This article has been written by Shraddha Vasanth, pursuing a Diploma in Business Laws for In-House Counsels from LawSikho.
Table of Contents
Introduction
Mergers, acquisitions and takeovers have always piqued the interests of various groups like corporations, lawyers, regulators and even students. However, over the past couple of years, some takeovers have grabbed headlines not so much for the deal itself, but for the way in which the deal was executed. Acquisitions like Sanofi-Aventis – Genzyme Corp, RBS – ABN Amro, Vodafone AirTouch – Mannesmann AG, InBev – Anheuser-Busch, L&T – Mindtree, Swaraj Paul- Escorts/ DCM have a common thread – that of being hostile takeovers.
Hostile takeover as the name suggests is the forceful acquisition or takeover of a company without obtaining the approval of the Board of Directors. Countries around the world have legislation that regulate acquisitions and takeovers of companies. In fact, mature economies like the US and UK have specific laws that deal with the different mechanisms of takeovers like the business combination laws, control-share acquisition laws, golden parachute restrictions in the US and the UK Takeover Code etc. in the UK and the like. However, in spite of all this, there has been a surge in hostile takeovers, which brings out the question if the takeover laws are actually effective in curbing such practices.
Hostile takeovers in the last decade
The last couple of years have seen various hostile takeovers, the world over. Some of the most infamous ones are given below, along with the mechanisms that were adopted for effecting them:
- Air Products & Chemicals Inc. takeover of Airgas Inc. (2009) – In an attempt to foil the takeover plan, Airgas used a poison pill as a defence, however, they were asked to prove that their valuation was actually what they claimed it was. It was during recession and their performance deteriorated, and they eventually had to exit at 2X the price offered by Air Products as a part of their takeover.
- Kraft Foods Inc. takeover of Cadbury PLC (2009-10) – Kraft foods made a $16.3 billion offer to buy out Cadbury, that was rejected by the board of Cadbury. However, after much resistance, the deal was finalised between the two companies. The lack of transparency in the offer process led the UK government to reframe the takeover regulations.
- Sanofi-Aventis’ acquisition of the American company, Genzyme Corporation (2010) – The reason for the acquisition was to gain access to Genzyme’s research on drugs that would treat rare genetic disorders. After multiple failed attempts at a friendly takeover, Sanofi-Aventis approached the shareholders of Genzyme directly; and eventually bought Genzyme for $20.1 billion.
- Acquisition of HP by Xerox (2019) – Xerox made a public offer to acquire HP, a much larger company. However, the acquisition was put off owing to the COVID-19 pandemic.
Compared to other countries, India has seen relatively few hostile takeovers. One of the reasons attributed to this is the fact that most Indian businesses are family owned with the promoters holding majority stake as well as senior positions in the companies. However, there have been instances of hostile acquisitions in India as well; some of the most significant ones are:
- Swaraj Paul’s acquisition of Escorts Limited and Delhi Cloth Mills (1983) – This was effected by purchasing shares directly from the stock markets. However, the deal was unsuccessful.
- Essel Group’s takeover of Iragavarapu Venkata Reddy Construction Limited (IVRCL) (2012) – Essel acquired a 10.7% stake in the target company, however made an exit and the deal fell through.
- Larson & Turbo’s (L&T) takeover of Mindtree (2019) – V. G. Siddhartha, the then single largest non-promoter of Mindtree held 20.32% in the company. When he was facing a liquidity crunch for his company, Coffee Day, L&T offered to buy out his stake at Rs. 980/- per share, amounting to Rs. 3,269 crores approx. This was however, opposed by the management of Mindtree, making this one of the largest hostile takeovers in India.
Hostile takeovers – causes and mechanisms
Causes
As explained above, hostile takeover is a forceful strategy that is aimed at taking over a company against the wish or approval of its board of directors. In such cases, the acquirer company directly approaches the shareholders, often through unfair means, with an intention to acquire their holding and in-turn, take charge of the company. This is typically done by making an open offer to all the shareholders.
