Decoding the Inefficacious Judicial Interpretation of Outbound Demergers in India

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Authors – Nikunj Mehta & Eshvar Girish, Students of School of Law, Christ University


Post the 1990’s, the adoption of globalization yielded several demergers and combinations around the world. To facilitate smooth conduction of such cross-border arrangements, Companies Act 2013, followed by Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 have been incorporated by the Indian legislatures.

Being enacted to cover both forms of arrangements (National and Cross Border), these legislative enactments are inclusive enough to cover multiple corporate However, while providing an exhaustive interpretation to the provisions of these legislation, the National Company Law Tribunal [NCLT], in its recently passed judgment, has put the applicability of these enactments over cross border demergers in question.

This article attempts to analyze the reasoning of this judgment. The same is done by countering the principles of statutory interpretations adopted by the tribunal in support of its reasoning. It then concludes with the suggestive interpretation of those provisions, in line with the objectives of the enactments.

Meaning of Demergers   

Since the term ‘demergers’ hasn’t been comprehensively defined under any Indian legislation, reference must be made to dictionaries and commentaries. Dr. J. C. Verma, in his commentary on ‘Corporate Mergers Amalgamations and Takeovers’, defines the term ‘demerger’. He defines it as split or division of a company into more number of companies, and new companies, the transferees, need not be the subsidiaries of the parent companies which have undergone such split or division. Moreover, the New Oxford Dictionary defines the term ‘demerger’. It defines it as ‘the separation of a larger company into two or more smaller organizations’.

Statutory Provisions Regarding Demergers

Companies Act

Demergers have not been defined in the Companies Act, 2013 [Act]. However, Section 230(1) of the Act describes it as the reorganization of the company’s share capital. This is either by the consolidation of shares of different classes, division of shares of different classes, or both.

Furthermore, Rule 25A under Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 [CAA Rules]also provides for regulating cross border arrangements. However, the term ‘demergers’ has not been explicitly mentioned under these rules.

Income Tax Act

Section 2(19AA)[5] under the Income Tax Act, 1961 has defined demergers in relation to companies as a transfer pursuant to the scheme of arrangement and is identical to section 293(1)(a) of Companies Act, 1956. It must satisfy Section 391 and Section 394 of Companies Act, 1956 in order to qualify as a demerger.

FEMA Cross Border Regulations

The term ‘Cross Border Merger’ in the draft regulations issued by RBI in April 2017 was defined as “any merger, demerger, amalgamation or arrangement between Indian companies and foreign companies”. However, the term ‘demerger’ was excluded from the Foreign Exchange Management (Cross Border Merger) Regulations [CBM Regulations] issued in 2018.

NCLT’s Order on Outbound Demerger of Sun Pharma

Sun Pharmaceutical Industries wanted to consolidate its holding structure through the process of restructuring its companies overseas and demerge two of its specified investment undertakings to two of its wholly-owned subsidiaries, being the resultant companies that are incorporated in Netherlands and United States.

The procedure to undertake any scheme of merger or amalgamation must be done in accordance with Section 230 to Section 232 of the Act. These provisions have to be adhered by the company. The requisite approval from the shareholders and creditors had been obtained. The Registrar of Companies, the Reserve Bank of India, the Securities and Exchange Board of India and the Income Tax authorities had also approved the scheme arrangement. However, it was disapproved by the Regional Director.

The contentions raised by the Regional Director was accepted by the Ahmedabad bench of NCLT. The bench held that the scheme of arrangement flouted the provisions under the Act. It also contended that Section 234 of the Act and Rule 25A of the CAA rules are silent on outbound demergers.

The tribunal, while adhering to the ‘cardinal rule of interpretation’ propounded that, the courts are not empowered to question the wisdom of the legislature when the terminology used under the statute poses an unambiguous meaning of the concept described. Further, while emphasizing on the absence of the term ‘demergers’ in the CBM Regulations, the tribunal concluded that they do not cover transactions related to outbound demergers under their purview.

Critical Analysis

Inclusive terms

The term ‘arrangement’ used as a technical jargon in the field of mergers and acquisitions includes a demerger. Mergers and demergers are essential in order to help companies execute or carry out acquisitions and divestments as and when necessary. The same tribunal in an order passed in 2018, by harmoniously reading section 234(1) with Section 232(1)(b) held that the provisions in the Act with the nomenclature ‘mergers and amalgamations’ is applicable to demergers as well. Hence, even in the absence of the term ‘demergers’ from the CBM Regulations, the broader term ‘arrangement’ must be interpreted to include comprehensive transactions under its ambit like the one in the current case.

Progressive nature of Companies Act

Amendments in the Act have constantly been made in consonance with the ever-changing dynamic and complex requirements of cross border arrangements (inbound and outbound). For instance, provisions for cross border mergers and amalgamations under Companies Act, 1956 defined transferee companies as to mean only companies registered under the CA 1956, i.e., necessarily an Indian company. This position has been altered by the Companies Act, 2013 which is a successor of the previous Act under which such restrictions have been removed by section 234 of Companies Act, 2013. The transferee company need not be an Indian company. Hence, due to the removal of such a prohibition, it can be said that the Act now permits cross-border mergers and demergers which is inclusive of inbound and outbound mergers and demergers as well.

Rule of Harmonious Construction

Whenever an absurdity arises with respect to the true sense of a provision under a certain statute, a court should harmoniously read the provisions in line with the purpose and intent of the statute to avoid unintended results. This rule has been termed as ‘harmonious rule of interpretation’.

In the previous case of Sun Pharmaceuticals, the NCLT had allowed the company to undertake an inbound cross border demerger under Section 234 of the Act. The Regional Director had objected to the inbound cross border demerger of Sun Pharma in the same manner as he did in the current case. However, the tribunal had approved the inbound demerger of Sun Pharma which is ironic because the same tribunal has disallowed the outbound demerger of Sun Pharma in the current case.

The tribunal while deciding the inbound demerger, observed that Section 232(1)(b) read with Section 234(1) of the Act implies a demerger. If the said provision is read in detail, then it can be ascertained that the transfer of part of the undertaking is allowed which is the type of transaction a demerger is based on. Section 234(1) further affirms that the given Section shall be applied mutatis mutandis to the schemes of mergers and amalgamations.

A harmonious reading of Section 234 along with Rule 25A and CBM Regulations denotes the inclusive nature of the regulatory framework for cross border transactions. Thus, contrary to the argument made by NCLT, all the provisions pertaining to cross border transactions through being worded differently (not explicit) is comprehensive enough to cover a diverse range of cross border arrangements which includes outbound demergers and inbound demergers.

Moreover, the findings of J.J. Irani Committee on Company Law must also be inculcated in deciding the outbound demerger case of Sun Pharma as it clearly states that demergers must be treated on the same level as mergers and acquisitions in its report. A thorough reading of the committee report implies that the provisions applicable to mergers and acquisitions are invariably applicable to demergers.

Closing Remarks

The vividly different interpretations rendered by the Ahmedabad bench of NCLT in two different cases of the same company for inbound demergers and outbound demergers respectively is unsettling and imposes a high degree of uncertainty on the permissibility of outbound demergers. The progressive nature of the Act and that of the legislature is in peril due to the order passed by the tribunal in the present case. Therefore, it is imperative for the legislature to clarify the permissibility of outbound demergers as it can substantially affect the shareholders as well as the businesses in achieving their objectives.


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