Like any other jurisdiction, cross-border investment in India needs to be undertaken with an understanding of legal and regulatory considerations, jurisdiction specific nuances and commercial deal points. Set out below is a high-level overview of some of the key legal and regulatory considerations for cross-border PE transactions involving unlisted companies in India.
Key regulations governing cross-border private equity investments
Parties to a PE transaction in India have to deal with various regulations in India depending on whether the transaction involves a foreign party, whether the investee is listed in India, the sector in which the investee operates and whether there are anti-trust issues involved.
The principal laws in India governing private equity investments and M&A are the Companies Act, 2013; the Indian Contract Act, 1872; the Foreign Exchange Management Act, 1999 (FEMA); the Income-tax Act, 1961; the Competition Act, 2002; and the Indian Stamp Act, 1899. In the case of listed entities in India, the regulations made by the public markets regulator, being the Securities Exchange Board of India (SEBI), are also applicable for transactions involving listed investee company.
The primary regulators for private equity transactions include the central bank of India, i.e., the Reserve Bank of India (RBI), SEBI, the Ministry of Corporate Affairs (for the Companies Act) and the Competition Commission of India (CCI). Various industries such as banking, insurance, broadcasting, civil aviation and defence have sectoral regulators which may set out certain conditions which apply or require approvals in case of private equity transactions. These could include change in control or acquisition of shareholding beyond specified thresholds, or provisions for transfer of licenses in case of regulated activities.
Structuring of cross border PE transactions
Most private equity transactions are typically structured through the primary or the secondary route, or a combination of both. Some of the key points to be considered for cross border PE transactions are:
- Capital controls: India does not have full capital account convertibility and despite recent relaxations of some of the capital controls (including allowing FDI in most sectors under automatic route), there are various conditions attached to foreign investments, such as sectoral caps for FDI, investment routes (FDI, FPI, FVCI), permitted investment instruments (equity or equity linked instruments), pricing (fair market value being the floor or cap, as applicable), modes of payment of consideration (deferred consideration, holdbacks or non-cash consideration), downstream investments and FDI screening. Moreover, exit rights providing assured returns or downside protections are not permitted. Deviation from conditions laid down under the exchange control laws require the prior approval of the RBI or the Government of India, as applicable. Therefore, the nature of investment instruments, consideration mechanism and its discharge, earn-outs, deferred consideration and pricing of exits are structured with due consideration to such capital controls.
- Regulatory / Anti-trust approvals: The transaction could require different regulatory approvals, consents and licenses depending on the industry / sector of the target, the shareholding percentage involved and the structure of the transaction. For Indian listed companies, any acquisition of shareholding beyond prescribed thresholds or acquisition of control, would trigger the requirement to make a mandatory tender offer under the takeover regulations. Parties should bear in mind the potential anti-trust related issues and consequential filings to be made with the CCI if certain prescribed thresholds or conditions are met. The feasibility and timelines of getting these approvals is an important consideration for the transactions.
- Tax considerations: As is the case with most jurisdictions, the extant taxation policies have a significant bearing on structuring and negotiation of private equity transactions in India as well. The tax treaties signed by the Indian government and the ensuing tax benefits (such as taxation of capital gains and dividends) may affect the decision of the PE investor with respect to the choice of jurisdiction of the investing entity as well as the investment instrument.
Key aspects of deal documentation
With the maturity and remarkable growth in the PE market in India in the last decade or so, the key provisions of deal documentation for PE investments have gradually evolved and largely mirror the UK or US market practice, subject to adaptation for Indian law. Transaction documents are usually investor friendly, except in situations of seller-led auction sales or where PE / institutional investors are the sellers.
Depending on the nature of PE investment (growth, minority or control), certain key contractual terms that have become well recognised and accepted as market practice include, extensive warranties with loss-based indemnities, conditions precedent, pre-closing covenants (including standstill and exclusivity/no shop), payment structures and mechanism (locked-box, post-closing adjustment, holdbacks, escrow, deferred consideration), termination, information and audit rights, governance / management rights, affirmative/veto rights on identified matters, transfer restrictions on shares (lock-in, claw-back, ROFO/ROFR, tag-along/co-sale), anti-dilution protection, pre-emptive rights, liquidation protection, exit rights, events of default, non-compete restrictions and dispute resolutions.
The typical exit modes preferred by PE investors include IPOs, private sales, strategic sales, drag along rights and buy-back/ put options. PE investors prefer to retain their flexibility in exercising any of the exit modes without any fetters.
Impact funds and the ESG aligned PE investors are now seeking inclusion of extensive ESG-specific warranties, adoption of ESG action plans, tailor-made sector-specific covenants related to ESG risk factors and robust default provisions (including accelerated exit and material breach) in case of breach of ESG commitments by the investee company in deal documents. This allows the investor to exit from companies that are not aligned on ESG principles.
