Workshop on Mergers & Acquisitions

February 17, 2005

Mohit Saraf
Partner Luthra and Luthra Law Offices

presented by

Why M&A?
Underlying Principle for M&A Transactions 2+24 Additional Value of Synergy

Why M&A?
Market Intensification: Horizontal Integration Buying a competitor Acquisition of equity stake in IBP by IOC AT&T merger into SBC enables the latter to access the corporate customer base and exploit the predictable cash flows typical of this telephony section Market Extensions New markets for Present products Maersk Pipavav : strategic objective of investing in a container terminal in the west coast Bharat Forges acquisition of CDP (Germany) S&Ps proposed acquisition of CRISIL
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Why M&A?
Vertical Integration : Internalization of crucial forward or backward activities Vertical Forward Integration Buying a customer Indian Rayons acquisition of Madura Garments along with brand rights Vertical Backward Integration Buying a supplier IBMs acquisition of Daksh

Why M&A?
Diversification: Overcome Barriers to Entry Product Extension: New product in Present territory P&G acquires Gillette to expand its product offering in the household sector and smooth out fluctuations in earning Free-form Diversification: New product & New territories Flight Centres proposed acquisition of Friends Globe Indian Rayons acquisition of PSI Data Systems
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Why M&A?
Advantages: Greater Economic Clout: Proposed merger of Petroleum PSUs P&G merger with Gillette expected to correct balance of power between suppliers and retailers. Economies of scale and Overheads: Size really does matter IOC & IBP Sharing

Synthesized capabilities Proposed merger of nationalized banks

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M&A Different Perspectives

Acquirer
Majority/ Strategic Partner

Minority/ Private Equity Investor

Target Company
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M&A
TRANSACTION ISSUES: TARGET
Due Diligence Full Disclosures Linked with Reps & Warranties Reps should be negative DD in case of Listed Company Post Closing Adjustment
Condition Precedents Definitive Include as Exhibits Survival of Reps for limited period
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M&A
TRANSACTION ISSUES: ACQUIRER
Due Diligence Risk Matrix and Value Depletor Material Contracts
Any subsisting contracts granting similar or superior rights to other investors Termination rights of major customers Approval rights of financiers

Title to Properties & Assets: esp. where main business is situated Statutory Dues Litigation : Contingent Liabilities IPR protection Tax Compliance (Settlement Commission)
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M&A
TRANSACTION ISSUES: ACQUIRER
Mode of Acquisition Pure Equity (Existing or New); Equity & Preference; Special Class (Differential voting rights, dividends or otherwise) Leveraged Acquisitions Corporate Governance Related Party Transactions (past & going forward) Board Representation - Quorum (Inclusive) - Fiduciary Responsibility of Board v. Shareholders

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M&A
TRANSACTION ISSUES: ACQUIRER
Deadlock Resolution Majority/ Strategic Partner Lenders Return on Investment Cap on dividends to preference shares Liquidation Preference

Lock - in of Promoters Enforceability of transferability restrictions

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M&A
TRANSACTION ISSUES: ACQUIRER
Non - Compete/ Non - Solicitation Payment for Goodwill to exiting partner Exclusivity

Enforceability against Company Company as party to SHA Exit Options Listing (Private Equity) Call/ Put Option
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M&A
TRANSACTION ISSUES: GENERAL
Effectiveness of SHA and SPA Indemnity Aggregate Liability Cap De Minimis Threshold Participative Rights v. Protective Rights Strategic Partner : Participative Rights
Control on Board Sharing Control

Private Equity : Protective Rights

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M&A
TRANSACTION ISSUES: GENERAL
Special Rights
Tag Along Rights: minority partner/ private equity Drag - Along Rights: majority partner Right to share the upside on revised valuation of Target eg: on Merger; Listing at higher valuation

