India

BACKGROUND AND INTRODUCTION

The Indian economy has grown in leaps and bounds since the 1990s when the foreign exchange reserves had fallen so low that it required the then finance minister, Manmohan Singh to initiate and introduce a spate of legal and regulatory reforms which were vital for developing domestic corporate acquisitions and for promoting cross-border mergers and acquisitions. This article charts the legal and regulatory environment for doing business in India and the mechanism for effecting corporate acquisitions and mergers and amalgamations by foreign companies.

POLICY CHANGES AND REGULATORY REFORMS

The Industrial Policy 1991 of the Government of India was instrumental in liberalizing the Indian economy by doing away with excessive and restrictive government controls and licensing with a view to promoting foreign investment in India. The government embarked on a series of initiatives in respect of liberalizing the policies relating to the following areas:

• industrial licensing;
• foreign investment;
• foreign technology agreements;
• public sector policy; and
• the Monopolies and Restrictive Trade Practices Act, 1969 (MRTP Act) (now been repealed by the Competition Act, 2002)

The Foreign Exchange Management Act, 1999 (FEMA) was a consolidating and amending Act which amended, repealed and replaced the draconian and restrictive Foreign Exchange Regulation Act, 1973. FEMA was enacted to amend the law relating to foreign exchange with the objective of facilitating external trade and payments and to promote the orderly development and maintenance of the foreign exchange market in India.

REGULATION AND LEGISLATIONS

The law relating to companies and certain other associations is contained in the Companies Act, 1956 (amended from time to time) the Act, and the rules framed within it. The other statutes to be considered in relation to acquisitions and mergers of companies are the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997 the Takeover Code (for companies whose stocks are listed on stock exchanges), FEMA and the regulations made under it (in the case of acquisitions and consolidations with foreign companies).

ACQUISITION OPTIONS FOR FOREIGN ENTITIES UNDER THE FOREIGN DIRECT INVESTMENT ROUTE

The foreign direct investment route (FDI) is vital for advancing India's foreign exchange resources, its technological base and for globalizing the Indian economy. All FDI proposals in India are subject to one of two approval routes depending on the nature of the proposal.

Automatic Approval of the Reserve Bank of India (RBI): In February 2000, the government made the approval of FDI proposals automatic in diverse industry sectors barring some which are considered by the authorities to be "sensitive" industries or activities in which approval for FDI must be more carefully considered.

Prior approval of the Foreign Investment Promotion Board (FIPB): For those FDI Proposals where a foreign company is engaged or proposes to engage in any activity in India, prior approval is required as follows:

• an industrial license is required under the Industries Development and Regulation Act, 1951 (industries involving alcohol or cigarettes; defense-related requirements; and so on);
• proposals in which the foreign collaborator has a joint venture or tie up;
• proposals where a foreign/non-resident Indian or overseas corporate body investor seeks to acquire shares in existing Indian companies; or
• proposals falling outside notified sectoral policy caps or under sectors where FDI is not permitted (the Ministry of Commerce & Industry, though the Department of Industrial Policy & Promotion regularly comes out with notifications and press notes detailing the government's policies with regard to the FDI norms in a sector-specific manner).

Setting up a joint venture company in India

It is possible for a foreign company to establish a joint venture with a third party in India. However, in the case of industry falling outside the automatic route, the prior approval of the FIPB will be necessary for FDI by the foreign company. Ordinarily, FIPB grants its approval on making a reasonable case to it on an FDI. While granting its approval, FIPB stipulates the terms and conditions and the payment of royalty and technology license fee to the foreign company.

If the FDI falls under the automatic route it is possible for a foreign company to establish a joint venture with a third party in India without requiring the prior approval of the FIPB provided of course the conditions mentioned above are satisfied. Prior approval from the FIPB is also necessary if the foreign company has an existing financial collaboration or a technical collaboration or a trade mark license agreement with any third party in India or if the investment is beyond the prescribed sectoral policy cap for the notified industry.

Allotment or transfer of shares of an existing Indian company

A foreign company has the option of acquiring an existing Indian company. Such acquisitions usually take place with the issue of fresh capital and/or transfer of shares of the existing Indian company to the foreign investor with the effect of transferring its control. Shares in an Indian company can be acquired from another foreign investor without any regulatory exchange control hurdles and from Indian shareholders through FIPB approval followed by RBI approval. Transfer of the controlling interest of an existing Indian company which is listed on the stock exchanges must be in compliance with the Securities and Exchange Board of India Act, 1992, listing agreements with the stock exchanges and the provisions of the Take Over Code.

RECONSTRUCTION AND AMALGAMATION OF COMPANIES

Mergers and amalgamations are strategies for corporate growth and expansion. Section 391 to 394 of the Act deals, among other things, with the reconstruction and amalgamation of companies or what is commonly referred to as "mergers". The procedure prescribes an application by the company to the concerned High Court by way of a scheme of compromise or arrangement with its creditors or members or any class of its members. Such a Scheme is a viable option for the amalgamation of two or more Indian companies. Moreover, sections 391 to 394 of the Act envisage a "single window clearance" by providing a composite code for facilitating mergers and amalgamations which obviates the need for making multiple applications under the Act and ensures that the interested entities are not put through unnecessary and cumbersome procedures involving protracted consequences for implementing such Schemes.

The single window clearance as envisaged by the Act, while encouraging corporate growth also takes into account and protects shareholders' interest and public interest at large, by conferring on the Court, wide discretionary powers to grant approval to the Schemes which seem fair and just and also to withhold assent or to grant approval on a conditional basis, if the Scheme prima facie appears to be patently unfair.

A Scheme is preferred over takeover bids owing to tedious compliance with the Takeover Code in the case of the latter, however a company must be authorized by its memorandum and articles of association in order for an amalgamation or merger by way of a Scheme. Amalgamations enjoy exemptions from the applicability of the Takeover Code.

The Scheme may contain applications for either:

• the reconstruction of any company or companies, or the amalgamation of any two or more companies; and
• The 'transferor Company', that is, a company wishing to transfer the whole or any part of its undertaking, property or liabilities to be transferred to another, 'transferee company'.

The High Court sanctioning the Scheme can provide for all or any of the following matters:

• the transfer to the transferee company of the whole or any part of the undertaking, property or liabilities of any transferor company;
• the allotment or appropriation by the transferee company of any shares, debentures, policies, or other similar interests in that company which, under the compromise or arrangement are to be allotted or appropriated by that company to or for any person;
• the continuation by or against the transferee company of any legal proceedings pending by or against any transferor company;
• the dissolution without winding up, of any transferor company;
• provisions for dissenting shareholders; and
• incidental and supplemental orders for giving full effect to the Scheme.

A Scheme comes into effect only on filing of the order of the High Court sanctioning the Scheme with the concerned Registrar of Companies.

Mechanism

After a scheme of amalgamation is prepared by the companies which have arrived at a consensus to merge and the respective boards of directors of the transferor and transferee companies have approved it, an application under section 391(1) of the Act is made to the High Court, for an order calling a meeting of its members. Following such an application being filed, the High Court gives directions fixing the date, time and venue and quorum for the members' meeting and appoints a chairman to preside over the meeting and submit a report to the High Court. Similar directions are also issued by the High Court for calling the meeting of creditors if that request has been made in the application.

Once the shareholders' general meeting approves the amalgamation scheme by a majority in number of members holding not less than three-quarters in value of the equity shares, the scheme becomes binding on all the members of the company.

Subsequent to the chairman submitting his or her report to the High Court, the amalgamating companies must make a joint petition to the High Court for approving the Scheme. The Court after perusing the petition and hearing objections raised, if any, will pass an order approving or disapproving the Scheme.

The Court is vested with the power under Section 394(2) of the Act to order the transfer of any property or liabilities from the transferor company to the transferee company and in pursuance of and by virtue of this order, the properties and liabilities of the transferor will automatically be transferred to the transferee company without any further act or deed.

