Until 2015, demergers were a popular form of divestment, where the business would be transferred under a court approved scheme as a going concern to the acquirer. Despite the fact that a typical scheme would take between nine to 10 months to be approved by a high court and would require consents from each class of creditor and shareholder of the company the ability to bind minority creditors and shareholders, transfer all licenses, approvals and permits through the sanction of the scheme brought certainty to parties.
As the entire business would stand vested in the acquirer by operation of law, other than stamp duty payable on the scheme, the costs associated with implementing the demerger were lower than contractual arrangements. Regulators also preferred demergers as they had the authority of the courts.
Since the jurisdiction for schemes was transferred to the National Company Law Tribunal and the Insolvency & Bankruptcy Code, 2016, was notified adhering to the strict timelines of the code has meant the case load of the already short-staffed tribunal has prioritized insolvency proceedings over demerger schemes. Almost overnight, a scheme that previously took nine to 10 months now started taking 15-18 months. Facing uncertainty on timelines, parties have reverted to opting for slump sales or business transfers or withdrawing schemes filed earlier. But does this necessarily spell the demise of demergers?
Weighing the pros and cons of a demerger scheme and a slump sale, parties need to balance the key objectives and challenges of the transaction. Where timing is paramount, parties are opting for slump sales that require fewer approvals and can be implemented within a matter of a few months.
However, companies in highly licensed or regulated industries prefer the demerger route to aid with transferring the business licenses to the transferee. Costs and tax treatment also determine whether parties opt for a slump sale or a scheme. A slump sale may be cost effective in an asset light company or a demerger may be beneficial being tax neutral and allowing carry forward of losses. Each route brings with it its own risks and challenges and one cannot rule out either demerger or slump sales.
In negotiating slump sales, the characterization of the business as an undertaking and excluding certain assets or liabilities is a matter of much deliberation. For it to be a slump sale, the undertaking being transferred must include all its assets, liabilities and employees essential to constitute a business as a going concern on a standalone basis.
Leaving assets or liabilities behind can result in characterization of the sale as an itemized asset sale instead of a slump sale, making it liable to Goods and Services Tax (GST) and higher capital gains tax. Tinkering with what constitutes an undertaking in a slump sale also poses challenges when negotiating the risk allocation between the parties for aspects of the business which are not being sold. Comparatively, a demerger is tax-neutral from a capital gains and GST perspective, subject to it meeting the condition of section 2(19AA) of the Income Tax Act, 1961, and permits the carrying forward of losses of the demerged business. From a taxation perspective, a court approved demerger scheme is beneficial compared to a slump sale.
Costs associated with a demerger include stamp duty on the sanction order. Different states have followed different methods for the levy of stamp duty on sanction orders. Some states treat the sanction order as a conveyance with applicable stamp duty being imposed on the shares issued pursuant to the scheme or the value of real estate in the state transferred pursuant to the scheme, while others do not stamp sanction orders at all or cap the fees.
Slump sale agreements on the other hand are stamped as agreements and every asset to be conveyed under the slump sale is treated individually with stamp payable on the instrument for its conveyance. In cases where land is required to be transferred pursuant to the slump sale, this can result in higher transaction costs as compared to a demerger scheme.
The government has announced the creation of more benches of the tribunal and filling of vacancies in the near term. This should result in a reduction of the case load of the tribunal, expediting demergers and making it an attractive route again. However, given the variables in determining the most commercially feasible transaction structure, both demergers and slump sales will be around for a long time to come.
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