Promoter-Friendly Amendments to the SEBI Takeover Regulations

Cash-starved companies are presently considering raising funds through various means during the economic downturn. When it comes to equity funding, the natural option would be to rely on their promoters to infuse more capital. Towards this end, the Securities and Exchange Board of India (SEBI) on 16 June 2020 issued amendments to the SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 2011. These first of two amendments increases the creeping acquisition limits under regulation 3 from 5% per financial year to 10%. However, this dispensation is temporary: it is limited to the financial year 2020-21, and covers only acquisition of shares by promoters in a preferential issue.

The second amendment relates to voluntary offers under regulation 6 by shareholders already holding more than 25% shares. The regulation permits de facto controllers such as promoters to make voluntary offers for an additional 10% shares in the company. However, acquirers who have acquired shares in the target in the preceding 52 weeks without triggering the obligation to make a takeover offer (for example, acquisitions under the creeping acquisition mechanism) are disqualified from making a voluntary offer under regulation 6. By way of the amendment, SEBI has relaxed this disqualification temporarily until 31 March 2021.

A combination of the amended regulations effectively offer promoters who hold between 25% and 75% shares in the company three different routes to enhance their stake during the period for which the amendments operate. First, they can acquire up to 5% shares within a financial year under the pre-existing creeping acquisition mechanism, which they can do so from the market or through negotiated purchases from existing shareholders. Second, they can acquire an additional 5% shares through a preferential issue of shares by the company under the new window created for the purpose. Alternatively, they can combine the first and second steps above, and acquire 10% through a preferential issue. Third, they can make voluntary offers for at least 10% shares under regulation 6, even if they have already acquired shares under the first two routes in the recent past. While this indeed enhances the ability of companies to raise capital in a difficult environment, it raises some issues as to why the dispensation is limited to promoters and cannot be extended to fund-raising from other investors as well.

Creeping Acquisitions and their Discontents

The creeping acquisition mechanism available under regulation 3(3) provides that any person holding between 25% and 75% shares in the company is entitled to acquire up to 5% voting rights during each financial year without triggering the MBR. If such an acquirer breaches this annual limit, it will have to make an offer to the other shareholders to acquire at least another 26% shares on a pro rata basis. This suggests that any incumbent already holding de facto control over the company may entrench itself further through gradual bite-sized acquisitions, a facility unavailable to outside acquirers.

Creeping acquisitions have attracted some level of controversy as they are an incumbent friendly measure. They enable those who are already in control of the company, such as promoters, to gradually increase their stake without the obligation of making a takeover offer to the other shareholders. This facility is not available to others, who will need to make an offer when they cross the threshold of 25% shares in the company. Interestingly, the fact that creeping acquisitions are promoter-friendly is writ large in the regulatory process from the very outset. For example, the Bhagwati Committee report of 1997 (in paragraph 6.2) “appreciated the fact that in a competitive environment, it may become necessary for person(s) in control of the company to consolidate their holdings either suo moto or to build their defences against takeover threats.” Furthermore, the report of the Takeover Regulations Advisory Committee in 2011 “underscored the fact that the creeping acquisition route is meant to facilitate consolidation by persons already in control or holding substantial number of shares. Therefore,  the  Committee  does  not  find  it  necessary  to  disturb  the  current policy  in  this  regard”. It is evident that creeping acquisitions have also been considered as defensive mechanism for promoters. It is in this background that one must consider the recent changes introduced by SEBI.

The Pro-Incumbency Effect

If creeping acquisitions attract criticism on the ground that they are incumbent-friendly, SEBI’s current amendments are likely to make those voices shriller. For example, creeping acquisition enables promoters to shore up their holdings during a downturn at attractive prices, and that facility has only been enhanced now. Such an enhancement is not novel, as SEBI had previously raised the creeping acquisition limit from 5% to 10% temporarily in 2001 for a year on the back of another economic downturn. At least, this time around, the enhancement of the limit is not across the board for all types of acquisitions, but only for preferential allotments wherein the company obtains the benefit of promoter funding.

It is precisely during an economic downturn that target companies become vulnerable to hostile takeovers. By providing promoter-friendly measures, the amendments may have the effect of equipping incumbents with additional forms of defensive mechanisms to ward off takeovers. Such takeover battles in the Indian context are not merely within the realm of a theoretical possibility, given that one seems to be brewing at the moment between Radhakishan Damani and the promoters of India Cements Limited.

Finally, in order to address funding concerns of companies, one option would have been to consider expanding the scope of exemptions from mandatory takeovers under regulation 10 by encompassing preferential issue of shares (whether made to promoters or not). This could be subject to conditions, including that the issue of shares is approved by a resolution passed by the shareholders (other than beneficiaries under the issue of shares), i.e. a whitewash procedure. This would ensure that all investors are treated on a level playing field, and is free of allegations of incumbent-friendliness.

– Umakanth Varottil