m & a: comparison of us & indian laws

Kumar Pallav

Corporate law: Policy Analysis

1

Paper on

“On the execution of a strategic acquisition: a comparison of

U.S. and Indian laws”

By: Kumar Pallav1

1 Candidate for LLM, class of 2010, NYU School of Law.

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Synopsis

1) The strategic acquisition: An importance of planned company acquisition……….. 3

2) Mergers and acquisitions as a source of value creation in business………………… 4

A) Motives and sources of value in mergers and acquisition

B) Economic drivers of mergers

B.1) Horizontal merger

B.2) Vertical merger

B.3) Conglomerate merger

C) Sources of value destruction in mergers

D) Institutional protection mechanism

3) The structure for the corporate acquisition in the U.S. ……………………………… 9

A) Three ways to a acquire control

A.1) Asset acquisition

A.2) Stock acquisition

A.3) Merger

B) Triangular merger as a solution and its purpose

4) Indian laws of Merger ………………………………………………………………… 14

5) Future role of M & A in India………………………………………………………... 16

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1) The strategic acquisition: The importance of planned company acquisition

Merger and acquisition is one of the most important and complex corporate

transaction. Business entities make use of mergers and acquisitions for expansion of

business as well as for gaining a competitive advantage in the industry. A corporate firm

may grow its business either by internal expansion or by external expansion. In the case

of external expansion, a corporate firm acquires a running business and grows overnight

through corporate combinations. These combinations are in the form of mergers,

acquisitions, and takeovers. They play an important role in the external growth of a

number of leading companies of USA and India. Mergers & acquisitions have become

popular because of the enhanced competition, free flow of capital across countries and

globalization of businesses. In the wake of economic reforms, Indian have learnt from US

industries and also started restructuring their operations around their core business

activities through acquisition and takeovers because of their increasing exposure to

competition, both domestically and internationally. 2

Mergers and acquisitions are strategic and complex decisions in order to maximize

company's growth by enhancing its production and marketing operations. The rise of

globalization has greatly increased the market for cross border acquisition. This rapid

increase has taken many firms by surprise because the majority of them never had to

consider acquiring. However, planned company acquisition is required due to the

financial, strategic and competitive reasons.

2 See Richard G. Parker and David A. Balto, “The Merger Wave: Trends in Merger Enforcement and

Litigation,” The Business Lawyer 351 (1999).

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2) Mergers and acquisitions as a source of value creation in business

A) Motives and sources of value in mergers and acquisitions

Merger and acquisition, generally, is a process whereby two businesses entities

combine their operating activities and may result in a new legal entity or one of the two

combining business entity remains in existence while the other does not. An acquisition

refers to the process when a company simply purchases another company where no new

company being formed. Mergers and acquisitions generally aim to generating cost

efficiency through the implementation of economies of scale. Tax gains and revenue

enhancement through market share gain are basic features of the motive behind M & A. 3

The principal benefits from mergers and acquisitions can be listed as increased

value generation, increase in cost efficiency and increase in market share. It is expected

that the shareholder value of a firm after successful mergers or acquisitions should be

greater than the sum of the shareholder values of the parent companies. An increase in

cost efficiency is affected through the procedure of mergers and acquisitions. This is

because mergers and acquisitions can lead to economies of scale. This in turn promotes

cost efficiency. As the parent firms amalgamate to form a bigger new firm the scale of

operations of the new firm increases. An increase in market share is one of the plausible

benefits of mergers and acquisitions. In case a financially strong company acquires a

relatively distressed one, generally the resultant organization can experience a substantial

increase in market share. The new firm is usually more cost-efficient and competitive as

compared to its financially weak parent organization. The Employee Retirement Income

Security Act of 1974 (ERISA), promote the employee benefit programs, which are

affecting the viability of mergers and acquisitions in the USA. Companies going for

3 William T. Allen, Reinier Kraakman, “Commentaries and cases on the law of business organization,”

423-449 (2003).

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mergers and acquisitions strive to iron out the internal differences to maintain a specified

level of employee satisfaction.4

In US regulation mergers began with the Sherman Act in 1890. Mergers can be

horizontal, vertical, and conglomerate. It depends on the nature of the merging

companies. Acquisitions occur between the bidding and the target company. Takeover

can be either hostile or friendly. In case of reverse takeovers, it occurs if the target firm is

larger than the bidding firm. In the course of acquisitions the bidder may purchase the

share or the assets of the target company. As seen from past experience mergers and

acquisitions are triggered by economic factors.

