Monday, November 28, 2011

Buybacks and open offer - recent decision of SAT

Recently, on 21st November 2011, the Securities Appellate Tribunal (SAT) held that the increase in percentage holding of a person consequent to buyback of shares does not amount to acquisition and thus cannot result in an open offer. This is, in my view, a correct legal interpretation of the law (as also argued by me in an earlier post here). But SEBI had, in practice, taken a view that such increase does amount to acquisition. On this basis, actually an assumption taking an unwritten law for granted, it granted exemptions, selectively and subject to certain conditions, from applicability of relevant provisions including open offer. Further, where such “acquisitions” triggered the open offer requirements and the “acquirers” did not make such offers, SEBI passed adverse orders (including the present one which is now reversed by SAT). It even inserted a proviso in the Regulations exempting increase in certain cases such “acquisitions” (briefly discussed earlier here) thereby implicitly assuming that such increases were “acquisitions”.
My earlier post here discusses this issue in more detail where some arguments are given why such increase should not amount to “acquisitions”. But, briefly, the issue is as follows. The Regulations place several obligations on an acquirer of shares such as making of disclosure of acquisition, making an open offer, etc. Acquirer is defined as a person who “acquires or agrees to acquire” shares, voting rights, etc. If the acquirer acquires 5% or more shares, he has to make certain disclosures. If he acquires 15% or more (under the 1997 Regulations), he has to make an open offer. And so on.
In case of buyback of shares, there is an involuntary or passive increase of percentage holding, if a person does not participate in it. For example, a person holding, say, 60% shares and does not participate in a 20% buyback of shares then, post-buyback, his percentage holding would be 75%. Thus, his percentage holding would have increased by 15 percentage points without his having acquired a single additional share. In my view, by any stretching of the term “acquirer”, this does not amount to acquisition of shares by an acquirer which should result in an open offer. One may argue that the intention of the law may be that such increases should also result in an open offer. One may also say a person holding, as in above example, 60% shares, may initiate a buyback, and then not participate in it thereby ensuring that his percentage holding increases. However, intentions or potential misuses cannot be allowed to stretch the interpretation of the law. It would smack of arbitrariness and as also discussed later leave several loose ends. Nevertheless, instead of simply making an amendment to the law, though several opportunities were available when other amendments were made, SEBI initiated and persisted in adopting a practice of taking a stand that such increases amounted to exemptions.
The SAT rejected this attempt in fairly clear and emphatic words. In the case under consideration, consequent to a buyback, the holding of the Promoters increased from 62.56% to 75%. While there are other aspects and issues in the case, the essential question before the SAT was whether this increase should result in an open offer.
The SAT relied on the definition of an “acquirer” under the Regulations as well as in a legal dictionary. It held that a passive increase in percentage holding pursuant to a buyback cannot amount to acquisition. It observed (emphasis supplied in all extracts):-
“In this context the word ‘acquire’ implies acquisition of voting rights through a positive act of the acquirer with a view to gain control over the voting rights. In the case before us, it is the admitted position of the parties that the appellants (promoters of the company) did not participate in the buy back and that there was no change in their shareholding. The percentage increase in their voting rights was not by reason of any act of theirs but was incidental to the buy back of shares of other shareholders by the company. Such a passive increase in the proportion of the voting rights of the promoters of the company will not attract regulation 11(1) of the takeover code. The argument of the learned counsel for the Board that merely because there is increase in the voting rights of the appellants, regulation 11(1) gets triggered cannot be accepted.”
Does such an increase amount to an “indirect” acquisition? This argument too was rejected by observing:-
“He also referred to the definition of ‘acquirer’ in regulation 2(b) of the takeover code and strenuously contended that a passive acquisition of the kind we are dealing with is indirect acquisition and, therefore, the provisions of regulation 11(1) are attracted. We have no hesitation in rejecting this argument outright. The words ‘directly’ and ‘indirectly’ in the definition of ‘acquirer’ go with the person who has to acquire voting rights by his positive act and if such acquisition comes within the limits prescribed by regulation 11(1) it would only then get attracted. Passive acquisition as in the present case cannot be regarded as indirect acquisition as was sought to be contended on behalf of the Board.
The SAT also rightly highlighted another absurdity involved. If the view that passive increase may also amount to acquisition, then even a non-controlling shareholder holding, say, 14% may find the requirements of open offer getting triggered off if he does not participate in a buyback and finds his holding increased to, say, 16%. The SAT observed:-
“Again, a non-promoter shareholder may increase his percentage of shareholding without participating in the buy back over which he has no control. In such an event he would be burdened with an onerous liability to make a public announcement. It is well settled principle of law that a provision ought not to be interpreted in a manner which may impose upon a person an obligation which may be highly onerous or require him to do something which is impossible for no action of his.”
Other difficulties in taking such an interpretation were highlighted. At the end, the SAT, in quite emphatic words, held that “we are of the firm opinion that passive acquisition does not attract the provisions of regulations 11(1) of the takeover code.”
Once such an interpretation is accepted, the following situations, arising out of buyback and under the 1997 Regulations, need to be considered:-

