Saturday, June 27, 2015

Analysis of the New SEBI Promoter Re-classification Norms

[The following guest post is contributed by Shashank Prabhakar, a Senior Associate with Finsec Law Advisors. These are the author’s personal views]

Shareholders in a listed company are classified under two broad categories, i.e., those that belong to the promoter / promoter group and those shareholders who are members of the public with no familial or formal business ties with the promoter / promoter group. The Securities and Exchange Board of India (SEBI), in its last concluded Board Meeting on June 23, 2015, has announced its intention to put in place a regulatory mechanism for re-classification of promoters of listed companies as public shareholders. Till date, there were no specific rules in place which allow a promoter or a member of a promoter group to exit this so called “group” and become a “public shareholder”.

Regulation 2(za) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations) defines a “promoter” to include (a) person or persons who are in control of the issuer; or (b) person or persons who are instrumental in the formulation of a plan or programme pursuant to which specified securities are offered to public; or (c) the person or persons named in the offer document as promoters. “Promoter group” inter alia includes promoters, their immediate relatives (spouse, parents, siblings, children of the person or that of spouse) and any body corporate in which 10% or more of the equity share capital is held by the promoter or an immediate relative of the promoter or a firm or Hindu Undivided Family (HUF) in which the promoter or any one or more of his immediate relative is a member. Those shareholders falling outside the scope of promoter / promoter group definitions are considered to be public shareholders.  

According to the SEBI press release, a promoter’s shareholding may be reclassified and can become public shareholding in three situations, i.e., when (a) there is a change in the promoter; or (b) death of the person named as promoter; or (c) when a company becomes professionally managed. I shall now analyze all the three situations and the conditions thereunder that need to be satisfied for successful reclassification.

Change in promoter

A change in the promoter of a company may occur when a new promoter replaces the existing promoter through an acquisition of shares or control that results in an open offer being made under SEBI’s Takeover Regulations or in any other manner, subject to two more conditions: (a) that the outgoing promoter’s shareholding is less than 10% and (b) the outgoing promoter will have to obtain the approval of the shareholders of the company in a general meeting for de-classification as a promoter (which seems to be an ordinary resolution).

These two conditions appear confounding. As is clear from the definition of promoter, no shareholder approval is necessary for one to be named as promoter. There are no barriers to entry into this club of “promotership”. As per the definition, the promoter does not even have to hold 10% of the target’s equity to call such shareholder a promoter. But once a person been named as a promoter, such person cannot become a public shareholder until he or she hold less than 10% and obtain shareholders’ approval! What if the existing promoter holds more than 10% but obtains the approval of the shareholders to continue as a public shareholder? Or consider a situation where the existing promoter never held more than 10% and a new promoter replaces such person by making an open offer to acquire shares and control under the Takeover Code. Will the existing promoter still have to take the shareholders’ approval in a general meeting to be re-classified as a public shareholder if such person decided to hold on to the stake (which was less than 10% to begin with) for mere investment purposes with no role to play in the management of the company? From that perspective, the imposition of a 10% threshold in order to be eligible for re-classification appears to be wholly arbitrary. The rationale for obtaining shareholders’ approval is also unclear and it may prove to be onerous not only for the existing promoter but also for the new promoter and the company, as they will now have to expend considerable resources in calling for a general meeting and putting this item up for vote. It is also unclear as to how it may benefit the company or the public shareholders, if at all.  

It also seems that SEBI wants the outgoing promoters to have very little, if not nothing, to do with the target company after they have been re-classified as public shareholders. The Press Release specifies that the outgoing promoter will have to obtain prior approval of the shareholders of the target if he or she wants to continue as a key managerial employee (KMP) in the target and in any case their appointment cannot exceed 3 years from the date of the shareholders’ approval. I find this condition very perplexing. What is the specific market failure or lacunae in corporate governance norms, if any, that SEBI is trying to address? It is obvious that SEBI is trying to prevent a Diageo vs. Dr. Vijay Mallya type of situation, in the future, by not only making it more difficult to retain erstwhile promoters in a professional capacity but also by imposing an absolute ban on them from continuing in the company for more than three years.