The causes for hostile takeovers remain the same as that of well-negotiated, friendly takeovers, which could be to get access to the target companies distribution channels, customer base, brand name, intellectual property, processes etc. Apart from the above, many times, it is also the poor or low valuation of a company that makes it an easy target for an acquirer to forcefully acquire it. Sometimes, the takeover may be an actual value add to the acquirer, and at others, it might be to just acquire a company that is cheap or under losses.
What is also interesting is that there are various dynamics that play a role in any acquisition, since these activities are primarily economic by nature. And like any economic activity, market forces like the bull and bear run have a significant impact on them. And it is in such recessionary market conditions that the stock prices of many companies crash and this lays a fertile ground for hostile takeovers. Moreover, many smaller companies struggle to do business during these times and hence, become susceptible to acquisitions.
Mechanisms
There are 2 very prominent mechanisms in which a hostile takeover is executed; they are:
- Tender offer – In a Tender offer, the acquirer offers to buy the target’s shares at a very high premium to the existing market price. Such offers fall under statutory purview and are called Open offers. There are many regulations as far as the documentation, timing, pricing etc. are concerned.
- Proxy – A proxy offer is more unregulated, in the sense that the acquirer directly approaches the shareholders to get them to vote through their proxies and oust the existing management; they would then appoint a new one that would approve the acquisition.
Defences to hostile takeovers
Where there are mechanisms for hostile takeovers, there are various tricks for thwarting them as well; some of the commonly used defences are:
- Poison pill – Poison pill is a type of security instrument that provides its holders with specific rights upon the occurrence of a trigger event like a hostile takeover. It typically involves issue of the company’s shares at a deep discount, so as to render the valuation of the company unattractive to the acquirer. On the other hand, this also increases the number of shares that are required to be bought, thereby making the deal more expensive to the acquirer. However, the bone of contention with poison pills is that they are issued by the board of directors without the approval of the shareholders. Apart from issuing poison pills as instruments, the board can also avail heavy borrowings, or the top management may even threaten to leave the company in case of takeovers. The crux of a poison pill is to make the company unappealing for the acquirer.
- Crown jewel – Crown jewel is also used by the target to make itself unattractive to the acquirer; under this mechanism, the crown jewel or the most profitable business/ assets of the target like R&D, intellectual property, trade secrets are sold or hived-off into separate entities.
- Golden parachute – This involves entering into/ altering the employment contracts with key managerial persons, stipulating the payment of a heavy compensation in case they are removed following a hostile takeover. Essentially, it is a tactic that makes the offer more expensive for the buyer and also poses restrictions in case the acquirer wants to reshuffle the board or bring in a new management.
- Greenmail – This involves re-purchasing shares by the target company itself, i.e., shares that have been bought by the acquirer are again bought back by the target by paying a higher price.
- Pac-man defence – In this defence, the target makes a counter offer and tries to purchase the shares of the acquirer itself, thereby attempting a takeover of their own. However, this mechanism can work only if the acquirer is smaller than the target company.
- Shark repellent – This mechanism is aimed at making it cumbersome for the acquirer to buy out the target. Under this mechanism, the target imposes a super-majority i.e., it may amend the charter documents/ articles of association to increase the number/ percentage of shareholder votes required to pass a resolution for acquisition, to say 95% thereby making it difficult to obtain. It can also take the form of ‘classified board’ and staggered retirement of directors i.e., delaying the retirement of directors by rotation.
- White knight – This is a mechanism wherein the target finds itself a new acquirer offering better terms than the acquirer.
- Some of the other techniques include preferential allotments to the promoter/ controlling group, issue of preference shares/ preferred stocks to the shareholders, buy-back of shares etc.
Laws governing takeovers
Takeovers impact not just the shareholders, but also other stakeholders like the employees, customers, vendors etc. since it involves a change in management and ways of doing business, and also impacts competition and market conditions. Hence, they are heavily regulated.
In the US, there are 6 kinds of state takeover laws including business combination laws, control-share acquisition laws, golden parachute restrictions, fair price laws etc. Even in the UK, there are a number of legislations like the UK Takeover Code, the Companies Act, 2006 etc.
