Workshop on
Mergers & Acquisitions
February 17, 2005
presented
by
Mohit Saraf
Partner
Luthra and Luthra
Law Offices 1
Why M&A?
Underlying Principle for
M&A Transactions
2+2≠4
Additional Value of “Synergy”
2
Why M&A?
Market Intensification:
• Horizontal Integration – Buying a competitor
Acquisition of equity stake in IBP by IOC
AT&T merger into SBC enables the latter to access
the corporate customer base and exploit the
predictable cash flows typical of this telephony section
• Market Extensions – New markets for Present products
Maersk – Pipavav : strategic objective of investing in a
container terminal in the west coast
Bharat Forge’s acquisition of CDP (Germany)
S&P’s proposed acquisition of CRISIL
3
Why M&A?
Vertical Integration : Internalization of crucial
forward or backward activities
• Vertical Forward Integration – Buying a
customer
Indian Rayon’s acquisition of Madura
Garments along with brand rights
• Vertical Backward Integration – Buying a
supplier
IBM’s acquisition of Daksh
4
Why M&A?
Diversification: Overcome Barriers to Entry
• Product Extension: New product in Present territory
P&G acquires Gillette to expand its product
offering in the household sector and smooth out
fluctuations in earning
• Free-form Diversification: New product & New
territories
Flight Centre’s proposed acquisition of Friends
Globe
Indian Rayon’s acquisition of PSI Data Systems
5
Why M&A?
Advantages:
• Greater Economic Clout:
Proposed merger of Petroleum PSUs
P&G merger with Gillette expected to correct balance
of power between suppliers and retailers.
• Economies of scale and Sharing Overheads: Size
really does matter
IOC & IBP
• Synthesized capabilities
Proposed merger of nationalized banks
6
M&A
Different Perspectives
Acquirer
– Majority/ Strategic Partner
– Minority/ Private Equity Investor
Target Company
7
M&A
TRANSACTION ISSUES: TARGET
Due Diligence – Full Disclosures
– Linked with Reps & Warranties
– Reps should be negative
– DD in case of Listed Company
– Post Closing Adjustment
Condition Precedents – Definitive
– Include as Exhibits
Survival of Reps for limited period
8
M&A
TRANSACTION ISSUES: ACQUIRER
Due Diligence – Risk Matrix and Value Depletor
– Material Contracts
• Any subsisting contracts granting similar or superior rights to
other investors
• Termination rights of major customers
• Approval rights of financiers
– Title to Properties & Assets: esp. where main business
is situated
– Statutory Dues
– Litigation : Contingent Liabilities
– IPR protection
– Tax Compliance (Settlement Commission)
9
M&A
TRANSACTION ISSUES: ACQUIRER
Mode of Acquisition
– Pure Equity (Existing or New); Equity & Preference; Special
Class (Differential voting rights, dividends or otherwise)
– Leveraged Acquisitions
Corporate Governance
– Related Party Transactions (past & going forward)
Board Representation
- Quorum (Inclusive)
- Fiduciary Responsibility of Board v. Shareholders
10
M&A
TRANSACTION ISSUES: ACQUIRER
Deadlock Resolution
– Majority/ Strategic Partner
– Lenders
Return on Investment
– Cap on dividends to preference shares
– Liquidation Preference
Lock - in of Promoters
– Enforceability of transferability restrictions
11
M&A
TRANSACTION ISSUES: ACQUIRER
Non - Compete/ Non - Solicitation
– Payment for Goodwill to exiting partner
Exclusivity
Enforceability against Company
– Company as party to SHA
Exit Options
– Listing (Private Equity)
– Call/ Put Option
12
M&A
TRANSACTION ISSUES: GENERAL
Effectiveness of SHA and SPA
Indemnity
– Aggregate Liability Cap
– De Minimis
– Threshold
Participative Rights v. Protective Rights
– Strategic Partner : Participative Rights
• Control on Board
• Sharing Control
– Private Equity : Protective Rights
13
M&A
TRANSACTION ISSUES: GENERAL
Special Rights
– Tag – Along Rights: minority partner/ private equity
– Drag - Along Rights: majority partner
– Right to share the upside on revised valuation of
