Friday, November 21, 2014

SEBI Reforms – Part 2: Delisting

Delisting of securities tends to be somewhat controversial given that it represents the tension between the interests of the controlling shareholder who want to delist the company and the interests of minority shareholders who are caught between the options of exiting the company at the offered value or remaining in the company without the liquidity and protections that a stock exchange listing provides. These controversies have played out in the Indian markets as well thereby necessitating a review of the SEBI (Delisting of Equity Shares) Regulations, 2009.

The review commenced with SEBI’s discussion paper on the topic earlier this year. Somasekhar Sundaresan and I have separately analysed SEBI’s discussion paper (here and here, respectively). SEBI’s approach has been to address two broad concerns. First, the constraints and complexities in the delisting regime make it difficult for controllers to successfully delist. Second, public shareholders holding a significant stake can dictate terms as to the determination of the delisting price and thereby hold the other shareholders to ransom.

In the recently announced reforms, SEBI appears to have considered responses to the discussion paper. In tweaking the regime, SEBI has addressed one of the above issues, but not the other. The reforms continue to protect the interest of minority shareholders against both the controllers as well as significant public shareholders. On the other hand, it has arguably made it more difficult for controllers to delist their companies (rather than ease the process as it initially set out to do). An analysis of a few of the reforms would demonstrate this point further.

SEBI has reinforced the importance of the reverse book-building (RBB) process for delisting. While the RBB has arguably operated in favour of public shareholders, its rigidity has paid put to controllers’ delisting plans. It appeared from the discussion paper that SEBI may be willing to reconsider the utility of RBB in delisting, but in the end decided to stay with the option. Hence, it is unlikely that the new regime would make a significant difference to controllers’ delisting efforts. Although some of us had suggested alternatives to the RBB method that might facilitate value-generating delisting that might nevertheless protect the minority shareholders, that option does not appear to have found favour with SEBI.

Furthermore, the thresholds for delisting continue to be quite daunting. A successful delisting requires the satisfaction of two conditions: (i) the shareholding of the acquirer together with the shares tendered by public shareholders must constitute 90% of the total share capital of the company, and (ii) at least 25% of the number of public shareholders must tender in the RBB process.

As for the offer price, it would be determined through RBB and shall be the price at which the shareholding of the promoter, including the shareholding of the public shareholders who have tendered their shares, reaches the threshold limit of 90%.

At the same time, SEBI has undertaken some efforts relax some aspects of the process. For instance, the timelines for delisting have been reduced from approximately 117 working days to 76 working days. Public shareholders will benefit from taxation benefits accompany the proposal to use the stock exchange platform for delisting (which have also been extended to buyback and takeovers). Finally, exemptions have been carved out for small and medium-sized companies who are spared the strict norms for delisting.

A surprise inclusion in the reforms (that was conspicuously absent in SEBI’s discussion paper) is the streamlining of SEBI’s takeover regulations with the delisting regulations. It would now be possible for an acquirer who has made an offer under the takeover regulations to delist directly without increasing the public shareholding. This would ease the process for acquirers who wish to make an offer to the target’s shareholders and simultaneously delist the target if the offer is successful. It creates the badly needed symmetry between the regimes relating to takeovers and delisting. This recommendation made by the Takeover Regulations Advisory Committee (TRAC), which was ignored in the SEBI Takeover Regulations of 2011 and also in SEBI’s discussion paper on delisting, has finally seen the light of day.

In all, the reforms relating to delisting represent a mixed bag. The changes are incremental in nature, which do not affect the overall philosophy or address the broader concerns and tensions in delisting. Given this scenario, it is not clear if we will witness significant changes in the manner in which delisting is carried out in India or the type of problems faced. Again, we will have to await the text of the amendments to the regulations before making more detailed prognoses.

Thursday, November 20, 2014

SEBI Reforms – Part 1: Insider Trading

Yesterday, SEBI’s board unleashed a series of capital market reforms. These relate to insider trading, delisting, enforceability of the listing agreement and several other matters. In this post, I briefly examine the implications of the reforms on regulations pertaining to insider trading.

The SEBI board has approved a new set of regulations dealing with insider trading. While the text of the regulations are awaited, here I discuss some of the broad reforms announced. The impetus for reforms in this area came from the report of the SEBI appointed committee that was issued in December 2013 (as previously discussed here). In the current reforms, SEBI has broadly adopted the recommendations of the committee on several aspects, but it has either not adopted others or made significant changes.

