Professional Documents
Culture Documents
LESSON 10:
DE-MERGERS
Objective
The objective of this lesson is to give you insight in to :
What is demerger
What is reconstruction
Demerger
Companies often have to downsize or contract their operations in certain circumstances such as when a division of the
company is performing poorly or simply because it no longer
fits into the companys plans or give effect to rationalization or
specialization in the manufacturing process. This may also be
necessary to undo a previous merger or acquisition which
proved unsuccessful. This type of restructuring can take various
forms such as demergers or spin offs, split offs, etc.
Large entities sometimes hinder entrepreneurial initiative,
sideline core activities, reduce accountability and promote
investment in non-core activities. There is an increasing
realization among companies that demerger may allow them to
strengthen their core competence and realize the true value of
their business.
Demerger is often used to describe division or separation of
different undertakings of a business, functioning hitherto
under a common corporate umbrella. A scheme of demerger,
is in effect a corporate partition of a company into two undertakings, thereby retaining one undertaking with it and by
transferring the other undertaking to the resulting company. It
is a scheme of business reorganization Justice N.V.
Balasubramaniam J in Lucas TVS Ltd. in Re. CP No. 588 and
589 of 2000 (Mad-Unreported).
Such a split or division may take place for various reasons e.g. a
conglomerate company carrying out various activities might
transfer one or more of its existing activities to a new company
for carrying out rationalization or embarking specialization n the
manufacturing process. Also, such a transfer might be of a less
successful part of the undertaking to a newly formed company.
The new company and transferee, need not be the subsidiaries
of the parent company which has affected/undergone such split
or division.
The term Demerger has not been defined in the Companies
Act, 1956. However, it has been defined in Sub-section (19AA)
of Section 2 of the Income-tax Act, 1961. According to the
said Sub-section, demerger in relation to companies, means
24
Demerged Company
Reconstruction
The expression reconstruction has been used in Section 394
of the Companies business of a company to one or more
other companies, specially formed for the purpose. The old
CORPORATE RESTRUCTURING
CORPORATE RESTRUCTURING
26
Demerger, division, split or spin off may take place when a new
company is formed for the purpose, inter alia, of taking over
the residual division of one or more of existing companies, on
the same being spun off in pursuance of a joint venture
agreement between the existing company and another company
and a scheme of arrangement is formulated in furtherance of
such joint venture agreement.
In a split-off, some of the shareholders in the parent company
are given shares in a division of the parent company, (usually a
subsidiary) which is split-off in exchange for their shares in the
parent company.
Split-off can also be used as one mode to defend against hostile
takeovers. Companies may choose to split off divisions to
make it less attractive to takeover bidders.
Defensive split-offs are however, a drastic takeover defence. The
most recent example is the plan of the management of Larsen
& Toubro (L&T) to split off its cement division to make it
difficult for Grasim Industries to take it over.
Steps to be taken for Demerger
27
CORPORATE RESTRUCTURING
CORPORATE RESTRUCTURING
Reverse Merger
It must be understood at the outset that amalgamation and
merger are corporate restructuring methods. Both the terms are
synonymous. The procedure to be adopted for both is the
same and the consequences of both are also the same. For
achieving amalgamation as well as merger, an existing company
(which is referred to as the amalgamating or merging or
transferor company), under a scheme of amalgamation or
merger, loses its own legal identity and is dissolved without
being would up and its assets, properties and liabilities are
transferred to another existing company (which is referred to as
the amalgamated or merged or transferee company).
Generally, a loss making or less profit earning company merges
with a company with track record, to obtain the benefits of
economies of scale of production, marketing network, etc.
This situation arises when the sick companys survival becomes
more important for strategic reasons and to conserve the
interest of community.
In a reverse merger, a healthy company merges with a financially
weak company. The main reason for this type of reverse merger
is the tax savings under the Income-tax Act, 1961. Section 72A
of the Income-tax Act ensures the tax relief, which becomes
attractive for such reverse mergers, since the healthy and
profitable company can take advantage of the carry forward
losses/of the other company. The healthy units loses its name
and surviving sick company retains its name. In the context of
the Companies Act, there is no difference between a merger and
a reverse merger. It is like any amalgamation. A reverse merger
is carried out through the High Court route.
A De-merger may take the form of a spin-off or a split-up. In
a spin-off an undertaking or division of a company is spun off
into an independent company. After the spin-off, the parent
company and the spun off company are separate corporate
entities. For example, the Information Technology, Division of
WIPRO Limited was spun off a separate company in the late
1980s. In a split-up, a company is split up into two or more
independent companies. As a sequel, the parent company
disappears as a corporate entity and in its place two or more
separate companies emerge. For example, the Ahmedabad
Advanced Mills was split up into two separate companies. viz.,
New Ahmedabad Advance Mills and the Tata Metal Strips.
Though spin-offs and split-ups are different in form, their
economic substance is the same.
Rationale: Spin-offs and split-up are regarded as devices for
enhancing corporate values by raising efficiency and performance. The principle sources of efficiency gain and performance
improvement are as follows:
Sharper Focus
Practice Questions
1. Distinguish between demerger & reconstruction.
2. Discuss the procedure for reconstruction.
3. Discuss the tax reliefs for the resulting company out of
demerger.
4. Discuss the Indian scenario for demergers & reconstruction.
5. What is reverse merger?