COVID-19 brings additional screening to Indian M&A

For a change, the COVID-19 pandemic is not the hot topic of discussion, at least in the business and legal circles for the last few days. Though we were all anticipating some action from the Government after China’s central bank raised its equity stake in HDFC to 1%. Surprisingly, the Indian Government rushed into amending the Foreign Direct Investment (FDI) Policy to curb opportunistic takeovers or acquisitions of Indian companies due to the current pandemic.

We believe that there is some disconnect in what was intended to be achieved from the policy change and its actual impact. While the majority feels that its a welcome change, sighting reasons like protection of sovereignty, protection of Indian companies, and the change being consistent with the moves of several other countries; we may be losing sight of two critical aspects: firstly, whether this policy change breaches any of India’s contractual obligation(s); and, secondly, whether a blanket approval requirement is reasonable, affecting the ease of doing business in India. Basis the available analysis of the policy change in the public domain, whether on news channels, print media and legal updates by magic circle law firms of India, everyone appears to be only concerned with the business impact of this policy change.

As per the new policy, all direct/indirect FDI from China will now require prior approval of the Indian Government. It is pertinent to note that the approval requirement also extends to transactions, where the direct/indirect beneficial ownership of the investment is from China. As if this construct was not broad enough, the policy also extends to divestments/transfer of existing Chinese FDI. Oddly, there is not a single exception to the blanket approval requirement.

This kind of blanket restriction has severe implications for Chinese players doing/intending to do business in India. Some of the critical and notable actions which will now require prior approval of the Government are, inter-alia:

• all fresh FDI from China, irrespective of the sector;

• acquisition of even a single share by way of FDI from China;

• any capital infusion in Indian subsidiaries of a Chinese company;

• Indian companies issuing bonus shares/shares under ‘rights issue’ to its Chinese shareholders or any shareholder, where the beneficial owner is from China;

• exercise of existing ‘call-option right(s)’ by the Chinese investors;

• exercise of exiting ‘put-option right(s)’ of a shareholder of an Indian company against a Chinese entity;

• any transfer of shares of an Indian company (whether by a third party / an exiting Chinese party) to a Chinese entity / any entity having a Chinese beneficiary;

• any intra-group arrangement where the shares of an India company is being transferred to another Chinese group company;

• any investment by a global fund having Chinese beneficiary;

• A global acquisition by a Chinese entity, where the target company has an Indian subsidiary / Indian joint-venture.

Unless a specific clarification or exemption is issued by the Government, all the above will also apply to investments from Hong Kong as it is a part of China, though having a separate administration.

It is interesting to note that there is no corresponding policy change for foreign portfolio investments. The more you analyse the implications of this policy change the more you will be inclined to believe that this goes far beyond the intent of curbing opportunistic takeovers/acquisition. We are not even highlighting the procedural and timing issues around the approval process. There’s no clarity, whether this policy change is just a stop-gap arrangement during a pandemic or a permanent one. Also, there’s no guidance on the status of ‘committed deals’, where the transaction documents / legally binding term sheets have already been executed with the Chinese counterparts.

It is disheartening to see that this kind of a sudden policy change under the guise of an ongoing pandemic doesn’t provide any exceptions or clarifications, nor does it cover for India’s existing contractual obligation.

The Government of India should be mindful of its contractual obligations towards China under the Agreement for the Promotion and Protection of Investments (Agreement). Though this arrangement was terminated by India with effect from 3 October 2018, the Government seems to have lost sight of the surviving provisions under the Agreement. Article 16, unequivocally states that notwithstanding any termination, the Agreement shall continue Ito be effective for a period of 15 years from the date of its termination in respect of investments made or acquired by China before the date of termination of the Agreement. India signed up this Agreement, providing China the ‘National Treatment & Most Favoured Nation Treatment’ protection. In light of this, India is contractually bound to adhere to the Agreement in respect of all investments made prior to 3 October 2018. Though there is an Article in the Agreement dealing with ‘Exceptions’, but our view is too narrow. It doesn’t provide India any reason to shy away from its contractual obligation. It will not be in good taste if India argues that the policy changes an action for the protection of its ‘essential security interest’ or there is an extreme emergency, where the policy change was applied on a non-discriminatory basis. We believe, that for all practical purposes, the policy will not apply to Chinese investments made prior to the termination of the Agreement

This policy will take the shape of law and will be effective from the date of FEMA amendments being notified.

We are hopeful the Government will soon come up with meaningful clarification while notifying the FEMA notification. The world order is changing, however, India’s contractual obligation and the ease of doing business in India should not be put to stake under the guise of the ongoing pandemic.

One cannot reach the destination by paddling in the opposite direction.

The authors are Abhishek Sinha & Varnica Raj Chauhan, who are Corporate Lawyers. The authors can be reached at abhishek@notjustlex.com and chauhanvarnica@gmail.com.

The opinions expressed in this article are those of the authors. They do not purport to reflect the opinion of the organisations to which they are associated.