Market overview

2019 emerged as the second-best year for M&A activity in India after 2018 with aggregate deal value reported to be in excess of US$73 billion,[2] despite global macroeconomic challenges and the onset of an economic slowdown in India. While the year-on-year decline was pronounced in strategic M&A, private equity (PE) and venture capital investments retained their 2018 momentum.

Two of the three largest M&A deals resulted from insolvency proceedings in the steel sector, including the US$7.21 billion joint acquisition of Essar Steel by ArcelorMittal and Nippon Steel,[3] one of the few successfully concluded transactions under the Insolvency and Bankruptcy Code 2016 (IBC), India’s revamped insolvency regime. Other sectors such as financial services, information technology, infrastructure and energy also saw significant M&A activity (both public and private), with domestic consolidations being predominant.

Five of the top 10 PE deals in 2019 were in the infrastructure sector (including Brookfield’s buyout of Reliance Jio’s tower assets, the largest ever PE deal in India).[4] In a first, the proportion of buyout and control deals in total PE investments was the highest. Platform deals through infrastructure investment trusts also contributed significantly by value to deal activity.

Amid a drop in initial public offerings (IPOs), PE exits were at a four-year low, with the largest share of exits by value (more than 40 per cent) achieved through open market sales, followed by negotiated secondary sales, strategic sales and IPOs.[5]

Regulatory considerations

While the regulatory framework has evolved and the market is more mature, M&A transactions still face challenges on account of a multiplicity of regulators, interpretational uncertainty and long-drawn-out approval processes. The regulatory framework that governs M&A in India, both private and public, is described below.

Companies Act

The Companies Act 2013 (Companies Act) and the rules issued thereunder regulate the process for issuance and transfer of securities and implementation of schemes of arrangement such as mergers and demergers. They also set out a corporate governance framework for Indian companies. While schemes of arrangement are court-driven processes and need to be approved by the shareholders and lenders before they see the light of the day, share acquisitions can be privately negotiated and do not require court approval. In relation to schemes, the Companies Act provides for the role of the National Company Law Tribunal (NCLT) – the forum responsible for approving schemes through its regional benches, protection of minority shareholders and a fast-track process in certain cases. In relation to squeeze-out of minority shareholders in unlisted companies, a helpful mechanism has been recently notified – shareholders with at least 75 per cent voting shares can now buy out the minority shareholders pursuant to a court-approved compromise or arrangement that includes a takeover offer.[6] One of the key challenges in implementing schemes of arrangement remains the timing uncertainty owing to delays involved in the NCLT approval process.

Foreign exchange laws

With progressive liberalisation of its foreign investment regime, India has been at the forefront of deal-making in Asia in recent times and has attracted significant funding from bulge-bracket PE funds.

Foreign investment in equity instruments (ie, equity shares, compulsorily convertible preference shares, compulsorily convertible debentures and share warrants) issued by Indian companies is regulated by the Foreign Exchange Management Act 1999 and the rules and regulations issued thereunder and the foreign direct investment policy framed by the government from time to time. The Foreign Exchange Management (Non-debt Instruments) Rules 2019 vest the Ministry of Finance with powers to regulate non-debt instruments (with debt instruments being regulated by the Reserve Bank of India (RBI), the central bank).

Depending upon the nature of the proposed investment, a foreign investor may choose to invest in India directly, or as a foreign portfolio investor registered with the Securities and Exchange Board of India (SEBI), the securities market regulator. Investment of less than 10 per cent in the shares of a listed company by a SEBI-registered investor is treated as foreign portfolio investment (FPI), while foreign investment in an unlisted company or in 10 per cent or more of the shares of a listed company is treated as foreign direct investment (FDI).

