This article is written by Utkarsh Tiwari, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

What does takeover of a company mean and why the directors are involved? The answer to this question is quite simple, takeover of a company means transfer of control, wherein an acquirer takes over the control of the target company by acquiring its considerable voting rights or shares. The directors are involved from the first stage to the last, in framing the restructuring process, and being instrumental in the entire process. The obligations listed out in SAST Regulations, 2011, are of paramount importance, the obligations of the acquirer company and that of Target Company enumerated in Chapter IV, is the point of contention under this Article.

Need and scope of SEBI Takeover Code, 2011

The growth in the business restructuring mode i.e. of Mergers and Acquisitions, the risk of hostile takeovers and competitive offers in the absence of proper regulations, and the constant loopholes in SEBI (Substantial Acquisition of Share and Takeovers) Regulations, 1994, consecutively in SEBI (Substantial Acquisition of Share and Takeovers) Regulations, 1997 mandated the need for the SEBI Takeover Code. The effective recommendations of C. Achuthan Takeover Regulations Advisory Committee (TRAC) SEBI came forward with SAST Regulations, 2011. The changes inculcated in the new takeover regulations were offer price calculation mechanisms, triggering events, indirect acquisitions, definition of person acting in concert, definition of control, creeping acquisition limit increased from threshold 15% to 25%, offer size of 26%, etc.^[1] Since it’s the board of directors that are directly involved in the complete process, from the commencement of takeover till the completion of substantial acquisition of shares by the acquirer, the duties of the directors becomes important at each and every stage. The obligations are therefore divided into two categories broadly under Chapter IV of the SEBI Takeover Code, 2011; Obligations of the Directors of Target company (Regulation 24), Obligations of the acquirer (Regulation 25) and Acquirer company (Regulation 26), Obligations of Target company (Regulation 27). Before getting to the obligations let’s discuss the important definitions which have an important role in understanding the obligations.

Definitions^[2]

• Persons acting in Concert or ‘PAC’- PAC consists of people in individual capacity/ company as a natural person or other legal entity which have a common goal of taking over the company through transfer of control and gaining the voting rights/shares in the target company or vice versa.
• Escrow Account – The acquirer needs to have funds to implement the acquisition pursuant to the open offer. Accordingly, minimum two minimum working days prior to the date of detailed public statement of open offer for acquiring shares, the acquirer has to create an escrow account (a designated special purposes account) and deposit. Escrow can be in the form of cash, bank guarantee or deposit of freely and frequently traded shares.
• Public Announcement – It is the first announcement made by the acquirer of the open offer disclosing details of the transaction and the intention to acquire shares of the target company from existing shareholders by means of an open offer. The public announcement has to be made on the date of agreeing to acquire shares or voting rights in, or control over the target company but depending upon the mode of acquisition.
• Detailed Public Statement – The detailed public statement is the next announcement made by the acquirer and the PACs disclosing all the relevant details in the open offer as may be specified in order to enable shareholders to make an informed decision with reference to the open offer. The detailed public statement has to be made within 5 working days from the date of making the public announcement.
• Letter of Open Offer – While the public announcement and the detailed public statement are disclosure made by the acquirer and the PACs to inform the public about an exit opportunity available to them, the letter of open offer is the offer made by the acquirer to the identified shareholders of the target company to purchase their shares. The acquirer has to submit a draft of the letter of open offer to SEBI for its comments. The letter of open offer has to be dispatched by the acquirer to the shareholders of the target company after incorporating the comments provided by SEBI, if any.
• Offer Period – Offer period is the all-encompassing period comprising all the activities of the takeover beginning from the date of the agreement to acquire shares, voting rights or control requiring public announcement, right up to the date of payment of consideration to the shareholders who have accepted the open offer.
• Tendering period – Tendering period is the part of the offer period and represents the days during which the shareholders can tender their shares as acceptance of the offer. It will start not later than 12 working days from the date of receipt of comments from SEBI and will remain open for ten working days.
• Competitive offer – Person other than acquirer who made the first public announcement, who makes an offer. Such an offer will be made within 15 working days of the date of the Detailed Public Statement made by the acquirer who has made the first public announcement.
• Conditional offer – It is an offer where the offer is made conditional to a minimum level of acceptance is known as conditional offer. Minimum level of acceptance engulfs within itself minimum number of shares which the acquirer desires under the said conditional offer. If the minimum number of shares are not met, then the acquirer is not under obligation to accept any shares under the offer.

