Monday, February 18, 2008

Hostile Takeovers in India: Opportunities and Challenges (Part 2)

After dealing with the history of hostile takeovers in India and possible regulatory obstacles, Shaun’s article moves on to deal with what I find is an interesting analysis of the availability of some of the key takeover defences in the Indian context. I highlight some of his observations (and also intersperse some of my own) below:

1. Poison Pill

A poison pill is a shareholder rights plan whereby a company distributes special stock warrants to its shareholders that entitle them to purchase shares of the company at a substantial discount in the event of a hostile takeover attempt, to the exclusion of the raider. The purpose of this defence is to substantially dilute the shareholding of the company to such an extent as to make the acquisition prohibitively expensive to the hostile acquirer. Although the Takeover Code does not proscribe the issue of such stock warrants, the SEBI (Disclosure and Investor Protection) Guidelines, 2000 (the DIP Guidelines), specifically Chapter 13, impose several restrictions on the issuance of warrants. First of all, issue of warrants at a discount is not possible at the warrants have to be priced at a minimum price determined in accordance with the DIP Guidelines with reference to the market price of the shares (paragraph 13.1.2). Secondly, such warrants can be outstanding only for a period of 18 months after which they would automatically lapse (unless exercised) (paragraph 13.2). Companies will find it difficult to return to shareholders every 18 months to seek a renewal of the shareholder rights plan. For these reasons, the poison pill does not work efficiently as a defence in the Indian context.

2. Staggered Boards

A staggered board of directors is considered to be another effective takeover defence, whereby 1/3rd of a company’s directors retire each year, and hence the entire board can be changed only once in 3 years. This works as an effective defence in some jurisdictions, Delaware in particular. Therefore, if a raider wishes to redeem the poison pill by capturing the board, it would have to wait at least 2 annual retirement cycles before it can obtain the ability to appoint a majority on the board. It may seem that since Indian companies also follow the staggered boards approach to appointment of directors (Section 256 of the Companies Act, 1956), it may seem that this operates as a perfect defence to takeover. But, there is one fundamental difference. Unlike under Delaware law, shareholders have the power to remove all the directors of the company without cause in a single shareholders’ meetings (Section 284 of the Companies Act). Hence, a hostile acquirer who acquires shares or voting rights that enable it to obtain a simple majority in a shareholders’ meeting can substitute the entire board, thereby paralyzing the staggered board defence.

3. White Knight

Another form of takeover defence that is not elaborated in the article, but nonetheless does exist, is the white knight defence. When a company is faced with a hostile acquirer, it often approaches another friendly entity to acquire shares in such target company so as to ward off the hostile acquirer. This is one defence that seems entirely permissible within the contours of the Takeover Code, as the Code permits competitive bids in the wake of a takeover offer. It is always open to the target company or its promoters to bring in a white knight, and this route was successfully utilized by the promoters of the GESCO real estate company when there was a hostile bid on it by the Dalmia group. The white knight was the Mahindra group that was recruited by the promoters to keep the Dalmia group at bay. To me, it seems that among the traditional takeover defences, the white knight is one that is available without doubt to a target company or its promoters in the event of a hostile acquisition of an Indian company.

4. Other Takeover Defences

Shaun’s article also deals with certain other defences such as scorched earth tactics (which is a form of a suicide pill) where the target company retaliates in the event of a hostile bid with actions that destroy the value of the company and make it unattractive to the hostile acquirer. For example, this could be achieved by selling the crown jewels of the company at a substantially low value. Such transactions may not only require the approval of shareholders (Section 293 of the Companies Act, 1956), but may also leave open the possibility of shareholder suits if it can be established that the company (being the board of directors) have not acted in good faith. The article identifies other defences including embedded defences – provisions in the articles of association entitling an incumbent to be a chairman for life, contractual provisions that trigger undesirable consequences in the event of a change in control, and the like.

In the Indian context, the most successful defence against hostile takeovers is the high stakes that promoters hold in their companies. Often, promoters also gradually shore up their stake (through the creeping acquisition route) to fend hostile bids. High promoter stakes make it difficult for raiders to take control without bringing the promoters to the negotiating table.

Finally, after dealing with takeover defences, Shaun analyses the shareholding pattern of large listed companies, and finds that although promoters hold large stakes thereby effectively defending themselves against hostile takeovers, there are several top Indian companies where the promoter holding is not high enough to preclude a takeover. One of the reasons why such companies have not been exposed to hostile takeovers yet may be explained by India’s favourable economic climate, where stock prices continue to grow thereby leaving few targets for hostile bidders (as such bidders usually pursue undervalued stocks). But, in the event that share prices were to fall, Indian companies will likely face the prospect of hostile acquisitions primarily by foreign acquirers, and therefore hostile takeover activity is a distinct possibility in the Indian scenario, which companies will have to face up to. The article concludes with some prescriptions for regulating hostile takeover activity in India.

This article is extremely relevant to the takeover field in India as it throws light on a hitherto under-researched area. Shaun’s findings are based not only on a research of the legal position on the books, but also on the basis of interviews of practitioners in the field. I would recommend it to all those having an interest in the M&A sector in India – it makes useful contribution from both academic and practical perspectives.

The article can be downloaded from LexisNexis or Westlaw.

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