Financing Domestic M&A

A Times
of India report
indicates that the Finance Ministry is considering a
proposal to allow banks to finance domestic M&A, i.e. acquisitions of local
targets by local acquirers. If this proposal goes through (although significant
doubts have been raised regarding that), it will mark a sea-change in the funding
of domestic M&A that is currently deprived of bank funding.
At present, there is some level of
discrimination between the financing of foreign and domestic acquirers. While
foreign acquirers are generally entitled to obtain flexible forms of financing
to make acquisitions of Indian companies, domestic acquirers are hamstrung when
it comes to bank financing, which is not available. Historically, it appears
that the policy of the Reserve Bank of India (RBI) shunned bank financing of share
acquisitions on the ground that it could lead to lending towards speculative
activity resulting in undue risks posed to banks. This inability of acquirers
(particularly domestic) to raise bank financing has been recognized even in the
report
of the Takeover Regulations Advisory Committee
(at pages 19 and 20). Any change
to this policy permitting bank financing of domestic acquirers would not only
propel greater domestic M&A but could also reduce the disparity among
foreign and domestic acquirers.
At the same time, it must be noted
that bank financing by itself may not be sufficient to create a vibrant market
for acquisition financing. Such financing is usually structured in the form of
leveraged buyouts (LBOs) that require the target to provide some support in the
form of guarantees or securities in favour of lenders so as to enable them to
lend to the acquirers. In other words, the acquirer leverages the assets of the
target while obtaining financing from the lenders for the acquisition. Such
leveraged financing in the customary form is not permissible in India due to
the rules against financial assistance that are contained in section 67(2) of
the Companies Act, 2013 (which compares with section 77(2) of the 1956 Act). Although
other jurisdictions carry whitewash provisions that enable shareholders to
approve the financial assistance so long as the company continues to be solvent
thereafter, such a facility is not available to Indian companies. The only
exception available is in the case of private companies, but this is not altogether
attractive as targets in large leveraged buyouts are likely to be public
companies. Moreover, since the definition of a public company is considerably
wide to include a private company that is a subsidiary of a public company, the
possibility of the exemption being invoked is rather minimal.
Although most
countries are progressively relaxing the rule against financial assistance but
at the same time incorporating protections to creditors and minority
shareholders, the rule in India continues to be rigid and inflexible. It is not
clear as why such a relaxation effort was not undertaken when Indian company
law was recently reformed with the enactment of the Companies Act, 2013. Unless
statutory amendments are introduced, acquisition financing by way of leveraged
buyouts would be a non-starter in the Indian context.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

4 comments

  • But isn't 67(2) only concerned with loans, advances or securities being forwarded by a company for the purpose of buying shares in the same company or its holding company?

    Aren't leveraged buyouts, buyouts made from borrowed money generally. And wouldn't the funds(loans) raised for such buyout usually come from an external source (like a bank, FIs, public funding, third part lender etc) usually??

  • @Anonymous. Section 67(2) would also cover any guarantee or security provided by the target company in favor of a lender who had advanced loans to the acquirer. Such a guarantee or security by the target company is common in a leveraged buyout although the actual funds may come from a third party such a bank. Hence, the restriction would apply.

  • Sir, request you to clarify the following.

    Assume an LBO structure involving three parties – Acquirer, Target and an SPV. The Acquirer would infuse funds into the SPV for it to buyout the Target. The remaining funds for this buyout would be sourced from an AIF which would infuse funds (primarily debt but also a certain about of equity to gain a small amount of controlling stake) in the SPV to facilitate this LBO transaction. Isn't this allowed in India?

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