This research paper explores the intricate legal landscape in India surrounding cross-border mergers and acquisitions in the contemporary business environment. The study highlights the complexities associated with corporate law, foreign exchange regulations, taxation, regulatory compliance and other vital aspects determining the possibility of a cross-border M&A transaction.
The findings contribute to the existing body of knowledge by analysing critical legal challenges and offering insights into possible strategies for overcoming these challenges. The research concludes with recommendations for regulators, corporations and lawyers, emphasising the importance of continuous awareness of the evolving legal landscape.
Keywords
Mergers, Acquisitions, Cross-border, Companies Act, FEMA, Merger Regulations, Tax, M&A, Regulations, Regulatory, Business, Transactions
Introduction
Mergers and acquisitions are considered pivotal inorganic growth tools for corporate bodies. The inorganic growth of a company means expanding its capacities through external actions but not through organic or internal strategies.
“Inorganic growth can be a game-changer, propelling a company to new heights by strategically expanding its footprint”.
These words from Indra Nooyi, former CEO of PepsiCo, signify how crucial mergers and acquisitions are for a company, especially when it wants to expand its footprint worldwide. These kinds of transactions at the cross-border level involving multiple jurisdictions have gained massive significance in the past three decades with the advent of globalisation and a substantial boom in the information technology sector.
Initially a closed economy, India wholly prohibited cross-border mergers and acquisitions from starting. However, with the advent of the 1991 liberalisation policy, it was required to change laws permitting and regulating these cross-border corporate transactions rather than prohibiting them entirely. These changes were first introduced through Section 234 of India’s newly enacted Companies Act, 2013. It empowered the central government and the Reserve Bank of India to make rules regulating these transactions. Also, other legal concerns are involved in corporate-level transactions, especially when two different jurisdictions are involved. These include FDI Regulations, Competition laws, Taxation laws, Securities laws, Stamp Duty related laws, and many others. In the present era, where large multinational companies with massive market caps exist, it is essential to understand and figure out a way to face various legal challenges we can expect while dealing with a cross-border M&A transaction.
Research Methodology
The research is based primarily on the doctrinal method. The researcher relied on authentic and credible secondary sources. The main objective of this research is to analyse various legal challenges in cross-border mergers under Indian law and to propose practical solutions for them.
Review of Literature
The article “Challenges in Cross Border Mergers” mainly discusses the complexities of cross-border mergers involving India, with a primary focus on the Companies Act, 2013 and other regulatory frameworks surrounding such transactions. It provides a comprehensive overview of the evolution of various important regulatory aspects, including Merger regulations under FEMA, the role of RBI, SEBI guidelines, competition concerns and many other regulatory intricacies associated with cross-border mergers in India.
The article “A New Dawn for India’s Cross Border Merger Regime” by Rishabh Shroff and Manu Varghese describes the significant shift in India’s corporate landscape with the enactment of Merger Regulations regulating cross-border mergers involving Indian companies. The authors highlight the jurisdictional criteria for cross-border mergers and compliance with FEMA regulations. While acknowledging the positive steps taken by the government and the RBI, it raises concerns about potential challenges, particularly in the tax domain.
What are Mergers and Acquisitions
M&A transactions refer to corporate transactions where two or more companies strategically combine their capacities through various contractual arrangements that can help them achieve their desired results. In today’s globalised era, these corporate transactions have gained great significance as they can help corporate bodies extend their wings beyond leaps and bounds to capture many new opportunities.
- Mergers
A merger is a transaction that combines the legal identity of two or more different corporate entities into a single corporate entity (Merger and Amalgamation) or separates the legal identity of a single corporate entity into two or more different corporate entities (Demerger). In almost all countries, the merger is a legal procedure requiring court or regulatory approval. These kinds of transactions combine or divide undertakings, contracts, employees, workers, legal proceedings, intellectual property, assets and liabilities of multiple entities.
Chapter XV (Section 230 to Section 240) of the Companies Act, 2013 is the fundamental Indian law regulating merger and amalgamation transactions. These provisions require the parties to draft a Scheme of Arrangement, which must be presented before the National Company Law Tribunal (NCLT), which has the proper jurisdiction and obtain its approval. It also requires the parties to obtain the consent of shareholders, creditors and regulators at various stages. There are other laws supplementing the company law in the process of mergers, which include securities laws in the case of listed companies, competition law, which triggers when a specific threshold is breached, the Stamps Act and many other laws based on various factors.
