Holding Period and Corporate Veil in a Takeover Offer

[Guest post by Vaneesa Agrawal, who is Partner, Suvan Law Advisors. She can be reached at info@suvanlaw.com.]

Last week Supreme Court of India issued a significant judgement in the matter of Laurel Energetics Pvt. Ltd. v. SEBI, Civil Appeal No. 5675 of 2017 on the issue of the interpretation of Regulation 10 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”).

Facts

Indiabulls Real Estate Ltd. (“IBREL”) is a listed company. Laurel Energetics Pvt. Ltd. (“Appellant”) is Wholly Owned Subsidiary of Nettle Construction Pvt. Ltd., which in turn is wholly owned by one Mr. Rajiv Rattan. Rattan India Infrastructure Ltd. is the target company (“Target Company”) in the present case.

In 2011, the board of directors of IBREL framed a demerger scheme by which the power business of the company was to be demerged and would vest in the Target Company. The aforesaid demerger was sanctioned by Delhi High Court and an Information Memorandum (IM) in terms of the listing agreement was filed by the Target Company, pursuant to which it was listed on BSE & NSE on 20 July 2012. The Appellant acquired 18% of the equity shareholding of the Target Company at a price of Rs. 6.30 per share sometime in July 2014. On 20 October 2015, Laurel and Arbutus Consultancy LLP along with various other entities, who were persons acting in concert (“PACs”), made a public announcement under Regulation 15(1) of Takeover Code, when an open offer was made for the acquisition of 35,93,90,094 equity shares of the Target Company from the equity shareholders of the Target Company at the price of Rs. 3.20 per share.

By a letter dated 04 December 2015, the Securities and Exchange Board of India (“SEBI”) observed that the exemption provisions contained in Regulation 10 would not apply to the 2014 acquisition, as a result of which the price of Rs. 3.20 per share was not accepted and the higher price of Rs.6.30 was stated to be the amount to be paid to the equity shareholders of the Target Company. By a letter dated 5 May 2016, containing SEBI’s Order, SEBI stated:

It has been observed that the acquisitions made through inter se transfers amongst promoters on July 9, July 10, 2014 September 5, 2014, and October 20, 2014, were not exempted from open offer obligations. You are advised to revise the Offer Price accordingly. Further, along with the consideration amount, you are advised to pay a simple interest of 10% per annum from the scheduled date of payment of consideration based on these triggering dates to the actual date of payment of consideration to the shareholders who were holding shares in the Target Company on the date of violation and whose shares are accepted in the Open Offer, after adjustment of dividend paid, if any. You are also advised to enhance the financial arrangements and the amount maintained in the escrow account in terms of the revised Offer Price and the revised Offer Size, if any.

An appeal against the SEBI communication was dismissed by Securities Appellate Tribunal (“SAT”) holding that Regulation 10 did not exempt the acquisitions of 2014, as a result of which the price payable per share necessarily became Rs. 6.30 instead of Rs. 3.20 per share. SAT’s order has been analyzed on this Blog here.

Appellant’s Threefold Arguments

1.     Object of the Regulation: Regulation 10 must be construed taking into account its object. When this is done, it is clear that the promoters of IBREL were the same right from the date of its incorporation, and  they continued as such even after the demerger into the present Target Company. The Regulation should be read in accordance with the object sought to be achieved, which is that where there is stability in the company and the promoters in that company do not change for a period of three years or more, inter se transfers between them at prices agreed to between them should be exempt from the Takeover Code. At no point of time have the promoters of the power business of IBREL and now of Target Company ever changed. Therefore, the object of the regulation is that promoters should not keep changing, and if on facts it is found that the same set of promoters continue, such cases should be exempted.

2.   Committee Reports: The Appellant sought to reply upon Reports of Achuthan Committee and Bhagwati Committee to show that the object of Regulation 10 is not to penalize persons who had remained in control of a particular business entity, notwithstanding that it may ultimately change form. Had no demerger taken place, it would be clear that the promoters of IBREL, having been promoters for over three years, would be exempt from the Takeover Code, in which case the 2014 purchases could not be taken into account for the purpose of the present open offer.

3.        Supreme Court Precedents: Various judgments hold that a mere change in form from a partnership firm into a limited company would not necessarily lead to the conclusion that, under various State Rent Acts, a sub-tenancy had taken place. These judgments would apply on the facts of the present case in as much as, at no point of time, have the promoters of the power business of IBREL and now of Rajiv Rattan ever changed.

SEBI’s Arguments:

1.     A well-reasoned SAT judgment ought not to be interfered with unless found to be perverse under 15-Z of the SEBI Act.

