[Medha and Purva are corporate law associates at leading law firms in Bangalore and Mumbai respectively.]
The onset of the coronavirus pandemic has significantly disrupted the continuity of businesses globally. Now more than ever, listed companies require immediate fundraising to meet their working capital requirements to avoid a liquidity crisis and ultimately bankruptcy. Certain measures and relaxations have been incorporated in legal systems globally to ensure business continuity and ease of capital raising to facilitate recovery in these unprecedented times. In this article, we analyse the measures taken by India and the United Kingdom to understand how the governments and the capital market regulators have responded to the economic turmoil brought about by the pandemic.
Position in India
Pursuant to the slowdown in the economy during the coronavirus pandemic, listed companies with high leveraging urgently needed capital infusions to avoid undergoing bankruptcy. In light of boosting investments, the market regulator Securities and Exchange Board of India (SEBI) has therefore amended the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations) and the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code) to offer relaxations to companies with stressed assets.
A consultation paper was floated on 22 April 2020 seeking stakeholder recommendations regarding the pricing of preferential issues and exemption from open offer obligations in companies having stressed assets. Pursuant to this, SEBI made the following amendments on 22 June 2020.
For companies having stressed assets, it is difficult to raise funds owing to a steep fall in their share prices. Prior to the amendment, the ICDR Regulations under Regulation 164(1) determined pricing of preferential allotment based on the average of the weekly high and low for a period of 26 weeks. This would have a negative impact on companies struggling to raise funds during the pandemic as the valuation of share price would undergo severe fluctuation owing to the extended period of time the global economy has been crippling under.
Thus, the ICDR Regulations were amended to introduce Regulation 164(A) where such a valuation of share price would be determined using a much shorter time period of 2 weeks preceding the relevant date. It is pertinent to note that these exemptions can only be availed listed companies on satisfying at least two of the following three objective criteria laid down by the regulator under 164A(2).
The market regulator SEBI also made corresponding amendments under the Takeover Code, by inserting Regulation 10(2B) to exempt such allottee company from making an open offer under Regulation 3(1) of the Takeover Code even if the resultant shareholding of the investor company breaches the threshold of 25% or more of the voting rights of the listed company. In ordinary market conditions, such a substantial acquisition by an investor would trigger the open offer obligations. This mechanism was envisaged to protect the rights of existing shareholders so that they may exercise an exit option if they no longer want to be associated with the business owing to a post-acquisition management change. However, in the times of a global pandemic, this would be an added financial burden on the incoming investor in addition to the funds he has infused into the stressed company, to guide the company out of the stress.
Thus, by incentivizing investors, who may potentially acquire a substantial shareholding over a stressed company after the preferential allotment, SEBI ensures that there is a smooth flow of funds into a company. Investors, especially private equity firms, have proven that by taking over operational control of stressed companies, they have managed to revive companies with distressed debt. It is pertinent to note that, to prevent misuse of these regulatory relaxations, SEBI has introduced a concept of a 3 year lock-in period for the investment made under these newly relaxed regulations instead of the earlier prescribed 1 year time period. This is to prevent the new investors from exiting from the shareholding at the first instance of profit-generation.
Preferential allotment of shares is by far the quickest and most efficient way for listed companies to raise capital. These relaxations will definitely provide stimuli to distressed listed companies to stay afloat and avoid insolvency owing to the pandemic.
Apart from the amendments to the ICDR Regulations, SEBI has offered relaxations under the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR Regulations) to newer listed companies to undertake fast track rights issue. The minimum listing and compliance period of 3 years has now been reduced to 18 months, we predict this will facilitate quick infusion of funds. The minimum subscription requirement for a successful rights issue has also been reduced from 90% to 75% of the issue size. These measures by the market regulator are complemented by the relaxations offered by the Ministry of Corporate Affairs (MCA) in the form of an extended interval of 180 days between 2 board meetings owing to social distancing norms, waiver of additional fees by defaulting companies to reduce compliance and financial burden and giving newly incorporated companies a timeline of 1 year to declare the commencement of business.
Additionally, we have studied regulatory changes that have been adopted in the United Kingdom and drawn conclusions as to the additional steps that can be taken by India to increase business efficacy and boost the economy.
Position in the United Kingdom
To help businesses during the pandemic, the Chancellor of the Exchequer announced that the United Kingdom government has introduced several measures such as the COVID-19 Corporate Financing Facility, coronavirus business interruption loan scheme and small business grants. Companies are encouraged to undertake business continuity planning to mitigate the impact of such uncertainties. The UK is proactively easing the burden on businesses by providing a business continuity toolkit to help them in identifying the critical aspects of their business, and to plan ahead. Further, the market regulator Financial Conduct Authority (FCA) has undertaken several measures to help listed companies raise funds smoothly during the crisis. The Pre-Emption Group (PEG) has temporarily relaxed its guidelines on pre-emption rights for listed companies by recommending that investors should consider supporting issuances of up to 20% of their issued capital, on a case-by-case basis as opposed to the previous 5% for general corporate purposes coupled with an additional 5% for specific investments or acquisitions. The COVID-19 pandemic is considered as an exceptional circumstance and thus the policy of a case-by-case analysis can be invoked. This has been endorsed by the policy statement. released by the FCA. The FCA has further noted that for secondary share issuances, companies can now use a shorter and simplified prospectus which eases time and complexity constraints. Relaxations in a company’s working capital statement requirements is a significant step to be noted. Pre-pandemic rules mandated that a clean working capital statement must not include any assumptions or qualifications as then the onus is on the investor to evaluate his decision. The FCA now approves companies to submit coronavirus related assumptions and qualifications in an otherwise Clean Working Capital statement. These policies will surely ease the process of recapitalization of companies during these unprecedented times.
In conclusion, governments and market regulators in India and the UK have actively responded to the economic crisis brought by the pandemic by offering various temporary relaxations to help business continuity. The regulators play a very important role in balancing the urgent need of capital by businesses and protecting the rights of investors by offering full disclosures. In India, SEBI has mandated companies to make full disclosures pertaining to the impact of the pandemic on business operations to investors. Taking away from the measures adopted by the UK, the Indian regulator can instead allow companies to make coronavirus related qualifications and assumptions pertaining to operations and profitability in an otherwise clean working capital statement. Further, the relaxations provided in the amended ICDR Regulations can be extended to businesses that currently do not satisfy the objective criterion to be deemed as 'stressed' but may soon be toeing the line of default. It is undeniable that the pandemic has completely changed the ways a company will continue doing business for the foreseeable future. Although the pandemic may be temporary, its economic consequences are here to stay. Thus, like the FCA in the UK, SEBI should follow a case to case analysis of a company to assess its eligibility for these relaxations instead of a strict objective criterion, to streamline business working which will ultimately boost the Indian economic landscape.