B) Economic drivers of mergers

B.1) Horizontal merger

Horizontal merger is a combination of two or more firms in the same area of

business. Two companies that are in direct competition and share the same product lines

and markets i.e. it results in the consolidation of firms that are direct rivals as Exxon and

Mobil. The objective behind horizontal mergers is to achieve economies of scale in the

production procedure. Horizontal merger give advantage of carrying off duplication of

installations, getting rid of competition, widening the line of products, services and

functions, decrease in working capital and fixed assets investment, minimizing the

advertising expenses, enhancing the market capability and to get more dominance on the

market. Horizontal mergers may also result in monopoly and give the economic power in

the hands of a small number of commercial entities. Generally, horizontal merger

delineates a form of proprietorship and control.5

4 See Leeth, John D. and Borg, J. Rody, “The Impact of Takeovers on Shareholder Wealth during the

1920s Merger Wave.” J. Fin. Quant. Ana. (2000). 5 Farrell, Joseph and Shapiro, Carl, “Scale Economies and Synergies in Horizontal Merger Analysis”

(October 2000). UC Berkeley, Center for Competition Policy Working Paper No. CPC00-15. Available at

SSRN: http://ssrn.com/abstract=502846 or doi:10.2139/ssrn.502846

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B.2) Vertical merger

Vertical merger is a combination of two or more firms involved in different stages

of production or distribution of the same product. A customer and company or a supplier

and company i.e. merger of firms that have actual or potential buyer-seller relationship as

Time Warner-TBS, falls under this type of merger.

In case of vertical merger, generally a product manufacturer merges with the

supplier of inputs. However vertical mergers may violate the competition in the markets.

Vertical merger can also block competitors from accessing the raw material source.

Vertical merger may be in the form of forward or backward merger. Generally in case of

the backward merger, a company combines with the supplier of material and when a

company combines with the customer, it is known as forward merger.

There are several reasons for the vertical integration by firms to adopt this merger.

The prime reason is reduction of uncertainty with respect to availability of quality inputs.

Generally firm enter into vertical mergers to avail the plus points of economies of

integration. This merger can convert a firm cost-efficient in terms of distribution and

production costs. This is also useful for the reduction of transactions costs like marketing

expenses and sales taxes.6 In USA, the vertical merger is governed by the „Clayton Act‟

(15 U.S.C.A. 12). A vertical merger transaction, sometimes, raise issues related to the

antitrust laws. Courts in United States has given a ruling on only in 3 cases pertaining to

vertical merger under section 7 of the Clayton as per the latest available information. In

the first case before the court, court contradicted the general assumption that section 7

was not applicable provision for vertical mergers.7 Furthermore the U. S. Supreme Court

6 Svetlicinii, Alexandr, “EU-US Merger Control Cooperation: A Model for the International Antitrust?”

(2006). Legal Life: Journal for Legal Theory and Practice of the Jurists Association of Serbia, Vol. 11,

No. III, pp. 113-126, 2006. Available at SSRN: http://ssrn.com/abstract=1325695 7 United States v. E. I. du Pont de Nemours & Co., 353 U.S. 586, 77 S. Ct. 872, 1 L. Ed. 2d 1057 (1957)

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observed in a case that the primary disadvantage of this merger falls in the throttling of

the spirit and essence of competition. The Court made its further observation that

regarding vertical mergers, two areas need close scrutiny and regulation. One prime

concern is the purpose and nature of the vertical merger arrangement.8 Additionally the

other parameter concerns that the industry concentration trend in that specific sector. In

its third judgment, Supreme Court quashed Ford's claim that its acquisition of Autolite

had made the latter a better competitor. Thus a vertical merger is a situation where a firm

acquires a product supplier or a customer. Vertical mergers may at times violate the US

federal antitrust laws.9

B.3) Conglomerate merger

Conglomerate merger is a combination of firms engaged in unrelated lines of

business activity. Generally it is a merger between companies what do not have any

common business areas or no common relationship of any kind. Consolidated firm may

sell related products or share marketing and distribution channels or production

processes.10

One of the prime aspects of the conglomerate mergers lies in the fact that it helps

the merging companies to be better than before. There are many reasons as why a

company may go for a conglomerate merger. The most important reason is that it adds

the share of the market that is owned by the company and indulges in cross selling.

Moreover, companies look to add to their overall synergy and productivity by adopting

this method of conglomerate mergers. There are several advantages of the conglomerate

mergers. One of the prime benefits is that conglomerate mergers lead the companies to

diversify. As a result, the merging companies bring down the levels of their exposure to

8 Brown Shoe Co. v. United States, 370 U.S. 294, 82 S. Ct. 1502, 8 L. Ed. 2d 510 (1962)

9 Ford Motor Co. v. United States, 405 U.S. 562, 92 S. Ct. 1142, 31 L. Ed. 2d 492 (1972)

10 Church, Jeffrey, “Conglomerate Merger: Issues in competition law and policy,” ABA Section of

Antitrust Law, 1503(2008). Available at SSRN: http://ssrn.com/abstract=1280524

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risks. On the other hand, there are several implications of conglomerate mergers. In one

case it is observed that companies prefer conglomerate mergers in order to increase their

sizes.11

C) Sources of value destruction in mergers

One way of the sources of value destruction in merger is entrenched managers.

Overpaying for low quality targets further exacerbates the losses to entrenched firm

shareholders. Study shows that bad takeover decisions are one way that entrenched

managers destroy shareholder value because of the consequent poor post-merger

operating performance, so study suggest that at least part of the lower operating returns

reported for firms in general are attributable to poor takeover decisions by entrenched

managers.12

Before the merger it should be examined first that whether merger and acquisition

create value for the shareholders or not. At present study produces little evidence that the

merger and acquisitions created long-term value for a fully diversified investor.

Furthermore, the stock price and operating performance of the acquirers underperformed

the stock price and operating performance of a control portfolio of utilities that did not

engage in merger activity.13

D) Institutional protection mechanism

Over the past decade, shareholder activists have increasingly applied pressure on

companies to restructure or seek a merger. In many cases, institutional investors cannot

11

Bauer, Joseph P., “Government Enforcement Policy of Clayton Act Section 7: Carte Blanche for

Conglomerate Mergers?” Cal. Law Rev., 348-375(1983). 12

Harford, Jarrad, Humphèry, Mark Laurence and Powell, Ronan, “The Sources of Value Destruction in

Acquisitions by Entrenched Managers” (2010). UNSW Australian School of Business Research Paper.

Available at SSRN: http://ssrn.com/abstract=1562247 13

Becker-Blease, John R., Goldberg, Lawrence G. and Kaen, Fred R., “Mergers and Acquisitions as a

Response to the Deregulation of the Electric Power Industry: Value Creation or Value Destruction?” J.

Reg. Eco. 1 (2008).

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„„exit‟‟ their investments due to the size of their holdings. As a result, institutional

investors now recognize that they can increase the returns on their investments by

actively monitoring corporate performance and communicating with the managers in

their portfolio companies. If management does not adequately respond to their concerns,

the investors often seek a change in control.

In the US, shareholder activists have used shareholder proposals and other tactics

to pressure companies to repeal classified boards, rescind poison pills, and reduce

compensatory severance packages. The mere threat of soliciting proxies by activists has

caused many companies to ease these types of acquisition roadblocks. Study reveals that

independent directors could provide an important internal governance mechanism for

protecting shareholders' interests especially in large scale transactions. On the other hand,

many studies found no effect. 14

3) The structure for the corporate acquisition in the U.S.

In the United States, public companies are regulated by both federal and state

securities laws. Companies that engage in M&A transaction, have to make certain filings

with the Securities and Exchange Commission (SEC). Securities laws require that for a

M&A of a certain size, companies must file a Form 8K before SEC. This filing contains

basic information on the transaction. The two most important securities laws are the

Securities Act of 1933 and the Securities Exchange Act of 1934.

Tender offers as an important M & A aspect, which is made directly to

shareholders of target companies, is regulated by the Williams Act of 1968 (15 U.S.C.A.

§ 78a et seq.). This act contains various sections that are relevant to the conduct of tender

14

Jagtiani, Julapa A. and Brewer, Elijah, “Target's Corporate Governance and Bank Merger Payoffs,”

(2007). Available at SSRN: http://ssrn.com/abstract=1088472

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offers. Section 13(d), which requires that if an entity, corporation, partnership, or

individuals acquire 5% or more of a company‟s outstanding shares, it must file a

Schedule 13D within 10 days of reaching the 5% threshold. In addition to this, Section

14(d) provides benefits to target company shareholders. It gives them more information

that they can use to evaluate an offer.15

Insider Trading Laws and various securities laws have been adopted to try to

prevent insider trading as one of the aspect in M & A. One important rule is 10b-5, which

prohibits the use of fraud and deceit in the trading of securities. The passage of the

Insider Trading Sanctions Act of 1984, however, specifically prevented the trading of

securities based on insider information.16

The Hart-Scott-Rodino Act, a crucial amendment to the Clayton Act, was passed

in 1976. For the first time merging parties above a certain size were required to report

their proposed transaction to the Commission and DOJ before the deal could be

consummated. Section 7A of the Clayton Act, 15 U.S.C. 18a, as added by Title II of the

Hart-Scott-Rodino Antitrust Improvements Act of 1976, requires persons contemplating

certain mergers or acquisitions to give the Federal Trade Commission and the Assistant

Attorney General an advance notice and to wait designated periods before consummation

of such plans. Section 7A(b)(2) of the Act permits the agencies, in individual cases, to

terminate this waiting period prior to its expiration and requires that notice of this action

be published in the Federal Register.

Procedural requirements for mergers and acquisitions, includes consolidations,

statutory mergers, share exchanges, and asset transactions. These requirements are well

prescribed in state statutes. The statutory fit is not as readily apparent for virtual mergers.

In a virtual merger, the shareholders of both entities have had no change in their

15

Evenett, Simon J., “Do All Networks Facilitate International Commerce? The Case of US Law Firms

and the Mergers and Acquisitions Wave of the Late 1990s” (2001). CIES Discussion Paper No. 0146.

Available at SSRN: http://ssrn.com/abstract=293804 or doi:10.2139/ssrn.293804 16

Rose, Amanda M., “Reforming Securities Litigation Reform: Restructuring the Relationship between

Public and Private Enforcement of Rule 10b-5.” Col. Law Rev.,1301(2008). Available at SSRN:

http://ssrn.com/abstract=1096864

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shareholder interests. Their company's identity has not been altered. However,

shareholders continue to have the right to elect company management and to vote on

matters provided by law. Although corporate assets have been transferred to the control

of a new entity, the company's continuing managerial input into the employment of those

assets may argue against the notion that there has been a disposition of assets warranting

a shareholder vote. In short, current statutory provisions regarding mergers and asset

transactions do not explicitly fit the virtual merger mode.17

Unless the articles of incorporation provide otherwise (which they rarely do),

shareholders do not vote except on matters specifically prescribed in the statute of the

state of incorporation. Thus, unless the transaction comes within the specific purview of a

statutory provision, there is no statutory mandate for a shareholder vote. A board can

decide to present a non-mandated matter to the shareholders, but such decisions are rare.

Shareholder voting procedures trigger substantial disclosure requirements cause

significant delays and costs, and may open the door to opposition by institutional

investors and litigious shareholders. Hence, recourse to shareholder approval is usually

invoked only in statutorily required circumstances. The statutory provisions are exclusive

unless shareholder voting is otherwise provided in the articles of incorporation or

shareholder agreement. If a proposed transaction does not fit into one of the statutory

pigeonholes, no shareholder vote is required. Shareholder appraisal rights also would not

apply as appraisal rights are generally tied to voting rights.18

A) Three ways to a acquire control

17

See Edward B. Rock, “The Logic and (Uncertain) Significance of Institutional Shareholder Activism”,

79 GEO. L.J. 445, 466-67 (1991) (explaining that institutional voting power may create agency problems

for smaller shareholder similar to the lack of control over management). 18

Securities Exchange Act of 1934, 15 U.S.C. § 78n (2001) and regulations thereunder, especially

Schedule 14a, Item 14, "Mergers, Consolidations, Acquisitions and Similar Matters."

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There are three principal legal forms of acquisitions; asset acquisition, stock

acquisition and merger.

A.1) Asset acquisition

Generally asset acquisition requires two corporations. In this acquisition, an X

corporation purchases majority of assets from Y corporation. For an approved traction for

X corporation, if paying in cash, than only management approval is required. However Y

corporation requires approval by majority of shareholders. In terms of liability, X only

acquires liabilities that attach to the purchased assets. On the other hand, Y retains it

liabilities unless it contracts them to X corporation (with respect to appropriate creditor

approval). Generally, X shareholders have same rights as before, but hopefully they may

get a high dividend in asset acquisition .Y shareholders retain dissenter‟s appraisal rights,

and pro rata of residual of Y corporation. Relatively asset acquisition has high transaction

cost.19

A.2) Stock acquisition

In stock acquisition, X corporation buys shares in Y corporation directly from Y‟s

shareholders. Y corporation is then dissolved passing its assets to X corporation, as a

result Y corporation is merged into X corporation or is run as a subsidiary of X

corporation. For transaction, if new stock must be created, majorities of X shareholders

are required for the creation and selling of X stock only requires management approval.

However each individual Y shareholder may buy at his will. X corporation usually

conditions its offer upon obtaining a controlling percentage of Y shares. In terms of

liabilities, upon the purchase of Y shares, X corporation has limited liability in terms of Y

corporation. Y corporation is left with all its liabilities until later actions. For the

shareholders, X shareholders have same rights as before, but hopefully they may get a

19

Fotaki, Maria, Markellos, Raphael N. and Mania, Maria, “Human Resources Turnover as an Asset

Acquisition, Accumulation and Divesture Process,” (2009).

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high dividend. Additionally, most of Y shareholders will become X shareholders and

those who did not sell retain dissenter‟s appraisal right, and will probably be froze out in

stock acquisition.

A.3) Merger

In this transaction, one corporation purchases the other or both dissolve and

become a new corp. The law treats them as the same. In order to complete this

transaction, X and Y corporations require approval by majority of shareholders. In terms

of liability, the surviving, or new, corporation retains all rights and all liabilities

(including unknown ones) of both corporations. However, the surviving or new

corporation can reorganize the equity of the old corporation by eliminating preferred

stock and the cumulative dividends that might be owed. In this aspect of transaction, X &

Y shareholders retain dissenter‟s appraisal rights.

B) Triangular merger as a solution and its purpose

Triangular merger requires at least three corporations. In this kind of merger, an X

corporation forms X-subsidiary corporation whose only assets are X shares. X-subsidiary

then does a stock for assets or stock for stock merger with Y Corporation or Y

shareholders. As a result, Y corporation merge or dissolves. In case the target is surviving

corporations than the merger is said to be the “reverse triangular merger”. If the

acquirer‟s subsidiary is surviving, than the merger is said to be “forward triangular

merger”. Generally liabilities of new acquisition are inevitable risky step. This is the

reason that most mergers are accomplished in a way that permits two separate corporate

entities to survive the merger and triangular merger is a solution for this purpose.

The triangular merger is a prime example of the narrow application of statutory

standards. Shareholders of the parent corporation in a triangular merger have no statutory

right to vote because their corporation is technically not a party to the merger. Although

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shareholders of an acquiring corporation might have voting and appraisal rights if the

target corporation merged directly into it, no voting or appraisal rights exist if the target

merges into the acquiring corporation's subsidiary. The avoidance of a shareholder vote

through the triangular merger has resulted in both litigation and some statutory reform.

