Friday, June 17, 2016

Wilful Defaulter Provisions: A Spanner in the Works for M&A Transactions?

[The following post is contributed by Malek Shipchandler, a lawyer at Shardul Amarchand Mangaldas & Co. Views expressed herein are solely that of the author and do not in any way represent the views of his organization]

The Indian securities regulator, the Securities and Exchange Board of India (SEBI) recently notified an amendment to the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Regulations) which prohibits a person or entity that is declared a “wilful defaulter” from making a public announcement to acquire shares of an Indian listed company (Listco) or enter into any transaction that would attract the obligation to make a public announcement to acquire the shares of a Listco under the Takeover Regulations (Prohibition). The text of this amendment viz. Regulation 6A reads:

“Notwithstanding anything contained in these regulations, no person who is a wilful defaulter shall make a public announcement of an open offer for acquiring shares or enter into any transaction that would attract the obligation to make a public announcement of an open offer for acquiring shares under these regulations.

Provided that this regulation shall not prohibit the wilful defaulter from making a competing offer in accordance with regulation 20 of these regulations upon any other person making an open offer for acquiring shares of the target company.”

The text of Regulation 2(1)(ze) which defines a “wilful defaulter” reads:

““wilful defaulter” means any person who is categorized as a wilful defaulter by any bank or financial institution or consortium thereof, in accordance with the guidelines on wilful defaulters issued by the Reserve Bank of India and includes any person whose director, promoter or partner is categorized as such;”

Under clause 2.1.3 of the master circular on wilful defaulters dated July 1, 2015 (Circular) issued by the Reserve Bank of India (RBI), a “wilful default” is deemed to have occurred where a person or entity (whether incorporated or not) has intentionally, deliberately and calculatingly defaulted in meeting payment obligations to a lender (a) when it has capacity to make the payment; (b) and has not utilized the finance availed of for purposes designated but instead diverted the funds for other purposes; (c) and has siphoned off funds nor are the funds available in the form of assets and (d) and has disposed off or removed the assets given (for securing the loan) without the knowledge of the lender.

Under clause 2.6 of the Circular, a guarantor (be it a group company of the defaulting entity or otherwise) that refuses to comply with a payment demand made by a lender, is also treated as a wilful defaulter.

A few observations and thoughts in connection with the above are set out below:

1.         Indirect open offers: The Prohibition, by using the language “any transaction that would attract the obligation to make a public announcement” (Language), covers indirect open offers as well. Therefore, hypothetically, where by virtue of an underlying transaction which results in a change in control of a Listco, an open offer obligation is triggered; if the acquirer (or even a person acting in concert with the acquirer) has been declared a wilful defaulter (in capacity of a borrower or guarantor) under the Circular, such acquirer and/or person(s) acting in concert cannot make an open offer – which essentially means, the acquirer and/or person(s) acting in concert cannot enter (or agree to enter) into any underlying transactions. Therefore, the Prohibition does not just extend to transactions directly involving a Listco. An intriguing conundrum would be a case of an overseas transaction triggering an indirect open offer in India where the acquirer or person(s) acting in concert have been declared wilful defaulters – this Prohibition would need to be given thought to while, inter alia, structuring global transactions affecting a Listco and which persons/entities to designate as “person(s) acting in concert” for purposes of the open offer.

2.         Creeping acquisition: The Prohibition does not appear to prohibit wilful defaulters from making creeping acquisitions. Essentially, a wilful defaulter already holding a 25% stake in a Listco, can undertake stake building by acquiring up to 5% in any financial year, since open offer obligations are triggered only when an acquisition is made of a more than 5% stake in a financial year. Whether this leeway (intentional or unintentional) afforded by SEBI actually resonates with its intent reflected at clause 17 of a discussion paper floated by it in January 2016, is questionable.