  1. If a person’s holding increases to 5% or more, will disclosure be required?
  2. If a person holding 5 or more% finds his holding increased by 2% or more, will disclosure be required?
  3. If a person holds less than 15% finds his holding increased to 15% or more, will an open offer be required?
  4. If a person holding 15% or more finds his holding increased, will such increase be counted as part of creeping acquisition or will he be entitled to acquire a further 5% in a financial year ignoring such increase?
  5. If a person holding 55% or less finds his holding increased beyond 55%, will he be deemed to have violated the Regulations?
-        And so on.

Applying the decision of the SAT, the answer to each of the aforesaid questions appear to be in the negative.

However, while this was the position under the 1997 Regulations, the question is whether it will also hold good under the 2011 Regulations. The curious thing is that while the corresponding wording in the definition of “acquirer” under the 2011 Regulations remains exactly the same, the Regulations have made further provisions on the assumption that such a passive increase amounts to acquisition. It has exempted two types of such increases (from below 25% to 25% or more, and more than the creeping acquisition if holding is already more than 25%) if certain conditions are satisfied. It is submitted that considering that even the 1997 Regulations did contain such a provision, the ratio of the decision of the SAT should hold good.
One will have to wait and see whether SEBI appeals to the Supreme Court and, if yes, what view the Supreme Court holds. It is also possible that SEBI may amend the Regulations.
In conclusion, one cannot help expressing disapproval of adopting a practice-makes-law approach of SEBI which results in the law becoming opaque and even arbitrary where the law is interpreted not in accordance with what has been framed in due process and duly notified or in accordance with well accepted rules of interpretation but according to “intention” and/or the present internal preference or practice of SEBI.

p.s.:- This is in continuation and conclusion of my earlier post here on the SAT decision. 


Anonymous said...

I think the the stand of SEBI is indicative of a deeper malaise, of trying to grab more discretion than what is given under the law.

Somasekhar Sundaresan said...

The SAT's analysis is perfect for an interpretation of the 1997 Takeover Regulations, but would be of no held in interpreting the 2011 Takeover Regulations, which has an explicit charge of the obligation to make an open offer in the language of the legislation. Regulation 10(3) and Regulation 10(4) show the clear legislative intent of the new law.

The old law indeed did not have a charging provision of this nature at all. Moreover, SEBI had itself issued many orders that are completely in line with what the SAT has said now. When SEBI changed its mind, it did not amend the 1997 Regulations and started passing a different type of order.

The 2011 Regulations will lay this controversy to rest. It is settled law that when interpreting a completely new law that deviates in material substance from the old law, interpretations of the old law would be of no use. The Supreme Court has said this on many an occasion - if I remember right, when deciding if the case law under the 1940 Arbitration Act would have relevance in interpreting the 1996 Arbitration Act.

Jayant Thakur, CA said...


Quite agree that the 2011 Regulations have gone a step or two further (which I have referred to in 3rd last para of my post), but still the ratio of the SAT decision isn’t really met.

Even the 1997 Regulations had an explicit reference in second proviso to Regulations 11(2) where “increase in the shareholding or voting rights..pursuant to a buy-back of shares” was not a permissible increase for that purpose. The 2011 Regulations do go one or two steps further but if one step is a wrong, one or two more do not make it right.

Unfortunately, the 2011 Regulations still do not create a charge. They have neither expanded the definition of “acquirer” nor created an explicit charge in any of the Regulations on open offer, creeping acquisition, disclosure, etc. Instead, it is assumed, quite wrongly as the SAT decision has held, that such increase consequent to buyback is already covered and then these 2011 Regulations go ahead and grant exemptions under certain circumstances.

The SAT decision has focussed on the definition of “acquirer” and has quite emphatically held that “passive” increase through buyback cannot be treated as acquisition. This aspect of the definition remains unchanged and hence there is a cloud on the 2011 Regulations too, imho.

Taking such an indirect method of inclusion is untidy too since it leaves many loose ends, albeit minor. For example, Will such a passive increase from 4.99% to 5.01% require disclosure? If yes, when?

The better course would have simply been to amend the definition of acquirer and include such passive buybacks.

Ira said...

