Stricter Framework for Sale, Lease or Disposal of Undertaking by a Listed Entity

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[Nitu Poddar is a Partner at Vinod Kothari and Company, and can be reached at corplaw@vinodkothari.com]

Disposal of an undertaking (whole or substantially the whole) can be carried out either as part of a scheme of arrangement or otherwise by way of slump sale or business transfer agreement (‘BTA’). Disposal, other than by way of scheme of arrangement, has so far been regulated according to section 180(1)(a) of the Companies Act, 2013 (‘Act’) which requires approval of the shareholders by way of special resolution. The Securities and Exchange Board of India (‘SEBI’) has prescribed an approval requirement in this regard by way of introduction of regulation 37A by way of theSEBI (Listing Obligations and Disclosure Requirements) (Second Amendment) Regulations, 2023 (‘Amendment Regulations’) effective from June 14, 2023 that requires listed entities to follow a stricter regime for disposal of undertaking. This mandates an approval from a majority of the public shareholders who are not interested in the transaction, disclosure of the object of the transaction, commercial rationale and use of proceeds arising from such transaction. While there is an exemption provided in case of transactions with a wholly owned subsidiary (WOS), the approval regime will apply in case of disposal of undertaking by such WOS or any reduction in shareholding in the WOS subsequent to transfer of the undertaking.

The said amendment is based on the Consultation Paper published by SEBI on February 21, 2023. Apart from incorporating the provisions proposed in this regard in the Consultation Paper, the amendment has introduced new provisions as well. The provision on seeking approval from the shareholders of the listed entity in case a WOS is used as a conduit for transfer in undertaking is a new requirement brought in through the amendment.

Effective Date

Regulation 37A came into force with immediate effect, i.e., from June 14, 2023. The Amendment Regulations clarify that the new provision will not apply in cases where the notice for seeking shareholders’ approval has already been dispatched.

Meaning of ‘Undertaking’

The meaning of the term ‘undertaking’ in regulation 37A is the same as that defined in section 180(1)(a) of the Act. The section refers to a numerical parameter of what should be considered as an undertaking. However, before testing the numerical parameter, one needs to assess whether the asset to be disposed of is at all an undertaking. For this, such asset should be capable of being identified as a unit, i.e., has assets and liabilities of its own discrete of the listed entity. Once this qualitative criteria is met, undertaking shall be covered under section 180(1)(a) and regulation 37A if:

investment of the company in such undertaking is more than 20% of its net worth; or
the undertaking generates at least 20% of the total income of the company.

Further, the expression “substantially the whole of the undertaking” means at least 20% of the value of the undertaking. For a detailed understanding on the meaning of the term, please refer to this article.

Approval From a Majority of Eligible Public Shareholders

In addition to the special resolution required under section 180(1)(a) and regulation 37A for disposal of undertaking, in case such undertaking is that of a listed company, regulation 37A additionally requires approval from majority of public shareholders who are not in any way interested in the transaction. Votes of only such public shareholders shall be counted for the second criteria above, who are not a party, directly or indirectly, to such sale, lease or otherwise disposal of the whole or substantially the whole of the undertaking of the listed entity (‘eligible public shareholder’). Thus, the voting strength of the promoters of the company is disregarded for the purpose of achieving the majority of minority vote.

This approval from the majority of the public shareholders is in addition to the approval through special resolution, where the promoters are entitled to vote. It is interesting to note that this approval criteria, while seems similar, is actually different from the one required for appointment of independent directors of a listed company under regulation 25(2A) of Listing Regulations or under regulation 37 in case of a scheme of arrangement (‘SoA’).

Approval under reg 37A	Approval under reg 25(2A)	Approval under reg 37
Special resolution; and	Special resolution; or	Majority of members representing 3/4th in value [as per section 230]
Approval from majority of the eligible public shareholders	Ordinary resolution and approval from majority of the public shareholders	Approval from majority of the public shareholders

As discussed in the Consultation Paper, the idea of placing this additional criteria for approval is to prevent prejudice to the public shareholders in case of disposal of undertaking outside the scheme of arrangement.

Disposal as a part of the SoA undergoes stringent scrutiny and approval regime including observation letter from stock exchange and approval from the National Company Law Tribunal (‘NCLT’). The requisite approval from shareholders also includes approval from the majority of shareholders in number representing 3/4th in value of the shares held by them.

Transaction Additionally Classifying as a Material RPT

Practically, there could be a situation where an undertaking is disposed to a related party. A question would arise with respect to the manner of seeking prior approval from the shareholders in case of a material related party transaction (‘Material RPT’) in terms of the Listing Regulations or the Act. In this regard, it should be noted that:

Approval from shareholders for an RPT is required only in case where such RPT is material in terms of either the Act, 2013 or the Listing Regulations;
If material, the approval requirement under RPT framework will be applicable which is considerably different from the approval framework for disposal of undertaking under section 180(1)(a) or reg. 37A.

