Thursday, October 30, 2008

Would increase in percentage holding because of buyback trigger the Takeover Regulations?

(Note:- SEBI had issued a press release on October 27, 2008, that I had discussed here, whereby, inter alia, SEBI announced its decision to exempt increase in shareholding on account of buyback upto 5% from applicability of creeping acquisition requirements. I had pointed out that a view is possible to hold that the increase on account of buyback should not trigger the Takeover Regulations and hence the exemption is not needed. Since there were some queries of readers on this point and also since Mr. Umakanth V. rightly highlighted this issue in more detail in this comment to my post, I thought I could share here an article on this issue that I had written earlier tin August his year in Bombay Chartered Accountants' Journal. This article, with some minor changes, is reproduced below.)

1) Would increase of Promoters’ percentage holding consequent to a buyback of shares attract the Takeover Regulations? Would the increase be counted for the creeping acquisition limits? Would an open offer result if the specified limits are exceeded? Would and should all or any of these be the result when the Promoters have not acquired a single further share? These are questions facing Promoters and listed companies as many of them go for buyback of shares to what is being claimed to be an attempt to boost the price of the company’s shares to a “fair” value. To understand this issue and see how a strange solution is proposed by SEBI and, even more strangely, accepted by companies and their promoters, let us first consider some background.

2) A peculiar problem arises when a listed company proposes to carry out buyback of its shares. It arises more out of a mathematical consequence than anything else but results in companies and their Promoters facing a dilemma and a delay. To describe it briefly, the issue is whether the increase in Promoters’ holding in a company arising solely as a result of buyback attract the Takeover Regulations? To give an example, let us say the Promoters of a listed company presently hold 40% of the share capital of, say, Rs. 10 crores, of the Company. The Company proposes to carry out a buyback (and let us say it will be successful) of 20% of its capital. The capital would reduce to Rs. 8 crores but the holding of the Promoters would remain at Rs. 4 crores. However, in mathematical terms, the holding of the Promoters would have thus increased from 40% to 50%? Since the Takeover Regulations permit only 5% acquisitions per year, would this limit said to have been exceeded?

3) In these times of dismal stock markets where many listed companies strongly believe – rightly or wrongly – that the market is undervaluing their shares and look at buyback as a serious option to correct this, this problem is being faced by many such companies.

4) Before we try to understand how this problem arises in law, see the obvious sense of absurdity involved here. The buyback is being carried out by the Company and the Promoters are not acquiring a single share. In other words, the quantity of shares held by them continues to remain the same. However, their percentage of holding increases. But this is not on account of any act on their part – at least not directly by way of acquisition – but is on account of an indirect consequence of the Company acquiring shares of other shareholders. The net consequence though is that their holding increases from and in the example given above increases higher than the maximum annual percentage permitted.

5) The Promoters of such companies are facing a dilemma and are concerned as to the possible consequences of the action of the company carrying out buyback of shares. Note that the problem arises not only when the 5% limit is exceeded. It even arises when the increase is less than 5% since in such a case, the Promoters would be concerned since it could be held that they would have to limit their further acquisitions only for the excess upto 5%. For example, if the net increase on account of buyback is 3%, they could be held to have to limit their increase only to a further 2%.

6) Incidentally, to cover yet another category of affected persons, it could happen that a person holding, say, 14% shares, may find his holding increasing beyond 15%. In the normal course, acquisition of shares in a listed company where the holding becomes 15% or more requires an open offer to be made. The issue then is whether such increase in holding to 15% or beyond on account of buyback of shares would also require an open offer to be made.

7) Further, at times, because of the buyback, even limits provided for other purposes such as that of continued listing may also get exceeded on account of the buyback.

8) Let us consider what the law provides.

9) Let us look first at the provisions relating to buyback. Clearly, these provide for buyback of shares and are not the source of the confusion (there are some provisions that restrict buyback when they conflict with continued listing requirements but these are not discussed here). However, it is worth considering these provisions not only for background of the issue but also since we need to understand what really happens in case of buyback of shares and whether the Takeover Regulations could possibly get attracted.

10) Readers would be quite familiar with buyback of shares under Section 77A and related provisions of the Companies Act, 1956 read with the SEBI Buyback Regulations since they are exactly one decade old now. Buyback of shares is simply the opposite of a fresh issue of shares where monies are received by the Company and shares issue. Buyback involves returning of monies by the company against which shares are taken back. Also, as per the clear provisions of law in India, buyback involve cancellation of the shares and thus an immediate and irrevocable reduction of capital. The point also is that by virtue of the so-called purchase of shares, there is no real purchase and holding of the shares by the Company and the only purpose for which it holds for a very short time the shares so purchased is to cancel them.

