This article is written by Afif Khan, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions), from Lawsikho, as a part of his coursework. Here he discusses “exemption provisions under takeover code.”

What is the Takeover Code and the need for such a code?

The shareholding in a public company is spread across geography, investment value and level. It involves a large number of investors that trade through open market operations in contrast with an unlisted company in which the investment is regulated through a contract between the investor and the investee. The Securities And Exchange Board Of India (Substantial Acquisition Of Shares And Takeovers) Regulations, 2011 (“The Takeover Code” or “The Code”) came into being because of the need to regulate shareholding in the public companies. This code aims to provide the minority shareholders the privilege of deciding the merits of a takeover and subsequently, an exit opportunity in case they want one. Further, the code seeks to regulate the market so as to make it orderly, transparent and fair.  

When does it apply and to whom does it apply?

The Takeover Code applies when an ‘acquirer’ either through himself or through a number of ‘persons acting in concert’ acquires or agrees to acquire substantial shares or voting rights[1] or control[2] either directly or indirectly[3] in a public company (“Target Company”). For such acquisitions, the Code sets out certain limits. If the acquirer wants to do any of the aforementioned actions beyond the limits then the code mandates that an open offer be made to all the shareholders in order to provide an exit-opportunity. 

The code defines an acquirer[4] as a person who either acquires or agrees to acquire shares, voting rights, or control in a target company. This can be done by the person either himself, or with persons acting in concert with him (“PAC”). Persons who come together with a common object or purpose of acquisition of shares or voting rights or exercising control over a target company are referred to as ‘persons acting in concert’[5] in the Code. Such exercise can be direct and formal, for example, through an agreement. Or indirect or informal, through an understanding or mere co-operation. 

One interesting way in which the code regulates acquisitions is by including control in the definition of acquisition. The implication of this inclusion is that if a person or persons acting in concert have the authority to appoint the majority of the directors or control management or policy decisions by virtue of their shareholding, management rights, voting agreements or shareholders agreements, then the code will apply to them as well. Further, such influence can be a result of a direct or indirect action as well as an individual or a concerted action. 

Hence, any acquisition of voting rights, shares, or control in a target company directly or indirectly, either individually, or through persons acting in concert beyond the permissible limit mandates an open offer to be made in the code. Now the question arises, what are the permissible limits and what is the open offer requirement?

Permissible Limits. What are they?

As has already been discussed the Code is enacted to ensure that the existing shareholders get an exit opportunity. The Code enables this by mandating an open offer to be made in case an acquisition is substantial, whether direct or indirect, or if there is a change in control. To examine whether the acquisition is substantial or not, the code puts an acquisition test in place. This happens in three scenarios. So if the acquirer either individually or with persons acting in concert with him, acquires shares entitling him to an ownership that is 25% or more, then the open offer requirement triggers.[6] This is the first type of requirement which usually happens in a case of direct acquisition. The second type of requirement comes when the acquirer either individually or through PAC already has 25% or more voting rights in the company but wants to acquire more then the Code mandates that he will have to make an open offer if this acquisition is of 5% or more shares in one financial year.[7] This is an example of creeping acquisition that the Code seeks to regulate. The third case when open offer requirements come to the fore is when the acquirer either individually or with PAC gains control[8] in the company without the acquisition of shares, for example by exercising power to appoint directors in the Board. 

That being said, it is important to mention that one can’t acquire more than 75% of shares in a public company. This is referred to as the permissible non-public shareholding in a listed company. This is derived based on the minimum public shareholding requirement under Rule 19A of the Securities Contracts (Regulations) Rules 1957 (“SCRR”) which mandates all listed companies, excluding public sector companies to have at least 25% of share capital of the company. 

We have discussed the permissible limits and how they trigger the open offer requirements. Let’s now examine what is the open offer requirement under the Code. 

What is the Open Offer requirement?

The code mandates you to make an open offer to all the public shareholders of the company in which you are acquiring shares. It gets triggered when the thresholds as described in the situations above are met. It gives the shareholders a chance to exit the company. The minimum offer size required for an open offer is 26%[9] for all of the above three scenarios. For the other three described below. It is different as will be dealt later. 

Open Offers are of three types – Conditional, Voluntary and Competing. Let’s have a brief look at them. 

1. Voluntary Open Offer – A voluntary open offer is made by a person who either himself or through PAC, holds 25% or more shares or voting rights in the company.[10] The minimum offer size requirement for this type of offer is 10% or more of the shares. Most companies opt for this type of offer in a situation where the acquirer is already having more than 25% of shares. Now, he wants to acquire more. He can either make creeping acquisitions by buying less than 5% shares multiple times or he can make a voluntary open offer in which he has to make a minimum offer size of 10%. The only restriction on someone making a voluntary open offer is that he or she can do it once every 6 months,[11] a time-restriction not found in any other type of offer. 
2. Conditional Offer – As the name suggests it is an offer in which the acquirer attaches a condition of minimum level of acceptance to his offer.[12] For example, A, is an acquirer who makes an open offer of 30%. But he puts the condition that this offer will only take effect if the minimum level of acceptance to this offer is 26%.
3. Competing Offer – A competing offer is like that of an auction. If the acquirer makes an open offer then another acquirer has the option to bid for the same shares if he does that within 15 days of the first bid,[13] and has a bid either equal or higher than the previous one.[14] The Code does not mandate any maximum limit to the number of times this process can go on. Further, the original acquirer can also bid again provided that he does it complying with the 15 days requirement as well as makes a bid of higher value. 

