Challenges In Cross-Border Mergers – Lexology
While the Companies Act 1956 (1956 Act) permitted an inbound merger, there was no provision for an outbound merger. However, with the implementation of the Companies Act 2013, which replaced the 1956 Act, outbound as well as inbound cross-border mergers are now permitted. In March 2018, the Reserve Bank of India (RBI) issued the Foreign Exchange Management (Cross Border Merger) Regulations 2018 (Cross Border Merger Regulations) to regulate cross-border mergers.
This chapter deals with regulatory framework relating to, as well as issues that need to be considered in, a cross-border merger (whether inbound or outbound).
Permissibility of cross-border mergers and demergers under Companies Act 2013
Chapter XV (Compromises, Arrangements and Amalgamations) of the Companies Act 2013 (2013 Act) read with the Companies (Compromises, Arrangements and Amalgamations) Rules 2016 (Merger Rules) deals with mergers, amalgamations, compromises and arrangements.
Section 234 of 2013 Act read with rule 25A of the Merger Rules sets out the enabling framework for mergers and amalgamations between an Indian company and a foreign company.
Cross-border merger is permitted only if the relevant foreign company is incorporated in any of the following jurisdictions:
- those whose securities market regulator appears in the list of Appendix A signatories to the multilateral memorandum of understanding of the International Organization of Securities Commissions (IOSCO) or one that is a signatory to a bilateral memorandum of understanding with the Securities and Exchange Board of India; or
- those whose central bank is a member of the Bank for International Settlements.
Further, such a jurisdiction must not have been identified in any public statement of the Financial Action Task Force (FATF) as:
- a jurisdiction having strategic anti-money laundering or combating the financing of terrorism deficiencies to which counter measures apply; or
- a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the FATF to address the deficiencies.
However, the extant regulations do not deal with cross-border demergers (ie, demerger of an undertaking from Indian company to foreign company or vice versa). Additionally, while the National Company Law Tribunal (NCLT) (Ahmedabad Bench) in its order (In the matter of Sun Pharmaceutical Industries Limited) approved a scheme of inbound demerger of an Indian company, in a subsequent order (In the matter of Sun Pharmaceutical Industries Limited) the same bench of the NCLT rejected a scheme of outbound demerger of the same Indian company on the ground that cross-border demergers are not permitted. These conflicting orders have resulted in lack of clarity as regards permissibility of cross-border demergers.
Key provisions of the 2013 Act that are applicable to cross-border mergers
A scheme of cross-border merger needs to comply with the provisions relating to domestic mergers as prescribed under the 2013 Act.
Consequently, a scheme of cross-border merger requires approval of the board of directors of the Indian company. Further, the scheme would also need to be approved by the majority of persons representing 75 per cent in value of the shareholders as well as creditors (if applicable). The respective meetings of the creditors or the members, as the case may be, of the relevant Indian company are convened and held as per the directions, and under the supervision, of the NCLT. This requirement of convening meetings can, however, be dispensed with by the NCLT where the creditors (having at least 90 per cent share in outstanding debt) and the shareholders agree and confirm to the scheme.
Besides the above, a scheme of cross-border merger would require approval or no-objection of other authorities including the Regional Director, the Official Liquidator, the income tax authorities, the RBI (if applicable) and other regulators (such as the Competition Commission of India (CCI)), if any.
In the case of a listed Indian company proposing a scheme of cross-border merger, a draft of the scheme along with other prescribed documents and fees needs to be filed with the relevant stock exchange or exchanges for obtaining a no-observation or no-objection letter prior to filing the scheme with the NCLT. The relevant listed Indian company is required to file the scheme with the NCLT within six months from the date of issuance of the no-observation or no-objection letter by the stock exchange. However, the requirement of no-observation letter or no-objection letter does not apply in the case of a merger of a foreign wholly owned subsidiary with its listed Indian holding company, but the draft scheme still has to be filed with the stock exchange for disclosure purposes.
