Hostile takeovers are rare in India; there have been only a handful of occurrences over the last few decades. Hence, the announcement by Larsen & Toubro (L&T) yesterday that it intends to launch a takeover of Mindtree set the Indian corporate scene abuzz because the promoters and management of Mindtree have sought to aggressively resist L&T’s attempts. It is billed as the first hostile takeover attempt in India in the information technology (IT) sector.
Hostile takeovers are few and far between in India because most listed companies continue to be promoter controlled. It is difficult for hostile acquirers to obtain control of a company without breaking up the promoter block. However, there are some companies in India that either do not have promoters (i.e., they are management controlled) or where the promoters hold a small percentage of shares that may be inadequate to thwart a hostile bid. In a curious turn of events, both the actors in this episode do not display significant promoter holding. While the acquirer, L&T, does not have any promoter, the promoters of the target, Mindtree, hold a mere 13.32%. Mindtree’s shareholding pattern presents a recipe for a hostile takeover in Indian context.
Given that the takeover has just been launched, it would be too early to make any predictions regarding the outcome. In this post, I propose to discuss some of the key features of the Indian takeover regime that will likely have an impact on the direction this battle may take.
The origin of the transaction can be attributed to the desire of one of Mindtree’s shareholders, Mr. V.G. Siddhartha and his related entities, to liquidate their shareholding in the company. Mr. Siddhartha has been the largest shareholder of Mindtree with a 20.32% stake, although he was not designated as a promoter. The takeover was activated when L&T entered into a share purchase agreement (SPA) to acquire Mr. Siddhartha’s shares in Mindtree at a price of Rs. 980 per share. Being less than the mandatory offer threshold of 25% as prescribed in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “Takeover Regulations), L&T would not have been obligated to make a mandatory offer. However, at the same as it entered into the SPA, L&T also placed an order with a broker to purchase up to 15% shares of Mindtree on the market at a price not more than Rs. 980 per share. It is L&T’s execution of the SPA coupled with its order to the broker that breached the 25% threshold, and hence L&T has announced a mandatory offer to Mindtree’s shareholders for an additional 31% shares at the price of Rs. 980 per share, to be paid in cash.
The transaction structure is an interesting one for a number of reasons. First, it enables L&T to purchase shares in Mindtree through three different modes, viz. (i) SPA, (ii) market purchases, and (iii) mandatory offer, thereby enhancing the likelihood of its obtaining control of the company. Second, L&T potentially had the option of making a voluntary offer after acquiring Mr. Siddhartha’s stake of 20%, but instead it decided to trigger the mandatory offer route by throwing in the market purchases through the broker into the mix. By structuring the offer in this manner, the transaction steers clear of several ambiguities under the Takeover Regulations that are involved in making a voluntary offer, especially when the acquirer holds less than 25% shares in the target (although SEBI has sought to clarify some of these through a set of FAQs).
SEBI’s Takeover Regulations follow the United Kingdom and other common law jurisdictions in adopting the “board neutrality” rule whereby the target’s board has weak powers to intervene in a takeover. Also known as the “no frustration” rule, it prohibits the target’s board from taking any frustrating action without the approval of the shareholders by way of a special resolution through postal ballot. It effectively transfers the power of initiating frustrating actions from the board to the shareholders. Hence, Indian target boards are generally hamstrung in their ability to use defensive mechanisms of the kind that are common in some jurisdictions such as the United States.
The main defence permissible under the Takeover Regulations is the white knight, which has been successfully used in India. This usually involves an acquirer that is friendly to the management or promoters making a competing offer to that of the hostile acquirer, thereby triggering a bidding war for the target’s control. The regulatory stance on white knights is understandable, as it does not permit the target’s board to prevent a takeover, but to generate options for shareholders to choose among competing bidders thereby leaving the ultimate decision to the shareholders.
Given this scenario, the board or promoters of Mindtree will be constrained from deploying or implementing any defensive mechanisms that would stymie L&T’s takeover moves. The principal option for them would be to secure and incentivise a friendly bidder to making an offer that competes with L&T’s. This would depend upon the commercials involved, i.e., whether any other friendly investors, whether strategic (such as another IT company) or financial (like a private equity firm) will be willing to outdo L&T’s offer that stands at Rs. 980 per share and to keep matching any counteroffers that L&T may put forth.
