M&A Due Diligence in India: Assessing Target Company Non-Compliance

We examine non-compliance actions that may be identified during the dealmaking process in India and their implications for foreign investors.

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In recent years, India has seen steady growth in mergers and acquisitions (M&A) and other investment activities. Yet, while the Indian government has prioritized simplifying compliance obligations to promote ease of doing business, India remains a compliance-heavy jurisdiction. This can surprise foreign investors accustomed to less stringent regulatory environments.

For foreign investors exploring M&A prospects with target firms in the Indian market, not all non-compliance are deal-breakers; their potential impact can vary depending on the nature of the non-compliance and the investor’s future plans for the target enterprise.

Amendments to Indian merger control regulations

The Indian merger control framework underwent significant changes, effective September 10, 2024, following the introduction of the Deal Value Threshold (DVT) and revisions to asset and turnover thresholds. These amendments modernize the regulatory environment in India, impacting businesses and advisors involved in dealmaking transactions.

1. Introduction of Deal Value Threshold (DVT):

• New criteria for notification to antitrust regulator, the Competition Commission of India (CCI): Transactions must be notified if:
  • The global deal value exceeds INR 20 billion (approx. US$238 million); and
  • The target has “substantial business operations in India” (SBO).
• Scope and applicability: Applies to pending, completed, and proposed deals signed before September 10, 2024. Includes global transactions and deals with interconnected arrangements.

2. Substantial Business Operations (SBO):

• SBO criteria include:
  • Gross merchandise value (GMV): At least 10 percent of global GMV and over INR 500 crore (approx. US$60 million) in India.
  • Turnover: At least 10 percent of global turnover and over INR 5 billion (approx. US$60 million) in India.
  • Digital sector-specific SBO: Entities providing internet services or digital content meet SBO if 10 percent of their annual average business users are in India.
• SBO assessment includes transitional arrangements and future considerations, adding complexity to compliance.

3. Expanded notification obligations:

• A broad approach mandates inclusion of all transaction-related considerations, increasing the likelihood of parties notifying to avoid regulatory risks.
• This could strain the CCI’s caseload and prefiling consultation mechanisms.

4. Changes to thresholds and exemptions:

• Asset and turnover thresholds: Revised to focus on transactions with potential competition concerns.
• De minimis exemption: Expanded to cover all transaction forms, excluding those triggering the DVT.

5. Material influence and control:

• Codification of “material influence” as a trigger for notification, broadening CCI’s jurisdiction over transactions that might affect management or strategic decisions.

Implications for businesses:

• The DVT introduces a significant regulatory hurdle for investments, especially in the digital sector, by capturing transactions that previously escaped review.
• Increased notification requirements and ambiguity in concepts like “material influence” could create uncertainty, underscoring the need for CCI guidance.
• While expanded thresholds and exemptions reduce the burden on SMEs, businesses must closely evaluate M&A deals to ensure compliance under the new regime.

Also read: India’s Anti-Trust Law Updates: Stricter Scrutiny, New Thresholds, and Faster Approvals

Dealmaking in India: Non-compliance actions and their punitive implications

Understanding the implications of non-compliance is crucial to addressing them effectively when seeking to negotiate M&A deals in India. In terms of India’s dealmaking landscape, these can be broadly categorized as follows:

1. Non-compliance attracting monetary penalties: These involve financial penalties that may vary in magnitude. For example, the failure to appoint a resident director may result in fines of up to INR 300,000 (approx. US$3,500) for the company and INR 100,000 (approx. US$1,200) per director. In cases where penalties accrue daily, such as non-compliance with registrar requests, costs can escalate rapidly. While monetary penalties are typically more straightforward to manage, challenges arise when such penalties cannot be determined in advance.
2. Non-compliance leading to imprisonment: Certain laws prescribe imprisonment for directors or officers responsible for compliance failures. For instance, the failure to pay gratuity contributions can result in up to two years of imprisonment, alongside monetary fines. While such instances are rare, foreign investors must evaluate the potential risk of imprisonment for the target company C-suite executives or senior management personnel.
3. Non-compliance affecting deal timelines: Some non-compliance, such as not issuing dematerialized (demat) shares or unfulfilled foreign exchange control reporting requirements, can materially delay deal closures. Addressing these issues in advance is crucial to avoid timeline disruptions.
4. Non-compliance impacting future business plans: Existing non-compliance might not immediately affect the deal but could hinder future restructuring or reorganization plans. For example, indirect transfers of Indian entities may face challenges if there are unresolved forex control non-compliance.

Strategies for addressing non-compliance during the dealmaking process in India

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Effectively managing non-compliance requires assessing their potential impact on deal value, timelines, and future business objectives. Foreign investors can adopt the following strategies based on the nature and implications of the non-compliance:

1. Rectification: Non-compliance actions can be rectified either as a pre-closing condition or a condition subsequent. For example, forex control reporting obligations may be best addressed by the seller before deal closure, leveraging their familiarity with past transactions.
2. Reduction in purchase consideration: Where monetary penalties are quantifiable and likely to materialize, parties may agree to reduce the purchase price to account for the non-compliance.
3. Negotiating specific indemnities in the contract: These are designed to protect the buyer against specific concerns that arise after disclosure and compensate the buyer for losses stemming from identified non-compliances. The terms, including monetary and time limits as well as minimum threshold amounts (de-minimis), are usually subject to negotiation.
4. Risk assumption by the buyer: If the non-compliance is minor or the associated risks are unlikely to materialize, the buyer may choose to assume the risk and address it through improved internal controls or housekeeping measures.

Conclusion

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Observing non-compliance in the target company in India need not derail the dealmaking process. However, thorough due diligence requires both impact assessments and tailored remedial strategies to mitigate risk exposure and ensure smooth transaction. By adopting a commercially pragmatic approach, foreign investors can navigate India’s compliance landscape effectively and achieve successful deal closures.

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