[The
following post is contributed by Vinod
Kothari of Vinod Kothari & Co.
following post is contributed by Vinod
Kothari of Vinod Kothari & Co.
The
subject matter of this post is current given that SEBI is in the process of engaging
in a public consultation based on its proposals. We are likely to carry a
series of posts on this issue so as to capture a varied set of views and
approaches.]
subject matter of this post is current given that SEBI is in the process of engaging
in a public consultation based on its proposals. We are likely to carry a
series of posts on this issue so as to capture a varied set of views and
approaches.]
If the ruling of the
Securities Appellate Tribunal (SAT) in Subhkam
and
the subsequent
decision of the Supreme Court leaving the matter undecided left
a gap in the law, it is good that the Securities and Exchange Board of India (SEBI”
has decided to complete the “subh-kaam”
(good work) after nearly five years. The proposed rule through a Discussion
Paper seeks to define “control” in the SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 (the SAST Regulations)
to mean acquisition of 25% voting rights, or the right to appoint a majority of
non-independent directors. The proposal also seeks to provide that negative
control, that is, protective rights typically conferring veto rights to a
non-majority substantial shareholder will not be taken as meaning control. If the proposal is accepted, India, like several
other countries in the world, will be moving from the concept of a de facto approach towards control to a de jure approach. While the de jure or objective approach, termed as
the “bright-line” test, has the advantage of greater certainty, it is ironical
that the move towards the objective, voting control based approach comes at a
time when several technology sector companies have demonstrated that voting
controls and the ability to derive economic benefits may be completely
dissociated.[1]
Securities Appellate Tribunal (SAT) in Subhkam
and
the subsequent
decision of the Supreme Court leaving the matter undecided left
a gap in the law, it is good that the Securities and Exchange Board of India (SEBI”
has decided to complete the “subh-kaam”
(good work) after nearly five years. The proposed rule through a Discussion
Paper seeks to define “control” in the SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 (the SAST Regulations)
to mean acquisition of 25% voting rights, or the right to appoint a majority of
non-independent directors. The proposal also seeks to provide that negative
control, that is, protective rights typically conferring veto rights to a
non-majority substantial shareholder will not be taken as meaning control. If the proposal is accepted, India, like several
other countries in the world, will be moving from the concept of a de facto approach towards control to a de jure approach. While the de jure or objective approach, termed as
the “bright-line” test, has the advantage of greater certainty, it is ironical
that the move towards the objective, voting control based approach comes at a
time when several technology sector companies have demonstrated that voting
controls and the ability to derive economic benefits may be completely
dissociated.[1]
Historical
setting of the existing definition of “control”
setting of the existing definition of “control”
An acquisition of “control”
by an acquirer over a listed entity commonly triggers a mandatory bid or
open-offer requirement. That is, the acquirer is mandated to make a matching
offer to the minority shareholders too, to provide to the minority shareholders
a level playing field. In India, the SAST Regulations contain two triggers for
a mandatory bid. Reg. 3 pertains to first-time acquisition by an acquirer, either
by itself or with persons acting in concert (PACs), crossing the threshold of
25% voting power. Reg. 4 triggers the mandatory bid requirement on acquisition
of “control” by the acquirer. “Control” is defined in Reg. 2(1)(e) as follows:
by an acquirer over a listed entity commonly triggers a mandatory bid or
open-offer requirement. That is, the acquirer is mandated to make a matching
offer to the minority shareholders too, to provide to the minority shareholders
a level playing field. In India, the SAST Regulations contain two triggers for
a mandatory bid. Reg. 3 pertains to first-time acquisition by an acquirer, either
by itself or with persons acting in concert (PACs), crossing the threshold of
25% voting power. Reg. 4 triggers the mandatory bid requirement on acquisition
of “control” by the acquirer. “Control” is defined in Reg. 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.
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.
The definition above, an
inclusive one, defines control of two types: (a) right to appoint a majority of
directors (say, management control), or (b) right to control policy decisions
(say, policy control). Either of these controls may arise either by virtue of
shareholding, that is, voting strength, or by way of management rights, or
shareholders’ agreements, or otherwise. The last expression “or otherwise”
makes the instrumentality of exercising control open-ended. Therefore, the
manner in which the control will be attained does not matter; what matters is
the factum of control either over management, or over policy-making.
inclusive one, defines control of two types: (a) right to appoint a majority of
directors (say, management control), or (b) right to control policy decisions
(say, policy control). Either of these controls may arise either by virtue of
shareholding, that is, voting strength, or by way of management rights, or
shareholders’ agreements, or otherwise. The last expression “or otherwise”
makes the instrumentality of exercising control open-ended. Therefore, the
manner in which the control will be attained does not matter; what matters is
the factum of control either over management, or over policy-making.
