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Workshop on
Mergers & AcquisitionsFebruary 17, 2005
presented
by
Mohit SarafPartner
Luthra and LuthraLaw Offices
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Why M&A?
Underlying Principle for
M&A Transactions2 + 2 4
Additional Value of ³Synergy
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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 toaccess the corporate customer base and exploit
the predictable cash flows typical of thistelephony section
Market Extensions ± New markets for Presentproducts
Maersk ± Pipavav : strategic objective of investing in a container terminal in the westcoast
Bharat Forge¶s acquisition of CDP (Germany)
S&P¶s proposed acquisition of CRISIL
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Why M&A?
Vertical Integration : Internalization of crucial
forward or backward activities
Vertical Forward Integration ± Buying a
customer
Indian Rayon¶s acquisition of Madura
Garments along with brand rights
Vertical Backward Integration ± Buying a
supplier
IBM¶s acquisition of Daksh
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Why M&A?
Diversification: Overcome Barriers to Entry
Product Extension: New product in Presentterritory
P&G acquires Gillette to expand its productoffering in the household sector and smoothout fluctuations in earning
Free-form Diversification: New product & New
territoriesFlight Centre¶s proposed acquisition of
Friends Globe
Indian Rayon¶s acquisition of PSI DataSystems
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Why M&A?
Advantages:
Greater Economic Clout:
Proposed merger of Petroleum PSUs
P&G merger with Gillette expected to
correct balance of power between suppliersand retailers.
Economies of scale and SharingOverheads: Size really does matter
IOC & IBP
Synthesized capabilities
Proposed merger of nationalized banks
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M&A
Different Perspectives
Acquirer ± Majority/ Strategic Partner
± Minority/ Private Equity Investor
Target Company
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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
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M&ATRANSACTION 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 mainbusiness is situated
± Statutory Dues
± Litigation : Contingent Liabilities
± IPR protection
± Tax Compliance (Settlement Commission)
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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
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M&ATRANSACTION 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
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M&ATRANSACTION 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
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M&ATRANSACTION 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
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M&ATRANSACTION 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
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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
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M&AREGULATORY FRAMEWORK
TR ANSACTION STRUCTURE
Companies Act
Income Tax Act
Stamp Acts
Competition Act
TR ANS-BORDER TR ANSACTIONS
Foreign Exchange Management Act
LISTED COMPANIES
SEBI Regulations
Stock Exchange ± Listing Agreement
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M&AOVERVIEW
Mergers Spin Offs Acquisitions
DEMERGER OTHERS
ASSETS
SHARES
CONTROL
SLUMP SALE
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ACQUISITIONS
Acquisition
Shares
Control
Acquisition of Assets
Slump Sale
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AcquisitionsISSUES: COMPANIES ACT
Sections 108A to G: Central Government approval if in excess of threshold prescribed
ambiguity as to µclassification of g oods¶
Section 372A: Compliance by transferee company inacquisition of shares
Section 77A: Buy Back may be used as a defense toa hostile takeover
Used in U.S.: PeopleSoft¶s attempt to thwartOracle
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AcquisitionsISSUES: FEMA
Acquirer - Non-Resident:
No approval required for purchase of shares (includingexisting 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
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AcquisitionsISSUES: FEMA
Target Company is a Non-Resident Direct investment in JV/ WOS outside India (other
than financial services) requires no approval subject toconditions including i nt er 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 MerchantBanker/ Investment Banker registered with SEBI/
appropriate authorities
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AcquisitionsISSUES: TAKEOVER CODE
Definition of ³Control - Inclusive
Ambiguous:- TATA Sellout in ACC.
Negative control?
S. 25(2) prohibits public offers after 21 days of thepublic announcement of first public offer
In case of indirect acquisition, foreign acquirer hasthree months from completion of transaction to makeopen offer. Therefore, foreign transactions can beconcluded prior to open offer in India.
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AcquisitionsRECENT CHANGES : TAKEOVER CODE
New thresholds of 54% and 74% in Regulation 7
55% shares cannot be allotted by preferentialallotment or market purchase ± consolidation bypublic offer only
Acquisition by public offer under 11(2) can be for onlyso many shares as will keep float above listingrequirements.
Where any acquisition reduces public float below
Listing Agreement requirements, acquisition tocomply with delisting guidelines
Where Code is triggered by a global deal, if the publicoffer will lower float to below the listing requirement,then acquirer has 12 months to raise float either by
fresh issue or by disinvestment.
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AcquisitionsISSUES: 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
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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
Transfer assets and liabilitiesA B
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MergersSTRUCTURE 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
DB
C
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Spin-OffsSTRUCTURE
YX YTransfer of undertaking Y
Company BCompany 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.
