Introduction
In India, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “Takeover Regulations”) adopt a mandatory tender offer regime for acquisition of listed companies in order to provide a level playing field to the public shareholders. The acquisition of a substantial shareholding stake and the acquisition of control are treated equally and require the acquirer to make an open offer to the public shareholders. Currently, the test to determine what constitutes change of “control” is principle-based, and therefore, there are a number of different opinions on whether a particular acquisition results in a change of “control.” In addition, at times, the Securities and Exchange Board of India (the “SEBI”) and the parties to an acquisition also have different interpretations on “control.”
In the matter of the acquisition of MSK Projects by Subhkam Ventures, the Securities Appellate Tribunal highlighted the need to differentiate between positive control and negative control, and held that certain rights were necessary to protect the financial investment made by the acquirer and should not be regarded as giving the financial investor “control” of the company. More recently, the acquisition of a 24% stake in Jet Airways by Etihad Airways came under the scanner, and the parties had to alter their agreements substantially.
Due to this lack of clarity, the parties to a transaction as well as their advisers have to constantly perform a balancing act. To redress this issue, the SEBI has released a discussion paper (the “Paper”) proposing a bright-line test to determine what constitutes change of “control.” The Paper specifies two rule-based options, one based on protective rights granted to an acquirer, and the other based on a numerical threshold. The SEBI has invited public comments on the foregoing options.
This update critiques the rule-based options proposed by the SEBI in the Paper.
Acquisition of “control”
Under the Takeover Regulations, the term “control” is defined to include:
- the right to appoint a majority of the directors; or
- the right to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding, management rights, shareholders or voting agreements, or in any other manner.
A similar inclusive definition of “control” exists in several other Indian legislations such as the Companies Act, 2013, the Foreign Direct Investment Policy of India and the Insurance Laws (Amendment) Act, 2015. The definition of “control” in the Competition Act, 2002 is also inclusive, although it is slightly different from the definition under the Takeover Regulations.
Option 1 – Protective rights framework
The first option proposed by the SEBI is based on the difference between positive control and negative control. Under this option, the SEBI has proposed that protective rights granted to an acquirer which are not participative in nature and do not give the acquirer the power to exercise control over the day-to-day running of the business or the policymaking process will not amount to acquisition of “control.” In the Paper, the SEBI has included an illustrative list of protective rights, which include the following:
- appointment of chairman or vice-chairman of the target company;
- appointment of an observer without any voting or participation rights;
- rights conferred on parties under a commercial agreement which are for mutual benefits, have been approved by the board of directors of the target company, and grant a right to the board of directors of the target company to terminate the agreement as also to enter into similar agreements with third parties;
- veto or affirmative rights on issues such as amendment of the charter documents, alteration of the capital structure, material divestment, or the transfer or disposal of an undertaking or material subsidiary of the target company;
- veto or affirmative rights on issues which are outside the ordinary course of business of the company or do not involve governance issues; and
- mandatory requirement to be counted in the quorum of a meeting where a veto or affirmative rights matter will be discussed.
The SEBI has proposed that the foregoing rights can only be granted to investors holding 10% or more shares of the target company and must be incorporated in the articles of association of the target company after obtaining approval of the public shareholders. Moreover, under this option, the target company must formulate a policy to define “material” and “ordinary course of business” for the purpose of exercise of veto or affirmative rights.
Option 2 – Numerical threshold
Under this option, the SEBI has proposed that the term “control” be defined as a right or entitlement to exercise at least 25% of voting rights of a company irrespective of whether such shareholding gives de facto control or the right to appoint a majority of non-independent directors of the company. The 25% threshold is based on the substantial shareholding trigger under the Takeover Regulations, and the fact that under the Companies Act, 2013, shareholding in excess of 25% entitles the holder to block a special resolution.
Is the SEBI’s proposal workable!
Under the protective rights framework proposed by the SEBI in the Paper, there continues to remain a risk of subjectivity. One, the verbiage in a contract may not necessarily be the same as that in the Paper, thereby leading to interpretational issues. Two, the SEBI may question the policy formulated by the target company on what is “material” and in the “ordinary course of business.” Three, the list of veto rights specified by the SEBI in the Paper does not include certain significant rights such as approval of the annual business plan and appointment of key managerial personnel, which were approved as “protective rights” by the Securities Appellate Tribunal in the Subhkam Ventures order. Four, in case where an open offer is being made, the requirement to obtain the public shareholders’ approval seems redundant as the public shareholders are being given an exit. Five, it is unclear as to what constitutes control for shareholders holding less than 10%, and this requirement to own 10% shares to be eligible for the application of the bright-line test seems redundant.
This begs the question whether the Takeover Regulations should really have the concept of change of “control” as a trigger for an open offer.
Most countries having a mandatory open offer regime have adopted the numerical threshold approach (the trigger ranging from 30% to 33%) without considering whether de facto control is acquired. The European Union Takeover Directive suggests a numerical threshold approach, but gives member states the flexibility to adopt a threshold suitable to their jurisdiction. The United Kingdom has moved from a “de facto control” approach to a numerical threshold approach given the ambiguities of the former.
An important aspect of this debate is whether companies have dispersed or concentrated shareholdings. In jurisdictions with concentrated shareholdings (like India, where many listed companies are promoter controlled), it is advisable that the numerical threshold is high. Therefore, in our view, the SEBI’s suggestion to adopt a 25% numerical threshold may not be suitable to the Indian market, and the numerical threshold in the definition of “control” as well as in the substantial shareholding criteria should be increased to at least 35%.
Further, financial and strategic investors who seek the protective rights (listed in the Paper) often bring in financial, technical and business expertise to a target company, which results in the affairs of the target company being managed more professionally and an overall value accretion. In actuality, this benefits the public shareholders much more in the long run. Therefore, rather than deeming anything more than the bare protective rights as a change of “control,” it may be better to give the parties the freedom to design their contracts and not worry about change of “control.”
The SEBI needs to think in a more affirmative manner, as opposed to taking a negative approach, which is the need of the hour.