Cross-Border Mergers & Acquisitions

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This blog post is written by Jui K, Graduate of Government Law College, Mumbai who pursued Mergers & Acquisitions Course from Bettering Results (BR). 

 

CROSS- BORDER MERGERS & ACQUISITIONS

UNDERSTANDING CROSS BORDER M&A

Cross-Border Merger means any merger, amalgamation or arrangement between an Indian company & Foreign company in accordance with (Compromises, Arrangements & Amalgamation) Rules, 2016.  Under the Companies Act, 2013, a Foreign Company is defined as a company or body incorporated outside India having a business place in India or not. 

There are two types of cross border mergers, Inbound Merger where the resultant company is an Indian company. Example, Acquisition of 77% stake in Flipkart by Walmart, Another is Outbound Merger where the resultant company is a foreign company. Example, acquisition of Hamleys by Reliance Group.

This concept has been mushrooming time and again and presently Indian companies are more prone to Cross Border Mergers & Acquisitions than other countries. For instance, TATA Steel acquired UK based company Corus. 

Mostly companies engage in cross border mergers to enter new geographical markets which enable companies to reach new customer bases and boost their global presence. Merging operations leads to growth in innovation and faster product development which aids to diversify revenue streams, reduction in dependency on the single market. This in turn mitigates risks associated with economic downturns, regulatory fluctuations and so on. Companies can gain access by merging/acquiring a company in another country because they can cross-sell products & services, leverage combined marketing efforts & improve competitive edge. 

GOVERNING LAWS:

  1. Companies Act, 2013
  2. SEBI (Substantial Acquisition of Shares & Takeovers) Regulations, 2011
  3. Foreign Exchange Management (Cross Border Merger) Regulations, 2018
  4. Competition Act, 2002
  5. Insolvency & Bankruptcy Code, 2016
  6. Income Tax Act, 1961
  7. Department of Industrial Policy & Promotion 
  8. Transfer of Property Act, 1882
  9. Indian Stamp Act, 1899
  10. Foreign Exchange Management Act, 1999
  11. IFRS 3B Business Combinations

DUE DILIGENCE SIGNIFICANCE

Due diligence is a comprehensive and a cumbersome process carried out before finalizing any significant deal such as mergers, acquisitions or investments which comprises thorough inspection and scrutiny of a target company such as its assets, liabilities, risks, potential etc. to ensure the buyer/investor knows what they are getting into. This process is generally undertaken by acquiring a company or investors with the cooperation of an expert team of Lawyers, Accountants, Financial Analysts and Industry Specialists for reviewing documents, analyzing data and conducting on-site visits or interviews with key personnel sometimes. Though the process is tedious it ends up in protecting buyers from unanticipated issues and gives a clear picture of what they expect from the deal. For the seller victoriously passing due diligence is crucial as it would result in successful completion of deal gaining trust and confidence of investors/buyers in their business.

  1. Legal DD:
  • It is the most crucial part of due diligence consisting of navigating through tedious & complex legal regulatory framework.
  • Review of all the notable documents such as customer-service agreement, partnership agreements etc. 
  • Investigate any ongoing litigation, its history, current disputes and pending claims.
  • Evaluation of IP regulation, ownership, and registration, status of patents, trademark, copyrights, trade secrets & IP related disputes.

    2. Financial DD    :
  • Scrutinizing Target Company’s financial health is imperative including audited financial statements, interim financial reports etc. 
  • Examination of any debts/liabilities including loans, bonds, off balance sheet liabilities & thorough analysis of profit margins, sustainable earnings, etc. 
  • Understand working capital position, company’s liquidity, etc.

 

3. Tax DD:

  • Ensure compliance with local, international tax laws, VAT/GST, & other relevant taxes, transfer pricing policies.

 

4. Operational DD:

  • Assess if business operations, supply chain management, manufacturing processes etc. could create additional value in transaction or not.
  • Analyze IT infrastructures software, cyber security & other issues, if any, employee – contracts, compensation structure, labor agreements, etc.

 

5. Cultural DD:

  • The corporate culture, management style, employee values, communication style including language differences & communication preference, workplace practices, conflict resolution should be reviewed.

 

6. Corporate Governance Ethics:

  • Study the company’s corporate governance practices, internal control system, bond structure & adherence to ethical standards, anti-corruption policies, bribery regulations, etc.. 

 

7. Environmental & Social DD:

  • Assesses if the company has complied with environmental regulations, sustainability practices, environmental liabilities, labor practices & community engagement & its impact on brand reputation & stakeholder relationships.

 

8. Other risks:

  • Indemnifying any geopolitical risks which may influence company’s government policies, sanctions, business restriction, etc. 
  • Analysis of currency fluctuations on valuation of a target company & its impact on the deal will be worth studying. 
  • Understanding market dynamics including market share, competition, customer base, customer supplier relationships is a key.

RECENT & RENOWNED DEALS:

  • Allen & Ovary & Shearman & Sterling:

Beginning with the most prominent leading international law firms who announced their merger by creating a law firm with over 3,900 lawyers across 49 offices worldwide & the merged entity aims to leverage their strengths with extensive geographical reach to offer their best services to global clients worldwide.

