Workshop on Mergers & Acquisitions

February 17, 2005 presented by Jairam Chandnani Partner Lexim Associates

1

Why M&A?

Underlying Principle for M&A Transactions 2 + 2 ≠ 4 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 –

products New markets for Present  Maersk coast – Pipavav : strategic objective of investing in a container terminal in the west  Bharat Forge’s acquisition of CDP (Germany)  S&P’s proposed acquisition of CRISIL 3

Why M&A?



Vertical Integration :

Internalization of crucial forward or backward activities •

Vertical Forward Integration

customer

–

Buying a  Indian Rayon’s acquisition of Madura Garments along with brand rights •

Vertical Backward Integration –

Buying a supplier  IBM’s acquisition of Daksh 4

Why M&A?



Diversification:

Overcome Barriers to Entry •

Product Extension

territory : New product in Present  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 Centre’s proposed acquisition of Friends Globe  Indian Rayon’s 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 Overheads:

 IOC & IBP

of scale and

Size really does matter

Sharing

•

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

Mergers M&A OVERVIEW Spin Offs Acquisitions

DEMERGER OTHERS ASSETS SHARES 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.: Oracle PeopleSoft’s attempt to thwart 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/ 21 appropriate authorities

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.

24

Mergers



Mergers



Spin-offs • Demergers

25

Mergers STRUCTURE 1

    A = Amalgamating Company: Ceases to Exist B = Amalgamated Company B receives all of A’s assets and liabilities Shareholders of A receive shares in B and maybe other benefits like debentures, cash A Transfer assets and liabilities B 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.

A B C D 27

Spin-Offs STRUCTURE

X Y Transfer of undertaking 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 of A Issues shares Company B 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 respect of notice/ advertisement HC’s directions in  Meetings of creditors and/ or shareholders: agreed to by majority in number representing ¾ 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 second motion petition Chairman’s Report for 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, Rajasthan and Gujarat Karnataka, 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 shareholding below prescribed limit.

if public 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.

43

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 management had to contend with 3 years.

OBC GTB’s 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