After being defined by the record-making acquisition of Flipkart by Walmart in 2018, 2019 witnessed a contraction in Indian M&A activity in terms of both volume and deal number owing to political uncertainty leading to a slowdown in the first half of 2019 and the economic slowdown affecting deal activity in the second half.
Deal value in 2018 touched a record of USD95.4 billion, while Baker McKenzie estimated that the M&A value in 2019 shrunk to an aggregate of USD52.1 billion. According to reports by EY, domestic deals constituted the largest part of M&A activity comprising 64% in terms of deal count and 58% in terms of disclosed value. Inbound deals contributed 24% of the total deal count and 36% of the disclosed deal value.
However, the M&A sector is showing resilience given the long term-nature of the sector and is also bolstered by business-friendly reforms being undertaken by the government of India and the generally favourable global outlook.
In 2019, the government of India made several moves to implement business-friendly policies in India. The Securities and Exchange Board of India (SEBI), which is the market regulator in India, has started considering introducing a new framework allowing issuance of shares with differential voting rights by technology companies which will allow promoters to retain control over the company for a longer duration while encouraging new age companies to list. Such listing will also enable long term investors in such companies to realise exits which will bolster India’s image as an attractive investment destination. Other reforms included tax incentives and exemptions from compliance with the Companies Act, 2013 for start-ups; as well as relaxation of foreign exchange regulations allowing easier access to foreign capital. The government of India also replaced existing foreign exchange legislation with new rules giving the central government of India more power over regulation of foreign investments in India. Another major trend in 2019 was the increased activity in the start-up ecosystem. Enterprise tech and fintech start-ups experienced the most aggressive M&A activity.
In August 2019, the Competition Commission of India (CCI), the nation's antitrust regulator, notified a "green channel" whereby deemed prior approval is granted to those combinations in which there is no vertical, horizontal or complementary overlap in the target and acquirer groups, which can include downstream portfolio companies in India as well. This is of particular importance to financial investors who acquire minority positions and have no operational activity in their "group".
The Insolvency and Bankruptcy Code (IBC) was introduced in 2016 to provide a framework for time-bound settlement of insolvency by formulating a survival mechanism or by ensuring speedy liquidation by a formal insolvency resolution process. 2019 saw an uptick in M&A activity in the sale of distressed assets in light of India’s apex court’s judgment upholding the primacy of financial creditors in the distribution of funds received under a corporate insolvency scheme. Some estimates put the deal value increased due to the IBC-driven sale of distressed assets at 50%.
The government of India also announced strategic disinvestment in five major public sector enterprises – the Bharat Petroleum Corporation Ltd (BPCL), the Shipping Corporation of India, the Container Corporation of India, the Tehri Hydro Power Development Corporation (THDCIL) and the North Eastern Electric Power Corporation Ltd (NEEPCO) – to boost the government’s revenue.
E-commerce and tech start-ups continued to see the bulk of M&A activity in India and accounted for about 46% of deals in 2019. Aside from this, sectors such as telecoms, infrastructure management, pharmaceuticals and healthcare also drew investor attention during the year. According to Grant Thornton, the energy sector experienced high-value deals with Adani’s IBC-driven acquisition of GMR Chhattisgarh and Essel Green Energy.
A few of the most notable deals of the year included Ebix’s 71% acquisition in Yatra, the acquisition of Aadhar Housing Finance by Blackstone Partners, Ritesh Agarwal’s increased stake in Oyo’s parent company Oravel Stays, and Dhanuka Lab’s acquisition of Orchid Pharma.
M&A activity driven by the IBC saw ArcelorMittal acquire Essar Steel for INR42,000 crores (approximately USD6.28 billion) and has paved the way for the proposed acquisition of Bhushan Steel by JSW Steel for INR18,900 crores (approximately USD2.7 billion) which is currently underway.
Canada’s Brookfield Infrastructure Partners acquired the telecom tower assets of Reliance Jio Infratel through a multi-stage deal for an estimated INR25,215 crores (approximately USD3.66 billion) making it the single largest foreign investment in an Indian infrastructure vehicle.
Companies are usually acquired by purchasing existing shares from shareholders or by acquiring new shares to gain control. Share swaps are also prevalent though they are not preferred as it gives rise to a tax liability without making cash available for meeting that liability. Stock options are issued in lieu of shares in some cases to defer the tax liability to a later date. Mergers are also undertaken through a court approval process, largely for tax reasons as they are time consuming in nature.
Acquisition by way of business transfer is also not uncommon as it is considered tax efficient. Asset sales being less tax efficient are undertaken only when the acquirer wishes to acquire specific assets without the past liabilities.
M&A in India does not have a primary regulator as it is governed by multiple pieces of legislation, depending on the mode of acquisition and the industry involved. The Companies Act, 2013; Indian Contract Act, 1972; Income Tax Act, 1961; and Competition Act, 2002 typically apply across all M&A activity. As a consequence, several regulating authorities play a role in M&A transactions, such as the Reserve Bank of India (RBI), the SEBI, the CCI, the Registrar of Companies under the Ministry of Corporate Affairs (RoC), and even stock exchanges, which are required to approve the merger schemes of listed entities prior to them being presented to the relevant tribunals. Sector-specific regulators, such as the Telecom Regulatory Authority of India (TRAI) and the Insurance Regulatory and Development Authority of India (IRDAI), and the concerned central and state ministries, also come into the picture for approvals and consents required for deals involving their respective industries.
