FOREIGN EXCHANGE MANAGEMENT ACT, 1999
Considering M&A transactions, FEMA regulations provide guidelines and conditions on issuance of shares or securities by an Indian entity to a person residing outside India or any transfer of security from or to such person.
Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000 deals with issue and acquisition of shares after merger or de-merger or of Indian companies.
The Department of Industrial Policy & Promotion issues detailed guidelines on foreign investment in India vide “Foreign Direct Investment Policy”.
Cross Border Merger/Demerger
Cross border merger involves merger, amalgamation or arrangement between an Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 notified under the Companies Act, 2013. A cross border merger is combination of two or more companies belonging to or registered in different countries. It is regulated by the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 notified under the FEMA on 20th March 2018.
A foreign company incorporated outside India may merge with an Indian company after obtaining prior approval of Reserve Bank of India and after complying with the provisions of sections 230 to 232 of the Companies Act 2013 and Companies (Compromises, Arrangements and Amalgamation) Rules, 2016.
There are two ways of cross border Merger
- Foreign Company Mergers into Indian Company (Inbound Merger)
- Indian Company mergers into Foreign Company (Outbound Merger)
The Cross Border Regulations state that compensation by the resultant company, to a holder of a security of the Indian company or the foreign company, as the case may be, may be paid, in accordance with the Scheme sanctioned by the NCLT. Section 234 of the Companies Act specifies the payment of consideration to be paid to the shareholders of the merging company in cash, or in Depository Receipts, or partly in cash and partly in Depository Receipts, as the case may be, as per the scheme to be drawn up for the purpose
A cross border merger involves transfer of asset by one company to another; therefore, it require to comply with exchange control regulation of each country which may not otherwise permits cross border transfer of assets or may permit, subject to specific regulatory approvals.
FEMA inter alia governs transactions between residents and non-residents wherein either of their assets and liabilities have an impact.
The valuation of the Indian company and the foreign company is to be done in accordance with Rule 25A of the Companies (Compromises, Arrangement or Amalgamation) Rules, 2016. Rule 25A of the said rules states that the transferee company shall ensure that valuation is conducted by, valuers who are members of a recognised professional body in the jurisdiction of the transferee company and further that such valuation is in accordance with internationally accepted principles on accounting and valuation. A declaration to this effect shall be attached with the application made to Reserve Bank of India for obtaining its approval.
Foreign Company merges into Indian Company
Pursuant to merger of a foreign company with Indian company, shareholders in foreign company, which may include residents as well as non- residents will become the shareholders of Indian Company. Mergers of companies in India shall be governed by the National Company Law Tribunal with appropriate jurisdiction. Once the scheme of merger of two or more companies has been approved by the NCLT, the resulting company allowed to issue shares to the shareholders of the transferor company resident outside India. Further assets and liabilities of the Foreign Company will become the assets and liabilities of the Indian Company.
- Issue/Transfer of securities to persons resident outside India: - The Regulations state that in order to transfer securities to persons resident outside India the pricing guidelines, entry routes, sectoral caps, attendant conditions and reporting requirements for foreign investment as laid down in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 have to be adhered to. Further, transactions with respect to a Joint Venture Foreign company or a Wholly Owned Subsidiary(WOS) or Acquisition of a Step down Subsidiary of the WOS of the Resulting company shall be governed by the Foreign Exchange Management (Transfer or issue of any foreign security) Regulations, 2004.
- No Prior Approval: if the percentage of shareholding of persons resident outside India in the transferee does not exceed the percentage specified in the approval granted by the Central Government or the Reserve Bank.
- Prior Approval: if the percentage is likely to exceed the percentage specified in the approval or the Regulations, the transferee has to obtain an approval from the Central Government (FIPB)/ Reserve Bank.
- Outside India Office of the Foreign Company: - Pursuant to the sanction of the scheme by the NCLT, the office of the Foreign Company(s) outside India shall be deemed to be the branch office of the resulting company outside India and it shall be permitted to undertake any transaction for the Branch office as allowed by the Foreign Exchange Management (Foreign Currency Account by a person resident in India) Regulations, 2015.
- Guarantees or Outstanding Borrowings of the Foreign Company: - The guarantees or outstanding borrowings of the foreign company now getting transferred in the name of the resulting company shall have to conform within a period of two years with the External Commercial Borrowings/Trade Credit or other foreign borrowing norms as laid down under Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 or Foreign Exchange Management (Borrowing or Lending in Rupees) Regulations, 2000 or Foreign Exchange Management (Guarantee) Regulations, 2000 except the conditions with respect to end use of funds. The repayment of such liabilities shall not be allowed within this period of two years.
- Assets/Securities/Liabilities to be acquired outside India: - If the Indian resulting company is permitted to acquire assets/liabilities outside India by the Foreign Exchange Management Act, 1999, it can transfer the same in any manner for undertaking transactions permitted under the Act and if such assets are not permitted to be acquired/held or any liabilities are there not permitted to be acquired /held, such assets shall be sold within two years and the proceeds shall be transferred immediately to India through banking channels, or; such liabilities can be paid off directly from such proceeds within a period of two years.
