1.2        What are the most significant factors currently encouraging or inhibiting private equity transactions in your jurisdiction?

 

• In addition to those discussed in question 1.1 above, the following factors encourage the ongoing investment trend:
• stable political regime and facilitative investment environment, including continued relaxations in foreign exchange regulations governing inbound investments;
• increased enforceability of investment agreements and effective bankruptcy regime; and
•  the exit aspirations and diversification mindset of the first- and second-generation promoters, respectively.

 

Some of the key inhibiting factors are:

• certain restrictive regulatory approval requirements for FDI from bordering countries;
• certain tax fair market value related changes that may result in additional tax liability for targets; and
• the current slowdown in IPO related PE exits.

 

1.3        Are you seeing any types of investors other than traditional private equity firms executing private equity-style transactions in your jurisdiction? If so, please explain which investors, and briefly identify any significant points of difference between the deal terms offered, or approach taken, by this type of investor and that of traditional private equity firms.

 

Lately, the impact investment funds, sovereign wealth funds (“SWFs”) and Indian family offices are executing PE-style transactions.  Indian companies, at times, favour SWFs over PE investments, given the long investment horizon and the absence of a short-term time-bound return of capital related outlook.  The holding period results in subtle differences in the structuring of transactions, governance and exit rights involving SWFs.

 

India continues to impose capital controls and prohibition on assured returns for FDI and, given the longer holding period for SWFs and such restrictions not being applicable to Indian family offices, there is increased flexibility to structure such transactions and growing preference for such investors.  In addition, it is also now a common practice for SWFs to co-invest directly in the target to have direct access (as compared to tiered), individual (as compared to derivative or collective) governance and exit rights, and better return economics.

 

As per the database of the Sovereign Wealth Fund Institute, the direct investment by SWFs in India increased from USD 3.797 billion in 2021 to USD 6.712 billion in 2022.  India witnessed some notable investments by SWFs in 2022, which included Abu Dhabi-based Mubadala Investment Company’s investment of INR 40 billion along with BlackRock Real Assets in Tata Power Renewable Energy Limited and Qatar Investment Authority’s investment of USD 1.5 billion in Bodhi Tree Systems.

 

Similarly, impact investment funds focus substantially more on specific environmental, social and governance (“ESG”) diligence, extensive representations, warranties and undertakings with respect to ESG as a part of deal documentation, with continued focus on best ESG practices after the investment and on certain investment sectors, such as clean/green energy infrastructure transactions.

 

2. Structuring Matters

2.1        What are the most common acquisition structures adopted for private equity transactions in your jurisdiction?

 

PE transactions are typically structured as under or through one or more of the following modes:

• acquisition vehicles: through the traditional route of investing directly, through special purpose vehicles (“SPVs”) incorporated in tax and investor-friendly jurisdictions, or trusts registered as alternative investment funds;
• investment routes: as either FDI, foreign portfolio investments (“FPI”) or foreign venture capital investments;
• investment instruments: by way of equity or preference shares, shares with differential voting rights, or partly paid shares and/or other equity-linked convertible instruments (such as warrants, compulsorily convertible preference shares or compulsorily convertible debentures); and
• acquisition structures: by way of share acquisition, business transfer, asset purchase and/or merger, demerger or amalgamations.  Shares of a public listed entity can also be acquired by triggering a voluntary offer/mandatory tender offer (“MTO”).

 

2.2        What are the main drivers for these acquisition structures?

 

India continues to be a regulation-heavy jurisdiction, regulating entry as well as exit for foreign investors.  Accordingly, structuring to ensure compliance with Indian regulations while achieving investment objectives is the main driver.  In addition, the key structuring considerations are: (i) tax considerations; (ii) return expectations; (iii) investment horizon; and (iv) any specific demands or conditions from the management team or sellers (in secondary transactions).

 

2.3        How is the equity commonly structured in private equity transactions in your jurisdiction (including institutional, management and carried interests)?