Foreign Director Investment (FDI) into India is governed by foreign exchange laws governing capital account transaction and is permitted through two routes (ie, the automatic route and the approval route). Under this regime, sectors operating under the automatic route can attract foreign investment without governmental approval. Sectors which are placed under the approval route, such as defence or atomic energy, require prior governmental approval. FDI is entirely prohibited in certain sectors, such as lotteries and tobacco production.
Foreign investments in India largely have to comply with the following:
According to reports, the government of India plans to bring a new law to protect foreign investment in 2020. The law is intended to strengthen dispute resolution through mediation and fast-track courts and provide for quicker resolution of investor disputes.
In India, any transaction which breaches certain prescribed asset or turnover thresholds (combinations) is regulated by the CCI.
Prior approval of the CCI is required for such combinations. The CCI may either approve the combination unconditionally or if it concludes that the combination could potentially have an appreciable adverse effect on competition (AAEC), it may either refuse to provide merger clearance, impose obligations on the parties which could be behavioural in nature, or may require disinvestment from particular business lines in order to eliminate the AAEC.
An exemption from the notification requirement has been provided for:
The Indian law on merger control also identifies certain categories of combinations which are ordinarily not likely to cause an appreciable adverse effect on competition. Accordingly, a notice to the CCI is normally not required to be filed for such combinations. However, this is a self-assessment test and if, upon a preliminary analysis, it is perceived that such a combination may cause an appreciable adverse effect on competition, the CCI may be notified to seek an approval. Of particular importance to financial sponsors/investors (who are not registered financial institutions as above) are the following categories:
In August 2019, the CCI has notified a green channel whereby deemed prior approval is granted to those combinations in which there is no vertical, horizontal or complementary overlap in the target and acquirer groups, which can also include downstream portfolio companies in India. This is of particular importance to financial investors who acquire minority positions and have no operational activity in their group’.
The key pieces of labour legislation are as set out below:
The government of India is set to implement the Code on Wages Act, 2019 (Wages Code) which has received presidential assent and unifies and subsumes four different acts, namely the Payment of Wages Act, 1936; the Minimum Wages Act, 1948; the Payment of Bonus Act, 1965; and the Equal Remuneration Act, 1976. The Wages Code harmonises the approach to "wages" across the four pieces of legislation with a common definition of wages and is intended to be applied uniformly to all employees as it proposes to do away with separate thresholds prescribed under the existing four pieces of legislation. The Wages Code also empowers the central government to set a national minimum wage which will be applicable across all states in India.
In M&A, it is crucial to ensure that all statutory payments under applicable labour legislations have been made in full to ensure that the liability does not pass on to the acquirer. Furthermore, in the event of termination of employees pursuant to an acquisition, the acquirer will have to take into account the retrenchment payments that might have to be made to terminated employees.
National security considerations in M&A in India are mainly reviewed on a sectoral basis. Foreign investment into media and defence, include a national security review when being evaluated for an FDI approval. In addition, any investment by a resident of Pakistan or Bangladesh requires the approval of the Ministry of Home Affairs. The Ministry’s approval is also required for the manufacturing of small arms and ammunitions.
An applicant who is a citizen of or is registered/incorporated in Bangladesh, Sri Lanka, Afghanistan, Iran, China, Hong Kong or Macau will require governmental approval for opening a branch/liaison office in Jammu and Kashmir, the North East region and the Andaman and Nicobar Islands.
Outbound mergers have been introduced to the Indian M&A regime, which allow mergers or amalgamation between an Indian company and a foreign company, wherein the resultant entity is a foreign entity. Outbound mergers with foreign entities are a norm in many foreign jurisdictions and enabling these provisions in India is a step towards globalisation, thereby facilitating ease of doing business in India. The regulations notified by the RBI allows the resultant company a time period of two years to ensure that the assets and liabilities undertaken pursuant to the merger are in compliance with the foreign exchange laws of India. For instance, if ,upon acquisition of a foreign company in an inbound merger, the resultant Indian company were to inherit the non-resident loans then the resultant company has to ensure that such loans are in compliance with the rules governing external commercial borrowing in India within two years from acquisition. In the event the resultant company is unable to regularise such assets and liabilities then they are duty bound to divest them within the stipulated time.
A merger between an Indian LLP with an Indian company is also now allowed.
Insider Trading Regulations
Under Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015, (Insider Trading Regulations) there is an obligation cast on persons handling unpublished price-sensitive information of a listed company to share such information only for a "legitimate purpose". The market regulator SEBI has asked listed companies to formulate a policy on what would constitute legitimate purpose to prevent reckless sharing of sensitive information.
Shares with Differential Voting Rights
The SEBI has proposed allowing the listing of shares with differential voting rights. Such shares can be listed if they are held by the promoter group and have a fixed conversion term of five years, which can be extended by the shareholders. Such shares cannot exceed 74% of the total voting power in the company and can have a maximum voting ratio of 10:1. This measure is intended to encourage technology companies to go public while allowing their promoters to exercise control post-listing in line with international practice.
Significant Beneficial Ownership
Significant beneficial ownership rules have been introduced for companies. The rules have been introduced to identify individuals who, directly or indirectly, have a significant holding or interest in a corporate entity. The rules are intended to identify the individuals who wield influence or control over a company but remain unknown.
