Door Opens For Cross-Border Mergers, But More Clarity Needed
Will failure to sell assets and securities not permitted to be held will be perceived as a contravention?
The Reserve Bank of India recently released draft regulations on cross-border merger transactions, which are issued under the Foreign Exchange Management Act, 1999 (FEMA). These draft regulations have been termed as the Foreign Exchange Management (Cross border Merger) Regulations, 2017. The draft regulations are being issued pursuant to the Ministry of Corporate Affairs notifying the following, with effect from April 13, 2017:
- Section 234 of the Companies Act, 2013 dealing with the merger or amalgamation of an Indian company with a foreign company; and
- Companies (Compromises, Arrangement and Amalgamation) Amendment Rules, 2017 which inserted Rule 25A in the Companies (Compromises, Arrangement and Amalgamation) Rules, 2016 to operationalise Section 234 of the Act.
In view of the notifications and the draft regulations, a foreign company incorporated outside India may now merge with an Indian company as an inbound merger; and an Indian company may merge with a foreign company incorporated in any of the jurisdictions specified in the rules as an outbound merger, after complying with relevant provisions of the Draft Regulations, Act and the Rules.
The draft regulations aim at addressing the issues that may arise when an Indian company and a foreign company enter into a scheme of merger, demerger, amalgamation or rearrangement. They provide clarity with respect to the treatment of borrowings, assets and securities that become part of the resultant company pursuant to completion of a cross-border merger. The draft regulations also lay down certain provisions for valuation and reporting to be adhered by the Indian company and the foreign company involved in the cross-border merger.
Key Points Of The Draft Regulations
Definition
The draft regulations have defined a ‘cross-border merger’ as “any merger, demerger, amalgamation or arrangement between Indian company(ies) and foreign company(ies) in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 notified under the Companies Act, 2013.”
Inbound Merger
In case of ‘cross-border mergers’ where the resultant company is an Indian company, the draft regulations provide that:
- The transfer and issue of security by the resultant company to a person resident outside India shall be governed by Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000.
- Borrowings and impending borrowings of the foreign company from overseas sources shall be governed by the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 or Foreign Exchange Management (Guarantee) Regulations, 2000, as applicable.
- The resultant company can (i) acquire and hold assets or securities outside India; and (ii) transfer assets or securities for undertaking a transaction, subject to whether the same is permissible under FEMA or the rules/regulations issued under it. In the event this is not permitted, the draft regulations require the resultant company to sell the assets or securities within a period of 180 days from the date of sanction of the scheme of the cross-border merger, and repatriate the sale proceeds to India immediately through banking channels.
Outbound Merger
In case of ‘cross-border mergers’ where the resultant company is a foreign company, the draft regulations provide that:
- A person resident in India shall be able to acquire or hold securities of the resultant company in accordance with the Foreign Exchange Management (Transfer or issue of Foreign Security) Regulations, 2000 or the provisions of the Liberalized Remittance Scheme, as applicable.
- The resultant company shall be liable to repay the borrowings or impending borrowings as per the scheme sanctioned by the National Company Law Tribunal.
- The resultant company can (i) acquire and hold assets or securities in India; and (ii) transfer assets or securities for undertaking a transaction, subject to foreign companies being permitted to do so under FEMA or the rules/regulations issued under it. In the event this is not permitted, then within a period of 180 days from the date of sanction of the scheme of cross-border merger, the resultant company shall sell the assets or securities, and repatriate the sale proceeds outside India immediately through banking channels.
Valuation
Further, the draft regulations require that a valuation of both the Indian company and the foreign company involved in the cross-border merger must be done in accordance with internationally accepted pricing methodology for valuation of shares on an arm’s length basis. Such valuation has to be duly certified by a chartered accountant/public accountant/merchant banker authorized to do so in either jurisdiction.
Reporting
The draft regulations make it mandatory to report to RBI any transaction arising due to a cross-border merger in the same format as otherwise required under FEMA or the rules/regulations issued under it.
The Indian company and the foreign company involved in the cross-border merger shall also be required to furnish such other reports as may be prescribed by RBI.
Not Enough Clarity
It is unclear if the failure of a resultant company to sell assets and securities not permitted to be held by it under FEMA or the rules/regulations issued under it, within 180 days from the date on which the scheme for inbound merger/outbound merger is sanctioned, will be perceived as a contravention of the draft regulations by the resultant company.
In the event that such a failure is in fact perceived as a contravention of the draft regulations, it is unclear what effect this may have on the sanctioned scheme.
Similarly, there is a lack of clarity with respect to the reports required to be furnished to RBI under Regulation 7(2) of the draft regulations. However, it is possible that RBI may elaborate on the same in the final regulations.
The Way Forward
The erstwhile Companies Act, 1956 had always permitted inbound mergers but failed to deal with outbound mergers. In view thereof, the move by the central government to allow outbound mergers is a positive one and is in line with other initiatives taken to liberalise the economy and make it more attractive for businesses. Outbound mergers will allow Indian companies to enter new markets, and have access to foreign capital and better equipped research and development facilities. Indian companies can use cross-border mergers as a tool to acquire businesses outside the country and directly integrate them into their own business operations. This will also enable cross-border reorganisation within group companies with interests in India.
However, it remains to be seen how the draft regulations are perceived and implemented by both Indian companies and the international business community in light of additional reporting requirements and extended timelines considering the involvement of multiple agencies at various stages in India and abroad.
The RBI has invited comments and suggestions on the draft regulations from members of public, including the stakeholders and experts in the area which may be sent to RBI latest by May 9, 2017.
Jay Parikh is a partner and Kriti Krishnan is an associate at Shardul Amarchand Mangaldas. The views and opinions expressed in this article are solely those of the author’s and do not necessarily reflect the official view or position of the firm.
The views expressed here are those of the author’s and do not necessarily represent the views of Bloomberg Quint or its editorial team.