This article aims to highlight the key legal considerations and gating requirements to be assessed by global investors undertaking big-ticket mergers and acquisitions (M&A) deals arising out of the acquisition of a majority shareholding or control of an entity not incorporated in India that has a direct or indirect subsidiary in India (“India Co”), leading to an indirect change of control of such India Co (“Indirect Acquisition”).
Approvals Under Foreign Exchange Regulations
The extant foreign exchange regulations in India provide, inter alia, the permissible entry routes (i.e., approval route, where approval from the government of India (“GOI”) is required, including in certain sensitive sectors such as pharmaceuticals, defense, etc.; and automatic route, where no such prior approval is required); sectoral caps; and other conditionalities that are applicable to investments by nonresidents. If the India Co operates in a sector falling under the approval route or a sector that prescribes any sectoral caps or conditionalities, the respective approval requirement or sectoral caps or conditionalities would be triggered in the case of Indirect Acquisitions as well.
On April 17, 2020, the GOI issued Press Note 3 of 2020 (“PN-3”), which provides that prior GOI approval needs to be obtained in cases where the beneficial owner of any investment in India (direct or indirect) is situated in or is a citizen of any country that shares land borders with India. While PN-3 does not prescribe any thresholds for determination of beneficial ownership, the prevalent market view is that if beneficial ownership of investments, whether direct or indirect, from land-bordering countries is less than 10 percent of the share capital of the acquirer, then no approval would be required under PN-3. The process for seeking approval under PN-3 can typically take up to fourteen weeks, and the approvals can take between nine and twelve months, based on the sector in which the India Co operates.
Obligations Under (Indian) Companies Act, 2013
Reconstitution of Board of Directors
The (Indian) Companies Act, 2013 read with rules framed thereunder, as amended from time to time (“Companies Act”), prescribes the minimum number of directors for a private company (two directors) and a public company (three directors). An Indirect Acquisition typically necessitates a reconstitution of the board of directors, wherein nominees of the acquirer are appointed as directors of the India Co. Furthermore, the Companies Act also prescribes that at least one director on the board of directors must be an Indian resident (someone who must have resided in India for a minimum of 182 days during the past financial year). Lastly, if any director is a citizen of any country that shares land borders with India, prior GOI approval would be required for their appointment. Under the Companies Act, a person has to obtain certain registrations to be eligible for appointment as a director, which can take up to two weeks from the date of submission of requisite documents, among other requirements.
Change in Nominee Shareholders
Under the Companies Act, a private company is required to have a minimum of two shareholders, and a public company is required to have a minimum of seven shareholders. Typically, in the case of an Indirect Acquisition, to meet the minimum shareholders requirement, group entities or individuals from the acquirer group hold at least one share of the India Co as nominee(s) and legal owner(s), with the acquirer holding beneficial ownership over such shares held by the nominee(s). The Companies Act also requires certain filings to be undertaken by the India Co to announce the change in nominee shareholders.
Change in Significant Beneficial Ownership
Under the Companies Act, an individual who holds a beneficial interest is required to make a declaration in connection with such beneficial interest. Individuals with a beneficial interest include those (a) who hold indirectly, or together with any direct holdings, not less than 10 percent of shares or voting rights in an Indian company; (b) who have the right to receive or participate in not less than 10 percent of the distributable dividend or any other distribution in a financial year through indirect holdings alone, or together with any direct holdings; or (c) who have the right to, or actually exercise, significant influence or control in any manner other than through direct holdings alone.
The Companies Act further clarifies that if the holding company of the India Co is a body corporate, the individual holding more than 50 percent of the share capital of the holding company will be the significant beneficial owner (“SBO”). However, if the holding company of India Co is a pooled investment fund (“PIF”) or an entity controlled by a PIF, the SBO could be either the general partner of the PIF or the investment manager of the PIF.
Since an Indirect Acquisition may trigger a change in the significant beneficial ownership of the India Co, the acquirer should take steps to identify such changes and, if applicable, cause the new SBO to make the necessary declarations. The India Co will also be required to maintain and update registers and make filings owing to the change in the SBO.
Obligations Under Charter Documents
All charter documents and material agreements affecting the structure and governance of the India Co should be reviewed to assess if any consent is required for undertaking the Indirect Acquisition or if the Indirect Acquisition triggers the exercise of any specific rights available to shareholders under such documents.
