De-Merger of a Company

De-merger means split or division of a business or any undertaking of a company, making them separate units or undertakings. In short, de-merger means separation of a large company into one or more small companies.
Section 232 of Chapter XV of the Companies Act 2013 and Companies (Compromises, Arrangements and Amalgamations) Rules outline the application and approval process of a demerger.

A demerger is a form of corporate restructuring undertaken by companies to promote specialization. It allows a company to expand its operations in a very systematic manner. Demerger allows a specific division or unit to grow as a separate and a focused entity, thereby increasing its efficiency and effectiveness. It benefits the shareholders by providing them better opportunities to participate in the management, operations, decision-making process and profits of the applicant company as well as the resulting company.

For example Jindal Stainless Limited demerged its three business namely power, domestic steel and international steel to leverage its idle capacity. The demerger distributed its debt worth INR 8580 crores and opened the doors to independently raise funds.

Forms of Demerger

Spin off

Under this type of demerger a subsidiary is formed with a proportion of shares, giving the subsidiary the freedom to make independent financial decisions and devise its own strategies for specific products.

Splits

Split-Off

A large company consisting of multiple businesses may want to split them into separate companies. In a split-off, the shareholders are given the opportunity to exchange their Parent Co shares for new shares of the subsidiary (Split Co). This “tender offer” often includes a premium to encourage existing Parent Co shareholders to accept the offer.

Split-Up

In contrast to the above, in a split-up the parent company does not survive. It is liquidated into the new companies that are created as part of the transaction.

Equity Carve Out

Under this form of demerger, the demerged company holds some stake in the subsidiary and offers a percentage of equity to general public by inviting IPO.

Divestitures

This demerger involves selling off the non-core, non-profitable units of an organisation.

In October 2022, Reliance group announced demerger of its finserv business operating under Reliance Strategic Investment (RSIL) (a wholly-owned subsidiary of Reliance Industries Limited) and formed Jio Financial Services, which was subsequently listed on the stock market. Shareholders of RSIL got shares of JFSL. This demerger helped the company to tap into the growing demand for financial services for retail business customers.

Demerger can be affected by any of the following ways:

1.    Demerger by agreement between promoters; or

2.    Demerger under the scheme of arrangement with approval by the Court under section 232 of Chapter XV.
Demerger by Agreement between Promoters

Demerger may occur through an agreement between the promoters of the demerging company. In such a scenario, the principal company may spin off its specific undertakings to the resulting company. All the property, liabilities and issues of the principal company, transferred to the resulting company immediately before the demerger, becomes the property, liabilities and issues of the resulting company.

Demerger under the Scheme of Arrangement with Approval by the Tribunals under Section 232 of the Companies Act

To effect a demerger, there must be a provision in the Memorandum of understanding of the principal company. The scheme of such an arrangement has to be submitted to the respective Tribunal having jurisdiction.

Process for Demerger

Whenever a company plans to dermerge one of its undertakings from main business, then the most adaptable process is demerger of the company.  A demerger is 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. A demerger is not specifically defined in the Companies Act, 2013. However, an explanation is given to section 230(1) of the said Act prescribes it as an arrangement for the reorganization of the company’s share capital by:

1.    Consolidation of shares of different classes

2.    Division of shares of different classes

3.    Or both

A demerger is mentioned in section 2(19AA) of the Income Tax Act, 1961, subject to fulfilling the conditions stipulated in section 2(19AA) of the Income Tax Act and shares have been allotted by the ‘resulting company’ to the shareholders of the ‘demerged company’ against the transfer of assets and liabilities.

Major Steps in the De-Merger of a Company

Preparation of the Scheme of Arrangement

Scheme of arrangement or compromise is the most crucial document prepared by the company contemplating to de-merged entity, by which the company binds all related stakeholders on the terms of the demerger.

A scheme of arrangement would deal with aspects such as the share swap ratio (if applicable), details of the transfer of debt or payment to creditors, transfer of employees, assets, liabilities and more. The scheme of arrangement can be proposed by the directors of the company or the liquidator of the company. The scheme of arrangement would have to be accepted by the shareholders, creditors, employees and all related stakeholders.

