CES Ltd’s demerger scheme – benefits whom out of all stakeholders?

CES Limited is an Information Technology (IT) and Information Technology Enabled Services (ITES) provider, dedicated to serving the midsize market of global enterprises. It has mainly two divisions i.e., IT Division and ITES Division. The Company is listed on BSE Limited and has only 26 shareholders.

Shareholding Pattern of CES Limited:

Shares of CES Limited are not frequently traded. Out of 14 shareholders, few shareholders might not be traceable since they are still holding the shares in physical form.

The Transaction:

Management of the CES Limited (Demerged Company) proposed the demerger of the “ITES Business” into its presently “wholly owned subsidiary” i.e., CES Technology Private Limited (Resulting Company) on going concern basis through scheme of arrangement.

Appointed Date fixed for this transaction is 1^st April 2022 and the scheme will become effective from the date of filing certified copy of the scheme with the Registrar of Companies.

ITES Division getting demerged has Total Assets of Rs.45.50 Crores consist of majorly Investments in the subsidiary companies in India, USA and Trade Receivables.

Since the investment in the foreign subsidiaries is getting transferred, post scheme of arrangement, Resulting Company will have to comply with the FEMA Compliances w.r.t Overseas Direct Investment.

Scheme of Arrangement also providing for the following:

1. Delisting of the Demerged Company from stock exchange.
2. Reorganization of capital of Demerged and Resulting Company

Rationale of the Scheme: –

The Demerged Company has excellent forays into the markets and with an objective to increase their market share; the promoters seek investment by external investors/ partners. The Board of Directors of the Demerged Company wants to delink the ITES business completely from all other activities hence considered prudent to demerge ITES business of the Demerged Company.

Company has proposed Delisting of the Demerged Company to save the high compliance cost.

Swap Ratio:

Upon the scheme becoming effective, 1 (One) fully paid-up equity share of the Resulting Company will be issued as fully paid up, for every 2 (Two) fully paid-up equity shares of the Demerged Company.

Shareholding pattern of “Resulting company” post scheme of arrangement:

No listing of the Resulting Company:

In most cases involving demerger of undertaking from the Listed Demerged Company into unlisted Resulting Company, post scheme of Arrangement Resulting Company gets listed on the stock exchange where shares of the Demerged Company are listed.

SEBI Master Circular dated 23^rd November 2021 governing scheme of arrangement of listed company do not contain any direct provision for the compulsory listing of the Resulting or Transferee Company where Demerged or Transferor Company is listed on the stock exchange.

Pursuant to section 232(3)(h) of the Companies Act, 2013 if the Transferor Company is listed company, Transferee Company shall remain unlisted until it becomes a listed company. Which means, Transferee Company shall not become mandatorily or automatically listed even though the Transferor Company is a listed company. The said section also provides the right to the shareholders of the Transferor Company to take exit for payment of the value of shares held by them

In the past, SEBI through its observation letter has raised objections in similar cases like scheme of Arrangement of Sterlite Technologies Limited, scheme of Amalgamation of Zodiac Ventures Limited. Contrary to it, SEBI issued No objection letter to scheme of arrangement of Alembic Limited where shares issued by the unlisted resulting company to the shareholders of the Alembic Limited were not listed.

Since the regulatory framework does not provide much clarity, companies have to rely on older precedents of draft schemes filed with the stock exchanges and SEBI’s observation letters for structuring the mergers or demergers involving a listed transferor company and an unlisted transferee company. This leads to uncertainty over whether SEBI would raise objections to such a scheme.

In this case, there will not be any benefit if the Resulting Company gets listed since there will be same set of shareholders as of the Demerged Company.

Delisting of the Demerged Company without exit opportunity:

Scheme of Arrangement provides for the delisting of equity shares from stock exchange “without providing for exit opportunity” to the shareholders and compliances of the SEBI Delisting Regulations shall be deemed to be exempted for the Demerged Company. Upon the intimation of order of Hon’ble NCLT to the stock exchange, stock exchange shall delist the shares from their exchanges as if the company has voluntarily delisted its shares from stock exchanges.

There is no direct provision under SEBI Delisting Regulations which provides exemptions from the compliances of Delisting Regulations. Scheme of Arrangement being single window clearance mechanism and Hon’ble NCLT being quasi-judicial body, decision of the NCLT will prevail over the stock exchanges. Stock Exchanges may ask the Demerged Company to pay the delisting fees through observation letter.

Whether SEBI will raise any objection in the observation letter?

Even though the scheme of arrangement including delisting will be approved by the shareholders, SEBI may direct the demerged company to give optional exit to the shareholders at fair value on the sole reason that there will not be any exit opportunity post scheme of arrangement and delisting of the Demerged Company and Resulting Company not getting listed.

Reorganization of Capital of the Demerged and Resulting Company: –

Clause no, 7.4 of the scheme of arrangement provides for the reduction of capital through reduction in the face value of the Demerged Company from Rs. 10 to Rs. 7 and accordingly paid-up capital of the Company shall be reduced from Rs. 36,40,00,000 to Rs. 25,48,00,000.  This reduction does not provide for any payment to any shareholder.

Since the Resulting Company is wholly owned subsidiary of the Demerged Company, there will be cancellation of investment and reduction in paid-up capital of the Resulting Company. Face Value of the Resulting Company will get reduced from Rs. 10 to Rs. 3.

Post Scheme of Arrangement, shareholders of the Demerged Company will hold shares in both the companies. Through scheme of Arrangement, value of share of the Demerged company i.e Rs. 10 will be divided in Demerged Company and Resulting Companies as follows: –

1. Face Value of the Demerged Company will be Rs. 7
2. Face Value of the Resulting Company will be Rs. 3

Conclusion

This is the scheme in which one of the businesses of the listed company goes private without giving an opportunity to minority shareholders. So, it is to be seen how stock exchanges and SEBI looks at the scheme before giving approval for the company to go head and file the scheme with NCLT.