Mergers and Acquisitions

Author: | Published: 12 Jul 2001
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Introduction

Mergers are those forms of business transactions where there is a combination of two or more companies, and in the process one or more such companies lose their corporate existence because they merge with the surviving entity. Acquisitions are those forms of business transactions where the shares in or control of a company is taken over by persons who, prior to the change in shareholding or control, did not possess such shareholding or control.

The size and the number of mergers and acquisition (M&A) activities taking place in India are insignificant compared to those in developed countries. However, there seems to be a growing trend towards such M&A activities in India. The main reasons for this increase in M&A activity may be the changes that have taken place over the last decade in the country's legal, policy and regulatory framework, such as:

  • amendments to the Monopolies and Restrictive Trade Practices Act 1969 (MRTP Act) in 1991 that dispensed with the need to obtain government approval for effecting M&A transactions in certain large or dominant undertakings (the test for dominance was based on the value of assets or the market share);
  • amendments to the Companies Act 1956 in 1996, providing for the free transferability of shares, thus reducing the grounds on which the board of directors of a company may refuse to register a transfer of shares;
  • progressive changes effected in the country's industrial licensing policy – based on the provisions of the Industries (Development and Regulation) Act 1951 (ID&R Act) – resulting in a reduction in the number of industries requiring licences to less than 10. The strict licensing regime had resulted in the creation of inefficient and non-viable small industrial units in sectors that were subject to licensing;
  • progressive changes effected in the government's foreign direct investment (FDI) policy since 1991 – government approval for FDI is now required only in a handful of sectors, and in all other sectors a foreign investor can take part in FDI without obtaining approval from any authority, and subject to no limits;
  • introduction of the Depositories Act 1996 providing for the dematerialization of shares in listed companies; and
  • framing of various regulations by the Securities and Exchange Board of India (SEBI), including the SEBI Substantial Acquisition of Shares and Takeovers Regulations 1997 (Takeover Regulations) that govern substantial acquisitions of shares in listed companies and takeovers of listed companies.

The trend towards M&A is more perceptible in certain sectors such as: (i) the consumer goods sector where companies want to rapidly gain market share (eg Tata Oil Mills merging with Hindustan Lever Limited, a subsidiary of Unilever; Coca Cola taking over Parle Products); (ii) the banking and financial sector, where size is increasingly becoming important and Reserve Bank of India is prescribing stricter norms in relation to the capital requirements of banks; (iii) sectors where more players (than the optimum numbers) came to operate due to the industrial licensing policy of the government, resulting in a need for a consolidation of industrial capacity (the cement industry is a classic case, where there are nearly 50 players controlling 110 million tonnes of capacity – 40 of them are marginal players each with around 1 million tonne capacity. Similar problems are being faced by the steel industry due to fragmentation of capacity); and (iv) sectors where the need for high technology is becoming very important (such as the telecommunications and pharmaceutical sectors). In addition to the foregoing, another major reason for this increase is that the M&A activities that are taking place globally are triggering events in India in the form of mergers with or takeovers of subsidiaries in India.

The current legal and regulatory framework

The Companies Act

Mergers

Mergers of companies can be effected only with the prior approval of a three-quarters majority of the shareholders of each of the companies participating in the merger, and only as sanctioned by the relevant court. The court, before sanctioning a scheme of merger, will take into account the views of all interested parties, including the creditors, government and employees.

Under the Companies Act, the transferee in a merger can only be an Indian company whereas the transferor can be a foreign company. However, the scheme of the Companies Act and other applicable legal and regulatory provisions would clearly imply that cross border mergers involving Indian companies ae not feasible under the current framework.

Acquisitions

There are no provisions in the Companies Act that directly govern acquisitions. However, there are some restrictions (sections 108A-108I of the Companies Act) that relate to the transfer of shares in certain companies if such transfers would result in the creation of a dominant undertaking (as defined under the MRTP Act), or an increase in the dominance of a dominant undertaking, or where the transferor was holding more than 10% of the share capital of the company prior to such a transfer. Such transactions require the approval of the central government. It may be noted that these provisions may seem out of place now, since the concept of dominant undertaking is of little relevance, even under the MRTP Act as far as M&A activities are concerned. Where the acquirer is a company, and if the shares so acquired are in excess of specified percentages of the paid-up share capital and free reserves of the acquirer, then the acquisition may only be made following a special resolution (special resolutions are resolutions passed by shareholders holding three-quarters of the share capital who are present and voting at a meeting) passed by the shareholders of the acquirer.

Under sections 409 and 250, the Company Law Board (CLB – a quasi-judicial body constituted by the central government under the Companies Act for the administration of company law) may pass orders preventing a change in the board of directors of a company, or restrict transfer of shares in a company that could prejudicially affect the affairs of a company. These are ways in which the existing management of a company may be able to resist a takeover attempt.

The Foreign Exchange Management Act 1999 (FEMA) and FDI policy

Mergers

Under the current leal and regullatory framework, it is not feasible to have Indian companies as party to cross- border mergers. To achieve a merger involving an Indian company, a foreign company can (i) set up an Indian entity and effect a merger of the entity with the Indian company, or (ii) acquire another Indian entity and thereafter effect a merger of the acquired Indian entity with the other Indian entity.

