By Sharvari Manapure and Priya Ganotra, Students at National Law University of Nagpur
The capital market around the globe has been scaling up and the American notion of Special Purpose Acquisition Companies (“SPACs”) has emerged into the limelight for investors. The SPACs are characterized as shell companies incorporated for the sole purpose of raising capital for acquisition of operational target companies without following the traditional process of initial public offering (“IPO”). This makes SPACs the foremost means for the operational target company to go public since the traditional method is often burdened with indirect expenses and delays, and SPAC counters this with quick execution and fewer expenditures. Additionally, SPACs are appealing because they are typically branded by reputed and high-profile founders and experienced management that leverage their expertise and hold credibility to create synergy.
The structure of a SPAC is often called “blank-check” companies due to its nature of acquiring an unspecified business funded by investors. The capital raised by a SPAC is held in a trust for a predetermined period of 2 years as per the American law, during which the SPAC acquires the target company, however, if it fails to consummate the acquisition, the funds are returned to the investor. In the first quarter of 2021, SPACs have raised USD 98 billion with a total of 308 listings on the stock exchange of the United States of America.
The scope and potential development of SPAC can be attributed to its ability to create lucrative prospects for investors by providing them room to negotiate at the company and investor level, providing higher valuation, and greater speed to capital. However, irrespective of the potential growth and the popularity revolving around SPACs, in the Indian market, there is no trace of it because of the hostile regulatory regime for SPACs. This article aims to analyze the legal standpoint for examining the legal feasibility and favorability for SPACs in the Indian domain.
Lack of Statutory Definition in India
In India, the favorability of SPAC has been negative due to a lack of legal clarity because SPACs are popularly construed as shell companies. The Government of India (“GoI”) isn’t inclined towards shell companies. It is vital to note that there is no statutory definition of shell companies in India, but, the Organization for Economic Cooperation and Development (“OECD”) defines it as a company formally or legally registered but operating as a “pass through entity” without any economic activity of its own. This permits shell companies to act as a curtain to hide the illegal acts by serving as a conduit and be used for purposes like tax evasions and money laundering offences.
The Companies Act 2013 (“CA Act”) vide Section 4 states that the Memorandum of Association (“MoA”) is the charter of the constitution of a company which must contain its objects clause indicating its sphere of activities. However, Section 248 mandates that if a company hasn’t commenced a business within a year of incorporation or conducted any business in an economy for two immediately preceding financial years and hasn’t applied for obtaining the status of a dormant enterprise, its name can be removed from the Register of Companies by the Registrar of Companies (“RoC”).
In India, there’s no statutory definition given to a shell company. The Hon’ble High Court of Guwahati in Assam Company India Ltd v. Union of India highlighted the characteristics of shell companies and noted the absence of their legal definition. It stated that the lack of legal clarity and statutory definition may lead to the misuse of the phrase ‘shell companies’. Interestingly, in 2017, the Prime Minister’s Office established a Task Force on Shell Companies to mitigate the risk of scaling up illegal activities by shell companies to been update its checks and balances concerning the rise in shell companies which directly impact SPACs in India.
However, the absence of a statutory definition of terms like ‘shell companies’ and ‘SPAC’ provides an expanded ambit of misuse of the law. This necessitates the need for statutory definitions as the embargoes imposed on ‘shell companies’ will engulf the scope of survival of SPACS and eventually leading to a hostile environment for them in India.
The Legal Impediment vis-à-vis SPACs in
Companies Act 2013
The CA Act’s mandate empowers the RoC to strike off and invalidate the companies that do not commence functioning and operations within a year from the incorporation of the company[i]. It is pertinent to note that when a target company is identified for an acquisition using SPAC, a de-SPAC transaction process commences. A de-SPAC is a business combination that permits an enterprise to go public by merging with a SPAC. Herein, SPAC acts as a buyer, makes a formal announcement of acquisition signing, and takes a shareholder vote for approval. Once the approval of the de-SPAC target shareholders is acquired alongside fulfillment of financing and other requirements, a de-SPAC transaction is consummated. It is quintessential to note that it takes two years to complete a de-SPAC transaction, however, if a SPAC fails to commence business operations within one year of incorporation, it shall be invalidated by RoC. In 2019-2020, over 14,484 companies were invalidated by RoC as per the mandate of MCA. Therefore, to validate the existence of SPAC, appropriate amendments are required to be made in the CA to eliminate the hostile environment for the survival of SPACs.
Securities Exchange Board of India Regulations
When it comes to Securities Exchange Board of India Regulations (SEBI) norms, there are predicaments in listing SPAC in the capital market of India due to the restrictions under with SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“SEBI (ICDR) Regulations”).