As noted above, in 2.4 Antitrust Regulations, prior approval of the antitrust authority will not be needed for combinations where the value of the consolidated assets of the target enterprise is less than INR350 crores (approximately USD50 million) in India or the value of the consolidated turnover is less than INR1,000 crores (approximately USD140 million) in India. This threshold-based exemption provides for speedy conclusion of transactions and has given an impetus to M&A activity in the country. This threshold exemption will remain in place until 2022 unless extended further.
Furthermore, acquisitions or combinations which fall within the categories of actions which are deemed, ordinarily, to not be likely to cause an appreciable adverse effect on competition are exempt from the prior approval of the antitrust regulator. Owing to this exemption, acquisition of a non-controlling stake or further investment in a joint venture without acquisition of control are also exempt from the antitrust regulator’s approval.
Further, the CCI has held that bids by entities belonging to the same group cannot per se be considered as amounting to cartel behaviour under Indian competition law. While examining the anti-competitive nature of the practice of price-setting by online cab aggregators like Uber, the CCI took the view that as the fares are estimated through an application by using algorithms which rely on big data and factors such as the time of the day and the local traffic situation; the resultant price for each trip is dynamic in nature and doesn’t involve any human intervention, being largely based on the "supply and demand" situation determined by the algorithms. Even though, the driver partners of the cab aggregators accede to the algorithmically determined price, the CCI was firm in its view that such conduct could not amount to collusion between the drivers as the fare for each trip is determined on the basis of a variety of factors, highlighted above.
Specific Relief Act
The Specific Relief Act, 1963 was amended in 2018 with a view to improve the enforceability of contracts and thereby further the ease of doing business in India. Before the amendment took effect contracts in India were specifically enforceable only under specific circumstances and largely in cases where monetary compensation was not deemed to be an adequate remedy. Courts were also given greater discretion in determining whether a contract was specifically enforceable or not. With this amendment, all contracts are deemed to be specifically enforceable unless otherwise determined under the Act, such as in the case of contracts whose specific performance depends on the personal qualifications of a person or involves performance of a continuous duty which is hard to monitor.
Insolvency and Bankruptcy Code
The newly introduced law on insolvency and bankruptcy also saw several amendments and judicial interpretations in an effort to align the new law with the changing landscape of corporate India. The apex court upheld the intent of the law by stating that defaulting promoters cannot participate in the resolution process and bid for a company and refused to draw any distinction between sincere promoters who are unable to repay debts and unscrupulous promoters who are accused of fraud.
A new regulation was introduced to ensure that in a resolution process the sale of the corporate debtor, or the business of the corporate debtor as a going concern, is given precedence over any other form of sale of assets. The law has further been amended to permit creditors to initiate insolvency proceedings against personal guarantors, in addition to initiating proceedings against the corporate debtor.
The apex court has held that there is no requirement under the IBC that the resolution plan should match the liquidation value of the corporate debtor; that, once a resolution plan is approved by the creditors, it shall be binding on all stakeholders, including guarantors; and that the profits made during the resolution process would not go towards payment of debts of any creditors.
The securities regulator has expanded the definition of "encumbrance" to bring within its ambit all kinds of restrictions on the free transferability of shares by whatever name called. This is intended to ensure that the promoters of listed companies do not flout the disclosure norms by using complex structures that avoid disclosure of such encumbrances created through structures like non-disposal undertaking, indirect pledge of shares through holding structures, etc.
With regard to listed companies, it is possible to acquire up to a 25% stake without making an open offer to the other shareholders. Persons holding 25% or more can acquire up to 4.99% in a financial year without triggering an open offer. Usually any acquisition of large stake in a listed company is preceded by discussions with the promoters of the company. Successful implementation of an offer bid is usually difficult in the absence of an agreement with the promoter group, as most listed companies are owned and managed by promoter groups in India. In the absence of an agreement with the promoters, stakebuilding will require the co-operation of other large shareholders of the target company.
With regard to unlisted companies, private or public, shareholders can build a stake through primary and secondary investments subject to the conditions of the charter documents, and this is always preceded by extensive negotiations with the promoter group.
In the case of listed companies, the following material disclosures have to be made to the stock exchanges and to the target company:
Insider Trading Regulations require insiders to make disclosures from time to time regarding their shareholding to the company. Insiders are also required to make disclosures, at the time of acquiring or selling such shares, to the company, which will then be disclosed to the stock exchanges by the company.
Listed companies do not have the flexibility to introduce higher or lower reporting thresholds in their by-laws and are bound by the central legislation. Furthermore, persons who can be deemed to be an "insider" under the Insider Trading Regulations are not allowed to trade when in possession of “unpublished price sensitive information”. A burden of proof is placed on such insiders who trade to prove that such information had no bearing on their trading decision.
Unlisted companies are not subjected to public disclosures other than the information that is filed annually as part of the company’s financials and other forms that are filed from time to time. However, companies are at liberty to include transfer restrictions in their by-laws governing shareholders, such as right of first refusal or restriction on sale to competitor, which can act as hurdles to stake building.
Under the Indian foreign exchange laws, unless an investment is made as part of a foreign portfolio investment, foreign investors cannot acquire shares from the market unless they already have a controlling stake in a listed entity.
Antitrust laws enforced by the CCI, and any industry-specific regulatory requirements (such as those relating to insurance companies or private banking companies), can act as hurdles to stakebuilding.
Dealings in derivatives are allowed. Foreign currency derivatives, credit derivatives and options contracts are allowed to be traded through stock exchanges or through the over-the-counter market, and are subject to the supervision of the SEBI and RBI.
