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Mergers and Acquisitions activity in India-glass half full or half empty

By Vineetha MG & Richa Roy
Posted: 1st June 2012 10:26

“2012 will be the year of mergers and acquisitions”-  according to an annual survey carried out by global consulting firm, Grant Thornton. 
The survey, conducted in the last quarter of 2011 among top private equity players and corporations indicates optimism for both inward and outward M&A activity by Indian corporations.  The actual FDI figures for the financial year ending March 2012, seems to confirm this - India had attracted foreign direct investment totalling USD 50 billion, with the January to March 2012 quarter alone seeing deals worth USD 18 million being closed. 
And yet these figures and the supposed buoyancy is dampened by numerous factors, including retrospective tax amendments that could severely impede cross-border M& A activity, a policy paralysis and the inhibition to take bold reformist measures, uncertainty at the centre as also various states including the credibility of the entire political class which is being marred by corruption scandals. 

It is difficult to say whether the glass is half full or half empty for M&A in India.  But it is certainly clear that several initiatives ranging from small clarifications to some big ticket reforms could give a huge fillip to M&A activity and in turn galvanise the real economy.

The much-discussed retrospective amendments to the Income Tax Act are yet to be passed, but the proposed amendments have now received some measure of certainty, with the Finance Minister clarifying that theamendments do not override the provisions of Double Taxation Avoidance Agreements (DTAA) which India has with 82 countries, and would impact those cases where the transaction has been routed through low tax or no tax countries with whom India does not have a DTAA.  Further, a reprieve has been received on the dreaded implementation of GAAR, which has been deferred by one year. 

There are several other areas of law and regulation, critical to mergers and acquisitions which are crying out for reform. 

One such area is the ambiguity surrounding the enforceability of put and calls options, with different regulators taking divergent views.  Put and call options in shareholders agreements afford parties the opportunity of an exit at a certain price upon the occurrence of certain triggers events.  Such contractually agreed transfer should be permitted so long as they are not speculative, subject to compliance with exchange control stipulated pricing guidelines where either the transferor or transferee are non-India.  However, a cloud of doubt exists over such options from an exchange control as well as securities regulation perspective in India.

The Reserve Bank of India (“RBI”) and the Department of Industrial Policy and Promotion (“DIPP”) have been taking a view that equity invested with such contractual options should be treated as debt and accordingly regulated far more stringently as external commercial borrowings.  On October 1, 2011, DIPP came out with a clarification that equity instruments issued to non-residents and having in-built options or supported by options sold by third parties would lose their equity character and would be treated as debt, which it retracted from subsequently.  Soon thereafter, the RBI has once again taken a disapproving view on put/call options in certain instances.  Some finality was expected in Consolidated FDI Policy released by the DIPP on April 1, but it was unfortunately silent on this point.  This could mean that the RBI could continue to view put and call options with suspicion on a case by case basis as they had been in the past, despite there being not formal codification on this issue.

In the context of securities regulation, the issue of put and call option came up in the Cairn Vedanta deal where SEBI directed the parties to that pre-emption rights and the put/call option be removed from the share purchase agreement between the parties.  SEBI’s view was that such arrangement  violated a notification dated March 2000 as it was not in conformity with the requirements of spot delivery contract or a derivative contract under Section 18A of the Securities Contract Regulation Act, 1956[1]  (“SCRA”).  SEBI’s view on put/call option arrangements was further substantiated in an interpretative letter dated May 23, 2011 issued to Vulcan Engineering Limited (“VEL”) that a put/call option would not qualify as a legal and valid derivative contract in terms of Section 18A of the SCRA, as it is exclusively entered between two parties and is not a contract traded on stock exchanges and settled on the clearing house of the recognised stock exchange.  In this backdrop, the Bombay High Court in MCX Stock Exchange Limited v SEBI held that, buy-back arrangements are not “forward contracts”, since such contracts merely confer an option on the promisee to cause the purchase of the shares held by the promisee and the actual contract for purchase and sale of shares does not fructify until the option is exercised.  The court further held that upon the exercise of the option by the promisee, the contract (in the present case) would be fulfilled by spot delivery and therefore be exempt from the purview of the restrictions under the SCRA.  Therefore, the courts seem to be taking a view that put options should be enforceable so long as the actual transfer when the option is exercise is completed on a spot delivery basis.  On appeal the Supreme Court did not go into the merits and disposed of the appeal by directing SEBI to make appropriate changes to the regulations without being bound by the observations or comments of the Bombay High Court.  One will need to wait and see the legislative outcome on this issue.

