Understanding The Emerging Landscape Of Spacs - An Indian Outlook
Author: LawSphereX
Category: Property & Real Estate
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UNDERSTANDING THE EMERGING LANDSCAPE OF
SPACS: AN INDIAN OUTLOOK
Maher Patel, B.Com. LL.B., Institute of Law, Nirma University, Ahmedabad
ABSTRACT
The Indian capital markets have experienced exponential growth in recent decades resulting in significant technical and regulatory changes. One of the key developments that have been witnessed by the capital markets globally is the resurgence of the Special Purpose Acquisition Company (SPAC). A SPAC is essentially a “blank cheque company”. In simple words, it is a sponsor-created which has no independent operations and such company gets publicly listed to raise capital for the purpose of acquiring a non-listed company having its independent operations. As a consequence of such process, the non-listed company enters the capital markets and becomes publicly-listed. Indian companies, by employing such a process, have embedded its traces in the foreign land like Renew Power (Operating Company) got listed on Nasdaq by merging with RMG Acquisition Corp. II (SPAC).
No SPAC has been listed on Indian stock exchanges till date. Therefore, India is still in its rudimentary yet increasingly developing stage of having the requisite framework that would permit SPAC listing in India. In this regard, the introductory limb of this paper examines the meaning and concept of SPACs. Secondly, it discusses intricacies involved in the implementation of cross-border SPAC mergers and regulatory framework in India. Thirdly, it enumerates the provisions relating to SPACs in the Consultation Paper on Proposed International Financial Services Centres Authority (Issuance and Listing of Securities) Regulations, 2021.
I. INTRODUCTION
Merger and acquisition (M&A) have been one of the prominent methods to restructure and strengthen companies while meeting their needs and objectives. This process is proven effective in fostering the growth and restoration of companies. The regulatory framework of company law mandates the careful implementation and oversight of these processes. M&A in itself is an intricate procedure which present challenges from the very outset, including commercial intent, negotiation, and due diligence. Due to the dynamic nature of M&A transactions, one recent development is the emergence of Special Purpose Acquisition Companies (SPACs). These companies are formed primarily to raise capital through an initial public offering (IPO).
2020 marked an exponential hike in number of companies that got listed through a SPAC,
especially on the National Association of Securities Dealers Automated Quotations (NASDAQ). Compared to the traditional way of listing i.e. IPO, SPAC requires less compliance and less time-consuming process. As a result, it has attracted Indian companies as well, like ReNew Power Private Limited got listed on NASDAQ through SPAC route by concluding a deal with RMG Acquisition Corp. II (SPAC). Despite their popularity in foreign jurisdiction, Indian markets have not witnessed any indigenously registered SPAC. Lack of requisite legal regime poses a challenge for SPAC to get listed and operate in India. Nevertheless, on account of the rapid growth of capital markets in India, it is only a matter of time before India witnesses the locally registered SPACs with specific laws regulating them. II. WHAT IS SPAC?
Special Purpose Acquisition Company (SPAC) is widely referred to as a “blank cheque company”. SPACs have become a medium to carry out various transactions, especially for converting a private company into a public company. It does not have any particular operating or any assets except cash and limited investment and as suggested by its name, it is incorporated for a special purpose. After incorporation, SPAC gets listed on the stock exchange by the way of an IPO. This helps it in raising capital that will be used for acquiring a target company. The
target company will be a private operational company which have business/operations of it’s own. The amount so raised by an IPO is kept in a “trust account” which can only be used for acquiring the target company. Following the acquisition of the target company by the SPAC and formation of an initial business combination, also referred to as the De-SPAC process, the acquired company, i. e. the private company, gets listed on the stock exchange and becomes a public listed company. The SPAC is later dissolved, and shares of the acquired company are traded on the stock exchange. To provide details of initial business combination, shareholders are provided with a proxy statement, before initiating the procedure of De-SPAC, which provides information relating to the target company i. e.
the company to be acquired, interests of the parties involved in the transaction, terms of the initial business combination, capital structure of the entity after acquisition, etc. 1 Upon receiving the proxy statement, the shareholders casts their votes on the initial business combination wherein they may either hold their shares or redeem their shares before the business combination is completed and receive their proportion of sum from the trust account. 2 Apart from capital raised by the IPO, SPACs also seek investment through a mechanism known as Private Investment in Public Equity (PIPE). The PIPE investors play an essential role when shareholders choose to redeem their shares and there is a capital deficit. Hence, when a SPAC requires additional capital, PIPE investors come into play and invest their money to help SPAC in acquiring the target company. 3 1 U. S.
