Is a Valuation Report a necessity in the case of a Demerger?

If your company has recently been demerged or on the verge of getting demerged then you might be confused as to the preparation of the valuation report and the importance attached to it. There are various factors of a company that are involved in a valuation report that may be required to smoothly complete the process of demerger and because of this reason, it creates confusion as to whether a valuation report is mandatory in case of demergers. 

With the help of this Article, we have tried to quickly provide you with accurate guidance as to whether a valuation report should be prepared and mandatory in the case of demergers or not.

What is a Demerger?

Demerger is a type of corporate restructuring that is performed to improve the overall performance and efficiency of the organization. Demerger as per the Income Tax Act, 1961 is a kind of transfer in consonance with the Scheme of Arrangement made under Section 230 to Section 233 of the Companies Act, 2013. 

In the action of Demeger, the resulting entity is either completely dissolved or incorporated into an altogether new entity. If a new entity is being incorporated out of the demerging entity then in such a manner the rights, liabilities, and operations of the demerging entity will become the rights, liabilities, and operations of the newly incorporated entity. 

There are various reasons for choosing demerger as a form of corporate restructuring. These are as:

• Growth and Expansion of the business
• Bifurcating the non-performing assets of the organisation
• Giving more importance to the core business values
• Due to regulatory reforms

What is the process of NCLT-approved Demerger? 

The main provision of the Companies Act, 2013 for the NCLT-approved procedure states that the statement of an auditor is required to prove that the treatment of accounts of the company as proposed in the scheme of arrangement has been approved in accordance with the accounting standards prevalent in the country. The process of NCLT-approved Demerger is jotted down below. 

• Board Authorization: The first step in the process of demerged approval by the NCLT is to check that the Board of Directors has the power to approve the Scheme of Arrangement. If the Board of Directors is not authorised to approve the Scheme of Arrangement then a special resolution is required to be passed to authorise the Board of Directors to approve the Scheme of Arrangement.

• Preparation of the Scheme of Arrangement: After giving the powers to the Board of Directors the next step in the process of the demerger is to prepare the Scheme of Arrangement and fix the date to implement the Scheme of Arrangement in consultation with the stakeholders of the demerging organisation. 

• Convene of the Board Meeting: After the preparation of the Scheme of Arrangement and fixing the effective date of it. The next step in the process of demerger is to convene a meeting of the Board of Directors in order to confirm the filing of the application for initiating the process of demerger in the National Company Law Tribunal (‘NCLT’). The application is filed to get the approval of the NCLT thereby appointing a Registered Valuer for the division of the assets of the demerging entity. 

• Presentation of the Application: After obtaining approval from the Board of Directors the application for the approval of the Scheme of Arrangement is presented to NCLT by submitting Form NCLT-1 accompanied by affidavits in Form NCLT-6. 

• Convening a Meeting: This step in the process of demerger is dependent on the whims of the NCLT. If NCLT finds it essential it may order convening a meeting of the Shareholders or Creditors after hearing the first motion petition. 

• Presenting the Notice of the Meeting: A notice in Form CAA-2 is required to be served upon the shareholders or creditors specifying the details of the scheme, and its effect on the key managerial personnel, employees, and directors of the entity along with a copy of the Valuation Report (if available and applicable).

The notice of the meeting is also required to be served upon various government entities that may be affected by the Scheme of Arrangement. The government entities are given 30 days to present any objection to the Scheme of Arrangement. 

The government authorities may be the Reserve Bank of India, Income Tax Department, Consumer Commission of India, Securities and Exchange Board of India, etc. 

• Voting: The stakeholders or the creditors of the organisation are required to vote on the Scheme of the Arrangement/ Demerger within a span of 30 days from the date of the receipt of the notice. The above-mentioned persons may submit their vote in person, or through a proxy, through the postal ballot vote system. Objections to not voting can be entertained by the person who either holds 10% of the shareholding of the entity or at least has 5% outstanding debt from the entity as disclosed in the latest financial audited account of the organisation. A report is required to be filed by the Chairman regarding the intimation of the meeting of the NCLT. 

• Filing the Second Motion Petition: The entity is required to file the second motion petition to the NCLT for approving the Scheme of the Demerger within the passing of 7 days from the date the report of the meeting is submitted by the Chairperson to the NCLT. 

