Given the drawn-out regulatory ambiguity around the meaning and scope of ‘control’ under the SEBI Takeover Regulations, 2011, some clarity on the issue had been long expected.
Vaibhav Kakkar & Avisha Gupta
Given the drawn-out regulatory ambiguity around the meaning and scope of ‘control’ under the SEBI Takeover Regulations, 2011, some clarity on the issue had been long expected. However, last month, by way of a press release, Sebi announced its decision to not amend the existing definition of control and retain its right to determine the acquisition of control on a case-to-case basis.
Under the Takeover Regulations, the acquisition of shares carrying voting rights of 25% or more requires an open offer to be made to the public shareholders. However, there is another trigger for open offer—the acquisition of control, which is to be independently ascertained, regardless of the quantum voting rights acquired. Given the inclusive definition of control prescribed under the Takeover Regulations, the test of control has always been a subjective matter, leading to much ambiguity and uncertainty. This has been particularly relevant in cases where investors acquire less than 25% voting rights, but negotiate certain additional rights only to protect their investment (i.e., protective rights), and not necessarily to gain operational management and control of the listed company (i.e., participative rights).
Apart from triggering an open offer, a determination of having acquired control has important implications under other laws as well, such as the Companies Act, 2013 and the FDI rules. For instance, under the Companies Act, 2013, a person in control of a company is deemed to be a promoter, and is ascribed certain specific and rather onerous responsibilities. Similarly, under the FDI rules, control is a determining factor for applicability of various sectoral compliances such as those in respect of civil aviation and insurance. While some regulators have been successful in bringing uniformity to the definition of control under various laws, the scope and meaning of the term has remained ambiguous.
Right from the Securities Appellate Tribunal decision in Shubhkam Holdings, Sebi’s informal guidance in R-Systems as well as its decision in Jet-Etihad, to the recent case of Clearwater Capital Partners and Kamat Hotels, a consistent trend, despite the interim uncertainties, that seemed to emerge is that merely acquiring protective rights should not amount to acquisition of control. That said, this position has never been conclusively settled, because of specific facts and circumstances in each case. Sebi, in March 2016, issued a ‘Discussion paper on Control’, wherein it proposed two ‘bright-line tests’ as possible alternatives to the current regime. The discussion paper emphasised the principle that affirmative rights which do not amount to the acquisition of control, are protective rather than participative and proceeded to lay down a list of affirmative rights which would not amount to control. The alternative option proposed, was setting an objective numerical threshold of 25% of voting rights to determine the acquisition of control. The discussion paper noted that while certain jurisdictions like the UK, Singapore and Australia define control as acquisition of voting rights above specified thresholds, other jurisdictions such as Canada, France, and Spain, define it to mean the right over the majority of voting rights or the ability to appoint a majority of the board members. Other countries, such as Brazil, China, and Italy, have a broad definition similar to that in India.
It was in this backdrop that the industry was expecting final clarity clarity on the issue. However, Sebi instead decided to not make any amendment to the definition of control. Sebi noted in its press release that no particular option garnered overwhelming support among stakeholders. Sebi’s reluctance to amend the definition also appears to stem from its potential impact on other laws. In the Jet-Etihad matter, for example, the meaning and scope of control was tested by multiple regulators/ministries, including the civil aviation ministry, FIPB, CCI, and Sebi. Each of them had differing views on what would constitute control, causing much confusion on the issue. This is perhaps an unintended consequence of a uniform definition of control across laws. Accordingly, a decision was taken based on feedback from other ministries and regulators, including the ministry of corporate affairs and RBI, who believe any bright-line tests for determination of control, would be prone to abuse.
Indisputably, it is perhaps unfeasible and rather perilous for a regulator to clearly define, in black and white, what rights would and wouldn’t amount to control. A determination of acquisition of control must be undertaken on the basis of particular facts, taking into consideration the context in which rights are sought by the investor; the specific nature of rights; or if there are any numerical thresholds agreed (above which the investors would have blocking rights), then the proportion that they bear to the total size and quantum of business. It is only through careful individual examination that one can determine whether rights sought are merely protective, or result in day-to-day control.
On the other hand, specifying a numerical threshold of 25%, below which there cannot be any acquisition of control, is also not prudent. That may enable structuring of transactions to yield de-facto (but not de-jure) control to the investors, and be prone to abuse due to possible malafide intentions such as bypassing licensing and other legal restrictions. This could result in situations where control of a listed entity has effectively changed without affording the public shareholders an opportunity to exit, while leaving regulators incapacitated to intervene. However, based on experience, it is clear that having no regulatory guidance on this issue results in much ambiguity and, at times, long drawn-out litigation and enforcement actions. Therefore, allowing clarity to develop through judicial decisions is perhaps not the most efficient solution. This also goes against improving the ease of doing of business and simplifying the regulatory framework.
Given that the issue of acquisition of control lies at the heart of almost every investment transaction into listed companies, even if explicit bright-line tests are not possible, some broad principles could perhaps be issued in the form of FAQs or notifications, to serve as guiding principles for regulators and investors. The IRDA can serve as an example—it has issued guidelines on the meaning of control in the context of insurance regulations, clarifying for instance that the right of a foreign investor’s nominee to constitute a valid quorum for meetings, is only a protective right and would not amount to control. Similar guidance from Sebi would certainly be met with much cheer.
Kakkar is partner, and Gupta is senior associate, Luthra & Luthra Law Offices. Views are personal