In India, there are 3 sets of laws that regulate takeovers. They are briefly explained below:
The Companies Act, 2013
The Companies Act lays down the broad framework for any form of merger, acquisition or takeover. It primarily applies to private and unlisted companies. Some of the key provisions with respect to takeovers are:
- Sec. 186 – This section deals with investments/ acquisition of shares by companies and lays down the procedure for the same. It lays down the maximum limits of investment that can be made by the board of directors and prescribes the procedure for availing shareholder approval for any acquisition beyond the limits, and disclosure requirements therein.
- Sec. 230(11) – This provision deals with acquisition of shares by insiders i.e., the existing shareholders holding more than 75% of the total share capital. In this case, the offer is to be made for acquiring only the remaining shares. In essence, this section does not per-se deal with hostile takeovers.
- Sec. 235 – This provision deals with companies that want to acquire the shares of another company. While there is no specific threshold limit of shares mentioned in the section, it is interesting to note that members holding 9\10th in value of shares of the target company are required to vote in favour of the resolution approving the scheme of arrangement.
- Sec. 236 – This provision deals with acquisition of shares by the majority shareholders by way of a squeeze-out of minority shareholding. Majority shareholding, in this context is 90%; and moreover, the price of shares is required to be negotiated with the minority shareholders and also needs to be valued by a Registered Valuer.
The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SAST Regulations)
The SEBI (SAST) Regulations deals with the acquisition of shares and takeovers of listed companies in India. Essentially, the regulations provide certain thresholds for acquisition of shares, beyond which the acquirer is required to make an open offer to the shareholders. The acquisition of management control, voluntary offers, delisting of shares, pricing guidelines for acquisition, disclosures to be made with reference to the same, and the obligations of the acquirer and target etc. are exhaustively dealt with in the regulations. Some of the key provisions are:
- Reg. 3(1) – When an acquirer purchases more than 25% of shares or voting rights in a target, it is said to be substantial acquisition; and when an acquirer crosses this threshold, they are required to make an open offer. This applies when the acquirer crosses the trigger point for the first time, i.e., it refers to acquisition of shares by outsiders/non-shareholders.
- Reg. 3(2) – The regulations also apply to consolidation of shares, by members holding 25% or more shares or voting rights in the company. This applies to any acquisition between 25% to 75% of shares or voting rights of the target. In such instances, every-time the acquire acquires more than 5%, an open offer is required to be made.
- Reg. 4 – This provision applies to acquisition of control, either with or without acquisition of shares. This would typically involve the powers to appoint new board of directors etc.
- Indirect takeovers – The regulations also apply to indirect takeover, i.e., acquisition of an unlisted company which has a controlling stake in a listed entity.
- Reg. 26 – This provision prescribes certain obligations, or rather places certain restrictions on the target company which include:
- Alienation any material assets of the company during the offer period
- Availing any material loans/ borrowings
- Issue or allotment of shares
- Buy-back of shares
- Entering into or terminating any material contracts
- Acceleration of contingent vesting of rights like Employee Stock Options (ESOPs)
The Competition Act, 2002 read with the Competition Commission of India (Procedure in Regard to the transaction of business relating to Combinations) Regulations, 2011 (Business Combinations Regulations
When hostile takeovers take place, specially, in countries like the US, often takeover regulations do not provide a recourse. It is in these circumstances that anti-trust laws are favoured as a defence mechanism to thwart hostile takeovers. Since anti-trust inquiries and investigations involve a lot of procedures and analysis, it could take years to arrive at a judgment.
The Competition Act, 2002, more popularly called anti-trust/anti-competitive laws regulate competition in the markets and to curb unfair trade practices like bid rigging, unfair pricing, abuse of dominant position, and other anti-competitive practices. The Business Combinations Regulations deals with acquisitions and takeovers and is the only regulations that deals with hostile takeovers in India; however, its scope remains very limited. Some of the critical provisions are:
- Sec. 5 of the Competition Act – This provision deals with acquisition and merger of entities, which cross certain thresholds. In such instances, the acquirer is required to obtain the permission of the Competition Commission of India (CCI). This is however a long-drawn process and as per the Competition Act, the acquirer cannot proceed with the consummation of the combination until completion of 210 days from the date of issuing notice to the CCI.
