Vineetha M.G, Yogesh Bhattarai
The anti corruption movement is perhaps the most enduring symbol of the year 2011 in India, and is likely to dominate popular dialogue for the years to come. Although the connection between corruption and mergers and acquisitions is not an immediate and obvious one, in cross-border deals, it assume significance partly owing to the vigorous enforcement of the Foreign Corrupt Practices Act, 1977 by the US Department of Justice in the recent years and the enactment by the UK Government of the Bribery Act, 2010 reportedly the strictest anti-bribery legislation till date.
It is a widespread perception that corruption in India is all-pervasive, a perception that is not entirely unfounded. India ranks 87 of a total of 178 countries in Transparency International’s Corruption Perception Index. The World Economic Forum’s Global Competitiveness Report cites corruption as the second most problematic factor in doing business in India consequently impeding cross-border M&A activity. International Institutional Investors believe that corruption compromises corporate governance, heightens reputational risks and increases the costs of doing business. Several doyens of Indian industry wrote to the Prime Minister in October 2011, urging the passage of a strong Lokpal bill as well as other measures to combat corruption. Recent decisions in high-profile cases do represent a very small step forward insofar as it seeks to penalise illegal gratification at the highest level; but the prevalent view is that of systemic failure and lack of accountability.
While India has had an anti-corruption legislation, the Prevention of Corruption Act, 1988 (“PCA”) in force for over two decades, the PCA has been observed largely in its breach. Few cases are brought against individual bribe givers and corporations alike under the PCA. This could be attributable partly to the lax enforcement of the PCA generally and an excessive focus on the “demand side” of corruption i.e. the bribe taker more than the bribe giver. In fact the PCA conceives of the bribe giver as an “abettor” and not the primary offender. The PCA surprisingly also does not expressly provide for prosecution of corporations. It is therefore not surprising that enforcement of foreign anti-corruption laws have affected and have the potential to affect cross-border M&A transactions in India to a greater extent than the PCA although recent events indicate that this is likely to change.
At a transactional level, there are specific considerations that must be borne in mind when structuring and documenting both in-bound and out-bound M&A transactions.
In-bound out-bound M&A transactions: Applicability of foreign anti bribery statutes
Certain jurisdictions have anti corruption and anti-bribery statutes that have extra territory jurisdiction which extends to the activities of associate companies in foreign jurisdictions. In the US, the Foreign Corrupt Practices Act, 1977 (“FCPA”) could potentially extend to a US investor’s investee company in India and could expose the investor’s management in the US to penal sanctions if an Indian investee company has been involved in bribing or unduly influencing a public official. The UK has enacted the Bribery Act, 2010 (“Bribery Act”) which came into effect in July 2011, which has a significant extra territorial reach as well. The Bribery Act criminalises the act of giving bribes to foreign public officials and private bribery in offshore jurisdictions which may be unconnected to the investor’s UK business.
FCPA applicability and offences: The FCPA imposes criminal and civil sanctions for both unlawful payment of bribes to foreign officials and accounting violations (falsifying books and records and/or inadequate internal controls). It has extremely broad jurisdiction over issuers and US persons and companies for acts both within and outside the US, and over others for acts within the US. Some defenses / exemptions under the FCPA include facilitation payments, payments permitted under local law and reasonable and bona fide business expenditures. There is no threshold for the dollar amount of infractions, and even what might be considered small bribes can result in big penalties, especially if FCPA violations are systemic. Significantly, the FCPA requires companies whose securities are listed in the United States to comply with its “accounting provisions”. These provisions require such corporations to: (a) make and keep books and records that accurately and fairly reflect the transactions of the corporation and (b) devise and maintain an adequate system of internal accounting controls. Penalties for breach of the FCPA can include fines and disgorgement of profits that a company might have realized from its unlawful conduct. These can run into millions of dollars. The FCPA is administered by the Department of Justice (“DoJ”) and the Securities Exchange Commission (“SEC”) both of which enforce the statute quite vigorously. Although the law was first passed in 1977, enforcement has ramped up in recent years as accelerating globalization has increased the opportunities for FCPA abuse. A recent study indicated that Asia is the second-most likely region to face prosecution under the FCPA and recently there have been several instances involving prosecution of Indian subsidiaries of US companies who were accused of bribing Indian public officials.
Bribery Act applicability and offences : In terms of the Bribery Act, a commercial organisation will be guilty of an offence if a person associated with the organisation; bribes another person with the intention of obtaining or retaining business or an advantage in the conduct of business for that organisation. The Bribery Act applies to UK corporations and non-UK corporations that carry on business (or part of a business) in the UK. The terms ‘associated person’ has a wide definition under the Bribery Act and the “Guidance about procedures which relevant commercial organisations can put into place to prevent persons associated with them from bribing” issued by the Ministry of Justice (“MoJ Guidance”) states that whether or not an entity is an ‘associated persons” depends on facts of each case. The MoJ Guidance provides that a joint venture (“JV”) partner is not necessarily “associated person” and the degree of control exercised over such a JV partner is a “relevant circumstance” in determining whether or not it is an associated person. In determining whether a foreign company is “carrying on business” in the UK, the MoJ Guidance provides that a “common sense” approach will be adopted to show “demonstrable business presence” in the UK. The MoJ Guidance specifies the parent of UK-incorporated subsidiary may be considered to be “carrying on business” if effective control is exercised by such a parent over the UK subsidiary. It is not abundantly clear whether Indian portfolio companies of UK private equity investors will be governed by the Bribery Act. However, bribery in a portfolio company does create significant risks to the value and marketability of the investment. Examples of how value can be impacted include the termination of revenue producing contracts procured by bribery, debarment from public procurement contracts, and the large fines and costs that may result from criminal or regulatory investigations as well as director’s liability (discussed below). Clearly bribery at portfolio company level may also have a negative impact on the investor/fund manager’s reputation. In terms of the MoJ Guidance, defenses for corporates under the Bribery Act include proportionate processes and procedures embedding in the company to prevent corruptions, top-level commitment by the senior management, processes for continuous risk assessment, due diligence, communication (including training) and monitoring and review. Indian companies expanding in the UK or associating with UK companies through the M&A route must seek to ensure that the aforesaid processes and policies are entrenched in their DNA.
Given the possible criminal sanctions that may ensue on account of triggering either the FCPA or the Bribery Act, investors from the US and UK respectively have become extremely cautious in investing in foreign companies and require investee companies to agree to arduous clauses on carrying out their business in a transparent and ethical manner. Indian companies seeking to enter into M&A transactions with the US or the UK must sensitise themselves of these concerns and ensure that their companies have a high standard of business ethics. The company must have in place appropriate policies for their employees regarding their conduct with public officials and penalise bribery or the use of influence. Given the sensitivity of US/UK based investors to FCPA and Bribery Act issues, the degree of confidence that an Indian promoter has in complying with such obligations is decisive for foreign investors. Accordingly, it is essential that Indian promoters must be aware of these issues and not display any hesitation or apprehension in complying with these covenants. It is not uncommon for the foreign investor to insist on anti-bribery representations and warranties and indemnities for breach of the same. Although enforcement of these provisions is fraught with risks e.g. the risk of the matter becoming public and the attendant scrutiny from multiple-regulators, they are indicative of the sensitivity of foreign investors to bribery issues especially in India where corruption is rampant.
Also, India Inc, which has been aggressively expanding abroad, must be mindful of the repercussions for their Indian global operations once they establish a connection with companies in the UK or the US.
Cross-border mergers and acquisition usually require managing host of cultural, communication and synergy issues following the merger and in particular, it is extremely crucial to ensure that policies relating to corruption and incentives and disincentives relating to behaviour of employees that could put the company at risk are in perfect sync.
Indian implications following prosecution under FCPA
In the event an Indian subsidiary of a US company faces prosecution by the DoJ or SEC, apart from sanctions under the FCPA and adverse reputational consequences, there could be far-reaching implications under Indian laws and regulations. Once FCPA prosecution is initiated or a settlement is reached regarding the Indian subsidiary of a US company, it is usually posted on the website of the DoJ / the SEC and therefore in the public domain. Indian authorities may then pick up such information and use it to initiate proceedings in India. In the past, the Indian Ambassador to the US had highlighted to the Prime Minister’s office the action taken by the DoJ and SEC in relation to offences under the FCPA by Indian subsidiaries of US companies and indicated that Indian authorities may also investigate the same.
