M & A: REGULATORY ENVIRONMENT DUE DILIGENCE Learning objectives After reading the chapter you will be able to understand

The Indian M&A scenario The legal due diligence The regulatory aspects of M&A in India

Chapter outline

1. M&A SCENARIO IN INDIA Legal due diligence

2. MERGER /AMALGAMATION The Companies Act Provisions The Income Tax Act Provisions Competition Act Provisions

3. ACQUISTION / TAKEOVER 4. CROSS BORDER M&A 5. FOREIGN DIRCET INVESTMENT (FDI)

Automatic Investment Restricted Investment Prohibited Sectors Instruments of FDI Foreign portfolio investment (FPI) Foreign venture capital investments Branch office/project office / liaison office in India

M&A SCENARIO IN INDIA

The merger

and acquisition term in India are quite new and

have grown

only in the last two decade. The M&A activity in India has shown substantial growth and garnered interest from global economies post the liberalization process taken up by Indian economy in the 1990s. The economies worldwide have seen a surge in inorganic growth activities including M&A. companies are purchasing growth and entering quick growth tarck with M&A as one of the tools for corporate growth.

TABLE 1: Deal Summary Volume Value (US$ bn) Year 2010 2011 2012 2010 2011 2012 Inbound 23 26 36 1.12 13.75 1.26 Outbound 46 34 26 13.26 1.73 0.69 Cross Boarder 69 60 62 14.39 15.47 1.96 Domestic & Internal Restructuring 119 82 115 3.05 2.40 16.32 M&A 188 142 177 17.44 17.87 18.27 PE 59 75 118 1.56 2.61 2.01 QIP 9 2 2 0.87 0.53 0.1 Grand Total 256 219 297 19.87 21.01 20.35

Dealtracker, Quarterly issue, Volume 8.3 (2012), Grant Thornton

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MERGER & ACQUISITION

AMALGAMATION  TAKEOVER

ABSORPTION CONSOLIDATION  

SEBI

FOREIGN ENTITY

FDI GUIDELINES (FIPB & DIPP)

FEMA 

GUIDELINES (RBI)

DOMESTIC  

COMPANISE ACT 1956

  2INCOME TAX ACT 1961

COMPETITION ACT 2002

Figure 1: the M&A regulatory system in india MERGER /AMALGAMATION In India merger and acquisition is amalgamation and takeover. The word merger is not defined under any Indian act. However we have the word amalgamation that is defined by income tax act. Merger means two firms merging to form a new entity or that an acquirer

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completely absorbs the target company. The former is technically known as consolidation while the latter is termed as absorption. In India the term merger is replaced by the term amalgamation. Thus merger in India means amalgamation which is categorized as consolidation and absorption. Amalgamation is regulated by companies act as it involves restructuring of the participating companies. It is scheme of rearrangement of share capital with the promoters. Amalgamation or scheme of rearrangement involves regulatory framework provided by the following acts

1. The companies act 1956 2. The income tax act 1961 3. The Competition act 2002

The Companies Act Provisions A typical merger or amalgamation in India involves high court of the concerned jurisdiction as Merger in India is a high court driven process (see table 2). the companies in India need to have the object clause of rearrangement of share capital in its memorandum of association. In case such when object clause of rearranging share capital does not exist then the company should call a board meeting and amend its MOA to incorporate the clause of restructuring. The procedure for amalgamation or scheme of rearrangement is complex but it not only takes care of the interest of creditors and shareholders but also safeguards public interest.

TABLE 2: The various steps involved are 1 Observing MOA of transferee company 2 Convening board meeting and Preparation of

valuation report and scheme document 3 Application to High Court 4 Notice to be given to stock exchanges 5 Court approves time, date, venue of the Board

meeting for merger 6 General Meeting convened for Passing of scheme

document 7 Results reported 8 Court Approval sought 9 Certified copy filed with Registrar of Companies

Section 390 to 394 of chapter V of the companies act 1956 governs the merger of two or more companies in India. These provisions provided in the abovementioned sections regulate all types of restructuring associated with companies formed under companies act ( whether in India or outside India) namely amalgamation, consolidation, absorption, spin off, de-merger etc. the amalgamation involves an arrangement between the companies and their shareholders to merge with each other. Thus an application needs to be provided by each of eth participating company to the company court. The court should have the jurisdiction over the company’s affairs. The court assesses and evaluates the documents submitted by parties and calls for scheduling meeting for the companies’ shareholder and creditor classes.. if the majority of shareholders and creditors equal to three fourth (3/4th ) in value of shareholders and creditors present and voting agree to the merger then its stands effected. The court then evaluates all facts and figures provided regarding the merger and sanctions the merger. The

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merger stands approved and sanctioned once a certified copy of the approval is filed with the registrar of eth companies. Along with the application fro approval the transferee needs to submit the latest audited balance sheet and memorandum of association and articles and copy of the board meting containing agreement to merge. Further the companies act provides that the transferor company which is the target company can be an Indian company or a company incorporated outside India. However the transferee company which is the acquirer should be an Indian company i.e. company formed under companies act 1956. thus a foreign company can merge with an Indian company but the reverse is prohibited under the act. The scheme of amalgamation is prepared by the companies involved in the merger once they officially agree to merge. This means that the merger attempt should be friendly and it should be accepted by majority of the shareholders and creditors. The consensus amongst the shareholders and creditors must be arrived in terms of eths strategic benefits arising post merger, the rationale fro the merger and the valuations agreed upon as well as the deal structure. The scheme of amalgamation is expected to consists of

The particulars about the transferor (target) and the transferee (acquirer), Main terms and conditions for transfer of assets and liabilities from the transferor to

the transferee, The Proposed date for the scheme, Share capital of the transferor and the transferee in terms of authorized capital, issued

capital ands subscribed and paid up capital. Proposed payment in terms of cash component and exchange ratio for target

shareholders. In context of exchange ratio the target shares are extinguished and new shares are issued.

