The acquisition of “control” of listed companies has always attracted a premium. This concept forms the rationale for requiring prospective acquirers acquiring such ‘control’ to be bound by onerous open offer obligations to acquire the additional shareholding of the target company.
In India, the law governing the acquisition of “control” of listed companies is laid out in the takeover regulations framed by Securities and Exchange Board of India (“SEBI”), which deal inter alia with the acquisition of shares, voting rights and control of listed Indian companies. A recent decision by SEBI however caused a lot of concern and disarray among investors and target companies alike in a case in which the pivotal issue examined was what constitutes “control” for the purposes of takeover regulations.
This article seeks to examine and analyse this decision of the SEBI and that of the appellate authority and the Supreme Court in what is popularly known as the “Subhkam Case”.
The facts of the case are as follows:
MSK Project (India) Limited (“Target Company”) was a company listed on the Bombay Stock Exchange. The Target Company had made a preferential allotment of equity shares to Subhkam Ventures (I) Private Limited (“Subhkam Ventures”) which constituted 17.90% of the shareholding in the Target Company. In this regard a share subscription and shareholders agreement (“Shareholders Agreement”) was also entered into between Subhkam Ventures, the Target Company and the promoters of the Target Company. The Target Company, being a listed company, such acquisition by Subhkam Ventures triggered the open offer requirements under Regulation 10 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Erstwhile Takeover Code”)
In compliance with the said Regulation 10 of the Erstwhile Takeover Code (which imposed open offer obligations on a prospective acquirer in the event of acquisition of shares or voting rights) Subhkam Ventures made a public announcement for an open offer to acquire shares of the Target Company from its public shareholders. Subhkam Ventures also filed a draft letter of offer with SEBI in accordance with Regulation 18 of the Erstwhile Takeover Code. However SEBI required the draft letter of offer to be revised to reflect that the open offer was being made under Regulation 12 of the Erstwhile Takeover Code as well as under Regulation 10.
Regulation 12 of the Erstwhile Takeover Code provided that irrespective of whether or not there has been any acquisition of shares or voting rights in a company, no acquirer shall acquire “control” over the target company, unless such person makes a public announcement to acquire shares and acquires such shares in accordance with the Erstwhile Takeover Code.
SEBI in making such requirement took the view that the following rights of Subhkam Ventures under the Shareholders Agreement, viz. (i) the right to appoint a nominee on the board of directors of the Target Company; (ii) the requirement of the presence of the director nominated by Subhkam Ventures to constitute a quorum for board meetings of the Target Company and (iii) affirmative voting rights constituted an acquisition of “control” of the Target Company by Subhkam Ventures thereby also inviting the provisions of Regulation 12 of the Erstwhile Takeover Code.
The term “control” has been defined in regulation 2(1) (c) of the Erstwhile Takeover Regulations as under:-
“control shall include the right to appoint majority of the directors or 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 or management rights or shareholders agreements or voting agreements or in any other manner”.
The point of law that was being disputed in this case was therefore whether these rights i.e. the right to nominate a director on the board of the company, the right to be present to constitute quorum and the affirmative voting rights all of which is essentially “negative control rights” constituted “control” for the purposes of the takeover code regulations.
Subhkam Ventures filed an appeal to the SAT against SEBI’s decision to treat the acquisition as an acquisition of “control”. The SAT overturned SEBI’s decision holding that “control”, as per the definition of the term in the Erstwhile Takeover Code, is “a proactive and not a reactive power”. It is a power by which an acquirer can command the target to do what he wants it to do. The SAT in its order further held that control really means creating or controlling a situation by taking the initiative. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. SEBI, feeling aggrieved by the decision of the SAT, appealed to the Supreme Court.
The SEBI’s decision of bringing “negative control” within the purview of “control” under the Erstwhile Takeover Code raised serious concerns among the private equity fund and venture capitalists community as these rights are commonly granted to investors under investment agreements entered into by them with target companies. Furthermore, most investors consider these rights critical in order to have some level of supervision over the target company’s operation and management. The entire investment community therefore looked to the Supreme Court to settle the question of “control” for once and for all and to clarify the point of law on the issue.
In the interim, SEBI had constituted a committee to suggest changes to the Erstwhile Takeover Code to address contemporary situations. Although the Committee suggested various sweeping changes, it seems that the Committee refrained from making any suggestions regarding ‘negative control’ in view of the pending Subhkam Case before the Supreme Court. Based on the recommendations of the said committee, SEBI has amended the Erstwhile Takeover Code by replacing it with Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“New Takeover Regulations”). However, the definition of the term “control” has not been amended.
Subsequently, both SEBI and Subhkam Ventures have reached an out of court settlement in the matter and hence in November 2011 the Supreme Court passed an order disposing off the appeal. The order of the Supreme Court also specifically stated that the order of the SAT would not be treated as a precedent in the matter of law. This added further ambiguity as to the position of law on whether the grant of certain rights in investment agreement would tantamount to the acquisition of “control” for the purposes of the takeover regulations.
In the absence of a clear regulatory framework which defines the roles and responsibilities of the parties which in turn provides clarity on ‘risks’ it becomes difficult for the parties to ascertain the risks involved in entering into any proposed transaction. As stated above, since under the New Takeover Regulations definition of “control” remains unchanged, the ambiguity regarding ‘negative control’ continues.
One of the options to bring more clarity to deal making from a regulatory stand point that is usually considered in cases of ambiguity of regulation is to approach the concerned regulator viz. SEBI under the the Securities and Exchange Board of India (Informal Guidance) Scheme, 2003 (“Informal Guidance Scheme”). Under the Informal Guidance Scheme the opinion of the SEBI can be sought on a particular issue of law or regulation on payment of a prescribed fee. However, considering the view that the SEBI has taken in the Subhkam case it is unlikely that under the Informal Guidance Scheme the SEBI will arrive at a different conclusion. The Informal Guidance Scheme therefore will not serve any practical purpose in this instance. The issue of “negative control” under the Erstwhile Takeover Regulations and the New Takeover Regulations (as the definition of “control” has not been amended) continues to remain ambiguous.
Further, although SEBI has raised the trigger limits for the open offer to 25% under the New Takeover Code, the acquisition of ‘control’, independent of the acquisition of shares, also triggers the open offer requirements. The minimum offer size in open offer has also been increased to 26%. The need for negative control for private equity (PE) and Venture Capital (‘VC’) investors is well recognized. Therefore having clarity on the implications of ‘negative control’ is imperative.
In the circumstances, if the regulators can lend absolute clarity on this issue, it can certainly boost the confidence of the PE and VC investors in undertaking much needed large investments in listed entities.
(Narendra is a partner and Mini is a manager with DSK Legal. The views expressed in this article are personal.)