Promoter Exits in India: Reined by the Market Watchdog?

[Guest post by Malek Shipchandler,
who practices law with a firm in Mumbai. Views are personal and do not
necessarily represent those of the firm.]
It was reported
last week that the Securities and Exchange Board of India (SEBI) is likely to
relax rules pertaining to promoter reclassification in listed companies. An
article co-authored by Gaurav Malhotra
and I for the Oxford
Business Law Blog
in December 2016 on this theme had endeavoured to
argue that the requirement of obtaining shareholders’ approval for
reclassifying promoters into the public category (pursuant to an open offer or ‘in
any other manner’) is counter-intuitive and therefore otiose. The article also
touched upon the apparent lacuna in the rules which do not explicitly provide a
route for promoters holding minimal (or even nil) shareholding to convert
themselves into the public category – except by way of seeking SEBI approval
through the informal guidance mechanism or approaching the stock exchanges. It
is hoped that SEBI irons out these wrinkles while reviewing the promoter
classification rules. For the benefit of readers, we set out below the text of our
previous article.
__
Most Indian listed companies are run
by promoters who are a set of persons and/ or families having effective control
over a listed company. The Securities and Exchange Board of India (SEBI),
the securities market regulator, has historically been wary of investor
protection issues that may arise between promoters of listed companies and
public shareholders. This is evident by the fact that SEBI, in the past year
itself, has restricted promoters from changing the objects of an issue as
stated in the issue prospectus (unless shareholder approval is obtained) and
barred promoters of companies undergoing compulsory delisting from receiving
shareholder benefits and being appointed as directors of other listed
companies.
The term ‘promoter’ has been defined
under Section 2(69) of the Companies Act, 2013 and Regulation 2(1)(za) of the
Securities and Exchange Board of India (Issue of Capital and Disclosure
Requirements) Regulations, 2009 to broadly mean persons having ‘control’
over a company. The shareholding pattern of listed companies is primarily
classified into two categories viz. promoter and public. Entry into
the promoter club has never been barred (as anyone who gains control over a
listed company, irrespective of shareholding, is categorized as a ‘promoter’)
and formal guidelines for exiting the promoter club did not exist until
September 2015.
SEBI introduced provisions relating
to promoter reclassification into public shareholders under the SEBI (Listing
Obligations and Disclosure Requirements) Regulations, 2015 (Listing Norms). Regulation 31A of the Listing Norms deals
with disclosures and conditions for reclassification. Regulation 31(A)(5) of
the Listing Norms requires a listed company to obtain shareholders’ approval
for the reclassification of its exiting/ selling promoter into a public
shareholder occurring due to control being established over the listed company
by an incoming promoter/ acquirer via (i) an open
offer in accordance with the Indian takeover code or (ii) in
any other manner. In addition, the exiting/ selling promoter is required
to, inter alia, have no more than ten percent shareholding in the
listed company, and abandon any special rights vis-à-vis the
listed company, established through formal or informal arrangements.
For those who may be less familiar
with the concept of an ‘open offer’, it is a procedure required to be
undertaken to acquire control over a company by triggering thresholds
prescribed under the Indian takeover code. The open offer procedure requires
the incoming promoter/ acquirer to provide an exit option to the existing public
shareholders of the listed company by offering to buy their shares – after
giving numerous disclosures and assurances in the open offer documents under
the regulatory scrutiny of SEBI. The expression ‘in any other manner’ would
appear to refer to methods such as court-blessed schemes of arrangements and
Reserve Bank of India regulated strategic debt restructuring schemes that can
facilitate the establishment (and replacement) of control over a listed
company. These schemes are exempt from open offer obligations under the Indian
takeover code as they already involve regulatory/ judicial oversight and/ or
approval of shareholders.
Interestingly, SEBI through its
recent informal guidance letters, has allowed existing promoters holding nil or
minimal shares to exit without obtaining shareholders’ approval – this appears
to be in sync with the Listing Norms (Regulation 31A(5) requires approval of
shareholders only when the promoter is being ‘replaced’).
Despite SEBI’s efforts to streamline
promoter reclassifications, there appear to be certain lacunae. It appears odd
and to an extent, even counter-intuitive, for the law to (a) require
shareholders’ approval in relation to reclassification of exiting/ selling
promoters into public shareholders pursuant to an open offer, when in fact the
law already provides the shareholders with full information/ disclosures about
the transaction (triggering such change in control) coupled with a fair option
to exit the listed company (in case of ‘open offer’) and an opportunity to
approve/ decline such replacement when put to vote (in case of ‘any other
manner’) and (b) allow an existing promoter with nil or
minimal shareholding to exit the listed company without shareholder blessing.
Delving into this apparent lacuna, a
scenario may be envisaged wherein shareholders show reluctance to give their
approval for reclassification after the exiting/ selling promoter has
transferred the entire stake to the incoming promoter/ acquirer (the earliest
this transfer may take effect under law based on the open offer procedure is
twenty-five working days after the signing of the acquisition agreement). This
would essentially translate into a situation wherein the exiting/ selling
promoter may continue having legal obligations as a ‘promoter’ along with the
incoming promoter/ acquirer despite not holding any shares.
From a M&A transaction
perspective where ‘conditions precedents’ are at the heart of any acquisition
agreement, the shareholders’ approval for reclassification being made a
condition precedent for the share transfer to occur may not be feasible, as a
shareholding of less than ten percent by the exiting/ selling promoter is a
prerequisite for seeking reclassification.
An escape from the aforesaid
situation can perhaps be found, oddly, through a literal interpretation of
Regulation 31A(2)–(3) of the Listing Norms coupled with a reading of the recent
SEBI informal guidance letters.
Through this route existing promoters can seek reclassification by approaching
the stock exchanges – without shareholders’ approval. As such, to obviate the
need for obtaining shareholders’ approval under Regulation 31A(5) of the
Listing Norms or on being refused such shareholders’ approval, the literal law
seemingly allows the exiting/ selling promoter to approach the stock exchanges
under Regulation 31A(2)–(3) of the Listing Norms to seek reclassification –
without obtaining shareholders’ approval. It should be acknowledged however
that this approach ostensibly defeats the spirit of Regulation 31A(5) of the
Listing Norms, which requires the exiting/ selling promoter to obtain
shareholders’ approval.
On a related note, Regulation 31A(5)
of the Listing Norms provides for “re”classification i.e. changing the status
of a shareholder from ‘promoter’ to ‘public’ and not “de”classification i.e. a
situation where the exiting/ selling promoter sells the entire shareholding to
the incoming promoter/ acquirer. However, on perusal of certain recent
transactions triggering an open offer, it can be seen that exiting/ selling
promoters are adopting the approach of obtaining shareholders’ approval despite
having transferred or agreed to transfer their entire shareholding to the
incoming promoter/ acquirer. This approach seemingly blessed by SEBI (considering,
open offers are overseen by SEBI) and reflecting its “once a promoter, always a
promoter” psyche is, respectfully, preposterous and needs correction before a
precedent is etched.
Having been established with the task
of protecting the interests of public investors and the development of the
Indian securities market – has SEBI, in its sincere effort, baked half-hearted
guidelines on promoter exits?
– Malek Shipchandler

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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