Private Equity

Defining and Identifying ‘Group’ Entities – The Slippery Slope of ‘Control’

Published In:Inter Alia Special Edition Competition Law October 2018 [ English ]

Competition regulators rely primarily on information furnished by parties notifying transactions, while assessing the potential impact on competitive conditions. To ensure that notifying parties provide all the information necessary for regulators’ assessment, merger control regulations usually contain a laundry list of information that must accompany merger notifications. Merger control regulations also empower regulators to seek additional information from notifying parties as well as third parties during their review process. As an extraordinary measure, merger control regulations empower regulators to take punitive actions against notifying parties for providing incorrect information or withholding information that the regulator considers material for their review.

Exercising its power to penalize companies for material non-disclosure for the very first time, CCI recently penalized UltraTech Cement Limited (‘UltraTech’) for not disclosing the details of shareholdings of Kumar Mangalam Birla (and his family members) (‘KMB’ / ‘KMB Family’) and the companies owned/ controlled by them in companies competing with Jaiprakash Associates Limited whose cement manufacturing plants were being acquired by UltraTech (‘Decision’). While this Decision marks the beginning of CCI’s use of its powers under Section 44 of the Competition Act, 2002 (‘Act’), it equally increases the scope of disclosures for notifying parties and adds to the uncertainty surrounding the already somewhat muddled discourse on ‘control’.

The prescribed longer form II requires notifying party(ies) to provide information on horizontal and vertical overlaps not just between the immediate parties to the transaction (i.e. the acquirer and the target enterprises[1], including their subsidiaries) but also between the group to which the acquirer belongs (i.e. the acquirer group) and the target enterprise (including its subsidiaries).

While determining the extent of UltraTech’s obligation to disclose its own and KMB’s shareholding in companies engaged in cement business that competed with the acquired target business, namely, Century Textiles and Industries (Century) and Kesoram Industries (Kesoram), CCI expanded the meaning of the term ‘control’ to include ‘material influence’ in addition to ‘de-facto’ and ‘de-jure’ control. In doing so, the Decision has altered one of the three tests for determining whether two or more enterprises belong to the same ‘group’.

Statutory Tests for ‘Group’

The Act defines a ‘group’ as: two or more enterprises that are directly or indirectly in a position to (‘Group Tests’):

i.    exercise 50%[2] or more of the voting rights in the other enterprise (‘Voting Rights Test’); OR
ii.   appoint more than 50% of the members of the board of directors in the other enterprise (‘Board Test’); OR
iii.  control the management or affairs of the other enterprise (‘Control Test’).[3]

While the Voting Rights Test and the Board Test are premised on objective parameters, the Control Test is nebulous. ‘Control’ is defined under the Act to ‘include’ controlling the affairs or management by one or more enterprises or groups, over another enterprise or group. This broad definition has led CCI to clarify the meaning of the term ‘control’ through its decisions.

Implications of the Decision

When examining whether Kesoram and Century satisfied the Control Test, the Decision does not identify any rights that KMB had in Kesoram and Century. Instead, CCI clarifies that while the ability to manage the affairs of the other enterprise (the definition of control under the Act) may be inferred from special or veto rights, other sources of control including, “status and expertise of an enterprise or person, board representation, structural/financial arrangements” may equally also exist. On this basis, CCI concludes in the Decision that all degrees and forms of control constitute control (within the meaning of the Act) and that ‘material influence’ is the lowest form of control followed by de facto control and controlling interest (de jure control).

In doing so, the Decision appears to expand an already diluted interpretation of the term ‘control’, to now include all forms of ‘material influence’. Not only does this interpretation deviate from a well-established, globally acceptable, definition of ‘control’ i.e. ‘the ability to exercise decisive influence over the management or affairs’ of another enterprise,[4] but owing to the definitional link between ‘group’ and ‘control’, expands the scope of the term ‘group’.[5]

The interlacing of the statutory definition of the term ‘group’ with the definition of the term ‘control’ and the subsequent dilution of the meaning of ‘control’ to include ‘material influence’ has far reaching implications (a) the computation of jurisdictional thresholds and the application of various exemptions available to intra-group transactions; and (b) ascertaining the extent of horizontal and vertical overlaps in merger filings.

