Thursday, May 15, 2014

SEBI Order on “Control” Under Takeover Regulations

Background and Facts

Last week, SEBI passed its order in the Jet-Etihad case relating to whether the investment by Etihad Airways in 24% shares of Jet Airways (India) Limited and the terms thereof amount to Etihad obtaining “control” in Jet so as to require Etihad to make a mandatory open offer under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the Takeover Regulations). After analyzing the investment terms, SEBI concluded that no such “control” relationship was created, and hence no mandatory open offer is necessary.

The brief facts that gave rise to the order are that Etihad entered into a set of agreements with Jet and its promoters by which it acquired 24% shares in Jet through a new issue of shares for USD 379 million. Apart from investment related matters, the agreements dealt with commercial matters of cooperation between the two airline companies. When the investment was under consideration by the Central Government, SEBI had expressed its opinion to the Central Government that the investment did not create a relationship of “control” for the purposes of the Takeover Regulations. Subsequently, the deal was cleared by the Central Government (Foreign Investment Promotion Board (FIPB)) as well as the Competition Commission of India (CCI). The CCI, while clearing the transactions, made some observations that indicated a possibility of “joint control” between Etihad and Jet’s promoters, following which SEBI issued a show cause notice alleging possible acquisition of joint control for the purposes of the Takeover Regulations. In this context, SEBI heard the various parties and passed its order.

Findings and Reasoning

In arriving at its conclusion, SEBI was guided by the fact that the FIPB had already concluded that “effective control” of Jet remained with the existing Indian promoters. This is particularly important because the definition of “control” in the Guidelines for Foreign Direct Investment (FDI) in the Civil Aviation Sector are in pari materia with the definition of “control” in Regulation 2(1)(e) of the Takeover Regulations. However, SEBI refused to be guided by the findings of the CCI on the ground that “one regulatory agency may be guided by the findings of other regulatory agency on a particular issue only if the two laws are pari materia in their substance and are being applied on the same set of facts and circumstances.” There are significant differences in the definition of “control” under the Competition Act, 2002 and the Takeover Regulations, and hence the latter needs to be independently examined to determine whether the requirement for a mandatory open offer arises.

In so examining, SEBI considered two broad issues: (i) whether Etihad and the existing promoters and persons acting in concert (PACs) due to the possible “joint control” over Jet; and (ii) whether the rights conferred upon Etihad under the transactions documents confer “joint control” over Jet. SEBI answered both in the negative.

As to the PACs issue, it was found that there was no common objective or community of interest to acquire control over the company. While there was some cooperation under the arrangements, they were between Jet and Etihad and not with the promoters. Hence, the target company itself cannot be considered a PAC.

As to the issue of “control”, it was found that Etihad has the right to nominate only 2 out of 12 directors. Moreover, the governance procedures indicate that material recommendations will be subject to the approval of both parties with the powers and supremacy of the board of Jet being unaffected. Crucially, Etihad does not have any affirmative or veto rights, quorum rights, casting vote or pre-emptive and tag along rights (regarding the transfer of shares).

Based on all of these reasons, SEBI concluded that Etihad is not in “control” or “joint control” of Jet for the purposes of the Takeover Regulations and hence is not obligated to make an open offer to the shareholders of Jet.


SEBI’s decision and reasoning were largely based on the specific facts of the case, which did not require it to delve deeply into the jurisprudence governing the issue of “control” under the Takeover Regulations. The issue of “control” has been the subject matter of controversy ever since the decision of the Securities Appellate Tribunal in the Subhkam case, although that decision was subsequently set at naught by the Supreme Court where the matter was settled. That uncertainty does not seem to have dissipated given that SEBI did not have to go deeply into that question in the Jet case. Unlike in the Subhkam case where the question of whether affirmative or veto rights amount to “control” was directly in consideration, the facts of the Jet case were more straightforward given that Etihad had agreed to amend the terms of the arrangements to reduce the management or control-type rights in order to steer clear of the controversy surrounding “control”. In other words, the more direct facts of the Jet case made the decision somewhat more straightforward.

The principal legal issue that received SEBI attention was the fact that where there are several definitions of “control” in different legislation or regulations, they must be applied by other regulators carefully. They can be given regard by other regulators only if the respective definitions are in pari materia. If not, the purpose and objectives of the different regulations must be considered when being adopted by other regulators. Hence, SEBI showed regard to the definition of “control” under the FDI policy which was in pari materia with the Takeover Regulations, but not the definition in the Competition Act which carried material differences.

Finally, this case also raises the broader question about whether it is possible for an acquirer to stay below the shareholding threshold for mandatory open offers (e.g. 25%) and deprive the minority shareholders of any exit through such offers. Under the scheme of the Takeover Regulations, that depends upon the rights conferred upon such acquirer under contract. If those rights elevate the position of the acquirer to one of “control”, an open offer becomes necessary, but not otherwise. Hence, one of the lessons from this case is for acquirers in such circumstances to structure their rights and position in the target carefully so as to steer clear of any involvement in the management and policy decisions of the target. While that would be determined on a case-by-case basis, the avoidance of some of the rights such as affirmative rights (veto) and quorum provisions may have helped resolved this case in a manner that is favourable to the acquirer.

1 comment:

Abhinandan said...

Business Reality: The initial Commercial Cooperation Agreement (CCA) indicated the intentions of the acquirer to control the target as clearly as daylight. For instance few of the clauses in the earlier agreement meant that:
- The areas of cooperation listed in the agreement were not subject to the approval of the Target
- Restrictions on Target entering into specified global frequent flyer programs
- Acquirer had the right to recommend suitable candidates for senior management positions
- Revenue Management function was to be managed by Acquirer
- Acquirer held the right to take lead in negotiations on aircraft and engine purchases
- Acquirer had prepared a detailed Governance Procedure to be adopted by Target
After the amendments sought by the regulator the Acquirer had a change of heart and chose to play second fiddle to the Target!

Plugging Loopholes

1. The CCI was confronted with a new corporate maneuver. A smaller inter-connected transaction preceding the acquisition was consummated and remained undisclosed. The transaction related to the sale of certain landing/take-off slots of Jet at the London Heathrow Airport to Etihad. The CCI apprehended that the transactions in fact camouflaged a financial implication that indicated circumventing the regulatory threshold on the sly. To plug this loophole, the CCI amended its Combination Regulations. The test whether a transaction should be subjected to pre-merger scrutiny was modified to focus on “substantive business rationale” or the “economic linkages”
2. The definition of control was modified to reflect the actual effect of influencing the decisions rather than just number of directors.

Full article "Acquisition Redefined" at