Key Regulatory Considerations For Mergers & Acquisitions In India

While there is a general thrust to make India an attractive destination for investments, the regulators are treading cautiously on this path by maintaining certain levels of restrictions and scrutiny.

INTRODUCTION

The Indian regulatory landscape governing foreign investments in India has undergone major changes in the last few years, with the Government of India (“GOI”) focusing on ease of doing business and the Make in India campaign. There has been strong focus on streamlining and easing the procedural requirements for inbound investments, by way of digitization and eliminating unnecessary procedural requirements. While there is a general thrust to make India an attractive destination for investments, the regulators are treading cautiously on this path by maintaining certain levels of restrictions and scrutiny.

India has strict capital control policies under its foreign exchange regulations and the type of investment (whether domestic or cross-border) is of significant importance while evaluating the applicable regulations. Indian regulations for investment and acquisitions are complicated and one has to navigate through many laws and regulations when implementing a merger or an acquisition (M&A), joint venture (JV) or setting up a greenfield project. We have set out some of the key regulatory considerations for M&As in India.

KEY LEGISLATIONS

(a) Corporate laws are primarily governed by the Companies Act, 2013 and the rules notified therein (“CA 2013”). All corporate entities must ensure compliance with the provisions of the CA 2013. CA 2013 also largely governs any amalgamation, mergers and demerger of corporate entities. The regulations were recently relaxed to permit the merger of foreign companies with Indian companies, thereby easing the process of ‘reverse flipping’, under which the holding / parent company is moved from overseas to India.

(b) Securities laws are primarily governed by the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992 and the rules and regulations notified therein (“SEBI Act”). The Securities and Exchange Board of India (“SEBI”) is the regulatory body overseeing the compliance of the securities laws. Any investment in an Indian listed company mandates compliance with inter alia the SEBI Act. The regulations also set out guidelines and scenarios triggering mandatory open offers, and/or disclosure requirements. Mergers/ demergers involving listed companies require the approval of the company law tribunal which may direct further approvals from regulatory bodies including SEBI, the Registrar of Companies (ROC) and the Reserve Bank of India (“RBI”), as applicable.

(c) Competition / antitrust laws are governed by the Competition Act, 2002. The regulatory body overseeing the compliance of the antitrust laws is the Competition Commission of India (“CCI”). Any investments involving combinations and M&As must be notified to the CCI if the asset size or turnover exceeds the thresholds notified under the Competition Act, 2002. Further, “combinations” in terms of the Competition Act, 2002, are reviewed by the CCI to assess if the transaction would have an adverse effect on competition or would lead to monopolistic dominance in the market. Deal value thresholds have been recently introduced in terms of which any M&A / combination transaction with a global transaction value exceeding `2,000 crore with the target company having ‘substantial business operations’ in India, will be subject to an approval from the CCI. The amended regulations define ‘deal value’ broadly, encompassing all types of consideration including direct, indirect, cash, non-compete payments, deferred payments, or otherwise.

(d) The Indian foreign exchange laws are encapsulated in the Foreign Exchange Management Act, 1999 and the rules, regulations and directions notified thereunder (“FEMA”). The government updates and consolidates its foreign direct investment policy from time to time with the extant version being the FDI policy dated October 15, 2020 (“FDI Policy”). The FDI Policy along with the rules framed under FEMA (collectively the “FDI Laws”), require careful evaluation before undertaking any cross-border investment transaction. The RBI is the central bank of India and nodal authority regulating the compliance of FEMA, banking, and other financial activities in India. Additionally, the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, GOI (“DPIIT”) is a key regulator of any foreign investments in India.

(e) Tax laws in India govern the applicability of direct and indirect taxes. The income which is deemed to accrue and arise in India including from capital gains, gifts, business and profits is covered under the Income Tax Act, 1961. Indirect taxes such as on goods and services, on registration of documents and properties, and stamp duty on documents are covered under various legislations governing such other taxes. It is important to consider various double taxation avoidance agreements and the conventions to which India is a signatory for structuring cross border investments.

M&A AND FDI LAWS

While there has been significant liberalisation over the years from the early 1990s, the regulators have been cautious while opening up sectors for foreign investment, especially in certain sensitive areas to avoid dilution of sovereign control. The FDI Policy and tax laws in India have provisions that prohibit transactions that may lead to speculation, money laundering, corruption and avoidance of taxes.

