(The following post is contributed by Avirup Bose, who holds law degrees from the West Bengal National University of Juridical Sciences and the Harvard Law School and is qualified to practice law in India and the U.S. Avirup has worked in the New York office of Weil Gotshal & Manges and in the New Delhi office of S&R Associates. He has also briefly worked at the Mumbai office of Trilegal. He can be reached at avirup.s.bose@gmail.com)
The Competition Commission of India (“CCI”) in a recent order dated May 17, 2012,[i] while approving a transaction between the Reliance Industries and the TV18 group of companies gave an interesting interpretation to the term “control” under the [Indian] Competition Act, 2002, as amended (“Act”)[ii]. The CCI held that the subscription of convertible securities (in the given case, Zero Coupon Optionally Convertible Debentures (ZOCDs)) with an option to convert such convertible securities into equity shares of the company confers upon such holder the “ability to exercise decisive influence over the management and affairs” of the acquired company and therefore amounts to control for the purposes of the Act. For a detailed analysis of the order refer to the discussions in the blog post by Prof. Umakanth, dated May 31, 2012.
The order provides an interesting opportunity for discussing why control is necessary for analyzing the competitive effects of a merger under any competition law regime. This is primarily because through a merger previously independent competitors can co-ordinate their price and output decisions to the possible detriment of the customers if such decisions are not sufficiently constrained by competition from rivals. In the context of merger analysis, a noted authority on antitrust law, sums up stating that: “[f]or antitrust purposes,….[a]ll that matters is that what used to be separate businesses pursuing independent profit motives have now been combined into one common ownership structure that gives the businesses a joint profit motive.”[iii] Therefore who controls the decision making of such common ownership structure is an important element for analyzing the probable anti-competitive behaviour of the post-merger entity. So if A acquires a rival firm B the determination of who controls the management and corporate decisions of the merged entity is important but also simple. However, the problem arises when A acquires only a part of the share capital of firm B or does so only for a passive investment purpose. For example in transaction referred to in the aforesaid order between Reliance Industries and the TV18 group of companies the subscription of the ZOCDs (without any voting rights) by a trust established for the benefit of Reliance Industries Limited could be perceived as granting the acquirer a mere financial interest and no corporate control over the affairs of the TV18 group of companies. The CCI thought differently and we shall discuss the reasons below.
One of the key elements in any merger analysis is to evaluate if any proposed transaction will create a corporate structure which will not be sufficiently constrained by competition from other rivals. When a firm acquires full ownership of its rival firm, the acquiring firm’s unilateral pricing incentives are affected by the fact that it now controls its erstwhile competitor. For every customer that the acquiring firm would lose for a give increase in the price of its products may now be directed towards its merged partner. This allows the acquiring firm to recapture some of the profits that would be otherwise lost absent the merger. However, when firm A acquires only a partial financial interest in a rival firm B, its rivals incentive to compete may remain unaffected thereby effectively constraining any anti-competitive pricing or output decisions of Firm A or the rival firms may tacitly cooperate to create a market concentration that leads to oligopolistic co-ordination. In these latter situations the degree of control or influence that Firm A has over the managers of Firm B, how such partial ownership may translate into control or influence, and how this influence may translate into competitive effects is the most vital aspect of the transaction’s merger analysis[iv].
This brings us to the crux of the question that in my view the CCI attempted to analyze in the aforesaid order. How does one determine if a transaction is solely for investment purpose or otherwise?[v]The term ‘investment’ has not been defined under the Act, however, under the U.S. antitrust law, the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR Regulations, the U.S. equivalent to section 6 of the Act) provides that an acquisition made ‘solely for an investment purpose’ is when the acquirer has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.[vi] If the acquiring firm is investing in the share capital of the rival firm such intention can be evidenced by the lack of veto rights, quorum requirements at board and committee meetings etc[vii]. However, when the acquiring firm subscribes to convertible securities without any voting rights, how does one analyze lack of an intention to control the business decisions of the acquired firm. In the context of the transaction between Reliance Industries and TV 18 group of companies, the CCI perceived the ability of the acquiring firm to convert the ZOCDs anytime within ten years from the date of subscription, into 99.99 per cent of the fully diluted equity share capital of the acquired firms to confer upon the acquirer the ability to exercise decisive influence over the management and affairs of the acquired firms[viii]. If a company has a debenture holder who can convert its debentures into almost 100 per cent of the firm’s share capital anytime, it cannot but be deferential to such debenture holders views about the affairs and management of the company.
Another interesting issue regarding partial stock ownership in rival firms that needs to be made in the passing (although it definitely merits a much more elaborate discussion) is the fiduciary obligation of the directors nominated by the acquiring firm to the board of directors (“Board”) of the acquired firm. A partial equity ownership interest usually entitles the acquirer to appoint one or more directors to the Board of the acquired firm. The appointed directors of the acquirer will owe their fiduciary obligations to the shareholders of the acquired firm which would require such directors to act solely in the interest of the acquired firm and ignore the impact of its actions on the acquiring firm, even though the acquiring firm may have a large financial interest in the acquired firm. To avoid such conflicts the investment agreements between the acquirer and the acquired firms usually require that certain specific pre-determined corporate actions (‘reserved matters’) can only be adopted at a shareholder meeting of the acquired firm’s shareholders where the acquiring firm as a shareholder can vote according to its economic interests. However, items on reserved matters list should be properly scrutinized before the consummation of the transaction such that it does not raise anti-competitive issues or at-least be neutral from a competition perspective. Also, the manner in which the acquirer and its nominated directors deal with any confidential information relating to the acquired firm that such directors may become privy to in their capacity as members of the Board of the acquired firm is also a sensitive issue from a merger analysis perspective to determine anti-competitive behaviour.
In a subsequent post, I shall discuss how the issue of control and partial stock ownership is dealt in certain other major antitrust jurisdictions of the world and if they bear any resemblance with the interpretation of the CCI in the order discussed above.
- Avirup Bose [i] CCI order No. C-2012/03/47, dated May 28, 2012.
[ii] For a detailed discussion on how the term ‘control’ has been defined under other statutes and regulations of India, See Sandip Bhagat et al., India: Defining Control, International Financial Law Review (IFLR), June 10, 2010.
[iii] Einer Elhauge and Damien Geradin, Global Competition Law and Economics, (Hart, 2011), p. 913
[iv] What amounts to effective control depends on the facts of a particular case. The U.S. Department of Justice and the Federal Trade Commission has brought complaints and entered into consent orders under the U.S. Clayton Act limiting partial stock acquisitions for as low as ten (10) per cent of holding of voting stock (Medtronic Inc. 63 Fed. Reg. 53, 919, 53, 920 (1988)
[v] An acquisition of shares or voting rights solely as an investment that does not entitle the holder to more than 25 per cent of the total shares or voting rights of the acquired firms are ordinarily not required to be filed for pre-merger approval to the CCI. See Regulation 4 and Schedule I(1) of the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011, as amended (“Regulations”). The term ‘investment’ is not defined under the Act or the Regulations.
[vi] 16 C.F.R. § 801(1)(I)
[vii] For a discussion on whether such affirmative rights amounts to control under the Takeover Code, see the transcript of a discussion titled, Subhkam Settled; Private Equity Unsettled, November 26, 2011 at www.moneycontrol.com.
[viii] CCI order No. C-2012/03/47, dated May 28, 2012, para. 15.