Papers on Takeover Regulation
I have posted two papers on SSRN, the titles and abstracts of which are as follows:
The mandatory bid rule (MBR), one of the basic tenets of takeover regulation, obligates an acquirer who obtains ‘control’ over a target company to make an offer to acquire the shares of the remaining shareholders. What amounts to ‘control’ is far from clear; some jurisdictions follow a quantitative approach based on a specific shareholding threshold such as 30% voting rights, while others follow a qualitative approach through a subjective determination based on several factors, such as the specific rights available to an acquirer under a shareholders’ agreement or the constitutional documents of a target.
The goal of this article is to consider the merits and demerits of these approaches. It seeks to do so by examining various models adopted in jurisdictions for pegging ‘control’ so as to invoke the MBR. It delves into the regulatory experience in India as that jurisdiction not only adopts a combined approach (taking into account both the quantitative and qualitative tests for control), but has also been subject to a great deal of controversy and litigation in recent years that have helped tease out the jurisprudential contours of the concept. It concludes with a normative assessment that points towards partial harmonisation.
Given its deep and liquid stock markets, India presents a favourable environment for public takeovers. In order to develop and regulate takeover activity, India’s securities regulator the Securities and Exchange Board of India (SEBI) has enacted specific regulations. While at a broad level these regulations appear to attribute their origins to the United Kingdom (UK) and other countries that have adopted the UK model or its variants, I argue in this paper that takeover regulation in India bears fundamental differences and unique characteristics that have necessitated special treatment.
Due to the prevalence of concentrated shareholdings in Indian companies, the incidence of hostile takeovers has been negligible. While SEBI’s takeover regulations do not confer much power to the target’s board to set up takeover defences, the nature of concentration of shareholdings and other factors offer sufficient protection to incumbent shareholders and managements against corporate raiders. Hence, substantial attention in India is focused on the mandatory bid rule (MBR), which operates to grant equality of treatment to minority shareholders by conferring them an exit option in case of a change in control. India’s takeover regulations are arguably stringent in implementing the MBR. This impedes value-enhancing takeovers unless they are effected with the concurrence of the controlling shareholders, who could potentially block them.
Added to this, India’s takeover regulations confer benefits on incumbents that would impede a market for corporate control in the conventional sense. For example, promoters can take advantage of creeping acquisition limits, and also certain exemptions from the MBR when they enhance their positions in the company. Hence, while the takeover regulation overtly appears designed to engender a market for corporate control, its operation coupled with the corporate structure and culture in India attenuate the possibility of takeovers.
Relying upon the political economy of takeover regulation, and more specifically the interest group theory, my goal in this paper is to demonstrate the influence of promoters in shaping India’s takeover regulation. I seek to do so both analytically and empirically. While the Indian markets have witnessed a constant stream of takeovers, they are almost entirely organized changes of control in a friendly manner that trigger the MBR. Voluntary, unsolicited offers that are common in the more developed markets are miniscule in number in India.Supreme Court on Takeover Offer Price
Under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations (both under the current version of 2011 and previous version of 1997), takeover offers are required to be made at a minimum offer price that is based on the historical market price over a specified period of time and also on other acquisitions made by the acquirer of persons acting in concert (PACs) during a similar period. The question of what types of previous or contemporaneous acquisitions by the acquirer or PACs must be considered came up for determination of the Supreme Court in A.R. Dahiya v. SEBI (judgment dated 26 November 2015 by Vikramjit Sen, J).
The facts of the case are that a Mr. Garg entered into a collaboration with the Haryana State Industrial Development Corporation Limited (HSIDC) to establish a venture in the form of Polo Hotels Ltd., being the target company. Under the terms of the venture, in certain circumstances Garg had an obligation to buy back the shares of HSIDC. In due course, Garg decided to sell his 28.09% shareholding in the target company to Mr. Dahiya (the appellant) at a price of Rs. 8.50 per share. This arrangement was approved by HSIDC, due to which Dahiya was to assume Garg’s obligation to buy back HSIDC as and when the obligation is triggered. Since the acquisition of 28.09% attracted the mandatory offer requirements of the 1997 Takeover Regulations, Dahiya made a public announcement of offer at a price of Rs. 8.75 per share and submitted the draft letter of offer with SEBI. Based on a complaint made to SEBI, it was found that certain PACs of Dahiya had bought shares belonging to HSIDC as part of the buyback obligation, although those transactions were entered into at a much higher price of Rs. 23.75 per share. The essential legal question therefore was whether the offer price payable by Dahiya must be Rs. 8.75 at which the offer was made, or at the higher price of Rs. 23.75 being the price at which Dahiya’s PACs acquired shares from HSIDC.
