Thursday, May 30, 2013

Supreme Court on Withdrawal of a Takeover Offer


The Supreme Court earlier this month issued its decision on the takeover offer by Nirma Industries Limited to the shareholders of Shree Rama Multi Tech Limited (SRMTL). The court concurred with the view of the Securities Appellate Tribunal (SAT) and the Securities and Exchange Board of India (SEBI) in disallowing the withdrawal of the offer by Nirma.

In a column appearing on CNBC’s The Firm – Corporate Law in India, Shishir Vayttaden sets out the facts and issues of the case in detail and also offers a critique of the judgment. Here I propose to summarise the key facts, deal with the overall policy issue at hand and also suggest a possible way out for acquirers desirous of retaining some flexibility to withdraw from the offer in case of unforeseen circumstances.

Nirma triggered the mandatory open offer obligations under the previous version of the SEBI Takeover Regulations of 1997 when it enforced a pledge of shares offered by the promoters of SRMTL. Since Nirma’s acquisition of shares exceeded the then prescribed threshold of 15%, it triggered an offer. During the course of the offer, certain revelations were made regarding the financial situation of the target company that became the subject of a financial fraud that significantly reduced the company’s share value. According to Nirma, these facts were not known to it during due diligence conducted prior to the offer. It therefore approached SEBI to withdraw the offer.

As SEBI and SAT (on appeal) refused to permit a withdrawal, Nirma approached the Supreme Court. The Supreme Court largely relied upon an interpretation of Reg. 27 of the Takeover Regulations, 1997 to come to the conclusion that the withdrawal was not permissible. Shishir has dealt with the reasoning of the court in detail in his column, and also pointed to some of the weaknesses of that approach.

Policy Analysis

From a policy standpoint, withdrawal of mandatory offers creates a conflicting situation. On the one hand, takeover regulation considers mandatory offers as sacrosanct as they are intended to offer equality of treatment and exit opportunities for minority shareholders when there is a change in control of the target. In other words, minority shareholders must be allowed to exit on same terms as those who have sold shares to the new acquirer who has obtained control over the target. This is the reason why withdrawals are treated with great circumspection by SEBI.

At the same time, there are situations where a withdrawal must be permitted because the circumstances that triggered the offer or the basis on which the offer was made may no longer exist. Such situations could be varied in nature. The first is impossibility, for example due to the death of an acquirer who is an individual. The second could be circumstances beyond the control of the acquirer, such as a drastic adverse change in the financial condition of the target, similar to the case of SRMTL. Thirdly, there could be situations where the acquirer is unable to perform its obligations under the offer on account of its own circumstances, e.g. inability to complete the offer due to lack of sufficient funds to discharge the consideration to shareholders tendering in the offer. While the first situation clearly makes a case for withdrawal, the third does not merit a withdrawal as that would affect the sanctity of a mandatory offer. It is the second situation, present in this case, which is somewhat tricky as it essentially involves a question of whether or not the acquirer ought to bear the risk of a change in the target’s financial condition. While the Supreme Court’s approach has been to place that risk on the acquirer, Shishir’s critique makes a strong case the other way.

Although the acquirer’s actions are in good faith and deserve some sympathy, a withdrawal of a mandatory offer could result in an incongruous situation unless the underlying transaction that triggered the offer is also unwound. This is because the promoters would have realised the full value on their shares and exited the company leaving the minority shareholders high and dry.

Way Forward

Fortunately, this incongruity has been addressed to some extent in the current version of the Takeover Regulations of 2011, which will likely provide greater leeway to acquirers to structure their transactions such that they are able to avoid any eventuality of the type that arose in the SRMTL case. A new ground has been inserted in the form of Reg. 23(1)(c) of the 2011 Regulations where one of the circumstances where an offer may be withdrawn is as follows:

(c)        any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met for reasons outside the reasonable control of the acquirer, and such agreement is rescinded, subject to such conditions having been specifically disclosed in the detailed public statement and the letter of offer; …

Hence, it is now possible to include a condition in the acquisition agreement that could provide for a “material adverse change” (MAC) clause. In the event that the MAC clause is attracted, the acquisition agreement need not be completed by the acquirer, and that can be a ground for withdrawal of the offer. This scheme of things is also consistent with the policy arguments discussed above. In such a situation, both the acquisition that triggered the offer as well as the offer itself would fail making it an “all-or-none” deal. Since there is no change in control, the principle of equality of treatment is not affected, and minority interests are untouched by this.

