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In a recent landmark order SEBI has held that that a voluntary offer once made under the takeover code can only be withdrawn under exceptional circumstances and a mere delay in the public offer coupled with fall in market price or devaluation of Earning Per Share (EPS) cannot be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 Although the ruling is based on the SAST Regulations 1997 (which now stands repealed by the SAST Regulations, 2011), the ruling still carries significance as the provision relating to withdrawal of offer is substantially the same in both the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

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.

Non Compete Fee, Takeover Code: Part 2

In my previous post I had briefly discussed the concept of non-compete fees and the legal issues surrounding it. In this post I shall discuss the prevailing position of law with regard to non-compete fees. The present position of law is clearly articulated in E Land Fashion China Holdings Limited v. Securities Exchange Board of India wherein the SAT while reversing the order of SEBI allowed the acquirer to pay the additional non compete fees to the exiting promoters.

Facts

The appellant entered into a share subscription agreement and a share purchase agreement with the target company and its promoters whereby it was inter alia agreed that the appellant would acquire 51% of the equity capital of the target Company at a price of Rs. 75 per share inclusive of a non-compete fee of Rs. 15 per share. The appellant and the target company and its promoters also executed a shareholders agreement. Since, the equity shares acquired by the appellant pursuant to the aforesaid agreements were in excess of 15% of the voting rights in the target company, the provisions of Regulation 10 and 12 of the Securities and Exchange Board (Substantial Acquisition of Shares and Takeovers) Regulation 1997 [Hereinafter “takeover code”] got triggered. Accordingly, the appellant made an open offer to acquire 20% of the voting capital of the target company at a price of Rs. 60 per share. The offer price did not include the additional Rs. 15 which was offered to the promoter group. Thereafter, SEBI directed the appellant to add  the non-compete fee paid to the promoters to the offer price.                                         

        

SEBI's Contention

SEBI argued that the non compete fee should be added to the offer price as (i) the existing promoters were still continuing to hold substantial shares (post offer shareholding) in the company and that they were not exiting completely (ii) the promoters had the right to appoint two directors and jointly select two independent directors in the company (iii) the shares of the promoters had a lock in period of 3 years i.e. the promoters were not entitled to transfer their shares without the written approval of the acquirer. The crux of SEBI's argument was that the exiting promoters even post offer would continue to hold substantial shares in the company and also control the company. In such a scenario, SEBI argued, it was unlikely that the promoters would totally exit the target company and offer competition.

SAT's Ruling

The SAT allowed the payment of the non compete fee to the promoters of the target company on the ground that the promoters had the experience and expertise to compete with the target company at a future point in time. In arriving at this conclusion SAT heavily relied on its earlier ruling in Tata Tea Ltd. v. Securities Exchange Board of India. In tata tea the tribunal had held that if the payment of non compete is based on a strong business rationale and is not a mere tool to reduce the cost of acquisition to discriminate against the public shareholders, the Board or the tribunal is not entitled to intervene.

Analysis

It is now fairly well settled that an acquirer is entitled to pay the promoter group of the target company an additional non-compete fee. However the non-compete fee can only to paid when there is a “lurking fear of competition”. The question as to what amounts to “lurking fear of competition” is a factual one and will have to be determined on a case to case basis. Additionally, the validity of a non-compete fee is not dependent on the extent of the threat of competition from the selling promoters i.e. even if the threat is remote it is not open for the Board or even the tribunal to intervene. The Board can intervene only when the non-compete fee is used as a design to reduce the cost of acquisition to discriminate against the public shareholders.

Although the controversy surrounding non-compete fee and the takeover code is clear (at least for the time being), several commentators (here and here) believe that non-compete agreements are in violation of S. 27 of the Indian Contract Act, 1872. The commentators argue that a SEBI Regulation cannot allow what the parliament expressly prohibits.      

  

Non Compete Fee, Takeover Code: Part 1

Non Compete Fee is fees that is paid to the selling promoter(s) so that they do not re enter the same business and pose a threat to the acquired Company. This fee is not included in the offer price made to the public shareholders. For e.g., the acquirer pays Rs. 75 per share to the promoters and an additional Rs. 15 per share as non compete fee i.e. the promoters are paid a total of Rs. 90 per share whereas the offer price made to the public shareholders is only Rs. 75 per share.

In principle there is nothing in either the Takeover Code or any other related legislation that bars an acquirer from paying an additional non-compete fee to the promoter(s). On the contrary, in recent years SEBI has approved several transactions (here and here) where the promoter group was paid a higher price per share compared to the public shareholders. The higher price being justified as a non-compete fee.  The takeover code, however, imposes a restriction on the acquirer in that the non-compete fee cannot exceed 25% of the price offered to shareholders in the open offer.

Allowing the acquirer to pay an additional non-compete fee has several commercial justifications. However such additional payments have to be regulated inorder to ensure that the public shareholders are not discriminated against unfairly. In other words SEBI has to ensure (which it has in several instances) that the non-compete fee is paid by the acquirer only when there is an actual threat of the selling promoter re entering into the business. The non-compete fee is not justified when say, even after the acquisition the promoter continues to be a co promoter or the board of directors of the acquired company has equal representation from the selling promoter and the acquirer. Ultimately whether the payment of non-compete fee is justified or not depends on the facts and circumstances of a particular case.

Interestingly the TRAC Report recommends that the non-compete fee should be completely done away with.  The following observations of the TRAC are apposite:

“4.9.4 The Committee concluded that in keeping with the spirit of equal treatment  for all shareholders, and the scope for abuse of non-compete payments, the  Takeover Regulations ought to be explicit that consideration paid for the  shares in any form to the selling shareholder and his affiliates, concurrent with the purchase of shares, whether termed as ―control premium, or ―non-compete fees or otherwise must be added to the negotiated price per share for the purpose of determining open offer pricing.

4.9.5 The Committee concluded that once the extant exemption in respect of non-compete fee is deleted from the Takeover Regulations, and it is clearly articulated that apart from the share acquisition agreement, consideration in any form inclusive of all ancillary and collateral agreements shall form part of the negotiated price, it is in the selling shareholders‘ interests to ensure that the negotiated price truly reflects the value of the scrip fairly. Since this negotiated price in any case would be one of the parameters for fixing the offer price, if such price were higher than other proposed parameters, all shareholders will get the same negotiated price.”

In a subsequent post we will discuss the recent ruling of SAT in E-Land Fashion China holdings Limited and other related judgments inorder to ascertain the prevailing jurisprudence on non-compete fees.