[Shreya Goyal is a 4th student at the West Bengal National University of Juridical Sciences, Kolkata]
The SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 govern the acquisition of shares in listed companies in India. These Regulations (and their predecessors) have been tested during many corporate takeover battles in India. In the recent takeover episode between L&T and the promoters of Mindtree, the role of independent directors of the target company came to the forefront, especially because it was an unsolicited takeover. The independent directors’ recommendation to shareholders was that the price offered is ‘fair and reasonable’. However, this poses an interesting question: is the role of independent directors limited to a comment on the price of the offer? In this post, I attempt to explain the law pertaining to the role of independent directors in offering their recommendation to the shareholders. I examine the difference between the law in the United Kingdom (UK) and India law and highlight the flaws in the present format prescribed by the Securities and Exchange Board of India (SEBI).
The board of directors owe fiduciary duties under section 166 of the Companies Act, 2013, which they must comply with at the time of an open offer for the target company. However, regulation 26(7) of the Takeover Regulations lays an additional obligation on the independent directors. It lays down a mandatory requirement on the committee of independent directors (IDC) to provide “written reasoned recommendations on the open offer to shareholders of the target company.” The IDC hence has to give reasons for their opinion on the recommendations. However, the Takeover Regulations do not clarify what factors the IDC should consider before making a recommendation. There has been no litigation pertaining to the recommendations of the IDC in India, unlike the UK that has already witnessed a catena of cases challenging the recommendations of the target’s board.
The Law in the UK
The number of takeovers in the UK is increasing and the role of the target’s board in a takeover bid has become ever more complex and challenging. The City Code on Takeover and Mergers (City Code) lists down the duties of the board, according to which the board is expected to provide sufficient information and advice to enable shareholders to reach an informed decision. This advice and sufficient information should be sent in a circular to the shareholders of the target company within 14 days of the publication of the offer document in terms of rule 25.1 of the City Code.
The most pertinent provision however is rule 25.2. This rule makes it necessary for the board to set out its opinion and give reasons for the same. It requires the board to give its views on implementation of the offer on all aspects of the company’s interests, specifically employment. It additionally requires to board to disclose the acquirer’s strategic plan for the company. Part b of rule 25.2 obliges the board to include the advice of the independent adviser with respect to the takeover bid taken. Even though the rules clearly states the contents of the circular to be distributed, the factors the director must consider before giving an opinion on the offer still remains a debatable question. The notes on rule 25.2 provide some clarity in this respect. The notes state that the board can consider any factor it deems relevant while forming its opinion. It clearly mentions that ‘offer price’ may not be a determining factor. While the City Code is clear that price need not be the only factor, it does not mention the other relevant factors the board could take into account. A few judgments challenging the recommendation of board consider certain relevant factors. These factors could be considered by the board, depending on the facts and circumstances of the open offer.
In Heron International v. Lord Grade, the Court evaluated factors such as (a) financial state of the company with respect to the investment needed in the target company, (b) whether an overhaul is needed in the management of the company, (c) whether there was a danger of an offer being revoked, and (d) the chances of success of competing offers. In Gething v. Kilner, [1972] 1 All ER 1164, the shareholders challenged the recommendation on grounds that the board did not include their reasons for rejecting the advice of independent financial advisors. The Court ruled that, as the offer was prime facie an advantageous offer, the directors could not be said to have acted unreasonably. Thus, as the directors had taken the advice of financial advisors, they could not be said to have breached their fiduciary duties.
Directors owe a fiduciary duty to the company under section 172 of the UK Companies Act, 2006 to consider its best interests. From the trend of the court judgments, one can conclude that the board is expected to take into consideration before accepting any offer: (i) the financial position of the company, (ii) the management position of the company, (iii) chances of the offer getting revoked, (iv) other possible offers in the market, and (v) the highest bidder. The directors are obligated to provide their opinion and sufficient information to the shareholders to reach an informed decision. The directors of the target company should give careful consideration before they enter into any commitment with an offeror. This could restrict their freedom to advise their shareholders in the future, thus resulting in a breach of their fiduciary duties.
The Indian Scenario
In India, only the independent directors are bound to give a recommendation to the shareholders as opposed to the approach in the UK, where the entire board gives its recommendation. There is no mandatory obligation on the IDC to seek advice from financial advisors and mention it in the recommendations, unlike obligations under the City Code. In India the only obligation on the IDC is to give recommendations in the prescribed form, and publish it.
Obligations under the SEBI format
The prescribed form has various categories that requires the IDC to disclose their relationship with the target company and the acquirer, reveal whether they have any shares in the target company or the acquirer, and bring to light details of independent advisors if any. Item 11 of the prescribed form requires the IDC to give their recommendation as to whether the offer is fair and reasonable or not. Item 12 requires a summary of the reasons for the recommendation. According to the note in the prescribed form the IDC has the discretion to add any other information under the headings provided, which is relevant for the shareholders to make an informed decision. However, in practice, only bare minimal information is provided. This has neither been questioned by SEBI nor challenged in any court.
Recommendations in the previous years
On previous occasions, the IDC has only evaluated whether or not the offer price is ‘fair and reasonable’. The IDC only comments on the fairness of the price. Typically the criteria used for determining fairness are: (i) compliance with pricing parameters under regulation 8 of the Takeover Regulations, (ii) the latest market price of the shares and (iii) the book value of the target to determine the fairness of the offer price. In most of the past open offers, the IDC has provided its written reasoned recommendations in favour of the open offer.
In the past three years there has only been one exception to the ‘rule’ of giving recommendation based on the price of the offer. This was in the case of the open offer of Jyoti Limited, where the IDC recommended against accepting the offer. The reasons cited were that the open offer may not remain valid because of material misstatements in the draft letter of offer regarding statutory approvals received before the offer. In all other recommendations, the IDC has only deliberated on the price of the offer, unlike the UK where the board is mandatorily required to provide the effects of the offer on the company and employment.
The flawed approach
The SEBI-prescribed form requires the IDC to give their recommendation on whether the offer is fair and reasonable. It does not require the IDC to give its views on the effects of the offer on the company’s interests or the acquirer’s plan for the target. Even though IDC carries various fiduciary duties under section 166 of the Companies Act, 2013, these duties effectively seem to take a backseat in case of a takeover. Under section 166(2) it is the directors’ duty to consider the best interests of the company and its employees. They are obligated to promote the best interests of the company. However the norm followed in India seems to suggest that the IDC is only responsible for ensuring the shareholders get the best price in the event of an open offer. To ensure the offer and its effects are completely transparent before the shareholders, additional requirements must be laid down by SEBI. The IDC must be obligated to give its views on: (a) the effects of the offer on employment, (b) effects of the offer on other interests relating to the company, (c) the plan of the acquirer for the target and (d) matters relating to the acquirer’s business.
The change in the SEBI format of submitting recommendations could help minority shareholders take a decision based on factors other than price. The present format is based on the assumption that shareholders only invest for the returns; however, it does not take into account shareholders who interests in the long-term future of the company may extend beyond that. Thus, the changes recommended will serve the interests of a larger category of shareholders. Hence, based on my analysis, I would suggest that SEBI add additional disclosure requirements to be complied by the IDC.
– Shreya Goyal