As a matter of practice, most of the terms of shareholders’ agreement pertaining to governance, voting rights, information, share ownership and transfer restrictions, privileges, voting and various protective provisions are incorporated into the charter document / articles of association of the company for the purposes of enforceability.
Warranties and indemnity
Typically, private equity and M&A transactions in India incorporate comprehensive and detailed warranties with recourse to indemnity for breaches. It is fairly common to incorporate sandbagging provisions and for bring-down of warranties at closing. Warranties, qualifiers (materiality, knowledge and monetary) and indemnities are heavily negotiated in India. It is not uncommon to see detailed limitations on liability being negotiated and incorporated in the transaction documents. Some of the standard limitations include monetary caps (de-minimis, basket and aggregate thresholds) and time limits / survival periods (varies for fundamental, business and tax warranties), no double recovery and mitigation. Fraud is carved out from limitations on liability.
PE or institutional investors (with a minority position) provide only a limited set of warranties around capacity, authority, title to shares and share transfer taxes, in relation to sale of their stakes. However, in situations where the PE investor has a majority position / control in the investee company, PE investors agree to provide limited business warranties. In cases of share transfers involving a foreign seller, extensive warranties for share transfer taxes with tax indemnities for such transfer taxes are also negotiated. In such situations (particularly for high value deals), buy-side W&I insurance and tax insurance is preferred. W&I insurance obtained for India deals have APAC style coverage (and not US style coverage) where known issues are excluded.
Conditionality and deal certainty
While it is an acceptable practice to incorporate closing conditions in a PE transaction, sellers and investee companies always push back against non-critical issues being included as a condition precedent. Regulatory approvals, lender and third-party consents, MAC (material adverse change) and key due diligence issues that need resolution prior to closing are incorporated as conditions precedent. MAC clauses are being increasingly used in PE transactions in the last decade, more so in transactions involving a substantial time gap between signing and closing. However, the MAC triggers (monetary thresholds and materiality) as well as carve-outs to MAC are extensively discussed and negotiated.
Break-fees or reverse break-fees as deal protection measures are not very common in India. However, their use is steadily increasing in the bigger and more complex M&A deals or in auction sales. Such fees are a matter of contractual negotiation between the parties and there are no specific regulations dealing with such fees (including quantum or trigger). Moreover, inclusion and/or payment of such fees as a deal protection measure have not been tested before a regulator or court of law.
Anti-trust related trends in PE transactions
- The CCI is currently conducting a market study into the competition issues in the PE sector to better understand and address the potential anti-competitive outcomes.
- Common shareholding and interest: The CCI is increasingly scrutinizing common ownership of PE investors in competing enterprises. The concern stems from the potentially diminished incentive to effectively compete even in the absence of a controlling stake in competitors. In a recent case, where the PE investor was increasing its shareholding and continuing to be a minority shareholder with affirmative voting rights and board representation rights on the target group, the CCI considered the acquirer’s indirect overlap (through a related fund) with the target enterprise to raise anti-competitive issues. The CCI’s concern was that the common interest and, direct or indirect, influence, if any, of the acquirer group in the two competing companies, may raise the risk of softening of competition between the two prominent players. The acquirer offered voluntary commitments to not participate in or influence the affairs of the overlapping business of the target to alleviate the potential competition concerns to receive an approval with modifications.
- Common directorship: Common directors in portfolio companies and concerns regarding information sharing and reduction in competition have also been scrutinized by the CCI. In a transaction involving a PE investor’s increase in minority shareholding along with a seat on the board of directors of the target, the CCI was concerned with the acquirer’s shareholding and board representation in competing pharmaceutical companies. The acquirer offered voluntary commitments to remove the nominee director from the board of the competing company to address the competition concern and received an approval.
PE investments in India remain significant, which reflect the sustained interest and confidence of investors in the promising economic conditions and growth potential of India. Given the complex and ever-evolving regulatory environment, foreign PE investors should consider seeking expert counsel when exploring investment opportunities in India.
External sources:
PE/VC Agenda – India Trend Book 2024, by EY-IVCA at https://www.ey.com/en_in/news/2024/01/2023-records-us-dollor-49-point-8-billion-pe-vc-investments-across-853-deals-ey-ivca-report
India Venture Capital Report 2024, by Bain Capital-IVCA at https://www.bain.com/insights/india-venture-capital-report-2024/#:~:text=Emerging%20from%20a%20challenging%202023,strategies%20and%20tightening%20governance%20guardrails.
The India Growth Story – the role of private equity and the 3D reset at https://www.schroders.com/en-ca/ca/professional/insights/the-india-growth-story-the-role-of-private-equity-and-the-3d-reset/