An order of the NCLT sanctioning the scheme may provide for the transfer of assets and/or the liabilities of the transferor company to the resultant company. In the case of an outbound merger, the relevant Indian company would be dissolved without winding-up upon the scheme of cross-border merger becoming effective, and any legal proceedings pending by or against the relevant Indian company would continue in the name of the resultant company.
A scheme of cross-border merger, once approved by the NCLT, would be deemed to be effective from the appointed date, which could either be a specific calendar date or an event-based date linked with certain conditions or events.
The relevant foreign company would also need to obtain the requisite approvals that it may require in its home jurisdiction in relation to a scheme of cross-border merger.
Further, a scheme of cross-border merger would need to comply with the conditions set out in the Cross Border Merger Regulations related to inbound and outbound mergers.
Last, in the case of cross-border mergers, a valuation has to be conducted (in accordance with internationally accepted principles of accounting) by a member of a recognised professional body in the jurisdiction of the resultant company. A scheme of cross-border merger may, among other things, provide for the payment of consideration to the shareholders of the transferor company in cash, by way of depository receipts, or a combination thereof. If the scheme of cross-border merger provides for payment of consideration by the resultant company in the form of fresh securities then the provisions of the foreign exchange regulations of India would also become applicable.
Issues under the Cross Border Merger Regulations
The Cross Border Merger Regulations prohibit:
- a person resident in India (PRI) from acquiring or transferring any security or debt or asset outside India; and
- a person resident outside India (PROI) from acquiring or transferring any security or debt or asset in India, on account of cross-border mergers,
unless such acquisition or transfer is either permitted under the Foreign Exchange Management Act 1999 (FEMA), or allowed by the RBI by way of any general or special permission.
However, any transaction on account of a cross-border merger (inbound or outbound) shall be deemed to have prior approval of the RBI (as required under rule 25A of the Merger Rules) if the conditions set out in the Cross Border Merger Regulations are fulfilled. If these conditions are not fulfilled, then the requirement of obtaining specific prior approval of the RBI would become applicable.
Conditions for deemed RBI approval in the case of inbound merger
The Cross Border Merger Regulations have set out, among other things, the following conditions for deemed approval of the RBI in the case of inbound merger:
- Where the scheme of inbound merger provides for issuance of shares or securities by the resultant Indian company to the securities holders of the foreign company, the resultant Indian company would have to comply with the pricing guidelines, sectoral caps, attendant conditions and reporting requirements as set out under foreign direct investment (FDI) Norms (discussed below).
- The resultant Indian company would also need to comply with the conditions set out in the overseas direct investment (ODI) Norms (discussed below) where the relevant foreign company is a joint venture (JV) or wholly owned subsidiary (WOS) of the Indian company.
- If the inbound merger of the JV or WOS results in acquisition of the step-down subsidiary of the JV or WOS of the Indian party by the resultant Indian company, then such acquisition should be in compliance with the ODI Norms.
- The guarantees or outstanding borrowings of the foreign company from overseas sources must conform to the external commercial borrowing (ECB) norms (discussed below) or trade credit norms or other foreign borrowing norms (including guarantee regulations) within a period of two years. No outward remittance is permitted towards repayment of such liability within such period of two years; however, the condition related to end use as set out in the ECB norms would not apply to such overseas borrowings.
- The resultant Indian company can acquire, hold and transfer any foreign asset or security only if it is permitted under the FEMA provisions. If it is not permitted to do so under FEMA, the resultant Indian company would have a period of two years to sell such asset or security and repatriate the sale proceeds to India. Repayment of foreign liabilities from such sale proceeds within the said period of two years is also permissible.
- The resultant Indian company can open a bank account in foreign currency in the overseas jurisdiction for the purpose of putting through transactions incidental to the cross-border merger for a maximum period of two years from the date of sanction of the scheme by the NCLT.
- Prior to the merger, all the companies involved in the inbound merger must complete all the regulatory actions with respect to non-compliance, contravention, violation, as the case may be, of the FEMA provisions.
