Bharat Vasani, general counsel of the Tata Group, explains the complex legal, business and regulatory issues involved in M&As in an interview with Sujata Agrawal.

What are the differences in acquisitions in India and overseas?
The business and legal environment in India differs from the environment overseas. Each country has its own set of issues, regulatory framework in terms of legal and judicial system, tax regime, social and cultural issues and business dynamics. There are very few geographies that have similar legal systems.

Factors that may not be very crucial in domestic M&As become critical in international acquisitions. For example, violation of environmental laws may not be taken very seriously in some states in India, while in the west, there are very stringent penalties including closure of a production facility for even minor environmental infractions. This necessitates a very comprehensive environmental due diligence exercise that has to be adhered to in an international acquisition, more so if the company is in the business of manufacturing chemicals.

In any acquisition, what are the factors that you need to focus on?
The first is to understand the strategic objectives of the acquisition. For instance, when Tata Chemicals was looking at acquiring a one-third equity stake in IMACID, a state-owned company in Morocco, the Tata Chemical's team was very clear that they wanted to secure a long-term assured supply of phosphoric acid for their Haldia facility.

Setting clear objectives helps us prepare a check list and tailor our due diligence exercise accordingly. In the case of the Tata Chemicals acquisition, we did not know much about Morocco and its legal system. Their legal system is a complex mixture of the French legal system (Napoleonic Code) with some strong Islamic influence. It was therefore necessary to have the right legal advisors on board to understand the complexities of the legal system impacting the acquisition.

So it is important to put together a team of specialists with complementary skills who can help in that jurisdiction. You need an investment banker who can guide in structuring the transaction and evaluating the target, and a local lawyer who is familiar with the jurisdiction and understands the legal nuances. You also need a tax expert, a finance expert, an environmental specialist, a manufacturing expert, an industry expert, etc.

What is the next step?
A key factor in M&A deals is the research involved on both the target company and the country. Thanks to the internet most of the information is easily available. So even before we begin the legal exercise we are familiar with the country's legal/ tax environment, economic system and other issues.

Nowadays, most of the companies which are up for sale prefer international competitive bidding. The bidding process is dictated either by the target company or its promoters. The company fixes a date and a time for conducting the due diligence and keeps the data ready in a data room. Most importantly, one needs interpreters in the data room as the documents may not always be in English. With technology advancements and the increasing number of cross border deals, targets have been making documents available to potential bidders through a 'virtual data room'. With this password protected internet link one can conduct an online due diligence sitting at one's desk.

M&A transactions are driven by timelines dictated by the target company and their investment bankers. If you don't work within the timeline, competing bidders from other countries, which don't have the legal constraints that we face in India will have the advantage of a head start.

What are these constraints?
According to the current RBI regulations, companies cannot bid for an overseas acquisition under the automatic route, if the total funds required for the acquisition exceed 200 per cent of the Indian company's net worth. There are several other aspects which need to be looked at to determine if the proposed acquisition falls within the 200 per cent limit.

Also, according to the Indian Companies Act, if the acquisition value exceeds 60 per cent of the Indian company's net worth or 100 per cent of it's free reserves, then the Indian company is required to take prior approval from its shareholders for making the investment in the target company. It means disclosing vital details about the target company to the shareholders, including the price being paid. This results in certain sensitive and confidential information, which could be of critical importance to competing bidders becoming available in the public domain even prior to submitting a bid to the target company.

Very recently, the Dr. J J Irani committee constituted for suggesting reforms in the Indian Companies Act has submitted a report to the government in which it has specifically recommended that when Indian companies participate in international competitive bidding, they should not be required to disclose such sensitive information as it puts them in a disadvantaged position vis-à-vis their competitors.

Due diligence is a critical factor in M&As. What does it involve?
Due diligence, with reference to M&As is the process of examining all aspects of a company including manufacturing, financial, legal, tax, IT systems, labour issues, checking for regulatory issues, as well as understanding issues related to IPR, the environment and other factors. It is done to investigate and evaluate a potential company for acquisition purposes. It helps the acquiring company to determine whether it is worth pursuing a target and at what price.

We are required to familiarise ourselves within a very short time frame with the benefits our companies hope to get by acquiring the target company. This helps us define the scope of the due diligence exercise more meaningfully.

Legal due diligence covers contractual documentation, litigation, ownership of movable, fixed and intangible assets like IPR, etc. It also looks at any contracts on which there could be onerous covenants or which may become infructuous by reason of change in control of the target following the acquisition. All these aspects could significantly impact the valuation of the target company.

The due diligence (DD) report aims at factoring all critical issues which impact the decision on valuation of the target. The DD report becomes the basis for negotiating and providing in the transaction documentation comprehensive representations and warranties - where the target company or its promoters provide indemnity for their representations and warranties. Secondly, issues that cannot be immediately resolved before closing the deal are put under what is called as 'Conditions Subsequent' (CS); Certain percentage of the purchase consideration is held back in an escrow account and released only when those conditions are met by the target company or its promoters.

