Workshop on

Mergers & Acquisitions

February 17, 2005

presented
by
Mohit Saraf
Partner
Luthra and Luthra
Law Offices 1
 Why M&A?

Underlying Principle for

M&A Transactions
2+24
Additional Value of Synergy

2
 Why M&A?
Market Intensification:
Horizontal Integration Buying a competitor
Acquisition of equity stake in IBP by IOC
AT&T merger into SBC enables the latter to access
the corporate customer base and exploit the
predictable cash flows typical of this telephony section

Market Extensions New markets for Present products

Maersk Pipavav : strategic objective of investing in a
container terminal in the west coast
Bharat Forges acquisition of CDP (Germany)
S&Ps proposed acquisition of CRISIL

3
 Why M&A?
Vertical Integration : Internalization of crucial
forward or backward activities
Vertical Forward Integration Buying a
customer
Indian Rayons acquisition of Madura
Garments along with brand rights

Vertical Backward Integration Buying a

supplier
IBMs acquisition of Daksh

4
 Why M&A?
Diversification: Overcome Barriers to Entry
Product Extension: New product in Present territory
P&G acquires Gillette to expand its product
offering in the household sector and smooth out
fluctuations in earning

Free-form Diversification: New product & New

territories
Flight Centres proposed acquisition of Friends
Globe
Indian Rayons acquisition of PSI Data Systems

5
 Why M&A?
Advantages:
Greater Economic Clout:
Proposed merger of Petroleum PSUs
P&G merger with Gillette expected to correct balance
of power between suppliers and retailers.

Economies of scale and Sharing Overheads: Size

really does matter
IOC & IBP

Synthesized capabilities
Proposed merger of nationalized banks

6
 M&A
Different Perspectives

Acquirer
Majority/ Strategic Partner
Minority/ Private Equity Investor
Target Company

7
 M&A
TRANSACTION ISSUES: TARGET
Due Diligence Full Disclosures
Linked with Reps & Warranties
Reps should be negative
DD in case of Listed Company
Post Closing Adjustment

Condition Precedents Definitive

Include as Exhibits

Survival of Reps for limited period

8
 M&A
TRANSACTION ISSUES: ACQUIRER
Due Diligence Risk Matrix and Value Depletor
Material Contracts
Any subsisting contracts granting similar or superior rights to
other investors
Termination rights of major customers
Approval rights of financiers
Title to Properties & Assets: esp. where main business
is situated
Statutory Dues
Litigation : Contingent Liabilities
IPR protection
Tax Compliance (Settlement Commission)

9
 M&A
TRANSACTION ISSUES: ACQUIRER
Mode of Acquisition
Pure Equity (Existing or New); Equity & Preference; Special
Class (Differential voting rights, dividends or otherwise)
Leveraged Acquisitions

Corporate Governance
Related Party Transactions (past & going forward)

Board Representation
- Quorum (Inclusive)
- Fiduciary Responsibility of Board v. Shareholders

10
 M&A
TRANSACTION ISSUES: ACQUIRER
Deadlock Resolution
Majority/ Strategic Partner
Lenders

Return on Investment
Cap on dividends to preference shares
Liquidation Preference

Lock - in of Promoters
Enforceability of transferability restrictions

11
 M&A
TRANSACTION ISSUES: ACQUIRER
Non - Compete/ Non - Solicitation
Payment for Goodwill to exiting partner

Exclusivity

Enforceability against Company

Company as party to SHA

Exit Options
Listing (Private Equity)
Call/ Put Option

12
 M&A
TRANSACTION ISSUES: GENERAL
Effectiveness of SHA and SPA

Indemnity
Aggregate Liability Cap
De Minimis
Threshold

Participative Rights v. Protective Rights

Strategic Partner : Participative Rights
Control on Board
Sharing Control
Private Equity : Protective Rights

13
 M&A
TRANSACTION ISSUES: GENERAL
Special Rights
Tag Along Rights: minority partner/ private equity
Drag - Along Rights: majority partner
Right to share the upside on revised valuation of Target
eg: on Merger; Listing at higher valuation
Right of First Refusal

