Understanding Demergers and Their Impact on Companies

Demystifying Corporate Restructuring

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Multiracial employees listen to indian boss in company meeting. Copy space.
Multiracial employees listen to indian boss in company meeting. Copy space.

Sometimes companies feel the necessity to modify their organizational structure, which can be attributed to various reasons. It could be done to make suitable financial alterations by reducing costs, consolidating debts, improving competitive advantages, focusing more on key products, or merging with another company, among other factors.

To bring about such changes, companies often resort to corporate restructuring. Corporate restructuring refers to the process through which a company implements organizational, structural, financial, or managerial changes. There are several forms of corporate restructuring, one of which is demergers. Companies opt for demergers when they aim to promote specialization.

Demerger company
Demerger

Demergers: Types of Demergers

Demergers are a type of corporate restructuring that involve the division or splitting up of a business entity into separate units or undertakings. While the term “demerger” is not explicitly defined in the Companies Act, 2013, it refers to an arrangement for the reorganization of a company’s share capital by consolidating or dividing shares of various classes, or both.

Under the Income Tax Act, 1961, a demerger is defined in Section 2(19AA). It involves the transfer of one or more undertakings to another company through a scheme of arrangement. In a demerger, the property or liabilities of the demerged company are transferred to the resulting company, and shareholders holding at least 75% of the value of shares become shareholders of the resulting company. The issues shared to the demerged company by the resulting company are distributed on a proportionate basis.

Demergers allow companies to expand their operations in a systematic and focused manner. By enabling separate growth as distinct entities, demergers increase the efficiency and effectiveness of the divided or split-up units. They also offer shareholders more opportunities to participate in the management, operations, decision-making processes, and profits of both the applicant company and the resulting company.

Types of Demergers

There are two main types of demergers:

  1. Spin-off: In a spin-off, the parent company separates an undertaking from itself, creating a new entity. The parent company and the spun-off company then operate as separate entities. This type of demerger often involves the sale and distribution of new shares of an existing business or a division of the parent company. Spin-offs are commonly pursued when a company wants to attract external investments.
  2. Split-up: In a split-up demerger, a company segregates into one or more independent companies, leading to the parent company ceasing its operations. The shares owned by the parent company are exchanged for shares of the newly formed company, which are distributed proportionately based on the original company’s ownership. Split-up demergers may be employed to prevent monopoly in the market, promote specialization, or achieve greater focus and control over the new entity.

Ways in Which Demergers Can Take Place

Demergers can occur in the following ways:

  1. Demerger by agreement between promoters: This type of demerger occurs through an agreement between the promoters of the demerging or parent company. It involves the division of undertakings from the parent company to the resulting company, resulting in the transfer of all assets and liabilities.
  2. Demerger under the scheme of arrangement with approval by the Court: This type of demerger requires a scheme of arrangement to be prepared, outlining the terms of the demerger and binding all stakeholders. The scheme of arrangement must be approved by the appropriate tribunal with jurisdiction. The process involves the preparation of the scheme, application to the tribunal, issue of notice, holding of a meeting, and petitioning and sanctioning by the tribunal.

Also read – Introduction To the Indian Tax System

The Reliance Industries Demerger of December 2005

A notable example of a demerger is the case of Reliance Industries Ltd. (RIL). In August 2005, the demerger of RIL was approved, resulting in the creation of four new entities: Reliance Communications Ventures, Reliance Energy Ventures, Global Fuel Management Services, and Reliance Capital Ventures.

The demerger was planned by the Ambani brothers, Anil and Mukesh, in a way that allowed petrochemicals, refining, oil and gas exploration, and textiles to remain with Mukesh and RIL. Communications, energy, and capital ventures were transferred to Anil’s control and management. Shareholders of RIL received shares of the resulting companies in a 1:1 ratio. For example, a shareholder holding 100 shares of RIL would receive 100 shares each of Reliance Communications Ventures Ltd, Reliance Energy Ventures Ltd (REVL), Reliance Capital Ventures Ltd (RECL), and Global Fuel Management Services Ltd.

The demerger scheme received approval from the board, Mumbai High Court, stock exchanges, and shareholders. It proved beneficial for shareholders due to the following reasons:

  • Shareholders received shares proportional to their holdings in RIL, allowing them equal participation in the growth and progress of the company.
  • Shareholders had the opportunity to participate separately and collectively in the overall growth of the four demerged independent companies.
  • The demerged companies were listed on the same stock exchanges as RIL, providing liquidity to shareholders.
  • Shareholders had direct participation, offering them growth prospects and involvement in the business.

To summarize, demergers are a valuable form of corporate restructuring when a company seeks to transfer one or more undertakings to another company or split them into separate entities. Following the proper procedure under Section 232 of the Companies Act, 2013, ensures the successful implementation of a demerger. The example of Reliance Industries Ltd. demonstrates the advantages of demergers for shareholders when well-planned and aligned with the organization’s overall benefit.

Conclusion

In conclusion, corporate restructuring is often necessary for companies to adapt to changing circumstances and improve their financial positions. Demergers, a type of corporate restructuring, provide companies with the means to specialize and focus on specific aspects of their business. They involve the division or splitting up of a business entity into separate units, allowing for individual growth and increased efficiency.

Demergers can take the form of spin-offs or split-ups, depending on the company’s objectives. It is crucial to follow the proper procedures, such as agreements between promoters or schemes of arrangement approved by the court, to carry out demergers successfully. The example of Reliance Industries Ltd. illustrates the benefits of demergers for shareholders, promoting fair participation, growth, and liquidity.


FAQs

1. What is corporate restructuring?

Corporate restructuring refers to the process by which a company brings about organizational, structural, financial, or managerial changes to adapt to new circumstances or improve its performance.

2. Why do companies opt for demergers?

Companies choose demergers when they want to promote specialization and focus on specific aspects of their business. Demergers allow for separate growth and increased efficiency of the divided units.

3. What are the types of demergers?

The two main types of demergers are spin-offs and split-ups. Spin-offs involve the separation of an undertaking from the parent company, while split-ups result in the parent company ceasing operations and forming one or more independent companies.

4. What is the procedure for conducting a demerger?

Demergers can take place either through an agreement between promoters or under a scheme of arrangement approved by the court. The process involves preparing the scheme of arrangement, filing an application with the tribunal, issuing notices, holding meetings, and obtaining sanction from the tribunal.

5. Can you provide an example of a real-life demerger?

One notable example of a demerger is the case of Reliance Industries Ltd. (RIL) in December 2005. The demerger resulted in the creation of four new entities, namely Reliance Communications Ventures, Reliance Energy Ventures, Global Fuel Management Services, and Reliance Capital Ventures, each specializing in different areas of business. Shareholders of RIL received shares in these resulting companies in proportion to their holdings in RIL.

Also read – Best Apps To Understand Stock Market

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