[Shinoj Koshy is a partner and Mayank Labh an associate at L&L Partners. The views expressed are personal and do not constitute legal advice.
An earlier post on the topic is available here.]
On 19 December 2019, the Ahmedabad bench of National Company Law Tribunal (“NCLT”) passed the order in which it rejected an application made by Sun Pharmaceutical Industries Limited (“Sun Pharma”) for a proposed demerger and transfer of two of its specified investment undertakings to two overseas resulting companies (“Outbound Demerger Order”). The order raises an interesting issue as to whether a cross-border demerger is allowed under section 234 of Companies Act, 2013 (“CA 2013”) read with rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016.
It is further interesting to note that the Outbound Demerger Order contradicts another order passed by NCLT, Ahmedabad on 31 October 2018 (“Inbound Demerger Order”) wherein the NCLT had approved an application made by Sun Pharma for inbound demerger involving transfer of a specified undertaking of Sun Pharma Global FZE (“Global FZE”), incorporated under the provisions of United Arab Emirates, with Sun Pharma. This post seeks to critically analyze section 234 of CA 2013 in light of the two above-mentioned orders.
The Sun Pharma NCLT Orders
Inbound Demerger Order
In the Inbound Demerger Order, as stated above, the NCLT had to decide on whether the demerger and transfer of a specified undertaking of Global FZE (an indirect wholly owned subsidiary of Sun Pharma) to Sun Pharma should be sanctioned under sections 230 and 232 read with section 234 of the CA 2013. While adjudicating on the matter, the NCLT had to evaluate the objection raised by the Regional Director that section 234 of the CA 2013 only refers to cross-border mergers and amalgamations and does not refer to refer to demergers.
However, the NCLT observed that the permissible transfer of part of the undertaking under section 232(1)(b) of the CA 2013 implies a demerger and that all other applicable provisions of the CA 2013 for merger or amalgamation can also be applied to a scheme of demerger involving the transfer of any part of the undertaking of a company. Further, it noted that section 234(1) of the CA 2013 confirms the above understanding as it provides that the provisions under the ‘Compromise, Arrangements and Amalgamation’ chapter of the CA 2013 apply mutatis mutandis to schemes of mergers and amalgamations between companies registered under CA 2013 and foreign company. Furthermore, according to the NCLT, the above view that transfer of part of the undertaking under section 232(1)(b) of the CA 2013 implies a demerger gets further buttressed by the fact that regulation 9 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017, inter alia, provides for demerger of Indian companies.
Outbound Demerger Order
In the Outbound Demerger Order, the NCLT had to adjudicate on the issue of whether a demerger and the transfer of two specified investment undertakings of Sun Pharma to two overseas resulting companies, viz. Sun Pharma (Netherlands) B.V. (“Sun Pharma Netherlands”) and Sun Pharmaceutical Holdings USA Inc. (“Sun Pharma USA”) should be sanctioned under sections 230 and 232 read with section 234 of the CA 2013. It must be noted that Sun Pharma Netherlands and Sun Pharma USA are directly or indirectly the wholly owned subsidiaries of Sun Pharma.
The NCLT observed that section 234 of the CA 2013 uses the words ‘merger’ and/or ‘amalgamation’ and does not include ‘compromise’ and/or ‘arrangement’ and therefore it may be construed that section 234 does not permit the ‘compromise’ and/ or ‘arrangement’ and/ or ‘demerger’ of an Indian company with a foreign company and vice versa. It further noted that rule 25A setting out the detailed procedure and requirements in relation to cross-border mergers also does not prescribe the procedure in respect of demergers and refers only to mergers and amalgamations.
Finally, the NCLT emphasized on the fact that the term demerger which was included within the definition of ‘cross border merger’ in the draft Foreign Exchange Management (Cross Border Merger) Regulations, 2017 (“Draft CBM Regulations”) had been subsequently omitted in the final Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“Final CBM Regulations”). Such omission, according to NCLT, indicated that a cross-border demerger was not allowed. According to the NCLT, had cross-border demerger been intended to be allowed, the word ‘demerger’ would not have been specifically deleted from the Final CBM Regulations. In light of the above considerations, the NCLT concluded that section 234 of the CA 2013 does not permit cross border demergers and rejected the application for the scheme of demerger.
A close and conjoint reading of the two orders highlights certain inconsistencies in the judicial logic. First, in the Outbound Demerger Order, the NCLT assumes that merely because section 234 of the CA 2013 and rule 25A are silent on outbound demergers, it means that outbound demergers are being prohibited under the CA 2013 and the rules made thereunder. Under section 394 of the Companies Act, 1956 (“CA 1956”), there was a prohibition on outbound merger or demerger as the transferee company was defined to mean only companies registered under the CA 1956, i.e., necessarily an Indian company.
