Executive summary: This article briefly examines a few key changes made to the process for court based restructurings introduced by the Companies Act, 2013.

Introduction

The Companies Act, 2013 (“2013 Act”), having been approved by the Lok Sabha in 2012, was approved by the Rajya Sabha on August 8, 2013 and now only awaits Presidential assent and notification in order to become law. Once notified, the 2013 Act will replace the more than 50 year old Companies Act, 1956 (“1956 Act”) in an effort to modernize and streamline the legal and regulatory framework in which Indian companies operate.

Whilst the 2013 Act introduces a number of far-reaching changes over the current legal regime, notably in the detailed treatment of corporate action and its regulation, and is characterized by the degree to which specific prescriptions or prohibitions in respect of such action have been set out whilst at the same time delegating a large number of matters (a common criticism is too many) for executive rule making, the focus of this article is to briefly examine the changes made to the process for court based restructurings and comment on the key aspects in relation to the same.[1]

Brief Overview of the Court Based Restructuring Process

Court based restructurings, referred to as “compromises” or “arrangements” between a company and its members or class or members, or a company and its creditors or class of creditors, are dealt with in Chapter XV of the 2013 Act (Clauses 230-240) and set out a framework that will replace the erstwhile framework under Sections 391-394 of the 1956 Act.

A brief overview of the key steps of the court based restructuring process is set out below:

• The first step is the making of an application to the Tribunal for sanctioning the compromise or arrangement. The application may be made by the company concerned or its members or creditors or class or members or creditors. In the event of a company being wound up, the application is required to be made by the liquidator.
• On receipt of the application, the Tribunal may order a meeting of the company’s various classes or members or creditors as it deems fit. The Tribunal may dispense with a meeting of the creditors or class or creditors where such creditors (or class of creditors), holding at least 90% in value of the debt, give their confirmation to the proposed compromise or arrangement through an affidavit.
• Appropriate details of the proposed compromise and arrangement are required to be given to the classes of members and creditors in order to enable them to take an informed decision. A copy of the valuation report in respect of the proposed transaction (if any), together with a statement disclosing the effects of the compromise or arrangement on the key managerial personnel and directors of the company is required to be shared with the members and creditors as part of the notice for the meetings.
• A copy of such notice is also required to be sent to the Central Government, the income-tax authorities, the Reserve Bank of India (“RBI”), the Securities and Exchange Board of India (“SEBI”) and the stock exchanges (for listed companies), the Registrar of Companies, the Official Liquidator and the Competition Commission of India (“CCI”) and such other sectoral regulators and authorities as are likely to be affected by the compromise or arrangement, requiring them to make representations (if any) on the proposed compromise or arrangement within a period of 30 days from the date of receipt of such notice.
• Where a majority of the persons representing three-fourths in value of the creditors or class or creditors, or members or class of members, agree to a compromise or arrangement, the Tribunal may sanction such compromise or arrangement, which order then binds the company and its creditors and members.

A Few Key Changes and Their Implications

A few of the important changes introduced by the 2013 Act are highlighted below;

(i)                 Enhanced Regulatory Scrutiny and Multiplicity of Regulators – As set out above, the 2013 Act now requires that companies forward the notice of the compromise or arrangement to a plethora of regulatory bodies including such other sectoral regulators or authorities which are, “likely to be affected by the compromise or arrangement”, together with such other documents as may be prescribed. It is currently unclear who these other sectoral regulators and authorities would be – whilst it can be expected that this will become established through market practice in the course of time for companies engaged in diverse businesses, a degree of uncertainty nevertheless remains at least at the initial stages.

The other question that arises is one of potential regulatory overlap. Under the Competition Act, 2002, the CCI is already empowered to rule on combinations within a period of 210 days of being notified of a proposed combination. Similarly, the SEBI is authorized to regulate, and has issued for this purpose, circulars dealing with court based restructurings of listed companies. It is currently unclear what happens if the CCI or the SEBI make or omit to make representations within the prescribed timeline of 30 days under the 2013 Act and what impact any such representation/omission will have on their independent statutory powers under separate legislation. Furthermore, it has always been understood that court approval for a restructuring does not do away with specific regulatory approvals that may be required for a proposed compromise or arrangement under different laws.

Accordingly, it is debatable whether it was necessary to require companies to notify specific regulators as part of the restructuring process through express legislation and whether such inclusion will result in regulatory overlap and confusion. Perhaps this is also something where market practice will evolve with the passage of time.

In any event, the requirement for dissemination of the scheme to such a variety of regulators can be expected to result in an enhanced level of regulatory and government scrutiny (particularly in the case of listed companies or schemes involving related party transactions) thereby necessitating a higher degree of foresight and care in undertaking and implementing a transaction and better transaction management.

(ii)               Prohibition of Treasury Stock – Companies are no longer permitted to hold treasury stock as a result of the compromise or arrangement either in their own name, in the name of a trust or on behalf of any subsidiary or associate company, and any such shares are required to be either cancelled or extinguished. Accordingly, a holding company will not be able to issue and hold shares in itself arising out of a merger of its subsidiary into such holding company.

