Tag: mergers

Categories
Corporate

[Video] Share transfer restrictions – Learn the practical stuff, understand the legal debates

A corporate lawyer’s job includes facilitating mergers and investments by and into businesses. Really experienced corporate lawyers become extremely familiar with shareholders’ agreements and joint-venture agreements but young corporate lawyers and law students working at corporate law firm internships are known to look at terms like ROFR, ROFO, tag-along, and drag-along with wonder.

These different types of share transfer restrictions are a massive and complicated topic. To make it easier to understand, we spoke to Arjun Rajgopal (Principal Associate, Khaitan & Co.) and Umakanth V., an Associate Professor at National University Singapore, and among the most respected names in Indian corporate law.

What we have below are two videos which contain a completely lucid, simplified, and practical explanation of shareholder restrictions. In the first part, we discuss their purpose, their different types, and how they work.

In the second part, we look at how Indian laws have treated share transfer restrictions and the massive debate over their enforceability. What did the Companies Act, 1956 say about them and how have things changed with the new Companies Act, 2013?

If you want to be a corporate lawyer, you cannot afford to miss these two videos.

 

Categories
Corporate

An introduction to strategies and risks in private equity for lawyers

PrivateEquityLawyer_AngiraSinghviCommon funding options available to companies include taking loans from banks, commercial borrowings, and issuing equity shares and convertible instruments. Even though the cost of borrowing is perceived to be lower than the cost of equity, companies often prefer not to take loans because among other reasons, loans require security, increase the repayment obligation on the company, and increase its debt-equity ratio.

Another option is to raise equity investment from a closed group of private persons directly. Well known examples of this category of investors, known as ‘private equity funds’ or ‘private equity firms’, include Blackstone, Goldman Sachs, Warburg Pincus, and Carlyle and their investments are called private equity (“PE”) investments. Their objective is to transfer back their shares in the company at a pre-determined rate at the end of a certain investment period and earn a return on these investments. In India, unless the gestation period of the target company’s business is long, this period ranges between three and five years.

In India, private equity investments are mostly made into private or public non-listed companies. While there is no bar, legally or conceptually, to making private equity investments in listed companies, the law governing the acquisition of shares in listed companies above a certain threshold makes them cumbersome.

Since it is aimed at maximising shareholder return in a fixed period, private equity helps in speeding up the process of achieving growth targets. Private equity can also help professionalise some mature companies that earn profits but do not have systems in place with respect to reporting, compliance, and accounting. It can also change the direction of a company and enable it to take calculated risks as opposed to the following the directions of one person. Remember also, that the private equity market is less transparent compared to the market for listed stocks and bonds, and so may offer more opportunities and higher returns.

Strategies

Even though most PE funds are generalists and invest into all kinds of promising ventures in a variety of sectors, specialised PE funds focusing on particular sectors or a particular strategy of investment, have emerged. Private equity investments can be used for financing start-ups, injecting working capital into a growing company, or acquiring a mature company. It can also be used to strengthen a company’s balance sheet.

– Among all categories of PE investments, venture capital, which is provided to start-ups and early stage growth companies, has the highest risk and the highest potential for returns. The strategy here is to invest in companies that promise a bright future. Their business model typically involves high technology industries such as information technology, healthcare, and green or renewable energy. Companies, if successful, experience higher levels of growth.

– Growth capital is provided to mature companies that have already made it through the early stages and are able to generate constant revenues. Such financing is usually for a major expansion or diversification that the company cannot fund on its own. Recently, on 1 May 2015, Goldman Sachs and Rocket Internet invested USD 100 million into food delivery portal ‘Foodpanda’. The investment is aimed at further expanding Foodpanda’s own delivery activities and improving overall customer experience across global markets.

– The strategy behind buyouts is to acquire a stake in a mature, established company with a strong market position in order to exercise influence on it. Privatising a company allows the management to take decisions or adopt strategies that could otherwise be difficult or controversial in a publicly listed company. For example, disposing off an undertaking or a substantial asset of a listed company may be a cumbersome task since the same requires a special resolution to be passed under company law. It is much simpler to pass such resolution after acquiring a stake in a company through which the investor can influence the decisions of the company.

Concerns

While a private equity investment may appear more appealing than a bank loan, there are risks involved in the transaction.

– The PE investor, even when holding a minority stake, exercises influence over the company and restricts the entrepreners discretion to a large extent.

– The costs of continuous and detailed reporting may be an added burden on the target company.

– There are likely to be restrictions on the transfer of shares of the current shareholders of the company for the benefit of the PE investor;

– The rights of the PE investor at the time of its exit from the company along with its return may often be unduly harsh on the promoters. For example, it may require the promoter to compulsorily sell his shares on terms and conditions agreed upon by the PE investor with a third party purchaser.

– Being pure investors, the interest of a PE investor in the company is limited to the recoupment of their investment.

These concerns, especially the risk of diluted control over the company, may often outweigh the benefits of PE investment.

Preparations

To ensure a successful PE investment, lawyers advising the parties have to ensure that both investor and the target are well prepared.

– The target company should weigh the limitations that are likely to be placed on the discretionary powers of its current owners against the need for money from the investors. Clients that are not from a professional background must be clearly advised about these consequences.

– The main concern of a PE investor is to ensure that it exits the company smoothly and with an acceptable return on its investment. An estimate of this return helps avoid disputes later. The target company should prepare this estimate professionally. This requires clarity on the current business situation as well as the forecast.

– A PE investor, prior to investing in the company, always conducts a penetrating due diligence on the target company. The investor will examine every aspect of the company including its governance, compliance, and reporting structures. By ensuring that it is compliant, for example, that meetings are held in time, that books and registers are well maintained, that all filings are made, that proper contracts have been entered into for all activities, and that licenses and registrations have been duly obtained and maintained, the target company can remove uncertainty and delays in the conclusion of a transaction. In fact, the target company should even conduct an internal compliance due diligence on a regular basis.

– Disagreement during the finalisation of transaction documents can be largely reduced if, before entering into a transaction, the framework of the investment is set out in a term sheet. There should therefore be clarity on issues such as the nature and type of instrument (whether a convertible or plain vanilla equity), the structure through which equity will be infused, the exit rights of the investor, restrictions on the transfer of shares of the current shareholders, and the governance of the company. The agreement on these issues can be revised after the reviewing the results of the due diligence.

I will reflect about private equity transactions in greater detail in a few more posts here.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.

Categories
Corporate

Three points to remember while drafting conditions precedent clauses

Drafting_for_Business_Deepa_Mookerjee.jpgA shareholders’ agreement is a contract that contains the rights and obligations of the shareholders in a company. It typically supplements either a share purchase agreement or a share subscription agreement. You can read more about them in my post on the documents that you will come across during M&A transactions.

Almost every shareholders agreement looks similar. You will see a title, a table of contents, a recital clause, an interpretation clause, and introductory clauses describing the transaction. These clauses have been discussed in detail in myLaw.net’s course on Advanced Commercial Contracts. In this post, I will explain the conditions precedent clause, which is typically seen in all shareholders agreements.

A condition precedent is usually a legal term describing a condition or event that must occur before a contract is considered in effect or any obligations are expected of either party. Here are a few examples.

A is purchasing 100% of the shares in a company whose main business is selling computers to the public. The company does not manufacture computers itself but sells the computers it receives from different distributors. From A’s perspective, the company’s relationship with its distributors is key because if the distributors don’t provide computers to the company, it will have nothing to sell. Many of the distributors’ contracts with the company require their prior approval before a 100% transfer of shares takes place. A would only want his obligation (to purchase shares and pay consideration for them) to be triggered once the company receives these approvals. The receipt of these approvals therefore, is a condition precedent that must be fulfilled by the company before the transaction is effective.

ConditionPrecedentClause

Take another example. B, a non-resident investor who has an investment in an IT company in Mumbai, wants to invest in an IT company in New Delhi. One of the terms of the transaction is that B must sell his interest in the Mumbai-based company before making the investment. So, the sale of those shares in the Mumbai-based company is a condition precedent that B must fulfill before he can invest in the Delhi-based company.

If these conditions are not fulfilled, there will be no deal. Common conditions precedent in M&A transactions include those in relation to obtaining approvals from the regulators, firing or hiring particular employees, ensuring that sufficient cash is available in the company, obtaining approvals from third parties, and ensuring that lease agreements are in place.

On whom is the obligation cast?