Conditions for deemed RBI approval in the case of outbound merger
The Cross Border Merger Regulations have set out, among other things, the following conditions for deemed approval of the RBI in case of outbound merger:
- If the scheme of outbound merger provides for issuance of shares or securities by the resultant foreign company to the shareholders of the relevant Indian company, such acquisition or holding of shares or securities of the resultant foreign company must be in compliance with the ODI Norms. Further, a resident individual is permitted to acquire foreign securities only if their fair market value is within the limits set out in the liberalised remittance scheme.
- Indian offices of the Indian company may be deemed to be branch offices of the resultant foreign company. Accordingly, the resultant foreign company can undertake only such transactions that a branch office is permitted to undertake in terms of the Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations 2016.
- The guarantees or outstanding borrowings of the Indian company shall be repaid as per the scheme sanctioned by the NCLT. The resultant foreign company cannot acquire any rupee liability towards an Indian lender, if such liability is not in accordance with the FEMA provisions. Further, a no-objection certificate or letter to this effect should be obtained from the Indian lenders of the Indian company.
- The resultant foreign company may acquire, hold or transfer any asset in India as permitted under FEMA. If it is not permitted under FEMA, then the resultant foreign company would have a period of two years to sell such asset or security and repatriate sale proceeds outside India. However, repayment of Indian liabilities from sale proceeds of such assets or securities within the said period of two years is permissible.
- The resultant foreign company may open a special non-resident rupee account in accordance with the Foreign Exchange Management (Deposit) Regulations 2016 for the purpose of putting through transactions under the Cross Border Merger Regulations for a maximum period of two years from the date of sanction of the scheme by NCLT.
- Prior to the merger, all the companies involved in the outbound merger must complete all the regulatory actions with respect to non-compliance, contravention, violation, as the case may be, of the FEMA provisions.
Key provisions of the FDI Norms
An investment by a non-resident through permitted equity instruments in an unlisted Indian company, or 10 per cent or more of the post-issue paid-up equity capital on fully diluted basis of a listed Indian company, qualifies as FDI and has to comply with the FDI Norms (including, without limitation, the pricing guidelines, sectoral caps, attendant conditions and reporting requirements as set out in FDI Norms).
Since the non-resident securities holders of foreign company would acquire shares or securities of the resultant Indian company (pursuant to a scheme of inbound merger), such issuance of shares or securities by the resultant Indian company to the non-resident securities holders of a foreign company would have to be in compliance with the FDI Norms.
The regulatory framework governing foreign investment in India is set out under the Foreign Exchange Management (Non-Debt) Instrument Rules 2019 and the consolidated FDI policy issued by the Department for Promotion of Industry and Internal Trade (collectively referred to as the FDI Norms).
As per the FDI Norms, Indian companies can issue only the following equity instruments to PROIs:
- equity shares (including partly paid shares);
- fully, compulsorily and mandatorily convertible debentures;
- fully, compulsorily and mandatorily convertible preference shares; and
- share warrants.
Any instrument that is non-convertible, optionally convertible or partially convertible is considered as foreign debt and not treated as FDI.
FDI is permitted under the ‘automatic route’, the ‘government or approval route’, or both in all sectors except prohibited sectors or activities. In sectors or activities where foreign investment is permitted under the automatic route no prior government approval is required. However, prior government approval is required, among others, for investment in sectors that fall within the approval route or where the foreign investment does not comply with the sectoral caps, the conditions set out for investment under the automatic route, or both.
Therefore a scheme of inbound merger would not be permitted if such inbound merger is likely to result in PROIs acquiring equity instruments in the resultant Indian company that is engaged in a sector where FDI is prohibited. Further, if the resultant Indian company is engaged in a sector falling under the approval route, prior government approval would be required before implementation of such scheme of inbound merger.