There are no specific provisions in the Indian antitrust laws or securities laws in relation to derivatives, and dealings in derivatives are bound by general disclosures to be made at the time of the agreement to acquire shares/assets.
After making a public announcement of an open offer, an acquirer is required to publish a detailed public statement in the newspaper. Detailed public statements, inter alia, identify the object, purpose, and strategic intent of an acquisition along with the acquirer’s future plans with respect to the target company.
Unlisted companies are not required to announce or disclose a deal to the general public.
In the case of listed companies, the mandate of disclosure largely rests on the principle of materiality and is governed by the listing and disclosure regulations of the markets regulator (SEBI), as well as the regulations of the stock-exchange where the securities of the company are listed. The company’s board is required to frame a policy for determination of materiality based on the criteria and guidelines prescribed by the listing and disclosure regulations of SEBI. Any corporate action pursuant to an M&A which involves acquiring shares, voting rights, or control is automatically considered material and required to be disclosed without applying the test of materiality as soon as reasonably possible and not later than 24 hours from the occurrence of event.
In addition, the listed entity is required to disclose certain events to the stock exchange within 30 minutes of the closure of the board meeting held to consider the same including any decisions pertaining to fund raising. Accordingly, and in conformity with the prescribed timelines, the parties disclose the deal upon signing of the definitive agreements.
Any premature announcement of the transaction is not advised, especially where it involves listed entities, since the same may lead to speculation and result in a violation of the regulations which prohibit market manipulation and the sharing of unpublished price sensitive information.
As discussed above, in 2.4 Antitrust Regulations, the antitrust laws in India also require mandatory prior notification of acquisitions that exceed prescribed asset or turnover thresholds, unless specific exemptions apply.
As discussed above, the market practice on timing of disclosure is harmonious with the legal requirements, wherein companies disclose the deal upon entering into binding definitive agreements which is also in compliance with the prescribed regulations.
The acquirer generally insists on legal, business and financial due diligence on the target to ensure that the affairs of the target are compliant with the regulatory framework.
The scope of the diligence also depends on the structure of the deal. For asset sales, the diligence is largely limited to assets while in other cases the diligence will encompass a review of the following:
Exclusivity is usually demanded during the negotiation of the term sheet. The parties generally agree not to solicit other bids for an agreed time to give the acquirer an opportunity to undertake due diligence of the company.
Standstill obligations are usually demanded at the definitive agreement stage. Once definitive agreements are executed, parties to such agreements undertake not to take any action other than in the ordinary course of business, or effect any substantial change in the financials of the company, or act in derogation of the obligations undertaken under the definitive agreements.
There are no restrictions on what a tender offer can contain. The tender offer is generally made by way of a memorandum of understanding or a term sheet which contain the broad outline of the transaction as well as the commercial terms. The tender offer letter generally contains the details of the offer (whether it will be by way of stock purchase, asset purchase, business transfer, or any other means); the purchase price; requests for due diligence; approvals required, if any, to consummate the transaction; and other covenants pertaining to confidentiality, non-disclosure, etc. While the tender offer is an indicative document signifying intention to enter into the transaction, these terms are carried forward in the definitive agreements and elaborated upon.
With regard to listed companies, a takeover bid may take 10–12 weeks from the date of public announcement (excluding any time spent on negotiations); while in the case of unlisted companies, the time period could range between three to six months depending on the length of diligence and negotiations.
However, these timelines could be affected by the time taken for obtaining approvals from various authorities such as SEBI, the CCI in the case of antitrust issues, or from the RBI in the case of issues related to foreign exchange regulation, in addition to approvals from any of the industry-specific regulators.
In case of listed companies mandatory offer threshold will trigger on acquisition of: (i) 25% or more of the voting rights, or direct or indirect control; or (ii) additional shares or voting rights, in a financial year, in excess of 5%, if the acquiring shareholder already holds 25% or more of shares or voting rights.
Commonly used forms of consideration include cash, stock and options and combinations thereof. Further, selection of the form of consideration also depends on various aspects such as the mode of financing and the incidence of taxation.
In case of listed companies, consideration is limited to the following: (i) cash; (ii) shares of the acquirer; (iii) listed secured debt instruments of the acquirer; and/or (iv) convertible debt securities of the acquirer.
Takeover can be subject to obtaining necessary statutory approvals and such other conditions as may be contractually agreed to in the original agreement which triggers the open offer.
However, the acquirer is bound to disclose all such pre-conditions in the public statement and letter of offer and regulators discourage subjective pre-conditions being used for reneging on an offer. Hence, it is advisable to ensure that the conditions to an acquisition are objective in nature.
An open offer should be for at least 26% of the target company, which ensures that the acquirer acquires a simple majority in the company if all the shareholders who are made an offer accept the offer. Shareholding in excess of 50% would enable a shareholder to pass ordinary shareholder resolutions which can approve corporate actions such as capitalisation of profit or, alteration of authorised capital. Shareholding in excess of 75% allows a shareholder to pass a special resolution which is the highest threshold in corporate governance one needs to clear for undertaking key corporate actions such as sale of assets, mergers or making investments.
Firm financial arrangements have to be made for fulfilling the payment obligations of an open offer. The acquirer has to open an escrow account and deposit an amount equal to 25% of the consideration of the first INR500 crores (approximately USD70 million) and additional 10% of the balance consideration. Deposit can be in the form of cash, bank guarantee or frequently traded securities.