Herein, the eligibility criteria for an IPO state that the companies are required to have at least Rupees 3 (three) crores worth net tangible assets in the previous three years, at least Rupees 1 (one) crore per year of net worth in the previous three years, and at least Rupees 15 (fifteen) crores of minimum average consolidated pre-tax operating gains during three years out of previous five years. Nevertheless, an alternate route can be adopted by SPACs by listing themselves through a book-building procedure conforming to which 75% of the IPO shall be allotted to the institutional buyers. However, this will curtail the opportunities of investment for retail investors as only 10% of the IPO can be allotted to them[ii].
Hence, it becomes mandatory for a SPAC to ensure that not more than 10% of its IPO can be allocated to retail investors to ensure that it complies with Regulation 6(1) and Regulation 32(2) of the SEBI (ICDR) Regulations. If a SPAC entity fails to meet this requirement of presently given criteria of retail participation, it shall not be accepted by the SEBI.
SPACs: A Pathway for Overseas Listings
The SPACs have echoed on Wall Street in the past few years; however, the buzz has reached the Indian shores due to the Companies Act 2020 Amendment (“2020 Amendment”) which allows the direct listing of the Indian companies on foreign stock exchanges[iii]. The 2020 Amendment enables diversifying the investor base and increasing accessibility to capital from overseas investors. The benefit herein is the increased demand for securities, decrease in the cost of capital, and attraction of higher valuations with a large investor base. The 2020 Amendment can be a gamechanger for SPAC mergers wherein the business combination of the SPAC and the Indian target entity will create an operating entity which is known as the De-SPAC transaction which requires an outbound merger. This can be done in two ways- firstly, when a share swap of an Indian company’s shares is against a SPAC (foreign incorporation) against consideration of obtaining ordinary shares of SPAC, holding an investment in SPAC, and becoming its legal subsidiary. Secondly, when a share swap is of a foreign holding company of an Indian business headquartered overseas is proposed with SPAC’s shares. It is pertinent to note that in light of such business combinations, SPAC being a foreign listed company aiming to acquire an Indian company, will have its shareholders fall under the Overseas Direct Investment Regulations.
However, for executing an outbound merger, the SPAC is required to comply with the requirement of the fair market value (“FMV”) of securities of the entity being in limits of USD 250,000 as stated under the Remittance Scheme under Foreign Exchange Management (Cross-Border Merger) Regulations, 2018. The SPAC merger requires the Reserve Bank of India (“RBI”) and National Company Law Tribunal’s (“NCLT”) prior approval along with its compliance to the provisions of the CA Act[iv]. Post completion of the de-SPAC transaction, the holding shares will either be a consideration for the listed merger or will be shares of the combined entity.
But, the issue arises concerning the limits imposed on the value of a security as it shall exceed the FMV, in case the Indian shareholder has a greater stake in the merged entity. Furthermore, another key issue that arises is procuring the NCLT’s approval because of lack of statutory definitions and conditions, SPAC shall be under the ambit of ‘shell companies’ that imposes cautious restrictions and creates a conflict for accessing funds for overseas mergers.
To Board or Not to Board the SPAC-Ship?
The notion of SPACs has opened an arena of expansion and growth for small companies however, the SPACs being non-operational companies can be misused for money laundering and tax evasions. SPACs have been a favorable route for promoters to take their investments public. With the fast momentum for SPACs around the globe, India has faced a setback due to a lack of legal and statutory clarity.
The performance rate of SPACs may vary based on the approach of law and the nature of business; however, the legal regime of India is required to establish a framework deliberating on parameters such as minimum subscription, offer size to the public, application size, sponsor holdings, etc.
It is the need of the hour for India, to make amendments in the regulatory frameworks supporting SPAC transactions for its credence and eliminating the emerging risks of financial crimes. An affirmative stride needs to be adopted by the Indian legal regime to accommodate SPACs. Efforts have been made by various jurisdictions to avoid financial risks stemming from insider trading and money laundering. Therefore, it is essential for the Indian legal regime to implement supervisory procedures requiring members of the company to conduct due diligence. The lawmakers are required to have a balanced approach while adopting SPAC in the Indian legal regime, to maintain an equilibrium between investor protection and viable option to raise funds for companies.
[i] Section 248 of the Companies Act, 2013.
[ii] Regulation 6(2) and Regulation 32(2) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
[iii] Section 23(3) of the Companies Act, 2013
[iv] Section 234 of the Companies Act 2013.