Directors’ obligations

Directors of Target Company

• Appointment of Directors (Regulation 24)^[3]

• Regulation 24 of the SEBI Takeover Code, 2011 bars any person acting in concert with the acquirer or person representing him, to be appointed as director in the target company.

This duty is levied upon the directors of the target company, wherein after making the open offer and the completion of the offer period, the transfer of control will only take place when the person acting in concert with the acquirer is appointed as director in the target company, and this will be continued in accordance with the shares and voting rights gained in the takeover.

However there are certain exceptions to the regulation, where the appointment of acquirer director can be made in the target company in following circumstances:

1. Where the consideration is paid up fully in cash in the escrow account in accordance to Regulation 17 of the SEBI Takeover Code, 2011, by the acquirer, then within 15 working days from the date of detailed public statement, such appointments can be made, and
2. When the withdrawal of open offer takes place due to the acquirer who even after exercising reasonable control failed to meet such conditions laid down in the agreement for acquisition making the obligation to make the open offer, given that such conditions are mentioned in the letter of offer and in detailed public statement (as under Regulation 23(1) (c) SEBI Takeover Code, 2011). In such a situation appointment can only be made when the acquirer has met those conditions or waived them off, in addition to this complies with the requirement of depositing cash in the escrow account.

• Conditional offer – The offer based on minimum level of acceptance as a condition for acceptance, the acquirer shall not appoint any director in the target company during the offer period, regardless of any provision made in SEBI Takeover Code, 2011.
• Competing offer – In case of pending competing offer, no such appointment can be made by the acquirer in the target company, such appointment can only be effected in the case of death or incapacitation of any director, through the mode of postal ballot taking approval of the shareholders of the target company.
• Prior appointments- If any prior appointments were made in the target company, then those appointed directors will not have any power to vote upon any matter with respect to the open offer, simple logic being the transfer of control is still in the process during the offer period.

Obligations of the Acquirer^[4]

• Payment obligation (Regulation 25(1)) – The acquirer needs to ensure that the financial arrangements are in place in order to fulfill the payment obligations that arise under open offer, and the required statutory approvals.
• Alienation of Property (Regulation 25(2)) – The acquirer has the obligation, to declare its intention in detailed public statement and letter of offer, clearly mentioning the medium to alienate the material assets of the target company, in case the acquirer fails to do so, after acquiring control over target company, stands barred for the period of two years after the offer period from making such alienation.

However in case of target company, wanting to part with its material assets, has to follow the following process:

• Despite the acquirer failing to mention its intention along with the mode to separate with the material assets in the detailed public statement and letter of offer, the target company can do so passing a special resolution of the target company by the mode of postal ballot, the notice sent to each shareholder must contain the reasons for such alienation.

• Obligations as to Veracity of contents (Regulation 25(3)) – The detailed public statement, letter of offer and the post offer advertisement shall contain the true and correct contents based on reliable and verifiable sources.
• No sale of shares (Regulation 25(4)) – The acquirer during the offer period has the obligation to refrain from selling any shares of the target company during the offer period.
• Liability (Regulation 25(5)) – The liability is divided in hybrid rule of joint and several, which means the acquirer as a whole is liable jointly, in realizing the same liability the persons acting in concert with the acquirer can also be held liable severally, in case of failure to abide by these regulations.

Obligations of the Target Company^[5]

• Business as of Past Practice (Regulation 26(1)) – The business of the target company should be carried out smoothly in consonance with past practice, irrespective of the fact that the public announcement is already made.
• Alienation and Voting Rights (Regulation 26(2)) – The board of directors of the target company or its subsidiaries without special resolution of shareholders of target company through postal ballot cannot do the following:

• Alienate the material assets or enter into contractual relationship out of the ordinary course of business
• Make any material borrowings out of the ordinary course of business
• Issuing or allotting any unissued securities which are authorized in nature, and gives the voting rights to the holders.

Moreover the target company may do the following prior to the public announcement of the open offer:

• issue or allot shares on convertible securities, and the terms entered for such conversion.
• Issue or allot shares in accordance with the respective public issue for which red herring prospectus has been filed with the Registrar of Companies, or
• Issue or allot shares in accordance with the rights issue for which the record date has been set out in public.

