What goes on behind the scenes of a multimillion-dollar deal and how do you ensure there are no hidden legal landmines?
Raghavendra Verma talks to the lawyers behind Essar’s acquisition of Trinity Coal to find out
The US$600 million purchase of West Virginia-based Trinity Coal Corporation by the Essar Group is yet another example of the growing global ambitions of Indian businesses. More so, as Essar intends to use half the coal from its new acquisition to fuel its steel plant in Canada. Given the recent failures of Indian energy companies to acquire assets abroad, this deal is being seen as a major coup.
Gokul Chaudhri, partner and leader of the energy and infrastructure practice at BMR Advisors in New Delhi, told India Business Law Journal, “We are seeing a shift in the type of companies that are going out [to acquire overseas assets]”. These companies are now “learning the game and learning how to win”, he adds.
Explaining why past attempts by government companies to buy assets overseas failed, Chaudhri says, “one reason was the influence of Chinese companies who were looking at the same transactions and were far more aggressive, nimble and savvy than the Indian public sector enterprises”.
During the five years under Denham’s control, Trinity’s annual productive capacity shot through the roof from 1.7 million tonnes to 9 million tonnes. Trinity, a major US coal producer, operates six mining complexes in the Central Appalachian coal basin and has an estimated 200 million tonnes of coal reserves. It employs 650 people and sells both steam and metallurgical coal to electric utilities, steel manufacturers and coal brokers in the eastern US.
The specialized nature of the business meant Essar’s lawyers had to tread carefully as they worked towards acquiring the company. “Mining is a heavily regulated business,” says Mukesh Bhavnani, legal head of the Essar Group in Mumbai.
In addition, Essar had to consider compliance with the US Foreign Corrupt Practices Act (FCPA). Bhavnani describes the FCPA as an extremely rigorous law, which all global businesses should be aware of. “This legislation has existed for several years, but in the recent past the US courts and public authorities have been taking a very strong view of its non-compliances,” he says.
The FCPA was enacted in 1977 to stop US residents and entities paying bribes to foreign government officials. However following a 1998 amendment, the law also covers bribes paid to foreign companies. “To ensure FCPA compliance, we tried to make sure that there were no show-cause notice or proceedings initiated against the company or anything else in the public domain that indicated its non-compliance,” explains Bhavnani.
As part of the final agreement, Essar took representations in warranties from Trinity’s management. This empowers Essar to enforce its right of indemnification against the management in case any non-compliance is noticed at a later date.
According to Chaudhri, most Indian companies know that sooner or later the FCPA will come into play and they need to be compliant. This could become an issue “when they acquire assets and build businesses in the US and try to raise money from capital markets there, or even when they partner with American companies”, he says.
No surprises in court
Essar also tried to ascertain if Trinity had any proceedings against it that could become hard to deal with in future. “Sometimes we do run into situations where we need to sit back and think, ‘Do we have a solution?’,” says Bhavnani. “For those that don’t have easy solutions, we determine the risk quantum and then start negotiating the price downward.”
Bhavnani told India Business Law Journal that on some other deals the risks were found to have been far too large, with a possibility of regulatory non-compliances or liabilities that could not be foreseen in monetary terms. “In such a situation,” he says, “you just step away from the transaction.”
A comprehensive due diligence list prepared by Essar’s legal team was shared with the counter party to provide access to documents. “After going through the documents we often recognize that the only way to deal with these transactions is to work on local statutory, regulatory and employment issues, such as what was the mining law that applied to this business, or what are the licensing constraints in Kentucky, or if there is any litigation that might come to the fore,” says Bhavnani. He believes it is best to hire local lawyers to undertake this kind of due diligence work.
For the rest of the documentation that relates to commercial arrangements and long-term commitments, Essar tried to use in-house resources. “This practice also helps in motivating my [younger] team members who are also learning by looking at the documents related to this huge transaction”, says Bhavnani.
The final countdown
Once the reports from lawyers and the internal team were reviewed, it was the time to negotiate the sale purchase agreement (SPA). According to Bhavnani, this is a fairly standard document with similar terms and conditions applying in most transactions. “We of course have to modify it to suit our situation in the context of our commercial negotiation and the due diligence process, after which it is circulated to the other party,” he says.
Between the signing of the SPA and the actual culmination of a deal, there is a period during which the agreed asset value could diminish. When Essar acquired Trinity, the two parties agreed that if the technical due diligence resulted in any kind of constraint that restricted Essar from researching or exploiting the entire mine, then the deal value would be lowered. However, such a situation did not arise.
As in various other overseas acquisitions, Essar acquired Trinity through a special purpose vehicle (SPV) – a holding company called “Essar Minerals, Delaware”. “SPVs are set up for tax reasons and to make the structure easy”, explains Bhavnani. “After all, you do not want to weigh down the operating business with tax and structuring issues of another business.” In addition, he said, having a SPV made future listing at the stock exchange or engaging a joint venture partner easier.
Finding a local expert
To see the deal through, Bhavnani had the support of four in-house counsel. Essar also hired a Kentucky-based law firm, Frost Brown & Todd, which was referred to them by an international firm with which they have regular dealings. “Since we do transactions in multiple jurisdictions, we build a database of some of the key law firms around the world, and also develop relationships,” Bhavnani says.
“We found [Frost Brown and Todd] to be extremely competent. Their fee rates were sensible, they had the experience for the size of the deal we were looking for and their experience in the mining trade was remarkable,” says Bhavnani.
Bhavnani’s advice for those looking to hire a law firm is to look beyond the big names and to carefully assess a firm’s area of specialization. “For a mining transaction, I will not go to a firm which is a specialist in financing matters or M&A,” he says. “In this business, unless you have a sense of the local regulations you can’t get a law firm to provide value.” According to Bhavnani, specialists provide advice on the relevant local laws, mining licensing regulations, possible limitations in terms of exploiting the mines, and ways of limiting risks.
The process of hiring Frost Brown & Todd included a phone conversation to assess their familiarity and experience, the details of their previous transactions, and a trip to Kentucky by a member of Essar’s in-house team. “We set out a scope of work that very exhaustively details the experience that they claim and then get them to work on it,” says Bhavnani.
While not disclosing the fee paid to Frost Brown & Todd, Bhavnani says that the charges of a firm in Kentucky were certainly less than the “phenomenal amount” charged by New York-based firms. According to him, the current hourly rate of a partner at a New York law firm ranges from US$400 to US$700.
However, Bhavnani notes that in addition to the hourly rate, he agrees on a capped maximum amount that would be paid. “Broadly we all know how much time a particular transaction would require,” he says. “For instance, if I expect to [spend] US$300,000 on the law firm, then I do a cap at that amount and say, ‘if you spend less time than expected then I will pay you less as per the hourly rate’.”
A senior partner of a well known New Delhi-based law firm – unconnected to this deal – told India Business Law Journal that this is a common practice in India and “to remain in business we all have to accept such terms and conditions”.
The finish line
After three and a half months of negotiations, deliberations and document processing, the deal was finally announced on 5 March, subject to the relevant approvals.
Putting the Trinity deal in the bag has not meant any lull in activity for Essar’s legal team. Within weeks of the announcement, the group signed an agreement to buy Aries coal mines in Indonesia for an undisclosed amount. Aries has a resource base of 100 million tonnes of thermal coal and mineable reserves of 64 million tonnes.
In a statement issued after the deal was announced, Prashant Ruia, Essar Group’s chief executive said, “the demand for minerals in India is high and only growing and there aren’t sufficient resources in India to meet that.”
He added that the company “will continue to look at acquisitions and further consolidation in this mineral space”.