In the evolving business environment, organizations can achieve growth through both organic and inorganic methods. Inorganic growth involves a swift expansion across key areas—workforce, customer base, infrastructure, and financial performance—through strategic transactions such as mergers, acquisitions, and de-mergers. These transactions have significant implications for the involved entities and require a nuanced understanding of the relevant legal and regulatory frameworks.
Mergers and acquisitions (M&A) have emerged as pivotal instruments for significant growth and are increasingly recognized by Indian entities as essential components of strategic planning. These transactions are employed across various sectors to strengthen market position, broaden customer bases, mitigate competition, or enter new markets and product segments.
While mergers involve the consolidation of two companies into a single new entity, acquisitions occur when one company purchases another, which may involve either an outright purchase or a management buyout (MBO), where the company's management acquires it from its current owners. De-mergers, which involve splitting a single entity into multiple distinct entities, should be treated equivalently to mergers and acquisitions under the applicable legal and regulatory frameworks.
A cross-border mergers and acquisitions (M&A) refers to a transaction in which two companies, domiciled in different jurisdictions, engage in a business combination involving the transfer of assets, operations, and, potentially, control. This process encompasses the acquisition of equity interests or assets and may involve the integration of business operations, management structures, and strategic objectives across national boundaries. Such transactions necessitate compliance with the legal and regulatory frameworks of the respective countries involved, including considerations related to foreign investment regulations, antitrust laws, and cross-border tax implications.
According to the data provided by the Institute for Mergers, Acquisitions, and Alliances (IMAA), there was a general increase in cross-border mergers and acquisitions (M&A) deals from 472 in 1985 to 8,500 in 2023. India's deal value in M&A activity decreased by 27% in 2023 compared to 2022. This indicates that the value of merger and acquisitions (M&A) deals in India decreased from US$186 billion in 2022 to US$136 billion in 2023.
The Companies Act, 2013 delineates specific procedural requirements for the approval of mergers and acquisitions (M&A), including obtaining shareholder consent and securing authorization from the National Company Law Tribunal (NCLT). Concurrently, the Securities and Exchange Board of India (SEBI) regulations impose stringent guidelines on substantial acquisitions of shares and takeovers to ensure transparency and fairness within the securities market. Additionally, the Competition Act, 2002 mandates that transactions potentially impacting market competition receive prior approval from the Competition Commission of India (CCI). Adherence to these regulatory frameworks is critical for the lawful and effective execution of mergers and acquisitions (M&A) transactions in India.
Many other legal frameworks are in place to regulate cross-border mergers. These include Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2016 notified by the Ministry of Corporate Affairs (MCA) which introduced Rule 25A, governing inbound and outbound mergers of Indian companies with foreign companies under certain conditions. Additionally, the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (FEMA 389/2018) issued by the Reserve Bank of India (RBI) provide a legal framework for cross-border mergers, ensuring that such transactions comply with foreign exchange regulations. Apart from these, there have been several decisions by the courts and tribunals creating certainty around the permissibility of cross-border transactions.
Specifically, Section 234 of the Companies Act, 2013 dealing with 'Merger or Amalgamation of Company with Foreign Company' was notified by the Ministry of Corporate Affairs in 2017. However, such schemes require prior Reserve Bank of India (RBI) approval and are limited to specific jurisdictions. Accordingly, in 2018, the RBI notified the Foreign Exchange Management (Cross Border Merger) Regulations to implement cross-border mergers. Despite these changes, legal uncertainty remained due to conflicting National Company Law Tribunal (NCLT) rulings on cross-border demergers.
In 2018, the NCLT Ahmedabad approved an inbound demerger of a foreign company with an Indian company interpreting a broad definition of ‘mergers and amalgamations’ under Section 234 of the Companies Act.
However, the same NCLT in re Sun Pharmaceutical Industries Limited CP (CAA) No. 79/ NCLT/AHM/2019 Ahmedabad 19.12.2019, denied an outbound demerger of Indian undertakings to an overseas subsidiary and said that Section 234 and the related rules do not allow demergers, thereby leaving general cross-border demergers in uncertainty.
To ease, these transactions, in August 2022, the Indian government notified new Foreign Exchange Management (Overseas Investment) Rules and Regulations, replacing the previous 2004 regulations which aimed to simplify the legal framework for overseas investments by Indian entities. These Rules try to create a more conducive environment for Indian entities to invest abroad. They explicitly classify demergers as a permissible route for overseas investments. This potentially reopens the discussion on cross-border demergers and signals the RBI's willingness to allow such transactions from a foreign exchange perspective.
Nevertheless, the following objections raised by the NCLT with reference to the literal interpretation of Section 234 of the Companies Act remained undiscussed.
However, the trend does indicate that NCLT has somewhat restricted itself in challenging schemes, which were supported by commercial wisdom and majority approvals.