In deciding this legal question based on an interpretation of the 1997 Takeover Regulations, the Supreme Court was concerned with two issues. First, the transaction involving the purchase of shares by Dahiya’s group from HSIDC was admittedly a transaction that was exempt from the mandatory offer requirements as Reg. 3(i) of the 1997 Takeover Regulations exempted “transfer of shares from state level financial institutions … to co-promoter(s) of the company pursuant to an agreement between such financial institution and such co-promoters”. Counsel representing Dahiya argued that since the transaction was an exempt one, it should not be considered for purpose of determining the price of the offer made by Dahiya. However, this argument was not accepted by the Court on the ground that the exemption operated only to the extent that the acquirer does not have to make a mandatory offer, but an exempted transaction must still be taken into account for the purpose of determination of the minimum offer price. The Court noted:
As required under Regulation 10, the Appellant did make a public announcement, but did not disclose its buy-back transaction with HSIDC. The Appellant has vainly and incorrectly attempted to justify his act of non-disclosure by stating that the transaction with HSIDC was protected by Regulation 3, which placed it beyond the ambit of Regulation 10, 11 and 12. In our view, Regulation 3 only protects a transaction between a co- promoter and a State financial institution to the extent that, as a consequence of such transaction a public announcement will not be required to be made as provided under Regulations 10, 11 and 12. However, it does not imply that the said transaction is to be protected from the rigours of other Regulations provided for under the Act. Thus, the transaction between the Appellant and HSIDC will have to be subject to Regulations 16 and 20, and the rate at which the Appellant bought back the shares from HSIDC had to be disclosed in the public announcement.
Second, Dahiya’s counsel argued that the transaction between his PACs and HSIDC fell through due to financial difficulties on the part of the acquirers. Moreover, the purchase price for the acquisition of shares from HSIDC was to be paid in installments, and that the unpaid amounts were represented by post-dated cheques issued by the acquirers in favour of HSIDC. The acquirers dishonoured those post-dated cheques. It was therefore argued that owing to the non-completion of the transaction, the price thereof ought not to be considered for the purposes of the offer made by Dahiya. The Supreme Court rejected this argument as well. The reasons stated were as follows:
In our view, the post-dated cheques amounted to a promise to pay and that promise would be fulfilled on the date mentioned on the cheque. Thus, this promise to pay amounted to a sale of shares/equity. The subsequent dishonouring of the post-dated cheque would have no bearing on the case. At the time of making the public announcement the Appellant had bought back the shares of HSIDC by making payment via the said post-dated cheques. Further, as the buy-back was in pursuance of an agreement, there was consensus ad idem. …
… Under Regulation 2 Clause (1) Sub-clause (a)- ‘acquisition’ means directly or indirectly acquiring or agreeing to acquire shares or voting rights in, or control over, a Target Company. This definition clarifies that an acquisition takes place the moment the acquirer decides or agrees to acquire, irrespective of the time when the transfer stands completed in all respects. The definition explicates that the actual transfer need not be contemporaneous with the intended transfer and can be in futuro.
Hence, even the existence of an agreement between the acquirer (and PACs) and any other party during the subsistence of an offer would be considered towards the offer price, whether or not that agreement was indeed performance. What is relevant is the agreement and not only an actual sale and purchase of shares.
Although the Supreme Court’s decision in this case was based on technical grounds and an interpretation of the 1997 Takeover Regulations, it adds to the case law that favours the sanctity of offer. In other words, once an acquirer makes an offer, the law ensures that the offeree shareholders become entitled to the “equal treatment” principle, of which the minimum-pricing requirement is but one manifestation.
The position seems to be clearer under the 2011 Takeover Regulations, which support the position arrived at by the Supreme Court. Reg. 8(2)(c) states that the offer price should take into account “the highest price paid or payable for any acquisition, whether by the acquirer or by any person acting in concert with him, during the twenty- six weeks immediately preceding the date of the public announcement”. The use of the expression “payable” suggests that even an agreement of the present type entered into by an acquirer or PAC has to be taken into account for minimum pricing, and not merely when the agreement is fructified into an actual acquisition. Moreover, the expression “acquisition” includes an agreement to acquire under the 2011 Takeover Regulations (Reg 2(1)(b)). Hence, the reasoning of the Supreme Court would apply with greater force under the Takeover Regulations as they currently stand.Voting Rights on Preference Shares: An Unclear Provision?
