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Trends and climate What is the current state of the M&A market in your jurisdiction?
The current state of the M&A market in India can be described as one of cautious optimism. While there has been a marginal decline in the volume of deals, there has been a considerable increase in their value (reaching a six-year high in 2017 according to reports).
The surge in value has been driven by high-value domestic and inbound acquisitions, including consolidation in several sectors such as telecoms, cement and energy. Outbound transactions have also seen a steady growth in value terms and Indian oil and gas, mining and pharmaceutical companies have been looking to grow their businesses.
Have any significant economic or political developments affected the M&A market in your jurisdiction over the past 12 months?
Yes, there have been significant economic and political developments in India that have affected the M&A market. The government is focused on the ease of doing business and a number of legal reforms have been introduced in the last year to facilitate this. A number of initiatives have been introduced to promote the ease of doing business, including:
- relaxed regulations providing self-certification mechanisms;
- tax exemptions;
- legal support and fast-track patent examination; and
- digitising clearance and permission portals.
Foreign direct investment (FDI) restrictions in several sectors such as defence, pharmaceuticals and civil aviation have also been relaxed. The Foreign Investment Promotion Board (the agency that grants approval for FDI proposals) has been abolished and replaced with a simpler approval regime. The Insolvency and Bankruptcy Code 2016 has also been introduced, which has built investor confidence concerning easier turnarounds and exits.
There has also been an increased focus on addressing the non-performing asset issue in the Indian banking sector. Driven by such concerns, many overleveraged companies were driven (by their lenders) to sell some of their non-core assets to reduce debts.
In the e-commerce sector, large global e-commerce players have assumed a dominant role in the Indian market, driving consolidation in the past 12 months as a means of survival.
Following the demonetisation of the Rs500 and Rs1,000 banknotes in November 2016, there was an economic downturn caused by a slowdown in manufacturing growth and bank lending to industries, which also led to slowdown in M&A activity in certain sectors. However, it is expected that this impact will be temporary and that demonetisation will ultimately lead to greater transparency, increased tax collection and investor confidence.
Are any sectors experiencing significant M&A activity?
The following sectors are experiencing significant M&A activity:
- financial services;
- IT and information technology enabled services;
- oil and gas;
- life sciences; and
Are there any proposals for legal reform in your jurisdiction?
The Goods and Services Act came into effect on July 1 2017 and is expected to revolutionise the indirect tax regime in India. It introduces a single tax on the supply of goods and services, from the manufacturer to the consumer, and is expected to add to economic growth.
The Insolvency and Bankruptcy Code 2016 will provide a significant M&A opportunity for the acquisition of stressed companies undergoing insolvency. Further, the personal bankruptcy regime is expected to be notified soon. Further, a comprehensive code for addressing insolvency in the financial sector has also been proposed.
The Real Estate Regulatory Act was recently introduced to reform the Indian real estate sector.
There is also a proposal for the simplification and consolidation of existing industrial and labour laws. The proposal is to condense the 44 existing enactments into four broad codes on wages, social security, safety regulations and trade unions.
Amendments to the Prevention of Corruption Act 1988 are proposed to introduce stringent measures to tackle corruption.
Further relaxation and reforms of FDI regulations are also expected.
Legislation What legislation governs M&A in your jurisdiction?
The Companies Act 2013 is the basic legislation that governs company structures and M&A transactions involving companies in India. The Limited Liability Partnership Act 2008 applies to M&A transactions involving limited liability partnerships.
If the M&A transaction directly or indirectly involves publicly traded companies, various Securities and Exchange Board of India (SEBI) regulations also apply
Cross-border M&A transactions are regulated by the Foreign Exchange Management Act 1999 and its associated rules and the Foreign Direct Investment (FDI) Policy promulgated by the Department of Industrial Policy and Promotion.
The Competition Act 2002 applies to M&A transactions that exceed certain assets or turnover thresholds.
Various tax laws, such as the Income Tax Act 1961, the Double Tax Avoidance Agreement with foreign countries and the Indian Stamp Act 1899 (which provides for stamp duty on the transfer or issue of shares or assets), also affect M&A transactions.
Other general laws such as contract law, IP law, labour law and environmental law also apply to M&A transactions.
Further, sector-specific laws governing M&A activity may apply in addition to general M&A law. For instance, M&A transactions in banking are regulated by the Reserve Bank of India, India’s banking regulator under the Banking Regulation Act and other regulations.
Regulation How is the M&A market regulated?
