Expansion of "group" in India: new notification needed to aid ease of doing business

Introduction
2011-2021 group definition notification
Assessing notifiability of transaction to CCI
Inconsistencies in "acquirer group" and "target" definitions​
Expansion of intra-group exemption
Comment

Introduction

A key notification regarding the definition of "group" under the Competition Act 2002 (as amended) quietly expired on 3 March 2021. As a result, any company that has a shareholding of 26% or more in another company forms part of a single group. This seemingly minor and little-noticed change has had a profound impact on:

• the determination of merger control notifiability;
• the application of "intra-group" merger control exemptions; and
• the abuse of dominance under the Act (potentially).

Given that India is one of the main investment destinations in the world, this may significantly complicate the merger control regime going forward.

2011-2021 group definition notification

Section 5 of the Act(1) defines a "group" as:(2)

two or more enterprises which, directly or indirectly are in a position to: (i) exercise 26% or more of the voting rights in the other enterprise; or (ii) appoint more than 50% of the members of the board of directors in the other enterprise; or (iii) control the management or affairs of the other enterprise.

Accordingly, every enterprise in which another enterprise exercises any of these rights forms a part of the latter enterprise's group.

Immediately prior to merger control coming into effect in India in June 2011, the Ministry of Corporate Affairs (MCA), through its notification dated 4 March 2011, exempted a group exercising less than 50% of voting rights in other enterprises from the provisions of section 5 of the Act for a period of five years. In 2016, the notification was further extended until 3 March 2021. In effect, for this 10-year period, the notification ensured that the first condition was modified from the "exercise 26% or more of the voting rights in the other enterprise" test to the "exercise 50% or more of the voting rights in the other enterprise" standard.

However, the notification expired on 3 March 2021 and has not been renewed since. Accordingly, the voting rights bright-line test to be part of a group has reverted to 26%, as provided under section 5 of the Act. There are several implications that have largely gone unnoticed globally and in India.

The most obvious result is that many more companies can now be considered part of a group if the top company shareholding is between 26% and 50% and has a share ownership of 50% or more. The turnover and assets of all these companies now have to be included in the notifiability assessment.

This is explained in the following example: entity A (as the ultimate parent entity of group A) has a 51% shareholding in A1. Further, other shareholders of A1 include independent private equity players: X and Y, where X has a 26% shareholding in A1 and Y has a 23% shareholding in A1.(3) When the notification was still effective, A1 belonged solely to group A. However, after it expired, A1 has been part of both group A and, separately, group X.

Assessing notifiability of transaction to CCI

After the expiration of the notification, assets and turnover for a relevant entity (in the acquirer group) have to be calculated by combining the consolidated financials with the financials of all other entities where the relevant entity has a shareholding between 26% and 50%, in order to determine whether a merger control notification is required.

Among other thresholds, transactions(4) require a merger control notification to be made to the Competition Commission of India (CCI) if the combined assets or turnover of the acquirer group, the transferee group and the target or transferor company jointly exceed specified financial thresholds under the Act. The specific thresholds where the precise meaning of "group" come into play while determining notification requirements in India are provided below:

As can be seen from these selected notifiability tests, asset and turnover financials for a group are relevant for several notification thresholds under the Act. In this regard, whether companies and other business organisations are part of a group becomes a critical issue when assessing merger control notifiability under the Act.

For context, a transaction becomes notifiable to the CCI if any of these thresholds are met.

To understand the true impact of the non-renewal of the group voting rights test, comparing how notifiable transactions were assessed prior to the expiration of the notification is useful. Between 2011 and 2021, parties would consider the consolidated financial statements of the ultimate parent entity of the acquirer group or transferee group to identify the assets and turnover at the group level. This was standard practice because consolidated financials included the assets and turnover of all entities in which the parent entity has 50% or more shareholding. This was a quick and efficient way to assess notifiability, as the 50% shareholding cut-off for consolidated financials tallied with the voting rights threshold set out by the notification.

