A comparison of M&A regulatory updates: India

India witnessed its highest level of deal-making in 2021 by both value and volume as the stock market boomed along with phenomenal IPO exits and long-awaited resolutions to some of the largest distressed assets, including by foreign investors.

While foreign investment in India continues to be regulated, foreign investment conditions are being progressively liberalised and the government seems keen to promote the ease of doing business; though still governed by a multitude of legislations, rules, regulations, notifications and policies.

KEY LEGISLATIONS

The central parliament has the legislative power to enact most of the statutes relevant to M&A, and such statutes do not vary from state to state. Key statutes are set out here:

• The Companies Act, 2013 regulating corporations;
• The Indian Contract Act, 1872 regulating contracts;
• The Foreign Exchange Management Act, 1999 regulating inbound and outbound investments and cross-border mergers;
• The Securities and Exchange Board of India Act, 1992 which prescribes the framework for acquisitions involving listed companies;
• The Competition Act, 2002 regulating combinations and prohibits anti-competitive agreements; and
• The Income Tax Act, 1961 which prescribes the framework for direct taxation.

The statutes are typically accompanied by rules, regulations and notifications; and in some cases, press notes or other policy documents. Additional statutes may also be relevant, depending on the business and structure of the M&A transaction.

THE REGULATORS

The central government – particularly the Ministry of Finance, and Department for Promotion of Industry and Internal Trade at the Ministry of Commerce and Industry (DPIIT) – issues the rules and policy framework for foreign investments. The Reserve Bank of India (RBI) regulates and implements the reporting mechanism for foreign investment. Other regulators are the Securities and Exchange Board of India (SEBI), when listed companies are involved, and the Competition Commission of India for antitrust approvals, where necessary.

ENTRY BARRIERS

A foreign investor typically needs to find answers to the following two questions if proposing to invest in India:

• Is foreign investment permitted in the business proposed to be set up or acquired? While most business sectors are open for foreign investment, a few are prohibited – namely atomic energy, gambling and lottery business, and chit funds; while certain sectors, such as defence and insurance, have conditions; and
• What will be the optimal entry route? India permits foreign investment in several forms, such as foreign direct investment (FDI), foreign portfolio investment (FPI), and foreign venture capital investment (FVCI). Depending on the M&A objectives, one of these entry routes may be preferable to the others.

Typically, foreign investment regulations cannot be circumvented by incorporating a company in India because a company such as this, controlled or majority-owned by non-residents and making downstream investment, would be subject to similar regulations applicable to non-residents.

M&A STRUCTURES

M&A structuring typically involves:

• Share acquisition, either as a primary subscription or secondary purchase;
• Asset purchase, which may be structured as an itemised asset purchase, or a slump sale, which is a term under Indian tax laws and provides tax efficiencies if a sale qualifies as such; or
• Mergers, demergers or amalgamations, which are implemented by a special court, the National Company Law Tribunal (NCLT). While fast-track mergers without requirement of NCLT approval are possible in the case of mergers between holding companies and wholly-owned subsidiaries, and small companies, these mergers still require a confirmation from the government.

For listed companies, additional requirements apply, including:

• A mandatory tender offer is required to be made for at least 26% shareholding if an acquirer proposes to acquire 25% or more shareholding or control;
• In certain situations, a mandatory tender offer may also be required in the case of a change in shareholding and/or control of a shareholder; and
• Listed companies are required to maintain a minimum public shareholding (typically 25%) at all times.

FOREIGN INVESTMENT

Investments by non-resident entities in Indian companies are governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (FEMA NDI Rules) and press notes issued from time to time by the DPIIT.

• Investment routes. While FDI is investment through capital instruments in unlisted companies, or 10% or more of a listed company, FPI is investment through capital instruments by non-resident investors registered with the SEBI in less than 10% of a listed company. While 10% is the individual limit for an FPI, total holdings of all FPIs of a company cannot exceed 24% of the paid-up equity capital or the paid-up value of each series of capital instruments. FVCI is an investment by non-resident investors in venture capital funds or undertakings in specified sectors such as biotechnology, nanotechnology and infrastructure.
• Entry restrictions. FDIs may either fall under the automatic or approval route, depending on the sector and percentage of investment. FDI under the automatic route requires no approval from regulatory authorities, but needs to comply with applicable sectoral caps, pricing guidelines, and FDI-linked performance conditions. FDI under the approval route requires prior approval from the relevant sector regulator or the RBI. Pursuant to a press note released by the DPIIT in 2020, any FDI from entities incorporated in countries that share land borders with India – or where the beneficial owner of investment is situated in, or is a citizen of, any such country – will mandatorily fall under the approval route. In addition, the FEMA NDI Rules impose a blanket prohibition on FDI in certain sectors.
• Pricing guidelines and reporting requirements. The FEMA NDI Rules prescribe pricing guidelines for the issuance and transfer of securities of an Indian company to non-residents. All such issuance and transfer involving non-residents are required to be reported to the RBI within prescribed timelines and in the form and manner prescribed.

KEY M&A DEVELOPMENTS

• FDI thresholds in sectors such as insurance and defence have been raised from 49% to 74% under the automatic route, subject to compliance with sector-specific conditions. FDI thresholds in telecoms, petroleum and natural gas have increased to 100% under the automatic route, in case of the government granting in-principle approval for strategic disinvestment of public sector undertakings.
• FDI up to 20% under the automatic route is now permitted in the Life Insurance Corporation of India, the country’s largest insurance company, ahead of its IPO.
• The Ministry of Corporate Affairs has permitted startups to adopt fast-track mergers without obtaining NCLT approval, as is required for regular mergers.
• The SEBI has permitted acquirers to make combined offers for delisting the shares of a listed target company while making an open offer.
• The RBI has issued draft guidelines aiming to tighten overseas direct investment (ODI) and financial commitments provided by resident entities, while also aiming to liberalise ODI-FDI structures.

M&A TRENDS

While the use of warranty and indemnity insurance is still at a nascent stage in India, there is a growing demand for such products, given the surge in foreign investments. Similarly, trends such as including break fee and reverse break fee provisions in investment documents are starting to gain prominence, although these largely remain untested from a regulatory perspective. The authors also see payment structures such as locked-box mechanisms, deferred payments and escrow arrangements gaining popularity; as well as increasing use of hell or high water clauses as a remedy to get mega-mergers through.

Furthermore, the authors expect the record M&A momentum of 2021 to continue gaining traction in 2022 – with a focus on fintech, electric vehicles, tech and data analytics, pharma and healthcare, and e-commerce and quick-commerce. Private equity investors are likely to participate in more control transactions; and the startup space is expected to remain vibrant. With abundant financial reserves and liquidity, valuations are expected to remain high, and more investments are expected to take the contested auction route than a negotiated one, and with capital markets playing hot and cold, private equity exits are more likely to be structured as dual-track exits, with simultaneous IPO and auction process in play.

With the growing relevance of environmental, social and governance (ESG) rights are going to play an even more important and central role in negotiations and overall management. More capital is also likely to be deployed for impact investments, especially those related to transitioning into cleaner and sustainable energy sources. All of this is likely to generate increased M&A opportunities.