Right of First Refusal

Earn-out Structure
Favorable Business Projections

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M&A
TRANSACTION ISSUES: GENERAL
FCPA Arbitration v. Litigation: Effective Remedy Proper Law of Arbitration ICC v. UNICITRAL Group Companies Doctrine Place of Arbitration Cost Effective

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M&A
REGULATORY FRAMEWORK
TRANSACTION STRUCTURE Companies Act Income Tax Act Stamp Acts Competition Act LISTED COMPANIES SEBI Regulations Stock Exchange Listing Agreement TRANS-BORDER TRANSACTIONS Foreign Exchange Management Act
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M&A
OVERVIEW Mergers Spin Offs Acquisitions

DEMERGER

OTHERS ASSETS

SHARES

CONTROL

SLUMP SALE
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ACQUISITIONS

Acquisition
Shares Control

Acquisition of Assets
Slump Sale
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Acquisitions
ISSUES: COMPANIES ACT
Sections 108A to G: Central Government approval if in excess of threshold prescribed ambiguity as to classification of goods Section 372A: Compliance by transferee company in acquisition of shares Section 77A: Buy Back may be used as a defense to a hostile takeover Used in U.S.: PeopleSofts attempt to thwart Oracle
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Acquisitions
ISSUES: FEMA
Acquirer - Non-Resident: No approval required for purchase of shares (including existing shares) From R From NR

Valuation prescribed in case of R-NR not less than Ruling Market Price - Listed Target Company Fair valuation by a CA as per CCI guidelines Unlisted Target Company
Press Note 18 replaced by Press Note 1 of 2005 Investment has to comply with FDI policy
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Acquisitions
ISSUES: FEMA
Target Company is a Non-Resident Direct investment in JV/ WOS outside India (other than financial services) requires no approval subject to conditions including inter alia Financial commitment < or = 100% networth

Investment by way of remittance only if valuation If > 5 million USD: by Merchant Banker/ Investment Banker registered with SEBI/ appropriate authorities Other cases: by CA/ CPA
Investment by share swap: valuation by Merchant Banker/ Investment Banker registered with SEBI/21 appropriate authorities

Acquisitions
ISSUES: TAKEOVER CODE
Definition of Control - Inclusive Ambiguous:
- TATA Sellout in ACC.

Negative control? S. 25(2) prohibits public offers after 21 days of the public announcement of first public offer

In case of indirect acquisition, foreign acquirer has three months from completion of transaction to make open offer. Therefore, foreign transactions can be concluded prior to open offer in India.
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Acquisitions
RECENT CHANGES : TAKEOVER CODE
New thresholds of 54% and 74% in Regulation 7 55% shares cannot be allotted by preferential allotment or market purchase consolidation by public offer only Acquisition by public offer under 11(2) can be for only so many shares as will keep float above listing requirements. Where any acquisition reduces public float below Listing Agreement requirements, acquisition to comply with delisting guidelines Where Code is triggered by a global deal, if the public offer will lower float to below the listing requirement, then acquirer has 12 months to raise float either by 23 fresh issue or by disinvestment.

Acquisitions
ISSUES: MISC
Stamp Duty No stamp duty if transferred shares are dematerialized Industrial Disputes Act (s. 25FF) Workmen employed by transferor company entitled to retrenchment benefits unless retained in employment on same terms.

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Mergers
Mergers Spin-offs
Demergers
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Mergers
STRUCTURE 1
A = Amalgamating Company: Ceases to Exist B = Amalgamated Company B receives all of As assets and liabilities Shareholders of A receive shares in B and maybe other benefits like debentures, cash

Transfer assets and liabilities

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Mergers
STRUCTURE 2
A, B and C = Amalgamating Companies: Cease to exist D = Amalgamated Company: may or may not have existed before Merger All assets and liabilities of A, B and C transferred to D Shareholders in A,B and C get shares in D.