In India, deal security measures such as break-up fees are often used in acquisition and sparsely used in investment transactions. In case of acquisitions as well as investments, parties agree to non-solicit as well as standstill provisions as a way of providing deal security.
An acquirer can seek board and observer rights as additional governance rights in addition to seeking a veto right on identified actions. However, in the case of listed companies, an acquirer has to take measures to ensure that the governance rights do not qualify as giving the acquirer "control" over the target, as that will trigger an obligation to make an open offer.
Shareholders can vote by proxy by depositing the duly signed proxy form with the company. It should be noted that a proxy does not have the right to speak at a meeting and is not entitled to vote except on a poll.
The most commonly used squeeze-out method in India is the reduction of share capital. Such a reduction involves a repurchase by the company of shares held by certain shareholders and a consequent cancellation of those shares. Such a scheme of reduction first needs to be approved by a special majority of three-quarters of the shareholders of the company and subsequently an application has to be made to the governmental tribunal for approval of the same. The tribunal would usually approve a majority-approved scheme and the scope of the judicial review is limited to ensuring the fairness of the scheme so the tribunal doesn’t normally opine on the economics of the deal.
Under the new Companies Act, 2013, a new provision enables the majority shareholders holding more than 90% of the share capital to squeeze out the remaining 10% of the minority shareholders by making an offer to buy out their stake. However, the provision does not clearly state that the minority shareholders are bound to accept the offer. Further, newly notified provisions of Section 230 of the Companies Act, 2013 permit majority shareholders, holding 75% of the share capital, to seek to take over the shares of the remaining shareholders by making an application to the governmental tribunal. However, the aggrieved party is permitted to approach the tribunal in a prescribed manner. As these provisions have been recently notified, their practical application remains untested and will have to be examined as jurisprudence develops around them.
There are no express restrictions on an acquirer obtaining irrevocable commitments to tender or vote by principal shareholders of the target company. However, any such commitment to participate in an open offer, prior to the announcement of that open offer, could result in such principal shareholders being considered as persons acting in concert with the acquirer and hence is not advisable.
Under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Regulations) public announcement of an open offer must be made by the acquirer on the date when it agrees to acquire shares, or voting rights, or control over the target company. This agreement may be written or oral. Given the conditions surrounding such an agreement, the parties always tend to take precautions to ensure that a binding agreement is only executed when they are prepared to make an open offer. Takeover Regulations also identify a specific time period depending on the mode of acquisition or type of instrument being acquired. In the case of convertible instruments, an open offer is made prior to conversion and not upon acquisition of convertibles. Public announcement has to be made by sharing information in the prescribed format with the relevant stock exchange with a copy being sent to the target company and SEBI.
Disclosures such as the object of the issuance, number of issued shares, subscription by promoters/directors, shareholding pattern and identification of proposed allottee are required to be made to the shareholders as well the RoC. Furthermore, the relevant stock exchange is required to be informed in case of issuance by a listed entity.
In addition, if the transaction requires CCI approval then relevant disclosures – such as details of nature of business undertaken by entities, their market shares and financials – have to be made.
Additionally, the details of any issuance are required to be filed with the RoC and the RBI (in case of non-residents).
While there is no specific requirement to produce financial statements under the Takeover Regulations, as part of a detailed public statement, every acquirer is required to provide details of its financials to the stock exchange, prepared in accordance with GAAP.
Key terms of the transaction documents need to be included in the public announcement and the detailed public statement. Also, the target company will need to disclose any price-sensitive information to the relevant stock exchange, including material terms of agreements that could be deemed price sensitive. In case of acquisition of shares by or from a non-resident, share purchase agreement has to be attached while reporting such sale or purchase to the RBI.
Furthermore, if a proposed acquisition triggers the requirement of making a merger filing, then the copy of the relevant transaction documents have to be shared with the CCI as part of the filing.
Every director has a fiduciary duty to act for the benefit of the members as a whole and in the best interest of the company, its employees, shareholders and all concerned stakeholders. Accordingly, the directors should have a clear road map and understanding of the intended goal of a business combination.
Under the Takeover Regulations the board of a listed target company is required to ensure that: (i) the business of the target company is conducted in the ordinary course during the offer period (including non-incurrence of any material borrowings); and (ii) no material assets are alienated in any manner whatsoever during such period. The board of directors of the target company are also required to constitute a committee of independent directors to provide reasoned recommendations on an open offer which the target will publish and make available to all the stakeholders for their consideration.
Companies with a large stakeholder base (which includes shareholders, debenture holders, deposit holders or any other security holder) or with turnover/net worth above the prescribed value, are bound to constitute special committees of the board. However, such committees are not unique to business combinations.
Indian law mandates that directors disclose their interest in other entities annually and update such disclosures timely. Further, a director is required to ensure that his or her interests do not conflict with the company’s and any interested director is not allowed to participate in a meeting where the board is resolving on matters in which he or she has an interest.
The business judgement rule has been upheld by Indian courts where directors have acted in consonance with their fiduciary duties and principles of due care and good faith.
However, under Indian law, the board is ultimately answerable to the shareholders and sale or merger of a company needs to be approved by the shareholders and cannot be undertaken only with the board’s approval. In such instances, the courts tend not to call into question the commercial wisdom of the shareholders, unless such action is shown to be manifestly unfair, and have indeed, upheld the commercial wisdom of shareholders of a company, who have ratified a scheme of merger or amalgamation with the requisite majority prescribed under the law. If a majority of the shareholders have voted in favour, Indian courts will not lightly disregard an informed view, one that they consider to lie in the domain of corporate strategy and commercial wisdom.
