This article is written by Nikunj Arora, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.

Introduction

On November 1999, the UK-based company Vodafone AirTouch, which is the world largest mobile phone group, announced a takeover bid for Mannesmann AG, a German telecommunications and engineering group, based on share purchase, and acquired the latter on February 4, 2000. This cross-border transaction was the largest merger in history since January 1985, valued at more than US $190 billion. This acquisition topped the list for Merger & Acquisitions (“M&A”) in general. Cross-border transactions or cross-border M&A, in simpler terms, refer to a merger between a national company with an international company or merger of two companies which are located in different countries resulting in a third company. The domestic or national company can be either private or public or state-owned company. The cross-border merger will result in the transfer of authority or control to the merged or acquired company, on the other hand, in cross-border acquisitions, there is a transformation of assets and liabilities of the domestic company to the foreign company. The laws which usually govern cross-border mergers in India are the following:

• Companies Act, 2013,
• SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011,
• Foreign Exchange Management (Cross Border Merger) Regulations, 2018,
• Competition Act, 2002,
• Insolvency & Bankruptcy Code, 2016,
• Income Tax Act, 2016,
• The Department of Industrial Policy and Promotion (“DIPP”),
• Transfer of Property Act, 1882,
• Indian Stamp Act, 1899,
• Foreign Exchange Management Act, 1999 (“FEMA”), and
• IFRS 3 Business Combinations.

It should be recalled that cross-border M&As complete just when there are motivating forces to do as such. As such, both the foreign company and the home country should gain from the arrangement; otherwise, the arrangement would go bad. 

Given the reality that numerous homegrown firms in many developing business sectors exaggerate their capacities to pull in M&A, the foreign firms need to do their due diligence while considering an M&A manage a homegrown firm. This is the motivation behind why numerous foreign firms take the assistance of the board consultancies and investment banks before they adventure into an M&A bargain. 

Aside from this, the foreign firms additionally consider the danger factors related with cross border M&A that is a blend of political danger, monetary danger, social danger, and general danger related with black swan events. The foreign firms assess potential M&A accomplices and nations by framing a risk matrix made out of every one of these components and relying on if the score is fitting, they settle on the M&A bargain. Cross-border M&A needs administrative approvals just as political help because, without such encouraging elements, the arrangements can’t go forward.

Issues/challenges to consider

Issues related to the target country 

• Political/ Governmental Intervention: The intervention of government or various governmental provisions or various political laws during or after the transaction has become serious issues which companies go through. Some of the examples are listed as:

1. German AMV Foreign Investment restrictions: Germany revised its own 2009 FDI regime, the Außenwirtschaftsverordnung (“AWV”), administered by the Federal Ministry for Economic Affairs (“BMWi”) in July 2017. Recent AWV impacted deals include: Yantai Taihai’s attempted acquisition of aerospace/nuclear component manufacturer Leifeld Metal Spinning (BMWi prohibited in August 2018); State Grid of China’s attempted acquisition of a 20 per cent stake in transmission-operator 50Hertz (failed after the German government-owned bank KfW invested instead in August 2018). The AMV allows the government of Germany to freeze/block the acquisition transactions of 25% or more of the voting rights of the target company, provided that, the investor is located outside the European Union (“EU”) / European Free Trade (“EFTA“) and the acquisition is in the military sector or possesses a serious threat to a fundamental interest of society. 
2. EU-Wide Regime: The EU Commission has drafted legislation concerning foreign direct investment (“FDI”) on September 2017, which proposes coordination mechanisms between EU-countries and the Commission, including a power for the Commission to review investments in projects of wider EU interest and issue a non-binding, but influential, opinion (e.g., if not followed, an explanation of “why not” must be provided to the Commission).

• Financial markets/economic instability: Regarding investments and acquisitions, economic integration or economic instability affects cross-border transactions in various ways. For instance, economic integration shall put pressure on the companies in such transactions to undergo a restructuring process, both internally and externally. For example, in a study of 2007-2008 during the global financial crisis, the study examines the impact of the financial crisis in the form of the market of 13 sub-continentals, three sectors and 21 industries. The study concluded with a remark that the rate of growth in the number (value) of cross-border acquisitions has markedly declined to report to continentals and industries during the crisis.  
• Intellectual property regime in target country

1. During cross-border M&A transactions, Intellectual Property (“IP”) due diligence is often brought up either too late in the process to be effective or not at all, although the due diligence process shall be conducted as early as possible.
2. Furthermore, there may be disputes which may lead to exposure problems. In the course of pending litigations, third party claims, licencing agreement obligations, existing liens or encumbrances, security measures regarding data protection, etc. may disable the buyer company to exercise the power of disposition. Such cross-border transactions which involve IP have a higher risk of exposure to allegations of infringement. 

