Monday, April 10, 2017

Has SEBI Altered Its Position on the Question of “Control”?

The issue of what amounts to “control” for purposes of the SEBI Takeover Regulations has been a vexed one, and has eluded any form of resolution for nearly 15 years. In a paper titled “The Nature of the Market for Corporate Control in India”, I have sought to summarize the present position (footnotes omitted):

Under Indian takeover regulation, it is possible to trigger the [mandatory bid rule (MBR)] even without acquiring shares or voting rights, which aggravates the severity of the rule for acquirers. This occurs when the acquirer directly or indirectly acquires control over the target. It has been the subject matter of considerable controversy in India as it has attracted significant attention of the regulator and the courts. …

In Subhkam Ventures v. Securities and Exchange Board of India, the SAT was concerned with the typical case where a financial investor took up a 19.91% stake in the target. The SAT closely analysed the contractual arrangements between the parties. It concluded that the investor’s right to nominate one among several directors on the board of the target did not confer upon it any control. Similarly, that the investor has affirmative or veto rights whereby the approval of the investor is required for the target to undertake several actions was insufficient to constitute control. These rights were in the form of protective provisions to safeguard the investment and therefore do not confer any control on the investor. This decision provided considerable relief to the investing community in India, who were able to successfully advocate their position seeking a narrow definition of control. But, the euphoria was short-lived, as SEBI preferred an appeal to the Supreme Court of India. Although a ruling from the highest court was expected with great anticipation, that was not to be as the parties settled during the pendency of the appeal. An added disappointment arose when the Supreme Court clarified that the order of SAT will not be treated as precedent and that the question of law was being kept open.

In all, SEBI continues to have the leeway to exercise a subjective determination of control, which it does in fact exercise quite widely, and the concept of ‘control’ continues to complicate matters under the Indian legal regime, particularly with respect to the MBR. Since potential acquirers in targets may be foisted with the MBR even though they stay beneath the initial quantitative threshold, this will have a chilling effect on takeovers and the market for corporate control.

Despite a rigid stance adopted by SEBI over the years, there appears to be more recent softening on its part. For instance, over a year ago it issued a Discussion Paper on “Brightline Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations” in which it sought to suggest alternatives to the current regime so as to introduce greater certainty to the concept of “control” under the SEBI Takeover Regulations.

More recently, there has been further indication that it might be willing to reconsider its stance. This emerges by way of SEBI’s order dated March 31, 2017 in the case of Clearwater Capital Partners and Kamat Hotels (India) Limited. In this case, Clearwater made a takeover offer by virtue of an increase in its shareholding from 24.50% to 32.23% that was due to a conversion of bonds held by it. As was the case in relation to several takeover offers, when Clearwater filed the draft offer document with SEBI it was asked to include a clause that the offer requirement was triggered by its acquisition of “control” in addition to its acquisition of shares. Due to stiff resistance from Clearwater, SEBI finally permitted it to proceed with the offer after making appropriate disclosures. Subsequently, it issued a show cause notice to Clearwater.

SEBI’s essential concern pertained to special rights that Clearwater obtained under its agreement with Kamat Hotels, and whether that amounted to “control”. The SEBI order notes:

It is observed that the provisions of the agreement entered into by the Noticees were similar to the one in Subhkam Case and such provisions have been interpreted by SAT as not triggering control under regulation 12 of the Takeover regulations, 1997. The apex court, in the appeal preferred by SEBI, kept the question of law, pertaining to the effect of such covenants in a shareholders agreement on the “control” of a company, open and thereby stated that the order passed by SAT will not be treated as precedent. Thus, what ultimately emerges from the given set of facts is that the parameters for trigger of regulation 12 were left undecided by apex court. In this backdrop, I have considered the disclosures made by the Noticees in the offer document. 

More importantly, the SEBI order finds that the protective provisions of the agreement relating to Clearwater’s investment in Kamat Hotels do not amount to “control”. It observes:

With regard to the issue of acquisition of control under the inter-se agreement dated August 13, 2010, I have carefully perused the clauses of the said agreement. It is apparent that the scope of the covenants in general is to enable the noticees to exercise certain checks and controls on the existing management for the purpose of protecting their interest as investors rather than formulating policies to run the Target Company. Further, I note that the shareholder agreement got extinguished on July 31, 2014. Thus, the clauses in the agreement, alleged in the SCN to have conferred “control’ on the noticees, can no longer be considered binding upon the promoters of the company and hence is not relevant for consideration at present. [Emphasis supplied]

On this ground, the action against Clearwater was dropped.

The broader question pertains to whether this signifies a change in SEBI’s stance and thereby enhances the permissibility of protective provisions such as veto rights in a manner that does not amount to conferring “control” upon the investor for purposes of the SEBI Takeover Regulations. As this analysis suggests, at one level this signifies SEBI’s acceptance of protective provisions in shareholders’ agreements involving listed companies without the same constituting “control”. However, it may be more prudent to adopt a more cautious approach. While SEBI has loosened its stance on the issue, it is not clear whether that constitutes a complete reversal as one might expect. This is especially because of the fact that SEBI’s position is represented by the single sentence highlighted in the paragraph above. In other words, SEBI’s order does not contain the level of reasoning one witnesses in such cases, or as seen in the SAT’s order in the Subhkam case. Moreover, SEBI’s reasoning is based on the specific facts of the case, including that the agreement in question was not meant to be long-lasting, and had in fact on July 31, 2014. Hence, it will be necessarily to place the importance of the ruling in its specific context. It might be that the final answer will emerge by addressing this issues through an amendment to the Takeover Regulations. However, it is unclear whether such an approach will be forthcoming, especially given that more than a year has elapsed since the Discussion Paper on Brightline Test was issued and there has been no further word on how, if at all, SEBI will implement that proposal.


1 comment:

vswami said...

SEBI as the regulatory authority over stock markets has presumably, in mind, the principal objective of protecting the larger interests of the investors in listed companies.
Per contra, it is altogether a different objective, or philosophy, with which the same concept of ‘control’ (or ‘controlling interest’) is pressed into service by the FM, in the income-tax regime, for garnering more and more revenue to the Treasury.
An instance in recent memory of that kind is the case of ‘Cairns’. For an analytical personal study, look up @https://www.linkedin.com/…/cairns-tax-dispute-update-swamin…

In both kinds of parallel disputes, in one’s perspective, the very fundamental issue that is still commonly struggling to receive a binding judicial view is, - what is really of relevance and should be the deciding criterion,- is it ‘de facto’ or ‘de jure’ ‘control’ ?

Any different but better perspective, the enlightened law pundits may have, and wish to share !