Offences under the PCA and directors liability : An Indian private sector official involved in offering bribes to a public official is liable for criminal prosecution under the PCA. In terms of Section 12 of the PCA, any person who abets the commission of an offence by a public official is subject to the same penalty as the public official. The offence of abetment under Section 12 of the PCA is an independent, distinct and substantive offence. Please note that under the PCA the intention of the bribe giver is what is important and a mere offer with the objective to offer gratification is sufficient to constitute an offence under Section 12 even if no money or other compensation is produced. This is the case irrespective of whether: (a) the public servant has or does not have the authority to do the favour or the public servant refuses to or (b) the public servant accepts or refuses to accept the bribe.
The PCA, unlike other Indian statutes, does not contain any provision that deals with offences committed by corporations. Most Indian statutes contain a provision in relation to infractions by a corporation, where in addition to the corporation, the persons in charge of and responsible for the business of the corporation are also made liable. Such a provision normally ropes in the directors of a corporation. In the absence of such a specific provision in the PCA, the normal rule in relation to the criminal liability of companies (as set out below) is applicable on account of the ruling of the Supreme Court of India. The Supreme Court of India relying on its earlier decision in Standard Chartered vs. Directorate of Enforcement, AIR 2005 Supreme Court 2622 held that a corporation can be prosecuted for an offence under the PCA and whilst the company cannot be imprisoned, it can be fined and convicted of an offence under the PCA (CBI v Blue Sky Tie Up Private Limited (Crim Appeal No. 950/2004). If companies can be prosecuted for offences under the PCA, the issue that arises and could be of concern to a foreign investor is the liability of its nominee directors. Under Indian law, directors of a company can be prosecuted for a criminal offence on the basis of a provision in the relevant statute that makes persons ‘in charge of and responsible for the business of the company’ liable for offences committed by a corporation. Most Indian statutes contain these provisions. However, the PCA does not expressly provide for prosecution of companies or directors. In the absence of an express provision in the statute that permits prosecution of directors, the issue of criminal liability of directors is not free from doubt. However, arguably, directors who had the knowledge of the offence and neglected to take steps to prevent the commission of the offence could be held liable.
The PCA does not compel either a bribe-giver or any third person to disclose the commission of an offence under the PCA. Whilst the PCA does contemplate immunity to the bribe-giver who confesses to paying a bribe to a public servant, the scope of this immunity has been narrowed considerably by judicial precedents to limited cases e.g. for entrapping a public servant who demands a bribe. There are no other provisions that incentivize whistleblowers to report offences under the PCA. In practice, few bribes are voluntarily reported for fear of adverse consequences arising out of the disclosure. Given the demand centric focus of the PCA, the supply side of corruption is not adequately addressed e.g. through provisions that compel disclosures in the accounts (like the FCPA). However, there have been instances of auditors of Indian companies raising red flags over disguised bribe payments. The Central Government (Auditor’s Report) Order issued under the Companies Act, 1956 requires an auditor in his report, to certify that no fraud has been committed by or against the company. This has been invoked to ensure unaccounted or disguised payments to be appropriately disclosed in the financial statements of the company.
Bills in the pipeline
India recently ratified the UN Convention against Corruption (“UNCAC”) and accordingly, is now obliged to take a range of measures against corruption, several of which may impact M&A transactions as well. The signatories to the UNCAC are bound to take measures to prevent corruption involving the private sector. Recent press articles have indicated that the Union Home Ministry is working on adding a chapter in the Indian Penal Code “(IPC”) to check corruption in the private sector which could potentially apply to transactions between two private entities as well, similar to the Bribery Act. Similarly, in line with requirements of the UNCAC, the government has a drafted the the Prevention of Bribery of Foreign Public Officials and Officials of Public International Organizations Bill 2011 (“FPO Bill”) which is the equivalent of the FCPA for Indian companies. The FPO Bill criminalises Indians offering or promising to offer a bribe to any foreign public official and officials of public international organisations for obtaining or retaining business; as well as abetting or attempting the aforesaid.
The significance of all of the aforesaid developments is that Indian companies must tread extremely carefully when contemplating cross-border M&A transactions and must have a “zero-tolerance” culture on corruption and bribery issues.