• Cultural Compatibility

1. The culture of the target company indicates the culture of the market being entered. Therefore, one way to gain an understanding of the market is by analysing or conducting due diligence of the company being acquired or merged with. 
2. There are various factors which define the culture integration such as awareness of partner’s corporate and national culture, leadership & leadership support, sufficiency and consistency of communication, etc. Culture clashes are already a given in any international or cross-border M&A. They could make or break the entire M&A process. Thus, it is important to pay as much attention to culture as you do to other aspects of M&A.

• Other issues/challenges

1. The complexity of the legal system where a lack of information about a legal system could lead to deadlock and a partial understanding of all parameters poses a risk of failure.
2. Antitrust issues make obtaining antitrust approvals a key part of the overall transaction process for many M&A transactions.
3. Currency fluctuations keep changing the valuation for the acquirer in the home country.
4. Tax policy if not stable and listed out clearly will scare away overseas acquirers. 

Hard issues relating to target country

• Tax considerations

Various countries’ tax reform’s fundamental changes to the taxation of multinational entities could particularly affect planning for cross-border deals. For instance: 

1. In 2018, Argentina’s new government made progress on structural reforms that attracted foreign direct investment, which affected major cross-border deals.
2. Columbia introduced a major tax reform in 2017. These tax reforms eased and simplified corporation taxation and also addressed tax evasion.
3. Tax losses cannot be passed on the buyer of a business. The difference between proceeds and tax value is usually taxable to sellers where the value of assets (some of them) realized exceed their tax values. 

• Key debt considerations

1. In India, the Reserve Bank of India (“RBI”) regulates the cross-border debt raised by Indian companies. Indian companies can access foreign debt through the external commercial borrowings route, or by issuing debt capital to foreign portfolio investors. This method is typically known as direct offshore funding. 
2. The firms with higher leverage are less likely to acquire foreign targets, whereas firms with lower leverage tend to be targets acquired by foreign firms. 
3. Firms adjust their capital structure after the acquisition by issuing more equity if they were overleveraged, or issuing more debt if they were underleveraged before the acquisition.

• Undisclosed liabilities

1. The acquirer company often insists on a wide No Undisclosed Liabilities representation because from the point of view of the buyer, the seller shall bear at least certain risk of undisclosed or unknown liabilities. 
2. The acquiree may argue that if the purchase agreement covers in detail all aspects of the target’s business, then why is broader representation needed or appropriate. 

Soft issues related to target company 

• Lack of proper communication channels

1. Communication is also required to enhance knowledge transfer and to help the integration of merging corporate structures and cultures (see here). Lack of communication may lead to culture clash, sometimes termed ‘merger syndrome’ and subsequently M&A failure (see here).
2. Continuous rather than intermittent fragmented communications are likely to help build a sense of trust, particularly if they are interactive (see here).
3. Strategic responsibility is a powerful idea and something that is fabricated or sabotaged during the M&A cycle. Communications may encourage obligation to the procedure of the merger going advances and impact representatives emphatically whenever conveyed in an ideal, nonstop and intelligent style.

FEMA Rules,  2019

The Foreign Exchange Management (Non-Debt Instruments) (Amendment) Rules, 2019, incorporated the following provisions which were not previously reflected in the Non-Debt Instruments (“NDI”) Rules.

• Hybrid securities: The preference shares or debentures or any other Government specified instrument can be transferred to a non-resident of India.
• E-commerce: e-commerce companies shall no longer include a foreign company or an office or branch or agency in India, owned and controlled by a person resident outside India conducting e-commerce business.

Foreign Portfolio Investors (“FPIs”): FPI could invest on a repatriation basis in other instruments as domestic mutual funds, etc.    

Inbound & Outbound Merger

Cross-Border Mergers can be either Inbound mergers or Out-bound Mergers. The former type of merger means a cross-border merger, where the resultant company is an Indian company, while the latter merger means a cross-border merger where the resultant company is a foreign company. A resultant company means an Indian company or a foreign company which takes over the assets and liabilities of the companies involved in the cross-border merger.

Provisions of the cross-border regulation 

• Issuance of securities: In the case of Inbound merger, The Indian company shall issue or transfer securities to the shareholders of the transferor company which may include both resident of India and non-resident of India. Such issuance of securities shall follow the pricing guidelines, sectoral caps, and other prescribed guidelines under the Cross-border regulation. In case the foreign company is a Joint Venture (“JV“), then it shall comply with the provisions of Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. When the inbound merger of the JV results into the acquisition of any of the subsidiary of JV of the Indian company, then such acquisition shall comply with the provisions of Regulation 6 & 7 of the Overseas Direct Investment (“ODI”) Regulation.