Target eg: on Merger; Listing at higher valuation
– Right of First Refusal
Earn-out Structure
– Favorable Business Projections
14
M&A
TRANSACTION ISSUES: GENERAL
FCPA
Arbitration v. Litigation: Effective Remedy
– Proper Law of Arbitration
– ICC v. UNICITRAL
– Group Companies Doctrine
– Place of Arbitration
– Cost Effective
15
M&A
REGULATORY FRAMEWORK
TRANSACTION STRUCTURE
•Companies Act
•Income Tax Act
•Stamp Acts
•Competition Act
LISTED COMPANIES
•SEBI Regulations
•Stock Exchange – Listing Agreement
TRANS-BORDER TRANSACTIONS
•Foreign Exchange Management Act
16
M&A
OVERVIEW
Mergers Spin Offs Acquisitions
DEMERGER OTHERS SHARES
ASSETS CONTROL
SLUMP SALE
17
ACQUISITIONS
Acquisition
• Shares
• Control
Acquisition of Assets
• Slump Sale 18
Acquisitions
ISSUES: COMPANIES ACT
Sections 108A to G: Central Government approval if
in excess of threshold prescribed
• ambiguity as to ‘classification of goods’
Section 372A: Compliance by transferee company in
acquisition of shares
Section 77A: Buy Back may be used as a defense to
a hostile takeover
Used in U.S.: PeopleSoft’s attempt to thwart Oracle
19
Acquisitions
ISSUES: FEMA
Acquirer - Non-Resident:
No approval required for purchase of shares (including existing shares)
• From R
• From NR
Valuation prescribed in case of R-NR not less than
• Ruling Market Price - Listed Target Company
• Fair valuation by a CA as per CCI guidelines - Unlisted Target
Company
Press Note 18 replaced by Press Note 1 of 2005
Investment has to comply with FDI policy
20
Acquisitions
ISSUES: FEMA
Target Company is a Non-Resident
Direct investment in JV/ WOS outside India (other than financial
services) requires no approval subject to conditions including inter
alia
• Financial commitment < or = 100% networth
• Investment by way of remittance only if valuation
– If > 5 million USD: by Merchant Banker/ Investment Banker
registered with SEBI/ appropriate authorities
– Other cases: by CA/ CPA
• Investment by share swap: valuation by Merchant Banker/
Investment Banker registered with SEBI/ appropriate authorities
21
Acquisitions
ISSUES: TAKEOVER CODE
Definition of “Control” - Inclusive
• Ambiguous:
- TATA Sellout in ACC.
• Negative control?
S. 25(2) prohibits public offers after 21 days of the public
announcement of first public offer
In case of indirect acquisition, foreign acquirer has three
months from completion of transaction to make open offer.
Therefore, foreign transactions can be concluded prior to
open offer in India.
22
Acquisitions
RECENT CHANGES : TAKEOVER CODE
New thresholds of 54% and 74% in Regulation 7
55% shares cannot be allotted by preferential allotment or market
purchase – consolidation by public offer only
Acquisition by public offer under 11(2) can be for only so many
shares as will keep float above listing requirements.
Where any acquisition reduces public float below Listing
Agreement requirements, acquisition to comply with delisting
guidelines
Where Code is triggered by a global deal, if the public offer will
lower float to below the listing requirement, then acquirer has 12
months to raise float either by fresh issue or by disinvestment.
23
Acquisitions
ISSUES: MISC
Stamp Duty
• No stamp duty if transferred shares are
dematerialized
Industrial Disputes Act (s. 25FF)
• Workmen employed by transferor company
entitled to retrenchment benefits unless retained in
employment on same terms.
24
Mergers
Mergers
Spin-offs
• Demergers
25
Mergers
STRUCTURE 1
A = Amalgamating Company: Ceases to Exist
B = Amalgamated Company
B receives all of A’s assets and liabilities
Shareholders of A receive shares in B and maybe other
benefits like debentures, cash
A B
Transfer assets and liabilities
26
Mergers
STRUCTURE 2
A, B and C = Amalgamating Companies: Cease to exist
D = Amalgamated Company: may or may not have
existed before Merger
All assets and liabilities of A, B and C transferred to D
Shareholders in A,B and C get shares in D.
