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The concept of ‘control’ under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “SEBI Takeover Code”) has been the centre of many a heated discussions in recent times. Under the SEBI Takeover Code, an acquirer is required to make an open offer to the public shareholders of a listed target company in two (2) circumstances. Firstly, when the acquirer acquires shares or voting rights upto or beyond a threshold limit of 25% (Regulation 3); and, secondly, when the acquirer takes over the ‘control’ of a company irrespective of his acquisition or holding of shares or voting rights in the target company (Regulation 4).
It is the determination of such ‘control’ by the acquirer that has been the bone of contention for investors, company, promoters, shareholders and SEBI alike. It is important to set out the contours of ‘control’ to ensure that millions of shareholders are not prevented from exercising their option of exiting the acquired Company once the new acquirer takes over ‘control’ of the company. Regulation 2(1)(e) of the SEBI Takeover Code lays down an ‘inclusive’ definition of‘control’ as including the below:
Although the SEBI Takeover Code has repealed the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“1997 Takeover Code”), the essence of the definition of ‘control’ has remained unchanged under the new Code, and both formats of the definition retain their ‘inclusive’ nature. Accordingly, this note relies extensively on the interpretation of ‘control’ in accordance with the 1997 Takeover Code so as to understand the nuances involved. It would also be pertinent to note herein that the proviso to Regulation 2(1)(e) of the SEBI Takeover Code makes it amply clear that merely by virtue of holding the position of a director or officer of a target company, a person ought not to be regarded as being in ‘control’ over the target company, as such.
It is often seen that investors may demand the ability to veto decisions by the company on one or more matters. A contentious issue that arises in such situations is whether such veto rights amount to ‘control’ under Regulation 2(1)(c) of the 1997 Takeover Code. To rephrase the question, whether the power to say ‘no’ would constitute ‘control’ for purposes of the SEBI Takeover Code? This note aims to delve into this aspect of ‘control’ in terms the SEBI Takeover Code. Exercise of a positive right by an acquirer signifies the right to compel the target company to act, whereas exercise of a negative right signifies the right to compel the target company to desist from certain action/s. Does Regulation 2(1)(c) of the 1997 Takeover Code contemplate a negative right? If it does, will such a negative right emanate from a veto right granted upon an acquirer? It is important to look into the content of the Code itself to extract a plausible solution. A plain and ordinary interpretation of an inclusive definition like ‘control’ under Regulation 2(1)(c) indicates that the relevant words “…to control the management or policy decisions” connote a form of ‘exercising restraint’, which is precisely what a negative right entitles its beneficiary to do.
Another reason why a provision in thelike of Regulation 4 (conducting a mandatory open offer to the public on acquisition of ‘control’) is inserted into the SEBI Takeover Code in the first place, is to ensure that shareholders and interested parties may exercise their exit options on an apprehension that the acquirer may use his negative rights in future in order to stall the independence of the promoters, thereby adversely affecting the management and control of the company. An additional perspective is that an acquirer seizing any degree of negative control, and preventing the company from acting in a particular manner, is not really different from such an acquirer compelling the company, under his positive rights mandate, to act in a manner as desired by him. Accordingly, just because a right is negative in nature, would not necessarily mean that such a right does not amount to ‘control’ under Regulation 2(1)(c) of the 1997 Takeover Code.
If it is maintained that negative rights may amount to ‘control’, it may have to be seen what kinds of veto rights amount to such negative rights. Veto rights are basically in the nature of ‘protective’ rights, that is to say, privileges to control major decisions of the firm. However, such protective rights may amount to a participative right, namely, rights that enable an acquirer to participate in determining certain financial and operating decisions of the investee that are made in the ordinary course of business.
The Securities Appellate Tribunal (“SAT”) in Rhodia v. SEBI (Appeal No. 36/2001, SAT-Mum, November 7, 2001) had expressly stated that for indicating when a veto right amounts to ‘control’ under Regulation 2(1)(c), it is not required from the acquirer to demonstrate that it participated in the day-to-day management of the company. Accordingly, SAT held that possession of veto rights would sufficiently establish ‘control’ in accordance with the 1997Takeover Code even while the acquirer is endowed with only ‘protective’ rights.
Although there are not many judicial pronouncements on this aspect, it may be relevant to place reliance on the reports by Emerging Issues Task Force (EITF) and Financial Accounting Standards Board (FASB) that have illustrated matters over which veto would not amount to participating rights, namely, amendments to articles of incorporation of the investee company, pricing on related party transactions, voluntary liquidation of the investee company or a decision to cause the investee to enter bankruptcy or other receivership, issuance or repurchase of equity interests, and like.
The press release notifying the amended definition of “control”, states that the amendment will ensure alignment of the scope of “control” with the definition of “control” as per the Substantial Acquisition of Shares and Takeovers Regulations, 2011 and the definition provided under the CompaniesAct 2013 [sec 2 (27)] to include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements. (Press Release dated 1 August 2013 issued by the Press Information Bureau, Government of India Press notes 4, 5 and 6 (2013 series) dated 22 August 2013 issued by Department of Industrial Policy and Promotion, Government of India
SAT in Subhkam Ventures (India) Private Limited v. SEBI [2010] 99 SCL 159 examined the definition of ‘control’ as laid down under the 1997 Takeover Code. It was held that veto rights acquired by a financial investor in a target company cannot be construed as a ‘controlling’ stake. SAT started off with a literal understanding of the term ‘control’ and found it to be a pro-active, and not a reactive power. It held that ‘control’, in essence meant creating or controlling a situation by taking initiative. Power by which an acquirer can only prevent a company from doing what the latterdesires would not, by itself, amount to ‘control’. SAT determined that the test of ‘control’ really was whether the acquirer is in the driving seat, that is, it must be ensured in each case that the acquirer is the driving force behind the company, and whether it is the one providing motion to the organization. Accordingly, SAT concluded that ‘control’, in short, meant ‘effective control’. Based on this reasoning, SAT held that since the appellant has the power to nominate only one (1) director to the company’s board of directors, the said nominee can, by no stretch of reasoning, exercise control over the affairs of the target company or control its board of directors. The single nominee would be in a microscopic minority and have no veto powers.