Securities and Exchange Commission, What You Need to Know About SPACs Updated Investor Bulletin (2021), SEC, https://www. sec. gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investorbulletin
2 Ibid
3 Lynwood Reinhardt & Brooke Dorris, SPACs: Why PIPE investment play a key role, INDIAN BUSINESS LAW
JOURNAL (July 21, 2021), https://law.asia/spacs-why-pipe-investments-play-a-key-role/
SPAC formation Raising of capital through IPO Target Search Fails to find a target Successfully finds a within lifespan target Shareholders’ [Not Approved] vote Dissolution of SPAC and return funds to [Approved] investors Closing of SPAC merger (De-SPAC) III. Intricacies of cross-border SPAC
A cross-border SPAC is one where a SPAC acquires target company in foreign jurisdiction to
get it listed on the stock exchange of the country where SPAC is publicly traded. Such transaction provides opportunities for companies to expand and maximise their profits. A cross border SPAC, on one hand, is similar to a foreign listing/ IPO as the purpose of such transaction is to attract investors from foreign jurisdiction. While on the other hand, it is different from foreign listing/ IPO as SPAC doesn’t have to comply to the strict and tedious listing regulations and other obligations of the foreign jurisdiction. However, it is to be noted that cross-border SPACs are not completely exempted from the regulations and obligations. Like, in Indian
scenario, if any out bound merger involves an Indian company, then in that case it is necessary to comply with the statutory provisions in the Companies Act, 2013 and other regulations by Reserve Bank of India in this regard which might lead to delay in completion of De-SPAC transaction. Typically, a SPAC has a 12 to 24 months period during which it has to identify the target, agree on the conditions of the purchase, and conclude the De-SPAC transaction. The SPAC may be wound up and the funds it raised will be reimbursed in case the concerned transaction does not conclude in the time limit stipulated. Section 234 of the Companies Act, 2013 read with Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 provides for merger and amalgamation of a foreign company with and into a company incorporated under the Companies Act, 2013, i. e.
an Indian Company, and vice versa. Additionally, the Reserve Bank of India (RBI) has formulated the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (FEMA Merger Regulations) in order to deal with the gaps in the given framework. Essentially, a cross border merger requires approval of the National Company Law Tribunal (NCLT) and if it is not in compliance with the (Cross Border Merger) Regulations, 2018 then a prior approval of RBI is also required. Before giving assent to a cross-border merger, NCLT will take into account observations and representations, if any, made by RBI, Registrar of Companies, Tax Authorities and other regulatory bodies.
Also, these regulators are more likely to object a De-SPAC on account of various factors, such as their unfamiliarity with working and benefits of SPACs, they might consider the transfer of all assets and liability by the way of merger to a blank cheque company imprudent, and they might have reservations due to the historical experiences where such company served as an instrument of money laundering. Following the merger, the merged entity and its offices in India are required to abide by the master directions and regulations of the RBI regarding the establishment of branch offices wherein it is required that the foreign entity, i. e. SPAC, have a profit making track record in the previous five financial years in order to be granted permission to establish a branch office.
Hence, in case of a cross border merger with SPAC which doesn’t have any operations of its own and has a limited life, this condition could not be fulfilled and it would require a prior approval of the RBI which may not be forthcoming
Given the existing legal system, it is likely that De-SPACs via cross-border mergers will not be completed within the timeframe specified. Even if regulatory authorities kept an open mind, they would conduct their own analyses, further delaying proceedings. 4 Although the Companies Act, Merger Rules, and Cross Border Merger Regulations have been in existence for some years, the fact that outbound mergers are still uncommon suggests that the current framework offers very little to facilitate cross-border mergers. Another challenge in cross-border SPAC would be issuing of shares to the shareholders of the target company. Following the conclusion of the De-SPAC, the target company’s shareholders might decide to continue holding their shares in the company.
In consideration for the target company’s shareholders’ shares in the target, the shares of the SPAC may be issued in order to fulfil their desire. RBI regulates the remittance of money outside of India because the Indian currency, i. e. Rupee, is not freely convertible. Although, Indian citizens are permitted to invest in the securities of foreign companies, RBI has limited their ability to do so by implementing the Liberalised Remittance Scheme (LRS). A resident may transfer up to USD 2,50,000 abroad every financial year under the LRS for specific permitted uses, such as investing in or purchasing shares of foreign companies. A prior approval of the RBI would be necessary for any remittances exceeding given threshold.
