An Insight into SEBI’s Consultation Paper on Minimum Public Shareholding

[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

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The NPA Conundrum: Evaluating the Bad Bank Approach

[By Shubham Nahata]   The author is a student at Hidayatullah National Law University, Raipur Introduction One of the most drastic and disastrous impacts of the economic slowdown induced on account of COVID-19 will be seen on the balance sheets(“B/S”) of banking and financial institutions. As the availability of easy credit will become the norm in the post COVID-19 society, banking institutions will need to deal with the herculean task of resolving stressed assets on their B/S. According to the Financial Stability Report, published by the Reserve Bank of India, scheduled commercial banks (“SCBs”) account for almost 9.3% of Gross Non-Performing Assets (“NPAs”) in the economy. Almost 85% of these stressed assets can be traced to the B/S of Public Sector Banking institutions (“PSBs”). One of the prospective solutions on cards for resolving the banking crisis is the creation of a ‘Bad Bank’ that would take over NPAs from banking and financial institutions. Unlike traditional banking institutions, it does not engage in credit lending functions, however, it assists in the recovery of stressed assets in the financial sector. The soundness of the credit infrastructure of an economy is largely dependent on the recovery and resolutions mechanism in place for dealing with stressed assets. This blog post maps the growth of different regulatory practices adopted overtime to deal with NPAs and analyses the viability of a Bad Bank structure based on the experiences of different jurisdictions. Mapping the Trajectory Different strategies have been adopted over time in order to deal with stressed assets in the banking infrastructure. It includes measures like corporate debt restructuring, recapitalisation of banks etc. in order to improve the capital adequacy and keep NPAs in control. However, the overtime rise of NPAs in an economy is a signal for the need for a robust and effective resolution and recovery infrastructure. Neo-liberal banking reforms introduced in the first decade of the 21st century although increased the credit flow in the economy but it also led to a steep rise in bad loans as well. In order to portray the sound health of the banking industry, drastic measures like Corporate Debt Restructuring (“CDR”) were taken. It involved complete overhaul strategies like conversion of debt into equity, reducing interest, or extending the maturity to maintain the soundness of B/S.  One of the benefits that restructuring offered was that it exempted banks from creating provisioning for stressed assets. However, the Reserve Bank of India (“RBI”) prescribed stricter norms for classifying and recognition of stressed assets in the economy after the Asset Quality Review of 2015. This led to a steep increase in the ratio of NPAs in the banking sector. In order to deal with the ‘twin balance sheet problem’, the Insolvency & Bankruptcy Code (“IBC”) was enacted in the year 2016 which provided an effective avenue for financial lenders to undertake the resolution of stressed assets. The Banking Regulation (Amendment) Act, 2017 also empowered the RBI to issue directions to the banks to undertake resolution process against defaulters under the IBC. Similarly, under the framework of Joint Lenders Forum, the Reserve Bank empowered the banks to undertake measures like Corporate Debt Restructuring, Strategic Debt Restructuring and, the Scheme for Sustainable Restructuring of Stressed Assets (“S4A”). S4A offered an opportunity to the lenders to identify the sustainable level of debt for the borrowers and convert the unsustainable part of debt into equity instruments. However, these policies were discontinued after the RBI notified Prior Framework in March 2018. The prior framework was struck down by the Supreme Court in Dharani Sugars and Chemicals Limited v. Union of India, for being violative of Section 35AA of the Banking Regulation Act, 1949. Hence, on June 7, 2019, the RBI notified Prudential Framework for Resolution of Stressed Assets (Prudential Framework) which prescribes an incentive-based approach for resolution of stressed assets to improve the resilience of the credit infrastructure of the economy. Bad Bank Economics Asset quality, capital adequacy, liquidity and, responsiveness to the market are considered to be the key indicators of the financial health of a banking enterprise. Overtime rise in the ratio of NPAs not only affects the asset quality of banking institutions but also affects its capital to asset ratio, in turn, fracturing its ability to lend swiftly in the market. Bad Bank is a special purpose vehicle constituted as an Asset Reconstruction Company (“ARC”) tasked with the objective of acquiring and managing stressed assets of banking and financial institutions. It acquires discounted stressed assets from banks by upfront payment of a certain proportion in cash and issuing security receipts for the rest of the amount. Bad Banks are tasked with the responsibility to uniformly carry out resolution and recovery steps in respect of stressed assets and increase the return on such assets. Generally, such a form of entity is funded by the government and banking institutions in order to carry out its activities. Bad Bank structure for resolution of NPA can be effective as compared to the recapitalisation of banks, as the latter increases the burden on the taxpayers to provide for weak recovery infrastructure for banking institutions.  Global Experience Different jurisdictions around the globe have found recourse in a Bad Bank framework in order to deal with the problem of mounting stressed assets in the banking industry. Sweden during the financial crisis of 1992, formed a state-owned company (‘Securum’) tasked with the objective of acquiring stressed assets from its banking institutions. Securum was successful in resolving banking crisis in the economy and was able to return a substantial amount of government funding. Similarly, the Korean Asset Management Corporation of South Korea was formed in order to deal with stressed assets lying with banking and financial institutions. It was successful in reducing the ratio of NPAs in the economy from 17% in 1998 to 2.2% in 2002. It also introduced and developed the market for asset-based securities which attracted investments from both domestic and foreign investors. After the global financial crisis of 2008, the United States of America also formulated

