Under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Regulations”), an acquirer must make a mandatory open offer to acquire the shares of the remaining shareholders when the acquirer acquires shares (with voting rights) beyond prescribed thresholds. Since the triggers are based on the acquisition of shares with voting rights, questions could arise whether shares issued by a company to an ESOP Trust under the SEBI (Share Based Employee Benefits) Regulations, 2014 (“SBEB Regulations”) would be considered for purpose of computing the triggers. This question came up in a request for informal guidance made by Capital Trust Limited to the Securities and Exchange Board of India (SEBI).
One of the promoters of Capital Trust holds 43.26% shares in the company. The company wishes to issue new shares to its ESOP Trust (set up for the benefit of the employees) and simultaneously wishes to convert certain pending warrants issued to the promoter into equity shares. Taken on a post-diluted basis after considering the issue of shares to the ESOP Trust, the increase in the promoter shareholding will be 4.99%, i.e. within the 5% creeping limit that would trigger the requirement for the promoter to make an open offer. The company requested SEBI’s informal guidance on two counts: (i) whether the shares allotted to the ESOP Trust would be taken as increase in share capital for the purpose of calculation of the conversion of warrants into equity shares; and (ii) whether the issue of shares to the promoter upon conversion of warrants is below the creeping acquisition limits prescribed in regulations 3(2) and 3(3) of the Takeover Regulations.
In response, SEBI issued an informal guidance on December 22, 2016. On the first question, SEBI examined the SBEB Regulations and found that under regulation 3(5) thereof the trustees of an ESOP trust are prohibited from voting on shares held by them “so as to avoid any misuse arising out of exercising such voting rights”. In other words, shares held by an ESOP Trust would effectively be disenfranchised.
This then leads to the answer to the second question on whether the mandatory offer requirements under the Takeover Regulations are triggered. Consequentially, SEBI found that the issue of shares to the promoter would exceed 5% of the voting rights in the company, and hence the promoter would be required to make an open offer to the other shareholders by virtue of creeping acquisition.
Although SEBI’s informal guidance is not explicit as to its reasoning, this outcome ensued because the shares held by the ESOP Trust would not be counted towards the computation of voting shares in the company. Since, in determining the open offer triggers, only the shares with voting rights are considered both in the numerator and denominator, the shares held by the ESOP Trust would be effectively disregarded for this purpose. Hence, the percentage of voting shares issued to the promoter would be computed without taking into account the shares issued to the ESOP Trust, and the issuance of such shares will exceed 5% thereby extending beyond the creeping acquisition limits and triggering and open offer.
In all, given that there is a prohibition on voting by trustees of an ESOP Trust, it is not possible circumvent creeping acquisition limits by structuring an issue of shares to the ESOP Trust, as the present informal guidance from SEBI categorically establishes.