Foreign investment under the ‘automatic route’ (ie, without prior government approval) is permitted in most sectors ranging from agriculture and manufacturing to civil aviation and B2B e-commerce. However, the government continues to prohibit foreign investment in certain sectors where it believes there are national security implications[7] or public policy considerations.[8] The government has restricted investment in certain other sectors through the requirement of:

  • prior government approval;[9]
  • caps on the maximum percentage of foreign shareholding;[10] and/or
  • compliance with certain conditions.[11]

Sector-specific caps on investments are, in general, composite in nature and include all types of foreign investment (ie, both FDI and FPI are counted towards such caps).

Recently, with the background of the covid-19 pandemic, the government has issued guidelines to curb ‘opportunistic takeovers/acquisitions of Indian companies’ by requiring government approval for all investments (including by way of secondary transfers) by entities incorporated in a ‘country which shares land border with India’[12] (including China) or ‘where the beneficial owner of an investment into India is situated in or is a citizen of any such country’. While intended to increase regulatory oversight over investment from these countries, the guidelines currently lack clarity on how beneficial ownership will be assessed (whether based on control or a specified shareholding threshold or in some other manner). Clarification from the government is expected in this regard, including on treatment of existing investments from these countries.

The foreign exchange laws also specify pricing guidelines and reporting requirements. As a general matter, the consideration payable by a foreign investor for any unlisted equity instruments issued by an Indian company or transferred by an Indian resident cannot be less than the fair market value of such equity instruments determined pursuant to a valuation in accordance with any ‘internationally accepted pricing methodology’. For a transfer of equity instruments by a foreign investor to an Indian resident, such fair market value serves as the ceiling. These pricing guidelines are not applicable to a transfer of equity instruments between two non-resident entities. Separate pricing norms are applicable to listed securities. While cash remains the most common form of consideration, share swaps also find a place in transaction structuring.

Sector-specific laws

Investments in certain sectors (such as financial services, telecoms services and insurance) are subject to incremental restrictions and conditions imposed by the relevant sectoral regulators. For instance, the RBI monitors the management and ownership of banks and non-banking financial companies (NBFCs) in India and prior RBI approval is required for change in shareholding and/or management linked to specified thresholds. Similarly, prior approval of the Insurance Regulation and Development Authority of India is required for acquisition of an interest in excess of specified thresholds in insurance companies. Investments in the telecoms sector need to comply with licence and security conditions prescribed by the Department of Telecommunications.

Tax considerations

Taxation is a significant factor in structuring M&A deals and exit transactions. A transfer of securities of an Indian company for gain generally attracts capital gains tax in India in the hands of the seller. The capital gains tax rate varies depending on the period for which the securities were held. Additionally, there is an obligation on the purchaser to withhold taxes from the consideration payable to a non-resident seller. Investments into India are often structured through vehicles incorporated in jurisdictions such as Singapore and Cyprus with which India has double taxation avoidance agreements (DTAAs). Since the Indian tax authorities have questioned the applicability of DTAAs in certain cases, purchasers frequently seek to withhold taxes even if treaty benefits are available; where this is resisted by the seller, parties resort to obtaining a ‘nil withholding’ opinion from an accounting firm or a certificate from the Indian tax authorities. Since the general anti-avoidance rules became operational in India effective April 2017, substance-based parameters have become increasingly important as tax authorities seek to deny tax benefits arising from ‘impermissible avoidance arrangements’ that, among other things, lack commercial substance.

In a sale of listed shares, the mode of implementing the transaction also determines the tax incidence – in general, on-market transactions are more tax efficient than transactions consummated off-market.

Additionally, tax by way of stamp duty is required to be paid on every instrument (including transaction agreements and instruments for issuance and transfer of securities), which could considerably increase the transaction costs. Effective 1 July 2020, transfers of securities in dematerialised or electronic form (which were previously exempt from stamp duty) are also subject to stamp duty. Insufficiency of stamp duty would not invalidate such instruments or documents but may render them inadmissible in Indian courts in a dispute situation.

