Overview Of Current Laws And Regulations Governing Mergers And Acquisitions In India, With A Focus On Cross-Border Transactions. By - Alan Baiju

Overview Of Current Laws And Regulations Governing Mergers And Acquisitions In India, With A Focus On Cross-Border Transactions.

Authored By - Alan Baiju

Introduction

A merger is when two or more separate companies combine to become a single company, with one company typically being the dominant organization. There are three types of mergers: horizontal, vertical, and conglomerate. On the other hand, an acquisition occurs when one company directly or indirectly acquires another company's shares, voting rights, properties, or control over management. Acquisitions can be friendly or hostile, depending on whether the target company's management agrees to the terms of the acquisition or not.

Legislative Framework

The main legislation and regulations governing Indian M&A activities are:

1. Companies Act, 2013: This is the primary legislation governing companies and mergers. It is administered by the Ministry of Corporate Affairs (MCA).
2. Securities Regulations: The securities markets are regulated by the Securities and Exchange Board of India (SEBI). The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code) govern substantial stake acquisitions in publicly listed companies. The SEBI (Delisting of Equity Shares) Regulations, 2009 govern take-private transactions.
3. Foreign Exchange Management Act, 1999 (FEMA): This act is administered by the Reserve Bank of India (RBI) and the Government of India. FEMA, the rules issued by the Government of India thereunder, and the associated RBI regulations regulate capital inflows and outflows.
4. Competition Act, 2002: The Competition Commission of India (CCI), the regulator established under the Competition Act, accords anti-trust approvals.
5. Income Tax Act, 1961: Administered by the Income Tax Department, the Income Tax Act along with double tax avoidance treaties entered into by the Indian government govern the tax treatment of M&A transactions.
6. Insolvency and Bankruptcy Code, 2016 (IBC): Administered by the National Company Law Tribunals, the IBC regulates auction sales under a corporate insolvency resolution process.

These regulations provide a framework for Indian M&A activities and ensure that such activities are conducted in a transparent and lawful manner.

Recent legislative changes in India have had an impact on M&A activities in the country. For instance, tax laws now allow businesses to opt for a lower corporate tax rate of 22% (as compared to the standard corporate tax rate of 30%), subject to certain conditions. The concessional rate of 25% has also been extended to companies with a revenue of up to INR 4 billion. In addition, a preferential tax rate of 15% has been introduced for new domestic manufacturing companies established and registered on or after 1 October 2019 and starting production on or before 31 March 2023.Another recent development is the abolishment of foreign investment caps for insurance intermediaries. The previous limit of 49% on foreign ownership of insurance intermediaries has been removed.

In terms of regulatory requirements, Indian M&A transactions above certain thresholds require approval from the Competition Commission of India (CCI). The 2019 amendment introduced a 'green channel' merger control route that allows for the approval of certain transactions with low competitive effects. Other recent legislative and regulatory developments include the imposition of stamp duties on the transfer and issuance of dematerialised securities, which were previously excluded from stamp duties. The implementation of the Personal Data Protection Bill 2019 has also had a significant impact on the Fintech, e-commerce, financial services, and healthcare sectors. Additionally, private unlisted InvITs have been included under SEBI's existing InvIT scheme, offering considerable market flexibility and lower regulatory scrutiny compared to listed InvITs. These developments are expected to have a bearing on future M&A deals in India.

Public M&A

In India, mergers and amalgamations must be approved by the National Company Law Tribunal. For publicly listed companies, acquirers can choose to gain control through either voluntary or mandatory tender offers. If an acquirer obtains 25% or more of the voting rights or ownership of a publicly listed company, they are required to make a public offer to acquire at least 26% of the target's stock, as per the Takeover Code. Acquirers must also ensure that the minimum public float of 25% is maintained at all times, unless the target is delisted under the transaction.

Delisting can be challenging in India, and requires a reverse book-building process to determine the offer price, which often results in a significant premium. If the discovered price is deemed unreasonable, the acquirer may make a counter-offer that cannot be lower than the book value. Hostile takeovers of publicly listed entities have been uncommon in India, with the exception of Larsen & Toubro's successful hostile takeover bid for Mindtree in 2019.

Public takeovers may require regulatory approvals from sector-specific regulators and anti-trust authorities. These approvals may be conditional and require additional compliance measures.

Private M&A

In private M&A transactions in India, the Completion Accounts system is commonly used for price adjustments, but locked-box pricing mechanisms are gaining popularity. Earn-out and escrow structures are also becoming more common, although cross-border transactions may face restrictions under the Exchange Control Regulations.