The FDI Policy provides for segregation of investment routes into either the automatic route or an approval route, and expressly prohibits foreign investment in certain sectors which include lottery business, gambling and betting including casinos, chit funds, investment in Nidhi company (a non-banking finance company doing the business of lending and borrowing with its members or shareholders) and trading in transferable development rights and real estate business or construction of farmhouses. In sectors where FDI is permitted, either certain ownership and control limits are specified with or without approval of the government or investment is permitted up to 100% ownership without any approval requirement. Any cross-border transfer of shares (including with a foreign owned and controlled company in India) would have to comply with pricing guidelines linked to the fair market value of the shares, which dictate the value at which the transfer should take place. There are additional layers of conditions or restrictions that may have to be complied with for certain sectors. Some key sectors that are subject to limits and conditions are broadcasting content services, print media, retail (wholesale or single brand), construction development, telecom, banking, aviation and defence. Foreign investment in such restricted sectors may be limited to a certain percentage or may require specific approvals or licenses from the relevant regulators prior to making the foreign investments and there may be additional conditions such as minimum capitalisation or lock-in requirements.

Curbing Opportunistic Takeovers

Amidst the trail of destruction left behind by the pandemic in 2020, failing business and trade, falling valuations and depleting cash flows resulted in organisations gasping for survival. This, in addition to the growing geo-political constraints developing in the subcontinent and India took a cautious step to curb opportunistic takeovers of devalued organisations from countries that shared a land border with India. The GOI thus notified Press Note 3 (2020) dated 17 April 2020 (“PN3”), imposing restrictions on direct and indirect foreign equity investments from land bordering countries into India. The investments originating or having beneficial ownership from the territory of the Peoples Republic of China including Hong Kong (“PRC”), Bangladesh, Pakistan, Bhutan, Nepal, Myanmar and Afghanistan (“Restricted Countries”) were thus made subject to approval (“PN3 Approval”) even if the investment would have otherwise qualified for an automatic route prior to the notification of PN3. It is pertinent to note that during this time, there were significant attempts made by entities from PRC to take over organisations in other jurisdictions at low valuations. This resulted in several countries bringing about similar restrictions to avoid a takeover of their local organisations by entities from PRC.

The Approval Dilemma: Significant and crucial investments have been made globally from PRC in certain sectors such as information technology, manufacturing, and trading. With PN3 Approval being sparsely given by the GOI, investments and growth across sectors have been adversely impacted. Indian investee companies which have had to seek alternate (and usually expensive) modes of investments such as debt funding. While there was a logic and rationale for the curbs imposed by the GOI under the PN3 during the time of its notification, it has evidently had a negative impact on genuine businesses curtailing their growth and restricting their operations. The average time taken to process an application for a PN3 Approval was significantly more than the 12-week period stated in the standard operating procedure for processing PN3 Approval applications, with the application going through a complicated and intricate scrutiny process within various governmental departments.

A New Dawn: There is a consistent effort by the GOI to make the FDI process easy and improve India’s position on the global ‘ease of doing business’ rankings. We note that PN3 Approvals are being given in genuine cases in far less time than the previous years. There are also instances of authorised dealer banks with delegated power from the RBI, approving investments from PRC where the beneficial ownership is less than 10%. Since there is no written policy on this stance, there is no certainty that every authorised dealer bank will take the same position, thus adding to the woes of investee companies that have marginal investments from Restricted Countries.

The good news is that based on our positive experience with procuring PN3 Approvals, we note that there is a genuine effort by the GOI to ease the stance. Based on our experience, we note that the sector in which the investment is proposed to be made and the rationale for investment is of significant importance. The GOI is considering applications for investment that will have a positive impact on the Indian economy such as creation of enhanced manufacturing capabilities, increase in employment opportunities, reduced dependence on imports and transfer of material technology to India. In our experience, typically an application for PN3 Approval goes through three levels of scrutiny:

1. Micro-economic Clearance – the relevant ministry/department of the ministry depending on which sector the investment is being made in, reviews and scrutinises the economic and overall impact of the investment on the sector.

2. Security Clearance – details of the investor and investee are required to be furnished, including granular details of the directors and shareholders are reviewed by the Ministry of Home Affairs.

3. Political Clearance – the Ministry of External Affairs evaluates the details of the proposal, especially with respect to the beneficial ownership of the investor.

Various representations have been made by the industry and global organisations to the GOI for easing the restrictions under the PN3. During her budget speech in 2024, the finance minister alluded to an easing of the PN3 restrictions. Similarly, the fact that PN3 Approvals are now trickling in also suggests a dilution of the rigid stand in the rise for a demand for economic growth by the industry.

India is one of the few nations that has a positive growth expectation despite the slowdown brought about by various factors including the pandemic and the global conflicts. While caution and restraint has helped India weather the storms, it may be time for India to evaluate its strategy and perhaps, ease some of these constraints and provide clarity on its current stand on PN3 to help catapult the FDI inflows and provide the much-needed fillip to Indian companies and businesses.