ABSTRACT
Assume for a moment that you are a financial investor acquiring less than 10% equity in a company, one board observer seat and certain veto rights. Would you be acquiring control of the company and need prior blessings of the competition regulator? On first blush, all you have done is made an investment, in the ordinary course of your business, and picked up a minority non-controlling stake in a company. "Business as usual" that should not require having to knock on the doors of the merger control gods? Unfortunately, that's not the case in India (assuming that the deal breaches the monetary thresholds stipulated for seeking the Competition Commission of India's (CCI) prior approval). In this article, we delve into why that is the case. We analyse how the Indian competition regulator approaches the acquisition of minority non-controlling interests by financial investors, ask if it is an appropriate regulatory approach and explore the way forward – both from the regulator's and the dealmaker's perspective.
INTRODUCTION
Globally, in the first quarter of 2023, institutional investors had raised USD 1.2 trillion1 and announced private equity (PE) deals worth USD 62 billion.2 However, it appears that the institutional investors have become victims of their own success. Lately, the acquisition of a minority (i.e., less than 25% voting rights) non-controlling interest (Minority Acquisition), typically made by financial investors such as PE and venture capital funds, has been subject to stricter anti-trust scrutiny in the United States of America3 and the European Union.4 In India, as well, Minority Acquisitions find themselves on shaky ground. In this context, this Article looks at the broad contours of the Indian merger control regime and the stance of the CCI on Minority Acquisitions. We assess where we are, ponder if it's a good place to be at and explore where we can go from here.
A. THE CCI AND MINORITY ACQUISITIONS – WHERE ARE WE?
Before diving into the murky waters of the regulation of Minority Acquisitions in India, a brief overview of the Indian merger control regime would be helpful.
Indian Merger Control Regime – A Brief Overview
Under the Indian merger control regime, a transaction needs to be notified to the CCI for its prior approval, if it: (a) breaches certain asset and turnover related thresholds;5 and (b) cannot avail of the target exemption[6] or any exemption set out in Schedule I of the CCI (Procedure in regard to the Transaction of Business relating to Combinations) Regulations 2011 (Combination Regulations) or in any other government notification. The exemptions covered under Schedule I of the Combination Regulations are referred to as Schedule I Exemptions.
It is pertinent to note here that a recent amendment made by the Competition (Amendment) Act, 2023 (Amendment Act) to the Competition Act, 2002 (Act), that is yet to enter into force, seeks to introduce a deal value threshold (DVT) in the Indian merger control regime. Once the DVT is implemented, it is expected that transactions: (a) with a deal value in excess of INR 2,000 crore; and (b) where the target enterprise has "substantial business operations in India", will also require prior approval of the CCI.7 Strangely, Schedule 1 Exemptions are not included in the proposed revised CCI (Competition Commission of India (Combinations) Regulations, 2023 (Revised Combination Regulations).8 It remains to be seen if Schedule I Exemption will continue to be force once the Revised Combination Regulations come into effect.
Exemption for Minority Acquisitions
The exemption for Minority Acquisitions is contained in Item 1 of the Schedule I Exemptions (Item 1 Exemption). To avail of the Item 1 Exemption, the acquisition should:
a. not entitle the acquirer / its group to hold 25% or more of the total shares / voting rights of the target; and
b. be made either solely as an investment (SIP) or in the ordinary course of business (OCB); and
c. not lead to an acquisition of 'control'.
A transaction is deemed to be SIP if less than 10% interest is acquired in the target and the acquirer has met the following cumulative requirements: (a) acquirer has not acquired any special right in the target (not available to ordinary shareholders); and (b) acquirer does not have a director in the target; and (c) the acquirer does not have a right or intention to nominate a director in the target nor does it intend to participate in the affairs or management of the target. Notably, the 10% threshold includes within its scope acquisition of options, warrants, convertible instruments, etc. regardless of when such instruments may be converted into equity. Further, while the term 'OCB' is not defined, it has been interpreted by the CCI through its decisions (as discussed below).
Dilution of Item 1 Exemption
On a plain reading of the Item 1 Exemption, it appears to have been designed to provide a safe harbour to minority non-controlling investments made by passive financial (non-strategic) investors as part of their routine investment activities. However, as discussed below, an increasingly narrow interpretation of the Item 1 Exemption by the CCI has diluted it significantly:
a. Lowering of the threshold of 'control' – Prior to the publication of the Frequently Asked Questions (FAQs)9 by the CCI in September 2022 (that are non-binding in nature and reflect the approach of the CCI), the CCI used to oscillate between the decisive influence standard10 and the material influence standard11 and gradually moved to material influence standard for the assessment of control. Now, the FAQs explicitly state that holding material influence over the target (i.e., the lowest level of control on the spectrum of control) implies control. The FAQs further clarify that 'material influence' may be inferred from a wide range of factors such as the shareholding and statutory rights held in the target, veto rights, consultation rights, rights to participate in the affairs and management of the target, board rights, expertise of the acquirer / person involved, board representation, structural or financial links with the target and commercial realities. In fact, acquisition of a board seat and/or an observer right coupled with certain veto rights, has been considered to trigger a filing. Needless to say, the material influence standard is highly subjective in nature. The Amendment Act, in provisions yet to enter into force, incorporates the material influence standard in the definition of 'control' as provided under the Act, which will further dilute the benefit of Item 1 Exemption.
b. Disregard for 'minority protection rights' – The FAQs clarify that the Item 1 Exemption is agnostic to the nature of rights being acquired. In other words, if any right is being acquired that is not available to an ordinary shareholder of the target, it will be deemed to be a special right regardless of its nature (i.e., whether a minority protection right or an information right). This approach also finds echo in Trian Partners AM Holdco, Limited / Invesco Limited (Trian Order)12 and PI Opportunities Fund – Pioneer Investment Fund / Future Retail Limited (PI Opportunities Order).13
c. Death knell for OCB – Over the years, the CCI has interpreted OCB in an increasingly narrow manner. In 2018, in Reliance Jio / Reliance Communications,14 the CCI interpreted OCB transactions to include transactions that were in the nature of revenue transactions (as understood for accounting purposes and to be determined by having regard to the business in question) and were 'frequent, routine and usual' in nature. The CCI clarified that 'revenue transactions' referred to short term transactions that were reflected in the profit and loss account or income statement of the enterprise. Subsequently, in March 2022, following the CCI's verdict in TPG / Busybees,15 the position of law relating to OCB was narrowed further – OCB would be available only if the intention of the acquisition was to benefit from the price movement of securities; and not be available if the acquirer could: (i) participate in the affairs of the target; or (ii) access commercially sensitive information (CSI) of the target. Finally, in September 2022, in the Trian Order[16] and PI Opportunities Order,17 the CCI held that 'an investment' is in the nature of a capital account transaction (i.e., transaction that alters the long term asset / liability of a company), and therefore precludes applicability of OCB. The current FAQs also echo this approach. Given this increasingly narrow approach to interpretation of OCB, it has been reduced to a sleepy paper tiger.
Increasing concerns about common ownership
Alongside the narrowing interpretation of Item 1 Exemption, concerns are rising regarding another phenomena that may be linked to Minority Acquisitions, viz. common ownership (CO). CO refers to an investor's parallel minority interest in competing firms in the same industry.[18] The CCI has also echoed concerns regarding CO. So far, the CCI's rising cognizance of CO related concerns have manifested in two ways: (a) as part of the remedies (mostly voluntary) involved in merger cases,19 and (b) as part of its observations in some of its orders.20 In 2018, in Meru / Uber,[21] (a case relating to abuse of dominance related allegations) the CCI articulated two theories of harm which may arise from CO, viz.: (a) unilateral effects, such as unilateral price / quality changes, which may harm one portfolio firm and benefit other portfolio firm/s of the common investor; and (b) coordinated effects, where CO facilitated collusive behaviour amongst competing firms. Whilst more clarity is expected on the CCI's position on CO in its proposed (and long awaited) market study on PE transactions (PE Market Study), 22 it is clear that the CCI is cognizant of the competition concerns that may arise from CO.