Given the limited powers of the board, a board in India will not be able to implement any of the commonly used takeover avoidance mechanisms by itself and will need the consent of the shareholders.
Independent outside advice is usually obtained in the form of valuation certificates from independent auditors, opinions from legal counsel on compliance with applicable laws and due issuance shares, and tax advice on complex structures.
In the case of listed companies, the committee of independent directors is allowed to seek external professional advice at the expense of the target company.
Decisions of the board without regard to stakeholder conflict resulting in benefits to that stakeholder have warranted judicial scrutiny and have been called out as invalid and of mala fide intent.
Furthermore, SEBI has proposed stringent disclosure rules for shareholder advisory firms (also known as proxy advisors) to address any concerns around conflict of interests and is considering prescribing a code of conduct for proxy advisers, which code would include disclosures on conflict of interest and how such conflicts are managed.
Indian Takeover Regulations do not recognise the term "hostile offer", and a hostile bid is generally understood to be an unsolicited bid without any agreement with persons in control of the target company. Hostile tender offers are not very common, largely due to complications in their implementation compared to negotiated transactions.
In hostile tender offer scenarios, the ability of directors to use defensive measure is constrained, largely by the Takeover Regulations requirements, which mandate that during the offer period the business of the target company should be conducted in the ordinary course of business consistent with past practices. Furthermore, all the material decisions (viz, sale of material assets, borrowings, buy-back) are subject to shareholders’ approval via a special resolution which requires the consent of three-quarters of the shareholders present and voting, which makes it difficult for directors to implement any defensive mechanisms by themselves.
Given that hostile tender offers are not common occurrence, it is difficult to identify any common defensive measures. Based on previous instances of hostile offer, Indian companies have adopted techniques such as the "white knight", ie, seeking the aid of a friendly investor to buy a controlling stake in the target company (including by way of a competing offer), issuance of additional shares to dilute the interest of the bidder and buy-back of shares.
Takeover Regulations do not identify specific duties of a director while implementing defensive mechanisms, although Indian company law does impose general obligations on directors which requires directors to carry on their duties with reasonable care and diligence, and to act in the best interests of the company, its employees and the shareholders.
Takeover Regulations do not specify any provisions which empower the board of directors to reject any offer bid or business combination. As stated above, as all material decisions (viz sale of material assets, borrowings, buy-back) are subject to shareholders’ approval via special resolution, directors have a very limited role and they are not in a position to thwart any acquisition bid.
Disputes largely arise in case of a disparity in the price paid in the case of an acquisition or if there is allegation of minority-shareholder oppression. Hence, in the absence of these factors, disputes are largely uncommon.
As noted earlier, in 10.1 Frequency of Litigation, disputes usually arise when there is a price differential between the sellers and the minority shareholders, who feel that their shares are not being valued on par with the promoters. Disputes also arise from allegations of minority oppression or mismanagement of the company where minority shareholders are not in agreement with the sale proposal.
Shareholder activism in India is slowly growing into an effective tool. In the last few years, institutional investors have begun to play a more active role in the management of companies. Most cases of activism arise when the majority shareholders move forward with a deal that leaves the minority shareholders in an unfairly prejudicial position. The Companies Act, 2013 also provides for the institution of class action suits against any fraudulent management or conduct in the affairs of a company. This was introduced in the wake of several instances of corporate fraud.
The year 2019 brought two major moves that could potentially expand shareholder activism in India. Firstly, SEBI introduced a framework to allow tech companies intending to be listed, to issue shares with superior voting rights. Secondly, the regulation of proxy advisers was addressed by SEBI in a working group report. Proxy advisors could be crucial to closing the divide between a company’s management and its shareholders.
The view of shareholder activists towards the M&A space largely depends on the whether there exists prejudicial treatment of minority shareholders and on the corporate governance structure of the company.
Shareholder activism in India is still gaining traction in the corporate space. Due to issues surrounding the implementation of legislation and sanctions in most cases, the full force of shareholder activism is yet to be seen. In the context of M&A, companies may have cause for concern if an announced deal places their minority shareholders in a detrimental position. Aggrieved shareholders are empowered under the Companies Act, 2013, subject to certain thresholds, to approach the National Company Law Tribunal (NCLT) to move against decisions of the company.
Charting Global "Macro Trends"
Deal-making in India, in recent years, has largely mirrored global mergers and acquisitions (M&A) market trends, retreating from record highs (in terms of deal value and volume) in 2017-18 to more customary average levels in 2019-2020. For instance, aggregate M&A deal value in India in 2019 softened to approximately USD52 billion, according to a report released by Oxford Economics. While the fall in M&A deal-making is largely linked to global economic and political uncertainty, a setback in deal activity in India has also been a corollary of investors treading carefully in the light of the country's 17th general election. Other factors include the softening of economic momentum, resulting in fewer available jobs and sluggish growth across all sectors. The World Economic Outlook Report released by the International Monetary Fund (IMF) also suggests that “India’s economy decelerated further in the second quarter (of 2019), held back by sector-specific weaknesses in the automobile sector and real estate as well as lingering uncertainty about the health of nonbank financial companies.”
However, the economic slowdown isn’t specific to India, but is more of a global phenomenon. IMF projections of India’s growth rate estimate improvement in 2020-21. These projections are bolstered by the mandate secured by the ruling government in the recently concluded general elections. This analytical prediction by the IMF should be positive news for foreign investors and improve investor confidence in the Indian market.