 

It is common for private companies in India to have several classes of equity or compulsorily convertible instruments, which can eventually be converted into equity securities.  The classes of securities progressively decrease from private companies to listed companies.  Equity for management personnel (except promoters) is typically provided in the form of ordinary equity shares, employee stock options (“ESOPs”), warrants (performance/exit linked), or convertible instruments.  Carried interests are typically structured upstairs (i.e., to offshore entities) and sideways (i.e., to the investing SPV).

 

2.4        If a private equity investor is taking a minority position, are there different structuring considerations?

 

Minority transactions are structured to protect against the erosion of investment value and dilution of stake, and to facilitate exits along with the majority stakeholders.  Such protections are classically structured as limited affirmative veto rights, anti-dilution rights, liquidation preference, information and audit rights, observer rights and certain negotiated transfer restrictions vis-à-vis other shareholders.

 

2.5        In relation to management equity, what is the typical range of equity allocated to the management, and what are the typical vesting and compulsory acquisition provisions?

 

Whilst not mandatory, the management is typically allocated equity in the form of ESOPs or warrants.  Promoters are not permitted to have ESOPs.  The ESOP vesting or conversion conditions are agreed on a case-to-case basis and usually linked to performance/exit conditions.  Indian law does not contain any compulsory acquisition provisions.

 

2.6        For what reasons is a management equity holder usually treated as a good leaver or a bad leaver in your jurisdiction?

 

A good leaver is characteristically someone who leaves by providing prior notice, with reasonable or without cause, and where termination is undertaken in compliance with the terms of his/her employment arrangement.  Contrarily, a bad leaver leaves without notice and/or for cause.

 

Given that it may be difficult to classify persons as good leavers/bad leavers at the outset, it is common to give the board of directors (the “Board”) the discretion to make this determination and/or capture such definitions in the relevant employment agreements.

 

3. Governance Matters

3.1        What are the typical governance arrangements for private equity portfolio companies? Are such arrangements required to be made publicly available in your jurisdiction?

 

Portfolio companies are governed by the terms of the shareholders’ agreement, which typically provide the following governance arrangements:

• appointment of the agreed number of nominees on the Board;
• mandatory participation of the nominees to form quorum in meetings of the Board and shareholders;
• affirmative veto rights on identified matters;
• information, inspection and audit rights; and
• policies and procedures to be implemented by the portfolio companies.

 

These arrangements are not required to be made public; however, these are usually included in the articles of association of the relevant portfolio company for the purposes of enforceability, and such articles of association are publicly available.

 

3.2     Do private equity investors and/or their director nominees typically enjoy veto rights over major corporate actions (such as acquisitions and disposals, business plans, related party transactions, etc.)? If a private equity investor takes a minority position, what veto rights would they typically enjoy?

 

Yes, typically PE investors and/or their director nominees are contractually entitled to veto rights at Board and shareholder meetings, as agreed under the shareholders’ agreement.  These include, among others, changes to the business plan, acquisitions and divestitures, financing and capital structure-related matters, entry into strategic partnerships, etc.

 

Depending on the minority position, the list of the veto rights may vary.  Minority investors typically negotiate limited veto rights on critical matters such as, among others, changes to constitution or capital structure, matters regarding liquidation, alteration of constitutional documents affecting their rights, etc.

 

In addition, under law, investors also have a statutory veto on all matters requiring a special resolution of shareholders if they hold more than a certain percentage of the equity capital (generally 25%).

 

3.3        Are there any limitations on the effectiveness of veto arrangements: (i) at the shareholder level; and (ii) at the director nominee level? If so, how are these typically addressed?

 

There are no such limitations.  However, investor nominees, like any other directors on the Board, have certain fiduciary duties, including to: (i) act in good faith to promote the company’s objects; (ii) act in the best interest of the company, its employees, shareholders and the community; (iii) not be involved in any situation with a direct or indirect conflict of interest; (iv) exercise due and reasonable care and independent judgment; and (v) not secure any undue gain or advantage.

 

3.4        Are there any duties owed by a private equity investor to minority shareholders such as management shareholders (or vice versa)? If so, how are these typically addressed?

