A recent interpretation of the takeover code threatens to rewrite the rules for M&A and add millions of dollars to the cost of Daiichi’s acquisition of Ranbaxy

The Daiichi-Ranbaxy deal is a classic lesson in how apparently minor details can develop into complex and protracted liabilities, sucking up resources and damaging reputations.

When Japanese pharmaceutical company Daiichi Sankyo took over Ranbaxy Laboratories for US$4.6 billion in June 2008 (see India Business Law Journal, July/August 2008), few could have imagined that just 18 months later the matter would be before the Supreme Court – a result of Daiichi’s indirect acquisition of Ranbaxy’s subsidiary Zenotech Laboratories.

The point of contention is an extra US$12.6 million that Daiichi might have to pay to acquire 20% of the public shareholding in Zenotech. The case hinges on the interpretation of the term “persons acting in concert” and the determination of the relevant date from which open offer prices are calculated.

The Securities and Exchange Board of India (SEBI), the Securities Appellate Tribunal (SAT), the Foreign Investment Promotion Board (FIPB), the Company Law Board (CLB) and Chennai High Court have all deliberated on various aspects of the dispute between Daiichi and Ranbaxy on one hand and Jayaram Chigurupati, the promoter, chairman and managing director of Zenotech, on the other. The case now rests before the Supreme Court.

Sowing the seeds

The origins of the saga can be traced back to nine months before the Japanese company entered the scene. Ranbaxy, then an independent pharmaceutical company, was seeking to expand. On 3 October 2007 it acquired a 44.59% stake in Hyderabad-based Zenotech at the price of Rs160 (US$3.40) per share. Of this 27.35% was bought directly from Chigurupati, and the rest through a preferential allotment of 5.5 million fully paid-up shares.

Since Ranbaxy had acquired more than 15% of Zenotech, the deal triggered regulations 10 and 12 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (the takeover code). Ranbaxy was therefore obliged to make a public offer for an additional 20% stake in Zenotech at the same price of Rs160 per share.

This offer remained open for three weeks from 24 December 2007. During this time only 2.2% of the shares were sold to Ranbaxy, taking its shareholding in Zenotech to 46.79%. The tendered shares were accepted and payment for them was made between 16 and 28 January 2008.

Five months later, on 11 June 2008, Daiichi Sankyo executed an agreement with Ranbaxy and its promoter family to acquire all of their shares in the company. A second equity purchase took the form of a preferential share allotment by the company, along with optional warrants representing nearly 10% of the fully diluted share capital.

On 16 June 2008, in accordance with the takeover code, Daiichi made a public announcement of its open offer to acquire an additional 20% stake in Ranbaxy. The offer was completed on 20 October 2008, making Daiichi the owner of 52.5% of Ranbaxy’s equity share capital. Ranbaxy became a subsidiary of Daiichi on that date, and therefore a “person acting in concert” as defined by regulation 2(1)(e)(2)(i) of the takeover code. Daiichi’s present holding in Ranbaxy is 63.92%.

During the hectic days preceding the announcement of the deal and the public offer for Ranbaxy, little was said about Zenotech, the company in which Ranbaxy – and now Daiichi – held a 46.79% stake. However, under the terms of the takeover code, Daiichi’s acquisition of Ranbaxy had once again triggered an obligation for the parent company to make an open offer for at least 20% of Zenotech’s shares.

On 19 January 2009, three months after acquiring Ranbaxy, the Japanese company made the necessary announcement. It offered to buy 20% of the public shareholding in Zenotech at the price of Rs113.32 per share. The timing of the announcement was in line with regulation 14(4) of the takeover code and the price was arrived at on the basis of Daiichi Sankyo’s interpretation of the code.

In its public offer statement, Daiichi contended that the offer price was in line with regulations 20(4) and 20(12) of the takeover code, as it was the highest stock price attained by Zenotech during the 26 weeks prior to the public announcement.

