Reverse Mergers in India

[Volume 2, Issue 6] – June, 2017

Author – Rachit Munjal, B.B.A; LL.B, College of Legal Studies, University of Petroleum and Energy Studies, Dehradun.

INTRODUCTION

The today’s business world is changing at an amazing pace; the requirement for growth at a steadfast and rapid pace is of utmost importance and thus companies keep finding different ways which will lead to cope up with the pace of the industry. Mergers and demergers are the ways adopted by majority of corporations within the trendy time to extend and enhance their profits and to contour their means of functioning.

Merger is one amongst the foremost common styles of company restructuring programmes that’s employed by the company world thus on accomplish growth for the corporate as an entire and therefore maximising its profits. In strict economic sense of the word it suggests that the “union of 2 or a lot of business interests, firms, undertakings, bodies or the other entities”. In company business it suggests that, mixing or merger of 2 or a lot of firms by the transfer of all property to one corporation. Generally, an organization with record of getting a less profit earning or loss creating blends or amalgamates with a viable company to own advantages of economies of scale of production and selling network etc of that viable company. As a consequence of this merger the profit earning company survives and therefore the loss creating company extinguishes its existence. But, in several cases, the sick company’s survival becomes a lot of necessary for several strategic reasons and to conserve community interest. This kind of non-routine merger is named a Reverse Merger.

CONCEPT OF REVERSE MERGERS

Reverse Merger could also be outlined in 2 ways that 1st wherever a company blend/merges with a subsidiary or investee company and second wherever a profit creating company merges with the loss creating company. The term Reverse merger has not been outlined below any of the statutes. However, tribunal has mentioned 3 tests for reverse merger-

i) Assets of transferrer Company being bigger than Transferee Company.

ii) Equity capital to be issued by the transferee company consistent to the acquisition exceeds its original issued capital.

iii) The modification of management within the transferee company clearly indicated that this arrangement was an appointment, that was a typical illustration of takeover by reverse bid.

Court control that clear theme of merging a prosperous unit with a sick unit can’t be aforesaid to be sinning the provisions of section seventy two A of the revenue enhancement Act, 1961 since the article of this provision is to facilitate the merger of sick industrial unit with a sound one. The Reverse merger is usually adopted for 2 main reasons-

it’s an alternate technique for personal firms to travel public, while not looking the long and complicated method of ancient IPO. During this a personal company acquires a public entity by owning the bulk of the shares that are held by the general public of a company. The general public “shell” could be a very important facet of reverse merger transactions that could be a public enterprise carrying Zero assets or liabilities. It is termed as a “shell” as a result of the sole factor remaining from the present company is its company shell structure.
Tax saving is another advantage of Reverse Mergers. The law((Section 72A Revenue Enhancement Act 1961)) provides tax relief for merger of sick firms with healthy and profitable firms to require the advantage of the transfer of losses.

RM AS different technique TO BECOME PUBLIC

Companies rather than hiring Associate in Nursing underwriter to sell the company’s shares in Associate in Nursing initial public providing, a personal company works with a “shell promoter” to find an acceptable non-operating or shell public company, personal company merges with the shell company (or a newly-formed subsidiary of the shell company). during this merger, the operative company’s shareholders square measure issued a majority stake within the shell company in exchange for his or her operative company shares. Then when merger the shell company contains the assets and liabilities of the operative company and is then controlled by the previous operative company shareholders. The shell company’s name is modified to the name of the operative company, its administrators and officers square measure replaced by the administrators and officers of the operative company, and its shares still trade on whichever exchange they were commercialism before the merger, indirectly the company’s company shell structure is maintained. Hence, the operative company’s business remains controlled by a similar cluster of shareholders and managed by a similar administrators and officers, however it’s currently contained inside a public company. In effect, the operative company succeeds the shell company’s public standing and so indirectly goes public.

Features of Reverse Mergers

Presently Reverse merger in Asian nation remains in its infancy stage thus we tend to might discuss the options of RM in line with the ideas created and settled in US.

Shell Characteristics

A public shell company may be a company that includes a category of securities registered underneath the Securities Exchange Act of 1934 (the “Exchange Act”) however has solely nominal operations and no or nominal assets apart from money and money equivalents. A public shell company exists as a result of either

(1) it had been a former operative company that went public then for a few reason ceased operations and liquidated its assets or

(2) It ne’er had any operations however was fashioned from scratch for the precise purpose of making a public shell.

In the former scenario, shell promoters gain management of defunct operative corporations by shopping for up a majority of their shares. within the latter scenario, shell promoters incubate the shells—they incorporate an organization, voluntarily register its shares underneath the Exchange Act, then timely file with the Securities and Exchange Commission (“SEC”) the specified quarterly, annual and alternative reports. Because the shell has no operations, it becomes fairly easy and cheap to create these filings. In exchange for lease Associate in Nursing operative company merge into a shell, the promoter charges the operating company a fee and retains an ownership interest in the shell post-merger.

