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Cross Border Demergers In The Light Of The Sun Pharmaceuticals Case

Diversification and globalization are the keys to the future - Fujio Mitarai

Cross-border mergers are an increasing phenomenon in light of these concepts. While the widespread integration of markets on a global scale intensifies there comes about a need to assess the intricacies of the legal framework that facilitates and authorize the same.

The Ahmedabad Bench of the National Company Law Tribunal (herein referred to as the tribunal) on the 19th of December, 2019 passed a very controversial ruling with regards to the Sun Pharmaceutical Industries Limited’s proposed scheme of cross border demerger. The ruling inferred that the lack of clarity in the legal framework implicates the exclusion of cross border demergers as a permissible arrangement under the law.

Cross Border Mergers are primarily dealt under section 234 of the Companies Act 2013, Rule 25A of the Companies (Compromise, Arrangements, and Amalgamations) Rules, 2016 (herein referred to as the Compromises Rules) and the FEMA Cross Border Merger Regulations (2018) (herein referred to as the Merger Regulations).

The Facts Of The Sun Pharmaceuticals Case

Sun Pharmaceutical Industries Ltd had filed for a scheme of demerger to transfer of two of its investment undertaking from Indian entity, Sun Pharma to overseas wholly-owned subsidiaries. This would result in the consolidation of the holding structure of these overseas subsidiaries.

The Listed company had obtained approval from the Stock Exchange Board of India, shareholder and its creditors. It had also attained approval from other relevant regulatory authorities such as the Income-tax authorities and the Registrar of Companies and the deemed approval of the RBI.

The Tribunal rejected the scheme on the grounds that  outbound merger did not fall within the ambit of section 234 of the Companies Act 2013. Adopting a literal interpretation of the impugned provision, the tribunal observed that the section only stipulated for merger and/or amalgamation’ and thus did not include arrangements (which covers demergers).

The Tribunal also observed that the term arrangement was expressly used in section 230 to 232 of the act thereby implicating that to permit a demerger it would require its literal inclusion within the language of section 234.

The tribunal supported this interpretation with that observation that Rule 25A of the Compromises Rules 2016 was silent on demerger and dealt only with mergers and/ or amalgamations. Moreover, the final and notified draft of the Merger Regulations, 2018 intentionally excluded the term demerger despite its presence in the draft regulation. [i]
The tribunal thus emphasized that the specific exclusion of the term arrangement reflected the legislative intent to exclude cross-border demergers from the permissible arrangements.

Legislative Analysis

Section 234 is relatively brief in comparison to the scheme of section 230-233 of the Act. It states that provisions of the impugned chapter XV (which deals with Compromises, Arrangements and Amalgamations), unless otherwise provided shall mutatis mutandis apply to the scheme of mergers and amalgamation between and Indian Company and a foreign company.[ii]

In the 1956 Act, section 394 permitted for a foreign company to transfer its undertaking to an Indian company. This was applicable to mergers as well as demergers. Whereas, Section 234 of the 2013 Act broadens its scope by permitting inbound as well as outbound mergers but it only refers only to Mergers and Amalgamations. There express reference to demergers or arrangement.  The literal interpretation of section 234 to exclude cross border demergers can prove to be problematic as the legislative intent behind it was to have a progressive perception towards the law in respect to cross border transactions. [iii]

With regards to the Merger Regulations, 2018 in dealing with the most crucial definition, Section 2(iii) defines Cross Border Mergers to mean any merger, amalgamation or arrangement in accordance with the Compromises Rules and the Companies Act, 2013. It is important to note that the Draft Regulations expressly included the word Demerger and the same is reasonably implied within the ambit of the term arrangement in the above definition.[iv]

Nevertheless, there exists a conflict between this provision and Rule 25A of the Compromises Rules coupled with section 234 of the Act. As seen above, the latter only provide for Mergers and Amalgamations without any mention of arrangement. Primacy is given to the Companies Act as it is the governing legislation with respect to Arrangements, mergers and Amalgamation. This dichotomy of views creates an ambiguity as to the legal position on Cross Border Demergers as it is seen to be contemplated in the Merger regulations.

Critique Of The Order

Merger and demergers facilitate the inorganic acquisition or transfer of investment undertakings. A merger encompasses the acquisition of the entire business by another entity whereas a demerger is the transfer of a specific business undertaking. [v]

The tribunal in another ruling of Sun Pharma Global FZE passed an order approving for a scheme of inbound demerger. The tribunal took a broader interpretation of section 234 stating that the entire chapter would mutatis mutandis apply to schemes between Indian and Foreign Companies. Moreover, the Tribunal placed reliance upon regulation 9 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 which provides for demerger of Indian companies.[vi]

The ruling on the outbound demerger placed reliance on the deletion of the expression demerger from the notified version of the Merger Regulations. This is flawed as it fails to acknowledge that demerger would come within the ambit of arrangement.

There is an inconsistency in the position of law in both the orders. The exclusion of demerger from the permissible arrangements with foreign companies is found to be a rather disputable interpretation of the impugned provisions.

To rectify the situation it is important to have in place a comprehensive legislation that would detect and rectify any and all inconsistencies with the laws governing cross border mergers. Moreover, there must be a removal of exit barriers. Exit and demerging of companies is a consequence that should be considered by the legislative scheme of the act. This will not only provide legislative clarity but will also improve the ease of doing business in India.

Concluding Remarks
The narrow interpretation of the tribunal may act as a hindrance to the progressive intent behind the laws governing cross border mergers. There is a need for clarity in the position of the law with regard to these intricacies so as to ensure the fulfillment of their objective. Till such time the company may appeal against the order so as to get a favourable ruling or resort to alternative modes of restructuring.

  1. Sun Pharmaceutical Industries Ltd. No.38/NCLT/AHM/2019
  2. PWC,Mergers and acquisitions: The evolving Indian landscape, (February 2017), landscape.pdf
  3. Dr. Jamshed J. Irani, Expert Committee Report on Company Law (May 31, 2005),
  4. Cross Border Merger Draft Regulations, 2017. Regulation 2(iv), Cross border merger means any merger,
    demerger, amalgamation or arrangement between Indian companies and foreign companies in accordance with the Co. Rules.
  5. M. Nirmala, Corporate Restructuring And Companies Act 2013- An Impact Analysis, 1 IJMSRR 26,
    ( November 2014),
  6. Sachin Dave, Divya Rajgopal, NCLT rejects Sun Pharma’s plan to demerge overseas subsidiary, (Jan 02, 2020)

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