Non-compete clause would help Vedanta's aspirations

With the passage of the Nuclear Civil Liability Bill last week, the selection of the hot topics for this column was narrowed down – the focus was on Vedanta and more Vedanta. Of the two Vedanta Stories, environmental and M&A the Cairn takeover debate appeared more exciting – why this deal has been hitting the headlines. 

For one, oil & gas (O&G) is not Vedanta’s core area of expertise, which is mines and metals; Vedanta has designated Sesa Goa, its Indian subsidiary to acquire 20 per cent of Cairn India’s public shareholdings in the Open Offer, wherein it highlights the ‘benefits’ from superior returns or surplus cash as one of the purposes. Questions have been raised as to the ethics of this move though not the legality, as Sesa Goa qualifies as a subsidiary and therefore a “person dee-med to be acting in concert. 

A minority Shareholder of Sesa Goa petitioned the Supreme Court for stay of the Open Offer, in a pending appeal in which the same Petitioner had challenged the indirect take over of Sesa Goa by Vedanta in 1998. Most Open Offers are subject to such show stoppers, and the process is never stayed by the Courts. As expected, the petition was dismissed. The drop in Sesa Goa’s Share Price is also a passing phenomenon.

The reaction of the Petroleum Ministry as well as on the part of the ONGC the owner of the balance 30 per cent balance stake of discomfort is palpable, the initial gut respon-ses varying from ONGC and GAIL making a joint counter bid or ONGC exercising its pre-emptive right. On the latter ONGC has backtracked, but the counter bid option is not entirely ruled out. In view of the Bombay High Court in the Maharashtra Scooters, preemptive right for listed companies may become increasingly difficult to enforce. 

To conciliate, ONGC government is believed to have agreed to restrict their royalty payment in proportion to their holding and not for the entire block. What remains is whether as a Contractor, Vedanta will have the capability to perform and track record expected and envisaged under the Production Sharing Contracts (PSC) which Cairns India had executed on the strength of its Parent possessing the knowledge and experience. 

Apparently most PSCs require the Government’s consent for change of control as well. Cairn’s revert that all such obligation arise only when the ownership of the block changes appears specious.

The other issue which has trig-gered considerable debate is on the pay-out of non-compete amount to the Promoters, who are not exiting entirely, over and above the share price paid to Cairn Energy. Non-compete covenants under Are prohibited under Section 27 of the Indian Contract Act 1961 as being in rest-raint of trade, the exception being when there is a protection of good-will involved which has been widened by way of judicial interpretation to extend to protection of trade secrets. Notwithstanding the legal embargo, non-compete fees are regularly paid out in M&A transactions particu-larly as Section 20(8) of the SEBI Takeover Code, recognises the exclusion upto 25 per cent of the Offer price as payment to Promoters.

While the Board has disallowed non-compete payments in the cases of Cemertrun and Tata Tea, the Appellate Forum (SAT) has upheld the justification, particularly in the Tata Tea case, where a non-compete fee for '3 crores was paid to the Sellers. SAT held that Sellers did have the capacity and knowledge to compete with the target Company, so the payment was justified. It is another matter that the legality has not been tested against the touchstone of Section 27 of the Contract Act. till date before the Supreme Court

Moreover, the Advisory Committee which is considering sweeping changes to the Takeover Code is seriously debating whether the non-compete fees should be retained at all, since it is difficult to assess whether there is any reasonable basis for the consideration. It may be noted that most jurisdictions do not countenance such payments. In the present case, however, it appears justifiable as the O&G is Cairn’s course expertise and for Vedanta a virgin territory, Cairn’s capabilities have to be retained and contained for at least the agreed three year period to leverage the acquisition. If non-compete had not been imposed, with Cairn while holding its current stake in the company permitted to acquire or set up a competing business, while being privy as a shareholder to all information in Cairn India, that could have been the end to Vedanta’s aspirations to be the Caliph instead of the Caliph.

Kumkum Sen is a Partner in Rajinder Narain & Co. and can be reached at Kumkumsen@rnclegal.com