  • Microsoft’s Acquisition of Activision Blizzard:

Two words capture the tenor of times in the gaming industry. Microsoft finalized a $68.7 billion deal to acquire Activision Blizzard. This could be termed as one of the arduous acquisitions as a 20 months battle was faced with UK & USA regulators. However, Microsoft managed to crack the deal by triumphing over the Federal Trade Commission in USA Federal Court & reconstructing the arrangement to mollify UK’s Competition & Markets Authority, the acquisition crossed the finished line on October 13, 2023 finally.

  • Vodafone Mannesmann 

This acquisition is a landmark case in the history of cross border mergers & acquisitions & took place in the year 2000. It was one of the biggest horizontal mergers in the telecom industry. The deal was time consuming including significant challenges such as cultural differences, regulatory scanning, financial crash, threat of political interference & so on. Nonetheless, this merger proved Vodafone to be the giant global player in the telecom sector.

KEY TRANSACTION DOCUMENTS

  1. Letter of Intent: 
  • It’s a written non-binding document which outlines an agreement in principle for buyer to purchase seller’s business stating proposed price & terms.
    2. Regulatory filings & approvals:
  • It consists of foreign investment approvals, securities law filings, antitrust filings & any other governmental consents.


3. Board Resolution & Shareholders approvals:

  • It comprises resolutions authorizing transactions, approval of transaction documents & any amendments to corporate charters & bylaws.4. Non-disclosure agreement:
  • It plays a vital role in protecting sensitive and confidential information exchanged in the negotiation process. 

 

5. Share Purchase Agreement:

  • This is the primary document governing sale/purchase of shares in the target company.

 

6. Asset Purchase Agreement:

  • Used when a transaction consists of purchase of specific assets instead of shares, purchase price allocation, representations & warranties, indemnities, closing conditions, etc.

 

7. Merger Agreement:

  • Used to outline terms under which two companies will combine & includes exchange ratios, representations & warranties, closing conditions, post-merger integration. 

 

8. Disclosure schedule:

  • It provides detailed information & exceptions to representations & warranties made in SPA/APA.

 

9. Term Sheet:

  • Summarizes key terms & conditions similar to letter of intent but meticulous in terms of tax structure, pricing, condition precedent & termination provisions.

 

10. Escrow Agreement:

  • Sets up an escrow to hold funds temporarily to ensure seller’s obligations & indemnities are met.

 

11. Transaction service agreement:

  • It governs provision of services by seller to buyer for a transactional period post-closing.

 

TAX CONSIDERATIONS:

  • If transfer is made for inadequate consideration & tax proceedings are on-going, then the transferor authorities can claim the amount from the transferee on proceedings completion.
  • No GST applicable to slump sale where all assets, rights, property, liability are transferred to transferee whereas where particular assets are bought GST is applicable. 
  • Section 50B implies tax implication of slump sale which applies to both domestic & Cross Border Mergers & Acquisitions transactions. Undertaker’s net worth is deducted from sale consideration to arrive at capital gains. If undertaking has been held for more than 36 months, LTCG (Long-Term Capital Gains) tax would apply & if the duration is less, then STCG (Short- Term Capital Gains) tax would apply. Any foreign currency consideration received in cross-border slump sale must be converted to INR at prevailing exchange rate on transaction date.
  • If acquisition is via selling shares, Securities Transaction Tax is payable by both buyer & if sales are sold through Stock Exchange, STT is imposed on purchase/sales of equity shares on the Indian Stock Exchange at 0.1% based on purchase/sales price.
  • When foreign company transfers shares of foreign company to another company & share value is procured from assets in India then capital gains derived on transfer will attract Income Tax in India.
  • Furthermore such shares payments are subject to withholding tax. Foreign company shares are deemed to derive value from Indian assets if such assets are valued at minimum 100 million & constitute at least 50% of asset value by such foreign company.
  • Transactions between parties in different countries must be conducted at arm’s length price which requires proper documents/compliance with transfer pricing regulations to tax penalty.
  • DTAA between countries could provide comfort from double taxation allowing tax credits/exemption which includes Slump sale also.
  • When a foreign (Parent) company owns an Indian subsidiary & this foreign company merges with another foreign company giving rise to newly formed company, this new company becomes the owner of the Indian subsidiary on the condition that at least 25% of the shareholders from original foreign company must also be shareholders in the new merged company & if this condition is met then the merger qualifies for certain tax exemptions.
  • A tax neutral status is provided where the resultant company is Indian (Inbound Merger) given transfer occurs through slump sale & shareholders continuing 3/4th of shares.

CONCLUSION

Cross border mergers & acquisitions are convoluted strategy becoming strenuous for the companies which desire to expand globally. Though it has got benefits, it also faces several challenges namely failure to integrate, political landscape, strategic, legal, accounting challenges, etc. Recently, cross border mergers & acquisitions noticed remarkable deals for instance Brookfield’s investment in Avaada Group which signifies ongoing globalization & sector specific trends. In order to navigate a successful deal, a thorough analysis of the above discussed is crucial which will circumvent perilous missteps, cultural clashes, etc. Meticulous study on latest happenings, peculiar case studies, commentaries provided by field experts provides valuable insights.

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