Earn-out Structure
Favorable Business Projections

14
 M&A
TRANSACTION ISSUES: GENERAL
FCPA

Arbitration v. Litigation: Effective Remedy

Proper Law of Arbitration
ICC v. UNICITRAL
Group Companies Doctrine
Place of Arbitration
Cost Effective

15
 M&A
REGULATORY FRAMEWORK

TRANSACTION STRUCTURE
Companies Act
Income Tax Act
Stamp Acts
Competition Act

LISTED COMPANIES
SEBI Regulations
Stock Exchange Listing Agreement

TRANS-BORDER TRANSACTIONS
Foreign Exchange Management Act

16
 M&A
OVERVIEW
Mergers Spin Offs Acquisitions

DEMERGER OTHERS SHARES

ASSETS CONTROL

SLUMP SALE

17
 ACQUISITIONS

Acquisition
Shares
Control
Acquisition of Assets
Slump Sale 18
 Acquisitions
ISSUES: COMPANIES ACT
Sections 108A to G: Central Government approval if
in excess of threshold prescribed
ambiguity as to classification of goods

Section 372A: Compliance by transferee company in

acquisition of shares

Section 77A: Buy Back may be used as a defense to

a hostile takeover
Used in U.S.: PeopleSofts attempt to thwart Oracle

19
 Acquisitions
ISSUES: FEMA
Acquirer - Non-Resident:
No approval required for purchase of shares (including existing shares)
From R
From NR

Valuation prescribed in case of R-NR not less than

Ruling Market Price - Listed Target Company
Fair valuation by a CA as per CCI guidelines - Unlisted Target
Company

Press Note 18 replaced by Press Note 1 of 2005

Investment has to comply with FDI policy

20
 Acquisitions
ISSUES: FEMA
Target Company is a Non-Resident
Direct investment in JV/ WOS outside India (other than financial
services) requires no approval subject to conditions including inter
alia
Financial commitment < or = 100% networth

Investment by way of remittance only if valuation

If > 5 million USD: by Merchant Banker/ Investment Banker
registered with SEBI/ appropriate authorities
Other cases: by CA/ CPA

Investment by share swap: valuation by Merchant Banker/

Investment Banker registered with SEBI/ appropriate authorities

21
 Acquisitions
ISSUES: TAKEOVER CODE
Definition of Control - Inclusive
Ambiguous:
- TATA Sellout in ACC.
Negative control?

S. 25(2) prohibits public offers after 21 days of the public

announcement of first public offer

In case of indirect acquisition, foreign acquirer has three

months from completion of transaction to make open offer.
Therefore, foreign transactions can be concluded prior to
open offer in India.

22
 Acquisitions
RECENT CHANGES : TAKEOVER CODE
New thresholds of 54% and 74% in Regulation 7
55% shares cannot be allotted by preferential allotment or market
purchase consolidation by public offer only
Acquisition by public offer under 11(2) can be for only so many
shares as will keep float above listing requirements.
Where any acquisition reduces public float below Listing
Agreement requirements, acquisition to comply with delisting
guidelines
Where Code is triggered by a global deal, if the public offer will
lower float to below the listing requirement, then acquirer has 12
months to raise float either by fresh issue or by disinvestment.

23
 Acquisitions
ISSUES: MISC
Stamp Duty
No stamp duty if transferred shares are
dematerialized

Industrial Disputes Act (s. 25FF)

Workmen employed by transferor company
entitled to retrenchment benefits unless retained in
employment on same terms.

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 Mergers

Mergers
Spin-offs
Demergers
25
 Mergers
STRUCTURE 1
A = Amalgamating Company: Ceases to Exist
B = Amalgamated Company
B receives all of As assets and liabilities
Shareholders of A receive shares in B and maybe other
benefits like debentures, cash

A B
Transfer assets and liabilities

26
 Mergers
STRUCTURE 2
A, B and C = Amalgamating Companies: Cease to exist
D = Amalgamated Company: may or may not have
existed before Merger
All assets and liabilities of A, B and C transferred to D
Shareholders in A,B and C get shares in D.