Pursuant to the sanctioned Scheme, the shareholders of the transferor company are entitled to get shares in the transferee company in the exchange ratio provided under the Scheme. The approval of the RBI is needed where the scheme of amalgamation contemplates issue of share/payment of cash to non-resident Indians/foreign nationals under the provisions of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (FEMA Regulations). In particular, Regulation 7 of the FEMA Regulations provides for compliance of certain conditions in the case of a scheme of merger or amalgamation as approved by the High Court.

Tax aspects of mergers and amalgamations

The Income Tax Act, 1961 (IT Act) prescribes varying rates of tax or tax exemptions depending on the structure adopted for the merger. The IT Act grants exemption to transfers by way of a scheme of amalgamation, or demerger and the rates of tax would be different depending on an amalgamation or a slump sale (that is, transfer of an undertaking as a result of the sale for a lump-sum consideration without values being assigned to the individual assets and liabilities in the sales).

The term 'amalgamation' is widely defined under the IT Act with the objective of encouraging amalgamation in public interest and as such the meaning not only includes the merger of one or two more companies to form one company but also the merger of one or more companies with another existing company.

Preference of mergers and amalgamations

Restructuring of business by way of a Scheme is preferred by companies on account of savings on tax which are far greater than with a direct purchase of assets or an acquisition which would be subject to heavy sales-tax and stamp duties. However, statutes pertaining to stamp duties have brought properties acquired by way of such Schemes under the ambit of 'conveyance' which is liable to stamp duties as per the rate applicable to conveyance under the Transfer of Properties Act 1882.

Stamp duty

Stamp duty is a state-subject and certain states have started to regard transfer by way of amalgamation as a conveyance. The Bombay Stamp Act, 1958 applicable to the State of Maharashtra has prescribed a stamp duty of 10% of the aggregate of the market value of shares issued or allotted in exchange or otherwise and the amount of consideration paid for one amalgamation. There is a ceiling of 7% of the true market value of the immovable property located within the State of Maharashtra of the transferor company or 0.7% of the aggregate of the market value of shares issued or allotted in exchange or otherwise and the amount of consideration paid for such amalgamation, whichever is higher. In the case of a reconstruction or demerger, the stamp duty must not exceed 7% of the true market value of immovables located within the State of Maharashtra transferred by the demerging company to the resulting company or 0.7% of the aggregate value of the market value of the shares issued or allotted to the resulting company and the amount of consideration paid for such a demerger whichever is higher.

ACQUISITIONS UNDER THE TAKEOVER CODE

Control of a company by corporate enterprises can also be achieved through the acquisition or takeover route which entails acquiring shares of the target company with the objective of gaining control over its management. The Securities Exchange Board of India, that is, the capital markets regulator, is the equivalent of the Securities and Exchange Commission which closely monitors and regulates acquisitions of companies whose shares are listed on one or more stock exchanges in India.

Takeovers can be the outcome of friendly negotiations, that is, accomplished with the agreement and consent of the acquiree company's executives or that of its Board of Directors or in an indirect or clandestine manner by not offering the target company a direct proposal to acquire its undertaking, but silently and unilaterally pursuing efforts to gain a controlling interest in the target company against the wishes of its management. The various ways in which an acquirer company can pursue such an acquisition of the target Company are variously termed as raids or takeover raids.

The Takeover Code seeks to prevent these sorts of hostile takeover raids which lead to acrimonious corporate wars and might impinge on ordinary shareholders' interests apart from having the potential to subvert public interest.

Statutory bids by way of a public announcement vide Regulations 10 and 11 of the Takeover Code are prescribed for the following acquisitions as regards a Target Company:

(i) acquisition of 15% or more of the shares or voting rights;

(ii) acquiring additional shares or voting rights to the extent of 5% or more shares or voting rights in any period of 12 months if the person already holds not less than 15% but not more than 75% of the shares or voting rights in a company; and

(iii) acquiring shares or voting rights along with persons acting in concert to exercise more than 75% of voting rights in a company.

