Saturday, March 19, 2016

Brightline Test for Acquisition of Control

[The following guest post is contributed by Supreme Waskar, who is a corporate lawyer]

In the backdrop of ambiguity and concerns in relation to acquisition of ‘control’ of a listed target company, the Securities and Exchange Board of India (“SEBI”) has initiated a consultation process by way of its discussion paper dated March 14, 2016 (“Discussion Paper”).

Existing scenario

The term control as defined in regulation 2(1)(e) of the SEBI (Substantial Acquisition and Takeovers) Regulations, 2011 (“Takeover Regulations”) provides for broad set of circumstances which would constitute control and at the same time it has left the scope open to include factors to be covered within the ambit of the definition. The existing definition of control under regulation 2(1)(e) of the Takeover Regulations requires consideration of facts and circumstances of each case, and as a result there have been multiple inconsistent views. Control is based on certain defined principles rather than on rules and there have been cases when a multitude of opinions gives rise to different assessments of what amounts to control over a listed company and have led to significant litigation in the past. In view of this, the Indian capital market regulator, SEBI, has proposed a bright line test for acquisition of control. 

SEBI propositions 

SEBI in its discussion paper has broadly suggested a list of two options: (1) adopting a numerical threshold of 25 per cent voting rights; or (2) putting in place a framework for protective rights.

(1) Adopting a numerical threshold of 25% voting rights

In the first option, SEBI has proposed a 25% voting right threshold or the right to appoint majority of non-independent directors as determining factors to identify control. Since the Companies Act recognizes any holding in excess of 25% as the threshold at which special resolutions can be blocked, it would be appropriate that 25% may also signify the threshold level for trigger of control in India.

(2) Framework for protective rights

In the second option, SEBI has proposed an illustrative list of protective rights that will not amount to acquisition of control subject to satisfaction of certain conditions. Under the protective rights, SEBI has proposed instances which will not amount to exercise of control in any manner.

(i)        Appointment of chairman/vice chairman: May be a nominee of an investor, provided the person does not hold any executive position and does not have a casting vote.

(ii)       Appointment of observer: Shall not have any voting or participation rights.

(iii)      Customary lender covenants: Banks/non-banking finance companies (NBFCs) may have customary covenants specified by lenders.

(iv)      Commercial Agreements: Rights conferred on the parties to a commercial agreement would not amount to control, provided it is for mutual commercial benefit and the board of the target company shall have approved, has the right to terminate and have the right to enter into similar arrangement with any other party.

(v)       Veto/Affirmative Rights: SEBI has provided illustrative list of veto/affirmative rights in matters that are not part of the ordinary course of business or involve governance issues and would be considered as protective in nature and would not amount to exercise of control over the target company.

(vi)      Quorum rights: For meetings involving the illustrative list of veto/affirmative rights: If 2 meetings are not quorate, the next meeting would be deemed to have quorum despite the absence of the investor nominees.  

The above-mentioned protective rights shall be subject to several conditions, such as:

(i)        Min 10% investment: The respective investors must invest at least 10% in the target company;

(ii)       Public shareholders approval: The grant of such rights will be mandated to required public shareholders’ approval (majority of minority);

(iii)      Incorporation in articles of association: The aforementioned protective rights shall also be incorporated in articles of association of the company;

(iv)      IPO: In case of an iniital public offering (IPO), the existing agreement needs to be modified or cancelled until the approval of public shareholder is taken after the listing.


- Supreme Waskar

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