Blockchain in Mergers & Acquisitions: A Pristine Notion in Indian Scenario
Updated: Mar 7, 2022
Authors: Sakshi Shrivastava & Ananya Pande
3rd year law students at Hidayatullah National Law University
India is one of the rapidly developing markets of the world, with a vast percentage of companies indulging in processes and transactions to boost the business growth. Mergers and Acquisitions (“M&A”) is one of such processes. The diverse innovations in technology are expected to bring about one such distinguished upgradation known as Blockchain Technology into M&A. Many institutions and companies have shown support to the idea of inclusion of Blockchain in M&A since it aids in reducing transactional and legal costs, eases up the time-consuming process as well as helps in maintaining transparency and trust.
However, the amalgamation of Blockchain and M&A is bound to face certain due-diligence issues as well as other challenges which shall be dealt with by the businesses intending to use this technology. The aim of this article is to provide an elementary introduction of Blockchain Technology as well as the issues and due diligence impediments faced during the usage of such technology in M&A.
II. Blockchain Technology in a Nutshell
Blockchain is known as "Distributed Ledger Technology" since it allows storage of data without the necessity of a central authority, meaning that the data is not required to be stored in a central database but is distributed across multiple computer systems which store data locally in blocks. There are two types of Blockchain Networks, i.e., Public Blockchain which is based on open network wherein information can be accessed by anyone, and Private Blockchain, that requires a permission/invitation for access, hence restricting the participant pool.
III. Sanctions Revolving Blockchain M&A
Since numerous businesses involving Blockchain contain digital assets that are likely to be considered securities, it becomes crucial to conduct a study which analyses whether the potential target company which is under consideration by another organization for a merger or acquisition is subject to any legislations or not. Companies that engage in the Blockchain technology face a substantial risk because such transactions may be restricted by sanctions that could hamper the merger or acquisition.
One of the largest roadblocks to the success of any Blockchain business is the lack of clear laws and regulations. One such stalemate revolving around these businesses involved the crisis of crypto currency which is one of the crucial uses of Blockchain technology. A situation arose when the Government of India formed a high-level Inter-Ministerial Committee to suggest a blanket ban on private cryptocurrencies. This was vehemently countered by the Apex Court in Internet and Mobile Association of India v. Reserve Bank of India (“RBI Case”). The Supreme Court of India (“SC”) issued a ruling quashing the prior ban by Reserve Bank of India (“RBI”). The Court looked at the case primarily through the lens of Article 19(1)(g) of the Constitution, which talks about freedom to practise any profession or carry on any occupation, trade, or business, as well as the proportionality concept. In addition to this, crypto assets are also not included in the ambit of money in Section 2(h) of the Foreign Exchange Management Act of 1999.
In M&A transactions, the acquirer and the seller are likely to have a significant distance between them, meaning that they are not closely associated with each other geographically. As a result, when evaluating a target, it must be taken into consideration that the target may be subject to wholly different legal requirements than the acquirer in terms of operation laws, regulations, and even business culture.
Finally, the acquirer-conducted due-diligence on targets that use Blockchain technology should include a thorough examination of any sanctions controls to prevent the termination of deals or hefty fines that come with varied sanctions violations involving international transactions. One such situation was when Punjab National Bank was not in a position to conclude the deal worth $267 million as it could not receive clearance from India’s Central Bank for the transaction involving General Atlantic Group (United States) and Verde Holdings (United States). To prevent such sort of penalties, the acquirer should put in place the required safeguards.
IV. Blockchain M&A and Impediments to Privacy
The use of a Blockchain in a business raises a number of new privacy concerns. Individuals in India have a variety of rights when it comes to how firms handle their data. In a Blockchain model, obtaining individual consent would necessitate the individual to consent electronically to an agreement before their personal details can be processed. In some circumstances, there is no mechanism to receive this consent directly from the individual, therefore Blockchain participants must depend on contractual representations of other participants in order to establish that they had acquired the needed consents.
Section 43A of the Information Technology Act, 2000, expressly states that whenever a corporate body holds or deals with any sensitive personal data and fails to maintain a suitable level of security to protect such data, the aggrieved party is entitled to damages. In addition, Section 72A of the Act provides for a three-year prison sentence or a fine of up to five lakh rupees, or both, if information is disclosed in violation of a lawful contract.