However, now that the voting rights threshold has decreased to 26%, consolidated audited financials alone will no longer be sufficient to identify the group to which an enterprise belongs – to the extent they do not include the assets and turnover of various entities where the ultimate parent entity will have shareholding or voting rights below 50% but above 26%.

This can be explained by expanding upon the example provided above: A1 is acquiring control or a shareholding in a third party (P) where A1 is the acquirer and P is the target. In this regard, the first group threshold (as mentioned in the above table) will be met if either:

• A (being the ultimate parent entity in the acquirer group) and P jointly have assets of more than 80 billion Indian rupees in India; or
• X (being the ultimate parent entity in the acquirer group) and P jointly have assets that total the same amount in India.

In this regard, prior to the expiration of the notification, the consolidated financials of A(9) were considered to identify the assets or turnover at the acquirer group level. However, now the assets and turnover of A or X will be calculated by combining the consolidated assets or turnover of A or X added with the assets or turnover of all other entities in which A or X has a shareholding between 26% and less than 50%.

Given that many large companies have a vast network of associate or affiliated companies (ie, companies in which the top parent entity has less than a 50% shareholding) and cross shareholdings, merger control notifiability assessment in India has become significantly more complicated. This will also likely increase the number of notifiable transactions in India.

Inconsistencies in "acquirer group" and "target" definitions​

Another impact of the notification's expiration is the differential treatment meted out to the direct parties to a transaction and the ultimate parent entity while assessing financials in notifiability exercises.

Under the Act, notification thresholds can be met or exceeded jointly, either by:

• group thresholds tests – the acquirer group or transferee group and the target or transferor company; or
• parties' thresholds tests – the acquirer and the target or the merging or amalgamating entities (ie, the transferor and the transferee companies).

To illustrate, using the above example, the acquisition of P by A1 requires a notification to the CCI if either the consolidated financials of A1 and P jointly meet any of the parties' thresholds tests or if A or X and P jointly meet any of the group thresholds tests in the manner explained above.

The expiration of the notification demonstrates an inconsistency in relation to what financials are included in an acquirer group in contrast with what financials are included with regards to:

• a target;
• an acquirer;
• a transferor company; or
• a transferee company.

Under the Act, those four entities each constitute an "enterprise", the definition of which clarifies that they include subsidiaries. This aligns with consolidated financial statements, which are inclusive of subsidiaries.(10)

Therefore, while applying the parties' thresholds tests, the consolidated financial statements of the relevant entities are enough to assess if notification thresholds are breached. However, as explained above, when calculating group thresholds tests now, the assets and turnover of the ultimate parent entity must be considered by combining the consolidated financials with the value of assets and turnover of all the entities in which the ultimate parent entity has a shareholding of between 26% and 50%. Given that the ultimate parent entity is also an "enterprise" under the Act, the threshold for identifying the assets or turnover of an ultimate parent entity should be the same as the threshold for identifying the assets or turnover of an acquirer, target, transferor company or transferee company.

The following example explains this dichotomy: if A is acquiring P (instead of A1 in contrast to the earlier example), the parties' thresholds tests will be met if the consolidated financials of A and P meet the notification thresholds. However, if group notification thresholds are applied, the consolidated financials of A (which is the ultimate parent entity in group A) will have to be added to the financials of all entities in which A has a shareholding of between 26% and 50% along with the consolidated financials of P.(11)

This dual treatment of A (depending on the nature of notification tests applied) is clearly a departure from the typical legal position. Further, this dichotomy does not make sense from a competition perspective, given that, when A is the acquirer and P is the target, the competitive concerns will not change simply because A is considered as the group entity rather than the direct party to the transaction. Therefore, it makes little sense that the assets or turnover figures of A (at the group thresholds test level) should be inflated against the figures considered for A (at the parties' thresholds test level).

Expansion of intra-group exemption

The CCI's (Procedure in regard to the transaction of business relating to combinations) Regulations 2011 exempt intra-group acquisitions if certain thresholds are met. Since the expiration of the notification, the scope of the intra-group exemption is widened, which can allow certain problematic transactions to pass through without CCI merger control review. Specifically, as explained below, transactions where a change in control occurs from negative control(12) to majority control can use the intra-group exemption, in contrast to the previous position where such significant change in control transactions would require approval from the CCI.

