How the EU Mobility Directive Shapes Indian Cross Border Demergers?

[Runjhun is a student at Dr Ram Manohar Lohiya National Law University.]

The European Parliament, issuing a formal green flag to cross border demergers (CBDs), enforced the EU Mobility Directive this year. The directive provides a legal framework concerning CBDs, delineating channels of CBDs and the extent of its application on the concerned undertakings. However, a noteworthy aspect of EU jurisprudence is that even before the directive, the courts interpreted the extant legislations in a manner that permitted CBDs and treated them no different than domestic demergers to uphold the economic freedom incorporated under Article 49 of the Treaty on the Functioning of the European Union. The complexity of fructifying a CBD was deemed such that it necessitated the birth of the said directive. In India, the approval of CBDs is reliant upon the discretion of judiciary which renders the stakeholders of a CBD in an uncertain and murky position. In light of the aforesaid, the author proposes a formal mechanism for the governance of CBDs, the inspiration of which can be sourced from the EU model of cross border demerger governance.

Is a Separate Mechanism Truly Required?

For a vivid understanding of the extant system of CBD governance in India, discussing the Sun Pharma matter to highlight the drawbacks of reliance on judicial interpretation becomes imperative. The National Company Law Tribunal, in one of its orders, rejected Sun Pharmaceutical’s application of an outbound demerger entailing the transfer of its investment undertakings to two overseas resulting companies citing the text of Section 232 of the Companies Act 2013. It noted that the section only refers to ‘mergers and amalgamations’ and even Rule 25A entails a framework for the governance of cross border mergers and does not contemplate demergers. It is noteworthy how this order runs in the face of the tribunal’s prior order, wherein the application of an inbound demerger of an undertaking of Global FZE to Sun Pharmaceuticals was approved. The differential interpretation of law in both the matters exposes the inconsistent reasoning by the tribunal and hence, makes a favorable case for a separate framework for CBDs in the Companies Act 2013.

Another frequently raised contention is that the required outcome of a cross border demerger will anyways be accomplished by alternative existent routes in the Companies Act 2013. An Indian entity willing to demerge into an overseas entity can achieve so by undergoing a domestic demerger and then a cross-border merger with the overseas entity, both of which find legislations to rely upon in the Indian legal framework. However, the process would be tedious and heavy on the financial resources of the demerging entity. In light of this and the importance of foreign direct investment that is attracted by way of overseas corporate restructuring, it is essential to have a legal mechanism in place that curbs the subjectivity emanating from judicial discretion. Therefore, the author contends that there be a comprehensive framework for the governance and facilitation of such big ticket corporate restructuring options.

A Roadmap for CBD Governance in India

The primary concern is the determination of such channels of CBDs that should be entailed in the framework. The EU Directive provides a satisfactorily comprehensive framework in this regard. There are three routes of materializing a CBD that can be incorporated in the Indian CBD framework:

A) Split-up: The demerged company transfers all its resources to multiple entities in exchange for equity stakes in the resultant entities to its shareholders.

B) Spin-off: The demerged company transfers a portion of its resources to another/other corporation(s) in exchange for equity stakes to its shareholders in the corporation(s).

C) Hive-down: The demerged entity transfers its resources to another/other corporation(s) in exchange for equity stakes to itself, and not its shareholders.

Another crucial aspect of CBDs is that they engage the procedural laws of both the jurisdictions, i.e, the host country and the overseas country. It becomes pertinent to conclusively determine as to what extent and from which stage onwards would the laws of the respective countries be applicable. The concept of pre-division certificate, as entailed in the EU Mobility Directive, provides sufficient lucidity to this hurdle. A pre-division certificate is issued by the authorities of the state of the demerged entity, which are accountable for sanctioning the concerned cross border demerger scheme. Once the authorities have conducted their requisite due-diligence and examination of the said demerger, the certificate is granted. Up till the grant of the certificate, the legislations of the demerged entity’s state are applicable. Post the issuance of the pre-division certificate, the concerned entities of the CBD would be subjected to the legislations of the state of the resultant entity. The provision of a pre-division draws a conclusive line between the applicability of laws of the respective states and provides a satisfactory mechanism for the said concern.

Further, it is a material contention that the EU Mobility Directive comes with its own set of setbacks that should be avoided when it comes to the Indian model of CBD regulation. Exemplifying the aforesaid, the directive prohibits such demergers where assets and liabilities are transferred to the existing entity, and not to a novel entity. A CBD for the absorption of the concerned entity by an existent acquiring entity has been rendered impossible. However, the author concedes to the alternative that the entity can demerge domestically and the resultant company can undertake a cross-border merger to achieve the same objective. It is imperative to recognize that the underlying intent of devising a separate framework for CBDs is to streamline the process, vis-à-vis the existent procedural complexities. The Indian model of CBD regulation should be better-off bypassing this provision to uphold the idea of ease of doing business and simplify the undertaking of a CBD.

Furthermore, the applicability of the EU Mobility Directive does not extend beyond limited liability corporations. To further fructify an expansive mechanism, the Indian model should cover all kinds of commercial entities and make separate accommodations for them, in case the nature of such entities and the successful implementation of the framework require so.

Safeguards and Way Forward

Establishing a comprehensive framework that entails certain complexities and accommodates corporate entities of varying nature is not a piece of cake. Further, care must be taken to ensure that the framework upholds the very intent of the Companies Act 2013, that is, protection of shareholders. Corporate restructuring can also be wielded by entities when they find themselves on the verge of insolvency or bankruptcy proceedings. Such evasions from the proceedings are detrimental to the interests of the creditors and proper safeguards should be in place to avoid them. Furthermore, concerns such as tax evasion, non-compliance with the extant legal requirements, violating the rights of minority shareholders, creditors, etc. should be severely frowned upon by the concerned authorities and CBDs be absolutely disallowed from materializing, regardless of the stage the violation is found in.

In conclusion, the prominence of cross border demergers should be acknowledged as a lucrative option of corporate restructuring, in light of their contribution to the state’s economy by way of attracting foreign direct investment. The complexities in the process of undertaking a cross border demerger should be taken into consideration and attempts to establish the proposed mechanism should be made by the concerned authorities. It is essential to accommodate the differences and challenges that the Indian commercial and corporate ecosystem would put forth in the suggested framework and be amenable to a dynamic approach with respect to that as the commercial ecosystem is volatile in nature. In the formulation of this stipulation, the EU's legal framework offers a comprehensive guideline delineating the permissible and impermissible actions pertaining to the regulation of CBDs.