[The following guest post is contributed by Vignesh Iyer of Vinod Kothari & Co. The author can be contacted at vignesh@vinodkothari.com]
The enactment of the Companies Act, 2013 (Act, 2013) has given rise to various issues with regard to compliance and interpretations of several statutory provisions. One such issue is the subject matter of this post.
Section 47 of Act, 2013 - Voting rights
Section 47 of Act, 2013 provides for voting rights of the shareholders. The same corresponds to Section 87 of the Companies Act, 1956 (Act, 1956). Section 87 of Act, 1956 clearly demarcated the rights of cumulative and non-cumulative preference shareholders in case of default in payment of dividend, whereas Section 47 of Act, 2013 does not provide for the same.
The second proviso to Section 47(2) of Act, 2013 provides:
“Provided further that where the dividend in respect of a class of preference shares has not been paid for a period of two years or more, such class of preference shareholders shall have a right to vote on all the resolutions placed before the company.”
It is evident that the above proviso has been muddled, which leads to several queries viz.:
- Does it mean a period of two consecutive years or any two years?
- If dividend is paid in such two years, will it extinguish the voting rights of the preference shareholders or will it be a permanent right?
- Whether subsequent payment considered as remedial?
- If remedial, how will it stand good in case of non-cumulative preference shares?
In the case of Suryakant Gupta vs Rajaram Corn Products (Punjab)[1] it was held that if dividend to preference shareholders is in default for a long time, they became entitled under Section 87 of Act, 1956 for exercise voting rights on preference share.
Section 87(2)(b) of Act, 1956 provided:
“Subject as aforesaid, every member of a company limited by shares and holding any preference share capital therein shall, in respect of such capital, be entitled to vote on every resolution placed before the company at any meeting if the dividend due on such capital or any part of such dividend has remained unpaid-
i. in the case of cumulative preference shares, in respect of aggregate period of not less than two years preceding the date of commencement of meeting; and
ii. in the case of non-cumulative preference shares, either in respect of a period not less than two years ending with the expiry of the financial year immediately preceding the commencement of the meeting or in respect of an aggregate period of not less than three years comprised in the six years ending with the expiry of the financial year aforesaid ”
Section 47 of Act, 2013 acts almost as a red alert for the defaulters as there is no clear line of distinction made with regard to the applicability of the section to cumulative and non-cumulative preference shares. Additionally, whether the right is of permanent nature or not has not been clarified too.
Accounting treatment
By virtue of attainment of voting rights on all matters of corporate affairs, the said preference holders will also acquire control. Thus, this will also result in consolidation of financial statements in the books of such preference shareholder. The obvious thought that would arise is whether such preference shareholder will have a right in the excess profits on the company? How will the minority interest be determined? Let us discuss an illustration:
Company X holds 75% equity in Company Y (a listed entity). Remaining 25% equity is held by public shareholders. Company X also holds 100% of non-cumulative preference shares in Company Y. Company Y has not distributed any dividend for last 3 years, pursuant to which Company X has acquired voting rights. The voting rights by being an equity and preference shareholder aggregates to 96% of paid up capital of Company Y.
Standard 5.1(a) & 8 of Accounting Standard 21[2] which deals with ‘Consolidated Financial Statements’ provides for the definition of the term ‘Control’ and presentation of Consolidated Financial Statements respectively.
Standard 5.1(a) reads:
“Control:
(a) the ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise;”
Primarily, voting power is said to be vested in the equity shareholders of a company as they are empowered to vote on all resolutions laid before the company. In the present case, Company X holds 75% of the equity share capital and 100% of the non-cumulative preference share capital which implies that Company X holds 75% of the voting power. Thus, Company X holds more than 50% of the voting rights in Company Y and consequentially Company Y is a subsidiary of Company X by virtue of Standard 5.1(a) of Accounting Standard 21.
While consolidation of financial statements is done 100%, calculation of minority interest will be done based on the share of net assets owned by the holding company. So in the present case, though there is an enhancement of voting rights of Company X from 75% to 96%, calculation of minority interest shall be done on the basis of Company X’s holding of 75% and not 96%. In case of non-cumulative preference shares, the calculation of net income shall exclude preference dividend unless it is declared.
Minority Interest = (Net Worth- Preference share capital) * 25%
Para 5.7 of Accounting Standard-21 reads:
“Minority interest is that part of the net results of operations and of the net assets of a subsidiary attributable to interests which are not owned, directly or indirectly through subsidiary(ies), by the parent.”
