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M&A Regulations in India

Mergers and Acquisitions (“M&A”) is the route most often adopted for corporate growth and expansion in India writes Diljeet Titus.

Through this article, the author attempts to describe inter alia the main regulatory clearances and approvals required to carry out proposed M&A activity in India. The main ways of obtaining control of a public company are (i) a merger or amalgamation under a scheme of arrangement; (ii) the acquisition of a company’s shares; (iii) the reconstruction of a “sick” company.

Merger in corporate business means fusion of two or more corporations by the transfer of all properties and liabilities to a single corporation. The term ‘amalgamation’ is used synonymously with the term merger, and has the same verbal meaning as that of merger. The expressions ‘amalgamation’ and ‘merger’ are not precisely defined in the Companies Act, 1956 (“CA56”) though these terms are freely and interchangeably used in practice. However, the Income Tax Act, 1961 (“IT Act”) defines the term ‘amalgamation’ as the merger of one or more companies to form one company in such a manner that all the properties and liabilities of the amalgamating company (s), before the amalgamation, become the properties and liabilities of the amalgamated company, pursuant to the amalgamation, and not less than three-fourth shareholders of the amalgamating company become the shareholders of the amalgamated company.

The term ‘takeover’, which also becomes relevant in the context of the present article, is neither defined in the CA56 nor in the Securities and Exchange Board of India Act, 1992 (“SEBI Act”), or in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulation 1997 (“Takeover Code”). In commercial parlance, the term takeover denotes the act of a person or a group of persons (acquirer) acquiring shares or voting rights or both, of a company (target company), from its shareholders, either through private negotiations with majority shareholders, or by a public offer in the open market with an intention to gain control over its management. Thus, the term ‘takeover’ may be described as the process whereby the majority of the voting capital of a company is bought through secret acquisition of shares or through a public offer to the shareholders.

Indian Legal Issues involved in M&A

    1. SEBI Takeover Regulations/Company Law in M&A:

Mergers are primarily supervised by the High Court(s) and the Ministry of Company Affairs. The SEBI regulates takeovers of companies that have shares listed on any stock exchange in India. The main corporate and securities law provisions governing mergers and takeovers are:

  • Sections 108A to 108I of CA56, which place restrictions on the transfer and acquisition of shares where the shareholdings of the bidder or transformer would either:
    • Result in a dominant undertaking; or
    • In case of a pre-existing dominant undertaking, result in an increase in the production, supply, distribution or control of goods and services by it.
  • Section 390 to 394 of CA56, which govern the schemes of arrangement between companies and their respective shareholders and creditors, under the supervision of the relevant High Court.
  • The Takeover Code, which sets out procedures governing any attempted takeover of a company that has its shares listed on one or more recognized stock exchange(s) in India. Regulation 10, 11, and 12 of the Takeover Code, which deal with public offers, do not apply to a scheme framed under the Sick Industrial Companies (Special Provisions) Act, 1985 (“SICA”), or to an arrangement or reconstruction under any Indian or foreign law (Regulation 3 (1) (j), Takeover Code).

The Takeover Code, however, does not apply to the following acquisitions:

  1. Allotment of shares made in public issue or in right issue;
  2. Allotment of shares to underwriters in pursuance of underwriting agreement;
  3. Inter-se transfer between group, relative, foreign collaborators and Indian promoters who are shareholders, acquirer and persons acting in concert with him;
  4. Acquisition of shares in the ordinary course of business by a registered stockbroker on behalf of his client, market maker, public financial institutions in their own account, banks and financial institutions as pledgees, international financial institutions, and merchant banker or promoter of the target company under a scheme of safety net;
  5. Exchange of shares received in a public offer made under the Takeover Code;
  6. Transmission of shares in succession or inheritance;
  7. Acquisition of shares by government companies and statutory corporations. However, acquisition in a listed public sector undertakings, through the process of competitive bidding process of the Central Government is not exempted;
  8. Transfer of shares by state level financial institutions to co-promoters under an agreement;
  9. Transfer of shares venture capital funds or registered venture capital investors to a venture capital undertaking or to its promoters pursuant to an agreement;
  10. Acquisition of shares in pursuance of a scheme of rehabilitation of a sick company, amalgamation, merger or demerger;
  11. Acquisition of shares of an unlisted company. However, if such acquisition results in acquisition or change of control in a listed company, the exemption will not be available;
  12. Acquisition of global depository receipts and American depository receipts so long as they are not converted into shares carrying voting rights.
  • Section 17, 18 and 19A of the SICA, which regulate schemes formulated by the Board for Industrial and Financial Reconstruction, a statutory body established under the SICA, for the reconstruction and amalgamation of “sick” companies (that is, any company which, at the end of any financial year, has accumulated losses equal to or exceeding the entire net worth). The Sick Industrial Companies (Special Provisions) Repeal Act 2003 (“SICA Repeal”), which repeals the SICA, has been enacted but has not yet come into force. Similarly, while the Companies (Second Amendment) Act, 2002 has introduced Chapter VIA in the CA56, which makes substantial amendments to the regime governing sick companies, these provisions are also yet to come into effect (there is no indication as to when these provisions are likely to come into force). As a result, SICA continues to be valid and binding.

