Mergers: Tool to Survive the Second Wave of Covid19
The term ‘Merger’ is not defined clearly under any enactment. But can be defined as the voluntary amalgamation of two companies on broadly equal terms into one new legal entity. Mergers often lead to an increased value creation for the corporation. It is a way for the corporations to expand their reach, expand into new segments, or gain market share.
How does a Merger Work?
A merger is a voluntary combining of two companies legally into one legal entity. The companies should have similar sizes, values and customer bases to be a merger and not an acquisition. If both parties expect to benefit from the merger, it qualifies as a “merger of equals.” Successful mergers can accomplish a variety of results. Merged companies often gain market share, reduce manufacturing costs, expand to new locations, increase revenues, and combine production of common products. All of these results will directly benefit the shareholders of the new company. After the merger, the shares of the new company are distributed to the original shareholders of the previous company.
Benefits of Mergers for Small Businesses amid the Second Wave of Covid19
- If the business is underperforming or is struggling with regional or national growth it may well be less expensive to buy an existing business than to expand internally.
- It will be cheaper to buy up new intellectual property, products or services than developing these alone.
- With the advancement of technology, it is difficult for small businesses to cope up with the technology due to financial restrictions. Mergers will help them in giving exposure to new technologies.
- With size, comes some economies of scale. So, mergers can be a faster route to business growth then organic growth to increase its sales margins by spreading costs out over a larger customer base.
Precautions before entering into a Merger
- Evaluate the financial feasibility of the company and analyse the financial ratios that helps to determine the current situation of the company and the future prospects of the same.
- Ensure that you have a team in place with the experience to assess a transaction, complete an investment, forecast its performance and tolerate sensitivities around the results.
- Determine operational and organisational challenges the companies may face after the merger and keeping the eyes open to potential roadblocks as much as the benefits of a target.
- Detailed study of company’s past data should be done which will help to develop Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis. It will also help to overcome obstacles, if any.
- An expert should be appointed so that a proper due diligence can be done to execute a check for a company.
Advantages of Post-Covid Merger
One of the main objectives of an entity is GOING CONCERN. Many business organisations shut down as a result of covid due to lack of resources in operating their routine transactions. The most suitable solution for small scale businesses post covid is merger. Mergers will lead to expansion of resources, retention of employment, fund rotation, adequate balance of demand and supply etc. As the firms emerge from the pandemic, mergers would be the best way to come out of the financial stress for small businesses. It will help leaders gain economies of scale or at least the potential to run more efficiently. Once the economy recovers and accelerates out of recession, the small businesses can take advantage of the environment to execute its strategic acquisition agenda and to position the business to exceed industry-average growth. Mergers are a great way to lock down your business and create job opportunities, allowing customers to access your products and services. It will be a mutually beneficial situation.
Disadvantages of Post-Covid Merger
Post-Covid, it will be difficult for the companies to combine two separate sets of employees to work together effectively with shared goals as that will require a common understanding and establishing common norms and values which would have been long gone during the pandemic.
Key Points for an Equitable Merger
- A merger of equals is where two companies of the same size combines to form a new entity resulting in a reduction of costs, the creation of synergies, and a reduction in competition, as there is no longer competition between the two companies for the same market share.
- The board of directors of the new company consists equally of members from each individual company. Power-sharing between the two executives will be as per the agreement.
- The merger is structured as a “stock-for-stock tax-free exchange,” where shareholders relinquish their old shares and receive the shares of the new company. The most difficult aspect of a merger of equals, is trying to combine two different corporate cultures into one.
- Both companies need to define the various roles, strengths, and weaknesses of both companies that will come into play in the new entity.
