Demerger under Company Law
“Demerger” can be defined as split or division of a company into more number of companies. The new companies, the transferees, need not be the subsidiaries of the parent companies undergone such split or division. The New Oxford Dictionary defines the term “demerger” as “the separation of a larger company into two or more smaller organizations.”
Justice NV Balasubramanam observed that a Scheme of demerger is in fact 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. The term ‘demerger’ has not been defined in the Companies Act, 1956. The concept of ‘demerger’ may, however, be deduced from:
(a) The expression, “arrangement” include “a reorganization of share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or by both those methods”;
(b) Sale, lease or otherwise disposal of the whole or the substantially whole of the undertaking or where the company owns more than one undertaking of the whole or substantially whole of any such undertaking;
(c) The scheme of compromise, arrangement or reconstruction under section 391/394 of the Companies Act, 1956.
“Demerger” has been defined under sub-sections (19AA) of section 2 of the Income Tax Act, 1961. The concept of demerger under the Income Tax Act 1961 is identical to that under section 293(1) (a) of the Companies Act, 1956. However, it must satisfy the requirements of section 391 and 394 of the Companies Act, 1956.
Reasons for demergers
Demerger is undertaken basically for two reasons. The first one as an exercise in corporate restructuring and the second one is to give effect to a kind of family partitions in the case of family owned/controlled companies essentially to give effect to informal family partitions.
Where demerger is an exercise of corporate restructuring the undertaking sought to be demerged is transferred from a transferor company to an existing transferee company. But where demerger is an exercise in family partition the different ‘undertakings’ of a company is transferred to a newly incorporated transferee companies to facilitate family partitions.
In a scheme of arrangement two groups in a family shall be allotted specific assets to their respective transferee companies from the parent transferor company where they are shareholders. Ordinarily all the shareholders of the transferor company receive shares in one or the other of the two transferee companies. As this mode of effecting transfer is not objected to by the Central Government and no provision of law which it can be said to violate has been brought to the notice of the Court it can be sanctioned. After the distribution of the assets in the manner provided in the scheme, no assets will be left with the transferor company and it is therefore sought to be dissolved, the same forming part of the scheme.
Demerger v. Reconstruction
Companies Act, 1956 does not define ‘demerger’ but covers ‘reconstruction’. The difference between these two terms lies only when a scheme of arrangement is framed for obtaining sanction of the court. Demerger definitely forms part of the scheme of arrangement or compromise. In addition, demerger, is most likely to attract the other provisions of the Companies Act, 1956 envisaging reduction of share capital comprising sections. The company is required to pass special resolution which is subject to confirmation by the court by making an application under section 101 of the Companies Act, 1956. It is necessary that the Articles of Association of the company should have a provision of reduction of its share capital in any way and its Memorandum should provide for demerger, division or split of the company in any way. Demerger, thus, resulting into reduction of company’s share capital would also require the company to amend its Memorandum of Association. Reduction would in share capital occur with transfer of assets or repayments to departing faction or group of members of the promoters of the company. Section 390(b) of the Companies Act, 1956 interprets arrangement appearing in section 391 or 393 of the Companies Act, 1956 and covers the ‘division’ under the expression “arrangement”.
Modes of Demerger
Demerger May Be Partial Or Complete.
Partial demerger results when a part/department/division of company is separated and transferred to one or more new company/companies formed with the same shareholders allotted shares in new company in same proportion as held by them in the demerged company. Complete demerger results when the whole of the business/undertaking of the existing company is transferred to one or more new company/companies formed for the purpose and the demerged company is dissolved by passing special resolution by its shareholders. Such company is wound up voluntarily and disappears. The shareholders of the dissolved company are issued and allotted shares in the new company/Companies as per the share exchange ratio sanctioned under the demerged scheme.
Demerger could be affected by either of the three ways, viz.
(i) Demerger by agreement between promoters; or
(ii) Demerger under the scheme of arrangement with approval by the court under section 391 of the Companies Act, 1956;
(iii) Demerger under voluntary winding up and the power of liquidator.
Demerger By Agreement
English Law is quite exhaustive on the issue of ‘demerger’. While ‘demerger’ is affected by agreement and original company is wound up after division, it was held in Cardiff Preserved Coal and Coke Co v. Norton that the liquidator cannot dispute the validity of the transaction and therefore cannot require its shareholders to transfer to him the shares which have been allotted in the new company or companies so that he may sell them and use the proceeds to pay the original company’s debt.