- M&A activity is regulated by the various laws and regulations mentioned above. The Companies Act 2013 regulates capital instruments that can be issued by companies, procedures and ways of raising capital by the company, the transfer of securities and schemes of arrangements, including mergers and amalgamations, board and shareholder consent requirements for M&A activity and board composition and powers.
- M&A activity in publicly listed companies is regulated by the SEBI through various regulations, including:
- the SEBI Substantial Acquisition of Shares and Takeovers Regulations 2011 (the Takeover Code), which provides for mandatory open offer requirements in the case of substantial acquisitions or the change in control of a publicly traded company;
- the SEBI Issue of Capital and Disclosure Requirements Regulations 2009, which provides for the manner and mode of issuance of capital by a publicly traded company; and
- the SEBI Prohibition of Insider Trading Regulations 2015, which provides for disclosures in the case of M&A transactions involving publicly listed companies.
- Cross border M&A transactions are regulated by the Reserve Bank of India and the Department of Industrial Policy and Promotion through the foreign exchange Laws. These laws provide for:
- restrictions or limits on foreign ownership in certain sectors;
- approval requirements for inbound or outbound investment in certain sectors;
- the instruments which may be issued by Indian companies to non-residents; and
- pricing for cross-border M&A transactions and reporting requirements.
M&A transactions that exceed certain assets or turnover thresholds require Competition Commission of India approval.
Are there specific rules for particular sectors?
FDI laws in India are sector specific. There are certain sectors in which FDI is completely prohibited (eg, in the real estate business). There are other sectors in which FDI can be made only following government approval (eg, FDI above 49% in the defence sector). In all other sectors, FDI can be made without government approval (ie, the automatic route), subject to compliance with specified conditions and pricing and reporting norms (eg, FDI in IT services).
In addition to general laws, sector-specific laws can apply to certain sectors. Such laws may provide for approval of the sectoral regulator for an M&A activity or provide for the fulfilment of certain conditions for M&A transactions in that sector. For example:
- Reserve Bank of India regulations apply to M&A transactions that involve banking and financial companies. There are prescribed conditions around shareholding caps, investor identity and Reserve Bank of India approval for certain types of M&A transaction.
- M&A transactions in the telecoms sector must comply with the guidelines issued by the Department of Telecommunications. These guidelines provide for instances where mergers of telecoms licences cannot be undertaken or Department of Telecommunications approval is required.
Types of acquisition What are the different ways to acquire a company in your jurisdiction?
Company X’s acquisition of Company Y may be structured in the following manner:
- Merger and amalgamation – Two (or more) companies may merge into one corporate entity thus dissolving the other entities. Therefore, in this structure, Company X will merge or amalgamate with Company Y so that Company Y (which will now also comprise Company X’s assets and liabilities) will survive. Company X will be dissolved. The consideration of the acquisition would be paid to Company X’s shareholders. This method requires preparation of a scheme of arrangement that is agreed to by the members and creditors of the combining parties and the merger or amalgamation is effected through approval of the scheme by the National Company Law Tribunal (NCLT) except in certain cases where NCLT approval may not be required.
- Share acquisition – Company Y may purchase securities of Company X from its existing shareholders or Company Y may subscribe to Company X’s newly issued securities. The securities may vary from equity shares, preference shares or other convertible instruments, depending on the applicable legal and commercial considerations.
- Asset or business transfer – Company Y may purchase a business division of Company X (on a going concern basis) or purchase specific assets or liabilities of Company X (ie, cherry picking its assets or liabilities). This is generally effected through a business or asset transfer agreement between the parties. A foreign company can purchase an Indian company’s business only through an Indian entity.
- Demerger – this is a combination of a merger and an asset transfer. In this case, Company X would transfer its business division to Company Y through an NCLT-approved scheme of arrangement and the consideration for such transfer would typically be the issuance of Company Y’s shares to Company X’s shareholders. A demerger is generally undertaken for certain tax considerations.
Due diligence requirements What due diligence is necessary for buyers?
The nature and scope of due diligence varies depending on:
- the nature and form of the transaction;
- the identity of the target; and
- the industry in which the target operates.
However, due diligence should include legal, financial, tax and environmental due diligence for buyers. The legal due diligence process includes a review of:
- the corporate details and company structure;
- material contracts;
- employment agreements, labour disputes, labour law registrations and compliance with labour laws;
- environment law registrations, compliance with environment laws and notices issued by environment regulators;
- litigation by or against the company, including legal notices and show cause notices;
- IP (trademark, patent or copyright) registrations, IP licensing and assignment agreements;
- insurance policies;
- registrations, consents and licences obtained by the company;
- owned and leased real property, including agreements concerning the property; and
- financing and security agreements concerning the company’s indebtedness.