Antitrust issues

An M&A transaction will require notification to, and approval of, the Competition Commission of India (CCI), India’s antitrust authority, if the assets or turnover of the parties to the transaction exceed certain specified thresholds. Combinations that cause (or are likely to cause) an ‘appreciable adverse effect on competition’ in India are void and prohibited. There is no specific timeline within which notifications are required to be made to the CCI; however, transactions that trigger a CCI approval may not be completed without such approval. This notification and approval requirement is subject to certain exemptions, including based on the target company’s assets or turnover in India. Certain other safe harbours may also be available subject to certain conditions, such as where the acquirer holds less than 25 per cent of the shares or voting rights of the target company following the transaction or intra-group transactions. Where a notification requirement is triggered, parties will need to be mindful of cooperation or conduct that may be viewed as ‘gun jumping’ prior to receipt of CCI approval.

The CCI has recently introduced a green channel or deemed approval process for transactions between parties that do not have any horizontal, vertical or complementary business overlaps in India (which would therefore be unlikely to cause an ‘appreciable adverse effect on competition’) – such deemed approval becomes effective upon submission to, and acknowledgment by, the CCI of a short-form filing.

Additional considerations for transactions involving listed companies

On-market versus off-market deals

Apart from schemes, an M&A deal can be concluded:

  • on the floor of the stock exchanges (often preferred owing to tax benefits), including through block trades or bulk deals;[13] or
  • as privately negotiated off-market deals.

A foreign investor can acquire shares on-market through the FPI route or the FDI route if such investor already has (and continues to hold) control over the target company in accordance with the SEBI regulations. In other words, a foreign investor that is not registered with SEBI as a foreign portfolio investor and does not have control over the target company can only complete such transaction off-market. A question that therefore becomes relevant is how an investor can demonstrate control in order to undertake the transaction on-market.

The SEBI regulations define control to include both de jure control by way of entitlement to exercise 25 per cent or more of the voting rights in a listed company and de facto control through control over management and policy decisions. In the absence of bright-line tests to determine de facto control, the special rights contractually granted to an acquirer need to be carefully considered. The acquisition of control of a listed company has significant implications – among others, it would trigger a mandatory tender offer (MTO) under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Regulations) and it could result in an investor being categorised as a promoter for purposes of the SEBI regulations.

Mandatory tender offer requirement

Under the Takeover Regulations, a person acquiring control[14] over a listed company is required to provide an exit opportunity to the public shareholders by offering to additionally acquire at least 26 per cent of the shares of such company through an MTO. The Takeover Regulations also incorporate the chain principle (ie, indirect acquisition of an Indian listed company would also trigger the MTO requirement). The prescribed formula for determining the MTO price is based on, inter alia, the agreed transaction price and the trading price of the shares during a specified look-back period. With a view to treating public shareholders equitably, any non-compete fees, control premium or other amount payable to any person in connection with the transaction is required to be added to the MTO price.

Subject to certain exceptions, an acquirer is not permitted to complete the underlying transaction until the MTO is completed. The acquirer is permitted to consummate the underlying transaction pending MTO completion either:

  • by depositing cash in escrow equivalent to 100 per cent of the MTO consideration (assuming 100 per cent acceptance of the MTO); or
  • through a preferential issue of fresh shares or a secondary sale through the stock exchange settlement process subject to such shares being kept in an escrow account and the acquirer not exercising any voting rights over such shares.

The Takeover Regulations permit the acquirer to withdraw an MTO on specified grounds, including if:

  • statutory approvals for the transaction are finally refused; or
  • the purchase agreement is rescinded pursuant to any pre-closing conditions not having been met for reasons outside the reasonable control of the acquirer.

As a practical matter, there has not yet been an instance where SEBI has permitted withdrawal of an MTO on account of non-fulfilment of a pre-closing condition. In one instance,[15] an acquirer was not permitted to withdraw the MTO despite a discovery of fraud by the promoters of the target company.

Uncertainties around the uptake in the MTO, the restrictions on closing the underlying transaction pending completion of the MTO and the limited circumstances in which SEBI permits withdrawal of an MTO often render control transactions in public M&A unattractive for investors.