Further, the English law supports that in such events where the creditor accepts an undertaking from the purchasing company to honour the original company’s obligation, or if he accepts a benefit from the purchasing company to which he is not entitled under his contract with the original company, there will be a novation and the original company’s liability will be discharged. Section 395 of the Companies Act, 1956 would be available to protect the interest of the shareholders dissenting from scheme or contract approved by majority even in the cases of demergers or divisions.
Demerger Under Scheme Of ArrangementOn the basis of the powers a company has in its Memorandum, it can carry out division or split of its entity in the same manner as it could accomplish amalgamation through a scheme of arrangement under the provisions of the Companies Act, 1956. The procedure laid down in Chapter-V under the Companies Act, 1956 regarding Arbitration, Compromises, Arrangements and Reconstruction would be followed in the case of division of the company.
Indian Law is silent on the issue of powers of the Court to pass ancillary orders in respect of demergers or division but English Law provides a deeper insight into the matter signifying that the Court has no powers under Section 425 of the UK’s Companies Act, 1985 while approving the scheme of arrangement for demerger or division which otherwise can be used in the case of amalgamation or merger.
Demerger Under Voluntary Winding UpThe original company which has split into several companies after division could be wound up voluntarily pursuant to the provisions of Sections 484 to 498 of the Companies Act, 1956.
Sub-Divisions Of Company
A sub-division in the form of bifurcation or trifurcation, as the case may be, can be affected by adopting the following modes:
By way of a scheme of Arrangement under sections 391-394 of the Companies act, 195
By transfer of business divisions of the company as ongoing business under section 395 of the Companies Act, 1956.
1.] Transfer By Scheme Of Arrangement/ Provisions of sections 391 to 394 are not Applicable to demerger of Foreign Companies: It can be drawn under sections 391-394 of the Companies Act, 1956, under which the company may contemplate to transfer two of its divisions to the other two new entities, which may or may not be its wholly owned subsidiaries. The scheme shall provide all the terms and conditions and mode of transfer of assets and liabilities of the respective divisions to the new entities and the method of allotment of shares to the shareholders. The share capital of the company may also be split into respective companies on the basis of net assets transferred to the respective companies.
2.] Transfer Under Section 395 of the Companies Act, 1956: It enables a company to transfer the whole of its undertaking to another company by as scheme or contract involving offer by the transferee company to purchase shares of the transferor company, when all or statutory majority of shareholders of the transferor company agree to such a scheme or contract. Thus, this process does not require any application to be made to the court either by the transferor company or by the transferee company, as required under section 391 of the Companies Act, 1956 for carrying out the Scheme.
Demerger/Hiving off/Spin off: Importance of the Appointed Date
Appointed date means the date for identification of assets and liabilities of existing company for transfer to new company. The ‘appointed date’ has been taken for identification and quantification of the assets and liabilities of the existing company and new company consequent upon proposed spin off. This identification is done on the basis of the audited balance sheet of the existing company for the financial year.
In the case of HCL LTd., In re and HCL Hewlett-Packard Ltd., In re, the Central Government had raised the objection in approving of the scheme for arrangement for spin-off the company’s division with new company that the “appointed date” under the scheme for transfer of division was falling prior to incorporation of new company. The court over ruled the objection by distinguishing the “appointed date” from “effective date”. The appointed date is relevant for fixation of the share valuation/ share exchange rate which the company would offer to the existing shareholders after bifurcation and spinning of the divisions.
Hiving-Off/ Demerger Through Sale Under Section 293(1)(A) of Companies Act, 1956
Popularly known as hiving off, this is, in the Company Law Terminology, either
a ‘sale’ or ‘disposal’ of the whole or substantially the whole of the undertaking, or
An ‘arrangement, compromise and reconstruction’.
