Why M&A Deals in India Require Specialized Assistance?
In India, M&A transactions are considered to be the highest in Asia, upon an average the amount of transactions made each year is an excess of $80-100 billion. There are several aspects involved for M&A in India due to the complications of cross broader transactions, it is crucial to have your expertise in Companies Act, Competition Act, FEMA Act 1999, SEBI (SAST) Regulation, etc.
1. The Regulatory Matrix: A guide to when and where to look
There is no particular regulation which fully deals with M&A transactions, the practitioner not only needs to be acquainted with the flow of money involved in the regulation of these transactions, the legal prospects includes the following:
> DPIIT for FDI policies
> The Ministry of Corporate Affairs (MCA), which deals with all corporate laws issues
> The Competition Commission of India (CCI) for any large merger cases
> SEBI for any acquisition of a public company
> The Reserve Bank of India (RBI) for all foreign exchange issues
The different bodies have their own timelines for compliance in such cross-border acquisitions involving publicly held Indian companies.
2. Two Types for FDI in India: Automatic v. Government Route
FDI is allowed in most forms via a binary mechanism as it allows 100% foreign ownership through Automatic Route. Investors are required to repatriate proceeds from FDI investment by sending notice to the Reserve Bank within 30 days after receipt of the investment. However, the Government Route applies to certain industries that are classified as being strategically significant and therefore required Government approval prior to making the investment.
The industries for which the Government has imposed restrictions on FDI include:
a. Banking
b. Defence Manufacturing
c. Establishing and operating Satellites
d. Broadcast Content Services
e. Mining of select minerals
f. Print Media
Certain industries are prohibited from receiving FDI. Examples of prohibited businesses’ activities are lotteries, gambling, chit funds, Nidhis and real estate businesses that are different from Townships and Construction – Development.
Pricing Norms- A Chief Compliance Area : Another significant compliance issue with inbound investment transactions is pricing under FEMA. The investment value for unlisted Indian companies’ equity instruments must be equal or exceed the fair market value (FMV) calculated by a SEBI-registered investment banking firm using generally accepted international valuation standards. Price may not be under the minimum value established by the SEBI Takeover Code in the case of listed companies. Failure to adhere to pricing norms renders the downstream investment invalid under FEMA, with consequences including compounding proceedings before the RBI and potential repatriation obligations.
3. The SEBI Takeover
SEBI regulates acquisitions of shares and takeovers by listed companies in India through the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 which requires acquirers to make an open offer to the public market (i.e. shareholders) when:
a. They acquire either 25% or more of the voting rights or shares in a targeted company (this is a ‘trigger’) or if they already have at least 25% and acquire more than 5% additional shares in a financial year (this is called a ‘creeping acquisition trigger’).
b. To comply with this requirement, an open offer must be made for the public’s minimum share of 26% of the total issued stock in the target company.
Categories of exemptions from open offer obligations include but are not limited to:
> The acquisition of shares by the Government
> The acquisition of shares through a scheme of arrangement approved by an NCLT
> Acquisition of shares as part of a preferential allotment at a price that complies with SEBI’s pricing guidelines
> Inter-se transfers made by promoters (subject to conditions)
Practitioners are regularly creating their deals/transactions to qualify for an exemption category wherever possible, while SEBI has demonstrated an interest in looking through the form and determining the true substance of arrangements in situations that clearly appear to be created to circumvent the intent of the Code’s provisions.
4. CCI Mergers & Control
Within the realm of CCI merger control, CCI is authorized to pre-notify parties intending to consummate a merger, without obtaining approval. Therefore, CCI’s jurisdiction extends to the completion of a merger subject to asset or turnover thresholds set by the Competition Act, 2002 as amended from time to time.
Thresholds (Post 2023 Amended) : The introduction of a new “deal value” threshold in the Competition (Amendment) Act, 2023 creates a new threshold for CCI in conjunction with the long-established asset/turnover thresholds and will thus impact how high-value digital/technology acquisitions are reported to CCI, as most of these companies may not have substantial fixed assets or revenues. The asset value threshold also now requires that a combination be notified when an acquirer and a target have consummated a combination that exceeds INR 2,000 crore in value and that the target businesses have a substantial business presence in India.
The traditional thresholds continue to be applicable today:
i. The value of combined assets located in India exceeds INR 2,000 crore or the aggregate turnover from India exceeds INR 6,000 crore.
ii. The aggregate value of combined assets worldwide is at least USD 1,000 million with at least INR 1,000 crore of assets in India or the aggregate value of worldwide turnover of the parties exceeds USD 3,000 million with at least INR 3,000 crore of turnover in India.
The Gun-Jumping Problem: In the event that a notifiable combination is consummated before obtaining CCI’s approval (i.e., gun-jumping), CCI can impose a financial penalty on the parties to the transaction equal to 1 percent of the combined worldwide turnover or combined worldwide assets of the parties. The size of many transactions that exceed the CCI’s thresholds exposes parties to a significant risk of financial penalties.
