Depending on the objectives of acquisition, there are different ways in which businesses can be acquired. In case the acquirer is interested in some assets only and not complete acquisition of an entity or a business undertaking, then such acquirer can acquire only identified asset(s). In such a case the focus of the acquirer is on the identified asset(s). If, however, the interest...
Depending on the objectives of acquisition, there are different ways in which businesses can be acquired. In case the acquirer is interested in some assets only and not complete acquisition of an entity or a business undertaking, then such acquirer can acquire only identified asset(s).
In such a case the focus of the acquirer is on the identified asset(s). If, however, the interest of the acquirer is in the entity as a whole then the acquisition can be done by acquiring the shares of that entity or merging or amalgamating that entity with the acquirer. Further, if an acquirer desires to acquire the complete business entity or an undertaking along with all the assets and liabilities then that can be possible through a slump sale on a going concern basis or demerger/spin off of that undertaking or business division into the acquirer.
Different Modes of Acquisition
The different modes of acquisitions that may be undertaken by an acquirer are described below. The decision of selecting a particular mode depends primarily on the objectives of the acquisition, the commercial and tax considerations and other factors as below except for the issues relating to competition law.
(a) Assets Acquisition
(i) Meaning
Under this, one company (the "Transferee Entity") purchases all or part of the assets of the other company (the "Transferor Entity"). This is a mode of acquisition in which typically the Transferee Entity is keen on acquiring only the identified immovable or movable assets of the Transferor Entity such as land, building, factory premises, machinery and equipment or even intangible properties such as copyrights, patents and trademarks, without acquiring any equity stake in the Transferor Entity. In this scenario, the Transferee Entity typically acquires the assets free of all encumbrances.
Acquisitions of movable assets are governed by the Sale of Goods Act, 1930 and acquisitions of immovable properties are governed by the Transfer of Property Act, 1882. The aforesaid statutes provide for numerous aspects of transfer, such as pre-requisites for valid transfers, rights and obligations of the Transferor Entity and the Transferee Entity, implied conditions and warranties, point of transfer of title and risk in the assets.
Acquisitions of intangible property such as copyrights, patents and trademarks are governed by the specific statutes dealing with these intellectual property rights. Acquisition of the same has to take place pursuant to a written document, and in respect of registered trademarks and patents, the transfer is effective only upon registration with the concerned registration authority.
(ii) Approvals
The mere sale or transfer of assets usually does not require any regulatory and statutory approvals. However, in certain cases, transfer of assets may be subject to the following one or more approvals:
- Where the assets to be transferred comprise substantial assets of the Transferor Entity to constitute a complete undertaking or a business division of the Transferor Entity, the consent of the shareholders of the Transferor Entity is required in case the Transferor Entity is a public limited company or a private limited company which is a subsidiary of a public limited company. This requirement arises from Section 293(1)(a) of the Companies Act, 1956. In the case of a listed company, the resolution of the shareholders has to be passed by means of postal ballot. This consent of the shareholders is required by way of a simple majority vote. In other words, a simple majority vote of the shareholders is sufficient for the transfer of substantial assets which constitute an undertaking or a business division.
- In case the assets that are proposed to be transferred have been mortgaged by the Transferor Entity in favour of any bank / financial institution, then the necessary approval is required to be obtained from the bank / financial institution and the Transferor Entity should also arrange to remove any charges that have been created on the assets so acquired.
(iii) Due Diligence
The asset acquisition involves a comprehensive due diligence pertaining to the Transferor Entity and the assets. The due diligence is necessary to ensure that the Transferor Entity has 'good and marketable title' to the assets and the assets are free from encumbrances. Generally, the practice in India is that a legal, technical (in respect of plant and machinery) and a financial due diligence is conducted. In a legal due diligence for an asset acquisition, a search at the office of the concerned Registrar of Companies where the Transferor Entity is registered is also generally conducted to ascertain any information regarding any charges that have been created on the assets.
In case the assets include properties, a title search is generally conducted at the office of the Registrar of Assurances (the Land Registry) to verify the title of the Transferor Entity in respect of the immovable property. In respect of intangible properties, verification of the title, if required, may be carried out from the concerned registry.
(iv) Statutory Cost
One of the major elements of the costs involved in asset acquisitions is the stamp duty. Stamp duty payable on most instruments is regulated by the applicable Stamp Act of a particular State in India where the transaction takes place. In respect of acquisition of assets, stamp duty is levied on certain categories of instruments and documents which vest the assets in the Transferee Entity at percentage based rates linked to the value of the assets in question. This duty is levied under the head of "conveyance".
