By Shreya Shrivastava
The COVID-19 pandemic has had a profound economic impact across the globe. The entire industrial sector has come to a halt and unemployment claims are soaring high with an all-time low demand, courtesy of government-mandated restrictions. It is quite obvious that this resulting market will likely bring a rise in instances of Mergers and Acquisitions [“M&A”] and would provide a breeding ground for hostile takeovers. In this blog, the author analyses the situation of M&A in India during pre-corona times and then moves on to analyze the latest amendment to FDI Policy in addition to highlighting the ambiguities in the amendment as well as answering the question as to whether this Chinese fear of domination is justified or not.
Takeovers, or acquisitions, are when one company, most often called Acquirer, acquires a major stake in another “Target Company” which gives it the controlling rights. This process is either friendly or hostile. Friendly takeovers are when the management of the Target Company is in agreement with the transaction and both the Acquirer and the Target Company consider it beneficial whereas in Hostile Takeover most often the Target Company is an unwilling participant, or simply, shark-bait. Hostile takeovers can come into force by the Acquirer directly approaching the shareholders of the Target Company by making an open offer or by putting up a fight to replace the management to get the approval for the acquisition.
Hostile takeovers have risen and are now an accepted phenomenon in the global corporate world. However, the situation remains quite contradicting in India where these takeovers are primarily governed by the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 [“Takeover Code”]. Despite this code putting no barrier on Hostile Takeovers, India has remained rather averse to this idea majorly due to, first, the presence of controlling shareholders in most Indian corporations and the significant shareholding of Indian financial institutions that generally side with these controllers, second, the necessity of getting hard to obtain government approvals for foreign acquisitions that would make hostile takeovers impossible, and third, provisions in the Indian Takeover Code favoring existing controlling shareholders.
Change in FDI Policy
There was an ongoing fear that foreign investors such as China might exploit this economic downturn in the wake of COVID 19 by acquiring businesses in India. Recent developments backed this apprehension. According to a recent paper published by Brookings India, the total current and planned investment by China in India is at least $26 billion. “Chinese companies have also invested in acquiring stakes in Indian companies, mostly in the pharmaceutical and the technology sectors, and participated in numerous funding rounds of Indian startups in the tech space. Another $15 billion approximately is pledged by Chinese companies in investment plans or in bids for major infrastructure projects that are as yet unapproved,” stated the paper, published on March 30. A few days ago, India was taken aback when it learned that the People’s Bank of China had upped its stake in HDFC to 1%. The Prime Minister’s Office has been receiving distress calls from various industrial bodies over this. It even received a letter from the Integrated Association of Micro, Small and Medium Enterprises of India, warning the government about the possibility of hostile takeover bids from Chinese investors, when Indian sectors are facing survival issues and their valuations are plummeting down amid the Covid-19 crisis. The Indian Council of Investors, an association group of investors, too had raised red flags on possible hostile Chinese takeovers.
In order to mitigate these potential concerns of hostile takeovers in India, the government modified its FDI policies. According to the revised FDI policy, “an entity of a country, which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route Before this, prior government approval was needed only for firms from Bangladesh and Pakistan to invest in India and investments from other countries were allowed under the automatic route subject to the sectoral caps and rules. The new rules imply that all Chinese firms now need to seek prior government approval before venturing into investments in India. It is hoped that this will impact not only the direct investment from China but also the investments by Chinese companies routed through other countries for their beneficial tax regime like Singapore and Mauritius.
There’s a possibility that these curbs on Chinese investments might have a significant impact on investment by Chinese players like Alibaba, Tencent, and Xiaomi in companies such as Paytm, Ola, Bigbasket, Byju’s, Dream11, MakeMyTrip and Swiggy for follow up funding. China has vehemently protested  this saying that these new norms violate the World Trade Organisation’s [“WTO”] principle of non-discrimination and are against the general trend of free trade. Indian trade experts have, however, said that India did not violate any norm of the WTO by making these FDI changes since the global body’s rules do not cover foreign investments.
While the intention of the government seems to be clear from the language and timing of the issuance of the press note, there appear to be certain ambiguities arising from the press note and the amendments to the Rules. The usage of the term “FDI” in the Press Note and the relevant amendments to Rule 6(a) of the Rules suggest that the restrictions are on investments that are construed as FDI which is defined under the Foreign Exchange Management (Non-debt Instruments) Rules, 2019  to mean “investment through equity instruments by a person resident outside India in an unlisted Indian company, or in 10% or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company”. Nowhere can it be implied that reference is made to investments by an FPI (Foreign Portfolio Investment) registered with SEBI which is permitted to invest in listed or to-be listed Indian companies’ securities, in the manner set out in Schedule II of the Rules or to investments under the FVCI (Foreign Venture Capital Investors) route, which is an investment in the securities of Indian companies operating in certain specific sectors, in the manner set out in Schedule VII of the Rules.
