Cross Border Acquisition

CROSS BORDER ACQUISITIONS

I.          Acquisition of Indian Company by Foreign Company

1.1       A popular and fast method of cross border restructuring is for an foreign company to acquire an Indian Company or an Indian Company to acquire a Foreign Company.

1.2       Let us study whether and if yes, how a Foreign  Company can acquire an Indian Company? This is a situation wherein a Foreign Company buys out the shares of an Indian Company from the shareholders of the Indian Company. Thus, ultimately if the Foreign Company is successful in acquiring the majority of the shares of  the  Indian  Company, then the Indian Company would become a Subsidiary of the Foreign Company. Examples include the acquisition of 51.5% stake in Matrix Laboratories Ltd., by Mylan Laboratories, Inc., USA. Subsequently Mylan made an open offer under the Takeover Regulations and today owns a 71% stake in the company. The relevant legal provisions in this situation are examined below.

II.        Companies Act, 1956

2.1       There is no restriction under the Companies Act on Indian shareholders selling their shares to a Foreign Company nor is there any bar on an Indian  company being held entirely by a Foreign Company.

2.2       The prior permission of the Competition Commission under the Competition Act, 2002 should be obtained in all cases where the same is applicable.

III.       FEMA, 1999 

3.1       Under the Foreign Exchange Management (Transfer or Issue of Security By a Person Resident Outside India) Regulations, 2000, a Foreign Company is permitted to purchase shares of an Indian Company from its Resident shareholders under the Automatic Route of the FIPB and the RBI. The conditions to be satisfied in this respect are as follows:

a)      The Indian Company must be a Company eligible for foreign direct investment under the Automatic  Route

b)      The SEBI Takeover Regulations must not be attracted. This effectively means that the sale must be for a stake which is equal to 14.99% or lower. In case the Acquirer (with persons acting in concert with it) already owns more than 15% but less than 55% in the Target Company, then the Takeover Code is triggered if more than 5% is acquired in any financial year.

c)      The Sectoral Caps (if any) must not be breached.

d)     Financial Services Sector Companies (e.g., Banks, Insurance Companies, NBFCs) are not covered under this Automatic Route. Hence, acquisition in this sector would continue to require prior RBI approval. However, such acquisitions do not require the prior permission of the Foreign Investment Promotion Board (‘FIPB’).

e)      The pricing in case of listed companies must be as per the RBI’s Guidelines.

f)       Form FC-TRS must be filed in quadruplicate along with relevant consent letters and other documents with the Authorised Dealer. 

3.2       Any other acquisition not satisfying the above conditions would fall under Regulation 10A(b) which states that any transfer of shares/convertible debentures by a person resident in India  to a person resident outside India requires prior FIPB / RBI Approval. 

3.3       Further, sometimes the Foreign Company may set up a wholly owned Indian subsidiary which would make the acquisitions. In such a scenario, the FIPB permission would be required for the transaction. Further, it needs to be borne in mind that the Investment company cannot leverage Indian debt to fund the acquisition. If it wants to borrow then it must do so from foreign sources.

3.4       Practical experience has shown that the RBI does not assent to transfer of shares from an Indian resident to a Foreign Company in tranches. Hence,  this is an aspect which should be borne in mind while structuring a transaction.  

3.5       In several cases, the Foreign Company desires to discharge the consideration not by way of cash, but by issuing its own shares. In such a scenario, the Indian shareholders would become shareholders of the Foreign Company. This type of structure would require the prior permission of the RBI. 

IV.       SEBI Guidelines

4.1       In case the Indian Company is a company listed in India, and if the Foreign Company acquires a stake equal to 15% or more in it, then  the Foreign Company would have to make a Public Offer of up to 20% of the shares held by the public for the acquisition of the shares under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997.  Continuing with the above example of Matrix Laboratories, Mylan had to make an open offer for 20% of the shares held by the public. The offer price must be higher of the following two prices:

            (a)        Negotiated Price between Acquirer and shareholders of Target Company

            (b)        Acquisition price paid by Acquirer in 26 weeks prior to PA

            (c)        Higher of the average of :

                        ·          weekly high/low of closing prices during 26 weeks; or

                        ·          average of daily high/low of closing prices during 2 weeks

            prior to the date of the Public Announcement. The Public Announcement is to be published in newspapers within four working of entering into Agreement or Deciding to Acquire shares in a listed company.