Certain categories of assets such as immovable property and intellectual property rights can only be sold by a written instrument, which in most States attracts stamp duty as a specific percentage of the market value of the property, without any ceiling. The Supreme Court of India has held that plant and machinery which is permanently fixed to the earth would constitute immovable property for stamp duty purposes. Tangible movable assets are commonly transferred by delivery. Where movables are to be transferred, the parties usually enter into an agreement for sale containing the terms and conditions but which contemplates a subsequent vesting of title to the buyer, by delivery.
Sales tax is also levied for transfer of movable goods within the territory of India. Where assets are acquired from a foreign entity, it is common for the parties to provide for a transfer of title in the goods when in transit, outside Indian territorial limits, for avoiding sales tax implications in India.
(b) Slump Sale
(i) Meaning
In a slump sale, one company (the "Transferee Entity") acquires the 'business undertaking' of other company (the "Transferor Entity") as a 'going concern' or 'slump sale', i.e. acquiring all the assets and liabilities of such business. Usually this arises in the sale of a division of the Transferor Entity to the Transferee Entity. The assets may include movables (tangible and intangible, including intellectual property) and immovable properties.
Since, in this case the Transferee Entity also acquires the liabilities, the assets may be encumbered to that extent. Further, the consideration for the acquisition of the business division is a lump sum price and separate consideration for each of the assets constituting the business division is not required to be assigned. The business undertaking can also be sold by demerging / spinning off the division. In such a case, the consideration for the purchase would be paid by issue of shares in the resulting company (the "Transferee Entity") to the shareholders of the demerged company (the "Transferor Entity").
(ii) Approvals
The regulatory and statutory approvals that are required in the case of 'slump sale' are the same as those covered under Section B(a)(ii) above. However, if the acquisition of the business undertaking / division is by a demerger, then this will require the approval of the board of directors, shareholders and creditors of the Transferor Entity and Transferee Entity, followed by the approval of the High Courts of the respective States in which the registered offices of the Transferor Entity and the Transferee Entity is situated. The approval of the shareholders and creditors is separately obtained by majority in number and 3/4th in value.
(iii) Due Diligence
In addition to the due diligence requirements specified in Section B(a) (iii) above, a due diligence exercise in this case would be required to cover (a) the existing contracts of the business division(s) to be acquired; (b) human resource matters for the employees to be hired who are working in the business division(s) to be acquired; (c) liabilities towards taxes(d) ongoing litigation, etc.
(iv) Statutory Cost
As opposed to sale of individual assets, a 'slump sale' is more tax efficient because it does not attract sales tax, which is otherwise levied on sale of individual assets. In the case of a 'slump sale', the transaction costs comprise stamp duty on conveyance on the value of the immovable property (land, buildings, plant and machinery that are permanently fixed or embedded to the earth) that are sold and transferred. Further, in case a business undertaking is transferred by way of a demerger pursuant to a court sanction as mentioned above, the court order sanctioning a scheme of demerger is treated as conveyance and attracts stamp duty in many States under the head of instruments for 'conveyance' of property.
(c) Equity Acquisition
(i) Meaning
Under this, one company (the "Transferee Entity") acquires the target company (or control thereof) through acquisition of the existing equity shares of the target company from its shareholders or by subscribing to the new equity shares that are issued by the target company.
(ii) Approvals
The requirement of regulatory approvals is critical in case the Transferee Entity is a foreign company (non-resident) and either acquires the existing equity shares of the target Indian company from resident / Indian shareholder(s) or subscribes to new equity shares that are issued by the target Indian company.
In both the aforesaid cases, the investment made by such Transferee Entity will be regarded as foreign investment. Foreign investments in India are regulated by the Foreign Exchange Management Act, 1999 and the various regulations framed there under ("FEMA") and the Consolidated Foreign Direct Investment Policy of the Government of India ("FDI Policy"), as revised from time to time. In most sectors up to 100% FDI is permitted without any requirement for prior approvals i.e., under the automatic route.
However, in certain sectors, FDI is subject to specified limits (sectoral caps) and can only be undertaken within these ceilings either through the automatic route, or with the prior approval of the Foreign Investment Promotion Board ("FIPB"), depending on the applicable guidelines. Sectoral caps are usually in the range of 26%, 49%, 51% and 74%. Some sectors also have minimum capitalization requirements, linked to the percentage of foreign ownership.