The former is governed by section 293(1) (a) of the Companies Act, 1956 and the latter falls within the ambit of sections 391/394 of the Companies Act, 1956. the former requires approval of the shareholders of the concerned company by an ordinary resolution, while the latter calls for the shareholders’, the creditors’ and the High Court’s approval. A straightforward hiving-off of any business of the company, for a lump-sum price, is mostly routed through section 293(1) (a) of the Companies Act, 1956, which is an enabling provision. It facilitates sale of business, which the section calls, ‘the whole or substantially the whole undertaking or one or more undertakings’. By resorting to the mechanism provided in this section, any company can sell the whole of its business or any one of its businesses as a going concern. The business to be hived-off is intended to become transferred from the main body of a commercial or industrial enterprise through the agency of new ownership.
In the hiving-off, the business or the undertaking is sold and transferred by the company to the buyer at a pre-determined price, under an agreement between the seller and the buyer. This agreement is usually called ‘Business Transfer or Assignment Agreement’. The various properties and assets and their values are not individually identified and determined. The price is a lump-sum or a ‘slump-price’. Although it comprises, inter alia, current assets or movables, the values of individual assets are not identified and stated in the agreement.
The agreement inter alia covers the following issues/ points-
Assignment of business and consideration to be paid.
Further assurances in respect of other documentation, assets and liabilities, etc.
Representation and warranties to be given by the seller.
Representations and warranties to be given by the buyer.
The provision in section 293 of the Companies Act, 1956 applies only to public companies and private companies which are subsidiaries of public companies. It is not applicable to a private company which is not a subsidiary of a public company.
This provision also applies to a company holding a license under section 25 of the Companies Act, 1956. This provision does not apply to the sale of shares in a company which owns an undertaking. When a shareholder sells his shares, the undertaking continues to remain with the company which has its own independent entity. Where the main business of company was not investing in shares, sale of shares held by it would not amount to sale of undertaking attracting section 293(1) (a) of the Companies Act, 1956.
The shareholders may give conditional consent. The shareholders may impose any conditions, except any condition, which would result in the reduction of the company’s share capital unless the provisions of the Act pertaining to the reduction of capital are complied with. The conditions may include, but not be limited to, regarding the use, disposal or investment of the sale proceeds which may result from the transaction of the sale, lease or disposal of the whole, or substantially the whole, of an undertaking of the company. This power is exercisable with the prior consent of the general meeting and cant be taken granted with the hope that shareholders will ratify the action.
Meaning Of Undertaking
Section 293 of the Companies Act, 1956, imposes on the powers of the Board of directors of a public company or a subsidiary company, in respect of the matters enumerated in clauses (a) to (e) of sub-section (1), a restriction to the effect that a decision in respect of those matters shall be taken with the consent of shareholders by an ordinary resolution passed at a general meeting. This section is the amplified version of Section 86H of the Indian Companies Act, 1913. The opening paragraph and clause (a) of sub-section (1) of section 293 read as follows:
Section 86H of the 1913 Act had provided that the directors of a public company or of a subsidiary company of a public company shall not, except with the consent of the company concerned in general meeting, sell or dispose of the undertaking of the company. The amplification of the provision was done in the 1946 Act on the recommendation of the Company Law Committee.
The question that often arises with regard to clause (a) of sub-section (1) of section 293 of the Companies Act, 1956 is as to what is the connotation of the expression “the whole, or substantially the whole of the undertaking of the company”. The Companies Act does not define the word “undertaking”. It has been used in several statutes and defined in some, and used but not defined in some of them.
For instance, in section 3(d) of the Industrial (Development and regulation) Act 1951, the expression ‘industrial undertaking” is defined as “any undertaking pertaining to a scheduled industry carried on in one or more factories by any person or authority including Government”, but the word undertaking is defined in this act.
Undertaking means an enterprise; a unit, a business as a going concern, the activity of the company duly integrated with all its components in the form of assets and not merely some assets of the undertaking. Undertaking means any business or any work or project which one engages in or attempts an enterprise analogous to business or trade. The business or undertaking must be distinguished from the properties belonging to the company.
The word undertaking means the entire organization. A company whether it has a plant or whether it has an organization is considered as one whole unit and the entire business of going concern is embraced within the term ‘undertaking’. Property, movable or immovable, used in the course of or for the purpose of business can be more accurately is described as the tools of business or undertaking, i.e. things or articles which are necessarily to be used to keep the undertaking going or to assist the carrying on of the activities leading to the earning of profits”.