Overview of India – M&A
While broader deal activity has fallen, a recent impetus to M&A activity has been the sale of distressed assets under the Insolvency and Bankruptcy Code, 2016 (IBC). Led by ArcelorMittal and Nippon Steel’s joint acquisition of Essar Steel, which was wrapped up when the Supreme Court cleared the USD6 billion (approximately INR42,000 crore) deal, the IBC enactment spurred deal-making at values rarely seen before. The trend has been observed and recorded in the "India M&A Report 2019", published by the Confederation of Indian Industry in association with Bain & Company. The report states that there has been considerable growth in the M&A industry due to acquisitions of distressed assets from 2016 until 2019, enabled by the time-barred insolvency resolution process under the IBC.
Other prominent deals during 2019 included the merger of the consumer mobile business undertaking of Tata Teleservices with Airtel in the telecoms space, IndusInd Bank’s acquisition of Bharat Financial Inclusion in the banking space, and the acquisition of Heinz India’s consumer wellness business by Zydus Cadila. Such deals have largely been driven by the growing need to focus on core businesses and the necessity of improving profitability against the backdrop of a looming recession risk.
Recent Legislative Developments
By enacting new laws and amending some pre-existing ones, the government has given clear signals to the investor community of its intention to ramp up levels of foreign investment. As India’s participation in global trade increases, insulating domestic markets from global macro-economic risks is nearly impossible. However, these recent changes give confidence that, although fiscal performance has been slow (but in line with the global trend) this one-off phenomenon should not dissuade future investment in the country. Some major reforms that were introduced in the latter part of 2019 are expected to directly impact M&A deal-making in India.
An example of such reforms is the securities regulator’s new framework on the issuance of shares with differential voting rights (DVRs), ie, superior voting rights (multiple votes on one share) or inferior voting rights (a fraction of the voting right on one equity share). Under the new framework, companies that have issued shares with superior voting rights to their promoters can list their securities on a stock exchange, subject to the conditions specified in this regard. The framework proposed at the board meeting of the Securities and Exchange Board of India held in June 2019, coupled with the amendment to the Companies Act, 2013 in August 2019, provides an effective tool for Indian promoters to receive investment without losing control.
The concept has been traditionally popular in the western world but has started gaining momentum in India only recently as the money markets mature. Such changes are likely to prove attractive to promoters who are not always able to meet a company’s growing funding demands due to lack of capital but are also unwilling to lose control as a result of raising capital. Traditionally, promoters who sought investments from external sources had to substantially dilute their shareholding in the company in order to access investment. This also resulted in key business decisions being made by investors who had brought in capital for the company. Therefore, the issuance of shares with DVRs will help promoters in retaining their right to vote on business decisions, irrespective of their capital contribution.
The government has also focused on on improving the "ease of doing business" rankings. This is critical in giving a leg up to its "Make in India" initiative. Manufacturers have traditionally been required to comply with numerous central and state-specific laws before undertaking operations. To simplify this rigmarole, the recently enacted Code of Wages, 2019 codifies four existing labour laws into one. The code, once made effective, will subsume and repeal the following important labour laws: (i) the Payment of Wages Act, 1936; (ii) the Minimum Wages Act, 1948; (iii) the Payment of Bonus Act, 1965; and (iv) the Equal Remuneration Act, 1976. This is expected to simplify the labour-compliance burden for entities operating in India.
The country’s antitrust regulator, the Competition Commission of India has also recently significantly changed the merger-control regime by introducing the concept of a deemed approval under the "Green Channel Route" for certain categories of combinations. This change is expected to drastically reduce the approval-wait timelines and give a fillip to deal-making by expediting M&As that meet the prescribed conditions.
Noteworthy changes have also been recently made to the exchange control regime. Pursuant to the recent changes, the government issued the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (Equity Investment Rules) and the Foreign Exchange Management (Debt Instruments) Regulations, 2019 (Debt Investment Regulations). The reporting procedures have also been recently revamped. Under the amended regime, a new classification of debt instruments and non-debt instruments has been introduced, with separate laws for both debt and equity investments aimed at making the process simpler. Another first-of-its kind piece of legislation is the Foreign Exchange Management (Cross Border Merger) Regulations, 2018, which allows for inbound as well as outbound mergers, permitting Indian companies to acquire and merge with foreign companies.
For the industry specifically, the government has made an attempt to revive the economy through the Taxation Laws (Amendment) Act, 2019 (the Act). The biggest change brought about by the Act is the reduction in the corporate tax rate of domestic companies to 22% and 15% (for new domestic manufacturing companies). It is hoped that the move to reduce corporate tax rates is will result in higher profits in the hands of individual stakeholders, which, in turn, will increase their disposable income leading to an increase in demand and consumption, simultaneously helping to revive the economy.
Sector-Specific "Bright Spots"
It is expected that the desire to increase scale and the pursuit of technological incorporation will continue to drive M&A transactions in the near future. For example, the Indian financial sector regulators have recently introduced two major reforms, namely, the "Regulatory Sandboxes" and "Innovation Frameworks". These developments aim to foster responsible innovation in financial services, promote efficiency, and bring benefits to consumers by incentivising market participants to test new products, services, or business models with customers in a live environment – subject to certain safeguards and oversight. The proposed benefits available to businesses under the sandbox framework require applicants to showcase the use of new or emerging technology, or the use of existing technology in an innovative way, to address a problem and bring benefits to consumers. This will allow either existing financial companies to tie up with technological platforms and provide better services through tech innovation or allow new space for start-ups to implement and test their technology, thereby easing access to financial services for customers. These initiatives are likely to give a spur to foreign funding or consolidation amongst existing companies. Either way, the M&A space is likely to benefit from this regulatory change.
