Deciphering Item 2: Unveiling the Competition Law Exemption

A common query which often comes up and entities across the M&A (Mergers and Acquisitions) industry struggle with is — if we want to increase stake in our group entity or controlled joint venture, will that also require a prior approval of the Indian competition regulator, Competition Commission of India (CCI)? In this article, we explain the nuances of a statutory exemption which entities can take advantage of, if they have a similar concern.

In September 2022, the CCI published revised frequently asked questions (FAQs) which in line with the CCI’s recent decisional practice, have changed the dynamics and interpretation of certain exemptions as the concept of “change of control” has been illustrated to mean “change in degree of control”. Under the existing merger control regime, there are 10 exemptions provided in the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 (‘Combination Regulations’). The key exemption in question is one which deals with transactions where an entity proposes to acquire additional shares and/or voting rights in its subsidiary (referred to as Item 2 exemption). The exemption has twofold conditions that are required to be cumulatively satisfied—

(i) prior to the acquisition, the acquirer should already hold 50% or more shares or voting rights in the target enterprise; and

(ii) the acquisition should not result in a transfer from joint control to sole control.

The critical aspect of Item 2 exemption (and many other exemptions in the Indian merger control regime) is the interpretation of “control”. The concept of control and its interpretation has evolved in the recent past, from a competition law standpoint. With the evolving jurisprudence, the change from joint control to sole control is now viewed as change in the “degree of control”, as opposed to the literal interpretation of Item 2 exemption.

The CCI, in the revised FAQs, has explained in detail the difference between “joint control” and “sole control”. As per the revised FAQs (keeping in line with principles of corporate law), if an entity has voting rights above 25% over another entity, it is deemed to have joint control over matters requiring special resolution. However, if an entity holds voting rights of 75% or more over another entity, it is deemed to acquire sole control over matters requiring special resolution.

In August 2023, the CCI dealt with the issue of whether a transaction (which was consummated in March 2021) resulted in transfer from joint control to sole control and determined if Item 2 exemption applied to the transaction. The transaction related to acquisition by Bharti Airtel Limited (BAL) of remaining 20% shareholding of its subsidiary (target), from a private equity player (seller). BAL already held 80% shareholding in the target prior to the transaction. The transaction also involved acquisition of a miniscule stake (of 0.664%) in BAL by the seller. (BAL order)¹.

The parties did not notify the transaction to the CCI (as BAL had relied on Item 2 exemption) and consummated the transaction without seeking its prior approval. As a result, after about 2 years of the parties’ consummating the transaction, the CCI imposed a penalty of INR 1 crore on BAL for gun jumping. The CCI held that Item 2 exemption is not available to BAL, even though its shareholding was increasing from 80% to 100% in the target. It was observed that prior to the transaction, the seller had material influence over the target (through various rights available with the seller), hence, the target was jointly controlled by BAL and the seller. Since post the transaction, BAL acquired sole control over the target and the seller completely exited from the target, the second limb of Item 2 exemption was not satisfied.

The BAL order clarifies the CCI’s stance on interpretation of “control” and meaning of “transfer from joint control to sole control”. The CCI reiterated its observations made in another penalty order² involving UltraTech Cement Limited, that “all degrees and forms of control” would constitute “control”. It was held that a constraining presence on the decision-making process or affairs or management of an enterprise by a person suffices control since control is viewed as the possibility of exercising material influence rather than its actual exercise. While determining the applicability of Item 2 exemption, the CCI has clarified that the interpretation of “joint control” and “sole control” would depend on the ability of an entity to exercise material influence over the management or strategic commercial decisions of the target. Therefore, joint control does not require for two enterprises to have equal rights or equal degree of control in the other enterprise.

The BAL order (in line with revised FAQs) makes it abundantly clear that the CCI will take a holistic view and will consider all rights being acquired or available with the shareholders of the target, to determine if an entity has control over another and accordingly assess the applicability of a statutory exemption to a particular transaction.

The CCI, in the BAL order, has assessed in detail the extent of influence exerted by a Board representative in the decision-making process of an entity. The CCI has explained that the extent of influence of a Board representative would depend upon several factors such as extent of industry knowledge, length of experience, recognition in the business world, etc. In the CCI’s opinion, the acquirer’s industry expertise may lead to its advice being followed to a greater extent than its extent of voting rights. Hence, a case-specific approach will need to be adopted to determine if a transaction will indeed lead to a change in degree of control.

Further, in a recent development, the Ministry of Corporate Affairs has released the Competition Commission of India (Exempted Combinations) Rules, 2024 (Draft Exemption Rules), earlier this year. Although the Draft Exemption Rules have not been officially notified yet and are not currently in force, it is expected that the Draft Exemption Rules will soon be in force. The Draft Exemption Rules propose to reintroduce the exemptions provided in Schedule I of the Combination Regulations. The current Item 2 exemption has been captured in Item 5 of the Draft Exemption Rules and the language of both the exemptions are broadly similar in nature. The Draft Exemption Rules aim to capture the same understanding, by introducing a uniform test of “change in control”, instead of relying on change of control from “joint” to “sole”.

In conclusion, it is advisable for parties to take a broad view and holistically consider all facts while assessing the applicability of Item 2 exemption to their transaction. As a thumb rule basis, the recent decisional practice of the CCI and revised FAQs, it is important to consider not only additional rights being acquired by the acquirer, but also dilution of rights of the existing shareholders of the target to consider applicability of Item 2 exemption.