The question of what constitutes “control” under the SEBI Takeover Regulations of 2011 is a vexed one. This is because an acquirer could acquire less than the mandatory offer threshold of 25% and still be required to make an offer if it is said to be in control of the target company. Control is defined in an inclusive manner and could result in some amount of subjectivity in its determination. The issue has been surfacing again and again in a few cases, where it is primarily the contractual arrangements between the parties that are under scrutiny, and specifically in terms of the rights conferred upon the investor/acquirer.
In an interesting column last week in the Financial Express, Menaka Doshi points to the background regarding the concept of “control” in the Takeover Regulations and stresses the paradoxical results it can lead to. She also sets out the background to the definition of “control” and the failed opportunity to receive an interpretation from the Supreme Court in the Subhkam case.
While the Takeover Regulations Advisory Committee (TRAC) that recommended the 2011 Regulations reemphasized the need for mandatory offers to be triggered by de facto control situations in addition to de jure control situations, the Committee refrained from making specific recommendations on type of exercise of the control (including the power of the investor/acquirer to say “no” to proposals of target companies). This was because the Subhkam case was pending before the Supreme Court at that stage with a ruling anticipated to clear the air.
The reason why I was drawn to this issue again now is because I was researching in a different context on the question of mandatory offers being triggered by a change in control, and was examining the position internationally. In a handful of jurisdictions that I examined, none of them had a subjective definition of control. All of them had a specific percentage threshold for defining control, similar to the 25% threshold in India. Examples are UK (30%), Singapore (20%), Hong Kong (30%), Malaysia (33%) and European Union (30%). Of course, the US takeover regime does not carry a mandatory offer obligation. India was the only jurisdiction I came across that has a subjective definition of control in addition to a percentage threshold, a point that Menaka too notes. While this will certainly benefit minority shareholders by providing them with an equal exit opportunity through mandatory offers during a change in control, it could also cause uncertainties as we have seen in the few Indian cases.
Interestingly, some other jurisdictions carried a subjective definition of control in their early years and, since it did not work well, migrated to a regime where control is defined through a specific percentage threshold. It would be useful to consider the merits and demerits of both approaches.
The reason for a subjective definition of control is that there can be various shades of control in a target company. That would depend not only on the legal rights conferred upon shareholders holding certain number of shares with voting rights (e.g. 75% to pass a special resolution), but also upon the distribution of shares among shareholders of the target (in a widely distributed shareholding, a small holding may be sufficient to gain control). Therefore, a subjective definition of control would enable SEBI to make a determination based on the facts and circumstances of individual cases. This would ensure that acquirers cannot circumvent their mandatory offer obligations by structuring their transactions through ingenious methods to stay outside the purview the rule. Although this approach could significantly minimise the circumvention or abuse of the rule, it is fraught with uncertainty that could severely impinge upon a free market for acquisition of shares in a listed company if acquirers are put under a constant fear of having to make an offer even though they do not fancy a controlling position in the target.
The element of uncertainty surrounding a subjective definition of control is removed in a specific numerical percentage threshold. A bright-line test such as 25% voting rights in a company, which is a proxy for control, introduces considerable ease in interpretation and implementation both for the regulators and the participants in the takeover market. However, one of the key disadvantages of this approach is that it introduces an element of arbitrariness to the process. While due care may be exercised while fixing the appropriate limit to determine control, it is always possible for persons acquiring shares in the targets to acquire such number of shares so that they stay below the threshold for mandatory offers. Hence, in India, it is possible for a person to acquire 24% shares with voting rights and avoid making an offer to acquire the remaining shares even though such level of shareholding may provide the person with de facto control of the target, especially if the remaining shareholding in the target is diffused.
Given that both the subjective and bright-line approaches have their disadvantages, neither may be considered optimal on its own. After having experimented with the subjective approach during their initial years of takeover regulation, several jurisdictions have reconciled to adopting the bright-line approach.
Only time will tell if India’s approach of combining both a numeric percentage threshold and subjective determination of control will be optimal or counterproductive. Even if there is no case yet to eliminate the subjective concept of control, it would do well for SEBI to delineate its scope as clearly as possible.