 

Indian law does not prescribe any specific duties for PE investors to other shareholders (including minority shareholders).  However, qualifying minority shareholders have the right to approach a special tribunal in case of oppression or mismanagement.

 

3.5        Are there any limitations or restrictions on the contents or enforceability of shareholder agreements (including (i) governing law and jurisdiction, and (ii) non-compete and non-solicit provisions)?

 

While Indian law does not contain any express limitation or restriction on contents or enforceability, parties typically opt for Indian law to be the law governing the substantial obligations set out under the shareholders’ agreements, to facilitate enforcement of provisions in respect of, or vis-à-vis, the company.  However, even where a shareholders’ agreement is governed by foreign law, in a dispute scenario, the arbitral tribunal (as arbitration is the preferred mode for dispute resolution in PE transactions) is likely to consider mandatory legal provisions of Indian law in respect of provisions concerning the Indian company, failing which the enforceability of the arbitral award in India may be affected.

 

Reasonable restrictions (in terms of period and scope) of non-compete and non-solicit covenants on management and key employees are common and generally enforceable.  However, non-compete provisions post-cessation of employment are contentious and may not be enforceable under Indian law.

 

3.6        Are there any legal restrictions or other requirements that a private equity investor should be aware of in appointing its nominees to boards of portfolio companies? What are the key potential risks and liabilities for (i) directors nominated by private equity investors to portfolio company boards, and (ii) private equity investors that nominate directors to boards of portfolio companies?

 

Indian companies law prescribes certain qualifications and conditions to be fulfilled prior to a person being appointed as a director on the Board.  Further, companies law also prescribes requirements regarding resident directors, women directors, independent directors and limits on the maximum number of directorships that can be held by a person.  Furthermore, the government has issued a notification that requires mandatory security clearance of proposed directors in Indian companies prior to being appointed, if such person is a citizen of any of India’s land-bordering nations.  These conditions are generally applicable and are not specific to PE investor nominees.

 

Directors, including PE nominees, are liable for statutory breaches, especially where they can be shown to have breached their fiduciary duties or where they had actual knowledge of the breach.  To manage liability, PE nominee directors are usually appointed in a non-executive capacity, as they are not employed by the company or involved in the day-to-day affairs.  As for investors, there is no apparent risk or liability (other than reputational liability) as India maintains separate legal entity of a company and its shareholders, until there is a reason for courts to lift the corporate veil.

 

3.7        How do directors nominated by private equity investors deal with actual and potential conflicts of interest arising from (i) their relationship with the party nominating them, and (ii) positions as directors of other portfolio companies?

 

In an actual or potential conflict of interest situation covered by Indian law, the law controls recusal and non-voting by interested directors.  In other cases, a director may recuse on grounds of propriety, and require the shareholder to vote on such matters.  Matters related to conflict on account of portfolio companies are handled through contracts.

 

4. Transaction Terms: General

4.1        What are the major issues impacting the timetable for transactions in your jurisdiction, including antitrust, foreign direct investment and other regulatory approval requirements, disclosure obligations and financing issues?

 

The time taken for transactions primarily depends on the nature of the investee (listed/unlisted) and the mode of acquisition.  Acquisition of private companies is comparatively quicker compared to that of public companies, followed by acquisitions through schemes.

 

Some of the key issues that commonly impact the timetable for transactions in Indian deals are:

• the timelines for obtaining regulatory approvals (from the Government of India (in case of investments from bordering countries or from entities with beneficial owners from bordering countries), the Reserve Bank of India (“RBI”), the Securities and Exchange Board of India (“SEBI”), the Competition Commission of India and other sector regulators, as the case may be) vary on a case-to-case basis and are often unpredictable;
• the timelines for obtaining approvals or sanctions that involve courts or tribunals in India may take inordinately long; and
• often, on the basis of the due diligence conducted, the seller is required to obtain contractual consents from third parties prior to consummation of the transaction, and buyers include measures for the investee company to rectify past non-compliances/regulatory lapses as pre-completion conditions to the transaction, all of which have an impact on the timetable.

