M&A lawyers see red in Sebi's control test

Going only by numerical threshold could create further ambiguities in determinig control definition in takeover code, they argue

Top law firms have expressed concern over the proposed move by the Securities and Exchange Board of India (Sebi) to introduce a 'Brightline' test for determination of 'control' in the takeover code for listed companies. While some say the current definition should be retained, others say not giving exit options in situations where control is transferred by means other than acquiring a specified shareholding could go against the objective of the code.

In March, Sebi had floated a discussion paper titled Brightline Tests for Acquisition of 'Control' under its Takeover Regulations. In this paper, Sebi had discussed two options. The first was to prescribe a framework of protective rights, which would not amount to control. The second was to set a numerical threshold of 25 per cent and exclude other means such as special rights from open offer requirements. The discussion described the second option as one which would reduce "uncertainty" and "bring clarity".

Business Standard reviewed some responses given by senior lawyers and merger & acquisition experts to Sebi and spoke to a few others to understand their positio. Most of them expressed concern over the proposed changes.

LAWYERS' FEEDBACK ON BRIGHTLINE PLAN

• 25% shareholding not an effective yardstick of "control" in every scenario
   
• Adoption of numerical threshold could have implication on other provisions, regulations
   
• Numerical threshold could hamper promoters too in certain capital intensive sectors
   
• Threshold of Illustrative rights described by Sebi under Option 1 is very low
   
• Case by case decision based on Facts & circumstances better to determine control

In their official response to Sebi, Delhi-based Shardul Amarchand Mangaldas & Co (SAMco) said, "Ideally, the current definition of 'control' as included in the Takeover Regulations should be retained, in line with recommendations by the Bhagwati committee and the Takeover Regulations Advisory Committee (TRAC). The proposal to adopt a bright-line test based on either a numerical threshold or illustrative rights not amounting to 'control', cannot be effectively applied as a blanket rule in all fact patterns and may lead to further ambiguities."

The firm's response, drafted by senior partners Prashant Gupta and Shuva Mandal, added, "If it is Sebi's intent to adopt a brightline test, we recommend such a test be based on a hybrid of the two proposed options, to address the issues that may arise (as detailed above) if one of the two is adopted to the exclusion of the other."

Sebi has been tinkering with the threshold for making an open offer for providing an exit to public shareholders every few years. In the 1990s, the threshold was pegged at 25 per cent. In between, it became 15 per cent and has currently come back full circle. The current definition was based on a detailed review by the TRAC, chaired by the late C Achuthan, in 2011.

According to Arindam Ghosh, partner, Khaitan & Co, if a numerical threshold is specified, "It would be possible to easily overcome the requirement by acquiring slightly less than the specified percentage and yet retain de facto control. In such cases, the public shareholders would be deprived of an exit in change in control situations - providing an exit in such circumstances is one of the fundamental objectives of the Takeover Code."

The numerical threshold could even hamper the promoters and professionally-managed firms in some cases. "Companies in capital-intensive sectors that continue to be run by the original promoters or professionally managed would be the most affected. This is because the investors, despite their holdings crossing specified thresholds due to their investment in the target company, may not be keen to be in control," he added.

Some lawyers said each option could suit a specific group of stakeholders. Vikram Raghani, partner, JSA, said, "Control should always be tested on the facts and circumstances of each case. While the numerical threshold test will end the debate on whether shareholder rights such as veto rights amount to control, from a public shareholders, perspective, an indicative list of protective rights is a better and more logical option."

Raghani said this would allow investors to have a better say on governance-related matters, yet protecting the public shareholders "if control is transferred to a new shareholder in the garb of protecting a financial investment."

Ghosh of Khaitan & Co said finding a right balance with an illustrative list, read with a definition that captures the scope of the term control would be key. "Having a framework for protective rights, which is all inclusive, may be detrimental since there would be a tendency to bypass these with a view to avoid making an open offer. Not providing an exit to public shareholders would again result in the fundamental objectives of the Takeover Code taking a hit."

SAMco suggested a "hybrid option to avoid situations where shareholders' agreements are used to confer 'control' artificially (where the shareholding may otherwise be below a prescribed numerical threshold). It suggested special rights conferred on shareholders should be included in articles and should be made subject to a majority approval of shareholders not getting these rights.

Further, SAMco said that adopting a bright-line test would have an impact on other provisions of the takeover code and other Sebi Regulations, such as the Issue of Capital and Disclosure Requirements. It wanted such impact to be assessed and appropriate exceptions/clarifications must be introduced with respect to such regulations, particularly for institutional and financial investors which do not have any operational control in the company.