[Tanishka Goswami is a student at National Law University, Delhi.]
The COVID-19 pandemic has locked down mergers and acquisitions (M&A) across the globe. For the first time since September 2004, no M&A transaction worth more than $1 billion has been announced anywhere in the world. Globally, airlines have lost about 19% in worldwide passenger revenue ($113 billion), prompting a sharp reduction in fare prices. The much-awaited privatization of India’s second-largest oil refiner, Bharat Petroleum Corp., has also been delayed due to revenue estimates declining by $2 billion.
In these times, market regulator Securities Exchange Board of India (SEBI) relaxed compliance norms pertaining to shareholding disclosures. Shareholders can now disclose relevant information pertaining to their shareholdings to companies and stock exchanges by 1 June 2020. Merchant bankers and other intermediaries have been directed by SEBI to make the necessary submissions online. Through this article, the author explores the possible impact of the pandemic on M&A activity and the change in how merchant bankers and legal advisors perform their functions as market intermediaries under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Code).
What responsibilities are merchant bankers and legal advisors entrusted with?
Regulation 27(2) of the Takeover Code requires merchant bankers, as managers to open offers, to ensure that offer documents are true, fair and adequate in all material aspects. In Almondz Global Securities Ltd. v. SEBI, the Securities Appellate Tribunal (SAT) categorically noted that a merchant banker is under a heavy responsibility to take proactive steps and verify the material surrounding the offer documents. This responsibility is discharged though due diligence processes, which help buyers determine the genuineness of the seller’s financial assets.
Under the SEBI (Merchant Bankers) Regulations 1992, due diligence involves ensuring the adequacy of firm financial resources with the acquirer. As noted in Imperial Corporate Finance and Services v. SEBI, due diligence does not mean passively reporting whatever is informed by the client, but necessitates proactive efforts from the merchant banker to find out whatever is worth finding out. The definition of what constitutes ‘material information’ becomes crucial to determine whether or not certain information merits disclosure. In Electrosteel Castings Limited. v. SEBI, the SAT noted that ‘material disclosure’ has to be determined objectively from the viewpoint of a reasonable investor. The tribunal hence specified:
“Thus, true and adequate disclosure is said to be made, if the disclosure is accurate and not misleading and does not omit a fact that is either material itself or is necessary to understand the facts that have been disclosed, so as to enable the investors investing in the issue to take an informed investment decision.”
Legal advisors, as ‘persons associated with the securities market’ under Section 11 of the SEBI Act 1992, are also under a duty to conduct robust legal due diligence of their client’s disclosures and representations. They are responsible to assess risks which could arise from omission to disclose material facts. Abstention from disclosing information which affects the market price of securities is a fraudulent trade practice under the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations 2003. Hence, market intermediaries act as cautiously as possible so as to not trigger the SEBI’s wide investigative powers.
What changes in this pandemic?
With global markets declining precipitously, the risks associated with negotiating M&A transactions have enhanced in this pandemic. These risks primarily fall on two major aspects of the process: due diligence exercises, and negotiation of material adverse change (MAC) clauses. The primary objective behind introduction of the Takeover Code was protection of investors’ interests. A disclosure-based regulatory regime in light of the Takeover Code necessitates transparency between investors and buyers, thereby enabling informed decisions.
The Indian legal system attaches a very high level of sanctity to takeover offers, thereby preventing withdrawal, let alone in exceptional circumstances. In Nirma Industries Limited v. SEBI, as also in SEBI v Akshya Infrastructure Limited, the Supreme Court of India (SC) categorically ruled that economic non-viability and non-profitability cannot serve as reasons permitting withdrawal of open offers. Regulation 23(1)(d) of the Takeover Code which provides for withdrawal in case the situation merits SEBI’s approval is hence triggered only when performance of the offer is totally impossible.
Due diligence processes
In this light, merchant bankers and legal advisors have to be increasingly wary of distorted corporate announcements which suppress material information. Undisclosed information is material when the probabilities and magnitudes associated with it can lead to a change in disclosures previously made in the public domain. Hence, affirmations that the buyers have ‘firm financial arrangements’ may drastically change in situations of falling corporate valuations.
As noted by the SAT in HSBC Securities Limited v. SEBI, merchant bankers cannot depend on any response from SEBI, the target company, or the auditor in order to discharge the basic responsibility of carrying out due diligence. Therefore, in present times where in-person meetings are difficult (and, in several cases, impossible), merchant bankers have to resort to videoconferencing and telephonic conversations to undertake necessary due diligence. The same has to extend to the buyer’s existing insurance policies, solvency or going-concern risks and lastly, the tendency to walk away from the transaction by invoking the MAC, or force majeure clause.