The proposed Conditions pertaining to dividend distribution, ranking of equity etc The proposed Conditions pertaining to provident fund, gratuity, super annuity funds

of the employee of the transferor company etc

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Amalgamation/Merger Scheme at Akzo Nobel India Limited

At a meeting held on 21st October 2011, the Board of Directors of Akzo Nobel India Limited has approved the draft scheme of Amalgamation of Akzo Nobel Car Refinishes India Private Limited, Akzo Nobel Chemicals (India) Limited, Akzo Nobel Coatings India Private Limited (collectively known as the 'Transferor Companies') with Akzo Nobel India Limited (the 'Transferee Company'). This merger of AkzoNobel group companies in India with Akzo Nobel India Limited is the most significant sustainable shareholder value creating initiative being taken by Akzo Nobel India. The merger will result in creating an integrated paints and coating company with capabilities to fully and efficiently service the needs of the customers. In addition the merger will be delivering various operating and financial synergies and will create a strong platform for fully unleashing the India Growth opportunities in Coatings and Chemicals. The Company has received No objection certificates from Bombay Stock Exchange Limited and National Stock Exchange Limited to proceed with the amalgamation proposal. The Company has also received approval from the Competition Commission of India for this Amalgamation. The exchange ratio of shares of the Transferor Companies and the Transferee Company have been fixed on the basis of the Valuation Reports prepared by independent firms of Chartered Accountants. The Company has also obtained a ‘fairness opinion’ on share valuation from an authorised Merchant Banker. The Appointed Date for the Scheme would be 1st April, 2011; The Scheme shall be conditional upon and subject to:

Shareholder approval; The requisite consent, approval or permission of the Central Government or

any Government Authorities which by law may be necessary for the implementation of this Scheme; and

Approval by all the jurisdictional High Courts On 22 December 2011, Hon'ble High Court at Calcutta has directed that a meeting of the Equity Shareholders of the Company be convened and held at Kala Mandir, 48, Shakespeare Sarani, Kolkata 700 017 on Tuesday, February 7, 2012 at 11:00 A.M. for the purpose of considering the proposed Scheme of Amalgamation. Notice of this meeting (with all its annexures) has already been sent to all the shareholders.  Source: company’s website media and news:  http://www.akzonobel.com/in/news/merger_scheme/

Further the scheme is approved by the transferor and transferee before applying to the court for sanction. However prior to shareholders the transferor and transferee also need to look at the status of financial institutions who have extended the debt components. Their approval is also required. In case the amalgamation requires issue or transfer of shares to non-resident Indians or foreign nationals then the approval of reserve bank of India needs to be taken. The conduct also needs to adhere to foreign exchange management regulations 2000 (FEMA). When the transferor and transferee are listed on the stock exchange they may additionally inform the concerned stock exchange. All listed companies adhere to listing guidelines and requirement. Number of shares issued and subscribed is an integral part of listing agreements. Scheme of rearrangement of share capital needs to address the stock exchange regarding the alteration in its capitals structure post amalgamation. The stock exchange is also apprised of the announcement effect on the

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share price as the words of the proposed amalgamation are spread in the market. After the scheme of amalgamation is effected the transferee that takes over the assets and liabilities of transferor needs to apply fresh to eths stock exchange for listing the new shares issued to the shareholders of eth transferor company. The Income Tax Act Provisions Normally income tax act levies tax on capital gain which is realized on transfer of capital assets. Capital assets are fixed assets generally property of any kind1. Section 45 of the income tax act levies capital gains tax on capital gains arising on transfer of capital assets. Normal business transactions other than amalgamation involving transfer of assets, immovable property of any kind is subject to capital gain tax. Capital assets may be short term or long term as per ITA. Capital assets held for 36 months or more are long term capital assets while those held for less than 36 months or12 months or less are short term capital assets. Transfer of long term capital assets creates long term capital gains while transfer of short term capital assets gives rise to short term capital gain. Both are taxed differentially. Section 47 of the income tax act exempts capital gain tax for merger under section 47 (vi) for amalgamating company2. Transfer of capital asset in a scheme of amalgamation by the amalgamating company to the amalgamated company is exempt from tax on capital gain provided the amalgamated company is an Indian company. Amalgamating company is the company which is merging i.e. Target Company. Amalgamated company is the company with which it merges i.e. acquirer. To be tax neutral amalgamation should qualify the definition provided by the income tax act and the related conditions. Section 2(1B) of the income tax act defines "Amalgamation", in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that – (i) all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation; (ii) All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation; (iii) Shareholders holding not less than 75% in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the

                                                            

1 Under the existing provisions of Section 2(14), a 'capital asset' means, property of any kind held for personal use by the assessee, whether or not connected with his business or profession, personal effects held for personal use by the assessee or any number of his family dependent on him are excluded from the ambit of the definition of capital asset. 2 http://law.incometaxindia.gov.in/DIT/Income-tax-acts.aspx  

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amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation. All above conditions should be satisfied in order to get tax exemption on capital gain in any amalgamation. If any cash consideration is paid to the shareholders of the amalgamating company its is liable to capital gain tax. If any of the above conditions is not satisfied then amalgamation is subject to capital gain tax. If a wholly owned subsidiary merges with its parent (see figure 2). As parents company shareholders holds the subsidiary the issue of other shareholders does not arise and the condition III is satisfied. At any time condition III is not satisfied then tax will be levied. To be tax neutral condition III is essential to be fulfilled. Merger of subsidiary into its parent is amalgamation if condition in section 2(1B) is satisfied and is tax neutral. Amalgamation applies only to companies formed under companies act and not other forms like sole proprietorship, partnership and cooperative societies. COMPANY 

‘A’ 

 

TRANSFEREE 

COMPANY  Merges into ‘B’    TRANSFEROR 

Figure 2: company A amalgamates company B Section 47 (via) states that where capital gain arises due to transfer of shares held in Indian company by amalgamating foreign company to amalgamated company foreign company the tax is exempted if

25% of the shareholders of amalgamating foreign company continue to remain shareholders of amalgamated foreign company and

Such a transfer is not subject to any tax on capital gain in the country where amalgamated company is incorporated.