There are also rules governing the acquisition of shares in an Indian company by a non- resident.

    2. Due Diligence in M&As:

The purpose of the due diligence exercise is to identify any issues that may affect the bid including, but not limited to, the price of the bid. Generally, the bidder (in case of recommended as well as hostile bids) will want to determine the following about the target company:

  • Its capital structure including shareholding pattern.
  • The composition of its board of directors.
  • Any shareholders’ agreement or restrictions on the shares, for example, on voting rights or the right to transfer the shares.
  • Its level of indebtedness.
  • Whether any of its assets have been offered as security for raising any debt.
  • Any significant contracts executed by it.
  • The status of any statutory approvals, consents or filings with statutory authorities.
  • Employee details.
  • Significant litigation, show cause notices and so on relating to the target and/or its areas of business.
  • Any other liability, existing or potential.

Public Domain

Information on a target that is in the public domain and is accessible to the bidder includes its:

  • Constitutional documents;
  • Annual reports and annual returns filed with statutory authorities, giving information on shareholdings, directors and so on.
  • Quarterly and half-yearly reports, in the case of listed companies (in accordance with the standard listing agreement prescribed by the SEBI).

A listed company must inform the stock exchanges of important decisions taken by its board of directors.

    3. Contractual Issues in M&As:

While economic and business reasons may be the factors behind both M&As, contractual and legal formalities involved are rather different. Share sale and purchase/acquisition agreement, asset and business transfer agreements, representations and warranties, indemnity, non-compete and non solicitation, confidentiality, governing law, post completion matters and indemnities are significant agreements and clauses to effectively execute M&As.

Contents of a Share Purchase Agreement

Condition precedent – The condition precedents incorporated in a share purchase agreement may include obtaining necessary approvals from various governmental regulatory bodies that may be necessary to effectively execute the share purchase agreement and the proper functioning of the target company.

Management and Control – The devising of an appropriate governance structure of the target company is of great importance for effective management, growth and success of the target company. The share purchase agreement should explicitly set out the participation of the acquirer and also the rights, obligations and duties of the management of the target company including that of the board of directors, nominee directors and the chairman.

Intellectual Property Rights – If the merger involves a transfer, assignment or right to use an intellectual property such as trademark, copyright, know-how, etc. the same should be protected in the share purchase agreement.

Non-Competition/Conflict of Interest – The non-compete clause in a share purchase agreement is incorporated with intent to restrain the contracting party from carrying out any independent activity in competition to that of the target company.

Deadlock Provision – The parties may have similar or dissimilar thinking patterns. Therefore, there has to be a mechanism for resolving any issues on which there is a deadlock between the parties. The chairman may be given a casting vote to avoid such a problem. 

Confidential Information – The share purchase agreement can make all the provisions contained in or related to or arising from the share purchase agreement to be confidential in nature

Survival Clause – It may be prudent to provide for certain obligations contained in or related to or arising from the share purchase agreement to survive pursuant to the termination of the share purchase agreement.

    4. Intellectual Property Law and M&As:

In case of M&A of companies, all the assets of the transferor company including intellectual property assets such as patents, copyrights, trademarks and designs vest in the transferee. Where the transferor company owns the intellectual property assets, such assets are transferred to the transferee company under the scheme of arrangement.

Unregistered trademark/copyright is transferable as any other right in a property under the scheme of arrangement framed under section 394 of CA56. In case of registered trademarks/copyrights and patents, the transferee company has to apply to the respective Registry for registering its title pursuant to the order of the High Court sanctioning the scheme.

The transmission/transfer of the trademark/copyright rights in the license may be permitted in an instance where the licensor himself assents to such transfer of a license subsequent to a merger.

    5. Exchange Control Issues:

The Foreign Direct Investment (“FDI”) regime in India has progressively liberalized and the Government of India recognizes the key role of FDI in economic development of a country. With very limited exceptions, foreign entities can now invest directly in India, either as wholly owned subsidiaries or as a joint venture. In an international joint venture, any proposed investment by a foreign entity/individual in an existing entity may be brought in either through equity expansion or by purchase of the existing equity.

Where the transfer of shares is by way of sale under a private arrangement, by a person resident in to a person resident outside India the price of the shares will not be less than the ruling market price in case of shares listed on a stock exchange or the value of the shares calculated as per the guidelines issued by the erstwhile Controller of Capital Issues and certified by a Chartered Accountant. In either of the cases the sale consideration must be remitted into India through normal banking channels. Lastly, to affect the transfer, a declaration in the form FC TRS should be filed with an authorized dealer along with the a consent letter indicating the details of transfer, shareholding pattern of the investee company after the acquisition of shares by a person resident outside India showing equity participation of residents and non residents, certificate indicating fair value of shares from a chartered accountant or in case of a public listed company copy of the broker’s note and an undertaking from the buyer to the effect that he is eligible to acquire shares in accordance with the FDI policy.

