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.
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.
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.