Section 72A of income tax act states that when sick and poorly performing companies merge with healthy company then the amalgamated company can avail the benefit of carry forward the loss and the unabsorbed depreciation of the amalgamating company. Provided following conditions are fulfilled

Amalgamated company continues the business of the amalgamating company for not less than 5 years from date of amalgamation

Amalgamated company holds at least 75% of the fixed assets (in book value) of the amalgamating company for not less than 5 years.

The amalgamated company is an Indian company. Competition Act Provisions Mergers generally and popularly happen in same business line or same industry value chain. These are technically termed as horizontal and vertical respectively.. Horizontal and vertical

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integration eliminates competition and creates monopoly that harms the interest of the general public and consumers and competitors in the market. In order to discourage monopolistic trade practice every country aims at doing away with unfair trade practices, restricting healthy competition and creation of monopoly. In India we has monopolies and restrictive trade practices act 1969. with changing nature of global competitive environment and emerging M&A trend in India MRTP act was abolished and competition act 2020 came into place. The act became operational as it became operational in may 2009. both the competition commission of India (cci) which regulates the law and the competition appellate tribunal that operates the law are operational since 20113. CA regulates anti competitive agreements, abuse of dominant position in the market and consolidation leading to monopoly creation. Any agreement between companies regarding activities related to procurement, production, distribution of goods and services , acquisition or control of knowledge and information which creates monopoly has adverse impact on competition (AAEC) in Indian market. Combination as per the act means,

1. The acquisition of control, shares or voting right or assets by an acquirer or an enterprise

2. The acquisition, merger or amalgamation among the enterprises 3. acquiring of control by a person over an enterprise when such person has already

direct or indirect control over another enterprise engaged in production, distribution or trading of a similar or identical or substitutable goods or provision of a similar or identical or substitutable service,

These combinations are subject to financial thresholds as stated by the act

the parties to the acquisition, being the acquirer and the enterprise, jointly have, assets of the value of more than rupees INR 15 billion or turnover more than INR 45 billion in India or in India and outside India, in aggregate, the assets of the value of USD 750 million of which at least INr 7.5 billion are in India, or turnover more than USD 2250 million of which alteast INR 22.5 billion should be in India

acquisition or merger where the group, to which the enterprise whose control, shares,

assets or voting rights have been acquired or are being acquired, would belong after the acquisition, jointly have assets worth more than INR 60 billion or turnover of more than INR 180 billion in India or in India and outside India, in aggregate, the assets of the value of more than USD 3 billion of which assets worth INr 7.5 billion should be in India or turnover of more than USD 9 billion including INr 22.5 billion in India.

Section 32 of the CA allows CCI to enforce competition law against foreign entities whose actions are perceived to create negative or diverse impact on the competition. This clause was missing in the earlier MRTP act. However in order to enforce this section the

                                                            

3 http://www.cci.gov.in/images/media/competition_act/act2002.pdf  

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government has to work in close association with the law enforcement agencies of other countries. Without their cooperation this particular section 32 of competition act would be meaningless. ACQUISTION / TAKEOVER The takeover or acquisition is regulated by Securities and exchange board of India act 1992 (SEBI), through substantial acquisition of shares and takeovers regulations 1997. As per SEBI act when an entity or a person acquires the control of the target company is termed as takeover. The control here implies substantial acquisition of shares or voting rights of the target company. As per Sebi act acquirer means any person who, directly or indirectly, acquires or agrees to acquire shares or voting rights in the target company, or acquires or agrees to acquire control over the target company, either by himself or with any person acting in concert with the acquirer. Further the word control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner The takeover of a substantial number of shares, voting rights in a listed Indian company is subject to the regulations provided in the SEBI takeover code. Substantial acquisition of shares or voting right of a target company is explained in two contexts, One from the context of threshold limit of disclosure and another from threshold limit for open offer. The basic rationale is that once an acquirer has reached a designated specific level of ownership in a target company he is required to adhere to specific rules of acquisition and disclosure as laid down by SEBI, before gaining any additional ownership in the same. Threshold limit for disclosure of substantial holding in Target Company

When an acquirer acquires shares or voting rights that increase his shareholding to 5%, 10% or 24% in the target company, he is required to disclose at every stage the aggregate of his shareholding to the concerned target firm and the concerned stock exchange where shares of Target Company are listed within 2 days of acquisition.

When a person holds shares or voting rights of about 25% or more but less than 55% engages in trading the shares (buy or sell) of about 2% or more he is required to disclose his cumulative shareholding every year to the target company as well as the concerned stock exchanges

Any person holding more than 25% shares or voting rights of a target company is required every year, to make a disclosure of his ownership to the target company within 21 days from financial year ending march 31 for purpose of dividend declaration.

In turn target company needs to submit every year, to eth concerned stock exchanges the information regarding share ownership, within 30 days from financial year ending march 31 for purpose of dividend declaration.

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Threshold limit for making an open offer

When an acquirer acquires shares that increase his ownership to 25% or more of shares or voting rights in a target company then he is required to make a minimum public offer of additional 26% of eth remaining shareholders of the Target Company.