Information What information is available to buyers?
The information available to buyers varies based on whether the target is publicly traded. If the target is not publicly traded, the information is limited to statutory corporate filings that must be made by the company with the registrar of companies (which are accessible at ww.mca.gov.in on payment of a fee). These include annual reports and financial statements, incorporation documents and filings concerning directors, encumbrances and certain types of shareholder resolution.
If the target is publicly traded, in addition to the information stated above, supplemental information is available on the Securities and Exchange Board of India (SEBI) website and the websites of the stock exchange where the shares of the target are listed. The law mandates that publicly traded companies disclose specified information to the public through stock exchanges (where their shares are listed). This includes information concerning:
- shareholding patterns (including director holdings);
- board and shareholder meetings;
- material agreements;
- arrangements and acquisitions;
- changes to capital structure;
- insolvency; and
- key decisions taken by the company.
The company’s website will also contain more extensive information.
Trademark, copyright and patent registration information is also publicly available on government websites (eg, www.ipindia.nic.in). Information regarding litigations and regulatory proceedings may also be available online, but given the lack of indexing, maintenance and search capability of such records, this is not conclusive or definitive.
Other sources of information include news reports, information disclosed by the company on its website and industry reports.
What information can and cannot be disclosed when dealing with a public company?
Under the SEBI (Prohibition of Insider Trading) Regulation 2015, a publicly traded company or persons specified as ‘insiders’ are prohibited from communicating unpublished price sensitive information (UPSI) regarding the company to outsiders. An outsider is also prohibited from soliciting such UPSI from an insider. Once an outsider gains access to UPSI, he or she is treated as an ‘insider’ and is thus prohibited from trading in the company’s securities while in possession of the UPSI. Accordingly, while public companies disclose information on stock exchanges, a potential acquirer should be careful in asking a listed target for – and the listed target should be wary of supplying – further information that is not publicly available and which on becoming available is likely to affect materially the price of the securities.
However, certain carve-outs are available which allow information to be communicated to potential acquirers in the pursuance of a potential transaction, provided that:
- the target’s board is of the opinion that such a transaction is in the company’s best interests;
- the potential acquirer has executed a confidentiality or non-disclosure agreement; and
- cleansing disclosures are made at least two days before the proposed transaction is enacted (in the event that the transaction does not trigger an open offer requirement under the SEBI Substantial Acquisition of Shares and Takeovers Regulations 2011 (the Takeover Code)).
The potential target or acquirer should also consider the desirability of making cleansing disclosures in the event that the transaction is aborted.
Stakebuilding How is stakebuilding regulated?
The Takeover Code regulates stakebuilding in publicly traded companies. Under the code, an acquirer must make an open offer to the target shareholders to acquire at least 26% of the target’s voting rights. The open offer requirements are triggered in the following cases:
- where the acquirer holds less than 25% of the shares or voting rights of the company and post-acquisition the holding becomes 25% or more;
- where the acquirer holds over 25% of the shares or voting rights of the company (but less than 75%, which is the maximum permissible non-public shareholding in a publicly traded company) and the acquirer acquires 5% or more of shares or voting rights during a financial year; and
- where the acquisition leads to change in control of the target.
The acquisition includes direct and indirect acquisitions and the shareholding of persons acting in concert with the acquirer.
The Takeover Code and SEBI (Prohibition of Insider Trading) Regulation 2015 also provide for mandatory disclosures to the SEBI and stock exchanges in the case of acquisitions that exceed the specified thresholds.
There are no stakeholding regulations in companies that are not publicly traded. However, the Foreign Exchange Management Act 1999 and its associated rules and the Foreign Direct Investment Policy promulgated by the Department of Industrial Policy and Promotion regulate foreign ownership in certain sectors and sector-specific laws may provide for shareholding caps and conditions in certain sectors.
Further, the Competition Act 2002 prescribes Competition Commission of India approval for share acquisition exceeding prescribed percentages, where prescribed assets or turnover thresholds are met.
Preliminary agreements What preliminary agreements are commonly drafted?
Preliminary agreements usually include:
- a term sheet, a memorandum of understanding or a letter of intent (containing the terms of the hand-shake agreement or outlining the preliminary commercial understanding of the proposed transaction);
- a confidentiality or non-disclosure agreement (to safeguard the information provided by the target to the acquirer for due diligence purposes); and
- an exclusivity agreement (requiring the parties, or generally the target, not to solicit competing bids for a specified period); this can form part of the aforesaid agreements
Principal documentation What documents are required?
