1. Introduction
In order to engage in any M&A activity in India, the parties must be mindful of plethora of laws and policies applicable to the transaction. These include central statutes ranging from company, contract, competition, foreign exchange, labor and employment, stamp duty which is pertinent for rates regarding transaction documents, share certificates, and tax, both direct and indirect; government policies; sector-specific regulations; state amendments to the central legislations; foreign investment norms when non-Indian investors acquire or sell and specific statutes applicable to listed entities and relevant for acquisitions involving companies listed on Indian stock exchanges. Companies in India are private, public, or listed and can be owned and/or controlled either by Indian or foreign entities or individuals. For the last category – owned and controlled by foreigners – additional rules apply when they invest in other Indian entities. Regardless of ownership, private companies have lower stringent compliance requirements even though corporate governance has undergone a complete paradigm shift, and all companies are expected to pay attention to detail and not take statutory mandates lightly.
Based on experiential insights and frequent questions during active transactions, past or current, this newsletter provides a selective overview of the M&A landscape which contracting parties must be cognizant of.
2. Types of Deals and Structuring
M&A activity is varied and can be classic, straightforward or creative. The deal structure essentially addresses how transactions will generate value for all the parties. When a party decides to sell, they engage with various advisers who, after their detailed review, put out an initial information memorandum for prospective buyers which may contain a suggestive deal structure. Thereafter, when matters progress and parties execute term-sheets, they usually have a clear idea of the broad contours of deal structure. But getting to this stage is not a simple task. Stakeholders consider many factors, including transaction consideration; conditions to close; overall deal timeline and how that aligns with their respective business objectives, conditions that can lead to deal collapse, and flexibility to alter deal structure means to work around such conditions. Structuring is crucial else the time and effort expended in due diligence may be futile. A comprehensive structure will factor potential future issues and devise strategies to mitigate unforeseen risks.
The three traditional ways to structure an M&A deal are an asset or business acquisition; share purchase or a merger. Of course, with the passage of time, parties are creative during the structuring process. The duration of a transaction primarily depends on the nature of the target, if it is private, public, listed or unlisted; manner of acquisition; the timeline for completing an effective due diligence process; drafting, negotiating and finalizing the transaction documents, fulfilment of agreed conditions precedent and upon receipt of relevant third party, government or otherwise, approvals.
2.1 Asset or Business Acquisition: In this traditional method, a buyer purchases certain assets or an entire business (slump sale) as a going concern of a target company. Parties may choose an asset acquisition if the prospective buyer wants to purchase assets while excluding the associated liabilities. Here, the target retains the corporate entity. Asset acquisitions are time intensive and with higher tax costs, while business purchase of an undertaking on a going-concern basis is both tax and time efficient. Indian law requires parties to pay applicable stamp duty on a document for it to be admissible as evidence in court. Stamp duty rates vary from state to state, and the amount depends on the document's subject and place of execution. In a slump sale, if immovable property is transferred it is necessary to execute a conveyance deed which must be stamped under the state law where the conveyance is executed and to which it relates.
2.2 Stock Purchase: Here, the buyer acquires all or most of a seller's stock from its shareholders and the target's entire assets and liabilities are transferred to the buyer. This structure works well for enterprises seeking a less time-intensive and costly process. Agreements are typically negotiated quickly, and taxes can be significantly lower. Of course, the buyer needs to do intense diligence as all financial and legal liabilities of the target are transferred upon closing. Shares of a public listed entity can be acquired by triggering a voluntary or mandatory tender offer.1 Further, stamp duty is levied on the issue and transfer of shares of Indian companies in accordance with prescribed uniform rates.
2.3 Merger & Amalgamation: In a merger, two organizations combine to form one corporate entity. Comparatively, mergers are generally a simple process, but in India these are driven by courts, even amongst group companies. Powers are delegated to the National Company Law Tribunal ("NCLT") who must approve the merger, thereby protracting the time involved. Now, fast-track mergers are possible where mergers occur between certain categories2 of companies which are outside NCLT's purview though they still require approval of the Central Government.