B D

C
27
 Spin-Offs
STRUCTURE

Transfer of undertaking Y
X Y Y
Consideration in cash
or issue of shares Company B
Company A

Consideration is usually shares of Company B but

maybe cash.
Process may or may not be Court sanctioned.
Salora spinning off Panasonic to Matsushita
under s. 391 Scheme. Consideration in cash.
28
 Demergers
STRUCTURE
Demergers are one type of spin-offs: under s. 391
A = Demerging Company
B = Resulting Company: may or may not have existed
earlier
A transfers undertaking to B
B issues shares to shareholders of A

Transfers undertaking Y
X Y Y

Company A
Shareholders Company B
of Issues shares
A 29
 Merger & Demerger
PROCESS
Phase- I
Draft Scheme
Notice to members of Board of both companies
Determine swap ratio based on valuation report
Board approval of both companies
Prior NoCs from secured creditors and shareholders for exemption
from meeting: Reduce Time and Costs
In ICICI Ltd. merger with ICICI Bank, meeting of preference
shareholders of ICICI Ltd. was dispensed with since sole
preference shareholder furnished an NOC
Phase- II
Draft Application under s. 391(1)
Application to HCs in respective jurisdictions of both companies for
sanction / direction to conduct meetings
Moving registered office to one jurisdiction: Reduce Time and
Costs

30
 Merger & Demerger
PROCESS

Phase- III
Notice of EGM to members with statement of terms of
merger, interests of directors and proxy forms: 21 days
Advertisement
Notice in 2 newspapers: 21 days
Affidavit certifying compliance with HCs directions in
respect of notice/ advertisement
Meetings of creditors and/ or shareholders: agreed to by
majority in number representing of value present and
voting
Chairman of meetings to file report within 7 days of meeting
Resolutions and Explanatory Statements to be filed with
RoC
31
 Merger & Demerger
PROCESS
Phase- IV (Approval of the Scheme)
HC to be moved within 7 days of Chairmans Report for
second motion petition
10 days notice of hearing of petition in same newspapers
Notice to Central Govt. (Regional Director), and OL (if
applicable): Submit reports
Objections raised in 391 proceedings
HC Sanction
Certified copy of HC Order to be filed with RoC within 30
days of order.

32
 Merger & Demerger
ISSUES: COMPANIES ACT
s 391 - 394: Complete Code, Single Window Clearance
Reduction of capital- Position unclear, Predominance of judicial view:
substantial compliance with s. 100- 102 required.

Transnational Mergers: 391 - 394 mechanism operates only where

amalgamated company is Indian. E.g. of transnational merger concluded
under 391 route - Bank of Muscat merging into Centurion Bank by order
of Karnataka HC

Alternative Mechanism: S. 494

Through Liquidation Process
Liquidator transfers assets to foreign company for shares
Process has to be altogether voluntary
Tax benefits are unavailable under this route

33
 Other Spin-Offs
ISSUES: COMPANIES ACT

Where spin-offs are outside the 391 mechanism, the

following compliances need to be ensured
293(1)(a) resolution
Voting has to be by postal ballot in a public listed
company

34
 Mergers and Demergers
ISSUES: INCOME TAX
Transfer of capital assets by amalgamating company to
amalgamated company is exempt from Capital Gains Tax
provided amalgamated company is an Indian company

Capital Gains Exemption in respect of shares issued to

members of amalgamating/ demerging company- s. 47

Exemption may not be available if members of amalgamating

company receive anything besides shares in the amalgamated
company like debentures or cash- Gujarat HC in Gautam
Sarabhai v. CIT, 173 ITR 216.

35
 Mergers and Demergers
ISSUES: INCOME TAX
In case of fraction shares, issue to trustee who
liquidates these and distributes money to shareholders
of amalgamating company.

Carry forward of losses and unabsorbed depreciation

provided the amalgamated company carry on the
business of the amalgamating company for at least 5
years s. 72A
Use of Reverse merger to meet above condition

Spin-off receives tax benefits under Income Tax Act

only if it is a demerger

36
 Slump Sale
ISSUES: TAXATION
Slump Sale = Transfer of undertaking without
itemizing individual assets and liabilities- s.2(42C)
Income Tax Act

Treated as capital gains

If undertaking is older than 3 years, long term capital

gains rates apply even if individual assets are new

Carry forward of losses and unabsorbed depreciation

unavailable
37
 Merger & Demergers
ISSUES: SALES TAX
No Sales tax on Amalgamation or demerger.