11) The buyback of shares needs approval of the Board of Directors and, under certain circumstances, the shareholders. At least in theory, the buyback of shares is not a decision exclusively of the Promoters and their involvement is to the extent of their participation in the Board and, if required, in the general meeting of the Company as shareholders.

12) However, despite this, without any act on their part, their shareholding increases. This point is important also, since, as we will see later on herein, the Takeover Regulations require expressly an act of purchase of shares by an acquirer.

a) In fact, ironically, the holding of the Promoters increases not on account of something they do but on account of something they do not do. Their holding increase not by a purchase of shares but by their not participating in the buyback.

13) Let us then consider the requirements of the Takeover Regulations.

14) An acquisition of shares may attract, keeping this discussion focused on the principal two categories of provisions, the requirements of disclosure of acquisitions under Regulations 7 and the requirements of making a public announcement under Regulations 10, 11 and 12. Incidentally, all these four Regulations require, though with only minor differences in language, “acquisition” of shares or voting rights. Thus, simplified a little, if a person acquires shares whereby his holding becomes more than 5% of the equity share capital of a listed company, he is required to make, under Regulation 7, disclosures in the prescribed manner. If a person holding 15% or more shares and acquires further shares amounting more than 5% of the capital in one financial year, he is required to make an open offer under Regulation 11. And so on.

15) The question is whether an increase in the shareholding of a person arising solely out of buyback of shares and without such person acquiring a single further share would attract any of the aforesaid Regulations? Prima facie, the answer seems to be no.

16) However, as several recent cases of buybacks or proposed buybacks show, the Promoters are adopting a peculiar, though obviously conservative and safe, solution to this dilemma. They are not going ahead with a buyback of shares based on the above interpretation. They are also not approaching SEBI under the Informal Guidance route seeking clarification that the provisions of the Takeover Regulations should not be attracted in such a case. Instead, they are approaching the Takeover Panel for exemption from the provisions of open offer as contained in Regulations 10/11/12. Strangely, the Takeover Panel and SEBI are taking a view, effectively as evident by some of the exemptions granted, that the Takeover Regulations are indeed attracted. However, in view of special facts and merits of the cases that have been published, formal exemption is being granted from the requirements of open offer.

17) Thus, for example, ICI India Limited has sought to carry out a buyback of shares and because of such buyback of the shares, the holding of the Promoters would increase from 50.83% to beyond 55% of the share capital of the company. The acquirer approached the Takeover Panel seeking exemption from the requirements of Chapter III of the Regulations. Several features of merit of the case were highlighted. There would not be any change in control of the Company on account of the increase. The buyback was at a price that was substantially higher than the book value of the shares. The obvious fact that the acquirer was not participating was also emphasized. And so on. Taking all these factors into account, SEBI granted exemption from the relevant provisions of Chapter III to such increase.

18) Similarly, exemption was granted to the Promoters of Natco Pharma Limited where their shareholding would have increased from 62.28% to 63.37% on account of a buyback. Exemption was also given to the Promoters of Abbott India Limited where their holding would have increased from 61.70% to 65.14% on account of the proposed buyback.

19) It is submitted that strictly speaking, a passive increase in holding of Promoters or other substantial shareholders is not something that could attract the requirements of open offer under the Takeover Regulations. Therefore, there is no question of granting exemption but in fact of clarification that the requirements of open offer are not attracted. Alternatively, if policy demands, the Regulations should be amended to specifically provide that even passive increases should attract such requirements of open offer and other requirements.

20) Of course there is another side to it also. Promoters cannot claim to be totally helpless in the matter of the increase of their shareholding on account of buyback. Practically speaking, it would normally they who would, through their control of the Company, propose the buyback. Also, they would be the ones who would vote for the buyback. They would also be the ones in most cases finalizing the terms of the buyback – or at least laying down the proposed terms of buyback. Finally, the increase in their holding happens because of their non-participation in the buyback which they were instrumental in proposing and approving. However, all this still cannot change the express provisions of law.

21) It has also to be realized that there could be some peculiar results also. Persons who may be substantial shareholders may find their holding increased though they are not Promoters. For example, a person holding 14% may find his holding increased to, say 16% on account of a buyback. It could be argued that to avoid such increase he should have participated in the buyback. However, just as saying that such a person should be required to make an open offer would be unfair, so would saying that such a person should have sold his shares would be unfair.

22) The conclusion is that there is a lacuna in the Regulations that creates the confusion. And filling this lacuna requires more than a simple provision that all increases on account of buybacks would be deemed to be acquisitions. There has to be a considered solution taking into account increases of holding of Promoters and non-Promoters as also covering situations where the holding may go beyond the maximum permitted for continued listing.

23) However, considering that all concerned appear to be happy with the status quo, we will continue to see the untidy solution of grant of exemption where exemption is not required, instead of a tidy law where internal inconsistencies between the two Regulations are removed.

(C) Jayant Thakur, CA


Laki said...

Observarions made in the article are very apt. The promoters are seeking exemption from the 'Take over committee' as a precautinery measure. Informal guidance is not a strong enough defense as disclaimer clauses that are appearing in these guidances protects only SEBI.

There are recent cases of informal guidance given in case of ESOP/ESOS allotment when 'Buyback' is open. According to me provisions of Section 77A(8) of Companies Act are clearly contradicted by SEBI's Clause 19(1) (b) of buyback Regulation. This is the classic case of too many regulators. Whereas the case made out by you, there are too many Regulations by same Regulator. Promoters are not too sure which is the safe bet to avoid possible actions by SEBI.

SEBI must immediately come out with amendments to its regulation which have legal sanctity.

Anonymous said...

As it is discussed above, the takeover code is triggered when an acquirer, acquires shares of voting rights… we see in Regs.6, 7, 8, 10, 11 and 12 of the code. I am concerned with the term “voting rights”. Whether can there be a situation where the voting rights are acquired without acquisition of shares? If answer is no, as it is deliberated above, would there have been a necessity to mention “shares or voting rights” in above regulations?

However, one can argue on the point of “acquiring voting rights” by an acquirer as acquisition is necessary. But the definition of acquirer states that any person who, directly or indirectly, acquires or agrees to acquire shares or voting rights in the target company. The term “indirectly” suggests that the acquisition need not necessarily be an acquisition made by any person himself.

Further, the object of the code is to provide disclosures/ opportunity to shareholders who are not in the Board or whose holding is not sufficient to effect decision making a choice to either continue or quit. Therefore any argument to the effect that the code should be triggered only when shares are acquired or the code does not cover a situation of acquisition indirectly as in case of buy back of shares by the company would be against the object sought to be remedied by the code.

In light of these arguments, I would like to differ with respect.

Anonymous said...

Agree with Anonymous says "indirectly" which is very wide.While interpreting any provisions,we also have to bear in mind the intention of the enactment, thus spirit also needs to be apprciated.

Jayant Thakur, CA said...

I refer to posts by Anonymous and Anonymous - the last 2 posts immediate preceding. Thanks to both and sorry for delayed reply. Let me try to give my views but please also see many other posts on this issue thereafter which will also throw light.

As I read the Takeover Regulations and as you rightly pointed out, they require that open offer, etc. be triggered (reading various provisions together) if an acquirer "acquires" shares. Further, as you rightly pointed out, definition of acquirer says that he is a person "who, directly or indirectly, acquires" shares, etc. As I read, the emphasis is on the word "acquire" and there has to be an "acquisition" even though indirect. There has to be an act by a person. Buyback is not on account of an act by such person or acquirer(I have discussed the issue regarding Promoters' Role in the buyback decision separately in my article but reason itself should not be sufficient, considering that buyback increases holding of all remaining shareholders).

Had the lawmakers used the word "increases" in place of "acquire" the answer could have been different (as by saying "if the holding of the Promoters increases" or similar words).

Also, see the Explanation in Regulation 11 (which applies to 10 and 11) both which discusses direct and indirect acquisitions. It talks of direct acquisition of shares of listed companies and indirect acquisition by way of acquisition of companies in India and abroad. I think some meaning is to be drawn from this also.

Read also paragraph 22 of the Bhagwati Committee's Second Report of 2002 (available on SEBI's website - sorry, dont have url handy!) which specifically deals with indirect acquisitions of this concept. In fact, the Report should also answer at least partially the first Anonymous reader's query relating to "voting rights".

All in all, I think the words "indirect" should not cover increase through buyback. I wholly appreciate the point that in laws such as Takeover Regulations, the interpretation has to be purposive but perhaps I have been able to persuade you of my views above that the intent too may have not been to cover buybacks. While I do not want to make this post unduly long, one last point I want to add is that if you go back to history of the Takeover Regulation in India, the first draft circulated by the Bhagwati Committee which culminated in the 1997 Regulation, they had put in place a clause saying that "The Regulations should be interpreted in spirit" or words to that effect. After a lot of debate in the press (I remember writing an article at that time in ET titled "The Spirit that will haunt" meaning that this is not a wise clause) and otherwise, these words were consciously dropped. Of course, I am not saying that this should mean that the Takeover Regulations should not be interpreted in their spirit but just recollecting an anecdote.

Anyway, assuming you have read this long reply till here - :) - and as you may have seen from the later posts and developments, this discussion may be academic now but still, thanks again, for your learned responses.

- Jayant