Withdrawal of Voluntary Offer: Takeover Code

In a recent landmark order SEBI has held that that a voluntary offer once made under the takeover code can only be withdrawn under exceptional circumstances and a mere delay in the public offer coupled with fall in market price or devaluation of Earning Per Share (EPS) cannot be reasons to permit the withdrawal of a public offer. Although the ruling is based on the SAST Regulations 1997 (which now stands repealed by the SAST Regulations, 2011), the ruling still carries significance as the provision relating to withdrawal of offer is substantially the same in both the regulations. But before we discuss the ruling let me state the facts briefly. 

Sometime in November, 2009 Mr. Promod Jain and Pranidhi Holdings Private Limited (acquirers) along with J.P. Financial Services Private Limited ( person acting in concert (PAC)) made a voluntary public announcement (not been triggered by any agreement) in accordance with regulation 10 and 12 read with regulation 14 of the SAST Regulations 1997 ("1997 regulations" or "old takeover code") to acquire 25% equity shares of the target company. As on the date of the public announcement, the acquirers and the PAC collectively held 6.47% equity shares of the target company. The controversy arose when the acquirers and the PAC requested SEBI for a permission to withdraw the open offer under regulation 27(1)(d) of the 1997 regulations in response to several complaints received against the target company and its promoters.

The factual ground(s) agitated by the acquirers for the withdrawal of the open offer was three fold. Firstly, it was contented that SEBI had unreasonably delayed in issuing observations to the draft letter of offer (DLO). Secondly, it was contended that the management/promoters of the target company had acted in a mala fide manner in the sense it had suppressed material facts, depleted valuable fixed assets of the company in gross violation of regulation 23 (1) (a) & (c) of the 1997 regulations and siphoned off funds by advancing fictitious advances and loans. Lastly, it was contended that the financial health of the target company had deteriorated in that the profitability of the target company had significantly declined from the profits in the periods just prior to making the public announcement resulting in negative EPS.

The legal submissions made by the acquirer in support of the above grounds were (a) the offer was voluntary and hence it did not give any vested right to shareholders as in the case of a triggered offer, (b) regulation 27 (1)(d) gives SEBI plenary discretion to allow withdraw of an open offer (c) the SAT ruling in the Nirma case has to be distinguished as it was based on a mandatory offer whereas in the present case the promoters had perpetrated the fraudulent activities after the public announcement was made (d) the public offer has to be governed by the provisions of the Indian Contract Act, 1872 and since the offer has not been accepted by the shareholders of the target company (no conclusion of the contract due to no acceptance) the offer can be withdrawn and (e) SAT has held in B.P. Amco Plc. and Castrol Limited v. SEBI and Luxottica Group SPA v. SEBI that when the offer does not materialize or in genuinely difficult situations the acquirer can withdraw the offer. 

On the first aspect (a) SEBI held that a voluntary offer is governed by the same provisions as a mandatory offer i.e. regulation 10 and 12 of the SAST regulations 1997 and hence, once the public announcement is made there is no difference between the two. They are governed by the same principles which is inter alia incorporated in regulation 22(1) which states that "the public announcement of offer to acquire the shares of a target company shall be made only when the acquirer is able to implement the offer" and the withdrawal of the same has to be in accordance with regulation 27(1). on the second aspect (b) SEBI held that the phrase 'such circumstances' as incorporated in regulation 27(1)(d) has to be read ejusdem generis in that SEBI has the power to permit withdrawal of open offer when the circumstances are similar to that in regulation 27(1)(b) & 27(1)(c). This view is supported by the Nirma case wherein the SAT had held that regulation 27 (b) to (d) has to be construed strictly and the phrase "such circumstances" in clause (d) had to be construed ejusdem generis i.e. there has to be an element of impossibility in implementing the offer. SEBI relied on the Nirma case on the ground that the ruling was based on the interpretation and scope of regulation 27 and was not fact specific (this answers the third aspect (c)). 

The novel fourth argument (d) also did not find favour with SEBI and rightly so, as SAST Regulations is a special law and all public offers such as the one in this case are to be governed by the SAST and not the Indian Contact Act. If the argument of the acquirer were to be accepted then it would lead to a peculiar situation wherein the acquirers would withdraw the public offer even when only some of the shareholders would have tendered their shares and others would have not. On the final aspect (e) SEBI distinguised the B.P.Amco and the Luxottica and rightly so on the ground that both the cases were based on regulation 27(1) as it stood prior to the amendment in 2002 and the public offer in those cases were made subject to the fulfillment of certain conditions which included statutory approvals. 

On the factual aspect of SEBI held that several complaints had been received against the acquirers and the PAC and hence there was some delay in issuing the observations. Further, SEBI held that an acquirer who wishes to invest a substantial sum of money and acquire control of the target company ought to have exercised proper due diligence before making the public announcement. This was buttered by the fact that the acquirer and the PAC was not an outsider in the sense they were holding approximately 6% of the equity shares in the target company. On the basis of these factual and legal findings SEBI refused to grant permission to withdraw the offer.

Impact: This case demonstrates albeit indirectly one of the issues relating to hostile takeovers in India under the old takeover code. Although under the new takeover code the situation has not improved greatly, on the contrary it has made hostile takeovers nearly impossible. But based on the background of the new takeover code i.e. TRAC Report it is possible to argue that this was not the intended consequence. However ruling(s) such as the present one will create more difficulty to an already hostile climate for hostile takeovers! I shall explore this aspect in a subsequent post.

Financial Stability Report: RBI

On 22 December, 2011 the Reserve Bank of India published the Financial Stability Report (FSR). The Report read in totality would suggest that though the Indian Economy (and especially the financial system) remains stable, there exists some disconcerting macroeconomic issues. The core issues include the Euro Zone Crisis, Slowdown in the US, inflation and elevated oil prices. The relevant portion of the report reads as under:

“Global risks have increased since the publication of the third FSR in June 2011. Heightened uncertainties arising from the deepening sovereign debt crisis in the Euro Area and slowdown in the US pose downside risks for the global economy and for India through trade and finance channels and, therefore, need to be monitored closely. External sector risks are likely to increase. Elevated oil prices also pose downside risks to global recovery and have significant implications for domestic inflation. The profit margin of the corporate sector has dipped, indicating its reduced pricing power in the face of rising raw material and interest costs, domestic and global.” (emphasis mine)

In so far as the financial markets are concerned, the report acknowledges that there has been a significant deterioration from June 2011 onwards and the situation could worsen further. The following portion is apposite:

“Systemic risks facing the global and domestic financial system have heightened of late. There is significant deterioration in financial market conditions, for both sovereign and non-sovereign sectors, as a result of downgrades by rating agencies and poor economic outlook. Funding markets for short and long term finance in most currencies have become stressed with financial and non-financial firms facing significant challenges in raising longer term funds. Financial markets are trading with a downward bias on the belief that effectiveness of monetary and fiscal intervention is considerably lower in advanced economies. High levels of volatility are unnerving market participants abroad. The fallout of these developments is starting to impact overseas borrowings by financial and non-financial firms in India. The Indian equity and foreign exchange markets witnessed large corrections attendant with high volatility. The resultant impact on investor sentiment has been offset partially through a recovery in Foreign Direct Investments (FDI) flows this year. Higher than expected government borrowings, coupled with loss in growth momentum, could stress domestic financial markets though.” (emphasis mine)

On the soundness and resilience of the financial institutions the report concludes that there has been an increase in Non Performing Assets (NPAs) especially sectors such as priority sector, retail, real estate and infrastructure. The relevant part reads as under:

“The recent regulatory prescriptions for European banks have brought in fears of deleveraging. The direct impact on Indian banks, though, is expected to be limited. The banking system remained sound with CRAR and core CRAR well above the regulatory minimum and NPA ratios that compared favourably with the major advanced countries as well as peer EMEs. Continuous decline in CRAR and deterioration in asset quality, however, indicated that the risks were rising for the banking sector; even as credit growth decelerated and slippages outpaced credit growth. The major sectors that contributed to the increasing trend in NPAs were the priority sector, retail, real estate and infrastructure. In the infrastructure segment, the power and telecom sectors saw increased impairments and restructuring. The banking stability map and indicator also depicted increase in vulnerabilities in the Indian banking sector” (emphasis mine)

There have been mixed reactions on the report. Some commentators believe that the FSR is ‘reassuring’ whereas others argue that there exists a ‘brewing banking crisis’.

Recent Developments

The Companies Bill, 2011 has been introduced in the Lok Sabha. A copy of the bill is available here. Some aspects of the bill has been discussed here, here, here and here. The report of the parliamentary standing committee on finance which had carried out detailed deliberations on the Companies Bill, 2009 is available here.

SEBI has released a concept paper on regulation of investment advisors.As per the paper, the regulation intends to "regulate the activity of providing investment advisory services is various forms by a wide range of entities including independent financial advisors, banks, distributors, fund managers etc.".