In terms of the recent amendment to the FDI Norms, apart from the sector or activity-specific restrictions, prior government approval would be required in the case of:
- any investment in an Indian company by an entity that is resident in a country sharing a land border with India (Restricted Territory) or the beneficial owner of the investment is a resident or citizen of a Restricted Territory; or
- any transfer of shares of an Indian company that, directly or indirectly, results in a resident or citizen of a Restricted Territory becoming the beneficial owner of the shares.
In view of the above, prior government approval would also be required where, pursuant to a scheme of inbound merger, the resultant Indian company proposes to issue equity instruments to a non-resident entity that is a resident of a Restricted Territory or where the beneficial owner of the such equity instruments would be a resident or citizen of a Restricted Territory.
The FDI Norms regulate the price at which a PROI can acquire or transfer the permitted equity instruments in Indian companies. The pricing guidelines provide for:
- a floor price in the case of acquisition of permitted equity instruments (either by way of subscription or by way of purchase from resident shareholders) by a non-resident investor, and
- a ceiling in the case of sale of permitted equity instruments by a non-resident seller to a resident purchaser.
In the case of convertible equity instruments, the price or conversion formula is required to be determined upfront at the time of issue of the instruments, and the conversion price cannot be less than the price arrived at when the instrument is issued.
Therefore, while determining the share exchange ratio in the case of scheme of inbound merger, the pricing guidelines as set out in the FDI Norms would also need to be complied with.
Reporting and filing requirements
Every Indian company issuing equity instruments to a PROI under the FDI route is required to file Form FC-GPR (in the Single Master Form) within a period not exceeding 30 days from the date of issue of the equity instruments. The resultant Indian company issuing permitted equity instruments to non-resident securities holders of the foreign company would also need to comply with the reporting requirements.
Key provisions of the ODI Norms
The Cross Border Merger Regulations provide that in the case of a scheme of outbound merger, the Indian resident shareholder may need to comply with the provisions of the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations 2004 and the Master Direction on Direct Investment in JV or WOS abroad issued by the RBI (collectively referred to as the ODI Norms). Any investment outside India by a PRI is regulated by the ODI Norms.
The ODI Norms provide for two routes of making ODI, the automatic route and the approval route (which requires prior approval of the RBI).
Under the automatic route, ODI is permitted provided the total amount of ODI made by an Indian party is within the prescribed ceiling, which is as follows:
- the total financial commitment of the investing Indian party should not exceed 400 per cent of the net worth of the Indian party as per the last audited balance sheet; and
- the annual financial commitment of the Indian party should not exceed US$1 billion.
Further, an Indian party is prohibited from making investment (or financial commitment) in a foreign entity engaged in real estate or banking business, without the prior approval of the RBI.
Separately, the Cross Border Merger Regulations also provide that in the case of individuals resident in India, the market value of the securities that the individual resident can acquire in the case of outbound merger must not exceed the prescribed limit (which is US$250,000 per financial year). The limit of US$250,000 is the aggregate limit and is applicable for all permitted capital account and/or current account transactions that may be undertaken by a resident individual in a single financial year.
In view of the above it is unclear whether an Indian company or an individual resident in India can acquire shares the market value of which exceeds the prescribed thresholds. Accordingly, if a scheme of outbound merger contemplates an all-stock transaction, it is advisable that the parties should obtain clarity on this from the RBI before proceeding with the transaction.
Brief overview of ECB norms relevant to cross-border mergers
An Indian company is permitted to borrow money from overseas lenders subject to compliance with the ECB framework.
In the case of inbound merger, where the overseas borrowings of the foreign company become liabilities of the Indian company, then such overseas borrowings would need to comply with the ECB framework within a period of two years.
The ECB framework sets out certain parameters (such as eligible lenders, minimum average maturity and all-in-cost ceiling) that need to be complied with by an Indian company in order to raise ECB under the automatic route (ie, without prior approval of the RBI). If any of these parameters is not met, then the Indian company would be required to obtain prior approval of the RBI in order to raise ECB.