Computation of jurisdictional thresholds

One of the eight jurisdictional thresholds/tests to determine whether a transaction is notifiable to CCI, involves computing the value of assets and turnover generated by the group to which the target/ merged entity will belong post the transaction (‘Group Thresholds’). Further to the Decision, notifying parties can arguably be required to carry out an onerous time-consuming self-assessment to identify each such enterprise in which it may directly or indirectly exercise ‘material influence’[6] to conclusively determine if the Group Thresholds are breached.

Consider the example of Enterprise A, that proposes to acquire 51% of the total share capital of Enterprise B. Enterprise A, also owns 25% of the total share capital of Enterprise C and has the right to appoint 1 director to the board of Enterprise C. Enterprises B and C operate in the same relevant market. Enterprise A satisfies neither the Voting Rights Test nor the Board Test in relation to enterprise C. Yet, the newly coined test of “material influence” can lead to the inference that as a result of its shareholding and presence on the board of enterprise C, Enterprise A controls Enterprise C. Such an inference, premised on the Decision is likely to lead to an incorrect agglomeration of minority investments made by an enterprise to comprise a larger group. This would increase the possibility of Group Thresholds being breached, resulting in the notification of transactions over which CCI lacks jurisdiction.

Yet, the expanded Control Test may not enable notifying parties to benefit from the “intra-group” exemption (provided under Item 8 of Schedule I of the CCI (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 (‘Combination Regulations’)) (‘Intra-Group Exemption’).[7] Consider the same example as above where Enterprise A decides to acquire additional shares in Enterprise C. Further to the Decision, while Enterprise A may arguably claim that Enterprise C satisfies the Control Test (and Enterprises A and C are part of the same group), the expanded scope of the Control Test may well allow Enterprise C to now belong to more than one ‘group’. Where a target (Enterprise C) is under the ‘joint control’ of a group other than that of the acquirer, the Intra-Group Exemption would not be available.

Mapping overlaps

The longer form II requires notifying party(ies) to provide information on horizontal and vertical overlaps not just between the immediate parties to the transaction (i.e. the acquirer and the target enterprises, including their subsidiaries) but also between the group to which the acquirer belongs (acquirer group) and the target enterprise (including its subsidiaries). Although the shorter form I does not require parties to map overlaps vis-à-vis the acquirer group, CCI nonetheless expects notifying parties to do so.

The expanded meaning of the term ‘control’ and the consequent possibility of a wider set of enterprises being agglomerated to comprise a ‘group’ adds another layer of complexity to the exercise of mapping overlaps. An informed mapping of overlaps requires the acquirer and the target to share the entire list of products/ services offered by them with their advisors. Companies which have been agglomerated as part of the acquirer or target group, only because of the material influence test may not share details of the products or services offered by them to help map overlaps exhaustively, thereby exposing the notifying party(ies) to potential risk of penalty for material non-disclosure.


The first two Group Tests, i.e., the Voting Rights Test and the Board Test clearly set out the legislative intention for identifying a ‘group’. The MCA in 2011 specifically increased the percentage thresholds in the Voting Rights Test to 50% (from 26%) so that only those entities that directly or indirectly held 50% or more shareholding or votes in another enterprise would constitute a group. The well-established statutory interpretation principle of ejusdem generis requires that the Control Test be interpreted in accordance with the Voting Rights Test and the Board Test. No wider construction may be afforded. However, the expansive interpretation of the Control Test in the Decision effectively dilutes, if not entirely negates, the statutory Voting Rights and Board Tests.

In sum, the Decision raises more questions than it answers. By expanding the meaning of the term ‘control’ to include control by way of ‘material influence’ – a term open to multiple interpretations, CCI has unwittingly also changed the meaning of the term ‘group’.  Notifying parties must tread with caution and till the time CCI issues a clarification, it would perhaps help to err on the side of caution. Notifying parties may also consider approaching CCI for pre-filing consultations, which may help address some of the ambiguities discussed above.

[1] The term “enterprise” is defined under the Act to include its “subsidiaries”.
[2] In 2011, by way of a notification, the MCA increased the percentage thresholds in the Voting Rights Test from 26% to 50% such that any ‘group’ exercising less than 50% of the voting rights in another enterprise is exempt from the provisions of Section 5 of the Act for a period of 5 years. The operation of the notification was further extended for 5 years (until 2021) in 2016.
[3] See Explanation (b) to Section 5 of the Act.
[4] Independent Media Trust, C-2012/03/47.
[5] The European Commission (‘EC’)considers ‘decisive influence’ i.e., the ‘power to block actions which determine the strategic commercial behavior of an undertaking’. In essence, EC may assess minority acquisitions only when such acquisitions result in the investor being conferred AVRs that allow it to veto decisions that are ‘essential for the strategic commercial behavior’ of an enterprise. The EC appears to distinguish between investor protection AVRs from those that relate to strategic decisions of business policy of the proposed target.
[6] In the Decision, CCI defined ‘material influence’ as “the lowest level of control, implies presence of factors which give an enterprise ability to influence affairs and management of the other enterprise including factors such as shareholding, special rights, status and expertise of an enterprise or person, Board representation, structural/financial arrangements etc.”.
[7] Item 8 exempts “an acquisition of shares or voting rights or assets, by one person or enterprise, of another person or enterprise within the same group, except in cases where the acquired enterprise is jointly controlled by enterprises that are not part of the same group.”

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SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 – Key Considerations for a Selling Shareholder in an IPO

Published In:Inter-Alia-Special-Edition-February-2019.pdf [ English ]

The Securities and Exchange Board of India (‘SEBI’) notified the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR 2018’) on September 11, 2018, which came into effect on November 10, 2018, thereby rescinding and repealing the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (‘ICDR 2009’).

These regulations primarily govern the process of an initial public offering (‘IPO’), which is an offer of specified securities by an unlisted issuer to the public for subscription for the first time. An IPO consists of either or both of the following components:

(i)      a primary component, being a fresh issue of securities by the issuer,

(ii)    or a secondary component, being an offer for sale by existing shareholders of the issuer (‘OFS’).

Some of the key changes brought about by and salient features of ICDR 2018 along with existing practices, more specifically provisions which are relevant from a private equity investor’s perspective vis-à-vis IPOs are summarized below:

1.      Selling Shareholders

(i)      ICDR 2018 has introduced a definition of ‘selling shareholder(s)’ which is defined as any shareholder of the person who is offering for sale the specified securities in a public issue. Consequently, the definition of ‘issuer’ has also been amended to mean a company or a body corporate authorized to issue specified securities under the relevant laws and whose specified securities are being issued and/or offered for sale in accordance with the provisions of ICDR 2018 (‘Issuer’). Therefore, the ambiguity under ICDR 2009 on whether a selling shareholder would amount to an Issuer, has been clarified.

(ii)    Pursuant to the inclusion of the aforesaid definitions, corresponding provisions for disclosures / confirmation requirements have been provided, which, inter alia, include the following:

• Statement by the selling shareholder on the cover page of the draft offer document/ offer document stating that it accepts responsibility for, and confirms, the statements made by it in the offer document to the extent of information specifically pertaining to it and its portion of the offered shares and that such statements are true and correct in all material respects and not misleading in any material respect;

• Aggregate pre-issue shareholding of the selling shareholder as a percentage of the paid-up share capital of the Issuer;

• Weighted average price at which specified security was acquired by the selling shareholder in the last one year;

• Average cost of acquisition of shares for the selling shareholder;

• Pre-IPO details (if applicable);

• A confirmation that the selling shareholder is not prohibited from accessing the capital market or debarred from buying, selling or dealing in securities under any order or direction passed by SEBI or any securities market regulator in any other jurisdiction or any other authority/court; and

• A confirmation that the selling shareholder is in compliance with the Companies (Significant Beneficial Ownership) Rules, 2018.

2.       Eligibility

(i)      Some of the changes introduced in respect of the eligibility requirements for promoters, directors and selling shareholders for an IPO are set ou below:

• The debarment of selling shareholders from accessing the capital markets has now been made an eligibility condition. However, ICDR 2018 clarifies that this restriction will not apply to a person or entity whose period of debarment has expired as on the date of filing of the draft red herring prospectus (‘DRHP’) by the Issuer with SEBI.

• Further, none of the promoters or directors of an Issuer should be fugitive economic offender (as defined under the Fugitive Economic Offenders Act, 2018).

(ii)     Additionally, the following amendments were introduced in respect of financial information linked to eligibility:

• The condition that the size of the IPO, including any previous issues in the same fiscal year, must not exceed five times the net worth of the Issuer, has been done away with.

• It has been clarified that the net tangible assets, average operating profits (with operating profit in each of these preceding three years), net worth and revenue of the Issuer has to be calculated on a restated and consolidated basis.

(iii)    It has also been clarified that the offered shares arising from convertible instruments may now be converted prior to filing the red herring prospectus (‘RHP’).