Conclusion
Going by the language of Section 47(2) of Act, 2013, in our view, the period of two years mentioned shall be any two years from the issue and need not be consecutive. In case of cumulative preference shares, payment of dividend in the subsequent years after defaults may be taken as a remedial step but in case of non-cumulative preference shares the question of subsequent payment being a remedial step for past defaults is not practical. However, the question persists whether the rights get extinguished by such remedial step or will it remain permanent.
- Vignesh IyerSEBI Adjudication Order: Disclosure of Encumbrances Over Shares
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “SAST Regulations”) contains provisions in Reg. 31 that requires promoters of a company to disclose to the company and the stock exchanges the details of shares encumbered by them and also any invocation or release of encumbrance. The genesis of the requirement to disclose pledge and other encumbrances arose after the Satyam scandal where promoter shares were pledged to financial institutional unbeknownst to the remaining shareholders. The drastic fall of the promoter shares upon invocation of the pledge adversely affected the shareholders. Hence, if a pledge or other encumbrance is likely to result upon invocation in a divestment of promoter share, then that is information worthy of disclosure to the other shareholders.
Recently, SEBI had occasion in an adjudication proceeding to consider the nature of such disclosure obligations. The case involved United Breweries (Holding) Ltd. and Kingfisher Finvest India Ltd., being the promoters of United Spirits Limited (“USL”). The brief facts are that SEBI’s investigation led to its allegation that, during 2012, the promoters of USL did not disclose the creation, invocation or release of certain pledges in respect of USL shares in a timely manner.[1]
In this post, I confine myself to one legal issue pertaining to promoters’ disclosure obligations. It was argued on behalf of the promoters that in case of invocation of the pledge, it is possible for them to discharge their disclosure obligation only when they themselves are made aware of the invocation by the lenders. In other words, the time period for disclosure must ought to be triggered only when the promoters become aware of the invocation. However, the Adjudicating Officer did not accept the argument and applied a strict interpretation of the disclosure obligation under Reg. 31 of the SAST Regulations. The order states:
Here, I do not agree with the aforesaid plea / contention of “knowledge/intimation” of invocation of pledge transactions on the two following grounds. Firstly, as per the bare reading of regulation 31(3) of the SAST Regulations, the disclosures are required to be made “within seven working days from the creation or invocation or release of encumbrance”. The said regulation clearly stipulates the mandatory requirement of disclosures to be made from the date of creation / invocation / release of the pledge and does not leave any scope of “knowledge/intimation” as prior condition for the person who is required to make such disclosures. Had the “knowledge / intimation” been the intent of the statute then, it would have been very well incorporated in the SAST Regulations itself. Secondly, while making / creating pledge of shares by the borrower, certain terms / condition as well as the timeline of invocation of pledged shares in case of breach in making payment/loan are pre fixed between the borrower and the lender. Needless to say that if such time line towards the pledged shares are there, then, the borrower … is supposed to know the last day after which invocation of pledged share may take place by the lender upon breach of payment.
Following this, the Adjudicating Officer also dealt with the fact that under the SEBI (Depositories and Participants) Regulations, 1996, the depository participants had an obligations towards the pledgor / pledgee to immediately notify any invocation of a pledge. For these reasons, the Adjudicating Officer came to the conclusion that information or knowledge of the invocation of the pledge is not a precondition for disclosure obligations on the part of the promoters to arise.
While this approach is consistent with the text and intent of the SAST Regulations, it does impose significant obligations on the part of the promoters to notify in a timely manner the creation, invocation and release of pledges. The knowledge of the promoters as to the invocation or release of the pledge does not come in the way of the disclosure obligation. As before, SEBI treats the disclosure obligation as an inherent aspect of securities market efficiency. As the Adjudicating Officer’s order observes:
Before arriving to the quantum of penalty in the matter, it is necessary to refer [to] the importance of such disclosures. The main objective of the SAST Regulations is to achieve fair treatment by inter alia mandating disclosure of timely and adequate information to enable shareholders to make an informed decision and ensuring that there is a fair and informed market in the shares of companies affected by such change in control. Correct and timely disclosures are also an essential part of the proper functioning of the securities market and failure to do so results in preventing investors form taking well informed decision.
Hence, in respect of one of the promoters, viz. United Breweries (Holding) Limited, the Officer imposed a penalty of Rs. 15,00,000, after taking into account the circumstances of the case. In respect of the other promoter, viz. Kingfisher Finvest India Ltd., the Officer found that the delay in disclosure was minimal, and hence no penalties were imposed.
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