Because of the effective expansion of the definition of "group" in March 2021, a change of negative to positive control can easily use the intra-group exemption and, therefore, may avoid scrutiny, even if such increment in control causes competitive concerns.

This is explained in the following example: A has a 26% shareholding in A1, and no other shareholder has more than a 26% shareholding.(13) In this regard, if A proceeds to acquire another 50% shareholding in A1 by way of either primary or secondary purchases (whereby A will have a 76% shareholding in A1), such transaction will be able to use the intra-group exemption. Importantly, the pass-through of such transactions can be problematic; as such, a significant change in the degree of control can have considerable competitive impact in the market.

Because of the expansion of the definition of "group", it is plausible that various transactions between entities (forming part of the same group under the updated "group" definition) could potentially end up escaping scrutiny by the CCI. Since the legislative intent behind the intra-group exemptions was to only allow non-problematic transactions to pass through, the non-renewal of the group definition notification can potentially problematic transactions to escape CCI merger control scrutiny in light of the effective modification of the intra-group exemptions.

Comment

Given that the MCA is committed to the principles of "ease of doing business", the non-renewal of the group definition notification is surprising. The absence of the notification significantly increases the regulatory burden on the CCI, while also increasing the burden on the parties to a combination to disclose additional information. Parallelly, the notification's expiration has also widened the scope of the intra-group exemptions, thereby possibly allowing potentially problematic transactions to escape merger control scrutiny. Curiously, the MCA has chosen not to tackle this issue yet, even though most of the problems related to it were highlighted by the Merger Working Group of the International Bar Association's Antitrust Section in its submission to the MCA dated 7 March 2022. Aside from merger control, the expiration of the notification can also have a far-reaching impact in assessing abuse of dominant position cases.(14)

The notification's expiration appears to be an oversight at first glance and an innocuous mistake when examined in more detail. It is hoped that India will issue a new notification to prevent the significant issues that have arisen in the past year from continuing.

For further information on this topic please contact Paku Khan, Soham Banerjee or Siddharth Bagul at Khaitan & Co by telephone (+91 120 479 1000) or email ([email protected], [email protected] or [email protected]). The Khaitan & Co website can be accessed at www.khaitanco.com.

Endnotes

(1) Relating to identification of notifiable transactions.

(2) Explanation (b) under section 5 of the Act.

(3) This example presumes that none of the shareholders have any affirmative voting rights or rights to appoint a director on the board of A1 excluding A.

(4) Potentially notifiable transactions under the Act are acquisitions, mergers, or amalgamations.

(5) This includes the acquisition of control in an entity that is competing with another entity already controlled by the acquirer.

(6) Please see endnote 5.

(7) Ibid.

(8) Ibid.

(9) Prior to the expiration of the group definition notification, A1 belonged solely to group A.

(10) Under the Companies Act 2013, a company is stated to be a subsidiary company if the holding company either controls the composition of the board of directors or exercises of controls more than one-half of the total voting power either on its own or together with one or more of its subsidiary companies. The definition of "subsidiary" under section 2(87) of the Companies Act 2013 is available here.

(11) For the avoidance of any doubt, prior to the expiration of the group definition notification, both the parties' thresholds tests and the group thresholds tests would be assessed using the consolidated financial statements of A and P.

(12) A shareholding between 26% to less than 50% where the shareholder can only block special resolutions.

(13) Presuming that no shareholder has any other control rights.

(14) Abuse of dominant position is dealt with under section 4 of the Act. The operative portion of section 4 clearly mentions that no enterprise or "group" shall abuse its dominant position. Further, section 4 defines the term "group" to have the same meaning as given under section 5 of the Act. Therefore, given the expansion of the "group" definition under section 5, the scope of the prohibition on abuse of dominance now extends significantly. This issue is further complicated since a single enterprise can now belong to three separate groups purely based on shareholding (presuming that at least three separate entities can have 26% shareholding in an entity).