When an acquirer holds more tahn25% but less than 55% of the shares or voting rights in a target company then for any additional purchase of more than 5% shares or voting rights entitled him to make an open offer of additional 26% of eth remaining shareholders of the target company.

When an acquirer holds more than 55% but less than 75% of shares or voting rights in a target company then for any additional purchase of shares he is entitled to make an open offer of additional 26% of the remaining shareholders of the target company

Logic behind 25% trigger threshold limit and 26% open offer The trigger point of 25% threshold limit followed by additional 26% open offer of the remaining shareholders of the target company is a recent amendment that corrected earlier trigger point of 15% threshold limit followed by additional 20% open offer. The takeover code has been amended by SEBI regulations 2011 and is operational since October 2011. the amendment has been made by SEBI on recommendation of the takeover advisory committee the Achuthan committee. As per the recommendations the amendment in the act pertains to three issues

The initial trigger point threshold limit is increased from 15% to 25% of the shareholding or voting rights in A target Company4.

Increase the minimum additional public offer size from 20% to 26% of the shareholding or voting rights in target company5.

Prohibit the payment of non-compete fees to the controlling promoters in the target company6.

The takeover trigger threshold limit has been increased from 15% to 25% of the shareholding or voting in a target company. It si interesting to note that the 25% trigger pint was a practice in India in the 1980s when it was subsequently reduced to 10% and later increased to 15% 7 .The committee observed that acquirer were able to get de-facto control in target company by merely acquiring 15% shares or voting rights8. This 15% became the substantial voting power. The promoters could control the company with merely 15% shares ownership and avoided more investment in equity due to open offer. Increase in the trigger point provided more investors to participate in the equity ownership of the company without triggering takeover regulations in form of open offer and disclosures. The promoters de-facto control is now defined by 25% and not 15% which was considered quite low. Open offer

                                                            

4 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘New Regulations’),  Regulation 3(1). 5 New Regulations, Regulation 8(7) 6 New Regulations, Regulation 7(1) 7 Reena Zachariah, SEBI’s Proposed Changes In Takeover Rules To Alter India’s M&A Scene,  August 10, 2011, available at http://articles.economictimes.indiatimes.com/2011‐08‐10/ news/29872000_1_offer‐size‐open‐offer‐acquirer  8 Takeover Code, Regulation 10 

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trigger threshold limits in other countries like UK is 30%, Singapore and south Africa and Hong Kong etc ranges between 30%-35%. Further companies act 1956 provides shareholder with control of 25% and above the veto right to block a special resolution 9 . Special resolutions are required for important strategic decisions like changes in provisions of Memorandum, share capital etc. the increase of the limit to 25% is also perceived to attract private equity investment in Indian companies. The companies will also find it easier to raise funds to finance takeover without triggering open offer10. Raising of minimum public offer from 20% to 26% has attracted much debate. The committee had recommended public offer of 100% which SEBI rejected and arrived at 26% figure based on certain reasons forwarded by it. The committee had recommended that 20% offer which prevailed earlier was skewed towards the promoters. It was a low number given that open offer provided an exit option to the retail public investors at large. It was argued that all promoters got the exit option by selling directly to the acquirer while public investors got the option to the tune of 20% only. The committee was of the view that if a shareholder wanted an exit option post change in ownership of the company, he should be provided the same. The option should be available to all investors and not to select few11. However Sebi rejected the 100% offer based on the fact that in India acquisition financing is not permitted by Indian banks. It is a actually prohibited. The RBI circular 1983, states that as equity capital is ownership fund that needs to be arranged by the shareholder himself cannot be financed by a bank on behalf of the shareholder. The shareholder has to arrange the equity capital from his own resources and personal funds. Banks cannot lend shareholders money to be invested in equity. It is because of this reason that the acquirers that acquire public listed company generally procure funds from

Cash surplus generated by the acquiring firm Loans from private players like investment banks, hedge funds, high net worth

individuals etc. Money raised through equity issue.

Fund raised through the above sources is not an easy task and is a cumbersome process in itself. Hence 100% open offer would require large funds and pose difficulty for the acquirer to raise the necessary funds. Proposed figure of 26% as open offer was based on reasons that 25% trigger point and 26% open offer would put the acquirer at 51% which is a controlling stake in a target company without 100% acquisition. 51% as compared to 35% (10% initial trigger followed by 20% open offer) under previous takeover code justified substantial acquisition of the controlling stake in a target company. Rather than having de-facto control in a target company with 35% stake the acquirer can be an actual owner with 51% stake in the target and without investing additional funds. Anon-compete fee was earlier required to be paid by the acquirers to the promoter(s) of the target company so that they do not re-enter into the same business and become competitor of                                                             

9 The Financial Express, New Takeover Guidelines Hike Open Offer Trigger To 25%, September  24, 2011 available at http://www.financialexpress.com/news/New‐takeover‐guidelines‐hikeopen‐offer‐trigger‐to‐25‐/850989/  10 Business Line Bureau, SEBI’s Takeover Code Raises Open Offer Trigger To 25%, July 28, 2011,  available at http://www.thehindubusinessline.com/markets/stock‐markets/article2302790.ece  11 TRAC RepoRt, supra note 1, ¶1.6. 