Acquisition of shares of foreign companies for consideration other than cash is also subject to the thresholds under the LRS as stated in the Cross Border Merger Regulations, 2018. Therefore, if a shareholder of the target is to receive shares of the SPAC (or any other foreign body corporate), the total value of the shares he bought during that financial year, along with any other remittances he made, cannot exceed USD 2,50,000. Thus, it is likely to consume more time to execute a De-SPAC through an outbound merger or an acquisition including a share swap, and it could be challenging to finish the De-SPAC during the SPAC’s term and as a result a cross-border SPAC may choose to acquire target companies in India indirectly or even avoid them completely.
4 Swankit Kumar Nanda & Deyasini Chakrabarti, SPAC: The Way ahead to Future, 5 INTERNATIONAL JOURNAL
OF LAW, MANAGEMENT AND HUMANITIES 87 (2022).
IV. Regulatory framework of SPAC in India
The present regulatory framework in India does not address the issues in relation to the SPAC in India. Unlike countries such as USA, India does not provide for a landscape that would support the operation of SPAC in India and thus, there is need to eliminate the hurdles which are coming in the way for providing a foundation to promote and facilitate functioning of SPAC in India. Companies Act, 2013 Neither the Companies Act, 2013 nor the Companies Act, 1956 defined or even mentioned about SPACs. Also, Section 4 of the Companies Act, 2013 provides that a company must have an object clause in its Memorandum of Association which would state the goals and objectives of the company.
5 This has posed a challenge in legal enforcement and administration of SPACs because SPACs do not have any operations or business of its own and they are incorporated with the only objective of acquiring a target company. Additionally, Section 248 of the Companies Act, 2013 have empowered the Registrar of Companies to strike out of any company from the Register of Companies, if they fail to commence their business within a year from the date of incorporation of such company. 6 In case of SPACs, they don’t have any business and average time period required for identification and acquisition of the target company is 18-24 months. Consequently, this provision poses a challenge in functioning of a SPAC. Furthermore, according to Section 230, 231 and 232 of the Companies Act, 2013 deals with compromise or arrangements between a company and its members or creditors.
Such scheme of arrangement is concluded only after approval of the NCLT. However, as discussed in the preceding section, it is an extensive procedure which involves approval and consideration from multiple regulatory authorities which is a time-consuming procedure. Similarly, Section 234 of the said Act provides with a cross border merger and mandates approval of the Reserve Bank of India. Thus, such provisions makes it unlikely to accommodate the working of SPAC within existing framework.
5 The Companies Act 2013, § 4(1)(c).
6 The Companies Act 2013, § 248(1)(a).
Regulations of Securities Exchange Board of India The Securities and Exchange Board of India (SEBI) is a regulatory authority which regulates the securities market in India and works to protect the interests of the investors. In 2018, the SEBI issued the SEBI (Issue of Capital and Disclosure Requirements) Regulation, 2018 (ICDR Regulations). Regulation 6(1) of these regulation provides for the eligibility criteria to issue an IPO, it states that:7
1. “Net tangible assets of not less than three crore rupees for the preceding three years;
2. During the preceding three years, an average operating profit of not less than 15 crore
rupees; and
3. In each of the preceding three years, a net worth of at least one crore rupees.”
SPACs evidently don’t fulfil any of these criteria because SPACs don’t have any business of it’s own and there are neither any operating earning nor any tangible assets except cash or other monetary investment. Additionally, as mentioned before, the life span of a SPAC is 18-24 months and thus providing any data of preceding three years is not feasible. Regulation 6(2) of the ICDR Regulations, states that if any issuer does not satisfy the condition mentioned in Regulation 6(1) then the issuer will be eligible to make an IPO only “if the issue is made through the book-building process and 75% of the issue shall be undertaken by the issuer to be allotted to qualified institutional buyers and if the issuers fails to do so then full subscription money shall be refunded.
”8 Thus, SPAC needs to comply with this condition since it is not able to fulfil the eligibility criteria provided in Regulation 6(1). Furthermore, to get listed on the National Stock Exchange (NSE), a company must have a track record of three years and positive earning before depreciation and tax for the past two years, which again poses a challenge before SPACs. V. Analysis of the emerging framework for SPAC in India and recommendations
7 Regulation 6(1), Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018.
thereto In the times of globalisation, a global capital acts as a catalyst of economic growth and development. Consequently, an International Financial Services Centre (IFSC), i. e. Gujarat International Finance Tec-City (GIFT City), is established in India with an aim of tapping global capital flows which are streamlined to meet developmental needs of India and for providing a globally competitive financial platform to international issuers which offers a wide range of international financial services. The International Financial Service Centres Authority (IFSCA) published a Consultation Paper on Proposed International Financial Service Centres Authority (Issuance and Listing of Securities) Regulations, 2021 (the Consultation Paper) which provided for a mechanism for listing of SPACs on the recognised stock exchanges in chapter VI.
