Unpacking SEBI’s Informal Guidance: Delving into Takeover Code Regulation 3

[By Shyama Singh]

The author is a student of Gujarat National Law University, Gujarat.

 

Background 

Through an informal guidance by way of an ‘interpretative letter’ dated 21st July 2023, the Securities and Exchange Board of India (“SEBI”) clarified whether open offer obligations under Regulation 3(3) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SEBI SAST Regulations”) or Takeover Code would be triggered. The clarification pertained to a situation where an increase in individual shareholding of promoters occurred, while the aggregate shareholding or voting rights of the promoter and promoter group did not exceed the 5% threshold. The guidance is significant since a plain reading of the SEBI SAST Regulations might initially suggest a contrary outcome than the guidance provided by SEBI. 

As for the binding nature of such guidance, the Securities Appellate Tribunal (“SAT”) emphasized in paragraph 28 of JK Paper Ltd. v. SEBI that any guidance is not binding on the Board. Nevertheless, Clause 12 of the SEBI (Informal Guidance) Scheme, 2003, indicates that the Board generally aligns its actions with the letters issued as informal guidance.  

Legal Framework 

Under Regulation 3(1) of the Takeover Code, an acquirer, together with persons acting in concert (“PAC”), is obligated to make a mandatory open offer if their combined holding reaches 25% or more of the target company’s shareholding, conferring them the right to exercise 25% or more of the voting rights. Regulation 3(2) stipulates that an acquirer, along with PAC, holding 25% or more of the target’s shareholding, must initiate an open offer when acquiring an additional 5% or more of voting rights in the target during a financial year. 

Subsequently, Regulation 3(3) elucidates that an acquisition leading to an individual’s shareholding surpassing the prescribed thresholds in either sub-regulations (1) or (2) necessitates an open offer obligation. This obligation holds true regardless of any change in aggregate shareholding with PAC. This means that if an individual acquisition exceeds the 25% threshold specified in sub-regulation (1) or surpasses the 5% threshold in a financial year after holding 25% or more under sub-regulation (2), Regulation 3(3) mandates a compulsory open offer, irrespective of whether the aggregate shareholding with PAC experiences any change or remains unchanged. 

Brief facts  

The informal guidance was sought by Kreon Financial Services Limited (“Kreon”), a publicly listed Non-Banking Financial Company registered with RBI and listed on BSE, concerning an increase in individual shareholdings of two promoters. These two promoters were Mr. Jaijash Tatia and Ms. Henna Jain. Through a board meeting dated 28.01.2021, board approval was received for the issuance of 95,00,000 warrants convertible to equity on a preferential basis to promoters, including Mr. Jaijash Tatia, Ms. Henna Jain, and other investors. The shareholders’ approval was received on 27.11.2021. Subsequently, an in-principle approval was received from BSE on 13.01.2022 for the allotment of these 95,00,000 warrants. On 24.01.2022, a board meeting approved the allotment of these 95,00,000 warrants. On 28.03.2023, another meeting approved the partial allotment of 28,77,000 equity shares against the partial conversion of the warrants. Resultantly, the shareholding of Mr. Jaijash Tatia and Ms. Henna Jain increased from 9.29% to 14.28% and 0% to 4.99%, respectively, in FY 2023. This increase was of 4.99% for both promoters. 

Since the warrants were only valid for 18 months, Kreon enquired whether a further conversion of the pending warrants into shares in FY 2024 would trigger the Open Offer Obligation as per Regulation 3(3) of the SAST Regulations since the individual shareholding/voting rights of the two promoters would increase by 5.37% and 9.84% post-conversion. This was notwithstanding that the promoter and promoter group’s combined shareholding/voting right would not surpass 5%, as mandated by Regulation 3(2) of the SEBI (SAST) Regulations. 

The shareholding of these promoters, along with PAC (i.e., the promoter group), was 50.60% in FY 2023. This aggregate shareholding was estimated to increase by 4.99%, i.e. to 55.59% after converting the remaining warrants in FY 2024. However, the individual shareholding of the two promoters would cross 5%. This was because the shareholding of other promoters in the promoter group decreased by 10.22% when the shareholding of the concerned promoters increased by 15.21%, resulting in a cumulative increase of 4.99%.  

