Planning and Strategy – Corporate Restructuring, Insolvency, Liquidation & Winding-Up Important Questions
Question 1.
Write a short note on Leveraged buyout.
Answer:
‘Leverage’ can be defined as a position where an entity uses borrowed funds over and above the ownership funds. In other words, the debt is more than the equity component.
Leveraged Buyout (LBO) is the acquisition of a company in which the acquirer uses only a small amount of own funds and borrows the rest. Leveraged buyout is defined as the acquisition of a company by a small group of investors, financed mainly by borrowing.
LBO is used as a strategy by an acquirer where the targeted acquisition is highly profitable and may provide huge cash inflows. The acquirer can generate such cashflows and use them to repay the debt/borrow¬ing.
The expectation with LBO is that the return/profits (%) generated on the acquisition will more than interest cost (burden) paid on the debt.
Hence, a favourable leverage position enables an acquirer to earn high returns while only risking a small amount of own capital.
LBO is used for acquisition of companies where –
- Stable, strong cash flow business
- Non-cyclical businesses
- Companies with large economic benefits
- Companies with good existing management teams etc.
Question 2.
Internal accruals accumulate to reserves prompts management to venture more avenues through acquisitions or mergers but during and after the process, funds available internally are inadequate. Suggest available avenues to fund the bids for Takeovers and Mergers in addition to internal accruals.
Answer:
Mergers and takeovers involve payment of consideration for acquiring the assets/shares of the target company. Hence, a considerable amount is required to finance such a transaction.
The purchase consideration depends on the Target Company valuation, carried out by registered valuers. Funding mergers and takeovers imply modes of raising finance to service the strategy.
A good funding strategy must ensure an optimum mix of available modes of payment so that the financial package chosen is suitable for both – the acquirer and target.
The capital structure shall also provide a desirable cost advantage to the acquirer. Several modes are available to fund mergers and takeovers, especially for an entity having strong balance sheet.
Where there is inadequacy of internally generated funds, borrowing is a viable option.
Following alternatives are available:
- Debentures and Bonds – secured borrowing from the general public, high fund-raising cost,
- Loans from Banks and Financial Institutions – fixed tenure borrowings, no dilution of control,
- Deposits from its directors, relatives, and business associates,
- External Commercial Borrowings (ECB) from non-resident investors,
- Loans from Central or State financial institutions,
- Rehabilitation Finance etc.
Any kind of borrowing attracts fixed interest/coupon commitment and repayment at maturity. Further, any default results in litigation and loss of goodwill. Hence, the decision to borrow funds shall be taken judiciously and diligently by the company.
Question 3.
“Fairness, reasonableness and made in good faith are the premises on which the Judicial Authority approves any scheme for amalgamation, – merger or demerger.” Offer your comments supported by any judicial pronouncements.
OR
Question 4.
“A Scheme, even approved by majority, can be rejected by Court but such a scheme must be held to be unfair to the meanest intelligence.”Analyse the statement citing important judicial pronouncements.
Answer:
The basic principle of shareholders’ democracy states that the rule of majority shall prevail. Further, it is also necessary to ensure that this power of the majority does not result in oppression of the minority and/or mismanagement of the company. Thus, the minority must be given opportunity to express their opinions during the decision-making process.
Any scheme which is fair, rational and made in good faith shall be sanctioned by the Tribunal, provided it is made in the interest of all stakeholders. Any scheme which is true and reasonable will be sanctioned if it is supported by sensible people to be for the benefit to each class of the members or creditors concerned.
In the case of Sussex Brick Co. Ltd., it was held that a scheme may have faults, but it may not be sufficient to reject it. If the Court/Tribunal is satisfied that the scheme is fair and reasonable and in the interest of general body of shareholders, the Court/Tribunal shall approve the scheme.
Further, it was held that in order to reject a scheme, it must be obviously unfair, prejudiced, unjust, and dishonest to the meanest intelligence.
It is the consistent view of the Courts that no scheme can be said to be fool-proof and it is the possible to find fault in a particular scheme but that by itself is not enough to warrant a dismissal.
Question 5.
Using any evident case, explain the concept of funding through leveraged buy-out for the acquisition of a company.
