Reconciling Stock Exchange Regulations with Insolvency and Bankruptcy Code, 2016: Analysis of Amendments in SAST Regulations and Delisting Requirements.[Ishaan Chopra]
Ishaan Chopra is a 3rd year B.A.LLB. (Hons.) student at NLIU, Bhopal
Section 30(2)(e) of the Insolvency and Bankruptcy Code stipulates that the resolution plan should be compliant with all the existing provisions of law. Accordingly, the regulations prescribed by Security and Exchange Board Of India (SEBI) need to be adhered to while contemplating and implementing a resolution plan. Where the corporate debtor is a listed entity, certain regulations of SEBI might impose cumbersome obligations upon newly reconstituted entity. The expenses and the time spent in fulfilling such obligations often render the stressed assets investments as economically unviable. This post seeks to analyze the recent amendments in SEBI regulations to make the implementation of resolution plan investor friendly and also suggests further changes in the existing framework to prevent burden upon the restructured entity.
Relaxation of Open Offer Requirements
Regulation 3 of SEBI (Substantial Acquisition of shares and Takeovers) Regulations, 2011 provides that an entity which intends to acquire any number of shares, which make the entities shareholding 25% or more in the target company, is obligated to make an open offer. Open offer refers to the statutory requirement whereby an acquirer makes an offer for at least additional 26% of the public shareholding. The purpose of SAST regulations is to ensure that substantial acquisitions of shareholdings do not jeopardize the interests of minority shareholders. Accordingly, the regulation seeks to provide a fair exit price to the minority shareholders. For a company facing ‘Corporate Insolvency Resolution Process (CIRP), the shareholders are the bottom of the waterfall prescribed by the IBC for payment preference. Accordingly, the liquidation value due to equity shareholders is less or in most cases nil. This can be portrayed through the recent Electrosteel resolution plan. Vedanta Ltd invested Rs1,805 crore to get a 90% equity stake in Electrosteel. This results in a valuation of remaining 10% public equity at Rs. 200 crore, less than a third of the company’s existing market capitalization of Rs. 653 crore.
SEBI in its discussion paper has noted that the investors acquiring stressed assets would not want to use up capital to buy back from existing shareholders. However, SAST Regulation 3 required a public announcement of open offer of at least 26% of capital when the resolution applicant intended to buy any quantum of shareholding which triggered the 25% threshold. The resolution plan will be compliant with SAST, when payment to all shareholders of target company who have tendered their shares have been made. The capital, which has out flown due to buying back existing shareholdings, could have been effectively used to revive the stressed assets of the reconstituted entity.
SEBI via Circular SEBI/LAD NRO/GN/2018/20  has now amended ‘Regulation 3’ of SAST. The amendment provides that any acquisition pursuant to a ‘Resolution Plan’ under section 31 of the IBC will be exempt from the open offer requirements. This gives a lot of flexibility to the resolution applicants/bidders in structuring their resolution plans to take over companies undergoing CIRP. The move is expected to make stressed investments more attractive.
Prior to the latest amendment an entity which was proposed to be delisted pursuant to a resolution plan approved under IBC, the provisions of SEBI (Delisting of Equity Shares) Regulations, 2009 (“Delisting Regulations”) needed to be complied with. SEBI’s delisting regulations require price discovery via reverse book building and impose other conditions such as shareholder approval. Reverse book building is the process by which a company that wants to delist decides on the price that needs to be paid to public shareholders to buy back shares. In this process, the tender price by the shareholder needs to be equal or above the floor price notified by the company. The final buy back price is determined by aggregating all the prices received from the shareholder.
The latest amendment via circular number SEBI/LADNRO/GN/2018/23  exempts the NCLT approved resolution plans from such delisting requirements. However, the caveat is that the resolution plan should provide either any specific procedure to complete delisting of shares or provide an exit option to existing public shareholders at a price specified in the resolution plan. According to the notification, the exit price will be liquidation value minus the dues that need to be paid as per the priority laid down under the insolvency code. The liquidation value is to be determined as per the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 and the order of priority enunciated in Section 53 of the IBC Code is to be followed. As equity shareholders are at the bottom of hierarchy in terms of priority, in most cases the liquidation value due to them will nil. But if the existing promoters or any other shareholders are given an opportunity to exit at a price, that is higher than the price derived from the liquidation value due, it will apply to public shareholders as well. The intention to delist an insolvent company, along with the justification for exit price, will need to be disclosed to the stock exchanges within one day of the resolution plan being approved. Exemption from the cumbersome delisting obligations will make stressed assets investments more viable for investors.