Dematerialization of Securities
Pursuant to a recent amendment to the Companies Act, all private companies (except small companies and government companies) in India (hereinafter “Covered Companies”) are now required to facilitate the dematerialization of their existing securities, and all fresh issuances are to be in dematerialized form. Earlier, this requirement only extended to public companies. This may have implications for Indirect Acquisitions if they involve either a pre-closing restructuring involving transfer of securities of a Covered Company or a change of the nominee shareholder, given that a security holder will be impeded from transferring the securities of a Covered Company that have not been dematerialized. Similarly, the person or entity that will become a security holder in the Covered Company will need to have a demat account in India. These requirements may have an impact on the timing of deal closing of such Indirect Acquisition.
Approval/Notification Under Antitrust Laws
The Competition Act, 2002 (“Competition Act”) sets out the thresholds for approval requirements for global M&A deals. The Competition Act exempts acquisitions, mergers, and amalgamations from the requirement of seeking approval from the Competition Commission of India (“CCI”) where the value of the assets of the target entity in India is less than INR 4.5 billion (approximately USD 53.80 million) or the turnover is less than INR 12.5 billion (approximately USD 149 million) (“De Minimis Exemption”). In the event that the De Minimis Exemption is not available to the parties, approval is required from the CCI based on the prescribed jurisdictional thresholds.
Recently, an additional threshold was introduced based on the global deal value (effective date September 10, 2024). An approval requirement is triggered when the global deal value exceeds INR 20 billion (approximately USD 242 million) and the target enterprise has substantial business operations in India (“Deal Value Threshold”). The parties/groups involved will no longer be able to avail themselves of the De Minimis Exemption if the Deal Value Threshold is breached. Accordingly, the parties will need to assess whether the Indirect Acquisition will exceed any of the thresholds above, triggering an approval/notification requirement from the CCI.
Tax Implications
Under the Indian income tax law (“IT Act”), an Indirect Acquisition may result in taxability of capital gains in the hands of the seller and corresponding liability of the acquirer for withholding taxes (subject to the provisions of any applicable double-taxation avoidance agreements). Indian tax laws deem the shares or interest of a nonresident entity to be capital assets situated in India if the shares of the nonresident target entity derive substantial value from assets located in India. Shares of a nonresident entity are considered to substantially derive their value from assets located in India if the value of such assets (a) exceeds INR 100 million (approximately USD 1.2 million) and (b) represents at least 50 percent of the value of all the assets owned by the acquirer.
If the capital gains are taxable in the hands of the seller, there will be a corresponding liability of the acquirer for deducting tax at source while remitting the sale consideration and for paying the same to the GOI within the prescribed timelines. For deducting tax at source, the acquirer would be required to obtain certain tax registrations. Obtaining such tax registrations can take up to four weeks from the date of application. Furthermore, if the nonresident seller does not have the requisite tax registrations in place, it could result in deduction at a higher rate. It is therefore important for the parties to examine at the outset the tax-related implications emanating from the Indirect Acquisition.
Other Points for Consideration
Sector-Specific Regulatory Approvals
Depending on the sector in which the India Co operates, the Indirect Acquisition may trigger a requirement to seek approval from the relevant regulatory body. For instance, any Indirect Acquisition involving a banking company in India would trigger the requirement to seek approval from the Reserve Bank of India (the central bank of India). It is important, therefore, for the parties to assess this requirement with respect to an Indirect Acquisition.
Treatment of Employee Stock Options
India’s foreign exchange laws allow a nonresident entity to issue employee stock options to employees of its Indian subsidiary if, inter alia, such stock options are offered globally on a uniform basis and the Indian subsidiary undertakes certain regulatory filings in connection with such issuance. Typically, the documents governing an Indirect Acquisition provide for cancellation, rollover, or swap of such global stock options. It is important for the parties to analyze the treatment of such global stock options pursuant to the Indirect Acquisition, as there could be implications under the foreign exchange laws.
Other Due Diligence Items
Other issues that emanate out of due diligence exercises, such as prior consents or notification requirements under material contracts, or lender consents getting triggered by an indirect change of control, will also have to be identified and addressed to ensure a seamless transition after the Indirect Acquisition.
Conclusion
While the issues discussed above are some of the common issues typically encountered in an Indirect Acquisition, the acquirer should undertake exhaustive legal due diligence from an Indian perspective to account for any other issue that may impact the Indirect Acquisition. Early identification of such issues is critical to ensure adherence to overall deal timelines.
