Thursday, May 31, 2012

Convertible Instruments and “Control” Under the Competition Act


Earlier this week, the Competition Commission of India (CCI) passed an order involving a transaction between the Reliance Industries group and the TV18 group of companies.
What otherwise appears to be a complex transaction can be described in a nutshell as follows. About 40% shares of Network18 and (indirectly) TV18, both of which are listed companies, are held by Mr. Raghav Bahl and his affiliates. It is proposed that the said 40% shares will be transferred to a group of private limited companies, which are collectively referred to as the “target companies”. In turn, Independent Media Trust (IMT), a trust established exclusively for the benefit of Reliance Industries Limited (RIL), would subscribe to Zero Coupon Optionally Convertible Debentures (ZOCDs) of the target companies.
The reason why the transaction had to be tested against the touchstone of the Competition Act is because both the RIL group and the TV18 group are said to be involved in similar businesses, viz:
- supply of television channels;
- event management services; and
- broadband Internet services through 4G technologies and the contents accessible through such services.
IMT’s application to the CCI was cleared, as it was found that the transaction is not likely to give rise to adverse effect on competition in India. This conclusion was arrived at after considering the nature and size of the market on all three counts listed above, and the participation of the RIL group and TV18 group in those markets. While the substance of the transaction and its effects on competition were resolved with relative ease, it is the CCI’s observations on a jurisdictional matter that may have the effect of rocking the boat on the interpretation of the expression “control”, a term which never ceases to provoke debate and discussion.
Let us first absorb the position adopted by the CCI through its own words:
14. In terms of the Investment Agreement, holder of each ZOCD has the option to convert the ZOCDs into equity shares of the target companies with voting rights at any time during a period of ten years from the date of subscription. Since the conversion option contained in each ZOCD entitles the holder to receive equity shares of the target companies, the ZOCDs are shares within the meaning of sub-clause (i) of clause (v) of Section 2 of the Act and the subscription to ZOCDs amounts to acquisition of shares of the target companies.
15. In the event of conversion of all the ZOCDs, IMT would hold more than 99.99 percent of the fully diluted equity share capital of each of the target companies. Acquisition of such a right to convert the ZOCDs into equity shares, at any time before the expiry of ten years from the date of subscription, confers on IMT the ability to exercise decisive influence over the management and affairs of each of the target companies and the same amounts to control for the purposes of the Act. Therefore, in the facts and circumstances of the instant case, the subscription to the ZOCDs amounts to acquisition of control over the target companies for the purposes of the Act. Since control over the target companies is being acquired by IMT, the subscription to ZOCDs in-turn would also result in indirect acquisition of control over Network18 and TV18 as these companies would be under the control of the target companies.
[emphasis added]
Two aspects become clear. First, the very fact that the holder of a convertible instrument has the ability to convert the securities into equity shares itself amounts to control on the ground that the holder has the “ability to exercise decisive influence over the management and affairs” of the company. In other words, even if the actual conversion is distant into the future, the mere possibility (or to borrow the usage in the context of hostile takeovers under Delaware law, the “omnipresent specter”) that the holder could convert into equity is sufficient to constitute control. Second, such control is acquired at the time of investment into the convertible instruments at the outset, and not deferred until the time that the conversion actually occurs. In other words, what matters is the mere possibility of control and not the actual availability or exercise of control. This approach arguably pushes the boundaries of what amounts to control, and may even result in unintended consequences if adhered to scrupulously.
A number of issues arise:
1. Query whether it was necessary for the CCI to have made these observations regarding control because it ultimately derived jurisdiction through section 5(a) of the Competition Act which applies when there is an acquisition of control, shares, voting rights or assets. In other words, mere acquisition of shares may trigger the said provision, and “shares” is defined under the Act (section 2(i)(v)) to include “any security which entitles the holder to receive shares with voting rights”, thereby ensnaring convertible securities such as ZOCDs.
2. This discussion also accentuates possible incongruities in the concepts of acquisition of shares and control under the competition law (regulated by CCI) on the one hand and takeover law (regulated by SEBI) on the other, although a large-sized M&A transaction involving a takeover is likely to trigger both sets of laws simultaneously.
First, while the competition law seems to be triggered merely upon the acquisition of shares (which includes convertible instruments), the mandatory open offer obligations under the SEBI Takeover Regulations arise only when the acquisition of shares entitles the acquirer to exercise voting rights beyond prescribed thresholds (Reg. 3). In other words, the acquisition of voting rights is crucial from the perspective of the Takeover Regulations, while it is not so for competition law.
Second, there is a distinct time difference regarding the operation of the triggers under both the laws. While the Competition Act gets triggered upon acquisition of convertible securities, the mandatory open offer obligations under the Takeover Regulations get triggered only upon conversion. This is expressly clarified in Reg. 13(2).
Third, the definitions of “control” also vary between the Competition Act and the Takeover Regulations, although the fluid nature of the concept may allow for some judicial or regulatory harmonization of the concept across the two sets of laws. It remains to be seen whether SEBI will take the cue from the extended application of “control” set out in the present order of the CCI. However, it is important to bear in mind that the concepts need to be applied in the context and recognizing the purpose of each legislation rather than universally.
Some of these issues will add to the complexity of structuring significant takeover transactions that will likely trigger both the sets of laws.
3. Finally, simply by way of analogy, it is interesting to note that the foreign investment policy of the Government of India and the RBI does not even recognize optionally convertible instruments such as ZOCDs as equity instruments in the first place. Optionally convertible instruments are treated as debt and swept into the external commercial borrowings policy. It cannot be any farther from exercising control over a company.

