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Anomalies in Consolidation of Holdings - Regulation 11 of the Takeover Code

This article deals with certain anomalies with respect to the consolidation of holdings
and public announcements in the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997.  Regulation 11 of these Regulations deals with the
consolidation of holdings and outlines the requisite thresholds for making a public
announcement. Public announcements are considered essential for safeguarding the interests of the shareholders. This article takes a look at the existing regime outlined for consolidation of holdings and highlights some of the anomalies and ambiguities existing in the present legal set-up like applicability of second proviso of Regulation 11(2) to Regulation 11(1), increase in shareholding owing to a buy-back of shares and the timeframe for consolidation of holdings. In light of the potential overhaul of the takeover regulations in India, it is important that the existing confusions are brought to light and done away with.

 

I. Introduction:

 

The Securities and Exchange Board of India (“SEBI”) is the market regulator of india and has the function of overseeing the function of regulating substantial acquisition of shares and take over of companies by virtue of Section 11(2)(h) of the Securities and Exchange Board of India, 1992 (“SEBI Act”).[1] In fact, it was only in November 1994, after the coming into force of the SEBI Act, that the SEBI Regulations for Substantial Acquisition of Shares and Takeovers were notified.

 

Although the 1994 Regulations were a step in the right direction, they contained certain deficiencies which required to be addressed.[2] Consequently, in November 1995, a Committee was set up by the Securities and Exchange Board of India (“SEBI”) which was headed by Hon’ble Justice P. N. Bhagwati, Former Chief Justice of India. The Committee was set up with the objective of reviewing the deficiencies of the existing Regulations and to suggest amendments for strengthening the regulatory framework, to make it fair, transparent, unambiguous and equitable to all parties involved in the acquisition process.[3] Subsequent to the recommendations of the Committee, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (hereinafter referred to as the “the Takeover Code”) was notified.

 

This paper deals primarily with Regulation 11 of the Takeover Code. The paper seeks to discuss certain “anomalies” which arise in course of operation of the said Regulation 11, especially with respect to the requirement of making a public announcement upon crossing of threshold fixed by The Takeover Code in acquisition of shares or voting rights of public company limited by shares and which is listed on recognized stock exchanges of India.

 

II. Regulation 11 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 1997:

 

Regulation 11 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“the Takeover Code”) deals with the consolidation of holdings. The Regulation is applicable to acquirers who, either by themselves, or together with their persons acting in concert (“PAC”)[4], hold at least 15% but less than 55%[5] of the total shareholding (“shares”) or voting rights in the target company[6]. By operation of this provision, an acquirer[7] is required to make an open offer[8] if he acquires more than 5% of the target company’s shareholding or voting rights in one financial year.

 

The Honourable Supreme Court of India has held in the case of Swedish Match v. SEBI[9] that the following pre-conditions need to be fulfilled before Regulation 11(1) could be attracted:

i.                    an acquirer had acquired shares in concert with another’

ii.                  such acquisition was more than 15% but less than 55% of the shares or voting rights in a company’

iii.                in the event the acquirer intends to acquire such additional shares or voting rights which would allow him to exercise more than 5% of the voting rights within a period of 12 months, public announcement is required to be made thereof; and

iv.                Such acquisition of additional shares contemplates three different situations, i.e. the acquisition may be by the acquirer himself or with the person acting in concert with the person with whom they had acquired shares earlier in concert with each other.

 

In the case of Eider E-Commerce Ltd. v. SEBI[10], SAT had opined by way of an obiter dicta that a person who was holding 54% could acquire only 1% under Regulation 11(1) and not 5%. This meant that the threshold of 55% prescribed in Regulation 11(1) could not be breached through the creeping acquisition route. Thereafter, in September 2009, Regulation 11(1) was amended.[11] This amendment provided that under Regulation 11(1), the post-acquisition holding or voting rights (of the acquirer and the PACs) could not exceed 55%[12] of the total shares or voting rights in the target company. However, SEBI has clarified that that once the 55% limit under Regulation 11(1) is exhausted, the acquirer can consolidate his shareholding or voting rights by additional/further acquisition up to 5%, as provided under the second proviso of Regulation 11(2). [13]

 

Such an embargo against exceeding the 55% limit prescribed in Regulation 11(1) is for the benefit of the existing shareholders, by prescribing a limit on the consolidation of holdings each financial year. It is in the larger interest of the public that any acquisition be limited and not allowed to proceed beyond certain limits without public knowledge. The existing shareholders should have adequate information available so as to exercise the option of exiting from the membership of the company if they so choose to.