Furthermore, Rule 5(6) of Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information), Rules 2011 provides individuals the right to demand the businesses to delete, correct or amend the personal or sensitive information supplied by them, which is discovered to be inaccurate or deficient. Due to the unalterable nature of Blockchain information, deleting and implementing adjustments to data that is stored on the chain is practically impossible. As a result, Blockchain-based business models must find alternate means to honour these requests, such as by distributing a decryption key to all users or by adding corrective annotations to the information that the individual requested to fix.
These issues can be addressed by adopting a private Blockchain rather than a public Blockchain, which allows all participants to contractually accept the rules for using personal data in Blockchain firms.
V. Intellectual Property Rights through the Lens of Blockchain
The potential for using Blockchain technology to manage Intellectual Property (“IP”) rights is enormous. It shall comprise circumstances where a trademark was first applied for, registered, and used in commerce; when a design, trademark, or patent was licenced, assigned, and so on. It would also address the practical issues of gathering, storing, and delivering such evidence. Here, perusal of Article 39.1 of Trade-Related Aspects of Intellectual Property Rights (“TRIPS”) Agreement becomes imperative as it provides that “in course of ensuring effective protection against unfair competition as provided in Article 10 bis of Paris Convention (1967), members shall protect undisclosed information” as provided in para 2 and 3 of the Article. Any act of competition that is opposed to honest industrial and commercial practices is defined as unfair competition under Article 10bis (2). India being a signatory to TRIPS must ensure that these terms are not breached and no IP right of any party is compromised.
The ability to track the whole life cycle of an IP right is a boon for M&As. It has a number of advantages, including more efficient audit of IP right. It significantly simplifies the due diligence procedures required for IP transactions.
Lastly, blockchain-related patents in M&A are on the rise not only due to companies investing in their own blockchain-related solutions, but also due to non-practicing entities acquiring blockchain‑related patents. Therefore, companies developing Blockchain technology may encounter a higher number of patent infringement claims than other targets involved in more traditional businesses.
VI. Taxation Due Diligence
Every M&A transaction necessitates thorough tax due diligence, including a thorough examination of the tax implications at various levels. Due to the fast-paced nature of the sector, M&A negotiations involving targets with digital assets necessitate a more thorough due diligence and examination.
Crypto-assets or crypto currency consist of a vital sphere where Blockchain Technology is utilised. However, they form a crucial hurdle in the intersection of Blockchain and M&A in the taxation space in India.
Earlier, there were no clear standards or procedures for determining whether digital assets are taxable. A proposal was made by Central Economic Intelligence Bureau to Central Board for Indirect Taxes and Customs to introduce crypto currency exchanges and platforms under the GST purview. Recently, the Union Budget of FY 2022-2023 was approved which proposes to levy a tax slab of 30% on the income generated from transactions including crypto-assets. Further, losses incurred from such transfers cannot be offset against other income or carried forward to the next financial year.
Additionally, valuation of digital assets and classification of receipts generated from the holding/selling of digital assets is notoriously difficult. Acquirers in a Blockchain-based M&A should be mindful of potential and heavy transfer tax implications that may arise as a result of the transaction, depending on the structure of the transaction and the classification of the digital assets.
Based on the inference drawn from the aforementioned scenario of Blockchain based M&As, it is evident that Indian masses lack clarity with respect to regulations for the same. We have seen people struggling with privacy laws, the predicament of valuation of digital assets and how the data within a Blockchain database is of immutable nature.
The bigger the Blockchain merger, the bigger is the challenge to secure the confidential data from leaking. All the sanctions that may lead to failure of M&A deals can be eluded if the acquirer and target both employ appropriate due diligence. If there is proper awareness and due diligence in practice, India can participate in this race alongside foreign business giants.
There is a rising trend in cross-border Blockchain based M&A deals which gives it a significant standing in the economy as well. It therefore appears to be only a matter of time before the legislations start addressing the potential hurdles in the large-scale legal application of this novel Blockchain technology such as questions of governing laws and jurisdictions, data security and privacy concerns.