In 2019, India improved its ranking by 23 points and reached 77th position in the World Bank’s ‘Doing Business 2019’ report. Long-due legal and policy reforms coupled with availability of high-quality assets on the block, acted as catalysts to make 2018 a blockbuster year for deal activity in India. In the shadow of corporate insolvency, business corporates are deleveraging their balance sheets and monetising non-core assets, while others have taken advantages of the availability of attractive assets and consolidated their market positions. There are several drivers for determining which manner of business M&A is commercially viable. Timing, nature of assets, approvals and cost of doing M&A can impact whether parties opt for slump sale or asset transfers over court approved mergers or demergers.
Up to 2015, demergers were a popular form of divestment, where the business undertaking would be transferred under a court approved scheme as a going concern to the acquirer. Despite the fact that a typical scheme would take between 9-10 months to be approved by the High Court and would require consents of each class of creditor and shareholder of the Company, the ability to bind minority creditors and shareholders, transfer all licenses, approvals and permits through the sanction of the scheme brought certainty to parties. As the entire business would stand vested in the acquirer by operation of law, other than stamp duty payable on the scheme, the costs associated with implementing the demerger were lower than contractual arrangements. Regulators also preferred demergers as they had the imprimatur of the courts.
Since the jurisdiction for schemes was transferred to the National Company Law Tribunal (Tribunal) and the notification of the Insolvency & Bankruptcy Code, 2016 (Code), adhering to the strict timelines of the Code has meant the case load of the already short-staffed Tribunal has prioritised insolvency proceedings over demerger schemes. Virtually overnight, a scheme that took 9-10 months started taking 15-18 months. Facing uncertainty on timelines, we have seen a resurgence in parties opting for slump sales or business transfers or withdrawing schemes filed earlier. But does this necessarily spell the demise of demergers?
Weighing the pros and cons of a demerger scheme and a slump sale, parties need to balance the key objectives and challenges of the transaction. Where timing is paramount, parties are opting for slump sales that require fewer approvals and can be implemented within a matter of a few months. However, companies in highly licensed/regulated industries prefer the demerger route to aide with transferring the business licenses to the transferor. Costs and tax treatment also determine whether parties opt for a slump sale or a scheme. A slump sale may be cost effective in an asset light company or a demerger may be beneficial being tax neutral and allowing carry forward of losses. Each route brings with it, its own risks and challenges and cannot rule out demerger or slump sales.
In negotiating slump sales, the characterisation of the business as an undertaking and excluding certain assets or liabilities is a matter of much deliberation. For it to be a slump sale, the ‘undertaking’ being transferred must include all its assets, liabilities and employees essential to constitute a business as a going concern on a stand-alone basis. Leaving assets or liabilities behind can result in characterisation of the sale as an itemised asset sale instead of a slump sale, bringing with it the disadvantages of Goods and Services Tax (GST) and higher capital gains tax being levied. Tinkering with what constitutes the ‘undertaking’ in a slump sale also poses challenges when negotiating the risk allocation between the parties for aspects of the business which are not being sold. Comparatively, a classical demerger is a tax-neutral transaction from a capital gains and GST perspective, subject to meeting the condition of Section 2(19AA) of the Income Tax Act, 1961 and permits carry forward of losses of the demerged business. From a taxation perspective, a court approved demerger scheme is beneficial compared to a slump sale.
Costs associated with a demerger include stamp duty on the sanction order. Different states have followed different methods for levy of stamp duty on sanction orders, with some states treating the sanction order as a conveyance and applicable stamp duty being imposed on the shares issued pursuant to the scheme or the value of real estate in the State transferred pursuant to the scheme, and others not stamping sanction orders at all or capping the fees. Slump sales agreements on the other hand are stamped as agreements as well as every asset to be conveyed under the slump sale is treated individually with stamp payable on the instrument for its conveyance. In cases where land is required to be transferred pursuant to the slump sale, this can result in higher transaction costs as compared to a demerger scheme.
The Government has announced the creation of more benches of the Tribunal and filing of vacancies in the near term. This should result in a reduction of the case load of the Tribunal, expediting the timeline for demergers and making it an attractive route again. However, given the variables in determining the most commercially feasible transaction structure, both demergers and slump sales will be around for a long time to come.
Contributed by: Natashaa Shroff, Partner; Taranjeet Singh, Principal Associate
The Bar Council of India does not permit solicitation of work and advertising by legal practitioners and advocates. By accessing the Shardul Amarchand Mangaldas & Co. website (our website), the user acknowledges that: