Introduction:
The words ‘Investment’ and ‘in the course of business’ have been the most contentious terms so far in the past many years. The word Investment, inherently, represents the various intentions that are present for a legal person interested in getting the returns of the investment. Whilst the word ‘in the course of business’ deals with the two conflicting presumptions of two different parties involved in two distinct businesses and two different parties involved in the same business. The terms are interpreted in the light of the effect / effects that the party approaching the High court / Competition Commission of India [hereinafter, CCI] / National Company Law Appellate tribunal [hereinafter, NCLAT], faces, on behalf of the market. The appreciable adverse effect on the competition in the market is assessed by acquirer’s intent to invest or his act of acquiring in an altogether different production market. The complications in assessing the ‘intent’ of investment and deciding on what amount to fall in the ambit of ‘course of business’, are further advanced by the addition of the terms ‘solely’ & ‘ordinary’ before them. Imposing restrictions upon the limit that can be acquired and additional requirements of control just adds on to the already difficult tasks of defining the terms. This specific practice of having more and more complications is present in the Indian competition law regime. This paper seeks to understand the various developments that happened in the due course of time and analyze the complications by describing the various principles developed in cases relating to Item-1 in India. It would be evident, once after the analysis, that the terms ‘control’, ‘investment’ & ‘in the ordinary course of business’ are restricted and are construed narrowly.
Item 1, exemption:
Item 1 of Schedule 1 of the Competition commission of India (Procedure in regard to transaction of Business relating to combinations) [hereinafter, the regulations] declares that there is no requirement to notify the commission if the acquisitions are either made in the ordinary course of business or for solely investment purposes as they are not likely to cause appreciable adverse effect in the competition. There are four pre-requisites, the four parts of Item 1, for availing the exemption to its fullest.
1. Acquisition of shares / voting rights should not lead to the acquisition of control – This describes the kind of acquisition that is required for the exemption.
2. Acquisition of them should be direct or in accordance of the execution any document including a shareholders agreement (SHA) or articles of association (AoA) – This describes the procedural aspect of the acquisition.
3. The acquisition should not entitle the acquirer to hold more than 25% of the total shares / voting rights – The upper limit /extent of acquisition.
4. The acquisition has to be made for the sole purpose of investment or in the ordinary course of business – The essential nature of the transactions, which is the primary requirement for availing Item-1.
The four parts of the Item – 1, the kind of transaction, the procedure of transaction, the limit on the transaction and the nature of transaction are often considered in a series by the commission over the years. The CCI has relied on different parts of the exemption at different stages. The development of scope of Item – 1 has been steady over the years and it has to be assessed in three time periods so that there is an understanding of the view of the commission on Item – 1.
Period – I: 2011 – 2013
Although the regulations came into force in 2011, it’s not until the later part of 2012, the commission was called upon to decide on Item – 1 exemption. The commission in the combination regulation [1] decided upon the factors required for appreciable adverse effect on competition (hereinafter, AAEC) and did not address the claim of Item 1 exemption. It took some more time to delve into the Item – 1. In the beginning of 2013, in the regulation between SAAB AB (Swedish Aerospace Defence company) and Pipapav defence, the commission had addressed the issue.[2] Relying on the first two parts of the exemption, the commission has opined that the right to nominate a director, which is an affirmative right flowing to the acquirer from the instrument of acquisition, would lead to an acquisition of control, irrespective of the amount / percentage of acquisition.
Period – II: 2014 – 2016
After inserting Item 1A, which deals with the acquisition of more than 25% shareholdings and less than 50%, the commission carved out a new principle relating to the first two parts of the exemption in the combination regulation between Alpha T.C Holdings & Tata Capital Growth.[3] It stated that an acquisition amounts to acquisition of control in cases where the instrument of acquisition involves some reserved matters / decisions which requires the prior approval of the acquirer. The reserved matters or decisions requiring prior approval should relate to the strategic commercial decisions of the business and should not be limited to minority protection rights that are flowing directly from the shares.
In the subsequent combination regulation, New Moon BV[4], where there is no transfer of affirmative rights involving strategic commercial decisions, the commission analyzed the extent of acquisition along with the nature of the acquisition. It said that, acquisition of shares / voting rights, even if they are less than 25% may raise competition concerns if acquirers & target are either engaged in business of substitutable products / services or are in activities at different stages or levels of production chain. In this regulation, the commission noted that there are no, considerable, horizontal overlaps and no vertical overlaps between the parties. Also since the combined share of the parties is less, the commission allowed the exemption.
Post the New Moon BV, on the 10th of February, 2015 two regulations by the commission have seen the first actual description of what amounts to ‘solely as investment’. In the SCM soilfert / MCFL / Deepak Fertilizers[5] and Zuari Fertilizers[6] the commission has carved out the principle – solely as investment means passive investment and not strategic investment. The commission has derived the strategic intent in the two regulations in two different ways. The parties in SCM Soilfert / MCFL / Deepak Industries have argued from a ‘transfer of control’ perspective i.e. that there is no transfer of affirmative control between the parties. The commission developed a relation between the nature of the transaction (acquisitions should be solely for investment purposes or should be made in the ordinary course of business) with the kind of the transaction (acquisition of shares or voting rights and not control). Strategic investment is derived from an acquisition that is made with an intention to participate in the formulation, determination / direction of basic business decisions of target. Such acquisition can be through voting rights or agreements about representation on the Board of directors of the target or affirmative / veto rights in the target. Whereas in Zuari Fertilizers, the parties argued that from a stance of intention i.e. to say that there is no intention to acquire any control in the company. However, the primary difference between the two regulations is that in the Zuari Fertilizers, there is no legal written & binding agreement between parties. The transaction in SCM Soilfert is an indirect transaction, resulting from a binding agreement, whereas the transaction in Zuari Fertilizers is a direct transaction, a direct acquisition of shares from the stock market. The Commission applied the same principle that is developed in SCM Soilfert regulation. It also added an additional circumstance to the principle. It said that strategic intent can be derived even in absence of written & binding documents between parties.
After these two landmark regulations one of which went for an appeal {SCM Soilfert, to CompAT (competition Appellate Tribunal)} and a series of regulations being decided upon the fact that there is transfer of control by way of appointment in the Board of directors, the commission came up with an addendum to Item 1 in form of an explanation.[7] It says that any transaction that is less than 10% will be considered as solely as investment only if the transactions do not involve agreements about representation on the Board of directors of the target.
The Commission applied the principles enumerated in SCM Soilfert & Zuari Fertilizers in the cases that followed. In the combination regulation,[8] the commission relied on the annual reports to establish the strategic intent, because the requirement of binding agreement was done away with. It said that the acquirer who seeks to influence management decisions, that are strategic commercial decisions, is an active investor and not a passive one. In the appeal of SCM Soilfert[9], the CompAT has upheld the principle laid down by the CCI in the SCM Soilfert regulation and referred to OECD[10] & Federal trade commission[11] for further support of the already stated principle in the New Moon BV Combination regulation.[12] It being that investment in a competitor is inconsistent with the purpose of being ‘investment only’.
Period – III: 2017-2018
This period depicts the development of the concept of acquisitions made in ‘ordinary course of business’ or atleast, the initiation of discussion of it. The claim related to such an acquisition was made by EMC ltd. infront of the commission.[13] The case involved EMC ltd. and it’s promoter group investing in the competitor of EMC ltd. They tried to fend off the commission by claiming that the promoter’s prior acquisition in competitor of EMC ltd. is in the ordinary course of business. The commission discussed the possibilty of these transactions falling into the ambit of ‘solely as investment’ without divulging into the claims of ordinary course of business. It referred to the Hart Scott Rodino Act[14] and opined that solely as investment exemption cannot be claimed in cases where the target holds more than 10% in the competitor of the acquirer or when the acquirer holds more than 10% in the competitor of the target. It later went forward in applying the principle laid down in SCM Soilfert & Zuari Fertilizers combination regulations. Relying on the annual reports of the target, it concluded that the acquisitions are strategic in nature.
In another combination regulation[15], that is related to acquisition of Intellectual property assets under Item 3, the commission hinted towards what would constitute an acquisition made in the ordinary course of business. It said that purchase of the Intellectual property of a competitor by a business enterprise cannot be construed as being a transaction in ordinary course of business. It mentioned that ITC ltd. is engaged in selling personal products & not in selling / purchasing intellectual properties and therefore the acquisition would not be in ordinary course of business. It can be derived that acquisition of the asset / shares / voting should be directly related to the business activity.
