Rhodia to Subhkam: What indeed is control?

The Securities Appellate Tribunal (SAT) has recently ruled, in the matter of Subhkam Ventures Pvt Ltd v SEBI, that control as defined under the takeover regulations does not include negative control.

The ruling, which is perceived by many as a landmark one, is contrary to a previous ruling by the SAT in the case of Rhodia SA v SEBI.

The takeover regulations essentially define control as an ability to appoint the majority of the directors on a board or an ability to control the management or policies of a company. Acquisition of 50% voting rights gives a person a clear ability to appoint the majority of the directors on a board and so there is not much ambiguity in this test of control.

The debate revolves around what amounts to an ability to control the management or policies of a company.

There is a school of thought that believes that granting veto rights to an investor is equivalent to giving the investor control.

Without going into the facts of the case or examining the extent of the veto rights that are granted, it would be dangerous to set this as a test for control. It is tantamount to saying that mere acquisition of a 26% stake in a listed entity amounts to the acquisition of control as a shareholder who then has the ability to block all special resolutions.

Whether the veto rights acquired amount to the gaining of control should be tested on a case-by-case basis. It would be impractical if any regulations or judge-made law sought to lay down a straitjacket test to establish this. The Rhodia case highlights this view.

In Rhodia’s case, the SAT ruled that Rhodia, although not a shareholder, was in a position to control the affairs of Danube, the step-up parent company of the target in India.

According to the facts, it appears that the SAT had deduced Rhodia’s ability to control the affairs of Danube not only due to the contractual veto rights vested with Rhodia on all major matters such as payments of dividend, acquisition or disposal of assets and issuance of securities, but also due to the other circumstances surrounding the case.

Rhodia in this case not only funded Danube but also completely controlled the bid placed by Danube’s wholly owned subsidiary for the purchase of a target company in the UK.

Based on all of the above it is not difficult to conclude that Rhodia did have some control over Danube’s affairs and exercised a degree of control well beyond its affirmative veto rights.

The recent SAT judgment on Subhkam examines whether granting certain affirmative voting rights to an investor amounts to the acquisition of control by an investor.

MSK Projects India, the target company, has a promoter in place and Subhkam is a financial investor in the company. Subhkam gets to appoint one nominee director on the board of the company and all committees of the board. It also has certain affirmative voting rights in its favour.

Up until now the transaction has all the trappings of a financial investment or a private equity investment in a listed company.

What differentiates this deal from other private equity deals is the long list of affirmative rights that Subhkam obtains pursuant to its agreement with the company. Further, any board meeting that seeks to resolve such matters, without the investor director of Subhkam being present, is invalid for lack of quorum.

The list of matters, which are 22 in number, includes not only standard items such as amendment to the charter documents, issue of shares and disposal of assets, but also items such as approval of the annual business plan and any deviation from it, appointment of key officials (CEO, COO, CFO and company secretary) their remuneration and powers, any joint venture of the company, any investments made by the company, incurrence of any indebtedness beyond a threshold, and settlements of legal claims in excess of Rs10 million (US$218,000).

The list is clearly an overkill and it is difficult for one to agree with the SAT’s view that these rights have been granted solely in the interests of minority protection and good corporate governance.

SAT in its ruling has maintained that this set of rights merely enables Subhkam to oppose a proposal and not to carry any proposal on its bidding.

It is true that Subhkam cannot ensure that its proposal is implemented by the company but with rights of this nature, Subhkam can definitely steer a company in the direction it seeks as the company can pretty much do nothing without the express consent of Subhkam (apart from routine day-to-day matters, which in any event do not require the decision making powers of the board).

If this is not control over the management or policies of the company then what is?

Akila Agrawal is a partner at Amarchand & Mangaldas & Suresh A Shroff & Co.