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the acquirer12. Under the earlier takeover code provisions the target company promoters were permitted to take such fee over and above the offer price13. Thus there existed an equality in the treatment by the acquirer between public shareholders and the promoters. The committee has recommended that the non-compete fee should be paid to the whole target company translating into the offer price and not be paid to a select few promoters who are selling their shares. Thus there should not be any difference in the offer price paid to selling promoters and the public shareholders at large. CROSS BORDER M&A In case a foreign entity is involved then the merger or acquisition is also regulated by Foreign exchange management act 1999 (FEMA) which is governed by RBI. A foreign entity can invest in India through FDI route or FPI route. FDI is foreign direct investment in equity of the Indian company. It is long term investment, FPI or Foreign Portfolio Investment is short term investment in securities listed in Indian Stock Exchange (see figure 3).                                                             

12 K. Venkatasubramanian, Non‐Compete Fees, August 22, 2012, available at   http://www.thehindubusinessline.in/iw/2010/08/22/stories/2010082251021200.htm 13 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (‘Takeover Code’),  Regulation 20(8) 

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Foreign Investment

Foreign Venture 

Capital Investment 

Foreign Direct 

Investment 

Foreign Portfolio 

Investment

Automatic Route FIIs  SEBI 

Regd.  Government Route

Figure 3: Modes of Foreign investment in india

NRIs    

PIOsRestricted route

Further FDI can be done by a foreign entity in the form of wholly owned subsidiary formed in India under companies act 1956 or as a joint venture firm. Foreign company can also set up a liaison office, project office or branch office in India to carry out certain activities permitted under FEMA regulations 2000 (see figure 4). Foreign Entity / Investment

Invests in India (FDI) Figure 4: modes of FDI entry by foreign entity

FOREIGN DIRCET INVESTMENT (FDI) Foreign Direct Investment is governed by RBI’s

(i) FEMA guideline Foreign Exchange Management Act 99. (ii) FDI regulations.

Indian Company Wholly owned subsidiary  

Joint venture 

Liaison office

Branch office

Project office

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Apart from RBI, FDI policy is also governed by Department of Industrial Policy and Promotion (DIPP) directives which are issued by the secretariat for industrial assistance (SIA) in Ministry of Commerce and Industry. The foreign investment schemes are implemented by the Foreign Investment Promotion Board FIPB which is a unit of Ministry of Finance and RBI (see figure 5). Figure 5: Role of RBI in cross border investment The Indian government through policy change initiated in 1990s has been able to garner foreign investments in India particularly foreign direct investment that has helped augment growth across all sectors. The regulatory system has supported the inflows in long term investment that ahs grown parallel with the economic growth of the country. The FDI has grown sharply post 2005 and peaked during 2008-10 (see figure 6).

figure6: trend in FDI The foreign direct investment FDI has been subject to sectoral limits as propounded by the Indian government policy and planning. The sectoral restrictions on investments are based on the rationale that the certain sectors may be propriety sectors requiring fund support in form of FDI. However certain other sectors are on the priority of state support and protection and opening of these sectors to the foreign players may risk the domestic players, hamper the in house competition and may put India incorporate on high risk. Hence sectoral limits are

Ministry of 

Commerce 

and Industry

RBI  Ministry of 

Finance 

DIPP 

FIPB 

FDI RegulationFEMA 

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ascertained by the Indian government based on fine explanation for restricted permission as well as prohibition. The trend in the pattern of FDI inflows in equity in Indian companies has reflected high confidence in service sector followed by computers, telecommunications and real estate etc(see table 2). Table 2:

FDI allowed by the Indian government in India by foreign companies and entities falls under three categories:

1. Automatic route of investment 2. Restricted investment 3. Prohibited investment

Let us discuss each one by one. Automatic Investment Permitted investment is also known as Automatic route of investment. It may be 100% investment or subject to sectoral limits put by the government. Under automatic route the foreign entity does not require any prior approval either from the government or the reserve bank of India. However it has to comply with the RBI’s Pricing guidelines. RBI’s Pricing

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guidelines state that the price of the shares transferred by an Indian resident to foreign resident should be at least equal to market price of the share in case of a listed company. In case of a private company the transfer price of shares should not be less than the fair value of the share as determined by a chartered accountant according to prescribed guidelines. Restricted Investment Those investment that are not prohibited and also do not fall under the automatic route are categorized as restricted investments. These may be either 100% ownership or subject to sectoral cap on FDI as proposed by the government. Defense equipment, electronic aerospace equipments, print media, broadcasting and courier service tobacco substitutes, manufacture of cigars, cigarettes of tobacco and tobacco substitutes, items reserved for small scale industries are restricted and require formal prior approval of the FIPB. The foreign entity is required to submit FIPB an application and information regarding identity of investors, partners, nature of business, financial health of investors and the business. FIPB approves the proposals on a case by case basis and the process takes roughly 10-12 weeks. Priority is given to those investment proposals that cater to the government’s requirement and industry need. In case of sectoral FDI cap the calculation of total investment of foreign investor includes both direct and indirect investment. Direct investment relates to direct holding by a foreign entity into an Indian company. Indirect investment is when foreign entity has a holding in Indian company which makes the investment. Prohibited Sectors The Indian government prohibits non-Indian i.e. foreign entity to invest in certain sectors.

1. Atomic energy and Railway Transport (other than Mass Rapid Transport Systems). 2. Lottery Business including Government /private lottery, online lotteries, etc 3. Gambling and Betting 4. agriculture ( excluding floriculture, horticulture, development of seeds, animal

husbandry, pisciculture and cultivation of vegetables, mushrooms etc under controlled conditions and services related to agro and allied sectors) and plantation activities (other than tea plantation).

5. housing and real estate business except development of townships, construction of residential and commercial premises, roads, bridges to the extent specified in notification no FEMA 136/2005-rb July 19, 2005.

