Friday, January 27, 2017

Supreme Court on Board Appointments During a Takeover Offer

Background

In Securities and Exchange Board of India v. Burren Energy India Limited (decided on 2 December 2016), the Supreme Court of India was concerned with a couple of issues relating to the technical interpretation of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (the “1997 Regulations”). This case involved an indirect acquisition of shares by an English company (Burren) of the Indian target company (Hindustan Oil Exploration Company Limited) through a Mauritius holding company. The acquirer entered into an agreement on 14 February 2005 to acquire the entire shares of the Mauritius holding company that in turn held 26% shares in the Indian target company. The acquisition of shares was completed on the same day. On that very day, the acquirer appointed two of its nominees as directors on the board of the target company. Since this amounted to an indirect acquisition of shares by the acquirer in the target company, which exceeded the 15% threshold prescribed for a mandatory offer, the acquirer made such an offer on the very next day, i.e., 15 February 2005.

Based on the above facts, the Securities and Exchange Board of India (“SEBI”) found a violation of regulation 22(7) of the 1997 Regulations and imposed a fine of Rs. 25 lakhs on the acquirer. On appeal, the Securities Appellate Tribunal (“SAT”) reversed SEBI’s decision, against which SEBI preferred an appeal to the Supreme Court. In its ruling, the Supreme Court set aside the order of SAT and concurred with the findings of SEBI, thereby reinstating the penalty on the acquirer.

Issues and Ruling

Regulation 22 (7) of the 1997 Regulations essentially provided that during the “offer period”, the “acquirer or persons acting in concert with him" are not to be entitled to be appointed onto the board of directors of the target company. In other words, there should be no change whatsoever in the composition of the board by which the acquirer obtains representation on it without its offer having been completed. Regulation 2(1)(f) provided that an “offer period” is to mean the period between the date of entering into a “memorandum of understanding or the public announcement, as the case may be” and the date of completion of the offer under the Regulations.

Given this legal framework, two questions came up for consideration before the Supreme Court. The first was whether the offer period had commenced on 14 February 2005 when the acquirer obtained the appointment of its nominees on the board of the target company so as to constitute a violation of regulation 22(7). This essentially revolved around the interpretation of the definition of “offer period” under regulation 2(1)(f). The second was whether the obligation under regulation 22(7) was applicable only to individual acquirers who appointed themselves onto the boards of the target companies or whether it was applicable also to corporate acquirers who nominated their representatives to the boards of the target companies. Here, I deal with each of the issues as addressed by the Supreme Court.

As regards the first issue pertaining to the offer period, regulation 22(7) makes references to two events as the starting point for commencement of the offer period. The first is a memorandum of understanding, and the second is a public announcement. In the present case, counsel for the acquirer adopted the argument that there was no memorandum of understanding executed by the acquirer for acquiring shares in the target indirectly, but rather that the parties had straight away entered into a binding agreement.  Hence, in the absence of a memorandum of understanding, the offer period should commence on the date of the public announcement, i.e., 15 February 2005. Since, the directors were already appointed on the previous day, their appointment does not relate to the offer period and hence there is no violation of the relevant regulations. This was also the reasoning adopted by the SAT. However, the Supreme Court did not accept the aforesaid argument made by the acquirer's counsel (that was accepted by SAT). The Court held as follows:

12. ... it is correct that in the definition of 'offer period' contained in Regulation 2(1)(f) of the Regulations, relevant for the present case, a concluded agreement is not contemplated to be the starting point of the offer period. But such a consequence must naturally follow once the offer period commences from the date of entering into a Memorandum of Understanding which, in most cases would reflect an agreement in principle falling short of a binding contract. If the offer period can be triggered of by an understanding that is yet to fructify into an agreement, we do not see how the same can be said not to have commenced/started from the date of a concluded agreement i.e. share purchase agreement as in the present case."

Here, the Supreme Court adopted a purposive interpretation of the definition of “offer period” under the 1997 Regulations, and eschewed a literal and hyper-technical stance taken by the SAT. Hence, it was found that the acquirer was in violation of regulation 22(7) by virtue of appointing its nominees on the date of the acquisition agreement.

As regards the second issue, the counsel for the acquirer argued that regulation 22(7) applies only to individuals and not to corporate entities, as the regulatory provision referred to the appointment of the acquirer on to the board of the target. However, this argument too was not accepted by the Supreme Court, which held:

The embargo under Section 22(7) is both on the acquirer and a person acting in concert. The expression 'person acting in concert' includes a corporate entity [Regulation 2(1)(e)(2)(i) of the Regulations] and also its directors and associates [Regulation 2(1)(e)(2)(iii) of the Regulations]. If this is what is contemplated under the Regulations we do not see how the first argument advanced ... on behalf of the respondents can have our acceptance.

Here, the Court adopted a slightly different approach to interpreting the provisions of the 1997 Regulations to arrive at its conclusion, i.e., by invoking the concept of “persons acting in concert”. The Court was not required to delve into the detailed aspects of persons acting in concert, as the letter of offer circulated to the shareholders clearly showed that the Mauritius company (which nominated the directors on the board of the target company) was acting in concert with the acquirer.

Implications under the 2011 Regulations

While these matters pertaining to a technical interpretation of the 1997 Regulations had to go all the way up to the Supreme Court in view of the varying findings arrived at by SEBI and SAT, there may be some cause to cheer. Both the issues that consumed the attention of these various forums have been addressed in the reforms to takeover law resulting in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “2011 Regulations”). First, regulation 2(p) of the 2011 Regulations defines “offer period” as commencing on “the date of entering into an agreement, formal or informal, to acquire shares, voting rights in, or control over a target company requiring a public announcement, or the date of the public announcement, as the case may be”. Hence, it covers both memoranda of understanding as well as firm agreements, or other formal or informal documents, thereby signifying the earliest time when the acquirer enters into any sort of arrangement to acquire shares in the target that may trigger a mandatory offer. In the absence of any such arrangement (e.g. in a stock market acquisition), the date of the public announcement will signify the commencement of the offer period. Second, regulation 24(1) of the 2011 Regulations provides that during the offer period, “no person representing the acquirer or any person acting in concert with him shall be appointed as director on the board of directors of the target company, whether as an additional director or in a casual vacancy”. By using the concept of a representative, it skirts the issue of whether only individual acquirers are covered or whether corporate entities are as well. The nature of the acquiring entity does not matter, so long as the person is appointed on the board to represent the interests of the acquirer during the offer period. Given this scenario, one may hope that the 2011 Regulation may foreclose the present type of litigation that arises due to lack of clarity in regulation, at least as regards the issues that exercised the mind of the Supreme Court in the present case.


No comments: