This article is the second part of the series on “Cross-border M&A in India”. Part–I dealt with highlighting certain present day practical challenges to be borne in mind by investors when considering investments in India. Part-II aims to provide certain practical solutions that can be adopted by foreign investors while structuring their Indian investments.
Practical Leverages – Escrows, Controlling Stakes, Dilutive conversion triggers
Given the challenges to enforcement of contractual rights, investors should attempt to structure deals with practical leverages. For instance, in an acquisition transaction, an escrow to secure indemnity obligations can be an effective tool. Indian businesses will rarely jeopardize the entire quantum of escrow by rejecting legitimate indemnity claims for lesser albeit substantial sums. In strategic ventures, where the investor is investing significant capital, it would be prudent for the investor to commence the partnership with a controlling stake or a higher shareholding threshold. Based on pre-agreed milestones the Indian counterpart can ‘clawback’ shareholding to the desired percentage after its initial commitments have been met. If milestones are not achieved or the counterpart defaults in performing its obligations a dilution of the counterpart’s shareholding can be triggered. A convertible debenture or a preference instrument that converts into equity shares based on contingencies can be a useful tool in such structures.
The above proposals are not exhaustive and are only meant to indicate the options that investors can consider while structuring their investments. The advantage of such structures is that the counterpart needs to approach a court to recoup positions from an investor. This shifts the balance of powers and may compel the counterpart to honour the terms of the contract in letter and spirit. For reasons discussed in Part I of this article series, in an Indian context, the party that needs to approach an Indian court to secure its rights is usually at a disadvantage. But, the Indian counterpart is not placed in an unfair position. If their position has merit they should be able to enforce their rights against the investor in the home country of the investor. As discussed in Part I, the enforcement position is generally skewed in favour of the Indian party and the above proposals only provide a balance to the foreign investor.
Financial Vigilance – a Stitch in Time Saves Nine
The adage that prevention is better than cure holds true while investing in India. It is advisable for any investor to regularly monitor the financials of an investee company through appropriate reporting and MIS mechanisms. This is not to suggest that it would be a fool proof method to prevent any untoward financial mismanagement. But, it does allow the investor to pick up any suspicious financial transactions and investigate the same further. Further, conducting an independent forensic review exercise on the investee company’s operations every 2 years is also an effective method to check financial mismanagement. This option depends on the stakes involved and will have to be balanced with the costs of conducting the forensic exercise. Discussions around regular forensic reviews could be uncomfortable at the commencement of a venture. But, attributing this requirement to the investor’s institutional policy is one way to present the requirement. Another option is for the investor to reserve the right to appoint a professional CFO for the investee company. Such a CFO should report directly to the board of directors of the investee company. There is usually resistance by domestic businesses on this point; but it is possible to find a middle ground.
Family Businesses – Multiple Members in Promoter Group
It is highly probable that traditional Indian family businesses will have multiple stakeholders as part of the promoter group. Instances of disputes among family members adversely impacting the underlying family business is not unheard of in India. There have been multiple such incidents widely reported in the Indian media over the past decade. An investor should consider the risks associated with a family dispute and must endeavour to hedge this in a sensitive manner. Engaging with the stake holders of an investee company on this point could create some discomfort during the deal. But, it would be wise to tactfully and sensitively address this concern than be left at the receiving end of a family dispute in future. Private family trusts with a lead promoter as the trustee to represent the promoters’ interests in the investee company could be a possible method to resolve this concern. A private family trust has multiple advantages and addresses most concerns of the investor and the promoter family members. The investor will be insulated from family disputes and can build contingency triggers within the investment agreement to account for any possible dissolution of the trust by its beneficiaries. The individual family members will have protection and corresponding remedies under trust law against a trustee for any breach of trustee’s fiduciary duties towards them.
Presence of Local Deal Team – India is Not the West
Over the last two decades of operating in India, most investors have realised that there is no substitute for knowledge of the local market. The Indian market and the business environment is unique and it is useful to have a minimal strength of deal members in India. It also helps to surround oneself with experienced advisors who understand the nuances of conducting an M&A deal in India. For e.g. new age technology and internet oriented business founders are very different from the traditional ‘brick and mortar’ business promoters. Certain businesses would have built a reputation, one way or the other, with their past conduct. A ground team will be privy to such knowledge and can offer some basic diligence on the proposed business counterpart. Lastly, deal makers should develop flexibility on certain legal issues peculiar to India, which may be in stark contrast from market standards in developed countries. For e.g. it is unreasonable to expect 100% compliance with all applicable laws in India! There will always be some level of related party transactions in any family business!
Pre-empt the Dispute and Prepare Early
An investor should always maintain regular records of the communication exchanged with the investee company and other shareholders. Initial misunderstandings or disagreements regarding documented rights or obligations of the investor can be an indicator of potential future disputes. The investor should not wait for matters to reach the stage of a formal dispute to commence the process of collecting information. Once formal disputes are initiated it may be practically difficult to obtain access to relevant information needed to support the investor’s case. Hence, regularly preparing and compiling records during the life of the deal is important to ensuring availability of relevant information in a potential dispute.
International Arbitration – Promising Recent Trends
Foreign investors should insist on international arbitration for resolution of contractual disputes. Recent decisions by courts in India, appear to favour enforcement of foreign arbitral awards. While, enforcement of a foreign arbitral award in India can also be subjected to certain delays, the chances of securing an expeditious final enforcement order are higher with a foreign arbitral award. Further, the reputation of international arbitration forums like Singapore International Arbitration Centre, London Court of International Arbitration etc., would prevent a counter party from challenging the enforcement on grounds other than ‘public policy’. The recent decision of the Delhi High Court in the Unitech case will go a long way in assuaging concerns of foreign investors on enforcement of foreign arbitral awards. Certain other high-profile matters, where foreign arbitral awards are challenged in Indian courts are awaiting outcome. Drawing from the Unitech judgement, it is expected that Indian Courts will continue to uphold the validity of foreign arbitral awards and refuse challenges to enforcement on ‘manufactured’ grounds of ‘public policy’.
As mentioned at the outset of this article series, the Indian opportunity is too attractive to be ignored by international investors and businesses. A better understanding of the ground realities of the Indian market will go a long way in boosting the confidence of investors to work within Indian conditions. Sophisticated investors understand that problems encountered on a deal are best resolved by solutions customised to deal commercials. But, in addition to being customised to relevant deal commercials solutions and structures must also be customised for Indian conditions. As with any unchartered market, there are challenges in India too; but none that cannot be overcome with diligence and a bit of ‘trial and error’.
Ajay Joseph
Partner, Veyrah Law
Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.