Now, the question arises, what should be done in a situation, where one does not want to make an open offer but still wants to acquire shares. For this, the Code has granted certain exemptions. Let’s have a look at them:

Exemption provisions under the Code

The Code has two types of exemptions, General Exemptions and Exemptions granted by the Board.

General Exemptions

These are given under regulation 10 of the Code. The logic behind extending these exemptions is that the person is not himself going out and acquiring the shares but is somehow getting them due to certain conditions, circumstances, and trigger events. Although, the Code has not made any categorisations, or divisions, for the sake of simplicity, I have categorised these as follows:

1st Category – Inter-Se Transfers[15] – These include:

1. Immediate Relatives[16] as defined under the Companies Act, 2013.
2. Promoters[17] – These are members of a company that are a part of the prospectus preparing process.  While the Companies Act, 2013 gives certain conditions when a shareholder can be considered a promoter, it is best to understand them as advertisers of a company that get investors to invest. 
3. A company, its subsidiaries, its holding company, other subsidiaries of such holding company, and persons holding not less than fifty percent of the equity shares of such company and also, other companies in which these persons don’t hold fifty percent of shares.[18]
4. Persons acting in concert[19] or shareholders acting in concert.[20]

For these persons to qualify for an exemption, three conditions are necessary.
First, for promoters and shareholders to qualify under the exemption, they need to have been the promoter or shareholder for at least three years prior to seeking such exemption. This is to avoid anyone from getting reclassified as a promoter[21] only for the purpose of seeking such exemptions. Second, there is a restriction on price[22] and finally, third, disclosure requirements under Chapter-V[23] must be met.

2nd Category – Intermediaries[24] – These include:

1. Underwriter[25]
2. Stockbroker[26]
3. Merchant bankers[27]
4. Anyone who acquires shares under regulation 44 of SEBI (ICDR) Regulations, 2009, with respect to a scheme of safety net.[28]
5. A registered market-maker of a stock exchange.[29]
6. A scheduled commercial bank which acts as an escrow agent for the parties.[30]
7. When shares acquired by a Scheduled Commercial Bank or a Financial Institution pursuant to invocation of pledge where these institutions act as a pledged.[31]
   

In all of these instances, the parties are acquiring shares, either for someone else, which is case (1), (2), (3), (4), (5), or are acquiring as pledgees, case no. (7), or as escrow agents pursuant to an escrow agreement, case no. (6). In all of these instances, the acquirer is not ‘out to get the shares’ for himself or herself but is getting them for someone else.

3rd Category – When the acquisition is pursuant to a disinvestment[32] and it is in many stages and the open offer requirement has been fulfilled at an earlier stage. The intention behind the open offer requirement is to give shareholders a chance to exit. If an investment is in stages, and the open offer has been made in an earlier stage then that chance has already been given. There is no need to make an open offer at every stage. 

4th Category – When the acquisition is pursuant to a scheme.[33] The rationale here is that since, a scheme needs the approval of a Tribunal, the interests of the shareholders are taken care of at that level only. Hence, there is no need for an open offer to be made. The Tribunal will not approve a scheme that goes against the interests of a shareholder. The instances included under this regulation are:

1. Scheme of revival under section 18 of the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986).[34]
2. An arrangement either involving the target company[35] or not involving the target company[36], as well as reconstruction, amalgamation, merger, or a demerger, pursuant to a court order.
3. Acquisition which is pursuant to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002).[37] This is a recovery mechanism, hence, again, in the interests of the shareholders. 
4. Acquisition pursuant to SEBI’s delisting regulations.[38] Again, in this case, the Stock Exchange has asked a company to get delisted and this is again, in the interests of the shareholders and the acquirer is not ‘out to acquire the shares’.
5. Acquisition by way of transmission, succession or inheritance.[39] Here again, the acquirer is getting shares involuntarily.
6. Acquisition of voting rights or preference shares carrying voting rights arising out of the operation of sub-section (2) of section 87 of the Companies Act, 1956 (1 of 1956).[40] This is given an exemption because this can only happen after a Shareholders’ Resolution is passed, hence, the interests of the shareholders are taken care of at this stage only. 
7. Acquisition of shares by way of conversion of debt into equity as part of the Strategic Debt Restructuring Scheme.[41] This is again, in accordance with the guidelines specified by the Reserve Bank of India.
8. Increase in voting rights arising out of payment of sums of monies and liens that were previously not paid under Section 106(1) of the Companies Act, 2013.[42] Under this section, a person’s voting rights get suspended if he does not pay his share of sums or calls on the shares that he has held. Once, he pays them, then his power to vote gets resumed. This is still voluntary, does not affect the other shareholders and hence, exempt.
   

