Wednesday, January 2, 2013

Mandatory Offers and Creeping Acquisitions

The Securities and Exchange Board of India (SEBI) passed an order under the SEBI Takeover Regulations of 1997 (that existed prior to October 2011) in relation to the shares of Khaitan Electricals Limited (the Target Company). In this order, the SEBI whole time member directed the promoters of the company to make an open offer to the other shareholders on account of certain acquisitions of shares by them in 2006-2007. Along with the open offer consideration, the promoters have been directed to pay interest at the rate of 10% per annum from June 16, 2007 to the date of payment of the consideration.

The key facts of the case are summarized in the gist of the show cause notices issued by SEBI to the relevant promoters of the Target Company:

... consequent to the acquisition of shares [by the promoters] on March 12, 2007, there was increase in their pre-acquisition shareholding (as on March 11, 2007) of -

(a) [Khaitan Lefin Limited (KLL), one of the promoters], individually, from 10,73,415 shares (10.52%) to 19,73,415 shares (17.16%) in the Target Company and KLL failed to make a public announcement to acquire shares in accordance with provisions of regulation 10 read with regulation 14(1) of the Takeover Regulations, 1997 within 4 working days from March 12, 2007;

(b) The promoter group, collectively, from 26,34,639 shares (25.83%) to 39,34,639 shares (34.21%) and the acquirers collectively failed to make a public announcement in accordance with the provisions of regulation 11(1) read with regulation 14(1) of the Takeover Regulations, 1997 within 4 working days from March 12, 2007.

Given these facts, two primary legal issues arose for consideration.

First, whether an acquisition by a single promoter of more than 15% shares will trigger an open offer requirement under Reg. 10 although the promoter group as a whole already held more than 15%. In other words, whether can be independent obligations under Reg. 10 (for individually crossing the 15% threshold) and under Reg. 11(1) (for collectively activating the creeping acquisition trigger of 5% additional shares) in respect of the same set of acquisitions.

Second, in the case of a creeping acquisition, what is the precise timing to be considered for the acquisition of 5% additional shares? Specifically, whether a dilution of shares during the period ought to be taken into account or netted off while considering the 5% limit.

The SEBI order holds against the promoters on both the issues, thereby mandating them to make an open offer.

On the first issue, the SEBI order reasons as follows:

11. Thus, the obligation to make public announcement under regulation 10 gets triggered when the acquisition of the acquirer, individually or collectively alongwith persons acting in concert with him, would cross the threshold limit of 15%. Thus, if individual acquisition of any person in a group (acting in concert) breaches the threshold limit of 15%, such acquirer is under obligation to make public announcement under regulation 10. In my view, there is no ambiguity in the language of regulation 10 with regard to the obligation of an acquirer whose acquisition increases his individual shareholding beyond threshold limit of 15% and no other interpretation can be given to it. …

14. … The intent and object behind the obligation with regard to public announcement under regulation 10, 11 and 12 is common. Regulation 10 does not exempt an acquirer from this obligation when he individually breaches the threshold of regulation 10 but his shareholding collectively with persons acting in concert with him is beyond the threshold prior to his individual acquisition as sought to be contended by the noticees. In my view, therefore, no interpretation can be taken in violation of the language of the regulations or to defeat the intent and object thereof.

On the second issue, the promoters argued that the amount of increase in the shareholding due to creeping acquisition must be computed as of the last date of the financial year, i.e. March 31, and that intermediate divestments and dilution must be netted off. This argument was not accepted by SEBI, which adopted the following reasoning:

21. … If the argument of the noticees is accepted, an acquirer may acquire any percentage of shares in a financial year and by the end of that financial year he may reduce it to 5% by sale of holding or otherwise. This is not the intention of the regulation which, since inception, had put a limit on percentage of creeping acquisition and did not allow netting of acquisition and disinvestment for determining the percentage of increase. …

22. I, therefore, am of the view that for the purpose of availing creeping benefit under regulation 11(1), the gross acquisition of the acquirer should not be more 5% in a financial year that starts on April 1st and ends on March 31st. Further, if at any point of time, in that financial year, the acquisition breaches the threshold of 5% creeping acquisition, the obligation to make public announcement is triggered at that time itself. Regulation 11(1) does not allow an acquirer to wait till end of the financial year after such breach.

24. In my view, from the definition of the word 'acquirer' under regulation 2(1)(b) and the provisions of regulation 11 of the Takeover Regulations, 1997 it is clear that the obligation to make public announcement is triggered on the date of agreement to acquire or acquisition of shares or voting rights, as the case may be. Thus, the shareholding shall be calculated and reckoned taking into account the shareholding of the acquirer immediately prior to the acquisition. I, therefore, hold that the shareholding of the acquirers as on the date of the acquisition of additional shares should be taken into account to determine whether the acquisition entitles the acquirer to exercise more than 5% voting rights in the Target Company in a financial year ending on March 31st. Further, the 5% increase in the financial year has to be calculated on gross basis without netting the dilution and/or divestment and acquisition. Accordingly, the arguments of the noticees in this regard also cannot hold good.

SEBI’s order is consistent with the text and intent of the 1997 Regulations. Although the facts of the present case gave rise to some issues that required a detailed consideration, the order merely buttresses the position adopted by the Regulations.

The legal difficulties emanating from the above discussion have been partially addressed in the 2011 version of the Takeover Regulations. The first issue regarding the mutual exclusivity of the initial trigger by individual acquirers (now standing at 25%) and the creeping acquisition trigger by the promoters collectively would continue to operate even under the 2011 Regulations, and to that extent SEBI’s order in the present case would continue to be relevant. As far as the second issue on computation of creeping acquisition limits is concerned, the position has been expressly clarified in the 2011 Regulations in Reg. 3(2) Explanation whereby the limit would be computed on a gross basis (without netting off dilutions). In that sense, SEBI’s order seems to suggest that the introduction of this explanation does not change the legal position, but rather clarifies something that was even previously the intention of the Takeover Regulations.

1 comment:

Somasekhar Sundaresan said...

I beg to differ, vehemently on the first count. The very edifice of the Takeover Regulations is linked to the concept of taking into account the holdings of all the persons acting in concert.

In the absence of any explicit and specific suspension of this concept, as is now the case under Regulation 3(3) of the new Takeover Regulations, 2011, the appraoch of saying any single person crossing 15% would trigger an open offer is not at all sustainable either under the letter or the spirit of the Takeover Regulations.

In fact, there are published orders of SEBI contrary to the current approach to re-thinking of the old Takeover Regulations, and the change in approach is inexplicable and wrong.

On the second issue, it is a necessarily a mixed question of fact and law, and therefore, it would not be possible to generalize a proposition. Suffice it to say, all recommendations of the Bhagwati Committee Report were not implemented and the dispensation on how to regard creeping acquisitions kept shifting regularly (from a floating period of twelve months to twelve calendar months to the financial year). In the absence of an explicit legislative intervention, how the old Takeover Regulations should operate in computing the 5% threshold, is not without debate.

Of course, the new Takeover Regulations have explicitly legislated how to reckon the 5% and therefore, therefore there is no longer any doubt on the subject.