TRAC recommendations are finally on track

By Arindam Ghosh and Moin Ladha, Khaitan & Co
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The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, have been the single-most important regulations for listed companies in India.

While they have served the capital market well, they have been plagued by ambiguities and drafting lacunae. In response, SEBI has acted proactively and made certain amendments and provided key clarifications to various facets of these regulations, which are known as the Takeover Code.

Moving with the times

As a sequel to these amendments, on 4 September 2009 SEBI constituted the Takeover Regulations Advisory Committee (TRAC) to review the Takeover Code and recommend amendments. Subsequently in July 2010, TRAC submitted an entire new scheme of the regulations, in a bid to make them commensurate with India’s position as the fourth largest economy in the world, in terms of purchasing power parity.

Arindam Ghosh Partner Khaitan & Co
Arindam Ghosh
Partner
Khaitan & Co

Almost a year after its publication SEBI has now approved certain recommendations of the TRAC and a new code is being drafted. SEBI’s decisions taken at a board meeting on 28 July have also brought the takeover trigger threshold back to what it was before 1990, when attempts at regulating takeovers were made by incorporating clause 40 in the listing agreement.

Initially the clause provided for making a public offer to the shareholders of a company by any person who sought to acquire 25% or more of the voting rights in the company. The threshold was later lowered to 10% and then increased to 15% where it settled for over a decade only to be increased once again to 25% as per SEBI’s recent decision.

Strategic changes

Moving the threshold from 15% to 25% will be welcome, as it will enable strategic investors to raise their stake. It will also give promoters more room to raise additional capital required for growth and further expansion by attracting strategic investors.

The mandatory offer size has been increased to 26% from the current level of 20%, as against 100% of the remaining public shareholding originally suggested by the TRAC. The original proposal was strongly opposed by industry as it would have adversely affected proposed acquisitions by Indian residents as acquisition finance would have been scarce.

While moving the mandatory offer size to 26% will raise the cost marginally it is not expected to hinder such transactions. Further, under the new code any takeover offer will potentially lead to the acquirer getting a more than 51% shareholding (assuming the open offer is fully accepted by the public shareholders).

One issue that may arise will be in relation to promoters or investors who might be in the 15-25% range. Under the old thresholds they could have crept up all the way to 55% without triggering an open offer, but now if their acquisition is about to cross 25%, they will have to consider an open offer or a specific exemption.

Moin Ladha Associate Khaitan & Co
Moin Ladha
Associate
Khaitan & Co

At odds with reality

The non-compete fee in the current regulations has always been a contentious issue. However, the new code does not contemplate an exemption for payment of non-compete fee to promoters and requires parity in the exit price offered to the promoters and public shareholders. This suggests, SEBI has failed to differentiate between promoters, who participate in the day-to-day operation and management of a company, and other investors. Given that Indian companies are strongly promoter driven, when promoters exit the company they can be a serious threat to the interests of new acquirers and the target company. In such circumstances, a non-compete payment over and above the purchase price is commercially viable.

While the inclusion of non-compete fee to the offer price aims to make the process simpler, precise, more expensive but unambiguous, it also aims to balance the interests of the shareholders, promoters, acquirers and the target company. To sum up, given the pros and cons it would have been in the interest of all to retain the existing non-compete related provisions with stricter norms to avoid misuse.

Other possible changes

The new code will also include specific provisions in relation to voluntary offers, mandatory requirements for recommendations on the offer by the board of target company and on allowing the successful bidder in a competitive offer to acquire shares of other bidders after the offer period without attracting open offer obligations. However, the analysis of these changes will only be possible once these are embodied in form of a regulation.

SEBI has attempted to protect the interest of all parties concerned while approving the recommendations. However, the actual impact can be ascertained only after the regulations are made effective.

Arindam Ghosh is a partner at Khaitan & Co in Mumbai where Moin Ladha is an associate. Khaitan & Co is a full-service law firm with offices in Bangalore, Kolkata, Mumbai and New Delhi.

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