 

III. Public Announcement:

 

Public announcement is triggered in various circumstances under the takeover code. It involves a minimum acquisition of 20% shares from public. Regulation 11(1) imposes the requirement of a mandatory public announcement in case an acquirer (either by himself or  through PACs) decides to obtain additional shares or voting rights in excess of 5% in a single financial year. The requirement of a public announcement implies that the acquirer would have to disclose his intention to acquire shares of the target company, from the existing shareholders of the target company, by way of an open offer. Such a declaration of intention is done generally by giving a notice in the newspapers. The basic objective of making a public offer is that the existing shareholders of the company are made aware of the potential acquisition of the target company and that they have the option to exit in case they so desire.[14] Details, purpose, future course and procedure of acquisition are some of the details which a public announcement is required to contain, along with the offer price, number of shares to be acquired from the public. [15]

 

Regulation 14 of the Takeover Code prescribes that the public announcement is to be made through a merchant banker. As soon as an acquirer enters into an agreement to acquire shares or decides to acquire shares or voting rights of a target company (or after any such changes which would result in the change in control of the target), the acquirer is required to make a public announcement within four working days[16] from the date of entering into the agreement with the Merchant Banker.[17]

 

IV. Regulation 11(2):

 

Regulation 11(2) of the Takeover Code is applicable to an acquirer who, either individually or together with his PACs already holds at least 55% of the target’s shares or voting rights but less than 75% of the same (or 90%[18], as the case may be). The said provision puts a restriction on such acquirers to acquire additional shares unless a public announcement is made. For an acquirer falling within the scope of Regulation 11(2), a public announcement is the only mode of acquiring any additional or further shares. This strict prohibition was for the welfare of the general public because an acquirer already holding a majority stake in the company would be inching closer to a special majority with every acquisition.

 

This prohibition was bypassed, by way of an amendment, at the time of economic slowdown in 2008. By virtue of an amendment dated October 30, 2008, a second proviso was added to Regulation 11(2)[19], which provides that an acquirer can acquire additional shares or voting rights (either by himself or by way of PACs with him) entitling him up to 5% additional voting rights in the target company without “the need of making a public announcement” subject to following conditions:

i.                    If the acquisition is made by open market purchase in normal segment on the stock exchange or by way of an increase in the shareholding or voting rights of the acquirer due to buy-back of shares of the target company;

ii.                  The shareholding of the acquirer post acquisition does not exceed 75%.

 

This amendment was perceived to be a reaction to the global financial crisis of 2008.The reason for providing the option of purchase of shares from the “normal segment” of stock exchange was to prevent irrational movements of stock prices[20], save the share prices from plummeting and causing monetary losses to shareholders. Furthermore, this amendment was envisaged to serve as a check against price manipulation since the amendment would result in a restriction against consolidation through bulk, block, negotiated deal or preferential allotments.[21]

 

However, confusion still prevailed on the question whether the second proviso of Regulation 11(2) was applicable to Regulation 11(1). This confusion was settled by the SEBI (Acquisition of Shares and Takeovers) (Third Amendment) Regulations, 2009 which inserted the words “notwithstanding the acquisition made under Regulation 10 or sub-Regulation (1) of Regulation 11” in the second proviso of Regulation 11(2). Insertion of the non-obstante clause would have the effect that irrespective of an acquisition under Regulation 10 or 11, the acquirer has further scope to consolidate his holdings by fulfilling the requirements laid down by the second proviso. However, anomalies might result due this amendment, and might increase the chances of circumventing the public announcement requirements, especially under Regulation 11(1). This has been explained in the following paragraphs.

