[By Chaitanya Vohra]
The author is a student of Rajiv Gandhi National University of Law, Punjab.
Introduction
In the corporate realm, one of the pertinent factors that affect the Ease of Doing Business is an investor-friendly environment. Hostile takeovers are successful acquisitions of a target without the green signal from the management of the target, thereby being viewed as pro-investor and anti-management of the target. Investors have a potential to benefit from hostile takeovers by virtue of receiving premium for their shares in cases of sell-out or a natural boost to their dividends in cases of threats of hostile takeover, thereby positively contributing to that investor-friendly environment, which will causally improve the Ease of Doing Business. Nevertheless, the route of hostile takeover is very rarely taken and is considered uncommon in India.
Although hostile takeovers are not expressly recognized and classified in SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘Takeover Code’), there are no statutory hurdles to the same under the Takeover Code. Upon scrutiny, the answer to the obvious question of the non-prevalence of hostile takeovers can be accredited to the combination of strong promoter influence, mandatory disclosure requirements, and strict regulatory controls over takeover offers. It is important to note that hostile takeover attempts will rise in future with increasing corporate restructuring and foreign investment, and such a change is considered inherently beneficial as it would facilitate corporate competence and foster capital market development.
The advent of hostile takeovers in India means the emergence of defence strategies adopted by the management of the target to deter the potential acquirer from a successful acquisition. This article highlights the prevalence of promoter-driven companies, which immensely help in the effectuation of the defence strategies. However, the promoter-driven companies appear to have been reduced in numbers as per the latest trends. This calls for the need for a robust and effective regulatory framework and, subsequently, the much-needed changes are effectively proposed. Thereupon, a reasonable argument is built which supports the need to expressly accommodate the proposed amendments in its existing regulatory framework. Moreover, these proposed changes will better equip the corporate entities for a shift towards a liberal environment with the surge of global interest in the M&A landscape in India.
The Shift from Promoter-Driven Shareholdings: Implications for Hostile Takeover Defences
The shareholders are ultimate arbiters in scenarios which require the adoption of defence strategies to hostile takeover, given the shareholder-centric nature of Indian law. In this regard, one of the effective ways to defend against a hostile takeover can be having a shareholding structure such that substantial control is in the hands of promoters. It is pertinent to note that such was the case in the recent past, as concentrated promoter shareholdings were a norm in this sense. However, these promoter-driven companies are no longer seen to be in trend due to the advent of investments by virtue of private equity funds and institutional investors. Acknowledging these changes, SEBI released a consultation paper seeking comments with respect to shifting from the concept of ‘promoter’ to ‘person in control’. In support of such changes, it has been prudently observed by SEBI that there has been a substantial reduction of companies having major promoter shareholding in the top-500 listed companies, from 58% in 2009 to 50% in 2018. These statistics heavily indicate the shift, which is the elephant in the room as the regulatory framework does not allow the nascent companies without the traditional shareholding structure to fully avail the defences in cases of a hostile takeover. It is pertinent to note that these defences to hostile takeover are numerous, ranging from poison pill to golden parachutes. However, these defences are toothless in the present regulatory structure. For instance, Regulation 26(c) of Takeover Code prohibits the practical application of poison pill defence mechanism and Regulation 26(d) of Takeover Code prohibits the employment of leveraged recapitalization defence. Thus, it can be implied in the present circumstances that the companies are encouraged to vest a major shareholding with promoters to ensure stability in the company. This is not ideal due to the fact that it emboldens the ongoing norm of promoter-driven companies, thereby punishing those who choose not to follow such a norm with the persistent threat of a hostile takeover. This threat persists due to the lack of a robust regulatory framework that provides for the feasibility of availing defences against hostile takeovers.
Therefore, based on the latest trends, the upcoming companies going away from the concept of promoter-driven shareholdings are put at a significant disadvantage as they cannot avail the appropriate defence strategies of hostile takeovers.
Pinpointing Hiccups in Effective Adoption of Hostile Takeover Defences
Upon a deeper dive, the Indian law appears to rely heavily on the concept of shareholder democracy, which was introduced in the Indian framework by the J.J Irani Committee. While the introduction of such a governance model can be attributed to past events such as the Satyam scandal case, and it presently acts as a safeguard for protecting the interests of shareholders, its application in certain circumstances can be deemed skeptical. One such specific circumstance can be taking the crucial decision of employing a certain defence strategy to avert a hostile takeover.
The shareholders acting as sole arbiters in this regard can amount to gross injustice to the future of the company due to the indifferent attitude of Indian shareholders towards understanding the policies and future objectives of the company. Hence, Indian shareholders appear to be gullible when their interests lie in reaping monetary benefits, as opposed to corporate successand preservation, thereby implying the slow death of the practicality of availing defences. It can be said that the shareholders who are not personally invested and associated with the company, as opposed to promoters, tend not to represent the class of long-term investors, which means that they are much more likely to bend to the will of potential acquirers in a hostile takeover by virtue of selling their shares at a premium, as opposed to supporting the stance of management.
Proposing Solutions
Consequently, this situation sends a message to all the companies to continue the ongoing norm of having a concentrated ownership structure in India. This ought to change, especially with the changing business dynamics and environment. Hence, this calls for a regulatory overhaul whereby some of the proposed solutions can be implemented.
One such solution can be giving explicit recognition to hostile takeovers and granting legal status to the defence strategies by stipulating certain legal principles and exceptions under which the target can equitably defend itself. To successfully implement this, the concept of shareholder primacy must be set aside, as when it is taken into account, the whole purpose of deployment of defence tactics comes down to maximizing economic value for shareholders, as held in Dodge v. Ford Motor Company. Hence, when seen through the lens of shareholder primacy, one comes to the conclusion that directors cannot deploy defence tactics which renounce wealth maximization of shareholders, as held in eBay Domestic Holdings, Inc. v. Newmark.
Additionally, the autonomy of management in certain cases like these must be upheld over shareholder primacy, such that the management is well justified in deploying defence tactics to avert hostile takeovers, provided that such a takeover is detrimental to the future of the company. This can be put into practice by implementing the business judgment rule, providing the much-needed relief for management. It is pertinent to note the Supreme Court’s judgment in Miheer H Mafatlal v. Mafatlal Industries, which held that the conduct of the director shall not be subject to judicial intervention, provided that it amounted to taking a commercial decision beneficial to the company.
This would also support the idea of Enlightened shareholder value, as the management can take certain actions and adopt defensive strategies with the view to promote the long-term success of the company. At the present time, Section 179 of Companies Act, 2013 does provide for the powers to the board, but there is a limitation on such powers on events requiring prior shareholder approval, as is necessary to deploy defence strategies under Regulation 26 of Takeover Code. In this regard, Regulation 26 of Takeover Code can be amended to introduce a Justifiable Defence Clause, which would allow the management of the target to seek SEBI’s approval within the offer period for effectuating defensive measures without special resolution in cases where a hostile takeover is against the company’s long-term interests.
Conclusion
The bone of contention lies in the limited feasibility of deploying defence strategies against hostile takeovers due to the existing regulatory framework, which heavily focuses on shareholder-centrism. Coupled with the rarity of alignment of interests between shareholders and management of the company, this issue becomes altogether more strenuous. As of now, this challenge is resolved by virtue of having promoter-controlled shareholdings in the company. However, with the recorded trends of moving away from the norm of promoter-driven companies, the issue of adequately defending against hostile takeovers is an unaddressed question. Therefore, the problems for availing defences with the present regulatory framework that nascent companies without the traditional and promoter-driven shareholding structure face are sufficiently highlighted, which include the prevalence of shareholder primacy over management’s autonomy in carrying out these crucial decisions for the company, coupled with the prevailing money-minded mindset of Indian shareholders. It is crucial to address this burning issue in the near future, as inaction could unintentionally imply support for the continued norm of promoter-controlled companies.