[The following
post is contributed by Soham Roy &
Akhil Nene, who are 5th year students at the National Law
University Odisha]
post is contributed by Soham Roy &
Akhil Nene, who are 5th year students at the National Law
University Odisha]
A non-compete fee is paid to exiting promoters
or founders of a company to ensure that they do not compete for a certain
period of time with the company they are exiting. Recently, there was considerable
controversy surrounding the HDFC
Life-Max merger as a result of Rs. 850 crore paid to the promoters of Max
Financial services as non-compete fee by HDFC Life. This is despite the fact
that the promoters of Max Financial Services will
retain a 6.7% shareholding in HDFC Life. The transaction is being
implemented through multiple steps and is structured as a scheme of arrangement
involving a merger/demerger. Apart from whether a non-compete fee may be paid
in a restructuring transaction involving a merger/demerger rather than a
takeover, the issue has raised a larger question on the justification of
payment of a non-compete fee selectively to a certain set of shareholders.
or founders of a company to ensure that they do not compete for a certain
period of time with the company they are exiting. Recently, there was considerable
controversy surrounding the HDFC
Life-Max merger as a result of Rs. 850 crore paid to the promoters of Max
Financial services as non-compete fee by HDFC Life. This is despite the fact
that the promoters of Max Financial Services will
retain a 6.7% shareholding in HDFC Life. The transaction is being
implemented through multiple steps and is structured as a scheme of arrangement
involving a merger/demerger. Apart from whether a non-compete fee may be paid
in a restructuring transaction involving a merger/demerger rather than a
takeover, the issue has raised a larger question on the justification of
payment of a non-compete fee selectively to a certain set of shareholders.
In the case of takeovers, regulation 8(7) of the
SEBI
(Substantial Acquisition of Shares and Takeover) Regulations, 2011 (the
“Takeover Regulations”) states that a non-compete fee paid to promoter group has
to be factored in the open offer price paid to other public shareholders, which
essentially means that all shareholders obtain an exit at the same price. The
provision was added to the Takeover Regulations on the basis of the
recommendations of the Achuthan
Committee Report. The Committee
opined that public shareholders and the promoters are on the same footing and
there should be not be any discrimination between these two groups of shareholders. The Committee was of the view that
preferential treatment in the form of a non-compete fee cannot be given to the
promoter group as this was against the principle of shareholder equality. The
Committee opined that non-compete should flow to the entire shareholder body and
not merely to a certain group of shareholders as they were in the nature of
compensation for loss of potential value on account of sacrificed business
opportunities.[1]
Although the payment of non-compete fee is not completely prohibited in the Takeover
Regulations, the Securities and Exchange Board of India (“SEBI”) has ensured
that all shareholders obtain the same exit price and that no preferential
treatment is accorded to one set of shareholders over the others.
SEBI
(Substantial Acquisition of Shares and Takeover) Regulations, 2011 (the
“Takeover Regulations”) states that a non-compete fee paid to promoter group has
to be factored in the open offer price paid to other public shareholders, which
essentially means that all shareholders obtain an exit at the same price. The
provision was added to the Takeover Regulations on the basis of the
recommendations of the Achuthan
Committee Report. The Committee
opined that public shareholders and the promoters are on the same footing and
there should be not be any discrimination between these two groups of shareholders. The Committee was of the view that
preferential treatment in the form of a non-compete fee cannot be given to the
promoter group as this was against the principle of shareholder equality. The
Committee opined that non-compete should flow to the entire shareholder body and
not merely to a certain group of shareholders as they were in the nature of
compensation for loss of potential value on account of sacrificed business
opportunities.[1]
Although the payment of non-compete fee is not completely prohibited in the Takeover
Regulations, the Securities and Exchange Board of India (“SEBI”) has ensured
that all shareholders obtain the same exit price and that no preferential
treatment is accorded to one set of shareholders over the others.
It is important to note that the Takeover
Regulations do not apply to schemes of arrangement under the Companies Act and
hence minority shareholders are not accorded the same level of protection that
they would have enjoyed in the case of a takeover.
Regulations do not apply to schemes of arrangement under the Companies Act and
hence minority shareholders are not accorded the same level of protection that
they would have enjoyed in the case of a takeover.
We argue that the protection given to minority
shareholders under regulation 8(7) of the Takeover Regulations should also be
extended to minority shareholders in a scheme of arrangement initiated under
the Companies Act. The payment of a non-compete
fee to a certain group of shareholders in a scheme adversely affects the rights
of minority shareholders. This is especially so in the case of a merger or
demerger involving listed companies where the minority shareholders constitute
a sizable fraction of the shareholding in the company. As in the case of the HDFC Life-Max merger,
there could be other merger/demerger schemes wherein a certain group of
shareholders obtain extra consideration in the form of a non-compete fee to the
detriment of other shareholders. There is a high possibility that the share
swap ratio will be affected as a result of the non- compete fee being paid to a
certain group of shareholders. Had the non-compete fee not been paid to the
promoters, an equivalent amount would have been accounted for in the books of
accounts of the transferee company and hence could have translated to a more
favourable share exchange (swap) ratio for shareholders. This would have
benefited all shareholders and not only a particular group of shareholders.
shareholders under regulation 8(7) of the Takeover Regulations should also be
extended to minority shareholders in a scheme of arrangement initiated under
the Companies Act. The payment of a non-compete
fee to a certain group of shareholders in a scheme adversely affects the rights
of minority shareholders. This is especially so in the case of a merger or
demerger involving listed companies where the minority shareholders constitute
a sizable fraction of the shareholding in the company. As in the case of the HDFC Life-Max merger,
there could be other merger/demerger schemes wherein a certain group of
shareholders obtain extra consideration in the form of a non-compete fee to the
detriment of other shareholders. There is a high possibility that the share
swap ratio will be affected as a result of the non- compete fee being paid to a
certain group of shareholders. Had the non-compete fee not been paid to the
promoters, an equivalent amount would have been accounted for in the books of
accounts of the transferee company and hence could have translated to a more
favourable share exchange (swap) ratio for shareholders. This would have
benefited all shareholders and not only a particular group of shareholders.
