Sunday, October 18, 2009

SAT on indirect acquisitions - correct in letter and spirit

Earlier this month, the Securities Appellate Tribunal (“SAT”) opined on the computation of the minimum offer price for an indirect takeover of a listed company. An interesting critique of this opinion was published on this blog the next day. The SAT had disposed of two appeals (Appeals No. 137 and 139 of 2009) by a common order. I respectfully disagree with the critique on the blog. In my view, the SAT decision is the correct one, both in letter and spirit of the Takeover Regulations.

(Disclosure: I appeared for the Petitioner in Appeal No. 139, a long-term investor in Zanotech. My client is therefore a beneficiary of the SAT’s opinion, which I believe renders an accurate opinion. My stand ought to be regarded as non-independent because of where I sat during the proceedings. However, the raison de etre of a blog is to debate issues – hence this post should be read subject to this disclosure of interest).

Factual Backdrop:

It would suffice to recap the facts thus: Ranbaxy acquired shares of Zanotech at a price of Rs. 160 per share to take a stake of over 44% in Zanotech in January 2008. Within a period of 26 weeks from the purchase at this price, in June 2008, Daiichi agreed to acquire shares of Ranbaxy by way of purchase from Ranbaxy promoters and by subscription to fresh shares of Ranbaxy. The deal was pathbreaking, was priced at a fantastic premium to the then prevailing price of Ranbaxy (a 31% premium to the previous day’s closing price and an 80% premium to the price that had prevailed a few months prior to the deal), and stunned the world.

Regulatory Provisions

The agreement to effect such a transaction (which would take Daiichi to over 63% ownership of Ranbaxy’s equity) triggered an obligation to make an open offer to shareholders of Ranbaxy for Ranbaxy shares and to shareholders of Zanotech for Zanotech shares. Regulation 14(1) of the Takeover Regulations required Daiichi to make an open offer for Ranbaxy within four days of the agreement. Regulation 14(4) of the Takeover Regulations provided Daiichi a time leeway of three months from the consummation of the Ranbaxy acquisition for making an open offer for Zanotech.

The minimum offer price for Daiichi’s open offer for Zanotech shares was regulated by Regulation 20(4) of the Takeover Regulations, since the shares of this target company were “frequently traded” within the meaning of the term in the Takeover Regulations, and by Regulation 20(12), which regulates the manner of price computation for deferred open offers made in the case of indirect acquisitions.

In a nutshell, in terms of Regulation 20(12), the provisions of Regulation 20(4) have to be applied to the price of the consequential target company (in this case, Zanotech), notionally at two points in time – once at the time of the public announcement for the main company (in this case, the public announcement for Ranbaxy), and then at the time of the public announcement for the consequential target company (Zanotech). The higher of the two computations would be regarded as the minimum offer price.

In other words, the provisions of Regulation 20(4) have to be applied mutatis mutandis at both points in time, and the higher of the two price computations would be the minimum offer price. Regulation 20(4) requires the minimum offer price to be the highest of the following:-


(a) the negotiated price paid by the acquirer;

(b) the price paid by the acquirer or persons acting in concert with him during the 26 weeks preceding the date of the public announcement;

(c) the average of the weekly high and low closing prices during the 26 weeks preceding the date of the public announcement; and

(d) the average of the daily high and low prices during the two weeks prior to the date of the public announcement.

Daiichi’s position was that (a) above had no relevance to the facts of the case – a position that is not really accurate because when it paid a fancy premium to market price to promoters of Ranbaxy, it valued the balance sheet of Ranbaxy, which included the significant holding of over 44% of Zanotech. The promoters of Ranbaxy therefore got paid for this value too. However, it should be fairly stated that this position of Daiichi was not under challenge in the proceedings before the SAT. I will come to the spirit of the Takeover Regulations a bit later and deal with this aspect of the case, to show how the SAT’s opinion states the correct position in law, both in letter and spirit.

The parameters in (c) and (d) above were indeed not relevant for the controversy because the market price was lower than the price offered by Daiichi to shareholders of Zanotech. The issue in controversy before the SAT was therefore the application of Regulation 20(4)(b), which corresponds to (b) above.