First, the crucial definition of “insider” has been widened to include “persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to unpublished price sensitive information (UPSI).”  It expands the nature of connections a person may have with the company so as to fall within the scope of an insider. Also, any person who is in possession of or has access to UPSI would also be an insider. At the same time, some proposals of the committee in this behalf have not been accepted, such as the inclusion of a public servant with access to UPSI as a connected person.

Second, immediate relatives would be presumed to be connected persons, with the burden shifted on to them to show that they were not in possession of UPSI. The evidentiary aspects of insider trading have been given great importance given the difficulties SEBI has faced in the past to establish that a person was in possession of UPSI. While the use of circumstantial evidence has worked in some cases, in others it has failed. This burden shifting effort may end up being somewhat crucial in SEBI’s efforts to curb insider trading.

Third, as regards communication of UPSI, certain allowance has been made for “legitimate purposes, performance of duties or discharge of legal obligations”. These has been a substantial discussion about the need for communication of UPSI in genuine commercial or investment transactions, such as due diligence for a private equity investments, which fell within the scope of the prohibition under the existing regime. The new regime makes some leeway for such genuine transactions (with some conditions) that may benefit the company and its investors more generally.

Fourth, where communication of UPSI is permitted, such as in the case of due diligence discussed above, the UPSI must be disclosed to the markets at least 2 days prior to the trading in the securities. This is necessitated so that information symmetry is created in the market such that no investor has any undue advantage.

Fifth, the scope of UPSI and “publication” have been clarified. For example, for information to be generally available (so as to fall outside the scope of UPSI), such information must be accessible to the public on a non-discriminatory platform which would ordinarily be the stock exchange platform. In other words, dissemination through the stock exchange is considered the preferred channel of publication. Furthermore, the definition of UPSI has been aligned with the information and disclosure requirements under the listing agreement.

Overall, some of the changes are indeed significant, given the mixed success of the present insider trading regime. However, as is usually the case, a lot will lie in the wording of the regulations and their interpretation.

Monday, November 17, 2014

The Bombay High Court on Mutual Mistake, Damages and Restitution

In Rolta v MIDC, the Bombay High Court has recently considered some important questions relating to the doctrine of mutual mistake, damages for breach of contract and restitution. It is worth examining the judgment closely as it appears to depart from some well-established principles of contract law.

The case arose out of a Memorandum of Understanding (‘MoU’) which Rolta and MIDC entered into in March 1999. The MoU provided that MIDC, which owned an industrial area known as the Millennium Business Park (‘the Park), would grant a 95-year lease of a building in the Park to Rolta. The building was described as ‘admeasuring 80,000 square feet…in the aggregate land area of 7435 square metres’. Rolta was to pay yearly rent of Rs. 100 and lease premium of Rs. 10.6 crores, the latter in four instalments. The first instalment, of about Rs. 53 lakhs, was paid as earnest money when the MoU was signed. The MoU provided that a lease deed for the building would be executed in the future on terms to be agreed and that Rolta was entitled to a refund of the earnest money without interest should agreement not be reached. Rolta already owned 25,000 square metres of land elsewhere, and it agreed to surrender 7435 square metres of this parcel of land to MIDC, with MIDC to facilitate the sale of the remainder of the parcel.

The lease deed which the MoU envisaged was never executed because a dispute arose between the parties about the construction of the MoU: Rolta claimed that it was entitled to a lease of the 80,000 sq ft building and of a certain portion of land referred to in the MoU (in exchange for the land it had surrendered), while MIDC said that the lease contemplated in the MoU was of the building only. Rolta sought specific performance and in the alternative damages. The arbitrator rejected the claim for specific performance (it is not clear on what grounds) but awarded damages instead. This was challenged in the High Court under section 34.

The Bombay High Court held that there was no contract between the parties because they did not ‘agree on the same thing in the same sense’. Before considering the Court’s reasoning, it is worth pointing out that the question of certainty of terms can arise in two different ways in specific performance cases. Under section 21(c) of the (old) Specific Relief Act, 1877, one ground for refusing specific relief was that the terms of the contract cannot be identified with ‘reasonable certainty’. This provision was omitted from the Specific Relief Act, 1963, based on the (erroneous) view of the Law Commission that any agreement whose terms are not certain is automatically void. That view is erroneous because, as Lord Hoffmann explained in Argyll Stores, the terms of an agreement may be sufficiently certain to constitute a contract, but not to justify the grant of specific performance. If, therefore, the Bombay High Court had invoked uncertainty as a ground for refusing specific performance, a question would have arisen about the effect of the deletion of section 21(c), but the Court went further and held that there was no agreement at all, that is, that there was no ‘consensus ad idem’ between the parties (see, eg, [36]). Yet, it also awarded ‘damages’ for breach of contract assessed on the basis that the contract ‘had never been entered into’.