B. IS THIS A GOOD PLACE TO BE?
Given the CCI's strict stance on Minority Acquisitions, a very technical interpretation of 'special rights' and SIP, a very wide interpretation of what may constitute 'control', the effective dilution of OCB, and increasing concerns regarding CO, the dealmakers find themselves treading on a very tight regulatory rope. Apart from being onerous for businesses, we discuss below why dilution of Item 1 Exemption may also be legally dicey.
The narrowing interpretation of the Item 1 Exemption sets a bad precedent in law, as it is contrary to the tenets of statutory interpretation. The Schedule I Exemptions are in the nature of exceptions to the rule under Sections 5 and 6 of the Act that mandate prior notification of transactions that meet certain thresholds. Regulation 9 (4) of the Combination Regulations clearly states that transactions such as those listed in Schedule I need not be normally notified as they are ordinarily not likely to cause an appreciable adverse effect on competition in India. Specifically, the Item 1 Exemption aims to filter out minority non-controlling acquisitions made SIP or in the OCB. Notably, the CCI itself has previously stated that the underlying intention behind introducing the Item 1 Exemption (and the subsequent amendments to the Item 1 Exemption) is 'providing relief to corporate entities from making filings for combinations which are unlikely to raise adverse competition concerns, reduce their compliance requirements, make filings simpler and move towards certainty in the application of the Act and the Combination Regulations'.[23] Accordingly, the overall objective of Schedule I Exemptions was to reduce the burden on the parties in cases of non-problematic transactions. This would also assist the CCI in prioritising transactions which were more likely to be problematic. A very narrow interpretation of the Item 1 Exemption effectively nullifies the statutory exemption and therefore runs counter to the legislative intent. The Supreme Court of India (SC) has time and again upheld the principle that legislative intent should guide statutory interpretation.24 Further, the SC has warned against both too strict and too narrow interpretation of provisions.25 Accordingly, a purposive and nuanced interpretation of Item 1 Exemption is the need of the hour.
Further, with the formalization of material influence as the standard for the assessment of 'control', the imminent implementation of DVT,26 and the dilution of the Item 1 Exemption, the floodgates of notifications have been laid open. In such a situation, deals that do not involve a change of control may also increasingly need to be notified leading to a deluge of precautionary filings. This may have a crushing effect on the already swamped and understaffed CCI and may be counterproductive for all stakeholders involved – the industry as well as the regulator.
C. WHERE DO WE GO FROM HERE?
While it is nobody's case that Minority Acquisitions should be handed a free pass, its regulation needs to be informed by commercial and ground realities, and be proportionate to the mischief it seeks to check. Regulation of Minority Acquisitions in India has veered far from these tenets of good regulation, as discussed below.
Recommendations on regulatory approach
To begin with, not all Minority Acquisitions raise competition or CO related concerns. For instance, acquisition of information rights regarding financial performance of a company based on audited statements, or affirmative vote rights to prevent leakage of value from a company, cannot be placed on the same footing as the right to nominate a director or possessing an affirmative vote right in relation to operational matters of a company. Passive financial investors need to be differentiated from active minority investors.