One of the lessons from the Supreme Court decision would be for transaction planners to structure the acquisition agreement and the open offer documents (public announcement and letter of offer) such that they protect the acquirer appropriate through MAC clauses and other similar conditional arrangements.

In structuring these arrangements, the key is to note that withdrawal will be permissible only if the circumstances giving rise to the inability of the acquirer to complete the offer is outside its control. Moreover, to take a cue from other jurisdictions such as the UK and Singapore, such circumstances should also be objectively determined and not by way of subjective determination by the acquirer. Furthermore, in similar circumstances, regulators in other jurisdictions have also paid heed to the sanctity of an offer and hence allowed a withdrawal for failure of a MAC clause only if the event is material in the sense that it strikes at the heart of the transactions, almost akin to a frustration of a contract (see UK Takeover Panel Statement 2001/15 involving an offer by WPP Group plc for Tempus Group plc following the events surrounding the September 11, 2001 attacks in the US). However, this standard has been subsequently diluted somewhat, although it remains fairly high.


Rushab Dhandokia said...

Hello Sir,

I have two observations.

The article states- "Hence, it is now possible to include a condition in the acquisition agreement that could provide for a “material adverse change” (MAC) clause. In the event that the MAC clause is attracted, the acquisition agreement need not be completed by the acquirer, and that can be a ground for withdrawal of the offer. This scheme of things is also consistent with the policy arguments discussed above. In such a situation, both the acquisition that triggered the offer as well as the offer itself would fail making it an “all-or-none” deal."

The statement, I assume, is limited to cover only those situations where the intention is to Acquire, hence we have the "Acquisition Agreement" ("Situation A"). Whereas in the present case the open offer was triggered because Nirma invoked the pledged shares only to recover their loan amount, and not to Acquire ("Situation B").

MAC clauses would be beneficial for cases like Situation A. How good will the MAC clause benefit to cases like Situation B, because anyways they will have to invoke the pledged shares to recover their loan amount.

Hence, Reg. 23(1)(c) of the 2011 Regulations, which states " the agreement for acquisition.." too would not serve any benefit for cases like Situation B. Thus, even the new regulations do not favor cases where the open offer is triggered for invoking the pledged shares.

MAC clauses, even if inserted in Acquisition Agreements, would come to rescue to only those situations where as per Reg. 23(1)(c) of the 2011 Regulations "any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met". Which means, only those conditions which, if not met Before making the open offer, qualifies one to withdraw the mandatory open offer.

However, what about cases, like the present case where the condition is not met After the open offer is made? Thus, if all the conditions stipulated in the Acquisition Agreement are met Before the open offer is made there would be no reason to withdraw the open offer if something contrary happens After the open offer is made.

Hence another reason why the 2011 Regulations, would not come to any benefit for cases like Nirma.

Rushab Dhandokia
4th year Law student
Nirma University

Umakanth Varottil said...

@Rushab. Thanks for your observations. I would like to clarify as follows.


The statement and the proposal in the post is intended to cover only acquisition of shares per se (your Situation A), and not acquisition through enforcement of a pledge of shares (your Situation B). Although the present case before the Supreme Court involved a pledge, most acquisitions are through a straightforward purchase of shares where the conditional approach may be adopted. In case of a lending and pledge scenario, the risk allocation mechanism is somewhat different as the lender becomes tied into the security at the time of lending itself (and assumes a certain amount of risk on the target) and not at the time of enforcement (by which time it is tied into the deal).