Mutual Mistake
How was the Bombay High Court able to reach the conclusion that a written MoU signed by the parties is in fact not a contract? By accepting the proposition that Rolta’s interpretation of it (lease of building and land) was ‘as plausible’ (see [32]) as MIDC’s interpretation of it (lease of building only) and therefore that there was no consensus ad idem:

The MoU which is, of course, final and upon which the lease deed had to be executed was, therefore, seen by the parties differently. The parties, therefore, did not agree to the same thing in the same sense…The question of termination is seen to be secondary—in fact there was no agreement at all and none to terminate.  

It is respectfully submitted that this conclusion is wrong, because it is founded on the erroneous premise that ‘consensus ad idem’ requires subjective agreement between the parties. The test, in both Indian and English law, is what a reasonable person in the position of the parties would have understood the contract to mean: in the case of a written agreement, this involves asking how a reasonable person in the possession of all the shared background knowledge (excluding pre-contractual negotiations) would have understood the language used. In ITC v George Fernandes—a case that the Bombay High Court cites—the Supreme Court said expressly that contracts are construed objectively, and the principle is also illustrated by the well-known case of Smith v Hughes, where Blackburn J said this:

I apprehend that if one of the parties intends to make a contract on one set of terms, and the other intends to make a contract on another set of terms, or, as it is sometimes expressed, if the parties are not ad idem, there is no contract, unless the circumstances are such as to preclude one of the parties from denying that he has agreed to the terms of the other…If, whatever a man's real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party, and that other party upon that belief enters into the contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party's terms.

The Bombay High Court unfortunately appears to have overlooked this principle. It relies on another well-known case—Raffles v Wichelhaus—but the crucial difference is that Raffles, unlike Smith and this case, is what is known as a ‘perfect ambiguity’ case, ie, a case where a reasonable person would have had no basis for preferring the interpretation of one party to that of the other. The plaintiff in that case alleged that the defendants had agreed to buy 125 bales of Surat cotton to arrive ‘ex Peerless from Bombay’ and that they had refused to accept delivery when the ship arrived in Liverpool. The problem was that there were two ships named Peerless: one left Bombay in October and the other in December. The defendants pleaded that they meant the October Peerless and that the plaintiff had refused to deliver any cotton when this ship had arrived in Liverpool. Contrary to the Bombay High Court’s analysis (see [21]), judgment was actually given for the defendant on the ground that the plaintiff’s demurrer to the defendant’s plea was bad, and the case has subsequently treated as an application of the objective principle to circumstances where the parties were simply at cross-purposes (see, eg, Bell v Lever and Professor Brian Simpson’s historical account).

In this case, therefore, the question was simply how a reasonable person with all the background knowledge available to MIDC and Rolta would have understood the MoU: he must, ex hypothesi, have construed it either as an agreement to lease the building only, or as an agreement to lease the land as well, and that is what the MoU (objectively) means, irrespective of what MIDC and Rolta (subjectively) thought it meant. It is difficult to see how the objective construction of the MoU could possibly lead to the conclusion that there is no contract.

Assuming there was no contract at all, the question of awarding damages for breach of contract does not arise. Yet, the Bombay High Court, at [41], held that Rolta was entitled to a refund of the earnest money (and certain other heads) it paid with 9 percent interest, on the ground that this is ‘adequate compensation to put the petitioner in the same position as he would have been had the contract not been entered into’. If the court was indeed awarding damages for breach of contract (leaving aside the difficulty that there is no contract to breach), the object of the award should have been to put the claimant in the position in which he would have been if the ‘contract had been performed’, not ‘if the contract had not been entered into’ (see section 73 of the 1872 Act and Robinson v Harman). It may be that the High Court was making a restitutionary award even though it used the language of ‘compensation’ and ‘damages’: however, even if MIDC was enriched by the payment of Rs. 53 lakhs, it appears that it had a change of position defence since it constructed a building for Rolta for which it did not receive full payment, and presumably undertook other obligations as well. There are similar difficulties in the Court’s analysis of the other two heads of damages that were awarded (see [41] and the counterclaim in [43]).

In short, the judgment is, with respect, questionable because it appears to construe the MoU in terms of what the parties subjectively thought it meant, and award ‘damages’ for the breach of a ‘contract’ with the use of a restitutionary measure (but without identifying the defendant’s enrichment).

Delaware Court Ruling on Deal Conditions in the Apollo-Cooper Merger

A recent Delaware court ruling deals with matters involving the “unraveling of the Agreement and Plan of Merger (the “Merger Agreement”) by which a large Indian tire manunfacturer—[Apollo]—was to buy a large American tire company—Cooper Tire & Rubber Company (“Cooper”).” Billed as among the largest overseas acquisitions by an Indian company, Apollo was to acquire all the shares of Cooper. However, once the deal was announced, the share price of Apollo went into a steep fall. More importantly, the deal received significant opposition from Cooper’s affiliate in China, Chengshan Cooper Tires (“CCT”) and its chairman as well as employees. In parallel, the deal also faced resistance from Cooper’s own workers’ union in the US, United Steelworkers (“USW”).

Although both Apollo and Cooper attempted for several months to address the concerns of CCT as well as USW, they did not succeed, and the Merger Agreement was finally terminated at the end of last year. Cooper’s efforts to seek specific performance from the Delaware courts did not succeed.

In the current round of litigation, Apollo requested the court for a declaration that “the conditions to closing had not been satisfied prior to the trial of this action, and Cooper [was], thus, not in a position to close the merger”. In order to consider whether this declaratory relief can be granted, the Chancery Court in Delaware examined the provisions of the Merger Agreement and specifically whether Cooper had satisfied the conditions precedent to closing the merger. The parties raised a number of issues, including whether a marketing period had taken place (to enable Apollo’s financing banks to make the debt to finance the merger), and whether several conditions precedent has been satisfied, such as the lack of a material adverse effect (MAE), and Cooper’s compliance with representations and warranties as well as covenants.

In its core analysis, the court considered two principal aspects. First, it found that during the period commencing the execution of the Merger Agreement, Cooper had failed “to cause CCT—its largest subsidiary—to conduct business in the ordinary course”. Hence, it had breached an important term of the Merger Agreement. Second, it found that MAE had occurred, due to which Apollo had no obligation to close the transaction. Hence, the court favoured Apollo and found that due to the lack of satisfaction of the conditions precedent, it had not committed a breach of the Merger Agreement, and was therefore entitled to the declaratory relief it sought.

The Chancery Court’s opinion is important as it sheds some light on the manner in which merger documents are to be interpreted. For instance, even though the MAE clause came with certain exceptions (such as the impact of the execution and delivery of the Merger Agreement on employees and labour unions), the court ruled that “it is axiomatic that contractual provisions must be read to make sense of the whole. … In other words, the logical operation of the definition of Material Adverse Effect shifts the risk of any carved-out event onto Apollo, unless that event prevents Cooper from complying with its obligations under the Merger Agreement; the parties agreed not to excuse Cooper for any such breach”.

Given the history of this litigation, it is possible that an appeal may be preferred against this decision. At the same time, the court’s opinion provides some guidance to company that are engaged in negotiating such complex documentation in M&A deals. While parties in India are becoming accustomed to drafting and negotiating such documentation, they have almost never been tested before the Indian courts. More importantly, it provides lessons for Indian companies engaging in overseas acquisitions (particularly in the US) is structuring their legal documentation carefully so as to ensure proper deal conditions and other protective devices that might step in to save them in case of a dispute.

Saturday, November 15, 2014

Indian Companies Issuing Securities Overseas

Historically, Indian companies have issued equity instruments in the form of depository receipts (either American depository receipts (ADRs) or global depository receipts (GDRs)) or convertible debt instruments in the form of foreign currency convertible bonds (FCCBs). Of late, such overseas securities issuances have reduced quite significantly. Now, the Government has revamped the legal regime for overseas issuance of securities so as to streamline it further, and facilitate further use of this capital raising route by Indian companies. The recent legal changes are two fold, one effected by the Ministry of Finance (MOF) and the other by the Ministry of Corporate Affairs (MCA).

