Post-Covid-19 implications for India's M&A

transactions and structures

Back to Corporate and M&A Law Committee publications

Raj Ramachandran

J Sagar Associates, Bangalore

raj.ramachandran@jsalaw.com

Introduction

The business uncertainties created by Covid-19 have resulted in unique

challenges for all stakeholders, including regulators, around the globe.
India too has promptly taken a few firm steps, the full impact of which
remains to be seen. The impact of Covid-19 and such developments in
regulations will necessarily result in changes in deal structuring, so as
to address the revised regulations as well as to adequately protect
businesses from any impact in the future, given the continuing
uncertainty.

Change in FDI policy: Press Note 3

Among the various measures taken by the Indian Government (the

'Government') to face the challenges and threats posed by Covid-19, a
significant measure introduced was Press Note 3 of 2020, which reflects
the policy of the Government to restrict investment from entities
located in neighbouring countries.

While the stated intent of the press note is to 'curb opportunistic

takeovers/acquisitions of Indian companies due to the current Covid-19
pandemic', and in this regard, it regulates investment from all entities
belonging to countries that share a land border with India, the key
impact has been on investment from China. The concern of the
Government was that the impact of Covid-19 on businesses and the
resultant value erosion should not be used as an opportunity by
specified foreign entities to take control of Indian entities. Prior to Press
Note 3, foreign investment was regulated only by sector and not by
region, except for Bangladesh and Pakistan.

The key aspect to be borne in mind is that, prior to the implementation

of Press Note 3, investment from China and other countries, such as
the United States, was under the automatic route, barring a few
sensitive sectors. This restriction caused considerable concern among
stakeholders because the restriction applied not only to new
investment, but also to entities where there was existing investment.
The result was that Indian companies that had such investors as
stakeholders were faced with double jeopardy: not only were they
restricted from seeking investment from China when they needed it the
most but they were now also faced with a situation in which several
provisions in the agreements seemed implausible.

The import of Press Note 3 was far wider, and it also covered indirect
transfers and investments.

Implementing and giving effect to various provisions and rights in

shareholders' agreements including call options, put options and drag
options now seems quite a task because they could trigger Government
approval, and cause attendant delays and other business concerns.

Actions under the Information Technology Act 2000

Under separate press releases, the Government, through the Ministry

of Information Technology, blocked several apps, 'in view of the
emergent nature of threats', and given that 'in view of information
available they are engaged in activities which is prejudicial to
sovereignty and integrity of India, defence of India, security of state and
public order'.

The order was issued by invoking power under section 69A of the
Information Technology Act 2000, read with the relevant provisions of
the Information Technology (Procedure and Safeguards for Blocking of
Access of Information by Public) Rules 2009. The stated intent is to
safeguard the interests of Indian mobile and internet users, and to
ensure the safety and sovereignty of Indian cyberspace.
The banning of several of these apps, along with the impact of Press
Note 3, is already causing some delays and concerns for foreign
investment into India, and the M&A transaction landscape will continue
to evolve to address the current situation and the continuing
uncertainty.

Transaction structuring

Due diligence will play a key role in identifying the risks and potential
disruptions to business. Acquirers will require clarity on whether key
contracts can be terminated at short notice or for reasons of force
majeure, or if key customers are likely to be impacted in the near
future. In certain cases, although contracts may not contemplate early
termination and it may appear that business will continue as usual, the
remedy available, if such a contract is terminated by the counterparty
or affected due to other reasons, will also need to be evaluated
carefully. The adaptability of the business to the post Covid-19 scenario
will also play a key role in the decision-making process.

The outcome of due diligence will largely dictate the structure of the
transaction, and the safeguards that will need to be provided for in the
transaction documents, after taking into account any likely changes in
law or government regulations restricting any actions/activities.

It is likely that there will be divestment of stakes by several

stakeholders, and in such cases, the regulations governing (1) deferred
consideration; and (2) pricing norms, will assume importance and need
to be reviewed carefully while the transactions are structured.

It is also likely that acquirers will stipulate a material adverse change

(MAC) or force majeure provision in order to be able to call off the deal
or be released from their remaining obligations should there be any
subsequent adverse impact on the business.

Some key aspects that are likely to emerge while structuring such
transactions are discussed below, having regard to the current foreign
exchange regulations.

Deferred consideration/purchase price adjustment

Although an acquirer will undertake due diligence of the business, the
true/full impact of Covid-19 remains unclear, and the prospects of the
business are not guaranteed. Acquirers are therefore likely to attribute
a fair portion of the consideration to the future performance of the
company over a defined period of time, and devise a deferred
consideration mechanism. While this may not be in the best interest of
the sellers/exiting investors, who will prefer a locked box closing
mechanism, any fixed-price deal may result in a comparatively lower
acquisition price.