3 comments:

vswami said...

The points raised / discussed in the write-up, in one’s perception, especially from a common sense approach, are mostly too technical or hyper technical to reconsider whether at all it is worth the trouble / wasting time and energy in deliberating on the present law on competition with a view to try and find any satisfactory solution.
It is not merely the concept - ‘control’ focused on, but every other English word or term employed in any statute has, as history of legal system (that is, for purposes of implementation or enforcement or adjudication) bears testimony, always given rise to problems galore in the matter of interpretation. According to a seemingly convincing legal view, in order to serve the intended objective, at least reasonably if not in a wholesome manner, even at the stage of framing any provision , in any case before its enactment , essentially two fundamentals need to be kept in view:
1.‘common sense’ is the touch stone of ‘logic’, and
2. ‘logic’ is the cornerstone of ‘law’.
To put it differently, any law conceived or legislated ignoring the said fundamentals is most likely to be confronted with problems in interpretation; particularly such an interpretation as will meet the intended purpose/objective.
A few random thoughts (pardon, to put crudely):
As widely felt, there is no escape from the reality, among others, that today we live in a growingly competitive environment (domestic or global). On the concept of ‘competition’ itself, the task of identifying much less deciding whether in a given situation any faulted practice is profoundly ‘healthy’ or otherwise is, for obvious reason, a highly ‘subjective’ one; never can be an ‘objective’ one. Further, any attempt at having an effective control as ideally desired in such matters has invariably proven a non-starter. On that premise, is it not high time that the present law on competition warrants a fresh look at, with a view to simplification, so as to suit/fit into the thinking/practical approach in modern times.
In the nature of things, perhaps, this is a matter which deserves in-depth deliberations more by socio-economic experts; not just law experts.

Anonymous said...

This is my take on the three issues raised by you.

1. I agree. The classical doctrine of ripeness would dictate that a court / tribunal should not decide an issue if it’s not necessary. So in this case, the def. of shares in the CA effectively settles the matter, and there was no need to reach the issue of control.
2. The definition of `shares’ and `control’ in the two laws is not necessarily harmonizable. The CA definition can and should be wider than that in SEBI regulations for two reasons. One, the focus of CA is to determine when a transaction results in a combination and determine if it has AAE on competition, so the law needs to cast the net a little wider. The focus of SEBI regulations is more limited, to give non-controlling shareholders an exit option upon change in the identity of the controlling shareholder group. Here, control should be strong enough so as to alter the underlying character of the company. Secondly, the CA only requires ex-ante clearance from the regulator, so erring on the side of overinclusive definition may only delay a few deals, but nothing more. SAST casts a positive obligation on the acquirer to make an open offer, which would be difficult to unwind at a later date. E.g. a person who acquires convertibles in a company but later decides not to exercise the conversion option would be stuck with shares if required to make an open offer on acquiring the convertibles. I agree that in practice it may become difficult to navigate the two legal provisions simultaneously!
3. The RBI treats the optionally convertible securities as ECBs and not equity. The amount of ECBs raised by the Indian companies is capped as a macroeconomic stability tool. Excessive borrowings can put pressure on the BOP scenario. So if the foreign investor chooses the redemption option, these effectively turn out to be debt instruments (as is happening with several FCCBs now).

Mangesh Patwardhan

vswami said...

As confusing, may I request for a clarification:
Is the writer of the last posted comment, 'Anonymous'(top) or 'Mangesh Patwardhan'(bottom)!