Furthermore, for a statutory bid, the consideration offered should be in cash and if in other securities the same be undertaken for cash offer; and the offer price must be the highest price which the offeror paid in the past 12 months for the same class of shares.

A bid to acquire part of the shares of a class of capital (when it is already holding some shares in the target company) where the offeror intends to obtain effective control of the target company through voting power is also prescribed. Such a bid is made for equity shares carrying voting rights.

Regulation 12 of Takeover Code qualifies a bid in the form of acquiring control over the Target Company irrespective of whether or not there has been acquisition of shares or voting rights in a company. For such an acquisition, it is necessary to make a public announcement in accordance with the Regulations.

Competitive bids can be made by any person within 21 days of public announcement of the offer made by the acquirer. Such a bid must be made through a public announcement in pursuance of the provisions of Regulation 25 of the Takeover Code. These competitive bids must be for the equal number of shares or more for which the first offer was made. No competitive bid can be made for the acquisition of shares of a financially weak company where the lead financial institution has accepted the bid of the acquirer on public announcement in terms of Regulation 35 of Takeover Code.

Tender offers where the acquirer pursues takeover without the consent of the target company by making a tender offer directly to the shareholders of the target company to sell (tender) their shares is prescribed. This offer is made for cash and the buyer gains control of target company by inducing in large number the shareholders of the target company to sell their shares to it at the offered price which is more than the market price of the target shares and thus having acquired strength, forces a merger on the reluctant target company management.

After the enforcement of the Takeover Code, public announcement is necessary as a mandatory bid for tender offer to acquire the shares or control in the target company if such a tender offer is more than the limits of shareholding outlined in Regulations 10, 11 &12 of the Takeover Code.

In view of the liberalization of the Indian economy, and the privatization programme initiated by the Indian government, mergers, amalgamations and acquisitions are encouraged. Foreign direct investment is also encouraged by the government but strict compliance with the statutes and rules is necessary and non-compliance attracts severe penalties.

About the authors

Sanjay Khatau Asher

Crawford Bayley & Co

Sanjay Khatau Asher is a partner at Indian law firm M/S Crawford Bayley & Co and practises corporate law and capital market law.

He graduated from the Institute of Chartered Accountants of India in 1986 as a chartered accountant. He became an advocate in 1989 and qualified as a solicitor in 1993 after passing the solicitors examination conducted by Incorporated Law Society. He is a member of the Institute of Chartered Accountants of India, the Bar council of Maharashtra and Goa, and the Incorporated Law Society.

Sanjay Asher has extensive knowledge of corporate and commercial practice. He practises in fields of corporate advisory, regulatory and compliance, commercial transactions, mergers and acquisitions, joint ventures, technical and financial collaboration, and capital insurance and exchange control regulations.

Sanjay Asher often speaks at study circles, conferences and seminars conducted by the Bombay Chartered Accountants' Society, the Institute of Chartered Accountants of India and the Institute of Company Secretaries of India.

Madhavi Ramachandran

Crawford Bayley & Co

Madhavi Ramachandran is an associate with M/S Crawford Bayley & Co. She graduated with a BA degree in English Literature from St Xavier's College, Bombay. She qualified as a lawyer in 2001. She is a member of the Bar Council of Maharashtra and Goa.

Madhavi Ramachandran is a leading member in the firm's corporate and commercial practice. She practises in fields of corporate advisory, regulatory and compliance, commercial transactions, mergers and acquisitions, joint ventures, technical and financial collaboration and exchange control regulations.

She is working in the field of corporate law and capital markets and presently she is involved in the some of the large privatization/disinvestment projects of India.

Vikas Kumar

Crawford Bayley & Co

Vikas Kumar has been a research assistant in the firm's corporate and commercial practice and its area of specialization of privatization/disinvestment. He is in the graduating class of the National Law School of India University, Bangalore.

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