Monday, August 9, 2010

Some Thoughts on the Supreme Court's Daiichi Opinion - The Significance of Paragraph 48

The Supreme Court’s judgment earlier this year on the SEBI Takeover Code is likely to prove extremely influential. A summary of the propositions that emerge from the judgment is available here, and comments on the SAT opinion are available here, and here. Two key issues deserve close scrutiny – the Supreme Court’s analysis of the relationship between Regulation 2(1)(e)(1) and 2(1)(e)(2)(i), and the scope of Regulation 20(4). In this post, I focus mainly on the first point, and a subsequent post will discuss the second.

As is well known, the issue before the Court was the “offer price” that applied to Daiichi’s public announcement, seeking to buy out shareholders of Zenotech – in which it had “indirectly” acquired a substantial stake, by virtue of its purchase of Ranbaxy shares. Offer price is governed by the provisions of Regulation 20 of the SEBI Takeover Code. Regulation 20(12), inserted by way of an amendment, provides that the offer price for an “indirect acquisition or control” shall be the higher of the price that prevails on the date of public announcement for the parent company and the date of public announcement for the target company. The method of computation of offer price is governed, however, by Regulation 20(4) and (5). Regulation 20(4), which was relevant in the present case, declares that the offer price shall be the highest of (a) the price negotiated under the agreement, (b) the price paid for the target share during the 26 week period preceding the announcement, and (c) the average of the weekly highs and lows of the target share computed in the specified manner. Sub-Regulation [“SR”] (a) is naturally inapplicable to an indirect acquisition, since there is no explicit agreement to acquire the “target”. The controversy in this case was over sub-regulations (b) and (c). SR (b) provides that the price in question is the price “paid by the acquirer or persons acting in concert with him for acquisition during the twenty six week period prior to the date of public announcement…, which the Zenotech promoters argued is applicable.

“Persons acting in concert” is in turn defined in Regulation 2(1)(e). The first part defines this term positively, and the second part is a deeming provision. The exact language used by this Regulation is important, and is reproduced below:

(e) "person acting in concert" comprises, -

(1) persons who, for 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 (formal or informal), directly or indirectly co-operate by acquiring or agreeing to acquire shares or voting rights in the target company or control over the target company.

(2) Without prejudice to the generality of this definition, the following persons will be deemed to be persons acting in concert with other persons in the same category, unless the contrary is established:

(i) a company, its holding company, or subsidiary of such company or company under the same management either individually or together with each other;

Relying on the deeming provision in Regulation 2(1)(e)(2)(i), the respondents argued that Ranbaxy became a “person acting in concert” with Daiichi the moment the agreement to acquire was signed, or alternatively when it became a subsidiary of the latter. The respondents then argued that the offer price was the price paid for the purchase of Zenotech shares by Ranbaxy at Rs. 160, which was within the 26 week period specified in Regulation 20(4)(b), but well before it became a person acting in concert with Daiichi. The Supreme Court rejected this contention for two reasons – that Daiichi and Ranbaxy did not constitute “persons acting in concert” under Regulation 2(1)(e)(1)/2(1)(e)(2)(i) and because Regulation 20(4)(b) was in any event not attracted. I will discuss the first point in this post.

The Supreme Court began its analysis of “persons acting in concert” by pointing out that Regulation 2(1)(e)(1) does not apply ipso facto to any acquisition of shares. It is submitted that this is correct, and that Regulation 2(1)(e)(1) has three distinct elements – (a) “persons”, which rarely poses a controversy; (b) who “directly or indirectly cooperate by acquiring (or agreeing to acquire) shares…/control”[“condition 1”] ; (c) for “a common objective or purpose of substantial acquisition of shares/voting rights/gaining control over the target company” [“condition 2”]. Regulation 2(1)(e)(2)(i), on the other hand, provides that the enumerated entities shall be “presumed to be persons acting in concert with other persons in the same category”. The Supreme Court, in paragraph 47, observes that the deeming provision means “that if one partner in the pair makes or agrees to make substantial acquisition of shares etc. in a company it would be presumed that he/it was acting in pursuance of a common objective or purpose shared with the other partner of the pair”, and that the “mere existence” of the holding-subsidiary relationship is insufficient to engage the deeming provision. It is submitted that this is also correct.