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Extension of Liability in Group Insolvency Proceedings

[By Ananya HS] The author is a third year student of the National Law School of India University, Bangalore. Background A significant proportion of Indian businesses are fundamentally structured as group enterprises operating as a single economic unit. These enterprises commonly engage in related party transactions in the nature of cross-collateralization, inter-corporate loans, and so on. These enterprises largely adhere to the concept of separate legal personality of group entities, but precedent suggests that the close linkage between different units of an enterprise in the areas of operation, business and management go on to raise unique challenges especially, when individual group entities become insolvent. Additionally, there are concerns of directors of the parent company in an enterprise exercising control over the subsidiaries, leading to further complications in the ascertainment of liability if a single entity approach is adopted. In certain enterprise groups, the parent company may also be deemed to be the director of the subsidiary.[i] The Insolvency and Bankruptcy Board of India (“IBBI”), in 2019, constituted a Working Group (“WG”) to prepare a report (“WG Report”),[ii] seeking recommendations for the introduction of a group insolvency framework. This step was taken in light of the various recent cases[iii] involving collective defaults and collapse of entire groups. The importance of considering unrecognised factors such as the position of a subsidiary in the group or the degree of integration between the companies, among other things, during insolvency resolution has also been acknowledged in this stead. The WG Report consists of a number of recommendations for amending the Insolvency and Bankruptcy Code, 2016 (“IBC”) in order to equip it to deal with the insolvency of conglomerates and groups. Among various suggestions, the WG categorically recommended that the IBC need not be amended to extend liability to parent companies or its directors in case of group insolvency proceedings. This piece argues that the recommendation of the Working Group against the extension of liability to directors of the parent company in case of group insolvency proceedings must not be a blanket one, and stresses the importance of lifting the corporate veil in this regard in certain situations involving group insolvencies. Observations of the Working Group – Problems and Inconsistencies The WG, in its report, has discussed the aspect of extension of liability at length, and several stakeholders seem to have indicated to the WG that there may be multiple cases where a need to hold the parent company and its directors liable may arise. This could be in the case of fraud, fund diversion, mismanagement of debtor, wrongful trading, or upon finding that the directors of the parent company were a shadow or de facto directors of the subsidiary company. The WG stated that the underlying purpose behind extending liability in such a manner is to pre-emptively deter perverse behaviour, and came to the conclusion that currently, the IBC is sufficiently equipped to deal with such behaviour by companies. This questionable conclusion was arrived at by examining the definition of “officer” of a company under the IBC, borrowed from Section 2(60) of the Companies Act, 2013, which encompasses a wide definition of who an officer in default is, and includes within its purview, shadow and de facto directors. The applicability of this definition to Chapter VII of Part II of the IBC, to hold such officers liable for the specified activities was deemed to be a sufficient ex-ante deterrent, leading to the abovementioned conclusion of the WG.[iv] The WG Report also fails to acknowledge another problem that exists in determining the liability of an individual appointed as a director in more than one of the subsidiary companies. If one director is slated to oversee the management of one or more subsidiaries, and of the group as a whole, conflicts of interest are bound to arise eventually, and such conflict may relate to incidence of control and ownership as well.[v] The WG has failed to supply substantial justification as to why it has provided a recommendation contrary to the opinions of stakeholders as well as established law in other jurisdictions. The UNCITRAL Guide on Insolvency Law (“Guide”) contains a list of circumstances where liability may, in fact, extend to directors of the holding company. The Guide also states that a mere incidence of control or domination of one member by another member will not serve as a ground for extension, and the WG Report uses it in order to support its recommendation. However, it is to be noted that the same is perfectly aligned with the argument of extending liability only in cases where there is a direct correlation between the working of the parent company and the insolvency of its subsidiary. The Guide provides for some indicative factors on which extension of liability can be based, including grievous negligence in the management of the subsidiary, breach of duty of care or diligence in management by the parent company, abuse of managerial power, or any direct causal link between the manner of management of the subsidiary and its subsequent insolvency.[vi] These grounds are beyond the purview of the provisions of the IBC, and cannot be classified as extraordinary circumstances, which would be dealt with by courts as and when they arise. Lifting the Corporate Veil – The Single Economic Unit Argument One of the key issues faced by group insolvency is the dichotomy that exists between effectuating the economic reality of an integrated business functioning through the establishment of subsidiaries, thus referring to the corporate group as a unit, or adhering strictly to the corporate form and treating each subsidiary as a separate legal entity. In situations like this, concerning subsidiary companies working within a single corporate group, an argument of a single economic unit can be made for the lifting of the corporate veil. This argument is based on the fact that subsidiary companies generally constitute a single unit for economic purposes, regardless of their separate legal personalities within the group, and must, therefore, be seen as a single legal unit.[vii]  Since all the

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