Regularly included as part of financing agreements, MAC clauses have been accorded a restrictive judicial interpretation in the past. The 2013 UK High Court judgment in Grupo Hotelero Urvasco SA v. Carey Value Added SL clarified that an adverse change would be material, if it significantly affects the borrower’s ability to repay the loan in question. A rare 2018 judgment of the Delaware Supreme Court in Akorn, Inc. v. Fresenius Kabi AG found the circumstances to be triggering a MAC clause. Following a precipitous decline in the buyer’s financial performance, quantitative analysis concluded that the decline would extend to 21% of the company’s valuation. The standard laid here was that an adverse change is material when the situation, viewed from a long-term perspective of a reasonable acquirer, threatens the overall earnings potential of the target in a duration-significant manner.
With respect to the Indian legal paradigm, there is a high burden to be discharged by the buyer to invoke a MAC clause. The SAT judgments in Luxottica Group SpA v. SEBI, as also B.P. Amoco Plc v. SEBI noted that performance of an open offer can be made subject to reasonable conditions, which, if not fulfilled due to reasons beyond the acquirer’s control, render withdrawal permissible. However, such conditions must be in tune with the Takeover Code. Regulation 23(1)(c) of the Takeover Code provides for withdrawal of an open offer in case any condition stipulated in the agreement triggering the acquisition is not met for reasons outside the reasonable control of the acquirer. However, the 2013 landmark SC ruling in Nirma Industries has made it clear that all conditions for withdrawal under the Code have to fall under the common ‘genus of impossibility’.
Further, in Subhishka Trading Services Ltd. v Blue Green Constructions & Investments, the Madras High Court deferred an amalgamation under the Companies Act 1956 only on the ground that the transferor company was in severe financial crisis and soon to be wound up. This dissolution of the company made the transaction impossible. Hence, given the sacrosanct nature ascribed to open offers, a very stringent set of possibilities which convince the SEBI about genuine difficulty in performance of the offers merits withdrawal.
How might courts and tribunals rule on this matter?
To arrive at some reasonable conclusions on this matter, it becomes critical to look at the interpretation accorded to force majeure clauses by Indian courts. Parties to an executable contract sometimes face unanticipated circumstances, which render performance impracticable. In such situations, a force majeure clause is triggered. It can be traced to Section 56 of the Indian Contract Act 1872, which allows temporary discharge of obligations on grounds of impossibility. The Indian legal understanding on the matter is perhaps best summarized in the case of Energy Watchdog v. CERC, wherein it was categorically held that force majeure clauses be granted a narrow and strict interpretation. Courts do not have the general power to absolve performance except when the very foundation of the contract is affected.
A diverging is precedent on the matter is the 2003 SARS outbreak. Therein, the Supreme Court of China issued a judicial interpretation specifying that, in case a contract could not be completed due to the outbreak or impact of administrative measures, such a situation was to be considered a force majeure event. However, by examining the jurisprudence on force majeure and MAC clauses, it becomes evident that courts and tribunals will be cautious in opening floodgate of litigation. The same will be done by critically examining the impact of the pandemic on specific businesses and their valuations. In the author’s opinion, hence, two aspects become significant: one, the specific nature of impact on the business and two, the language of the clause agreed to by the parties.
Conclusion: What should market intermediaries focus on?
In case of agreements which have already been entered into, merchant bankers and legal advisors should rest their focus on prompting disclosures from buyers. These disclosures should reflect changed financial performances, employee counts, supply-chain relationships. The same will enhance transparency in decision-making, thereby ensuring that market dealings are bona fide in nature. With respect to agreements which are being negotiated, focus should be placed on making the MAC clauses as exhaustive as possible.
Even though such clauses are exclusive to each transaction, ‘pandemics’ or ‘epidemics’ are generally not discussed as part of exclusions to MAC. Hence, legal advisors have an added responsibility to ensure that their buyer-clients secure the option to walk away in case of disproportionate financial impact on the target. Sellers, on the other hand, now have to push for post-closing price adjustments in order to balance the risk of fluctuations in valuations. The same will prevent buyers from abandoning deals in case the effects of the pandemic extend. It will be interesting to look at the approach SEBI takes, and the possible guidance it issues for the COVID-19-hit securities market.
Miriam P. Hechler, 'The Role of the Corporate Attorney within the Takeover Context: Loyalties to Whom?'  21(3) Delaware Journal of Corporate Law 943.
Satyabrata Ghose v Mugneeram Bangur, AIR 1954 SC 44.