Has SEBI Altered Its Position on the Question of “Control”?

The issue of what amounts to “control”
for purposes of the SEBI Takeover Regulations has been a vexed one, and has
eluded any form of resolution for nearly 15 years. In a paper titled “The Nature of the Market for Corporate
Control in India
”, I have sought to summarize the present position
(footnotes omitted):
Under Indian takeover
regulation, it is possible to trigger the [mandatory bid rule (MBR)] even
without acquiring shares or voting rights, which aggravates the severity of the
rule for acquirers. This occurs when the acquirer directly or indirectly
acquires control over the target. It has been the subject matter of
considerable controversy in India as it has attracted significant attention of
the regulator and the courts. …
In Subhkam Ventures v.
Securities and Exchange Board of India, the SAT was concerned with the typical
case where a financial investor took up a 19.91% stake in the target. The SAT
closely analysed the contractual arrangements between the parties. It concluded
that the investor’s right to nominate one among several directors on the board
of the target did not confer upon it any control. Similarly, that the investor
has affirmative or veto rights whereby the approval of the investor is required
for the target to undertake several actions was insufficient to constitute
control. These rights were in the form of protective provisions to safeguard
the investment and therefore do not confer any control on the investor. This
decision provided considerable relief to the investing community in India, who
were able to successfully advocate their position seeking a narrow definition
of control. But, the euphoria was short-lived, as SEBI preferred an appeal to
the Supreme Court of India. Although a ruling from the highest court was
expected with great anticipation, that was not to be as the parties settled
during the pendency of the appeal. An added disappointment arose when the
Supreme Court clarified that the order of SAT will not be treated as precedent
and that the question of law was being kept open.
In all, SEBI continues to have
the leeway to exercise a subjective determination of control, which it does in
fact exercise quite widely, and the concept of ‘control’ continues to
complicate matters under the Indian legal regime, particularly with respect to
the MBR. Since potential acquirers in targets may be foisted with the MBR even
though they stay beneath the initial quantitative threshold, this will have a
chilling effect on takeovers and the market for corporate control.
Despite a rigid stance adopted
by SEBI over the years, there appears to be more recent softening on its part.
For instance, over a year ago it issued a Discussion Paper on “Brightline
Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations
” in
which it sought to suggest alternatives to the current regime so as to introduce
greater certainty to the concept of “control” under the SEBI Takeover
Regulations.
More recently, there has been
further indication that it might be willing to reconsider its stance. This
emerges by way of SEBI’s
order dated March 31, 2017
in the case of Clearwater Capital Partners and
Kamat Hotels (India) Limited. In this case, Clearwater made a takeover offer by
virtue of an increase in its shareholding from 24.50% to 32.23% that was due to
a conversion of bonds held by it. As was the case in relation to several
takeover offers, when Clearwater filed the draft offer document with SEBI it
was asked to include a clause that the offer requirement was triggered by its
acquisition of “control” in addition to its acquisition of shares. Due to stiff
resistance from Clearwater, SEBI finally permitted it to proceed with the offer
after making appropriate disclosures. Subsequently, it issued a show cause
notice to Clearwater.
SEBI’s essential concern
pertained to special rights that Clearwater obtained under its agreement with
Kamat Hotels, and whether that amounted to “control”. The SEBI order notes:
It is observed that the
provisions of the agreement entered into by the Noticees were similar to the
one in Subhkam Case and such provisions have been interpreted by SAT as not
triggering control under regulation 12 of the Takeover regulations, 1997. The apex
court, in the appeal preferred by SEBI, kept the question of law, pertaining to
the effect of such covenants in a shareholders agreement on the “control” of a
company, open and thereby stated that the order passed by SAT will not be
treated as precedent. Thus, what ultimately emerges from the given set of facts
is that the parameters for trigger of regulation 12 were left undecided by apex
court. In this backdrop, I have considered the disclosures made by the Noticees
in the offer document. 
More importantly, the SEBI
order finds that the protective provisions of the agreement relating to
Clearwater’s investment in Kamat Hotels do not amount to “control”. It
observes:
With regard to the issue of
acquisition of control under the inter-se agreement dated August 13, 2010, I
have carefully perused the clauses of the said agreement. It is apparent that the scope of the covenants in general is to enable
the noticees to exercise certain checks and controls on the existing management
for the purpose of protecting their interest as investors rather than
formulating policies to run the Target Company.
Further, I note that the
shareholder agreement got extinguished on July 31, 2014. Thus, the clauses in
the agreement, alleged in the SCN to have conferred “control’ on the noticees,
can no longer be considered binding upon the promoters of the company and hence
is not relevant for consideration at present. [Emphasis supplied]
On this ground, the action
against Clearwater was dropped.
The broader question pertains
to whether this signifies a change in SEBI’s stance and thereby enhances the
permissibility of protective provisions such as veto rights in a manner that
does not amount to conferring “control” upon the investor for purposes of the
SEBI Takeover Regulations. As this
analysis
suggests, at one level this signifies SEBI’s acceptance of protective
provisions in shareholders’ agreements involving listed companies without the
same constituting “control”. However, it may be more prudent to adopt a more
cautious approach. While SEBI has loosened its stance on the issue, it is not
clear whether that constitutes a complete reversal as one might expect. This is
especially because of the fact that SEBI’s position is represented by the
single sentence highlighted in the paragraph above. In other words, SEBI’s
order does not contain the level of reasoning one witnesses in such cases, or
as seen in the SAT’s order in the Subhkam case. Moreover, SEBI’s reasoning is
based on the specific facts of the case, including that the agreement in
question was not meant to be long-lasting, and had in fact on July 31, 2014.
Hence, it will be necessarily to place the importance of the ruling in its
specific context. It might be that the final answer will emerge by addressing
this issues through an amendment to the Takeover Regulations. However, it is
unclear whether such an approach will be forthcoming, especially given that more
than a year has elapsed since the Discussion Paper on Brightline Test was
issued and there has been no further word on how, if at all, SEBI will
implement that proposal.

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

  • SEBI as the regulatory authority over stock markets has presumably, in mind, the principal objective of protecting the larger interests of the investors in listed companies.
    Per contra, it is altogether a different objective, or philosophy, with which the same concept of ‘control’ (or ‘controlling interest’) is pressed into service by the FM, in the income-tax regime, for garnering more and more revenue to the Treasury.
    An instance in recent memory of that kind is the case of ‘Cairns’. For an analytical personal study, look up @https://www.linkedin.com/…/cairns-tax-dispute-update-swamin…

    In both kinds of parallel disputes, in one’s perspective, the very fundamental issue that is still commonly struggling to receive a binding judicial view is, – what is really of relevance and should be the deciding criterion,- is it ‘de facto’ or ‘de jure’ ‘control’ ?

    Any different but better perspective, the enlightened law pundits may have, and wish to share !

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