The principal documents vary depending on the structure of the transaction as follows:
- A merger, amalgamation or a demerger involves preparation of the scheme of arrangement between the relevant companies, their members and the creditors.
- A share acquisition involves a share subscription agreement (for investment in new shares) or a share purchase agreement (for the purchase of existing shares). A shareholders’ agreement (setting out the inter se rights and obligations of shareholders) is also entered into in cases where existing shareholders retain their shares or where two or more acquirers purchase a company. Further, where shareholders’ agreements are entered into, a company’s articles of association are amended to reflect the agreement’s terms.
- An asset or business transfer involves an asset purchase or a business transfer agreement.
- A host of ancillary documents may be required depending on the nature and type of transaction, including:
- employment agreements;
- transfer agreements concerning intellectual or real property;
- the novation or assignment of contracts; and
- non-compete agreements with existing or exiting shareholders.
Which side normally prepares the first drafts?
The acquirer typically prepares the first drafts. However, where a sale occurs pursuant to a bid process, the first drafts of the definitive agreements are typically drafted by the sellers, followed by a review by the acquirer.
What are the substantive clauses that comprise an acquisition agreement?
Subject to issues arising from publicly traded targets or foreign direct investment and tax considerations, an acquisition agreement typically comprises the following clauses:
- purchase and sale – which specifies what is being sold and purchased in the case of business or asset transfers, the contours of business or assets being sold and inclusions and exclusions thereto;
- sale, payment mechanism and structure, escrow and holdback arrangements;
- closing transaction conditions;
- pre-closing obligations for parties, including positive and negative covenants (eg, standstill provisions);
- the closing mechanism;
- conditions subsequent to closing;
- representations and warranties, including survival, exceptions and disclosures;
- indemnity provisions;
- limitation of liability provisions, including baskets and caps;
- dispute resolution;
- governing law and jurisdiction; and
- boilerplate clauses.
Further, shareholders’ agreements or investment agreements may include provisions concerning:
- restrictions on the transfer of shares by shareholders, including promoter lock-in, restriction on transfer to competitors, right of first refusal and right of first offer and tag-along or drag-along provisions;
- pre-emptive shareholders’ rights on further issuance of capital by the company;
- board representation rights;
- affirmative or veto rights for shareholders on certain material actions;
- information rights;
- exit rights in the case of minority investment (eg, put, tag and initial public offerings); and
- deadlock resolution provisions.
What provisions are made for deal protection?
The provisions made for deal protection are:
- confidentiality provisions;
- exclusivity and non-solicitation covenants;
- positive and negative covenants (eg, standstill provisions) for the period between the agreement and closing dates;
- the escrow of selling shareholders’ shares; and
- break-fee provisions, although this is uncommon in India.
Closing documentation What documents are normally executed at signing and closing?
The principal agreements, such as asset or business purchase agreements, share subscriptions or share purchase agreements and shareholders’ agreements, are usually executed at signing.
At closing, in the case of the issue of new shares, board resolutions for the allotment of shares and share certificates are issued. In the case of share transfers, the prescribed SH-4 forms to effect the transfer of shares are executed. In the case of business or asset transfers, ancillary documents to transfer particular assets, an example conveyance deed for transfer of land and an assignment agreement for IP transfer are executed.
Mergers and demergers are executed through a scheme of arrangement filed with the National Company Law Tribunal (NCLT). Once the NCLT order approving the scheme has been obtained, a filing is made with the Registrar of Companies and a board meeting is held to close the transaction.
Further, certain corporate filings may need to be undertaken with the Registrar of Companies. In the case of cross-border share acquisitions, filings are also made to the Reserve Bank of India at closing or within a prescribed period from the closing.
Are there formalities for the execution of documents by foreign companies?
No, there are no such specific formalities. However, filings may be required with the Reserve Bank of India at closing or within the prescribed period from the closing.
Are digital signatures binding and enforceable?
Yes, digital signatures are binding and enforceable in India.
Foreign law and ownership
Foreign law Can agreements provide for a foreign governing law?
Yes, parties can contractually decide to provide for a foreign governing law in an agreement. This is typically done where one of the parties is situated in a foreign country or the subject matter of the contract is situated outside India. However, M&A agreements involving Indian shares or assets typically provide for Indian law.
Foreign ownership What provisions and/or restrictions are there for foreign ownership?