Earlier, where the foreign entity proposed to invest not through a fresh issue of shares (i.e. by subscription to new equity shares), but through the purchase of shares from an existing Indian shareholder, application for approval was required to be made to FIPB , even if the proposed investment was within the parameters set out under prescribed laws. Such an acquisition also required the Reserve Bank of India ("RBI") approval with regard to pricing.
However, the Government has dispensed with the requirement of obtaining prior approval from the FIPB and the RBI in respect of transfer of shares/convertible debentures, by way of sale, from residents to non-residents (including transfer of subscribers' shares) of an Indian company in sectors other than the financial service sectors (i.e. banks, non-banking financial companies, asset reconstruction companies, insurance companies, CICs, infrastructure companies in the securities market such as Stock Exchanges, Clearing Corporations and Depositories and Commodity Exchanges) provided the following broad conditions are satisfied:
(i) The activities of the Indian company are under the automatic route of the FDI policy and the transfer does not attract the provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 ("Takeover Code");
(ii) The non-resident shareholding, after the transfer, is within the sectoral limits prescribed under the FDI policy;
(iii) The price at which the transfer takes place is in accordance with the pricing guidelines prescribed by the SEBI/ RBI.
Further, in case the shares of the target Indian company are listed on one or more stock exchange(s) in India, the Transferee Entity will be required to comply with the provisions of the Takeover Code. The Takeover Code, inter alia, requires the Transferee Entity to make a public offer for acquiring an additional 20% equity shares of the target company from the public at a price to be calculated as per the formula provided in the Takeover Code in case the proposed acquisition would result in - (i) the Transferee Entity holding (directly or indirectly) 15% or more of the voting rights of the target company or (ii) a change in the management or control of the target company.
(iii) Due Diligence
In addition to the due diligence requirements specified in Section B(a) (iii) above, any acquisition of shares and more particularly in an acquisition of majority shares, a comprehensive due diligence on the target company and all its affairs and business operations including but not limited to pending and threatened litigation against the target company, status of regulatory compliances, direct and indirect tax liabilities and contingent liabilities, if any is necessary and critical.
(iv) Statutory Cost
Transaction cost consists of share transfer stamp duty which is normally levied at a uniform rate throughout India at 0.25% of the value of the shares being transferred. Both, the share purchase agreement and the share transfer deed attract stamp duty. The 0.25% duty is levied on the share transfer deed whereas the share purchase agreement carries stamp duty as applicable as per the Stamp Act of a particular state in India. However, in some States, where the agreement pertains to a transfer of marketable securities, it attracts a percentage based duty, on the value of the shares, without any ceiling. However, where the shares are held in dematerialized form, no stamp duty is payable on transfer of such shares.
(d) Amalgamation
(i) Meaning
Under this, one or more companies are merged or amalgamated into another company which may be an existing company or a new company formed for this purpose. Upon the merger or amalgamation the merging or amalgamating entity(ies) are dissolved without being actually wound up.
(ii) Approvals
In addition to the approval of the board of directors, separate approvals of the shareholders and creditors of all the companies involved in the scheme of amalgamation are required. The scheme of amalgamation is deemed to have been approved, if the approval is granted by majority of the shareholders or creditors, as the case may be, who separately constitute 3/4th in value. Once both the shareholders and the creditors have approved the scheme of amalgamation, the scheme of amalgamation is filed with the respective High Courts where the registered offices of the companies involved in the scheme are situated.
However, in case if any listed company is involved, then at least a month before the scheme is filed with High Court for approval, the listed company has to file the scheme of amalgamation with the stock exchange for approval along with an auditors' certificate to the effect that the accounting treatment provided in the scheme is in compliance with all the accounting standards. While obtaining the approval of the shareholders, the company has to disclose that it has obtained a fairness opinion from an independent merchant banker on valuation of assets/ shares done by the valuer.
(iii) Due Diligence
For merger and amalgamation, the same level of diligence as prescribed in Section C (iii) will be applicable.
(iv) Statutory Cost
The scheme of amalgamation is approved and sanctioned by an order of the High Court which has the effect of transferring all the assets, properties, rights, powers, liabilities, proceedings of the transferring entity(ies) to the transferee entity. The court order has been held to be a conveyance for the purposes of the stamp duty and therefore stamp duty on conveyance as applicable in a particular state in India is charged on the court order. Having said this, this issue of stamp duty on the court orders is still not very clear.