Let’s take a closer look at the examples above. You will see that the obligation to fulfill the condition precedent in the examples is cast on different parties. In the first example, the obligation to obtain approvals from distributors is cast on the investee company, that is, the company in which the investment is being made. In the second example, it is cast on the foreign investor. Conditions precedent can thus differ on the basis of the party on which the obligation to fulfill it, is cast. Some obligations can be cast on the investee company, some on the investor, and some jointly on the investee company and its shareholders.

For instance, C is a foreign investor who wants to invest in a company operating in a sector where the approval of the Reserve Bank of India is required for any foreign investment. Typically, the burden of obtaining this approval is cast jointly on all parties because each party’s cooperation is required for obtaining this approval.

While drafting a conditions precedent clause, you must take care to identify the party on whom the obligation to fulfill a particular condition is imposed. This is vital as each party is responsible to fulfill its own obligations in relation to the conditions precedent. While casting an obligation on the investee company, you should examine whether it is also useful to cast the obligation on its shareholders (or at least the majority shareholders) if they control the operations of the company.

The right to waive a condition precedent

Another point vital to this discussion is whether conditions precedent can be waived. Look at the first example. Assume that the investee company has only obtained approvals from fifty percent of its distributors. A, the investor, would really want the deal to go through and should be happy with approvals from these distributors if they are the major ones and would want to waive the condition that approvals must be obtained from all the distributors. Once A has waived the fulfillment of this condition, the deal can go through. The right to waive the fulfillment of a condition precedent is very important in all M&A transactions. Always include this right when you are drafting a condition precedent. The important point to keep in mind is that the person who has the right to waive the condition must be different from the person who is obliged to fulfill the condition.

In the first example, the right to waive the fulfillment of the condition in relation to obtaining consents from distributors must be with A and not the investee company. The investee company can never have the right to waive fulfillment of a condition that it is obliged to fulfill. Similarly, in the second example, the right to waive the condition in relation to withdrawal from the Mumbai-based IT company is on the investee company and not B, the investor.

Since these are all contractual rights, it is up to the parties to decide whether they would like to waive the conditions in part or in full. As a lawyer, your duty is to ask these questions from your client before you start drafting so that you can use the words that are appropriate to your client’s interests.

When should the conditions precedent be met?

Finally, always insert a date by which all the conditions precedent must be met. This is typically called the ‘long stop date’ and is important to ensure that there is no undue delay in the performance of the contract or the fulfillment of the conditions. Parties know that they must fulfill the conditions precedent by a specific date. While drafting this clause however, always include the following or similar words:

“The Conditions Precedent must be satisfied by April 20, 2015 or any date as may be mutually agreed between the Parties.”

The words in plain text above give the parties to a contract the right to mutually agree and extend the time for the fulfillment of the conditions. If, for example, regulatory approval — a condition precedent for a particular deal — takes longer than anticipated, the parties should have the right to extend the long stop date if they feel the need to do so. This is also important because if conditions precedent are not satisfied, the transaction is terminated, and parties must have the flexibility to prevent this.

As you start drafting conditions precedent, you will realise that there are many nuances to the manner in which you draft these conditions. For instance, you may use the words ‘use all reasonable efforts’ to dilute the obligation on a party. In such cases, that party only has to show that it has used all reasonable efforts to fulfill the condition and that will be enough (even if the condition has not been fulfilled).

Keep drafting and with practice, you will get better at drafting conditions precedent clauses.

(Deepa Mookerjee is part of the faculty on myLaw.net.)

Categories
Corporate

Five tips to help you negotiate an M&A transaction like a boss

Drafting_for_Business_Deepa_Mookerjee.jpgThinking about negotiations, we may picture lawyers from opposite sides meeting in a conference room. Negotiations however, can take place over the phone or even through email. While most ‘big-ticket’ M&A transactions will comprise at least one meeting where the parties and lawyers are physically present to discuss all the major issues, minor issues can always be discussed through email or over a phone call. Remember, after having studied how to conduct an effective due diligence exercise and draft a comprehensive report, we are now moving ahead in the timeline of an M&A transaction. Actually, as you will see below, it often happens at the same time as the due-diligence.

Consider this scenario. Care Insurance Limited, a foreign insurance company, is investing in 26% of the equity share capital of Happy Life Insurance Limited, an Indian insurance company, and both companies have entered into a memorandum of understanding (a preliminary document about which we have already learnt), quite a few issues remain open. Care Insurance has two options. It can (a) wait to see the results of the due diligence exercise and then commence negotiations; or (b) if it is reasonably sure about its intention to invest, it can commence negotiations while the due diligence exercise is going on and then decide on any issues that may arise from the due diligence. More often that not, parties chose the second option unless they expect to see major red flags after the due diligence.

M&A negotiations can start in one of two ways — either one of the parties will circulate a first draft of the definitive documentation that can then be negotiated at a meeting or the parties will circulate a list of major negotiation points, which once decided, will then be inserted into definitive documentation. The choice of process is entirely up to the parties.

NegotiationInProgressRemember that a negotiation process is very sensitive and delicate as parties (sometimes with completely opposing positions), need to arrive at a mutually acceptable solution. Your job as a lawyer is to facilitate the closing of a deal. Here are five points you should keep in mind while preparing for a negotiation. Some of these may seem pretty obvious but after several negotiations, you will realise that even the smallest issue can make a difference.

1. Think about what to negotiate

Always sit with your clients to prepare a comprehensive list of issues that you would like to negotiate, before any meeting with the opposing counsel. Unless your clients would like to keep their position confidential till time the negotiation commences, it is best to set out their positions on these issues and circulate it to the other side. At times, the opposing counsel will also set out their responses to the issues you have circulated. The result is that before the negotiation commences, you will have a document that lists the major negotiating points and the views of both sides on each. This will help structure the discussion as the parties will be focused on the issues at hand. It will also give each side some time to consider the other party’s position before the negotiation commences, often aiding in a smoother negotiating process.

2. Be on the same page as your client

It is best to have a few meetings with your client (whether over the phone or in person) before your meeting with the opposing counsel. You should know how your client would like to see each individual issue resolved. Make sure that you have discussed possible outcomes with your clients and that you have taken them through both the best and the worst-case scenarios. Think about how the issues might relate to each other—for instance, is there some issue your client might be willing to concede in order to succeed in another aspect of the case? Finally, and importantly, make sure that you have determined—in consultation with your client—your ‘bottom line’, that is the point beyond which you cannot concede in a negotiation. If for example, Happy Life believes that Care Insurance must at least invest Rupees One Hundred crore for purchasing 26% shares in the company, then Rupees One Hundred crore is the bottom line. You cannot go below this number in your negotiations.

3. Know the transaction

APCCLP_CompanyLaw-BannerKnow the contours of the transaction and the several issues that can arise. Be aware of the law and the manner in which it relates to the transaction. This will ensure that you never agree to anything that is illegal (due to your ignorance of the law) which you will have to go back on later. For instance, you should be aware that the maximum permissible limit of foreign investment in any insurance company is 26%. Also, be aware of the manner in which the Foreign Investment Promotion Board allows a company to make this investment. Is investment allowed by way of preference shares or only equity shares? How can a foreign partner exit the company? Is there any guidance on the number of directors that can be appointed by a foreign partner? You should have answers to all these questions before you start negotiations.

4. Keep copies of all supporting documents ready

Make sure that you have enough copies of all supporting documentation (emails, preliminary documents, term sheet, reports and the like) that you might need before you enter into a negotiation. Keep additional copies in case anyone needs it. It is always best to have more copies so the negotiation does not need to be halted for something as trivial as taking printouts or photocopies. Also, make sure you have enough stationery – pens, papers, and notepads — for all participants in the negotiation.

5. Plan the conference

Make sure you have a comfortable environment for the negotiation. It should take place in a private room, such as a conference or meeting room. If possible, you can provide a smaller, private room for the other side to go to if they need to discuss anything in private during the course of the negotiation. This is typically called a break out room.

Ensure that facilities such as printers and photocopying machines are available through the duration of the conference. Finally, keep in mind that refreshments such as water, juice, lunch, and dinner should be provided to all the parties with minimal fuss so that they can be focused on the discussion rather than deal with ancillary issues.

Remember planning the meeting is as important as your conduct in negotiations. Good planning leads to an effective negotiation while incomplete planning will result in a bumpy negotiation process.

In my next post, I will discuss the manner in which you should conduct yourself at negotiations and the steps you should take to conclude your negotiation successfully.

(Deepa Mookerjee is part of the faculty on myLaw.net.)

