Stalemate on the SAT in the PNB Housing Preferential Allotment Case

A two-member bench of the Securities Appellate Tribunal (SAT) yesterday returned a split verdict on the legal issues surrounding the preferential allotment of shares by PNB Housing Finance Limited. The facts are relatively straightforward. Since PNB Housing’s controlling shareholder, Punjab National Bank, was unable to infuse funds due to the lack of regulatory approval from the Reserve Bank of India, the company decided to undertake a preferential allotment of shares in favour of four institutional investors. Accordingly, PNB Housing convened an extraordinary general meeting (EGM) to obtain the approval of its shareholders.

In the days running up to EGM, the Securities and Exchange Board of India (SEBI) wrote to PNB Housing stating that the company shall not act upon the preferential allotment of shares without obtaining a report from a registered valuer regarding the pricing of the issue of shares. On the prevalent facts, no such report had in fact been obtained. Against this communication from SEBI, PNB Housing preferred an appeal before the SAT. While the Presiding Officer (PO), Justice Tarun Agarwala, rejected the need for a report from a registered valuer, the Judicial Member (JM), Justice M.T. Joshi, held otherwise. The matter will now be placed before the PO for on the administrative side for determining a process for resolution of the deadlock. In the meanwhile, the SAT’s order of 21 June 2021, by which it directed PNB Housing to hold the EGM and enable the shareholders to decide on the agenda item relating to the preferential allotment, but that the results not be declared and instead kept in a sealed cover, would continue.

Procedural Matters: Natural Justice and Jurisdiction

At a procedural level, a question arose whether SEBI’s action of restraining PNB Housing from proceeding with its shareholder decision-making on the agenda item relating to the preferential allotment was premature and in violation of the principles of natural justice (as no prior hearing was accorded to PNB Housing). The PO held that such an action smacked of arbitrariness, and violated the principles of natural justice, as the decision was taken without putting PNB Housing on notice. He also found that SEBI lacked jurisdiction to take decisions in the absence of a shareholder decision on the preferential allotment. Although the reasoning is not entirely clear, the JM instead took the view that SEBI was well within its means to act in the manner it did, in view of the urgency of the situation.

There is some merit in the PO’s view regarding natural justice. However, given the water that has already flown under the bridge, there may be limited consequences. At most, the SAT can remit the matter back to SEBI for a full consideration before passing any further orders. In any event, the preferential allotment transaction is in abeyance for all intents and purposes.

While on the procedural ramifications, the ruling also raised an interesting question regarding SEBI’s jurisdiction, which I allude to in the concluding observations below.

Substantive Issue: Hierarchy of Norms

The principal conundrum before the SAT was whether the preferential allotment must be conditional upon the valuation of shares in the preferential allotment being in accordance with the report of a registered valuer. This required the SAT to analyse a quadrumvirate of legal norms under corporate and securities law, being the following:

1. Articles of association of the company: Article 19(2) provides that the price of shares in case of a preferential allotment must be “determined by the valuation of a registered valuation”. This is the main plank on which SEBI’s case rests.

2. Companies Act, 2013: Section 62(1)(c) similarly specifies the requirement of such a valuation report, although that is subject to the provisions of Chapter III of the Act, “and any other conditions as may be prescribed”. Thus, the rulemaking domain acquires prominence.

3. Companies (Share Capital and Debentures) Rules, 2014: Rule 13 provides that the pricing for a preferential allotment of shares of a listed company does not have to be determined by a registered valuer. Moreover, the Rules suggest that in case of any conflict between the Rules and any regulations prescribed by SEBI, the Rules will take a back seat.

4. SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: Regulation 164 prescribes a regulatory formula for determination of the minimum price for a preferential allotment, which is based on the prevailing market pricing during specified historical periods. Regulation 164 do not stipulate the need for a registered valuation report.