Usually, for mergers, amalgamation, or demergers it is essential to factor in six to eight months depending on the NCLT jurisdiction and the complexity involved. For fast-track mergers, there was no specific timeline involved for the agencies (these included Registrar of Companies and official liquidators) to submit suggestions or objections to the scheme before the Central Government. Now, they must do so within 30 days from the receipt of the scheme of merger. Central Government must consider the suggestions and objections, if any, within a time-bound manner and issue its order accordingly. Further, the concept of deemed approvals has been introduced in both situations – where there are objections and suggestions and if there are none. So, if the Central Government does not pass a confirmation order or act within the prescribed statutory period, it will be deemed to be approved. Like with other structures, a court order sanctioning a scheme is also to be stamped, in accordance with the state-specific law.
3. Certain Considerations for Foreign Investors
The Foreign Direct Investment ("FDI") policy combined with Foreign Exchange Management Act ("FEMA") and several rules and regulations thereunder are triggered where non-resident investors are involved. Parties must be aware of and understand applicable pricing norms, documents required for the statutory reporting and specific conditions applicable to certain sectors. Timely understanding of all these matters is an imperative given the likely nuisance caused if the requirements are not fulfilled. Under the FDI policy, foreigners can invest up to 100% in Indian companies under the "automatic" route in most sectors. However, there are restrictions in some areas. For example, in an acquisition of or an investment in a brownfield pharma company foreign entities can acquire 74% of equity without prior regulatory approval and beyond 74% requires government approval. Similarly, there are caps in other sectors too, like defense and foreign investment is prohibited in atomic energy, gambling, lottery and chit funds.
FEMA regulations mandate when a foreign entity acquires shares of an Indian company it must be reported to the RBI in the prescribed form. This reporting is routed through AD or authorized dealer banks. Parties have to ensure deal consideration meets pricing guidelines i.e., to say the price cannot be less than the one determined in accordance with the guidelines. Regardless of whether the transaction is under the automatic or approval route, it is necessary to adhere to the pricing guidelines for determination of the price at which shares of an Indian entity can be either transferred between resident(s) and non-resident(s) or issued to a non-resident. A frequently asked question is if non-cash consideration is possible. While non-cash consideration is permitted, in some instances it may be necessary to have a valuation report by a registered valuer as well. It is also possible tax authorities determine the fair value of non-cash consideration. If such value is deemed higher than the agreed consideration, it could lead to higher tax liability for the seller.
A very important development occurred during the pandemic. In order to protect domestic industry and prevent hostile takeovers, the government issued a press note3 which states prior government approval is required if (a) FDI is routed through entities incorporated in a land-bordering country or where the beneficial owner of an investment is situated in or is a citizen of any restricted country;4 (b) transfer of ownership which attracts direct or indirect FDI in an Indian investee entity where beneficial ownership comes within the ambit of the restrictions above. If the restriction does not apply, investors are obligated to confirm this in a declaration. Subsequently, even the Ministry of Corporate Affairs implemented amendments to Foreign Exchange Management (Non-Debt Instruments) Rules ("NDI Rules"). An Indian company issuing shares needs to enquire about the status of the proposed shareholder and ensure prior approval is taken if a proposed shareholder is from a land-bordering country. Accordingly, even the Companies Act was amended in 2022 and it is now mandatory to report compliance with the NDI Rules in various areas. This means corresponding declarations are to be given at various stages, be it formation of a new company, private placement, share transfer and even appointment of directors. For the last, before appointment, it is essential to obtain security clearance from the Ministry of Home Affairs for nationals of a country which shares a land border with India. The director must attach the approval along with his consent letter to act as a director of the company.
It is necessary to at least touch upon Environmental, Social, and Governance or ESG factors in the Indian M&A landscape as they influence financing, valuation, and integration. Non-compliance with ESG standards can deter potential investors while compliant entities can ask for a premium. ESG elements are increasingly scrutinized during due diligence and transaction documents also include specific related warranties, indemnities and covenants. Private and unlisted companies can certainly benefit from voluntarily adopting ESG practices.
