This article briefly discusses the treatment of minority investments under the Indian merger control regime and its implications for private equity funds.
Introduction to Indian merger control regime and minority investment exemption
An acquisition of one or more enterprises or merger or amalgamation of enterprises, where certain prescribed assets or turnover thresholds ("Jurisdictional Thresholds") are exceeded needs to comply with the merger control provisions provided in Sections 5 and 6 of the Competition Act, 2002 ("Act") and the Competition Commission of India (Procedure for transaction of business relating to combinations) Regulations, 2011 ("Combination Regulations").
The Combination Regulations also provide for certain exemptions for minority investments for transactions where the parties exceed the Jurisdictional Thresholds (and do not benefit from the de minimis exemption).
Regulation 4 of the Combination Regulations read with Schedule I provides a list of transactions that would ordinarily be unlikely to cause an appreciable adverse effect on competition in India, and therefore a merger notification for such transactions need not normally be filed with the Competition Commission of India ("CCI").
Of particular relevance to the private equity space is the exemption under Item 1 of Schedule I pertaining to minority investments, which applies to acquisitions:
1. made 'solely as an investment' or in the 'ordinary course of business';
2. which do not entitle the acquirer to hold 25% or more of the total shares or voting rights of the target company; and
3. do not lead to the acquisition of 'control' of the target.
(collectively, "Minority Acquisition Exemption").
In 2016, an explanation was added to the Minority Acquisition Exemption which clarified that an acquisition of less than 10% of shares or voting rights shall be treated as 'solely as an investment' if the following conditions are met:
- the acquirer possesses only such rights exercisable by the ordinary shareholders of the target;
- the acquirer is not a member of the board of directors of the target enterprise and does not have a right or intention to nominate a director on the board of directors of the target enterprise; and
- the acquirer does not intend to participate in the affairs or management of the target enterprise.
- (collectively, "Sub-10% Exemption").
Application of the Minority Acquisition Exemption by CCI
For the applicability of the Minority Acquisition Exemption, all the three requirements must be met and the applicability of the exemption is required to be tested on a case-by-case basis.
'Solely as an investment' or 'Ordinary course of business'
The CCI has interpreted 'ordinary course of business' to mean 'frequent, routine and usual' and that "the activities for which business is established would be the activities in ordinary course" [Bharti Airtel Limited, (C-2017/05/509)], whereas the phrase 'solely as an investment' means 'passive investment' and any investment in a target enterprise which is done with a strategic intent cannot be treated as 'solely as an investment'. [Zuari Fertilisers and Chemicals Limited/ Zuari Agro Chemicals Limited, (C-2014/06/181)].
Based on the decisional guidance of the CCI, a minority investment would not be considered as being 'solely as an investment' or in the 'ordinary course of business' if:
1. if the transaction is a repeat investment by an acquirer in the same sector (the CCI considers such investments to be strategic even if made by a private equity investor); or
2. the parties to the transaction are competitors or are virtually situated [New Moon BV (C-2014/08/202)].
In a recent case of April 2020, the CCI observed that, "…[a] holistic appreciation of the shareholding and the nature and extent of rights acquired in the target enterprise would be relevant in determining whether the given acquisition is a mere investment or not. Representation on the board of directors (nomination of a director or an observer) and/or its committees (audit committee, appointment & remuneration committee, etc.); veto or consultation rights with respect to strategically important corporate actions such as change in capital structure, mergers and acquisitions, appointment or termination of key managerial personnel, amendment to charter documents (articles of association and memorandum of association) and commencement of new line of business; and the right to access non-public information, are all relevant in determining whether the acquisition is a mere investment or strategic in nature." [Canary Investment Limited/Link Investment Trust II/Intas Pharmaceuticals Limited, (C-2020/04/741)].
The CCI has held that a board seat and/or affirmative rights enjoyed by a minority shareholder over certain strategic commercial decisions of the target are sufficient to be considered as (joint) control, even though the acquisition of shares/voting rights is of less than 25%. These control rights include, but are not limited to, a single board seat and/or veto rights over: (i) appointment and termination of key managerial personnel (including material terms of their employment); (ii) approval of the business plan; (iii) approval of budget; (iv) entry or exit into lines of businesses, or (v) amendment to the memorandum of association or articles of association.