Share price dispute

This price calculation became the bone of contention in the dispute that ensued. Zenotech promoter Chigurupati, together with his wife and a Delaware-based company that they collectively own, still owns a 26% stake in Zenotech. He argued that the offer price should be at least Rs160 per share (38% more than the prevailing market rate in January 2009), the same as that paid by Ranbaxy in January 2008.

When Daiichi announced the open offer for Zenotech, the global financial crisis was at its peak and share prices had collapsed. As a result, the market value-based price that it offered for the shares was comparatively low. In contrast, when the acquisition of Ranbaxy by Daiichi was announced in June 2008, not only was the share market relatively healthy, but Daiichi paid a 31% premium to Ranbaxy’s promoter, Malvinder Singh.

“A rising tide should lift all boats, not just one,” Chigurupati told Business World magazine in January 2009, alleging that Daiichi had promised to buy the rest of his stake at a huge premium but was now refusing to follow through.

Daiichi did not respond publicly to Chigurupati’s allegations, even when on 27 January 2009 he complained to SEBI that the Japanese firm had violated the takeover code and demanded that the open offer be made at the rate of Rs160 per share.

Chigurupati and another minority shareholder also argued before SEBI that the open offer to Zenotech shareholders should have been made simultaneously with the offer made to Ranbaxy shareholders in June 2008. He contended that in not doing so, Daiichi had violated the mandatory provisions of regulation 14(1) of the takeover code.

Rejection on all fronts

SEBI investigated the matter and five months later, on 22 June 2009, ruled in favour of Daiichi. Having postponed the share offer for the duration of the investigation, Daiichi promptly announced July 15 as the new opening date for the public offer.

But Chigurupati, who by this time was presenting himself as a champion of minority shareholders’ rights, was committed to challenging the decision at every possible forum. He filed a writ petition with Madras High Court, which on 14 July issued an interim injunction against the new offer date.

On 9 July Chigurupati approached the CLB to request the removal of two of Zenotech’s independent board members, who had been appointed by Ranbaxy, on grounds of operational mismanagement. At around the same time, he sought the cancellation of the FIPB’s approval – issued a year earlier – for Daiichi to acquire a 20% stake in Zenotech through an open offer. In his application to the FIPB, Chigurupati contended that the approval had been granted without verifying facts and in the absence of a mandatory no-objection letter from “the Indian entity”.

Chigurupati’s complaints were met with rejection on all fronts. The FIPB rejected his appeal, saying that the acquisition approval had been granted to Daiichi after due deliberation. The Madurai bench of Madras High Court also dismissed Chigurupati’s petition and reversed its earlier injunction blocking the public offer. This happened shortly after Daiichi had sought the intervention of the Supreme Court, which overruled the high court and gave the green light for the public offer to go ahead.

As Daiichi tried for a third time to commence its open offer, setting 12 August 2009 as the new date, Chigurupati fired the last arrow in his quiver. On 7 August he appealed to the SAT against SEBI’s ruling of 22 June 2009. On 10 August the tribunal directed both parties to maintain the status quo and postponed the public offer yet again.

Different rules for indirect deals

The SAT’s deliberations took two months and the ruling was delivered on 7 October. Daiichi Sankyo was represented in the case by Iqbal Chagla, Janak Dwarkadas and Rohan Rajadhyaksha. Ranbaxy’s case was presented by HS Mattewal, Anand Pathak and RS Sachdeva. The advocates for Chigurupati were Ravi S and Vinay Chauhan, while SEBI was represented by Kumar Desai and Daya Gupta.

In the judgment, signed by presiding officer justice NK Sodhi and member Samar Ray, the SAT agreed with SEBI that Daiichi was not obliged under regulation 14(1) of the takeover code to make a public offer to Zenotech shareholders at the same time as its offer to Ranbaxy shareholders. Indeed, it stated that Daiichi’s obligation to make a public offer is governed by regulation 14(4) of the code, not regulation 14(1) as Chigurupati had contended.

According to regulation 14(1), “The public announcement … shall be made by the merchant banker not later than four working days of entering into an agreement for acquisition of shares”. In contrast, regulation 14(4) states, “In case of indirect acquisition or change in control, a public announcement shall be made by the acquirer within three months of consummation of such acquisition.”