The foreign ownership of assets in India is primarily governed by the Foreign Exchange Management Act 1999 and associated rules and regulations and the Foreign Direct Investment (FDI) Policy promulgated by the Department of Industrial Policy and Promotion. FDI laws that govern the acquisition of Indian shares are sector specific. There are certain sectors in which FDI is completely prohibited (eg, in the real estate business). There are other sectors in which FDI can be made only with government approval (eg, FDI above 49% in the defence sector). In all other sectors, FDI can be made without government approval subject to compliance with specified conditions and pricing and reporting norms (eg, FDI in IT services).
Valuation and consideration
Valuation How are companies valued?
In the case of publicly traded companies, a valuation should be undertaken in accordance with guidelines under the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulation 2009.
In the case of the issue of new capital by unlisted companies (ie, non-publicly traded companies), the issue of shares cannot be undertaken at a price less than the company’s fair market value. While the valuation must be undertaken by registered valuers, the rules concerning registered valuers have not yet been issued. Therefore, valuation is typically undertaken by chartered accountants or SEBI registered merchant bankers.
Further, in the case of foreign direct investment (FDI) in unlisted companies, the companies’ shares must be valued by a SEBI registered merchant banker or a chartered accountant, adopting any internationally accepted pricing methodology on an arm's-length basis.
If the SEBI Substantial Acquisition of Shares and Takeovers Regulations 2011 are triggered on account of an acquisition, the valuation of shares offered to the public is to be undertaken as per the regulations.
Consideration What types of consideration can be offered?
In domestic deals consideration can be offered as cash or non-cash (including shares in the acquirer entity).
In the case of FDI in Indian companies, consideration is generally paid in cash and the amount paid by a non-resident to an Indian resident should agree with SEBI guidelines (in the case of listed companies) or be equal to or more than the fair market value of the shares (in the case of unlisted companies). However, a non-cash consideration is also permitted in limited cases, such as:
- the conversion of a foreign lender’s debt to equity; and
- the conversion of amounts due to a foreign acquirer for technical know-how, royalty and the import of capital goods and pre-incorporation expenses.
The regulations also permit the swap of shares, provided that the swap arrangement meets the pricing or valuation requirements.
General tips What issues must be considered when preparing a company for sale?
While the issues will differ from company to company and transaction to transaction, some common issues that may be considered include:
- being organised and preparing a divestiture plan so that resources, funding and timing fall into place;
- undertaking due diligence to ensure that all key permits, consents and registrations are in place;
- evaluating procurement and revenue streams to ensure that supply contracts with key vendors and customers are in place;
- evaluating whether consents or approvals are required under material contracts and the likelihood of obtaining such consents or approvals within the planned timeframe;
- evaluating whether any regulatory consents or approvals are required and the likelihood of obtaining such consents or approvals within the planned timeframe;
- reviewing restrictions in financing agreements and the requirement of lender consents;
- organising financial results that highlight key financial metrics and sound financial projections;
- evaluating which employees are critical to the business and are likely to remain if a succession plan is put in place;
- reviewing regulatory restrictions around ownership control and requirements; and
- ensuring that a team of advisers is in place that can adapt to various structuring alternatives while keeping the transaction objective in mind.
What tips would you give when negotiating a deal?
Preparation is key to good negotiations and this means understanding the client’s needs. Understanding what the other party wants is of equal importance and this can provide valuable leverage in making concessions and adjustments, which enable parties to get what they want.
It is also important to understand cultural differences in cross-border M&A transactions and matters that may be sensitive to Indian parties.
When negotiating for a seller it is important to:
- know the target’s history;
- ensure full disclosure to avoid any post-closing claims; and
- understand to what extent the seller is willing to provide indemnity – Indian promoters of family run businesses are reluctant to give extensive representations or warranties and indemnities to the acquirer and are wary of unlimited and unseen liabilities devolving on them.
When negotiating for the buyer it is important to:
- know the diligence details;
- understand the matters which are non-negotiable (Foreign Corrupt Practices Act compliances);
- be wary of unclear disclosures made to representations and warranties; and
- prepare a post-closing implementation and integration plan.
Hostile takeovers Are hostile takeovers permitted and what are the possible strategies for the target?
There is no concept of ‘hostile takeover’ under Indian law. Most Indian companies are promoter driven and run by business families and therefore such takeovers are uncommon in India compared to Western European jurisdictions. Further, the Securities and Exchange Board of India regulations mandate several disclosures, shareholder approvals and procedural requirements for the takeover of a publicly traded company which make it difficult for hostile raiders to acquire targets. Further, acquirers face practical difficulties in acquiring a target without the cooperation of the target’s board of directors and promoters.