2.     It is not possible to go to the object of a provision when the language of the said provision admits of no doubt.

Applicable Provisions of the Takeover Code

Definitions.

2(z) “target company” means a company and includes a body corporate or corporation established under a Central legislation, State legislation or Provincial legislation for the time being in force, whose shares are listed on a stock exchange;”

General exemptions.

10. (1) The following acquisitions shall be exempt from the obligation to make an open offer under regulation 3 and regulation 4 subject to fulfilment of the conditions stipulated therefor,—

(a) acquisition pursuant to inter se transfer of shares amongst qualifying persons, being,—

(i)    immediate relatives;

(ii)  persons named as promoters in the shareholding pattern filed by the target company in terms of the listing agreement or these regulations for not less than three years prior to the proposed acquisition;

Judgement & Analysis

The Supreme Court dismissed the appeal while upholding the SEBI and SAT orders, providing three-fold reasons:

Lifting of Corporate Veil Not Envisaged

1.        The target company is clearly defined and “means” only Rattan Limited. To go behind Rattan Limited would not only be contrary to the clear language of Regulation 10(1)(a) but would also introduce a concept, namely lifting the corporate veil by the Court, contrary to the Regulation 10(1)(a) itself. Regulation 10 also contains sub-regulation (iii) which, in the circumstances specified, lifts the corporate veil. Sub-regulation (iii) is set out hereinunder:

(iii) a company, its subsidiaries, its holding company, other subsidiaries of such holding company, persons holding not less than fifty per cent of the equity shares of such company, other companies in which such persons hold not less than fifty per cent of the equity shares, and their subsidiaries subject to control over such qualifying persons being exclusively held by the same persons;

A reading of this sub-regulation would show that holding companies and their subsidiaries are treated as one group, subject to control over such companies being exclusively held by the same persons. This shows that it has been statutorily recognized in sub regulation (iii) that in a given situation, namely holding-subsidiary relationship, the corporate veil would be lifted. Moving on to sub-regulations (iv) and (v), it is clear that these two sub-regulations follow the pattern contained in sub regulation (ii) in as much as when it comes to PACs, the period should be not less than three years prior to the proposed acquisition, and disclosed as such pursuant to filings under the listing agreement. Also, when it comes to shareholders of a target company who have been PACs for a period of not less than three years prior to the proposed acquisition and are disclosed as such pursuant to filings under the listing agreement, the corporate veil is not lifted. The difference between sub-regulations (ii), (iv) and (v) on the one hand, and sub regulation (iii) on the other, again shows us that it is impermissible for the court to lift the corporate veil, either partially or otherwise, in a manner that would distort the plain language of the regulation. Where the corporate veil is to be lifted, the regulation itself specifically so states.

Even on Facts 3-year Holding Period Not Complete

2.       Coming back to Regulation 10, it is thus clear that persons named as promoters in the shareholding pattern filed by the Rattan Company in terms of the listing agreement between the two stock exchanges is what is to be looked at. And for this purpose, persons must be promoters of the Rattan Company for not less than three years prior to the proposed acquisition in order that the exemption under Regulation 10 would apply. On the facts of this case, therefore, the information memorandum having been filed on 19 July 2012 pursuant to which listing took place one day later, is the relevant date from which this period is computed. This being the case, three years had not elapsed on 9/10 July 2014, which was the date on which the earlier purchase of shares had taken place.

Precedents Distinguishable

3.     The cited judgements do not advance the Appellant’s case in as much as it is not possible to construe the regulation in the light of its object when the words used are clear. This statement of the law is of course with the well-known caveat that the object of a provision can certainly be used as an extrinsic aid to the interpretation of statutes and subordinate legislation where there is ambiguity in the words used. According to Supreme Court, the literal language of the regulation clear and beyond any doubt. The language of sub-regulation (ii) becomes even clearer when it is contrasted with the language of sub-regulation (iii).

This is a significant judgement from Supreme Court on the relevance of the three-year holding period especially in cases of indirect listing under the process of a corporate restructuring and lifting of corporate veil for the purposes of mandatory takeover offer. Unfortunately, Supreme Court did not delve into an aspect of SAT Order whereby SEBI disowned the view under an Informal Guidance taken by an official of SEBI saying it as “a mistake made by an officer”. The Supreme Court, in my respectful submission, also lost an opportunity to describe the legal status of informal guidance issued by a department of SEBI and to set right the frequent differing views adopted under the Informal Guidance Scheme, creating more confusion than guidance.

– Vaneesa Agrawal


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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