4.2       Sometimes the Foreign Company may acquire an Indian listed Company and it may want to delist the company.  In such a case, it would have to follow the Delisting Guidelines issued by SEBI.  If as a result of the acquisition, the  non-public holding falls below the minimum level specified under the Listing Agreement (e.g., 25%), then the Foreign Company has to buy out the balance public holding in accordance with the reverse book-building process, wherein the acquirer quotes a floor price and the shareholders tender their bids for prices at which they want the acquirer to buy out their shares. The acquirer is free to accept or reject the bids. If he accepts the bids then he must continue to offer the same price to any shareholder for a period of six months from the date of delisting. If he rejects the bids then, he must ensure that the non-promoter holding is restored to the minimum level specified in the Listing Agreement.

For example, in the case of eServe International Ltd., once it was acquired by Citibank Overseas Investment Corp., Citibank delisted its shares by following the reverse book building guidelines. The reason for delisting cited in this case was that Citibank wanted to keep several sensitive data confidential and way from the public domain.   

V.        Tax consequences 

5.1       The shareholders  of the Indian Company would have to pay Capital gains Tax on the sale of shares by them to Foreign Company, unless the shareholders are located in tax havens such as  Mauritius, etc. The tax rate would depend upon whether the gain is long-term or short-term in nature and whether the shares are listed or unlisted. It may be noted that normally the listed shares would also be sold on an off-market basis and hence, the benefit of claiming the long-term gains as exempt would not be allowed to the shareholders of the Indian company. However, if these shares are sold through the stock exchange, e.g., by  way of a block deal, etc., then this exemption would be available.  

5.2       The provisions of s.79 are also relevant in this respect in case the Indian Company is an unlisted company. S.79 of the Act provides that in case of an unlisted company any carry forward and set off of business losses and capital losses would not be allowed unless 51% of the voting power is beneficially held by the same persons on the last day of the year in which the loss is incurred and the last day of the year in which the set off is claimed.  Hence, in case Indian Company is  an unlisted company and it has carry forward business and capital losses  and if more than 51% of its equity shares are acquired by a foreign company, then carry forward and set off of losses would not be available. However, this section only applies in case of acquisition of equity shares and not to preference shares. Further, as laid down recently by the Supreme Court in the case of  CIT v. Concorde Industries 116 Taxman 845  (SC) and Shri Subhalxami Mills, 249 ITR 795 (SC) this section does not apply to carry forward of unabsorbed depreciation.

VI.       Stamp Duty implications

6.1       In case the shares are in physical form then stamp duty @ 0.25% of the value of shares transferred is payable. No stamp duty is payable in case of shares in Dematerialised form. 

VII.     Directors’ Responsibilities

            Although the Directors of an Indian company which is being acquired by a foreign company do not have much of a substantial role to play, there are certain obligations which are cast upon them under the SEBI Takeover Regulations. Hence, in case a listed company is being acquired, the Directors should become aware of the requirements.  They should seek assistance of experts as to the legal and procedural requirements so that there are no last moment surprises. 

            Compliance of Indian and foreign laws in such cross-border acquisitions is essential. A part of the Auditor’s attest function is to ensure compliance with laws. By enquiring and asking relevant questions, an Auditor can add value to his services.

VIII.    Takeover of a Foreign Company by an Indian Company

            Let us now examine  how an Indian Company can takeover a Foreign Company. This is a situation wherein I Co buys out the shares of F Co from the shareholders of F Co. Thus, ultimately if I Co is successful in acquiring 100% of the shares of  F Co, then F Co would become a Wholly-Owned Subsidiary of I Co. This is known as Overseas Investment and is becoming very popular with Indian companies buying out companies abroad. Examples of overseas acquisition include, the most famous $12.2 billion acquisition of Corus by Tata Steel,  several acquisitions by Mahindra & Mahindra, Bharat Forge, Suzlon, etc.

IX.       Companies Act

9.1       Under s.372A  of the Act, no public company (listed or unlisted)  can acquire securities of another body corporate exceeding 60% of its own paid-up capital and free reserves or 100% of its free reserves, whichever is more, without the permission of its shareholders by way of a Special Resolution. Further, the investment must be approved at a meeting of the Board of Directors. The investing company also requires the prior approval of the Public Financial  Institution, if any term loan is subsisting. S.2(7) defines the term  “body corporate” to include a company incorporated outside India. Thus, takeover of F  Co by I Co would attract the provisions of s.372A.

