Section 394A of the Companies Act 1956 requires Central Government [powers delegated to Regional Directors] to prepare report on schemes involving arrangement, mergers, amalgamation, etc. of companies for its submissions to Court. Recently, MCA has issued Circular No. 1/2014 dated 15 January 2014 requiring Regional Directors to also seek the representation of the Income-tax Department and/or other sectoral regulators while preparing the aforesaid Report. The learned author in this article explains the new requirements in the Circular, their impact on the schemes and comparison with the existing requirements under the provisions of the Act/ Rules and Companies Act, 2013.
New prescriptions
Mergers have just got a little more complicated and even more time consuming than earlier. Yet another round of notices/objections by statutory authorities have been added to even otherwise a fairly long existing list. Now, the Ministry of Corporate Affairs (MCA) requires that the Regional Director should invite, in certain cases, objections to a scheme of amalgamation/arrangement, etc. (Schemes) from other regulators like Income-tax department, SEBI, RBI, etc. – refer circular number F. No. 2/1/2014 dated 15th January 2014.
Abuse of Schemes
Mergers, demergers, schemes of arrangements/ reduction, etc. have often been used, with the incidental or even main object to circumvent various laws, avoid taxes, window dress accounts, etc. Carried forward losses may be made available to other profit making companies to help reduce their taxes. Reserves otherwise not “free” become so after such schemes. Items of expenditure/losses that should have gone to reduce profits are debited to reserves. The rules relating to listing of shares on stock exchanges may also be sought to be bypassed. Even shareholders’ wealth have been found to be expropriated by schemes such as that for forced buybacks of shares and so on.
The impression – and this is only partly correct – is that the ‘scheme’ing parties are often able to convince the court that, since shareholders/creditors have duly approved the scheme and that there is nothing wrong on the face of the scheme, it should be approved. The court is also sought to be persuaded that its role is limited in such cases and, particularly when the interested parties have not objected before the court, the court should sanction the Scheme. Belated objections are also sought to be rejected.
Interestingly, existing provisions for sanction of such schemes already require a series of approvals under direct supervision of the high court. This is without considering several specific approvals/clearances/filings required under other laws. The schemes almost always require approvals of shareholders/creditors at meetings conducted under court’s supervision. Depending upon the type of scheme, a detailed audit is required to be carried out by a specially appointed auditor. A notice has to be served to the Regional Director seeking his comments, on behalf of the Central Government. Finally, the Court has to sanction the scheme. Often, this ends up being a bureaucratic nightmare with the petitioners having to run from the proverbial pillar-to-post to expedite things.
To add to this, now, the MCA has added yet another window of delay and objections from multiple authorities. Let us understand what the new requirement is.
New requirement of inviting objections from other regulators including income-tax authorities
As stated above, a notice has to be served, as required by section 394A, on the Regional Director (RD) of the proposed scheme. The RD acts for this purpose on behalf of the Central Government. The Court is required into consideration the representations, if any, of the RD.
Other regulators/departments such as the Incometax department usually do not have a direct role in the proceedings though of course they may still object directly to the court. Such other regulators/ departments may of course also convey their views to the RD.
However, it was recently found,by the MCA (so the circular states), that the RD ‘did not project the objections of the income-tax department’ in a particular scheme. Considering this, certain obligations have been placed on the RD.
It is now prescribed that the RD should do two things. Firstly, when it receives such a notice of scheme u/s. 394A, it has to invite specific comments from the income-tax department. If no comments are received within 15 days of receipt of communication from the RD, the RD may presume that the Income-tax department has no objections.
Secondly, the RD should also examine the scheme to consider whether feedback from other sectoral regulators should be obtained. If yes, a similar opportunity should be given to them. Though not named, it appears that comments of regulators like SEBI, RBI, etc. may be invited in appropriate cases. It is quite possible that in practice, the RD may routinely send the scheme to various regulators for their comments.
What should the RD do if comments are received? Does it merely forward them like a post office? The answer is, generally, yes. The RD is not required to decide on the correctness or otherwise of the comments and rightly so. However, the RD is still given some discretion. If it has ‘compelling’ reasons to doubt the correctness of the comments, then it is required to make a reference to the MCA. The MCA, in turn, will take up the matter before the concerned other Ministry before taking a final decision on what approach to take before the Court.
Needless to emphasise, the individual regulators/ departments are free to appear directly before the court and make their objections.
However, the objections/comments of the regulators/ departments are binding on the court. The court has wide power and discretion to examine the specific objections on their merits and may accept or reject the same.
