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  • Ishaan Saraswat

To Break Up or Not: Unfolding the Cross-Border Demerger Conundrum In India

[Ishaan is a student at Jindal Global Law School. The following post has been authored by him with inputs from Prof. Sakshat Bansal at Jindal Global Law School.]

On 31 October 2018, the NCLT Ahmedabad bench (NCLT Ahmedabad Bench) allowed an inbound demerger and transfer of a foreign undertaking with Sun Pharmaceutical Industries Limited (Inbound Demerger Case). In the very next year, the NCLT Ahmedabad Bench, refused Sun Pharma’s application for an outbound demerger since the Companies Act 2013 (CA 2013) did not expressly provide for ‘demergers’ (Outbound Demerger Case).

The NCLT Ahmedabad Bench’s judgment in the Outbound Demerger Case hinges on two folds. Firstly, the NCLT Ahmedabad Bench reasoned that while under Sections 230 and 232 demergers are encapsulated by the terms ‘compromise’ and ‘arrangements’, Section 234 of the CA 2013 does not give reference to either ‘demergers’, ‘compromise’, or even ‘arrangement’. To buttress this, the NCLT Ahmedabad Bench also added that neither does Rule 25A of Companies (Compromises, Arrangements, and Amalgamations) Rules 2017 (Compromise, Arrangements, and Amalgamation Rules) (the rule corresponding to Section 234) mention either of these terms.

Secondly, the NCLT Ahmedabad Bench also opined that a ‘cross border merger’ in the Foreign Exchange Management (Cross Border Merger) Draft Regulations 2017 (Draft FEMA Merger Regulations) was defined as “any merger, demerger, amalgamation or arrangement between Indian company(ies) and foreign company(ies) in accordance with Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016”. However, when the Foreign Exchange Management (Cross Border Merger) Regulations 2018 (FEMA Merger Regulations) were finally notified, ‘demerger’ was removed from this definition, the corollary being that cross-border demergers are not governed by the regulations.

Critical Analysis of the Opposing Judgments in Question

With respect to the NCLT Ahmedabad Bench’s construction of the silence on ‘demerger’ under Section 234 and the Compromise, Arrangements, and Amalgamation Rules as prohibition, this article would like to emphasize the rationale given by the same bench in the Inbound Demerger Case. In that order, the NCLT Ahmedabad Bench had reasoned that Section 232(b) of CA 2013 provided that an undertaking being transferred could be “whole, or any part of the undertaking”, which in its opinion is a demerger. The NCLT Ahmedabad Bench concluded that since Section 232 is titled ‘Merger and Amalgamation’, this phrase would include demergers too by virtue of the provision’s content. The view that demergers are possible under Sections 230 and 232 has also been taken by other benches. Subsequently, according to the NCLT Ahmedabad Bench, since Section 234(1) stipulates that the section shall apply “mutatis mutandis to the schemes of mergers and amalgamations”, it would include Section 232’s understanding and hence include demergers as well.

Essentially, the position of law is that if the letter of the law is capable of being given an alternate meaning, then that must be done by the court; however, if the same is not possible, only then must the ordinary rule of literal interpretation be adopted. The Inbound Demerger Case subscribed to this principle of interpretation by adopting the term ‘demerger’ alternatively for ‘merger and amalgamation’. The Outbound Demerger Case, however, did not seek for an alternate meaning, but rather, proceeded to adopt the literal construction of Section 234.

Further, the Foreign Exchange Management (Cross Border Merger) Regulations 2018 (FEMA Merger Regulations) removed the word ‘demerger’, contrasted with its inclusion under the draft FEMA Merger Regulations. However, it may be noted that in the Outbound Demerger Case, the NCLT Ahmedabad Bench initially reasoned that ‘arrangements’ and ‘compromises’ under Sections 230 and 232 of CA 2013 included demergers. Interestingly, the NCLT Ahmedabad Bench did not deploy this construction whilst observing the FEMA Merger Regulations. The FEMA Merger Regulations still define a ‘cross border merger’ as “any merger, amalgamation or arrangement between an Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 notified under the Companies Act, 2013.” While it is arguable that the NCLT Ahmedabad Bench failed to recognize this, demergers can, hence, still be read into the term ‘arrangements’ under Regulation 2(iii) the FEMA Merger Regulations.