9.2       The prior permission of the Competition Commission under the Competition Act, 2002 should be obtained in all cases where the same is applicable.

X.        Foreign Exchange Management Act

10.1     Fortunately, the position is much better here than for an Indian Company merging into a Foreign Company. The Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2000 are relevant. Regulation 14 of these regulations permit an Indian Company to acquire a Foreign company by way of bidding or tender procedure.

10.2     The conditions for automatic investment are as follows:

(i)   there is no limit on the amount of investments which can be made

(ii)   F Co must be engaged in a bona fide business activity 

(iii)  Foreign Investment drawn from the authorised dealer does not exceed 400% of the networth of I Co as per last audited balance sheet. In computing the networth, the networth of the holding / subsidiary can also be reckoned.

(iv)    Investment can also be made out of the balance held in the EEFC account of I Co.  or out of ADR / GDR proceeds.

In case I Co does not satisfy the above conditions, then it requires RBI permission for making the tender offer.. 

10.3     In case I Co wants to takeover F Co in what is known as an “all-stock deal”, i.e., no outflow of cash, then it can do so by a share-swap. The condition is that I Co can issue listed ADRs/GDRs to the shareholders of F Co in return for acquiring the shares of F Co from these shareholders. A large number of Software Companies have used this route of acquisition. However, it is necessary that the sectoral caps, if any, applicable to I Co are not breached as a result of the issue of ADR/GDR. The acquisition of foreign shares under this mechanism is under the Automatic Route of the RBI, however, the inward leg, i.e., the issue of ADR/GDR would require the prior approval of the FIPB.  

XI.       Income Tax Act

            This transaction would be tax neutral in India. However, the shareholders of F Co may have to pay Income Tax, if any, in their country.

XII.     Stamp Duty

            Acquisition of shares does not require any conveyance and hence, there is no question of any stamp duty arising in India. It needs to be verified whether acquisition of shares abroad attracts stamp duty in the country of the situs of the shares.

XIII.    Stock Exchange Requirements

            In case F Co is a listed or a publicly traded company, then I Co would have to follows the requisite requirements of the exchanges where F Co is traded or listed. Most countries such as the USA and UK have a Takeover Code and various Disclosure and Compliance requirements for acquisition of shares of a publicly traded company.

In the USA, acquisitions must comply with the requirements of the Tended Offer Act of 1968, also known  as the Williams Act. However, what is a tender offer is not defined by the Williams Act. Besides this Act,  the Securities Act of 1933 and the Securities Exchange Act of 1934 are also relevant in the USA.   The Securities Exchange  Commission requires certain disclosures to be filed with it.

Under the Tender approach, any Acquirer who desires to acquire more than 5% of the Target Company’s shares must file with the Securities and Exchange Commission and the Target Company, a disclosure Form. Amongst other details the Form contains information as to who the bidder is, what are his sources of funds, purpose of the bidding, financial information about the Acquirer and the Target Company, etc. Any tender offer must remain open for at least 20 days.

            As is the case with mergers, tender offers can also be One-Step Tender Offers or Two-Step Tender Offers (this is explained elsewhere). In addition to the federal requirements, many US states have enacted Second Generation State Takeover Statues to supplement the federal laws in this respect. Insider Trading rules are also important in this respect. Any acquirer who acquires more than 10% of the capital of a Target Company becomes an Insider and becomes subject to Insider Trading rules.  

            In the United Kingdom,  all mergers and acquisitions must comply with “The City Code on Takeovers and Mergers” and “The Rules Governing Substantial Acquisitions of Shares.”   This Code is very similar to our  SEBI Takeover Code, in fact, our Code is based on the UK Code.

            Disclosures by I Co. under the SEBI Insider Trading Regulations must be borne in mind.

XIV.    Directors’ Responsibilities

            The Directors of an Indian company which is acquiring a foreign company not have of a substantial role to play, there are several obligations which are cast upon them under the Indian laws. Hence, the Directors should become aware of the requirements.  They should seek assistance of experts as to the legal and procedural requirements so that there are no last moment surprises. 

            Compliance of Indian and foreign laws in such cross-border acquisitions is essential. A part of the Auditor’s attest function is to ensure compliance with laws.