B D
C
27
Spin-Offs
STRUCTURE
Transfer of undertaking Y
X Y Y
Consideration in cash
or issue of shares Company B
Company A
Consideration is usually shares of Company B but
maybe cash.
Process may or may not be Court sanctioned.
Salora spinning off Panasonic to Matsushita
under s. 391 Scheme. Consideration in cash.
28
Demergers
STRUCTURE
Demergers are one type of spin-offs: under s. 391
A = Demerging Company
B = Resulting Company: may or may not have existed
earlier
A transfers undertaking to B
B issues shares to shareholders of A
Transfers undertaking Y
X Y Y
Company A Company B
Shareholders
of Issues shares
A 29
Merger & Demerger
Phase- I
PROCESS
Draft Scheme
Notice to members of Board of both companies
Determine swap ratio based on valuation report
Board approval of both companies
Prior NoCs from secured creditors and shareholders for exemption
from meeting: Reduce Time and Costs
In ICICI Ltd. merger with ICICI Bank, meeting of preference
shareholders of ICICI Ltd. was dispensed with since sole
preference shareholder furnished an NOC
Phase- II
Draft Application under s. 391(1)
Application to HCs in respective jurisdictions of both companies for
sanction / direction to conduct meetings
– Moving registered office to one jurisdiction: Reduce Time and
Costs
30
Merger & Demerger
PROCESS
Phase- III
Notice of EGM to members with statement of terms of
merger, interests of directors and proxy forms: 21 days
Advertisement
Notice in 2 newspapers: 21 days
Affidavit certifying compliance with HC’s directions in
respect of notice/ advertisement
Meetings of creditors and/ or shareholders: agreed to by
majority in number representing ¾ of value present and
voting
Chairman of meetings to file report within 7 days of meeting
Resolutions and Explanatory Statements to be filed with
RoC
31
Merger & Demerger
PROCESS
Phase- IV (Approval of the Scheme)
HC to be moved within 7 days of Chairman’s Report for
second motion petition
10 days notice of hearing of petition in same newspapers
Notice to Central Govt. (Regional Director), and OL (if
applicable): Submit reports
Objections raised in 391 proceedings
HC Sanction
Certified copy of HC Order to be filed with RoC within 30
days of order.
32
Merger & Demerger
ISSUES: COMPANIES ACT
s 391 - 394: “Complete Code”, “Single Window Clearance”
• Reduction of capital- Position unclear, Predominance of judicial view:
substantial compliance with s. 100- 102 required.
Transnational Mergers: 391 - 394 mechanism operates only where
amalgamated company is Indian. E.g. of transnational merger concluded
under 391 route - Bank of Muscat merging into Centurion Bank by order
of Karnataka HC
Alternative Mechanism: S. 494
• Through Liquidation Process
• Liquidator transfers assets to foreign company for shares
• Process has to be “altogether voluntary”
• Tax benefits are unavailable under this route
33
Other Spin-Offs
ISSUES: COMPANIES ACT
Where spin-offs are outside the 391 mechanism, the
following compliances need to be ensured
• 293(1)(a) resolution
• Voting has to be by postal ballot in a public listed
company
34
Mergers and Demergers
ISSUES: INCOME TAX
Transfer of capital assets by amalgamating company to
amalgamated company is exempt from Capital Gains Tax
provided amalgamated company is an Indian company
Capital Gains Exemption in respect of shares issued to
members of amalgamating/ demerging company- s. 47
Exemption may not be available if members of amalgamating
company receive anything besides shares in the amalgamated
company like debentures or cash- Gujarat HC in Gautam
Sarabhai v. CIT, 173 ITR 216.
35
Mergers and Demergers
ISSUES: INCOME TAX
In case of fraction shares, issue to trustee who
liquidates these and distributes money to shareholders
of amalgamating company.
Carry forward of losses and unabsorbed depreciation
provided the amalgamated company carry on the
business of the amalgamating company for at least 5
years – s. 72A
• Use of Reverse merger to meet above condition
Spin-off receives tax benefits under Income Tax
Act only if it is a demerger
36
Slump Sale
ISSUES: TAXATION
Slump Sale = Transfer of undertaking without
itemizing individual assets and liabilities- s.2(42C)
Income Tax Act
Treated as capital gains
If undertaking is older than 3 years, long term capital
gains rates apply even if individual assets are new
Carry forward of losses and unabsorbed depreciation
unavailable
37
Merger & Demergers
ISSUES: SALES TAX
No Sales tax on Amalgamation or demerger.
Where effective date is retrospective, any transfers
between amalgamating company and amalgamated
company retrospectively cease to be liable to sales
tax- Mad HC Castrol Oil v. State of TN, 114 STC 468
Some Sales Tax enactments contain specific
provisions to tax such transactions eg. S.33C,
Bombay Sales Tax Act. No such provision in Central
Sales Tax Act.
38
Merger
ISSUES: STAMP DUTY
Divergences between states: Shopping for beneficial rates
usually pointless
Duty to be imposed on value of shares transferred not on
individual assets transferred: Bom HC in Li Taka AIR 1997
Bom 7
States with Specific entries: Maharashtra, Karnataka,
Rajasthan and Gujarat
39
Merger
ISSUES: STAMP DUTY
States without specific entries: Unclear if duty leviable.
• Cal HC in Madhu Intra Ltd. v. ROC, 2004 (3) CHN 607 -
394 Order is not an instrument chargeable to duty
• Supreme Court in Ruby Sales v. State of Maharashtra
(1994) 1 SCC 531 - specific inclusion of civil court
decrees in Bombay Stamp Act only abundant caution
1937 Notification under Indian Stamp Act, 1899 remits
duty when merger is of a 90% subsidiary: Remission
not available in states with own legislations eg. Kerala,
Karnataka, Maharashtra, Gujarat and Rajasthan
Gujarat and Maharashtra have limits on stamp duty for
mergers and demergers at Rs.10 crore and Rs. 25
crore. 40
Merger
ISSUES: SEBI
Acquisition of shares pursuant to a scheme of
arrangement or reconstruction under any law, Indian
or foreign – exempt from SEBI Takeover Code.
Exemption claimed unsuccessfully by Luxottica in the
acquisition of Ray Ban Sun Optics India
Listing Agreement:
• Scheme before the Court/ Tribunal must not violate,
override or circumscribe the securities laws or stock
exchange requirements
• Disclosure required
41
Merger
ISSUES: SEBI
Shares allotted by unlisted transferee company to
shareholders of listed transferor company under a
HC sanctioned scheme – can be listed without an
IPO subject to conditions (DIP).
Eg. Dabur Pharmaceuticals
Constitutes ‘Price Sensitive Information’ in terms of
Insider Trading Regulations.
Compliance with Delisting Guidelines if public
shareholding below prescribed limit.
42
Mergers
MISCELLANEOUS ISSUES
Foreign Exchange Management Act, 1999
• Where the amalgamated company is Indian, non
resident shareholders of the foreign amalgamating
company require RBI approval to receive shares.
• Where the amalgamated company is foreign, the
issue of its shares to Indian shareholders requires
RBI approval.
• Automatic route available where non residents have
to be issued shares in a merger of Indian companies.
43
Mergers
MISCELLANEOUS ISSUES
Human Resources
• Workmen entitled to retrenchment benefits
unless retained in employment on same terms.
• Adjustments of pay scale needs to be resolved.
Global Trust employees were retained on same
terms in OBC. Pay packages of former GTB staff
could be altered only after 3 years. OBC
management had to contend with GTB’s complex
salary structure.
44
Mergers & Acquisitions
COMPETITION LAW
Monopolistic and Restrictive Trade Practices Act,
1969
• Status: Repealing provision in Competition Act, 2002
not notified.
• No Central Government approval required for a merger
or acquisition under the MRTPA
• Act attracted only if amalgamated company discovered
to be monopolistic in its working not at stage of
amalgamation- Hindustan Lever, 1995 Supp (1) SCC
499
45
Mergers & Acquisitions
COMPETITION LAW
Competition Act, 2002 (Partially notified)
• Merger or Acquisition = “Combination” if stipulated
thresholds respecting aggregate asset or turnover
are exceeded
• Prior approval of combination is not mandatory
• Test – “Cause or likely to cause an appreciable
adverse effect on competition within the relevant
market”
46