SEBI’s guidance and analysis 

SEBI noted that the individual shareholding of Mr. Jaijash Tatia and Ms. Henna Jain was below 25%, and thus, open offer obligations were not triggered for them under Regulation 3(3) read with Regulation 3(2) of the SEBI SAST Regulations, 2011, even if they acquired 5.37% and 9.84% respectively.  

The guidance tendered by SEBI might seem incorrect initially since the shareholdings of the two promoters increased by 5.37% and 9.84% when they aggregately held 50.60% along with PAC before the acquisition. One might conclude that this situation would attract Regulation 3(2) and mandate an open offer thereunder. This conclusion would be based on an understanding that Regulation 3(2) mandates an acquirer who acquires more than 5% when already holding 25% or more together with PAC, to make an open offer. However, this is an incorrect and partial understanding of the Regulation. A complete reading would reveal that SEBI’s guidance aligns with the SAST Regulations and no open offer is required. 

As per Regulation 3(3), an open offer obligation is triggered when, ‘individually’, the thresholds under sub-regulations (1) and (2) are exceeded. In the present case, the 25% or 5% thresholds under sub-regulation (1) and (2) were not breached ‘individually’. However, under sub-regulation (2), one may argue that the shareholding of the promoter and PAC was well beyond 25%, after which the two promoters individually acquired more than 5%, mandating an open offer obligation. Such an interpretation is incorrect.  

It has been noted that Regulation 3(3) addresses breaches at the individual level, contrasting with the provisions outlined in Regulations 3(1) and 3(2). Sub-regulations (1) and (2) cover situations wherein individuals and PACs ‘collectively’ exceed the prescribed thresholds. This can also be gathered from the language employed in these sub-regulations, which uses the word “them,” meaning the individual acquirer, together with PAC collectively exercising more than 25% or 5%, as the case may be.   

The present case is peculiar as it falls under neither Regulation 3(3) nor Regulation 3(2). While the individual acquisition exceeded 5%, the promoters did not hold 25% individually to attract Regulation 3(3). Further, their acquisition beyond 5% did not entitle the promoter along with PAC to ‘collectively’ exercise more than 5% in that financial year. Thereby not meeting the threshold under Regulation 3(2). Thus, SEBI validly held that open offer obligations under Regulation 3(3) read with Regulation 3(2) of the SAST Regulations would not be triggered since the individual shareholding of the two promoters is below 25%.  

Conclusion 

Initially, it may seem perplexing to witness an acquisition over 5% without triggering an open offer, given the acquirer and PAC’s combined holdings exceeded 25%. However, the absence of an open offer complies with legal requirements as thresholds under Regulation 3(2) or 3(3) were not surpassed. A mandatory open offer would have been necessary if the promoter group’s aggregate shareholding surpassed 5% or if each of the two promoters individually held over 25%. 

Furthermore, SEBI’s guidance aligns with a purposive interpretation of the regulations outlined in the Takeover Code. A primary aim of this Code is to shield public shareholders, granting them the option to divest their investment in the target company during a significant involuntary acquisition or takeover. In the current situation, the conversion of warrants facilitated promoters in acquiring shares. Notably, the issuance of warrants in this instance had prior approval from existing shareholders. Since warrants inherently confer the right to purchase shares, it can be deduced that shareholders tacitly endorsed the change in shareholding and acquisition. In such circumstances, a purposive interpretation of the Code eliminates the need for an open offer. 

Lastly, the guidance has clarified that Regulations 3(1) and 3(2) pertain to the collective exercise of rights by an acquirer and PAC, while Regulation 3(3) focuses on individual exercise. This clarification could establish a precedent for other companies, given its issuance as an interpretative letter by SEBI. Consequently, when an individual acquisition surpasses 5%, but the individual holds less than 25%, or the aggregate increase in shareholding with PAC remains below 5%, there would be no obligation for an open offer under the Takeover Code. 

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