Demerger of a Company

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Demerger is a disjoining or a separation of one or more units of a company to form a new company independent from the original one. The following definition of demerger is excerpted from section 2 (19AA) of Income Tax Act, 1961-

“Demerger”, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company”

Demerger is a form of corporate restructuring which in undertaken by companies in order to promote specialization. Companies have started practicing demerger because of the many benefits it offers. Demerger allows a company to expand its operations in a very systematic manner. It allows a specific division or unit to grow as a separate and a focused entity, thereby increasing its efficiency and effectiveness. It benefits the shareholders by providing them better opportunities to participate in the management, operations, decision making process and profits of the applicant company as well as the resulting company.  

Demerger can be affected by any of the following three ways:

  1. Demerger by agreement between promoters; or
  2. Demerger under the a scheme of arrangement with approval by the Court under section 391;
  3. Demerger under voluntary winding up and power of liquidator.

Demerger by agreement between promoters

Demerger may take place by agreement between promoters of the demerging company. In such a scenario, the principle company may spin off its specific undertakings to the resulting company. All the property, liabilities and issues of the principle company, transferred to the resulting company immediately before the demerger, becomes the property, liabilities and issues of the resulting company.

Demerger under the a scheme of arrangement with approval by the Court under Section 391 of the Companies Act

In order to affect a demerger, there must be a provision in the Memorandum of understanding of the principle company. The scheme of such arrangement has to be submitted in the respective High Courts of the states where the head office of the principle as well as resulting company is registered.

The procedure for demerger by this method is as follows-

  1. Preparation of Scheme of Arrangement

The scheme of arrangement is prepared after consulting the interested parties and stakeholders. Such arrangement is approved by the board of directors. Also, the share exchange ratio is determined while balancing the interest of all the parties.

  1. Application to court for direction to hold meetings of Members/Creditors

The summons is issued under section 391 by a judge of the concerned High Court after an application is filed in Form 33 accompanied by an affidavit in support in Form 34. The scheme of such arrangement must also be annexed. Additional documents that are to be filed before the High Court are:

a) Memorandum and articles of association of the Company;

b) Latest Audited Balance Sheets ;

c) List of Shareholders and Creditors;

d) Extract of Board Resolution approving the Scheme, and

e) Draft notice of Meeting, Explanatory Statements and Proxy.

  1. Obtaining court’s order for holding meeting of Members/Creditors

The court examines the fairness of the scheme submitted by the applicants and subsequently issues summons in Form 35 of the Court Rules. The court has to ensure that the scheme is capable of being implemented.

  1. Notice of meeting of Members/Creditors

A notice in Form 36 is sent to the interested parties by the persons authorized by the courts at least twenty one days before the date of the meeting accompanied by the proposed scheme and proxy forms. Such notice shall also be advertised in Form 38 in such newspapers that are well circulated among the interested parties.

  1. Holding meeting of Members/Creditors

A meeting shall be held according to the directions of the court and the result of such meeting shall be decided by separately counting votes in favor and against the motion. The chairperson of each meeting shall submit a report in Form 39 within the time prescribed by the court.

  1. Petition to the Court for sanctioning the scheme of Demerger

A petition in Form 40 has to be submitted to the court for sanctioning the scheme of demerger. It has to be approved by three-fourths of members/creditors in order to file a petition to sanction the same.

  1. Court’s order on petition sanctioning the scheme of Demerger

After hearing the objections, the Court may pass an order approving the scheme of scheme of demerger in the same newspaper in which the notice of meeting was advertised.

Demerger under voluntary winding up and power of liquidator

The 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. In such a situation, the company getting wound up may transfer or sell wholly or a part of its operations to another company. The liquidator of the transferor company may, with the sanction of a special resolution of that company receive, by way of compensation or part compensation for the transfer or sale, shares, policies, or other like interests in the transferee company, for distribution among the members of the transferor company or any other purpose.

There are demergers 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. In the private sector, the demerger of the Reliance group into Reliance Industries Ltd. and Anil Dhirubhai Ambani group is by far the biggest demerger witnessed in India. The public sector is also well abreast with this emerging idea of reconstruction.

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