The above decision was upheld on appeal, with the following observation:
“The business or undertaking of the company must be distinguished from the properties belonging to the company. In this case, it is only the properties belonging to the company that has been dealt with by the Board of directors under the deeds of hypothecation and mortgage in favour of the bank. Hence, the learned company judge was right in holding that no part of the undertaking of the company was disposed of in favour of the bank”.
Section 2(v) of the MRTP act, 1969, defined prior to 1st august, 1984, the expression undertaking’ thus- “Undertaking means enterprise which is engaged in the production, supply, distribution or control of goods of any description or the provision of service of any kind.’ This definition was changed to the following one with effect from 1 august, 1984:
“undertaking means an enterprise which is, or has been, or is proposed to be, engaged in the production, storage, supply, distribution, acquisition or control of articles or goods, or the provision of services, of any kind, either directly or through one or more of its units or divisions, whether such unit or division is located at the same place where the undertaking is located or at a different place or at different places.”
A somewhat similar question arose in a different context in the case of R C Cooper v. Union of India, necessitating discussion of the meaning of the word ‘undertaking’ as interpreted in judicial decisions, Indian and English. The Hon’ble A N Ray, J., in his judgment, observed that the expression ‘undertaking’ meant a going concern; that an undertaking meant the entire organization; that it is an amalgam of all ingredients of property and was not capable of being dismembered.
Sale Of Shares Whether Attracts Section 293(1) (A) of Companies Act, 1956
Section 293(1) (a) of the Companies Act, 1956 contemplates sale of undertaking. When a person holding shares in a company which owns an undertaking, sells his shares, there is no sale of undertaking. This provision does not cover sale of shares in a company which owns an undertaking. When a shareholder sells his shares, the undertaking continues to remain with the company which has its own independent entity.
Brooke Bond India Ltd. v. U B Ltdconsidered the connotation of the word ‘undertaking’ in the context of a slightly different standpoint, namely, whether section 293(1)(a) of the Companies Act, 1956 applies to the sale of shares carrying controlling interest in a company under an agreement which seeks to transfer , as a result of the sale of shares, a division or unit of the company. Answering the question in the negative, B. N. Srikrishna, J, held that notwithstanding the fact that, both in the agreement and in the plaint, there had been use of expressions like sale of the “food business” of the seller to the purchaser and there has been reference to the seller’s food business carried on through KPL and HI, prima facie, the agreement merely contemplated sale of the controlling shares of KPL. Even if the sale of the shares, whatever their number, amounted to a transfer of the controlling interest of a company, it could not be expected to be sale of any part of the undertaking so as to come within the mischief of section 293(1)(a) of the Companies Act, 1956. The agreement was, therefore, not hit by section 293(1)(a) of the Companies Act, 1956.
In Tracstar Investment Ltd v. Gordon Woodroffe Ltd, it was argued that the provisions of section 293 are not applicable in case of sale of shares held by a company in another company as it cannot be treated as an undertaking, the Court applied the test laid down in P.S. Offshore and accepting the above argument the Company Law Board held that the provisions of Section 293(1)(a) of the Companies Act, 1956 were not attracted.
Thus, where a company holding shares in another company which owns an undertaking, seeks to sells those shares whatever their percentage may be, such sale does not amount to sale of an undertaking or substantially the whole of the undertaking and therefore, the provisions of section 293(1)(a) of the Companies Act, 1956 are not attracted. Such sale of shares does not require consent of the shareholders by ordinary resolution.
Procedure For Securing Approval Under Section 293(1)(a) of the Companies Act, 1956
To secure approval of the company at general meeting under section 293(1)(a) of the Companies Act, 1956, the following procedure should be followed:
The proposal for sale, lease or otherwise disposing of an undertaking of a company, will be placed before the Board of Directors of the Company for its consideration and approval. The Board will pass the following resolutions:
to approve the proposal;
to decide the date, time and place of the annual general meeting;
to authorize the company and secretary/ director to issue notice of the general meeting.
Intimation to stock exchange
In the case of a listed company, intimation of the Board’s decision will be given to all the Stock Exchanges on which the company’s shares are listed, immediately after the Board on the same day.
A general meeting will be convened to pass necessary resolution.
