Legal Agreements

Demerger in India: Overview and Procedure

The company, when desirous of splitting its business activities, goes into the process of the demerger. The zeal for earning profit and expanding business activities has forced the companies to merge with other companies through compromise or arrangement. As a result, these tie-ups may or may not work in favour of the companies, and when the corporate restructuring does not fulfil the motive, the corporate has to restructure itself by diversifying its business components. This diversification or corporate restructuring is termed as “Demerger”. The corporate restructuring or Demerger in India is governed by the Companies Act 2013 and Companies (Compromises, Arrangements and Amalgamations) Rules, 2016. The present article covers the overview and the general procedure for demergers.

What is Demerger?

The demerger in India is governed by the Companies act 2013^[1]. The meaning of “Demerger’ is not expressly defined under the act. Hence, the act, through the explanation of Section 230 (1), defines demerger as an arrangement and a reorganisation of the share capital of a company through:

• Consolidation of Shares of Different classes
• Division of shares into different classes
• Both methods

Moreover, the taxability of the demerger in India is governed by Income-tax Act 1961. According to the IT act, the Demerger under Section 2 (19AA) is defined as the transfer of demerged company into a resulting company in a scheme of arrangement wherein a “demerged Company” according to Section 2(19AAA) is a company whose undertaking is transferred to the resulting company by virtue of demerger. Since the demerger is a type of compromise or arrangement, the governing provisions for the Demerger in India are defined under Sections 230 & 232 of the Companies Act 2013 and the procedure for filing application and approval for such is mentioned under Companies (Compromises, Arrangements and Amalgamations) Rules, 2016.

Therefore, in general terms, the meaning of Demerger in India can be understood as the transfer of demerged company (transferor) to a resulting Indian company (Transferee) company through a scheme of arrangement or compromise wherein all the shares and assets are transferred to the resulting company. Since the Companies act is silent on the cross border mergers, hence in a scheme of demerger, the resulting company shall be an Indian Company.

Types of Demergers

The different types available for demergers in India are:

• Spin-Off

The spin-off is a type of demerger wherein the parent company forms a wholly-owned subsidiary of its own by distributing all the shares of the Subsidiary company on a pro-rata basis. Through this scheme of the arrangement, both parent and subsidiary company continues to exist in the market. A large number of corporates adopt this scheme by establishing a subsidiary company, the company can invest its time in other services, and at the same time, the subsidiary company, after parting with the parent company, can take its decision solely and adopt business practices which are best suitable for their needs.

• Split -up

The split up is the type of demerger wherein the parent company is divided into two or more separate companies. The parent company ceases to exist after its divisions, and its shareholders are transferred to the new companies in consultation with them. The company usually takes this type of demerger if they cannot handle different verticals of their business segment; subsequently, they split all the verticals into different companies and appoint board members for the same. This gives the vertical company to focus on their specialisation and adopt the best suitable practices.

• Equity Carve-out

The equity carve-out is a type of demerger wherein the parent company forms a subsidiary company of its own and, at the same time, holds control over the activities of the subsidiary company. This scheme of the demerger is similar to a spin-off except that the controlling interest in equity carves out remains with the parent company. Also, some part of the shares of the subsidiary company is offered to the public through public issues.

• Divestitures

The divestiture is a type of demerger wherein the parent company sell one of its segment for cash and securities to a third party. The company generally undertakes this demerger scheme to raise funds if they plan to diversify investment strategies in other business activities in a different sector.

Modes of Demerger in India

The demerger in India of a company can be carried out in the following ways:

• Demerger by Agreement

The demerger in India may take place through an agreement between the parties. In a demerger agreement, the parent company decides to form a subsidiary through Spin-off and agrees to transfer all its assets, liabilities, and shares to the resulting subsidiary company. The agreement binds the party to the contract and compels them to stick to its term and conditions.

• Demerger by Scheme of Arrangement

The demerger in India takes place according to Section 232 of the Companies Act 2013 under the scheme of arrangement. Under this arrangement, the company has to first amend its MOA & AOA and prepare a draft scheme of arrangement that the board of directors should adopt through resolution. After the resolution, the company must apply to the Tribunal along with the necessary documents for the implementation of the terms and conditions of the scheme of arrangement.

Procedure of Demerger

The general procedure for demergers in India is as follows:

• Preparation of Draft scheme of Arrangement( Demerger)

The scheme of arrangement (Demerger) is an important document in the demerger process. It is a draft document that entails all the provisions relating to the demerged company’s shares, assets, and liabilities. The directors or liquidators may propose the draft scheme of arrangement in the board meeting. Moreover, it is also mandatory to serve the board and all the interested parties with a notice of meeting and make ensure that the resolution is achieved to approve the draft scheme.

• Filing of application to Tribunal

The demerged company shall make an application to the Tribunal along with the following documents:

1. Draft scheme of Arrangement (Demerger)

2. Latest financial statements

3. Latest Auditors’ Report

4. Information on the pendency of any proceedings or investigation

5. Any other information

• Issue of the meeting notice

The Tribunal, upon hearing the applicant, shall call for the meeting and direct that the notice be sent to all the creditors, members and debenture holders through e-mail, post, courier or any other mode as directed by the Tribunal.

• Holding Meetings of creditors or members

On the receipt of the notice, a meeting is held between the creditors or members and voting is performed on the draft scheme of arrangement (Demerger). The draft scheme of arrangement must be approved by a majority of the creditors or members present & voting.

• Affidavit of Service and Report of the Result

The chairperson appointed by the Tribunal shall send an affidavit signifying the directions of the Tribunal for issuance and advertisement of notice etc. are complied with. Further, the chairperson shall also send a report to the Tribunal about the result of the board meeting.

• Sanction of the Scheme  at meeting and filing a petition

The member of the board meeting after sanctioning the scheme at the board meeting are eligible to file a petition to the Tribunal for the approval of the scheme of arrangement (demerger).

• Approval of the Scheme

The Tribunal, after examining all the documents, shall sanction the scheme and also order for the modification, if any. The Tribunal shall also intimate the approval to the Registrar of Companies (ROC).

Conclusion

The demerger enables the company to diversify its losses by splitting the underperforming part of the business into a separate entity. It enables the holding company to sustain itself out of the remaining funds and helps maintain the goodwill of the company in the market. Since the demerger is a scheme of arrangement, the demerger in India shall take place according to the Companies Act 2013. The draft scheme of arrangement shall be prepared by the company and submitted to the Tribunal along with the application for demerger. The Tribunal maintains judicial scrutiny over the whole process and protects the investor’s interest.

Read Our Article: Tax Implications on Demerger of Company under IT Act