[Arpit Saini is a student at National Law University, Jodhpur.]
The corona virus disease (COVID-19) has unsettled the stock markets. The increased outbreak of the virus has forced the government to impose lockdown and halt several business activities for an unforeseeable time period. The result will be a massive impact on the economy. For corporations, concerns have arisen over adequacy of earnings and successful repayment of debt. Uncertainty of the implications has shaken the confidence of investors. Resultantly, investors have sold their shares and the stock prices of companies have plummeted.
In addition to being a serious concern for the economy, the fall in prices has left certain companies vulnerable to a hostile takeover. Opportunistic companies may use the situation to gain a controlling interest in companies with a strong business model and growth potential. In this piece, we look at the possibility of a hostile takeover in the Indian corporate regime, assess the measures to defend a hostile takeover and identify the most appropriate measures for the current pandemic.
The threat of a hostile takeover in India
Takeover is defined as the ‘acquisition of control by one company (acquirer) over another company (target)’. ‘Control’ is considered to be acquired when the acquirer company either has the right to appoint majority of the directors or has control over the management / policy decisions.[1] When a friendly acquisition bid is rejected by the management of the target, hostile bidders seek to acquire the voting rights (open offer) or influence the shareholders (proxy vote) to replace the management of the target and proceed with the takeover transaction. The bids are primarily governed by the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code). The Takeover Code makes no distinction between a friendly and a hostile takeover but only mandates the fulfillment of certain conditions. The acquirer necessarily has to make a public announcement of an open offer for the shareholders of the target company.[2] The offer provides an exit opportunity to the shareholders, who may not be in support of the change in management after the takeover. The open offer can be mandatory or voluntary. An acquirer who holds 25% of the voting rights in the target company has to compulsorily make the offer to hold more than 25% or more of the voting rights or shares.[3] However, the acquirer can also voluntarily make an open offer to acquire shares, if he holds less than 25% of the shares or voting rights.[4] Besides the open offer regulations, there are other disclosure obligations and restrictions on corporate transactions during the period of open offer, but these obligations hardly constitute a major challenge for a hostile bidder.
In India, successful attempts have been limited, but the recent Mindtree takeover by Larsen & Toubro (L&T) has highlighted the prospects of hostile takeovers. Historically, restrictive government policies and traditional corporate structure with high stakes owned by the promoters have made acquisition a challenging task. However, it is noticeable that there have been a considerable number of hostile bids. Also, the companies with low promoter shareholding are prone to the threat of a hostile takeover. As a proof, the promoters of Mindtree held a mere 13.3% of the shares before the takeover. Interestingly, in addition to the low promoter shareholding, a ‘triggering event’ activated the takeover process in the case of Mindtree. The event was VG Sidhhartha’s (who held 20.32 % of the stakes in Mindtree) sale of stakes in a desperate attempt to pare his corporate debt. Once L&T acquired these stakes, it went on to buy shares from the open market and subsequently made a mandatory open offer when it reached the threshold of 25%. Many investors sold their stakes when L&T made the offer. Eventually, L&T acquired 60% stake and exercised complete control over the management of Mindtree. Thus, a hostile acquisition is probable in the present Indian corporate regime even when it has been a rare occurrence.
COVID-19 can understandably be a triggering event making the companies susceptible to hostile takeovers. The fall in stock prices certainly makes share acquisition convenient and attractive. Apprehending the threat of hostile takeover by foreign firms, the government has already updated the FDI norms. Any further investment from China, and all countries sharing border with India, will now require a government approval. The domestic cash-rich companies in the country, however, have no such restriction. It is, therefore, plausible that hostile activities initiate once the market stabilizes. It follows that vulnerable companies must prepare themselves with an appropriate takeover defense.