Promoter by way of inheritance

SEBI has clarified that in cases of transmission / succession / inheritance, the inheritor shall be classified as a promoter. The press release can be treated as a mere clarification of the existing legal position. Regulation 10 of the Takeover Regulations provides an exemption from making an open offer in cases of transmission / succession / inheritance.

Re-classification when no identifiable promoter

SEBI has allowed existing promoters to be re-classified as public shareholders where the company becomes professionally managed and does not have any identifiable promoter provided that no person or group along with persons acting in concert with them can collectively hold more than 1% of the company’s shares. However, mutual funds / banks / insurance companies / financial institutions / FPIs can each hold up to 10% of the shares of the company. Most listed companies in India are family run and professionally managed firms are few and far between.

As far as the first condition is concerned, I feel that the threshold of 1% is extremely low. There could be situations where the existing promoters may cease to exercise control or manage the affairs of the company, directly or indirectly, but may want to retain their shares for purely investment purpose and continue in the company as a public shareholder. By setting the threshold so low it also appears that SEBI is not comfortable with a promoter-less company.

It is also crystal clear that SEBI is not in favour of a situation where the erstwhile promoter holds an important position in the company. He / she is required to obtain the shareholders’ approval to continue as a KMP and in any case the appointment cannot exceed more than 3 years from the date of approval.

Additional Conditions

SEBI has also imposed certain additional conditions which are required to be satisfied for completion of reclassification, the most important of which are: (a) The existing promoter shall not have any special rights through any formal or informal arrangements; (b) even after the existing promoter’s shares have been reclassified as public, his / her shareholding cannot be counted towards achieving minimum public shareholding norms under the listing agreement read with Section 19A of the SCRA.

The draft paper on promoter reclassification that was released by SEBI for public comments specified that “post-reclassification, no shareholding agreement shall exist and all past agreements between (i) outgoing promoter / promoter group entities and the continuing promoter / promoter group entities and (ii) outgoing entities and the company, shall be made null and void.” The SEBI Notification of October 3, 2013, has allowed promoters of listed companies to enter into shareholders’ agreement with certain special rights between such shareholders. For example, put and call options, tag along rights, drag along rights, etc. under shareholders’ agreements are now valid. The existence of put and call options between two shareholders does not threaten either the company or other shareholders who are not party to the shareholders’ agreements. Further, the very concept of “special rights” is vague and will need to be clarified by SEBI. The existence of such rights between shareholders does not create any confusion as far as deciding the issue of control of the target company is concerned. It would have been acceptable for SEBI to bar the existing promoter from entering into any agreement which would confer voting rights on him / her disproportionate to his / her shareholding, but to ban all “special rights” seems a little excessive.

The second condition, interestingly, creates a third category of shareholders who are neither promoters nor public shareholders! Post re-classification, for the limited purpose of calculating the company’s total public shareholding for the purpose of compliance with Section 19A of the SCRA read with clause 40A of the listing agreement, the erstwhile promoter’s shareholding will not be considered even though for all other purposes the erstwhile promoter is actually a public shareholder!

Conclusion

In light of the arguments presented above, I feel that SEBI has been over cautious and has needlessly complicated the process of re-classification and made it onerous on the outgoing promoter. A simpler approach would have been to subject the issue re-classification of promoters to the test of “control” under the Takeover Code, given that the definition of control takes into account both de facto and de jure control and also given that it has been extensively tested in courts / tribunals. Additional protections that SEBI may feel necessary can be built on this basic premise. In such a scenario, if the outgoing promoter is not found to be in “control” of the company, then he / she should not be classified as a promoter. Those who seek re-classification of their shareholding may apply to SEBI with reasons stating why they are not in “control” of the company and SEBI may apply its mind and decide whether the applicant’s shareholding is eligible for reclassification. It has been my experience that SEBI has always insisted that those acquiring shares or control under the Takeover Code have been asked to classify themselves as promoters of the target company. Under this approach, once the open offer has been completed and a new promoter has been formally announced, the outgoing promoter can be classified as a public shareholder, as has been done in many instances in the past.   
 

 - Shashank Prabhakar

2 comments:

Chandragupta said...

Why does a company, once listed, need a classification called " promoter" in the first place?

Shreya said...

Conceptually there shouldn't be a problem with that, since public shareholding only needs to be at 25% minimum. Regn. 31A of SEBI's LODR regulations also require such a breakdown