Lastly, the removal of the term ‘demerger’ from the definition cannot lead to the conclusion that the FEMA Merger Regulations cannot govern the transaction. The process laid down in the regulations regarding inbound and outbound transactions as was present in the Draft FEMA Regulations still remains. Moreover, in the Outbound Demerger Case itself, the NCLT Ahmedabad Bench acknowledged that the Reserve Bank of India had approved the cross-border demerger. Hence, a presumption by the NCLT Ahmedabad Bench that the FEMA Merger Regulations do not allow such a transaction would be fallacious. Again, the Inbound Demerger Case fortifies this rationale that cross-border demergers are within the confines of the law.

A Departure from CA 2013

It may be noted that Section 394(1)(b) of the Companies Act 1956 (Old Act) stated that “a part of the undertaking of any transferor company may be transferred to a transferee company”, where a transferee company as per Section 394(4)(b) refers to an Indian company, i.e., a company within the meaning of the act, while a transferor company includes any body corporate, whether a company under the Old Act or not. Hence, a transferor can be a foreign company too. Essentially, this provides for inbound mergers and demergers but prohibits outbound transactions since the transferee is an Indian entity.

In the Outbound Demerger Case, the NCLT Ahmedabad Bench acknowledged this and stated that it was very much possible for a foreign company to transfer its undertaking or business to an Indian company under the Old Act, since Section 394 of the Old Act applied to both demergers as well as mergers, which, however, is not possible under Section 234 of CA 2013 since it does not expressly mention ‘demerger’.

Therefore, the rationale that cross-border demergers are not allowed because Section 234 does not mention ‘demerger’, in the context of Section 394 of the Old Act, would result in an incorrect conclusion. This is because Section 394 of the Old Act did not use the term ‘demerger’ either. It simply said that the whole or a part of the business can be transferred, which is also provided by Section 232 of CA 2013, which then applies to Section 234 mutatis mutandis.

We must also observe the Dr. Jamshed J. Irani Committee’s report (Expert Committee Report) on developing the Old Act in the context of the economic and business environment, and since it played a major role in the formulation of the CA 2013. Per the Expert Committee Report, the committee took the view that the legislation must enable uniformity in pursuance of mergers, demergers, amalgamations, or schemes of reconstruction, to allow Indian firms to be competitive in the restructuring exercise in the global context. The committee also implored the law to be forward-looking and recognize outbound transactions by accepting foreign transferee companies. The decision of the NCLT Ahmedabad Bench in this regard reverses these ideals by altogether barring cross-border, both inbound and outbound demergers.

Concluding Remarks and the Way Forward

The need for the hour is, therefore, for a policy clarification from the legislature since the judiciary can only either take a textual interpretation or read into the existing black letter – which are both subjective approaches. As per the above analysis, it is evident that demergers are recognized under CA 2013 per Section 232. Further, demergers can also be read into the draft FEMA Merger Regulations under ‘arrangements’. A reference in this respect may be made to other statutes. Section 2(19AA) of the Income Tax Act 1961 (IT Act) gives reference to Section 234 of CA 2013 whilst defining a demerger. Nonetheless, the provision that finally enables the cross-border transaction is Section 234 of CA 2013, which is eerily silent on the possibility of demergers.

The scenario as is unfolding right now is that the ambiguity is resulting in bottlenecks on investments entering the country (i.e., inbound demergers), and bottlenecks on investments leaving the country (i.e., outbound demergers). Cross-border demergers have the entire regulatory setup available, but the its substantive possibility has become a question mark. Such equivocality reflects instability in dealing with investments, which may be reflected in India’s poor sovereign rating too. The policymakers must be clear on their stance. Countries like the United Kingdom and Singapore expressly bar cross-border demergers, whilst countries like Belgium and Switzerland provide for cross-border demergers by drafting the relevant provisions in an analogous manner to the cross-border merger ones. Only once there is a policy clarification, would India seem like a low-risk country capable of attracting further cross-border M&A activity.

Therefore, there must be an attempt at progressive reform in pursuit of enabling cross-border demergers through regulatory and judicial certainty. From a statutory standpoint, in the Indian scenario, the addition of the term ‘demerger’ to Section 234 of CA 2013 may be a good starting point, since suitable references exist under the FEMA Merger Regulations, the Compromise, Arrangements, and Amalgamation Rules, and the IT Act.


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