On 12 October, 2011, the OECD's Centre for Tax Policy and Administration introduced a public discussion draft on proposed changes to the Commentary on Article 5 (Permanent Establishment) of the OECD Model Tax Convention. Public Comments are invited on the discussion draft before 10 February, 2012. 

Legal Status of a Child Marriage: Madras HC Decides

Recently, a Full Bench of the Madras High Court decided on the legal status of a marriage concluded in contravention with the prohibition of Child Marriage Act, 2006. The Full Bench held that such a marriage was valid unless it is annulled by a competent court. The decision arose out of a Habeas Corpus petition filed by T Sivakumar, for the production before the court of his minor daughter. Against the petition, the minor daughter filed an affidavit stating that she had left her parental home on her own accord and married the Second Respondent. The Division Bench hearing the matter had doubts over the decision of a Division Bench of the Madras High Court in G Saravanan v the Commissioner of Policy, Trichy where it was held that child marriage was valid and the husband of the child was entitled to the child's custody. The following questions were referred to the Full Bench:

"(1) Whether a marriage contracted by a person with a female of less than 18 years could be said to be valid marriage and the custody of the said girl be given to the husband (if he is not in custody)?

(2) Whether a minor can be said to have reached the age of discretion and thereby walk away from the lawful guardianship of her parents and refuse to go in their custody?

(3) If yes, can she be kept in the protective custody of the State?

(4) Whether in view of the provisions of Juvenile Justice (Care and Protection of Children) Act, 2000, a minor girl, who claims to have solemnized her marriage with another person would not be a juvenile in conflict with law and whether in violation of the procedure mandated by the Juvenile Justice (Care and Protection of Children) Act, 2000, the Court dealing with a Writ of Habeas Corpus, has the power to entrust the custody of the minor girl to a person, who contracted the marriage with the minor girl and thereby committed an office punishable under Section 18 of the Hindu Marriage Act and Section 9 of the Prohibition of Child Marriage Act, 2006 ? and

(5) Whether the principles of Sections 17 and 19(a) of the Guardians and Wards Act, 1890, could be imported to a case arising out of the alleged marriage of a minor girl, admittedly in contravention of the provisions of the Hindu Marriage Act?"

The Full Bench answered these questions as follows:

Nature of a marriage in Contravention of Prohibition of Child Marriage Act

"The marriage contracted by a person with a female of less than 18 years is voidable and the same shall be subsisting until it is annulled by a competent court under Section 3 of the Prohibition of Child Marriage Act. The said marriage is not a 'valid marriage' stricto sensu as per the classification but it is 'not invalid'. The male contracting party shall not enjoin all the rights which would otherwise emanate from a valid marriage stricto sensu, instead he will enjoin only limited rights."

Status of the Adult Husband vis-a-vis the Minor

The adult male contracting party to a child marriage with a female child shall not be the natural guardian of the female child in view of the implied repealing of Section 6(c) of the Hindu Minority and Guardianship Act, 1956."

"The male contracting party of a child marriage shall not be entitled for the custody of the female child whose marriage has been contracted by him even if the female child expresses her desire to go to his custody. However, as an interested person in the welfare of the minor girl, he may apply to the court to set her at liberty if she is illegally detained by anybody."

Legal Status of the Married Minor Girl

"A minor girl whose marriage has been contracted in violation of Section 3 of the Prohibition of Child Marriage Act is not an offender either under Section 9 of the Act or under Section 18 of the Hindu Marriage Act and so she is not a juvenile in conflict with law."

Rights of Parents vis-a-vis Married minor Girl

"The minor girl cannot be allowed to walk away from the legal guardianship of her parents. But, if she expresses her desire not to go with her parents, provided in the opinion of the court she has capacity to determine, the court cannot compel her to go to the custody of her parents and instead, the court may entrust her in the custody of a fit person subject to her volition."

"If the minor girl expresses her desire not to go with her parents, provided in the opinion of the court she has capacity to determine, the court may order her to be kept in a children home set up for children in need of care and protection under the provisions of the Juvenile Justice (Care and Protection) Act and at any cost she shall not be kept in a special home or observation home meant for juveniles in conflict with law established under the Juvenile Justice (Care and Protection) Act, 2000."

"Whether a minor girl has reached the age of discretion is a question of fact which the court has to decide based on the facts and circumstances of each case."

Considerations in a Habeas Corpus Petition Similar to the Instant Case

"In a habeas corpus proceeding, while granting custody of a minor girl, the court shall consider the paramount welfare including the safety of the minor girl not withstanding the legal right of the person who seeks custody and grant of custody in a habeas corpus proceeding shall not prejudice the legal rights of the parties to approach the civil court for appropriate relief."