Reg. 3 incorporates the de jure or objective rule, linking the
mandatory bid requirement with 25% voting power. Reg. 4 does not look at voting
rights at all – it focuses on the de
facto or control over policy-making, either by controlling the management
of the entity, or otherwise.
mandatory bid requirement with 25% voting power. Reg. 4 does not look at voting
rights at all – it focuses on the de
facto or control over policy-making, either by controlling the management
of the entity, or otherwise.
As is evident from the
above, India has adopted a “mixed approach”, that is, a combination of the
objective and the subjective approaches.
above, India has adopted a “mixed approach”, that is, a combination of the
objective and the subjective approaches.
Globally, while some
countries have used the economic or subjective model, many other countries have
used the objective model. The relative merits and demerits of each approach
have been a subject matter of debate[2]. The OECD Competition
Committee discussed the two approaches at the roundtable on the Definition
of Transaction for the Purpose of Merger Control Review held in June 2013,
relevant extracts whereof have been reproduced hereunder:
countries have used the economic or subjective model, many other countries have
used the objective model. The relative merits and demerits of each approach
have been a subject matter of debate[2]. The OECD Competition
Committee discussed the two approaches at the roundtable on the Definition
of Transaction for the Purpose of Merger Control Review held in June 2013,
relevant extracts whereof have been reproduced hereunder:
“An objective approach
typically relies on percentage thresholds for share acquisitions, such as the
acquisition of a 50% interest or of a 25% interest in the target. Objective
criteria make the system more predictable and transparent. However, it is
possible to structure their transactions “around” the thresholds to avoid
notification and review. At the same time, setting an objective threshold too
low to make avoidance strategies more difficult could impose unnecessary costs
on all sides involved, as it could capture too many transactions that are
highly unlikely to have any adverse effects on competition.
typically relies on percentage thresholds for share acquisitions, such as the
acquisition of a 50% interest or of a 25% interest in the target. Objective
criteria make the system more predictable and transparent. However, it is
possible to structure their transactions “around” the thresholds to avoid
notification and review. At the same time, setting an objective threshold too
low to make avoidance strategies more difficult could impose unnecessary costs
on all sides involved, as it could capture too many transactions that are
highly unlikely to have any adverse effects on competition.
“Economic” criteria are
more directly aligned with the mechanism through which a transaction might harm
competition, by focusing on whether a transaction will enable a firm to acquire
the ability to exercise some form of influence over a previously independent
firm. Different legal systems define different levels of intensity of
influence, such as “decisive influence,” “significant influence,” “material
influence,” or “competitively significant influence.” These definitions capture
the reason for possible competitive concerns more directly than objective
criteria and therefore “target” more effectively potentially problematic
transactions. They also make it more difficult to game the system. At the same
time, though, they require more case specific interpretation. They[3]
can therefore create uncertainty and make the process less transparent.
Guidelines by competition authorities, informal guidance, and consistent
decision making can to some extent address potential problems in this respect.”
more directly aligned with the mechanism through which a transaction might harm
competition, by focusing on whether a transaction will enable a firm to acquire
the ability to exercise some form of influence over a previously independent
firm. Different legal systems define different levels of intensity of
influence, such as “decisive influence,” “significant influence,” “material
influence,” or “competitively significant influence.” These definitions capture
the reason for possible competitive concerns more directly than objective
criteria and therefore “target” more effectively potentially problematic
transactions. They also make it more difficult to game the system. At the same
time, though, they require more case specific interpretation. They[3]
can therefore create uncertainty and make the process less transparent.
Guidelines by competition authorities, informal guidance, and consistent
decision making can to some extent address potential problems in this respect.”
