This article is written by Advocate Shamika Vaidya pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com. Here she discusses the exemptions to the open offer under the Takeover Code.

Introduction

Getting an exemption from the open offer is a great advantage for a company. A company already has a huge capital commitment when it is acquiring 25% or more in a company. With the exemption, it is free from the obligation of purchasing additional shares. The takeover code exempts certain transaction from the obligation to make an open offer. Having said that, not every company coming under the ambit of exemption is able to avail the privilege of an exemption as several factors are considered by the market regulator.

The purpose behind an open offer

• On the bare perusal of Section 3(1), it is evident that a company acquiring stake/ voting rights in other company which is equal to or more than 25% has to fulfill the obligation of an open offer.
• The decision of shareholders to invest in a company has relied on factors like shareholding patterns, promoters, dividends etc.
• Whenever a company is acquired by another company beyond a threshold, there is a considerable change in the shareholding patterns and voting rights. These changes are instrumental in determining the future of the company.
• All things considered, shareholders who are not inclined to continue their investments by the company are given an exit opportunity by the virtue of the open offer.

Purpose behind exemptions to the open offer

• Exemptions established in the code have strong logic backing them. For example, underwriters are granted the exemption and the reason is apparent. They are part of transactions like IPO and assume the risk of the company by charging fees and as a part of IPO have to acquire shares which, otherwise may trigger takeover code.
• Similarly, let us consider the case, where there is an escalation in the shareholdings of other shareholders as a result of forfeiture of partly paid shares of defaulting shareholders. It is preposterous to make them buy shares of the defaulting shareholders.

Informal Guidance Letter from SEBI

• In the event, any company is uncertain about the exemption of a proposed transaction, it can seek informal guidance from SEBI by writing an application to the board.
• Securities and Exchange Board of India (Informal Guidance) Scheme, 2003 states the compliances and procedure for seeking guidance. (See the scheme here)
• The guidance is not to be construed as SEBI’s order and where the statute is clear on a provision there is no necessity to seek the informal guidance. This was ruled by the appellate tribunal in Arbutus Consultancy LLP Vs SEBI.

Application for seeking exemption

• SEBI released a Circular (C. No. SEBI/HO/CFD/DCR1/CIR/P/2017/131)  introducing a format for making an application for seeking exemption from the open offer.
• The acquirer company has to file an application before the board along with a duly sworn affidavit and details of the proposed acquisition.
• The Application must contain details of the proposed acquisition and the grounds under which the exemption is sought.
• On the application, if the Board is convinced that an exemption is in the interest of the investors in the securities market, it may grant an exemption from making an open offer.
• A reasonable opportunity is given to the acquirer to put forward relevant facts and explanation as to why an exemption should be granted.
• A panel of experts can offer a recommendation to the Board. If the Board is convinced that granting an exemption is for the benefit of the shareholders it can grant an exemption to the applicant and thereafter he is not under the obligation to announce an open offer.
• A non-refundable fee of five lakh is to be paid along with the application. (SEBI Circular)

Exemptions

Inter Se transfers

• Inter se transfer between immediate relatives, between a company, its subsidiaries, its holding company and other subsidiaries of such holding company are exempted from the obligation of the open offer. Also, transfer to Person Acting in Concert for three years or more, prior to the proposed acquisition is exempted.
• Regulation 10(1)(a)(ii) states that the inter se transfer amongst the promoters can only be exempted under the code if the promoters holds shares for at least a period of three years prior to the proposed acquisition.
• Primarily, there is no change in the ownership in inter-se transfers. Moreover, these acquisitions are either part of the corporate restructuring as in the case of transfers between holding company and subsidiary or to secure the future of the descendants of the promoters in case of transfer to trust.

Cases

• Neeman Family Foundation Trust is a trust of Max Group promoter and proposed to acquire a stake of 25% in Max Financial Services and Max-Ventures and Industries.
• The application for seeking exemption under the code was rejected by SEBI on the grounds that the trust does not meet the stipulated mandate of disclosure as a promoter for three years prior to the acquisition.
• Similarly, in Weizmann Forex Ltd. the inter se transfer of the shares within their group could not avail the exemption as they could not fulfill the condition put forward in Regulation 10(10(a)(ii).

Trusts

• There is a significant increase in the transfers of business assets including shares of listed entities to family trusts.
• SEBI receives a plethora of application to seek the exemption for the transfer of shares from promoters to Trusts.
• The following conditions are taken into consideration for the grant of exemption;
• There should be no change in the ownership or control of the shares or voting rights in the target company.
  • The trust has to be a mirror image of the promoters holding.
  • The beneficiaries cannot be other than individual promoters, immediate relatives and lineal descendants.
  • The beneficial interest of the trust cannot be transferred, assigned or encumbered in any manner.
  • On dissolution, the assets cannot be transferred to anyone except beneficiaries or their legal heirs.
  • The trustees cannot be entitled to transfer or delegate their powers to anyone other one or more of themselves.

Intermediaries

Intermediaries registered with the Board are engaged by the Companies and have to fulfill their transaction related roles. They do so on behalf of their clients and considering this the capital regulator granted exemptions to certain transactions between intermediaries and their clients which involved the transfer of shares by the intermediaries which would otherwise trigger the open offer.  

