Recent challenges in the Indian M&A space

Author: | Published: 1 Aug 2012
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India has emerged as a preferred destination for global investments, fuelled by more than two decades of economic reforms. Inbound investments into India have risen steadily in the last few years. Data released by the Department of Industrial Policy & Promotion (DIPP) indicates that foreign direct investment (FDI) inflows into India for the period between April 1 2011 to February 29 2012 stood at US$28.4 billion, up by nearly 50% from the previous financial year.

The rise in foreign inflows into India is a welcome trend, especially at a time when the financial world is still recovering from the global economic crisis. Acknowledging the importance of foreign investment in the Indian economy, regulators in India, as well as the Indian judiciary, have taken proactive measures to spur a growth in investment. While the positive steps taken by the regulators and the Indian judiciary have been lauded by the industry, some challenges in the M&A space still remain. In this article, we seek to highlight certain key developments that may affect M&A activity in India.

New Takeover Code

One of the significant changes in the Indian regulatory landscape in recent times has been the introduction of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the Takeover Code), which came into force on October 23 2011 and has imparted some much-needed clarity to the law relating to takeovers in India.

Open offer trigger thresholds/ open offer size/ acquisition financing

Under the Takeover Code, the threshold for triggering an open offer on an initial acquisition of shares or voting rights in a listed Indian company has been increased from 15% to 25%, enabling investors to acquire larger stakes in Indian listed companies without attracting open offer obligations.

Further, the minimum open offer size under the Takeover Code has been increased from 20% to 26% which, combined with the increased open offer trigger threshold, provides an acquirer with the ability to acquire 51% shares or voting rights i.e. de jure control over a listed Indian company, assuming full acceptance of the open offer. It appears that the Securities and Exchange Board of India (Sebi) has followed an 'all or nothing approach' in the context of acquisitions of Indian listed companies, preferring that acquirers either have a stake of less than 25% in the company and thereby have no ability to exercise control over the decisions taken by the company or have a 51% stake and have the de jure right to control the company.

Another consequence of the increase in the open offer threshold and the open offer size is that the funding requirements for acquisition of Indian listed companies have increased. This may prove to be a hurdle for Indian acquirers on account of the unavailability of bank finance in India for funding share acquisitions. Under the extant regulatory regime in India, banks in India are not permitted to grant loans for funding Indian promoters' contributions towards the equity capital of a company. Furthermore, under the external commercial borrowings policy issued by the Reserve Bank of India (RBI), external commercial borrowings raised by an Indian corporate are not permitted to be used for the purposes of investment in capital markets or the acquisition of companies. Foreign acquirers, on the other hand, are not subject to these restrictions while raising funds overseas for acquisitions in India. This disparity in the regulatory treatment of foreign acquirers and Indian acquirers may have unintended consequences on M&A transactions involving the acquisition of Indian listed companies.


While the Takeover Code has gone to great lengths to simplify the takeover process, Sebi has still not addressed whether the acquisition of 'negative control' triggers open offer obligations under the Takeover Code. Judicial pronouncements have, in the past, held that affirmative/ veto rights (being in the nature of negative control) granted to an investor amount to 'control' and thereby trigger open offer requirements under the Takeover Code. However, the Securities Appellate Tribunal, taking a progressive stand in the case of Subhkam Ventures, held that rights that are meant to protect the interests of an acquirer and its investment, and are not in the nature of rights according day to day operational control over the business of a target company, do not constitute control. The Subhkam Ventures judgment was greeted with euphoria by investors as it provided much-needed clarity on a grey area of law. However, when Subhkam Ventures went up in appeal to the Hon'ble Supreme Court of India, it declined to take a stand on the issue of negative control. The end result is that the question of whether 'negative control' amounts to 'control' under the Takeover Code still remains open to interpretation.

Interaction between different laws and regulators

The interaction between laws and regulators governing the Indian investment market, while bolstering the environment for investment, has, at times, unintended and unforeseen consequences. For instance, the interplay between the Takeover Code and the Competition Act, 2002 (Competition Act) poses a peculiar problem for acquirers of listed Indian companies.