This listing will help the sponsors to raise capital required for acquisition of the target company. Regulation 66 of the Consultation Paper states that SPACs shall be eligible only if “the primary objective of the issuer is to effect a merger or amalgamation or acquisition of shares or assets of a company having business operations” and “the issuer does not have any operating business”. 9 Regulation 68 of the Consultation Paper states that the listing of a SPAC will be considered by IFSCA “on a case-by-case basis. ”10 This emphasises on the discretionary power vested with IFSCA which not restrained in any way and so the decisions of the authority may suffer from arbitrariness or be affected by any personal or political considerations which may impact the ease of doing business.
This could result in an instance where the SPAC which has fulfilled all statutory requirements but it might still not be permitted to be listed due to this power. Therefore, it is necessary to amend this Regulation to at least compel the IFSCA to provide its reasons for rejecting a SPAC’s listing and make them publicly available. Regulation 71 deals with the initial disclosures that must be provided in the SPAC’s offer document. 11 This is a crucial document that helps investors make well-informed decisions about the money they want to invest in the business. It is to be noted that the disclosure 9 Regulation 66, Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021.
10 Regulation 68, Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021. 11 Regulation 71, Consultation Paper on Proposed International Financial Services Centres Authority (Issuance And Listing Of Securities) Regulations, 2021.
requirements, as proposed by the IFSCA, might not be adequate because the existing regulations have very broad limits. To ensure that the SPAC sponsors and directors are held responsible for their conduct, this Regulation needs to be amended and rules in this regard needs to be provided. Further, Regulation 72 provides for the issue size of the SPAC which must not be less than USD 50 million. The threshold provided is a balanced one as if it would have been lower than USD 50 million then it would have been difficult to attract long-tern and large investors and if it would have been higher then it wouldn’t provide opportunity to the start-ups and small and medium enterprises to be part of the business combination.
VI. Suggestions
Apart from the recommendation provided in the above section, there are some other suggestions, as mentioned below, which should be considered while addressing the issues related to the regulatory framework to facilitate SPAC in India:
1. Since it is assumed that shell companies are the main vehicle for money laundering, there
needs to be an explicit distinction between SPACs and shell companies. The legislature should provide a clear definition of a SPAC which the current legal framework fails to provide for. Moreover, there is a need to incorporate legal provisions relating to SPAC to put it on a legal standing.
2. To create a desired model aimed specifically at SPACs, the current legal framework, which
includes the Companies Act of 2013 and tax regulations, needs to be amended. It is necessary to amend the said Act to include rules and regulations that control the management, incorporation, and other elements of SPAC. Since, it is different from a traditional scheme of compromise and arrangement, there is a need to relax the rules, approvals and compliance for a SPAC merger so that it can be concluded within it’s lifespan. Additionally, there is a need to amend the Tax Regulation to provide SPAC access to the same tax exemptions that angel investors, venture capitalists, and start-ups enjoy.
3. The listing of SPAC at the IFSC is in its nascent stages, and it is not a well-established
system as yet because GIFT City is the only IFSC in India which is also not fully developed. This would pose hurdles in effective and efficient implementation of the proposed regulations. Also, as mentioned in the preceding section, some of the regulations
in the Consultation Paper needs to be amended keeping in view the interest of the issuer, the investors and other stakeholders.
4. There is a need to set up an expert committee which will delve into the intricacies revolving
around the feasibility of SPAC in India. The committee needs to analyse laws relating to SPAC in other jurisdictions, study how these jurisdictions have implement regulations relating to SPAC and consequently conclude whether market conditions in India are suitable for such development. VII.
Conclusion In the light of the above discussion, it is clear that SPACs are popularly seen as a substitute for traditional IPOs, and their widespread use has had a big impact on the Indian markets as well. The prominent private firms are choosing this path more and more often to list on overseas exchanges. As elaborately discussed above, there are regulatory obstacles in India’s path that must be overcome as it becomes challenging to make full use of what SPACs have to offer in the absence of an effective legal framework. Undoubtedly, SPACs provide a viable and profitable substitute for the conventional IPO. It is important to note that in spite of their widespread appeal, SPACs also suffer from certain disadvantages. Because of their complex nature and large investment volume, they are appropriately referred to as risky investments.
Investors put their faith in the management’s “know-how” with the expectation that they would pinpoint the ideal target and provide the highest possible returns. From the management’s point of view, the usual 18-24 month window for selecting a target while simultaneously safeguarding investors by guaranteeing their money back in the event that a sale falls through puts the management under extreme strain and the management tends to conclude the transaction in the given duration. Therefore, before choosing between SPACs and IPOs, investors must examine the benefits and drawbacks of each option.