The extant foreign exchange regulations governing transactions with a

deferred consideration structure stipulate that the deferred
consideration will need to be paid by the buyer within a period not
exceeding 18 months from the date of the share purchase agreement,
and only 25 per cent of the full consideration can be deferred.

Where the seller of the shares is an Indian party and the buyer a non-
resident foreign party, the stipulation of the quantum of consideration
that can be deferred and the timeline for payment of this ensures that
the Indian party receives the remaining consideration within the
specified period of time, having received the substantial value upfront.

However, where the seller is a non-resident and the buyer a resident

Indian party, the Indian authorities should consider relaxing such a
requirement because the benefit of the relaxation would be to the
Indian party.

While parties can agree on a purchase price adjustment (both increase

and decrease) where certain conditions are met or not complied with,
or business targets not achieved, there is also a stipulation under the
Indian foreign exchange regulations that the effective price should be
compliant with pricing guidelines, and hence, any adjustment
contemplated as part of the commercial terms will need to pass this
test.

Pricing guidelines

The basic principle of the pricing guidelines is that a transfer between a

resident Indian party and a non-resident cannot be at a consideration
lower than the fair market value (a minimum floor price) if the seller is a
resident Indian party. Conversely, the consideration cannot be higher
than the fair market value (ie, a maximum ceiling price) if the buyer is a
resident Indian party. The aforementioned principle would not apply if
the seller and buyer are both non-residents, and hence, such
transactions could be structured with ease, subject only to commercial
considerations.

If the acquirer is a foreign-owned and controlled company (FOCC)

incorporated in India and the seller is a resident Indian party, the
transaction should ideally be permitted at any price and without regard
to the deferred consideration norms, particularly where the funds
proposed to be used for the acquisition are from internal accruals of
the FOCC.

MAC

MAC clauses are quite standard in M&A deals that entitle an acquirer to
walk away from the otherwise binding transaction if the business of the
target entity is impacted between signing and closing, or there is an
unforeseen event, where the business is likely to be materially
impacted, that alters the basis on which the various terms were drawn
out and agreed.

The cue should be taken from recent changes in law/regulations, such

as the introduction of Press Note 3 and the Government order banning
certain apps, each of which could potentially have a material impact on
the business of the target entity, and similar circumstances would need
to be specified as events that constitute a MAC.

The impact of Covid-19 in itself would constitute a MAC for businesses

in specific sectors, and given that the full extent of the impact remains
uncertain, transaction documents will continue to have sufficient
safeguards built in for investors/acquirers to walk away from
transactions that are impacted due to Covid-19 without having to suffer
any break fees or other consequences.

It is, however, important to have specific objective criteria to determine

if a particular event or development would constitute a MAC. Where the
criterion is not objective or is open to interpretation that itself could
trigger a dispute, this leaves the parties open to liability.

Force majeure

Although it is not typical for transaction documents in M&A deals to

include a clause on force majeure, parties are likely to consider
including a clause on force majeure in light of Covid-19 or a pandemic
in general, or generally to address a situation where a certain
obligation/action is beyond the control of such parties. While such
provisions were hitherto perceived as an 'easy way out', Covid-19 has
highlighted the fact that similar circumstances could result in certain
obligations/actions becoming unachievable.

For example, if an Indian entity had executed an agreement with a

target for acquisition, and such an Indian entity was directly impacted
by the introduction of Press Note 3, the same entity would squarely
constitute force majeure because the acquirer Indian entity may have
expected to receive funds from its offshore parent to fund the
acquisition.

Similar to the case of MAC, it is important to stipulate the criteria as

objectively as possible in order to avoid any disputes.

Representations and warranties insurance/warranties and indemnities insurance

The impact of Covid-19 is pushing several companies to seek fresh

investment for the continuance of business. In some cases,
stakeholders are actively pursuing a sale of the business entity given
the uncertainty of a positive business outlook in the near future. Such
distressed sale transactions are likely to open up additional challenges
and considerations. Typically, sellers will provide representations and
warranties to the acquirer in relation to the shares, the business and
the entity. These are also backed by indemnity obligations so that, if
any liability arises in the future, the acquirer can recover the losses
from the sellers.

However, where transactions are undertaken due to the distress of the

seller, the acquirer is likely to seek representations and warranties
insurance (RWI)/warranties and indemnities insurance. This will ensure
that if any claim arises in the future, the acquirer can directly claim
from the insurance company instead of being concerned about the
potential financial condition of the sellers. A seller in distress may end
up exhausting the sale proceeds to meet other liabilities, and the
acquirer would not want to be in a situation where an indemnity claim
is rendered infructuous due to the bankruptcy of the seller. Such
insurances are fairly common in large transactions, and are likely to be
resorted to more often.

It is also important to bear in mind that RWI will not typically cover all
occurrences of claims/losses. While it will cover a claim where the
representations were inaccurate, what will not be covered are breaches
of covenants, or where certain liabilities were known beforehand to the
parties.