This article is written by Aditi Vinzanekar.
Table of Contents
Introduction
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter “the Takeover Code”), prescribe that an acquirer gaining substantial shares or voting rights i.e., 25% or more, must make an open offer to all the public stakeholders of the target company. Irrespective of the shares or voting rights acquired, the acquirer also must make an open offer upon acquiring control of the target company. It, therefore, becomes crucial to substantially understand the meaning of the word ‘control’ and its implications. However, due to the conflicting definitions of ‘control’ by Indian legislation and courts as well as the ambiguous interpretations of the word, there is an absence of an exhaustive definition of the word. Recognizing this ambiguity and its potential impact on investors in the public space in India, the Securities Exchange Board of India (Hereinafter “SEBI”) sought to define ‘control’ and initiate a public consultation process. This paper attempts to explain the concept of ‘control’.
Meaning and Definitions of ‘Control’
For the last couple of years, there has been a considerable debate over the meaning of the word control and its implications in Indian Corporate Law. The most substantial definition of the term has been given in the Takeover Code. In India, the term ‘control’ has been defined both qualitatively and quantitatively.
Qualitative Control
From the definition of control, as defined under the Takeover Regulations, 2011, it has been observed that regulation 2(1)(e) defines “control” as inclusive of:
- The right to appoint a majority of directors,
- The right to control the management,
- The right to control the policy decision.
This definition creates ambiguity, and difficulty in assessing whether an acquirer has acquired ‘control’ since an acquirer could acquire less than the mandatory offer threshold of 25% and still be required to make an offer if, based on the above-given conditions, it is said to be in control of the target company. However, this subjective definition of control would enable SEBI to decide based on the facts and circumstances of individual cases.
Quantitative Control
SEBI has thus specified that ‘control’ be determined by the right to exercise at least 25% of the voting rights of the target company. This triggers open offers since public shareholders who have invested in the company, relying on the management/promoters of the company should be given an exit opportunity so as to withdraw their investments if there is a change of ‘control’ in the company.
International Perspective
After the examinations of several countries, it was noticed that some of them had subjective definitions for ‘control’ in the context of corporate laws, and some stuck to specific quantitative determinations. Similar to India’s 25% threshold, the latter had a specific percentage threshold for defining ‘control’, for example, UK, Hong Kong and the European Union have thresholds of 30%, Singapore has 20%, and Malaysia has 33%. Now it should be noted here, that some of these countries also carried a very subjective definition of the word ‘control’ in their early years, but due to the ambiguity surrounding such subjective definitions, these jurisdictions migrated to legislations that defined the word ‘control’ more quantitatively through a specific percentage threshold. Countries like Brazil, China, Denmark, Indonesia, Italy and Nigeria have definitions similar to India which are quantitative as well as qualitative. While countries like Canada, France, Ghana, Norway and Spain have purely qualitative definitions.
Bright Line Tests
The Discussion Paper published by SEBI (hereinafter “Discussion Paper”) hinted to the need of “bright lines” on control. The proposed test is a different approach to defining control, which prescribes a list of “Special Rights” that would be protective rights that do not amount to the acquisition of control, as opposed to the formula-based method adopted before. However, as mentioned earlier, the preparation of an exhaustive list defining protective rights will naturally be a challenge. Bright-line tests have widely been criticized for their inability to address factual intricacies, by addressing issues in an over-simplified manner, which may not always ensure a fair and equitable outcome. Therefore, in early 2017, SEBI announced its decision to drop the proposal of adopting the “bright-line test” to determine the acquisition of “control”.
Special Rights
If an investor creates terms of investment in a target company, by obtaining contractual rights that are not available to other shareholders (“Special Rights”), are deemed to be indicative of ‘control’, then the investor would be required to undertake an Open Offer. This sparked a substantial debate regarding what kind of rights can be secured by investors and what those rights could imply in the context of ‘control’. Therefore, SEBI described certain rights that it deems to be protective in nature and which do not amount to exercise of ‘control’.
Protective Rights
SEBI has made an effort to identify several kinds of rights that could be conferred upon shareholders which would not amount to ‘control’ such as the right to appoint Chairman/ Vice Chairman, or an observer, quorum rights, veto / affirmative rights etc. These rights have been enumerated and explained in the Discussion Paper published by SEBI. These rights have been classified as proactive and not reactive in nature. The intention is to safeguard the interests of investors, rather than confer ‘control’. Further, special rights conferred pursuant to a commercial agreement would not amount to ‘control’ if:
- the said commercial agreement is fair / mutually beneficial to both the target company and the investing party,
- the Board of Directors of the target company has approved the commercial agreement and also possesses the right to terminate the said agreement,
- the commercial agreement is a non-exclusive agreement, and therefore does not restrain the target company from entering into similar contracts with any other party.