In respect of possible defence strategies, there are restrictions under Indian laws regarding:
- the pricing of convertible instruments (making so-called ‘poison pill’ tactics unviable); and
- the disposal of assets during takeover bid process (making so-called ‘crown jewel’ tactics unviable).
One means of guarding against hostile takeovers is the 'brand pill', a strategy used by Tata Group which involves establishing a clause in a company’s charter documents under which the target will no longer be able to use its brand in the event of a takeover. The rationale behind this strategy is that the core value of well-known entities like Tata is concentrated in the brand name and image and therefore excluding the brand from any deal would significantly lower its value and negate several post-merger synergies.
Warranties and indemnities
Scope of warranties What do warranties and indemnities typically cover and how should they be negotiated?
Warranties are provided by sellers or targets in M&A transactions on:
- the title of shares (in the case of share acquisition) provided by selling shareholders;
- due incorporation, status, power and authority;
- capital structure;
- compliance with the law, which is generally negotiated with promoters on account of multiple laws and legal requirements;
- books and records;
- financial statements;
- business permits and authorisations – this again is negotiated on account of multiple permit and authorisation requirements and the sellers negotiate to limit this to key permits or authorisations;
- employment matters, including benefit plans, registrations and labour disputes;
- material contracts;
- anti-bribery warranties – foreign buyers typically insist on Foreign Corrupt Practices Act-type warranties
- intellectual property;
- real estate;
- receivables and inventories;
- absence of changes and undisclosed liabilities;
- related party transactions; and
- environment law matters.
Warranties are structured in India as representations and warranties, as the acquirer can avail of different remedies for a breach of the same.
The process of drafting the terms of warranties in an M&A transaction involves several rounds of negotiations by the buyers and sellers. The buyers seek as many representations and warranties as they deem necessary to minimise their risks, while the sellers seek a seamless exit with the least amount of liability possible. When negotiating such transaction agreements, the target typically wants representations and warranties to be ‘narrowly drawn’ (ie, limited to a few specific issues). Conversely, the buyer requires the representations and warranties to be ‘broad and flat’ (ie, to use general language designed to cover as many potential issues as possible).
Qualifiers such as materiality and knowledge are common and insisted on by the sellers – especially if the company is large and has been in existence for a long time. The due diligence process may also affect the scope of any representation or warranty. Typically, specific representations and warranties are added to address the issues and risks identified during due diligence. Conversely, sellers insist on disclosures being made against the representation or warranty. Generally, disclosures against representation or warranty are specific; however, sellers are increasingly insisting on general disclosures being included in the scope of disclosures, especially disclosures made in the data room.
Indemnities are typically provided for in misrepresentation and breach of warranties and covenants. Specific indemnities are added to address the issues and risks identified during the due diligence. Further, indemnity for certain pre-closing actions or taxes are also common, especially in cases of business transfers. Indemnity clauses, as well as the limitation on indemnity clauses are also negotiated, with the buyer seeking indemnity for all pre-closing matters while the seller insists on limiting the indemnity to a breach of representation and warranty.
From the buyer’s perspective the following may be considered:
- the use of the phrases ‘hold harmless’ and ‘protect from liability’;
- the obligation to defend begins the moment that any claim is made;
- an inclusive definition of phrases such as ‘losses’ or ‘liability’;
- the use of ‘arising out of’ instead of ‘result of’ or ‘connection of’;
- a tax gross-up;
- depositing the claim amount with the arbitrator; and
- the fraud and wilful negligence exclusion from any indemnity cap.
From the seller’s perspective the following may be considered:
- setting out clearly the de-minimis, basket or deductible thresholds;
- ensuring a cap on total liability;
- a duty to mitigate;
- provisions concerning the defence takeover in the case of third-party claims;
- survival periods for indemnity clauses; and
- joint and several liabilities for inter se sellers and between sellers and the company.
Limitations and remedies Are there limitations on warranties?
A party cannot claim damages for a breach of implied warranties. Only express warranties are covered. Further, under Indian law, a party cannot claim damages for a breach of representation if it had the means to discover the same information with ordinary diligence.