Categories
Uncategorized

Six tips for an effective due diligence process

Drafting_for_Business_Deepa_Mookerjee.jpgEven though Ray Limited has agreed in principle to acquire 30% shares in Whirl Limited and has signed a memorandum of understanding to this effect; it does not have enough information about that company. For instance, it does not know whether and to extent the company is in debt, how its business is doing, and who its main customers are. Obviously, just as you will not buy a car or a home theatre without a thorough investigation of its benefits, Ray Limited will never purchase shares in Whirl Limited without having complete knowledge about that company. Ray Limited will only invest in Whirl Limited once it carries out a thorough investigation of Whirl Limited. Such an investigation, called a ‘due diligence’ process, helps an investor carry out a cost-benefit analysis of whether the investment is beneficial. During this process, an investor investigates the financial, commercial, and litigation-related details and contractual and other information about the target company.

Such investigations can be of different types. They include:

– Commercial due diligence: This consists of a review of the industry, market, and business model of the target company;

– Reputational due diligence: This includes a review of the credit worthiness and reputation of the target company;

Financial due diligence: This includes a review of the tax, financial position, policies, and internal controls of a target company; and

Legal due diligence: This is usually very broad in nature, and consists of a review of all relevant documentation and material contracts. This due diligence process, which is the focus of this post, aims to understand the business and identify potential legal issues that can impede the transaction or affect the transaction value.

Requisition list

As a lawyer carrying out a legal due diligence, the first step is to send to the target company, a questionnaire or list of the documents you require. This list is typically called a requisition list or a due diligence checklist. It helps the other side of the transaction organise documents in the manner you want and ensure that all the documents you require are provided to you. In the absence of such a list, confusion is likely to arise about the nature of documentation required.

APCCLP_CompanyLaw-BannerThis information is provided by the target company in a data room, set up for the purpose of the diligence. Such a data room is either a physical data room or an online data room, which is becoming more prevalent these days. Depending upon the nature of the deal and the extent of confidentiality required for the documents, the target company can grant limited access to the advisors of the acquirers or permit them to examine the records, contracts, and information about the company in person (in a physical data room) or download or edit them (in an online data room).

You will always have to comply with the directions of the target company in relation to handling sensitive information. For instance, you may be asked to not make copies of any documents. You will have to strictly comply with that direction.

While carrying out this investigation, bear in the mind the following:

1. Remember, what you are doing can make or break a deal.

You are the one who has access to all the company’s records and therefore, you have a responsibility to provide a complete and true picture of the company you are investigating. Your client will depend on your report to make a final decision. Never cut corners while investigating. Ensure that all the information is made available to you. If you face a problem accessing any information about the target company (which you feel is vital), let your client know that your investigation will be incomplete unless the information is provided to you.

2. Never assume any fact.

Always ask for documents or written evidence to confirm any statement made by the company. For instance, if a company says it has paid off a loan of Rupees 10 crore in the last two months, ask for written evidence (such as a letter or undertaking from the bank) stating that the loan has in fact ben repaid. If you don’t get what you have asked for in the beginning – ask again.

3. Never forget the nature of the transaction.

The type of documents you will ask for depends on the type of transaction. For instance, if you are only going to buy a specific part of the business, ask only for the documents relevant to that part. If you are acquiring the whole company – you need documents pertaining to the whole company.

4. Always be polite and courteous to those who are providing you the documents.

A Business Men Climbing a Pile of Papers
It can often seem like this but make sure you retain your cool during a due diligence process.

Remember, the documents will often be provided to you by employees or company secretaries who have little or no background to the deal and may not know the reason why the document may be important to your investigation. Patience is key to a successful due diligence investigation.

5. Where you can, make copies of documents.

Always keep copies of all documents you have looked at (if you are permitted to photocopy documents). If not, make detailed notes of every document. This will be helpful while preparing the report as you can look at your notes to refresh your memory. Remember, once the target company has provided some information, it is unlikely to provide it again. So, your notes will form the basis of the report and your conclusions regarding the deal.

6. Be efficient.

Almost all due diligence investigations are carried out within a limited time period. Parties are eager to close the deal and there is immense pressure on lawyers to carry out a diligence efficiently and effectively. While actions such as sending a requisition list will help save time, never hurry up the investigation and ignore documents just to complete the process on time. If necessary, ask your client for more time after providing a detailed explanation about why you need more time.

After this process is complete, as a lawyer you will be asked to prepare a due diligence report setting out details about the investigation and your conclusion about the legal issues in the deal. I will discuss the important points to keep in mind while drafting the due diligence report in my next blog.

(Deepa Mookerjee is part of the faculty on myLaw.net.)