- Acquisitions
Corporate acquisition is a transaction through which an acquirer company acquires ownership or control over a target company or the target company’s business by way of asset purchase, slump sale, share purchase or any other contractual arrangement.
Types of Acquisitions
- Slump Sale: Slump sale refers to a transaction where a company sells an entire business undertaking without assigning values to individual assets and liabilities. A slump sale is a suitable form of acquisition transaction when the seller intends to sell, and the buyer intends to purchase the whole business unit.
- Asset Purchase: Unlike slump sale, in this transaction, the agreement details the values of individual assets and liabilities which the buyer wishes to take. Here, the buyer has the flexibility to negotiate and pick and choose the assets and liabilities from the business of the seller company, which he desires to have on its balance sheet.
- Stock Acquisition: Stock acquisitions involve acquiring the target company’s stock through various means. It includes acquisitions through share purchase transactions, share subscription transactions, open market purchases or any other. This acquisition may sometimes result in a change in control of the target company.
Many other acquisition transactions, like management buyout and tender offer, can be structured. Each of these transactions has its pros and cons like tax implications, differences in transfer of control and many other weights. The choice between these transactions depends on many factors: the acquirer’s intention, its strategic objectives, the corporate structure of the target company, and many others.
What is a Cross-border M&A Transaction
A Cross-border M&A transaction is an M&A transaction where the parties to the transaction are incorporated in different national jurisdictions. The country where the acquirer is incorporated is called the ‘home country’, and the country where the target company is incorporated is called the ‘host country.’
Under the cross-border merger regulations, cross-border mergers are categorised into two categories.
- Inbound Cross-border Merger
When companies from India and other jurisdictions merge and form a resultant Indian company, it is called an inbound cross-border merger.
- Outbound Cross-border Merger
When the resultant company formed as the outcome of the merger transaction conducted between an Indian and a foreign company is a foreign company, it is called an outbound cross-border merger.
Regulatory Framework in India
- Section 234 of Companies Act, 2013 and Rule 25A of Companies (Compromise, Arrangement and Amalgamation) Rules, 2016
Section 234 under the Companies Act, 2013 is the fundamental provision under Indian law providing a framework for regulating cross-border mergers involving Indian and foreign companies. This section confers power upon the central government and Reserve Bank of India to make rules regulating cross-border mergers. Foreign Exchange Management (Cross-Border Merger) Regulations, 2018, have been notified in pursuance of this power. In addition to the provisions of Chapter XV of the Companies Act 2013, a cross-border merger involving an Indian company must adhere to these regulations.
Rule 25A of Companies (Compromise, Arrangement and Amalgamation) Rules, 2016 outlines legal provisions permitting mergers between Indian and foreign companies. The rule permits foreign companies to merge with Indian companies. However, it mandates obtaining prior approval from RBI. Also, it emphasises the importance of conducting valuation by members of a recognised professional body. Rule 25A allows the merger of an Indian company only with a foreign company incorporated in specified jurisdictions.
- Cross-border Merger Regulations
These regulations are a cornerstone regarding the legal aspects of cross-border mergers in India. Cross-border merger regulations define cross-border mergers as any merger, amalgamation or arrangement between an Indian and a foreign company which is in accordance with Companies (Compromise, Arrangement and Amalgamation) Rules, 2016. These regulations deal separately with inbound mergers and outbound mergers. Some of the Important aspects of the regulations regarding Inbound and Outbound mergers can be traced below:
- Transfer of Securities
Inbound Merger: The resultant company can transfer its shares to a person resident outside India, subject to Indian foreign exchange regulations.
Outbound Merger: In this case, the Indian residents who are the transferor company’s shareholders can acquire the resultant company’s securities. However, the acquisition must be within the limits of the Liberalised Remittance Scheme.
- Branch/Office outside India
Inbound Merger: The office of the foreign company outside India is deemed as the branch/office of the resultant Indian company outside India.
Outbound Merger: In this transaction, the office of the transferor Indian company in India shall be considered as the branch/office of the resultant foreign company in India.
- Borrowings and Guarantees
Inbound Merger: Borrowings and guarantees of the transferor foreign company shall vest with the resultant company, subject to FEMA compliance within two years.
Outbound Merger: Borrowings and guarantees of the transferor Indian company shall vest with the resultant company subject to NCLT-sanctioned terms.
- Bank Accounts
Inbound Merger: India allows the resultant Indian company to maintain an overseas bank account for up to two years.
Outbound Merger: It permits opening a Special Non-Resident Rupee account for up to two years.