Daiichi’s position, which was endorsed by SEBI, was that Regulation 20(4)(b) had no application to the case. Their contention was that the price paid by Ranbaxy for its acquisition of shares of Zanotech ought not to be factored into the computation on the ground that when Ranbaxy had bought a 44% stake in Zanotech in January 2008, Ranbaxy had not been in concert with Daiichi. Their argument was: for applying Regulation 20(4)(b), one would have to determine whether Ranbaxy had donned the cap of a “person acting in concert” with Daiichi when the acquisition in question (in January 2008) had been effected. If the answer were to be in the negative, in their view, the price paid by Ranbaxy for shares of Zanotech ought to be ignored for the open offer for Zanotech by Daiichi, although it was the enjoyment of ownership of this stake that triggered the open offer in the first place.

It should be noted that when Regulation 14(4) was inserted into the Takeover Regulations, the provisions of Regulation 20(12) were correspondingly inserted into the scheme of the Takeover Regulations. Therefore, the position in law was that if one were to give a leeway of time for making an open offer belatedly, the provisions of Regulation 20(4) would have to be notionally applied at two different points of time, with the higher of the two computations being adopted as the minimum offer price.

Moreover, Regulation 20(4) provides that any price paid by a person acting in concert for shares of the target company during the preceding 26 weeks ought to be taken into account. Regulation 20(4) does not condition the application of Regulation 20(4)(b) to the price paid by a “person acting in concert” with the words “provided such person had been acting in concert at the time of such acquisition”. So long as a person is acting in concert when a public announcement is made, any acquisition by him in the preceding 26 weeks would have to be considered as one of the price factors for purposes of Regulation 20(4).

Example of Consequences

The interpretation sought to be provided in the earlier critique on the blog proceeds on the footing that one would have to determine whether the person now acting in concert had been acting in concert at the time he acquired shares – a position not available in the Takeover Regulations, and rightly so. If such a position were to be accepted, any acquirer making an open offer would be at liberty to ignore the price paid by a person now acting in concert, although those very acquisitions led to the open offer threshold being reached, on the simplistic ground that when he acquired shares, he had not acted in concert with the acquirer now making the offer.

An example would make this clearer. Assume Mr. A, Mr. B and Mr. C independently and without any common objective or concerted action acquire shares of varying proportions, each less than 5% of XYZ Ltd., a listed company, between January and March of a calendar year. In April, a merchant banker who sees the opportunity for a deal by bringing them together, invites them for a discussion, and they collectively resolve to form a company called ABC Ltd. to make an open offer for shares of XYZ Ltd. In other words, the concert is born in April.

ABC Ltd. now agrees with a shareholder holding 2% shares in XYZ Ltd. to acquire shares that would take the collective holding to beyond 15% in XYZ Ltd. and therefore makes an open offer under Regulation 10 of the Takeover Regulations. ABC Ltd. could also make a voluntary open offer to acquire shares of XYZ Ltd. In either example, ABC Ltd. would be the acquirer, and each of Mr. A, Mr. B and Mr. C would be persons acting in concert.

If the position endorsed in the earlier critique on this blog, and indeed the position taken by Daiichi and SEBI were to be adopted, the price paid by each of Mr. A, Mr. B and Mr. C would have to be totally ignored on the ground that when they acquired shares taking them up to just below 15%, they had not acted in concert. Therefore, the acquisition of the very shares that took them to the threshold of a trigger under the Takeover Regulations would have to be regarded as wholly irrelevant. Such a position would be a travesty, conflicting with the very purpose of including the criterion of price paid in the preceding 26 weeks – a requirement similar to those found in takeover laws across the globe.

In other words, the very price paid by each of Mr. A, Mr. B and Mr. C would have to be disregarded for an open offer by ABC Ltd., a company formed by them subsequent to their acquisitions – a position that would require infliction of considerable violence to the provision i.e. by reading into the regulation a further proviso (incorporating non-existent words set out in bold italics above). Such an interpretation would require introduction of a requirement to check the state of mind of the person who acquired shares to ascertain existence of concert at the point of acquisition, although such person is currently indeed a person acting in concert.