The Securities Appellate Tribunal (hereinafter “SAT”) also passed an order in the case of Subhkam Ventures Private Limited. v. the Securities Exchange Board of India, holding that protective provisions in shareholders’ agreements (such as affirmative rights) adopted by investors do not amount to “control” for purposes of Takeover Code. During an appeal to the Supreme Court, however, stated that the solution for the question of ‘control’ is keeping the question of law open and further clarified that the impugned order passed by the SAT will not be treated as a precedent. This is because SEBI has only so far provided an indicative list, acquisition of other rights would need to be examined on the basis of the specific facts and circumstances of each case.
Advantages
This subjective definition allows more room for SEBI to make determinations based on the facts and circumstances of individual cases, rather than having a black and white approach to all the cases. The primary advantage of such subjective-ness is that it ensures that acquirers cannot avoid mandatory offer obligations by structuring their purchases in such a way that they stay outside the purview of the rule. For example, it is possible in India for an acquirer to purchase 24% shares with voting rights, and therefore avoid having to make an open offer, even though the shareholding gives him de facto control of the company. Having a qualitative definition provides an avenue for this to be avoided. The Ministry of Corporate Affairs has also suggested to SEBI that it would be more appropriate to take decisions on a case-to-case basis and to therefore not change the definition of ‘control’.
Disadvantages
Although the above-given logic does hold merit, there still exists the risk that acquirers would be put under an unnecessary fear and apprehension of investing in public listed companies, even if their intention is not to gain a controlling position in the target company. The absence of a solid precedent for defining ‘control’ leaves uncertainty. The extent of influence by the investor over the board of directors is not ascertainable in most cases, due to the ambiguity. The regulatory interference and policing is increased greatly due to the lack of a solid precedent, making the process all the more complicated and expensive, also imposing on the free market. It contradicts the Indian government’s original approach to liberalizing the market.
Conclusion
The decision of SEBI’s to not adopt bright-line tests has led to a significant step back from its original proposal via the Discussion Paper to simplify acquisitions of listed companies. Now, there is a return to the lack of clarity and after the Supreme Court’s order in the Subhkam Ventures case, there is also a lack of a binding judicial precedent on which there could be some reliance. Evidently, due to the above-given advantages of having a subjecting definition of control, SEBI is not amenable to a rigid rule-based test as of now. Although, as of now, the subjective definition also clearly has its advantages, by allowing each case to be scrutinized individually, it also seems like it is a missed opportunity to simplify the regulation of acquisitions in the Indian market. Both options clearly display both operational and conceptual deficiencies. However, from the perspective of an investor, the present scenario is riddled with uncertainties.
References
- Cyril Shroff, Anshuman Jaiswal, “Controlling ‘Control’ under Indian Takeover Regulations”, Indian Corporate LawBlog, Cyril Amarchand Mangaldas, (April 1st, 2016) available at https://xbma.org/indian-update-controlling-control-under-indian-takeover-regulations/ and https://corporate.cyrilamarchandblogs.com/2016/04/defining-control/
- Samie Modak, “Sebi Scraps 'Bright Line' Control Test Proposal”, Business Standard, (September 8, 2017), Last Updated: September 9, 2017.
- Subhkam Ventures (I) Pvt. Ltd. vs. Securities Exchange Board of India (Appeal No. 8 of 2009 decided on 15.01.2010)
- The Securities Exchange Board of India v. Subhkam Ventures (I) Private Limited (Civil Appeal No. 3371 of 2010 decided on 16.11.2011)
- Prarthna Baranwal, “SEBI’s Bright Line Tests for ‘Control’ – An Analysis”, Insights, Lakshmikumaran & Sridharan Associates, (April 26, 2016) available at https://www.lakshmisri.com/insights/articles/sebi-bright-line-tests-for-control-an-analysis/
- Umakanth Varottil, “Defining “Control” in Takeover Regulations”, India Corp Law, (May 28, 2013) available at https://indiacorplaw.in/2013/05/defining-control-in-takeover-regulations.html
- Report of The Companies Law Committee, Ministry of Corporate Affairs, (February 2016)
- VCC Staff with DSK Legal, “The Dilemma Of Control”, VCCircle, (February 9, 2012) available at https://www.vccircle.com/dilemma-control
- Majumdar & Partners, “Brightline Tests To Determine Change Of “Control” For Takeovers A No Go”, Insights,Majumdar & Partners, (September 11, 2017), available at https://www.majmudarindia.com/insight/bright-line-tests-to-determine-change-of-control-for-takeovers-a-no-go/
LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join:
