In a previous post on the Lexygen Blog, I had noted that due to recent merger control rulings by the Competition Commission of India (“CCI”), the exemption given to acquirers from notifying minority/significant minority acquisitions that were made “solely as an investment” (“Investment Exemption”) had more or less evaporated. Ideally, funds would like the Investment Exemption to be available to them because it obviates the need to go through the CCI’s (sometimes lengthy) merger review process.

In interpreting the Investment Exemption, the CCI had tried to draw a line between purely financial ‘portfolio’ investors and investors that it perceived as ‘strategic’, and limit the benefit of the Investment Exemption to the former – fair enough, given the intent of antitrust merger review. However, the CCI’s interpretation of the term “solely as an investment” in the Investment Exemption was somewhat out of sync with commercial realities: in the CCI’s view, if the terms of an acquisition provided an acquirer with affirmative rights and a seat on the investee’s board, the acquirer took on the colour of a ‘strategic investor’, and such an acquisition was not considered to be made “solely as an investment’.

Interpretational issues aside, there were two issues with the CCI’s interpretation of the Investment Exemption: (a) the parameters it employed to characterize an investor as ‘financial’ or ‘strategic’ were subjective; and (b) it was not a desirable outcome for funds since it would result in more deals having to go through CCI review. The CCI has now amended the Investment Exemption, and this amendment is discussed below.

The Investment Exemption as it previously stood was designed thus: it had two ‘limbs’: the ‘solely as an investment’ limb and the ‘ordinary course of business’ limb. To take the benefit of the Investment Exemption, an acquisition had to fall under one of these two limbs, could not result in an acquisition of over 25% of the target’s shares or voting rights, and further, could not result in an acquisition of control over the target.

Now, an explanation has been added to the Investment Exemption which states that an acquisition of a sub-10% stake shall be treated as being made “solely as an investment”, provided the following two conditions are met: (I) the acquirer’s rights are on par with the rights of ordinary shareholders of the investee (“Proviso Condition I”), and (II) the acquirer does not have a board seat, does not have the “right or intention” to get a board seat, and does not intend to participate in the affairs and management of the investee (“Proviso Condition II”, and together, the “Proviso Conditions”).

Despite some language issues, the intent seems to be clear that any acquisition of a 10%+ stake (or any acquisition where the deal terms include affirmative rights or a board seat for the acquirer) would not be regarded as being made “solely as an investment”. The amendment now seems to split the Investment Exemption into layers based on the shareholding acquired:

(i) between 0% and 10%, the ‘solely as an investment’ limb and the ‘ordinary course of business’ limb are available (if the Proviso Conditions are met); and

(ii) between 10% and 25%, only the ‘ordinary course of business’ limb is available.

Coming to the Proviso Conditions, they now codify the stand the CCI has been taking in its rulings. Consequently, investments/acquisitions by funds that breach the financial thresholds enacted in section 5 of the Competition Act, 2002 (the “Act”) will have to undergo CCI review since customary deal terms such as affirmative rights and a board seat will immediately disqualify such funds from availing the Investment Exemption.

The Proviso Conditions on a closer look reveal ambiguities: What does the CCI mean when, in Proviso Condition I, it refers to rights on par with ordinary shareholder’s rights? Does ‘ordinary shareholders’ connote holders of equity shares? What would the outcome be when an investor acquires preference shares of a certain class that carry special rights – but are also held by all extant shareholders save the promoters? How will the CCI try to gauge whether a fund plans to participate in the affairs and management of an investee under Proviso Condition II, absent tell-tale indications in the deal documentation? These questions must be looked at keeping in mind the intent behind the amendments to the Investment Exemption.

To understand the intent behind the amendments to the Investment Exemption, it might be useful to look at a similar ‘investor only’ exemption available in the United States under the Hart-Scott-Rodino Antitrust Improvements Act, 1976 (the “HSR Act”). The HSR Act’s ‘investor only’ exemption is designed much like the Investment Exemption, (it has a 10% cap and a disqualification for acquirers who intend to participate in the target’s management), and has been interpreted by the American antitrust regulators in a strict manner based upon an inquiry into the entire background of circumstances and behaviour involved in an acquisition. For example, the HSR’s ‘investor only’ exemption was very recently denied to an activist hedge fund that acquired a small stake in a large tech company and attempted to participate in the company’s management and affairs by trying to influence the company’s board composition. The jurisprudence behind the HSR Act’s ‘investor only’ exemption, though criticised by American legal practitioners and academics, is clear on the point that any acquisition that results in the acquirer being in a position to influence an investee’s management and affairs is a potential antitrust concern. With these amendments to the Investment Exemption, the CCI seems to have bought into this logic.

In fact, the CCI’s stance appears to have hardened considerably on this matter: previously, the CCI only considered the power to influence the ‘basic business decisions’ of a target to be off limits for an acquirer that wanted to avail the Investment Exemption, whereas Proviso Condition II now seems to place a complete embargo on an acquirer participating in a target’s affairs and management, if the acquirer is desirous of availing the Investment Exemption.

Going forward, it should be noted that certain de minimis exemptions from the merger review provisions of the Act are set to expire early this year. Combined with the amendments to the

Investment Exemption detailed above, the effect is that the universe of acquisitions by funds that fall under the scope of the CCI’s merger review provisions is set to expand. However, it should also be noted that the Act exempts Foreign Portfolio Investors and a sub-category of Category I Alternative Investment Funds (Venture Capital Funds), from its merger review provisions.

In conclusion, funds must, when contemplating deals in the sub-10% space, consult their advisors and: a) identify entities that form part of their ‘group’ as defined under the Act (for the purpose of computing whether the financial thresholds for notification to the CCI are breached or not); and b) holistically consider the deal terms and the surrounding circumstances to ascertain whether the Investment Exemption will be available for that particular deal.