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Importance of compliance risk management in M&A transactions


Introduction

M&A deals or transactions have been for many years the primary process used by big and small businesses to achieve growth , expand and also improve their business. Business transactions in most cases have an impact whether large or small within the market they serve and also for the parties themselves involved in it. Hence most business transactions have to adhere to specific regulations to ensure the transaction is fair and equitable for both parties involved and also to ensure that the market where such transactions occur is not adversely affected by such transactions. Managing risk is also imperative to any business transaction so that the deal being conducted is without any ambiguity and both parties realise the full value of the transaction without any adverse situations attached to it.


M&A transactions


What does an M&A transaction mean ?

M&A or mergers and acquisitions is a business process by which two or more companies combine in various ways through a number of different transactions which could include - purchasing assets , tender offers and also acquisition of the management of a company.


The Companies Act 2013 does not define the term but provides an explanation about the concept of this process. It explains that a “merger” simply does not only imply the accumulation of the liabilities and assets of two very different business entities but also as a resultant of the transaction gives rise to organization of two entities into one singular business.


M&A transaction as by the name are of two types -


Merger- Whereby two different businesses combine to form a new singular entity which has a distinct identity from the parent companies.


Acquisition - Whereby one business is absorbed completely by another business and the independent existence of the acquiree company no longer exists.


Legal Compliance

Compliance means the act of adhering to a certain amount of regulations implemented by the government to ensure that any form of business transaction is within the permissible financial and ethical standards and that they do not cause adverse effects on society and markets during such transactions or during the everyday course of business of companies.


Compliance for businesses is not just limited to interpreting what a given legislation implies but the very act of adhering to such given regulations at all points of time throughout the lifespan of a given business. This would mean that companies have records of checks and have policies and procedures around such given legislations.



Laws governing M&A deals in India

Mergers and acquisition transactions are regulated by very specific laws formulated by the indian government and every transaction needs to abide by the rules stated in the given regulations to achieve a successful outcome. The laws governing M&A deals in India are as follows -


Companies Act 2013 - The new act with circulars , rules , orders , notifications and enhanced disclosure norms provide better protection to investors and minorities and thus ensure M&A deals are smooth and efficient.


Indian contract Act, 1872 - Focuses on general principles of contracts and how collection of damages can be included incase of a breach of contract. This is very important as M&A deals typically have numerous contracts involved in them and such measures are necessary to safeguard interests of all parties.


Specific relief Act, 1963 - Specifies remedies for private parties who have faced civil or contractual breach of rights. Mentions remedies for breach of contract.


Income Tax Act , 1963 - it contains various provisions which deal with taxation aspects of various forms of M&A deals. IT act also deals with indian mergers as well as deals that have a cross border aspect to them.

Competition Act , 2002 - This is an extremely important regulation that all M&A deals need to comply with. The competition act promotes fair competition in all markets and also restricts anti competitive agreements which may have anti competitive aspects related to them.


Foreign Exchange Management Act , 1999 - The FEMA regulations are used to govern all mergers and amalgamations which take place between indian and foreign and indian companies , it covers investment related information including inbound and outbound investments.


Securities and Exchange Board India Act , 1992 - Rules and regulations of the SEBI Act govern the securities market of india. Which also include acquisition of companies listed on the stock exchange of India.



Due Diligence

Due Diligence is the precursor for every M&A deal that takes place. It is essentially investigative procedures used to determine the overall health and internal affairs of a company that is set to be acquired. Due Diligence plays an extremely important role in transactions as it enables the acquirer to understand the overall value of the company and as a result the acquirer is able to make a fair offer during a transaction. Due Diligence helps an acquirer understand the underlying risks and liabilities if any associated with a given company which enables the acquirer to make a decision whether to acquire a given company if risks and liabilities seem to large or to develop a specific strategy to deal with such liabilities and risks if they are in manageable amounts post acquisition.


Regulatory Due Diligence

Regulatory Due Diligence is a process which involves systematic review of a given company's regulatory compliance status and that of its suppliers , agents and partners.


The information that is required to be reviewed when such a due diligence is carried out while assessing transactions includes -


  • Regulatory investigations audits and reviews

  • Existing compliance policies for the prevention of fraud.

  • Written standards of conduct

  • Compliance programmes or appointment of a compliance officer.

  • Audit processes

  • Inclusion of compliance regulatory training for employees.

  • Contracts and agreements with suppliers and partners.



These investigations are conducted to find out any unknown issues or “Red Flags” which can help mitigate the regulatory risk of any transaction. It can also help a business to understand other roadblocks to a deal like - regulatory obligations, legitimacy of business partners and also help evaluate business impact and rectify any issues if present.


Risk and Compliance management in India

India at present does not possess standard legal guidelines when it comes to corporate risk and compliance management. In current times however compliance with labour , industrial , financial and corporate laws have picked up great pace and importance in the corporate sector.


Labour Compliance

India is a nation with a humongous labour force and the same forms the core of the country. Labour force is a quintessential component of any company in the corporate sector and hence well defined labour compliances have become a core part of the functioning of any company and non compliance with the same can lead to severe consequences in terms of legal action. For proper management of corporate risk , companies in current times are required to use effective contract management with their employees along with other related third parties as per the Indian Contract Act 1872.


A very recent development in the corporate risk management with regards to the labour force is the pre-emptive screening of employees. Pre-emptive screening of employees or conducting background checks before hiring isn't a mandatory requirement under any regulation in the country except in case of banks, schools etc under specific government notifications.


There are specific acts with regards to labour compliance which need to be strictly adhered to which include -

  • the Industrial Disputes Act 1947;

  • the Employees State Insurance Act 1948;

  • the Employees’ Provident Funds and Miscellaneous Provisions Act 1952;

  • the Payment of Bonus Act 1965;

  • the Factories Act 1948;

  • the Contract Labour (Regulation and Abolition) Act 1970;