Companies Act, 2013

Impact on M&A

December 18, 2015

Lalit Kumar, Partner

J. Sagar Associatesadvocates & solicitors

Ahmedabad | Bengaluru | Chennai | Gurgaon | Hyderabad | Mumbai | New Delhi

Outline

• Schemes of Arrangement

• Slump Sale

• Private Placement

• Structuring an investment

• Private ‘listed’ company

• Loans, Investments and Guarantees

• Nominee Director

• Increased protection to shareholders

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Quagmire of rules !@#!

Schemes of Arrangement

Schemes of Arrangement

• Process and provisions more detailed, comprehensive and transparent

• Approving authority National Company Law Tribunal and not High Court

• Demerger not specifically mentioned or defined but covered (Section 232 (1) (b))

• Certificate by the company’s auditor to be filed NCLT to the effect that the accounting treatment, if any, proposed in the scheme of compromise or arrangement is in conformity with the accounting standards prescribed under Section 133

• Merger of listed company with unlisted company – exit opportunity to dissenting shareholders - Contradiction to SEBI regulations, which require mandatory listing in such situations

• Fast track merger – between “small companies” and “holding and wholly owned subsidiary” – will it be really fast track?

• Exit to dissenting shareholders and takeover offer

• Purchase of minority shareholders – obligation of the acquirer acquires 90% or more – still squeeze out not possible - Price of acquisition determined by a registered valuer

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Schemes of Arrangement

• Cross border merger - If merging Indian company has real estate, then what would be the impact under FEMA and Stamp duty Act?

• Enhanced disclosure - Notice and documents to be also uploaded on company’s website, Yearly reporting in a statement with ROC until completion of scheme

• Voting through postal ballot (including e-voting)

• Representation from various authorities

• Difficult to raise objections to schemes - Objections to be by not less than 10% shareholders and 5% debt

• Dispensation of creditors’ meeting – if 90% in value agree by affidavit

• Restriction on treasury stocks

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Slump Sale

Slump Sale

• Clear definition of “Undertaking” and “substantially the whole of the undertaking” (s. 180 (1) (a))

o “Undertaking” means an undertaking in which the investment of the company exceeds 20% of its net worth as per preceding financial year’s audited balance sheet or which generates 20% of the total income of the company during the previous financial year

o “Substantially the whole of the undertaking” means 20% or more of the value of the undertaking as per the audited balance sheet of the preceding financial year

• Board’s approval followed by shareholders approval by special resolution by postal ballot

• Whether holding of “shares or securities” constitute an “undertaking”?

• Whether mortgaging of the whole or substantially the whole of its undertaking for obtaining loans or other financial assistance covered by Section 180 and treated as a sale of undertaking?

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Private Placement: A cumbersome process!

Is there a way out?

Private Placement by Unlisted Companies

• New issuances by private companies to be either (i) rights or bonus issues, or (ii) private placement (s. 23(2))

• Private placement defined (s. 42(2) Explanation II)

o any offer of securities/ invitation to subscribe to securities to a select group of persons through issue of a private placement offer letter

o offer/ invitation to persons not exceeding 50 (or a higher number if prescribed) in a financial year + prescribed conditions

• Issue of equity instruments now have to comply with private placement norms and preferential allotment norms!

• Rules define “Preferential Offer” to mean:

o Issue of equity shares or convertible securities

o To any select person or group on a preferential basis

o Excludes public issue, rights issue, ESOP, ESPS, sweat equity, bonus, DRs issued outside India or foreign securities

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Private Placement by Unlisted Companies

• Private placement limit does not include QIBs and ESOPs (s.42(2))

• Rules prescribe:

o 200 person limit

o The value of the offer or invitation per person must be with an investment size of not less than INR 20,000 of the face value of the securities – Very Tricky Issue!o Above 2 conditions not applicable to NBFCs and HFCs

if RBI / NHB have prescribed regulations and they are compliant with them

o Special resolution to issue all securities required for each offer

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Private Placement by Unlisted Companies

• Preferential issue price to be determined by registered valuer (s. 62 (1) (c))

o Rules state that valuer can choose amongst multiple valuation methods, depending on the purpose of valuation, such as NAV method, market price method, PECV method, DCF method, weighted average method etc.

o Rules state that conversion price also has to be determined beforehand on the basis of the registered valuer report – Is the flexibility on conversion formula gone?

o What is the correct process now specially for PE investors? Posing implementation challenges

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Confusing Private Placement Process!

