While India, like most global economies, is reeling under the effects of Covid-19, the government has taken, and is expected to take, more efforts towards a v-shaped recovery of the economy. Significant changes introduced in 2020, vis., the FDI norms for investments in defence, digital media and single brand retail; tax exemptions for sovereign funds and pension funds investing India; decriminisation of a host of offences under the Indian corporate laws; overhauling of select labour laws, coupled with the judgement against India in the Vodafone in relation to Bilateral Investment Treaty dispute are expected to impact transactional trends in 2021.
In the backdrop of the legal hits and misses 2020, due to the pandemic as well as other reasons, we look at what 2021 has in store particularly for private equity and mergers and acquisitions (M&A).
In April 2020, the Indian government amended the exchange control regulations providing that private investments into Indian companies by entities which have beneficial ownership in any country sharing a land border with India would require the prior approval of the government. This was a veiled attempt to restrict takeover of Indian companies by Chinese investors. particularly at a time when the macroeconomic conditions and political sentiments across the globe were in doldrums.
However, the manner in which the restriction is drafted is extremely broad and restricts not just new investors, but even further investment by existing investors irrespective whether such investment is a majority or a minority investment. Further, the wide language means that any investment by an entity with any amount of direct or indirect Chinese/neighbouring investments is covered by the restriction. This concern was exacerbated by the fact that large Chinese investors had investments in some of the largest global private equity funds and in some of the biggest multinational corporations.
The government has yet not provided clarifications or safe harbours including on the extent of indirect investment required by entities / persons resident in the specified countries which are now under the approval route. News reports have suggested that a minimum shareholding threshold is likely to be prescribed for indirect / beneficial ownership by investors coming from such countries below which an approval would not be required, providing much needed relief to global investors. Very recently, the government also issued a notification citing that multilateral trade organisations which are either based out of or have beneficial ownership in countries which share the land border with India are permitted to invest in India without being subject to a government approval. Hopefully, 2021 will bring about safe harbours / objective bright line tests to address the concerns.
Traditionally, alternative investment funds (AIFs) with foreign investors have been permitted to invest at par with domestic investors if their manager and sponsor are both owned and controlled by resident Indians. However in such funds, important limited partners (LPs) seeking some level of control, or offshore funds (which used Indian AIFs as a SPV for investments into India) often have representation in the investment committees (IC/s) of these AIFs. The ICs would have the final / binding decision taking authority for the AIFs, with respect to investments. SEBI has recently raised concerns on these structures and has sought clarification from the government if such AIFs should be considered as domestic owned and controlled AIFs. In case the government deems these AIFs with ‘non-resident controlled’ ICs as non-residents, a number of compliance requirements would be applicable to these AIFs, which could result in significant drawbacks. For instance, FDI pricing norms and sectoral caps would apply, which were hitherto not applicable to these AIFs.
The decision of the Indian government on this would have considerably retrospective implications as well and grandfathering existing investments would be critical. Any other view could result in unwinding of structures. Reconstitution of the ICs and governance structures of AIFs to ensure they are both Indian ‘owned and controlled’ is likely to be a concern for non-resident investors having significant capital commitments in AIFs and could force AIFs to migrate their control structures.
In addition, considering Infrastructure Investment Trusts (InvIT) and Real Estate Investment Trusts (REIT) are looked at par with AIFs under the Indian exchange control norms, the final decision of the government in this regard may also have similar implications on InvITs and REITs.
Indian companies in asset light sectors such as technology have been skeptical about valuations in India and hence are hesitant to list in India. This has resulted in Indian companies to ‘flip’ or ‘externalise’ their operations overseas, where they move the core business (including intellectual property) to companies in offshore jurisdictions. These ‘flipped’ entities have also raised funds from global investor. The Indian government has not been overly ecstatic about this, since it results in shifting of value outside India.
In this background and mushrooming of more special purpose acquisition company (SPACs) for Indian acquisitions, the securities regulator SEBI has now permitted Indian companies to directly list on offshore markets. The Companies Act, 2013 has also been amended to enable the same. These changes are expected to usher in the next phase of Indian companies, especially in the technology space, to go global through listing in mature stock exchanges like NASDAQ, albeit without shifting base outside India.
The Insolvency and Bankruptcy Code, 2016 (IBC) was introduced in 2017 with enormous expectations, and a hope to resolve India’s burgeoning NPA situation. While the experience has been mixed, the suspension of new cases under IBC due to the pandemic has been widely criticized by varied stakeholders. Pertinently, the suspension of the IBC in totality, instead of a deferral has resulted in a free hand to corporate debtors and has reduced the efficacy of the IBC altogether.
In this backdrop, the Indian government considered introducing ‘pre-packs’ under the IBC, where a resolution plan that is agreed between the lenders and potential investors can be submitted to the court for its approval. The pre-pack insolvency mechanism is also likely to make the resolution process more efficient, thereby resulting in only cases where such options are not possible requiring judicial intervention. While the pre-pack resolution framework under IBC is expected to be welcomed by promoters as well, since (as per reports), it appears that promoters are not going to be compelled to give up control of the corporate debtor (which is a requirement under the resolution process under IBC, currently), it is to be seen how the Indian government expects to implement the same, considering the interests of operational creditors need to be protected as well.
The chairman of the Indian antitrust watchdog, the Competition Commission of India recently mentioned that the operations and activities of private equity players shall be monitored and scrutinised closely, including the rights they have in companies, which may impact competition. This could become a serious bone of contention since private equity firms have enjoyed certain exemptions, which supported transactions and fostered faster deal making.
2020 has been a difficult year for business globally and India is no exception. 2021 brings with its hopes and promises for the business environment as well and the changes mentioned above are expected to have substantial influence on deal making trends in 2021. Long-pending demands such as real ‘single window clearance’, further ‘easing ‘doing business in India’, objectivity and certainty in tax regulations aside, the Indian government needs to focus on an overall approach to foster more business and investments. In addition to a ‘single window clearance’, a ‘single window regulation’, where all applicable laws in relation to a proposed change are introduced and implemented at the same time (tax, exchange control, securities regulation, antitrust, corporate laws, etc.) could go a long way in achieving desired objectives, as opposed to having changes introduced sequentially over a span of multiple years.
Views are personal. The authors are co-founders of Bombay Law Chambers, a Mumbai-based boutique law firm.