Making Mergers Easier: More Companies To Get On The Express Lane

The Draft Amendment seeks to introduce two major additions to the classes of companies eligible to undertake the fast-track merger process.

First, every unlisted company, save for a company registered under Section 8 of the Act, which has less than Rs 50 crore worth of borrowings from banks/financial institutions/other body corporates and has not defaulted on any of its repayments in respect of the borrowings can undertake a fast-track merger with an unlisted company satisfying the same criteria.

As a matter of compliance, a certificate from the auditor of the company certifying that the company meets the applicable criteria shall be submitted. The explanatory note to the draft amendment states that the intent behind this suggestion is to cover companies with reasonable debt exposure.

While the intent of the government to include companies having low debt exposure is clear, the basis for characterisation of a debt of Rs 50 crore as reasonable remains unclear. This addition is a curious change as the classification solely relates to the company's debt and covers low-debt unlisted companies irrespective of their size or relation with the other merging entity, which was the earlier basis for classification. Moreover, the definition of debt includes loans from "any other body corporate", which is likely to cover inter-corporate deposits and any other loans, which may not necessarily resemble a traditional credit facility.

The proposed move comes as a major relief for companies which are relatively debt-free and satisfy a major chunk of their working-capital requirements through their cash reserves or equity-based funding. At the same time, the scheme leaves out entities, which may be prudent borrowers in respect of their repayment obligations, but the volume of their borrowings exceeds Rs 50 crores due to the scale of their business.

An interesting implication of the Draft Amendment would be disinclination of unlisted companies to increase their borrowings beyond Rs 50 crore even if they have a clean repayment history. This may conflict with the Reserve Bank of India's aim to increase lending and investment in the country, which was signalled by the recent reduction in the policy repo rate. The extent of the interaction between these competing objectives may only be apparent after the Draft Amendment is implemented as companies may not always be incentivized to borrow lesser in order to undertake a faster process for mergers.

Second, the other addition to class of companies, which can undertake a fast-track merger, relates to group entities. In the current regime, only mergers between holding companies and wholly owned subsidiaries are covered. The draft amendment expands the scope to cover mergers between holding company (listed or unlisted) and one or more of its unlisted subsidiaries and mergers between one or more subsidiary companies of the same holding company, provided the transferor company is unlisted. This proposed change is a welcome move for large corporate groups and would ease restructuring of group companies even when the unlisted subsidiary is not wholly owned.