status as mergers.

The Ministry of Corporate Affairs notified section 234 of the act in 2017 and required applicants to obtain the approval of the RBI to undertake such cross-border mergers. To ease the process, the RBI notified the regulations in 2018, which allowed for deemed approval of the RBI in the event that all conditions stated in the regulations were satisfied.

Though the regulations in defining the term cross-border mergers do not include the word “demerger”, the broad reading of section 232 of the act allowing domestic demergers and of section 234 stating that provisions relating to domestic mergers and amalgamations apply to cross-border mergers as well, supports the argument that cross-border demergers are, in fact intended to be allowed. This view is also supported by a 2018 decision of the NCLT in the matter of Sun Pharma applying to undertake an inbound cross-border demerger under section 234. Even though the registrar had raised the same objection as in the present case that a demerger was not allowed under the act, the NCLT gave consent.

The lack of consistency in the different interpretations by the same tribunal on the permissibility of demergers is disquieting. This present order may be viewed as a setback to the progressive intention of the legislature to permit cross-border mergers. It is, therefore, critical that the position on demergers is clarified by the legislature. Until then, stakeholders will have to resort to alternative restructuring mechanisms to achieve their business objectives.

Nisha Mallik is a partner and Roshni Menon is an associate at Samvad Partners.

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