Nidhi Khadria and Arun Madhu of Phoenix Legal highlight regulatory changes that will affect the drafting of M&A contracts
In late 2009, the Indian securities market regulator tasked a group of industry experts with the job of re-examining India’s existing legislation governing takeovers of publicly listed companies (which was framed in 1997). The group, known as the Takeover Regulations Advisory Committee or TRAC, released its report in mid-July this year, proposing radical reforms to the existing framework.
The Takeover Code: version 3.0
Salient highlights of the report include a proposal to revise the trigger for a mandatory tender offer from 15% to 25%. Currently, purchasers acquiring 15% or more of a target company are expected to make a mandatory open offer of at least 20% to provide an exit option to the other shareholders. Increasing the threshold to 25% is a move which has been long sought after, given that a 15% purchase does not result in the acquisition of discernible control. Another highlight is the suggested change in the minimum offer size from 20% to 100%, which will result in purchasers (who acquire more than 25%) having to make an open offer to buy out the entire share capital of the company.
Those active in the PIPE (private investment in public equity) space are likely to welcome these changes as they pave the way for larger deals without being burdened with the arduous and expensive open offer process. The increase in the minimum offer size, however, will lead to a consequent rise in acquisition costs, leading to the likelihood that there will only be room for serious players in the public M&A game.
Pricing and conversion conundrums
Convertibles (i.e. instruments such as preference shares or debentures, which are convertible into ordinary shares) have been popular as investment instruments for the flexibility that they offer in the protection of various rights and the structuring of commercial objectives by the mere adjustment of conversion ratios.
However, changes resulting from India’s consolidated foreign direct investment (FDI) policy in April and October this year have created an air of uncertainty around the use of such instruments. Indian FDI policy now states that the “pricing of capital instruments (read ordinary shares and convertibles) should be decided/determined upfront”. The introduction of this seemingly innocuous statement has led to a flurry of questions. Do conversion ratios now need to be fixed upfront leaving no flexibility for adjustments on specific triggers? Would an agreed conversion formula be sufficient to meet policy requirements, or do actual numbers need to be tied down?
Foreign investors holding convertibles such as preference shares will still enjoy preferential rights to dividends and capital on liquidation over ordinary shareholders, however, those looking for more than that would do well to check with the regulator first.
The validity of contractual restrictions on share transfers and pre-emptive rights (such as right of first refusal, tag along right, drag along right, etc.) in Indian public companies has been largely litigated in Indian courts for close to 20 years now. Until fairly recently, there were no restrictions on the free transfer of shares of an Indian public company, regardless of whether such transfers were self-imposed and consensual. A decision of a single judge of Bombay High Court in February in the case of Western Maharashtra Development Corporation v Bajaj Auto Limited, which maintained that the right of pre-emption for shareholders of a public company created restrictions on the free transfer of shares, is the most recent in a line of several decisions underlining this view.
But since then, things have changed. Investors and joint venture partners alike heaved huge sighs of relief this September following the decision of a larger bench of the same high court in the case of Messer Holding Limited v Shyam Madanmohan Ruia & Others. The decision clarified that “The concept of free transferability of shares of a public company is not affected in any manner if the shareholder expresses his willingness to sell the shares held by him to another party with right of first purchase (pre-emption) … The shareholder has freedom to transfer his shares on terms defined by him, such as right of first refusal, provided the terms are consistent with other regulations.” The court thus upheld the principle that shareholders of a public company are free to decide the manner in which the shares they hold will be transferred and the restrictions on such transfers between shareholders.
While they rejoice, many are aware that the Supreme Court could eventually decide the validity of such restrictions and rights and could swing either way.
Finally, tax indemnities appear to be the flavour of the season in light of Bombay High Court’s recent decision in the Vodafone tax case. The court held that Indian tax authorities were justified in proceeding against the purchaser for not withholding amounts under Indian tax laws in a deal involving two foreign entities and the shares of a foreign company, on the grounds that the eventual underlying asset being transferred was Indian. With an adjudged liability of nearly US$2.6 billion, the tremors of the judgment and the Indian tax authorities’ aggression are being sensed globally by sellers who are disposing of Indian assets.
Most of them (including those located in tax havens) are now being forced to provide indemnities to purchasers for any action which may be taken by the Indian taxman by virtue of the purchaser (regardless of its location) failing to withhold amounts towards Indian tax. Important negotiation points for these indemnities include caps on the amount and duration of the indemnity, and also, in exceptional cases, whether the indemnity will be backed by an insurance policy, with purchasers often insisting on such added assurance.