3.       Group Companies

(i)     Group companies have been defined to include: (a) companies with which the Issuer has had related party transactions during the past three fiscal and stub periods (as appearing in the audit report and financial statements), and (b) other companies considered material by the board of directors of the Issuer.

(ii)     Promoters and subsidiaries have been excluded from the definition of group companies.

4.       Definition of Promoter

(i)      The definition of ‘promoter’ has been aligned with the definition provided under Section 2(69) of the Companies Act, 2013. Accordingly the following persons can be classified as promoters: (a) persons named as such in the offer document or identified by the Issuer in the annual return; (b) persons who have control over the affairs of the Issuer, directly or indirectly whether as a shareholder, director or otherwise; and (c) persons in accordance with whose instructions the board of the Issuer is accustomed to act (except a person acting in a professional capacity).

(ii)     The threshold of shareholding which exempts a person from being categorized as a promoter has been increased from 10% to 20%. Further, venture capital funds, alternate investment funds (‘AIFs’), foreign venture capital investors (‘FVCIs’) and insurance companies have been added to the list of investors who (in addition to financial institutions, scheduled commercial banks, foreign portfolio investors other than Category III foreign portfolio investors, mutual funds) will not be deemed to be promoters merely because they hold 20% or more in the Issuer. Consequential changes have been made in various provisions, including, the definition of promoter group.
(iii)    Persons instrumental in formulation of a plan or programme of the offer have now been excluded from the definition of promoter.

(iv)   The proviso under the definition of ‘promoter’ under ICDR 2009 in relation to a financial institution, scheduled commercial bank, foreign portfolio investor other than Category III foreign portfolio investor and mutual funds, continuing to be deemed promoters of the subsidiaries or companies promoted by them or mutual funds sponsored by them has been done away with.

5.       Minimum Promoters’ Contribution, its Eligibility, Pledging and Certification

(i)      In addition to the promoters of an Issuer, certain regulated entities such as AIFs, FVCIs, scheduled commercial banks, public financial institutions (‘PFIs’) or insurance companies registered with Insurance Regulatory and Development Authority of India (‘IRDAI’), are now permitted to contribute in a manner which would enable meeting the shortfall (if any) in the minimum promoters’ contribution, subject to a limit of 10% of the post-issue capital (without being identified as promoters).

(ii)     Ineligibility conditions have now been extended to securities which are contributed towards promoters’ contribution by the additional regulated entities identified above, i.e., securities acquired by promoters, AIFs, FVCIs, scheduled commercial banks, PFIs or insurance companies registered with IRDAI, during the preceding one year at a price lower than the offer price of the IPO.

(iii)     As per ICDR 2018, promoters’ contribution and other securities held by the promoters (and locked-in) can also be pledged with systemically important non-banking financial companies and housing finance companies, in addition to scheduled commercial banks and PFIs.

(iv)     In line with ICDR 2009, ICDR 2018 provides that lock-in on minimum promoters’ contribution is effective for a period of three years from the latter of the date of allotment in the IPO or the date of commencement of commercial production. However, the definition of the term ‘date of commencement of commercial production’ has been amended to mean the last date of the month in which commercial production of the ‘project’ in respect of which the IPO proceeds are proposed to be utilized as per the DRHP/ offer documents, is expected to commence.

(v)      Statutory auditors are mandatorily required to certify the amount paid as well as credited to the Issuer’s account by each of the promoters.

6.       Pre-IPO / Restriction on Further Capital Issues

For further capital issuances between the date of filing the DRHP and the listing of the specified securities offered in the IPO, the Issuer is required to disclose details of either the number of securities proposed to be issued or amount proposed to be raised in the DRHP/ offer document and not both. ICDR 2018, as was the case in the ICDR 2009, contemplates only issuance of securities.

7.       Re-filing of the Draft Offer Document

Pursuant to the amendment to ICDR 2018, which was effective from December 31, 2018, any changes in the draft offer document, as elaborated below, will require re-filing of the draft offer document with SEBI:

(i)     in case of a fresh issue of securities, any increase or decrease to the estimated issue size by more than 20%;

(ii)    in case of an offer for sale, any increase or decrease in either the number of equity shares offered for sale or the estimated issue size by more than 50%; and

(iii)    in case of a fresh issue of securities and an offer for sale, the respective limits set out above will apply.