There exists a chance that Shells may or may not have stock that trades publicly. Typically, the stock of a former in Operation Company will trade in public. The corporate can have listed its stock or otherwise expedited commercialism on a public market back when it completed its IPO. A shell formed from scratch by a shell promoter typically does not have publicly traded stock.

Legal Structure and Compliance

An RM is typically structured as a reverse triangular merger. Specifically, the public shell (“ShellCo”) forms a new, wholly-owned empty subsidiary (“Merger Sub”). Merger Sub then merges into the private operating company (“OpCo”) pursuant to the applicable state corporate statute. Upon consummation of the merger, OpCo.’s shares are converted into shares of ShellCo constituting a majority stake in ShellCo (typically an 80 to 90 percent stake). Following consummation of the merger, OpCo is a wholly-owned subsidiary of ShellCo and OpCo’s former shareholders own a majority of the outstanding shares of ShellCo.

Alternatively, the transaction could be (and sometimes is) structured as a direct merger where ShellCo merges directly into OpCo. The reverse triangular merger structure is preferable, however, as a result of it reduces group action prices. Since OpCo survives the group action, there’s no ought to modification merchant numbers, leader identification numbers, bank accounts, property titles, etc. to boot, structuring the group action as a reverse triangular merger might eliminate the necessity of obtaining ShellCo stockholder approval to shut the group action. this is able to enable ShellCo to avoid holding a shareholders’ meeting and so the time and expense related to filing with the SEC for review and mailing to its shareholders a close proxy statement and alternative materials pro re nata by SEC proxy rules.

Whether stockholder approval of ShellCo is needed depends on ShellCo’s state of incorporation Associate in Nursingd whether or not its shares square measure listed on an exchange. the overall rule underneath state company law is that approval is needed solely from the shareholders of the businesses which will merge within the group action. In Associate in Nursing RM structured as a reverse triangular merger, ShellCo stockholder approval wouldn’t be needed as a result of Merger Sub and not ShellCo are merging with OpCo within the group action. However, many countries and {also the} stock exchanges also need stockholder approval before an organization will issue shares constituting over two hundredth of its pre-transaction outstanding shares.ShellCo would make up these rules, if applicable, as a result of it’ll be supply overrun two hundredth of its pre-transaction outstandingshares as a part of the RM. Note, however, that Delaware, among alternative states, doesn’t have a two hundredth rule. Hence, if ShellCo may be a Delaware corporation Associate in Nursingd doesn’t have shares listed on an exchange, ShellCo stockholder approval isn’t needed. Merger Sub stockholder approval is obtained from its sole stockholder, ShellCo, acting through its board. stockholder approval by OpCo is needed, however since OpCo is personal, it’s not subject to SEC proxy regulations; ordinarily it will get the requisite stockholder approval quickly through written stockholder consent in stead of a gathering.

Reverse Mergers vs. IPOs:

In this section we’ll justify what a reverse merger is, why it would be useful for a few corporations and what circumstances warrant its use, yet as what constitutes a shell company within the RM method.

In his book, Reverse Mergers, David Feldman (2009) describes the reverse merger method in-depth and explains why it’s a viable possibility for little corporations. abundant of the fabric during this section is taken from his book. amazingly, this is often one among the sole books written on the topic Associate in Nursingd though it’s geared toward an yankee audience it’s nonetheless relevant even to the Indian market, because the method is comparable. variations between the 2 square measure in the main found in regulative necessities and legislation.

A reverse merger is once “a personal company purchases management of a public one, merges into it, and when the merger is complete becomes a publicly traded company in its own right” . If the public company has no real ongoing business then it is often referred to as a “shell”. The reasons for going public this way will become apparent as we go through the advantages and disadvantages below. Feldman names seven advantages and two disadvantages of RMs when compared to IPOs. We cover each briefly.