While warranty and indemnity insurance is not yet prevalent in India, the market for such products is growing rapidly due to an increase in cross-border transactions and the need for seller credit risk mitigation. However, compliance periods and insurance rates are higher than in developed markets.

Private takeover offers are not allowed in India because private companies are allowed to restrict the transfer of shares. However, exceptions to this rule include transactions involving the exercise of contractual rights, such as tag-along and drag-along rights of majority investors or the sale of pledged securities by lenders. In February 2020, the Ministry of Corporate Affairs issued guidelines for the operationalization of private takeovers by the National Company Law Tribunal, which require shareholders with a 75% or more interest in a company to buy out the minority subject to certain conditions and defined pricing standards.

Indian law generally governs private M&A transactions, but cross-border transaction documents for dispute resolution often provide for foreign-seated arbitration in Singapore, New York, or London.

Cross Border Mergers and Acquisitions

In today's global market, cross-border mergers and acquisitions (M&As) have become increasingly popular. The liberalization of financial policies, policy reforms, and regional agreements have contributed to the cross-border reallocation of capital. In the past, developed countries such as the EU15 and the United States were the primary acquirers and target countries of M&As.

Cross-border M&As involve deals between international corporations and domestic companies in the target region. This trend has been propelled by the globalization of the world economy. The 1990s were a "golden decade" for cross-border M&As, with a nearly 200 percent increase in the number of these transactions in the Asia Pacific region. The reason for this was that many countries in this region were opening up their economies and liberalizing their policies, providing these deals with the necessary impetus. Latin America and Africa have also been drawn into more cross-border M&As in recent years due to political gridlock in countries such as India, which cannot decide whether more foreign investment is necessary, China's dominance, and Africa's rapid emergence as an investment destination. Furthermore, Latin America's high economic growth rates have made it an attractive location for cross-border M&As.

Legislative framework of cross-border M&A

Prior to the Companies Act 2013, Indian law only allowed inbound mergers, which meant that only foreign firms were permitted to merge with Indian companies and not the other way around. However, the Act proposed providing for all types of mergers under section 234, which was not published at the time. Under the Companies Act 2013, Indian companies are now allowed to merge with foreign corporations. The Act states that provisions relating to mergers and amalgamations shall extend to companies listed under the Companies Act and those incorporated within the jurisdiction of countries approved by the central government in consultation with the RBI[1]. The definition of a foreign company has also been expanded to include any company or corporate body incorporated outside India, whether or not it has a place of business in India. As per the definition section, a foreign company is a corporation registered in any jurisdiction outside India which has a place of business in India,[2] whether on its own, through an agent, physically, or electronically, and conducts its business in India in some other way[3]. Payment of consideration can be rendered to the shareholders of the merged companies in the event of a merger corporation.

To implement section 234 of the Act, the Ministry of Corporate Affairs, in consultation with the RBI, notified the corresponding rules on April 13, 2017. The Companies (Compromise, Arrangement and Amalgamation) Amending Rules 2017 inserted Rule 25A and Annex B in the Companies (Compromise, Arrangement and Amalgamation) Rules 2016 regarding the operation of Section 234. The rules provide that both categories of mergers, inbound and outbound, are subject to the prior approval of the RBI and the provisions of the Companies Act 2013. For an outbound cross-border merger, the foreign entity concerned should be in consultation with the RBI from a jurisdiction approved by the central government.

Factors to be considered for cross-border mergers and acquisitions.

The Companies Act 2013 allows for the merger of Indian companies with foreign corporations. However, for an outbound cross-border merger, the foreign entity must be in consultation with the Reserve Bank of India (RBI) from a jurisdiction approved by the central government. The Act notes that provisions relating to mergers and amalgamation shall extend mutatis mutandis to mergers and amalgamation between companies listed under the Companies Act and those incorporated within the approved jurisdiction.

The Ministry of Corporate Affairs, in consultation with the RBI, notified section 234 of the Act with corresponding rules via notification dated 13 April 2017. The rules provide that both categories of mergers, i.e., inbound and outbound, are subject to the prior approval of the RBI and the provisions of the Companies Act 2013.For an outbound cross-border merger, the foreign entity concerned should be in consultation with the RBI from a jurisdiction approved by the central government. These jurisdictions include states whose stock market regulator is a signatory of a bilateral Memorandum of Understanding with SEBI or the Multilateral Memorandum of Understanding with the International Securities Commission, or those whose central bank is a member of the International Settlement Bank (BIS).