- FDI Regulations
Foreign Direct Investment (FDI) Policy and Regulations play a significant role in governing cross-border M&A transactions in India. Some of the essential aspects are as follows:
- Cross-border M&A transactions must adhere to the sectoral caps and entry routes specified under FDI regulations
- Cross-border M&A transactions must comply with pricing guidelines specified by RBI. The valuation at which shares of Indian entities are issued to foreign entities shall be subject to scrutiny by the RBI.
- Companies involved in a cross-border M&A transaction must file requisite forms and documents with RBI and other relevant authorities.
- Taxation Laws
Tax is a significant business cost to be considered while making any business decision, particularly when competing with other global players. Mergers and Acquisitions will have different tax treatments based on how the transaction is structured. So, this remains a significant factor in how the professionals structure the deal.
Under Indian law, Mergers are treated as tax-neutral transactions and are exempt under Income from capital gains under section 47 of the Income Tax Act, 1961. With regard to Cross-border merger transactions, the law is not entirely tax-neutral. If the transaction is an inbound merger and the resultant company is an Indian entity, this exemption will certainly cover it. However, in the case of an outbound merger, this exemption is not available and will lead to a tax burden on the parties.
For Acquisitions, the treatment for cross-border acquisitions is the same as domestic acquisitions under Indian law. For a slump sale, the seller must pay the tax under the head of capital gains for the difference between the lump sum consideration received and the net worth of the undertaking. In case of an asset sale, the seller will have a similar capital gains tax obligation, which is assessed by taking each asset individually. Also, the seller’s gains are assessed under capital gains for the share purchase. An additional securities transaction tax is levied if the shares subject to the transaction are listed.
- Other Related Legal Aspects
Various other legal provisions regulate cross-border M&A transactions. The combination regulations of CCI regulates competition law aspects of M&A transactions in India. It obligates the parties to notify the CCI before consummating the transaction if it crosses certain thresholds under the regulations. The parties can consummate the transaction only after getting a clearance from CCI that the combination has no appreciable adverse effects on the competition in India. In the event jurisdictional thresholds laid down in this act and regulations are exceeded by the transaction and this transaction may have considerable adverse effects on competition in the relevant market, the transaction may be prohibited by the Competition Commission of India.
In the case of Indian listed entities, SEBI and stock exchanges come into the picture. In case of a scheme of arrangement involving an Indian listed entity, the listed entity is required to obtain a no-objection certificate from SEBI and stock exchanges for the approval of the scheme by the NCLT. Also, the provisions of Takeover Code are applicable when a foreign player is acquiring shares or control over an Indian-listed company and is obligated to make an open offer under the Takeover Code to the shareholders of the listed target company if the acquisition triggers any of the open offer obligations specified in the code.
Another important legal aspect is the laws related to stamp duty. Stamp duty is levied on instruments in India, which include agreements for share purchase, business transfer, asset sale and scheme of arrangement. In India, state governments generally govern stamp duty under the federal structure. It is crucial to ascertain under which state laws the stamp duty must be paid for the agreement. Also, the valuation of assets and consideration is another critical element for calculating stamp duty.
Many other legal aspects are required to be seen with due consideration in a cross-border M&A transaction. These include property laws, insolvency laws, accounting rules and standards.
Legal Challenges
Cross-border M&A transactions come with many legal challenges in India when compared with Indian domestic M&A transactions. Recent changes in laws after the advent of the Companies Act, 2013 are making it relatively easy and desirable for businesses, both Indian and foreign, to go for cross-border M&A transactions involving India. However, the law related to cross-border corporate transactions is still nascent, and the parties face many legal challenges under various laws. These include:
- There are many legal challenges under Indian law for outbound mergers, which makes it an undesirable option for the parties. The capital gains tax exemption to merger transactions provided under section 47 of the Income Tax Act, 1961, is not available to outbound mergers under Indian law. Along with this, Indian resident shareholders of the transferor company are facing challenges with the annual limit on the amount a resident can remit abroad under the Liberalised Remittance Scheme (LRS), as their limit under this scheme can be breached by the outbound merger transaction. These legal provisions under Indian law make outbound mergers unattractive and objectionable to various parties involved, mainly resident shareholders of the transferor company.
- In the scheme of arrangement submitted by Sun Pharmaceutical Industries Limited to NCLT Ahmedabad Bench, it contemplated the transfer of two of its investment undertakings to overseas resultant companies. However, NCLT rejected the scheme, stating the following:
- Section 234 does not provide for demergers of Indian companies with foreign companies,
- Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 is silent on demergers.
