SEBI ISSUES GUIDELINES FOR MERGERS BETWEEN LISTED AND UNLISTED COMPANIES

Listed companies which propose to enter into a Scheme of Arrangement such as Mergers, Amalgamations and Demergers under the Companies Act, require prior approval from SEBI and the Stock Exchanges on which the securities of the concerned company are listed under the SEBI (Listing and Obligations and Disclosure Requirements) Regulations 2015 ("LODR Regulations").

Under the LODR Regulations, the listed company shall ensure that the Scheme of Arrangement does not violate the Securities Laws or the requirements of the Stock Exchange. The Stock Exchanges review the Scheme of Arrangement filed with it by the listed company, and thereafter, issue a No-Objection Letter or Observation Letter approving the Scheme of Arrangement, after incorporating the comments from SEBI in respect of the same.

However, in order to avoid the formalities attached to fresh listing of securities of a company, unlisted companies amalgamate with a listed company to dodge the disclosure requirements and the time consuming process of an Initial Public Offering (IPO). Therefore, SEBI has, in its recent Press Release, proposed additional conditions to be followed for the scheme of arrangement s between listed and unlisted companies to prevent backdoor listing by unlisted companies through mergers with listed companies.

SEBI has proposed the following measures:

• In case of merger of an unlisted company with a listed company, the unlisted company shall comply with the requirement of disclosure of material information as specified in the format for abridged prospectus. This is to ensure that the unlisted company makes full and proper disclosures as is required under an IPO.
• The pre-scheme public shareholders of the listed company and the Qualified Institutional Buyers (QIBs) of the unlisted company, shall, together, hold not less than 25% of the total shareholding in the merged company. The objective is to have wider public shareholding and to prevent very large unlisted company to get listed by merging with a very small company.
• The unlisted company can be merged with a listed company if it is listed on a stock exchange having nationwide trading terminals.
• The pricing of the shares issued shall be as per the pricing formula specified under the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 (“ICDR Regulations”). This is to prevent issue of shares to select group of shareholders instead of all shareholders pursuant to the scheme.
• To ensure larger participation of public shareholders, their approval through e-voting is required in the following cases:
  • When the merger of an unlisted company with a listed company results in reduction of the shareholding of the pre-scheme public shareholders of the listed company to less than 5% of the merged company.
  • When the scheme of arrangement involves transfer of whole or substantially the whole of the undertaking of a listed company and consideration for such transfer is not in the form of listed equity shares.
  • When the scheme of arrangement involves merger of unlisted subsidiary with listed holding company where the shares of the unlisted subsidiary have been acquired by the holding company directly or indirectly from the promoters/promoter group.
• Companies would be required to submit compliance report confirming compliance with the circular and Accounting Standards duly certified by Company Secretary, CFO and Managing Director.
• With a view to simplify the process, schemes which provide for merger of a Wholly owned Subsidiary (WoS) with the parent company shall not be required to be filed with SEBI. Such schemes shall be filed with stock exchanges for the limited purpose of disclosures only.

MHCO COMMENT:

The aforesaid guidelines issued by SEBI are a positive step towards minimizing back door listing by unlisted companies. The stringent disclosure requirements by unlisted companies shall help to protect the interests of the public shareholders and strict adherence to the pricing guidelines prescribed under ICDR Regulations, shall ensure that the valuation and pricing of shares is not skewed in favour of the unlisted company.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.

ISSUANCE OF CONVERTIBLE NOTES IN STARTUPS PERMITTED

Vide a notification dated 10 January 2017, the Reserve Bank of India (RBI), has amended the Foreign Exchange Management (Transfer or issue of Security by a Person Resident outside India) Regulations, 2000 (FEMA 20/2000), implementing a key change in the foreign exchange policy by allowing startup companies to issue convertible notes to foreign investors.

A convertible note is an instrument given as a debt and convertible to equity at the option of the holder, upon a future contingency taking place, usually when start-ups get an additional round of investments. Therefore convertible notes allow investors to invest in start-ups without worrying about their valuations which are difficult to determine at inception, as convertible notes are merely an instrument advanced as a loan, and converted to equity at a later stage, when the startup is better established.

Following are the salient features of the Notification:

Definition of convertible note: The notification defines a convertible note as an instrument issued by a startup company evidencing receipt of money initially as debt, which is repayable at the option of the holder, or which is convertible into such number of equity shares of such startup company, within a period not exceeding 5 years from the date of issue of the convertible note, upon occurrence of specified events as per the other terms and conditions agreed to and indicated in the instrument.