6. trading in transferable development rights (TDRs) 7. retail trading (except single brand product retail trading) 8. business of chit fund 9. nidhi company 10. Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco

substitutes Instruments of FDI

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The foreign investment in the Indian company can be in the form of foreign institutional investor FII or Non Resident Indian (NRI) and investments through depository receipts and foreign currency convertible bonds and debentures. If the investing company and target company is owned and controlled by Indian companies and citizens then foreign investment in the inverting Indian company is not considered indirect foreign investment. For calculation of total holding in case of restricted investment, both direct and indirect holding of foreign entity is considered. Foreign Entity that invests in equity shares and fully convertible preference shares and fully convertible debentures with the pricing being decided upfront falls in the ambit of FDI. As per FDi policy the price of the equity shares or convertible preference shares or debentures is determined and stated upfront at the time of the issue and not post the issue. As per FEMA guidelines the valuation of shares is done by DCF method of valuation for unlisted companies and valuation as per SEBI (ICDR) regulations for listed companies. Any investment other than equity share or that may or may not give an option to the investor to convert its instrument into equity and which does not involve upfront pricing of the instrument is not termed as FDI. Rather it is termed as ECB (external commercial borrowing) and has to comply with the ECB guidelines. Taxes levied on foreign entity investment

1. Capital gain tax 2. Dividend tax 3. Stamp duty 4. Value added tax (VAT)- purchase of movable assets in asset purchase transaction 5. Security transaction tax (STT).

Foreign portfolio investment (FPI) Foreign Portfolio Investment is done by foreign institutional investors-FIIs. This is regulated by SEBI (FII) Regulations and FEMA guidelines. All FIIs need to register under SEBI (FII) regulations 1995 and Regulations 5(2) of FEMA notification no 20 dated may3, 2000 as amended from time to time14. All FIIs registered with SEBI get a blanket approval from RBI to invest in India under portfolio investment scheme. FIIs include-

1. Asset Management Companies (AMC) 2. Pension Funds 3. Mutual Funds 4. Investment Trusts 5. University Funds 6. Endowment Funds 7. Charitable trusts and societies.

The FII investment has grown post liberalization policy adopted the Indian government. Post 2003 after the Global IT buble bust the FII investment has sharply risen in indain capital market. The Indian capital market has shown parallel growth along with FIIs’ investment

                                                            

14 http://www.rbi.org.in/scripts/FAQView.aspx?Id=26 retrieved on October 26th 2012. 

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growth. During the financial global crisis of 2007-08 the FIIs pulled out invested funds as can be seen in table 3, followed by surge in their investment post 2009 onwards.

Table 3 : FII Investment Details (All values in INR crores)

Financial Year Equity Debt Total 1992-93 - - 13.4 1993-94 - - 5,126.5 1994-95 - - 4,796.3 1995-96 - - 6,942.0 1996-97 - - 8,574.5 1997-98 5,267.0 691.1 5,957.2 1998-99 -717.2 -867.0 -1,584.0 1999-00 9,669.5 452.6 10,122.1 2000-01 10,206.7 -273.3 9,933.4 2001-02 8,072.2 690.4 8,762.6 2002-03 2,527.2 162.1 2,689.3 2003-04 39,959.7 5,805.0 45,764.7 2004-05 44,122.7 1,758.6 45,881.3 2005-06 48,800.5 -7,333.8 41,466.7 2006-07 25,235.7 5,604.7 30,840.4 2007-08 53,403.8 12,775.3 66,179.1 2008-09 -47,706.2 1,895.2 -45,811.0 2009-10 110,220.6 32,437.7 142,658.3 2010-11 110,120.8 36,317.3 146,438.1

2011-12 (till Aug 31, 2011) 2,367.6 8,186.2 10,553.8 Source : : http://www.sebi.gov.in/Index.jsp?contentDisp=Department&dep_id=3

Investment made by individual FIIs cannot exceed 10% of paid up capital of a firm. Investment by a sub account of FII cannot exceed 5% of paid up capital holding in and company by all FIIs and sub accounts of FIIs cannot exceed 24% of paid up capital. General permission of sale and purchase of shares and debentures of listed companies on stock exchange are notified by portfolio investment scheme. Non resident Indians and person of Indian origin are also allowed to invest in shares and fully convertible debentures of Indian company on stock exchange under PIS through a designated bank branch that deals in portfolio investment. As far as government securities are concerned only NRIs and SEBI registered FIIs are permitted to purchase government securities. Foreign venture capital investments All foreign venture capital investor need to register themselves with SEBI as per SEBI regulations and sector specific caps of FDI. The registered foreign venture capital institutions can invest through equity, equity linked and debt instruments through an initial public offer or private placement. The price of the instrument is determined mutually by both the parties. They can also invest in securities on recognized stock exchange. The Reserve bank of India

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in 2012 through circular no 93 has allowed FIIs registered with SEBI to invest in eligible securities through private arrangement or purchase from third party15. This has enhanced the investment flexibility available to the foreign venture capital institutional investors. The service sector, information technology sector along with telecommunication sector have shown graet interest from FIIs side and have garnered maximum investments (see table 4). Table 4: FVCI status as on june 2011 Particulars as on June 30, 2011 (Rs. In crore)

Sectors of Economy VCF FVCI Total*

Information technology 554 3475 3961

Telecommunications 1092 7234 7878

Pharmaceuticals 464 971 1316

Biotechnology 167 141 272

Media / Entertainment 924 718 1119

Services Sector 1334 2191 2837

Industrial Products 1030 1202 1919

Real Estate 9131 2962 10784

Others 11526 18204 24759

Total 26222 37098 54844

* excludes Rs.8476 crore of FVCI investments through VCFs Source : http://www.sebi.gov.in/Index.jsp?contentDisp=Department&dep_id=3 Note: 1. The above report is compiled on the basis of quarterly information submitted to SEBI by registered Venture Capital Funds and Foreign Venture Capital Investors.