In this scenario, there are effectively two layers of conflict as to whether a registered valuation report is required or not in case of a preferential allotment of shares by a listed company. The first layer is a “inter se regulatory conflict”, i.e., among the various laws and regulations. This is relatively simpler to reconcile because the Companies Act (item 2 above) offers deference to the Rules (item 3) which, in the case of listed companies, in turn hands over domain to the SEBI regulations (item 4). Hence, the ultimate point of focus might lie with the SEBI regulations. Since the pricing of a preferential allotment by listed companies under those regulations essentially follow a formulaic pricing methodology rather than a valuation-based pricing, the approach followed by PNB Housing is arguably sustainable.

The second, and perhaps more complex, layer to tackle is the “contractual-regulatory conflict”. How do we reconcile the scenario wherein the articles of association of the company requires a registered valuer’s report, but the regulatory set up does not (as concluded above)? This does not present easy answers. Here, it is necessary to refer to section 6 of the Companies Act which provides that (i) the Act would override anything “to the contrary” contained the articles of association of a company, and (ii) any provision in the articles “shall, to the extent which it is repugnant to the provisions of this Act, become or be void, as the case may be.” The question, therefore, is whether there is at all a repugnancy between the Companies Act and PNB’s articles of association and, if so, whether the requirement of a registered valuation report in the articles can be overridden by the Act (and consequently the waterfall of norms through the Rules and SEBI regulations). This is the issue that split the SAT-bench right through the middle.

The PO took the view that the ICDR Regulations are a complete code in itself for preferential allotment of shares by listed companies. Moreover, he seemed concerned that if one were to have regard to the articles of association, then there could be two different mechanisms for preferential allotments, one in case of companies with a registered valuation requirement in their articles and another in case of companies without such a provision. Hence, the PO found that SEBI’s communication to PNB Housing was not sustainable, and therefore allowed the company’s appeal.

On the other hand, the JM approach the issue differently. He placed reliance on the fact that the articles of association are a contract between the members of the company, and cannot be disregarded even if the other legal and regulatory norms discussed earlier do not mandate a registered valuer’s report. The JM noted that there is no repugnancy or discrepancy between the articles of association of PNB Housing and regulation 164 of the ICDR Regulations, as “both provisions can stand together” (para 44). He also referred to the decision of the Punjab and Haryana High Court in Amruta Kaur Puri v. Kapurthala Flour Oil and General Mills Company Pvt. Ltd., in which a quorum in the articles of association for the board meeting of a company was upheld even though it imposed a requirement that was over and above that required by the Companies Act, 1956. This logic suggests that there is no repugnancy when the articles of association impose a requirement than is higher than what the Act requires. Surely, the converse position by which the articles of association erodes the requirements of the Act cannot be sustained, as it falls in the face of section 6 of the Companies Act, 2013. For these reasons, the JM upheld SEBI’s position, and dismissed the appeal.

Concluding Observations

As is clear, the PNB Housing case gives rise to a key question that relates to the hierarchy of norms (whether legislative, regulatory or contractual), and how any repugnancy must be dealt with. The complexity of the issue is evident from the diversity of opinions that emerged from the SAT. In my view, the conclusion of the JM that it is possible to contractually stipulate additional norms over and above the regulatory requirements is persuasive. If not, several clauses in shareholders’ agreements and consequently articles of association of companies which have specific protective clauses in favour of specific investors (such as private equity investors) could suffer an unexpected fate regarding enforceability on the ground that they are repugnant to the Companies Act. Surely, this cannot have been intended, nor is it optimal to withdraw the contractual freedom of parties to design their affairs (so long as it does not erode the basic minimum set out by the Companies Act).

That leaves only one question. If the bar to the preferential allotment without a registered valuation emerges as a contractual matters, as even the JM has concluded, to what extent, if at all, can SEBI intervene? Or is it an issue left to the shareholders to agitate the issue as a matter of company law in an appropriate forum? This issue requires greater consideration.

In all, although the legal question is a straightforward one, it generates knotty issues of interpretation that might have widespread ramifications even beyond the PNB Housing case. The next stage of the legal campaign is likely to continue before the SAT, albeit in a different incarnation.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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