In support of this part of its decision, the SAT quoted its 2006 ruling on the case of Hardly Oil v Securities and Exchange Board of India: “If we read regulation 14(1) in isolation it would cover both direct as well as indirect acquisition but when this clause is read along with the clause (4) thereof it leaves no room for doubt that regulation 14(1) deals only with direct acquisition and regulation 14(4) deals with all indirect acquisitions.”

Unexpected twist

Despite agreeing with SEBI on the timing of the open offer, the SAT’s ruling had a nasty sting in its tail for Daiichi. To the surprise of many, it directed Daiichi to make an open offer for Zenotech at the price of Rs160 per share. The target company’s share price jumped 20% on the day the ruling was announced, closing at Rs125.90.

The rising cost of healthcare: Daiichi may need to spend an extra US$12.6 million on its purchase of Ranbaxy.
The rising cost of healthcare: Daiichi may need to spend an extra US$12.6 million on its purchase of Ranbaxy.

The decision was based on an interpretation of SEBI’s rules for calculating open offer prices. The rules state that the price should be the highest of: (i) the negotiated price between the acquirer and target, (ii) the price that the acquirer paid for any shares in the target in the 26-week period leading up to the date of the public announcement of the open offer, or (iii) the highest stock price, or two-week average, attained by the target’s shares in the 26-week period prior to the announcement of the open offer.

However, for indirect acquisitions there are two open offers, one for the parent and a second for the subsidiary, and therefore two different dates on which these calculations can be based. This effectively puts six potential prices into play.

In the Daiichi-Ranbaxy-Zenotech case, the dates on which the two open offers were announced were 16 June 2008 and 19 January 2009 respectively. The SAT stated that according to regulation 20(4) of the takeover code, the offer price should be calculated with SEBI’s valuation rules using each of these dates as a reference point. The highest of the two figures should be the offer price.

But the story doesn’t end there. Regulation 20(4)(b)specifies that in determining the price for the acquisition of shares of the target company, the 26-week period prior to the date of the public announcement applies not only to the acquirer but also to “persons acting in concert with him”. Daiichi had contended that on 16 June 2008, Ranbaxy was not acting in concert with it. Ranbaxy was a seller, and based on long-standing practice a seller can never be a “person acting in concert” with a buyer.

Daiichi therefore believed that the price paid by Ranbaxy in its January 2008 open offer for Zenotech shares was of no consequence and that regulation 20(4)(b) did not apply in this case.

However, the SAT ruled that whether or not Daiichi and Ranbaxy were acting in concert on 16 June 2008 was irrelevant. The important point, it said, was that they were acting in concert on 19 January 2009, which the SAT had already deemed a relevant date for the calculation of the open offer price.

In the most crucial and contentious part of its decision, the SAT said: “While determining the price on 19 January 2009, regulation 20 requires Daiichi to find out whether it, or any person acting in concert with it on that date, had paid any price for acquisition to the shareholders of the target company during the 26-week period prior to 16 June 2008” (the date of Daiichi’s announcement of its public offer for Ranbaxy). Calculated in this way, Daiichi is obliged to pay the same price per share in its open offer for Zenotech as that paid by Ranbaxy in its original open offer, which was concluded in January 2008.

Future implications

In announcing its decision the SAT stated: “The intention of the framers of the takeover code is clear that while giving an exit option to the shareholders of the target company, they have to be given the highest price worked out on the basis of different parameters referred to in regulation 20.”

Clearly taken aback by the judgment, Daiichi’s legal team successfully applied to the Supreme Court on 9 November for a stay on the tribunal’s order. While the Supreme Court reviews the case, tensions at Daiichi are running high. If the company fails to obtain a favourable verdict it will have to pay a great deal more than the additional cost of the shares alone. The interest rate charged by SEBI for an incorrect open offer price ranges from 6-10% per year.

The SAT’s interpretation effectively extends the 26-week period used for calculating the open offer price to nearly a year. If not reversed by the Supreme Court it will have a significant impact on the future of indirect acquisitions in India.