It appears that the
objectives of competition law are better served by a subjective definition,
whereas those of takeover triggers, requiring open offer, may choose a more
certain, objective standard. Therefore, the UK Takeover Code defines “context”
of takeover offers to mean acquisition of 30% or more voting rights,
irrespective of whether de facto control
exists. However, section 26 of the
UK Enterprise Act, 2002, pertaining to combinations, continues to use three
tests for control, with de facto control
being the focal point.
objectives of competition law are better served by a subjective definition,
whereas those of takeover triggers, requiring open offer, may choose a more
certain, objective standard. Therefore, the UK Takeover Code defines “context”
of takeover offers to mean acquisition of 30% or more voting rights,
irrespective of whether de facto control
exists. However, section 26 of the
UK Enterprise Act, 2002, pertaining to combinations, continues to use three
tests for control, with de facto control
being the focal point.
The existing mixed
approach in India has its roots in the recommendations of the Bhagwati Panel,
which recommended in 1997, that the takeover regulations should contain an
inclusive definition of the term ‘control’ which would serve to indicate the
circumstances when compliance with the provisions of the Regulations would be
necessitated, even where there has been no acquisition of shares, so that SEBI
would not be on an uncharted sea in investigating whether there has been change
in control. The Committee explained that control of a company is interlinked
with its fortunes and any change in control could not be without impact on
company’s policies and business prospects and is, thus, linked to investors’
interest. And, given that investor protection is a mandate of SEBI, takeover
which entails change in control should necessarily be the concern of SEBI.
approach in India has its roots in the recommendations of the Bhagwati Panel,
which recommended in 1997, that the takeover regulations should contain an
inclusive definition of the term ‘control’ which would serve to indicate the
circumstances when compliance with the provisions of the Regulations would be
necessitated, even where there has been no acquisition of shares, so that SEBI
would not be on an uncharted sea in investigating whether there has been change
in control. The Committee explained that control of a company is interlinked
with its fortunes and any change in control could not be without impact on
company’s policies and business prospects and is, thus, linked to investors’
interest. And, given that investor protection is a mandate of SEBI, takeover
which entails change in control should necessarily be the concern of SEBI.
The Takeover Regulations
Advisory Committee set up under the chairmanship of Mr. C Achuthan, concluded
that a holding level of 25% of voting rights permits the exercise de facto control. The existence or nonexistence of control over a listed company
would be a question of fact, or at best a mixed question of fact and law, to be
answered on a case to case basis. Acquisition
of de facto control, and not just de jure control should
expressly trigger an open offer. The Committee had recommended the definition
of “control” be modified to include “ability” in addition to “right” to appoint
majority of the directors or to control the management or policy decisions
would constitute control.
Advisory Committee set up under the chairmanship of Mr. C Achuthan, concluded
that a holding level of 25% of voting rights permits the exercise de facto control. The existence or nonexistence of control over a listed company
would be a question of fact, or at best a mixed question of fact and law, to be
answered on a case to case basis. Acquisition
of de facto control, and not just de jure control should
expressly trigger an open offer. The Committee had recommended the definition
of “control” be modified to include “ability” in addition to “right” to appoint
majority of the directors or to control the management or policy decisions
would constitute control.
The
SEBI proposal
SEBI proposal
The
SEBI Discussion Paper proposes, as one of the options, to amend the definition
of “control” in the SAST Regulations as follows:
SEBI Discussion Paper proposes, as one of the options, to amend the definition
of “control” in the SAST Regulations as follows:
“(a) the right or entitlement to exercise
at least 25% of voting rights of a company irrespective of whether such
holdings gives de facto control
at least 25% of voting rights of a company irrespective of whether such
holdings gives de facto control
and/or
(b) the right to appoint majority of the
non-independent directors of a company”
non-independent directors of a company”
The
definition of “control” is linked with Reg. 4 of the SAST Regulations. As
already mentioned above, Reg. 3, as it stands currently, invokes a public offer
requirement on acquisition of 25% voting rights. Defining “control” also as
acquisition of 25% voting rights creates an overlap between Reg. 3 and Reg. 4,
and would largely make Reg. 4 unnecessary.
definition of “control” is linked with Reg. 4 of the SAST Regulations. As
already mentioned above, Reg. 3, as it stands currently, invokes a public offer
requirement on acquisition of 25% voting rights. Defining “control” also as
acquisition of 25% voting rights creates an overlap between Reg. 3 and Reg. 4,
and would largely make Reg. 4 unnecessary.
Accounting
standards dealing with consolidation have a far clearer, though subjective,
definition of control, being significant influence, and shared control, which
have stood the test of time. Control is ability to control policy-making,
whereas significant influence is the ability to influence decision-making.
Where control is shared by two or more entities, it is deemed to be a case of a
joint venture. There are illustrative shareholding levels – for instance, 20%
to 49% to be an indication of significant influence, but the shareholding level
is itself not decisive, as the shareholdings simply create a rebuttable
presumption of an influence.
standards dealing with consolidation have a far clearer, though subjective,
definition of control, being significant influence, and shared control, which
have stood the test of time. Control is ability to control policy-making,
whereas significant influence is the ability to influence decision-making.
Where control is shared by two or more entities, it is deemed to be a case of a
joint venture. There are illustrative shareholding levels – for instance, 20%
to 49% to be an indication of significant influence, but the shareholding level
is itself not decisive, as the shareholdings simply create a rebuttable
presumption of an influence.
The
proposed rule defines 25% voting rights to be the bright line of control –
whereas there are several cases of passive investors where an investor acquires
26% voting rights merely to be able to block special resolutions. The other
shareholder may be holding 74%, and therefore, has clear control on policy-making,
as the right to appoint or remove directors needs only a simple majority vote.
The 74% shareholder very clearly controls the entity – therefore, it is a clear
contrast with the reality to regard the 26% owner to be controlling the entity,
since it is not even a case of a shared control. While it may be perfectly
alright to relate the mandatory bid requirement to acquisition of 25% or more
voting rights, but defining “control” to mean crossing the bright line of 25%
may have serious repercussions on several other laws that may tag themselves to
the definition given in the SAST Regulations. In fact, it may be much better to
retain the definition of control containing the de facto test, but to delink
the mandatory bid requirement from the acquisition of control, and retain the
existing threshold pertaining to shareholdings alone.
proposed rule defines 25% voting rights to be the bright line of control –
whereas there are several cases of passive investors where an investor acquires
26% voting rights merely to be able to block special resolutions. The other
shareholder may be holding 74%, and therefore, has clear control on policy-making,
as the right to appoint or remove directors needs only a simple majority vote.
The 74% shareholder very clearly controls the entity – therefore, it is a clear
contrast with the reality to regard the 26% owner to be controlling the entity,
since it is not even a case of a shared control. While it may be perfectly
alright to relate the mandatory bid requirement to acquisition of 25% or more
voting rights, but defining “control” to mean crossing the bright line of 25%
may have serious repercussions on several other laws that may tag themselves to
the definition given in the SAST Regulations. In fact, it may be much better to
retain the definition of control containing the de facto test, but to delink
the mandatory bid requirement from the acquisition of control, and retain the
existing threshold pertaining to shareholdings alone.
The
other proposal, named as Option 1 in the SEBI Proposal, is actually
clarificatory, as it seeks to lay down illustrative situations where negative
control or protective clauses in shareholders’ agreements will not be regarded
as “control”. There has never been a doubt, except arising out of SEBI’s own
appeal against SAT ruling in Subhkam case, that negative control is not
a control. If the driver driving a car is the one controlling the car, the
passenger sitting in the backseat is well within his rights to caution or
reprimand the driver, if he is driving too fast, or too badly, or stop him from
going in the wrong direction. Such an exercise of shareholder right is, by no
stretch of argument, a case of control. On the contrary, it is quite likely
that the list of protective rights that SEBI seeks to lay down, though
illustrative, will be read literally by regulators as well as practitioners,
who may tend to think that all that is not covered by the illustrative list may
be falling on the other side of the bright line, and therefore, may be
construed as “control”.
other proposal, named as Option 1 in the SEBI Proposal, is actually
clarificatory, as it seeks to lay down illustrative situations where negative
control or protective clauses in shareholders’ agreements will not be regarded
as “control”. There has never been a doubt, except arising out of SEBI’s own
appeal against SAT ruling in Subhkam case, that negative control is not
a control. If the driver driving a car is the one controlling the car, the
passenger sitting in the backseat is well within his rights to caution or
reprimand the driver, if he is driving too fast, or too badly, or stop him from
going in the wrong direction. Such an exercise of shareholder right is, by no
stretch of argument, a case of control. On the contrary, it is quite likely
that the list of protective rights that SEBI seeks to lay down, though
illustrative, will be read literally by regulators as well as practitioners,
who may tend to think that all that is not covered by the illustrative list may
be falling on the other side of the bright line, and therefore, may be
construed as “control”.
Impact of the proposed change on other regulations
The proposed amendment
of definition casting a statutory presumption of control on holding of 26%
voting rights may affect definitions used in several other regulations as well.
While the Companies Act 2013 continues to use the subjective, factual
control-based definition presently there in the SAST Regulations, the SEBI
(Issue of Capital and Disclosure Requirements) Regulations, 2009 (the ICDR
Regulations), which define important terms such as “promoters”, import the
definition of “control” from the SAST Regulations. If the 26% owner of equity
is regarded as controlling an entity, it will also imply that such a
shareholder will also be a deemed promoter of the entity. The definition of “promoter” in the ICDR
Regulations is, in turn, relied upon by several of SEBI’s regulations. Indeed,
even the Companies Act definition of a “promoter” may be influenced by the
characterization of the 26% equity owner as promoter in filings with the stock
exchanges. In short, there may be a substantial ripple effect of the change of
definition of “control” under the SAST Regulations.
of definition casting a statutory presumption of control on holding of 26%
voting rights may affect definitions used in several other regulations as well.
While the Companies Act 2013 continues to use the subjective, factual
control-based definition presently there in the SAST Regulations, the SEBI
(Issue of Capital and Disclosure Requirements) Regulations, 2009 (the ICDR
Regulations), which define important terms such as “promoters”, import the
definition of “control” from the SAST Regulations. If the 26% owner of equity
is regarded as controlling an entity, it will also imply that such a
shareholder will also be a deemed promoter of the entity. The definition of “promoter” in the ICDR
Regulations is, in turn, relied upon by several of SEBI’s regulations. Indeed,
even the Companies Act definition of a “promoter” may be influenced by the
characterization of the 26% equity owner as promoter in filings with the stock
exchanges. In short, there may be a substantial ripple effect of the change of
definition of “control” under the SAST Regulations.
Conclusions
The so-called gap in the
law that the SEBI Proposal seeks to fill, frankly, is illusory, as
practitioners generally do not regard protective rights as amounting to control
at all. The factual determination of control, irrespective of shareholding
strength, is an investigative power that regulations have had over the years,
and continues to be basis of the Companies Act definition of “control”, as also
the basis of accounting standards. On the contrary, a purely rule-based bright
line, given the trend set by technology companies dissociating economic
benefits of ownership from voting rights, may not be desirable in our system,
which has relied upon a principles-based approach, rather than rule-based
approach, as the basis of implementation of law.
law that the SEBI Proposal seeks to fill, frankly, is illusory, as
practitioners generally do not regard protective rights as amounting to control
at all. The factual determination of control, irrespective of shareholding
strength, is an investigative power that regulations have had over the years,
and continues to be basis of the Companies Act definition of “control”, as also
the basis of accounting standards. On the contrary, a purely rule-based bright
line, given the trend set by technology companies dissociating economic
benefits of ownership from voting rights, may not be desirable in our system,
which has relied upon a principles-based approach, rather than rule-based
approach, as the basis of implementation of law.
–
Vinod Kothari
Vinod Kothari
[1]Google,
Facebook, Alibaba, etc. use dual class shares, whereby the general shareholders
will derive dividends and other economic benefits, but the ability to manage
companies will stay with the so-called management shares, or class B shares. In
case of listed entities, there are some jurisdictions that permit companies to
have non-proportional voting rights, USA being the prominent among them. Other
countries are currently contemplating similar enabling statutes. See a write-up
on the issue here: https://indiacorplaw.in/2014/09/dual-class-share-structures.html.
Facebook, Alibaba, etc. use dual class shares, whereby the general shareholders
will derive dividends and other economic benefits, but the ability to manage
companies will stay with the so-called management shares, or class B shares. In
case of listed entities, there are some jurisdictions that permit companies to
have non-proportional voting rights, USA being the prominent among them. Other
countries are currently contemplating similar enabling statutes. See a write-up
on the issue here: https://indiacorplaw.in/2014/09/dual-class-share-structures.html.
[2]
Among scholarly writings on the subject of bright-line versus subject tests for
“control” in relation to takeovers, see V. Umakanth, at https://indiacorplaw.in/wp-content/uploads/2016/03/SJLS-Jul-15-208.pdf.
Among scholarly writings on the subject of bright-line versus subject tests for
“control” in relation to takeovers, see V. Umakanth, at https://indiacorplaw.in/wp-content/uploads/2016/03/SJLS-Jul-15-208.pdf.
[3] http://www.thetakeoverpanel.org.uk/wp-content/uploads/2008/11/code.pdf