From Blurred Line to Bright Line: Concept of Control under the Takeover Law.

[Deeksha Malik]

The author is a Fifth Year B.A. LL.B. (Hons.) student at NLIU, Bhopal

The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter “Takeover Code”) prescribes a threshold limit of 25% of shares or voting rights in the target company which, when triggered, would require the acquirer of such shares or voting rights to make an open offer by way of a public announcement.[1] Irrespective of such acquisition, an acquirer is also obligated to make such an offer when he acquires control over the target company.[2]

Regulation 2(1)(e) of the Takeover Code provides an inclusive definition of “control”, taking within its ambit the right to appoint majority of directors to the Board of the target company or to control the management or policy decisions of the said company by a person acting individually or in concert with other persons, either directly or indirectly, including by virtue of their shareholding, management rights, shareholder agreements, voting agreements or in any other manner. The definition expressly excludes exercise of control by a director or other officer of the target company merely by virtue of his holding such position.

At this juncture, it is pertinent to note that the Bhagwati Committee, the recommendation of which formed the basis on which the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 were framed, suggested that though it is difficult to lay down a precise definition of “control” on account of the numerous different ways in which it could be exercised over a company, it is necessary to provide a broad inclusive definition which would “serve to indicate the circumstances when compliance with the provisions of the Regulations would be necessitated, even where there has been no acquisition of shares, so that SEBI would not be on an unchartered sea in investigating whether there has been change in control.”[3]
It is against this backdrop that SEBI on March 14, 2016 came out with a discussion paper seeking comments from the public over the issue of the concept of control under the takeover law.[4]

Various Approaches to Determination of Acquisition of Control

Essentially, there are both objective and subjective tests to determine acquisition of control. The quantitative approach focuses on numerical thresholds in order to ascertain whether or not there has been an acquisition of control over the target. Many jurisdictions, including the European Union[1], Hong Kong[2], Italy[3] and Austria[4] opt for this approach on account of the relative efficiency and consistency in its application; such standards also significantly reduce the need for litigation. However, there appears to be considerable variation as regards the fixation of the shareholding percentage threshold for voting rights which would trigger the mandatory offer rule (ranging from 20% to 50% voting rights).[1] Much depends on the shareholding pattern that generally prevails in a particular jurisdiction; if shareholding is dispersed in that it is spread over a large number of shareholders, the trigger limit should be kept low, and vice-versa.[2]

Objective standard has its own share of disadvantages. Being ‘mechanical’ in its application, it increases the possibility of sophisticated avoidance attempts. Let us take example of an acquirer ‘A’ in India, the takeover law of which provides for a trigger limit of 25% voting rights. ‘A’ acquires 24.5% of the voting rights in a company, thereby doing away with the requirement of an open offer and the economic cost it entails. If there is no other shareholder that exercises similar voting rights, one may reasonably draw the inference that A has a de facto control over the company. Similarly, there could be various kinds of agreements enabling a ‘stealthy’ acquisition of voting rights, and a takeover regulation providing for only an objective standard would not be able to catch hold of such an acquirer.

On the other hand, some countries adopt the subjective route, enabling courts and regulators to check any kind of de facto control over the target. In countries such as Canada, France and Spain, an entity is deemed to be having control over another company if it is has the right to exercise majority of the voting rights at the general meeting of the company or has the ability to control the composition of a majority of the board members of the company.[3] Likewise, countries such as Brazil, China and Indonesia define control in terms of the ability to exercise influence over the company’s policies or its shareholder meetings.[4] Therefore, we find that a de facto concept of control essentially encompasses various modes through which an acquirer may gain control. Some of these modes could be the right of an acquirer to appoint or remove majority of the board of directors, ability to directly or indirectly determine the management or policy of the company[5], and the like. The process envisages fact-specific determination, making the law highly uncertain and unpredictable. In fact, many jurisdictions which previously had subjective definitions of control switched to objective definitions.[6] Indeed, such standards fail to take into account many situations where, as a protective measure, financial investors or borrowers seek certain rights in the company without any intention to seek control.

The Combined Approach in India

India follows both quantitative and qualitative approaches to determination of acquisition of control, providing a numerical threshold of 25% while at the same time giving a subjective definition under regulation 2(1)(e). As a result, the jurisprudence developed over time shows inconsistency among judicial decisions and multiple opinions as regards the scope of control. In 2001, the Securities Appellate Tribunal (SAT) held the acquirer in question to be in control over the target as it had veto rights on major decisions on structural and strategic changes.[7] More recently, in 2010, SAT significantly changed its stance in the much-talked-about case of Subhkam Ventures (I) Pvt. Ltd. v. SEBI[8]. In this case, Subhkam acquired more than 15% in the target company and made a public announcement in term of Regulation 10 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997. When draft letter of offer was filed with SEBI, the latter asked Subhkam to file the same in terms of Regulation 12 as well[9] precisely because the shareholder agreement conferred on it several rights such as veto on company policies. In a landmark and pragmatic ruling, SAT laid down a distinction between positive control and negative control, holding that acquisition of a negative or reactive power would not tantamount to be acquisition of control under the takeover law since such power is essentially conferred on the person for the purpose of securing his investment. SAT noted, thus:
“Control, according to the definition, is a proactive and not a reactive power. It is a power by which an acquirer can command the target company to do what he wants it to do. Control really means creating or controlling a situation by taking the initiative. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. In that event, the acquirer is only reacting rather than taking the initiative. It is a positive power and not a negative power… The test really is whether the acquirer is in the driving seat…”[10]Interestingly, on appeal, the Supreme Court essentially left the question of law open[11], thus bringing the issue back to square one.

