A Legal Practitioner's Thoughts On Merging Across Borders

A Legal Practitioner's Thoughts On Merging Across Borders

India’s legislative changes have opened doors for cross-border mergers however navigating the complexities, particularly the legal, regulatory and tax hurdles across borders and practical challenges like cultural integration require careful planning and expertise

Introduction

A tongue-in-cheek article that we read suggested that there were mergers and acquisitions in the time of the caveman.2 While the history of M&A (Mergers & Acquisitions) is popularly considered to start with the great merger movement in the United States of America (between 1895 and 1905), in India, cross-border M&A became prominent only after the economic reforms from 1991. Cross-border M&A affecting India could be said to have been significant right from the days of the East India Company.3 The continued evolution of corporate laws and globalization have opened doors for exciting possibilities in the business world. M&A have become a key strategy for companies to transform their business.

From an India perspective, cross-border mergers can be broadly categorized into 2 (two) categories i.e., an inbound merger or an outbound merger. While an inbound merger brings a foreign company into the fold of a domestic company, an outbound merger sees a domestic company venturing out to become part of a foreign entity.

Unleashing Global Growth: India’s Shift in Cross-Border Mergers

The Indian corporate landscape limited the occurrence of outbound mergers due to restrictions under the erstwhile Companies Act, 1956. This hindered the Indian companies’ ability to expand globally through M&A. A turning point came in 2017 with the notification of Section 234 under the new Companies Act, 2013. This section removed the previous limitations, paving the way for both inbound mergers and outbound mergers.

Sections 230-234 of the Companies Act, 2013, establish a comprehensive framework governing all types of cross-border mergers in India. This legislative shift has unlocked exciting opportunities for Indian companies to participate in the global M&A landscape, fostering international expansion and growth.

Cross-border M&A also involves the “movement” or ‘change in control” of foreign assets and liabilities, which was either restricted or heavily regulated by exchange control laws in India. The Reserve Bank of India (RBI) took a vital step in 2018 and notified the Foreign Exchange Management (Cross-Border Merger) Regulations, 2018 (“Merger Regulations”). These regulations aimed to streamline the process of cross-border M&A by providing clear guidelines and bringing in a uniform approach to govern cross-border M&A.

This two-pronged approach of legislative changes and regulatory clarity has unlocked exciting opportunities for Indian companies. It has empowered them to participate actively in the global M&A arena.

Adding another dimension to this evolving landscape is the Indian government’s ambitious project Gift City (Gujarat International Finance Tec-City). This initiative aims to establish a global financial and technology hub, located onshore India but acting like an offshore jurisdiction, and has the potential to significantly impact cross-border M&A involving Indian companies.

Practical Considerations in Cross-Border M&A

The aphorism that states: “All that glitters is not gold” is one that should not be ignored in navigating and completing cross-border M&A. While successful stories abound, a cross-border M&A could be a laborious and costly process that requires navigating through legal, tax and regulatory hurdles across multiple jurisdictions and requires specialized knowledge. Political shifts, changes in geo-commercial dynamics, and even value erosion may sometimes occur during the extended approval processes.

Determining the value of businesses and identifying key value drivers and indicators across borders is often challenging due to diverse legal requirements (corporate, merger control and tax, to state some of the main factors), and regulatory and financial environments. In addition to the above, fluctuating exchange rates could create obstacles in prolonged M&A requiring multi-jurisdictional approvals.

While the notification of the Merger Regulations simplified the process, Indian laws for cross-border M&A still have nuances and intricacies that present some limitations that need to be addressed. Jurisdictional restrictions under Press Note 3 and Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, limit the scope of cross-border mergers to and from some countries. Notably, in the case of inbound mergers, where the host country has fewer restrictions and the transferee company has businesses in these restricted jurisdictions, additional corporate restructuring becomes necessary, adding to the complexities and costs.

Beyond the initial, and admittedly interesting and challenging, issues a cross-border M&A will also have to deal with post-merger considerations since the laws of the home country will apply to the resultant/surviving entity. For example, in case of India, foreign borrowings of the resultant company need to follow the applicable external commercial borrowings regulations. ESOPs (Employee Stock Option Plans) need to conform to Indian tax and legal considerations, and even ordinary going-concern policies such as employee handbooks, safety and health regulations and employee benefit programs will need to be analyzed from and Indian law, regulatory and tax perspective.

Further, Indian entities listed on a recognized stock exchange face limitations in pursuing cross-border mergers as they require separate approvals from the Securities and Exchange Board of India (SEBI) and the relevant stock exchanges where their securities trade.

In the case of outbound mergers, Indian residents receiving shares in the resultant foreign company are subject to limits specified under the liberalized remittance scheme. Similarly, Indian entities are also required to comply with the applicable overseas direct investment laws. These regulations not only impact deal structures but could also impact the manner of payment of consideration in such mergers. We have had to address many of these issues over various transactions involving cross-border M&A and have found that many of these issues assume differing degrees of prominence in ways that do not lend themselves to a templatized approach. Cross-border M&A is case-specific. Understanding the needs and potential benefits for all relevant stakeholders is key, as there is “no one-size-that-fits-all”.

While India’s legislative changes offer some promise for cross-border mergers, navigating the complexities discussed above along with regulatory challenges such as adherence to sectoral caps, foreign investment restrictions in identified sectors, tax and regulatory matters, political concerns, and bridging the gap of cultural differences make cross-border M&A both challenging, and when achieved so much more satisfying.

Conclusion

Cross-border M&A, despite their sometimes seemingly labyrinthine challenges, offer a unique proposition with the potential to create significant value. They can be a powerful tool for achieving inorganic growth in terms of size, resources, and market share, propelling companies into international markets by leveraging established presence and distribution channels and sometimes access to further capital.

For some entities, changing their domicile through a cross-border merger also becomes a strategic move. This can be particularly attractive for entities looking for more robust corporate laws, tax and employee talent availability, manufacturing prowess, easier access to funding for growth, or even return on exit to name a few prominent advantages. India’s legislative changes have opened doors for cross-border mergers. However, navigating the complexities, particularly the legal, regulatory and tax hurdles across borders and practical challenges like cultural integration require careful planning and expertise.

While principles may not have changed much in the last few thousand years in the M&A world, it becomes ever more crucial to find the right balance in every transaction. In cross-border M&A, the key stakeholders usually only have one chance to do the right transaction with the right advisors. They need to make the most of that chance in a market that now includes what we believe is a much more open, commercial, and resilient India.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.