Points of difference	Approval under reg 37A	Approval under reg 23
Resolution type	(i) Special resolution; and (ii) Approval from majority of the eligible public shareholders	Ordinary resolution
Resolution type		Ordinary resolution
Who cannot vote	For the purpose of the second criteria of approval, public shareholders who have a direct or indirect interest in the transaction, cannot vote.	All related parties of the company cannot vote irrespective of whether such entity is a related party to the particular transaction or not.

Accordingly, two separate resolutions ought to be obtained from the shareholders for approval (i) for sale, lease or disposal of undertaking; and (ii) for approval of a Material RPT.

Information to be Disclosed to the Shareholders

Section 180(4) of the Act requires the special resolution to include conditions regarding the use, disposal or investment of the sale proceeds arising from the disposal of undertakings. Regulation 37A additionally requires the following disclosure in the explanatory statement:

object of such disposal;
commercial rationale of such disposal;
use of proceeds arising therefrom.

In case of a Material RPT, the disclosures will be required to be made in terms of SEBI Circular dated November 22, 2021.

Transfer of an Undertaking to a WOS

Considering a WOS to be an extension of the holding company, the provision of 37A has exempted the approval regime for transfer of undertaking to the WOS. However, if such WOS further transfers the undertaking to any other entity, or the listed company intends to dilute its shareholding in the WOS, the approval regime under regulation 37A will be applicable. It may be noted that this is a new insertion and was not part of the Consultation Paper. It would be useful to examine a few scenarios here:

Scenarios	Applicability of reg 37A on the Listed Entity (‘LE’)
LE transfers an undertaking to WOS	Not applicable
LE transfers an undertaking to a 90% subsidiary	Applicable
LE transfers an undertaking to WOS which further transfers the same undertaking to another entity	Applicable
LE transfers an undertaking to WOS. The WOS transfers some other undertaking to another entity	Not applicable
LE has not transferred any undertaking to WOS. WOS intends to transfer its undertaking to another entity.	Not applicable
The WOS is itself a result of hive off (outside scheme) of an undertaking from the LE. It now intends to transfer its undertaking to another entity	Applicable. Considering the WOS itself in toto is a result of transfer of an undertaking by the LE, any further transfer by it ought to be covered by reg 37A.
LE has transferred an undertaking to the WOS pursuant to SoA. Now the WOS intends to transfer that undertaking to another entity	Not applicable
LE has transferred its undertaking to WOS. Now LE intends to dilute its shareholding in the WOS: – by transferring its shareholding in the WOS; – by allowing the WOS to issue convertible securities to any other entity	Applicable
LE intends to dilute its shareholding in any other WOS	Not applicable. However, applicability of clause (5) and (6) of regulation 24 of Listing Regulations is to be checked individually for each case.
LE has transferred the undertaking to its WOS prior to the amendment, the WOS is further transferring such undertaking post this amendment	Applicable. Keeping in mind the intent of the provision, if the WOS, to which an undertaking was transferred prior to the notification of the Amendment Regulations, intends to transfer such undertaking to any entity, the provisions of reg 37A should be made applicable and requisite approval from the shareholders of the LE is required to be obtained.

It should be noted that the above requirement is exclusive of the requirement under clauses (5) and (6) of regulation 24 and that under clause (4) of regulation 23 in case of Material RPT undertaken by the unlisted subsidiaries of the listed entity.

The difference in the applicability of shareholders’ approval requirement is summarized hereunder:

Point of difference	Regulation 37A	Regulation 24(5)	Regulation 24(6)
Applicability	Using a WOS to transfer an undertaking outside scheme, to a third party	Disposal of shareholding / control in a material subsidiary such that it ceases to be a subsidiary	Selling, disposing and leasing of assets, outside scheme, amounting to more than 20% of the assets of the material subsidiary on an aggregate basis during a financial year
Materiality of the subsidiary relevant?	No	Yes	Yes
Approval required by LE	(i) Special resolution; and (ii) Approval from majority of eligible public shareholders	Special resolution	Special resolution

Non-applicability of Regulation 37A

It is quite common for companies to seek a parallel approval under section 180(1)(a) of the Act along with approval for borrowing limits under section 180(1)(c). The requirement of regulation 37A is exempted for disposal of undertakings arising out of any covenant under any agreement with financial institutions and debenture trustees, e.g., in case of security enforcement.

Immediately Actionable for Listed Entities (‘LE’)

Extension of the provision to WOS requires some background work to be done by the LE which has WOS(s). The LE needs to check back whether there has been any transfer of undertaking to the WOS or if the WOS is actually an outcome of spin off from the LE.

Having done so, the LE and its WOS needs to be adequately sensitized with the amendments so that the LE can be alerted in case (i) the undertaking from the LE is proposed to be transferred to another entity; or (ii) the LE intends to dilute its shareholding in the WOS (even by 1%) where an undertaking has been transferred.

– Nitu Poddar