 

4.2        Have there been any discernible trends in transaction terms over recent years?

 

As PE in India continues to develop, transaction terms have gradually evolved and become standardised in various aspects.  For instance, warranty coverage, indemnity caps and survival periods, scope of veto rights, etc. are well recognised.  There is a growing trend of investors having equal or, in certain cases, even greater management rights than the founders.  There is an increased focus on thorough due diligence for every transaction, which often includes specific ESG, anti-bribery and anti-money laundering (“ABC/AML”) and tax diligence.  Further, trends such as break fee and reverse break fee provisions are also starting to gain prominence, although these largely remain untested from a regulatory perspective.  Payment structures such as locked-box mechanisms, deferred payments and escrow arrangements are also gaining popularity, as well as the increasing use of ‘hell or high water’ clauses as a remedy to complete mega mergers.

 

5. Transaction Terms: Public Acquisitions

5.1        What particular features and/or challenges apply to private equity investors involved in public-to-private transactions (and their financing) and how are these commonly dealt with?

 

Public-to-private or (take-private) transactions are difficult to achieve on account of: (i) the requirement that the majority of public shareholders must approve such transaction; and (ii) the price must be discovered through a reverse book-building process that often results in high price discovery.  Typically, such transactions are attempted only when the investor is willing to pay a high premium, and financing is arranged offshore.  Take-private transactions, completed through a court-approved insolvency, are relatively easier and an exception, but this typically only suits special situation funds and may also take a long time to consummate.

 

5.2        What deal protections are available to private equity investors in your jurisdiction in relation to public acquisitions?

 

Indian law is premised on the protection of interests of public shareholders and provides little protection to investors in public acquisitions.  However, stringent insider trading norms and continual disclosure norms protect the investors as well.  Further, for deal-protection, PE investors are known to contractually bind the investee to covenants on exclusivity, break fees, etc.  Additionally, listed companies are mandated to make disclosure of material facts and events, which provides a certain degree of comfort to PE investors.

 

6. Transaction Terms: Private Acquisitions

6.1        What consideration structures are typically preferred by private equity investors (i) on the sell-side, and (ii) on the buy-side, in your jurisdiction?

 

Cash (paid through banking channels) is the most prevalent form of consideration, both on the sell-side and buy-side.  This is primarily due to legal limitations surrounding the form and structuring of consideration involving foreign investors.

 

On the sell-side, investors may negotiate the amount of consideration payable, provided that the price complies with the FDI regulations on pricing guidelines.  Non-cash consideration (such as a share swap) is permitted under Indian law; however, the income tax authorities have the authority to determine its fair value, which may be deemed higher than the agreed consideration and increase the seller’s tax liability.  On the buy-side, investors may opt to defer payment of part of their consideration.  Foreign investors are permitted to defer up to 25% of the total consideration, for a maximum period of 18 months.

 

6.2        What is the typical package of warranties / indemnities offered by (i) a private equity seller, and (ii) the management team to a buyer?

 

PE sellers generally provide limited representations and warranties to the buyer in respect of their title to shares, authority, capacity and solvency.  Indemnities are, accordingly, limited to breach of these representations and warranties only.  In addition, PE sellers may agree to a specific indemnity for identified breaches, with negotiated terms on quantum, trigger thresholds, etc.  PE sellers are generally keen on hassle-free exits, and do not typically provide any business warranties on the grounds that they were financial investors and not in active management.

 

PE buyers on the other hand, customarily seek comprehensive warranties (comprising of customary fundamental warranties, business warranties and tax warranties), with recourse to general and specific indemnities from the management team and the sellers upon breach.  These include, the scope of warranties, as well as limitations and exclusions for indemnities, which are often heavily negotiated.  Use of representations and warranties insurance (“RWI”) policies for acquisition and exit transactions is now more common than it used to be a few years ago.

 

6.3        What is the typical scope of other covenants, undertakings and indemnities provided by a private equity seller and its management team to a buyer?