Consideration in cashor issue of shares
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DemergersSTRUCTURE
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
X Y Y
Company BCompany A
Transfers undertaking Y
Shareholders
of
A
Issues shares
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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: R educ e T ime and Costs
In ICICI Ltd. merger with ICICI Bank, meeting of preference shareholders of ICICI Ltd. was dispensedwith since sole preference shareholder furnished anNOC
Phase- II
Draft Application under s. 391(1)
Application to HCs in respective jurisdictions of bothcompanies for sanction / direction to conduct meetings
±M
ovi ng reg ist ered offic e to one j ur isdiction:R
educ eT ime and Costs
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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 HC¶s directions inrespect of notice/ advertisement
Meetings of creditors and/ or shareholders: agreed to by
majority in number representing ¾ of value present andvoting
Chairman of meetings to file report within 7 days of meeting
Resolutions and Explanatory Statements to be filed withRoC
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Merger & Demerger PROCESS
Phase- IV (Approval of the Scheme)
HC to be moved within 7 days of Chairman¶s 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 30days of order.
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Merger & Demerger ISSUES: COMPANIES ACT
s 391 - 394: ³Complete Code´, ³Single Window Clearance´
Reduction of capital- Position unclear, Predominanceof judicial view: substantial compliance with s. 100- 102required.
Transnational Mergers: 391 - 394 mechanism operatesonly where amalgamated company is Indian. E.g. of transnational merger concluded under 391 route - Bankof 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 ³altogether voluntary´
Tax benefits are unavailable under this route
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Other Spin-OffsISSUES: 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
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Mergers and DemergersISSUES: INCOME TAX
Transfer of capital assets by amalgamating companyto amalgamated company is exempt from CapitalGains Tax provided amalgamated company is an
Indian company
Capital Gains Exemption in respect of shares issuedto members of amalgamating/ demerging company-s. 47
Exemption may not be available if members of amalgamating company receive anything besides sharesin the amalgamated company like debentures or cash-Gujarat HC in Gautam S ar abhai v. CI T , 173 ITR 216.
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Mergers and DemergersISSUES: 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 depreciationprovided 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
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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
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Merger & DemergersISSUES: SALES TAX
No Sales tax on Amalgamation or demerger.
Where effective date is retrospective, any transfers
between amalgamating company and amalgamatedcompany retrospectively cease to be liable to sales
tax- Mad HC Cast r ol Oil v. S tat e of TN , 114 STC 468
Some Sales Tax enactments contain specificprovisions to tax such transactions eg. S.33C,
Bombay Sales Tax Act. No such provision in Central
Sales Tax Act.
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Merger
ISSUES: STAMP DUTY Divergences between states: Shopping for beneficial rates
usually pointless
Duty to be imposed on value of shares transferred not onindividual assets transferred: Bom HC in i T aka AIR 1997
Bom 7
States with Specific entries: Maharashtra, Karnataka,
Rajasthan and Gujarat
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Merger ISSUES: STAMP DUTY
States without specific entries: Unclear if duty leviable. Cal HC in M adhu I nt r a Ltd. v. R OC, 2004 (3) CHN 607 -
394 Order is not an instrument chargeable to duty
Supreme Court in R uby S al es v. S tat e of M ahar asht r a(1994) 1 SCC 531 - specific inclusion of civil court
decrees in Bombay Stamp Act only abundant caution
1937 Notification under Indian Stamp Act, 1899 remitsduty when merger is of a 90% subsidiary: Remissionnot 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.
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Merger ISSUES: SEBI
Acquisition of shares pursuant to a scheme of arrangement or reconstruction under any law, Indianor 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
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Merger ISSUES: SEBI
Shares allotted by unlisted transferee company toshareholders of listed transferor company under aHC sanctioned scheme ± can be listed without anIPO subject to conditions (DIP).
Eg. Dabur Pharmaceuticals
Constitutes µPrice Sensitive Information¶ in terms of Insider Trading Regulations.
Compliance with Delisting Guidelines if publicshareholding below prescribed limit.
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MergersMISCELLANEOUS ISSUES
Foreign Exchange Management Act, 1999
Where the amalgamated company is Indian, nonresident shareholders of the foreignamalgamating company require RBI approval to
receive shares.
Where the amalgamated company is foreign, theissue of its shares to Indian shareholdersrequires RBI approval.
Automatic route available where non residentshave to be issued shares in a merger of Indiancompanies.
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MergersMISCELLANEOUS 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 GTB¶s complex
salary structure.
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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 amerger or acquisition under the MRTPA
Act attracted only if amalgamated companydiscovered to be monopolistic in its working not atstage of amalgamation- H i ndustan Lev er , 1995
Supp (1) SCC 499
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Mergers & Acquisitions
COMPETITION LAW
Competition Act, 2002 (Partially notified)
Merger or Acquisition = ³Combination´ if stipulated
thresholds respecting aggregate asset or turnover
are exceeded
Prior approval of combination is not mandatory
Test ± ³Cause or lik el y to cause an appreciabl e
adv er se eff ect on competition w ithi n the rel evant
mar k et