Up until now, we have covered the exemptions that exempt open offer requirements under regulation 3 and 4. These were on the basis of the nature of acquirers that were provided exemptions. Now, further categorisation is on the basis of the regulation the exemption seeks to exempt. 

5th Category – Exemption under regulation 3

The acquisition of shares of a target company, when undertaken according to a scheme of corporate debt restructuring[43], excluding a change of control shall be exempt. But such acquisition can only be exempt when it is authorised by 3/4th of the total shareholders, i.e., by way of special resolution. 

6th Category – Exemption under regulation 3(1)

When an increase in the voting rights of a target company goes beyond the threshold limit of 25% as given under regulation 3, arising due to the buy-back made by the company then such a shareholder(s) will be exempt from making the open offer.[44] Provided that within 90 days of such increase in voting rights the shareholder decreases his shareholding to below the threshold limit, that is 25%, given under regulation 3.  

7th Category – Exemption under regulation 3(2)

Regulation 10(4) exempts increase in voting rights arising out of:

1. Acquisition pursuant to a rights issue;[45]
2. Acquisition pursuant to a buy-back;[46]
3. Acquisition according to a share swap scheme;or[47]
4. Acquisition of shares in a target company from either from a venture capital fund or a foreign venture capital investor that is registered with the Board, that is by promoters of the target company pursuant to an agreement between such promoter, venture capital fund or foreign venture capital investor.[48]

We have dealt with the general statutory exemptions provided in the Code, now let’s deal with exemptions that the Board, SEBI, provides.

Exemptions by the Board

Regulation 11 of the Code talks about exemptions to be provided by the Board. It says that apart from the above mentioned category of exemptions provided, the Board can exempt a person or class of person if it is of the view that an exemption may be provided to them. For availing the exemption granted by SEBI, the acquirer or the target company, as the case may be, needs to file a specific application with SEBI together with a non-refundable fee of INR 50,000. SEBI will pass a reasoned order on the application, after affording reasonable opportunity of being heard to the applicant and after considering all the relevant facts and circumstances.[49]

Conclusion

The Takeover Code was enacted as a measure to give shareholders a right to exit a company. Pursuant to this goal, the Code mandates an open offer requirement. But not all companies have to comply with this open offer requirement and the Code also gives certain exemptions for such companies. Hence, we have described them above and categorised them for convenience of the reader.

References 

1. Regulation 3
2. Regulation 4
3. Regulation 5
4. Regulation 2(a)
5. Regulation 2(q)
6. Regulation 3(1)
7. Regulation 3(2)
8. Regulation 4
9. Regulation 7(1)
10. Regulation 6(1)
11. Regulation 6(2)
12. Regulation 19(1)
13. Regulation 20(1)
14. Regulation 20(2)
15. Regulation 10(1)(a)
16. Regulation 10(1)(a)(i)
17. Regulation 10(1)(a)(ii)
18. Regulation 10(1)(a)(iii)
19. Regulation 10(1)(a)(iv)
20. Regulation 10(1)(a)(v)
21. https://www.mondaq.com/india/CorporateCommercial-Law/762486/New-Rules-For-Promoter-Re-Classification-In-Listed-Companies
22. Regulation 10(1)(a)(v)(i)
23. Regulation 10(1)(a)(v)(ii)
24. Regulation 10(1)(b)
25. Regulation 10(1)(b)(i)
26. Regulation 10(1)(b)(ii)
27. Regulation 10(1)(b)(iii)
28. Regulation 10(1)(b)(iv)
29. Regulation 10(1)(b)(vi)
30. Regulation 10(1)(b)(vii)
31. Regulation 10(1)(b)(viii)
32. Regulation 10(1)(c)
33. Regulation 10(1)(d)
34. Regulation 10(1)(d)(i)
35. Regulation 10(1)(d)(ii)
36. Regulation 10(1)(d)(iii)
37. Regulation 10(1)(e)
38. Regulation 10(1)(f)
39. Regulation 10(1)(g)
40. Regulation 10(1)(h)
41. Regulation 10(1)(i)
42. Regulation 10(1)(j)
43. Corporate Debt Restructuring Scheme notified by the Reserve Bank of India vide circular no. B.P.BC 15/21.04, 114/2001 dated August 23, 2001, or any modification or re-notification thereto; Regulation 10(2)
44. Regulation 10(3)
45. Regulation 10(4)(a)
46. Regulation 10(4)(c)
47. Regulation 10(4)(d)
48. Regulation 10(4)(f)
49. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Ma%20Lab/Takeover%20Code%20Dissected.pdf

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