 

PE sellers typically agree to provide:

• standstill covenants in terms of conduct and state of operations of the investee company during the period from signing to completion;
• undertakings for agreed-upon actions for pre-completion (fulfilment of conditions precedent), completion and post-completion (if any); and
• indemnities for breach of limited warranties and material covenants.

 

6.4        To what extent is representation & warranty insurance used in your jurisdiction? If so, what are the typical (i) excesses / policy limits, and (ii) carve-outs / exclusions from such insurance policies, and what is the typical cost of such insurance?

 

RWI is rapidly gaining favour in transactions with PE sellers and is now more common than it used to be a few years ago.  RWI policies are generally co-terminus with the survival period for claims.  Liability limits are usually set out for the primary insurer, beyond which there is a tower of excess insurance with multiple insurers.  Standard exclusions are insurer-specific, but generally include: issues known to the investor; estimates or projections; purchase price adjustments; consequential losses; uninsurable and criminal fines; stamp duty-related non-compliances; secondary tax liabilities; anti-bribery and corruption; and punitive damages, etc.  Lately, COVID-19 is also being included.  Further, the insurer may seek specific exclusions depending on the nature of the investee’s business and specifics of the transaction.  Although the premium will depend on the transaction risk, as a general rule, it is in the range of 3–8% of the policy limit.  Additionally, parties must bear a specified ‘retention amount’ before the payment obligation under the policy starts, which is generally a specified percentage of the investee’s enterprise value.

 

6.5        What limitations will typically apply to the liability of a private equity seller and management team under warranties, covenants, indemnities and undertakings?

 

For competitive auctions, we have seen RWI policies as the sole recourse for buyers.  For those transactions that do not include such policies, the most common limitation concerns the quantum of liability and the claim periods.  Parties negotiate and set out the thresholds for de minimis and aggregate liability.  The maximum period within which indemnity claims can be brought is also set out and varies for each kind of warranty.  Parties also agree to standard principles of ‘no double-recovery’ and a duty to mitigate on the indemnified party.  Other acceptable exclusions are: contingent liabilities; tax liabilities (arising after completion); liabilities on account of change in law (after completion); voluntary acts or omissions by the indemnified; or loss otherwise compensated.

 

6.6        Do (i) private equity sellers provide security (e.g., escrow accounts) for any warranties / liabilities, and (ii) private equity buyers insist on any security for warranties / liabilities (including any obtained from the management team)?

 

Typically, PE sellers or buyers do not provide any security for warranties/liabilities.  Lately, buyers are seeking RWI in acquisitions involving PE sellers as a substitute for escrow.  PE buyers, in some cases, may defer payment of a part of their consideration amount.  This in turn acts as a security against breach of warranties/liabilities by the sellers.  We have also seen sophisticated acquirers requiring a backstop from private equity sellers exiting through an SPV in certain situations and even negotiate for equity commitment letters (“ECL”) from such private equity sellers.

 

6.7        How do private equity buyers typically provide comfort as to the availability of (i) debt finance, and (ii) equity finance? What rights of enforcement do sellers typically obtain in the absence of compliance by the buyer (e.g., equity underwrite of debt funding, right to specific performance of obligations under an equity commitment letter, damages, etc.)?

 

Leveraged buyout transactions are generally prohibited in India, unless such leverage is structured overseas, and therefore most transactions are structured without any financing outs and as straight equity investments.

 

There is no general statutory obligation on PE buyers in private acquisitions to provide any financing comfort.  Sellers can contractually negotiate and agree on their enforcement rights.  In most cases, buyers provide fundamental warranties regarding sufficiency of funds, and provisions for funding obligations are simultaneous with the seller’s obligation to transfer securities.

 

Some sellers may insist on an ECL from PE buyers, especially when they invest through SPVs.  Common rights of enforcement available on breach include indemnity, specific performance and dispute resolution.

 

6.8        Are reverse break fees prevalent in private equity transactions to limit private equity buyers’ exposure? If so, what terms are typical?