The specific limitations that are typically provided in acquisition agreements include:
- disclosures made against representations or warranties in a disclosure schedule or letter – this is often the point of much negotiation, as the seller’s counsel try to make disclosures apply to all representations and provide for general disclosures, while the acquirer's counsel seeks to confine disclosure to specific disclosures against specific warranties in the agreement;
- caps on the amount of indemnity that the buyer may claim for a breach of warranties (this can be anywhere between 25% and 100% of the transaction value);
- a de-minimis threshold (ie, a minimum threshold of the buyer’s individual claims – typically between 0.1% and 0.5% of the transaction value) and a basket threshold (ie, a threshold that must be met in order for the liability of the sellers to arise – typically between 0.5% and 2% of the transaction value);
- time limits for the survival of warranties, typically fundamental warranties (eg, on the title of shares), are generally unlimited in time and tax warranties are generally limited to seven to eight years while other warranties are generally limited to three years. A longer period of five to 10 years may be provided for environment-related warranties.
What are the remedies for a breach of warranty?
A breach of warranty pre-closing would typically provide the non-defaulting party with a right to terminate the acquisition contract in addition to claims for damages or indemnity.
Post-closing, a non-defaulting party may consider the following remedies:
- A claim indemnity under the contract – where a holdback or escrow arrangement is provided, the indemnified party may have a contractual right to offset the indemnity amount against any holdback amount or amount held in escrow for such purposes.
- A non-defaulting party may approach the arbitral tribunal (if an arbitration provision is provided) or court (where an arbitration provision is not provided) for a damages claims. An arbitral court would typically insist on proof of damage.
- Other remedies may be provided in the transaction document (eg, put or call options on the breach of contract).
Are there time limits or restrictions for bringing claims under warranties?
Indian limitation laws provide for a three-year time period from the date on which the cause of action arises (typically from the discovery of the breach of warranty).
Tax and fees
Considerations and rates What are the tax considerations (including any applicable rates)?
From a tax point of view, M&A transactions can be broadly classified as follows:
- a purchase of shares;
- a merger (amalgamation);
- a demerger (generally referred to as hiving-off);
- a slump sale (another variant of hiving-off); and
- an itemised sale of assets.
Capital gains tax is payable by the seller of a capital asset on the gains that arise from the sale of that asset. Tax rates differ depending on whether the capital asset is held by the seller for more than 36 months (20% of the gain, plus cess) or less than 36 months (30% of the gain, plus cess).
Where the capital asset involved is shares, the selling shareholder pays tax on gains arising from the sale. Further, if the seller receives an amount less than the fair market value of the shares, the difference between the fair market value and the purchase consideration is deemed to be the transferor's income; the transferor will be liable to pay income tax on the same. If the seller and buyer are non-residents, the buyer must withhold taxes from the purchase consideration unless the non-resident seller is located in a jurisdiction with which India has a double tax agreement and India has given up its right to tax the capital gains under that agreement.
A merger and demerger may be tax neutral (subject to such merger/demerger satisfying certain conditions).
In the case of a slump sale, the consideration received by the seller will be treated as a capital gain arising from a single transaction (provided that the prescribed slump sale conditions are met – that is, the consideration should be a lump-sum consideration without assigning separate values to each individual asset or liability). In the case of the itemised sale of assets, indirect taxes such as sales tax or value added taxes may be levied.
Exemptions and mitigation Are any tax exemptions or reliefs available?
Mergers and demergers (approved by the National Company Law Tribunal) may be outside the tax net, subject to certain conditions being met. Further, losses brought forward may be given a new lease of life if structured appropriately. In the case of a slump sale, the entire consideration received by the seller company will be treated as a capital gain arising from a single transaction (provided that the prescribed slump sale conditions are met).
What are the common methods used to mitigate tax liability?
Depending on its aims, a deal may be structured as a merger, demerger or slump sale. In the case of the acquisition of shares by a foreign acquirer, a transaction is structured to avoid the double taxation of income in India and the acquirer’s country of residence. For instance, foreign acquirers may route the transaction through an investment vehicle located in a jurisdiction which has a favourable tax treaty with India (eg, Singapore, Cyprus, the United Arab Emirates and the Netherlands).
Fees What fees are likely to be involved?
M&A transactions include registration fees where immovable property is involved and stamp duty on definitive agreements and legal fees.
Management and directors
Management buy-outs What are the rules on management buy-outs?
There are no separate rules concerning management buy-outs and general laws applicable to another acquirer also apply in this case. However, there are regulations restraining voting by interested directors due to a conflict of interest. Further, the Securities and Exchange Board of India (SEBI) (Prohibition of Insider Trading) Regulations 2015 restrict insiders from trading while in possession of unpublished sensitive information (UPSI) in the case of publicly traded companies.
Directors’ duties What duties do directors have in relation to M&A?