How is the acquisition price decided?
The value or amount is finally decided only after the due diligence exercise is completed and the valuer has considered how the findings impact the valuation. One may have a ballpark figure in mind based on the financials of the target evaluated in accordance with internationally accepted norms of valuation.

But the final figure usually changes significantly once the due diligence findings are factored in. It is then that you know the actual value of the target company — whether the cash flow is sustainable in the future; whether assets are legally held in the name of the company; whether feedstock supply is guaranteed for long-term; are there any major liabilities that could wipe out future profitability; are there any contingent liabilities that do not appear in the accounts, etc.

If the target company has a presence in several countries, the exercise becomes even more difficult. One needs to rely on local lawyers and tax experts in each of the different geographies to get the flavour of local regulatory and tax issues and then factor them into the valuation exercise as well as in the contractual documentation to protect one's interests.

Another major challenge is the varying accounting standards adopted by different countries for accounting treatment of different items. This poses a very significant challenge in ascertaining the true value of the target company.

The most crucial aspect in any overseas acquisition is the structuring of the deal and the vehicle used for funding. This is generally dictated by Double Taxation Avoidance Treaties (DTAs) between various countries. For example, India has a very favourable tax treaty with Mauritius and hence major inbound investments in India are routed through special purpose legal entities set-up in Mauritius.

What about government regulatory approvals?
Every cross-border M&A transaction requires regulatory approvals not only in India but also overseas where the target company is located. In India, post 1991, monopoly legislation was scrapped when the entire chapter 3 of the MRTP Act was abolished. But in the west, a paramount consideration is whether the proposed acquisition would lead to market dominance by the acquirer.

In the US or in EU (European Union), the anti-trust laws are very stringent. One requires approval from the Federal Trade Commission or the Department of Justice for any acquisition in the US and from the European Commission (EC) for any target in EU. In most jurisdictions where the target company has business presence, it requires pre-merger notification.

We had to examine these anti-trust aspects when VSNL acquired assets of Tyco Global Network in the US. One also needs to carefully look at employees' immigration and visa issues if the acquisition pertains to the IT sector in the US.

Similarly, in Europe, EC examines in great detail whether the acquisition would lead to a distortion in market competition. Sometimes, proposals are cleared only if the acquiring company agrees to divest some of its businesses. In the UK, there is a very interesting law called 'TUPE' — Transfer of Undertaking and Protection of Employees Act. It dictates how employees are to be protected when the ownership of a company changes.

When getting into an M&A, is there a country of preference where one's comfort level with the legal system would be higher?
I find that the English legal system is the easiest to deal with as we have inherited our legal system from the British and it is therefore similar based on Common law principles. We understand the English legal and regulatory nuances better than those of say, US, Canada, France, South Africa or eastern European countries.

With many more acquisitions happening in the Tata Group, we are now quite familiar with various jurisdictions such as South Africa, France, Morocco, Egypt, etc. Though certain acquisitions did not materialise, the knowledge we gathered was very useful.

Has the Tata Group ever been involved in a hostile acquisition?
We have never made a bid for a hostile takeover. As a Group philosophy, we do not get involved in hostile bids. A point to note is that hostile acquisitions are not liked by the employees, existing shareholders or the existing management. Governments too do not like them because of possible adverse political fallout.

I must add that the one thing we do as a Group is meticulous homework before we decide to bid for any target. We don't just jump into the fray! Some people may feel that we are a little slow in our responses, but I think that it is always better to be fully prepared before entering the acquisition arena.

Is there a point at which companies can walk out of a deal?
Yes, if the strategic objective is not fulfilled, companies can leave the deal. For example, Tata Chemicals acquired Brunner Mond for its soda ash facility in Kenya. If during the process of acquisition they were to find that because of a change of shareholding they would not get the mining rights for soda ash, then it could have become a deal breaker.

Such issues are termed as Conditions Precedent (CP). CPs are clearly spelt out in the agreement and before the legal closing of the transaction, lawyers go through each CP and check that they are satisfied. If even one is not satisfied, the deal falls through.

What happens if a company walks away after closing the deal? What are the legal implications?
If all the CPs are satisfied and the company still walks away, it can be sued for breach of contract. Most international acquisitions have an arbitration clause. Arbitration generally takes place at a neutral venue; where neither the buyer nor the seller is located. However arbitration could be expensive, more so if it goes against you.

What are some of the challenges after an acquisition?
Surveys have shown that more than 90 per cent of international M&As have been failures. There are classic examples of large companies having failed due to the wrong M&A strategy and profitable companies having got into rough weather because they acquired a wrong company.

The real challenge, after an acquisition, is the integration of the two companies. That is why the Tata Group gives so much emphasis to integration. There is a focus on aligning the acquired company's processes with the Group's through the business excellence model and the adherence to the Tata Code of Conduct. Successful integration is an intrinsic part of the Tata Group's M&A strategy.

Uploaded on July 12, 2006