In the example given above, another consequence would be that since the persons acquiring shares had not been concert when they acquired it, their holding should not be regarded as triggering the requirements of an open offer under Regulation 10 – an absurdity, because the Takeover Regulations do not require consideration of the state of mind when the acquisition was made to trigger an open offer obligation, as indeed they do not require consideration of the state of mind for computation of the minimum offer price for such an open offer.

When a provision of law is crystal clear, it ought to be applied as it is. If a person were to be in concert when the public announcement is made, any and every acquisition made by him in the 26 weeks prior to the public announcement would have to be factored into the computation of the minimum offer price. This is because the collective acquirers (including the person now acting in concert) would enjoy the benefits of the collective ownership, and the price paid for such collective ownership is a fair criterion for inclusion in determination of the minimum offer price.

In the same example given above, if any of Mr. A, Mr. B or Mr. C were to acquire a single share in April after the birth of concert, Daiichi, SEBI and the critique on this blog, would have that price considered for computation of the minimum offer price, but would ignore the prices paid between January and March on the ground that during that period there had been no concert.

There is no leeway in Regulation 20(4)(b) to impose such additional convoluted criteria to determine the state of mind in relation to each historical acquisition to ascertain if there had been concert at the relevant time. Such a position under Regulation 20(4)(b) does not change merely because the acquisition is an indirect acquisition and Regulation 20(12) has been applied.

Mutatis Mutandis Application

Moreover, Regulation 20(12) requires a mutatis mutandis application of Regulation 20(4) at two points in time. If one could legitimately argue that a person who is now in concert was not in concert when he acquired shares within the 26-week period prior to the first public announcement, and therefore the price for those acquisitions should be ignored, one could equally be able to legitimately argue that during the first public announcement the consequential target company was not the target company at all, and therefore Regulation 20(4)(b), which deals with the price of the “target company” ought to have no application.

Since, Zanotech is now the “target company” (in the public announcement made in January 2009), the mutatis mutandis application of Regulation 20(4)(b) would have to be effected as if Zanotech had hypothetically been the target company in June 2008 (when the open offer for Ranbaxy had been announced). Similarly, if Ranbaxy is now a person acting in concert with Daiichi in January 2009, the provisions of Regulation 20(4)(b) would apply to acquisitions by Ranbaxy made in the 26-weeks prior to June 2008 by way of a mutatis mutandis application. Any contrary reading of such hypothetical application would be an absurdity because one could well argue that Zanotech had not been the target company in June 2008 and therefore, its share price movements were irrelevant in June 2008.

It is an admitted fact that Ranbaxy acquired shares of Zanotech at a price of Rs. 160 within the 26 weeks preceding Daiichi’s open offer for Ranbaxy. Daiichi therefore got into the agreement to invest in Ranbaxy in June 2008, with eyes open and fully aware that within a period of 26 weeks preceding its deal, Ranbaxy had made acquisitions at Rs. 160. Had Daiichi done the Ranbaxy deal after 26 weeks of Ranbaxy’s last acquisition of Zanotech shares, indeed, the price paid by Ranbaxy would have become irrelevant because Regulation 20(4) would let only price paid in the preceding 26 weeks to be taken into account. The law is after all about drawing a clear line on the ground and treating people on either side of the line in a specific predictable manner.

Indeed, when Daiichi paid for shares of Ranbaxy, it is presumed to have read Ranbaxy’s balance sheet, which included the 44% holding in Zanotech acquired at a price of Rs. 160 per share, and therefore when it valued Ranbaxy, it did not ignore the value of Zanotech shares in Ranbaxy’s balance sheet. Daiichi is also presumed to have read the Takeover Regulations and the deeming provision imposed by Regulation 20(12) read with Regulation 20(4), when it agreed to take over Ranbaxy in June 2008.

Letter and Spirit Served

Even from a spirit perspective, it is noteworthy that the Takeover Regulations require sharing with the common shareholder the benefits provided to the seller of substantial shareholding. When Daiichi paid the promoters of Ranbaxy the fancy price it paid, it was indeed also paying for Ranbaxy’s holding in Zanotech.