To set up an Indian entity, the foreign company may require approval from the Foreign Investment Promotion Board of the Government of India (FIPB) if the case is not covered under the automatic approval route prescribed by the Indian government. Under current FDI policy, no approval from the FIPB will be required for a foreign company to subscribe for shares in Indian companies unless:

  1. industrial licensing applies to that sector;
  2. the foreign investor has or had a previous joint venture or collaboration in India with any other
  3. the foreign investor wants to acquire existing shares from any other shareholder rather than investing in a fresh issue of shares; or
  4. where automatic approval is not permitted in that sector (like in civil aviation).

Acquisitions

Foreign companies will be able to acquire shares in Indian companies from other existing shareholders. The acquisition of shares in an Indian company by a foreign company from a shareholder resident in India will require prior approval from the FIPB. The Indian company in this regard will support the application to the FIPB. This would imply that hostile takeovers of Indian companies by foreign companies are almost impossible. Following the receipt of FIPB approval, the foreign company will be required to make an application to the Reserve Bank of India (RBI) giving details of the price at which the shares will be acquired together with the valuation of shares.

The Takeover Regulations and the Listing Agreement

Mergers

The Listing Agreement (an agreement entered into between a company whose shares are listed on stock exchanges with the stock exchange) requires companies whose shares are listed on stock exchanges to make relevant and timely disclosure of price-sensitive information. Such information would include any decision taken by the company in relation to mergers.

Acquisitions

The provisions of the Takeover Regulations apply in cases involving a substantial acquisition of shares in a company whose shares are listed on stock exchanges. Further, the Takeover Regulations do not apply in cases like: (i) the allotment of shares in a public issue of shares; (ii) the preferential allotment of shares made to any person in terms of an authorization made by the shareholders passing a special resolution; and (iii) inter se transfers amongst Indian promoters and foreign collaborators. In addition, the SEBI may grant an exemption from the provisions of the Takeover Regulations in certain cases, based on the facts of the case. Under the Takeover Regulations, there are some obligations on the part of the acquirer and the target company.

Obligations to disclose: any person who has acquired more than 5% of the shares or voting rights in a company must, within four days, disclose this fact to the target company and the target company must in turn disclose this to the stock exchanges. Every person holding more than 15% of the shares or voting rights must disclose this shareholding within 21 days of the end of March every year, and the target company must in turn disclose this to the stock exchanges. Similar obligations for the target company are also specified in the Listing Agreement.

Obligations to make a public offer: no acquirer can acquire more than 15% of the shares or voting rights in a company unless it makes a public offer to acquire a minimum of 20% of the voting capital of the company. There are detailed provisions in the Takeover Regulations in relation to the contents of the public offer, specific timelines for the completion of various activities, and general obligations of the acquirer.

Industries (Development and Regulation) Act (ID&R Act)

The objective of the ID&R Act is to provide for the development and regulation of certain industries specified in the schedule to the Act. Under the provisions of the ID&R Act, the central government is empowered to take over the management and control of industrial undertakings. The government may take such steps if the industrial undertaking violates any of the directions issued by the government, or where the undertaking is managed in a manner that is detrimental to the industry concerned or to the public interest.

The Sick Industrial Companies (Special Provisions) Act 1985 (SICA)

SICA provides for the revival of sick industrial companies (a sick industrial company is a company that owns one or more industrial undertakings (as defined under the ID&R Act) that has been in existence for not less than five years and has accumulated losses in excess of its net worth). Under the Act, a Board for Industrial and Financial Reconstruction (BIFR) has been constituted to look into the issues affecting such sick companies and to sanction appropriate schemes for their revival. A domestic bank or financial institution having some interest in such a sick company usually prepares such schemes. In some cases, the revival plan may include the merger of the sick company with any other company or vice versa. The procedure for mergers under SICA is different, in that these mergers need not follow the detailed provisions laid down under the Companies Act.

The Depositories Act 1996

With the introduction of the Depositories Act, provisions have been made for trading in the shares of listed companies in dematerialized form. Due to the free transferability of such shares, it is practically impossible for companies to refuse to register a transfer of shares, thus facilitating hostile takeovers.

Some considerations in planning for M&A

Transaction costs

Mergers

Since a scheme of merger will have to be sanctioned by the relevant court, legal costs for completion of the proceedings will be relevant.

Acquisitions

In cases of acquisition of listed companies, provisions of the Takeover Regulations will have to be complied with, which includes appointing a merchant banker and making the public offer. The entire process of making and completing the public offer will have to be completed by the acquirer.