However, at this point, there are certain observations in paragraph 48 that require close analysis. Commenting on the SAT’s decision to apply the deeming provision, the Supreme Court makes the following observations: (a) the deeming provision must be read “in conjunction with regulation 2(1)(e)(1); and (b)

“the word ‘comprises’ in Regulation 2(1)(e) is significant. It applies to regulation 2(1)(e)(2) as much as to regulation 2(1)(e)(1). A fortiori, a person deemed to be acting in concert with others is also a person acting in concert. In other words, persons who are deemed to be acting in concert must have the intention or aim of acquisition of shares of a target company. It is the conduct of the parties that determines their identity… In order to hold that the person is acting in concert with the acquirer or another person it must be established that the two share the common intention of acquisition of shares of some target company [emphasis mine].

It is submitted, with respect, that these observations were unnecessary for the disposition of the case and may therefore constitute obiter dicta and in any event, that they may merit reconsideration. It is settled law that a deeming provision in any statute makes legal or possible what would otherwise not be with reference to the main provision. For example, if s. 1 of a statute declares that is “any person who possesses characteristics A, B and C is X…”, and s. 2 provides that “Without prejudice to the generality of the foregoing provision, person C shall be deemed to be X”, the implication normally is that person C would not fall within s. 1 and is covered only by virtue of the deeming provision. The expression “without prejudice to the generality” is employed only to prevent any suggestion that the deeming provision narrows the ambit of the main provision. Although this is not an inflexible test, this result usually follows. A comprehensive analysis of the significance of a deeming provision is available in Doypack Systems, (1988) 2 SCC 299 and Consolidated Coffee Board, (1980) 3 SCC 358.

Applying these principles to Regulation 2(1)(e)(2), it is clear that it obviates proof of one of the conditions we identified above in Regulation 2(1)(e)(1) for the enumerated entities. It is also clear this cannot be “Condition 1” above (the direct or indirect acquisition of shares or voting rights or control) – for that is a largely question of fact. Therefore, the function of the deeming provision must be to dispense with proof of “Condition 2” – that the acquisition was “for a common objective or purpose…”, and the position then is that the law presumes, in the case of the enumerated categories, that any such acquisition is for a common objective or purpose of substantial acquisition. In this context, the Supreme Court’s observations in paragraph 48 that persons “deemed” to be acting in concert must have the “intention or aim of acquisition”, that this is determined by “the conduct of the parties” and most of all, that “it must be established that the two share the common intention of acquisition” may, with respect, merit reconsideration. This is especially significant because the Supreme Court in paragraph 47 recognised that the significance of the deeming provision is to dispense with proof of the mental element. It is also submitted that the court’s reliance on the word “comprises” is not conclusive, because it clearly could not have been intended to make Sub-Regulations (1) and (2) identical.

It must be noted, however, that there are two ways in which the observations in paragraph 48 may be distinguished in subsequent cases. First, it is possible to take the view that the Supreme Court did not pronounce on the scope of Regulation 2(1)(e)(2)(i), but merely found that the “contrary had been established” on the facts of the case, since Daiichi had not acquired Ranbaxy for the purpose or with the objective of acquiring Zenotech. This inference, however, is not obvious from the text of the decision, especially because of the Court’s general observations on the deeming provision in paragraph 48. Secondly, the Court found that Regulation 20(4)(b) requires that the acquisition must be made at the time the person acting in concert is in that relationship with the acquirer, and not before. The length of this post does not permit a detailed discussion of this point, which I will discuss subsequently. It will suffice to note here that the point was central to the case, as the Court recognised in paragraph 40, and one may argue that its analysis of the deeming provision therefore represents obiter dicta.

It will be interesting to note how courts interpret this opinion – for it is certain that paragraph 48 will be cited to argue that the onus of proof does not shift to the person acting in concert even under the deeming provision.


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