- Reg. 5(8) of the Business Combination Regulations – This provision dilutes the provision of 6(2)(b) of the Act with regard to submission of the other document (meaning any binding document conveying an agreement or decision to acquire control, shares, voting rights or assets). The regulation provides that in case the takeover is hostile, the acquirer may submit documents that are in their possession at the time of making such notice. The complete details may be furnished when such information is available to the acquirer.
Brief analysis of the provisions
A brief analysis of the above provisions in the context of hostile takeovers suggests that the Companies Act, per-se, does not differentiate or deal with hostile takeovers. It deals with instances, mostly of friendly takeovers or acquisition by/ among promoters. In the same vein, the SEBI SAST Regulations also do not recognise a takeover as being hostile or otherwise. The distinction seems to be more on the lines of outsiders and insiders. While a takeover by an outsider can be friendly or hostile, the law does not provide anything specifically to address the issue.
On the contrary, some of the other provisions in the Act and the Regulations may prove to be disadvantageous to the takeover defences of the target. For instance, if the target wants to hive-off the crown jewel of the business, such sale falls within the purview of Sec. 180(1)(a), wherein a special resolution (approval of 3/4th of the shareholders) is required at their duly held meeting. This could be a time-consuming process. Moreover, Reg. 26(2) also, very similar to the Companies Act, does not permit defences such as crown jewel, as material assets cannot be sold during pendency of the open offer.
Even a procedure like buy-back, which is regulated under Sec. 68-70 are heavily regulated. Since buy-back is being used as a takeover defence, assuming that more than 25% of shares are being bought back, the process requires shareholder approval; and are further prohibited by Reg. 26(2). Even preferential issue of shares under Sec. 42 and 62 and issue of preference shares that require shareholder approval are all time consuming and cannot be taken to avert takeovers swiftly. Hence, it may be said that these provisions favour the acquirer more than the target. Moreover, the intent and purport of these provisions is regulations of these events themselves and providing fair disclosures to the shareholders on matters that affect their voting rights. In other words, these provisions are not framed with reference to hostile takeovers.
As far as the anti-competition laws are concerned, they are primarily concerned with regulating competition and prevention of abuse of domination by a few large players. Though filing of anti-trust suits to thwart hostile takeover is used as a quick defence mechanism, it defeats the very purpose of these laws. Moreover, the Business Combinations merely recognises hostile takeovers as a prevalent practice, but does not address the issue of hostile takeovers.
It is also interesting to note that the term ‘hostile’ is not defined anywhere in any of the above-mentioned legislations. Hence it can be said that there are no laws that specifically deal with the issue of hostile takeovers; as the primary focus of all takeover laws is to ensure that the shareholders are made aware of the change in management and are given an exit opportunity owing to the same.
Conclusion
While the takeover laws do not specifically deal with hostile takeovers as seen above, there is a correlation between such laws and hostile takeovers. A study conducted by researchers in the US has concluded that business combination laws have lowered the rate of hostile takeovers quite significantly. Whereas on the contrary, other laws like the ones related to poison pills have overall, led to a surge in hostile takeovers.
However, the importance of these laws can never be undermined as they play a crucial role in regulating the entire gamut of activities of mergers/ acquisitions; and that the takeover is actually friendly or hostile is quite irrelevant as hostility ultimately becomes a threat as perceived by the management, because, what is thought of as hostile by the management may actually be in the best interests of the shareholders and other stakeholders, and that hostility or otherwise remain not just legal matters but also matters of commercial intention of the parties.
References
[1] https://money.howstuffworks.com/hostile-takeover.htm#pt2 [2] https://ethicalboardroom.com/the-comeback-of-hostile-takeovers/ [3] http://vinodkothari.com/wp-content/uploads/2020/04/Article-on-Decoding-the-Takeover-Code.pdf [4] http://vinodkothari.com/wp-content/uploads/2020/02/Takeover-under-CA-2013.pdf [5]https://indiacorplaw.in/2020/06/competition-regulatory-framework-governing-hostile-takeovers-in-india.html [6] https://www.sebi.gov.in/sebi_data/faqfiles/sep-2019/1567577569364.pdf [7] https://www.mondaq.com/india/shareholders/804526/hostile-takeovers-in-india [8] https://www.icsi.edu/media/webmodules/CRILW_PART_1.pdfStudents of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
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