However, such restrictions have been removed by section 234 of the CA 2013. It does not require the transferee company to be an Indian company. Thus, the specific prohibition under the CA 1956 for outbound merger or demerger has been removed. In such a situation, it is arguable that the legislature, by removing the above prohibition, has now permitted cross-border mergers and demergers, thereby allowing both inbound and outbound mergers and demergers.
Second, the reliance placed by the NCLT in the Outbound Demerger Order on the deletion of the term ‘demerger’ from the Final CBM Regulations to hold that the intention was to prohibit demerger is internally inconsistent with its reasoning provided in the Outbound Demerger Order. In paragraph 15, it holds that the term ‘arrangement’ is an inclusive term that includes ‘demerger’. However, while interpreting the Final CBM Regulations which define cross-border merger as “any merger, amalgamation or arrangement between an Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 notified under the Companies Act, 2013”, it relies on the deletion of the term ‘demerger’ from the definition of a ‘cross-border merger’ between the Draft CBM Regulations and the Final CBM Regulations to conclude on the legislative intent to exclude ‘demergers’ from the purview of cross-border mergers. Thus, it effectively fails to recognize that while the expression ‘demerger’ has been deleted, the final rules continue to include the term ‘arrangement’ which, by its own holding, is a wider term that includes a ‘demerger’.
Third, the Outbound Demerger Order fails to recognize its own logic of interpretation in the Inbound Demerger Order where it allowed an inbound demerger under section 234 of the CA 2013. This clearly breaches the legal continuum as, in the Outbound Demerger Order, it interpreted the same section 234 to be inapplicable to demerger per se thereby raising questions regarding its own earlier interpretation.
Finally, under the CA 1956, inbound demerger was allowed in light of section 394(1)(b) (which is akin to section 232(1)(b) of the CA 2013) read with 394(4)(b) of the CA 1956. However, applying the literal rule of interpretation, the NCLT has held that in the absence of the term ‘demerger’ in section 234 of the CA 2013, both inbound and outbound demerger are barred under section 234 of CA 2013.
The CA 2013 is a progressive enactment that recognizes the economic reality of India Inc and its increasing globalization. Consequently, any interpretation of a change introduced by the CA 2013 which results in a situation which is regressive than the CA 1956 must be rejected in favour of a more progressive interpretation. Moreover, it is a cardinal rule of interpretation that a statute must be read literally but “if such a reading leads to absurdity and the words are susceptible of another meaning, the Court may adopt the same. But if no such alternative construction is possible, the court must adopt the ordinary rule of literal interpretation.” In the present case, a literal interpretation does lead to the absurdity that the CA 2013, which is supposed to be a progressive enactment, has been rendered regressive compared to the CA 1956 such that it has been interpreted to prohibit both inward and outward demergers. Further, this view leads to situation wherein an Indian company can merge with the foreign company and vice versa but the assets or undertaking of an Indian company cannot be transferred to the foreign company and vice versa. The rationale for such a position is rather incomprehensible. This lack of a rationale for differential treatment of cross-border mergers and cross-border demergers gets further pronounced when viewed in light of the Report of the Expert Committee on Company Law (the JJ Irani Committee Report) which stated that demergers are to be treated on par with mergers and acquisition regime and the laws framed for mergers and acquisitions should duly cater to de-mergers as well.
The Outbound Demerger Order suffers from a flawed interpretation of the scheme of the CA 2013, and internal consistency of judicial logic. The NCLT should have taken a purposive way of interpreting provisions on cross-border mergers rather than literally interpreting it. In doing so, it fails to recognize the objective behind the law, which is to lay down a forward-looking law that recognizes the realities of India Inc and facilitate cross-border mergers and amalgamations.
– Shinoj Koshy & Mayank Labh
 Section 394(4)(b) of Companies Act, 1956.
 Jugalkishore Saraf v. Raw Cotton Co. Ltd., AIR 1955 SC 376; GP Singh, Principles of Statutory Interpretation 71 (9th ed. 2004).
 Para 1 of Chapter X of Report of the Expert Committee on Company Law, http://www.mca.gov.in/MinistryV2/report+of+the+expert+committee+on+company+law.html.
 Para 21 of Chapter X of Report of the Expert Committee on Company Law, http://www.mca.gov.in/MinistryV2/report+of+the+expert+committee+on+company+law.html