• Business transfers are a type of transaction under mergers and acquisitions.
• It is a general notion that acquirers are more inclined towards asset purchase than any other mode as it gives them the option of acquiring whatever assets they would like, however, the sellers don't prefer this, thus a midway has recently gained popularity which is either "business transfer" or "slump sale" as the new modes of acquisitions.
• In the Indian context, acquisition of a 'business' can be through, transfer of an entire undertaking as a going concern or transfer of just the selected assets that are required for the business. The transfer of an undertaking itself can be achieved in two different ways: one, a 'slump-sale' and the other, a court approved demerger. Since each of these modes of acquisition will have far-reaching and different implications for the buyer and the seller, the choice of structure that meets the expectations of the parties, complies with applicable legal requirements, and most importantly tax efficient is important.

What is a Business Transfer and Slump Sale?

• Business under Section 2(17) of the Goods and Services Tax Act, 2017, means any activity concerned with trading, commerce, manufacturing, profession, and ancillary services taken with a view to make a profit in money.
• Section 2(42C) of Income Tax Act, 1961, "Slump Sale means Transfer of one or more undertakings, by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales."
• It simply means the sale and transfer of the entire business undertaking of the seller as a going concern for a lump-sum consideration.
• ITA recognizes multiple forms of transfer under section 2(47) including 'transfer by way of sale' and 'transfer by way of exchange'. The erstwhile definition of slump sale under ITA makes it clear that transfer by way of sale is what would constitute a slump sale and not transfer by any other mode.

Transfer of an Undertaking

• Section 2(19AA) of the IT Act lays down that any part of an undertaking/unit/division of a business activity taken as a whole without assigning values to the individual assets and liabilities of the said business activity constitutes an 'undertaking' for slump sale.
• The parties could be allowed to identify and agree on the undertaking to be transferred and the constituents thereto without any restriction.
• However, the enterprise to be transferred has to meet the requirements under the ITA. The enterprise to be transferred must form an identifiable stand-alone business activity and also has to consist of all assets as well as liabilities including employees, contracts, and licenses that are necessary for conducting such business.
• Though in a slump sale, it is desirable to transfer all the assets and liabilities of the transferred business to the transferee, the judgment of Premier Automobiles Ltd. v. ITO (2003) 264 ITR 193 (Bom) has permitted the exclusion of some assets and liabilities provided such assets and liabilities are sufficient for the business to be run and generate revenue independently on its own account.

Transfer as Going-Concern

• Such transfer from the seller to the buyer, including all assets and liabilities, should not hamper or interrupt the conduct of the business and shall be simultaneous. The buyer shall, therefore, be under an obligation to be ready with infrastructure, license, and preparedness to run the business simultaneously with the consummation of slump sales.

 

Demerger:

• A de-merger is when the company spins off one or more divisions to operate either independently or be sold off.
• Demerger is defined under Section 2(19AA) of the Income Tax Act as "the transfer of one or more undertakings by a demerged company to another company."
• All the properties and liabilities of the undertaking, being transferred by the demerged company, immediately before the demerger, become the properties and liabilities of the resulting company by virtue of the demerger. They are transferred at values appearing in its books of account immediately before the demerger;
• In consideration of the demerger, the resulting company issues its shares to the shareholders of the demerged company on a proportionate basis;
• The shareholders holding not less than 3/4th in value of the shares in the demerged company become shareholders of the resulting company or companies by virtue of the demerger;
• The transfer of the undertaking is on a going concern basis.

Lump Sum Consideration:

• The slump sale consideration has to be an aggregated amount and no values can be assigned to assets and liabilities. He is acquiring an independent business, not individual assets. The value of the business has necessarily to be worked out as a whole and the aggregate consideration arrived. However, working out the value of an asset or liability for stamp duty, registration charges or other similar taxes should not be regarded as attributing value to individual assets or liabilities.
• Possibly, working capital may need to be adjusted for a period subsequent to the signing of the business transfer agreement and the actual date of transfer. However, the nature of the transaction should not be affected by reason of a working capital adjustment under the BTA in any case. This very issue has been addressed by the Bombay High Court in Premier Automobiles Ltd vs. ITO, wherein it has been held that even referring to the value of net current assets in a slump sale agreement does not mean the itemized sale of assets. Even deferred payment can be slump sale.

Business Transfer Agreement:

• A business transfer agreement may be defined as a legal agreement between a willing seller and a willing buyer of a business.
• Defines selling of assets or liabilities and provides for a full and sweeping transfer of ownership.
• The agreement should spell out the terms of the sale regarding type of transfer, tax liability, terms of sales, representation of the parties, lists of assets, liabilities, capitals, loans, contracts, customers, employees, insurance, and intellectual property.
• The agreement should be comprehensive in structure because corporate governance is quite complicated and it involves tax liabilities.
• To execute a business:
• Agreement to sell: This in essence lists the intention of parties entering into a business transfer agreement by way of sale, and it does not really affect the transfer yet, since there is no immediate transfer; it only provides for the procedure of such transfer if it comes into effect.
• Deed of Conveyance: A deed conveyance executes the actual sale or transfer of assets and liabilities to the purchaser, ensuring the agreement to sell comes into force after the transfer.