 

There are no provisions for payment of reverse break fees under law; however, this can be agreed contractually.  Typically, the terms include those in respect of quantum, trigger for payment, mode of payment, etc.  Due to the absence of an express legal regime, effecting payment of reverse break fees from a resident to a non-resident may face regulatory hurdles, such as obtaining RBI approval prior to payment.

 

7. Transaction Terms: IPOs

7.1        What particular features and/or challenges should a private equity seller be aware of in considering an IPO exit?

 

• The lock in period of pre-IPO securities held by promoters and non-promoters is 18 months and six months, respectively, from the date of allotment and subject to further conditionalities.
• Other than the board nomination right, no special rights such as affirmative voting matters, are permitted to continue post-listing.

 

7.2        What customary lock-ups would be imposed on private equity sellers on an IPO exit?

 

All pre-IPO shareholders (other than promoters) are statutorily locked-in for a period of six months from the IPO.

 

7.3        Do private equity sellers generally pursue a dual-track exit process? If so, (i) how late in the process are private equity sellers continuing to run the dual-track, and (ii) were more dual-track deals ultimately realised through a sale or IPO?

 

In the financial year 2022–23, approximately INR 52,116 crores were raised by 37 Indian companies, through IPOs.  While this is a dip since the numbers in 2021–22, the first quarter of 2023 witnessed a 33% increase in the number of IPOs in India as compared to the same period last year.  Therefore, IPOs have been the preferred exit path; although many deals nowadays are structured as dual-track deals, benchmarking purposes prior to the IPO run-up and/or a full-exit are preferred by PE investors.

 

8. Financing

8.1        Please outline the most common sources of debt finance used to fund private equity transactions in your jurisdiction and provide an overview of the current state of the finance market in your jurisdiction for such debt (including the syndicated loan market, private credit market and the high-yield bond market).

 

 

Funding through privately placed non-convertible debentures (“NCDs”) is a popular form of debt financing.  Funds can be raised through FPIs who can subscribe to NCDs issued by Indian companies as there is no cap on interest payout and can be accompanied with redemption premium, which in turn can provide equity upside.

 

Additionally, Indian assets can also be used to secure NCDs through an Indian debenture trustee, who holds security on behalf of NCD holders.  The RBI prohibits Indian banks from granting loans for the purpose of acquisition of shares.  While non-banking financial companies in India are permitted to lend funds for the purposes of acquisition financing, high borrowing costs prove to be a disincentive for PE investors.  Hence, any form of acquisition financing is often limited to offshore sources, which is also challenging owing to restrictions on the creation of security on Indian assets in favour of non-resident lenders.  Investment structures using Indian companies owned or controlled by foreign investors are also not feasible, as the law prohibits such companies from raising any debt from the Indian market for any further downstream investments.

 

8.2        Are there any relevant legal requirements or restrictions impacting the nature or structure of the debt financing (or any particular type of debt financing) of private equity transactions?

 

There are limited end-use restrictions on unlisted NCDs that are privately placed; however, NCDs issued to FPIs for the purpose of acquisition must be listed.  The RBI has introduced a voluntary retention route investment mechanism to enable FPIs to invest in Indian debt markets without any restrictions on minimum residual maturity, subject to a minimum retention period of three years, provided that FPIs retain at least 75% of invested capital in India for such period.

 

8.3        What recent trends have there been in the debt-financing market in your jurisdiction?

 

There is a decreasing interest of investors in instruments like rupee-denominated (masala) bonds.  As such instruments are denominated in Indian rupees, overseas lenders are expected to bear the risk of exchange rate fluctuations.  Accordingly, masala bonds are not popular among PE investors.  SEBI continues to make amendments to protect investors of listed debt securities and enable debenture trustees to perform their duties more effectively.

 

9. Alternative Liquidity Solutions

9.1        How prevalent is the use of continuation fund vehicles or GP-led secondary transactions as a deal type in your jurisdiction?

 

While GP-led secondaries were traditionally not seen favourably, these are now being considered in the Indian context, especially to continue investments in assets that can yield higher returns in the future.