Directors’ duties have been statutorily recognised in the Companies Act 2013 which applies to all types of director, including independent directors. These duties include the requirement to:
- act in good faith in order to promote the company for the benefit of its members as a whole and in the best interest of all stakeholders;
- exercise duties with due and reasonable care, skill and diligence and independent judgment; and
- avoid a situation in which a director may have direct or indirect interest that conflicts, or possibly may conflict, with the company's interest.
Therefore, if an M&A proposal is presented to a company board, the directors should ensure that it is in the best interest of the company and its stakeholders, including its employees.
In the case of an M&A transaction involving a publicly traded company, its directors have certain additional obligations. Under the SEBI (Prohibition of Insider Trading) Regulations 2015, UPSI can be communicated by the listed company to potential acquirers in pursuance of a potential transaction only if the target’s board is of the opinion that the transaction is in the company’s best interest. Further, in the case of an open offer under the SEBI Substantial Acquisition of Shares and Takeovers Regulations 2011, the directors (especially independent directors) of a listed company have certain additional duties, including providing a reasoned recommendation to the target’s shareholders on the open offer.
Consultation and transfer How are employees involved in the process?
Before closing, the buyer must typically hold meetings with the target’s key employees to assure and ensure their continuity in the business. Apart from key employees and employees who are involved in the transaction (eg, by providing information to the acquirer), employees are not typically involved in the negotiation of the transaction.
As employees are not transferred in share acquisitions, typically no documents are executed by employees at the time of closing (unless the acquirer requires them to sign new employment agreements). In the case of business transfers, transfer letters may be issued to employees or employees may be asked to resign from the transferring company and execute new contracts with the acquiring company.
What rules govern the transfer of employees to a buyer?
The Industrial Disputes Act 1947 governs the transfer of employees. In the case of the transfer of employees following the transfer of a whole undertaking or amalgamation, merger or demerger, the transferring company must provide a termination notice and retrenchment compensation to the employees, unless the transfer is on a continuity of service basis and the terms are no less favourable than the terms of employment with the transferring company.
Employee rights in the case of the transfer of an undertaking are governed by the terms and conditions of their employment contracts. If the buyer refuses to employ such employees and the seller does not wish to retain them, the seller must provide them with their contractual termination entitlements and gratuity benefits (if any). However, typically, in mergers, amalgamations or business transfers, employees are transferred on a continuity of service basis on terms no less favourable than their terms of employment with the transferring company.
Share acquisitions do not involve the transfer of employees, as the employer remains the same.
Pensions What are the rules in relation to company pension rights in the event of an acquisition?
Acquisitions do not affect employees’ statutory pension benefits. However, in business transfers, mergers or amalgamations, the acquirer must ensure that the transferred employees are provided benefits which are no less favourable than the existing ones (ie, the continuity of benefits is maintained).
Other relevant considerations
Competition What legislation governs competition issues relating to M&A?
Competition issues relating to M&A transactions are governed by the Competition Act 2002.
Anti-bribery Are any anti-bribery provisions in force?
Yes, the Indian Penal Code 1860, the Prevention of Corruption Act 1988, the Prevention of Money Laundering Act 2002, the Right to Information Act 2005, the Central Vigilance Commission Act and the Lokayukta Acts of States contain anti-corruption and anti-bribery provisions. These laws prohibit a public servant from accepting gifts or favours for official acts and also penalise the bribe giver if it is proven that he or she was involved in the offence committed by the public servant.
Receivership/bankruptcy What happens if the company being bought is in receivership or bankrupt?
The Insolvency and Bankruptcy Code 2016 provides for a two-stage process to tackle insolvency. In stage one, a company undergoes a corporate insolvency resolution process (CIRP) for six to nine months, during which its financial creditors attempts to resolve the insolvency. If the CIRP fails, the company enters stage two, which involves its mandatory liquidation. Stage one must precede stage two.
Under the CIRP process:
- an insolvency professional is appointed;
- the company board is suspended; and
- a moratorium is placed on actions by and against the debtor company.
Any party may propose a plan to resolve a company’s insolvency. Such plans may include the sale of a company or its assets to another entity or further financing by lenders. If a resolution plan is approved by creditors and the National Company Law Tribunal, the company will continue to operate as per the resolution plan. If the plan is not approved or fails, a liquidator is appointed and the liquidation process starts. During the liquidation process, a liquidation estate is formed and company assets are distributed to creditors or shareholders as per the waterfall mechanism provided under the Insolvency and Bankruptcy Code. Following such distribution, the company is dissolved.
Law stated date
Correct as of Please state the date as of which the law stated here is accurate.
June 26 2017.