The aforesaid changes brought about by ICDR 2018 to the regulatory regime governing Indian capital markets transactions will have a bearing on investors in private companies who intend to exit by way of an OFS as part of an IPO. Accordingly, investors may take note of the factors impacting any transactions that are contemplated subsequent to the date of notification of ICDR 2018.

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FPI & Debt Securities – Hop on Hop off

Published In:Lex Witness [ ]

Reserve Bank of India (“RBI”) vide circular dated June 15, 2018 (“Circular”) revised norms with respect to investments made by Foreign Portfolio Investors (“FPIs”) in corporate debt securities in India. While the Circular was supposed to have eased norms with respect to investment in corporate bonds by introducing new amendments like revising the minimum residual period of 3 years to 1 year, the Circular, at the same time, had restricted FPIs from investing in more than 50% of a single issue of corporate bond and also restricted FPIs from investing more than 20% of its debt portfolio into a single corporate entity. These two restrictions dampened FPI investments in debt market and created a blockage on the flow of foreign capital from FPIs into India. RBI may have intended to diversify risk for FPIs and incentivize them into seeking more investment opportunities; however these two conditions halted, upto a large extent, investment transactions in debt securities by FPIs.

Given the widespread consternation generated as a result of the restrictions imposed by the Circular and the likely implications on investments in debt markets in India by FPIs, RBI on October 5, 2018, made another attempt and released a discussion paper titled, ‘Voluntary Retention Route’ for investment by FPIs by (“VRR Paper”) which proposes to introduce a separate channel to enable investments by FPIs in debt markets in India (“VRR Route”).

We have examined the VRR Paper and some of the key aspects proposed in the VRR Paper are as follows:

·         RBI to prescribe a limit on the total amount that may be invested via the VRR Route (“Investment Limit”).

·         Investment Limit shall be in addition to ‘General Investment Limit’ as per RBI Circular No. 22 dated April 6, 2018.

·         The total amount for investment through the VRR Route shall be separately indicated for government securities and corporate debt and shall be individually allocated to FPIs through an auction process

·         RBI shall allocate an investment amount to each FPI (“Committed Portfolio Size”) which allocation will be determined basis the period for which the FPI proposes to invest the Committed Portfolio Size (“Retention Period”). The Retention Period shall be for a minimum of 3 years or a period as prescribed by RBI for each auction.

·         FPIs are required to, within a period of 1 month from the date of announcement of auction results, invest a minimum of 67% of the Committed Portfolio Size, in debt instruments and remain invested for the Retention Period.

·         Investments through this route shall be exempt from regulatory restrictions imposed by the Circular such as the cap on short-term investments (less than one year) at 20% of portfolio size, concentration limits and caps on exposure to a corporate group (20% of portfolio size and 50% of a single issue).

·         Income from investments through the VRR Route may be reinvested at the discretion of the FPI and such investments can exceed the Committed Portfolio Size.

·         FPIs shall open a special non-resident rupee ‘SNRR’ bank account for investment made through the VRR Route and securities account for holding debt securities under the VRR Route.

·         FPIs, one month prior to Retention Period, can choose to extend the Retention Period, for an additional period equivalent to the Retention Period. FPIs can also exercise their option to exit, liquidate its portfolio or move the investments to the ‘General Investment Limit’ at the end of the Retention Period.

·         FPIs can exit and liquidate their investments, prior to the Retention Period, by selling their investments to other FPIs.

Although the VRR Paper seeks to provide operational flexibility for investments by FPIs in corporate debt instruments in India and eliminate the challenges faced by FPIs due to the Circular, the real impact can be assessed only once the final circular is out. With the proposed relaxation being enforced, FPIs will be able to access the VRR Route by voluntarily committing to retain a certain percentage of their investments in India for a period of their choice. While the timelines and modalities around the implementation of the auction process and the structuring of investment transactions by FPIs still remain to be tested, given the relaxation proposed to be introduced by RBI, FPIs may be able to undertake investment transactions, in debt securities as sole or majority investors. One can argue that there exists a strong case for removal of the two conditions imposed by the Circular in place of a new policy or scheme.

Foreign capital is one of the most important ingredients for continuous growth of the economy considering the financial crunches and scarcity of domestic capital. Therefore, the need of the hour is to remove any such obstacles for allowing FPIs, amongst others, source of foreign capital, to invest into Indian debt securities.


Hardeep Sachdeva, Senior Partner
Ankit Jaiswal, Associate

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