 

9.2        Are there any particular legal requirements or restrictions impacting their use?

 

The formation and allocation towards continuation funds has its own set of legal, tax, regulatory and governance complications.  The structures of such funds should be considered and analysed in the context of the rollover LPs, the assets being continued and the advantages of leveraging an existing structure as compared to setting up a new investing vehicle.

 

10. Tax Matters

10.1      What are the key tax considerations for private equity investors and transactions in your jurisdiction? Are off-shore structures common?

 

PE investors should evaluate the tax treatment of capital gains, dividend income and interest income, and keep in mind the investment instrument employed and the jurisdiction through which the investment has been made.  An offshore investor can choose between being governed by the domestic tax law or the relevant tax treaty, whichever is more beneficial.  Offshore structures for investment in India are fairly common, particularly from jurisdictions with favourable tax treaties with India.  Further, Indian tax laws contain general anti-avoidance rules, whereby Indian tax authorities have the power to deny tax benefits if the arrangement does not have commercial substance and its main purpose is to obtain tax benefits.

 

10.2      What are the key tax-efficient arrangements that are typically considered by management teams in private equity acquisitions (such as growth shares, incentive shares, deferred / vesting arrangements)?

 

Most PE investors use the traditional route of investing directly or through SPVs.  Use of convertible instruments (at times with profit-linked conversion) is fairly common.  Deferred consideration per se may not be workable because of regulatory constraints and complications in treatment of capital gains tax.

 

10.3      What are the key tax considerations for management teams that are selling and/or rolling over part of their investment into a new acquisition structure?

 

In case of a direct transfer of investments held in Indian companies, tax implications could arise in India even where such transfers are part of an internal reorganisation.  In case of multilayer offshore holding structures, gains derived from an indirect transfer of Indian assets may be taxable in India.  Thus, transfer of shares or interests in foreign entities that derive their value substantially from assets located in India would be subject to tax in India even without direct transfer of Indian assets.  However, certain types of corporate reorganisations, such as offshore mergers and demergers, may be tax-neutral, subject to conditions.

 

10.4      Have there been any significant changes in tax legislation or the practices of tax authorities (including in relation to tax rulings or clearances) impacting private equity investors, management teams or private equity transactions and are any anticipated?

 

Typically, any changes in Indian taxation laws are brought about annually as part of the union budgetary exercise.  Under Indian tax laws, a private company is assessed to tax on share premium upon issue of shares in respect to the consideration received from a resident if the consideration exceeds the fair market value of the shares.  Recently, under the Finance Act, 2023, the scope of applicability of angel tax has been widened to include non-resident investors.  With this, companies issuing shares above fair market value to non-resident investors will also now fall within the ambit of angel tax.  Some of the other key changes brought about by the Union Budget 2023 includes the extension of tax incentives for start-ups, extension of concessional tax rates on domestic manufacturing companies, taxation of online gaming and increase in withholding tax rates on payment of royalty and fees for technical services.

 

11. Legal and Regulatory Matters

11.1      Have there been any significant legal and/or regulatory developments over recent years impacting private equity investors or transactions and are any anticipated?

 

• In 2020, India introduced mandatory government approval for foreign investment from countries sharing its land borders/investors whose ultimate beneficial owners were citizens of, or situated in such countries.  This is principally aimed at curbing Chinese investments and potential takeovers in light of the pandemic-induced slowdown.  Subsequently, investments that would otherwise be automatically permitted now fall under the approval route if the PE investor has a ‘beneficial owner’ from any of India’s bordering countries.
• In June 2022, India introduced the mandatory security clearance of persons who are citizens of India’s land bordering countries prior to such persons being appointed as directors on the Board of Indian companies.  This is aimed at reducing the backdoor control of Chinese investors in Indian companies.
• The Indian Supreme Court has also ruled that two Indian parties are permitted to choose a foreign seat of arbitration and an award passed therein would be enforceable as a foreign award.  This will enable PE investors investing through an Indian investing vehicle to choose a foreign seat of arbitration.
• FDI thresholds in sectors such as insurance, telecom and defence have been further liberalised.
• Recently, by way of a notification in May 2023, the Finance Ministry has also included practicing chartered accountants, company secretaries and cost and works accountants carrying out financial transactions (such as buying and selling of immovable property, managing client money, securities and assets, operation or management of companies, etc.) on behalf of their clients within the ambit of anti-money laundering laws.

