In this article, Devasheesh Pathak discusses the provision of Mandatory Bid Rule under the Takeover regulation in India.
Introduction
A body corporate typically operates by the “majority-rule” and hence the other shareholders of the target company, especially minority shareholders, are often left to the whims & fancies of such majority shareholders who might not always end up taking a decision in everyone’s favor. Change in majority stake over the shares of such a target company often tends to leave other minority shareholders high & dry and at the behest of such decisions of the majority. It becomes really problematic for such minority shareholders, unwilling to continue as shareholders when such a change in control takes place since they are uncertain about the new objectives of the company. Hence, there arose a need to propose a protective mechanism or rule for such unwilling minority shareholders and thus provide them with an easy exit option at a fair value at such instances of share acquisitions.
The mandatory bid rule (MBR, in short), having its origin in the UK, was put in place in order to uphold the idea of equal treatment of all other shareholders and thus this rule proved to be an elixir for such minority shareholders. As per the mandatory bid rule, the acquirer of shares in the target company needs to offer to buy more shares of the rest of the shareholders once a certain threshold, necessary for triggering the MBR, is reached. The mandatory bid rule ensures that all the shareholders in a company, or for that matter the target company, are treated fairly and equally & that the minority shareholders are not coerced into acceding with the majority’s decision. However, despite being a protective tool for the minority shareholders, the mandatory bid rule has a few shortcomings as well including an impact on the value of the firm.
This paper is an attempt to critically analyse the mandatory bid rule as it exists today and determine the loopholes, if any, in the rule itself or its implementation. Further, the regime in India on the mandatory bid rule shall be analysed in this paper along with a comparative analysis of the regime prevalent in other developed countries including the US & the UK. The paper shall also discuss the potential changes that can be implemented in order to fill in the loopholes present in the mandatory bid rule in the context of India.
The Global Context
The mandatory bid rule has its origins in the self-regulatory City Code on Mergers & Takeovers in the UK during the mid-90s.[1] The City Code on Mergers & Takeovers was enacted in response to the rampant abuses in the takeover market, with the purpose of guaranteeing equitable as well as fair treatment of all the shareholders involved in any such takeovers and providing a well-defined framework for such takeovers to take place.[2] This Code underwent amendments in the year 1968 and it was finally in the year 1972 when the Takeover Panel, a self-regulatory body under the City Code, came up with the mandatory bid rule according to which all such bidders who purchased 40% or more of any company’s shares were obliged to offer to purchase the rest of the outstanding shares from the rest of the shareholders. This ensured that the other shareholders, specifically minority shareholders, were treated equitably & fairly with the other shareholders involving such highly consequential transactions like takeovers.
Until the 1980s, the United Kingdom was the sole nation in the entire European Union to have a strict regulatory system in place on rules pertaining to mandatory bid and takeovers, in general. However, by the 90s, a few other countries across Europe as well began adopting the mandatory bid rule as it existed under the UK system thus benefitting from the experience of the latter. Such acceptance of the mandatory bid rule came about in the response to the surge in takeover activities across Continental Europe around the early 90s.
The fundamental rationale behind the introduction of the mandatory bid rule was to ensure fairness and equity & most of the member states of the EU even subscribed to this rationale. However, the reasons for such countries subscribing to this rationale were different.
For instance, under the German laws, this rule was introduced with the sole objective of providing an exit option to the minority shareholders in cases of such change in control of the companies during takeovers. They considered takeovers to be sinister and hence favored the view that the minority shareholders should be given an exit opportunity at a fair value in such situations.
On the other hand, under the British law, the mandatory bid rule focussed more on the fair division of takeover premium amongst all the shareholders instead of leaving it in the hands of a selected few. Under the British law, the change of control effected through takeovers was considered as something good and hence all the shareholders were entitled to a fair share in the premium.
Despite such an agreement amongst all the member states on the necessity of having the mandatory bid rule, there did exist certain differences in the wording of the rule itself owing to disagreement on certain important features under the rule like the triggering of MBR, control threshold & pricing under the MBR. The member states could not satisfactorily reach to a common definition for control threshold owing to the differences in the ownership concentration levels across different states. And thus, till date there exist quite many differences in the rule across different countries pertaining to its implementation, threshold requirements, pricing, etc. This paper shall be dealing specifically with such differences & loopholes in the mandatory bid rule as they exist today in the later paragraphs. Also, the rule and its effectiveness shall also be analysed subsequently.
The Indian Context
Although the origins of the mandatory bid rule under the Indian law can be traced to the UK law, however, there exist fundamental differences between the takeover regulations in India and the UK or other countries.
The mandatory bid rule in India stems from the principle that all the shareholders should be treated equally & fairly and thus it focuses on the equitable distribution of control premium amongst all such shareholders including the minority shareholders in cases of takeovers. The rule was devised to safeguard the minority shareholders from any potential abuses of the new acquirer and thus it provides an exit opportunity to such shareholders whenever a change in control effected through takeovers takes place.[3] Thus, undoubtedly the mandatory bid rule has become the centrepiece of takeover regulations in India. However, the rule has also been criticised widely for being a hindrance in the consummation of value-increasing takeovers owing to the increased costs and thus it deters a large number of acquirers from taking control over a company.
Under the Indian law, the mandatory bid rule finds its existence in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. These regulations primarily deal with the takeover market, laying down key rules and regulations to be followed during such processes involving takeovers.
It is pertinent to note here that the outcomes of the mandatory bid rule yield differently in a company with a concentrated shareholding as opposed to a company with diffused shareholding. In the case of the company with its shareholdings concentrated in the hands of a few, the MBR might operate in a way favorable to the controlling shareholder but unfavorable to the potential acquirer & minority shareholders as well.[4] Thus, the mandatory bid rule, in such companies, might lead to even more concentration instead of diffusion in the shareholding.
As per the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter referred to as the Code), there are three ways through which MBR can be triggered by an acquirer. Firstly, as per Regulation 3(1) of the Code, MBR gets triggered in such cases where the acquirer either purchases shares or voting rights in such a manner that it entitles him to exercise 25% or even more voting rights in any such target company.[5] In such cases, the acquirer must make an offer to other shareholders of the target company to buy their shares at a fair price at the time of acquisition thus giving the minority shareholder an opportunity to exit safely.[6]
Secondly, as per Regulation 3(2) of the Code, the incumbents already holding 25%-75% shares in the target company cannot acquire more than 5% shares in the same target company in any given financial year without triggering the MBR.[7] Thus, if the acquisition in any financial year exceeds 5% then, in that case, the acquirer will have to make an offer for the acquisition of other shares in the target company.[8] This type of acquisition is termed as creeping acquisition where the acquirer, already holding more than 25% shares, keeps on buying shares on a yearly basis and thus the MBR is triggered once it passes the threshold prescribed.
Click hereThirdly, as per Regulation 4 of the Code, the final trigger happens in cases where the acquirer, irrespective of the shares or voting rights, acquires control over the target company.[9] In such a case as well, the acquirer taking up control is required to offer to purchase the shares of such target company.[10] However, there exists no specific clarity as to what the term “control” actually means and that is the reason why this issue is still a debatable one. Regulation 2(e) of the Code defines control to include the following-
“the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.”[11]
Thus, as defined statutorily, the meaning of control for the purposes of takeovers shall imply the right to appoint directors on the board and to control the management, policies, & decision-making in the company to an extent. Control over the board may also arise in situations where the acquirer, despite holding below 25%, is the single largest shareholder in the company. The statutory definition, however, seems to be a bit unclear as to what the control of management shall include since it is much easier to ascertain the existence of a right to appoint directors but not the former.