The SEBI Proposal

In an attempt to move towards to a clearer understanding of the concept of control, SEBI has, through the Discussion Paper, proposed two options and invited comments thereupon. The first option is the qualitative standard, in respect of which SEBI has provided an illustrative list of situations where negative control or exercise of rights under a protective clause in the shareholder agreement will not be treated as acquisition of control. Therefore, appointment of chairman or vice-chairman who does not hold any executive position and does not have a casting vote, appointment of observer who does not have any voting or participating rights, customary lender covenants, rights conferred under a commercial agreement provided it is for mutual commercial benefit, veto/affirmative rights, and quorum rights in case two earlier meetings pertaining to the affirmative rights are not quorate would be deemed to be out of the ambit of the concept of control. [12] However, the grant of these rights may be subject to certain conditions. Some of these conditions as recommended by SEBI are investment of at least 10% or more in the target company by the investor, formulation of policy (subject to shareholders’ approval and incorporation into the Articles of Association) by every company for the purpose of defining the parameters that will be “material” or “outside the ordinary course of business”, and cancellation/modification/suspension of existing agreements till the approval of public shareholders (majority of minority) is obtained in case of IPOs.[13]

While these may serve as adequate safeguards, they throw certain significant challenges. For example, SEBI proposes that rights given to parties pursuant to a commercial agreement would not amount to control provided the Board has the right to terminate the agreement and enter into similar arrangement with any other party. Such unilateral termination, or cancellation of agreement in case of IPOs (as pointed out earlier), would act as a major deterrent as regards the investors.

The second option is the numerical threshold of 25%, which would be in tune with the 25% trigger provided for substantial acquisition as well as the 25% holding over and above which one has the right to block special resolutions under the Companies Act 2013.[14]

Conclusion

Lawyers and M&A experts are of the view that SEBI should retain the mixed standard for control-acquisition determination, for, while the numerical threshold would enable clarity and predictability, the subjective threshold would be a more logical option so far as public shareholders are concerned. However, an indicative list of situations where exercise of certain rights would not amount to control may be inserted. Nonetheless, “given that ‘control’ is an elusive concept, by design any definition of control will grant discretion to regulator, and this is not the case just in India but the world over.”[15]

[1] Countries such as the UK and China, for instance, provide 30% threshold, while India has a 25% limit. See Umakanth Varottil, Comparative Takeover Regulation and the Concept of ‘Control’, 2015 Sing. J. Legal Stud. 208, 215.
[2] Umakanth, 115.
[3] Discussion Paper, supra note 4, para 20.
[4] Ibid, para 21.
[5] One example of a regulation taking such mode within the ambit of control is Indonesia. See Yozua Makes, Challenges and Opportunities for the Indonesian Securities Takeover Regulations: A Comparative Legal Analysis, (2013) 8 University of Pennsylvania East Asia Law Review 83, 98.
[6] Defining “Control” in Takeover Regulations (IndiaCorpLaw, 29 May 2013) <http://indiacorplaw.blogspot.in/2013/05/defining-control-in-takeover-regulations.html>.
[7] Rhodia SA v. SEBI, (2001) 34 SCL 597.
[8] Subhkam Ventures (I) Pvt. Ltd. v. SEBI, [2010] 99 SCL 159 (SAT-MUM).
[9] 12. Irrespective of whether or not there has been any acquisition of shares or voting rights in a company, no acquirer shall acquire control over the target company, unless such person makes a public announcement to acquire shares and acquires such shares in accordance with the regulations: Provided that nothing contained herein shall apply to any change in control which takes place in pursuance to a special resolution passed by the shareholders in a general meeting: Provided further that for passing of the special resolution facility of voting through postal ballot as specified under the Companies (Passing of the Resolutions by Postal Ballot) Rules, 2001 shall also be provided.Explanation.- For the purposes of this regulation, acquisition shall include direct or indirect acquisition of control of target company by virtue of acquisition of companies, whether listed or unlisted and whether in India or abroad.
[10] Supra note 16, para 6.
[11] Subhkam Ventures- Question of Law Remains Open (Amarchand & Mangaldas & Suresh A. Shroff Insight Issue, 05 December 2011) <http://aibi.org.in/InsightIssueDec2011.pdf>.
[12] Discussion Paper, supra note 4, para 27.
[13] Ibid, para 28.
[14] Ibid, para 30.
[15] The Elusive Concept of Control (Business Standard, 9 August 2015) <http://www.business-standard.com/article/opinion/the-elusive-concept-of-control-115080900762_1.html>.