The Economic Times examines
a recent trend whereby companies have preferred asset sales or business sales (also known as “slump sales”, an expression that bears uniqueness to India, as I am yet to come across that expression elsewhere) over takeovers thereby shortchanging minority shareholders of the seller companies. The argument goes: by structuring the deal as a business sale, all that is required is an ordinary resolution of the shareholders, which is not difficult to muster where promoter shareholding is significant; moreover, minority shareholders are deprived of the exit option otherwise available under the takeover regulations. While that is certainly understandable, and I am myself fairly sympathetic to that line of argument, this is a function of the manner in which M&A transactions are subject to regulation.
While teaching M&A, one of the aspects I stress is that parties are usually able to structure transactions in different ways to achieve similar commercial goals (or end-games). However, it is often the case that regulations are structured to address the means rather than the end. That provides sufficient leeway to parties and their advisors to structure deals in a manner that is least susceptible to shareholder veto or that provides minimal protection to minority shareholders (in that it does not enable them to participate in the benefits of the deal on par with promoters or management).
To illustrate, a typical M&A deal involving a public listed company can structured either as a sale of business or slump sale (regulated principally by contract), a scheme of arrangement (governed by sections 391-394 of the Companies Act, 1956) or a takeover (regulated by SEBI through the takeover regulations). Although it is not possible to use any scientific metric or parameter that indicates whether one type of structure is optimal to minority shareholders as opposed to others, some qualitative assessments can certainly be attempted, as follows:
1. A business sale is perhaps least effective for minority shareholders, as a simple majority of shareholders can approve the transaction. Since the voting requirement is a majority of “those present and voting”, it is not even necessary that the controlling shareholders hold more than 50% shares, or sometimes even anywhere close to that, in the company to exercise effective control.
2. A scheme of arrangement provides greater protection to minority shareholders. For example, there is a requirement for approval by “classes of shareholders”, which makes the classification exercise quite crucial. The required threshold for shareholder approval is also higher: majority in number holding 3/4th in value of shares. More importantly, the scheme and the process are subjected to close scrutiny by courts. Nevertheless, one downside of the scheme from the minority perspective is that, once approved, it is binding even on dissentient shareholders. There is no exit route, as Indian corporate law does not provide for automatic appraisal rights (in the form of buyout of dissenting shareholders) as does exist in jurisdictions such as the US (Delaware) and New Zealand. In theory, an Indian court can order a buyout of dissenting shareholders under section 394(1)(v) of the Companies Act, but I am not aware of such discretion having been exercised in practice, at least not in any of the high-profile schemes of arrangement.
3. The most significant right that a takeover provides is the option to minority shareholders to exit on same terms as controlling shareholders or promoters. In the Indian context, however, this right may be somewhat diluted because the acquirer only needs to accept a minimum of 26% shares from public shareholders. In any event, the takeover regulations are structured primarily with a view to protecting the interest of minority shareholder through the exit and other rights.
Given the current state of regulation, the choice of structure is left to the companies, their management and promoters. Courts and regulators usually tend not to disturb the choice, except in extreme circumstances. This concern also appears to be somewhat universal. For example, even in the US context, there has been a history of companies using business sales and asset sales in order to achieve the same result as a statutory merger (or amalgamation as we understand) without providing shareholders either approval rights or appraisal rights or both. More often than not, courts have accepted the structures and denied the arguments of minority shareholders to treat the transactions as de facto mergers (that would have provided minority shareholders the same rights as in a statutory merger). The other example is the use of statutory merger or amalgamation structures to squeeze out minority shareholders, where the US (Delaware) courts have been more sympathetic to the concerns of minority shareholders than courts in the Commonwealth (in countries such as India, UK and Singapore). We have had occasion to discuss the squeeze outs issue in the past.
Coincidentally, I just read an extremely insightful paper that compares minority shareholder rights under a scheme of arrangement and a takeover: Jennifer Payne, “Schemes of Arrangement, Takeovers and Minority Shareholder Protection”, 11 Journal of Corporate Law Studies 67 (2011) (an earlier version of the paper is available on SSRN). The paper seeks to address issues of the kind discussed in this post, although the author concludes that the different levels of protection available to minority shareholders are justified because the purpose of minority protection is different under the two structures.