A frequent metaphor of mergers and acquisitions is the marriage of companies.
The antonym to marriage is divorce, and the term “corporate divorce” is used to define how previously merged companies are separated.
The demerger is defined in the Business Dictionary as “a situation where an entity undertakes a reorganization of its operations and structure, leaving its members in the same economic position as they were immediately before the reorganization.
It is a form of structural readjustment for corporations in which a corporate or trust group splits into two more entities or groups. Similarly, some jurists have defined demerge.
CONCEPTUAL FRAMEWORK AND LAW REQUIREMENTS
The basic requirement of Section 279 of the Companies Act, 2017 is as follows:
(i) there must be a compromise / arrangement/ Scheme;
(ii) proposed between a company and its creditors;
(iii) application to be made to the Commission now the High Court,
(iv) supported by meetings;
(v) mandatory filing of material facts relating to the company which is;
(a) financial position;
(b) auditor’s report;
(c) latest accounts of the company;
(d) the pendency of any investigation proceedings;
(e) supported by the affidavits.
Demerger of the company:
The demerger is a business stratagem in which a single business is broken into components; as such it allows a conglomerate to split off its different varieties to invite or prevent acquisition, to raise capital by selling off components that are no longer part of the fundamental merchandise line of business or to generate distinct lawful entities to manage diverse management; it is, in fact, a method of corporate streamlining and restructuring by dint of which business operations are segregated into one or more components.
Demerged company connotes and exemplifies a conglomerate (transferor company) whose undertaking is transferred pursuant to demerger to a resulting company (transferee company). The expression ‘demerger’ is not expressly defined in the Companies Act. Sections 279 to 282 of the Companies Act contain provisions regarding Compromises, Arrangement, and Reconstruction. However, it could very well be said that the same is covered under the expression arrangement, as defined in subsection (6) of Section 279 of the Companies Act which reads as follows:
“the expression “arrangement” includes a re-organization of the share capital of the company by the consolidation of shares of different classes or by the division of shares into shares of different classes or by both those methods,”
The term demerger finds mention in subsection (19AA) of Section 2 of the Indian Income Tax Act, 1961. According to the said subsection, demerger in relation to companies means a transfer, pursuant to a scheme of arrangement under Sections 391 to 394 of the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company in such a
i. All the property of the undertaking being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company.
ii. All the liabilities related to the undertaking, being transferred by the emerged company, immediately before the demerger, become the liabilities of the resulting company of virtue of the demerger.
iii. The property and the liabilities of the undertaking, being transferred by the emerged company are transferred at values appearing in its books of account immediately before the demerger;
iv. The resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis;
v. The shareholders holding not less than three fourths in value of the share in the demerged company (other than shares already held therein immediately before the demerger or by a nominee for, the resulting company or, its subsidiary) become
shareholders of the resulting company or companies by virtue of the demerger.
vi. The transfer of the undertaking is on a going concern basis;
vii. The demerger is in accordance with the conditions, if any, notified under Subsection (5) of Section 72A of the Income Tax Act 1961 by the Central Government on this behalf.
The Honorable High Court has explained the meaning and significance of demerger as follows:
Demerger connotes and designates some or all of the transferor company’s assets, rights, and obligations which are to be divided between one or more transferee companies in return for the shareholders in the transferor company receiving consideration in the form of shares in the company.
The de-merger is a business stratagem in which a single business is broken into components.
This allows a conglomerate to split off its different varieties to invite or prevent an acquisition, to raise capital by selling off components that are no longer part of the business’s fundamental merchandise line, or to generate distinct lawful entities to manage diverse management. It is in fact a method of corporate streamlining and restructuring by dint of which business operations are segregated into one or more components.
The demerged company connotes and exemplifies a conglomerate (transferor company) whose undertaking is transferred pursuant to demerger to a resulting company (transferee company) whereas the resulting company (transferee company) means a company to which the undertaking of the demerged company is transferred in a demerger and the resulting company
in consideration of such transfer of undertaking issues shares to the shareholders of the demerged company.
The transfer pursuant to a scheme of arrangement becomes the property of the resulting company and by virtue of the demerger, all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company.
The assets and the liabilities of the undertaking or undertakings being transferred by the demerged companies are transferred at values appearing in its books of account immediately before the demerger and the resulting company issues in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis. So far as the exchange ratio of equity shareholders and the transferee-company is concerned, the court held that the valuation of shares is a technical and complex problem that can be appropriately left to the consideration of experts in the field of accountancy. Pennington in his ‘Principles of the Company Law’ mentions four factors that have to be kept in mind in the evaluation of shares: (1) Capital Cover (2) Yield (3) Earning Capacity and (4) Marketability. For arriving at the fair value of a share, three well-known methods are applied:
(1) The manageable profit basis method (the Earnings Per Share Method)
(2) The net worth method or the beak value method, and
(3) The market value method,”
The swap ratio is the exchange ratio in which the shares of a target company are swapped for a share in an acquiring company. Said ratio largely depends on the total value of assets of a target company, though at times it can also depend on negotiations and benefits that acquiring company would be receiving by taking over operations of a target company.
The swap ratio’s rationale is to give investors the same relative value in shares of a new company so that the investment remains relatively unaffected from an investor’s perspective. Such arrangement is essential in giving the same amount of confidence to investors even after the merger or acquisition gone through and at the same time, it is not fair for the investors of the acquiring company to offer high returns for investors of the target company, which is why the “swap ratio” is kept reasonable to maintain an equilibrium between investors of both the companies.