 

V. Application of Second Proviso to Regulation 11(1) and the Potential Situations of Bypassing Regulation 11(1):

 

A situation may arise where an acquirer already has a shareholding of 50% and he seeks to consolidate his shareholding by 10% additional shares. As per Regulation 11(1), he can acquire 5% shares without making a public announcement. Thereafter, he would reach the threshold of 55%, which should have been the maximum acquisition allowed in a single financial year[22] as Regulation 11(1) lays down that any acquisition under 11(1) can not breach the threshold limit of 55% in the same financial year. However, this acquisition under Regulation 11(1) triggers the non-obstante clause of the second proviso.[23] Therefore, the second proviso to Regulation 11(2) becomes applicable to Regulation 11(1) as well, and this implies that the mode of acquiring which the second proviso provides, could also be employed in case of acquisition governed by sub-Regulation (1). In the example cited above, after reaching the limit of 55%, the acquirer can go ahead to acquire an additional 5% as per the route provided in the second proviso. This would result in his total shareholding at 60%, clearly bypassing the limit of 55% set by the Regulation 11(1). In other words we can say that the second proviso has increased the threshold limit for making public announcement from 55% to 60% in appropriate cases under Regulation 11, enabling an acquirer to increase his shareholding up to 60% without being required to make a public announcement. This leads to an anomalous situation as Regulation 11(1) makes a public announcement mandatory the moment acquisition crosses the maximum limit of 55% in a single financial year

 

VI. Applicability of a time frame in the Second Proviso to Regulation 11(2):

 

Another ambiguity arises by the fact that although Regulation 11(1) limits the further acquisition to 5% without public announcement in a financial year ending on March 31[24], the second proviso imposes no such time limit to calculate the consolidated holdings. As per a clarification issued by the SEBI[25], the relaxation under the second proviso is available to an acquirer covered by Regulation 11(2). The additional 5% may be acquired in one or more tranches and such an acquisition is not qualified by a time frame i.e. the said acquisition will not be hit by a restriction that it should be covered within a specified time period. However, the aggregate holding of the acquirer along with the persons acting in concert with him should not exceed 75%. 

 

Moreover, in the same clarification[26], SEBI has explained that the calculation of the 5% acquisition is to be calculated by aggregating all purchases without netting the aggregate sales. In the case of Kosha Investments Ltd. v. SEBI[27], SEBI contended that it would not net off the sales made by an acquirer during a financial year so that if on a gross basis, the acquirer’s purchases of shares in the year exceeded 5%, he would be considered as having triggered an open offer. This contention was claimed to have its backing in the Bhagwati Committee Report. In the Second Bhagwati Committee Report[28], it had been put forth that the percentage level referred to should be computed on a gross purchase basis at any point of time to decide whether the Regulations are attracted. However, in the Kosha Investments case, it was concluded that even after netting the shares sold by the acquirer, it had acquired more than 5% in the same financial year.

 

VII. Anomalous Situations Arising in Case of a Buy-back of Shares:

 

A buy-back of shares under Section 77A of the Companies Act, 1956 may result in the increase of the shareholding of a promoter. In fact, the second proviso to Regulation 11(2), which came into force from October 30, 2008, gives an exemption to an acquirer from the obligation of making an open offer in case the shareholding or voting rights of the acquirer increase beyond 5% pursuant to a buy-back of shares by the target company.[29]

 

SEBI has considered the issue in the recent orders related to OCL India Limited[30] and Ajanta Pharma Limited[31]. The orders have addressed the situation where the provisions of the Takeover Code were inadvertently triggered owing to a buyback of shares by a listed company resulting in an increase in the shareholding or voting rights in the company.

 

In the OCL Case[32], the failure to make an open offer and the absence of an exemption application was held to be a violation of Regulation 11(1) of the Takeover Code. It was held that the acquisition of shares was not necessary to trigger off the requirement to make an open offer and that the mode of exceeding the thresholds given in the Takeover Code was not even relevant.[33] Furthermore, SEBI observed that an exemption in cases like the present one, where the buy-back resulted in the increase in shareholding or voting rights, was based on the discretion of SEBI and would be analyzed on a case-to-case basis.

 

In another order related to Ajanta Pharma Ltd.[34], the acquirers (belonging to the promoter group) had filed an application seeking exemption for a proposed a buyback of shares, which would result in an increase in the shareholding by 7.10% and trigger off the requirement of making an open offer under Regulation 11(2) of the Takeover Code.[35]. The acquirers were eligible to acquire up to 5% without a public announcement and SEBI had clarified earlier that the aforesaid 5% limit could be availed in one or more tranches, without any restriction on the time frame of acquisition[36]. Therefore, SEBI held that exemption was required for the remainder 2.10% only.[37] Exemption was granted to the acquirer after imposition of certain conditions like compliance with statements/disclosures/undertaking and ensuring adherence to all the applicable laws.