Acquisitions pursuant to schemes of arrangement are, subject to certain conditions, exempt from the MTO requirement – public M&A transactions are often structured with this in mind. In addition to the existing exemptions available for acquisitions pursuant to resolution plans approved under the IBC, SEBI has recently exempted allottees in preferential issues by listed companies with stressed assets[16] from MTO obligations and has also eased the pricing norms for preferential issues of shares by such companies. These relaxations are expected to provide a greater impetus to M&A involving distressed assets.

Minimum public shareholding requirement

Every listed company in India is required to maintain a minimum public float of 25 per cent. Under the Takeover Regulations, an acquirer is not permitted to acquire or enter into an agreement to acquire shares or voting rights that would result in the maximum permissible non-public shareholding of 75 per cent being breached. If an MTO results in a breach of such non-public shareholding threshold, the acquirer is required to bring down the non-public shareholding to 75 per cent within 12 months from the date of breach. SEBI has prescribed a number of ways to undertake such a dilution or sell-down, including offers for sale to the public through a prospectus or various primary issuances. Non-compliance with the minimum public float requirement can, among other things, result in imposition of fines by the stock exchanges, freezing of the promoter shareholding, and ultimately delisting. This minimum public float requirement further complicates the issues already at play in public M&A deals.

Prohibition of insider trading

The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 2015 (Insider Trading Regulations) prohibit trading (which is broadly defined to include not just subscribing, buying or selling or agreeing to subscribe, buy or sell, but also dealing or agreeing to deal) in listed or to be listed securities when in possession of unpublished price-sensitive information (UPSI).[17] Insider trading is a rebuttable presumption – innocence may be established by demonstrating, for example, that Chinese walls were in place. For transactions that do not trigger an MTO, UPSI needs to be whitewashed at least two days prior to execution of definitive agreements in respect of the transaction. In MTO-triggering transactions, UPSI is deemed to be whitewashed when the MTO is made. Investors and insiders (including promoters and management) have to be equally mindful about inadvertent communication of UPSI during management discussions and/or the due diligence exercise and subsequent trading in securities when in possession of UPSI in the absence of appropriate checks and balances.

Disclosure requirements

The SEBI regulations prescribe events-based disclosure requirements (eg, completion of an acquisition transaction) as well as certain continual disclosure requirements (eg, shareholding of a significant shareholder) for listed companies, their promoters and significant shareholders.

Structuring and other considerations

The current legal framework affords flexibility to investors to structure their transactions based on the size of investment, the investment horizon and the desired outcome of the investment. Control deals or joint ventures pursuant to schemes of arrangement are more commonplace in strategic transactions. Where the objective is short-term financial returns, investors take a minority interest with basic protective rights. In recent times, there is an increasing interest from PE funds in control transactions with a view to creating value for Indian businesses, improving governance standards and bringing in a level of sophistication to an otherwise promoter-driven Indian market.

Choice of equity instrument

In addition to equity shares, investors have the option to invest in compulsorily convertible securities. Such instruments provide investors with the ability to convert at a price that is linked to the achievement of agreed performance milestones and/or the valuation of the company (subject to applicable pricing restrictions). Equity-linked convertible instruments also provide investors with the right to receive dividends or coupons and liquidation proceeds in preference to equity shareholders. Subject to certain conditions, Indian companies may also issue warrants or partly paid-up shares. In either case, at least 25 per cent of the consideration has to be paid upfront, with the balance amount payable to the company within 18 months (in the case of warrants) and 12 months (in the case of partly paid-up shares). Convertible instruments and share warrants afford useful structuring options in the public M&A space as well, where MTO obligations under the Takeover Regulations are not triggered at the time of their issuance (since such instruments typically do not carry voting rights) but at the time of their conversion (which may be staggered over a period of 18 months).