The Securities Appellate Tribunal, in the case of Subhkam Ventures Private Limited vs. SEBI[12] relating to the definition of the term ‘control’, held that control implies some positive power and thus rejected the view taken by SEBI that affirmative voting rights (AVMs) of the acquirer, found in shareholder agreements, would amount to taking over control of such target company.[13] The tribunal held that holding AVMs in the target company implies negative power and thus it could not amount to the acquirer being in “control” of the target company. However, in the intervening period, after an appeal was preferred against this order before the Supreme Court, the Takeover Regulations Advisory Committee (TRAC) came up with the new Takeover code recommendations in 2010. Since the parties had already reached a settlement before the apex court could take up the matter, the court held that the previous observations of the SAT would have no precedential value.
Further, in the case of Ashwin K Doshi v. Securities and Exchange Board of India[14], the Securities Appellate Tribunal observed that the definition of “control” is a subjective one and depends on case-to-case basis & that it must be given wider connotation and interpretation.[15]
Loopholes in the Mandatory Bid Rule
Despite being a tool for protecting the interests of minority shareholders, the mandatory bid rule is often criticised for a few shortcomings or loopholes present therein. The rule, as it exists today, is considered to be a comprehensive one however subjective analysis of the same points to a few lapses in the rule itself.
The foremost critique of the mandatory bid rule has been that it prevents the occurrence of value-increasing takeovers and at the same time it makes takeovers a really expensive venture. High-value takeovers are prevented from even taking place due to the enhanced expenditure as a consequence of the application of the MBR. The acquirers are prevented from concluding high-value takeovers since the MBR gets triggered once their total shareholdings exceed the threshold of 25%[16] and hence the costs of such an acquisition increase manifolds due to the mandatory bid rule coming into play. Back in July 2011, the Securities and Exchange Board of India increased the threshold for triggering the MBR to 25% from the earlier 15%.[17] Considering the concentrated shareholding pattern in India, the current threshold for triggering the MBR seems to be in line with such a pattern however it is not adequate still, in the true sense. Contrasting this with the MBR thresholds of around 30-35% in certain other countries including the UK, the threshold in India is still low given the level of concentration of shareholdings in the country. Thus, it might prove to be really beneficial if the current threshold for triggering MBR is increased by a significant amount as this will go a long way in ensuring that value-increasing takeovers are concluded with ease without overburdening the acquirer.
Another shortcoming of the mandatory bid rule lies in the fact that many times the incumbent promoters tend to benefit from the creeping acquisition limits and hence eventually strengthen their control in the company. To reiterate, as per Regulation 3(2) of the Code, MBR is triggered once the acquirer purchases more than 5% shares in the target company in any given financial year thus proving to be a promoter-friendly mechanism. Creeping acquisition thresholds under the Code give a leeway to the promoters who might continue to purchase shares around 5% without triggering the MBR & hence concentrate their holdings in the target company. This method is often adopted by the promoters to ensure protection against hostile takeovers but however, it has the effect of depriving the shareholders of equal treatment in such cases thereby being contrary to the perceived objectives of takeover regulations. Thus, decreasing the creeping acquisition threshold by a certain amount might check this problem of the promoters taking undue advantage of the mechanism. It should be kept in mind that the acquirer in such a case is already holding more than 25% shares in the company and thus there lies a potential that he might abuse his position to take advantage of the creeping acquisition limits to the detriment of other shareholders. Hence, a slight reduction in the current threshold for creeping acquisition might prove to be successful considering the concentrated shareholding pattern in India.
Yet another aspect of the mandatory bid rule that has continuously vexed the courts as well as the regulatory bodies is the definition of the term “control” under Regulation 4 of the Code. As per the statutory definition under Regulation 4, control shall include the right to appoint directors on the Board of the company, to control the management as well as the policies of the company.[18] However, the definition as provided in the Code seems to be silent on the actual meaning of the term “control the management & policies” since this is more of a subjective test in contrast to the “right to appoint directors” which is clearly an objective one. Thus, the definition of “control” has been highly controversial and debatable. About a couple of years ago, a discussion paper on “Brightline Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations” was issued by SEBI wherein it suggested a few alternatives to the definition of control thus granting somewhat certainty to the current definition.[19] However, disagreement still exists on the actual definition of the term control and hence the courts in India, at certain occasions, have dealt with this divisive issue relating to the rights included within the definition of “control”. On one such occasion, in the case of Clearwater Capital Partners v. Kamat Hotels (India) Limited, SEBI observed that the protective provisions included in the shareholders’ agreement between these two entities did not amount to Clearwater taking up “control” over the target company Kamat Hotels. The Securities and Exchange Board of India observed that the shareholders merely had certain rights to exercise control over the management so as to protect their interests as investors of the company and the same did not amount to the shareholders having the right to formulate policies for the target company.[20]
Further, in Subhkam Ventures[21] case as discussed in the preceding paragraphs, it becomes quite evident that the courts have, on certain similar occasions, interpreted the term “control” widely so as to ensure that the minority shareholders are safeguarded at such changes in “control” pursuant to takeovers.
