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
Overheads: Size really does matter
IOC & IBP
Sharing
• 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
DEMERGER
Spin Offs
OTHERS
ASSETS
Acquisitions
SHARES
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/21
appropriate authorities
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
23
fresh issue or by disinvestment.
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
Transfer assets and liabilities
B
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.
A
B
D
C
27
Spin-Offs
STRUCTURE
X
Transfer of undertaking Y
Y
Company A
Y
Consideration in cash
Company B
or issue of shares
 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
X
Y
Company A
Transfers undertaking Y
Shareholders
of
A
Y
Company B
Issues shares
29
Merger & Demerger
PROCESS
Phase- I
 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 30
Time and Costs
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”
33
• Tax benefits are unavailable under this route
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 companys. 47
 Exemption may not be available if members of
amalgamating company receive anything besides shares
in the amalgamated company like debentures or cashGujarat 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
40
crore.
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
shareholding below prescribed limit.
if
public
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