The recent corruption scandals have impacted M&A transactions as well, in cross-border deals, owing to the vigorous enforcement of the Foreign Corrupt Practices Act, 1977 by the US Department of Justice in the recent years and the enactment by the UK of the Bribery Act, 2010 reportedly the strictest anti-bribery legislation till date.  The Foreign Corrupt Practices Act, 1977 (“FCPA”) could potentially extend to a US investor’s investee company in India and could expose the investor’s management in the US to penal sanctions if an Indian investee company has been involved in bribing or unduly influencing a public official.  The UK has enacted the Bribery Act, 2010 (“Bribery Act”) which came into effect in July 2011, which has significant extra territorial reach as well.  The Bribery Act criminalises the act of giving bribes to foreign public officials and private bribery in offshore jurisdictions which may be unconnected to the investor’s UK business.  Accordingly, foreign investors and JV partners insist on covenants, representations, on-going compliances such as the adoption of codes of conduct, annual certifications and audits.  Also, India Inc, which has been aggressively expanding abroad, has become mindful of the repercussions for their Indian global operations once they establish a connection with companies in the UK or the US.  India recently ratified the UN Convention against Corruption (“UNCAC”) and accordingly, is now obliged to take a range of measures against corruption, several of which may impact M&A transactions as well.  The signatories to the UNCAC are bound to take measures to prevent corruption involving the private sector.  Recent press articles have indicated that the Union Home Ministry is working on adding a chapter in the Indian Penal Code (“IPC”) to check corruption in the private sector which could potentially apply to transactions between two private entities as well, similar to the Bribery Act. 

Outbound M&A activity is also expected to be on the upswing this year, since several Indian corporate houses are looking to use cash reserves to acquire appropriately valued businesses abroad.  Apart from access to markets and potential for increased revenues, such acquisitions could result in the transfer of technology and skills for the Indian purchaser.  Some clarity from RBI on holding and operating structures set up by Indian parties and the manner and extent to which Indian parties may provide financial support to their overseas entities would go a long way in helping Indian companies in their overseas direct investment.  While it is clear that an Indian party’s exposure to its overseas subsidiaries and joint venture companies cannot exceed 400 per cent of its net worth (a prudent figure), it is unclear as to the levels of subsidiaries to which financial support can be extended.  For instance, while an Indian party may extend a guarantee or other financial support to a step down operating company, it is unclear whether the intermediate company must be subsidiary or a joint venture, a holding company or an operating company.  There have been mixed signals from the RBI as to whether an Indian party can extend financial support to step down companies only if they are holding companies, or if they are operating companies.  We understand that the regulator has concerns of opaqueness, and round tripping while the Ministry of Finance would like to provide reciprocal treatment with regard to preventing complex structures to avoid tax.  RBI could consider codifying the manner in which overseas investments may be held through various levels of subsidiaries and joint ventures, with adequate safeguards as to disclosure.
Raghuram Rajan, the former chief economic advisor to the Prime Minister, in a recent speech said that one of the short term actions that the government should take is to “be kinder to foreign investors… avoid the tremendous uncertainty created by catch-all measures …we should focus instead on clearly delineating specific actions we want to prevent.” We believe the same applies equally to India Inc looking at expanding abroad.  If the government and regulators set down some bright line tests, lay down some certainty regarding some issues fundamental to M&A activity, it could go a long way in reinvigorating the economy. 

[1] In terms of Section 18A of the SCRA, contracts in derivatives are legal and valid if such contracts are (i) traded on a recognized stock exchange; (ii) settled on the clearing house of the recognized stock exchange, in accordance with the rules and bye-laws of such stock exchange

Vineetha M.G. is partner in AZB & Partners.  The focal areas of her practice are project and corporate finance, venture capital and private equity investments.

Ms. Vineetha has extensive experience in the infrastructure space, specifically the power, oil and gas, telecom, roads, airports, railway, and port sectors.  She has advised and represented the entire spectrum of participants in these sectors. Ms. Vineetha is also widely experienced in setting up and advising onshore and offshore venture capital and private equity funds which invest in several sectors, including infrastructure.  In this domain, she has also advised major private equity funds and their investors in relation to investments in India, in both listed and unlisted companies, as well as exits from investments.

Ms. Vineetha took her B.A.LLB (Hons.) from the National Law School of India University, Bangalore, in 1998 and began her career at ICICI Bank Limited, Mumbai, in the same year.  Since 2002 she has been with AZB & Partners and became a partner with the firm in April 2006.  Legal 500 (Asia-Pacific), in their 2008-09 edition, named her among the “leading individuals” in the country in the practice area of ‘Banking and Finance’.  The International Financial Law Review, in its publication ‘IFLR 1000: The Guide to the World’s Leading Financial Law Firms’ published in the year 2009, named Ms.  Vineetha among clients’ favourite lawyers to work with who also acknowledged her for being attuned to client requirements, and for her timely delivery and great accessibility.  Ms Vineetha has contributed articles on several issues in various publications and has been a panelist / speaker at several conferences and seminars.

Vineetha can be contacted via email at:

Richa Roy is a Senior Associate with AZB & Partners.  Her focal practice areas are banking and financial services, private equity and venture capital funds and foreign inward investment law. 

She has advised on the structuring and setting up of several funds and feeder structures investing in capital markets, real estate, private equity and other asset classes in India and drafted and negotiated key documentation in this regard, including subsequent investment by such funds.  She has advised on several diverse bank regulatory and securities law issues including relating to the offer of a large Indian bank’s private wealth management products in 50 countries across the world and helped set up a compliance program in this regard. 

Richa took her B.A.LLB (Hons.) from the National Law School of India University, Bangalore, in 2005 and began her career at ICICI Bank Limited, Mumbai, in the same year.  Since 2008 she has been with AZB & Partners.
Richa can be contacted via email at:

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