    6. Monopolies and Restrictive Trade Practices Act, 1969 (“MRTP Act”) and     Competition Act, 2002 (“CA02”):

The MRTP Act aims towards controlling monopolistic, restrictive and unfair trade practices, which curtail competition in trade and industry. Monopolistic trade practice includes a trade practice unreasonably preventing or lessening competition in the production, supply or distribution of any goods or in the supply of any services. Sections 108A to 108I incorporated in CA56 restrict the transfer of shares by body or bodies corporate under the same management holding 10% or more of the subscribed share capital of any company without intimating the Central government of the proposed transfer.

The Competition Commission can investigate any combination, which is a merger or acquisition where any of the following apply:

    • The parties jointly have assets exceeding INR 10 billion (about US$ 227 million) or turnover of more than INR 30 billion (about US$682 million) in India, or assets of US$ 500 million (about EUR 413 million) or turnover of more than US$ 1.5 billion (about EUR 1.2 billion) in India or outside India.
    • The group to which the company will belong after the acquisitions and the company jointly have assets exceeding INR 40 billion (about US$ 909.6 million) or turnover of more than INR 120 billion (about US$ 2.7 billion) in India, or assets of US$ 2 billion (about EUR 1.7 billion) or turnover of more than INR 120 billion (about US$ 2.7 billion) in India, or assets of US$ 2 billion (about EUR 1.7 billion) or turnover of more than US$ 6 billion (about EUR 5 billion) in India or outside India.
    • The bidder already has direct or indirect control over another enterprise engaged in the production, distribution or trading of a similar, identical or substitutable good or service, and the acquired enterprise and this other enterprise jointly have assets exceeding INR 10 billion or turnover of more than INR 30 billion in India, or assets of US$ 500 million or turnover of more than US$ 1.5 billion in India or outside India.
    • The enterprise after the merger or acquisition has assets exceeding INR 10 billion or turnover of more than INR 30 billion in India, or assets of US$ 500 million or turnover of more than US$ 1.5 billion in India or outside India.

While investigating the combination, the Competition Commission must examine whether it is likely to cause, or causes, an adverse effect on competition within the relevant market in India. The Competition Commission has 90 days from the date of publication of details of the combination by the parties to pass an order approving, prohibiting or requiring modification of the combination, or to issue further directions. If it does not do this, the combination is deemed approved. There is no obligation to suspend the combination while the investigation is taking place.     

    7. Tax Implications in M&As:

Amalgamations and Demergers attract the following taxes:-

  • Capital Gains TaxUnder the IT Act, gains arising out of the transfer of capital assets including shares are taxed. However, if the resultant company in the scheme of amalgamation or demerger is an Indian Company, then the company is exempted from paying capital gains tax on the Transfer of Capital Assets.
  • Tax on transfer of Share Transfer of Shares may attract Securities Transaction Tax and Stamp Duty. However, when the shares are in dematerialized form then no Stamp duty is attracted.
  • Tax on transfer of Assets/Business Transfer of property also attracts tax which is generally levied by the states. 
    • Immovable Property – Transfer of Immovable Property attracts Stamp Duty and Registration fee on the instrument of transfer.
    • Movable Property - The transfer of Movable Property attracts VAT which is determined by the State and also Stamp Duty on the Instrument of transfer.
  • Transfer of tax Liabilities
    • Income Tax – The predecessor is liable for all Income Tax payable till the effective date of restructuring. After the date of restructuring, the liability falls on the successor.
    • Central Excise Act – Under the Central Excise Act, when a registered person transfers his business to another person, the successor should take a fresh registration and the predecessor should apply for deregistration. In case the predecessor has CENVAT Credit, the same could be transferred.
    • Service Tax – As regards service tax, the successor is required to obtain fresh registration and the transferor is required to surrender his registration certificate in case it ceases to provide taxable services. The provisions regarding transferring the CENVAT credit are similar to the Central Excise provisions.
    • Value Added Tax – Usually statutes governing levy of VAT specify for an intimation of change of ownership and name to the relevant authority, but these statutes do not provide any specific guidelines with regard to the transfer of tax credit. The obligation of the predecessor and the successor is joint and several.

There is a growing need to bring a change in the present law but a coordinated approach should be taken while bringing amendments in the CA56. The change is required to provide for maximum flexibility and to provide equal opportunities to economic players in the global market. This would also help in bringing Indian law in consonance with the law regarding mergers in other countries.
DILJEET TITUS is the Managing Partner of Titus & Co., Advocates and can be reached at dtitus@titus-india.com

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