"While considering the custody of a minor girl in a habeas corpus proceeding, the court may take into consideration the principles embodied in Sections 17 and 19(a) of the Guardians and Wards Act, 1890 for guidance."

Decision: Sivakumar v the Inspector of Police, Thiruvallur MANU/TN/3959/2011: 2011-5-LW 1

SAT Upholds SEBI Ruling in the Sahara Case

The Securities Appellate Tribunal has upheld SEBI's ruling in the Sahara Case. In line with SEBI's ruling, SAT has also found that optionally fully convertible debentures (OFCDs) issued by the two Sahara Group Companies ( SIRCL and SHICL) are securities and that the issue was a public issue requiring mandatory listing and that SEBI has the jurisdiction under the SEBI Act to deal with all kinds of companies, whether listed or not.

The SAT order is available here. The impugned SEBI order is available here.

National Competition Policy

Shri Dharmendra Kumar committee which was constituted by the MCA for framing the National Competition Policy (NCP) has submitted a draft policy. At first blush one may question the rationale for a National Competition Policy considering that we have a Competition Law (Competition Act, 2002) already in place. Perhaps the answer to this ticklish question lies in the Raghavan Committee Report which observed as follows:

“An effective competition policy promotes the creation of a business environment which improves static and dynamic efficiencies and leads to efficient resource allocation, and in which the abuse of market power is prevented mainly through competition. Where this is not possible, it requires the creation of a suitable regulatory framework for achieving efficiency. In addition, competition law prevents artificial entry barriers and facilitates market access and complements other competition promoting activities. Trade liberalisation alone is not sufficient to promote competition and there is a need for a separate competition policy”

In other words Competition Law is only a subset of an overarching Competition Policy. Be that as it may, the committee lays down the NCP as under:

-Rule bound, fair, transparent and non discriminatory market regulatory procedures.

-Independence of the regulatory body.

-Establishing a ‘level playing field’ for both the government enterprises and the private sector.

-Fair pricing of public utilities and third party access to ‘essential facilities’. In other words it requires the dominant infrastructure owners (electricity, communications etc.) to grant to third parties access to their infrastructure on reasonable and competitive terms and conditions.

-Promotion of competition through regional, national and international co-operation.

The draft policy also mandates the Central and the State Government to undertake a Competition Impact Assessment of the existing policies, statutes, regulation that prima facie undermines competition (an illustrative list of parameters for conducting Competition Impact Assessment has been provided). Further for the implementation of the policy the government is mandated to set up a National Competition Policy Council (NCPC). The role of the NCPC is primarily to provide technical assistance in conducting the Competition Impact Assessment.

The NCP is indeed a necessary and welcome move. However, one may question the legal relevance of such policies i.e. extent to which they are legally enforceable. 

Takeover Code Revamp: Update

In a recent board meeting SEBI considered and accepted most of the recommendations of the TRAC. Some of the major recommendations that has been accepted by SEBI includes the following:

-Initial trigger threshold increased to 25 % from the existing 15 %

-scrapping of non compete fee. (the issue of non compete fee has been discussed on this blog previously and is available here and here)

-In cases of competitive offers, the successful bidder can acquire shares of other bidder(s) after the offer period without attracting open offer obligations.

-Voluntary offers have been introduced subject to certain conditions.

-A recommendation on the offer by the Board of Target Company has been made mandatory.

The two important recommendations that has not been accepted in totality are:

-offer size increased from a minimum 20% to 26% of the total issued capital. It is to be noted that TRAC had recommended an offer size of 100%.

-existing definition of 'control' retained. TRAC had proposed a broader definition of 'control' i.e. not just the right but also the ability to manage the company and appoint majority directors.

A summary and initial reaction on the development is available here.

Convertible Debentures: New Rules

The MCA has recently released the Draft Public Companies (Terms of Issue of debenture and of raising loans with option to convert such debentures or loans into shares), 2011. The rule if and when becomes effective will supersede the Public Companies (Terms of Issue of debenture and of raising loans with option to convert such debentures or loans into shares), 1977. 

The 2011 rules are more or less similar to the 1977 rules albeit one significant difference. As per the 2011 rules a public financial institution or a bank can now only convert all or any part of the debentures, if (a) the company has defaulted in the repayment of, or payment of interest on, such loans and debentures; and (b) the bank or public financial institution has given the company a notice of its intention to convert the debentures at least 30 days prior to the intended date of conversion.     

