[The following post is contributed by Supreme Waskar, who is a corporate lawyer in Mumbai.
An earlier post on this topic is available here.]
The existing definition of control under regulation 2(1)(e) of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “Takeover Regulations”), defines “control” in inclusive manner as a right to (a) appoint a majority of directors; or (b) control the management; or (c) control the policy decisions of the target company. Such rights can be exercisable directly or indirectly and can accrue to persons in any manner, including shareholding or contractual rights. Accordingly, for the assessment of acquisition of control, it is simple and straightforward in cases where the rights/control accrues through shareholding/voting rights in the company. However, in cases of rights accruing through contractual agreements, such assessment becomes complex and requires consideration of facts and circumstances on case-to-case basis.
Special Contractual Rights: Protective Rights vs. Participative Rights
Special contractual rights of investors, which are protective in nature as against participative ones, are aimed with the purpose of allowing the investor to protect its investment or prevent dilution of its shareholding in the target company. Looking at the basic principles under the Takeover Regulations and judicial trends, it appears that special contractual rights which provide the investor the power to exercise control over the day-to-day running of the business or the policy making process of the investee company are participative in nature and shall amount to control. Special contractual rights which are protective in nature in nature do not amount to control and may be permissible. However there has been no specific or exclusive list of special contractual rights prescribed by the Securities and Exchange Board of India (“SEBI”), which can be categorized as investor protective rights not amounting to control, or special contractual rights which can be categorized as investor participative rights amounting to control.
SEBI’s Un-executed Attempt to Resolve the Ambiguity
In the background of ambiguities and concerns in relation to permissible investor protection rights, on March 14, 2016 SEBI had initiated a consultation process regarding brightline tests for acquisition of ‘control’ under the Takeover Regulations by way of its discussion paper (“Discussion Paper”). A bright-line test is a simple, clear and objective standard set of rules which can be applied to resolve ambiguous issues by setting a basic standard that clarifies the ambiguity and establishes a simple response. The purpose of a bright-line rule is to produce predictable and consistent results in its application.
Basically, the brightline test was going to set certain fixed rules and an exclusive list of protective permissible rights, subject to certain conditions, which may not amount to control under the Takeover Regulation. In my earlier post here, I had discussed in detail the two broad options/brightline-rules for acquisition of ‘control’ suggested by SEBI in its Discussion Paper i.e. first option – adoption of a numerical threshold of 25% voting rights (“Threshold Option”); or second option – putting in place a framework for permissible protective rights (“Protective Rights Option”). In the Threshold Option, SEBI had proposed a 25% voting rights threshold as the determining factor to identify control. In case of adoption of the Threshold Option, the acquisition of control through other means such as special contractual rights would not trigger control and thereby not necessitate an open offer and reduce the uncertainty in the assessment of acquisition of ‘control’ and bring in the requisite clarity. In the Protective Rights Option, SEBI had proposed an illustrative list of permissible protective rights that will not trigger control subject to satisfaction of certain conditions. In case of that option, investor having the permissible protective rights would continue to be a public shareholder and acquisition of the said rights would not trigger ‘control’.
Full-stop to Brightline Test
On September 8, 2017, after examining the issue closely, and in view of the public comments received on the same and considering the current regulatory environment, SEBI decided not to adopt the brighline test and to continue with the practice of ascertaining acquisition of ‘control’ as per the extant definition in the Takeover Regulation on case-to-case basis.
Implications of SEBI’s Resistance to Adopt a Brightline Test
SEBI has refrained from resolving the ambiguity as to permissibility of protective rights aimed with the purpose of allowing the investor to protect its investment or prevent dilution of its shareholding. Due to SEBI’s resistance to adopt brightline test, the ambiguity will still prevail on whether any contractual right of the investor is protective in nature, which do not trigger control/open offer, or whether any contractual right of the investor is participative in nature and triggers control/open offer. Conservatively, investors will have to seek SEBI’s view on each and every occasion before executing investment agreements in case of listed companies; otherwise, based on existing broad principles and precedents they will have to decide/take a call on the permissibility of protective rights tagged with risk that they might trigger control and an obligation to make an open offer.
– Supreme Waskar