4. Employee Matters
No transaction is effective without adequate attention to employee-related matters, as the people are the ones who must ensure the deal succeeds post-closing. Apart from looking at humane considerations, it is necessary to examine employee benefits in depth. Since India does not have social security from the state for private sector workforce, the law provides obligations on organizations. Further, certain social security laws (like Provident Fund ("PF") and State Insurance Acts) expressly impose joint and several liability on a buyer in cases of transfer of an establishment. It is necessary to touch upon treatment of 3 important social security benefits. Firstly, gratuity is a benefit payable to employees who have worked in a company for 5 years. The employer pays 15 days wages for each completed year of service, payable when an employee retires or leaves the company. Liability can be funded or non-funded. In the former, money is deposited in a separate corpus while, in the latter, employers only make accounting provisions of this head. Secondly, PF is a benefit where both employer and employee contribute, either to a government fund or to an organization's internal PF trust. Organizations sometimes secure an exemption and opt to use their own trusts versus the government ones. Thirdly, superannuation is a retirement benefit offered to employees; it can be a defined benefit or a contribution plan. Employers contribute on behalf of employees to a fund. Upon retirement, one-third of the accumulated benefit can be withdrawn.
If a business is transferred as a going concern, here are some key points: (a) buyer would be the successor and may face liability for pre-transfer employee costs. Hence, it is necessary to demarcate the pre-transfer and post-transfer liabilities in the transaction documents. Often, the transferor indemnifies the transferee for pre-transfer claims; (b) where the PF contribution is deposited with the government fund, the accumulated sums stay there and remain accessible to the employee. In the case of internal trusts, the accumulated PF for impacted employees would have to be transferred in accordance with law. No payments will be made to the employees; (c) if the buyer has no parallel schemes and does not intend to establish one, superannuation benefit(s) of a seller would have to be settled pursuant to the existing plan.
Additionally, in the transfer of an undertaking, blue-collar employees (workmen In India) who have been in continuous service for a year are entitled to notice and compensation equal to 15 days' average pay for every completed year of service or part thereof in excess of six months. If service is not impacted and employment terms remain favorable as before, such compensation need not be paid.
Where the employee transfer is with continuity of service (a) parties must agree about associated liabilities towards accrued benefits, those linked with duration of the employment and how they shall be addressed; (b) accumulated corpus of gratuity, superannuation, leave encashment and retrenchment (if applicable) would be transferred or adjusted in the consideration; (c) the buyer would agree to assume identified liabilities associated with the duration of service so no payments will be made to employees upon closing; and (d) if parties agree to transfer employees on favorable terms which match their current employment and where buyer does not have any superannuation scheme or fund, the buyer may need to match with alternate financial compensation.
5. Conclusion
Structured deals, which include spin-offs, separation, and carve-out transactions continue to drive volumes as companies exit non-core businesses. Clearly, M&A is no piece of cake. It is both a laborious and involved process, so it is necessary parties spend adequate time and resources understanding the applicable law, policy, and practical aspects. Regulatory environment, interventions by regulators and compliance issues continue to be key challenges and play a role in the volume ups and downs. So, stakeholders must continue to identify and know the processes in a rapidly changing environment, equip themselves to navigate hurdles, and strategize with counsel. Depending on the deal structure, seeking regulatory, employment and tax advice early on is highly advisable. In the end, transaction preparation is critical to successful execution.
Footnotes
1 Here parties must follow the prescribed rules pursuant to the takeover regulations contained in SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
2 Under section 233 of the Act, these include mergers between small companies or between a holding and its wholly owned subsidiary. For a company to qualify as a WOS, it is necessary to ensure the ownership status of the shares held by shareholders. They cannot hold shares in their individual capacity and instead must hold them as nominee of the holding company.
3 DPIIT File No. 5(5)/2020-FDI Policy, dated April 17, 2020
4 Currently, these are Afghanistan, Bangladesh, Bhutan, China, Myanmar, Nepal and Pakistan. Investments from Hong Kong, Macau and Taiwan are considered as proposals from China and subject to the restriction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.