Procedure of a Merger
Before the companies get into a merger there is a process which they need to follow to get their merger registered under the Companies Act, 2013. The process is as follows:
- Examination of object clauses
- Intimation to stock exchanges
- Approval of the draft merger proposal by the respective boards
- Application to National Company Law Tribunal
- Joint Application
- Dispatch of notice to shareholders and creditors
- Holding of meetings of shareholders and creditors
- Petition to the National Company Law Tribunal for confirmation and passing of orders
- Filing the order with the registrar
- Transfer of assets and liabilities
- Issue of shares and debentures
Documents Required for a Merger
Documentation will depend on the nature of transaction. However, generally the following documentation will be required:
- Documents for obtaining approval from the Board of Directors and Shareholders of both the acquirer and target company, wherever applicable
- Scheme/Petition to be filed before the concerned authority
- Notices to the shareholders and creditors
- Consent from the shareholders and creditors
- Notice to be published in newspaper
- Public Announcement in case of acquisition of shares of a listed company
- Various affidavits, declarations and other documents
- Share subscription/ purchase agreement
- Share Transfer form and
- Reporting to stock exchanges in a prescribed format in case of a listed company, as applicable
Legal Compliances for Merger
Foreign Exchange Management Act (FEMA), 1999 and Reserve Bank of India
The Reserve Bank of India (RBI) notified the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 and they have come into effect from March 20, 2018. The Regulations provide the guidelines for mergers and amalgamations between Indian and foreign companies, covering both, inbound and outbound investments. As per Regulation 3, no person resident outside India shall acquire or transfer any security or debt or asset in India on account of cross border mergers except in accordance with the FEMA Act. Where inbound mergers are concerned, the resulting company may issue or transfer any security to a person resident outside India in accordance with the guidelines and conditions provided in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017. In case of outbound mergers, residents of India may acquire or hold the resulting company’s securities in accordance with the Foreign Exchange Management (Transfer or issue of any Foreign Security) Regulations, 2004. Regulation 9 further states that the resultant company or companies involved in the cross border merger shall be required to furnish reports, as may be prescribed by the Reserve Bank of India. Cross border mergers lead to inflow of Foreign Direct Investment in the country, and hence would be required to comply with FDI policy of India.
Income Tax Act, 1961
In order for a merger to be tax neutral, it must satisfy specific criteria and qualify as an amalgamation under the Section 2 (1B) of the Income Tax Act, 1961 which defines the term ‘amalgamation’ as the merger of one or more companies with another company or the merger of two or more companies to form one company. The company (entity) or companies (entities) which so merge are referred to as the amalgamating company or companies, and the company with which they merge or which is formed as a result of the merger, as the amalgamated company.
Goods and Services Tax (GST) Act, 2017
Under the GST regime, Central GST and State GST is levied on all intra-state supplies of goods and/ or services, and Integrated GST is levied on imports and all supplies of goods and/or services undertaken in the course of inter-state trade or commerce. Since a ‘business’ per se does not qualify as ‘goods’ or ‘services’ under the GST Act, no GST is levied on slump sale transactions. Further, since ‘shares’ are covered under the definition of ‘securities’ and ‘securities’ are specifically excluded from the ambit of ‘goods’ under the GST law, there would be no GST incidence upon transfer of shares, including in case of amalgamations and demergers.
Further, in a case of transfer pursuant to sanction of a scheme or an arrangement for amalgamation or, as the case may be, demerger of two or more companies pursuant to an order of, Tribunal, the transferee shall be liable to be registered, with effect from the date on which the Registrar of Companies issues a certificate of incorporation giving effect to such order of the Tribunal. Section 18(3) of the GST law also permits transfer of unutilized GST credit to the transferor in the case of transfer of a business. Further, Rule 41 of the GST Rules prescribes Form ITC-02 which is required to be submitted by the transferor furnishing complete details of merger along with the details of unutilized input tax credit lying in the hands to the transferee. The transferor shall also submit a copy of a certificate issued by a practicing chartered account or cost accountant certifying that merger has been done with a specific provision for transfer of liabilities.
As per Section 87 of the GST, the transactions between two or more companies during the intervening period (period between appointed date and effective date) are liable for GST.