It is also unclear if these restrictions would apply to “foreign investments” (defined under the Rules to mean any investment made by a person resident outside India on a repatriable basis in equity instruments of an Indian company or to the capital of an LLP) in LLPs. The subject line of the press note only intensifies this ambiguity. It reads “curbing opportunistic takeovers/acquisitions of Indian companies”, without referring to LLPs, and the amendments to Rule 6(a) of the Rules, which only pertain to investments in equity instruments of an Indian company under Schedule I of the Rules.
Further, the requirement of seeking government approval might lead to many entities facing operational difficulties. For instance, the approval requirement seems to be applicable in all cases of further investments without any prescribed threshold. It does not pay any heed to whether or not such investments are in the form of a rights issue (where all or almost all existing shareholders also participate) or preferential allotments, making it difficult for entities to raise further capital, especially in the scenario where these entities already have existing investments from investors situated in countries like China. Further, there is no clarification about the applicability of the approval requirements where there is no change in the shareholding percentage of the investor pursuant to a follow-on investment.
It may be pertinent to note that there are presently no such equivalent restrictions under the ECB (Extra Commercial Borrowing) regulations, and therefore, an eligible borrower could avail ECB from a recognized lender (including a foreign equity holder in one of India’s neighboring countries which are FATF compliant) for any immediate funding requirements subject to the all-in cost ceiling, limits of ECB, etc. Having said this, it should be borne in mind that any conversion of the ECB or any part thereof, into shares of the Indian company, would be subject to the restrictions and approval requirements under the FDI policy and the Rules.
Furthermore, the definition of ‘Beneficial Ownership’ is left open for interpretation. In terms of Press Note, prior government approval will be required for any FDI wherein the ultimate beneficiary is a Chinese entity without delving into the ambit of ‘beneficial ownership’ and the method of computation for the same. While the Ministry of Corporate Affairs had issued guidelines for determination of ultimate beneficial ownership of companies, it was restricted to identification of ‘individuals’ who may be treated as ultimate beneficial owners, and the same determination will clearly not apply in the present case. It would be interesting to see as to how the government determines the ambit of beneficial ownership, considering that investors often have multi-layered structures, spread across various jurisdictions.
Since there is no clear indicator of ‘beneficial ownership’, it is quite possible that private equity (PE) funds which have investments from China (either by insurance companies/funds or sovereign funds) may now be required to seek prior government approval for any investments, even if such investors in PE funds are passive investors not exercising any control.
In addition, even minority investments/non-control investments by any foreign investor in a joint venture in India may require government approval, if the beneficial ownership of such foreign investors is determined to be held by Chinese entities.
It is recommended that the government/RBI should provide necessary clarifications on these ambiguities at the earliest. With there being no time limit regarding the applicability of these restrictions, all one can do is wait patiently to tell if these amendments to the Rules turn out to be a boon to the economy or otherwise.
Focus on China Justified?
It is interesting to note that the government is not concerned with possible suspected takeovers from any European or US-based entities, rather its attention seems to be focused on entities backed by the People’s Republic of China and there is a justifiable reason for this. China is known all over the world for its investments which economists believe are often opportunistic and are routed in areas where it seeks to increase its clout. The continent of Africa is an example of this, where China has in the past years, spent billions, seeking to increase its influence in the region. Heavy investments have been made in infrastructure projects, projects involving natural resources, and also in ports. However, all these efforts are turning out to be futile in the wake of allegations of widespread racism directed at African students studying in China who ironically were accused of being carriers of COVID-19. This resulted in Chinese envoys being summoned by many governments in Africa seeking answers about the ill-treatment of African students and their eviction from their places of residence in China, souring the China-Africa friendship.
Coming to the Indian borders, it is well-documented that China is looking forward to increasing its foothold in the region and has been constantly met with Indian Opposition. The China Pakistan Economic Corridor that aimed to give China access to ports is one such example of Chinese ingression in areas too close for India’s comfort. In fact, there are reports that say that China has increased its investments in infrastructure projects in Pakistan in light of this proposed project.
On the Indian front, Chinese investments in India have risen from $1.8 billion in 2014 to an estimated $8-9 billion in 2017. Greenfield investments have seen a substantial rise. Other Indian entities have seen an influx of Chinese investments into it. These are not minuscule rises in investments which can be ignored. This move of the Government to amend FDI policy may not be perfect, yet it should be seen as one which will ensure that no Indian entity will be impacted severely during these unpredictable times. India will come out of COVID-19, and when it does, there is absolutely no doubt that it would be in India’s best interest to have ownership of its entities intact and in Indian control.
The author is a second year student, currently pursuing their law degree from the Dr. Ram Manohar Lohiya National Law University, Lucknow.
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