Historically, companies have found treasury stock to be a useful tool for liquidity and as a source of easy finance. Such stock has also indirectly served to cement the control of the “promoter” or controlling shareholder. Minority investors have however frowned upon this.

It is unclear what happens to companies which already own such stock. The grandfathering provisions of the 2013 Act provide that any action taken under the erstwhile act will be valid so long as it is not inconsistent with the 2013 Act. However, as the 2013 Act contains an express bar on companies holding such stock there are two views possible – the first that companies already holding such stock will be required to cancel or extinguish such shares (which will have a bearing on the shareholding pattern and balance sheet of such companies) and the second, that historical holdings will be exempt.

(iii)             Restructuring with Foreign Companies permitted – Whilst the 2013 Act continues to permit arrangements between a company and its members and/or creditors (or a class of members and/or creditors) as before, Indian companies and foreign companies in jurisdictions notified by the Central Government have now been permitted, pursuant to Clause 234 of the 2013 Act, to enter into amalgamations with each other subject to such rules and conditions as may be prescribed by the Central Government and the RBI in this behalf.

Under the 1956 Act, it was not possible for an Indian company to merge with, or demerge an undertaking into, a foreign company, although a foreign company (in any jurisdiction and not just a notified jurisdiction) could merge/demerge into an Indian company. Inbound mergers were possible but not outbound mergers.

The change set out in the 2013 Act is a significant step forward in providing companies greater flexibility in restructuring their operations. However, the key will lie in the manner in which this is implemented and the countries which are notified as being eligible jurisdictions for inbound and outbound mergers. Suitable changes in the Foreign Exchange Management Act, 1999 & Rules (FEMA) will also be needed. Also the Income Tax law will need to be amended to extend the exempt nature of such transaction to such reverse cross border mergers as well

(iv)             Threshold for Raising Objections – Unlike the 1956 Act, the 2013 Act now prescribes a threshold for objecting in court to the proposed scheme of compromise or arrangement. Only persons holding not less than 10% of the shareholding or having outstanding debt amounting to not less than 5% of the total outstanding debt as per the company’s latest audited financial statement may object to the scheme.

It has been market experience in India that small investors acquire a small stake (sometimes just one share) in a large number of companies only with a view to objecting to schemes and hold transactions to ransom (usually there is a delay of a few months in the implementation of the transaction whilst the court considers their objections). The introduction of a threshold therefore will reduce frivolous objections/harassment by such professional troublemakers and is a welcome step. Sadly the message coming from SEBI, under recent pronouncements (4^th February) are at variance with the 2013 Act and seem to empower minority shareholders.

(v)               Simplified Merger Process for Certain Categories of Companies – Further to Clause 233 of the 2013 Act, (a) two or more small companies i.e. companies which are not public companies, have a paid up capital not exceeding INR 5,000,000/- (Rs. 5 million) and a turnover (as part their last profit and loss statement) not exceeding Rs. 20,000,000/- (Rs. 20 million) (or such higher amount as may be prescribed); (b) holding companies and their wholly owned subsidiaries; and (c) such other class of companies as may be prescribed; can now each enter into schemes of merger/amalgamation pursuant to a separate and simplified procedure and subject to satisfaction of certain conditions which are as follows: (a) giving of notice of the proposed scheme and seeking objections/suggestions to the same from the concerned Registrar of Companies and the Official Liquidator; (b) consideration of such objections/suggestions and approval of the scheme by the members holding at least 90% of the total number of shares, (c) filing of a declaration of solvency in the prescribed form with the Registrar; and (d) the scheme being approved by a majority representing nine-tenths in value of the creditors of the respective companies. If the Registrar and Official Liquidator do not have any objection to the scheme once approved, and if the Central Government is not of the view that the scheme is against public interest or the interests of the creditors, the Central Government is required to register the scheme which has the effect of consummating the merger/amalgamation.

(vi)             Restructurings Involving Listed and Unlisted Companies – The 2013 Act provides that in case of a merger of a listed company into an unlisted company, if the shareholders of the listed transferor company decide to opt out of the transferee company, provision is required to be made for the payment of the value of their shares and other benefits in accordance with a pre-determined price formula or after a valuation is undertaken, and the Tribunal is empowered to make such arrangements, provided that the price is not less than the minimum price specified by the SEBI pursuant to regulations framed by it. It is only when the Rules are out that clarity will emerge, but this seems like a light touch back door delisting possibility.

Summary

The 2013 Act nuances the current legislative framework for court based restructurings set out in the 1956 Act by providing greater transactional flexibility (by permitting outbound mergers)[2], shunning a one-size fits all approach (by creating a simplified regime for certain categories of companies) and removing common process bottlenecks (by introducing a high threshold for objections). However, certain process changes introduced by the 2013 Act (such as the requirement to notify a whole host of regulators) would also create uncertainty/confusion, in the initial stages of the implementation of the 2013 Act.

The 2013 Act as it stands now is a mixed blessing and a lot hinges on the rules that are notified and the manner in which the legislation is implemented going forward. It is to be hoped that both will be facilitative of such transactions going forward.