3.         Exemptions: The Takeover Regulations exempt an acquirer from complying with open offer related obligations if certain transactions and/or thresholds are met with. Examples are inter-se promoter transfers, inter-group transfers and schemes of arrangement (directly or indirectly involving the Listco, whether implemented in India or overseas). The exemption provisions can be availed of when an open offer obligation is triggered. Therefore, it can be mooted that the Prohibition extends to exempted transactions under the Takeover Regulations as well, because, if not for the exemptions, the transaction (i.e. an acquisition) would otherwise trigger open offer obligations. To articulate this interpretation differently: the exemptions can be ‘activated’ only if and when an open offer obligation is triggered; thus. Perhaps, by way of insertion of another proviso (instead of a FAQ or an informal guidance), SEBI could consider clarifying its position.

4.         Competing offers: The proviso to the Prohibition allowing wilful defaulters to make a competing open offer looks out of place and begs the question: why? SEBI’s intent behind this proviso can be gauged from clause 19.4 of the discussion paper floated by it in January 2016 which states: “If a hostile bid is made on a listed company which is controlled by a person categorized as a wilful defaulter, restricting such wilful defaulter from making a counter offer may not be legally tenable.” The question of legal tenability in allowing a wilful defaulter to make a competing offer is another discussion altogether. Be that as it may, SEBI, to align the literal construction of the proviso with its intent, could consider crisping the proviso to state: “… this regulation shall not prohibit a person in control of the target company who is a wilful defaulter from making a competing offer…”, since the extant proviso appears to allow any wilful defaulter to make a competing offer.

5.         Consequences: While SEBI’s insertion of this Prohibition is well intended, there is no express provision spelling out the consequence(s) if a wilful defaulter violates the Prohibition. The author has discussed a similar lapse in relation to another amendment by SEBI here. As such, the consequence(s) under the general provisions of the Takeover Regulations and/or SEBI Act, 1992 will not only fall on the wilful defaulter (and person(s) acting in concert), but also on the merchant banker appointed to manage the open offer.

- Malek Shipchandler


vswami said...

“.......Prohibition is well intended, there is no express provision spelling out the consequence(s) if a wilful defaulter violates the Prohibition.”
“The author has discussed a similar lapse in relation to another amendment by SEBI here.”
To comment:
The point(s) of inadequacy /insufficiency of the subject prohibition(s) lately inserted by the SEBI on the two referred successive occasions, as focused on by the learned lawyer, in one’s independent perspective, are not without substance or merit. To add with the same breath, however, which requires a far more serious / anxious consideration is, how any such prohibition brought into being by a regulatory authority could be effectively and successfully invoked, and enforced, in a case where the faulted default, even if held to be ‘wilful’ by applying the specified tests, is anterior, in point of time, to the date on which the prohibition is notified and brought into being. To be precise, the difficulty as envisaged concerns giving the prohibition a retrospective / retroactive legal effect.
It is commonly known that even in respect of matters coming within the purview of tax (es) regime e.g. income - tax, the government / concerned law and finance ministries , have for valid / sound reasons, as a matter of policy, departing from the historically indulged in obnoxious practice of, unlike until the very recent past , chosen to refrain from retrospective /retroactive enactments, by way of amendments or otherwise.
On the mentioned aspect, readily comes to mind published tax articles, in which own independent thoughts / viewpoints have been shared; citation of one of which is: (2008) 169 TAXMAN 14.

Anonymous said...

Very well thought through, analysed and most importantly articulated. Thanks for this post!

vswami said...

Looking back through the archives it has since been noticed that the comments , wrt an earlier Post @ though not posted or displayed on the website of ICL, - as then covered in a personal blog, copied and pasted below* - gave rise to a like piquant situation :
Any such action by a regulatory authority, SEBI being one among the lot, with the object of 'regulating' the market players' activities, unless initiated so also completed promptly, or in any event within a reasonable time frame, cannot but in the nature of things, prove futile, rather stale.
This is a bizarre instance in which SEBI cannot be regarded to have displayed any diligence in discharging its duties. Especially, what is required is that the facts and circumstances to be kept in view for coming to a right conclusion were those as obtained at the relevant point time i.e. year 2000. The point to be seriously considered how is it possible to bring on record any evidence to support a stand that SEBI has chosen to take after a lapse of years passed by.
The above added feedback is simply intended to focus on the fact that the want of diligence as displayed, and noted, nearly four years ago has remained to be realised as yet.

Manya Agarwal said...

What about convertible bonds, or corporate bonds? Does this extend to them as well?