Role of the Target’s Board
Given the resistance displayed by Mindtree’s promoters and management to L&T’s approach, all eyes will now be focused on Mindtree’s board. Under the SEBI Takeover Regulations, while the ultimate decision on whether to sell or hold on to shares rests with the shareholders (which the board cannot interfere with or frustrate), the target’s board nevertheless has a duty to make recommendations to the shareholders on how they should react to the offer. Since the promoters and management are inherently conflicted on matters relating to the takeover, the regulations require the target to constitute a committee of independent directors that will provide reasoned recommendations on such open offer. Such a committee is entitled to seek independent professional advice at the expense of the target. The independent committee will usually seek the advice of a financial advisor on whether the price offered by the acquirer is fair and reasonable to the target’s shareholders. This would form the basic premise upon which the committee would advise the shareholders on whether to accept the offer or not. The committee’s recommendations are advisory in nature rather than binding, thereby leaving the decision to the shareholders to determine the success (or failure) of the offer.
Directors of the target (including members of the independent committee) would also be bound by fiduciary duties, which are codified in section 166 of the Companies Act, 2013. Given the near-absence of hostile takeovers in India, one cannot expect jurisprudence to have developed in this field. Ultimately, the question would be whether the board acted in the interest of the company. As section 166(2) explicitly states, the board would be guided not only by the interests of shareholders, but also other stakeholders such as employees, customers and creditors. It will have to consider whether the long-term interest of the company would be in jeopardy if the takeover offer is allowed to succeed. If the board has adopted a view in good faith that the hostile offer is not fair and reasonable to the shareholders, that finding can operate as a shield for the board to approach a white knight and possibly incentivise such a white knight to make a competing offer.
The prevailing view in leading takeover jurisdictions is, however, that when the board adopts the view that the company is up for sale, then the only duty of the target’s board is to obtain the best price for the shareholders. Referred to as the “Revlon rule”, the directors will then largely be driven by the short-term interests of the shareholders to divest in favour of one of the competing bidders at the best available price. Depending on the path that the L&T-Mindtree saga takes, these duties on the independent committee of the target as well as the entire board would take shape.
Other Factors at Play
As takeover regulation in India preserves the ultimate decision-making to the shareholders, much will be determined by whether some of the large institutional investors of Mindtree find L&T’s offer favourable or not. It turns out that L&T’s offer price is only marginally at a premium to the prevailing market price. Analysts and proxy advisory firms are likely to play an important role in guiding investors’ decisions.
The battle between the raider and the target is likely to be fought across several dimensions. Both are likely to appeal to investors to swing the decision in their favour. They have already begun to call upon the court of public opinion (here and here), given the high stakes involved in the transaction and its impact on the IT industry more broadly. Not unexpectedly, the popular press as well as social media may play a big role in shaping investor sentiment, stakeholder concerns and public opinion.
 SEBI Takeover Regulations, reg. 26(2).
 For a more detailed discussion of this issue, please see the paper on the Nature of the Market for Corporate Control in India (pages 28-30).
I have two questions. One, SAST Regulations require that the committee of independent directors makes recommendations on the open offer to the shareholders of the target company. This suggests that here the constituency that they specifically serve is the shareholders. On the other hand, they are basically acting as a committee of independent directors, they would also be bound by s. 166 of the Companies Act, 2013 which requires them to act in good faith in order to promote the objects for the benefit of certain other stakeholders as well. For example, in case the interests of the shareholders and employees do not align in a takeover context such as these, how do they handle such conflict? If the interests of various stakeholders were always aligned, there would be no need to specifically mention all stakeholder groups.
Two, Revlon Rule definitely makes sense in jurisdictions where the potential acquirer would typically buy out the entire public shareholding. Since none of the current shareholders would stay put in the company, the only relevant factor is the price at which all of them can cash out. This is not the case in India. If L&T is able to complete the takeover as planned, other shareholders would still continue to hold about 33% of the capital. For the shareholders who go out, maximising the exit price is the only relevant consideration. For those who stay behind, long term considerations such as the identity of the acquirer and his post-acquisition plans, impact on employee morale and culture issues will be important in determining the case for acquisition. In fact, assuming the independent directors continue to serve on the Board post-acquisition, they would have a continued fiduciary duty towards the shareholders who stay back, rather than those who go out. The same shareholder may also end up retaining part of his shareholding, either because he did not tender his entire shareholding in the open offer, or the open offer was oversubscribed. How would and should Revlon play out in this context?