With regard to the healthcare sector, the recent focus on the implementation of the National Digital Health Blueprint (NDHB) is expected to bring key changes. Electronic medical records, mobile healthcare, digital-health-knowledge resources and technology-enabled care are some of the technologies gaining wide acceptance in the sector. India’s medical technology sector is forecasted to grow markedly, and the NDHB aims to leverage digital technologies to enhance the efficiency and effectiveness of delivery of all healthcare services. While recognising the deficiencies that exist in the current healthcare systems, the NDHB policy recommends a paradigm shift from the existing system of "silos" to a holistic and comprehensive health eco-system, founded on the latest digital architectures and technologies. It is hence predicted that companies are likely to acquire, partner, or collaborate – as the case may be – across healthcare sectors in 2020, citing access to technology as the main reason to pursue a deal. The Ministry of Health and Family Welfare has introduced a draft bill: the Digital Information Security in Healthcare Act (DISHA), to secure healthcare-sector data in India while giving people complete ownership of their health data. In 2019, DISHA was submitted to the Ministry of Electronics and Information Technology to be subsumed into the upcoming Personal Data Protection Bill.
For the real estate sector, one of the most prominent pillars of an emerging economy, recent years have not been very favourable due to a shortage of consumer demand. However, the recently formed regulator, the Real Estate Regulatory Authority (RERA), has taken measures that are assisting in the completion of projects within the timelines prescribed by the Real Estate (Regulation and Development) Act, 2016, which has pushed developers to change their strategies. With sales going down and prices not moving up, cash flows have dried up and construction activities have slowed down dramatically. Moreover, due to ample rental inventory, the housing rental levels are static and, despite lower bank lending rates, buyers prefer to stay away from leveraged home purchases. The situation is worse for smaller real estate companies because of a reluctance by lenders to fund such activities, given the ongoing lending crises and fears of default. Therefore, developers are keen to merge, consolidate, and enter joint ventures with established and prestigious developers.
While there is a substantial inventory of both finished and unfinished residential projects in India, rent-yielding commercial assets have become scarce in recent years, and the sector is becoming lucrative as new investment options become available for investors, in the form of warehousing, co-working spaces, and co-living. The first real estate investment trust (REIT) offering, launched in March 2019 by Embassy Parks, opened up a new asset class for investments in the country. India is expected to see the launch of more REIT offerings in 2020, which investors should seriously consider. In respect of assets, it is expected that, as in 2019, M&A deals undertaken through the IBC regime for the sale and purchase of distressed assets, will continue to see a surge in 2020.
The insurance industry is also looking at major changes. Currently, foreign direct investment in insurance is capped at 49% which, according to many industry observers, may be raised to 74%. Earlier, a relaxation of the investment cap was provided to insurance intermediaries, which can now receive foreign investments of up to 100%.
COVID-19 – Impact on M&A
India was already in the throes of a slowdown when the novel coronavirus (COVID-19) pandemic struck. India’s rate of real GDP growth had decelerated to its lowest in over six years in the third quarter of 2019-2020 and now the country faces a period of significant economic disruption as the country locks down to slow the spread of the virus. Effects of India’s 21-day lockdown are reverberating, with varying degrees of severity, across all the sectors of the Indian economy. The services sector, including segments such as aviation, retail and entertainment have been severely hit. The manufacturing sector, too, has suffered drastically with production shutdowns, and labour and supply chain disruptions. As India learns to adjust to the "normal" after COVID-19, every stakeholde – from the government to promoters, corporates, and bankers – needs to take quick action to adapt.
Until the COVID-19 infection spread curve flattens significantly, successful policies for recovery are introduced and business productivity resumes, India’s domestic and global M&A deal activity will likely remain soft when measured against deal volume norms over the past few years.
This does not mean that attractive and opportune strategic and financial transactions will not continue, or that announced deals will not be consummated. If there is an economic justification for merging or acquiring a particular business or company, COVID-19 and its consequent economic impacts should not alter the underlying rationale for pursuing and executing deals.
Undoubtedly, the current situation has also led to significant volatility in asset prices of Indian companies, requiring investors, such as global funds, to review the health of their portfolios. As a result, this situation will lead to the repricing of financial assets and churning of fund portfolios, while generating new investment opportunities, as demand for alternative capital picks up and need-based M&A (disposal of non-core assets) gains momentum.
2020 and Beyond
Given the IMF predictions, the government’s initiatives and the not-so-dismal performance of the Indian M&A industry, the expectations for India are considerable. The current government has implemented, and will continue to put into force, multiple policies to attract foreign investors by streamlining laws that had hitherto spelt complexity. Opening up more sectors to foreign investment through automatic routes will help attract capital, especially when fresh lending to the industry is at an all-time low. Key proponents of the industry believe that the financing slowdown led by the crisis in the shadow banking industry and coupled with the impact of COVID-19 will, in turn, pave the way for consolidation.
To quote the aforementioned report, “India’s M&A space, despite the global headwinds, is expected to remain stable in the next few years, with private investments reviving against the backdrop of a more favorable business environment.”