- Foreign Exchange Management (Cross-border Merger) Regulations, 2018, apply only to mergers and amalgamations of Indian companies with foreign companies but not the demerger of Indian companies with foreign companies.
This legal position is hindering corporate restructuring transactions in India involving foreign demergers.
- Also, the Cross-border Merger Regulations, do not explicitly provide for a fast-track merger. This implies that even if all the requirements under section 233 relating to fast-track mergers are fulfilled, cross-border mergers will not be eligible for fast-track mergers. This is another lacuna existing in the current Indian legal system relating to cross-border transactions.
- Different countries have different legal procedures regarding these transactions. Therefore, legal systems and regulatory frameworks across various jurisdictions can be challenging in navigating compliance management for a cross-border M&A transaction. This includes legal frameworks in other countries governing Antitrust, Intellectual Property, Environmental Protection, Labour and Taxation laws.
- There is another provision in the Foreign Exchange Management (Cross-border Merger) Regulations, 2018, which restricts outbound mergers. Not all companies from all countries can merge an Indian-incorporated company into them. As per the regulation, the eligible jurisdictions are as follows:
- Those whose securities market regulator is a signatory to the Multilateral Memorandum of Understanding of the International Organisation of Securities Commission or Bilateral Memorandum of Understanding with SEBI
- Whose central bank is a member of the Bank of International Settlements
- Jurisdictions not identified in the public statement of FATF for deficiencies relating to anti-money laundering or combating terrorism financing or jurisdictions which are not having an action plan developed by FATF to address these deficiencies.
Significant business countries like the USA, UK, Germany, Japan, Russia, France, Singapore, Mauritius and China are eligible under these provisions. However, it should be remembered that Indian companies are not eligible to make an outbound merger with a company in all jurisdiction worldwide. This is another crucial challenge for Indian companies desiring an outbound merger.
There are many other critical challenges for cross-border M&A transactions, particularly contract drafting. Different countries around the world have different kinds of corporate laws. Maintaining compliance with the corporate laws of both the host and the home country becomes a challenge for the legal advisors. Also, the way of conducting Due Diligence is different in different countries. This is primarily because the legal environment is different in different countries. Understanding the requirements and standards of due diligence requires keeping in view the host country’s laws, which is another challenging task. Ascertaining the value of stamp duty and identifying the correct state law under which the stamp duty falls is another challenge in cross-border M&A transactions. Making sure that the provisions regarding the protection of IP is another important task for the parties. Protecting and transferring valuable intangible assets is crucial for the success of the transaction. There will be many other legal concerns like national security, competition regulation and environmental protection. Strategically planning to design a route for the transaction complying with all these laws remains very critical.
Suggestions
- Many legal restrictions make outbound mergers from India undesirable. These include no exemption from capital gains tax, LRS limit, no provision for outbound demerger and many others. There is a need to ratify these legal provisions to make outbound merger transactions more encouraging and friendly to businesses.
- Another important aspect is meeting all the contractual requirements for complying with the laws of both the host and the home countries. Parties and their legal advisors have to take necessary care to ensure that the transaction meets all the legal criteria required under both laws.
- Making legislative changes that provide for fast-track cross-border mergers in India will encourage businesses that qualify for fast-track mergers.
- Parties must remember that proper and timely communication and discussions with regulators of both the host and the home country are crucial for the transaction to be processed without any unexpected legal hindrance.
- Parties involved in an M&A transaction must ensure that no party has a dominant position in the transaction. They should have the necessary precautions, strategy, planning and communication system to make the transaction’s end result a win-win situation for both companies.
Conclusion
In today’s globalised era, cross-border M&A transactions have become a critical part of the corporate strategy of many big multinational companies. Welcoming these transactions in India by making various specific legal and regulatory changes in the past decade is a great sign for international businesses. However, there are some limitations under Indian laws, most of which are addressed in this research paper, which need to be addressed by the regulators and the legal society in the country to make India more welcoming and friendly for businesses. Adding to this, the negative impact of COVID-19 on undertaking significant corporate transactions will be visible in many companies for another few years. So, to make India investor-friendly and to help Indian manufacturers and service providers reach a global audience, the government, regulators, and legal professionals need to recognise the importance of cross-border corporate transactions and make it more encouraging and flexible for the dynamically changing business landscape.
Name: Vinay Yerubandi,
College name: Damodaram Sanjivayya National Law University