The regulator also needs to be cognizant of the abilities, incentives and deterrents already in place for the investors, their nominee directors and the target firm's management. Typically, a minority shareholder (mostly holding negative control) cannot drive management decisions of a company.27 Another key question to ask is why the company management would defer to the wishes of a minority investor. The incentives to act in anti-competitive manner need to be weighed against deterrents such as reputational risk arising from taking compromised calls vis a vis the company, cost of oppression and mismanagement lawsuits under the Companies Act, 2013 and breach of contractual obligations in the employment agreements. One must also not forget that nominee directors of PE funds, in the case of same sector investments, are also regulated by the Securities Exchange Board of India (Alternative Investment Funds) Regulations, 2012, as amended (AIF Regulations).28 Illustratively, the fund managers are obligated to disclose any conflict of interest to their investors,[29] act in accordance with a codified code of conduct,30 and are required to institute written policies and procedures to identify, monitor and appropriately mitigate any potential conflict of interest throughout the scope of its business.[31]
On a more academic note, there is very little evidence to support that CO leads to competition concerns.32 Before assuming that Minority Acquisitions can lead to coordinated effects, it is important for the regulator and think tanks to undertake studies and develop tools, such as the Modified Herfindahl Hirschman Index (MHHI) (that is used to measure market concentration on account of CO, since the traditional Herfindahl Hirschman Index does not account for the effects of CO), to study the correlation between CO and market concentration.33
Another policy recommendation is to factor in the pro-competitive effects of Minority Acquisitions - such as bringing professional management to the table, overall increase in shareholder value and productivity of the target, and boosts to innovation and operations on account of capital availability.
Recommendations to the dealmakers
From the perspective of dealmakers, given the current regulatory environment on Minority Acquisitions, it is important to tread cautiously. Dealmakers should be aware that Minority Acquisitions can trigger a CCI filing if any right that is not available to the ordinary shareholder of the target is being acquired / proposed to be acquired (regardless of the nature of such right). Further, there should be no action taken or internal documentation (much less public statements) from which the CCI may infer the intention of the acquirer to assume any board right / control of the target, in any manner.34
Next, if the acquirer has any interest in a business that competes with that of the target, care should be taken to exchange any CSI only on a clean team basis, after securing proper legal advice. In such cases, the transaction documents need to be drafted carefully to ringfence against any regulatory curveballs. One may consider providing for a longer timeline for CCI approval, enhanced cooperation obligations on the target, reverse termination fees, etc.
Importantly, institutional investors should be careful not to appoint the same individual as nominee director / representative on the board of competing firms. Not only this, should an investor hold interests in firms within the same sector, extreme caution should be observed to ensure that there is no exchange of CSI pertaining to the competing firms; and internal processes and protocols should be strictly observed to avoid cross pollination of CSI and / or any other person in the investor firm acquiring CSI regarding competing target firms. Chinese walls, iron curtains and information barriers should not just be corporate buzzwords but part of the firm culture and protocols. Robust internal governance, transparency and adherence to extant regulations should be a top priority for any institutional investor. It is important to eliminate any risk of reputational damage, which may sully any future engagements with the CCI.
To circle back, where do we go from here? While the dealmakers should be careful not to set off explosions while treading the minefield of Minority Acquisitions, it behoves the regulator to take a considered view of the market dynamics, and not throw the (Minority Acquisition) baby out with the (interventionist) bathwater.
Footnotes
1. See, Private Equity Pulse: Takeaways from 1Q 2023, Ernst & Young, available at: https://www.ey.com/en_gl/private-equity/pulse.
2. Ibid.
3. See, Private equity's favorite way to make acquisitions may be illegal, FTC chair Lina Khan says, Paige Hagy, Fortune, 20 July 2023, available at: https://fortune.com/2023/07/19/private-equity-ftc-mergers-acquisitions-rollup-strategy-lina-khan-antitrust/. See more on this, United States: 4 Areas Of Heightened Antitrust Risk In Private Equity, Ann O' Brien and Lindsey Olson Collins, 29 May 2023, available at: https://www.mondaq.com/unitedstates/antitrust-eu-competition-/1321574/4-areas-of-heightened-antitrust-risk-in-private-equity.
4. See, DG Comp Looking into Common Ownership, Says Vestager, Global Competition Review 19 February 2018, available at: https://globalcompetitionreview.com/article/1159160/dg-comp-looking-into-common-ownership-says-vestager
5. See Section 5 of the Competition Act, 2002.
6. If the target enterprise / portion of asset or business proposed to be acquired has either assets of less than INR 350 crores (~ USD 42.5 million) in India or turnover of less than INR 1000 crores (~USD 121.6 million) in India, then the transaction is not required to be notified to the CCI for its prior approval. This exemption is valid till 27 March 2027.
