[By Shaurya Singh and Sanya Goel]
The authors are students at the Jindal Global Law School, Sonipat.
The shareholder rights plan, commonly known as the ‘Poison-pill’ is a strategy used to defend against a hostile takeover by issuing new shares at discount to the existing shareholders other than the acquirer. This dilutes the shareholding of the acquirer while providing an opportunity to the other shareholders to raise their holdings at a discounted price. Therefore, the cost of acquisition significantly rises which would make the target company less attractive to the acquirer considering its higher price. Hence, deterring the hostile acquirer to complete the acquisition and pull out of the deal. This defense strategy has proven its mantle by breaking the jaws of some of the biggest corporate sharks over the years in the US. However, a series of regulations make the poison pill illegal in India. This article stresses the need for importing the poison pill to safeguard Indian companies and points out the fault in the current regulations which freely facilitate hostile takeovers.
The Paramount of Defence:
There have been several instances where this strategy has proved its effectiveness by saving well-known companies from non-consensual takeovers. Yahoo, acquired the poison pill in 2001 to save itself from being acquired by Microsoft. Along the same lines, Netflix, the current largest streaming service used the strategy as a defence against Carl Icahn’s takeover. Hence, the viability of the Poison Pill is very evident but especially when being used as the only defence strategy it might not guarantee complete safety from the takeover.
Swallowing the pill:
Poison-pill on paper makes up for a very robust strategy, however, there might be some cases where the acquirer has enough resources to complete the deal regardless, especially when the acquisition is happening without keeping profitability at the centre. In such cases, the acquirer would not care if the profitability of the venture is being compromised or not. Hence, the higher cost of acquisition is less likely to create a deterrence making the poison pill useless.
For instance, Elon Musk’s bid for Twitter was not motivated by profits but was rather being done to save the freedom of speech of individuals on the internet. According to Musk, Twitter being one of the most influential social media platforms, was not fully allowing individuals to express free speech and he wished to acquire it to allow free expression. He pitched an offer of 43 billion dollars which was more than entire the market capitalisation of Twitter (37 billion USD). Here, Twitter did initially deploy the poison pill to avoid acquisition but the board later did accept the Musk’s Bid considering the value of the offer. The offer was withdrawn later, but the pill would not have saved Twitter given the amount of money Musk was ready to spend on the deal. A key take away from the said case is that if the acquirer has enough resources, is willing to pay the high cost of acquisition, and can directly or indirectly influence the board of the company, then the target company would not be able to defend itself only by relying on the pill.
However, the case of Twitter itself is an exceptional scenario as a majority of the hostile takeovers are motivated by profitability. Therefore, a higher cost of acquisition due to the poison pill can save the target company in most cases. Additionally, the presence of a staggered board of directors comprised of firm individuals adds to the effectiveness of the pill.
The Staggered Aegis:
The provision for a staggered board of directors has been introduced in India through the Companies Act, 2013. While Section 169 of the Companies Act, 2013 allows for the removal of a director from the company before their period in office expires given that they are given a fair chance to be heard, exceptions to the same are provided in Section 242 and Section 163. A director appointed by the NCLT under Section 242 is not subject to the provisions of Section 169. Similarly, the provisions of Section 169 do not apply in a situation where the company has availed the option to appoint two-thirds of the total number of directors in compliance with the principle of proportional representation of Section 163 which basically translates to the existence of a staggered board. The staggered board complements the pill and these two together make a very viable defence. Theoretically, the acquirer could fire the entire current board and exert control over the newly elected board, thereby dismantling the pill. The staggered board prevents that. Therefore even in the presence of multiple resisting shareholders, the acquirer would not gain control over the board for a long time.
The introduction of the staggered board is indeed a positive step but to fully utilize its defensive aspect poison pill is needed, which is restricted by a series of regulations framed by SEBI.
The Fault in Our Codes
Considering the regulations that regulate takeovers, it is safe to claim that India is a takeover-friendly country. This may not necessarily be a negative thing, given that the legislation has also been flexible enough to permit M&A transactions with minimum intrusion. But that does not mean that the law should freely allow hostile takeovers. The SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 or the ‘Takeover Code’ mandates the acquirer to make a public announcement once it obtains 25% of the shares and this is the only major obligation for the acquirer to undertake a takeover. On the other hand, 26(c) of the takeover code prohibits poison pills, as it states that the target company can not issue any securities which entitle the holder to voting rights. Also,26(d) refrains the target company to “implement any buy-back of shares or effect any other change to the capital structure”. Additionally paragraph 13.1.2 chapter 13 SEBI (Disclosure and Investor Protection) Guidelines, also restricted a company from deploying the poison pill as it did not allow for discount warrants less than the pricing structure prescribed in paragraph 13.1.1. The same approach was transferred to the Issue of Capital and Disclosure Requirements (ICDR) Regulations,2018 which prevent preferential share issuance or the issuance of warrants at a significant discount by establishing minimum or floor prices.
Therefore, if the acquirer publicly announces that it is coming to take over, the target company is left with its hands tied behind its back. There remains no escape given that the acquirer has enough resources to undertake the full takeover.
Larsen &Toubro’s hostile acquisition of Mindtree should have been the wake-up call for fixing the fault in the takeover code. The promoters often sell and reduce their holdings when their company goes public to utilize the cash in business expansion, and in a lot of cases hold less than 51% equity in their own company. Corporate raiders often capitalise on this to gain control of the target company. L&T had an enormously large cash reserve with them of about $2 billion and when its buyback bid was denied by SEBI, it caught sight of Mindtree- a promising business venture which had great future prospects, which the original promoters might never see under their control. V.G Siddhartha was looking to sell his 20% stake of Mindtree which L&T agreed to buy and pitched an open offer to the major shareholders to acquire 25% more stakes. Eventually, L&T had a 60% holding in Mindtree- effectively completing the hostile takeover.
This was indeed the failure of the regulations which do nothing to protect the target company but only make things worse, and even after 3 years of this takeover, no regulatory changes have been made by SEBI.
Conclusion
The current takeover code allows the sharks to feed on any fish they desire, they just have to make sure the ocean knows before they munch these fin-less fishes. SEBI is supposed to make the environment fair for every stakeholder of our markets, be it retail investors, institutional investors, or listed companies. However, it has ignored the interests of the companies by not offering any protection from hostile takeovers. Law in general should be the savior of the grieved, not a tool for further prosecution. It is about time when the regulator imports the poison pill from the US. By doing so, the normal procedure for standard takeovers would not be affected and stay streamlined, while the companies would have a robust defence system in their armory which would complement the presence of the staggered board brought in by the Companies Act, 2013.