Deferred consideration arrangements

Investors often seek to defer payment of a portion of their purchase consideration to hedge their investment risks. Such deferral could be warranted until the occurrence or non-occurrence of specific events (such as achievement of certain financial targets, procurement of a critical regulatory approval in relation to the business, publication of audited financials or disposal of a material ongoing litigation). In transactions involving foreign buyers, up to 25 per cent of the purchase consideration can be held back for a period of up to 18 months from the date of the share purchase agreement without prior RBI approval. From a seller’s perspective, an escrow mechanism may be preferred (as compared with a holdback by the buyer) as an independent third party controls the escrowed consideration and is required to release the escrow at predefined milestones. Alternatively, if the full consideration is paid by the buyer upfront, the seller can provide an indemnity for up to 25 per cent of the total consideration for a period of up to 18 months from the date of payment of the consideration in full. As a mechanism for risk allocation between parties, this enables greater flexibility in payment structuring in secondary transactions and also facilitates post-closing purchase price adjustments and earn-outs.

Promoter and management incentives

Promoters of an Indian company are not eligible to be issued stock options. Some investors agree to share a portion of the upside realised at exit with the promoters (in case of listed companies, such arrangements require prior approval of the company’s board of directors and public shareholders and in an MTO-triggering transaction, any non-compete or other fees paid to a promoter will be considered in determination of the MTO price). Promoters may also be compensated through brand licence fee arrangements. Management personnel are typically incentivised through performance-linked management fees and/or stock options.

Due diligence

It is important to carry out a legal, accounting and financial diligence exercise in relation to the Indian target company prior to making an investment, including in relation to assets and liabilities, statutory records, litigation, contracts and agreements, local regulatory compliance and, where relevant, compliance with any laws of the jurisdiction of the foreign investor in relation to anti-corruption. Since certain laws in India (such as labour and employment laws) may vary from state to state, such exercises are best carried out in association with counsel well-versed in local laws.

There is no centralised registry for land records in India; typically, local counsel are engaged to review land and revenue records. Similarly, there is no centralised database for litigation records. Foreign investors sometimes also consider engaging investigative agencies to conduct background checks on the Indian target company and its promoters.

Due diligence of a listed company is subject to the Insider Trading Regulations, as discussed above. A potential investor may be provided with access to UPSI if the board of directors of the company is ‘of the informed opinion that the proposed transaction is in the best interests of the company’; there is an additional exemption for communicating or procuring such information if it is in ‘furtherance of legitimate purposes, performance of duties or discharge of legal obligations’. The availability of these exemptions will need to be evaluated, and persons accessing such information would need to enter into confidentiality and standstill agreements (agreeing not to trade in the listed company’s securities for a specified period).

W&I insurance

While the traditional protection afforded by indemnity-backed representations and warranties have a strong foothold in the M&A landscape, warranty and indemnity (W&I) insurance is gaining traction in India. W&I insurance is perhaps more relevant in the Indian context given the chequered history of Indian promoters in honouring their indemnity obligations and the requirement of RBI approval for indemnity payouts by an Indian resident to a non-resident. This product has also assumed relevance where sellers (particularly PE funds with limited fund lives) are looking for clean exits without any residual liabilities.

Dispute resolution

Owing to the backlog of cases before the Indian courts, litigation in India is protracted and may not be an efficient means of obtaining relief in disputes. It could also be used effectively by an opponent as an instrument to delay transactions or contractually agreed processes. From a foreign investor’s perspective, foreign-seated arbitrations under an institutional framework[18] are preferred. Indian courts generally adopt a pro-arbitration approach in relation to enforcement of foreign awards in India. Pursuant to the Arbitration and Conciliation Act 1996 (Arbitration Act), Indian courts have the power to grant interim relief to parties even in foreign-seated arbitrations, unless otherwise agreed by the parties to the arbitration agreement. In contracts among Indian parties, ad hoc arbitration under the Arbitration Act is popular, although parties also refer disputes to Indian arbitral institutions.[19] The Arbitration Act requires arbitral tribunals to render an award within 12 months of completion of pleadings, extendable by six months by agreement of the parties and thereafter only by the jurisdictional court. This 12-month period is directory (not mandatory) where one or more parties to the dispute are foreign.