Branch office/project office / liaison office in India Foreign companies and entities desirous of ding business in India through opening liaison office/ branch office/ project office in India, need to submit an application in form FNC along with required documents to foreign investment division of foreign exchange department of RBI, through authorized dealer bank. If the business operations of the foreign entity fall in the category where 100% FDI is permitted under automatic route, RBI gives an approval by itself. Wherein the business activities of the foreign entity fall under category where 100% FDI is not permitted under automatic route then the approval is sanctioned by RBI in consultation with the ministry of finance. The offices are permitted to be set up initially for a period of three years and later get extended only after an approval is given by the authorized dealer of the concerned jurisdiction. The offices are required to file annual activity certificate along with balance sheet and profits attempt, generated by the auditors. The offices are permitted to carry out only specified activities and operations in India and further need to endorse it to the authorized dealer periodically. The financial consideration required for opening these offices in India has been categorized for each. Branch office set up is sanctioned only when the foreign entity or company has a

                                                            

15 http://www.rbi.org.in/scripts/FAQView.aspx?Id=26 retrieved on October 26th 2012. 

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consistent profitability record for preceding 5 years. Secondly the parent foreign company should have a net worth of not less than USD 100,000 or its equivalent16. Branch office is allowed to pursue activities and business operations of their parent foreign company in India. General activities include trade activities of import and export of goods and services, consultancy and professional advisory services, research and analytical work related to parent company’s operations, buying and selling on behalf of parent company etc. the branch office cannot pursue manufacturing activities, retail; trading either directly or indirectly. The net profits after tax earned by branch office is allowed for remittance outside India subject to certification and submission of the audited financial results by chartered accountant. For liaison office the requirement is that a Liaison office set up is sanctioned when the foreign entity or company has a consistent profitability record for preceding 3 years. Secondly the parent foreign company should have a net worth of not less than USD 50,000 or its equivalent17. Liaison office is allowed to carry out only liaison activities. These include activities that allow communication between head office in foreign country and the business entities in India. It cannot carry out any business operations in India and thus is not permitted to earn any income in India. The expenses of liaison office are met by the parent foreign company through inward remittance of money in form of foreign currency. Liaison office can participate in activities related to representing parent company in India fro business transactions and deals, engaging and facilitating export and import activities, facilitating business communication between parent company and its Indian alliances. A project office is set up to execute activities of parent foreign company for a specific project undertaken. The parent company should have secured a contract from an Indian company to execute a project in India. The requirement for the project office are that funding capital should be remitted by foreign parent company and that the project has sought a formal approval by the competent authority. The Indian counterpart that gave the project to the foreign entity or company should have been granted term loan by either bank in India or public financial institution. KEY TERMS Amalgamation Absorption Consolidation Takeover Merger Acquisition foreign institutional investor-FII

Foreign venture capital investments-VCFI

Automatic Investment

Restricted Investment Prohibited Sectors Foreign portfolio investment (FPI)Instruments of FDI Cross Border M&A Foreign Direct Investment (Fdi) Branch office project office liaison office Security Exchange Board Of India-SEBI

Reserve bank of India Department of industry policy & promotion-DIPP

FIPB Ministry of commerce- MOC Ministry of finance-MOF PROJECT ASSIGNMENT

                                                            

16 ibid. 17 ibid. 

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SELect two major industry sectors in India, say telecommunication and pharmaceutical sectors. Identify the major high profile publicly announced mergers anda cqusition in the sectors in the alst five years. Write the legal issues involved in the M&A bid? Whether the comapnise concerned vercome the legal hindrance

Annexure I: COMPANIES ACT 1956: CHAPTERV SECTION 390-394

MERGER PROVISIONS 390 Interpretation of sections 391 and 393. In sections 391 and 393,- (a). the expression" company" means any company liable to be wound up under this Act; (b). the expression" arrangement includes a reorganization of the share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or, by both those methods; and (c). unsecured creditors who may have filed suits, or obtained decrees shall he deemed to be of the same class as other unsecured creditors. 391. Power to compromise or make arrangements with creditors and members. (1). Where a compromise or arrangement is proposed- (a). between a company and its creditors or any class of them; or (b). between a company and its members or any class of them; the Court may, on the application of the company or of any creditor or member of the company, or, in the case of a company, which is being wound up, of the liquidator, order a meeting of the creditors or class of creditors, or of the members or class of members, as the case may be, to be called, held and conducted in such manner as the Court directs. (2). If a majority in number representing three- fourths in value of the creditors, or class of creditors, or members, or class of members as the case may be, present and voting either in person or, where proxies are allowed 1[ under the rules made under section 643], by proxy, at the meeting, agree to any compromise or arrangement, the compromise or arrangement shall, if sanctioned by the Court, be bind- ing on all the creditors, all the creditors of the class, all the members, or all the members of the class, as the case may be, and also on the company, or, in the case of a company which is being wound up, on the liquidator and contributories of the company: Provided that no order sanctioning any compromise or arrange- ment shall be made by the Court unless the Court is satisfied that the company or any other person by whom an application has been made under sub- section (1) has disclosed to the Court, by affidavit or otherwise, all material facts

