Mandatory Offers and Creeping Acquisitions

The Securities
and Exchange Board of India (SEBI) passed an order
under the SEBI Takeover Regulations of 1997 (that existed prior to October
2011) in relation to the shares of Khaitan Electricals Limited (the Target
Company). In this order, the SEBI whole time member directed the promoters of
the company to make an open offer to the other shareholders on account of
certain acquisitions of shares by them in 2006-2007. Along with the open offer
consideration, the promoters have been directed to pay interest at the rate of
10% per annum from June 16, 2007 to the date of payment of the consideration.
The key facts of
the case are summarized in the gist of the show cause notices issued by SEBI to
the relevant promoters of the Target Company:

consequent to the acquisition of shares [by the promoters] on March 12, 2007,
there was increase in their pre-acquisition shareholding (as on March 11, 2007)
of –
[Khaitan Lefin Limited (KLL), one of the promoters], individually, from
10,73,415 shares (10.52%) to 19,73,415 shares (17.16%) in the Target Company
and KLL failed to make a public announcement to acquire shares in accordance
with provisions of regulation 10 read with regulation 14(1) of the Takeover
Regulations, 1997 within 4 working days from March 12, 2007;
(b) The
promoter group, collectively, from 26,34,639 shares (25.83%) to 39,34,639
shares (34.21%) and the acquirers collectively failed to make a public
announcement in accordance with the provisions of regulation 11(1) read with
regulation 14(1) of the Takeover Regulations, 1997 within 4 working days from
March 12, 2007.
Given these
facts, two primary legal issues arose for consideration.
First, whether an acquisition by a single promoter of more than
15% shares will trigger an open offer requirement under Reg. 10 although the
promoter group as a whole already held more than 15%. In other words, whether
can be independent obligations under Reg. 10 (for individually crossing the 15%
threshold) and under Reg. 11(1) (for collectively activating the creeping
acquisition trigger of 5% additional shares) in respect of the same set of
Second, in the case of a creeping acquisition, what is the precise
timing to be considered for the acquisition of 5% additional shares?
Specifically, whether a dilution of shares during the period ought to be taken
into account or netted off while considering the 5% limit.
The SEBI order
holds against the promoters on both the issues, thereby mandating them to make
an open offer.
On the first
issue, the SEBI order reasons as follows:
Thus, the obligation to make public announcement under regulation 10 gets
triggered when the acquisition of the acquirer, individually or collectively
alongwith persons acting in concert with him, would cross the threshold limit
of 15%. Thus, if individual acquisition of any person in a group (acting in
concert) breaches the threshold limit of 15%, such acquirer is under obligation
to make public announcement under regulation 10. In my view, there is no
ambiguity in the language of regulation 10 with regard to the obligation of an
acquirer whose acquisition increases his individual shareholding beyond
threshold limit of 15% and no other interpretation can be given to it. …
… The intent and object behind the obligation with regard to public
announcement under regulation 10, 11 and 12 is common. Regulation 10 does not
exempt an acquirer from this obligation when he individually breaches the
threshold of regulation 10 but his shareholding collectively with persons
acting in concert with him is beyond the threshold prior to his individual
acquisition as sought to be contended by the noticees. In my view, therefore,
no interpretation can be taken in violation of the language of the regulations
or to defeat the intent and object thereof.
On the second
issue, the promoters argued that the amount of increase in the shareholding due
to creeping acquisition must be computed as of the last date of the financial
year, i.e. March 31, and that intermediate divestments and dilution must be
netted off. This argument was not accepted by SEBI, which adopted the following
… If the argument of the noticees is accepted, an acquirer may acquire any
percentage of shares in a financial year and by the end of that financial year
he may reduce it to 5% by sale of holding or otherwise. This is not the
intention of the regulation which, since inception, had put a limit on
percentage of creeping acquisition and did not allow netting of acquisition and
disinvestment for determining the percentage of increase. …
I, therefore, am of the view that for the purpose of availing creeping benefit
under regulation 11(1), the gross acquisition of the acquirer should not be
more 5% in a financial year that starts on April 1st and ends on March 31st.
Further, if at any point of time, in that financial year, the acquisition
breaches the threshold of 5% creeping acquisition, the obligation to make
public announcement is triggered at that time itself. Regulation 11(1) does not
allow an acquirer to wait till end of the financial year after such breach.
In my view, from the definition of the word ‘acquirer’ under regulation 2(1)(b)
and the provisions of regulation 11 of the Takeover Regulations, 1997 it is
clear that the obligation to make public announcement is triggered on the date
of agreement to acquire or acquisition of shares or voting rights, as the case
may be. Thus, the shareholding shall be calculated and reckoned taking into
account the shareholding of the acquirer immediately prior to the acquisition.
I, therefore, hold that the shareholding of the acquirers as on the date of the
acquisition of additional shares should be taken into account to determine
whether the acquisition entitles the acquirer to exercise more than 5% voting
rights in the Target Company in a financial year ending on March 31st. Further,
the 5% increase in the financial year has to be calculated on gross basis
without netting the dilution and/or divestment and acquisition. Accordingly,
the arguments of the noticees in this regard also cannot hold good.
SEBI’s order is
consistent with the text and intent of the 1997 Regulations. Although the facts
of the present case gave rise to some issues that required a detailed consideration,
the order merely buttresses the position adopted by the Regulations.

The legal difficulties
emanating from the above discussion have been partially addressed in the 2011
version of the Takeover Regulations. The first issue regarding the mutual exclusivity
of the initial trigger by individual acquirers (now standing at 25%) and the
creeping acquisition trigger by the promoters collectively would continue to
operate even under the 2011 Regulations, and to that extent SEBI’s order in the
present case would continue to be relevant. As far as the second issue on
computation of creeping acquisition limits is concerned, the position has been
expressly clarified in the 2011 Regulations in Reg. 3(2) Explanation whereby
the limit would be computed on a gross basis (without netting off dilutions).
In that sense, SEBI’s order seems to suggest that the introduction of this
explanation does not change the legal position, but rather clarifies something
that was even previously the intention of the Takeover Regulations.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • I beg to differ, vehemently on the first count. The very edifice of the Takeover Regulations is linked to the concept of taking into account the holdings of all the persons acting in concert.

    In the absence of any explicit and specific suspension of this concept, as is now the case under Regulation 3(3) of the new Takeover Regulations, 2011, the appraoch of saying any single person crossing 15% would trigger an open offer is not at all sustainable either under the letter or the spirit of the Takeover Regulations.

    In fact, there are published orders of SEBI contrary to the current approach to re-thinking of the old Takeover Regulations, and the change in approach is inexplicable and wrong.

    On the second issue, it is a necessarily a mixed question of fact and law, and therefore, it would not be possible to generalize a proposition. Suffice it to say, all recommendations of the Bhagwati Committee Report were not implemented and the dispensation on how to regard creeping acquisitions kept shifting regularly (from a floating period of twelve months to twelve calendar months to the financial year). In the absence of an explicit legislative intervention, how the old Takeover Regulations should operate in computing the 5% threshold, is not without debate.

    Of course, the new Takeover Regulations have explicitly legislated how to reckon the 5% and therefore, therefore there is no longer any doubt on the subject.

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