Exits

2019 was a slow year for PE exits in general, and exits through IPOs in particular. As a general matter, strategic sales and sales on stock exchanges have had a comparatively higher share in PE exits (by value) in recent times.[20] From the perspective of an Indian promoter, an IPO may be the preferred means of providing an exit to an investor although it involves significant time and effort as compared with a secondary sale or strategic sale (involving entry of new investors) or a put option or buyback (involving payments from the promoter or the company). An Indian promoter may be reluctant to facilitate non-IPO sale processes for various reasons such as resistance to being traded from one PE sponsor to another (in a secondary sale) or apprehensions about the prospective acquirer’s role (in a strategic sale).

Offers for sale in IPOs

In order to undertake an IPO, a company is required to satisfy certain eligibility criteria in relation to profitability, net worth and net tangible assets, and the IPO valuation is dependent on prevailing market conditions. Certain issues to consider in respect of an offer for sale through an IPO are set out below.

In order to be eligible to be offered for sale in an IPO, subject to certain exceptions, the equity shares should have been held by the selling shareholder for a period of at least one year prior to the date of filing of the draft red herring prospectus (DRHP). For such calculation, the holding period of convertible securities prior to conversion into equity shares will be considered in the case of compulsorily convertible securities, but not in the case of optionally convertible securities. This could affect the DRHP filing timeline if the exiting investor is considering an internal restructuring prior to the IPO (such as a transfer to an affiliate) or conversion of optionally convertible securities. No convertible securities are permitted to remain outstanding as on the date of filing the red herring prospectus – in the event that the IPO is unsuccessful, this could be an issue to consider for the investor as it will no longer enjoy the benefits of holding a convertible instrument.

The offer documents are required to identify one or more promoters, who are required to hold at least 20 per cent of the post-issue capital in the company for a period of three years after the IPO (this is termed promoters’ contribution, and identification of such shares for purposes of the three-year lock-in is subject to prescribed eligibility norms). Promoter is defined to include person(s) directly or indirectly in control of the issuer company, person(s) in accordance with whose advice, directions or instructions the board of the company is accustomed to act and those named as promoters in offer documents or annual returns of the company. In addition to being subject to the three-year lock-in, entities that are named as promoters in the offer documents will also be:

  • required to provide certain disclosures and negative confirmations from entities identified as part of the promoter group;
  • subject to an obligation to provide an exit offer to dissenting shareholders if the company proposes to amend the disclosed use of proceeds after the listing; and
  • subject to ongoing obligations under the Takeover Regulations, the Insider Trading Regulations and the listing regulations.

SEBI typically requires special rights to select shareholders (eg, PE funds) to fall away upon IPO listing and trading and/or may require that approval be sought of the post-listing public shareholders for any rights that SEBI may permit to survive post-listing. Typically, PE investment agreements specify that the investor will not be considered a promoter in an IPO or otherwise. However, given the scope of the promoter definition, the nature of rights available to an investor will be subject scrutiny to determine whether such rights are likely to constitute control, and whether, therefore, such investor should be classified as a promoter.

In addition to the promoters’ contribution, the entire pre-issue share capital of the company is required to be locked in for a period of one year after the IPO. Equity shares held by venture capital funds, category-I or category-II alternative investment funds (AIFs)[21] and foreign venture capital investors are exempt from such requirement if the shares have been held by them for a period of at least one year from the date of purchase – the investor entity seeking to use such exemption should have a valid SEBI registration certificate and its initial investment in the company should have been classified under the appropriate exempted category in its filings with regulatory authorities. In addition to the statutory lock-in, the IPO investment banks usually seek a contractual lock-up on the company and the selling shareholders in the transaction agreements in order to have an orderly after-market.

