[By Abhinav Gupta and Aayush Khandelwal]
The authors are students at National Law University, Jodhpur.
Introduction
The Securities and Exchange Board of India (‘SEBI’) on August 19, 2020, issued a consultation paper to rejig the threshold for minimum public shareholding (‘MPS’) in companies which have undergone a resolution process under the Insolvency and Bankruptcy Code, 2016 (‘IBC’) and seek to relist following the resolution process. To enable MPS compliance, the consultation paper also proposes relaxation in the lock-in requirements of the shareholding of the incoming investor or promoter. In this article, the authors provide an insight into the proposals put forth by SEBI and the rationale behind the same. Further, they undertake an analysis of the viability of the options so suggested by the SEBI.
Existing Norms Governing MPS and Lock-In Requirements for Such Companies
Every listed company has to maintain a minimum of twenty-five percent public shareholding as mandated by Rule 19A(1) of the Securities Contracts (Regulations) Rules, 1957 (‘SCRR’). This mandate is known as the ‘public float’ rule. SEBI vide an amendment in 2018 allowed buyer in a resolution plan to acquire more than seventy-five percent of shares in a company which is otherwise restricted due to the ‘public float’ rule (see Regulation 3(2) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011).
However, as per rule 19A(5) of the SCRR, a company has to increase the public shareholding to twenty-five percent within three years if the public shareholding falls below twenty-five percent but is above ten percent, pursuant to the implementation of a resolution plan under the IBC. The rule further provides that if the public shareholding falls below ten percent then it must be increased to at least ten percent within eighteen months from the date of such fall.
Further, the preferential issue of equity shares in terms of resolution plan approved under the IBC is exempted from complying with the provisions of Chapter V of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’). The only condition applicable is the lock-in period of one year (see Regulation 167(4) of the ICDR Regulations). This lock-in period implies that the shares issued pursuant to the resolution process cannot be sold by the shareholder for a period of one year from the date of trading approval.
Proposals by SEBI
SEBI has proposed the following suggestions in the consultation paper.
Changing the period to achieve MPS:
SEBI has suggested three options to rejig the threshold for MPS:
- Companies may be mandated to increase the public shareholding to ten percent within six months against the existing duration of eighteen months. They must increase the public shareholding to twenty-five percent within three years.
- Companies may be required to have at least five percent public shareholding at the time of relisting. They must increase the public shareholding to ten percent within twelve months, and twenty-five percent in the next twenty-four months.
- Companies may be required to have at least ten percent public shareholding at the time of relisting. They must increase the public shareholding to twenty-five percent within three years.
Relaxation of the lock-in period:
Another proposal by SEBI is to dilute the lock-in period requirement for the incoming investors. The rationale behind removing the period is that the lock-in period of one year on the equity shares of the incoming investor restricts the dilution of shares to comply with MPS norms. However, the relaxation of the lock-in requirement shall only to the extent which enables MPS compliance.
Disclosures pursuant to the approval of the resolution plan:
The consultation paper also proposes a standardized reporting framework pursuant to the approval of the resolution plan under the IBC. The proposed disclosure will incorporate detailed pre and post shareholding patterns, details of funds infused, creditors paid-off, additional liability on the incoming investors, the impact of the resolution plan on the existing shareholders, etc. Under the current provisions, the company is required to disclose only the salient features of the resolution plan approved under the IBC. SEBI is of the view that such additional disclosures may aid the public shareholders in the price discovery mechanism on re-listing of shares.
An Analysis of the Proposals by SEBI
Various relaxations to companies that have undergone the resolution process were given to facilitate the effective and timely resolution of the listed companies. The significant change in management during resolution proceedings prompted the regulator to ease certain norms and provide a suitable framework for compliance with securities law. However, such relaxations may sometime prove to be counterintuitive. For instance, the relaxation in the public float rule may lead to extremely low public shareholding which can be seen in the case of Ruchi Soya Industries Ltd. Post-resolution the public shareholding in Ruchi Soya Industries came down to a meager 0.97% and the share prices saw an increase of 8764% (from INR 17 to INR 1519).
Such a low public shareholding raises concerns with respect to fairness and transparency, price manipulation, and the requirement of increased surveillance measures. Moreover, if a certain limited set of people hold most of the shares it would lead to manipulation or perpetration of other unethical activities in the securities market and limited participation in trading of shares resulting in demand and supply gap. This aligns with the observation of SEBI in the matter of E-land Apparel Ltd. that, “a dispersed shareholding structure is essential for the sustenance of a continuous market for listed securities to provide liquidity to the investors and to discover fair prices.”
According to SEBI, these concerns can be tackled only after a minimum of ten percent of shares of a company are held by the public. For this reason, the regulator intends to lower down the relaxation period provided to achieve MPS. However, in our opinion, reducing the period to achieve MPS is concerning and poses a wide array of issues.
The manner in which companies can achieve MPS is complex procedures. It may take time to issue shares to the public while complying with the provisions. A timeline as low as six months might not be sufficient to conduct proper due diligence and compliances. In addition to this, promoters who have to sell a huge quantity of shares through ‘offer for sale’ within such a limited time might have to reduce its floor prices to make it attractive for the public. Moreover, if the promoters seek to reduce their shareholding within a short span of time it might lead to high price volatility. It becomes further important because SEBI has adopted a strict stance in cases of non-compliance. For instance, in the matter of Sayaji Hotels Limited, SEBI refused to take into account failure to achieve MPS for reasons such as lack of response from existing shareholders, bad profit history, and recession in the industry. Such strict enforcement within short deadlines might prompt companies to not relist in the first place which defeats the objective sought to be achieved by the regulator through these proposals.
As regards to the proposal of having five percent MPS on relisting, currently, there is no requirement of MPS for relisting. However, it is highly unlikely that a threshold as low as five percent is enough to address the concerns which prompted such changes in the first place. The only benefit of having such a low threshold is that the incoming investors may be incentivized to keep the corporate debtor listed post-resolution considering under the current regime only six companies chose to remain listed post-resolution (see Annexure 2 of the consultation paper).
The second proposal with respect to the removal of the lock-in period is in line with the objective of SEBI to expedite the process of achieving the minimum public shareholding post-resolution process. Considering the regulator seeks to reduce the time limit to achieve MPS, it is indispensable to remove the one-year lock-in period, as such a lock-in period prevents the investors from transferring their shares. Furthermore, it will not adversely affect the objective of stabilizing stock prices after the resolution process, considering this relaxation is provided only to the extent of facilitating MPS requirements.
The third proposal regarding setting up a standardized disclosure framework provides a comprehensive set of information that assists the investor in decision making. These disclosures will further help companies in achieving MPS as information such as future business strategy might attract prospective investors by providing them with an insight into the prospects of the company.
Conclusion
The proposals by SEBI are a positive step towards ensuring stability and liquidity in the market. SEBI has in earlier instances realized the need of the market and provided relaxation to companies that have undergone resolution. Whilst it is important to ensure that these relaxations are not counterintuitive, at the same time it is pertinent to keep practical considerations in mind. Removal of the lockdown period is important to achieve the MPS within a specified limit. However, such a time limit should be decided by keeping in mind hurdles that companies might face in issuing shares to the public. A reasonable amount of time has to be given to the companies to comply with the provisions. Hence, in our opinion the removal of the lock-in period and increased disclosure requirements are welcome moves, reducing the time limit to achieve MPS is a bit concerning. It is yet to be seen how the stakeholders react to the proposals by the SEBI and whether it sufficiently tackles the problems it seeks to address initially.