This blog post will discuss two recent merger control orders passed by the Competition Commission of India (“CCI”), Cairnhill CIPEF Limited & Anr. (“Cairnhill”), and Caladium Investment Pte. Limited (“Caladium”), and their implications for minority/significant minority acquisitions by investment funds. These orders indicate the manner in which the CCI will regard affirmative rights and board representation rights – terms often found in agreements between investment funds and their targets – during its merger review process.

A. Background

The Competition Act, 2002 (“Competition Act”) enacts a ‘suspensory’ merger control regime. This means that transactions which fall under the Act’s definition of ‘combination’ will not take effect unless they are notified to the CCI, and subsequently approved by it. The CCI is allowed a maximum of 210 days to complete the exercise of scrutinizing a combination for possible anticompetitive effects, a time period which may be lengthened by the CCI.

Regulations made under the Act (“Combination Regulations”) provide that an acquisition of shares or voting rights, even though a “combination”, need not normally be notified to the CCI for its approval if:

(a) it is made solely as an investment (emphasis added);

(b) the acquisition does not exceed 25% of the total shares or voting rights of a target company; and

(c) the acquisition does not lead to an acquisition of ‘control’ (emphasis added) over the target (“Investment Exemption”).

The Investment Exemption, if available, is beneficial for investment funds because it tends to substantially reduce deal timelines and transaction costs.

B. Cairnhill and Caladium

In Cairnhill, two private equity funds (together, “Cairnhill Fund”) acquired an 11% stake in Mankind Pharma Limited (“Mankind”) through secondary transactions, and contended before the CCI that they could avail of the Investment Exemption. Cairnhill Fund’s agreements with Mankind provided for a seat on its board, and certain affirmative rights for Cairnhill Fund (typically, this is accomplished by providing for a list of ‘reserved matters’ in the deal documentation – matters on which the investee cannot proceed without the investor’s consent). The CCI denied Cairnhill Fund the Investment Exemption due to those terms, and observed that “an acquisition could be considered to be made solely as an investment if the acquirer has no intention to directly or indirectly participate in the formulation and determination of the business decisions of the target”.

The takeaways from Cairnhill are (a) in the CCI’s eyes, the mere presence of affirmative rights (in particular, Cairnhill Fund’s veto over Mankind commencing any new businesses) and board representation rights evidenced the Cairnhill Fund’s intent to participate in the target’s management; and (b) a transaction on such terms will not satisfy the “solely as an investment” criterion.

In Caladium, the presence of similar (but slightly more extensive) affirmative rights, led the CCI to conclude that Caladium Investment Pte. Limited, (an affiliate of a sovereign wealth fund), had acquired ‘joint control’ over its target – control being ‘joint’ because it was shared with the target’s existing shareholders. The Investment Exemption was not discussed in Caladium.

C. CCI Jurisprudence

The stance taken by the CCI in Cairnhill and Caladium with regard to affirmative rights is not a novel one. In a notification by Alpha TC Holdings Pte. Limited and Tata Capital Growth Fund I (“Alpha”), who had acquired around 17% of their target’s equity, the CCI, upon being confronted with an extensive list of ‘reserved matters’ found that the investing funds’ consent was needed when the target made “strategic commercial decisions”. In the CCI’s view, this could not be regarded as a ‘mere minority protection right’. Consequently, the CCI found that the funds had acquired ‘joint control’ of their target, and denied them the Investment Exemption. It is noteworthy that the CCI seemed to perceive ‘joint control’ as sufficient to deny an acquirer the Investment Exemption, whereas the text of the Investment Exemption speaks only of ‘control’.

Conversely, in a notification by Omega TC Holdings Pte. Limited and Tata Capital Limited upon their acquisition of a 26.33% stake in Tata Projects Limited (“TPL”), the CCI observed that the funds “do not enjoy any veto rights regarding the strategic or commercial decisions” of TPL and thus, had not acquired ‘control’ over TPL.

The CCI’s thinking on affirmative rights in the above cases seems to stem from two of its earlier orders: SPE Mauritius Holdings Limited (“SPE”), and Deepak Fertilizers (“Deepak Fertilizers”). In SPE, the CCI laid down that two persons are in ‘joint control’ of a company when one person is able to block “strategic commercial decisions” and cause a deadlock, and acknowledged that contractual arrangements could lead to a situation of ‘joint control’, but cautioned that “mere investor protection rights” should be differentiated from ‘control’ rights. In Deepak Fertilizers, the CCI observed that having affirmative rights or board representation rights would enable an acquirer to participate in the target’s business decisions, and if an acquisition is made with intent to “participate in the formulation, determination or direction of the basic business decisions of the target”, or is “likely to cause or result” in the same, then such acquisition would not be regarded ‘solely as an investment’. However, the CCI also observed that an acquisition made by a passive investor would be regarded as being made ‘solely as an investment’.

D. Analysis & Conclusion

The goal of merger review is to act as a preventive measure to ensure that strategic M&A activity does not beget entities that can exert their market power to cause anticompetitive effects. The Investment Exemption focuses the scope of the Competition Act’s merger review provisions by recognizing that (a) there are two kinds of investors – strategic and financial, and (b) acquisitions by the former merit antitrust review, while acquisitions by the latter do not.

The Investment Exemption aims to distinguish these two categories of investor by employing the words “solely as an investment”, but issues arise with the test the CCI uses to distinguish the two kinds of investors: it looks into the underlying documentation and the rights contained therein, and then uses these as a proxy to characterize the investor. Another issue is the CCI’s idea of when ‘control’ over a target is acquired.

Thus, what investment funds may perceive as necessary protective covenants when investing in companies where they hold minority stakes (and cannot be certain of high corporate governance standards), the CCI regards as rights that result in the holder crossing the fault line between a ‘financial’ and a ‘strategic’ investor, and possibly, acquiring ‘control’ over the company. The development of the CCI’s jurisprudence in this regard, culminating in Cairnhill, has hollowed out the Investment Exemption to the point where it may not be very useful to investment funds.

The brevity required of a blog post means that this may not be the right place to delve into the correctness of the CCI’s interpretation of ‘control’ under the Competition Act. However, in my view, the CCI is not entirely right in regarding the presence of affirmative rights and board representation rights in deal documentation as a solid indicator that an investor is ‘strategic’ as opposed to ‘financial’. In fact, their presence supplies the opposite inference: that the investor is not interested in the day-to-day running of the business, knows that its lack of involvement may lead to negative outcomes, and is protecting its interests by ensuring that it can exercise oversight, or in a worst case scenario, cause a deadlock. Further, in my view, in Cairnhill (as well as in Alpha), the CCI has interpreted the Investment Exemption in a restrictive manner that is contrary to its intent.

Going forward, as regards acquisitions that breach the Competition Act’s thresholds for merger review, a minimal ‘reserved matters’ list structured to leave intact the target’s ability to make “strategic commercial decisions” on its own may persuade the CCI that the acquirer is not in ‘joint control’ of the target. However, the CCI orders cited above provide only suggestive guidance on what “strategic commercial decisions” are, and thus, this is a significant grey area.

In any case, going by Cairnhill, the mere presence of affirmative rights and board representation rights might prove fatal to an attempt to invoke the Investment Exemption, unless an acquirer can demonstrate that the ‘reserved matters’ list does not give it a right to participate in the target’s “basic business decisions”. In conclusion, it is hoped that the CCI will, in future, interpret the Investment Exemption in a manner more aligned with its intent, and with market realities.