The commission came up with new proposed amendments in 2018 for the regulations.[16] With regards to Item – 1, the commission intends to substitute the entire Item – 1, explanation pertaining to the 10% criterion with a proviso. According to the proviso, the parties claiming the Item – 1 exemption, should now prove to the commission that they are acquiring the rights of an ordinary shareholder; acquirer is not a member of the board of directors in the target company and also shouldn’t have right / intention to nominate a director; acquirer & target are not in the same lines of business and if they are, the acquisition should not be over 5%; & the acquirer is a pooled investment vehicle which collects funds from investors for investing in accordance with a defined investment policy.
Standing of Item -1 after the developments:
The scope of item 1 has evolved a lot over the three periods. The item-1 exemption currently, after assessing the various parts of the exemptions in light of all the various judgements, is described below.
The first part of the exemption, the kind of transactions i.e. the acquisitions should not amount to acquisition of control, has widened from just focusing on the instrument of attaining control[17] to focusing on the intention to be a part of the business activities[18]. This is evident from change in conduct of the commission in deciding the combinations on the affirmative rights perspective to acquisitions usurping decisions regarding basic business. It is a pertinent fact that the standard of control has risen from acquisitions of obtaining control through involvement in strategic commercial decisions (that are not flowing from minority protection rights) to acquisitions of obtaining control through involvement in basic business decisions, which is of a larger ambit when compared to control over just strategic commercial decisions. The commission’s response by way of substitution of the explanation, directly reflects the crystallization of the principles, carved out in the regulations of SCM Soilfert, Zuari Fertilizers & New Moon BV, that there shouldn’t be a transfer of control of basic business decisions to the acquirer from the target. However, it is yet to be seen which kind of control test would the commission employ & incorporate in case of Item – 1 exemption, in light of the Ultratech Combination regulation.[19] The Commission differentiated the kinds of control, present in the combination regulation, being – Control by material influence (by way of shares, voting rights & Board representation etc.), De-facto control (control by way of acquiring more than 50% consensus of votes in business decisions, which is assessed by considering commercial realities) & De-jure control (having a shareholding of more than 50%). By virtue of the conduct of the commission so far and the substitution of Item 1 explanation, the control by material influence seems to be prevalent in the Item – 1 exemptions.
The upper limit of the acquisition, the third part of the exemption, post the addition of explanation in 2016, had created new set of transactions. Transactions involving less than 10% acquisition of shares / voting rights and transaction with acquisition of more than 10% and less than 25%. The assessment as to the nature of these two transactions, differentiated by the limitations, did create an evident problem for quite some time. The confusion pertains to whether the latter kind of transactions are considered as ordinary course of business alone and are not to considered under the ambit of ‘solely as investment’ and whether the former kind of transactions should only be perceived under the ambit of ‘solely of investment’ and not ordinary course of business. However, this was kept to rest when the commission has substituted the explanation with the proviso.
The fourth part of the exemption i.e. the nature of transaction, has specifically narrowed down to claims involving strategic investments and parties present only in the business of acquisition of shares / voting rights. The intention of a legal person, inherently present in investment, while investing are captured by the commission by using various factors. The factors, that commission usually considers for a transaction to benefit from ‘solely as investment’ especially now that the commission does not require a binding legal document to assess the strategic intent by virtue of the decision taken in Zuari Fertilizers, are as follows:
- How is the transaction made?
- Series of steps involved.
- The time gap, if any, between the transactions.
- Hastiness present in transactions.
- What is the intention behind the investment?
- Return / dividend on shares.
- The movement of the competitors.
- Sound investments by a prudent investor.
- Contemporary press releases.
- Investment enhancing the value of the shareholders of the target.
- Economic & Commercial perspective of the transaction.
- Specifics & circumstances – Audit reports / Newspaper statements / Interviews.
If all or any of the factors is present, then it is most likely that commission will find the transaction to be a strategic investment. Also, a transaction will not be considered as solely as investment if the transaction involves the acquirer holding more than 10% in the target’s competitor or target holding more than 10% in acquirer’s competitor.[20] The fourth clause in the 2018 proviso that is currently in place, hints about the nature of transactions made in ‘ordinary course of business’ and the definition of ‘ordinary course of business’. This also resembles the opinion of the commission taken in the ITC ltd combination regulation[21]. The conflicting presumptions, two different parties involved in two distinct businesses or two different parties involved in the same business, is dealt by leaning towards the latter presumption in cases involving ‘ordinary course of business’. However the exemption of transaction made in ordinary course of business is still pretty much vague except for the requirement that the acquirer’s primary purpose of business should be of acquisition of shares / voting rights.
Conclusion:
The Item – 1 exemption stands this way and one can only wonder how much can an entity benefit from such heavy requirements and scrutiny by the commission. For a party to claim Item – 1 in today’s competition law regime, especially for a party involved in same business, it is highly impossible because of the numerous requirements that came into being because of the various combination regulations. Whether the commission approach reaches the international standards is a different question, but the response to the question as to whether such approach in restrictive in the sense that there is very limited scope for parties to avail the benefits of Item -1, is in the negative. The reasons for such is not just the fact that the commission construed it narrowly but also the fact that the exemption is supposed to provide benefits of non-notification to the suppliers. The commission’s approach of restricting the incentive that was given is making the restriction itself to be in vain for the parties. Perhaps, the approach is advantageous to consumers, but it sure is detriment to the suppliers as there are not many transactions that fall under the ambit of the Item – 1 with the minimum scope present.
[1] Regulation between Peter England, Aditya Birla group and Pantaloons Ltd., C – 2012/07/69.
[2] Regulation between SAAB AB ltd. & Pipapav Defence ltd., C – 2012 /11/95.
[3] Regulation between Alpha T.C. Holdings Pte Ltd. & Tata Capital Growth Fund I, C – 2014/07/192.
[4] Regulation between Abott Laboratories, Mylan Inc. & Moon of PA Inc., C – 2014/08/202.
[5] Regulation between SCM Soilfert, MCFL & Deepak Fertilizers, C – 2014/05/175.
[6] Regulation between Zuari Fertilizers & MCFL, C – 2014/06/181.
[7] The Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Amendment Regulations, 2016, Competition Commission of India, Available at https://www.cci.gov.in/sites/default/files/regulation_pdf/167506.pdf , Accessed, April 22nd,2019.
[8] Regulation Between Piramal Enterprises Ltd. & Shriram Group, C-2015/02/249.
[9] SCM Soilfert Ltd. v. CCI, 2016 SCC Online Comp AT 441.
[10] The concept of Merger transaction, OECD, Available at http://www.oecd.org/daf/competition/Merger-control-review-2013.pdf Accessed, 22nd April, 2019.
[11] 15 USC 18a: Premerger notification and waiting period, Hart-Scott-Rodino Act, Federal Trade Commission, Available at http://uscode.house.gov/view.xhtml?req=granuleid%3AUSC-prelim-title15-section18a&edition=prelim Accessed, 22nd April, 2019.
[12] Regulation between Abott Laboratories, Mylan Inc. & Moon of PA Inc., C – 2014/08/202.
[13] Regulation between EMC ltd, MBECL & MKN, C – 2015/07/293.
[14] 15 USC 18a: Premerger notification and waiting period, Hart-Scott-Rodino Act, Federal Trade Commission, Available at http://uscode.house.gov/view.xhtml?req=granuleid%3AUSC-prelim-title15-section18a&edition=prelim Accessed, 22nd April, 2019.
[15] Regulation between ITC ltd. & Johnson & Johnson Group, C-2017/02/485
[16] The Competition Commission of India (General) Amendment Regulations, 2018, CCI, Available at: https://www.cci.gov.in/sites/default/files/regulation_pdf/193680.pdf Accessed, 22nd April, 2019.
[17] Regulation between SAAB AB ltd. & Pipapav Defence ltd., C – 2012 /11/95.
[18] Regulation between SCM Soilfert, MCFL & Deepak Fertilizers, C – 2014/05/175
[19] Regulation between Ultratech Cement Ltd. & Jaiprakash Associates Ltd., C – 2015/02/246
[20] Regulation between EMC ltd, MBECL & MKN, C – 2015/07/293.
[21] Regulation between ITC ltd. & Johnson & Johnson Group, C-2017/02/485
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