Modes Of Demerger Under Company Law Article

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Modes of Demerger under Company Law

There are demerger in the public and the private sectors. The contemporaneous method to combat the present economic situation in India is being well dealt with the equipment of Demergers.

Author: Praveen Kumar

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Demerger Defined --------------------------------
“Demerger” can be defined as split or division of a company into more number of companies. The new companies, the transferees, need not be the subsidiaries of the parent companies undergone such split or division[1]. The New Oxford Dictionary defines the term “demerger” as “the separation of a larger company into two or more smaller organizations.”

Justice NV Balasubramanam observed that a Scheme of demerger is in fact a corporate partition of a company into two or more undertakings, thereby retaining one undertaking with it and by transferring the other undertaking to the resulting company or companies. It is a scheme of business reorganization.[2] The term ‘demerger’ has not been defined in the Companies Act, 1956.

Reasons for demergers ---------------------------
Demerger is undertaken basically for two reasons. The first one as an exercise in corporate restructuring and the second one is to give effect to a kind of family partitions in the case of family owned/controlled companies essentially to give effect to informal family partitions[7].

Where demerger is an exercise of corporate restructuring the undertaking sought to be demerged is transferred from a transferor company to an existing transferee company. But where demerger is an exercise in family partition the different ‘undertakings’ of a company is transferred to a newly incorporated transferee companies to facilitate family partitions[8].

In a scheme of arrangement two groups in a family shall be allotted specific assets to their respective transferee companies from the parent transferor company where they are shareholders. Ordinarily all the shareholders of the transferor company receive shares in one or the other of the two transferee companies. As this mode of effecting transfer is not objected to by the Central Government and no provision of law which it can be said to violate has been brought to the notice of the Court it can be sanctioned. After the distribution of the assets in the manner provided in the scheme, no assets will be left with the transferor company and it is therefore sought to be dissolved, the same forming part of the scheme.[9]

Modes of Demerger---------------------------

(1) Demerger May Be Partial Or Complete.
Partial demerger results when a part/department/division of company is separated and transferred to one or more new company/companies formed with the same shareholders allotted shares in new company in same proportion as held by them in the demerged company. Complete demerger results when the whole of the business/undertaking of the existing company is transferred to one or more new company/companies formed for the purpose and the demerged company is dissolved by passing special resolution by its shareholders[13]. Such company is wound up voluntarily and disappears. The shareholders of the dissolved company are issued and allotted shares in the new company/Companies as per the share exchange ratio sanctioned under the demerged scheme.

Demerger could be affected by either of the three ways, viz.

(i) Demerger by agreement between promoters; or

(ii) Demerger under the scheme of arrangement with approval by the court under section 391 of the Companies Act, 1956;

(iii) Demerger under voluntary winding up and the power of liquidator.

(2) Demerger By Agreement
English Law is quite exhaustive on the issue of ‘demerger’. While ‘demerger’ is affected by agreement and original company is wound up after division, it was held in Cardiff Preserved Coal and Coke Co v. Norton[14] that the liquidator cannot dispute the validity of the transaction and therefore cannot require its shareholders to transfer to him the shares which have been allotted in the new company or companies so that he may sell them and use the proceeds to pay the original company’s debt.[15]

Further, the English law supports[16] that in such events where the creditor accepts an undertaking from the purchasing company to honour the original company’s obligation,[17] or if he accepts a benefit from the purchasing company to which he is not entitled under his contract with the original company,[18] there will be a novation and the original company’s liability will be discharged. Section 395 of the Companies Act, 1956 would be available to protect the interest of the shareholders dissenting from scheme or contract approved by majority even in the cases of demergers or divisions.

(3) Demerger Under Scheme Of ArrangementOn the basis of the powers a company has in its Memorandum, it can carry out division or split of its entity in the same manner as it could accomplish amalgamation through a scheme of arrangement under the provisions of the Companies Act, 1956. The procedure laid down in Chapter-V under the Companies Act, 1956 regarding Arbitration, Compromises, Arrangements and Reconstruction would be followed in the case of division of the company.

Indian Law is silent on the issue of powers of the Court to pass ancillary orders in respect of demergers or division but English Law provides a deeper insight into the matter signifying that the Court has no powers under Section 425 of the UK’s Companies Act, 1985 while approving the scheme of arrangement for demerger or division which otherwise can be used in the case of amalgamation or merger[19].

(4) Demerger Under Voluntary Winding UpThe original company which has split into several companies after division could be wound up voluntarily pursuant to the provisions of Sections 484 to 498 of the Companies Act, 1956.

Conclusion ---------------------------
There are demerger in the public and the private sectors. The contemporaneous method to combat the present economic situation in India is being well dealt with the equipment of Demergers.

The demerger of the Reliance group is by far the biggest corporate restructure story in the private sector. The split in the group led to the formation of the two independent entities Reliance Industries ltd. led by Mr. Mukesh Ambani and the Anil Dhirubhai Ambani Group led by the younger brother Mr. Anil Ambani. RIL proposed the demerger “in order to enable distinct focus of investors to invest in some of the key businesses and to lend greater focus to the operation of each of its diverse businesses”[42]. Also, the other well known demergers that caught the attention of the public which had enormous repercussions were: Eveready Industries separated its tea business into McLeod Russell; Auto ancillary company Rane Madras transferred its investments into separate company and the investment company was also listed. The demerger list also includes Vardhman Spinning and Morarjee Realities. GTL is demerging its IT infrastructure business to GTL Infrastructure[43].

CITATIONS
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[1] J. C. Verma, ‘Corporate Mergers Amalgamations and Takeovers: Concept, Practice and Procedure’, 5th ed. 2008, at p.264
[2] Lucas TVS Ltd. in re CP No. 588 and 589 of 2000 (Mad-unreported)
[3] Under Section 390 of the Companies Act, 1956
[4] Under the provisions of Section 293(1)(a) of the Companies Act, 1956
[5] As amended by the Finance Act, 1999 w.e.f. 1-4-2000.
[6] K. R. Chandratre, ‘Corporate Restructuring’, 1st ed. 2005, at p.865
[7] Sridharan & Pandian, ‘Guide to Takeovers & Mergers’, Edition 2002, p.286

About Author

MBA,LL.B.,LL.M.,JRF
Member, High Court Bar Association, P & H high court, Chandigarh
The author can be reached at: ad.praveenkumar@gmail.com
PH: 0091-9416529035

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Modes of Demerger under Company Law