The Securities and Exchange Board of India (“SEBI”) on 22 April 2020 issued a consultation paper for easing pricing norms for preferential issues in companies having stressed assets. It aims to provide objective criteria for classifying a company as ‘stressed’. The document issued by the securities regulator also proposes a relaxation of the open offer requirement in such companies.
Criteria to identify a stressed company
The consultation paper designates a company as ‘stressed’ if it satisfies any two of the following three conditions:
- the listed company has made a disclosure of defaults for two consequent quarters on payment on interest or repayment of principal amount on loans from banks or financial institutions and listed and unlisted debt securities in accordance with the mandate of the SEBI Circular dated 21 November 2019;
- the borrower company comes within the ambit of an inter-creditor agreement in terms of the RBI Prudential Framework for Resolution of Stressed Assets dated 7 June 2019; and
- the listed company has been subject to a severe downgrading of credit rating of the listed instruments to grade “D”.
SEBI has identified that listed companies which are under financial distress require an urgent infusion of funds. The securities regulator considers the existing norms of raising capital as a major impediment. Defaults in servicing debts and disclosure of financial results have also aggravated the crisis. As a consequence, the prospects of such stressed companies in the capital market have suffered.
SEBI is of the view that an inadequate flow of funds can have a detrimental effect on the operations of the companies. As a consequence, the entities may be pushed to the brink of an insolvency or bankruptcy claim. Therefore, SEBI has proposed suitable exemptions to the regulations concerning preferential allotment to offer the stressed companies an opportunity to revive their fortunes.
Exemptions from pricing norms proposed
Regulation 164(1) of the SEBI (Issue of Capital and Disclosures Requirement) Regulations, 2018 (the “ICDR Regulations”) currently imposes an onerous obligation that the issue price shall not be less than average of the weekly high and low for a period of twenty-six weeks and average of the weekly high and low for two weeks preceding the date of preferential allotment. Regulation 158(2) of the ICDR Regulations only offers an exemption from fulfilling the pricing norms when the preferential issue has been made in pursuance of a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 (“IBC”).
According to SEBI, the “significant latency in the pricing period” leads to a wide gap in between the pricing at the beginning of the twenty-six week period and the current price when the company raises funds. The sweeping nature of the pricing norm thus works against the interests of stressed companies, as their financial condition deteriorates with the passage of time. Subsequently, the sharp decline in prices disincentivizes investors from acquiring shares at a higher value and deprives the company of utilizing the preferential allotment route for raising funds.
Furthermore, SEBI has observed that the limitation of preferential issues to five qualified institutional buyers in regulation 164(4) of the ICDR Regulations is also a major hindrance for a stressed company to infuse capital. Therefore, the regulator has proposed an exemption in the pricing norms for stressed companies. The pricing of preferential issues will not be less than the average of the weekly high and low of the volume weighted average prices of the concerned equity shares quoted on a recognized stock exchange during the two weeks preceding the relevant date of issue. The exemption seeks to provide greater leverage to the many businesses under severe financial stress to attract investors and alleviate their plight.
Exemption from open offer
SEBI has also taken cognizance of the need to utilize the investment potential of investors who already have a substantial holding in a stressed company. Such an investor is shackled by the obligation in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SAST Regulations”) to make an open offer in accordance with regulations 7 and 8 for breaching the 25 percent voting rights threshold.
The mandatory requirement of an open offer has been perceived by SEBI to be a major obstacle against a viable financial stimulus that may be extended to the stressed company by existing investors. Therefore, the consultation paper offers a blanket exemption from making an open offer for the allottees of preferential issue in stressed companies if the acquisition exceeds the 25 percent limit in regulation 3(1) of the SAST Regulations.
Procedural compliances for corporate governance
SEBI’s consultation paper also lays down additional criteria to safeguard the interests of minority shareholders. It specifies that the preferential issue can only be made to persons or entities that are not a part of the promoter or promoter group on the relevant date of a board meeting. The resolution for preferential issue and the exemption from open offer must subsequently be approved by a majority of minority shareholders. The promoters or promoter group or any proposed allottee who already holds securities in the listed company prior to the preferential issue will not be included in such a majority grouping.
Furthermore, the consultation paper also imposes a disclosure requirement that will incorporate the proposed use of preferential issue proceeds in the explanatory statement submitted for shareholder resolution. This facilitates greater transparency in the preferential allotment process and adds to the confidence of minority shareholders.
Conclusion
SEBI’s consultation paper comes at a critical time when the government has decided to suspend insolvency filings for six months in view of the Covid-19 pandemic. It is a welcome step as it could clear the regulatory hurdles that dissuade investors from providing any major impetus to businesses under dire financial stress. Therefore, if the proposals advanced materialize into a set of concrete amendments to the existing regulations, they could offer a window for stressed companies to tide over their difficulties in the long-term. It remains to be seen what response the consultation paper evokes from the companies reeling under loan obligations in key sectors of the Indian economy.
– Rongeet Poddar