However, the law laid down in Subhkam Ventures was ephemeral. The Supreme Court in an order (Civil Appeal No. 3371 of 2010) dated November 16, 2011, clarified that the impugned order passed by SAT would not be treated as a precedent. This order by the Supreme Court was a result of an out-of-court settlement between the parties. Accordingly, the contentious issue remained open-ended, and subject to interpretation by the SEBI, SAT and other courts.
Notably, the Takeover Regulations Advisory Committee (“TRAC”) constituted to review the 1997 Takeover Code had stated that any blanket provision whereby a right to say ‘no’ is, in all circumstances, deemed to either constitute ‘control’ or not to constitute ‘control’ may be liable to misuse. Accordingly, TRAC refrained from suggesting that affirmative rights relating to governance of a listed company ipso facto constituted ‘control’. TRAC, however, suggested that acquisition of de facto control, and not just de jure control should be sufficient for automatically triggering an open offer. It is this understanding of TRAC that lead to its recommendation that the definition of ‘control’ be modified to include the ‘ability’ in addition to the ‘right’ to appoint majority of the directors or to control the management or policy decisions of a company, in order to constitute ‘control’.
It may be asserted that SEBI had considered the TRAC Report prior to formulating the SEBI Takeover Code, and it conclusively decided to overlook the said recommendation of TRAC. Accordingly, SEBI’s intentional decision of rejecting TRAC’s recommendation on this aspect is a conclusive proof that there must be de jure control of the acquirer over the target company in order to trigger an open offer. SEBI has done away with the ‘de facto control’ test as was suggested by TRAC. A natural consequence of this omission would bethat merely holding a large block of shares in a target company with widely dispersed shareholding is not enough to trigger the consequences under the SEBI Takeover Code of acquiring ‘control’.
It is further evident that only material rights granted expressly to the acquirer, and not just prospective ability to effect decision-making sans such rights, fall under the erstwhile Regulation 2(1)(c) definition. A positive right in the form of regulating day-to-day functions would certainly qualify as a ‘right’ under Regulation 2(1)(c) to control the management or policy decisions. On the other hand, in a situation like Subhkam Ventures, wherein the acquirer had virtual control over twenty-two (22) significant matters, SAT appears to have adopted the reasoning that only ‘positive’ control may lead to Regulation 4 (SEBI Takeover Code) activation. Under the Companies Act, 1956, decisions by an Indian company are generally taken either at meetings of its shareholders or at those of its directors. If the acquirer in Subhkam Ventures was empowered to stall decision makings in these board meetings on application of his veto rights, an exercise of evaluating his participation in day-to-day functioning of the target company, which in any event does not call upon the decisionmaking powers of the board, seems redundant.
The recent case in this regard was the Jet-Etihad deal in which the regulators raised concerns over the terms of agreement between Etihad Airways and Jet Airways in relation to the acquisition of minority stake by Etihad in Jet. The regulators feared control of Jet wouldpass into foreign hands because of the manner in which the deal had been structured despite Eithad acquiring minority stakes in Jet. So although the deal has a green signal from FIPB and CCI which ruled in favour of the deal as one of ‘joint control’, SEBI is yet to give its final nod. Etihad was asked to appear before SEBI for personal hearing. It has been argued that the definition of ‘control’ from securities law perspective should be different from that of competition law. SEBI’s clearance might come as a big relief for Etihad, who would have had to shell out another Rs 2,000 crore on the open offer to the minority shareholders of Jet and the additional stake bought through the open offer would have clashed with the foreign direct investment (FDI) regulations as well. (Current FDI norms allow a foreign airline to hold up to 49 per cent in a domestic carrier. The open offer, if fully successful, would have increased Etihad’s stake to 51 per cent). This deal is an important precedent to determine what constitutes ‘control’ for sectors where substantial ownership and effective control is statutorily required to be vested with Indian nationals for instance aviation.
To summarize the above: with respect to affirmative veto rights, the assessment has to be a fact-based endeavour to be taken up on a case-by-case basis. However, in situations like Subhkam Ventures wherein veto rights of the acquirer sneak into a ‘majority’ of the company’s decision making processes, the tilt is invariably towards establishing a ‘control’ under the SEBI Takeover Code, which appears to be a reasonable one.
Ketan presently serves as the Sr. VP (Legal) with the Srei Group, and has extensive experience relating to providing advice and representation on M&A transactions, general corporate matters, commercial agreements, intellectual property, employment issues, banking and project finance, taxation, private equity and capital markets. His wide experience extends to advising on compliance matters arising under anti-corruption laws, and he has advised several multinational corporations on their entry strategies into India, and has diverse experience in providing corporate advice and representation, with focus areas being corporate restructuring, private equity, banking and finance, energy and infrastructure, real estate and construction, telecommunications as also capital markets, both domestic and international. He is a qualified company secretary, possesses a dual qualification to practice law in India and the United Kingdom, and is a member of the Delhi High Court and Supreme Court Bar Associations.
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