Acquirers of listed Indian companies may find it difficult to adhere to the timelines under the Takeover Code given the operation of the Competition Act. The Competition Act requires an acquirer to obtain approval of the Competition Commission of India (CCI) in respect of any agreement or other document relating to the acquisition of shares or voting rights or the acquisition of control of a target company, which triggers certain combination thresholds under the Competition Act. An open offer under the Takeover Code cannot be completed prior to obtaining CCI approval as the Competition Act requires an acquirer, who has made a notification to the CCI, to stand still until receipt of the CCI's order approving the acquisition or passage of 210 days from the date of notification to the CCI. While an acquirer is permitted to seek an extension of time for payment of consideration to the shareholders who have accepted the open offer, in cases of delays caused by non-receipt of statutory approvals, under the Takeover Code, such extension is not automatic and is also subject to payment of such interest as Sebi may direct. Therefore, the differences in timelines under the Takeover Code and the Competition Act could lead to an escalation of costs for acquirers.

Restrictions on transferability of shares in public companies

Uncertainties regarding the enforceability of certain rights that are commonplace in M&A transactions, such as pre-emption rights, drag-along rights, tag-along rights, rights of first refusal, pose a challenge to M&A activity in India.

Indian courts have held that provisions restricting the transferability of shares in a public company are not enforceable against the concerned public company as they are repugnant to the provisions of the Companies Act, 1956 (Companies Act), which requires shares or debentures of a public company to be freely transferable.

However, Indian judicial precedents on the enforceability of transfer restrictions inter se the shareholders of a public company have been contradictory. The Bombay High Court has taken the view that transfer restrictions (pre-emption rights) in relation to the shares of a public company, that have been consensually agreed among shareholders, are enforceable as the Companies Act does not restrict the right of shareholders to enter into consensual arrangements, so long as the same are in conformity with the articles of association of the company and the Companies Act. Given that inter se private agreements containing transfer restrictions do not impact the nature of the instrument (i.e. shares), such agreements should be enforceable like any other agreement and the Bombay High Court's judgment is a step in the right direction.

Enforcement of options

On a related note, the enforceability of put and call options in relation to shares of an Indian company remains a vexed issue, with regulators adopting differing views. Put and call options on shares form an intrinsic part of the exit strategy of investors in M&A transactions and issues regarding their enforceability are a cause for concern.

While the RBI has not issued any specific regulations prohibiting call or put option agreements in relation to shares of an Indian company, it takes the view that grant of a put option to a non-resident investor at an agreed price, in respect of equity investments in an Indian company made by such non-resident investor, provides an exit route and an assured return (i.e. at a pre-determined price or a fixed IRR) to the non-resident investor. It thereby imparts debt like features to equity shares, making such shares ineligible as FDI compliant instruments under the extant FDI regime.

The DIPP has taken contrary positions in relation to the enforcement of options in relation to shares of an Indian company, granted to non-resident investors. In the consolidated FDI policy (FDI Policy) issued by the DIPP on September 30 2011, the DIPP provided that equity instruments issued or transferred to non-residents, having in-built options or supported by options sold by third parties, would not qualify as eligible FDI instruments. Upon protests from all quarters of the industry, this paragraph was deleted by the DIPP. Subsequently, no such fetters on transfer or issuance of equity instruments with in-built options to non-residents have been included in the FDI Policy issued thereafter.

The Sebi has also expressed concerns in respect of put and call options in relation to securities in public companies on the grounds that such options violate the Securities Contracts (Regulation) Act, 1956 (SCRA) which regulates the purchase and sale of marketable securities in India. Pursuant to notifications issued by the Sebi under the SCRA, contracts for sale or purchase of securities are permitted only on a spot delivery contract basis. Judicial precedents have held that contracts for sale and purchase of securities of an Indian company on a future date at a predetermined fixed price may not constitute spot delivery contracts and may, therefore, not be permitted under the provisions of the SCRA.

However, the Bombay High Court, in its recent judgment in MCX Stock Exchange Limited v. SEBI, has held that in cases of options in securities, a contract for sale and purchase of securities only comes into existence when such options are exercised at a future date. Once the contract for sale and purchase of securities has come into existence, the transfer of securities takes place on a spot delivery basis as permitted under the SCRA. The judgment in MCX has been hailed in many quarters as providing an aura of legitimacy to put and call options in respect of securities of an Indian company and may have the effect of making regulators rethink their position. Though investors need to bear in mind the conflicting stances taken by regulators at different times, the judgment in MCX opens up new ways of structuring investments into India.

Political scenario: judicial activism versus executive interference

While separation of powers is the hallmark of the Indian democracy, and plays a large role in fostering a stable environment for investments, recent events may have blurred the lines between the executive, judiciary and the legislature in India.

