In India, under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “ Takeover Regulations”), there exists a mandatory tender offer regime for acquisition of listed companies. Under this regime, both, the acquisition of a substantial shareholding stake (25%) and the acquisition of “control” are treated equally, and require the acquirer to make an open offer to the public shareholders. Currently, under the Takeover Regulations, the test to determine what constitutes change of “control” is principle-based. Keeping in sync with global norms, in early 2016, the Securities and Exchange Board of India (the “SEBI”) released a discussion paper (the “ Paper”) to explore brightline tests to determine what constitutes as change of “control.”
Last week, the SEBI communicated that it would not introduce any brightline tests to determine what constitutes change of “control” because such types of tests may result in the regime being abused. The SEBI also opined that any change in the definition of “control” under the Takeover Regulations would have “far reaching consequences” over other Indian legislations, most of which contain similar definitions of “control.”
This update critiques the SEBI’s decision to forbid a brightline test to assess change of “control.”
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.
Why the principle-based definition has not worked!
Over the years, the principle-based definition of “control” under the Takeover Regulations has posed to be a problem as there are a number of different opinions on whether a particular acquisition results in a change of “control.” In addition, at times, 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 SEBI and the Securities Appellate Tribunal (the “SAT”) had different opinions on whether certain board representation and quorum rights, and affirmative voting rights on reserve matters, given to the acquirer, Subhkam Ventures, resulted in an acquisition of “control.” After due consideration, the SEBI concluded that the affirmative shareholder rights given to Subhkam Ventures resulted in “control” of MSK Projects by Subhkam Ventures , and thereby, triggered the open offer requirements of the Takeover Regulations. However, on appeal, the SAT 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 Subhkam Ventures and should not be regarded as giving the financial investor “control” of the company. While the SAT’s ruling was investor friendly, India’s Supreme Court, in refusing to opine on the “control” issue, mentioned that the SAT’s ruling must not be adopted as a precedent on this issue. These rulings highlight the fact that the regulators and courts have different views on what constitutes change of “control,” which only compounds the difficulty for investors and deal makers in negotiating shareholder rights.
In 2014, the acquisition of 24% stake in Jet Airways by Etihad Airways came under the scanner of the SEBI, the Competition Commission of India and the erstwhile Foreign Investment Promotion Board, pursuant to which the parties had to alter their agreements substantially.
More recently, in the matter of the acquisition of Kamat Hotels by Clearwater Capital Partners, the SEBI made a passing reference to the SAT’s ruling in Subhkam Ventures, when clarifying that the quorum and affirmative voting rights acquired by Clearwater Capital Partners were to protect the financial investor and must not be held as acquisition of “control” of Kamat Hotels.
Brightline tests proposed by the SEBI in the Paper
In the Paper, the SEBI proposed two options for a brightline test, one based on protective rights granted to the acquirer, and the other, based on a numerical threshold.
Protective rights framework
Under this option, the SEBI had 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 policy making process will not amount to acquisition of “control.” An illustrative list of protective rights was also included in the Paper. Further, it was proposed that these protective rights could 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, the target company would be required to formulate a policy to define “material” and “ordinary course of business” for the purpose of exercise of veto or affirmative rights.
Under this option, the SEBI had 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 gave de facto control or the right to appoint a majority of non-independent directors of the company. The 25% threshold was based on the substantial shareholding trigger under the Takeover Regulations and the ability of holders of 25% plus one (1) share to block a special resolution under the Companies Act, 2013. 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.
Back to square one!
The SEBI’s decision not to adopt a brightline test is a significant step back from its proposal to introduce a brightline test and simplify acquisitions of listed companies. Now, not only is there a lack of clarity or binding judicial precedents on what constitutes “control,” but it is also clear that the SEBI is not amenable to a rule-based test at least for now. The SEBI’s decision also suggests a policing approach through regulatory oversight that appears to be above the interests of investors. This is in contradiction to the Indian government’s approach to liberalize the Indian market and reduce regulatory intervention.
It must be noted that while acquisition of “control” under India’s merger control and foreign investment regime merely triggers regulatory approval requirements, the consequences under the Takeover Regulations are far reaching and can make the acquisition extremely complicated and expensive.
We feel that this is a missed opportunity to simplify the takeover regime in India and promote listed company acquisitions, and we hope that the SEBI will reconsider its decision soon.