 

VIII. Conclusion:

 

In September 2009, a Committee was set up by SEBI to review the Takeover Code in its existing form and recommend changes. This Committee was spearheaded by C. Achuthan, former presiding officer of the Securities Appellate Tribunal. The Committee has recommended the increase in the threshold limit from 15% to 25%, along with increasing the size of the mandatory offer in the event of crossing the threshold from 20% to 100%. The suggested measures are perceived to be friendly to the promoters and have been made after perusing the norms prevalent in different countries the world over. Also, the requirement of an open offer for the entire 100% in the target in case the holding of an acquirer crosses 25% would provide an exit option to all shareholders, irrespective of the size of the shareholding, which is intended to ensure equality of opportunity and fair treatment of all shareholders. However, there are concerns that potential domestic acquirers may not be able to fund the increased cost of acquisition subsequent to the recommendations, and the same would result in an edge to potential foreign acquirers. There are also recommendations to disallow buy back of shares by the promoters in case it breaches the threshold limit. This measure would mean that a promoter cannot use buy back as a defence against hostile takeovers. 

 



[1] Also, as per Section 12A(f) of the SEBI Act, no person shall directly or indirectly, “acquire control of any company or securities more than the percentage of equity share capital of a company whose securities are listed or proposed to be listed on a recognised stock exchange in contravention of the Regulations made under this Act.

 

[2] Justice P. N. Bhagwati Committee Report on Takeovers, (Securities and Exchange Board of India, 1997)

[For instance, the provisions related to the open market acquisition of shares, competitive bid and revised offer in the 1994 Regulations allowed hostile takeovers and competitive offers to be launched. This displayed the inadequacies of the existing regulatory mechanism and the same required to be addressed in order to make the framework more comprehensive and equitable in nature.]

 

[3] Ibid

[4] Regulation 2(1)(e) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations defines the term “Persons acting in Concert” (PAC). The term has been defined to comprise of persons who co-operate with each other for the purpose of acquiring or agreeing to acquire shares or voting rights or control in the target company. The cooperation with the acquirer may be direct or indirect.

 

[5] The SEBI (Substantial Acquisition of Shares and Takeovers) (Amendment) Regulations, 2005, w. e. f. 3-1-2005 replaced 75% by introducing the upper limit of 55%.

 

[6] Regulation 2(o) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations: “target company” means a listed company whose shares or voting rights or control is directly or indirectly acquired or is being acquired.

 

[7] Regulation 2(1)(b) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997: “acquirer” means any person who, directly or indirectly, acquires or agrees to acquire shares or voting rights in the target company, or acquires or agrees to acquire control over the target company, either by  himself or with any person acting in concert with the acquirer;

 

[8] The term ‘open offer’ refers to an offer in which the bidder makes its intention known through an open advertisement, followed by letters of offer to shareholders, to buy the shares of the target company at a stated price.

 

Regulations 10, 11 and 12 of the Takeover Code oblige the acquirer to make an open offer whenever he breaches the thresholds or shareholding or from acquiring control. Regulation 22(1) of the Takeover Code effectively prohibits an acquirer from breaching those thresholds and from acquiring control unless he is able to implement the offer. Cited from Shishir Jose Vayttaden, SEBI’s Takeover Regulations, (LexisNexis Butterworths Wadhwa Nagpur, New Delhi, 1st edn., 2010), p. 263

 

[9] (2004) 11 SCC 641

 

[10] SAT Order dated 20 August, 2008, Appeal No. 176/2007

 

[11] The SEBI (Substantial Acquisition of Shares and Takeovers) (Third Amendment) Regulations, 2009, w.e.f. 6-11-2009

 

[12] Ibid; The following words were added in Regulation 11(1) “with post acquisition shareholding or voting rights not exceeding fifty five per cent”.

 

Prior to the amendment, an acquirer could acquire less than the aforesaid 5% shares every financial year and avoid the obligation of a public announcement. In this manner, the acquirer could potentially keep increasing his stake each fiscal year and even cross the 55% mark as no limit had been laid down. [Cited from Tanya Mehta, Plugging loopholes in the Takeover Code: An Analysis of the Recent Amendments, E-Newsline December 2009]

 

[13] PR No.300/2009, dated September 22, 2009

 

[14] A Reference Guide for Investors on Substantial Acquisition of Shares and Takeovers, Securities and Exchange Board of India, available at http://investor.sebi.gov.in/Reference%20Material/Guide-Substantial-E.pdf <Last visited on September 1, 2010>

 

[15] Ibid

 

[16] As per Regulation 14(1) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997

 

[17] As per Regulation 14, it is to be noted that in case of an acquisition under Regulation 11, if the acquirer is acquiring shares which, along with voting rights already held by the acquirer or PACs, exceed the limit prescribed under the Regulation, then such acquirer is required to make a public announcement not later than four working days before acquiring voting rights on such securities upon conversion, or exercise of option.