• Making any material change in capital structure of the target company or executing buy back of shares of target company,
• New contractual relationship, novation or termination of the same, out of the ordinary course of business in which the target company or its subsidiaries are party.
• Any person to which the target company owes the obligation to acquire shares or any other obligation as such, the contingent vesting of a right with such person, cannot be made except special resolution by the target company through postal ballot.

• Voting by Target company (Regulation 26(3)) – With respect to the matters mentioned above in Regulation 26(2), the target company and its subsidiaries in any general meeting of the target company’s subsidiary, will be required to vote in accordance to the procedure as under special resolution passed by the shareholders of the target company.
• No Record Date (Regulation 26(4)) – No record date is required to be fixed by the target company for any corporate action on or before the 3rd working day of the start of the tendering period till the end of such tendering period.
• Record and Particulars (Regulation 26(5)) – The target company has to hand over two kinds of lists to the acquirer within two working days from the identified date:

1. List of shareholders, containing names, addresses, shareholding and folio number in electronic form, and
2. List of pending applications for registration of transfer of shares
3. Given that, acquirer shall indemnify the target company the cost incurred in providing the above mentioned lists.

• Independent Directors Committee (Regulation 26(6)) – The board of directors of target company need to form a committee of independent directors for the purpose of publishing reasonable recommendations on such open offers being made, such committee formed may seek external expert advice at the expense of the target
• Recommendations of Independent Directors Committee (Regulation 26(7)) – The target company must publish the recommendations received from the committee at least two working days before the commencement of tendering period. The publication so made, should be in the same newspapers as that of announcement of open offer, copy of the publication of the report should be provided to the following;

1. Board of directors,
2. Where the shares of the target company are listed, stock exchanges, where the stock exchange distribute the same to the public, and
3. Manager of the open offer, manager to open offer to every competing offer, if any.

• Verification of Shares (Regulation 26(8)) – The tendered shares in acceptance of the open offer needs to be verified, and the target company shall extend all possible support to the acquirer for the same.
• Information in competing offers (Regulation 26(9)) –The target company board of directors has an obligation to provide any information and the cooperation needed in the process to the acquirer making competing offers.
• Registration of Transfer of Shares (Regulation 26(10)) – In accordance to the terms of the agreement, open market purchases or through open offer, as the above mentioned conditions are fulfilled and the offer period is complete with complete transfer of consideration price, with adherence to the obligations of the acquirer and the target company. The target company directors must transfer the shares in physical form to the acquirer, and execute the registration of transfer of shares application, and that of shareholders, immediately.^[6]

Conclusion

The obligations covered under this Article are statutory, as they are laid down in SEBI Takeover Code, 2011. More importantly, the directors of both the target and the acquirer company need to be on their toes, to look after the complete takeover process in the entire offer period, the strategic benefit, financial benefit, consequences of accepting or denying competitive offers, contingent offers, providing exit opportunities to the minority shareholders etc. The directors of both the entities have to ensure the entire takeover to be protected against hostile takeovers and be ready with defenses available.

References

^[1] https://www.sebi.gov.in/sebi_data/faqfiles/oct-2020/1602498070087.pdf

^[2] https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-substantial-acquisition-of-shares-and-takeovers-regulations-2011-last-amended-on-march-6-2017-_34693.html#

^[3] Regulation 24 of SEBI Takeover Code, 2011 (https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-substantial-acquisition-of-shares-and-takeovers-regulations-2011-last-amended-on-march-6-2017-_34693.html#)

^[4] Regulation 25 of SEBI Takeover Code, 2011 (https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-substantial-acquisition-of-shares-and-takeovers-regulations-2011-last-amended-on-march-6-2017-_34693.html#)

^[5] Regulation 26 of SEBI Takeover Code, 2011 (https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-substantial-acquisition-of-shares-and-takeovers-regulations-2011-last-amended-on-march-6-2017-_34693.html#)

^[6] Regulation 26 of SEBI Takeover Code, 2011 (https://www.sebi.gov.in/legal/regulations/apr-2017/sebi-substantial-acquisition-of-shares-and-takeovers-regulations-2011-last-amended-on-march-6-2017-_34693.html#)

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