• Complete record of all offerees to be maintained (s. 42(7))o Name of offeree to be recorded prior to invitation to subscribeo Rules – letter of offer and application form to be sent within 30

days of such recording

• Private placement details to be filed with ROC (s.42(7))

• Allotment within 60 days failing which money to be refunded with 15 days; interest on delay in refund (s. 42(6))o Does not tie in with FDI policy?

• No fresh offer unless earlier offer completed/ withdrawn (s.42 (3))

• Non-compliance with private placement norms - deemed to be a public offer (s.42 (4))

• Penalty – Company, promoters and directors liable, penalty is amount involved in offer or Rs. 2 crores, whichever is higher. Company has to refund all monies to subscribers within 30 days of order (s. 42(10))

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Structuring an investment

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Are you my subsidiary?• Test of subsidiary is exercise or

control of > 50% of the total share capital instead of > 50% equity share capital (s. 2(87))

• So an investor holding CCPs of a greater amount than equity shareholders may become the holding company of its portfolio entity?

• PE investors not registered as companies under 2013 Act also covered?

• 50% test can be satisfied directly or together with other subsidiaries (s. 2(87))

• Holding of CCDs does not trigger the provision

• Whether foreign holding companies included? Section 4(7) gone!

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What makes you a promoter?

• “Promoter” includes a person that: (s. 2(69))

o has direct or indirect control over the affairs of the company

o as a shareholder, director or otherwise

• “Control” includes (s. 2(27))

o Right to appoint majority of the directors

o Right to control the management or policy decisions

o Exercisable by a person or persons acting individually or in concert

o Directly or indirectly

o Including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner

o But does not apply for the test of subsidiary – subsidiary’s test still on controlling the composition of the Board of Directors

o There is mix up of the concept of control – At some places 2013 Act says control as per the SEBI regulations

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What makes you a promoter?

Will veto rights make an investor or investor director a promoter?

Subhkam Ventures (SAT) says NO

SEBI’s position: the definition of “control” would include veto rights since such negative control would effectively control the management and policy decisions of a company

Differing from the SEBI’s position, Securities Appellate Tribunal (SAT) in order dated January 15, 2010 held: “control” meant positive control, that is, the ability to cause a company to perform certain actions, and that it did not cover rights constituting “negative control”, i.e. the right to prevent the company from doing certain actions. The SEBI had appealed the aforesaid decision of SAT before the Supreme Court

Both SEBI and Subhkam Ventures reached an out of court settlement in the matter and the Supreme Court passed an order disposing off the appeal. The Supreme Court’s order dated November 16, 2011 accepting the out of court settlement between SEBI and the respondents, specifically states that the question of law (i.e., whether negative control is control) remains open and that the SAT decision would not be treated as precedent. This observation has far reaching ramifications

Multi Screen Media (CCI) says YES

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Promoters’ liability

Promoters’ liability includes:o Breach of private placement norms (s.42(10))

o Personally liable for fraudulent misstatement in prospectus (s.35)

o Exit option where objects of public issue varied without special resolution (s.13(8) and s.27)

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Sample Veto Rights which may not trigger control

• amendment of charter documents (including change of name)

• increase or decrease of share capital

• acquisition or disposal of material assets

• amalgamation and merger of the company or demerger, share exchange, equity transfer, business transfer or business acquisition, or dissolution or any other transaction of similar nature

• approval of financial statements and dividend distribution

• material change in operation

• change in business plan

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Shares with differential rights: What’s the difference?