Advantages

Lower cost. One of the puzzles of IPOs is the high underwriting costs . This is avoided in the RM process. RMs are much less costly and the total cost can often be pre-determined . In his experience, most RMs cost less than $1 million whereas an IPO will cost at least three or four times that much, excluding underwriting commissions (2009). For a RM the biggest cost is generally the price of the shell.
Speedier Process. RM takes two to three months; an IPO takes nine to twelve. There are fewer steps and fewer parties involved. There is also no disclosure document that needs to be approved by the SEC.
Not Dependent on IPO Market for Success As discussed earlier, IPOs follow a wave-like pattern and prefer to go public when the economy is doing well . This is not an issue for RMs, because they are not sensitive to the market and that makes them a good choice in any market condition.
Not Susceptible to Changes from Underwriters Regarding Initial Stock Price Underwriters can choose to change the price at the last minute if the market sentiment drops just before the IPO. Cancellations of IPOs are also not uncommon.
Less Time-Consuming for Company Executives IPOs take time, time that could be used to run the business. RM is less time- consuming as mentioned earlier and no new investors need to be found. That means more time for business decisions.
Less Dilution, RM less money is raised, during a time when the company supposedly is undervalued . It is better to raise money when the stock price is higher, because it doesn’t dilute ownership. Theoretically, new companies on the public market should trade higher after six months or so if the business grows. That is a big “if” however. Additionally, underwriters tend to try to take in as much money as possible without regard to how much the company doing the IPO actually needs (what you might call a “good” problem). This is because the underwriter takes a percentage fee of what is raised.
Underwriters Unnecessary, underwriters try to make a company look as profitable as possible before the IPO, which sometimes means selling off new subsidiaries that have not yet started making money . RMs do not have that problem as there are no underwriters involved.

Disadvantages

Less Funding RMs bring in less money than IPOs but that may not be relevant criticism of the method. Nothing stops the company from taking in new capital once they are public. This may even be beneficial if the stock price is higher at that point.
Market Support is harder to Obtain Underwriters will for some time after the IPO of a firm act as market makers, as well as trying to hype the stock during and after the offering. This often results in what Feldman calls a “pop in the stock price” which is unlikely in a RM because no one is covering the stock. A rise is more likely to come from years of improved performance rather than what he calls “manufactured support”.

To sum up, the main situations in which RMs are preferable to IPOs is when firms are small, markets are down, initial injection of money is not the main aim, time is of importance, or simply when hefty fees wish to be avoided. These are definitely compelling reasons to perform RMs.

RM IN TAX:

Section 72A of the Income tax, 1961 is meant to facilitate rejuvenation of sick industrial undertakings by merging with healthier industrial companies having incentive in the form of tax savings designed with the sole intention to benefit the general public through continued productive activity, increased employment avenues and generation of revenue. Sickness among industrial undertakings is a matter of grave national concern and section 72A provides for reviving financially non-viable business undertakings. The section provides for an effective course to facilitate the amalgamation of sick industrial units with sound ones by providing incentives and removing impediments in the way of such amalgamation. to avoid wasting the govt from social prices in terms of loss of production, employment and uneconomical burden of taking up and running sick industrial units square measure a number of the motivating factors for introducing section 72A.

Provisions of section 72A:

1) uniting ought to be between corporations and none of them ought to be a firm of partners or sole man of affairs.

2) the businesses getting into uniting ought to be engaged in either industrial activity or shipping business, so corporations engaged in commercialism activities or services shall not be entitled for taxation edges underneath section 72A.

3) when uniting the sick or financially unviable company shall survive and alternative financial gain generating company shall extinct.

4) one among the merger partners ought to be financially unviable and have accumulated losses to qualify for the merger and also the alternative merger partner ought to be profit earning in order that tax relief to the utmost extent may well be had.

5) uniting ought to be within the public interest.

6) Accumulated loss ought to arise from Profits and gains from business or profession and not be loss underneath the heading Capital gains or speculation.

7) Merger should result into following benefits: a) carry over of accumulated losses of the amalgamated company. b) carry over of unabsorbed depreciation of the amalgamated company. c) Accumulated loss would be allowed to hold forward for eight consecutive years. 8) For qualifying, carry over of losses, the provisions of section seventy two ought to haven’t been contravened.

9) equally for carry over of unabsorbed depreciation the conditions of section thirty two mustn’t are desecrated.

10) specified authority must be happy of the eligibility of the corporate for the relief underneath section seventy two of the revenue enhancement Act. it’s solely on the advice of the required authority that Central Government might enable the relief.

11) the corporate ought to build Associate in Nursing application to a specified authority for requisite recommendation of the case to the Central Government for granting the relief.

Prevalence of Reverse Merger in Indian Industries:

Presently in Asian nation Reverse merger remains in its infancy stage , but slowly and steady it’s gathering its quality in Indian company sector. Some smart examples wherever reverse merger has taken place are:

In 2002 , the board of administrators of ICICI andICICI Bank approved the reverse merger of ICICI, ICICI Personal money services restricted and ICICI Capital services restricted into ICICI Bank.
The Sajjan Jindal-controlled Jindal Iron and company (JISCO) and its subsidiary, Jindal Vijaynagar steel (JVSL), square measure reaching to consolidate their businesses to form a Rupees 4000 croreplus entity. As per the set up, the parent JISCO are united into JVSL in a very reverse merger. (source: Business customary October twenty one, 2010).
Merger of CORUS with TATA
Godrej soaps LTD.(GSL) with pre-merger turnover of RS.436.77 Crores and entered into theme of reverse merger with loss creating Gujarat innovative chemicals limited(GGICL) with pre-merger turnover of Rs sixty Crores.