Answer:
‘Leverage’ can be defined as a position where an entity uses borrowed funds over and above the ownership funds. In other words, the debt is more than the equity component.
Leveraged Buyout (LBO) is the acquisition of a company in which the acquirer uses only a small, amount of own funds and borrows the rest. Leveraged buyout is defined as the acquisition of a company by a small group of investors, financed mainly by borrowing.
In other words, an LBO is the purchase of a company using a large amount of debt or borrowed cash to fund the acquisition, instead of using its own money or raising equity from investors.
The Acquirer borrows large amounts through a combination of re-payable bank facilities and/or public or privately placed bonds.
Further, the Acquiring company may float a Special Purpose Vehicle (SPV) as a 100% subsidiary with a minimum equity capital. The SPV can leverage this equity to raise significantly higher debt to buy out the target company.
The target company’s assets can be used as collaterals for availing the loan and once the debt is redeemed, the acquiring company has the option to merge with the SPV. The debt will be paid off by the SPV using the cash flows of the target company.
The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.
Example – Bharti and Zain deal Bharti started its telecom services business by launching mobile services in India in 1995. Zain established in 1983 was the first mobile operator in Kuwait. In 2010 Bharti Airtel entered into exclusive agreement with KSC (Zain) for the acquisition of Zain Africa International BV (Zain Africa).
The acquisition deal was done as a leveraged buyout and the loan for financing the transaction was availed by two Special Purpose Vehicles (SPVs). The acquisition was routed through SPVs keeping Bharti Airtel’s standalone financials intact. However, it did not relieve Bharti from its responsibility as a borrower.
Question 6.
Merger and Amalgamation is one of the most attractive routes to enter into a new business. Explain the advantages of starting a new business through merger/amalgamation.
Answer:
A merger or amalgamation is a type of arrangement, whereby assets of two or more companies get transferred or come under control of one company. Basically, it is a legal process whereby two or more companies come together for growth, expansion and prosperity
An organisation could venture into a new business taking any of the routes like financing a new start-up, joint venture, strategic partnership.
However, the reasons why mergers and acquisitions appear to be the most attractive route, despite all the compliances are as under –
- Economies of scale by expansion and diversification to tap global markets.
- Quick entry into the market as against starting from the scratch vide a start-up route.
- Bigger market share, large customer base.
- Reduce the cost of operations.
- Access to scientific research and technological developments.
- Augmenting effectiveness of managerial capabilities and available infrastructure.
- Ensuring regular supply of scarce raw materials.
- Overcoming entry barriers and attaining competitive advantage.
- Ready availability of the necessary infrastructure.
- Ready availability of a brand name.
- Skipping entire gestation period which is cumbersome and costly in terms of time and effort.
Question 7.
“There may be no express protection to any dissenting minority shareholder to file his objections as a matter of right, yet the Courts/ Tribunals, while approving the Scheme, follow judicious approach by inviting objections through Public Notice in Newspapers.” Elucidate.
Answer:
The basic principle of shareholders’ democracy is that the rule of majority shall prevail. However, it is also necessary to ensure that this power of the majority does not result in oppression of the minority and/or mismanagement of the company.
Generally, minority represent those members who are not in the control or management of the affairs of the company. Thus, the minority must be given opportunity to express their opinions during the decision-making process.
As per section 230(4) of the Companies Act, 2013 it is provided that in a scheme of arrangement any person or persons holding at least 1096 of the shareholding or 596 of the total outstanding debt can put objection to the proposed scheme.
Other modes of ensuring/providing protection to the minority shareholders as given below –
- Dual majority – minimum 3 /4th in value of shares held and simple majority in number of persons, thereby making it difficult for the resolution to pass.
- Appeal to the Tribunal to set aside the scheme of compromise or arrangement.
- Independent Chairman conducts and supervises the meetings, ordered by the Tribunal.
- Intimation to various regulatory authorities (RBI, SEBI, Income Tax, FEMA, CCI) for inviting and considering their objections/ suggestions.
- Notice of the meeting published in newspapers and websites for maximum coverage.