Sending copies of notice to Stock Exchange
In the case of a listed company, three copies of the notice of the general meeting will be sent to all the Stock Exchanges on which the company’s shares are listed, immediately after meeting on the same day.
Intimation to Stock Exchange
Intimation of the resolution passed at the general meeting will be given to the stock exchange at the earliest.
Chapter V of Part VI is the alternative/Powers of Court to sanction demergers
The alternative for demerging companies into the transferee company is to go via Chapter V of Part VI of the Companies Act, namely to treat the transfer of a full or part of a unit or business or undertaking as coming within the purview of Court’s power to sanction schemes of arrangement between shareholders of transferor company and the transferee company. Courts have the powers while ordering a scheme of arrangement to pass orders to effect that the “transfer” to the transferee company of the whole or part of the undertaking property or liabilities of any transferor company.
There are demerger in the public and the private sectors. The contemporaneous method to combat the present economic situation in India is being well dealt with the equipment of Demergers.
The demerger of the Reliance group is by far the biggest corporate restructure story in the private sector. The split in the group led to the formation of the two independent entities Reliance Industries ltd. led by Mr. Mukesh Ambani and the Anil Dhirubhai Ambani Group led by the younger brother Mr. Anil Ambani. RIL proposed the demerger “in order to enable distinct focus of investors to invest in some of the key businesses and to lend greater focus to the operation of each of its diverse businesses”. Also, the other well known demergers that caught the attention of the public which had enormous repercussions were: Eveready Industries separated its tea business into McLeod Russell; Auto ancillary company Rane Madras transferred its investments into separate company and the investment company was also listed. The demerger list also includes Vardhman Spinning and Morarjee Realities. GTL is demerging its IT infrastructure business to GTL Infrastructure.
The Public Sector is also well abreast with the concept of Demergers. Though it is one of the fundamental pillars of the government’s policy to streamline the entire economy, this mode of corporate restructure has not however been exploited the way it ideally should have been. It prominently features on the government’s plans and visions for the restructuring of the economy. Therefore, when fully exploited, the concept of demergers will help reshape the PSUs by allowing them to shed their excess staff strength and loss making assets.
With the rise of new regional economic powers in the world, there has been a rise in what has been termed as economic patriotism. But, despite the challenges, demergers (and mergers) are the tools that hold an answer to the Indian corporate community’s thirst and relentless enterprise for a global presence today.
 J. C. Verma, ‘Corporate Mergers Amalgamations and Takeovers: Concept, Practice and Procedure’, 5th ed. 2008, at p.264
 Lucas TVS Ltd. in re CP No. 588 and 589 of 2000 (Mad-unreported)
 Under Section 390 of the Companies Act, 1956
 Under the provisions of Section 293(1)(a) of the Companies Act, 1956
 As amended by the Finance Act, 1999 w.e.f. 1-4-2000.
 K. R. Chandratre, ‘Corporate Restructuring’, 1st ed. 2005, at p.865
 Sridharan & Pandian, ‘Guide to Takeovers & Mergers’, Edition 2002, p.286
 M.C. & M. Corporation Pvt. Ltd., C.P. 105 to 107 of 1999(Mad-unreported)
 Within the ambit of section 390, 391, 392, 393 and 394 besides section 394A of the Companies Act, 1956
Sections 100 to 105 of the Companies Act, 1956
 K. R. Sampath, ‘Law and Procedure for Mergers/ Joint Ventures Amalgamations Takeovers and Restructure’, 4th ed. 2008, at p.796
 A.K.Ramaiya, ‘Guide to the Companies Act’, 16th Ed, Reprint 2006, Part 2, p.3203
 (1867) 2 Ch. App 405.
 Butterworth: Encyclopedia of Forms and Precedents, volume 11, p. 235. Also, the only remedy available to the liquidator and to unpaid creditors of the original company is to follow its assets into the hands of the new company and to require the new company to apply them in satisfying the debts and liabilities of the original company. The right to follow the original company’s assets appears to be derived from the equitable rules relating to tracing assets, and it seems that the right is available to the original company’s creditors, even though they cannot prove that the original company’s directors or shareholders had any intent to defraud them.