In addition, the jurisdiction must not be listed in the Financial Action Task Force's public statement (FATF) as a jurisdiction with specific anti-money laundering or anti-terrorism funding weakness usually protected by countermeasures. It must also not be a jurisdiction that has not made significant progress in addressing the deficiencies or has not committed itself to any action plan established with the Financial Action Task Force to address the deficiencies.

It is essential to note that cross-border M&A only materializes when incentives are available for both parties to do so. Due diligence is crucial when negotiating an M&A transaction, especially with domestic firms in emerging markets that often overstate their capabilities to attract M&A. Management consultants and investment banks are often hired to assist multinational companies in identifying potential M&A partners and countries.

International firms also face various risk factors associated with cross-border M&A, such as political risk, economic risk, social risk, and general risks associated with black swan incidents. International companies create a risk matrix consisting of all these elements to determine potential M&A partners and countries.

The factors that inspire cross-border M&A firms include globalization of the financial market, market pressure and declining demand due to foreign competition, seeking new business opportunities as technology rapidly evolves, improving the productivity of companies in the manufacture of goods and services, achieving the goal of growing profitably, increasing the production scale, and technology sharing and innovation that reduces costs. Regulatory approvals and political support are also necessary for cross-border M&A to take place. Without such facilitating factors, the agreements cannot be concluded.

Recommendations to promote cross-border M&A in India Top of FormBottom of Form

Cross-border mergers and acquisitions (M&A) are becoming increasingly common in today's global economy. However, existing legislation, such as the Income Tax Act and Exchange Control Regulations, needs to be amended to ensure consistency and clarity in the procedures. For instance, the Indian Income Tax Act currently exempts mergers where the transferee is an Indian corporation, but not when the transferee is a foreign corporation. The lack of clarification on the legality of demergers also needs to be addressed.

To ensure continuity, the Reserve Bank of India (RBI) should establish a comprehensive regulatory structure that outlines the eligibility requirements and other considerations to be taken into account when reviewing cross-border M&A transactions. The Indian Companies Act's provisions on agreements, arrangements, and mergers also need to be amended to comply with the new provisions on outbound mergers, particularly with respect to the applicability of foreign company laws.

It is crucial to coordinate all cross-border merger transactions with the criteria outlined in Indian foreign exchange legislation. Rule 25A requires compliance with Sections 230 to 232 of the Act, with the transferee company seeking permission from the National Company Law Tribunal (NCLT). However, cross-border mergers are exempted from the applicability of section 233, which means that a wholly owned foreign subsidiary cannot merge into its Indian holding company, or vice versa, using the fast-track merger process.

The competition act should also be appropriately applied in the case of cross-border M&A to ensure that the transaction does not lead to a reduction in competition. The Indian government must make more clarifications and amendments, taking into account the practical implications of cross-border mergers. These changes will help promote transparency, consistency, and clarity in cross-border M&A transactions.

Conclusion

Despite facing global economic headwinds and poor macroeconomic indicators, India's M&A operations are expected to display continued resilience. This is largely due to the implementation of recent business-friendly reforms, such as favourable tax policies and the elimination of some sectoral foreign investment limits, as well as proposed regulatory reforms. In addition to these factors, there are several other developments that are likely to drive M&A activity in India. For example, the continued divestment of state-owned properties, increasing trust in the insolvency process, and the appetite for buyouts and domestic consolidation are all likely to contribute to a robust M&A landscape in the country.

Furthermore, new investment instruments, such as InvITs and REITs, have gained prevelance. These instruments provide investors with greater flexibility and choice and are likely to attract more capital into the M&A space.

Under the new cross-border system, the path to community restructuring exercises and making Indian companies more internationally significant and successful is clearer than ever before. The implementation of a roadmap and framework for governing cross-border mergers is a welcome move that provides regulatory certainty for these transactions. The ultimate goal should be to increase the foreign market accessibility of Indian companies.

However, there are still challenges associated with cross-border mergers and acquisitions, particularly with regards to cultural and regulatory discrepancies between different jurisdictions. To address these challenges, the Indian government needs to make numerous amendments and clarifications, taking into account the practical nature of these transactions.

Overall, the outlook for M&A activity in India is positive, with a combination of favorable regulatory reforms, divestments, and new investment instruments likely to attract more capital into the market. The government's commitment to addressing the challenges associated with cross-border transactions is also a positive step towards further promoting the country's M&A landscape.

[1] Section 234, Companies Act 2013

[2] Explanation, Section 234, Companies Act 2013

[3] Section 2(42), Companies Act 2013