SEBI on “Control”: Financing vs. Acquisition

Background and Context

Under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and its previous version of 1997, it is possible for a person to trigger the mandatory takeover offer requirement even without acquiring a single share in the company. This is because the person may be in “control” of the company as defined in the Takeover Regulations, which is determined qualitatively by looking at the facts and circumstances of each case.

The “control” trigger for mandatory offers has been a vexing one ever since it was introduced under the law. Given that the regulator, the Securities and Exchange Board of India (SEBI), can exercise considerable discretion in determining when a person is said to be in control, it has generally not found favour with market participants. Numerous efforts were made to streamline the rather over-broad definition of “control” under the Takeover Regulations, but they have been in vain. Failed regulatory and adjudicatory efforts abound. While the Securities Appellate Tribunal (SAT) sought to provide an element of concrete guidance in the Subhkam case, the Supreme Court set at naught the effort as the matter was settled on appeal. In the meanwhile, the Takeover Regulations Advisory Committee (TRAC) that recommended the provisions of the 2011 Takeover Regulations did not attempt to address the question of control as the ball was then in the Supreme Court. Finally, SEBI too sought to exemplify the aspect of control by coming up with a discussion paper, but it has failed to follow through with the matter.

Under the current dispensation, therefore, not only is the definition of “control” sufficiently vague in nature, but it confers significant discretion on SEBI to interpret the term. Hence, parties are required to exercise caution while entering into arrangements relating to shares of listed companies, lest they unwittingly trigger the mandatory takeover offer requirements. In some cases, for instance take the Jet-Etihad case, parties have even been willing to give up on rights under contractual arrangement lest they invoke the mandatory offer trigger.

It is in this background that SEBI last week issued an order involving New Delhi Television Limited (NDTV) in which it required Vishvapradhan Commercial Private Limited (VCPL) to make a mandatory takeover offer to the shareholders of NDTV in view of financing arrangements it entered into with the promoters of NDTV. This is an illustration of the type of concerns that may arise due to the broad and ambiguous nature of the definition of “control” in the Takeover Regulations.

SEBI Order

In the NDTV case, in 2008 the promoters, being RRPR Holding Pvt. Ltd (RRPR), Prannoy Roy and Radhika Roy, made an open offer to acquire shares in the company. While the promoters obtained financing from various sources for making the offer, in question is a loan of Rs. 350 crores taken from VCPL. The loan and allied arrangements between NDTV’s promoters and VCPL were quite elaborate. For instance, VCPL obtained warrants in RRPR which conferred upon it the right to convert those warrants into 99.99% of the equity share capital of RRPR. Moreover, VCPL had a purchase right by which it could acquire the shares of RRPR from its shareholders. In addition, VCPL obtained a call option in respect of shares that RRPR held in NDTV. All of these shareholding rights were further buttressed by veto rights that VCPL obtained by which several actions could not be carried out by RRPR (and, to a lesser extent, NDTV) without the prior approval of VCPL. In this milieu, the essential question that SEBI considered based on its investigation is whether this package of rights conferred VCPL with “control” in respect of NDTV, which is a listed company.

Based on the submissions and arguments of the parties and SEBI’s own analysis, the issue boiled down to whether the aforesaid arrangements were in the nature of a financial transaction (whereby VCPL simply financed NDTV’s promoters for acquisition of shares in the company) or whether it was an acquisition transaction (by which VCPL sought to acquire control over the company). In answering the question, SEBI essentially reviewed the transaction documentation before coming to the conclusion that the transaction related to an acquisition by VCPL (rather than a pure financing) and hence it is required to make a mandatory offer to acquire shares from the other shareholders of NDTV. SEBI found that the combination of the various transactional arrangements conferred VCPL with “control” over NDTV.

SEBI was guided substantially by the fact that the various rights given to VCPL as described above (e.g. conversion, purchase, call, etc.) were exercisable “at any time during the tenure of the Loan or thereafter”. In other words, the exercise of these rights were not directly linked to the failure of the promoters to repay the loan. Using this, SEBI concluded that the transaction was one of acquisition in the garb of a loan or asset recourse lending transaction.

Some of SEBI’s observations are worth quoting:

23. All the aforestated concerns attached to the manner in which the loan agreements and call option agreements were entered into and the subsequent conduct of the noticee do not substantiate its argument that the transaction was only in the nature of a loan. Instead, it appears that the loan agreement and call option agreements were used to shroud the true nature of the transaction which was acquisition of beneficial interest in NDTV Ltd. The elaborate mechanism adopted by the noticee and its associates appear to be solely to deflect attention from this acquisition and thus covetously overcome the obligations imposed by the Takeover Regulations.

24. In effect, the transaction is not to secure the loan but to acquire control over all the affairs of the Target Company leaving only the right to control the “editorial policies of NDTV” to the Promoters and Borrowers, right from the day of execution of the loan agreement. Thus in my view, the takeover exercise has been conveniently couched as a loan agreement with the predominant intention of the Noticee being to acquire control over NDTV without contemplating any repayment of the loan, whatsoever, from the Promoters or Borrowers. The transaction documents admittedly confer Conversion Option, Purchase Option and the Call option, and if the voting rights is to give full effect to the Transaction Documents, it would straightaway mean that the 52% of the voting rights of NDTV have to be exercised by the Promoters as per the dictates of the Lender and the same may traverse the specified Veto rights under Schedule 3.

Accordingly, SEBI ordered VCPL to make a takeover offer to the shareholders of NDTV within 45 days from the date of the order.

Impact

SEBI’s order continues to raise concerns relating to the interpretation of the definition of “control” under the Takeover Regulations. It has arrived at its conclusion only based on a documentary examination. For example, it did not matter that VCPL has not in fact exercised any of the rights (such as conversion, purchase and call option). The existence of the rights is sufficient to constitute control, and the actual exercise appears entirely irrelevant. Although VCPL’s legal team had raised concerns in relation to the lack of proper investigation and also the inordinate delays in initiating action (given that the transaction in question occurred in 2008), SEBI refuted these objections. SEBI also refused to be drawn in to a discussion of other cases where SEBI found to the contrary based on an examination of the facts of the case. For example, SEBI arrived at a contrary conclusion in the Kamat Hotels case, although that does not find a mention in the present order.

Given these circumstances, the matter is certainly likely to go up on appeal. Until then, the SEBI order has the effect of exacerbating the confusion surrounding the element of “control”. It reinforces the considerable discretion the regulator possesses in interpreting the expression in the context of the facts and circumstances, usually based on the contractual arrangements between the parties. In terms of novelty, it has the effect of providing some guidance on distinguishing between financing and acquisition transactions. Market players will need to structure financing arrangements carefully to avoid its recharacterization as an acquisition of control, a fate suffered by the present case.