Tax considerations

Mergers

Complex tax considerations arise with mergers. Various benefits such as an exemption from tax on capital gains, and allowances of carryforward benefits of unabsorbed expenses and losses are possible only if the merger satisfies the conditions of being an amalgamation under the Income Tax Act 1961 (the Income Tax Act does not use the term merger but uses the term "amalgamation". To qualify as an amalgamation, specified conditions have to be satisfied). One of the reasons for companies to choose a merger – rather than an asset or business acquisition – is to reduce the incidence of stamp duties on the transfer of immovable assets; such duties usually range between 4% and 12% in the states where the property is situated. However, some of the states in India have made changes to the applicable stamp duty laws that provide for the stamping of an order of the court in mergers as a conveyance. In such cases, there will be an additional stamp duty impact, based on the value of shares issued/assets acquired in a merger.

Acquisitions

Tax considerations are relatively less in the case of acquisitions, since the major tax impact would be in the nature of share transfer taxes at the rate of 0.5% of the consideration. From the point of view of the sellers of shares, any capital gains on the sale of such shares will be subject to tax at a concessive rate (where the shares are held for at least 12 months prior to transfer) and at normal rates in other cases. In the case of foreign investors, the actual incidence and rates of duty will depend on the provisions of the applicable double taxation avoidance agreement. In cases of transfer in excess of 49% of the shareholding in certain companies (like clodely held private companies), the Company will forego the benefits of carrying forward and setting off any unabsorbed losses incurred by that company in the previous years.

Legal and regulatory approvals

The legal and regulatory approvals required for effecting a M&A transaction are different. A complete and clear understanding of the applicable legal and regulatory framework must be made before a final decision is taken. In some cases, these considerations determine whether one should go for a merger or an acquisition. For example, direct cross-border mergers are not feasible in India, and the hostile acquisition of an Indian company by a foreign one is also practically impossible.

Time considerations

Mergers

Mergers can be effected only with the sanction of the court. It takes not less than 6-9 months from the time of making an application to the court until the final order of sanction is received from the court. Further, courts have wide powers to effect changes in the scheme of merger. There are further uncertainties – for example, any interested party such as employees and the government may raise objections to the scheme, resulting in further delays in implementing the scheme.

Acquisitions

In cases of acquisitions, though the timeline specified under the Takeover Regulations will have to be complied with, completion is after acquisition of the initial 15% of shares by the acquirer. Further, since the Takeover Regulations permit conditional offers, uncertainty as to whether the acquirer may not be able to acquire the minimum number of shares can be overcome.

Relevant issues in relation to mergers and acquisitions

Whose interests are paramount?

Although it is said in corporate democracy that the will of the majority shall prevail, there have always been questions about the role played by management, since families traditionally control many Indian companies. Further, the interests of other minority shareholders and other stakeholders have been ignored in some cases of M&A. It was recently reported (The Economist Newspaper Group Limited, May 10 2001) that a Paris court blocked Schneider Electric's proposal for taking over Legrand, a rival company, for a deal worth $7 billion on the grounds that the proposed deal discriminated against the preference shares held by minority shareholders of Legrand. Similar issues relating to the valuation of shares and the scheme of merger have been raised in India in the past. There is a need to strike a balance between the absolute rule of corporate democracy and the interests of all stakeholders.

The role of the board becomes crucial in such major decisions. With the exception of the Takeover Regulations that provide for the general obligations of the board of directors of the target company, there are no specific guidelines as to the conduct of the board in relation to M&A transactions. In the emerging era of corporate governance, it would be appropriate if issues relating to disclosure and transparency could be strengthened.

Hostile takeovers

Since the Takeover Regulations were announced, there have been around 975 reported cases of completed takeovers, of which a mere eight have been hostile. In many publicly held Indian companies, the shareholding of financial institutions is substantial. Generally, the financial institutions have exhibited a tendency not to disturb the existing management even if the existing management has not really performed. The role of financial institutions in the recent attempt to take over Bombay Dyeing – one of the country's largest textile manufacturers – is a case on point. It is high time that the financial institutions had clear policies to make the conduct of such matters transparent, since financial institutions are supposed to be the custodians of public money.

Mergers and monopolies

After the amendment to the MRTP Act in 1991, there are no provisions under which mergers that give rise to a monopolistic situation are considered and cleared by any authority. This is in sharp contrast with the situation prevailing in many developed countries. For instance, while the UK has its own restrictions on the formation of monopolies due to M&A activities, the EU also has controls in place on such transactions, so that cross-border transactions do not result in such a situation in the EU as a whole. In India however, to a limited extent, this situation is addressed by the provisions of the Companies Act that require prior permission from the central government in relation to certain transactions regarding the transfer of shares. However, there are no such provisions in relation to a merger transaction. The time is ripe to introduce changes in the legislation to address the issues relating to the formation of monopolies arising out of M&A activities by way of suitable competition laws.

The role of regulatory and other agencies

There is growing uncertainty about the role played by the CLB and SEBI in relation to certain matters involving M&A activities, due to the fact that their powers seem to overlap in some cases. In one recent case of an attempted hostile takeover, CLB favoured the idea of freezing the voting rights of the hostile bidder while SEBI seemed to favour a hands-off approach. In the future, such friction is expected to increase. There are no material advantages to having two such bodies when in reality one can effectively perform the required tasks.


Mergers and Acquisitions

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