In case of an outbound merger, the Foreign Company would issue securities to the shareholders of an Indian company which may include both, resident of India and non-resident outside India. If shares are being acquired by a resident of India, then such acquisition shall be subject to the ODI Regulations as prescribed by the RBI.

• Vesting of assets & liabilities: In case of Inbound merger: Firstly, Any borrowings or guarantees of the transferor company shall become the borrowings or guarantees of the resultant company and a timeline of two years has been provided to conform with the external commercial borrowings compliance. The end-use restrictions would not apply in such cases. Secondly, any asset acquired by the resultant company can be transferred in any manner as permissible under the Act or regulations. Where such asset is not permitted to be acquired, the resultant company shall sell the same within two years from the date of sanction of an order by the National Company Law Tribunal (“NCLT”) and the sale proceeds shall be repatriated to India immediately through banking channels. Where any liability outside India is not permitted to be held by the resultant company, the same may be extinguished from the sale proceeds of such overseas assets within two years.

In the case of Outbound merger: Firstly, the guarantees or borrowings of the resultant company shall be repaid as per the scheme sanctioned by the NCLT. Further, they should not acquire any liability not in conformity with the Act or regulations as prescribed. A no-objection certificate to this effect should be obtained from the lenders in India of the Indian company. Secondly, any asset acquired can be transferred in any manner as permissible under the Act or the regulations thereunder. In cases where it cannot be held or acquired by the resultant company, it shall be sold within two years from the date of sanction of the scheme by the NCLT and the sale proceeds shall be repatriated outside India immediately through banking channels. Repayment of Indian liabilities from sale proceeds of such assets or securities within two years shall be permissible.

Valuation: The valuation shall be done as per Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016 i.e., by Registered Valuers who are members of recognized professional bodies in the prescribed jurisdictions of the transferee company and such valuation is following internationally accepted principles on accounting and valuation. 

Analysis of Etihad-Jet Airway deal

In 2013, Etihad Airways PJSC acquired a 24% stake in Jet Airways (India) Ltd. for $379 million (INR 2,060 crores). This acquisition transaction set a stage for the Mumbai-based airline (Jet Airways) to become the first beneficiary of a policy change that allowed foreign airlines to invest in domestic ones. The board of Jet Airways is controlled by a non-resident Indian businessman Naresh Goyal, who eventually approved the sale by way of preferential allotment of 27 million shares to Etihad at a price not less than INR 754.74 apiece. 

Legal, regulatory & tax considerations

1. Investment in Indian airlines is permitted up to 49%, however, Etihad purchased only 24% stake in Jet Airways. This is because under the Takeover Code if an acquirer acquires 25% or more of the voting power of the target company, it is required to make an open offer for a minimum of additional 26% shares from public shareholders. Hence, Etihad’s only 24% stake in Jet is to avoid the open offer obligations under the code.
2. Any investment into a domestic airline shall be first approved by the Foreign Investment Promotion Board (“FIFP”). Therefore, Jet (the target company) had filed for approval from the FIPB for the preferential allotment of shares to Etihad.
3. As no open offer was made by Etihad as per Regulation 3(1) and 4 of the Takeover Code, the deal was inspected by Securities and Exchange Board of India (“SEBI”) and finally on May 2014, SEBI held that an open offer would not be required under the Takeover Code. 
4. Competition Commission of India (“CCI”) approval: The issue that arose before the CCI was whether the Deal will cause an appreciable adverse effect on competition (“AAEC”) in India under Section 3 of the Competition Act. CCI with a 2:1 majority approved the combination, which crossed the threshold limit under Section 5 of the Competition Act. 
5. Under the FDI policy, any proposal with total equity inflow of more than INR 12,000 million requires the approval of the Cabinet Committee on Economic Affairs (“CCEA”). Thus, the arrangement got approved by CCEA. 
6. The entities also took into consideration the Bilateral Air Services Agreement (“BASA”) which was executed between India and UAE in 2013. 
7. Tax implications: The issuance of shares was done by way of preferential allotment; hence, there was no tax incidence on the parties. 

Therefore, the companies took into consideration all the above issues/challenges that were required to structure such a cross-border deal. 

