Brief on Cross Border Mergers

CROSS-BORDER MERGERS

I.          Introduction

1.1       We live in a global village! Globalisation and technological innovations have triggered a slew of restructuring initiatives the world over. India is in the forefront from this restructuring wave. In fact several global investors are asking international companies whether they have an Indian connection?

1.2       Today, more than ever, India is witnessing a number of cross-border Mergers and Takeovers. Foreign companies being merged into Indian companies, Indian companies taking over Foreign companies, and Foreign companies taking over Indian companies are all becoming everyday news.

1.3       With such a plethora of cross-border transactions taking place, it is essential to consider the legal aspects of these deals. This column proposes to examine some of the aspects involved cross-border restructuring over the next few Articles.

II.        Merger of a Foreign Company with an Indian Company

2.1       The Companies Act, 1956 permits such a merger. However, the position is not so clear under the FEMA.  When F Co merges into I Co, shareholders of F Co would be allotted shares in I Co. The questions which arise under various laws are examined hereunder.

2.2       Companies Act, 1956

Any merger involving an Indian Company would be governed by the Companies Act, 1956. Sections 391 to 394 of the Act deal with Mergers of companies.  S.394 of the Act provides for facilitating amalgamation of companies. S.394 states that the section only applies to a Transferee Company which is a company within the meaning of the Act, i.e., an Indian Company. However, the Transferor Company is defined to include any Company, whether Indian or Foreign. Hence, as F Co., i.e., the transferor company can be a foreign company, the provisions of s.391-394 are applicable. The recent decision of the Andhra Pradesh High Court in the case of Moschip Semiconductor Technology Ltd., 120 Comp. Cases 108 (AP) clearly supports this point. This case dealt with the merger of a company incorporated in California, USA with an Indian Company. The Andhra Pradesh High Court held that in light of the clear legal position under the Companies Act, there could be no legal bar for entering into a scheme between a foreign company and an Indian company. The Court further held that in the days of globalisation, a liberal view is expected to be taken enabling such scheme of arrangements between domestic and foreign companies.

The decision of the Karnataka High Court in the case of Bank of Muscat, (2004) 120 Comp. Cases 340 (Kar) is also relevant.  A very interesting issue arose in this case.  The case dealt with the merger of a foreign banking company which operated in India through a branch. The registered office of the bank was in Karnataka. However, pursuant to the provisions of the Companies Act, which requires all foreign companies to file their documents and get registered with the Registrar of Companies, Delhi, the company was registered with the Registrar in Delhi.  A scheme for merger of this foreign company with an Indian bank was presented before the Karnataka High Court where the company’s registered office was located.  An issue arose as to whether the scheme should be presented before the Registrar of Delhi or Karnataka. The Court held that the scheme was correctly presented before the Registrar of Karnataka since the test for determining the jurisdiction was where  the company’s registered office was located and not where the company was registered.

S.394 requires certain conditions to be fulfilled by the Transferor Company, subsequent to which the High Court would grant permission for a merger. In this case since  the Transferor Company is F Co, it is a moot point  as to how the Indian courts would supervise the Merger Scheme. I Co has to file a petition in Indian courts and F Co in foreign courts if required.

2.3       Foreign Laws

2.3.1    Some foreign jurisdictions, e.g.,  England, Jersey, do not permit the merger of their companies with foreign companies (Indian companies). Thus, the Indian as well as the foreign law on mergers should be considered.

2.3.2    If F Co is a company listed in any stock exchange abroad, then the disclosure and compliance requirements of that stock exchange would need to be fulfilled. For instance,  in the USA, the Securities and Exchange Commission has prescribed various disclosure requirements in such a case. In the USA, for instance, in case of a corporation which is fully owned by non-US citizens, its activities might be restricted and /or it might have to pay additional taxes because of its foreign citizenship. In addition, there are certain reporting requirements for foreign controlled companies such as under the International Investment and Trade in Services Survey Act or the Tax Equity and Fiscal Responsibility Act, 1982. 

2.3.3    In the USA there are state laws in addition to the federal (central) law on mergers. Some states for instance,  require that  a non-US company must form a subsidiary within the USA in order to consummate a merger with a US company. In case the state in which F Co is registered is different from that of the state in which the subsidiary is formed, then the respective laws of both the states need to be complied with.

2.4       FEMA Provisions

This issue is likely to be the biggest stumbling block in such a cross-border merger. The Foreign Shareholders of F Co would now become shareholders in I Co. Thus, I Co would have foreign shareholding but there would be no inflow of foreign funds into the Company. The Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 cover a situation where foreign shareholding arises by virtue of merger of two Indian companies but does not envisage a situation of a Foreign Company   merging into an Indian  Company. Thus, the issue of shares by I Co to foreign shareholders of F Co would require the permission of the FIPB and /or Reserve Bank of India under the aforesaid Regulations.  Considering the rapid pace at which global mergers are being witnessed and the increasing Indian participation in such merger, it is not only desirable but quite necessary that the FEMA Regulations expressly cover  such a situation. 

2.5       Competition Act

Once all the provisions of the Competition Act, 2002  become applicable, the prior permission of the Competition Commission under should be obtained whenever the same is applicable.