The selling shareholder will need to reach an understanding with the company on its involvement in key IPO-related decisions (such as determination of the IPO price and size) and the sharing of expenses in the IPO (the Companies Act prohibits financial assistance by a company for purchase of its own shares).

Although a selling shareholder may seek to limit its contractual liability in the IPO agreements and only certify statements or undertakings made in the offer documents about or in relation to itself and the equity shares offered for sale by it in the IPO, there are statutory provisions governing prospectus liability (including civil and criminal penalties) that should be kept in mind. There is little case law guidance in India on liability of a non-promoter selling shareholder in an IPO. However, civil and criminal liability of directors could remain relevant where the investor has a nominee director on the board of the company. There may also be liability issues to consider in jurisdictions outside India where the equity shares in the IPO are offered and sold.

A selling shareholder can access funds from the public issue account only after receipt of listing and trading approvals. If such funds are to be paid into an account outside India, discussions with the relevant authorised dealer bank that will remit funds outside India will need to be initiated early to mitigate the risk of delays.

Sales on stock exchanges

In case of a listed company (and following the expiry of IPO-related lock-ins), an investor may sell its equity shares to any third party on the screen-based trading platforms of the stock exchanges pursuant to block trades or bulk deals through a stockbroker, who may require the seller to execute a placement agreement with certain representations, warranties and indemnities. Bulk deals are generally preferred owing to pricing flexibility as compared with block trades.

Secondary sales and strategic sales

In any sale process, whether strategic or other, a selling shareholder will require the active assistance of the promoters and management team. Given that promoters often resist providing such assistance (even where they are contractually required to facilitate an exit), PE sellers would be well advised to discuss the sale process with the promoters and management team at an early stage, and analyse existing rights for possible leverage in connection with the exit. Promoters and senior management personnel may also wish to monetise their shares and exit along with the PE seller, although a purchaser would typically require such persons to continue in the company and execute non-compete undertakings prior to closing. Accordingly, an incentives package (together with the provision of some liquidity) may need to be considered.

In the transaction documents, PE sellers often seek to limit their representations and warranties to certain fundamental title and tax matters, even where they hold a majority interest in the company. Indemnity caps and baskets are heavily negotiated and the outcome is typically influenced by the deal size, the number of bidders, the reputation of the company and its management team, due diligence findings and the profile of the industry in which the company operates. Due diligence red-flag issues and regulatory approvals and contractual consents (if applicable) are typically reflected as pre-closing conditions.

Auction processes (typically assisted by investment banks) are gaining traction in India from the perspective of potentially better valuation and deal terms and protection against the risk of a single seller pulling out of the transaction at the last minute. Although there is no formal regulatory view (including from SEBI) regarding break fees and reverse break fees, such deal-protection devices are often discussed and negotiated; payment of such fees by an Indian resident to a non-resident will require RBI approval. Some PE investors also prefer a dual-track process of simultaneously preparing for both an IPO and a secondary sale.

Put options

PE investors sometimes have the right to put their shares to the company’s promoters if the promoters have been unable to deliver any other exit within a specified time period. Put options over shares of an Indian company are enforceable, subject to satisfaction of certain conditions including that the seller must have held the relevant securities for at least one year prior to the sale. Additionally, applicable pricing restrictions under the foreign exchange regulations must be complied with. Assured or guaranteed returns are not permitted. The successful exercise of such options also depends on the cooperation of the promoters against whom the put is sought to be enforced. In recent judgments, courts have taken a pro-enforcement view of foreign seated arbitral awards involving breach of put option clauses by Indian promoters;[22] however, given that legal proceedings can be long drawn-out, in certain cases PE investors have exited at a lower return than initially agreed pursuant to out-of-court settlements. Remittance of sale proceeds to a non-resident may be subject to RBI approval and the RBI is likely to consider whether the remittance complies with the principle of ‘no assured return’. Given the risks and limitations associated with this option (particularly the cap on price where a foreign seller is involved), this is among the less favoured exit options.