- Opening of a temporary bank account: - The resultant company may open a bank account in foreign currency in the overseas jurisdiction required for transacting incidental to the cross-border merger for a maximum period of two years from the date of sanction of scheme.
Where the Indian company is operating in sector where FDI Policy has prescribed any sectorial cap or conditionally, the merger will be subject to compliance with such conditions.
- The transferee company and transferor company are not engaged in activities which are prohibited under the foreign direct Investment Policy (viz. agriculture, plantation, real estate business and trading in transferable development rights).
- No allotment to shareholders, where FEMA prohibits allotment of shares in Indian to residents of certain countries.
Indian Company merges into Foreign Company
Indian Companies can merge with Foreign Companies which are incorporated in jurisdiction mentioned in the Annexure B to Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 after obtaining the prior approval of the Reserve Bank of India.
Pursuant to merger of an Indian company with Foreign Company, shareholders in Indian Company, which may include residents as well as non- residents will become the shareholders of Foreign Company.
Foreign Company may with prior approval of the RBI merge with Indian company or vice versa and terms and condition of scheme of merger may provide among the other thing for the payment of consideration to shareholders of the merging company in cash or in Depository Receipts. And the Indian shareholders should be permitted to receive Indian Depository Receipts (IDR) in lieu of Indian shares especially in listed companies or foreign securities in lieu of Indian shares so that they become members of the foreign company or holders of security with a trading right in India (especially in listed companies).
- Acquisition of securities by residents outside India: - Resident individuals can acquire or hold securities of the resulting foreign company pursuant to the compliance with the Foreign Exchange Management (Transfer or issue of any Foreign Security) Regulations, 2004 and provided that the fair market value of such securities is within the prescribed limits under the Liberalized Remittance Scheme laid down in the Act or rules or regulations framed thereunder.
- Office of the Indian Company: - Pursuant to the sanction of the scheme by the NCLT, the office of the Indian Company shall be deemed to be the branch office of the resulting company and it shall be permitted to undertake any transaction for the Branch office in accordance with Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016.
- Guarantees or Outstanding Borrowings of the Foreign Company: - The guarantees or outstanding borrowings of the Indian company now getting transferred in the name of the resulting company shall be repaid as per the Scheme sanctioned by the NCLT in terms of the Companies (Compromises, Arrangement or Amalgamation) Rules, 2016 but it shall not acquire such liability to be paid to the lender in rupees, which is not in conformity with the Act or rules or regulations made thereunder. A no-objection certificate to this effect should be obtained from the lenders in India of the Indian company
- Assets/Securities/Liabilities to be acquired by the Resulting company: - If the resulting company is permitted to acquire assets/liabilities in India by the ‘Act’, it can transfer the same in any manner for undertaking transactions permitted under the Act and if such assets are not permitted to be acquired/held or any liabilities are there not permitted to be acquired /held, such assets shall be sold within two years and the proceeds shall be repatriated immediately outside India through banking channels, or; such liabilities can be paid off directly from such proceeds within a period of two years.
- Opening of a temporary bank account: - The resulting company may open a Special Non-Resident Rupee Account (SNRR Account) in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016 for the purpose of putting through transactions under these Regulations for a maximum period of two years from the date of sanction of scheme.
The companies involved in the cross border merger shall ensure that regulatory actions, if any, prior to merger, with respect to non-compliance, contravention, violation, as the case may be, of the Act or the Rules or the Regulations framed thereunder shall be completed.
The resultant company and/or the companies involved in the cross border merger shall be required to furnish reports as may be prescribed by the Reserve Bank, in consultation with the Government of India, from time to time.
Role of the Reserve Bank in the approval: Onerous condition
Sub-section (2) of Section 234 of the Companies Act, 2013 requires a prior Reserve Bank approval in the cross-border mergers. This is unusual and should be left to the wisdom of the authorities managing Foreign Exchange Management Act, 1999 and its Regulations, prescribing the exchange control laws in India. It should be noticed, that even under the current framework, Regulation 7 of the FEMA (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (‘FEMA 20’) mere reporting to the Reserve Bank by the transferee or the new company within the 30 days period in the manner prescribed is the general norm to be followed. Only respite is, that sub-section (2) is ‘subject to any other law for time being in force’. Thus, Regulation 7 of FEMA 20 should override the prior approval requirements. A corresponding overriding provision will have to be introduced in the FEMA (Transfer or Issue of any Foreign Security) Regulations, 2004 (‘FEMA 120’) for the benefit of cross border mergers involving a foreign transferee company. In Rule 25A of the (Compromises, Arrangement or Amalgamation) Rules, 2016 it is also clarified that no amendment shall be made in this rule without consultation of the Reserve Bank of India.