Further within the Paper we’ll discuss the some case studies.

CASE STUDIES:

Case 1: The Bihari mills case

It was this case in which the Gujarat high court for the first time stated the various dimensions and implications of a reverse merger. After defining what a reverse merger is the Gujarat high court examined these two questions:

Whether the decision of the transferor company to merge into the transferee company, which apparently seems to be unusual, is warranted in the peculiar facts and circumstances? Whether the scheme offends any statutory provisions and therefore, is against the public policy?
Whether the scheme is just and fair to all the interests concerned and therefore, is one which a prudent businessman would evolve and implement?

The court quoted from the 4^th edition of the book Takeovers and mergers by Einberge and blank that:

Where a holding company wishes to acquire the complete control of a smaller subsidiary company. On a share for share basis, and the directors of subsidiary company Approve the proposal, it may be considered desirable to effect takeover by way of a ‘reverse bid’ instead of a straight forward share for share bid by holding company For the capital of subsidiary company In the reverse bid, subsidiary company (at the instigation of the controllers of holding company) Makes a share for share bid for the whole of the equity capital of holding company If the bid is accepted by the holders of at least 90% in value of each class of equity capital of holding company , and compulsory acquisition of any outstanding minority shares id carried out, the former shareholders of holding company will finish up as the majority shareholders in the enlarged capital of subsidiary company And the pre existing shareholders of subsidiary company Will hold a minority interest in subsidiary company Holding company will be a wholly owned subsidiary of subsidiary company. It will be observed that the position will be identical, in economic effect, with the position which would have been reached if holding company Had made an share for share bid for the capital of subsidiary company In either event, the original shareholders of the two companies will finish up holding the shares of the company in roughly the proportion which the value of the net assets of the one company bears to the value of the net assets of the other company or which the earnings of one bear to the earnings to the other (or a mixture of the two) and the other company will be the wholly owned subsidiary of the company in which the two groups of shareholders hold share subsidiary.

“The tests which are to be taken care during takeover by reverse bid are:

If the assets of holding company exceed the assets of subsidiary company.
If net profit of holding company exceed net profits of subsidiary company.
If the consideration offered by subsidiary company exceed the value of net assets of holding company.
If the equity share capital to be issued by subsidiary company as consideration for the acquisition exceeds the amount of the equity capital of subsidiary company in issue prior to the acquisition.
If the issue of shares in subsidiary company would result in a change in control of subsidiary company through the introduction of a minority holder or group of holders.((RAMANUJAN.S, MERGERS ET AL, 197,[LEXIS NEXIS, 3RD ED. 2012]))”

The court after analysing the various parameters concluded that the above case is a case of reverse merger.

Facts of the case:

The transferor company Being M.H.company and Bihari Mills being the transferee company the transferee is the subsidiary of the transferor. The transferee suffered losses for 8 years so the merger was as a helping hand for the company

After considering all the accounts of the two companies the court sanctioned the reverse merger.

Case 2: Reverse Merger of Chemplast and Urethanes

This is the case of rehabilitation of urethanes India ltd which was incorporated in 1985 accumulated losses amounting to Rs. 503 lacks. Being the subsidiary of Chemplast it had given corporate guarantee for the loans availed by Urethanes. The date of merger was appointed October 1, 1991.

The details of the merger:

The scheme was mooted by ICICI the leading institute of that time.
Exchange ratio was set to be one share in Chemplast for one share in Urethane.
After the completion of the merger Urethanes would get the shares of the merged company listed in the Madras and Bombay Stock Exchanges.
The managing director and the executive directors of Chemplast would become the managing director and executive directors Urethanes.
On the scheme being effective, the name of Urethanes India Ltd. Would be changed to Chemicals and Plastics India Ltd.
Income and profits accruing to the undertaking of Chemplast or losses incurred by such undertakings on and from October 1, 1991 would, for all purposes, be treated as income, profits and/or losses of Urethanes.

This is how the reverse merger led to the rehabilitation of urethanes India ltd. But according to the 1995 annual reports showed that it was not a successful merger as it was expected to be.

Conclusion

Reverse merger is the best way of going public without making an initial public offer (IPO). In the recent years reverse mergers are gaining a lot of importance worldwide, it is just a matter of time when it will be considered the best way to go public. In spite of being a time and money saving method it has a number of shortcomings one of which being the improper way of doing analysis of the companies the audits are not properly checked. A case of fraud when a Chinese private company tried to get itself listed in the US stock market opened the eyes of many public companies and more stringent laws were imposed by the SEC.

India having a very wide and good corporate law structure helps companies to easily go public by way of reverse mergers but also keeps a check that no fraud is committed. So in a country like India reverse mergers can be enjoyed by companies easily and to the fullest.