LEGAL ASPECTS OF CORPORATE MERGER AND ACQUISITION

This article is written by Gracy Shukla of 1^st Year of B.A LL. B of Lloyd Law College, an intern under Legal Vidhiya.

Abstract

The aim of this paper is to discuss the legal aspects of corporate mergers and acquisitions. Mergers and acquisitions are different methods through which companies join or acquire other companies. This paper discusses what are mergers and acquisitions, what risk factors are there when merger and acquisition deals take place, what are the legal steps involved in the merger and acquisition agreements, what is the impact of merger and acquisitions on the shareholders and provisions related to M&A in India to understand how rules regulate these agreements and consequences of non-compliance. There are multiple types of merger present through which companies combine or consolidate their businesses, one company buys another company’s rights and both companies come under one banner of corporation. Mergers and acquisitions are important in the corporate field and there are many big mergers that have happened throughout the world, which are also included in this paper as well. This research paper finds the meaning of mergers and their different types as well also acquisitions in which a company is acquired by another company which is different from a merger.

Finally, this paper focuses on the legal aspects of merger and acquisition present in India and what are the ways to better the legality of M&A deals. Remember that mergers and acquisitions are an important part of the corporate field. And through big landmark deals in mergers and acquisitions the corporate world has reached a mew height.

Keywords

Merger, acquisitions, transaction, parent, target, shareholder

Introduction

Mergers and acquisitions are two different ways in which companies are combined. In this combination it can be either the whole business is combined, or their assets are combined. When a merger happens the two or more different companies come under the banner of one single corporation and merging the companies requires a valuation of the other company or companies. Throughout history many big mergers have happened, IMAA (Institute for Mergers, Acquisitions & Alliances) gives extensive and up to date information, data, research on M&A and provides statistics for the same. According to IMAA’s M&A statistics by industries since 1985 more than 126’000 transactions have been announced since 1985 with the valuation of about 6’100 billion USD. Technology came second in the list with 5’000 billion USD and 118’000 deals and the financial sector with more than 111’000 transactions and 10’800 billion USD[1].

Mergers and acquisitions are used interchangeably but there is a slight difference between them. A merger is the fusion of two or more companies. All assets, liabilities, and the stock of the merged company are transferred to Transferee Company. While in acquisitions one company is completely absorbed by another company and usually the absorbed company loses its identity, which is not the case with merged companies. The advantages and disadvantages of mergers and acquisitions depend on the new companies’ strategies, market valuation, market environment, business culture, costs and changes in power. All these factors determine whether the M&A deals were beneficial or not for the corporation[2].

In the upcoming sections this paper includes the meaning of merger and acquisitions and their types, impact on shareholders, legal steps involved, legal risks that are considered when reviewing M&A deals and the provisions related to M&A deals in India and suggestions to betterment.   

What are Merger and Acquisitions

Businesses grow over time and expand their services to the majority. Mergers and acquisitions are two inorganic ways to grow a business. There are many M&A occurring around the globe. While mergers can be defined as the means of unification of two or more corporations, acquisitions are deals in which one corporation buys the other corporation and combines the bought entity.  It may be in the form where one business buys another or a management buyout, where the management buys the business from its owners[3]. The term M&A is also used to describe the divisions of financial institutes that facilitate or manage such activities.

MERGER

In a merger both the board of directors of the companies agree and seek the approval of the shareholders. In a merger companies combine to boost their forte, creating a bigger piece of industry pie for the new company that is formed. “Merger of equals” is a voluntary fusion between two entities on equal terms into one entity. Mergers are commonly done to seek market gains, reduce the cost of operation, unite common product, increase revenue and profits. For example, HBC merged with Neiman Marcus Group to its another owned business, Saks Fifth Avenue. Both are luxury retailers, but their sales are going down due to online shopping. This merger will help both the businesses to compete against the online retailers and combine them with one luxury retail brand like Saks Global[4]. 

Based on the relationship between the two companies’ mergers are structured into different ways like Horizontal merger when two companies who are in their direct competition merge together or we can say they operate in the same industry offering the same service. This merger commonly aims to create larger business with greater market share as the competition between a few firms is generally higher. For example-The merger of Hewlett- Packard (HP) and Compaq 2011. Another type of merger is Vertical merger it is a union between two companies in the same industry but on dissimilar stages of the production process. The merging of the upmarket with the down-market is what a vertical merger is known as. The aim behind this type of merger is to enlarge the synergies and competency of their consolidated business. For example, Walt Disney merged with Pixar in 2006. A Conglomerate Merger is a merger between firms that are involved in totally distinct business. The aim of this merger is to create a big company. For example, Amazon and Whole foods 2017. A Market Extension Merger is a merger that occurs between companies that deal with the same type of product but in a different market. The aim of this merger is to provide the merging companies’ bigger market. For example, Eagle Bancshares Inc by the RBC Cantura in 2002. Congeneric Merger happens between the companies who are in the same industry but sell different products. The aim of this merger is to quickly increase its market share and expand its product line. For example, Broadcom and Mobilink Telecom 2002.

ACQUISITIONS

Acquisition is a transaction in which one company buys the other company, it may purchase most or all another company’ share to gain control of that company. There is often a no-shop clause during the process of approval as the target company may or may not know about the acquisition. Acquisition occur mainly between large companies, but mergers happen between small or medium size companies. In acquisition companies buy more than 50% of the acquired company. Investment bank helps in this combination because it has very complex legal and tax ramifications. It is a financial transaction as the company takes over the majority of its target company’s share. The main aim of acquisition is to gain control of the operations, production, resources, Market Share, customer etc. There are different types of acquisition like Vertical acquisition in which the parent company acquires the target company in the same industry but at different stage. Horizontal acquisition happens when the parent company buys their direct competitor. For example, Exxon and Mobil in 1998. Conglomerate acquisition parent company buys a target company which is in an entirely different industry. For example, Johnson & Johnson and Actelion 2017. Congeneric acquisition also known as market extension in this acquisition the parent company buys target company which is in the same industry but have dissimilar product line. For example, Procter & Gamble and Gillette in 2005.  

Both merger and acquisition are a crucial part of the business world as they expand the market and choices for customers. Merger and Acquisition are more than just buying companies, they also include joint ventures, minority investment and partnership.

The Impact of M&A on Shareholders

The effect of M&A deals varies with the market view of the transaction’s value. There can be both positive as well as negative effects of M&A deals on shareholders. In a study it was

found that around 95.6% respondents accept that Customer involvement is affected during M&As, therefore it is required to well maintain the communication to avoid losing customers, M&A includes debt where lenders role come into picture therefore selection of good lenders is very vital (94.5%), Vendors also pay heeds to the M&As as it would impact their businesses as well (92.4%), Advisors are required in order to accelerate the process of M&A (90.8%), The acquiring firm pay a little more than it is supposed to pay as a result the acquired firm shareholders will get more benefits (89.1%), M&A results in clashes among the top management due to the distinct cultures of the two organizations (86.4%), M&As create anxiety in employees mind which leads them to job hunt, there is it advised to have a strong communication with the employees(84.8%) and it is also advised the acquisitions clear and loud because in M&A situation the rivals will try to attract the customers through doubts about the ventures[5]. The relation between parent firms and target firm is not always negative, but parent company does have dominance over the target firm, which also impacts their stakeholders. The shareholders of the resultant company have less voting power which often leads to conflicts and ends up with greater blunders than expected like genuine shareholders quitting the company. That is why it is necessary to maintain good communication with the shareholders and clarify the benefits that the acquiring company will bring on the table. Mergers and acquisitions not only impact on the stakeholders but also the stock prices of both the companies and entities involved. Its impact varies in various situations. The success of the deal also determines the impact it will have on both the target’s stakeholder and the parent company’s stakeholders[6].  

What are the Legal Activities Involved?

M&A is a very complex legal system which involves lots of legal steps at every stage of the deal. Corporate laws are the ones which deal with mergers and acquisitions, in other words M&A is a branch of corporate law. It is important for the parties involved to know all the laws related to M&A to avoid any kind of hinderances. The lawyers of corporations mitigate these deals for which they require a thorough knowledge of this branch of corporate law. The process of M&A can takes up to several months due to its complexity. Here are the legal steps involved in merger and acquisitions deals:

• Non- Disclosure Agreements: the very first step involved is the buyer and the seller’s consent to a non-disclosure agreement. An NDA provides protection to both parties regarding their sensitive information. Also known as confidentiality agreement, secrecy agreement or proprietary information agreement. An NDA restricts the wider use of the sensitive information exchanged among the companies involved. Non-disclosure agreements are industry standard.
• Letter of intent (LOI): it is the second legal step which is a non-binding document outlining the key terms and conditions. The LOI is a preliminary agreement that establishes the framework for the transaction and sets the stage for further negotiations. It helps both parties understand their intentions and work towards a successful deal[7]
• Due Diligence: it’s the most monotonous task for a lawyer. It is the process of investigating and analyzing all the details of the target company to validate their purchase. It requires a lot of time and involvement of many entities like finance, law and HR. Identifying the risks and making a detailed decision on them makes M&A easier. In mergers and acquisitions, the due diligence stage is one of the most important stages. Allowing the acquiring company to identify dealbreakers, assess risks, make informed decisions, negotiate effectively, ensure compliance, and for integration, and set the stage for a successful and value-based M&A[8].  
• Deal structure: it refers to the terms and conditions of the transaction like how the purchase will be, legal regulatory requirement and the allocation of risks and rewards involved in the M&A deal. It also determines the form of consideration, such as assets or security that will be exchanged between the parties. Deal structure is a complex process involving legal, financial and accounting consideration. There are different types of deal structures such as Stock purchase in which the buyer acquires all the stocks of the target company. The buyer obtains all the assets, liabilities, and responsibilities of the target company. Asset purchase is in which the parent company buys a specific asset or business unit which is necessary for the operation of the business of its target company. The seller retains the ownership of the left-over assets and liabilities. A merger is another type of deal structure in which the companies merge their assets, liabilities and operation to create a new entity. It is cost effective and enhances the financial as well as strategic capability of the merged companies, but it can also be very complex and time-consuming. Leveraged Buyout (LBO) is a deal structure in which the parent company borrows money to buy the target company and by using the asset as the collateral of the target company it pays off the debt. It is a risky move as it will put a burden on the target company and its stakeholders. Joint ventures are when entities are willing to contribute their assets and resources for a partnership with limited liabilities which is operated as a separate entity. The company moves with a common objective and where it can be cost saving, it also requires careful planning and coordination and can have potential risk of management disputes.
• Representation and Warranties: they are statements on which the parties agree during M&A transaction. These are facts and promises made by the parties in the contract and are heavily negotiated during the transaction process. These are vital components of the agreement, serving to provide the buyer with a shot of the business at a specific point in time—like the business’s financial health, compliance with laws, ownership of assets, and much more. Breach of any terms in the reps would result in the end of the deal.
• Definitive Purchase Agreement: it is the final stage of the M&A deal which suppliants any other agreement previously made by both the parties. Often referred to as the ‘signing phase’ in which all the terms and conditions are finalized. It is a legally binding contract between the entities. Another name for this structure is known as Stock purchase agreement. There are two types of DPAs: Stock purchase agreement and Asset purchase in the stock purchase agreement, the seller transfers all the shares to the buyer while in the asset purchase agreement the seller transfers individual assets to the buyer for them to merge it into their existing company asset.

In addition, there are many M&A firms providing specialized service in assisting their customers with due diligence, negotiations and contract drafting. The M&A firms provide guidance for effective M&A deals and ensure smooth transactions for their clients. There are many risks involved which need careful examination by the lawyers to mitigate the potential risk.

Legal Risk Involved

 Brett Shawn, senior vice president at Warburg Pincus has identified the most common risk that are looked for by the lawyers in M&A deals. These risks are as follows: –

• Diligence risks: this factor is looked for verifying everything about the target company. This process is called legal due diligence. The intent of legal due diligence is to get a legal view of the target company. The aim is to ensure everything is in order and determine if there are any legal reasons why the acquisition shouldn’t proceed. Companies use due diligence to promote efficiency and speed by having a checklist to keep everything organized.
• Financial risk: sometime parent companies may pay more than the worth of the target which ultimately puts a financial risk on the parent company. Buyers also sometime take loans to acquire the target company and face huge losses.
• Antitrust risks: Antitrust is a governing body that makes sure market competition and prevents cartels. M&A lawyers prepare the important documents and ensure that the deal goes through without hampering antitrust laws[9].
• Deal jump risk: it is the type of risk that board members may act in an illegal way that results in the deal being jumped, it can be in the form of passing on sensitive information or breaking the rules of the M&A agreement.

Ways to Avoid Risk in an M&A Agreement

The M&A deal is a neck-breaking and complex procedure which also involves lots of risk and some risk factors are mentioned above. Here we will discuss some methods to prevent this risk from taking place. The lawyers mitigating these deals need to be very careful.

Due to weak due diligence and lack of expertise in due diligence result in difficulties in deals this issue needs to be handled from the beginning with experts in this field with broad knowledge and experience for the deal. Expertise in business, legal and financial matters are the general traits that should be present in the team, but the team should be more specific to the deal. With the growing popularity of experts in this network the importance of assembling an expert team has increased and is important as well. The role of the diligence team is crucial in both pre- merger and post-merger and acquisition agreements. The due diligence team is required to prepare the due diligence request list which will allow them to ask the right question and avoid any risk of surprise in the end and provide acceleration to the process. The financial risk is very important to deal with carefully, the unexpected costs that come up without planning are burdensome to the companies and to avoid these companies need to critically plan the estimate of cost in every stage. A study of Harvard Business review found that between 70% to 90% of M&A deals fail every year due to overvaluation[10]. To avoid this risk, make sure you conduct a thorough and objective evaluation. M&A project management platforms can help teams be more efficient.

Risks are an inevitable part of deals even if the top companies sometime fail to avoid this risk. What needs to be kept in mind is that hiring an expert team with broad knowledge in the field is essential as these risks are not avoidable and can end larger corporations. Being aware of the risks can minimize the chances of them occurring and can save the business from greater impact.

Legal Framework of M&A in India

In this section we will investigate the legal framework of M&A deals in India. The process of merger and acquisition is set out in the Company Act. Approval of the board of directors, shareholders and regulatory authorities like Security and Exchange Board of India (SEBI), Competition Commission of India (CCI) and National Company law tribunal (NCLT). The company act is the primary legislation in India which provide the legal framework for mergers and acquisitions, it set out the procedure for mergers and acquisitions including approval of least70% shareholders and they should be present and vote for it and regulatory bodies like NCLT, CCI, SEBI. The valuation of shares is also set by the act requiring an independent valuer appointed by the company. The act also provides the protection of minority shareholders by treating the share of minority on par as majority shares. They have the right to object as well. The Competition Act 2002 regulates competition in the market by prohibiting the anti-competition agreement. These agreements may contain fixed prices, limit production, and other things which can have an adverse effect on the market’s competition. It also prohibits the enterprise from abusing its dominant position. The CCI is responsible for evaluating whether the merger and acquisition can impact on the market’s competition. The SEBI requires companies to disclose information like the terms and conditions, valuation, and potential risk or benefits about the merger and acquisition transaction, making sure that all the relevant information is provided to the investor. It specifies the procedure for acquiring approval of stock exchanges and shareholders of the M&A transactions. SEBI makes sure that the transactions are fair and transparent in nature. There are consequences as well for the non-compliance of the rules like imposition of penalties, rejection of M&A, legal action under the Company Act, damage to reputation and delays in the transaction[11].

Amendments in Indian Framework

The regulatory bodies are constantly working to improve the M&A legal framework. 2023 has witnessed some amendments in the Competition Act 2002. These amendments are Deal value threshold for combination; this prohibits transaction above a Rs. 2,000 crore thresholds of assets and turnover. The amendment modifies the definition of control as the aptitude to workout fabric influence over another enterprises or group by one or more ventures or group. Act has reduced the period to 150 for the approval of combination. The act provides that those enterprises not into similar trade shall be ventured into anti-competitive agreements. However, these amendments according to the experts have their own drawbacks like the companies would be required to reassess their deals following the compliance under the law, the revised threshold makes more M&A deals to fall under the purview of CCI, there will be a burden over the smaller deals now if they increase their deal value. Although not all the amendments are in work, these significant changes are showing a positive outlook for the ministry as they are improving but how much these amendments will help the businesses it is still unexplored.

Conclusion

In conclusion, mergers and acquisitions are a widespread practice used by companies to achieve growth and expansion of their business. They involve legal framework and complex legal procedures with potential risk which require proper planning, execution and integration. The impact of mergers and acquisitions relies heavily on strategies, communication, and expertise. Companies need to be very careful when doing any merger and acquisition and critically evaluate their benefits and potential risk. Mergers and acquisition provide significant opportunity by expanding the business world, bringing growth and development and making competition higher in the market which give the companies a challenge to innovate and explore the hidden areas of their field, it also has considerable risk and challenges like financial risk which no company wants. The process of merger and acquisition is very complex and cost effective but once done successfully can give tremendous, good results. Nonetheless the success of the merger and acquisition depends on the potential of the companies involved and their work towards their aim. Lastly, M&A is a compound process, and it is always advisable to seek expert guidance when dealing which such transactions and compliance with the rules and regulations to avoid any kind of non-compliance consequences.

References

1. IMAA, https://imaa-institute.org/mergers-and-acquisitions-statistics/ma-statistics-by-countries/(last visited Oct. 10, 2024).
2. Afzal shah Sayed, Legal aspects of mergers & acquisition https://www.slideshare.net/slideshow/legal-aspects-of-mergers-and-acquisition/179524543 (last visited Oct.13,2024).
3. Ministry of corporate affairs https://www.mca.gov.in/content/mca/global/en/data-and-reports/reports/other-reports/report-company-law/mergers-and-acquisitions.html(last visited Oct. 10,2024).
4. Neiman Marcus Group, https://www.neimanmarcusgroup.com/HBC,-Parent-of-Saks-Fifth-Avenue,-to-Acquire-Neiman-Marcus-Group-for-2-65-Billion-and-Establish-Saks-Global,-a-Technology-Powered-Luxury-Retail-Company. (last visited Oct.12,2024).
5. Dr. Ajay Kumar, Impact of mergers and acquisitions on various stakeholders: An Analytical Study, 55(1) (PAE) 190, 194 (2018), http://psychologyandeducation.net/pae/index.php/pae/article/view/7750 .
6. Ankita Tiwari, how do Mergers and Acquisitions affect shareholders? Enter slice (Oct. 12,2024 6:15 PM)https://enterslice.com/learning/how-do-mergers-and-acquisitions-affect-shareholders/.
7. Wojcik law firm https://www.wojciklawfirm.com/m-a-letters-of-intent (last visited Oct. 12, 2024).
8. Louis Lehot, Eric Chow, The importance of Due Diligence in M&A Transactions, Foley Blogs (Oct.13,2024 10:58 PM), https://www.foley.com/insights/publications/2023/08/importance-due-diligence-m-a-transactions/. .
9. M&A Science, https://www.mascience.com/community-blog/mergers-and-acquisitions-m-a-law-a-complete-guide#:~:text=for%20their%20clients.-,What%20legal%20activities%20occur%20at%20each%20stage%20of%20a%20deal,take%20several%20months%20to%20complete (last visited Oct.13,2024).
10. finance alliance, https://www.financealliance.io/risks-of-mergers-and-acquisitions/ (last visited Oct. 12,2024).
11. Jay Bhavesh Parekh, Understanding legalities- mergers, acquisitions and combinations, 17 Chartered Secretary (CS) 67, 67-68 (2023).

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[1] IMAA, https://imaa-institute.org/mergers-and-acquisitions-statistics/ma-statistics-by-countries/

(last visited Oct. 10, 2024).

[2] Afzal shah Sayed, Legal aspects of mergers & acquisition https://www.slideshare.net/slideshow/legal-aspects-of-mergers-and-acquisition/179524543 (last visited Oct.13,2024).

[3] Ministry of corporate affairs https://www.mca.gov.in/content/mca/global/en/data-and-reports/reports/other-reports/report-company-law/mergers-and-acquisitions.html

(last visited Oct. 10,2024).

[4] Neiman Marcus Group, https://www.neimanmarcusgroup.com/HBC,-Parent-of-Saks-Fifth-Avenue,-to-Acquire-Neiman-Marcus-Group-for-2-65-Billion-and-Establish-Saks-Global,-a-Technology-Powered-Luxury-Retail-Company (last visited Oct.12, 2024).

[5] Dr. Ajay Kumar, Impact of mergers and acquisitions on various stakeholders: An Analytical Study, 55(1) (PAE) 190, 194 (2018), http://psychologyandeducation.net/pae/index.php/pae/article/view/7750 .

[6] Ankita Tiwari, How do Mergers and Acquisitions affect shareholders? Enter slice (Oct. 12,2024 6:15 PM)https://enterslice.com/learning/how-do-mergers-and-acquisitions-affect-shareholders/ .

[7]  Wojcik law firm https://www.wojciklawfirm.com/m-a-letters-of-intent (last visited Oct. 12, 2024).

[8] Louis Lehot, Eric Chow, The importance of Due Diligence in M&A Transactions, Foley Blogs (Oct.13,2024 10:58 PM), https://www.foley.com/insights/publications/2023/08/importance-due-diligence-m-a-transactions/. .

[9] M&A Science, https://www.mascience.com/community-blog/mergers-and-acquisitions-m-a-law-a-complete-guide#:~:text=for%20their%20clients.-,What%20legal%20activities%20occur%20at%20each%20stage%20of%20a%20deal,take%20several%20months%20to%20complete (last visited Oct.13,2024).

[10] finance alliance, https://www.financealliance.io/risks-of-mergers-and-acquisitions/ (last visited Oct. 12,2024).

[11] Jay Bhavesh Parekh, Understanding legalities- mergers, acquisitions and combinations, 17 Chartered Secretary (CS) 67, 67-68 (2023).

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