Suggestions

The following are the possible suggestions to consider while structuring cross-border M&A deals:

1. There should be comprehensive Due-Diligence which may often involve a simple investigation or human resource due-diligence. Thus, reasonable steps shall be taken not only by the acquirer but also by the acquiree. 
2. The team set for cultural integration purposes in cross border mergers and acquisitions will have to ensure that new business culture is developed that will be inclusive of all the aspects as previously held by the cultures of the involved businesses.
3. The monopoly controlling policies shall be fully understood wherever there is a task to initiate a cross-border M&A exercise.
4. All the specifications and guidelines on how and when tax should be remitted to authorities once the cross border merger and acquisition venture has been initiated must be fully understood.
5. There should be a win-win strategy in a cross-border M&A transaction and both the companies shall be benefited with the same.
6. There may be strong communication or town hall meetings which can be fundamental to success. 
7. The acquirer shall strive to understand where the key and operational decision making in the target lies, i.e, whether at the promotional level or management level.
8. Flexible organisational structures are essential to ensure the ability to adopt cultural, social and other factors that vary across markets.

Conclusion 

Besides the above issues or challenges during a cross-border M&A transaction or before structuring such a deal, another impactful issue which is to be considered is the on-going COVID-19 pandemic. 

The current pandemic situation has changed all the aspects of a corporate transaction in every country and every state. However, the M&A activity has not come to a complete standstill. During the ongoing lockdown period, buyers should maintain focus on due diligence that can be achieved remotely, and sellers should ensure that they both set up and maintain an easy to use and comprehensive virtual data room. 

The current crisis represents an opportunity for the buyers to renegotiate the purchase price down, even late in the transaction timetable, and shall aim to shift the payment obligation as late as possible whether by way of earn-outs or other purchase price adjustments to counteract any forecast reduction in profits of the seller in the period following completion. The global business lockdown has created opportunities for Indian firms waiting with cash eyeing quality international assets. The telecommunication sector grew 220x in comparison to 2019 and the deal value increased by 19% primarily due to the deal in which Facebook acquired Jio Platforms from Reliance Industries for $5.73 billion. In the first half of the calendar year 2020, out of all deal categories like inbound, outbound and domestic, the greatest M&A deal activity was witnessed in the domestic category which recorded 179 deals compared to 38 inbound and 24 outbound deals. 

In China, the situation was different because, in the first five months of 2020, Chinese outbound M&A activity collapsed compared to previous years (Figure 1). 

The number of newly announced transactions dropped from around 90 per month in the 2016-2018 period to barely 30 per month between January-May 2020. Compared to the same period in 2019, new outbound deal-making by Chinese firms is down 71% in volume and 88% in value terms. Average monthly transaction values dropped from a peak of more than $20 billion in 2016 to $12 in 2018 and a mere $1.3 billion in 2020. So far this year, all companies in China combined have spent around the same amount on overseas acquisitions as HNA Group did in 2016 on one transaction – its purchase of a 25% stake in Hilton Worldwide Holdings ($6.5 billion).

This article is an attempt to analyse the issues while structuring a cross-border M&A. These points underscore how important it is for the domestic party and the international party to consider these issues while making a cross-border deal.  

References

1. https://www.grantthornton.in/globalassets/1.-member-firms/india/assets/pdfs/the-rise-of-the-cross-border-transaction.pdf
2. https://assets.kpmg/content/dam/kpmg/xx/pdf/2018/04/taxation-of-cross-border-m-and-a.pdf
3. https://www.goulstonstorrs.com/whats-market-blog/trends-in-ma-provisions-no-undisclosed-liabilities-representations
4. https://www.grantthornton.co.uk/insights/2018-setting-new-records-for-indian-ma/
5. https://www.fortuneindia.com/opinion/impact-of-gdpr-on-ma-transactions-in-india/102437
6. http://www.lawstreetindia.com/experts/column?sid=481
7. https://www.assocham.org/upload/event/recent/event_1205/Vijay_Paradkar.pdf
8. https://www.herbertsmithfreehills.com/latest-thinking/political-intervention-in-global-ma-the-development-of-foreign-investment-regimes
9. https://www.mondaq.com/turkey/corporate-and-company-law/1004980/intellectual-property-considerations-and-issues-in-ma-transactions
10. file:///C:/Users/Dell/Downloads/sustainability-10-02499.pdf
11. https://www.mondaq.com/india/maprivate-equity/695282/cross-border-mergers-key-regulatory-aspects-to-consider
12. https://www.globallegalinsights.com/practice-areas/mergers-and-acquisitions-laws-and-regulations/india
13. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Ma%20Lab/Jet-Etihad_Deal_Dissected.pdf
14. https://www.livemint.com/Companies/zY6HS6C2FeFMOncS2WeRML/Jet-AirwaysEithad-deal-may-finally-be-cleared-by-board.html
15. https://rhg.com/research/whos-buying-whom/

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