 

[18] As per Proviso 1 to Regulation 11(2) of the Takeover Code, for such target companies which have obtained a listing of their shares by making an offer of at least 10% of issue size (as per S. 19(2)(b) of the Securities Contract (Regulation) Rules, 1957), the outer limit for the purpose of this Regulation is 90% instead of 75%.

 

[19] SEBI (Substantial Acquisition of Shares and Takeovers)(Amendment) Regulations, 2008 dated 30 October 2008 to give effect to the Press Release dated 27 October 2008 to amend SEBI Takeover Code

 

[20] Preeti S. Manerkar, “Corporate Governance: Modest Progress In India”, Standard and Poor’s Country Governance Study, March 2009, p. 3, Available at: http://www2.standardandpoors.com/spf/pdf/equity/India_Corp_Gov.pdf <Last visited on September 1, 2010>

 

[21] Sachin Khedekar, “Creeping acquisition: Cushioning the fall or a slow squeeze?”, Capital Market, Vol. XXIII/23, Jan 12-25, 2009, pp. 10-14, at p. 10

[22] The SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2002, w.e.f. 9-9-2002

 

[23] Inserted by the SEBI (Substantial Acquisition of Shares and Takeovers) (Third Amendment) Regulations, 2009, w.e.f. 6-11-2009

 

[24] By virtue of the SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2002, w.e.f. 9-9-2002

 

[25] Vide SEBI Circular, CFD/DCR/TO/Cir-01/2009/06/08, dated August 6, 2009

 

[26] Ibid

 

[27] SAT Order dated August 8, 2005, Appeal No. 64/2004

 

[28] Securities and Exchange Board of India, Report of the Reconvened Committee on Substantial Acquisition of Shares and Takeovers under the Chairmanship of Justice P. N. Bhagwati, May 2002, p. 26

 

[29] Earlier, for any increase in the holding of promoters owing to buyback, exemption under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations was necessary. It has now been decided to automatically exempt increase or consolidation up to 5% per annum as a result of buyback by the company. Cited from Sachin Khedekar, “Creeping acquisition: Cushioning the fall or a slow squeeze?”, Capital Market, Vol. XXIII/23, Jan 12-25, 2009, pp. 10-14, at p. 10

 

[30] Order of SEBI dated January 28, 2010, Available at: http://www.sebi.gov.in/cmorder/ocl.pdf, <Last visited on September 1, 2010>

 

[31] Order of SEBI dated January 29, 2010, Available at: http://www.sebi.gov.in/cmorder/ajpharma.pdf <Last visited on September 1, 2010>

 

[32] SEBI had to analyze the effect of a buy-back which had resulted in the inadvertent increase in the voting rights of the promoters from 62.56% to 75%, which effectively triggered off the requirement of making an open offer under Regulation 11(1) of the Takeover Code, as it was then. (In 2003, Regulation 11(1) allowed an acquirer who was holding between 15% and 75% of shares or voting rights to increase his shareholding or voting rights by 5% in one financial year without triggering off the requirement of an open offer.) Cited from Order of SEBI dated January 28, 2010, Available at: http://www.sebi.gov.in/cmorder/ocl.pdf <Last visited on September 1, 2010>

 

[33] Citing the decision of the Securities Appellate Tribunal (SAT) in the case of Shri. Kiron Margadasi Financiers v. Adjudicating Officer, SEBI, Appeal No. 21/2001, where it was held “it is not the manner in which the shares are acquired. It is the effect that triggers action. If the acquisition has no impact on the voting rights, Regulation is not attracted”

 

[34] Order of SEBI dated January 29, 2010, Available at: http://www.sebi.gov.in/cmorder/ajpharma.pdf <Last visited on September 1, 2010>

 

[35] The proposed buy-back would have had the effect of increasing the shareholding of the promoters from 66.82% to 73.92%.

 

[36] Vide SEBI Circular, CFD/DCR/TO/Cir-01/2009/06/08, dated August 6, 2009

 

[37] Para 4.3 of the Order of the SEBI dated January 29, 2010