RBI Permits Deferment of Consideration and Escrow Mechanism Under Automatic Route

[The following post is contributed by Abhishek Dubey who is a Managing
Associate with BMR Legal, Delhi. The views expressed here are personal.]
In continuation of its policy to
rationalize the existing regime under the Foreign Exchange Management Act and to
promote the ease of doing business, the Reserve Bank of India (RBI) has amended
the Foreign Exchange Management (Transfer or Issue of Security by a Person
Resident outside India) Regulations, 2000 to permit, under the automatic route,
deferment of purchase consideration and escrow mechanism in share purchase
transactions involving foreign investment. Under the earlier regime, deferment
of purchase consideration was not permitted and escrow mechanism was permitted (with
several restrictions) under the automatic route for a maximum period of only
six months. The amendment regulations have been notified in the official
gazette and are effective from May 20, 2016. The amendment regulations can be
accessed here.
The text of the newly introduced
Regulation 10A is reproduced below:
“10A.
In case of transfer of shares between a resident buyer and a non-resident
seller or vice-versa, not more than twenty five per cent of the total
consideration can be paid by the buyer on a deferred basis within a period not
exceeding eighteen months from the date of the transfer agreement. For this
purpose, if so agreed between the buyer and the seller, an escrow arrangement
may be made between the buyer and the seller for an amount not more than twenty
five per cent of the total consideration for a period not exceeding eighteen
months from the date of the transfer agreement or if the total consideration is
paid by the buyer to the seller, the seller may furnish an indemnity for an amount
not more than twenty five per cent of the total consideration for a period not
exceeding eighteen months from the date of the payment of the full
consideration:
Provided the total consideration finally paid for
the shares must be compliant with the applicable pricing guidelines.”
The amendment regulations seek to
introduce the following:
(i)   Deferment
of Purchase Consideration
: The amendment regulations permit deferment of
purchase consideration in share purchase transactions involving foreign investment
(both inbound and outbound) for a maximum period of 18 months from the date of
the definitive agreements. The amount of the consideration that is sought to be
deferred under the share purchase agreement shall not be more than 25% of the
total consideration.
(ii)  Escrow
Arrangement
: The buyer and the seller can enter into an escrow agreement
and open an escrow account in India for depositing the deferred consideration.
The escrow amount shall not exceed 25% of the total consideration and the
duration of the escrow account shall not be more than 18 months from the date
of the share purchase agreement.
The flexibility conferred by the RBI of having an
escrow account will provide significant comfort to the buyer in securing its
indemnity rights and having an effective remedy against the seller for breach
of warranties. Further, hold-back of consideration by the buyer in the escrow
may give impetus to a trend of ‘post-closing purchase price adjustment’ in the
Indian M&A space.
It is to be noted that the reference date for
commencement of the 18 month period for escrow arrangement as well as for
deferred consideration mechanism is the date of the share purchase agreement.
The date of the share purchase agreement is referred to as the “execution” date
which is different from the date of “closing” when the seller transfers the
shares to the buyer and buyer transfers the consideration to the seller. The
time gap between execution date and closing date may range from 60 days to 180
days and even more in large transactions requiring approvals from regulators
(CCI / FIPB / DGCA). Therefore, the effective life span of the escrow account
or effective period of deferment consideration would depend on the time gap
between execution of the share purchase agreement and closing of the
transaction – it can be full 18 months only in transactions that sign and close
simultaneously. 
(iii) Seller
Indemnity
: The amendment regulation provides that if the seller has
received full consideration from the buyer, the seller may provide an indemnity
to the buyer for a maximum period of 18 months from the date of payment of full
purchase consideration. The indemnity could be of a maximum amount of 25% of
the total purchase consideration.
The introduction of restrictions on subsets of
indemnity is a potential cause of ambiguity because in the regime existing
prior to this amendment there were no limits prescribed for indemnification time
period or indemnification amount. The indemnification period is usually
contractually agreed between the parties based on various factors such as the
time period prescribed by the statute of limitation, the lookback period under
taxation laws and practical considerations such as the time required by the buyer
in discovering non-compliances after taking over the target or time probability
of a claim arising. Similarly, the liability cap under the indemnification
provisions is usually a fraction of or in certain transactions a factor of the
total purchase consideration. Given that the objective of the amendment
regulations is to rationalize the existing FEMA regime, the interpretation of
this insertion needs to be seen.
It is to be noted that while the reference date for
commencement of the 18-month period in case of deferred consideration and
escrow account is the execution date of the share purchase agreement, that in
case of seller indemnity is the date of closing of the transaction, i.e., the
date when the seller receives the purchase consideration and transfers shares
to the buyer. Therefore, the effective protection offered to the buyer by the
amendment regulations is more in the case of seller indemnity in comparison
with deferred consideration or escrow arrangement.
Conclusion
Deferred consideration mechanism
and indemnity escrows are recognized features of M&A transactions
worldwide. However, Indian definitive documents for cross-border transactions carried
ambiguity in respect of these globally accepted risk allocation mechanisms
until now. With the introduction of the flexibility of having deferred purchase
consideration mechanism or an indemnity escrow account in Indian cross-border
transactions, the RBI has taken a significant step not only towards buyer
protection but also towards aligning the Indian M&A landscape with the regime
prevalent in acquirer / investor states.  

– Abhishek Dubey

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.

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