Conclusion
The mandatory bid rule, as it exists today, evolved in response to the prevalent abuses in the takeover market in Europe in the mid-90s. It was formulated with the sole objective of providing a protective tool to the minority shareholders in cases of takeovers and the equal distribution of takeover premium amongst the shareholders. The Indian law on takeovers is comparatively even stringent and the rules on mandatory bid are often interpreted strictly. Under the Indian law as well, the MBR gets triggered in three situations however the thresholds are different than other countries and these triggers are encapsulated in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. The initial trigger limit has been set at 25% or more of shareholding under the Code. Further, the threshold of 5% has been set for creeping acquisition cases. Also, the final trigger happens when the acquirer obtains “control” of the company and in such cases, the voting rights or shareholdings are not taken into consideration. The Indian law on takeovers seems to be quite in line with the prevalent shareholding pattern in the country.
However, despite being a meticulously designed rule, there do exist certain shortcomings in the mandatory bid rule as it exists under the Indian laws. As discussed in the preceding paragraphs, the threshold for the initial trigger as well as the creeping acquisition threshold under the Indian laws is still not adequate, keeping in mind the concentrated pattern of shareholding in India. Also, the controversy surrounding the actual definition of “control” has not been resolved satisfactorily as of yet. Hence, the current regime in India on the mandatory bid rule needs certain modifications to be in consonance with the shareholding pattern in the country.
To sum up, we can plausibly agree over the fact that the mandatory bid rule in India is effective to great extent for the minority shareholders and it seeks to ensure fair & equitable treatment. However, considering the loopholes existing therein, the current regime on MBR in India can be made even more effective by plugging all such loopholes in the desired manner. Only when such loopholes are plugged can we say that the mandatory bid rule in India is really effective.
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[1] Jeremy Grant, Tom Kirchmaier, Jodie A. Kirshner, Financial Tunneling and the Mandatory Bid Rule, January 2009.
[2] Ibid.
[3] U. Varottil, Comparative Takeover Regulation and the Concept of ‘Control, Singapore Journal of Legal Studies, 208-31 (2012).
[4] Kraakman, The Anatomy of Corporate Law, p. 254.
[5] Regulation 3(1), SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[6] Ibid.
[7] Regulation 3(2), SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[8] Ibid.
[9] Regulation 4, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[10] Ibid.
[11] Regulation 2(e), SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[12] Subhkam Ventures Private Limited vs. SEBI, Appeal No. 8 of 2009 (Securities Appellate Tribunal, 15/01/2010).
[13] Ibid.
[14] Ashwin K Doshi v. Securities and Exchange Board of India, Appeal No. 44 of 2001 (Securities Appellate Tribunal, 25/10/2002).
[15] Ibid.
[16] Regulation 3(1), SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[17] Anirudh Laskar & Vyas Mohan, India raises threshold for mandatory takeover offer, Livemint, available at https://www.livemint.com/Politics/JpNtBUVruCRadEdslrPVAO/India-raises-threshold-for-mandatory-takeover-offer.html, last seen on 18/08/2018.
[18] Regulation 4, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[19] Securities and Exchange Board of India, Brightline Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations, available at https://www.sebi.gov.in/sebi_data/attachdocs/1457945258522.pdf
[20] Ibid.
[21] Supra at 12.
