Saturday, February 16, 2013

When a Rights Offering Becomes a Public Offering


In August last year, the Supreme Court unequivocally ruled in the Sahara case on the issue of when an offer of shares by an unlisted company would become a public offering thereby invoking SEBI’s jurisdiction.

One of our readers, Sumit Agrawal, has brought to our attention a decision of the Kerala High Court in Securities and Exchange Board of India v. Kunnamkulam Paper Mills Ltd, where it was held that in certain circumstances a rights offering by an unlisted company may amount to a public offering where SEBI would obtain jurisdiction.

Facts

An unlisted company made a rights offering in which it allotted shares in 2001 to 163 persons, which included persons who were not existing shareholders of the company. This was because existing shareholders had a right to renounce their rights shares offered to them in favour of others. After issuing a show cause notice and following the necessary procedures, SEBI passed an order finding that this amounted to a public offering and that the company had not complied with the requisite disclosure obligations that apply to a public offering.

The company filed a writ petition against SEBI’s order before the Kerala High Court. The single judge quashed SEBI’s order on a finding that by virtue of section 55A of the Companies Act, 1956, it is only the Central Government that has powers of oversight over unlisted companies and that SEBI has no jurisdiction in the matter. SEBI appealed to a division bench, which delivered the present decision.

Decision

The court considered two broad questions. First, it considered whether a rights offering with renunciation rights amounts to a public offering or not. Second, it considered whether SEBI has jurisdiction over such an offering if it was held to be a public offering.

On the first question, the court considered the ambit of section 67 of the Companies Act, which determines when an offering becomes a public offering. Under the proviso to section 67(3), any offering to more than 50 persons is treated as one made to the public. This general principle was then applied to a rights offering that carries renunciation rights. A rights offering under section 81(1)(c) of the Companies Act includes a “right exercisable by a person concerned to renounce the shares offered to him or any of them in favour of any other person”. Reading these aspects together, the court observed:

That being the situation when a company exercises its power under S. 81(1)(c) which gives right to a shareholder to renounce the shares in favour of persons who are not shareholders and when such a right is given to 50 or more persons that also will be deemed to be an offer made to any section of the public as provided under S. 67(1) and (2).

On the second question regarding jurisdiction, the court interpreted section 55A of the Companies Act and also the provisions of the SEBI (Disclosure and Investor Protection) Guidelines, 2000 and found that SEBI has jurisdiction over any public offering by an unlisted company. Since the present offering was treated as one to the public, it did not seem to leave any doubt in the court’s mind regarding the existence of SEBI’s jurisdiction.

Analysis

The Kerala High Court’s ruling hinges on the renunciation right given to 50 persons or more. That would make a rights offering a public offering. From a structuring standpoint, where unlisted companies are proposing a rights offering, it would help to insert some conditions or restrictions regarding the exercise of renunciation rights. There may have to be a mechanism whereby renunciation rights would be restricted to less than 50 persons. This may be difficult to implement in a company that has more than 50 shareholders, because that would then mean that the renunciation rights of certain shareholders might have to be taken away altogether, the possibility of which may itself be debatable. Providing renunciation rights to some but not all shareholders may raise questions of fairness inter se among shareholders of a same class.

A strict reading of the proviso to section 67(3) could lead to a situation where a rights offering per se (with or without renunciation rights) in an unlisted company that has more than 50 shareholders would itself amount to a public offering because an offer is being made to 50 shareholders or more. That would be an extreme situation. Fortunately however, the Kerala High Court has not gone that far. Its decision is based on renunciation rights to non-shareholders. Therefore, what seems to matter (although the court has not expressly ruled on this) is that where the rights offering and renunciation result in offers being made to more than 50 outsiders who are not yet shareholders of the company, that would become a public offering.

In the case of listed companies, matters may take on a different turn altogether. Even if there are renunciation rights that may be available to more than 50 persons, it is doubtful whether that would make it a public offering. In such a scenario, the issues may be somewhat moot because SEBI does have jurisdiction over listed companies, and moreover the current regime on share offerings by listed companies contained in the SEBI ICDR Regulations provides for a separate regime (including disclosures) for rights offerings.

Sahara Case: It is interesting to note that the Kerala High Court did not refer to the Sahara case at all in its interpretation of the provisions of the Companies Act and the SEBI Act. This might be because the Kerala High Court had heard the final arguments even before the Supreme Court delivered the Sahara judgment. Nevertheless, the extensive debate that took place on the Sahara case prior to that before SEBI and the Securities Appellate Tribunal (SAT) on issues that have substantial bearing do not find any mention at all in Kerala High Court’s observations. In any event, the two rulings appears to be in tandem and do not give rise to any substantive inconsistency.

Finally, on the Sahara case itself, the episode is still ongoing. SEBI has now issued two orders of attachment (here and here) relating to the two Sahara companies for failing to comply with the directions of the Supreme Court. It remains to be seen as to when, where and how these orders would be challenged. Primary issues may be whether SEBI has the jurisdiction to pass these orders. The touchstone against which these issues must be examined would not only be SEBI’s powers under the SEBI Act but also the power it derives through the order of the Supreme Court which lays down the consequences of Sahara’s non-compliance. We will need to watch this space. 

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