1.       Underwriters
2.       Stock Brokers
3.       Merchant Bankers
4.       Registered stock marker
5.       Scheduled Commercial Bank acting as an escrow agent

Insolvency and Bankruptcy Code

• The acquirers of distressed companies are not under the obligation to make an open offer. The relaxation is granted with an intention to ease the additional burden on the acquirer from infusing an additional capital pursuant to acquiring the stake in the company.
• Furthermore, the provision is envisaged to boost acquisitions of such companies.
• Under the (CIRP) Corporate Insolvency Resolution Process under the Insolvency and Bankruptcy Code, a company can be restructured in order to come up with a modified repayment plan and on the failure of any restructuring can be acquired by an interested company.
• However, the market regulator came across cases where the lender acquiring shares in a distressed company had to face complexities to exit because of the takeover norms.
• The acquisition of Bhushan Steel by Tata Steel, acquisition of Electrosteel by Vedanta, acquisition of Monnet Ispat by JSW Steel was under IBC and were exempted from the open offer.

Strategic Debt Restructuring Scheme

• Prior to the Insolvency Code, RBI had introduced schemes like Strategic Debt Restructuring Scheme in order to cope with the increasing Non-Performing Assets of the Public Sector Banks.
• Under Strategic Debt restructuring Scheme, banks who had advanced loans to corporate borrower could convert a part or full of the loan taken by the company into equity shares as per the RBI guidelines and Banking Regulation Act and the scheme was exempted from the obligation of the open offer.
• SEBI in its informal guidance during the recent proposed acquisition of Jet Airways by Etihad stated that no exemption can be granted to the companies carrying out acquisitions for exercising Strategic Debt Restructuring if it is not under IBC. (Read here)

 Disinvestment

• Regulation 2(g) defines disinvestment as the direct or indirect sale by the Central/State Government or by a government company of shares or voting rights or control over a target company, which is a public sector undertaking.
• Power Finance Company (PFC) who proposes to buy the government stake of 52.63%  Rural Electrical Corporation (REC) was exempted from making an open offer to the minority shareholders of the target company.
• ONGC bought stakes of 51.11% in HPCL oil refiner and was exempted from the code as well.

Investment Funds  

• Investment funds like (AIF) Alternate Investment Fund and Venture Capital Fund are exempted from making an open offer when their investments cross the threshold that can trigger an open offer.

Buyback of shares

• In Raghu Dalmia Vs. SEBI, the appellate tribunal ruled that, if buyback of shares results in the increased shareholding of the promoter it will not trigger an open offer.
• The increase in the percentage of the voting rights or shareholding pattern of the promoters who are actively involved in the process of the buyback is the result of the reduction of the share capital of the company on account of the buyback of shares and therefore will be considered as the passive acquisition.  

Forfeiture of shares

• Any increase in the shareholding due to forfeiture of partly paid shares is a result of non-payment by defaulting shareholders as per the provisions of the Companies Act.
• The increase in the shareholding as a result of the expiry of call notice period and forfeiture of shares are treated as passive acquisitions.
• Accrual of voting rights to the remaining shareholders upon expiry of call notice issued to the shareholders holding partly paid-up shares is also passive.

Capital Infusion

• An exemption was granted to six Public Sector Banks namely- PNB, Syndicate Bank, Vijaya Bank, Union Bank of India, Canara Bank and Bank of Baroda by the board pursuant to the capital infusions by the Central Government.
• SEBI stated that as there is no change in control of the banks as well as there will be no change in the number of equity shares held by public shareholders pursuant to the proposed transaction and therefore is fit to e exempted. (Read more here)

Acquisition under the SARFAESI Act, 2002

• The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) vests powers to the banks to auction properties of borrowers who default the loan repayment.
• Asset Reconstruction Companies are regulated by the Reserve Bank of India and acquire financial assets from the banks and financial institutions.
• The lenders are duty bound to give back the control of the company after recovering their dues and are therefore fall under the ambit of exemption.

Linde India Limited  and Praxair Inc, Reg 10 (1)(d)(iii)

• The merger between Linde India Limited, a German company, and Praxair Inc., an American company had to be approved by the Federal Financial Supervisory Authority of Germany pursuant to reviewing it. Here there was no direct involvement of the Indian Company.
• Further, Praxair was under the  to make disclosures under U.S federal securities Law and Delaware law
• The parties requested SEBI to grant an exemption under Regulation 10(1)(d)(iii) which states an order from the court or competent authority under foreign law on arrangements that do not have direct involvement of the target company as a transferor/transferee company are exempted.
• SEBI was of the view that there was the absence of ‘court or competent authority’ and therefore did not grant an exemption under the code.

Other exemptions

• Acquisition by way of transmission, inheritance, and succession.
• Acquisition of shares by any shareholder of a target company up to his entitlement, pursuant to a rights issue;
• Exchange of shares

Specific Exemption

• SEBI has the discretionary power to grant exemption specifically to a transaction if it in the interest of the stakeholders of the company despite its absence in the code.
• Etihad owns 24% in Jet Airways and is willing to invest more on certain conditions one of them being, it should be granted an exemption from the open offer.
• On approaching SEBI, it was of the view that an open offer exemption is possible under the takeover code to save a company for the investors’ interest. (Read the story here). The transaction is under process and there is a fair possibility of they not being granted an exemption as well considering other factors.

Pursuant to exemptions, a report is to be filed by the acquirer with the stock exchanges where the shares of the target company are traded within four working days from the date of acquisition. Further, the stock exchanges have to disseminate the information to the public.

Conclusion

A lot depends on the application for granting exemption from the open offer. A well-drafted letter stating appropriate reasons as to why the transaction should come under the ambit of exemption or how it is beneficial to the shareholders, can not only save a lot of capital but also time and effort. Nonetheless, if the open offer is triggered the procedure put forward by the act has to be followed. To know the step by step procedure, continue reading from here.