[The following post is contributed by Abhishek Dubey who is a Managing Associate with BMR Legal, Delhi. The views expressed here are personal.]
In continuation of its policy to rationalize the existing regime under the Foreign Exchange Management Act and to promote the ease of doing business, the Reserve Bank of India (RBI) has amended the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 to permit, under the automatic route, deferment of purchase consideration and escrow mechanism in share purchase transactions involving foreign investment. Under the earlier regime, deferment of purchase consideration was not permitted and escrow mechanism was permitted (with several restrictions) under the automatic route for a maximum period of only six months. The amendment regulations have been notified in the official gazette and are effective from May 20, 2016. The amendment regulations can be accessed here.
The text of the newly introduced Regulation 10A is reproduced below:
“10A. In case of transfer of shares between a resident buyer and a non-resident seller or vice-versa, not more than twenty five per cent of the total consideration can be paid by the buyer on a deferred basis within a period not exceeding eighteen months from the date of the transfer agreement. For this purpose, if so agreed between the buyer and the seller, an escrow arrangement may be made between the buyer and the seller for an amount not more than twenty five per cent of the total consideration for a period not exceeding eighteen months from the date of the transfer agreement or if the total consideration is paid by the buyer to the seller, the seller may furnish an indemnity for an amount not more than twenty five per cent of the total consideration for a period not exceeding eighteen months from the date of the payment of the full consideration:
Provided the total consideration finally paid for the shares must be compliant with the applicable pricing guidelines.”
The amendment regulations seek to introduce the following:
(i) Deferment of Purchase Consideration: The amendment regulations permit deferment of purchase consideration in share purchase transactions involving foreign investment (both inbound and outbound) for a maximum period of 18 months from the date of the definitive agreements. The amount of the consideration that is sought to be deferred under the share purchase agreement shall not be more than 25% of the total consideration.
(ii) Escrow Arrangement: The buyer and the seller can enter into an escrow agreement and open an escrow account in India for depositing the deferred consideration. The escrow amount shall not exceed 25% of the total consideration and the duration of the escrow account shall not be more than 18 months from the date of the share purchase agreement.
The flexibility conferred by the RBI of having an escrow account will provide significant comfort to the buyer in securing its indemnity rights and having an effective remedy against the seller for breach of warranties. Further, hold-back of consideration by the buyer in the escrow may give impetus to a trend of ‘post-closing purchase price adjustment’ in the Indian M&A space.
It is to be noted that the reference date for commencement of the 18 month period for escrow arrangement as well as for deferred consideration mechanism is the date of the share purchase agreement. The date of the share purchase agreement is referred to as the “execution” date which is different from the date of “closing” when the seller transfers the shares to the buyer and buyer transfers the consideration to the seller. The time gap between execution date and closing date may range from 60 days to 180 days and even more in large transactions requiring approvals from regulators (CCI / FIPB / DGCA). Therefore, the effective life span of the escrow account or effective period of deferment consideration would depend on the time gap between execution of the share purchase agreement and closing of the transaction – it can be full 18 months only in transactions that sign and close simultaneously.
(iii) Seller Indemnity: The amendment regulation provides that if the seller has received full consideration from the buyer, the seller may provide an indemnity to the buyer for a maximum period of 18 months from the date of payment of full purchase consideration. The indemnity could be of a maximum amount of 25% of the total purchase consideration.
The introduction of restrictions on subsets of indemnity is a potential cause of ambiguity because in the regime existing prior to this amendment there were no limits prescribed for indemnification time period or indemnification amount. The indemnification period is usually contractually agreed between the parties based on various factors such as the time period prescribed by the statute of limitation, the lookback period under taxation laws and practical considerations such as the time required by the buyer in discovering non-compliances after taking over the target or time probability of a claim arising. Similarly, the liability cap under the indemnification provisions is usually a fraction of or in certain transactions a factor of the total purchase consideration. Given that the objective of the amendment regulations is to rationalize the existing FEMA regime, the interpretation of this insertion needs to be seen.
It is to be noted that while the reference date for commencement of the 18-month period in case of deferred consideration and escrow account is the execution date of the share purchase agreement, that in case of seller indemnity is the date of closing of the transaction, i.e., the date when the seller receives the purchase consideration and transfers shares to the buyer. Therefore, the effective protection offered to the buyer by the amendment regulations is more in the case of seller indemnity in comparison with deferred consideration or escrow arrangement.
Deferred consideration mechanism and indemnity escrows are recognized features of M&A transactions worldwide. However, Indian definitive documents for cross-border transactions carried ambiguity in respect of these globally accepted risk allocation mechanisms until now. With the introduction of the flexibility of having deferred purchase consideration mechanism or an indemnity escrow account in Indian cross-border transactions, the RBI has taken a significant step not only towards buyer protection but also towards aligning the Indian M&A landscape with the regime prevalent in acquirer / investor states.
- Abhishek Dubey