Sebi should clarify its position on affirmative rights and vetoes
There are two very interesting control dramas playing out right now. In one the foreign investor doesn?t want control, at least not the kind that triggers a mandatory open offer. But it does want the right of first refusal, the right to tag along, to appoint directors on board (3/14) and to every board committee, for its directors to be counted towards quorum at board and shareholder meetings, to appoint the vice-chairman and ensure the promoter chairman doesn?t have a casting vote, appoint one of two joint auditors and so on.
Despite these special rights being embedded in Jet Airways? Articles of Association, Etihad expects that by buying just 24% (for $379 million) in the Indian airline company it is a small but safe distance (1%) away from the substantial acquisition trigger. But Etihad may be on a slippery ground.
The back story
Under India?s takeover regulations, an acquisition of 25% voting rights or a change in control both require the acquirer to make a 26% tender offer to the target company?s shareholders.
Many countries, such as the UK, South Africa, Spain and other EU members, Russia and Singapore, among others, also mandate such tender offers, but they rely on a numerical measure of control. For instance, the UK Takeover Code defines control as ?an interest, or interests, in shares carrying in aggregate 30% or more of the voting rights of a company, irrespective of whether such interest or interests give de facto control?. So, if an acquirer crosses the 30% control threshold, it is required to make an open offer.
India has picked a different route; control is defined both quantitatively and qualitatively. Substantial acquisition of 25% voting rights of a company is one measure of control (the power to block special resolutions). The takeover code also defines control to ?include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner?.
The inclusion of ??shareholding or management rights or shareholder agreements or voting agreement? has netted many a reluctant offer in the past. Sebi has often interpreted affirmative rights or vetoes (negative control) as amounting to control even though private equity or other financial investors prefer to label such rights as protective provisions or minority protection rights.
The Subhkam saga
The most cited case is Subhkam?where Subhkam (the acquirer) was found by Sebi to have triggered a change in control as the shareholding agreement with the target (MSK) gave Subhkam the right to nominate a director (1/10), who had the right to be on any board committee and whose presence would be counted towards quorum. That?s not all. The investor director?s affirmative vote was required for an amendment to the articles, change in share capital, approval of annual business plan, restructuring of the company, appointment of key officials and some 16 such corporate actions. Subhkam appealed to the Securities Appellate Tribunal (SAT), which determined these rights as protective and not amounting to control. The two-member bench said control is a ?proactive and not a reactive? power. And that ?power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control?. Sebi appealed to the Supreme Court, but before the apex court could make a final determination of whether affirmative rights and vetoes constitute control, the case was withdrawn as the investment had been exited.
You may find it interesting to know here that, not so long ago (in 2002), Sebi had taken a narrower view of control and SAT broadened it to opine that ?control by its very nature is not amenable to any precise standard definition of general application? and that ?defacto control over the Board can exist without any legal power at all?. The case was Gujarat Ambuja?s purchase of a 14.4% equity in ACC?at the time, the substantial acquisition trigger was 15%.
But to return to present circumstances, the lack of an outcome in the Subhkam case hasn?t changed Sebi?s view of control. Earlier this year it found that private equity firm Clearwater Capital?s investment in Kamat Hotels amounted to a change in control as ?the Inter-se Agreement gives certain veto rights to the Acquirer which apparently relate to policy decisions to the Target Company?.
Back to the present
The rights granted to Etihad in the Jet deal may differ from the cases cited above, so it?s not clear yet how Sebi views the changes to Jet Airways? Articles of Association or any other terms in the shareholders? agreement between the two airlines. But given the history, it is very possible that Etihad, who ostensibly doesn?t want control, may likely be found in control and have to make an open offer.
It is unfortunately quite the opposite for Diageo. It wants control over United Spirits?yes, it very much does so. Not just the just-shy-of-25% kind but it is willing to exceed 50% ownership of voting rights. That is why it agreed to purchase a 19.3% stake in USL from the UB Holdings Group and subscribe to another 10% via a preferential allotment by USL. In anticipation of thus crossing the 25% trigger, Diageo was obliged to announce an open offer for 26% of USL shares, which, if fully subscribed, would take its shareholding to 53.4%, giving it clear control over USL.
But it hasn?t all gone to plan yet. All or most of USL shares owned by the UB Holdings Group are reportedly pledged with lenders to group company KFA or tangled in a winding up case filed by KFA?s unsecured lenders and hence may be unavailable for sale to Diageo.
The 26% open offer closed last week after receiving a very poor response?garnering barely 60,000 shares or 0.44%.
We don?t know yet whether together, the sale of USL shares by the UB Holdings Group, the preferential allotment by USL and the open offer, will amount to a majority stake for Diageo.
But even if it doesn?t, some good lawyering will protect Diageo?s interests. Because the deal lays down that in the event Diageo does not acquire a majority interest in USL ?UBHL has agreed to vote its remaining shareholding in USL (14.9%) as directed by Diageo for a four year period?. UBHL?s voting support will extend to ensuring that Diageo nominees are appointed to the USL board.
Let?s suppose for a moment that even the remaining USL shares owned by UBHL are encumbered and may not amount to much voting support. Well, Diageo seems to be drawing comfort from not just the voting arrangements but also governance arrangements that it refers to in its press release but the details of which are not yet public.
Look at the sweet irony of it all. Etihad wants control but through special rights and governance arrangements, without crossing 25% ownership and without having to do an open offer. Diageo wants to own more than 25%, did an open offer and yet may wield control only through special voting and governance arrangements.
Sometimes M&A can be just as painful as the contents of the book that lent its title to this column!
PS: Here?s some good news. In an interview on Monday the Sebi chairman told me that Sebi is considering offering more clarity regarding its position on affirmative rights and vetoes.
Menaka Doshi is corporate editor at CNBC TV18. Views are personal
Equal & Opposite is a column that explores business practices prompted by legal & regulatory action and vice versa