A B C
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Spin-Offs
STRUCTURE

Transfer of undertaking Y Y

Company A

Consideration in cash Company B or issue of shares

Consideration is usually shares of Company B but maybe cash. Process may or may not be Court sanctioned. Salora spinning off Panasonic to Matsushita under s. 391 Scheme. Consideration in cash.
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Demergers
STRUCTURE
Demergers are one type of spin-offs: under s. 391 A = Demerging Company B = Resulting Company: may or may not have existed earlier A transfers undertaking to B B issues shares to shareholders of A Transfers undertaking Y Shareholders of A

Y
Company B

Company A

Issues shares

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Merger & Demerger

Phase- I Draft Scheme Notice to members of Board of both companies Determine swap ratio based on valuation report Board approval of both companies Prior NoCs from secured creditors and shareholders for exemption from meeting: Reduce Time and Costs In ICICI Ltd. merger with ICICI Bank, meeting of preference shareholders of ICICI Ltd. was dispensed with since sole preference shareholder furnished an NOC Phase- II Draft Application under s. 391(1) Application to HCs in respective jurisdictions of both companies for sanction / direction to conduct meetings Moving registered office to one jurisdiction: Reduce 30 Time and Costs

PROCESS

Merger & Demerger

PROCESS
Phase- III Notice of EGM to members with statement of terms of merger, interests of directors and proxy forms: 21 days Advertisement Notice in 2 newspapers: 21 days Affidavit certifying compliance with HCs directions in respect of notice/ advertisement Meetings of creditors and/ or shareholders: agreed to by majority in number representing of value present and voting Chairman of meetings to file report within 7 days of meeting Resolutions and Explanatory Statements to be filed with RoC
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Merger & Demerger

PROCESS
Phase- IV (Approval of the Scheme) HC to be moved within 7 days of Chairmans Report for second motion petition 10 days notice of hearing of petition in same newspapers Notice to Central Govt. (Regional Director), and OL (if applicable): Submit reports Objections raised in 391 proceedings HC Sanction Certified copy of HC Order to be filed with RoC within 30 days of order.

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Merger & Demerger

ISSUES: COMPANIES ACT
s 391 - 394: Complete Code, Single Window Clearance Reduction of capital- Position unclear, Predominance of judicial view: substantial compliance with s. 100- 102 required. Transnational Mergers: 391 - 394 mechanism operates only where amalgamated company is Indian. E.g. of transnational merger concluded under 391 route - Bank of Muscat merging into Centurion Bank by order of Karnataka HC Alternative Mechanism: S. 494 Through Liquidation Process Liquidator transfers assets to foreign company for shares Process has to be altogether voluntary 33 Tax benefits are unavailable under this route

Other Spin-Offs
ISSUES: COMPANIES ACT
Where spin-offs are outside the 391 mechanism, the following compliances need to be ensured 293(1)(a) resolution Voting has to be by postal ballot in a public listed company

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Mergers and Demergers

ISSUES: INCOME TAX
Transfer of capital assets by amalgamating company to amalgamated company is exempt from Capital Gains Tax provided amalgamated company is an Indian company Capital Gains Exemption in respect of shares issued to members of amalgamating/ demerging companys. 47
Exemption may not be available if members of amalgamating company receive anything besides shares in the amalgamated company like debentures or cashGujarat HC in Gautam Sarabhai v. CIT, 173 ITR 216.

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Mergers and Demergers

ISSUES: INCOME TAX
In case of fraction shares, issue to trustee who liquidates these and distributes money to shareholders of amalgamating company. Carry forward of losses and unabsorbed depreciation provided the amalgamated company carry on the business of the amalgamating company for at least 5 years s. 72A Use of Reverse merger to meet above condition

Spin-off receives tax benefits under Income Tax Act only if it is a demerger
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Slump Sale
ISSUES: TAXATION
Slump Sale = Transfer of undertaking without itemizing individual assets and liabilities- s.2(42C) Income Tax Act Treated as capital gains If undertaking is older than 3 years, long term capital gains rates apply even if individual assets are new Carry forward of losses and unabsorbed depreciation unavailable
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Merger & Demergers