• New DVR rules are more stringent than existing DVR rules:

o Track record of distributable profits in last 3 FYs – means companies with less than 3 years of existence cannot issue DVRs

o No default in filing financial statements for the last 5 FYs

o No default in (i) redemption of preference shares, matured deposits or debentures, (ii) repayment of term loans of scheduled banks and PFIs, (iii) payment of interest or declared dividend, and (iv) employee statutory payments

o DVR shares cannot exceed 26% of the total equity share capital including DVRs

o Company not been penalised by a court or Tribunal in last 3 years of any offence under the RBI Act, SEBI Act, SCRA, FEMA Act or any special act

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Preference Shares

• Can be for upto 30 years for infrastructure projects provided prescribed % of shares are annually redeemed at the preference shareholders’ option (s. 55(2) First proviso)

• Premium on RPS only payable out of profits (and not securities premium a/c) for some companies (s.55 (2)(d))

• Provision for issue of new RPS to redeem earlier RPS in case of failure to redeem or pay dividend - consent of NCLT & 75% (by value) of preference shareholders needed (s.55(3))

• Rules suggest:

o special resolution needed in a general meeting for issue

o no subsisting default in dividend payment or redemption

o AOA to set out provisions on (i) priority, (ii) participation in surplus dividend or assets, (iii) cumulative or not, (iv) conversion rights, (v) voting rights, (vi) redemption

• Distinction between cumulative and non-cumulative preference shares w.r.t voting rights removed – all kinds of preference shares entitled to vote on all matters if dividend remains unpaid for 2 years

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Don’t sweat – sweat equity is here to stay

• No share issue at a discount except sweat equity (s. 53(1))

• Sweat Equity Shares (s. 54)o Rules have new conditions:

Permanent employee for the last one year Employees of subsidiaries and holding companies

included All directors entitled to sweat equity 25% cap on total sweat equity issues

I've got the power

Increased power to more than 25%shareholding

• Several matters now need a special resolution of shareholders – this may reduce debates on veto rights where investors hold more than 25%:

o Sale, lease or disposal of undertaking (s. 180(1)(a))

o Investment of compensation received in a merger/ amalgamation (s. 180(1)(b))

o Borrowings exceeding paid-up capital & free reserves (excl. temp loans) (s. 180(1)(c))

o Remitting or giving time for repayment of director's dues (s. 180(1)(d))

o Amendment of entrenched provisions in AOA (s.5(3))

o Preferential offers and issue of ESOPs (s. 62(1)(b) and (c))

o If rights affected due to variation of rights of other class (s. 48(1) Proviso)

o Issue of convertible debentures (s.71) or non-convertible debentures

o Removal of auditors (s.140)

o Expanding board size beyond 15 (s.149(1))

o Reappointment of independent director after term of up to 5 consecutive years (s.149(10))

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Private “Listed Company”: A new beast of burden

Private “Listed Company”

• A company is a listed company if any of its securities are listed

o Private company that issues listed NCDs on a private placement basis is a listed company

• Increased compliances of a listed company:

o CS certificate accompanying Annual returns to certify compliance with Act (s. 92(2))

o In case of change in number of shares held in a listed company by a promoter or top 10 shareholders – return to be filed with the RoC within 15 days (s. 93)

o Board Report to include the manner in which the formal annual evaluation of performance of the Board, Committees and directors has been done (s. 134 (3)(p))

o Director’s responsibility statement must state that internal financial controls laid down by them were adequate and effective (s. 134(5)(e))

o No auditor to be appointed for > 5 years, no audit firm to be appointed for >10 years (s. 139(2))

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Private “Listed Company”

• Must have an Independent Director

• Must constitute Audit Committee (s. 177(1)) and Nomination and Remuneration Committee (s. 178(1))

• Vigil mechanism for directors and employees to report genuine concerns (s. 177(9))

• Secretarial Audit must be conducted (s. 204(1))

