Tuesday, October 11, 2011

Hostile Takeovers under the New Code

The new SEBI Takeover Code is set to come into force on October 22, 2011. One of the issues that has received great attention is the ability (or otherwise) of acquirers to carry out a hostile acquisition of an Indian listed company under the new Code. A recent press report has the background.

As far as the Takeover Code of 1997 is concerned, we have previously seen (here and here) that the Code itself does not prohibit hostile takeovers. Moreover, the operation of several corporate and securities laws in India come in the way of establishment of customary takeover defences by Indian companies or their promoters. It is only the high incidence of promoter shareholding in most Indian companies that generally operates to stave off hostile raiders on such companies.

The issue of hostile takeovers acquires importance in the new Code as it specifically prescribes conditions upon which an acquirer can make a “voluntary offer” to acquire shares of an Indian listed company. Regulation 6 sets out the conditions, which can be summarized as follows:
1. A voluntary offer can be made only by a person who holds at least 25% shares in a company, but not more than 75% (taking account of the maximum permissible public shareholding). Hence, a person who does not hold any shares, or holds less than 25% shares, in a company cannot make a voluntary offer without first triggering the mandatory public offer requirement by crossing the 25% threshold.

2. A voluntary offer can be made only by a person who has not acquired any shares in the target company in the preceding 52 weeks prior to the offer. In other words, there is a 52-week moratorium on acquisitions before the acquirer can make a voluntary offer.

3. During the offer period, the acquirer cannot acquire shares other than through the voluntary offer.

4. Once the voluntary offer is completed, the acquirer shall not acquire further shares in the target company for 6 months after completion of the offer. However, this excludes acquisitions by making a competing offer.
All these conditions that operate before, during and after the voluntary offer effectively make a classic hostile takeover almost impossible in the Indian context. It appears that this is a wholly unintended consequence.

In order to ascertain the possible intention of the regulator, it is necessary to examine the source of this rule. This can be traced to the report of the Takeover Regulations Advisory Committee (TRAC), and Regulation 6 is effectively a reproduction of the draft suggested by TRAC. While the acceptance of the TRAC recommendations is understandable, the context in which the conditions were imposed is entirely different. This context appears to have been disregarded while accepting the draft of TRAC in the final Code.

Readers may recollect that TRAC had recommended that an offer under the Takeover Code must be for the entire remaining share capital of the company (i.e. up to 100%). One exception that was made related to voluntary offers, where a 10% limit was allowed. The reason for imposing several conditions for a voluntary offer appears to be to ensure that the acquirer becomes entitled to a lower offer size of 10% only when these conditions are satisfied. The relevant portions of the TRAC report are extracted below:
Voluntary Offers 
Current Provisions:

2.18 Currently, the Takeover Regulations provide for consolidation of shareholding by an acquirer who is desirous of maximizing his shareholding without breaching the minimum public shareholding requirements. The offer size for an open offer under this provision is the lower of 20 % or the maximum permissible acquisition without breaching the minimum public shareholding requirement.

Committee Deliberations:

2.19 The Committee observed that with the proposed increase in the open offer size to 100% of the voting capital of the target company, there is a need to provide for flexibility to acquirers to voluntarily make open offers outside the mandatory public offer requirements. The Committee felt that voluntary offers are an important means for substantial shareholders to consolidate their stake and therefore recognized the need to introduce a specific framework for such open offers. However, to discourage nonserious voluntary offers, the Committee decided to set a minimum offer size of 10 %.

2.20 The Committee also observed that, inasmuch as the voluntary open offer is permitted as an exception to the general rule on the offer size, the ability to voluntarily make an open offer should not be available if in the proximate past, any of such persons have made acquisitions within the creeping acquisition limits permitted under the Regulations. Similarly, such an acquirer should be prohibited from making acquisitions outside the open offer during the offer period, and should also be prohibited from any further acquisitions for six months after the open offer. Also, such an offer should not lead to breach of the maximum permissible non-public shareholding.

Committee Recommendation:

2.21 The Committee therefore recommends that acquirers collectively holding shares entitling them to exercise 25 % or more voting rights in the target company may voluntarily make an open offer to consolidate their shareholding. The Committee has proposed a minimum open offer size of 10 % consistent with the rationale of consolidation option outside the creeping route. Voluntary offers should not, however, be of a size that could lead to breach of the maximum permissible non-public shareholding.

(See Regulation 6 of the Proposed Takeover Regulations)
The TRAC report (especially the underlined portions above) clearly indicate that the reason why all these conditions were introduced is because a voluntary offer (with a size of only 10%) was considered as an exception (with greater leniency to the acquirer) compared to the general offer size of all the remaining shares of the company (i.e. up to 100%). While the final form in which the new Takeover Code was accepted makes significant deviations from the overall offer size requirements by limiting it to 26%, there was no attempt to address the consequential conditions for voluntary offer that were based on the general offer size being 100%. Although the purpose for the introduction of these conditions loses relevance with the non-acceptance of the 100% offer size requirement imposed by TRAC, they have nevertheless found their way into the new Code leading to possible difficulties in effecting hostile takeovers.

Another possible interpretation is that given the genesis of these conditions as discussed in the TRAC report, they must become applicable only when a voluntary offer seeks to avail of the lower offer size of 10%, but not otherwise. In that sense, the voluntary offer mechanism in the Code is only an option that can be availed of by acquirers, but nothing prevents them from making a full offer for all of the remaining shares of the company (or even the general offer size of 26% that has been now prescribed) without complying with these conditions. However, these matters are open to interpretation, and clarity from regulators would help create the certainty required of the legal environment on this essential aspect of takeovers under Indian law.


Mandar said...

With respect, this reading of Regulation 6 is contestable. Regulation 6 speaks to Voluntary Offer. A hostile acquirer holding less than 25% or not holding any equity capital in the target company, may nonetheless make an offer for 26% ( the minimum required under the regs) pursuant to Reg. 3 of the takeover code. (That in effect says that any acquisition in excess of 25% cannot be made except by making a public offer under the takeover regulations; and the minimum number of shares to be acquired would be 26%). So, The corollary is there is no prohibition on voluntary offers by persons holding less than 25 per cent so long as the minimum offer size is 26 per cent.

V. Umakanth said...

@Mandar. The interpretation you propose is similar to what has been suggested in the last paragraph of the post. A combined reading of the various provisions of the Code (and the intention garnered from the TRAC report) would mean that the restrictions on voluntary offers apply only if the acquirer wishes to take advantage of the minimum offer size of 10% but not otherwise. However, although this should be the better approach, it remains to be seen whether the alternate interpretation is the one that would hold sway with the regulator.

Mathews P. George said...

@ Umakanth Sir & Mandir

I would like to disagree.
Regulation 7 states as follows:
"The open offer made under regulation 6 shall be for acquisition of at least such
number of shares as would entitle the holder thereof to exercise an additional ten
per cent of the total shares of the target company...." Note that it uses "at least". Therefore, the conditions in Regulation 6 should be applicable for all voluntary acquisitions beyond the set limit of 10% - though it is harsh. But as long as Regulation 7 contains "at least", I dont think any other interpretation is feasible.