An ECB can be raised by only those Indian entities that are eligible to receive FDI. Under the automatic route, an Indian company is permitted to raise ECB from a non-resident person if such non-resident person is:
- a resident of a FATF or IOSCO-compliant country;
- multilateral and regional financial institutions where India is a member country; or
- an individual provided that such individual is foreign equity holder of Indian borrowing entity, or subscribes to bonds or debentures that are issued by an Indian borrowing entity and listed abroad.
All-in cost of ECB cannot exceed the benchmark rate plus 450 basis points spread. Prepayment charge or penal interest, if any, for default or breach of covenants cannot exceed 2 per cent over and above the agreed rate of interest on the outstanding principal amount.
The minimum average maturity period (MAMP) for ECB cannot be less than three years. However, for certain specified categories of ECB, different MAMP has been specified under the ECB norms (for example, MAMP is one year only in the case of ECB raised by manufacturing companies up to US$50 million or its equivalent per financial year, and five years in the case of ECB raised by an Indian entity from a foreign equity holder for working capital purposes, general corporate purposes or for repayment of rupee loans).
Stamp duty implications in the case of cross-border mergers
Both inbound and outbound mergers may also have implications in India under the legislation related to stamp duty, which is the Indian Stamp Act 1899 (Indian Stamp Act). In India, both the central legislature as well as the state legislatures can frame the law on stamp duty. Accordingly, almost every state has enacted its own law on stamp duty.
While some states have adopted their own stamp acts, certain other states have adopted the Indian Stamp Act and have merely revised the schedule on the stamp duty rates. Some states have specifically provided for levy of stamp duty on court orders approving scheme of merger or amalgamation, although there are still several states that do not have a specific entry for stamp duty on court orders approving schemes of merger or amalgamation.
The Supreme Court of India has, in the past, held that court orders approving schemes of amalgamation or merger are subject to stamp duty, which is calculated on the basis of the consideration received by shareholders of the transferor company. Accordingly, an order of the NCLT approving a scheme of cross-border merger may attract stamp duty.
Implications under merger control framework
Both inbound and outbound mergers would also be subject to the merger control framework of India if the proposed transaction meets the jurisdictional thresholds. These thresholds are revised from time to time by the government of India, in consultation with the CCI.
The merger control framework is governed by the Competition Act 2002 and the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations 2011 (Combination Regulations). Any transaction (including mergers and amalgamations) that meets the jurisdictional thresholds, and is likely to have an appreciable adverse effect on competition (AAEC) within the relevant market in India is prohibited under the merger control framework.
The current jurisdictional thresholds are:
- at the individual level:
- the parties have combined assets of more than 20 billion Indian rupees or combined turnover of more than 60 billion Indian rupees in India; or
- the parties have combined assets of more than US$1 billion, including at least 10 billion Indian rupees in India, or combined turnover of more than US$3 billion, including at least 30 billion Indian rupees in India;
- at the group level:
- the group has assets of more than 80 billion Indian rupees in India or turnover of more than 240 billion Indian rupees in India; or
- the group has worldwide assets of more than US$4 billion including at least 10 billion Indian rupees in India or worldwide turnover more than US$12 billion including at least 30 billion Indian rupees in India.
A transaction (including cross-border merger) meeting the prescribed threshold is required to be notified to the CCI, and cannot be effective until a period of 210 days has passed or the CCI has approved the proposed combination (whichever is earlier).
Schedule I of the Combination Regulations, however, sets out certain categories of combinations that are ordinarily deemed to have no AAEC in India. There is no requirement to notify such categories of combinations to the CCI. In addition to this, the government of India has exempted any transaction involving acquisition or merger or amalgamation from the notification requirement where the value of assets being acquired, taken control of, merged or amalgamated is not more than 3.5 billion Indian rupees in India or turnover is no more than 10 billion Indian rupees in India.
In the case of domestic mergers, there are certain tax benefits available under Indian income tax laws. However, similar benefits are not available in the case of outbound mergers. As a result, not many Indian companies are currently keen to opt for outbound mergers in the absence of tax reliefs.
