Monday, March 10, 2008

Hostile Takeovers & Embedded Defences

The Financial Times reported last week in the context of EADS (the maker of the Airbus aircraft) that “France and Germany are finalising changes to EADS’ corporate by-laws to prevent foreign investors building significant stakes in – or even taking over – Europe’s flagship aerospace and defence company.” The plan is to restrict any investor deemed predatory from owning more than 15% in the company.

This report reminded me of a previous discussion on this blog on hostile takeovers and possible defences. The EADS proposal is a classic case of an embedded takeover defence where the company and its controlling shareholders amend the charter documents of the company (or even a contract the company enters into) so as to impose restrictions on hostile acquirers. While the Financial Report news item implies that such restrictions would be enforceable under the laws governing EADS, an entirely different outcome would ensue under Indian law.

Following certain amendments to the Companies Act, 1956 in 1996 and the introduction of Section 111A(2), all shares of a public company (and therefore a listed company as well) are freely transferable. Any restrictions on transferability of shares of a public limited company in the articles of association would not be enforceable as it would violate the provisions of the Act. Hence, any provision (such as the one proposed for EADS) in the articles of association of an Indian company restricting an acquirer from acquiring shares in a company beyond a specified percentage will not be valid in India. The only restrictions that can be validly imposed are those specified in sub-section (3) of Section 111A, which is essentially for transfers involving violations of specific laws such as the SEBI Act, or other law for the time being in force.

Moreover, since shares of a public company are traded in dematerialised form, any acquirer may acquire shares from the market and such transfer does not required submission to, or approval of, the board of directors of the target company. Hence, there is no question of the board of directors even getting an opportunity to block transfers (that are in excess of stipulated limits) before they are actually effected. Of course, in the case of foreign acquirers, the applicable policy on foreign direct investments (FDI) would have to be complied with. Therefore, these types of embedded defences that restrict acquirers from building up stakes in a company would not come to the rescue of controlling shareholders in Indian companies.

Promoter Shareholding

Our earlier analysis on the best form of takeover defence in India had concluded as follows:

“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.”
There is some recent evidence of this phenomenon, where promoters are shoring up their stake in companies in the wake of a falling market. Yesterday’s Business Standard has a report, stating:

“Promoters of 54 small- and mid-size firms buy 8.3mn shares between Jan 10 - Feb 27.

Promoters of mid- and small-cap companies are grabbing the opportunity provided by a falling market to raise their holdings in their respective companies.

In most cases, the shares of their companies are trading at over 30 per cent discount to the all-time high market prices.”

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