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relating to the company, such as the latest financial position of the company, the latest auditor' s report on the accounts of the company, the pendency of any investigation proceedings in relation to the company under sections 235 to 251, and the like. (3). An order made by the Court under sub- section (2) shall have no effect until a certified copy of the order has been filed with the Registrar. (4). A copy of every such order shall be annexed to every copy of the memorandum of the company issued after the certified copy of the order has been filed as aforesaid, or in the case of a company not having a memorandum, to every copy so issued of the instrument constituting or defining the constitution of the company. (5). If default is made in complying with sub- section (4), the company, and every officer of the company who is in default, shall be punishable with fine which may extend to ten rupees for each copy in respect of which default is made. (6). The Court may, at any time after an application has been made to it under this section, stay the commencement or continuation of any suit or proceeding against the company on such terms as the Court thinks fit, until the application is finally disposed of. 392. Power of High Court to enforce compromises and arrangements. (1). Where a High Court makes an order under section 391 sanctioning a compromise or an arrangement in respect of a company, it— (a). shall have power to supervise the carrying out of the compromise or arrangement; and (b). may, at the time of making such order or at any time thereafter, give such directions in regard to any matter or make such modifications in the compromise or arrangement as it may consider necessary for the proper working of the compromise or arrangement. (2). If the Court aforesaid is satisfied that a compromise or arrangement sanctioned under section 391 cannot be worked satisfactorily with or without modifications, it may, either on its own motion or on the application of any person interested in the affairs of the company, make an order winding up the company, and such an order shall be deemed to be an order made under section 433 of this Act. (3). The provisions of this section shall, so far as may be, also apply to a company in respect of which an order has been made before the commencement of this Act sanctioning a compromise or an arrangement. 393. Information as to compromises or arrangements with creditors and members. (1) Where a meeting of creditors or any class of creditors, or of members or any class of members, is called under section 391,- (a) with every notice calling the meeting which is sent to a creditor or member, there shall be sent also a statement setting forth the terms of the compromise or arrangement and explaining its effect; and in particular, stating any material interests of the directors, managing director, managing agent, secretaries and treasurers or manager of the company, whether in their capacity as such or as members or creditors of the company or otherwise, and the effect on those interests, of the compromise or arrangement, if, and in so far as, it is different from the effect on the like interests of other persons; and (b) in every notice calling the meeting which is given by advertisement, there shall be included either such a statement as aforesaid or a notification of the place at which and the manner in which creditors or members entitled to attend the meeting may obtain copies of such a statement as aforesaid. (2) Where the compromise or arrangement affects the rights of debenture holders of the company, the said statement shall give the like information and explanation as respects the trustees of any deed for securing the issue of the debentures as it is required to give as respects the company' s directors. (3) Where a notice given by advertisement includes a notification that copies of a statement setting forth the terms of the compromise or arrangement proposed and explaining its effect can be obtained by creditors or members entitled to attend the meeting, every creditor or member so entitled shall, on making an application in the manner indicated by the notice, be furnished by the company, free of charge, with a copy of the statement. (4) Where default is made in complying with any of the requirements of this section, the company, and every officer of the company who is in default, shall be punishable with fine which may extend to five thousand rupees; and for the purpose of this sub- section any liquidator of the company and any

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trustee of a deed for securing the issue of debentures of the company shall be deemed to be an officer of the company: Provided that a person shall not be punishable under this sub- section if he shows that the default was due to the refusal of any other person, being a director, managing director, managing agent, secretaries and treasurers, manager or trustee for debenture holders, to supply the necessary particulars as to his material interests. (5) Every director, managing director, managing agent, secretaries and treasurers or manager of the company, and every trustee for debenture holders of the company, shall give notice to the company of such matters relating to himself as may be necessary for the purposes of this section; and if he falls to do so, he shall be punishable with fine which may extend to five hundred rupees. 394. Provisions for facilitating reconstruction and amalgamation of companies. (1) Where an application is made to the Court under section 391 for the sanctioning of a compromise or arrangement proposed between a company and any such persons as are mentioned in that section, and it is shown to the Court- (a). that the compromise or arrangement has been proposed for the purposes of, or in connection with, a scheme for the reconstruction of any company or companies, or the amalgamation of any two or more companies; and (b). that under the scheme the whole or any part of the undertaking, property or liabilities of any company concerned in the scheme (in this section referred to as a" transferor company") is to be transferred to another company (in this section referred to as". the transferee company"); the Court may, either by the order sanctioning the compromise or arrangement or by a subsequent order, make provision for all or any of the following matters:- (i) the transfer to the transferee company of the whole or any part of the undertaking, property or liabilities of any transferor company; (ii) the allotment or appropriation by the transferee company of any shares, debentures, policies, or other like interests in that company which, under the compromise or arrangement, are to be allotted or appropriated by that company to or for any person; (iii) the continuation by or against the transferee company of any legal proceedings pending by or against any transferor company; (iv) the dissolution, without winding up, of any transferor company; (v) the provision to be made for any persons who, within such time and in such manner as the Court directs, dissent from the compromise or arrangement; and (vi) such incidental, consequential and supplemental matters as are necessary to secure that the reconstruction or amalgamation shall be fully and effectively carried out: Provided that no compromise or arrangement proposed for the purposes of, or in connection with, a scheme for the amalgamation of a company, which is being wound up, with any other company or companies, shall be sanctioned by the Court unless the Court has received a report from the Company Law Board, or the Registrar that the affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest: Provided further that no order for the dissolution of any transferor company under clause (iv). shall be made by the Court unless the Official Liquidator has, on scrutiny of the books and papers of the company, made a report to the Court that the affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest. (2) Where an order under this section provides for the transfer of any property or liabilities, then, by virtue of the order, that property shall be transferred to and vest in, and those liabilities shall be transferred to and become the liabilities of, the transferee company; and in the case of any property, if the order so directs, freed from any charge which is, by virtue of the compromise or arrangement, to cease to have effect. (3) Within thirty days after the making of an order under this section every company in relation to which the order is made shall cause a certified copy thereof to be filed with the Registrar for registration. If default is made in complying with this sub- section, the com- pany, and every officer of the company who is in default, shall be punishable with fine which may extend to five hundred rupees. (4) In this section-

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(a) " property" includes property, rights and powers of every description and" liabilities" includes duties of every description; and (b) " transferee company" does not include any company other than a company within the meaning of this Act; but" transferor company" includes any body corporate, whether a company within the meaning of this Act or not.

ANNEXXURE II

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