4) Indian laws of merger

The basic governing laws in use the term 'amalgamation' for merger, however

basic characteristics are the same with comparison to US laws relating to merger.20

The

Income Tax Act, 196121

defines amalgamation as merger of one or more companies with

another or the merger of two or more companies to form a new company, in such a way

that all assets and liabilities of the amalgamating companies become assets and liabilities

of the amalgamated company and shareholders not less than nine-tenths in value of the

shares in the amalgamating company or companies become shareholders of the

amalgamated company.22

The fundamental law related to mergers and acquisition is codified in the Indian

Companies Act of 1956. Section 391 to 396 of the Companies Act, 1956 deal with the

compromise and arrangement with creditors and members of a company needed for a

merger. This provision is different in United States for creditors and in case of fraudulent

transfer; such transfer is governed by Securities Exchange Act of 1934. Generally

tribunals in India control over the merger transaction. Section 392 confers the power to

the Tribunal to enforce and supervise such compromises or arrangements with creditors

and members. On the other hand, for the protection of the deal, section 395 gives power

and duty to acquire the shares of shareholders dissenting from the scheme or contract

20

MCA: notification, Available at http://www.mca.gov.in/Ministry/notification/pdf/AS_14.pdf 21

Income Tax laws, Available at http://www.taxmann.com/directtaxlaws/Income-tax-acts.aspx 22

India Code Information System, Available at http://indiacode.nic.in/

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approved by the majority. Additionally section 396 deals with the power of the central

government to provide for an amalgamation of companies in the national interest.23

The other regulations are provided in the Foreign Exchange Management Act of

1999 and the Income Tax Act of 1961. Besides, the Securities and Exchange Board of

India (SEBI)24

has issued guidelines to regulate mergers and acquisitions. The SEBI

(Substantial acquisition of Shares and Takeover) Regulations of 1997 and its subsequent

amendments aim at making the take-over process transparent, and also protect the

interests of minority shareholders, which is moreover the same protection which is

provided in the United States.25

SEBI has the same role as SEC in the United States.

Moreover the Competition Act of 200226

in India works similar to the Hart-Scott-Rodino

Antitrust Improvements Act of 1976 of USA, to regulate business combination with

respect to antitrust laws.27

The basic difference between India and US merger laws is that there are no

specific state laws to be complied within India for merger. All companies are regulated as

per the Companies Act of 1956. Basically Indian legal system is not much complex with

respect to merger and acquisition, but it needs a more regulatory reform as reflected in

the United Stated. In terms of minority shareholder‟s right, Indian laws are not effective

to protect the minority shareholder‟s right due to lack of information sharing needs.

Generally for shareholder‟s, it is hard to get proxy statement and registration document

because it is not totally available online, as it is provided online by Security Exchange

Commission in USA. On the other hand, due to the lack of awareness to the minority

shareholders for their rights, case laws have not developed up to the extent to provide a

reformative Indian legal system for merger and acquisition for shareholder‟s protection.

23

MCA report, Available at http://www.mca.gov.in/Ministry/reportonexpertcommitte/chapter10.html 24

SEBI: Gov. of India, available at http://www.sebi.gov.in/ 25

“Merger and acquisition, “available at http://business.gov.in/growing_business/mergers_acq.php 26

Competition Act of 2002, at http://www.unctad.org/sections/ditc_ccpb/docs/ditc_ccpb_ncl_India_en.pdf 27

Ministry of Corporate affairs: Acts, bills and rules, at http://www.mca.gov.in/Ministry/acts_bills.html

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5) Future role of Mergers & Acquisitions in India

The increased competition in the global market has prompted the Indian

companies to go for mergers and acquisitions as an important strategic choice.28

The

trends of mergers and acquisitions in India have changed over the years. Prior to

recession in year 2007, there were 287 accomplished deals from the month of January to

May in 2007. It involved monetary transaction of US $47.37 billion involving 102

countries. Vodafone‟s acquisition of a controlling interest in Hutchison Essar and Tata

Steel‟s acquisition of the European steelmaker, Corus headlined a frenzy of acquisitions

of foreign companies by Indian corporate enterprises in the past years. Indian global open

market is prime attraction for the merger and acquisition activities. The Indian buy-outs

of US companies were recorded at $2.9 billion in second quarter and $2.95 billion in first

quarter of 2007-08.29

Present globalization trends increased the merger transactions

between India and United States, and give boost to the future role of India in merger and

acquisition activities.

28

World Economic Report, available at http://www.un.org/esa/policy/wess/wesp2007files/wesp2007.pdf 29

Assocham research bureau, reports available at http://www.assocham.org/arb/aep.php

m & a: comparison of us & indian laws

Documents

income tax act

institutional protection mechanism

securities exchange act

planned company acquisition

antitrust laws

securities laws

indian laws

appraisal rights