5. Cross-Border Mergers
The following deals with outbound and inbound cross-border mergers across India:
> Section 234 of the Companies Act, 2013
> Companies (Compromises, Arrangements and Amalgamations) Rules 2016
> RBI Cross Border Merger Regulation 2018 published under FEMA.
Outbound Mergers (Indian Company Merging Into Foreign Company): The resultant entity from an outbound merger would be the foreign company. Shareholders of the Indian company will receive shares or some other consideration from the foreign entity; as such the Indian company ceases to exist effectively. However, in an outbound merger, there are Overseas Direct Investment (ODI) implications under FEMA and the resulting entity must be incorporated in a jurisdiction that is FATF compliant and not included on the SEBI non-compliant list.
Inbound Mergers (Foreign Company Merging into Indian Company): The resultant entity from an inbound merger would be the Indian company; therefore, the foreign company would merge into the Indian company. The shareholders of the foreign company receive shares in the surviving Indian merger; and therefore if the merger does not satisfy automatic route conditions for FDI, as with regards to the foreign companies’ shareholders being citizens of a country sharing a land border with India (Pakistan, China, Bangladesh, etc.,) that require separate Government approval for any investments made within India, RBI approval is required.
6. Options for Acquiring a Business Entity
Tax Implications: Selecting the appropriate structure of your transaction is an important factor to consider when planning an M&A (mergers and acquisitions) transaction within the Indian market due to the consequences it may have on stamp duty obligations, taxation terms of regulation approvals required (i.e., CCI, SEBI, FEMA), as well as third party approvals.
Slump Sale: A slump sale is defined under Sec 50B of the Income Tax Act 1961 as the transfer of an undertaking (i.e., business) as a going concern for a lump sum amount without allocating individual values to the assets and liabilities of that undertaking. Slump sales typically arise in the context of business unit carveouts. The tax consequences of completing a slump sale include potential treatment as long-term capital gains or short-term capital gains depending on whether the undertaking was owned for the appropriate period of time. Additionally, the absence of the requirement to assign the separate value of each asset being transferred through the slump sale structure creates a compelling reason for completing an M&A transaction through the structure in certain instances. Asset-by-asset acquisition provides for selectivity – the acquirer picks up the assets and liabilities that it wishes to continue and leaves behind ongoing liabilities, litigation exposure or undesirable contracts. The disadvantage is that it adds complexity to the sale process, as each class of asset has its own stamp duty and contracts will usually require the individual consent of all counter parties to assign them. GST implications of the transfer of individual assets will also need to be assessed.
Share Acquisition: One method of purchasing a business entity is to acquire the shares of the target company; therefore, the buyer steps into the shoes of the existing shareholders and assumes all the rights of those shareholders. All regulatory approvals necessary to complete the transaction (i.e., CCI, SEBI, FEMA) will apply at the time of completing the transaction, however, the contracts (and/or agreements) with the target entities will continue unchanged (unless there is a change in control clause). In addition, stamp duty on the transfer of shares to the buyer is due at a rate of 0.015% on the amount of consideration paid to the seller for shares acquired by way of delivery.
7. Representations, Warranties and Indemnity in Market Practices
Over the last decade, the M&A documentation practices in India have continued to move closer to global standards; this is particularly true for both PE-backed transactions and cross-border transactions. Despite this improvement, there still remain many specific nuances regarding the market in order to make them work properly:
> The complexity of India’s direct and indirect taxation system requires special consideration with tax indemnities, especially with respect to the implications of the Goods and Services Tax (GST) regime, the requirements for transfer pricing and the implications of the General Anti-Avoidance Rule (GAAR) under the Income Tax Act.
> Evolving market practices include the continued use of Warranty and Indemnity (W&I) Insurance for transactions related to India, especially for PE exits, although the market is still not as deep as in the UK and US and the pricing reflects this.
> MAC (material adverse change) clauses require careful drafting from an Indian perspective since there is Regulatory Conditionality that may increase the timelines and/or change the circumstances of the parties at the time of closing.
> Competitive auction processes have moved toward the use of locked-box mechanisms in lieu of completion accounts, causing a decline in disputes occurring after closing.
8. Cross Border Transactions Dispute Resolution
There has been a significant change in the landscape of dispute resolution of the cross border M&A deals. There are several organisations organised globally for arbitration like LCIA, ICC, and SIAC, of the centres are outside India like Singapore and London. Nationally, the SC has accepted concepts like competence-competence and separability making the arbitration agreements more clear. There are several efforts by the legislature as well to revamp the administrative framework with the help of recent changes in Arbitration and Conciliation Act, 1996. Nevertheless, questions still arise in regards to structuring dispute resolution and interim relief in India.
9. Conclusion
Accuracy is essential for professionals India in order to maintain stringent guidelines on M&A and FDI transactions. Failure of it may create several severe and irreversible problems, from invalid investments owing to pricing discrepancies to mandatory open offers to invalid investments owing. Hence, it is crucial for legal professionals to thoroughly understand the multi-disciplinary nature of M&A in India’s muti-disciplinary structure of transactions. There is a need to be continuous updates from the ever changing laws to the changes in the digital realm.