Buybacks

Buybacks by Indian companies are subject to several restrictions and are typically the exit of last resort where there is no prospect of an alternative exit at an attractive valuation but the company has sufficient reserves to fund a buyback. A buyback offer is required to be made to all shareholders on a proportionate basis (and not selectively).

The statutory limit for a buyback is 10 per cent (or 25 per cent if approved by a 75 per cent shareholders’ majority) of the aggregate of the company’s total paid-up capital and free reserves; for this reason, PE investors typically obtain contractual commitments from promoters and other shareholders agreeing not to tender their shares in any buyback so as to not exhaust the statutory buyback limit. A one-year cooling-off period is required between successive buybacks. Companies also need to fulfil certain other eligibility requirements in order to undertake a buyback, including in relation to a good compliance track record in the preceding three years and the permissible post-buyback debt:equity ratio. A buyback can be funded from the company’s free reserves, securities premium account or proceeds of issue of shares or other specified securities (but not the proceeds of an earlier issue of the same kind of securities); money borrowed from banks or financial institutions is not permitted to be used to fund the buyback.

There are additional regulations governing buybacks by listed companies, including the modes through which such buybacks can be implemented. These include buyback from existing shareholders on a proportionate basis through a tender offer (which involves a SEBI review process) or from the open market through a book-building process.

Opportunities and closing thoughts

Despite a marked slowdown in economic growth, the year 2019 saw PE investments retaining their momentum from the record 2018 levels. India’s place in the World Bank’s ease-of-doing-business rankings for 2020 rose to 63 out of 190 countries.[23] Large control deals by PE investors showed a shift in focus from pure financial returns to value creation. Despite the insolvency resolution process proving to be much slower than the 270 days envisaged under the IBC, distressed assets presented attractive opportunities for several investors. These were encouraging trends going into 2020, despite global headwinds and challenges faced domestically, which were particularly pronounced in the banking, NBFC, infrastructure and real estate sectors.

Deal activity has reduced drastically in the wake of the covid-19 pandemic, with investors looking to recalibrate their strategies amid the economic slowdown and liquidity crunch. In the first quarter of 2020, PE and M&A investments reduced by 65 per cent and 29 per cent respectively as compared with the first quarter of 2019.[24]

While the outlook for sectors worst affected by the pandemic, namely, aviation, tourism and hospitality remains uncertain, there is a renewed focus on sectors such as healthcare, pharmaceuticals, insurance, essential consumer goods, technology and telecoms (including sub-sectors such as ed-tech, e-commerce, health-tech and diagnostics). For example, in April–June 2020, a group of investors led by Facebook announced cumulative investments in excess of US$15 billion in Jio Platforms (telecoms)[25] and Carlyle announced a buyout of SeQuent Scientific (healthcare).[26] It is likely that the M&A space will see significant consolidation activity as several businesses will struggle to survive the crisis and will be absorbed by larger competitors with greater liquidity.

Investors are likely to have greater leverage as companies compete for capital funding, and tranched closings and/or deferred consideration arrangements may become more common as investors may be more conservative in their risk assessment prior to deploying capital. Due diligence processes are likely to involve a greater focus on compliance with obligations under key business contracts, debt/insolvency risk, compliance with covid-19-related government directives and compliance with data protection laws.

In addition, increased regulatory oversight on investments from China pursuant to the recent FDI guidelines will also have an impact on deal structuring, and clarity will be required from the government in relation to the precise contours of the restriction.

It is likely that investors will hold onto their portfolio positions in the medium term until valuations improve rather than exit their positions at deep discounts, although funds close to the end of their fund lives may be forced to evaluate secondary sales to specialist funds. The outlook for recovery of Indian capital markets currently remains uncertain, especially since the fiscal stimulus announced by the government to date to address the current crisis is likely to be deficient.