• Notice and other documents for convening a meeting pursuant to an order by the Tribunal in case of a compromise or arrangement being proposed by a company with its creditors or member must be sent to SEBI (s. 230(3) first proviso)

• SEBI shall enforce provisions relating to forward dealing and insider trading (s. 458(1) proviso)

Loans, Investments and Guarantees

S. 185 – person in whom director is interested

• Section 185 restricts (subject to some exceptions) a company to provide loans to, or guarantees or securities for loans availed by, directors or person in whom a director is interested (corresponding to Section 295 of the 1956 Act)

Lending Company (A)(Lender / Guarantor /

Security Provider)

Holding Company (B)

Director of A or B(“Director”)

Partner or Relative of such Director

Partnership Firm where the Director or his/her

relative is a partner

Private Company where the Director is a director

or member

Public Company where the Director is a director

or member

Body corporate where 25% or more voting power is exercised or

controlled by the Director or 2 or more

such Directors

Body corporate whose BOD, MD or Manager is accustomed to act on the instructions of the Board

or any directors of the lending company

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S. 185 – a bone of contention?

Changes from the 1956 Act

• Now applicable to certain kinds of private companies

• Exemption for the following from applicability of the section:

o Loan by Holdco to a WOS

o Guarantee / security by Holdco for a loan made to its WOS

o Guarantee / security provided by Holdco for loan from bank or FI to its subsidiary

o Loans for which guarantee/security given above must be used by the subsidiary for its principal business activities

• Carve-out of “save as otherwise provided in the Act” – Bad drafting of law

• “Ordinary course of its business” exception:

o Company providing loans, or guarantees or security for loan

o Loan is at atleast bank rate of interest declared by RBI

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S. 185 – a big bone of contention!

Implications / issues

• Meaning of “subsidiary” = majority of equity + CCPs, and not only equity!

• Rules do not exempt a loan to, or guarantee or security for a loan availed by, a group company or JV company that is not a subsidiary

• Exemption for guarantee/security for a loan by a subsidiary (non-WOS) is only if the lender is bank or FI

• “Principal business activity” is not defined

• Loans for on-lending or equity infusion may not get the benefit

• Protection for lenders – R&W, certificate, board resolution?

• What constitutes “ordinary course of its business”?

• Loan availed at a rate which is not at bank rate of interest is not within the purview of the “ordinary course of its business” exception – could impact guarantees/security for ECBs by group companies and FX loans availed by offshore JV entities

• Does “loan” include “debentures”?

• Whether Section 186 is a carve-out to the applicability of Section 185?31

S. 186 - Loans, Investments and Guarantees

• Section 186 deals with conditions subject to which a company can give loans to, or guarantees or securities for loans availed by, other persons, or invest in securities of other persons (corresponding to Section 372A of the 1956 Act)

Changes from 1956 Act

• Now applies to loans to any person (including individuals) and not only body corporate

• Private companies have to comply with restrictions

• Special resolution required where the limits under the section are exceeded based on aggregate amounts of loans, guarantees and security – however 1 year grace period has been provided in the Rules

• No special resolution of shareholders needed where:

Loan, guarantee or security to WOS or JV company

Acquisition by a Holdco of securities of WOS

• Disclosures of amount and purpose of loans, investments and guarantees in the accounts

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S. 186 - Loans, Investments and Guarantees

Changes from 1956 Act (contd)

• Exemptions continue for loans, guarantees and security by banks, insurance companies, housing finance companies, and most types of NBFCs

o Exemption on “company engaged in the business of financing of companies” clarified in the Rules to include NBFCs in the business of giving any loan to a person or providing any guarantee or security for due repayment of any loan availed by any person in the ordinary course

• Companies providing "Infrastructural Facilities" remain exempt from compliance – these are now defined and list has been expanded (Schedule VI)

• Companies registered under Section 12 of SEBI Act will have additional limits on inter-corporate loans and deposits as may be prescribed

• Interest rate on inter-corporate loans not linked to prevailing bank rate: Rate of interest on a loan cannot be lower than the prevailing yield of one year, three year, five year or ten year Government Security closest to the tenor of the loan