The aforementioned amendments have dealt with certain pertinent issues that were raised in the SEBI discussion paper. However, SEBI has not clarified its position on the trading of stocks of the companies undergoing CIRP. Further, the status of reclassified shares for the purpose of restructuring has not been discussed. The following are some suggestions for further reconciliation of the stock market regulations for enhancing resolution of stressed assets.
Permitting Stock Exchange Trading
SEBI in a recent working paper called for public comments on continuation of trading of entities undergoing CIRP .Continuation of trading in of listed corporate debtor would facilitate transparency and better price discovery and would, therefore, be in the interest of investors. Equity value does not necessarily become zero due to the initiation of the CIRP. However, continued trading on the stock exchanges would depend on such companies meeting the listing standards of the exchanges. Trading in shares of companies going through the bankruptcy process is a high risk strategy. In USA initiation of proceedings under chapter 11 of the bankruptcy code does not bar trading of the listed corporate debtor. Even when corporate debtor is unable to meet the listing requirements, it continues to trade in over the counter exchanges. In Indian context, I am of the opinion that trading of such entities should not be barred. In most instances, the company’s plan of reorganization will cancel the existing equity shares. However, Trading in shares on the stock exchanges allows price discovery of securities and provide a platform to the public shareholders to exit the company and transfer risk to those are willing to assume such risk. Trading in the Futures and Options segment of the stock is generally more volatile and creates heavy fluctuations which are largely independent of the market fluctuations.
Re- Classification of promoters and Minimum Public Shareholding Requirements.
Under Regulation 31A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, SEBI has provided a mechanism for reclassification of promoters as public shareholders in cases where the role of an existing promoter changes drastically and the ordinary compliance obligations are no longer warranted. As per Regulation 31A, a promoter or the company can request the stock exchange(s) for reclassification of a promoter under three situations: a) a transmission/succession/inheritance, b) a change in the promotership after an open offer, and c) when a company becomes ‘professionally managed’. The re-classification is also contingent upon other factors such as absence of special rights, the existing shareholdings of the promoter and key managerial positions assumed.
The approach adopted by SEBI in informal guidance in Alembic Pharmaceuticals  and Gujrat Ambuja Exports  portrays that re-classification can be provided in conditions other than the statutorily prescribed scenarios. Validity of such a reclassification is then dependent on subjective analysis of factors such as control exercised by the promoter, presence of any special rights and quantum of shareholdings. In case of a reconstituted entity, the resolution plan approved by NCLT may dilute the promoter shareholding and decimate promoter’s control over the entity. In such a scenario, the fear regarding the reclassified promoter exercising effective control over the organization through public shareholding is unfounded. Such re-classifications will suffice the subjective requirement of “no effective control” prescribed by SEBI in the aforementioned informal clarifications. Hence, an amendment which provides an exemption for NCLT approved re-classification should be introduced. The contentious issue is whether such re-classified shareholding should be included while examining the compliance with Minimum public shareholding requirements. The MPS requirements for listed companies have been stipulated in regulation 38 of the Listing Regulations, which mandates that a listed entity requires the maintenance of a minimum public shareholding of 25% at all times of each class or kind of equity shares or convertible debentures issued by a listed company The LODR Regulations 31A (7)(b) categorically provide that the reclassified shareholdings shall not be included for achieving Minimum level of Public Shareholding. However, Infusion of outside capital during CIRP may reduce the public shareholding below the 25% threshold. In such a case, to avoid violation of minimum public subscription requirements, restructured entities should be provided a grace period to comply with the statutory requirements.
SEBI in its working paper recognizes that Minimum public subscription requirements are onerous obligations for a newly reconstituted company. The immediate obligation to fulfill the prescribed MPS norms is not in the interest of a newly revived company. A newly reconstituted firm might not be able to garner enough public interest to fulfill the subscription requirements. The author suggests that the grace period for compliance, should be increased from case to case basis, taking into consideration the prevailing public subscription levels and investor interest in the reconstituted entity. An amendment empowering NCLT to determine such a grace period for meeting MPS requirements will be welcomed by the stressed asset investors.