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Mergers & Acquisitions


While some Indian corporates have been bold acquirers in big-ticket overseas acquisitions, such transactions are rare, often complex, and risky. Indian acquirers have typically used internal accruals or resorted to overseas debt to finance offshore acquisitions due to regulatory restrictions preventing them from using their stock as consideration for the acquisition. Recent liberalisations in the overseas investment framework suggest that this constraint may be going away. While these regulatory changes may provide additional structuring options for cross-border M&A/ restructuring, decisions of certain tribunals on these (relatively recent) amendments may play spoilsport.

With this article, we take you through these recent regulatory changes and also certain judicial decisions that muddy the analysis of whether cross-border demergers are permissible under the automatic route.

Cross-border schemes of arrangement – Changes in law

From 2004 to 2022, overseas investments by Indian entities were governed by the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004. In August, 2022, the Foreign Exchange Management (Overseas Investment) Rules, 2022 (“OI Rules”), and the Foreign Exchange Management (Overseas Investment) Regulations, 2022, were notified with the stated objective of promoting ease of doing business in India by creating a simplified legal framework for overseas investments by Indian entities.

In 2017, the Ministry of Corporate Affairs (“MCA”) notified Section 234 of the Companies Act, 2013 (“Act”), titled ‘Merger or Amalgamation of Company with Foreign Company’, thereby formally recognising cross-border mergers. Simultaneously, Rule 25A was included in the Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016 (“CAA Rules”), providing for mergers or amalgamations of foreign companies with Indian companies and vice versa. While these provisions ostensibly opened the door to cross-border schemes of arrangement, they presented only a partial picture, since the Act and CAA Rules specified that such schemes required prior Reserve Bank of India (“RBI”) approval and only permitted transactions with foreign companies incorporated in limited jurisdictions. The missing piece of the puzzle was supplied by the RBI, when it notified the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“2018 Regulations”), for implementation of cross-border mergers.[1]    

Other views emerge

Despite the clear regulatory intent to allow cross-border schemes, the legality of such transactions remained murky due to developments before various National Company Law Tribunals (“NCLT”). In one such case, the Regional Director, North Western Region, objected to a demerger of a foreign undertaking to an Indian entity, on the basis that the text of Section 234 of the Act (extracted below) only refers to a “merger or amalgamation” and does not contemplate “demergers”.

S. 234(1):                “The provisions of this Chapter unless otherwise provided under any other law for the time being in force, shall apply mutatis mutandis to schemes of mergers and amalgamations between companies registered under this Act and companies incorporated in the jurisdictions of such countries as may be notified from time to time by the Central Government.” (emphasis supplied)

On October 31, 2018, the NCLT, Ahmedabad, issued an order overruling the Regional Director’s objection and sanctioning the demerger (“Inbound Demerger Case”).[2] In coming to its decision, the NCLT relied on Section 232 and noted that despite its title reading “Merger and amalgamation of companies”, Section 232 actually contemplated a broader range of transactions, including demergers. The NCLT adopted a broad reading of the term “mergers and amalgamations” based on Section 232 and given the mutatis mutandis language in Section 234, ruled that a similar understanding can be imported to allow demergers under Section 234.

While the legality of inbound demergers were therefore clearer, the NCLT, Ahmedabad, thereafter issued an order[3] casting doubt on the legality of outbound demergers, (i.e., acquisition of an Indian undertaking by a foreign entity) (“Outbound Demerger Case”), reopening the debate on cross-border demergers once again.

In the Outbound Demerger Case, an Indian entity sought to transfer certain Indian undertakings to its overseas subsidiaries through a demerger.[4] The NCLT disallowed the demerger, on the basis that: (i) Section 234 of the Act and Rule 25 of CAA Rules only refer to “mergers and amalgamations” and do not contemplate demergers or other schemes of arrangement; (ii) the notified version of the 2018 Regulations contained the following changes to the definition of “cross-border mergers” from the definition contained in a draft of 2018 Regulations:

Cross border merger means any merger, amalgamation or arrangement between Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 notified under the Companies Act”

In the NCLT’s view, these changes suggested an intention to exclude demergers from the scope of permitted cross-border transactions. In the concluding paragraphs of its order, the NCLT made a broad observation that cross-border demergers (i.e. whether inbound or outbound) are not permitted.

While the NCLT’s order notes the contrary finding in the Inbound Demerger Case, it did not enter into a detailed discussion on why it disagreed with the rationale adopted in the Inbound Demerger Case. Additionally, the NCLT’s view that the 2018 Regulations do not permit demergers appears somewhat unfounded, given that the parties to the demerger in the Outbound Demerger Case had obtained deemed approval for the restructuring from the RBI. One would assume that if the RBI’s intention was to indeed prohibit such transactions under the 2018 Regulations, such deemed approval would not have been forthcoming.

Implications of OI Rules on Cross-Border Demerger

The OI Rules appears to create a conducive environment for Indian entities to invest abroad and capitalise on overseas opportunities, including M&A transactions. Interestingly, their enactment may have reopened the discussion on whether cross-border demergers are permissible.

Rule 11, read with Schedule I of the OI Rules, indicates that an Indian entity may make overseas direct investments by various routes, including “merger, demerger, amalgamation or any scheme of arrangement as per the applicable laws in India or laws of the host country or the host jurisdiction, as the case may be.” Similarly, Rule 13, read with Schedule III, suggests that Indian individuals may hold overseas direct investments or overseas portfolio investments by way of “swap of securities on account of a merger, demerger, amalgamation or liquidation.

At the minimum, these changes address some of the issues raised by NCLT, Ahmedabad, in the Outbound Demerger Case and appear to signal the RBI’s willingness to allow such transactions, at least from a foreign exchange standpoint.

That said, NCLT, Ahmedabad’s, objections to outbound demergers based on the omission of a specific reference to “demergers” in Section 234 continues to remain open. Since there are different views on interpreting this provision (indeed by the same NCLT), one hopes that regulatory clarity will emerge either through an amendment to this provision, clarity from the MCA or alternatively, a decision on this point by an appellate authority.

[1] RBI Notification No. FEMA. 389/2018 dated March 20, 2018.

[2] 2018 SCC Online NCLT 28560 dated October 31, 2018.

[3] 2019 SCC Online NCLT 737 dated December 19, 2019.

[4] Coincidentally, though both the Inbound Demerger Case and the Outbound Demerger Case involved the same petitioner (i.e. Sun Pharmaceuticals Industries Limited) and the same NCLT (i.e. NCLT, Ahmedabad), the tribunal nonetheless came to divergent views in the two decisions.