Withdrawal Constraints in Hostile Takeovers: An Examination of Voluntary Open Offers During COVID-19
[Pranav Mihir Kandada is a student at NALSAR University of Law.]
The economic uncertainty brought about by the present pandemic situation has broadly resulted in two issues with respect to takeovers across the globe.
The first is the plunge in the share prices of many public companies. This plunge has presented an opportunity for corporate raiders (particularly foreign investors) to initiate hostile takeovers. Several countries, including India, have tightened their FDI rules to deal with this issue.
The second issue is the withdrawal of takeover offers made previously due to the adverse impact of the pandemic on the acquirer’s position. Instances relating to the second issue are gradually surfacing. An early instance was Xerox’s withdrawal of its hostile takeover offer to HP. Xerox stated that it was no longer conducive for them to pursue the acquisition and cited the pandemic and resulting “macroeconomic and market turmoil”. Recently, TA Enterprise sought permission from the Securities Commission Malaysia to withdraw its conditional voluntary takeover offer on TA global citing the adverse impact of the pandemic on the target’s financial position.
Such instances, in the Indian context, would further complicate the issue of withdrawal of voluntary open offers, particularly in hostile takeovers. At present, SEBI has brought in relaxations regarding procedural matters but intends to stick to the existing framework as far as possible. Against this background, this article seeks to point out the manner in which a hostile acquirer in India is heavily constrained by the regulatory framework with respect to withdrawing its open offer. As a hostile takeover bid is essentially a voluntary open offer, the article shall also serve as an examination of the effect of regulations on the exercise of the right of voluntary open offer.
Withdrawal of an open offer
Withdrawal of an open offer is not allowed under the Takeover Code except under certain circumstances mentioned in Regulation 23(1). The regulation provides three specific circumstances that would merit withdrawal along with a fourth general provision.
Regulations 23(1)(a) and 23(1)(b) deal with lack of statutory approvals and death of a natural acquirer respectively. If the acquirer is a company (and not a natural person), and has previously received approval from SEBI, neither provision can be invoked. Regulation 23(1)(c) is inapplicable to hostile acquirers as it contemplates non-fulfilment of conditions in the agreement for acquisition attracting the obligation to make the open offer. Hostile takeover bids are usually initiated against the interests of the management of the target company and are addressed directly to its shareholders as a voluntary open offer. Hence, they typically do not have underlying agreements that trigger such offers. A letter of offer, which is issued to the shareholders of the target company, is finalized upon acceptance by the shareholders. It should not be considered an agreement in itself, as it is unilaterally extended to the shareholders of the target company.
Since a voluntary open offer in a hostile takeover does not meet the three circumstances, the acquirer must rely on Regulation 23(1)(d) which states that an open offer may be withdrawn in such circumstances as in the opinion of the board merit withdrawal.
SEBI’s discretionary power
The discretionary power of SEBI in allowing withdrawal of an open offer was decided by the Supreme Court in the case of Nirma Industries v SEBI which dealt with the identical regulation 27(1)(d) of the previous Takeover Code (1997). The court held that since the enumerated specific provisions deal with the genus of impossibility, the general provision must be limited to circumstances of impossibility as well. This position, based on the principle of ejusdem generis, was extended to Regulation 23(1)(d) of the present Takeover Code (2011) in the matter of open offer of Jyoti Limited. Hence, the scope of SEBI’s discretionary powers is limited to cases where it is impossible for the acquirer to complete the offer. The Supreme Court further held in the case of Nirma Industries that an offer cannot be withdrawn because it has become uneconomical for the acquirer. The realm of impossibility in circumstances is distinct from the realm of undesirability in economic terms. The court reasoned that permitting withdrawals in such cases would have a destabilizing effect due to unscrupulous elements speculating in the stock market.
The position implies that the reasons cited by Xerox or TA Enterprise for withdrawal of the open offer may not be favoured if they were made to SEBI. A plunge in stock prices of the target or financial instability of the acquirer certainly makes the acquisition undesirable but does not render it impossible. However, this would adversely affect those potential acquirers in industries that have come to a complete standstill (such as the automobile industry). Whether the lack of a cash flow or revenue to a particular company and the effects of the global recession on its finances meet the standard of impossibility is something the courts must decide on a case-to-case basis in each industry. However, hostile acquirers who may seek to withdraw on similar grounds of market turmoil as in other jurisdictions and not on the solid ground of impossibility, would not be able to do so.
Material adverse change and other conditions
The non-fulfilment of a MAC clause in an underlying agreement that triggered the open offer may help the case of an acquirer under Regulation 23(1)(c). It remains to be seen whether the Board would accept such change in circumstances as a material adverse change or not. However, such reliance on a MAC clause is unavailable to the hostile acquirer in India. A MAC clause lists certain conditions that are agreed upon, the non-fulfilment of which would bring cause for invocation. The Takeover Code, under Regulation 19(1), provides for a conditional open offer but with respect to only one condition: a minimum level of acceptance. Further, the Report of the Takeover Regulations Advisory Committee shows that the committee had noted that in certain jurisdictions, the acquirers are allowed to specify conditions to the offer and non-fulfilment of either conditions in the offer document or that of the triggering agreement would be grounds for withdrawal. In the subsequent deliberation and proposed takeover regulations, the committee consciously excluded the provision for withdrawal upon non-fulfilment of conditions specified in the open offer. In Luxottica Group SPA v SEBI (2003), the SAT had stated that reasonable conditions may be put in the offer document and difficulty in fulfilling these conditions may be grounds for withdrawal. However, the Supreme Court’s decision in the case of Nirma Industries limits grounds for withdrawal to the genus of impossibility.
It can be argued that Regulation 23(1)(c) provides for a ‘triple lock’ with respect to non-fulfilment of conditions: the conditions must belong to an underlying trigger agreement, the non-fulfilment must be due to reasons beyond the reasonable control of the acquirer, and the effect of such non-fulfilment must be rescission of the underlying agreement. This circumstance belongs to the genus of impossibility as there is rescission of the agreement, thereby making performance impossible. Thus, even if non-fulfilment of conditions in the letter of offer was given the same status as that in an underlying agreement, Regulation 23(1)(d) would not allow withdrawal. Only the first lock is opened by non-fulfilment. The second lock may also be opened as the pandemic situation is certainly beyond the reasonable control of the acquirer. However, it is the effect of rescission and not the cause of non-fulfilment that guides the genus of impossibility. This third lock cannot be opened by non-fulfilment of conditions unilaterally put forth in a voluntary open offer, including a MAC clause. Hence, it would not be a ground for withdrawal.
There appear to be heavy constraints on a hostile acquirer trying to withdraw the open offer once made. Provisions that may come to the rescue of an acquirer who enters into an underlying agreement with the target company do not seem to be applicable to hostile acquirers. This problem may exacerbate due to the present situation and the unforeseen changes in financial position of companies in India. The reason behind such limitations on the hostile acquirer is perhaps the fact that hostile takeovers are a rare occurrence in India, thereby leading to less deliberation on provisions that would address their situation. Although the bar of impossibility is to prevent the destabilizing effect caused by unscrupulous elements speculating in the stock market, it might not be fair to declare those seeking to withdraw in these circumstances as unscrupulous, especially if the particular industry has come to a standstill. However, allowing hostile acquirers to invoke their own unilaterally imposed conditions would be unfair as well. Overall, such constraints on withdrawal impose severe limitations on the exercise of the right of voluntary open offer granted by the Takeover Code. Even if hostile takeovers are a rare occurrence, the right to make a voluntary open offer must be furthered with reasonable remedies for unprecedented situations.