 Butterworth: Encyclopedia of Forms and Precedents, volume 11, p. 235-237
 Re International Life Assurance Society and Hercules Insurance Co. ex p Blood (1870) LR 9 Eq 316
 Re Anchor Assurance Co (1870) 5 Ch App 632
 This fact is evidenced from the following extract from Butterworth:
“The court cannot make ancillary orders of the kind mentioned above when approving a scheme of arrangement to effect a division. Nevertheless, the court’s approval of the scheme is effective to create, extinguish, transfer or modify rights and liabilities without ancillary orders being made under the court’s powers described above, and so when the scheme has been approved, the only acts which need to be done by the parties are those required by the general law to transfer the assets of the original company to the acquiring company. Shares and debentures of the acquiring company will, ofcourse, be issued in accordance with the scheme, and the holdings of shareholders and debenture holders of the acquiring company will be cancelled by the scheme itself.” Butterworth: Encyclopaedia of Forms and Precedents, Volume 11, p.244 (Para 128.3)
 (1994) 80 Comp Cas 228 (Del)
 This agreement seeks to transfer to the buyer the business as a going concern, lock, stock and barrel, that is to say, all properties (immovable and movable), assets, other rights, licences, permits, titles, liabilities, employees, etc. at the negotiated price.
 Brooke Bond India Ltd v. UB Ltd (1994) 13 CLA 391(Bom)
 Tracstar Investment Ltd. v. Gordon Woodroffe Ltd (1996) 20 CLA 267(Mad)
 Section 293(3) of the Companies Act, 1956
 Tracstar Investment Ltd. v. Gordon Woodroffe Ltd (1996) 20 CLA 267(Mad)
 Para 102 of its report: “Section 86H of the Act of 1913 imposes some restrictions on the general provisions of directors. We have considered it necessary to amplify these powers and also to add to the restrictions. Thus we recommend that clause (a) of section 86H should be so elaborated as to prohibit the directors of a public company or of a subsidiary company of a public company from selling, leasing or otherwise disposing of the whole or substantially the whole of the undertaking of a company, provided that, where a company owns more than one independent undertaking, the directors should not dispose of any such undertaking, without the consent of the shareholders by an ordinary resolution”.
 P.S. Offshore Inter Land Services Pvt Ltd. v. Bombay Suppliers & Services Ltd. (1991) 5 CLA 376
 Secretary, Madras Gymkhana Club Employee Union v. Management of the Gymkhana Club, AIR 1968 SC 554. Also see D.N.Banerjee v. P.R. Mukherjee, AIR 1953 SC 58
 International Cotton Corporation Ltd. v. Bank of Maharashtra (1970) 40 comp cas 1154 (Mys)
 Rustom Cavasjee Cooper v. union of India (1970) 40 comp Cas 325(SC).
 Re Yallama cotton, woolen & Silk Mills Co Ltd (1970) 40 comp Cas 466 (Mys).
 See International Cotton Cororation (P) Ltd. v Bank of Maharashtra (1970) 40 comp Cas 1154 (Mys)
 (1970) 40 Comp Case 325 (SC)
 (1994) 79 Comp Case 346 (Bom): (1994) 13 CLA 391
 (1996) 20 CLA 267 (Mad)
 K. R. Chandratre, ‘Corporate Restructuring’, 1st ed. 2005, at p.869
 Listing Agreement, Clause 29, 36
 Supra n.44 at p.871, also see A.K.Majumdar & G.K.Kapoor, ‘Company Law and Practices’, 12th Ed. 2007, p.1026
 Listing Agreement, Clause 36.
 Supra n.44 at p.870
 Section 394(1)(b)(i) of the Companies Act, 1956
 Tushyant trivedi, ‘Four Demergers and a Farewell’, as in ENS Economic Bureau on August 4, 2005, http://www.indianexpress.com/oldStory/75636/, (last accessed on 25th September, 2010)
 T.Banusker, ‘Capital gains on sale of demerged company shares’, The Business Line, on Jan 9, 2010, http://www.thehindubusinessline.com/iw/2005/01/09/stories/2005010901371400.htm , (last accessed on 16th September, 2010)
 Vivek Kaul, ‘Reliance demerger: You ain't seen anything yet’ on Tuesday, December 27, 2008, http://www.dnaindia.com/money/report_reliance-demerger-you-ain-t-seen-anything-yet_1004360, (last accessed on 25th September 2010).
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