Contract mergers: Aiding corporate efficiency

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n India, the process of mergers is court driven. While the process may be initiated through common agreements or a “scheme” between amalgamating parties, the legal cover is provided only upon the sanction of such an agreement by the relevant high courts in accordance with the Companies Act, 1956. Under Indian law, approval by at least 75% of shareholders and creditors is required.

The entire process of a merger as envisaged under Indian law is lengthy and ridden with complexities. High courts have wide discretionary powers, to either accept, modify or reject a scheme, and can even order the winding-up of a company if the merger is considered an unsuccessful proposal.

Before granting or rejecting a scheme, courts consider a number of factors such as, prejudice caused to shareholders and creditors, reasonableness and justness of the scheme, and the interest of the employees. Obviously, such scrutiny brings with it inordinate delays and introduces an element of unpredictability in what is essentially a business decision. While the supervisory role of a judicial body cannot be eliminated altogether, it may be more desirable to limit this role.

An alternative methodology suggested by the JJ Irani committee report was“contractual mergers”, a process where the amalgamating companies enter into a contract and conclude a deal without any prior judicial scrutiny. Mergers by contract obviate the need for court sanctions and meet the requirements of expediency. In this context a parallel is found in section 77A of the Companies Actwhich recognizes action by a company’s board or the company itself, deciding on the capital, without court intervention.

Contractual mergers are globally accepted and successfully employed in various jurisdictions such as New Zealand, Delaware and Canada.

The law on contractual mergers in New Zealand prescribes two modes for mergers; the short-form – for the amalgamation of group companies – and the long-form – for all other companies. Under the short-form method, an agreement is approved by the board of directors of the merging companies, who also certify that the merged company will satisfy the “solvency test”.

A written notification is given to the secured creditors of the companies 20 days prior to the filing of the merger proposal. The merger becomes effective once the contract is filed with the registrar.

The long-form method entails a similar process and requires in addition, the offer of a public notice. The amalgamation proposal is then approved by the shareholders of each company through a special resolution.

Proposals can be set aside or modified by a court on an application made(by the requisite minority) before the date on which the merger becomes effective. A majority of merger agreements provide a “compulsory buyout right” with respect to minority shareholders who vote against it. The use of either method is found to be more efficient, just as secure and far less time-consuming when compared to the Indian model.

Mergers in Delaware usually take the form of statutorily recognized contractual mergers. These mergers do not require the prior approval or supervision of the court. Interested companies enter into a contract of merger, subject to the prior approval of the scheme by the board of each of the companies and the subsequent approval by the simple majority of their shareholders.

However, the requirement of shareholder approval has been dispensed with in certain cases, such as where the merger agreement does not amend the certificate of incorporation of the constituent corporation, or if each share of the constituent corporation is identical to that of the resulting or surviving corporation. After obtaining shareholder approval, the contract is filed with the relevant authority and becomes effective, thereby eliminating the intermediate stage of obtaining court approval for the purposes of enforcement. The procedure is further simplified for mergers between a holding and its subsidiary company.

The Companies Act should be amended to provide statutory recognition to contractual mergers which would bring speed and vibrancy to the corporate environment in India. Based on the New Zealand model, short-form mergers may be prescribed for group companies and long-form for non-group companies. Revisions should ensure that contracts are approved by the company board for all mergers, which should also certify that the amalgamated company will satisfy the solvency test.

For mergers between group companies, a notice would have to be provided to all shareholders and creditors. In all other cases, shareholders must be sent an exhaustive disclosure statement and report of the details of the merger, the secured creditors should receive a copy of the proposal and a public notice of the amalgamation must be given. The right to get the contract of merger set aside or modified should also be prescribed for shareholders or secured creditors, on the condition that their dissent was recorded at the meeting called to consider the amalgamation.

This would hasten the merger process, removing the unnecessary time delay tactics of minority shareholders who abuse the process of the Indian courts, in matters that are essentially commercial and need final approval expeditiously.

Shardul Shroff is the managing partner of Amarchand & Mangaldas & Suresh A Shroff & Co, where he specializes in mergers and acquisitions.