Where effective date is retrospective, any transfers

between amalgamating company and amalgamated
company retrospectively cease to be liable to sales
tax- Mad HC Castrol Oil v. State of TN, 114 STC 468

Some Sales Tax enactments contain specific

provisions to tax such transactions eg. S.33C,
Bombay Sales Tax Act. No such provision in Central
Sales Tax Act.
38
 Merger
ISSUES: STAMP DUTY
Divergences between states: Shopping for beneficial rates
usually pointless

Duty to be imposed on value of shares transferred not on

individual assets transferred: Bom HC in Li Taka AIR 1997
Bom 7

States with Specific entries: Maharashtra, Karnataka,

Rajasthan and Gujarat

39
 Merger
ISSUES: STAMP DUTY
States without specific entries: Unclear if duty leviable.
Cal HC in Madhu Intra Ltd. v. ROC, 2004 (3) CHN 607 -
394 Order is not an instrument chargeable to duty
Supreme Court in Ruby Sales v. State of Maharashtra
(1994) 1 SCC 531 - specific inclusion of civil court decrees
in Bombay Stamp Act only abundant caution

1937 Notification under Indian Stamp Act, 1899 remits

duty when merger is of a 90% subsidiary: Remission not
available in states with own legislations eg. Kerala,
Karnataka, Maharashtra, Gujarat and Rajasthan

Gujarat and Maharashtra have limits on stamp duty for

mergers and demergers at Rs.10 crore and Rs. 25 crore.
40
 Merger
ISSUES: SEBI
Acquisition of shares pursuant to a scheme of
arrangement or reconstruction under any law, Indian
or foreign exempt from SEBI Takeover Code.
Exemption claimed unsuccessfully by Luxottica in the
acquisition of Ray Ban Sun Optics India

Listing Agreement:
Scheme before the Court/ Tribunal must not violate,
override or circumscribe the securities laws or stock
exchange requirements
Disclosure required

41
 Merger
ISSUES: SEBI
Shares allotted by unlisted transferee company to
shareholders of listed transferor company under a
HC sanctioned scheme can be listed without an
IPO subject to conditions (DIP).
Eg. Dabur Pharmaceuticals

Constitutes Price Sensitive Information in terms of

Insider Trading Regulations.

Compliance with Delisting Guidelines if public

shareholding below prescribed limit.

42
 Mergers
MISCELLANEOUS ISSUES
Foreign Exchange Management Act, 1999
Where the amalgamated company is Indian, non
resident shareholders of the foreign amalgamating
company require RBI approval to receive shares.

Where the amalgamated company is foreign, the

issue of its shares to Indian shareholders requires
RBI approval.

Automatic route available where non residents have

to be issued shares in a merger of Indian companies.

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 Mergers
MISCELLANEOUS ISSUES
Human Resources
Workmen entitled to retrenchment benefits
unless retained in employment on same terms.
Adjustments of pay scale needs to be resolved.
Global Trust employees were retained on same
terms in OBC. Pay packages of former GTB staff
could be altered only after 3 years. OBC
management had to contend with GTBs complex
salary structure.

44
 Mergers & Acquisitions
COMPETITION LAW
Monopolistic and Restrictive Trade Practices Act, 1969
Status: Repealing provision in Competition Act, 2002
not notified.

No Central Government approval required for a merger

or acquisition under the MRTPA

Act attracted only if amalgamated company discovered

to be monopolistic in its working not at stage of
amalgamation- Hindustan Lever, 1995 Supp (1) SCC
499

45
 Mergers & Acquisitions
COMPETITION LAW
Competition Act, 2002 (Partially notified)
Merger or Acquisition = Combination if stipulated
thresholds respecting aggregate asset or turnover
are exceeded

Prior approval of combination is not mandatory

Test Cause or likely to cause an appreciable

adverse effect on competition within the relevant
market

46