Essential Clauses in a Business Transfer Agreement:

1. Parties to the Agreement:

   • This clause simply identifies the parties who are entering into the said agreement and clearly provides for incorporating their correspondence details to identify them.
   • The residence aspects in relation to business need to be traced since without it, the nonresident cannot carry on business in India if he does not have in the territory of India a functional place of business.
   • Therefore, to give effect to such a business, a non-resident business has to establish a place of business in India and also adhere to the provisions of the Companies Act, 2013 with regard to the same.
      

2. Recital Clause:

   • The recitals clause which generally gives a background to the circumstances under which parties have entered into the agreement.
   • It is not an operative clause itself but a substantive clause setting out the current state of affairs between the parties, which is helpful in interpretation of the agreement in its entirety or particular clauses.
      

3. Transfer and Description of Transfer:

   • The transfer clause is that part of an agreement that outlines the procedure of transfer. This will define the nature of the transaction between the parties and outline the mode of transfer and associated liabilities thereof.
   • This clause should be carefully drafted, listing the assets and liabilities, and including a separate schedule annexed to the agreement, which will clearly indicate the assets and liabilities, and any encumbrances.
   • Hereby, the Seller is obliged to transfer, grant, sell, convey, assign, and deliver the business as a going concern to the Buyer, free of all encumbrances whatsoever, on the date of closing. The Buyer hereby agrees to accept, purchase, and acquire all the rights and interests of the Seller in the business and its assets and liabilities, including everything mentioned in Schedule A of this agreement, as an ongoing concern.
      

4. Representation and Warranties of the Parties:

   • The clause in business transfer agreement states that only a few representations need to be made for the agreement to be effective. On breach by any of the parties, the agreement can be withdrawn. Warranties mean the assurance given by a party to ensure that something is done. This clause embargo future right protection.
      

Confidentiality:

• Confidentiality in business transactions, especially in business transfers, can be fatal if the information to be exchanged between the parties spills out in the open market. It is, therefore, of essence to have confidentiality clauses that would protect the interest of parties and their information. In a business transfer agreement, the business is transferred with all the confidential information attached to it thus the need to have confidentiality over the information protected.

Indemnification:

• Indemnification means security against legal liability for other's actions. The concept of Indemnity is embodied u/s 124 of the Indian Contract Act, 1872 which states that "a contract whereby one party promises to save the other from loss caused to him by the conduct of the promisor himself or by the conduct of any other person is called a contract of indemnity".
• An indemnity clause is an important factor in business transfers, as this would protect the purchaser from unknown liabilities on assets and loans. It ensures that the interest of the buyer will be protected and that no dispute will occur in the future. This clause shall include all possible situations of indemnity.
• Seller's indemnification: The Seller shall defend the Buyer against all damages, penalties, costs, and expenses, including but not limited to reasonable attorneys' fees actually incurred by Buyer, that shall or may accrue to the Buyer by virtue of claims, actions, demands, or assessments arising out of breach by Seller of any of the warranties or covenants contained herein or in any instrument supplemental hereto.
• Purchasers' indemnification: The buyer agrees to release and save harmless the seller and its affiliates, directors, officers, employees, shareholders, members, partners, agents, attorneys, representatives, successors, and assigns from and against any loss arising from the undertaking, assets, employees, taxes, breach of representations or warranties, breach of covenants, transactions contemplated under this agreement, including tax liability, and usage of the seller's name in relation to the undertaking after the effective date.

Termination of the agreement:

• The termination clause is a very essential legal provision that itinerates how the agreement can be terminated on specified grounds or on breach of duty. It shall form part of the terms and conditions of the agreement and the consequences of termination.

Governing Law and Jurisdiction:

• This clause specifies under what laws the agreement and any matter incidental thereto be governed by and where does the jurisdiction of the dispute lie. This becomes essential especially in the cases of international entities.

Conclusion:

• Business transfers, largely through slump sales and demergers, remain an integral part of the mergers and acquisition scene in India. The legal definitions of these transactions are rather convoluted, with intricate tax issues, and this forms a challenge for buyers and sellers. Buyers usually prefer asset purchases because of the selectivity inherent in such deals; on the other hand, sellers are keen to sell whole undertakings since it is easier and cleaner.
• A slump sale or a business demerger is a complex legal and financial exercise involving issues such as lump sum considerations, comprehensive business transfer agreements, and compliance with specified conditions precedent. Business transfers in the form of slump sales or demergers would call for detailed due diligence, clear-cut representations, and warranties having confidentiality assurances, indemnity clauses, and specific termination conditions to protect the interest of both the parties.
• In the final analysis, the transfer method must be selected to square with the parties' strategic goals that ensure compliance with laws and regulations, minimize tax liabilities, and offer least disruption to the ongoing business operations. Proper structuring of the business transfer agreement and complying with the laws and jurisdiction governing such agreement should achieve a successful and mutually beneficial transaction.