- In case of takeovers, SEBI (SAST) Regulations shall be followed.
- Tribunal has power to modify the scheme to protect the minority.
- Exit route available to dissenting shareholders.
- NOC from stock exchange where shares of the company are listed.
- Separate hearing of the petition by the Tribunal, prior to sanctioning the scheme.
Question 8.
“In addition to the normal event risks, stock swap mergers involve risks associated with fluctuations in the stock prices of the two companies”. Comment on the statement in view of the funding through swaps or stock to stock mergers.
Answer:
Mergers and takeovers involve payment of consideration for acquiring the assets/shares of the target company. Hence, a considerable amount is required to finance such a transaction.
The purchase consideration depends on the Target Company valuation, carried out by registered valuers. Funding mergers and takeovers imply modes of raising finance to service the strategy.
A good funding strategy must ensure an optimum mix of available modes of payment so that the financial package chosen is suitable for both – the acquirer and target.
In stock swap mergers or stock to stock mergers, the holder of Target company’s shares receives shares of the Acquiring company’s capital. Many mergers used stock for stock deals.
A merger arbitrage specialist will sell the Acquiring company’s stock short and will purchase a long position in the Target company, using the same ratio as that of the proposed transaction.
If the purchasing firm is offering a half share of its stock for every share of the target company, then the merger arbitrageur will sell half as many shares of the purchasing firm as he or she buys of the target company.
By going long and short in this ratio, the manager ensures that the number of shares for which the long position will be swapped is equal to the number of shares sold short. When the deal is .completed, the manager will cover the short and collect the spread that has been locked in.
Stock swap mergers may involve event risk. In addition to the normal event risks, stock swap mergers involve risks associated with fluctuations in the stock prices of the two companies.
The deal involves exchange of shares where there may be drastic fluctuations. Merger arbitrageurs derive returns from stock swap mergers when the spread or potential return justifies the perceived risk of deal’s failing.
Question 9.
“While standard parameters day a crucial role, funding/borrowing for takeover should be organized in such a way that best suits the facts and circumstances of the specific case and should also meet the immediate needs and objectives of the management”. Elucidate the statement with emphasis on the demerits of borrowing from the financial institutions and banks.
Answer:
Mergers and takeovers involve payment of consideration for acquir¬ing the properties/shares of the Target Company. The consideration depends on the target company valuation.
Funding mergers and takeovers imply the modes of raising finance to service the corporate restructuring strategy. A good funding strategy must ensure an optimum mix of available modes of payment so that the financial package chosen suits the financial structures of the acquirer.
The capital structure shall also provide a desirable cost advantage to the acquirer. The cost of capital of funds raised shall differ as per different financial packages selected.
Funding of a merger or takeover can be done using own funds as well as borrowed funds, i.e. through financial leverage. However, borrowings from banks, financial institutions have their own merits and demerits.
Merits of borrowed funds include income tax benefits, fixed maturity, no dilution of control etc.
However, demerits of borrowing include the following –
- Assets provided as a collateral/security;
- Disclosure of financial statements, and other relevant information of the company;
- Fixed and mandatory interest burden each year maximum coverage.
- Mandatory redemption on maturity
- Default risk, leading to insolvency proceedings against the company.
Hence, funding of a merger or takeover shall be thoroughly planned and executed. Borrowings shall be well-organized, based on the current circumstances.
Question 10.
How the rights of the minority shareholders are protected during merger/amalgamation/takeover?
Answer:
Generally, minority represent those members who are not in the control or management of the affafrs of the company. Thus, the minority must be given opportunity to express their opinions during the decision-making process.
As per section 230(4) of the Companies Act, 2013 it is provided that in a scheme of arrangement any person or persons holding at least 10% of the shareholding or 5% of the total outstanding debt can put objection to the proposed scheme.
Following are measures for ensuring protection to the minority shareholders as given below –
- Dual majority – minimum 3/4th in value of shares held and simple majority in number of persons, thereby making it difficult for the resolution to pass.
- Appeal to the Tribunal to set aside the scheme of compromise or arrangement.
- Independent Chairman conducts and supervises the meetings, ordered by the Tribunal.