The SAT’s stance in saying that passive share accretions are not “acquisitions” is entirely unjustifiable since the Takeover Code (both old and new) exhaustively lists out which cases of increase in shareholding are not “acquisitions” and grants automatic exemptions to such cases. Any interpretation which seeks to create further such cases simply serves to dilute the law.

The SAT has held that to qualify as an acquisition there should be a “positive act of the acquirer with a view to gain control over the voting rights”. The SAT observed that an ordinary shareholder would not know when his shareholding has increased beyond the Takeover trigger thresholds and therefore a buyback would create an onerous obligation to make an open offer (unless it is not deemed to be an “acquisition”). Usually, buybacks are deliberately initiated by promoters with shareholdings above the trigger thresholds; they are well-informed as to when their shareholdings trigger a resultant open offer and often anticipate such increases. Ordinary shareholders tend not to have shareholdings in excess of 15% or 25% and would not be in any danger of unwittingly triggering the Takeover Code.

Incidentally, one similar case of passive acquisition is through inheritance or succession, where the shareholder comes to own shares without any voluntary act of his own. Such acquisitions are also automatically exempted (both under the old and new Takeover Code). This defeats the argument that courts ought to carve out new situations for passive acquisitions since the drafters had evidently considered which cases of passive acquisition need to be exempted from the ambit of the Takeover Code.

Since the old Takeover Code expressly states that a buyback will trigger open offer obligations (unless certain conditions are met), any judgment that seeks to read down the clear legislative dictat must be seen to be per incuriam. The old Takeover Code (by way of a 2008 amendment) states that a buyback will not trigger an open offer if restricted to a 5% increase and the acquirer’s total shareholding does increase beyond 75%. This provision does not seem to have been considered in the SAT judgment. (It is possible to argue that the buyback in question occurred before the amendment in 2008 and, therefore, the later amendment should not influence the interpretation of law for an earlier period but even this argument was not cited in the SAT judgment. Besides the amendment only clarifies the position of law (that buybacks are generally not exempt) and a later clarification (as opposed to an amendment) may influence the interpretation of law for an earlier point in time.)

Another issue here is that the SAT has generally held that passive acquisitions are exempt from open offer obligations. Therefore, questions may be raised both under the old and new Takeover Code as to whether other types of “passive” acquisition should be similarly exempt. Should a capital reduction under Section 100 of the Companies Act be exempt as a passive acquisition? Is a public shareholder who tenders shares in an open offer and receives shares of another listed company in exchange acquiring shares “with a view to gain control over the voting rights” of the second company? Incidentally, this was a case of automatic exemption under the old Code but is not accorded similar status under the new Code. Should we examine every automatic exemption under the old Code which is not similarly protected under the new Code and argue that it is not a case of acquisition? Or should we assume that the drafters had considered these questions and in their considered view listed out the only circumstances in an acquisition is exempted?

Anonymous said...

In case of a buyback through "open market" route, regulation 15(b) of the SEBI (Buy Back of Securities Regulations), 1998 does not permit a company to buy back shares from the promoters of the company.

Thus, passive acquisition by the promoter is bound to happen post buy back (from non-promoters only).

Jayant Thakur, CA said...


The provisions of Regulation 15(b) (Chapter IV) relate to buyback through the open market where promoters are debarred from selling their shares to the company.

However, Chapter III which provides for buy-back through tender offer does not contain any such restriction and generally all shareholders including promoters may participate.

Prof Bala said...

rWhile researching in a different context came across this post on buybacks. Thought will share a different perspective on "passive acquisitions" arising from buyback consequences, especially in case of shareholders not exercising their option to sell back.
To my mind, in such cases the shareholders "actively" decide not to participate in the buyback exercise to the full or partial extent of their entitlement. It might well be a deliberate action to achieve a certain desired result say of increasing their shareholding at the company's expense. Shouldn't they be subject to the same regulations that a shareholder following a more staightforward approach of open ("active") acquisition?
Perhaps, controlling or dominant shareholders should also be mandatorily required to disclose in advance of their intentions not to participate in the buyback and offering to comply with regulations if as a result their shareholding levels reach appropriate trigger points.
Any thoughts?ecdoda

Prof Bala
Dr N Balasubramanian

Anonymous said...

Dear Mr. Thakur,

That's precisely my point. Passive acquisition is bound to happen in case of buyback through stock exchange route, unlike in case of tender offer route where the promoters have to disclose their intent and can participate.

So if SEBI's own buy-back regulations do not permit participation by promoters under the stock exchange route, why should SEBI be worried if promoters shareholding is increasing (purely for mathematical reasons) and when post buy-back there is no change in control.