Pertinently, while following the decisive influence standard for several years, in Ultratech, (C-2015/02/246) the CCI lowered the threshold for control to 'material influence', which is internationally recognised to be the lowest threshold for control.
In 2019, the Competition Law Review Committee recommended that the concept of 'control' be clarified and a list of minority rights which would not be considered to confer control be introduced.2 In February 2020, the Ministry of Corporate Affairs, released a draft Competition (Amendment) Bill, 2020 ("Amendment Bill"), which proposed to amend the definition of 'control' to include the ability to exercise 'material influence' over 'management or affairs or strategic commercial decisions'.
In order to avail of the Minority Acquisition Exemption, the total shares or voting rights acquired pursuant to the acquisition must not be more than 25%. In case of convertible instruments, this exemption would not be available in case the acquirer would acquire over 25% of shares or voting rights post conversion.
Application of the Sub-10% Exemption by CCI
The criteria for the application of the Sub-10% Exemption means that its application will be limited and is intended to cover retail transactions undertaken on the stock exchange which do not confer any rights to the acquirer (apart from ordinary shareholder rights).
31 acquisitions of less than 10% stake have been notified to the CCI since the introduction of the Sub-10% Exemption in 2016. In many of these transactions, the stake being acquired was less than 10% with no additional rights except the right to nominate a single director to the board of the target enterprise.
There have also been peculiar instances where merger notifications have been filed with the CCI for transactions which prima facie appear to have been eligible for the Sub-10% Exemption. However, such filings appear to have been made by way of abundant caution as there were existing commercial relationships between the parties [Amazon.com NV Investment Holdings LLC/Shoppers Stop Limited, (C- 2017/12/538) and Amazon.com NV Investment Holdings LLC. / Quess Corp Limited, (C-2019/08/680)].
Assessment for private equity
Private equity funds often invest in multiple companies in the same sector. However, given the restricted scope of the Minority Acquisition Exemption, several private equity players have had to notify minority investments with the CCI owing to the (i) investor protection rights under the transaction documents being considered as conferment of control by the CCI, and/ or (ii) transactions being repeat investment in the same sector therefore being considered as 'strategic' investments by the CCI.
In a recent transaction, ChrysCapital acquired approximately 6% stake in Intas Pharmaceuticals along with a board seat and veto rights. Given the overlaps between the ChrysCapital's existing investee company i.e. Mankind Pharma and Intas Pharmaceuticals, high market share of certain overlapping products and state of competition, ChrysCapital voluntarily offered to remove their director on the board of Mankind Pharma as a condition for approval for the acquisition of stake in Intas Pharmaceuticals. [Canary Investment Limited/Link Investment Trust II/Intas Pharmaceuticals Limited, (C-2020/04/741)].
Accordingly, the CCI views the issues surrounding common shareholders in competing enterprises such as interlocking directorates and access to information very seriously, and therefore the private equity funds should be careful in their dealings while investing in competing entities.
There is an adage that if it isn't broken, then don't fix it. The CCI precedents have already reduced the applicability of the Minority Acquisition Exemption for private equity funds, and the further lowering of standard for 'control' as proposed by the Amendment Bill should not be adopted.
Internationally, the 'material influence' standard is followed by United Kingdom where there is a voluntary (and not mandatory / suspensory) merger control notification regime. The European Union follows a 'decisive influence' standard, which is what the CCI has largely relied on. The adoption of the material influence standard will lead to an unnecessary burden on the industry to notify transactions on the basis of special status etc. The CCI always has the ability to enquire into a transaction which was notifiable but was not notified, and as such, this lowering of the standard of control is not required.
1. The author is Partner and National Head - Competition Law, Trilegal and can be reached at firstname.lastname@example.org. She would like to acknowledge the research by Gautam Chawla, counsel, and Aditi Khemani and Simran Kathuria, associates in the competition practice at Trilegal.
2. By way of full disclosure, the author was part of the working group of the Competition Law Review Committee appointed by the Government of India.