SEBI’s Perplexing Take on Open Offer Mandate for Indirect Acquisitions
[Ishaan and Avinash are students at Jindal Global Law School.]
The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code) categorises acquisitions into two viz. direct and indirect acquisitions. Regulation 4 of the Takeover Code mandates that the acquirer give an open offer to the existing shareholders. This is done in order for the acquirer to attain control over the target company (TC), irrespective of whether it is acquired directly or indirectly.
Nevertheless, the Takeover Code contains certain general exemptions from this mandate under Regulation 10. The relevant exemption for this article is Regulation 10(1)(a)(ii), which removes the obligation to give an open offer if the acquisition is an inter se transfer amongst qualifying persons (the qualifying persons being promoters in the TC) and if the same has been disclosed to be in that capacity to the stock exchange for at least three years (promoter exemption).
Overview of the Issue
On 6 March 2018, SEBI provided an informal guidance to Navkar Builders Limited (Navkar). Navkar Builders Limited, the TC, had sought guidance regarding two transactions that were to take place. The promoter group of the TC entailed two natural persons, Dakshesh Shah and Samir Patel, and an artificial entity, Navkar Fiscal Services Pvt. Ltd (NFSPL). All three had been disclosed as promoters in the TC for at least three years.
The three parties collectively had 39.94% shareholding in the TC, with Dakshesh Shah having 6.65%, Samir Patel having 4.46%, and NFSPL having 28.82%. The first transaction was NFSPL acquiring shares of Samir Patel in the TC. This would not affect Dakshesh Shah but would increase NFSPL’s shareholding to 33.29%. SEBI did not mandate an open offer here because it matches the requirements of the promoter exemption.
The second transaction is the bone of contention for this paper. This transaction is the transfer of shares between the promoters of NFSPL itself. NFSPL only had two shareholders – Dakshesh Shah and Samir Patel, with no change in such shareholding pattern between the two for more than three years. Dakshesh Shah held 50.05% of NFSPL, while Samir Patel held 49.95% of the shareholding. The transaction entailed Samir Patel transferring 49.45% of his shareholding in NFSPL to Dakshesh Shah and 0.50% to Dakshesh Shah’s wife. This gives Dakshesh Shah massive control of NFSPL, which in turn has control over the TC. This would amount to an indirect acquisition of the TC by Dakshesh Shah.
SEBI acknowledged that this was an indirect acquisition pursuant to an inter se transfer between the promoters of NFSPL. Regardless, SEBI mandated an open offer to the shareholders of the TC because the promoter shareholding of NFSPL was not disclosed to the stock exchange, hence failing the requirements of the promoter exemption under the takeover code.
There are two issues arising here, first regarding the disclosures to be made by a private company, and second whether the disclosures required under the Takeover Code are regarding the promoters of the TC, if such promoters are juridical persons.
The informal guidance stipulated that TC’s promoters, Dakshesh Shah and Samir Patel, were not disclosed as promoters of NFSPL as well to the stock exchange. When it comes to disclosing promoters in the shareholding pattern, the obligation is present under Regulation 31(4) of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations 2015 (LODR). This obligation pertains to public companies. Per the facts of the case, such disclosures were made regarding the TC, a public company.
It would be odd to have the public company obligations under LODR imposed on a private company. The new disclosure format does not mandate private companies to provide such information. In the present case, the guidance has the effect of selectively extending the application of LODR to private companies as well. SEBI has no discernible rationale to support this position.
Further, the informal guidance stated that NFSPL’s promoters were disclosed only as the promoters of the TC and not as promoters of NFSPL to the stock exchange. The promoter exemption’s wording states that the persons should be named as the “promoters in the shareholding pattern filed by the target company”. There is no requirement under the takeover code to be disclosed as the promoter of a promoter company of the TC.
In the Matter of M/s. SH Kelkar and Company Limited (Kelkar), the fact pattern was similar to Navkar’s. Here, the shareholding of the promoter company (again a private company) was being transferred to a trust, by way of which the trust indirectly acquired the TC. The question was whether the promoter exemption would apply. The court concluded that the trust was not named as a promoter of the TC for at least three years and, therefore, would not be exempted. Accordingly, there was no question of who was disclosed as the promoter of the private company whose shareholding was being transferred. Here, we see that the court only looked at the textual requirements of Regulation 10(1)(a)(ii) and did not lift the corporate veil of the promoter. They only looked at whether the entity was listed as a promoter for the exception to apply. This point on leaving the corporate veil untouched is central to the point of this article.
Reluctance to Raise the Veil
Per Laurel Energetics Private Limited v. SEBI (Laurel Energetics), Regulation 10(1) makes it impermissible for the court to lift the corporate veil, either partially or otherwise, in a manner that would distort the plain language of the regulation. The court opined that for where the corporate veil is to be lifted, the regulation itself would expressly state it. Accordingly, per the court, the literal language of Regulation 10 was clear and beyond any iota of doubt; hence, there should be no need to go to the objective of the regulation.
Simply put, in this informal guidance, the transaction entailed a promoter exercising control in a promoter company. All in all, the control over the TC remains within the original promoter group. Applying purposive interpretation as provided for in K. Sreenivasa Rao v. Regional Director, SEBI (Sreenivasa Rao), the objective of the Takeover Code in mandating an open offer is to allow the other shareholders to make their choice to stick with the company after a possible transfer of control to third parties. There was no such situation warranting an open offer in the informal guidance.
Therefore, the promoter exemption makes it clear that the promoters to be disclosed are the ones of the TC. The Takeover Code is not allowing any room for additional obligations, especially that of a private company. In this regard, the informal guidance in question obfuscates the interpretation of the general exemption. Further, looking at Kelkar, Laurel Energetics and Sreenivasa Rao, it is important to note that the SEBI takes a very different position with respect to disclosures of promoter patterns as opposed to the aforementioned cases.
The essence of this article pertains to the reliance that the SEBI has placed on ‘informal guidance’. Informal guidance on a matter that has such far-reach consequences on the functioning of a company, as was in Navkar, would set a dangerous precedent for the manner in which such a statutory body operates. The informal guidance in Navkar had the effect of requiring the company to initiate an open offer for the remaining shareholders, even though the promoters were arguably operating within the textual requirements of Regulation 10(1)(a)(ii).
Open offer requirements take time and money to implement, which can be a genuine bottleneck in time-sensitive arrangements. More importantly, utilising such informal guidance as the letter of the law can lead to a lack of clarity in what the applicable law is and would not form part of a coherent legal system. The lack of clarity is compounded in situations where promoters of a company are juridical entities themselves. Any disclosures pertaining to such promoting entities would amount to lifting the corporate veil, which, based on common law jurisprudence, cannot be done unless on the grounds of illegality or public interest. Any guidance on disclosures vis-à-vis the promoter patterns of juridical entities acting as promoter companies should be officially notified.