Impact on Schemes
In theory, it may appear that the new requirement is beneficial and does not create any fresh hurdle or delay. It ensures that that the interests of various stakeholders whom the regulator represents are taken into account. The 15-days period for submissions of comments may not, in practice, really add to the overall time taken for attaining sanction of the court. The court would also have the benefit of all views before sanctioning the scheme. The applicants may also have to worry less of regulators raising objection later when irrevocable steps of implementing the scheme may have been taken.
In practice, however, it is quite likely that this would add to the delay and possibly make the matter more litigious. Often, a scheme may involve serious tax implications. It will have to be seen whether the Income-tax department promptly replies with all its detailed objections in 15 days. What would happen if the income-tax department (or other regulator) seeks extension of time?
Interestingly (as also discussed later), there already exist specific requirements for inviting comments from certain authorities. For example, in case of certain schemes involving listed companies, the draft scheme has to be filed with the stock exchange 30 days in advance during which they may give their comments. Courts have held that if the stock exchange does not respond within 30 days, the scheme does not have to be held up and the court may still go ahead and sanction it. Thus, it is possible that the parties may represent before the court to go ahead and consider the scheme in case of delay in receipt of comments. Granting of time to a regulator is at the discreation of the court however in practice it is quite likely that extension of time will be granting resulting overall delay particularly in complex cases. One has also to remember that the delay may come from any of the various regulators/department to whom the RD has sent notice.
Existing requirements of approval/NOCs, etc.
As stated earlier, the new requirement is in addition to the several existing requirements by various authorities/regulators. In fact, there is a contradiction in approach in several provisions. On the one hand, several provisions give exemption if the restructuring is carried out through the court route. The SEBI Takeover Regulations, for example, give exemptions where the acquisition of shares is through specified schemes. The Income-tax Act, 1961 too grants exemptions to transfers made through specified Schemes. At the same time, there are provisions for obtaining clearances/approvals or just a notice
in some laws.
For example, under certain circumstances, prior approval of the Reserve Bank of India would be required in case of mergers of non-banking financial companies. The Listing Agreement requires listed companies, under certain circumstances, to file the proposed scheme 30 days in advance with stock exchanges. There is even an overriding requirement that schemes should not be used to circumvent securities laws.
However, the new requirement inreases one general layer of scrutiny whereby a specific notice is to be given to Income-tax department and the RD is also required to generally consider whether notice to other regulators should also be given.
Companies Act, 2013
The provisions of this Act, though not yet notified in this respect, provide for a generic, though ambiguously worded, requirement of giving notice. Section 230(5) of the Act requires that a notice with prescribed documents would have to be sent to ‘the Income-tax authorities, the Reserve Bank of India, the Securities and Exchange Board, the Registrar, the respective stock exchanges, the official liquidator, the Competition Commission of India….. and such other sectoral regulators or authorities that are likely to be affected by the compromise or arrangement and shall require that representations, if any, to be made by the authorities within a period of thirty days from the date of receipt of such notice, failing which, it shall be presumed that they have no representation to make on the proposals’.
The scope of this prescription is different from that set out in the circular. It is wider in some aspects but narrower in others. It requires that a notice has to be given to all the specified authorities and others too which are likely to be affected by the scheme. It may sound strange that authorities like SEBI are to be notified even in cases where the companies involved may be unlisted or otherwise not affected by regulations governed by SEBI. Perhaps the intention is, as appears from latter words, that only those authorities. who are likely to be affected by a scheme should be so notified.
Conclusion
Authorities/regulators like SEBI, MCA, RBI, Income-tax, etc. do have powers to examine the merger and its implications even after the scheme is sanctioned. If the scheme results in violation of any requirements specified under the respective laws, they can take appropriate action. For example, the Reserve Bank of India can initiate action if a non-banking financial company is amalgamated in a manner that any of the requirements of the Act/Directions are contravened. Similarly, SEBI/stock exchanges have powers to examine the implications in case of a merger. Thus, it is not as if that a cheme, on approval, would make the provisions of such laws redundant.
However, at the same time, certain schemes may have consequences which cannot be annuled. For example, there have been schemes of forced buyback of shares whereby shares of even dissenting shareholders or those who have not positively consented have been bought at specified price. Once this is done, it may be too late for the regulators concerned to take corrective action.
Thus, this new requirement gives an opportunity, to the concerned authorities to examine and present their objections before the court, either directly or through the RD. This would/should avoid subsequent action by the Regulators who were given the requisite notice.
Only time will show whether these new requirement will save time and avoid subsequent action. I believe we don’t need more laws – what is required is better administration.