Further, in the case of inbound mergers, the resultant Indian company is not permitted to repay overseas borrowings for a period of two years. This could result in entities facing challenges in obtaining approvals or consents from foreign lenders to such condition. If the foreign lenders do not accept this condition, parties may have to restructure the terms of such overseas borrowings in order to bring them in line with the provisions of the Cross Border Merger Regulations.
 Vineet Aneja is managing partner and Neetika Ahuja is an associate partner with Clasis Law.
 The term ‘inbound merger’ is defined under the Cross Border Merger Regulations to mean a cross-border merger where the resultant company is an Indian company. The term ‘resultant company’ is defined in the Cross Border Merger Regulations to mean an Indian company or a foreign company that takes over the assets and liabilities of the companies involved in the cross-border merger.
 The term ‘outbound merger’ is defined under the Cross Border Merger Regulations to mean a cross-border merger where the resultant company is a foreign company.
 The term ‘cross-border merger’ is defined under the Cross Border Merger Regulations to mean any merger, amalgamation or arrangement between an Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules 2016 notified under the Companies Act 2013.
 Bodies corporate incorporated or registered outside India are covered within the meaning of person resident outside India. Residential status of a foreign individual as a person resident outside India or a person resident in India would depend on the purpose and period of stay in India of such foreign individual. If a foreign individual stays in India for a period of 182 days or more during the preceding financial year for employment, carrying out business or other purpose, then such foreign individual would become a person resident in India.
 An Indian branch office of a foreign company is permitted to undertake certain activities including, among others, the export or import of goods, providing professional or consultancy services, acting as buying or selling agent of a foreign company, rendering technical support to the products supplied by parent or group companies and representing a foreign airline or shipping company.
 Prohibited sectors or activities include lottery business, gambling and betting, manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes, real estate business (other than development of townships, construction of residential or commercial premises, roads or bridges and real estate investment trusts), chit funds and Nidhi companies.
 Prior to its abolition, in May 2017, the relevant authority was the Foreign Investment Promotion Board (FIPB). After abolition of the FIPB, the relevant authority to grant approval for foreign investment is the relevant department or ministry that is concerned with the sector in which the relevant Indian company, in which foreign investment is proposed to be made, is engaged.
 Every Indian company that has received or expects to receive foreign investment or indirect foreign investment is required to file the Entity Master on the FIRMS (Foreign Investment Reporting and Management System) platform at https://firms.rbi.org.in.
 ‘Financial commitment’ means the amount of direct investment by way of contribution to equity (equity shares, compulsorily convertible preference shares and other preference shares), loan and 100 per cent of the amount of guarantees and 50 per cent of the performance guarantees issued by an Indian party to or on behalf of its overseas JV or WOS.
 ‘Real estate business’ means buying and selling of real estate or trading in transferable development rights but does not include development of townships, construction of residential or commercial premises, roads or bridges.
 The ECB framework of India comprises of the Foreign Exchange Management (Borrowing and Lending) Regulations 2018, and the Master Direction-External Commercial Borrowings, Trade Credits and Structured Obligations issued and updated by the RBI from time to time.
 Benchmark rate in the case of foreign currency ECB/trade credit (TC) refers to six-month LIBOR rate of different currencies or any other six-month interbank interest rate applicable to the currency of borrowing (for example. EURIBOR). Benchmark rate in case of rupee-denominated ECB/TC will be prevailing yield of the government of India securities of corresponding maturity.
 The term ‘relevant market’ means the market that may be determined by the CCI with reference to the relevant product market or the relevant geographic market or with reference to both the markets. ‘Relevant product market’ means a market comprising all those products or services that are regarded as interchangeable or substitutable by the consumer, by reason of characteristics of the products or services, their prices and intended use. ‘Relevant geographic market’ means a market comprising the area in which the conditions of competition for supply of goods or provision of services or demand of goods or services are distinctly homogeneous and can be distinguished from the conditions prevailing in the neighbouring areas.