Micro Finance Institutions: Draft Bill

Micro Financial Institutions (MFIs) are entities which provide small credits to individual(s) or groups. Typically MFIs provide micro credit facilities, assist in remittance of funds, provide pension and insurance services etc. MFIs do not strictly fall within the category of a banking company or a co operative society engaged primarily in agricultural operation or industrial activity. The MFIs are seen more as an extended arm of the banking system which provides credit or other financial services to the poor households and their micro enterprises.

Last year the Andhra Pradesh Government introduced the Micro Finance Institutions (Regulations and Money Lending) Act, 2010 which had thrown the industry into crisis by imposing several restrictions. As a result the Reserve Bank of India appointed an expert committee lead by Y.H. Malegam. The Malegam Committee submitted its report on January 19, 2011 and based on the recommendations of the committee the government has introduced the Micro Finance Institutions (Development and Regulation) Bill, 2011. The object of the bill is “to provide a formal statutory framework for the promotion, development, regulation and orderly growth of the micro finance sector and thereby to facilitate universal access to integrated financial services for the unbanked population.”

Some of the salient features of the Bill are as follows:

-Establishing a Micro Finance Development Council which will advice and assist the government in framing policies for the sector. The bill also seeks to establish a State Advisory Council.

-The MFIs can only operate business after obtaining a certificate of registration from the Reserve Bank of India. The existing MFIs will also have to apply for the registration within three months from the commencement of the Act.

-Any MFI which becomes ‘systemically important’ will have to convert its institution into a Company registered under the Companies Act, 1956. An MFI can become ‘systemically important’ if it deploys a certain amount of funds for providing micro credit to a minimum number of clients. The exact figures relating to the amount and the clients are not specified in the bill and rightly so. The RBI has been delegated the power to frame rules in this regard.

-The Bill gives wide powers to the RBI. Some of the specific powers conferred on the RBI are (i) to formulate policies (ii) to prescribe minimum standards required to be followed by MFIs in relation to method of operation, recovery, management and governance (iii) calling for information and data from the MFIs, among others.

-Any restructuring of the MFIs will require the prior approval of the RBI.

-The Bill mandates the establishment of a Micro Finance Development Fund. The fund will be applied towards providing the MFIs with financial assistance.

-The Bill once it comes into force will override the provisions of all other existing laws. Further, the Bill provides that any MFI registered with the RBI under the provisions of this Act (now bill) will not be treated as a money lender for the purposes of any state enactment. In effect this implies quite clearly that the Andhra Pradesh Micro Finance Institutions (Regulations and Money Lending) Act, 2010 would not be applicable to the MFIs holding a certificate of registration under the provision of this Act/Bill.

The Bill is of immense socio economic importance. The views of the Industry and further analysis of the Bill is available on live mint and the Wall Street Journal.

Pledge of Shares, FDI

In recent times Government/RBI has made several attempts to liberalize, rationalize and simplify the processes associated with FDI flows to India and reduce the transaction time. In furtherance of this, the RBI vide a circular dated May 2, 2011 has delegated its powers to AD Category-I banks to allow non resident investors to pledge their shares held in an Indian Company, subject to certain conditions. The conditions prescribed are as follows:

In case shares are pledged in favour of an Indian bank the following conditions are applicable:

1. In case of invocation of pledge, the transfer of shares should be in accordance with the FDI Policy existing at the time of creation of pledge.
2. A declaration from the statutory auditor that the loan proceeds would be applied for the declared bona fide  business purpose.
3. The Indian company whose shares are pledged will have to comply with the SEBI disclosure norms. In other words the Indian Company would have to comply with Regulation 8A of the Takeover Code and Clause 35/41 of the Listing Agreement.  
4. The lender bank will have to comply with the provisions of S. 19 of the Banking Regulation act, 1949. In other words the lender bank cannot hold shares as a pledge of an amount exceeding thirty percent paid up share capital of that company or thirty percent of its own paid up share capital and reserves, whichever is less.

In case shares are pledged in favour of an overseas bank the following conditions are applicable:

1. Loan is utilized for genuine business purpose overseas and not for any investments either directly or indirectly in India.
2. Overseas investment should not result in any capital inflow into India.
3. In case of invocation of pledge, the transfer of shares should be in accordance with the FDI Policy existing at the time of creation of pledge.
4. A declaration from the statutory auditor that the loan proceeds would be applied for the declared bona fide business purpose.

A VCCIRCLE article analyzes the effect of the circular in detail. On a parting note though, the circular comes at a time when pledging of shares may not be commercially viable due to the prevailing market prices of these shares.