Reg. 23(1)(c) only stipulates where the condition (such as a MAC clause) must find its place and not the time when it can be invoked. It must be contained in the agreement that triggered the offer. If all the conditions are met and the acquisition under the agreement is completed before the offer, then it is a fait accompli and no condition can be invoked thereafter. Hence, if MAC risk is to be avoided, the agreement is to be structured such that it must not be completed until the open offer itself is completed so that both are kept conditional whereby the acquirer is not exposed to the interim MAC risk. In other words, acquisitions under both the agreement and open offer must be completed simultaneously which underscores the “all-or-none” principle enunciated in the post. This approach is also expressly recognised under the Takeover Regulations in Reg. 22 where private acquisitions triggering the offer can be completed only after the offer period, although there is an exception if the acquirer places 100% of the open offer consideration in escrow.

Somasekhar Sundaresan said...

Imagine a blind person walking on a busy road known to be a busy one (and therefore risky for the blind man) but one in which traffic rules apply. At a red signal, the traffic is expected to stop. The blind man is forced to comply with certain requirements like using his white stick, which he scrupulously does. Then imagine the blind man getting knifed and robbed.

Holding that the brunt of a corporate fraud that belies all known and published information is to be borne by an innocent acquirer who makes an informed decision trusting the information available to him, and which information turns out to be fraudulent and even worse, far more adverse than what it purports to be, is like saying the blind man should have been up and ready for being robbed and knifed and that he deserves no protection because (a) he should have been able to see despite blindness; (b) despite being blind, he walked on a risky busy road full of traffic; and (c) being knifed and robbed is excusable because traffic could have in any case killed him.

Every man is liable to suffer business losses on the basis of informed decisions taken by him using the information legitimately available to him. No man should be condemned to being cheated and defrauded with no protection from the law in a mature and civil society.

Curtailing SEBI's power to permit withdrawal to only cases of legal impossibility is unbelievably illogical. An action that is legally impossible to perform does not need permission for not being performed. The law prohibits it from being performed in any case!

The Supreme Court is always right because it is final. It is not final because it is right.

Disclosure: I was involved in the appeal against the SEBI Order rejecting the withdrawal.

Anonymous said...

Mangesh Patwardhan

I think the Supreme Court reached the right result but, it is submitted with respect, through partially flawed analysis. The policy underlying open offer requirement is that when I buy shares in company, I do not look at it legalistically (as an investment in a juristic entity with perpetual succession etc….). Rather I repose my Berle-Meansian faith in the current promoter group. If there is a change in control, I should have the right to exit. It is a sort of statutorily granted tag along right to the non-promotor shareholders. It is undeniable that change in control did take place, triggering this right. The issue whether Nirma was defrauded by the target company promoters, and if so what remedies it has against THEM is totally distinct from the one involved here. Therefore, in my humble view, the Court could have avoided the remarks on Nirma walking into the situation with `open eyes’ and still reached the same result.

Even otherwise, allowing Nirma to withdraw the open offer or reduce the offer price does not change anything for the target company promoters. Only that the burden of their alleged fraudulent conduct is redistributed by putting some of it on the minority shareholders. With your analogy, it is like allowing the blind man (who was robbed) to rob someone else to recoup part of his losses, while the robber goes away scot free! This of course is an atypical case, arising out of invocation of pledge by a non-bank / FI. In the normal case, the acquirer would be able to void the original acquisition agreement if fraud is discovered, also eliminating the need to make an offer.

However, I do agree with you that the erstwhile Regulation 27 is superfluous, for the reasons stated by you.

Vijay said...

The target should have been wound up. Nirma shouls have filed petition for winding up and got order appointing OL in target. This would create legal impossibility for open offer. No point trying to just used SAST

Anonymous said...

Readers, who are following this case may want to read a further development pertaining to this case.

Rushab Dhandokia
Studet, Institute of Law- Nirma University.