The notification however, is applicable only to companies defined as start-ups, in the applicable government circular, which defines an entity as a startup, if 5 years have not elapsed from the date of its incorporation, its turnover for any of those years does not exceed Rs 25 crores and it is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property. Therefore entities which fall outside this definition shall be unable to avail of the benefits of this notification.

Persons eligible to purchase convertible notes: A person resident outside India (other than an individual who is citizen of Pakistan or Bangladesh or an entity which is registered / incorporated in Pakistan or Bangladesh), may purchase convertible notes issued by an Indian startup company for an amount of Rs 25 lacs or more in a single tranche. A person resident outside India may acquire or transfer, by way of sale, convertible notes, from or to, a person resident in or outside India, provided the transfer takes place in accordance with the pricing guidelines as prescribed by RBI. However, a startup company engaged in a sector where foreign investment requires Government approval may issue convertible notes to a non-resident only with approval of the Government. NRIs may acquire convertible notes on non-repatriation basis in accordance with the applicable FEMA Regulations.

Other formalities: A startup company issuing convertible notes to a person resident outside India shall receive the amount of consideration by inward remittance through banking channels or by debit to NRE / FCNR (B) / Escrow account maintained by the person concerned in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016, as amended from time to time.

The startup company issuing convertible notes shall be required to furnish reports as prescribed by Reserve Bank.

MHCO COMMENT:

The notification is an encouraging step towards promoting a conducive environment for start-ups in the country and shall be instrumental in boosting both investor sentiment and promoting entrepreneurship in the country.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.

TESTAMENTARY DISPOSITIONS OVERRULE NOMINATIONS UNDER THE COMPANIES ACT

The Bombay High Court has in the recent judgement of Shakti Yezdani And Anr vs Jayanand Jayant Salgonkar ("Yezdani" ) clarified the contentious question regarding legal rights of nominees with respect to shares by holding that nominations with respect to shares of a company, do not overrule testamentary dispositions with respect thereof and a mere nomination does not confer beneficial ownership to the nominee.

The question of a nominee's ownership rights, first arose before the Court, in 2010 in the case of Harsha Nitin Kokate v. Saraswat Co-operative Bank Limited (2010 ( 112 ) BOMLR 2014) ("Kokate") wherein after a judicial analysis of Sections 109A and 109B of the Companies Act, 1956 (which deal with nomination), it was held that a nominee is entitled to the beneficial ownership of the shares or securities which are the subject matter of nomination to the exclusion of all other persons who are entitled to inherit the estate of the holder, according to applicable succession laws.

However, this view was overruled in the case of Jayanand Jayant Salgaonkar vs. Jayshree Jayant Salgaonkar ("Salgaonkar" ) in 2015, where it was held that legal heirs and not nominees are entitled to beneficial ownership of the shares and securities of a company. In that case, late Jayant Shivram Salgaonkar expired, leaving behind shares in several companies. However, there were discrepancies between the bequests of the said shares in his will and persons appointed as nominees of the same, thereby leading to a dispute with regards to their ownership.

One of the Defendants in Salgaonkar preferred an appeal to the division bench against the said decision, thereby leading to the present case. The division bench considered a slew of judgements in Yezdani, put forth by both parties, including the recent judgement of Indrani Wahi vs. Registrar of Co-operative Societies, pronounced by the apex court, wherein it was held that a nominee of shares in a co-operative society is a mere trustee for the legal heirs of the member and nomination by itself does not have any relevance to the issue of title between the inheritors or successors to the property of the Deceased. The Court also considered a number of judgements dealing with statutes that contain similar provisions for nomination. While upholding the view pronounced in Salgaonkar and denouncing the stance taken by the Kotate judgement, the Court held that

"Considering the consistent view taken by the Apex Court while interpreting the provisions relating to nominations under various Statutes, there is no reason to make a departure from the consistent view. The provisions of the Companies Act including Sections 109A and 109B, in the light of the object of the said Enactment, do not warrant any such departure. The so called vesting under Section 109A does not create a third mode of succession. It is not intended to create a third mode of succession. The Companies Act has nothing to do with the law of succession...Hence, the view taken in Kokate's case is not correct."

MHCO COMMENTS:

Even though this decision appears inconsistent with the wordings of Section 109A and 109B of the Companies Act, 1956 (which is identical to the corresponding Section 72 of the Companies Act, 2013), it goes a long way in clearing up the confusion on the legal rights of nominees. Accordingly, this decision constitutes a binding precedent for future cases as well, unless set aside by the apex court.

The views expressed in this update are personal and should not be construed as any legal advice.
Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.