• Obtaining the order of Demerger by NCLT: The last step in the process is to obtain the order of the demerger by the NCLT. The order of the NCLT for the approval of the Scheme of Demerger is required to be filed to the Registrar of Companies within 30 days under FORM INC-28. 

Hence, this concludes the process of obtaining the approval for the Scheme of Demerger from the NCLT. 

Valuation under the Companies Act, 2013

It is the process of defining and determining the value of a company in terms of its economic capacity. Valuation is used by the investors, stakeholders, or even intermediaries to know the actual worth of the company. Valuation is performed to determine not only the value of the business but sometimes for establishing partner ownership, divorce proceedings, or from the point of view of taxation. Hence, deriving a valuation report for the organisation is a pivotal piece of evidence. 

Section 247 of the Companies Act, 2013 at a glance

Section 247 of the Companies Act magnifies the importance of the appointment of a registered valuer for the valuation of the stocks, shares, property, debentures, goodwill, net worth of the organisation, its assets, etc of an organisation. For the fulfilment of these above purposes, an organisation is required to appoint a Registered Valuer (‘RV’) who in turn will be registered under the Insolvency and Bankruptcy Board of India (‘IBBI’) and the RV is required to be appointed by the Board of Directors or the Audit Committee. The RV is required to follow the rules and regulations as specified in the IBBI.

Conditions which necessities the preparation of the Valuation Report mandatory

In various instances, it becomes necessary to prepare the Valuation Report by the registered Valuer appointed under the IBBI Code. These instances are as under:

• Acquisition of the shares of Minority Shareholders by the existing majority shareholders as provided under Section 237 of the Companies Act, 2013.
• Buyback of Shares 
• Liquidation of the organisation under the Insolvency and Bankruptcy Code, 2016
• Issue of the shares other than the right issue
• Restructuring of the organisation as provided under Sections 230-232 of the Companies Act, 2013. 
• Issue of the Sweat Equity Shares
• Allotment of the Shares but in consideration other than cash 

Now the question triggers as to the requirement of a Valuation Report in case of a Demerger. Let’s understand it in more detail in the next section. 

Importance of Valuation Report in Case of Demerger

As per the above discussion, it can be ascertained that preparing a Valuation Report under Section 230-232 of the Companies Act, 2013 while performing the restructuring of the organisation is very essential to the fact that the allotment of the shares is based upon the actual valuation of the organisation.  There are three approaches to finding the Valuation of an organisation and these are as:

• Asset Based Valuation 

• Market-Based Valuation

• Income Based Valuation 

These are the three approaches to Valuation that must be followed while calculating the exact valuation of an organisation. Apart from obtaining the Share Entitlement Ratio in the case of the Demerger it also becomes essential to find the right number of shares to be allocated to the shareholders of the new entity. If the Demerged entity will be used as a Shell Company then in such a case it is highly required to have a Valuation Report in order to truly determine the Capital Structure of the Demerged Entity.  

Conclusion

A Valuation Report is mandatory and one of the essential documents to be obtained in order to smoothly complete the process of the Demerger. A Valuation Report is required to be sent along with the Notice of the meeting ordered by the NCLT for the approval of the Scheme of Amalgamation. 

Frequently Asked Questions

Q1. Do you need a Valuation Report when filing a scheme of demerger?

Ans1. Yes, a Valuation Report is required to be sent to the NCLT along with the application for the Demerger to NCLT. 

Q2. What is a Merger/Demerger Valuation?

Ans2. Valuation for Merger/Demerger is to arrive at the cost of the shares of the company. It does mean the absolute value but to the relative value. 

Q3. Why is a Valuation necessary in a Demerger Scheme?

Ans3. A Valuation Report is necessary in the case of a Demerger Scheme in order to arrive at the correct share distribution ratio after the completion of the Demerger.

Q4. What are the approvals required for Demerger?

Ans4. It is imperative to obtain the approval of the NCLT to initiate the Demerger of an entity. 

Q5. What happens in the case of Demerger?

Ans5. In the case of the Demerger the parent companies are bifurcated into separate units which will eventually be formed into a new entity or dissolved altogether.