Moreover, as in the HDFC Life-Max case, one
witnesses scenarios where the continuing shareholders in the transferee company
in a scheme of merger/demerger are paid a non-compete fee. Such a payment to shareholders who have not
completely exited is unfair, and the rationale behind the payment of such a fee
is defeated since a these shareholders continue to hold a stake in the new
merged/resulting entity. Even if the regulator does not subscribe to the view
that payment of non-compete fee to a select group of shareholders is per se prejudicial to the interests of
the minority shareholders, the regulator ought to regulate the payment of
non-compete fee to exiting shareholders. The regulator could consider
abolishing the payment of non-compete fee to shareholders whose existing stake
in the transferee company is above a certain threshold. In other words, the
payment of non-compete fee is understandable when the promoters of the
erstwhile transferor company hold a miniscule proportion of the shares in the
transferee company, and not when that stake is material or substantial. The
regulator can prescribe this threshold. Through this option, the regulator can
protect the interests of the minority shareholders.
witnesses scenarios where the continuing shareholders in the transferee company
in a scheme of merger/demerger are paid a non-compete fee. Such a payment to shareholders who have not
completely exited is unfair, and the rationale behind the payment of such a fee
is defeated since a these shareholders continue to hold a stake in the new
merged/resulting entity. Even if the regulator does not subscribe to the view
that payment of non-compete fee to a select group of shareholders is per se prejudicial to the interests of
the minority shareholders, the regulator ought to regulate the payment of
non-compete fee to exiting shareholders. The regulator could consider
abolishing the payment of non-compete fee to shareholders whose existing stake
in the transferee company is above a certain threshold. In other words, the
payment of non-compete fee is understandable when the promoters of the
erstwhile transferor company hold a miniscule proportion of the shares in the
transferee company, and not when that stake is material or substantial. The
regulator can prescribe this threshold. Through this option, the regulator can
protect the interests of the minority shareholders.
Companies often justify the payment of such a
fee by stating that such a fee is only paid after it has received the consent
of minority shareholders. A SEBI
Circular dated November 30, 2015, which applies to all listed companies
undertaking a scheme of arrangement imposes some conditions for the payment of
non-compete fee to minority shareholders. Paragraph 9 of the aforesaid SEBI
circular mandates the approval by majority of the public shareholders in case of
certain payments or issue of shares made to the promoters. It is important to
realize that the minority shareholders are often under a lot of pressure to let
the deal go through without hurdles and therefore they might vote in favour or
abstain keeping in mind that the injustice that is accrued to them as a result
of the non-compete fee being paid to certain shareholders do not outweigh the
benefits of seeing the deal to fruition without hurdles. Deals like this may be
renegotiated if the non-compete is not paid to the promoters. The non-compete
is only one component of the scheme and it is entirely plausible that minority
shareholders may abstain or vote in favour of the non-compete keeping in mind
the possibility of the entire deal being renegotiated if the non-compete is not
paid to the promoters.
fee by stating that such a fee is only paid after it has received the consent
of minority shareholders. A SEBI
Circular dated November 30, 2015, which applies to all listed companies
undertaking a scheme of arrangement imposes some conditions for the payment of
non-compete fee to minority shareholders. Paragraph 9 of the aforesaid SEBI
circular mandates the approval by majority of the public shareholders in case of
certain payments or issue of shares made to the promoters. It is important to
realize that the minority shareholders are often under a lot of pressure to let
the deal go through without hurdles and therefore they might vote in favour or
abstain keeping in mind that the injustice that is accrued to them as a result
of the non-compete fee being paid to certain shareholders do not outweigh the
benefits of seeing the deal to fruition without hurdles. Deals like this may be
renegotiated if the non-compete is not paid to the promoters. The non-compete
is only one component of the scheme and it is entirely plausible that minority
shareholders may abstain or vote in favour of the non-compete keeping in mind
the possibility of the entire deal being renegotiated if the non-compete is not
paid to the promoters.
The Achuthan Committee report correctly
identified the scope of abuse of non-compete fees. The Committee correctly
opined that control was only an incidental benefit of share ownership and there
is no basis for the payment of a non-compete fee to a certain select group of
shareholders. As a result of the Committee report, the regulator plugged any scope
for misuse by way of the Takeover Regulations.
identified the scope of abuse of non-compete fees. The Committee correctly
opined that control was only an incidental benefit of share ownership and there
is no basis for the payment of a non-compete fee to a certain select group of
shareholders. As a result of the Committee report, the regulator plugged any scope
for misuse by way of the Takeover Regulations.
Protection of minority shareholders is one of
the most important functions of the regulator. As discussed in this post,
payment of non-compete fee to a certain select group of shareholders in a
merger is prejudicial to the interests of the minority shareholders. If the
payment of such a fee is not abolished, the regulator should at least regulate
the payment of non-compete fee to shareholders who have not completely exited. The
current situation leaves much to be desired.
the most important functions of the regulator. As discussed in this post,
payment of non-compete fee to a certain select group of shareholders in a
merger is prejudicial to the interests of the minority shareholders. If the
payment of such a fee is not abolished, the regulator should at least regulate
the payment of non-compete fee to shareholders who have not completely exited. The
current situation leaves much to be desired.
– Soham Roy & Akhil Nene