It has been a period of far-reaching changes in commercial law, with the Direct Taxes Code and the IFRS (International Financial Reporting Standards) being adopted by 2011 and now the publication of the Draft Takeover Regulations, 2010 (“Draft Code”) prepared under the chairmanship of C. Achuthan, former presiding officer of the SEBI appellate tribunal. Hot on its trail, businesses are anticipating the Companies Bill and competition law merger regulation guidelines which would complete the four corners of major changes to corporate law and life in 2010-11.
After 2001, this is the first major recast of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2010 (SEBI takeover code). Since it is fresh off the press, my attempt is to focus on only a few key elements of change in this Draft Code, which are significant and far reaching to the business community and the practitioner alike.
One of the most significant changes concerns the threshold, which triggers a takeover offer where the acquirer and persons acting in concert with such acquirer would trigger a mandatory offer after breaching the 25% limit of shareholding or voting rights. As a corollary, the Draft Code permits creeping acquisition of up to 5% shares or voting rights in any financial year after crossing the threshold trigger limit of 25%. Another major but subtle change has been made to the concept of control where the explanation of “cessation of control in relation to joint control”; not constituting a change of control has been deleted from the definition of the word “control”.
Acquisition of direct or indirect control of a listed company cannot now be undertaken without making a public announcement of an open offer. In the existing SEBI Takeover Code, explanation to Regulation 12 dealt with indirect acquisition through acquisition of holding companies – foreign or Indian. The Draft Code elaborately prescribes processes for dealing with indirect acquisition of shares or control and have an equally detailed offer price determination mechanism in Regulations 5 and 8. New concepts like primary acquisition, disclosure of the intention or the decision to make the primary acquisition and its announcement in the public domain have been introduced in the context of indirect acquisitions, which will be subject to expert scrutiny in the very near and short term.
A missed opportunity
Given market realities, we have to recognize that it is impractical for large billon dollar transactions to be undertaken on the basis of limited public information filed by the promoters and persons acting in control with the stock exchange. It is in the interest of the market, and the interest of the acquirer, that the US model, which provides transparency in scrutiny of business data be brought in use even in India. We must encourage a change in law which debunks the “sham” that most merchant bankers, accountants and law firms engage in, especially when a negotiated purchase of controlling interest in a listed company is being developed. The Achuthan committee had been given suggestions for introducing transparency in negotiated acquisitions of public listed companies and due diligence concerning public listed companies, (for scrutiny of information not available in the public domain), however, there is no change forthcoming in this space so far.
Interesting variations have also been made concerning voluntary open offers, mandatory open offers and offers which would result in delisting of a listed company based on the threshold of holdings by persons in control and persons acting in concert with such persons. Again marrying the formulaic pricing under the Draft Code, with the reverse Swiss auction in delisting offers remains a challenge.
Further, Regulation 3 of the SEBI Takeover Code which prescribed the statutory exemptions, have now been shifted to the provisions in Regulations 10 and 11 in the Draft Code. Chief Justice P.N. Bhagwati’s prescription that “power corrupts and absolute power corrupts absolutely” had resulted in a “swing change” in dealing with provisions for exemptions in the 1994 Takeover Code. His prescription was based on his judicial experience and statesmanship that regulatory discretion should be curtailed and exemptions should be express rather than implied or left to a regulator’s discretion. This still holds good in current times. Consequently, the proposal set out in Regulation 11 of the Draft Code, taking away the requirement of making a mandatory reference to the Takeover Panel by SEBI before granting an exemption is a retrograde move. Discretion in important market-linked regulations must always be controlled and minimal. The earlier formulation of the SEBI Takeover Code in my book, is still superior. We must consider and critique the Achuthan Committee’s deliberations on why there is a “peechhe hat” move on this score.
Deliberations on the non-compete fees are likely to invite major criticism as the distinction between the control premium, non-compete fees and the rationale to pay the “knowledge holders and know-how brains” of a listed company has been mixed up and blurred. An acquirer of a listed company is unlikely to pay value to an existing promoter and persons acting in control with such person, if the “brains” and the “know-how holder” can replicate value and knowhow in another company, after the public acquisition. Non-compete payment can be made to non-shareholders who have embedded knowledge and knowhow of the nuances of running processes and developing products. To negate such non-compete payments as permissible payments, not affecting share price in a public offer is short sighted; as knowhow providers and “the brains” cannot be denied price for their ability to be paid for their goodwill and knowhow. How can you tell a non-shareholder, having such knowhow, that you cannot be paid, either for being a non-shareholder promoter and a technocrat knowledge provider? Further, the Takeover Code cannot do away with the Indian Contract Act, 1872 for payment of goodwill and knowhow to such persons as non-compete consideration. Even the Income Tax Act recognizes this currently. The Achuthan Committee needs to relook and reconsider the issue as to how they would deal with a true non-compete fee payment for knowhow and a voluntary reasonable restraint of not engaging in replicating the same process or product, for a period post-sale to non-shareholders not forming part of the selling shareholders. This question had vexed the Bhagwati committee and will continue to trouble future SEBI committees, as it is a complex issue, best left alone!
In this instalment, I shall deal with the last issue concerning exempt acquisitions (Regulations 10 and 11 of the Draft Code) relating to acquisition of control or shares pursuant to an amalgamation, merger or demerger either in India or abroad. Whilst detailed provisions have been made for indirect acquisition in Regulation 5 and 8 of the Draft Code concerning offer price, the “ipsi dixit” of cash compensatory exits to the extent of 25% of the consideration through a scheme of arrangement or the continuation of a 33% past shareholder continuity in schemes as exempt from the SEBI Takeover Code negates several well considered international SEBI precedents, which the Takeover Panel has approved, like in Eaton Corporation, Abbott Laboratories, etc. When a global merger is undertaken in an international context, which is exempt under international law of the foreign jurisdiction, when such re-construction is undertaken, pursuant to arrangements being approved by competent authorities of foreign nations; the globally recognized three company merger processes applied e.g. in the Daimler Chrysler structure or the Proctor & Gamble Gillette cases run the risk, now, of being non-exempt amalgamations or schemes. This would trigger alarm bells in the context of global transformation, in a world affected by deflationary and recessionary factors, and where reconstruction will be the norm of business for the next five coming years.
Shardul S. Shroff , managing partner, Amarchand Mangaldas, was a member of the two Bhagwati committees, constituted in 1994 and 2001, for drafting and reviewing the Sebi takeover code 1997, and is an active practitioner in the public takeover space.
We welcome your comments at firstname.lastname@example.org