February 23 2010
In a recent landmark judgment in M/s Subhkam Ventures (I) Private Limited v The Securities Exchange Board of India(1) the Securities Appellate Tribunal held that an affirmative vote given to an acquirer under a share subscription and shareholders' agreement executed between the acquirer and the target did not bestow on the acquirer control over the target.
On October 20 2007 the board of directors of MSK Projects (I) Ltd issued and allotted 4.45 million fully paid-up equity shares on a preferential basis, representing 19.91% of the company's equity share capital.
Subhkam Holding Private Limited, now taken over by acquirer M/s Subhkam Ventures (I) Private Limited, was allotted 4 million shares representing 17.9% of the post-preferential issue of equity capital. The allotment was made after shareholders of the target passed a special resolution under the Companies Act 1956 on August 27 2007. On October 20 2007 a share subscription and shareholders' agreement was executed between the acquirer, the existing promoters of the target and the target.
The agreement contained a recital stating that:
Since the acquirer's acquisition, together with its existing shareholding and those of persons acting in concert with it, exceeded 15% of the voting rights in the target, Regulation 10(2) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997 (Takeover Code) was triggered and, accordingly, on October 24 2007 a public announcement was made to acquire 4,577,572 of the target's equity shares from its public shareholders.
On the date of the public announcement, the acquirer, along with persons acting in concert with it, held 5,423,000 equity shares of the target, representing 24.26% of its equity share capital.
On November 2 2007 the acquirer filed a draft letter of offer with the Securities and Exchange Board of India (SEBI) through its merchant banker, which contained required disclosures in terms of Regulation 18 of the Takeover Code.(3)
Clause 3.3.3 of the draft letter stated that:
"The Acquirer is merely a financial investor and this acquisition will not result in a change in control of the Company and therefore, the Acquirer will not be in control of the management of the Target Company."
Through a letter dated December 5 2007 sent through its merchant banker, the acquirer clarified to SEBI that it would not acquire control of the target and further undertook that if it were to acquire control at any later stage, it would comply with the Takeover Code and make an offer to public shareholders under Regulation 12 of the Takeover Code.(4)
In its comments under Regulation 18(2) of the Takeover Code, SEBI directed that the offer letter be revised to reflect that an open offer was being made under Regulations 10 and 12 instead of only Regulation 10 of the Takeover Code.
The acquirer offered to amend Clauses 5 and 9 of the agreement, which gave ample powers to the acquirer, by virtue of which it could exercise control over the target. However, SEBI directed the acquirer to abide by its comments.
The acquirer appealed to the Securities Appellate Tribunal, which was allowed on the grounds that SEBI's decision was not reasoned. The decision was thus remanded back in order for a fresh order to be passed. Through its order dated December 15 2008, SEBI reiterated its earlier decision, giving detailed reasons. The acquirer again appealed before the Securities Appellate Tribunal.
The main issue for consideration before the tribunal was whether the provisions of the agreement executed by and between the acquirer, the target and its promoters gave the acquirer 'control' over the target.
While allowing the appeal and setting aside SEBI's decision, the tribunal held that Regulation 12 of the Takeover Code was not triggered by the provisions of the agreement.
The tribunal observed that Regulation 10 of the Takeover Code applies where an acquirer, by virtue of its acquisition, exercises 15% or more of voting rights in the company, and Regulation 12 of the Takeover Code applies where an acquirer acquires control over the target, irrespective of whether there has been any acquisition of shares or voting rights in that company. Both regulations may be triggered simultaneously, but they can also apply independently in different sets of circumstances.
Regulation 2(1)(c) of the Takeover Code defines 'control' as follows:
"include the right to appoint the 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 definition has two features: (i) the right to appoint the majority of directors; or (ii) the ability to control management or policy decisions by various means referred to in the definition.
This control of management or policy decisions could be by virtue of shareholding or management rights or a shareholders' agreement or voting agreements. The tribunal also referred to Black's Law Dictionary (8th Edition) at page 353, which defines 'control' as:
"the direct or indirect power to direct the management and policies of a person or entity, whether through ownership of voting securities by contract, or otherwise; the power or authority to manage, direct or oversee."
Control is a proactive power by which an acquirer can command the target to do as it wants.
The tribunal observed that the target's board of directors consisted of 10 directors, including a nominee of the acquirer. Since the acquirer had the power to nominate only one director, that nominee could not exercise control over the target's affairs or control its board of directors.
The tribunal observed that giving a right to the acquirer to participate in the governance of the target was different from giving it control. Clauses which give an investor director the right to be a member of any committee or board and to vote at all meetings of such committee, or which ensure the investor director's presence to meet quorum for board meetings, do not vest any control.
The tribunal held that the clause that gave affirmative voting rights to the acquirer was only to protect the interests of the acquirer and its investment and gave no control to the acquirer. The protective provision under the agreement was not in the nature of day-to-day operational control over the target's business. Such provisions merely enable the acquirer to oppose a proposal and not carry out any proposal on its bidding. A protective provision contained under the agreement imposed fetters on the target for the purpose of good governance. It is conventional for financial investors to protect their investment and the target from the whims and fancies of the promoters that manage the target.
However, such fetters fall short of the existence of 'control' over the target company. Every fetter of any nature in the hands of any person over a listed company cannot result in that person gaining control over that company.
This decision interprets and determines the term 'control' within the context of takeovers of public listed companies in India. Although the decision is subject to scrutiny by the Supreme Court, the Securities Appellate Tribunal's interpretation has larger ramifications within the securities law field, as it is a strict interpretation which excludes various factors that can amount to an acquirer's exercise of control over the target.
For further information on this topic please contact Tejas Karia or Nitesh Jain at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 2692 0500), fax (+ 91 11 2692 4900) or email (firstname.lastname@example.org or email@example.com).
(1) Appeal 8/2009, decided on January 15 2010.
(2) Acquisition of 15% or more of the share or voting rights of any company.
(3) Submission of letter of offer to SEBI.
(4) Acquisition of control over a company.
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