In M/s Miheer H. Mafatlal v. Mafatlal Industries Ltd. (supra) and Hindustan Lever Employees' Union v. Hindustan Lever Ltd.(civil) No. 11006 of 1994 (SC), the facts were different, and the scheme in question unduly favored the promoters. It is notable that courts, relying on the ruling of the Supreme Court in Miheer H Mafatlal have generally held that the scope of judicial review in such matters is highly limited, and not appealable in nature. As long as there are no objections to a scheme no fault or illegality has been pointed out and relevant documents have been placed before concerned parties at the relevant time, courts have been held not to be in a position to interfere with schemes of arrangement. This is because such schemes are based on the wishes of concerned shareholders, creditors, experts, and professionals, apart from competent authorities, after scrutiny of the accounts and affairs of the companies.
In fulfilling its broader mandate to act in the public interest, the National Company Law Tribunal (NCLT) has recently undertaken a more comprehensive review of merger transactions. The NCLT assessed in some recent judgments whether the proposed merger aligned with its stated objectives, scrutinizing the genuine intent and purpose behind the transaction.
Recent judicial trends indicate that the NCLT is extending its review beyond mere procedural compliance. The Tribunal is actively examining reorganization schemes to ensure that they are not merely cosmetic corporate restructuring exercises but rather serve substantial business purposes and do not adversely impact public interests. Compliance with statutory provisions and fairness to stakeholders are necessary but not sufficient. The schemes must also demonstrate a legitimate business rationale or contribute positively to the business environment or general public. The applicants are required to substantiate their proposals with merit-based justifications to satisfy the Tribunal's heightened scrutiny. Another decision by NCLT suggests another trend emphasizing the importance of public interest. In the case of Wiki Kids Limited v. Regional Director and Others [Company Appeal (AT) No. 285 of 2017], the National Company Law Appellate Tribunal (NCLAT) upheld the NCLT’s decision to reject a scheme of amalgamation since no evident public interest was involved.
It observed that Wiki Kids was incorporated in 2004 and does not have any commercial operations or income except for the interest received from fixed deposits. Which had used almost all its paid-up capital — thereby reducing its net worth to INR 22 lakh (Indian Rupees Twenty-Two Lakhs Only). Under the newly proposed share exchange ratio, Wiki Kids shareholders were to get INR 4 lakh (Indian Rupees four Lakhs only) Avantel shares translating into ~INR 12.4 crores (Indian Rupees Twelve crore and forty lakh only) in value for transfer of business though compared to net worth of only INR~1 crore (Indian Rupees one crore only) on Wiki kids books. Since the promoters of Avantel owned 99.9% of shares of Wiki Kids, NCLT observed that it was a clear scheme to benefit the promoters financially by INR 12 crores (Indian Rupees twelve crores only) and hence against the public interest.
On appeal, the Appellants argued that the scheme was in compliance with all legal requirements and that no objections had been raised by authorities like the Securities and Exchange Board of India (SEBI) or the Income Tax Department. They also claimed that the share exchange ratio was fair, based on expert valuations and potential future business growth. However, the NCLAT rejected these arguments, emphasizing the disclaimer in the valuation report, which disclaimed the accuracy of the information provided by the management. The NCLAT ruled that schemes of amalgamation must benefit all shareholders and not just a few. It also affirmed the NCLT’s jurisdiction to assess whether a scheme is fair, even if detailed mathematical analysis is not involved. The tribunal distinguished the case from precedents such as
In light of these developments, it is imperative for applicants to articulate the objectives and rationale of their proposed schemes with greater precision and detail. Future applications under Sections 230-232 of the Companies Act should move beyond rote procedural compliance and avoid generic template filings. Applicants must substantiate their proposals with comprehensive evidence demonstrating how the scheme will achieve the articulated objectives and provide clear benefits and efficiencies. Additionally, applicants must be prepared to present a robust justification to the National Company Law Tribunal (NCLT), showing that the proposed merger or reorganization serves a legitimate business purpose and aligns with the broader public interest. This detailed approach is essential to meet the NCLT’s enhanced scrutiny and to ensure that the transaction is not only procedurally compliant but also substantively beneficial to the general public.
As India continues to present attractive investment opportunities due to its strong economic growth and large domestic market, cross-border acquisitions are likely to increase. However, a lack of regulatory clarity around cross-border demergers and further liberalization in policies will be needed to realize this potential. The stable Gross Domestic Product (GDP) growth of the country along with a well-regulated inflation rate has been appealing for overseas investors in any sector. Recent NCLT decisions have highlighted two important trends: A limited scope for challenging schemes backed by commercial wisdom and majority approvals, as seen in the Zee-Sony merger case, and an emphasis on public interest in approving schemes of amalgamation, as demonstrated in the Wiki Kids Limited case. Greater clarity in regulations and a more friendly regulatory environment for cross-border mergers and acquisitions (M&A) would result in higher Foreign Direct Investment (FDI) inflows. When carried out as envisaged, cross-border mergers and acquisitions (M&As) can spur economic growth by introducing new technologies, know-how, and capital.