- Intimation to various regulatory authorities (RBI, SEBI, Income Tax, FEMA, CCI) for inviting and considering their objections suggestions.
- Notice of the meeting published in newspapers and websites for maximum coverage.
- In case of takeovers, SEBI (SAST) Regulations shall be followed.
- Tribunal has power to modify the scheme to protect the minority.
- Exit route available to dissenting shareholders.
- NOC from stock exchange where shares of the company are listed.
- Separate hearing of the petition by the Tribunal, prior to sanc tioning the scheme.
Question 11.
“There have been occasions when shareholders holding miniscule shareholdings have made frivolous objections against the restructuring scheme, just with the objective of stalling or deferring the implementation of the scheme. The courts have, on a number of occasions, overruled their objections.” Comment on the statement with relevant case law.
Answer:
A scheme of merger and amalgamation is approved by majority shareholders, in a meeting, duly convened and conducted under the supervision of the Tribunal. The Tribunal shall sanction the scheme only if the same is approved by the required shareholders’ majority.
Every shareholder has the freedom to voice his opinion in the meeting or through an affidavit submitted to the Tribunal. Dissenting shareholders represent those members who do not agree with the resolution, ie. they vote against the resolution. Such dissenting members are given opportunity to express their opinions during the decision-making process.
However, there have been some occasions where shareholders holding a small number of shares, have made frivolous objections against the scheme, just to defer the implementation of scheme.
On various such instances, the Courts have overruled their objections. But companies had to bear the consequences in the form of time and cost overruns.
In 2003, Parke-Davis India Ltd. and Pfizer Ltd. were considering implementation of a scheme of merger. The minority shareholders of Parke-Davis India Ltd. objected to the scheme on the grounds that approval from requisite majority as prescribed under the Companies Act, 1956 had not been obtained. They filed a petition before the division bench of the Bombay High Court.
The division bench of the Bombay High Court by its order executed a stay order in March 2003 restraining the company from taking further steps in the implementation of the scheme. Later, the dissenting shareholders filed a Special Leave Petition with the Supreme Court. Finally, the Supreme Court dismissed the petition filed by the shareholders. Parke-Davis then proceeded to complete the implementation of the scheme of amalgamation with Pfizer.
Similarly, in the case of the merger of Tomco with HLL, the minority shareholders put forward an argument that, as a result of the amalgamation, a large share of the market would be captured by HLL.
However, the Court turned down the argument and observed that there was nothing unlawful or illegal about it. To curb such practice of frivolous objections, Section 230(4) of the Companies Act, 2013 provides that in a scheme of arrangement any person or persons holding at least 1096 of the shareholding or 596 of the total outstanding debt can put objection to the proposed scheme.
Question 12.
Interna1 accruals are an Important source of funding mergers and takeovers.’ Comment on the same with provisions for Issuing equity with differential voting rights.
Answer:
Mergers and takeovers involve payment of consideration for acquiring the properties/shares of the target company. The consideration depends on the target company valuation.
Funding mergers and takeovers imply the modes of raising finance to service the corporate restructuring strategy.
Funds may be raised through internal sources such as Equity capital, Preference Capital, accumulated reserves and profits.
As per the Companies Act, 2013, an Indian company is permitted to issue equity instruments with differential rights as to dividend and or voting. Companies may issue non-voting shares.
Such issue gives companies an additional source of funds without dividend cost and without the obligation to repay, as these are other forms of the equity capital. Generally, promoters prefer such securities since there is no loss of control.
A company limited by shares may issue equity shares with differential rights subject to the following conditions:
- There must be an authority in the Articles of Association of the company
- Obtain shareholders’ approval through ordinary resolution in general meeting
- The equity capital with differential rights shall not exceed 74% of the total voting power
- No default in filing annual accounts and annual returns for three years
- No default in repaying deposits or paying interest thereon; in redeeming debentures; and paying dividend after declaration; and
- The company has not been convicted of any offence under Securities Contracts (Regulation) Act, 1956; SEBI Act, 1992 and Foreign Exchange Management Act, 1999.
- A company shall not convert its existing equity share capital with normal voting rights into equity shares with differential voting rights and vice versa.