New Delhi, May 5 -- Is deferred consideration in mergers and acquisitions (M&As) permissible when an Indian subsidiary of a foreign company is buying shares of an Indian company from an Indian seller or sellers?
The Indian foreign exchange laws were silent on the payment of deferred consideration in M&As involving Indian subsidiaries of foreign owned or controlled companies (FOCCs). On Jan. 20, 2025, the Reserve Bank of India issued master directions wherein it seems that the RBI has clarified that the conditions (discussed below) which are applicable to non-residents in respect of deferred and indemnity payments will also apply to FOCCs as well.
Deferred consideration in M&A deals
In M&A deals, for various commercial reasons, the buyer (whether resident or non-resident or FOCC) may not want to pay the entire purchase price upfront and part of the purchase price may be deferred, which is paid after transfer of shares.
A deferred payment can come into play in earn-out deals, i.e., where sellers are incentivised to achieve certain financial, operational or commercial milestones after the transfer of shares, and part of the consideration is paid if such milestones are achieved.
The deferred consideration can also come into play when the transaction involves post-closing adjustments to bridge any valuation gap between estimated or target financial parameters (such as working capital, net debt or cash) to numbers achieved until the date of the transfer of shares. Note that India's foreign exchange laws do not specifically contemplate purchase price adjustments and, therefore, these are not specifically permitted.
Conditions applicable for deferred consideration in M&As involving non-residents
Under India's foreign exchange laws, in a transaction involving the transfer of an Indian company's shares between residents and non-residents, not more than 25% of the total consideration may be deferred and paid by the buyer within 18 months of the transfer agreement. It needs to be ensured that the total consideration finally paid for the shares should comply with the pricing guidelines, i.e., if the buyer is a non-resident then the purchase price cannot be less than the fair value and if the buyer is a resident, then the purchase price cannot exceed the fair value.
In the case of an unlisted Indian company, the fair value is determined in accordance with any internationally accepted pricing methodology on arm's length basis, duly certified by a chartered accountant or a SEBI-registered merchant banker or a practicing cost accountant. The deferred amount can either be held back by the buyer or settled through an escrow account. The period of such escrow account should not exceed 18 months from the date of the transfer agreement. Collectively, all requirements in this paragraph and the one above are referred to as conditions.
With respect to indemnity payments, under India's foreign exchange laws, in a transaction involving the transfer of an Indian company's shares between residents and non-residents, not more than 25% of the total consideration may be indemnified by the seller for a period of 18 months from the date of payment of the total consideration.
Deferred consideration involving FOCCs and certain limitations
M&As involving FOCCs are considered capital account transactions and are subject to foreign exchange laws, and related conditions and restrictions as applicable to direct foreign investment by foreign companies in India.
As the foreign exchange provisions were silent on the applicability of the conditions mentioned above to FOCCs, there was regulatory uncertainty if FOCCs could use these deferred and indemnity payment structures, as available for non-residents. FOCCs were thus at a disadvantage, when compared to non-residents.
The RBI's master directions seem to provide much needed clarity that the conditions cited above will apply to FOCCs also for any deferred or indemnity payments structures.
It is pertinent to note that the deferred price or indemnity payments are permitted in transactions involving the transfer of shares and not allowed in the case of primary investments (i.e., if a foreign investor or FOCC subscribes to fresh securities in an Indian company).
Deferred payment structures may also not be implementable in the case of public companies as the Securities Contract (Regulation) Act, 1956 read with SEBI's notifications applicable to public companies require any contract for the sale or purchase of securities to be a spot delivery contract. This means that the actual delivery of securities and the payment of a price need to be done either on the same day or on the next day. Deferred payment structures involve part payment after the transfer of shares.
Another issue often faced by foreign investors is that set-offs (towards obligations such as indemnity payments) are not permitted in transactions involving the deferred payment.
Conclusion
To conclude, relaxations granted by the RBI to FOCCs to structure deferred payment deals is a welcome and much-awaited move. FOCCs will now have greater flexibility in deal structuring.
Presently, there is uncertainty around reporting of such transactions by FOCCs involving the deferred payment of the purchase price. FOCCs are required to file Form DI to report the transaction with the RBI within 30 days of allotment or transfer of equity instruments, and notify the Secretariat for Industrial Assistance (SIA), Department for Promotion of Industry and Internal Trade within 30 days of investment. This Form DI does not contemplate any deferred payment and in light of this development, it is expected that the RBI would update the same.
Bhavik Narsana is a partner and Shweta Dwivedi is a consultant in the corporate M&A and PE practice at law firm Khaitan & Co. Views are personal
Published by HT Digital Content Services with permission from VC Circle.