ISSUES: SALES TAX
No Sales tax on Amalgamation or demerger. Where effective date is retrospective, any transfers between amalgamating company and amalgamated company retrospectively cease to be liable to sales tax- Mad HC Castrol Oil v. State of TN, 114 STC 468 Some Sales Tax enactments contain specific provisions to tax such transactions eg. S.33C, Bombay Sales Tax Act. No such provision in Central Sales Tax Act.
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Merger
ISSUES: STAMP DUTY
Divergences between states: Shopping for beneficial rates usually pointless Duty to be imposed on value of shares transferred not on individual assets transferred: Bom HC in Li Taka AIR 1997 Bom 7 States with Specific entries: Maharashtra, Karnataka, Rajasthan and Gujarat

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Merger
ISSUES: STAMP DUTY
States without specific entries: Unclear if duty leviable.
Cal HC in Madhu Intra Ltd. v. ROC, 2004 (3) CHN 607 394 Order is not an instrument chargeable to duty Supreme Court in Ruby Sales v. State of Maharashtra (1994) 1 SCC 531 - specific inclusion of civil court decrees in Bombay Stamp Act only abundant caution

1937 Notification under Indian Stamp Act, 1899 remits duty when merger is of a 90% subsidiary: Remission not available in states with own legislations eg. Kerala, Karnataka, Maharashtra, Gujarat and Rajasthan Gujarat and Maharashtra have limits on stamp duty for mergers and demergers at Rs.10 crore and Rs. 25 40 crore.

Merger
ISSUES: SEBI
Acquisition of shares pursuant to a scheme of arrangement or reconstruction under any law, Indian or foreign exempt from SEBI Takeover Code.
Exemption claimed unsuccessfully by Luxottica in the acquisition of Ray Ban Sun Optics India

Listing Agreement:
Scheme before the Court/ Tribunal must not violate, override or circumscribe the securities laws or stock exchange requirements Disclosure required

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Merger
ISSUES: SEBI
Shares allotted by unlisted transferee company to shareholders of listed transferor company under a HC sanctioned scheme can be listed without an IPO subject to conditions (DIP).
Eg. Dabur Pharmaceuticals

Constitutes Price Sensitive Information in terms of Insider Trading Regulations.

Compliance with Delisting Guidelines shareholding below prescribed limit.

if

public

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Mergers
MISCELLANEOUS ISSUES
Foreign Exchange Management Act, 1999 Where the amalgamated company is Indian, non resident shareholders of the foreign amalgamating company require RBI approval to receive shares. Where the amalgamated company is foreign, the issue of its shares to Indian shareholders requires RBI approval. Automatic route available where non residents have to be issued shares in a merger of Indian companies.
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Mergers
MISCELLANEOUS ISSUES
Human Resources Workmen entitled to retrenchment benefits unless retained in employment on same terms. Adjustments of pay scale needs to be resolved.
Global Trust employees were retained on same terms in OBC. Pay packages of former GTB staff could be altered only after 3 years. OBC management had to contend with GTBs complex salary structure.

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Mergers & Acquisitions

COMPETITION LAW
Monopolistic and Restrictive Trade Practices Act, 1969 Status: Repealing provision in Competition Act, 2002 not notified.

No Central Government approval required for a merger or acquisition under the MRTPA
Act attracted only if amalgamated company discovered to be monopolistic in its working not at stage of amalgamation- Hindustan Lever, 1995 Supp (1) SCC 499
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Mergers & Acquisitions

COMPETITION LAW
Competition Act, 2002 (Partially notified) Merger or Acquisition = Combination if stipulated thresholds respecting aggregate asset or turnover are exceeded
Prior approval of combination is not mandatory Test Cause or likely to cause an appreciable adverse effect on competition within the relevant market
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