2.6       Stamp Duty 

Stamp Duty is a state subject and hence, the exact impact would have to be examined in the light of the applicable law. However, the broader incidence would be more or less the same in all states. To illustrate the point, let us take the example of the Bombay Stamp Act, 1958. The term conveyance is defined under s.2(g) of the Act to include every order of the High Court u/s.394 of the Companies Act in respect of amalgamation of companies by which property is transferred to any person. Now in case of  a merger of a Foreign Company into an Indian Company, there is no order of an High Court by virtue of which property of an Indian Company is transferred, nor is the property being transferred located/situated  in   India. What is being transferred is foreign property of a Foreign Company. However, issue of shares to the  shareholders of F Co would attract stamp duty @ 0.7% if  I Co is located in Maharashtra.

III.       Transaction Structuring      

3.1       Structuring the transaction is a matter of detailing and would have to be dovetailed to suit individual requirements. The structure adopted in most cases. Is that the foreign company directly merges into the Indian company. However, some of the other possible structuring  options which are being used in the USA  include,  a one-step transaction or a two-step transaction.

3.2       In a one-step transaction, the Acquirer floats a 100% subsidiary which would merge into the Target Company. Upon merger, the shareholders of the Target Company receive cash on merger and the shareholders of the Subsidiary, i.e., the Acquirer receives the entire shares of the Target   Company. In this case, the Target Company requires to solicit proxies from the shareholders and it must vote the proxies at a meeting of the shareholders called to approve the merger. There are procedures laid down for the manner in which these proxies are to be solicited and voted.

3.3       In a two-step transaction, the Acquirer floats a 100% subsidiary which makes an open offer for the shares of the Target Company. After it obtains the desired percentage of voting power, the Subsidiary is merged with the Target Company and the shareholders of the subsidiary, i.e., the Acquirer  receives the entire shares of the Target   Company. Those shareholders of the Target Company who did not sell their shares in the open offer would now receive cash.

3.4       The difference between the one-step and two-step approach is one of timing. The two-step approach can be completed very soon and there are lesser filings to be done with the Securities Exchange Commission. On the other hand, in the one-step approach or proxy solicitation method, the proxy materials must be submitted for review to the SEC and this process takes some time. Further, the shareholders’ meetings  require some time before they are conveyed. Thus, the entire process to gain control could take longer.

IV.       Merger of an Indian Company with a Foreign Company

4.1       Let us now examine whether an Indian Company can merge into a Foreign Company. In such a case, the shareholders of the Indian  Company would be allotted shares in the Foreign Company.

4.2       Companies Act, 1956 

            The provisions of sections 391 to 394 of the Companies Act deal with Mergers. S.394 states that the section only applies to a Transferee  Company which is a company within the meaning of the Act, i.e., an Indian Company. However, the Transferor Company is defined to include any Company, whether Indian or Foreign.

Thus, in this case, the Transferor is an Indian Company but the  Transferee is a Foreign Company. Hence, the  provisions of  s.394 would not apply to a merger of an Indian Company  into a Foreign Company. It is a moot point as to how such a merger can be consummated?  This is the biggest stumbling block to such cross-border mergers. It is submitted that with the increase in India-centric business decisions,  the law  requires an urgent amendment to deal with such situations. This is one area where a representation needs to be made to the legislators to amend the law.

4.3.      FEMA provisions

            The Indian resident shareholders would become shareholders in a Foreign Company by virtue of the merger. The Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2000 are relevant in this respect.   These regulations permit Indian companies to acquire shares of foreign companies under certain circumstances. Individuals are also permitted to acquire shares of a  foreign company but only under certain cases. The Regulations  do not envisage a situation wherein Indian shareholders of an Indian Company may be allotted shares of the Foreign Company.

To enable the Indian shareholders to hold shares in the Foreign  Company, the Indian Company would have to seek the prior permission of the RBI for the merger scheme (assuming that the merger is possible under the Companies Act). RBI’s permission would be an essential condition for the success of the merger.  Here too, an amendment to the Regulations would be highly desirable. However, till such time as the Companies Act is amended, any amendment to the FEMA Regulations would be of little solace.

4.4.      Stamp Duty implications

            As stamp duty is payable on a document and not on a transaction, it would be payable on the document which is executed for transferring the properties of the Indian Company. The rate of duty applicable would be that as is applicable on a conveyance. 

4.5.      SEBI Takeover Regulations

In case of a merger, the Indian shareholders would receive shares in the foreign company and there would not be any acquisition of the Indian company. Hence, even if the Indian company is  a listed company, the SEBI Takeover Regulations would not apply.

4.6.      Foreign laws

In addition to compliance with the Company Law of the foreign transferee company, if the Foreign Company is a company listed on any stock exchange abroad, then the disclosure and compliance requirements of that stock exchange would need to be fulfilled. For instance, in the USA, the Securities and Exchange Commission has prescribed various requirements. Besides, many countries such as the USA have an Anti-trust Law which aims at preventing monopolies and mega mergers which are harmful to the competition. These laws need to be considered while structuring a cross-border merger. In the UK, mergers and acquisitions may need the approval of the Monopolies and Mergers Commission. For instance, in the USA certain business combinations require filings and clearances with the Federal Trade Commission (FTC) or Department of Justice (DOJ) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the  HSR Act). The HSR Act requires parties to a merger to file certain information before the FTC and the DOJ before the merger proceeds. There is a minimum waiting period after filing the information with these agencies.  All mergers and acquisitions which satisfy certain conditions must be reported under the HSR Act. For instance, in the acquisition of Honeywell by GE, USA, the Agencies asked GE to divest certain businesses as the merger was contrary to the Anti-trust provisions.

V.        Directors’ Responsibilities

5.1       Directors of an Indian company into which a foreign company wants to merge should become aware of the requirements.  They should seek assistance of experts as to the legal and procedural requirements of the foreign country so that there are no last moment surprises.