As a matter of administrative convenience, in indirect acquisitions, one does not sparse the value paid for the business of the target company across individual assets forming part of the target company’s business. However, what is clear is that the sellers of Ranbaxy shares fully realized the value of Ranbaxy’s shareholding in Zanotech. Such value was not being assessed for being shared with shareholders of Zanotech. In the circumstances, the least one would do is to apply the provisions of the Takeover Regulations as they are, and take into account the price that was paid by Ranbaxy for the very acquisition of 44% stake in Zanotech. The inclusion of such a price factor, a statutory requirement, was being frustrated, thanks to considerable violence to the plain and logical provisions of Regulation 20(4)(b) by reading non-existent words into it viz. the requirement of determining whether at the time of each prior acquisition, the person who acquired shares had been acting in concert, regardless of him being in full concert when the public announcement is actually made.

Therefore, not only a plain reading of the Takeover Regulations, but also the spirit of the Takeover Regulations loudly and clearly show how the price of Zanotech ought to have been computed. The decision of the SAT, therefore, in my respectful submission, is faultless.

2 comments:

Anonymous said...

Both arguments made as regards the computation of the open offer price stand on credible ground. Much of the interpretation depends on the when does one becomes a "person acting in concert". Mere intention is often difficult to prove, especially, when there is no paper trail leading as evidence. But apart from these legal arguments, mine is an economic one.

While I am all for shareholders being given the rightful exit price, I feel it is far fetched to expect the acquirer to pay a price that was not negotiated by it or by those that later become its "persons acting in concert". Law should negate the use of hindsight as much as possible. In situation like that in Ranbaxy-Daichi, the prevailing market price, after the direct acquisition, should be an objective determinant.

Reason being, once the acquisition of the listed parent is made, the expectation that an open offer for the indirect acquisition could swing the price both ways, and if our markets are fair, to its fundamental price. This I believe is a bipartisan determinant of the market price. The market will factor-in the price paid by the then "persons acting in concert" in moving the price.

Avinash Balasubramaniam said...

Sir,

Having read your views, what I hitherto considered as large size flaws in the SAT order are in fact quite sound!. There is still, in my view, one issue which needs to be reconciled.

Daiichi by acquiring Ranbaxy in June’08, consequently agreed to acquire control in Zenotech. The Code is triggered with respect to Zenotech when such an agreement was entered into, since with respect to Zenotech, Daiichi becomes the acquirer. It stands to reason that by mutatis mutandis application of Regulation 20(4) Zanotech should be considered the target company in June 2008 (when the open offer for Ranbaxy had been announced). The mutandis mutatis application would notionally deem Ranbaxy as a person acting in concert as on June 08.

To return to your example, where we start from clearly established facts that A, B, C independently acquire shares in X Ltd in the Jan-March period and the concert between them is born in April and subsequently ABC Ltd, the offspring of this concert, then acquires shares of XYZ Ltd which takes their collective holding beyond 15%.

Persons acting in concert is defined to mean persons who with a common objective or purpose of substantial acquisition of shares or voting rights or gaining control over the target company, pursuant to an agreement or understanding, directly or indirectly co-operate by acquiring or agreeing to acquire shares or voting rights in the target company.

The definition, in my view, presupposes a common objective, that is to say that the acquisition of shares or voting rights must be actuated by the common objective.

The words set out in the bold italics (of your comment), in my view, is not so much an artificial requirement, but that which is presupposed in the definition of PACs. It then leads to the conclusion that A, B, C were not persons acting in concert with ABC, but that is not to say we must not aggregate the holding of A, B and C (acquired before the concert is born) in deciding if the threshold of 15% is breached when ABC makes its acquisition. Therefore, it is still debatable whether the Takeover Code clearly draws the line to include any and every acquisition made by a person now in concert in the 26 weeks prior to the public announcement.

Coming back to the Daiichi case, can it then be said that its still possible for Daiichi to pay less, if it can establish that it came into picture only after January, for the deeming provisions only raises presumptions that are rebuttable?


We’ll wait to see if Zenotech shareholders are richer or not, I am definitely richer in information!