Competition Act, 2002
Sections 5 and 6 of the Act and the Competition Commission of India CCI (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 (Combination Regulations) are the prime laws dealing with combinations. Any merger that meets the jurisdictional thresholds, as provided in Section 5 of the Competition Act, 2002 is a “combination” for the purpose of the Act. The thresholds relate to the assets and turnover of the parties to the combination, i.e., target enterprise and acquirer or acquirer group or merging parties or the group to which merged entity would belong. The Act requires mandatory notification of all combinations. All combinations must be notified to CCI prior to the same coming into effect. However, the CCI has also relaxed the norms for small enterprises in this regard. Transactions where the value of assets / business / division / portion being acquired i.e. Target Business, taken control of, merged is not more than Rs. 350 crores in India or turnover of said Target Business of not more than Rs. 1,000 in India, are exempt from the provisions of Section 5 of the said Act for a period of five years from 29th March, 2017. In cases where the enterprises are engaged in similar business and their combined market share post combination is more than 15%, or engaged at different levels of the production chain in different markets, and their individual or combined market share is more than 25% in the relevant market, Regulation 5 (3) recommends parties to file their notices in Form-2.
Companies Act, 2013
Being a corporate action, it is subject to compliance of regulations and procedures prescribed by Companies Act, 2013 (as amended from time to time), rules, orders and other circulars as issued by the Ministry of Corporate Affairs in this regard Sections 230 to 240 of the Companies Act, 2013 and, the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 specifically contain the provisions regarding mergers and amalgamations. Further, the Companies Act, 2013 has introduced the concept of Fast Track Merger ‘for Small Companies and merger of Holding companies with its wholly owned Subsidiary Companies.
Section 233 of Companies Act, 2013 read with Rule 25 of Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 deals with the procedure. It is a unique concept as unlike other companies, a scheme of merger or amalgamation entered into between two or more small companies or, a holding company and its wholly-owned subsidiary company does not require approval of the High Court. Only the approval of regional directors, Registrar of Companies and Official Liquidator is required. Thus the small companies do not have to go through unnecessary formal and other processes for getting the scheme of merger approved. Further, Section 234 of the Companies Act, 2013 permits mergers between Indian and foreign companies with prior approval of the Reserve Bank of India (“RBI”)with effect from April 13, 2017. The procedure prescribed under CA 2013 for undertaking mergers must be followed.
Famous Mergers in India
In April 2017, Flipkart Group announced a merger with India’s eBay division, raising 1.4 billion USD from global high-tech giants eBay, Tencent and Microsoft. E-bay sold its business to Flipkart to invest 500 million USD in cash and acquired an equity stake in Flipkart. This transaction allows Flipkart customers to use eBay’s global stock to access a variety of product options, while eBay customers can access Indian stocks with even more rewards. Flipkart will continue to function as an independent entity on eBay.
In August 2016, Aditya Birla Nuvo Ltd (ABNL) announced the merger with Grasim Industries Ltd (Grasim) to liberalize shareholders’ value and create 9 billion USD (60,300 crore INR) enterprise.
In 2017, India’s largest oil producer, Cairn India Limited (Cairn), merged with Vedanta Limited (Vedanta), metals and mining giant in a share-deal of 2.5 billion USD. Equity and preference shares of Vedanta were allotted to public shareholders of Cairn.
The recent merger which took place in 2020 is between Indus Towers and Bharti Infratel. Vodafone Idea, which had a stake in Indus Towers also received a cash consideration. The new entity was named as Indus Towers Limited and was listed on both National Stock Exchange of India Limited and Bombay Stock Exchange.
The COVID-19 crisis has had a profound impact on humans and the economy, but history suggests how mergers will play out. As the M&A market shrinks, M&A tends to outperform those that do not. There is no doubt that the pandemic slowed down mergers. There is a pause and, indeed, disruption. Potential leaders must balance risk and liquidity by balancing inflation flexibility and growth opportunities. Actions corporations take now will affect its present and future existence. In the coming months, mergers will be phased out according to industry, sector, severity of weakness and growing market demand. We all face a cycle of short-term stabilization measures with strategic steps to create a new future for businesses and industries. Now is the time to manage your business carefully. Through multiple mergers and acquisitions, management is raising the level of emergency response and making a difference for the future. Companies that benefit from mergers and acquisitions are part of the overall 12-year crisis response. Those who leverage M&A well as part of a holistic response to the crisis over the next 10-12 months will be more likely to outmanoeuvre uncertainty and outperform those who do not in the next three to seven years.
Authored By: Adv. Anant Sharma & Aashita Khandelwal