Application in Tribunal

A demerger can be completed by making an application to the tribunal and through orders issued by a Judge. Hence, to commence the demerger process, an application must be filed in the prescribed form along with the affidavits of the promoters and the following documents:

• Memorandum and Articles of Association of the Company
• Latest Audited Balance Sheets
• List of Shareholders and Creditors
• Extract of Board Resolution approving the Scheme
• Scheme of Arrangement
• Draft notice of Meeting, Explanatory Statements, and replacement or substitute

Issue of Notice

A notice must be sent to the interested parties by the authorized individuals, 21 days before the date of the meeting along with the proposed scheme of arrangement and proxy forms. This notice would be publicized in specified Form through newspapers that are well circulated among the interested parties.

Holding of Meeting

A meeting should be held according to the guidelines of the tribunal and the output of such meetings should be recorded along with votes in support of or against the motion. The chairperson of the meeting must submit a report in Form 39 within the time approved by the tribunal.

Petition and Sanction of the Tribunal

A petition has to be submitted to the tribunal for authorizing the demerger. It has to be sanctioned by three-fourths of members/creditors to file an appeal. Once the tribunal hears the objections, it verifies the applicability of the scheme submitted and later issues an order. The tribunal would then pass an order approving the demerger in the same newspaper in which the notice of the meeting was advertised.

Key steps to be followed for demerger of a company

Step-1 Preparation of Scheme of Arrangements

Preparation of scheme of arrangement along with the disclosures such as material facts relating to the company, the latest financial position of the company, pendency of any investigation or proceedings against the company, transfer of employees, liabilities, and assets, share swap ratio, if applicable. Further, the scheme of arrangement shall also be adopted by the Directors of the company.

Step-2 Filing application with NCLT

Scheme of arrangement along with other necessary documents and demerger application is filed with NCLT.

Step-3 Directions issued by NCLT

The NCLT shall provide directions to the company to convene a meeting of shareholders and creditors of the demerged and resultant company.

The company shall send individual notice and explanatory statement in form CAA-2 as per the requisite procedure.

The Company shall further publish the advertisement notice for the meetings at least 30 days before the date fixed for the meeting.

Step-4 Notice to Statutory Authorities

The company shall send the notice in form CAA-3 to the sectoral regulators/statutory authorities as directed by the NCLT and representations from such sectoral regulators/statutory authorities shall be invited within 30 days from the date of notice.

Step-5 Filing of affidavits before NCLT

The Chairman of the meeting shall file an affidavit before the NCLT within 7 days before the date fixed for the meeting stating all requirements have been complied with

Step-6 Convening meeting of members/creditors to obtain their consent

The Company convene meeting of members/creditors within 1 month from the date of receipt of the notice. The scheme of arrangement requires sanction from the majority of persons representing the ¾th value of creditors/ members. Report of such meetings shall be filed in CAA-4 to NCLT within 3 days after the conclusion of meeting.

Step-7 Petition to NCLT

After obtaining members/creditors consent and representation from statutory authorities, the company shall file a petition conforming arrangement in form CAA-5 within 7 days of filing the report by the Chairman.

Step-8 Hearing before NCLT and Order of Demerger

NCLT shall fix the date for the hearing of the petition and the notice of hearing shall be advertised in the same newspaper in which the notice of the meeting was advertised. Then the NCLT may pass the order for demerger.

The company shall obtain a certified copy of the order and file the same to ROC in form CAA-7 within 30 days of the date of receipt of the order.

Step-9 Annual Statement

The company shall file a statement certified by the chartered accountant,  cost accountant, or company secretary with the ROC every year in form CAA 8 within 210 days from the end of each financial year until the scheme is fully implemented, indicating whether the scheme is compiled as per the order of NCLT or not.

Tax Benefits of Demerger

Under section 47(vib) of the Income Tax Act, 1961, a demerger involving transfer of capital assets by the demerged company to the resulting company (Indian Company), will not attract levy of capital gain tax.

Similarly, under section 47(vid) of the Income Tax Act, 1961 if there is an issue or transfer of shares by the resulting company in consideration of the demerger of the said undertaking(s), to the shareholders of the demerged company, the transaction will not be amenable to capital gains tax.

We can address your concerns related to Demerger of a Company. You can get in touch with us by submitting a query below.