7. The CCI released a draft of the (revised) Competition Commission of India (Combinations) Regulations, 2023 for public comments on 5 September 2023. The public comments were accepted till 25 September 2023. The Amendment Act as notified by the government is available here.
8. See, Background Note and the Revised Combination Regulations.
10. Independent Media Trust / RB Mediasoft Private Limited, 28 May 2012, available at: C-2012/03/47.
11. UltraTech Cement Limited / Jaiprakash Associates Limited, 12 March 2018, C-2015/02/246.
12. See Para 41 and Para 46, Trian Order, available at: C-2021/01/810.
13. PI Opportunities Order, available at: https://www.cci.gov.in/images/caseorders/en/1666179771.pdf.
15. TPG Growth V SF Markets Pte. Limited / Busybees Logistics Solutions Private Limited, 23 March 2022, available at: C-2022/02/905.
16. See supra 11.
17. See supra 12.
18. See, Mere Common Ownership and Antitrust Laws, Thomas A. Lambert, 61 B.C. L. Rev. 2913.
19. See C-2016/11/459. Voluntary commitments are provided at Para 25, See, C-2018/09/601. Voluntary commitments are provided at Para 18, Canary Investments Limited and Link Investment Trust II, Combination Registration No. C-2020/04/741, See C-2023/04/1017. Voluntary commitments are provided at Para 10.
20. Ibid.
21. See Para 46 and Para 52, Meru Travel Solutions Pvt. Ltd v. M/S ANI Technologies & Ors, Case No. 25-28 of 2017
22. See comments of Mr. Ashok Kumar Gupta, available at: https://www.business-standard.com/article/finance/competition-commission-to-study-ownership-patterns-of-pe-investors120120400618_1.html.
23. CCIs Annual Report, 2011-12, Page 33, Para 2, available at https://www.cci.gov.in/sites/default/files/annual%20reports/CCIANNUALREPORT201112ENGLISH.pdf.
24. In Balwant Singh v Jagdish Singh & Ors. [2010] 8 S.C.R. 597 (Para 4), available at: https://main.sci.gov.in/pdf/SupremeCourtReport/2010_v%208_piii.pdf.
25. See BSES Ltd. v. Tata Power Co. Ltd. [(2004) 1 SCC 195], Kameshwar Singh Srivastava v IV Additional District Judge Lucknow and Ors, [1987 AIR 138].
26. See supra 7.
27. See, Lucian A. Bebchuk, Alma Cohen & Scott Hirst, 31 J. ECON. PERSP. 89, 110 (2017) "An understanding of agency problems of institutional investors leads to the conclusion that modern corporations do not suffer from too much shareholder intervention, but rather from too little."
28. Available at:
29. Regulation 21, AIF Regulations.
30. Regulation 20, AIF Regulations, Fourth Schedule AIF Regulations.
31. Part 1, Fourth Schedule, AIF Regulations.
32. See, Antitrust for Institutional Investors, Edward B Rock and Daniel L Rubinfeld, NYU Law and Economics Research Paper No. 17-23, (2017); Fiona Scott Morton & Herbert Hovenkamp 127 YALE L.J. 2026, 2031 (2018).
33. See, O., Teodoro, A. Alternative approaches to measuring concentration in liner shipping. Marit Econ Logist, 723–746 (2022). https://doi.org/10.1057/s41278-022-00225-x.
34. See PI Opportunities Order. For guidance on how to deal with internal documents from merger control perspective, please see India: Internal Documents: Relevance In A Merger Control Regime, Aparna Mehra and Ritika Sood, September 2021, available at: https://www.mondaq.com/india/antitrust-eu-competition-/1112390/internal-documents-relevance-in-a-merger-control-regime.
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