• New format of the register prescribed, and the register may be maintained electronically

• Entries have to be made in the register in 7 days of the transaction

• Restricted up to two layers of investment companies

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S. 186 - Loans, Investments and Guarantees

Implications / issues

• All loans/guarantees/security to or for JV companies / subsidiaries / WOS will have to comply with all conditions in S. 186 (other than a special resolution of shareholders). Therefore:

• Loans cannot be interest free and must be at the prescribed interest rates

• All directors present at the meeting must consent

• Prior approval of a PFI whose loan is subsisting will be needed if the limits are exceeded or a default on loan or interest to such PFI subsists – PFIs include LIC, IDFC Company Limited, UTI

• No default should be subsisting on payment of deposits or interest thereon

• Disclosures have to be made in the accounts

• Register has to be maintained

• Calculation of interest rate on inter-corporate loans is not clear

• “Joint venture company” is not defined – what threshold of shareholding is necessary?

• Post facto approval of shareholders cannot be obtained for guarantees

• NBFC exemption is ambiguous

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Nominee Director - To be or not to be?

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Duties Codified: Company before Self

• Duties (s. 166): Directors must:

o act in accordance with the articles of the company

o act in good faith to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment

o exercise duties with due, reasonable care, skill and diligence

o exercise independent judgment

o no involvement in conflicting situations or those that may conflict

o not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates

o not assign his office

•Should nominee directors give up their board seats? Investors to act through only shareholders vote?

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What should nominee directors do?

• What should nominee directors know and be cautious before taking a board seat?

• What should the nominee directors ensure for not being considered as “officers in default”?

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Independent Director

• Definition more extensive than listing agreement (s. 149(6))

o Nominee director cannot be an independent director (s. 149(6))

o Onus on Board to choose a person of integrity, expertise and experience (s. 149(6)(a))

• Appointment for 5 years, maximum of 2 consecutive terms (s. 149(11))

• Break of 3 years before reappointment (s. 149(11)

• Not subject to retirement by rotation (s. 149(13))

• Greater liability – duties and responsibilities codified in a schedule (Sch. IV)

• No stock options can be issued to independent directors – sitting fees, re-imbursement of expenses and profit related commission permitted (s. 149(9))

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Increased protection to shareholders

Shareholder rights protected

• Statutory legitimacy to contractual restrictions on transfer of securities between shareholders (s. 58(2) Proviso)

• Variation of shareholder rights: consent of 3/4th of the members of other class of shareholders also required if rights of such class affected (s. 48(1) Proviso)

• AOA can contain entrenchment provisions

o Specified provisions of AOA to be altered only if conditions/procedures more restrictive than those applicable for special resolution complied with (s. 5(3))

o To entrench: 100% shareholder resolution for private company/ special resolution for public company (s.5(4))

o Point to check in a due diligence

o Closing action if SHA provisions need to be entrenched

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Beware of public market concepts

• Forward dealing: Prohibits directors and KMPs of all companies to buy in the company, its holding, subsidiary or associate company, the a right to call/ the right to elect to call for delivery or a right to make delivery at a specified price and within a specified time, of a specified number of relevant shares or a specified amount of relevant debentures (s. 194)

• Insider trading: Any person including directors & KMPs of all companies prohibited from insider trading (s. 195)

o Insider trading includes – act of subscribing, buying, selling securities or entering into an agreement to do the above if the person is reasonably expected to have access to non-public price sensitive information

o No exemption for unlisted companies including private companies – confusion all over – Case of swimming without water!

o Does not prescribe mode or manner of publication of NPSI

o Does this impact secondary sales and investments?

o Will a call or put option be impacted?

o Penalty is 5 lac to 25 crore or 3 times the amount of profits made42

Thank You

Disclaimer:This presentation has been compiled for general information and does not constitute professional guidance or legal opinion. Readers should obtain appropriate professional advice.