SEBI pricing norms for merger schemes

By Promode Murugavelu and Karthika Menon, Shardul Amarchand Mangaldas & Co
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Listed companies undertaking schemes for compromises and arrangements have to comply with conditions prescribed by the Securities and Exchange Board of India (SEBI). The framework for this is set out in a circular issued by SEBI on 10 March 2017, as amended from time to time.

Promode Murugavelu Shardul Amarchand Mangaldas & Co
Promode Murugavelu
Shardul Amarchand Mangaldas & Co

Listed companies can issue shares as part of a scheme, as per the exchange/entitlement ratio approved by their board of directors. The board is to approve such a ratio based in part on: (i) the report of the audit committee recommending the scheme; (ii) the valuation report of an independent chartered accountant; and (iii) the fairness opinion of a SEBI-registered merchant banker on the valuation of the listed and unlisted entities. As per the March 2017 circular, a valuation report is only required in cases where there is a “change in the shareholding pattern”, i.e. where there is any change in the proportion of shareholding of any of the existing shareholders of the listed company in the resultant company; any new shareholder being allotted equity shares of the resultant company; or any existing shareholder exiting the company under the scheme.

In light of SEBI’s board decision on 14 January 2017 to revise and streamline the regulatory framework governing schemes, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR), were amended on 15 February 2017 and the pricing formula pertaining to preferential allotment contained in chapter VII of the ICDR has been made applicable to issuance of shares under schemes in case of “allotment of shares only to a select group of shareholders or shareholders of unlisted companies”. As per SEBI’s press release dated 14 January 2017, the decision to make the ICDR pricing formula applicable was to “prevent issue of shares to select group of shareholders instead of all shareholders pursuant to the scheme”. SEBI has specifically included the words “or shareholders of unlisted companies” in the 2017 ICDR amendment.

Karthika Menon, Shardul Amarchand Mangaldas & Co
Karthika Menon
Shardul Amarchand Mangaldas & Co

The rationale for making the ICDR pricing formula applicable where selected promoters/shareholders are allotted shares is clear. Applying this to all allotment of shares to shareholders of an unlisted company, including where the allotment relates to an amalgamation of an unlisted company into and with a listed company, where the unlisted company is a third party entity and the shares are issued by the listed company to all the shareholders of the unlisted company based on the share exchange ratio, is not clear.

SEBI’s recent changes do not take into account, or impact, transactions where the listed company pays consideration in cash or through issue of securities other than shares; a reverse merger where the shares are allotted by the unlisted transferee company to the shareholders of the listed company; or a demerger where the shares are issued by the transferee company to the shareholders of the listed company. A scheme where consideration is made partly in cash or through issue of other instruments, and the rest through issue of shares, purely for commercial reasons and all based on the same valuation, may also have to comply with the ICDR pricing formula. This may hamper the ability and flexibility of listed companies to undertake and structure genuine M&A transactions.

Under regulation 37(2) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, a listed company must obtain an observation letter or no-objection letter from the stock exchanges before it can file a scheme with the National Company Law Tribunal. In the past, SEBI and stock exchanges issued observation letters or no-objection letters only after SEBI was satisfied that the scheme was not against the interest of the public shareholders. In light of this and the need prescribed in the SEBI framework to procure separate public shareholder approval for schemes where any additional shares have been allotted to promoters, promoter groups or other related/interested persons, SEBI could have made the 2017 ICDR amendment applicable only to schemes where the promoters of a listed company or any other group of shareholders get preferential treatment/benefit in a scheme and not to other schemes.

SEBI has been constantly refining the provisions pertaining to schemes undertaken by listed companies. The latest iteration set out in the March 2017 circular addresses several issues faced by listed companies in the past. As highlighted above, some ambiguities have crept in due to the 2017 ICDR amendment. It is hoped that SEBI will iron out these ambiguities soon.

Promode Murugavelu is a partner and Karthika Menon is a senior associate at Shardul Amarchand Mangaldas & Co. The views and opinions expressed are solely those of the authors and do not necessarily reflect the official view or position of the firm.

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