Analysis of the options proposed by SEBI for ascertaining “control”

[The following guest post is contributed by Amitabh Robin Singh, who is an
Associate at DSK Legal.
In this, he highlights the benefits and also offers a
critique of SEBI’s recent proposals to define “control”]
Recently,
the Securities and Exchange Board of India (“SEBI”) released a discussion
paper
to lay down a bright line test for the acquisition of “control” under
the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”). The purpose of this is
to lay down an objective test, which will lead to predictability and
consistency in the regime regarding the acquisition of control as per the
Takeover Code.
Control
is defined in the Takeover Code at Regulation 2(1)(e) as follows:
“control” includes the right
to appoint majority of the directors or to control the management or policy
decisions exercisable by a person or persons acting individually or in concert,
directly or indirectly, including by virtue of their shareholding or management
rights or shareholders agreements or voting agreements or in any other manner:
Provided that
a director or officer of a target company shall not be considered to be in
control over such target company, merely by virtue of holding such position.
SEBI goes on to break down the definition into
three components, being: the right to appoint the majority of directors, the
right to control the management and the right to control the policy decisions
of the company.
Further, SEBI lists out the definitions of control
as laid down in various legislation such as the Companies Act, 2013 (“Companies Act”), the Insurance Act,
1938 (as amended by the Insurance Laws (Amendment) Act, 2015), the Foreign
Direct Investment (FDI) policy for the current year and the Competition Act,
2002 (“Competition Act”). While the
Competition Act definition is specific to regulating combinations under Section
5, it can be seen that the use of the words “affairs or management”
seems to set a lower threshold than as envisaged in the Takeover Code, seeing
that simply controlling the “affairs or management[1]
of the enterprise will amount to controlling it.
Also, due to the fact that multiple sectoral
regulators have varying definitions of control (such as the Insurance
Regulatory and Development Authority of India guidelines
on “Indian owned and controlled” companies), may create confusion, and so SEBI
would like to mandate an objective test to ascertain when someone is in control
of a company. 
Further, the discussion paper goes on to examine
how control is defined for other countries such as Germany, Hong Kong and Singapore
where there is a tight numerical threshold regardless of the grant of de
facto
control of the company. It also goes on to mention that countries
such as Canada, France and Spain employ the test of ascertaining whether the
entity has directly or indirectly, over the majority of the voting power at
general meetings or can control the composition of the majority of the board of
directors. However, in countries such as the USA and Japan, control is
undefined for the purpose of takeovers. Yet other countries possess definitions
similar to India’s which are not only concerned about the composition of the
board of directors or voting rights but also the ability to control policy
decisions.
In view of the above, SEBI has devised two options
which are as follows.
The first option contemplates laying down an
illustrative list of “protective” rights, which may be granted to an investor
without amounting to control. These are opposed to “participative” rights seeing
that these protective rights would merely allow the investor to protect the
amount invested and ensure its stake is not diluted, but will not allow it to participate
in the day-to-day affairs of the company or the policy making process. SEBI is
of the opinion that an affirmative vote on something such as changing the “significantly”
business activity will be protective and not participative. Once again, the “significance”
of a change is a moving target which may inject further subjectivity.
In this option SEBI placed reliance on the decision
of the Securities Appellate Tribunal (“SAT”)
in the matter of Subhkam Ventures
(I) Private Limited v.
SEBI
(“Subhkam”),
wherein SAT opined that “control, according to the definition, is a
proactive and not a reactive power.
” SAT went on to use the metaphor of a
car to define control by saying that one needs to be in the driver’s seat to be
in control and be in control of the steering, accelerator, gears and brakes to
be in control. Where a party is only reacting instead of taking the initiative
on matters, it will not amount to control of the company.
In the Subhkam order, there were 22 rights
listed out by SAT that figured in the
relevant
agreement that it deemed to be
protective and not amounting to control of the company. SAT further laid down
that the investor merely wants to ensure that the company does not undergo a
paradigm shift from its present path without the affirmative vote of the
investor.
In light of the above decision, SEBI has proposed
the idea of having a list of certain illustrative protective rights which would
not amount to control subject to certain conditions such as that the
investor who possesses the protective rights should hold at least 10% or more
in the investee company. (In the Subhkam case the relevant agreement
provided that the rights that accrued to it would fall away upon the investor
ceasing to hold 10% or more in the company.)
While grant of such protective rights will be
subject to obtaining the approval of the public shareholders of the investee
company, these rights will also be required to be incorporated in the Articles
of Association of the company post such approval.
Also, it is proposed that every company should
formulate a policy to ascertain which transactions are “material” for
the purpose of affirmative votes on “material divestment” and “material
acquisition
”. The discussion paper also recommends a policy to define “outside
the ordinary course of business
” for the purpose of the illustrative list
of rights where activities such as having an affirmative vote on related party
transactions which are not “in the ordinary course of business”.
While this test does attempt to shore up the
definition of control, a problem that may arise here is that there will still
be an element of subjectivity figuring in the equation. This is because SEBI
can only prescribe an indicative list of affirmative votes that will be
protective rather than participative in nature. It will be impossible for an
exhaustive list to be laid down that will encompass every single voting matter
due to the fact that new rights may be evolved and worded in different ways
which would be read subjectively and in different lights and through different
prisms. Hence, this option will result in more cases ending up before the
regulator and may not be as productive as envisioned, with investments still
getting mired in disputes as to whether control has been acquired or not.
The second option that SEBI has proposed in the
discussion paper is to adopt a flat numerical threshold to ascertain control.
Seeing that under the Companies Act a special resolution requires a
three-fourths majority, an investor holding more than 25% will be able to block
special resolutions. Hence, SEBI deemed it prudent that 25% be the threshold
for triggering control in listed companies.
SEBI also raised an interesting point here that
under the SEBI (Listing Obligations and Disclosure Requirements) Regulations,
2015, a listed company is required to compose its board of at least one-third
of the directors on the board being independent directors if the chairman is a
non-executive director and must have half of the directors on the board being
independent directors if the chairman is an executive director (there was a
similar provision in the erstwhile form of the listing agreement). Hence, appointing
the majority of the directors may be a highly remote possibility in the case
where the chairman in non-executive and not possible in a case where the
chairman of the board is an executive director. Therefore, SEBI proposed that
the definition read as the right to exercise 25% of the voting rights
regardless of considerations of de facto control and/or the right to
appoint the majority of non-independent directors.
While this option does lay down a more objective
and “bright line” test to ascertain control, one issue in such a case may be
where the investee company is starved for funds and issues/sells shares to an
investor in distress, the investor may still hold only 24% or less of the
equity of the company and also stay below the director threshold, but it may
have affirmative votes on a bouquet of matters that will tantamount to control,
but will fall outside the purview of the Takeover Code due to the fact that the
definition itself precludes the concept of de facto control. The rights
granted to an investor in such a case may put the investor in the driver’s seat
and allow it to proactively steer the policies of the company. Hence this may
lead to “effective control” as contemplated in Subhkam without
tripping the definition of control in the Takeover Code and consequentially
having to launch an open offer.
As it can be seen, while both options proposed by
SEBI may have their own lacunae, they also both represent a substantial step
forward in providing predictability and clarity in the regime defining
“control” for the purposes of Takeover Code, which is imperative for improving
the ease of doing business in India.
Amitabh Robin Singh



[1]
Emphasis provided

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.

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