New Scheme for Depository Receipts

Hitherto, all types of instruments, viz. GDRs, ADRs and FCCBs were governed by the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipts Mechanism) Scheme, 1993, which had been amended from time to time. By virtue of a notification issued by the MOF on October 21, 2014, the issuance of depository receipts has been taken out of the 1993 Scheme and is now regulated by the Depository Receipts Scheme, 2014. The 2014 Scheme allows Indian companies, whether listed or unlisted, to access the international capital markets using depository receipts. Such issuances can either be through a public offering of depository receipts or through a preferential allotment or qualified institutional placement. They can also either be sponsored by the issuer company or even unsponsored (e.g. when an existing shareholder offloads its holding through the issue of depository receipts). These issuances are subject to the usual foreign investment regime, including in relation to sectoral caps as well as pricing.  Moreover, such issuances are permitted only to investors in certain specific jurisdictions as listed in the 2014 Scheme, which currently consists of a list of 34 countries.

The 1993 Scheme stands repealed to the extent that it applies to depository receipts. It will, however, continue to apply to FCCBs.

The 2014 Scheme effectively modernizes the process for overseas issuance of equity instruments by Indian companies. It is facilitative in nature, but at the same time contains some restrictions to guard against potential abuse of the mechanism.

Clarification for Foreign Debt Instruments

Separately, the MCA has issued a circular on November 13, 2014 clarifying that Chapter III of the Companies Act, 2013 will not apply to FCCBs or foreign currency bonds issued overseas by Indian companies. In other words, foreign issuance of debt instruments by Indian companies will not be subject to the prospectus and other disclosure requirements applicable under Indian law. This eases the regime for foreign issuance of debt instruments by Indian companies, making that route attractive for those companies that would like to avoid the onerous requirements under the Companies Act.

This dispensation is available only for issue of foreign debt instruments, and does not seem to be available for equity instruments such as ADRs/GDRs. Although previously both equity and debt instruments issued through this route required minimal compliance with local disclosure requirements, the new regime distinguishes between the two types. The regime governing foreign issuances of depository receipts therefore remains uncertain. It is not clear whether this is the result of a deliberate regulatory strategy. This may provide some amount of regulatory arbitrage favouring the FCCB regime over that of depository receipts.

Thursday, November 13, 2014

SEBI Informal Guidance: Scope of Prohibition

[The following post is contributed by Supreme Waskar, partner at Sterling Associates, Mumbai]

Almondz Global Securities Limited (“AGSL”) is a stock broker and merchant banker registered with SEBI. On March 21, 2014 SEBI had prohibited AGSL from taking up any new assignment or involvement in any new issue of capital including an IPO, follow on issue etc, from the securities market in any manner whatsoever for a period of five years and in addition to this, on April 11, 2014 SEBI had also suspended certificate of registration of AGSL, as a merchant banker, for a period of 6 months (“Prohibition”). 

Further, AGSL through letters dated July 07, 2014 and subsequent clarifications thereto had requested SEBI for its informal guidance in form of interpretative letter (by virtue of interpretive letter, concerned department of SEBI gives an interpretation of any of the provisions of the SEBI Act, rules, etc., thereunder or of any Act being administered by SEBI.) on following issues:

1.         Whether AGSL as a stock broker, can handle any issue of debt securities offered on private placement basis;

2.         Whether regulation 4(3) of the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 also applies to issue of debt securities on private placement basis: and    

3.         Whether any stock broker can handle issue of debt securities offered on private placement basis.

Without necessarily agreeing, SEBI took a view that firstly SCRR, 1957 prohibits a stock broker from being engaged as principal or employee in any business other than that of securities except as a broker or agent not involving any personal financial liability. Secondly the activities specified by AGSL i.e. handling issue of debt securities offered on private placement are in nature of activities carried out by a merchant banker and can be performed only by a registered merchant banker, therefore AGSL (stock broker) cannot perform the above activity. SEBI’s intention is clear from this interpretative letter that “one cannot seek to achieve some purpose which it is otherwise not competent to perform.”

Informal guidance is advance guidance on the interpretation of the provisions of SEBI Act, Rules, Regulations, and Circulars. It is a formal scheme launched by SEBI in the name of providing informal guidance. As the name suggests the guidance provided is 'informal' and is not to be construed as a conclusive decision of any question of law or fact by SEBI. SEBI’s informal guidance are views of SEBI, neither obligatory nor authority of law. Moreover, such letter giving informal guidance cannot even be construed as an order of the Board under section 15T of the SEBI Act and as such will not be appealable. However, one may always have a different view than SEBI’s view in its informal guidance.

The issue raised in this matter is whether the prohibition restricts AGSL from handling of issue debt securities on private placement basis in the context of SEBI (Issue and Listing of Debt Securities) Regulations, 2008 which do not require appointment of merchant banker for handling of issue debt securities on private placement basis, which is answered negatively by SEBI.

- Supreme Waskar