As described in our related blog entry, Indian acquisitions of United States companies may not be matching the pace of 2007, though the numbers are still significant. In managing the legal aspects of their US acquisitions, here are some of the challenges facing Indian companies:
Under-appreciation of US Acquisition Legal Risk. This can lead Indian companies to make harmful assumptions, such as by favoring stock purchases over asset purchases, and also by underestimating the importance of good legal input. For example, as we discussed in our February, 2008 article on Indian acquisitions by US companies (posted elsewhere in this blog), though an asset purchase in India would result in very high stamp duties and other consequences, an asset purchase is often considered in the US for tax reasons and to limit the liabilities that would be transferred as part of the business in a stock purchase.
Also due to the complex legal risk environment in the United States, stock as well as asset purchase agreements have evolved into a careful interplay of promises made by the seller regarding the condition of the business (representations and warranties), disclosures which make exception to these promises (as part of disclosure schedules attached to the agreement) indemnification provisions which set the terms for how any breaches of the promises will be paid for, and possible escrow amounts which are reserved to pay for the breaches.
An informed buyer needs to carefully decide what due diligence information is required from the US seller and be willing to take a careful look at the legal due diligence materials provided by the seller- not just cross this off the “to do” list once a seller provides initial information that may be inadequate. The seller’s representations and warranties then need to make meaningful statements that really reflect the underlying business, not just heavily-qualified and general statements that give the Indian buyer little ability to hold the US seller to its word.
These aspects of the agreement operate as a form of insurance policy which protects the buyer in the event the condition of the business is different than what was expected. Litigation from suppliers or employees, product liability claims from customers and other risks can undermine an attractive purchase price and lead to a drain in time and resources that the Indian buyer needs to use in integrating and running its US business.
The underestimation of such legal risk issues in the United States is natural for investors from countries that do not carry a similar level of risk at home – this is not unique to India and we have seen similar issues faced by investors from countries such as Korea (from the early 1990s) and Japan (from the mid-1980s) in their earlier stages of cross-border acquisitions. However, though also not unique to India, we are concerned over the longer-term fall-out from corporate India’s strong emphasis on cost as the primary factor in working with US lawyers.
Evaluation of US Counsel Based on Price Only. US legal costs can be intimidating for Indian companies. The process of performing US legal due diligence and documenting a US acquisition is a time-intensive process that can lead to significant cost savings through the containment of US legal risks. In part due to this increased legal risk component in the US, the documentation and due diligence process is a more intensive process as compared with acquisitions in India, and US legal costs are more expensive that legal costs in India.
Many Indian companies understandably try to contain these legal costs, though we have found a tendency to search for the lowest priced lawyers, preferably those that will offer a fixed overall cost. This limits the pool of experienced merger and acquisition lawyers who are at the lower end of the cost spectrum. Those with the lowest cost will not likely have the right mix of acquisitions experience, cross-border legal sensitivity and experience in India as well as the US which offers a perspective on the Indian company’s priorities and needs. The legal costs of deals between parties in two countries are also inevitably higher due to time zone and other reasons, one of the many factors that may not be taken into account by law firms without significant cross-border experience.
Will a firm willing to handle an acquisitions project for a very small fixed amount be able to devote its experienced team members to the project and enough effort to the details that require input? Most will say yes, but how realistic is this?
Limited Information Offered to US Counsel Submitting a Proposal. Since some Indian companies may view acquisition legal input as something of a fixed-price commodity service, companies may have limited sensitivity to the information that goes into the preparation of a meaningful proposal to handle the legal issues of an acquisition. A meaningful proposal will tell the Indian company what it will actually be receiving - for example, what level of due diligence and participation in document drafting and review? Indian companies should be more open to discussing their priorities and needs with US counsel to enable such counsel to provide a realistic proposal. If the proposal is not fixed but carries some level of assumptions, this may be more a mark of experience than an attempt to be vague and evasive.
The Good News - A Less Cumbersome US Regulatory Environment. We have also worked with US companies in India and recently assisted a US company with the sale of its Indian subsidiary. Indian companies are very familiar with the web of Indian rules that require at least two shareholders, demand physical board meetings (not teleconferences) and involve numerous filings, such as to obtain director identification numbers for new directors. At least for privately held companies, the legal process for creating and operating US companies is simpler and less expensive.