A recent example of judicial activism is the Hon'ble Supreme Court's judgment in the 2G spectrum allocation case, where it was held that the first-come-first-served policy followed by the Government of India (GOI) in issuing telecom licenses and 2G spectrum was inherently flawed and was illegal. On that basis, the Hon'ble Supreme Court quashed the telecom licenses already issued to certain telecom operators in accordance with such policy. The Hon'ble Supreme Court's order, to retrospectively unravel an economic policy of the GOI that had already been acted upon several years ago, has been viewed with much trepidation by investors. It has created uncertainties in the investment environment in India and has left the telecom industry, as well as the banks with exposure to it, reeling under the shock.

Conversely, the Hon'ble Supreme Court has, in its recent judgment in the Vodafone case, displayed the robustness of the Indian judiciary and its role in protecting the rights of investors in India when it held that the gains arising to a foreign company from the transfer of shares of a foreign holding company, which

indirectly held underlying Indian assets, were not exigible to income tax in India. This judgment had the effect of clearing uncertainty over the taxation of cross border transactions and was helpful in bolstering the confidence of foreign investors investing into India. However, in a retrograde move, the GOI has enacted certain amendments, by way of insertion of clarifications to the Income Tax Act, 1961, in the Finance Act, 2012 with retrospective effect. This may, in effect, overrule the Hon'ble Supreme Court's judgment in the Vodafone case. Foreign investors, as well as Indian industry, have voiced their concerns with respect to these amendments and it remains to be seen if the income tax authorities in India will aggresively raise tax demands on past transactions on the basis of these amendments.

The road ahead

While the M&A space in India has faced its challenges over time, investors have much to look forward to. The spate of reforms in India continues unabated with some key regulatory changes under consideration. These include the integrated goods and services tax, the new companies law, financial sector reforms in banking and insurance, and FDI proposals in sectors such as single brand retail and aviation. The Indian judiciary also has been playing an active role in recognising and protecting the rights of investors, in sync with economic realities. This is evident from the decisions in the Vodafone case and the MCX case, which have gone a long way in bolstering the confidence of investors. Regulators in India are stepping up to the challenge and have reacted swiftly to the extant market conditions in order to aid investors and ensure that India remains one of the prime destinations for M&A activity.

Shardul S Shroff
  Shardul Shroff, managing partner with over 32 years of experience, is considered a leading authority on corporate governance, infrastructure, projects and project finance, privatisation and disinvestment, mergers and acquisitions, joint ventures, banking and finance, capital markets and commercial contracts. He regularly counsels boards and directors on corporate governance matters and actively participates in the Independent Directors Dialogue.

He is actively involved in the formulation and drafting of various important economic legislations and company law reforms in India. He has also been on a number of high-powered committees appointed by the Government of India, including committees on various legislations. He has served as a member on FICCI's M. Damodaram Committee, the high powered Naresh Chandra Committee (2nd Committee) (2003) and the high powered JJ Irani Committee (2006) that deliberated on the principles of corporate governance with reference to the new Companies Bill 2008.

He is the chairman of CII National Committee on Legal Services and the associate president of Society of Indian Law Firms (SILF). He is also the recipient of 'National Law Day Award' from the President of India for his unique contribution to the field of corporate law. He was recently awarded as the 'Best Corporate Lawyer of India' at the LegalEra Law Awards 2011-12. Also, he has been honoured for his 'Outstanding Contribution to the field of Law' by Chambers and Partners at The Chambers Asia-Pacific Awards 2012.

Gunjan Shah
  Gunjan Shah, partner at Amarchand & Mangaldas & Suresh A Shroff & Co, is a prominent figure in the practice of corporate law, mergers and acquisitions and banking and finance law, having featured extensively in leading international publications such as the Chambers and Partners and the Asia Pacific Legal 500. She holds a bachelor's degree in law from the National Law School of India University, Bangalore, and a master's degree from the University of Oxford.

Gunjan Shah practices in the areas of corporate and securities law, mergers and acquisitions, private equity, corporate and structured finance, debt restructuring and debt capital markets. She has held a number of spotlight positions on legal panels and forums conducted by International Financial Law Review and the Institute of Company Secretaries, and has been a guest speaker in a number of national law schools.

As per Chambers and Partners, Asia Pacific, 2012, clients have rated Gunjan Shah highly for her 'practical and commercially viable advice', and they value her ability to 'provide good advice' and her 'really strong grasp of law, skills in negotiating and top notch commercial sense'.

The Legal 500, 2012 has described Gunjan Shah as 'responsive and knowledgeable' and 'thoughtful and very knowledgeable', and a person who is a mainstay of the banking, finance and capital markets practice.

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