The Securities and Exchange Board of India (SEBI) no longer considers entities that are not scheduled commercial banks (SCBs) or all India financial institutions (AIFIs) as “lenders” for exemption from a mandatory open offer under regulation 10(1)(i) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (regulations).
The takeover code conferred exemption to mandatory open offer for:
- acquisition of primary shares from a borrower company or secondary shares from lenders pursuant to a debt restructuring scheme under the guidelines issued by the Reserve Bank of India (RBI),
- acquisition of shares, not involving a change of control, in a corporate debt restructuring scheme notified by the RBI, if the scheme has been approved by a special resolution of shareholders,
- conversion of lenders’ debt into equity as a part of a debt restructuring scheme.
On 29 March 2019, SEBI amended the regulations. It deleted the first two exemptions and added an explanation to the third exemption that defined lenders as all SCBs (excluding regional rural banks) and AIFIs. A similar explanation was added to the provision exempting lenders (who acquire securities pursuant to conversion of debt as part of debt restructuring under RBI guidelines) from compliance with the chapter for preferential issue under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Some of SEBI’s justifications for the amendments were:
- In case of a resolution plan under the Insolvency and Bankruptcy Code, 2016 (IBC), for which an exemption is available, the committee of creditors is required to act in the best interest of all stakeholders. However, in case of a non-IBC resolution, the lenders may not necessarily act in the best interests of all stakeholders.
- Lenders are not required to select the best resolution plan in a non-IBC restructuring.
- Exemptions were granted earlier for debt restructuring mechanisms that no longer exist (such as the corporate debt restructuring scheme).
- There is no longer an institutional framework to oversee debt restructuring, such as the corporate debt restructuring standing forum, the overseeing committee or the independent evaluation committee.
- Exemption for lenders to convert their debt into equity should continue as “a necessity in their ordinary course of business”.
Analysing SEBI’s rationale
There are two key takeaways from the March amendment. First, an acquirer subscribing to shares or purchasing shares from lenders, as a part of debt restructuring, must do a mandatory open offer if the takeover code thresholds are met. Second, only SCBs and AIFIs can convert their debt to equity without a mandatory open offer. However, the rationale does not entirely complement the amendment because:
- The apprehension that lenders may not act in the best interest of all stakeholders in a non-IBC restructuring is not completely addressed as conversion of debt into equity is exempt from an open offer. In many cases, this conversion could be at one rupee. Upon conversion, the shareholding of the others (including public shareholders) will be diluted. If the conversion is exempt, then a sale post-conversion ought to be exempt as well.
- The much-awaited Prudential Framework for Resolution of Stressed Assets issued by the RBI on 7 June 2019 provides for checks and balances for resolution plans. The RBI requires that the residual debt has a credit opinion of RP4 (debt facilities that carry moderate credit risk) or better given by an RBI-authorized credit rating agency.
- By limiting the definition of lenders, asset reconstruction companies, lenders for external commercial borrowing, and other secured lenders have been excluded. The rationale that debt conversion may be a “necessity in their ordinary course of business” applies equally to others as well.
- While the IBC process results in an approval from the National Company Law Tribunal (NCLT), the scope of review is limited. The Supreme Court has held that the NCLT cannot make enquiries or issue directions in relation to the commercial wisdom of financial creditors and it cannot scrutinize the justness of their opinions.
- It is possible to delist a company pursuant to the IBC process where the public shareholders may not be better off. If an open offer exemption is not available, lenders may initiate an IBC process even when a debt restructuring may have worked.
Hopefully, following the 7 June RBI circular, SEBI may consider restoring the exemptions from open offer that were earlier available, in the best interest of all stakeholders.
Ambarish is a partner and Mihir Roy is a senior associate at Shardul Amarchand Mangaldas & Co.
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