Dichotomy between items 8 and 9
The onset of the covid-19 pandemic in early 2020 brought with it the full force of both a sudden economic downturn and a massive cultural shift in the manner of doing business. Corporate restructuring programmes are at the heart of the transition, as the government and corporate sector look to tide over financial difficulties and adapt to the new business climate. Public reports suggest that large conglomerates, such as the following, are already evaluating the feasibility of such organisational overhauls:
- Vedanta Limited;
- Shriram Group;
- Shapoorji Pallonji; and
- Infrastructure Development Finance Company Limited.
Corporate restructuring is a catch-all phrase that includes:
- capital structure modifications;
- intragroup acquisitions;
- intragroup mergers;
- intragroup amalgamations; and
Given the context of the current business climate, this article briefly discusses the costly and perhaps unintended insufficiency in the intragroup acquisition exemption that is provided to notifiable transactions under the merger control regime.
A transaction must be notified to the Competition Commission of India (CCI) if the transacting parties jointly breach certain monetary thresholds under the Competition Act 2002 (the Act). A notifiable transaction cannot be consummated (in part or in full) prior to the receipt of the CCI approval. The purpose behind this suspensory regime is to ensure that the potential anti-competitive impact of a transaction does not affect a market before the CCI is able to review and remedy any potential impact.
Cognisant of the wide net cast by the Act's monetary thresholds, and the fact that not all kinds of transactions are likely to have an anti-competitive impact on markets, the CCI introduced certain transactions that do not normally need to be notified to it.(1)
These categories of transaction are recorded in Schedule I of the Combination Regulations. Simply put, transactions provided for in Schedule I are, for all practical purposes, exempt from notification requirements.
Items 8 and 9 in Schedule I of the Combination Regulations are most relevant to this issue, as they deal with intragroup acquisitions and intragroup mergers or amalgamations, respectively.
According to item 8 in Schedule I, an intragroup acquisition is exempt from notification obligations if both the following criteria are satisfied:
- both the acquirer and the target belong to the same "group"; and
- the target is not and/or will not be under the joint control of more than one group (i.e. the acquirer group).
On the other hand, item 9 in Schedule I provides that an intragroup merger or amalgamation is exempt from notification obligations if both the following criteria are satisfied:
- both the merging or amalgamating parties belong to a variation of the "group";(2) and
- the merger or amalgamation does not result in the transfer from "joint control" to "sole control" (according to item 9).
Evidently, the requirements under items 8 and 9 of the Combination Regulations are distinct from each other. Whereas item 8 is strictly inapplicable if the target is controlled by more than one group, under item 9, an intragroup exemption remains applicable to both, solely and jointly controlled targets, as long as there is no change in the nature of control after the transaction.
The following section breaks down this key distinction and expounds on the implications of the constructs of items 8 and 9.
Dichotomy between items 8 and 9
In order to better understand the requirement differences under items 8 and 9, it is important to define the idea of "control" from an Indian competition law standpoint.
"Control" is a loose concept that is used to capture even the lowest degree of influence that an enterprise can exercise over another enterprise. For context, an illustrative list of "control rights" identified in the CCI's decisional includes:
- affirmative rights in relation to the commencement of a new business line;
- the right to appoint an observer;
- detailed information rights that are not available to ordinary shareholders; and
- rights in relation to amendments to charter documents.
Item 8 is inapplicable where the target is jointly controlled by another group to which the acquirer does not belong. At first glance while this requirement may not appear prohibitive – the following example will clarify the functional issue attached item 8.
Entity A has a diverse capital shareholding structure and its primary shareholding (eg, 70%) lies with the promoter group or family. However, the remaining shareholding is dispersed between many entities including one or more private equity (PE) investors who individually may enjoy certain investor protection rights like, the right to an observer seat or certain select veto rights, (relating to items like changes in the charter documents or the possibility to enter a new line of business), which are typically seen as control rights by the CCI .
Should the promoter family want to undertake an internal group restructuring and transfer its 70% shareholding in one target to another (which is a wholly owned entity of the promoter group family), the transaction would not benefit from the intragroup acquisition exemption. This is because the original target is technically under the "joint control" of the promoter family and several minority PE investors. This means that the mere transfer of the shareholding between members of the same group, without the acquisition of any additional or incremental control rights, is reportable to the CCI.
In fact, the CCI has already evaluated such "joint control" cases. In Taurus-Capricorn,(3) Max India Limited transferred its shareholding in a certain target entity to its wholly owned subsidiaries. However, Max and other enterprises jointly controlled the target. Therefore, the CCI noted that the transaction did not benefit from the item 8 exemption.
On the other hand, the intended transfer of a shareholding in one target to another can be achieved differently. The revised transaction structure would play out as follows: the promoter group or family of one target would merge or amalgamate the other target. At the same time, and as consideration for the merger, the PE investors would acquire shareholding in post-merger target entity. The revised structure would benefit from item 9 and not be notifiable to the CCI because:
- the same promoter group or family exercise over 50% shareholding in both targets – therefore, they belong to a variation of a "group"; and
- the target that is now part of a post-merger entity would remain under the "joint control" of the promoter group or family and the PE investors.
At this juncture, it is relevant to reiterate that the purpose behind the introduction of Schedule I was to allow a pass-through mechanism for transactions that are unlikely to have any competitive impact in the markets. In the item 8 example provided above, the intragroup acquisition by latter target would not cause any change in the competitive landscape, as the control structure of the former target would remain unchanged. Therefore, the target entity will continue to operate in the same manner as it was before the transaction. Given this, and in the spirit of both Regulation 4 and Schedule I of the Combination Regulations, these kinds of intragroup transactions should be allowed the benefit of an exemption. This problem is not present under item 9, as intragroup mergers or amalgamations are not subject to the same oddity – item 9 envisages situations of joint control of the merging parties. Therefore, if the transaction were structured as a merger involving the target, as illustrated above, it would be exempt from notification obligations, as there would be no change from joint to sole control.
With rising PE investments and debt and equity financing, most corporates have multiple distinct groups exercising control over a target. Therefore, item 8 of the Combination Regulations, despite being a well-intentioned provision, is unable to benefit many intragroup acquisitions.
As a matter of practice, the CCI periodically finetunes the Combination Regulations and has amended the Combination Regulations 10 times since its inception in 2011.
The CCI may wish to consider resolving this issue in the next set of amendments by modifying item 8 to mimic the benefits under item 9. Such an amendment will have a twofold benefit – it will:
- introduce consistency by removing the absurd distinction between mergers and acquisitions; and
- provide much-needed relief for several businesses, which will promote the ease of doing business in India.
For further information on this topic please contact Pranjal Prateek, Soham Banerjee or Alisha Mehra at Khaitan & Co by telephone (+91 22 6636 5000) or email ([email protected], [email protected] or email@example.com). The Khaitan & Co website can be accessed at www.khaitanco.com.
(1) Regulation 4, the Competition Commission of India (procedure in regard to the transaction of business relating to combinations) Regulations 2011 (the Combination Regulations).
(2) The definition of "group" includes cases where one enterprise holds 26% or more (read to be 50% or more based on an exemption that has recently expired on 3 March 2021) voting rights in the other. Under item 9, the exemption applies on account of either one transacting party holding more than 50% shareholding or voting rights in the other transacting party, or a third entity(ies) within the same group holding more than 50% shareholding or voting rights in each of the transacting parties.