The prescription
Developing takeover defense strategies is a challenging task in India. The regulatory regime primarily aims to protect the shareholders’ interests and therefore, occasionally operates as a hindrance to the defenses. Substantively, a number of defenses are rendered ineffective by the Indian regime. Under the commonly used form of ‘poison pills’, the target issues shares to the existing shareholders (except the acquirer) at a substantial discount to dilute the value of shares and make the acquisition onerous. However, the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009[5] and the SEBI (Disclosure and Investor Protection) Guidelines 2000[6] require the share prices of such preferential issue to be the average of the weekly high and low quoted on the stock exchange in the preceding six months or two weeks, whichever is higher. Thus, an Indian company cannot issue discounted shares to the shareholders. ‘Staggered boards’ provides that only certain number of management board members (usually one third of the total) is re-elected in the annual general meeting. It increases the time duration within which the acquirer will gain complete control over the management even if it has majority of the shares/voting rights, therefore making the takeover unattractive. In India, however, the directors are liable to be removed by a simple majority of shareholders.[7] Thus, if the acquirer has majority of the voting rights, he can easily replace the members of the board. ‘Differential voting rights’ (DVRs) can be used to issue superior voting rights shares to the promoters and therefore dilute the value of voting rights shares with the acquirer. However, the DVRs framework by SEBI does not allow the issue of superior voting rights by a listed company.
Moreover, the current pandemic has also eliminated some other defenses. Although unsuccessful, Mindtree allegedly used the distribution of huge dividend to increase the share price and make the takeover unattractive. With financial and liquidity concerns, dividends may make the acquisition unappealing, but the target will be incapable to pay the dividend. These concerns also eliminate the ‘Pac-Man Defense’, where target threatens to counter-attack and acquire substantial shares in the acquirer company, and the ‘Greenmail’, wherein the target buys its stakes from the acquirer at a premium.
Thus, companies have to set up a defense from the restricted options. Finding a ‘White Knight’ might be the first option, wherein significant shareholding of the target is acquired by a friendly company to tackle the acquirer. Further, unconventional embedded defenses can also provide a suitable strategy. Anti-takeover amendment can be used to amend the articles of association or byelaws[8] to make the takeover unattractive. For example, ‘supermajority agreement’ requires at least 75% of shareholder approval for a change in control. The agreement can involve the board clause which lets the management decide when the supermajority provision will activate, and thereby leave a scope for friendly mergers. Also, L&T has made amendments to confer the promoters with rights to appoint certain percentage of management board and lifetime chairmanship. However, the amendments shall not be ultra vires to the Companies Act 2013 or the memorandum of association. Another option is change in control provisions i.e. contractual arrangements with a third party to put burden on the target if the takeover attempt is successful. For instance, companies can house their brand and valuable assets in a separate private company owned by the promoters to protect them from acquisition. Tata companies have successfully used the ‘brand pill’ which restricts the use of their brand name by the acquirer on takeover. Companies can also make the material contracts of the target subject to change of control; such that the contracts terminate if a hostile takeover is completed.
Conclusion
The Takeover Code does not expressly prevent hostile takeovers in India. This makes the low-promoter shareholding companies in the market susceptible to takeovers. The COVID-19 pandemic and the growing uncertainty over the financial impact has led to the fall in share prices of the companies. Consequently, the situation provides an opportunity for hostile bidders to acquire control in susceptible companies with development potential. Thus, companies need to prepare a strategy to defend a possible acquisition bid. However, strict regulatory provisions and present financial burden eliminate most of the commonly used takeover defenses for the Indian companies. In such adversity, white knight or embedded defenses may come to the rescue of these companies against the bidders.
[1] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011, Regulation 2(1)(e).
[2] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011, Regulation 4.
[3] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011, Regulation 3(1).
[4] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011, Regulation 6(1).
[5] SEBI Issue of Capital and Disclosure Requirements (ICDR) Regulations 2009, Regulation 76.
[6] SEBI Disclosure and Investor Protection (DIP) Guidelines 2000, 13.1.1.
[7] Companies Act 2013, Section 169.
[8] Companies Act 2013, Section 31.