Sunday, July 20, 2008

Share Buyback: The Effect of Shareholders' Resolution

In a recent case decided last week, the Securities Appellate Tribunal (SAT) had the occasion to decide on the effect of a shareholders' resolution in the context of a buyback of shares. The SAT decision is available here.

The facts of the case are fairly straightforward. The company involved, D-Link India Ltd, proposed to the shareholders a resolution for the buyback of its shares pursuant to Section 77A of the Companies Act, 1956. Under this provision, such a resolution is valid for a period of 12 months, within which period the company may act upon the resolution. If the company, however, fails to proceed with the buyback, the resolution lapses at the end of the 12-month period.

In this case, D-Link India Ltd failed to initiate any buyback within the 12-month period, due to which its shareholders' resolution lapsed. SEBI initiated action against the company on the grounds that the company never had any intention of buying back its shares, and that the convening of the shareholders’ meeting and the announcement of a buyback was only for the purpose of misleading the investors. Consequently, following the request of some investors who bought shares in the company in anticipation of a buy-back, SEBI passed an order stating that the company violated Regulation 5(1)(a) of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices Relating to the Securities Market) Regulations, 1995. Hence, the company was directed not to buy, sell or deal in the securities in any manner directly or indirectly for a period of one month. The company went on appeal to the SAT against such order.

SAT overturned SEBI's order, primarily on two grounds:

1. Shareholders’ Resolution Only Enabling in Nature

The first issue considered was whether the company was under any obligation to proceed with the buyback after its shareholders had passed a special resolution authorising the company to carry out the buyback. In his behalf, SAT noted:

“On a reading of the provisions of section 77(A) of the Act and the relevant provisions of the buy-back regulations … we are of the considered view that a company is under no obligation to buy-back its securities even if its shareholders have passed a special resolution authorizing it to buy-back on the terms and conditions mentioned in the resolution. Section 77(A) of the Act is only an enabling provision and all that it mandates is that no company shall buy-back its own securities unless it is authorized by its articles and also by its shareholders. But even where the shareholders pass a special resolution, it does not become obligatory for the company to buy-back the shares.”
2. Not Misleading Investors

As for the allegation of misleading the investors, SAT was of the considered opinion that there is no material on the record to indicate that the company had no intention to buy back its shares when the shareholders passed a resolution. It held that there can be no inference of the company's lack of intention to buy-back merely because it made no offer to the shareholders to buy back its securities. There has to be some other material or circumstances from which such an inference could be drawn, which was absent in this case. SAT then dealt with in detail the factual circumstances based on which it had arrived at this conclusion.

Lastly, SAT also made an overarching observation relating to the role of SEBI has a securities market regulator, and the scope of its powers in transactions such as buyback of shares by listed companies:

“We wonder how [SEBI] is concerned whether the company increases the investor wealth of its shareholders through the buy-back process or by making investments in infrastructure. This is not a matter which affects the securities market. [SEBI] is primarily a market regulator and its duty is to ensure that the market remains a safe place for the investors to invest. It cannot interfere with the business decisions taken by the company so long as they do not prejudicially affect the securities market.”
Two broad principles emerge from the decision:

1. As regards certain provisions of the Companies Act, such as Section 77, the effect of a shareholders' resolution is that it is only enabling in nature. Merely because shareholders have approved a transaction, it does not thereby become obligatory on the company to effect such a transaction. Such a resolution only provides authority to the board of directors to then decide on the details of the transaction, and even to decide on the essential question of whether the transaction should be given effect to in the very first place. In a sense, such a resolution recognises the primacy of the directors in such a context. Other examples of such resolutions where the board is given the power to effect a transaction (without being obligated to do so) include issue of shares, disposal of an undertaking or substantial assets, borrowing of funds, etc.

2. When it comes to an action relating to fraudulent and unfair trade practices, since there is an element of “mens rea” involved in proving an offence, SEBI as the regulator has the onerous task of proving that element. As noted previously on this Blog, the discharge of such a burden is quite difficult, and mere determination on the basis of circumstances may not be adequate. This often substantially reduces the success rate of the regulator in such actions, with the D-Link case being one such example.

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