[Aishwarya Singh is a lawyer based in Mumbai. The views expressed in the article are personal.]
This post discusses the regulatory framework relating to mergers or demergers involving a listed company and an unlisted company, wherein the whole or part of the undertaking, property or liabilities of a listed company, being the transferor company, are transferred to an unlisted company, i.e., the transferee company. The pertinent question is whether the transferee company is required to list its shares pursuant to such mergers or demergers.
Section 232(3)(h) of the Companies Act, 2013, which deals with mergers and amalgamations of companies, states:
where the transferor company is a listed company and the transferee company is an unlisted company, –
(A) the transferee company shall remain an unlisted company until it becomes a listed company;
(B) if shareholders of the transferor company decide to opt out of the transferee company, provision shall be made for payment of the value of shares held by them and other benefits in accordance with a pre-determined price formula or after a valuation is made, and the arrangements under this provision may be made by the Tribunal.
The above provision of the Companies Act in effect allows a company to delist its shares by entering into a scheme of arrangement for merger or demerger. The transferee company is not under an obligation to list its shares. This provision seemingly allows companies to circumvent the SEBI (Delisting of Equity Shares) Regulations, 2009 that prescribe a specific procedure for delisting and mandate the provision of an exit opportunity for public shareholders.
Regulation 37 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 mandates that the listed company proposing to undertake a scheme of compromise or arrangement has to file the draft scheme with relevant stock exchanges for obtaining their ‘observation letter’ or ‘no-objection letter’ before filing such a scheme with National Company Law Tribunal (NCLT). Regulation 94 of the aforesaid Listing Regulations further requires the concerned stock exchanges to forward such draft schemes to the Securities and Exchange Board of India (SEBI) for approval. Hence, schemes in violation of the Delisting Regulations may not receive SEBI’s approval.
In the past SEBI had raised objections to such schemes. SEBI in its observation letter dated 28 August 2015 objected to the scheme of arrangement between Sterlite Technologies Limited (STL) and Sterlite Power Transmission Limited (STPL). The scheme involved a demerger of power products and transmission grid business from STL, a listed company, into SPTL, which was an unlisted company. SEBI raised concerns over the partial delisting of the shares of STL without providing an exit opportunity to the public shareholders. SEBI observed that this was an attempt to circumvent the Delisting Regulations.
Similarly, SEBI in its observation letter dated 4 August 2015 observed that the scheme of amalgamation of Zodiac Ventures Limited (ZVL), which is a listed company, with Zodiac Developers Private Limited (ZDPL), an unlisted company, does not provide an exit opportunity to the public shareholders in violation of the Delisting Regulations. The scheme involved the amalgamation of the entire business and undertaking of ZVL with ZDPL and dissolution of ZVL.
It is important to note that the above observations were made by SEBI before its Circular on ‘Schemes of Arrangement by Listed Entities and (ii) Relaxation under Sub-rule (7) of rule 19 of the Securities Contracts (Regulation) Rules, 1957’ dated 10 March 2017. The 2017 Circular confers greater participation for the public shareholders. It provides that the votes cast by the public shareholders in favour of the scheme should be more than the number votes by public shareholders against it, if the scheme involves a transfer of ‘whole or substantially the whole of the undertaking’ of the listed entity and the consideration for the same is not in the nature of listed equity shares. The expression ‘substantially the whole of undertaking’ has the same meaning as set forth in section 180(1)(a)(i) of the Companies Act. However, the 2017 Circular does not provide any clarity on whether the unlisted transferee company is required to list its shares pursuant to scheme.
Following the Circular, most of the draft schemes filed with the stock exchanges provide that the unlisted transferee company will become listed consequent to the merger or demerger. However, interestingly, under the composite scheme of arrangement between Alembic Limited, Shreno Limited and Nirayu Limited which was filed with the stock exchanges on 20 November 2018, the real estate undertaking of Alembic Limited (listed company) was to be demerged and transferred to Shreno Limited (unlisted company). The shareholders of Alembic Limited were to be issued non-cumulative redeemable preference shares as consideration for the transfer. These shares were not be listed on stock exchanges pursuant to the scheme. The scheme further provided that it will be acted upon only if the votes cast in favour of the scheme by the public shareholders are more than the votes cast against it in accordance with the 2017 Circular. SEBI issued a no objection letter for the scheme on 25 January 2019.
Since the regulatory framework does not provide much clarity, companies have to rely on older precedents of draft schemes filed with the stock exchanges and SEBI’s observation letters for structuring the mergers or demergers involving a listed transferor company and an unlisted transferee company. This leads to uncertainty over whether SEBI would raise objections to such a scheme.
SEBI’s primary concern with such schemes is that they do not provide for an exit opportunity to the public shareholders of the listed company. The author suggests that there should be no bar to such schemes if the requirements under the 2017 Circular are followed, which ensure greater participation of the public shareholders in the approval process of the scheme. Section 232(3)(h)(B) of the Companies Act also provides that the NCLT can make provisions for shareholders to exit the transferee company and are paid for the value of the shares held by them by using a pre-determined price formula or valuation.
There is a need for SEBI to remove the ambiguity on the validity of such schemes. Further, since the listed companies have to seek a ‘no-objection’ letter before filing the scheme with the NCLT, the concerns regarding backdoor delisting can be addressed by ensuring that only those schemes are approved which provide a justifiable rationale for the proposed arrangement.
– Aishwarya Singh