 

11.2      Are private equity investors or particular transactions subject to enhanced regulatory scrutiny in your jurisdiction (e.g., on national security grounds)?

 

Transactions involving foreign investment from India’s land bordering countries/investors whose ultimate beneficial owners are citizens of, or situated in such countries requires prior regulatory approval.

 

In the last few years, another significant development has been a disclosure requirement of beneficial ownership for all companies.  While this is not specific to PE investors, it mandates all Indian companies to investigate their ultimate beneficial owners and make appropriate public disclosures.

 

11.3      Are impact investments subject to any additional legal or regulatory requirements?

 

SEBI had introduced social venture funds, as category-I alternative investment funds, with relaxed investment conditions to enable investors to primarily invest in social ventures and social enterprises.  Further, SEBI has also put in place a legal framework for the issue of green bonds.

 

11.4      How detailed is the legal due diligence (including compliance) conducted by private equity investors prior to any acquisitions (e.g., typical timeframes, materiality, scope, etc.)?

 

PE investors usually conduct thorough legal due diligence on the investee company prior to investing.  The scope, materiality and timeframe for diligence varies with each transaction, depending on the nature and sector of the investee, mode of acquisition, the transaction timetable and the approvals required to be obtained.

 

Generally, the scope of the legal diligence includes corporate matters, licences, contracts, indebtedness, labour, litigation, real and intellectual property, insurance, etc.  The timeframe depends on the nature and scale of operations of the investee and can take a minimum of two to three weeks.  Materiality thresholds for review are case-specific and are generally applied to contracts and litigation.

 

11.5      Has anti-bribery or anti-corruption legislation impacted private equity investment and/or investors’ approach to private equity transactions (e.g., diligence, contractual protection, etc.)?

 

PE investors are now increasingly undertaking specific due diligence for evaluating the investee company’s compliance with domestic ABC/AML laws as well as internal standards.  There is also a growing (and recommended) trend of engaging specialists to undertake such diligence.  Separately, investors also seek wide warranties and undertakings from the investee company, founders, sellers (in a secondary transaction), and their immediate relatives, in respect of compliance with ABC/AML laws, their past and present conduct, the relationship with government officials, etc.

 

11.6      Are there any circumstances in which: (i) a private equity investor may be held liable for the liabilities of the underlying portfolio companies (including due to breach of applicable laws by the portfolio companies); and (ii) one portfolio company may be held liable for the liabilities of another portfolio company?

 

While the investor may not be liable per se, its nominee director may be held liable for actions of the investee in his/her capacity as a director, to the extent he/she had knowledge of the breach.  Under Indian law, it is unseen for one portfolio company to be held liable for liabilities of another portfolio company.  There is a remote possibility of this happening contractually; for instance, in the case of cross-guarantees.

 

12. Other Useful Facts

12.1      What other factors commonly give rise to concerns for private equity investors in your jurisdiction or should such investors otherwise be aware of in considering an investment in your jurisdiction?

 

With Indian laws on foreign investment, securities and corporate management being complex and constantly evolving, investors must engage qualified local legal, financial and tax advisers at the inception of every transaction, leading to unavoidable cost expenditure, even for transactions that eventually fall through.  The Indian judicial process, with its uncertain timelines, has been a concern; though investors invariably choose arbitration for dispute resolution.  Lastly, while investors have been concerned about the lengthy timelines taken to obtain regulatory approvals in India, we are now able to provide estimated timelines for obtaining these, which is reassuring to investors.

 

This article was originally published in ICLG on 25 September 2023 Co-written by: Iqbal Khan, Partner; Devika Menon, Principal Associate. Click here for original article

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