Keywords: L&T, Mindtree, hostile takeovers
(Pranshu Gupta is a IV year B.A.LL.B student at National Academy of Legal Studies & Research (NALSAR) University, Hyderabad)
INTRODUCTION
Recently, Mindtree Ltd., an IT services firm went through a hostile takeover by the technology and engineering giant Larsen & Toubro (L&T), which is the first such takeover in India in the IT sector. In the M&A sector, takeovers are a general phenomenon.
However, a hostile takeover is particularly rare, especially in the context of India. In this article, the legal implications of the moves of both the companies in the takeover battle would be discussed in terms of the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (hereinafter ‘Takeover Code’).
BACKGROUND
L&T acquired approximately 66% stake in Mindtree in a three-pronged process:
L&T acquired approximately 66% stake in Mindtree in a three-pronged process:
- Firstly, L&T purchased 20.32% stake of coffee baron V.G. Siddhartha for an amount of Rs. 3,369 crores under a share purchase agreement. He was the single largest non-promoter shareholder in the company.
- Secondly, it made an on-market purchase of around 15% shares of Mindtree through their broker, subject to various regulatory approvals.
- Lastly, L&T made an open-offer for an additional 31% shares in Mindtree.
THE LEGALITY OF MINDTREE'S MOVES
In order to prevent the hostile takeover by L&T, Mindtree considered a proposal of buyback of its fully paid up equity shares in its board meeting dated 20th March 2019. However, in the adjourned meeting dated 26th March 2019, the proposal of buyback was dropped. Seemingly, this was intended to be used as a ‘poison pill’ by sucking out surplus cash from the company.
A ‘poison pill’ is a tool employed by a target company as a takeover defence mechanism in a hostile takeover so as to make it less desirable to the acquirer, or to make the transaction too expensive. It is called poison pill because it can also lead to a decrease in shareholder value and might create hardships for the management in the future.
In the present case, on April 17, Mindtree approved an interim dividend of Rs 3 per share, a final dividend of Rs 4 per share and a special dividend of Rs 20 per share to celebrate the twin achievements of exceeding $1 billion annual revenue milestone and the 20th anniversary of the company. While the interim dividend was payable on April 27, the final and special dividend would be payable upon receiving shareholders’ approval in the next Annual General Meeting (hereinafter ‘AGM’). This move would result in the severance of Rs. 530 crores from the cash reserves out of a total Rs. 1,100 crores as on March 2019, thereby making the takeover less desirable and expensive.
As per Regulation 26 of the Takeover Code, it is the duty of the board of directors of the target company to make sure that the business of the target company is conducted in the ordinary course, consistent with past practices during the offer period. Also, no material assets shall be alienated during this period unless an approval has been obtained from the shareholders through a special resolution. In the present case, although alienation of Rs. 530 crores from the company reserves might amount to an ‘alienation of material assets’, the strategy adopted by Mindtree is legally valid under the Takeover Code.
In order to prevent the hostile takeover by L&T, Mindtree considered a proposal of buyback of its fully paid up equity shares in its board meeting dated 20th March 2019. However, in the adjourned meeting dated 26th March 2019, the proposal of buyback was dropped. Seemingly, this was intended to be used as a ‘poison pill’ by sucking out surplus cash from the company.
A ‘poison pill’ is a tool employed by a target company as a takeover defence mechanism in a hostile takeover so as to make it less desirable to the acquirer, or to make the transaction too expensive. It is called poison pill because it can also lead to a decrease in shareholder value and might create hardships for the management in the future.
In the present case, on April 17, Mindtree approved an interim dividend of Rs 3 per share, a final dividend of Rs 4 per share and a special dividend of Rs 20 per share to celebrate the twin achievements of exceeding $1 billion annual revenue milestone and the 20th anniversary of the company. While the interim dividend was payable on April 27, the final and special dividend would be payable upon receiving shareholders’ approval in the next Annual General Meeting (hereinafter ‘AGM’). This move would result in the severance of Rs. 530 crores from the cash reserves out of a total Rs. 1,100 crores as on March 2019, thereby making the takeover less desirable and expensive.
As per Regulation 26 of the Takeover Code, it is the duty of the board of directors of the target company to make sure that the business of the target company is conducted in the ordinary course, consistent with past practices during the offer period. Also, no material assets shall be alienated during this period unless an approval has been obtained from the shareholders through a special resolution. In the present case, although alienation of Rs. 530 crores from the company reserves might amount to an ‘alienation of material assets’, the strategy adopted by Mindtree is legally valid under the Takeover Code.
- Firstly, going by the company’s past practice, Mindtree has declared special dividends on four separate occasions in the last 10 years in the range of Rs 1 to Rs 5 per share marking the completion of its 10 and 15-year anniversaries, 10 years since IPO, and crossing $100 million in revenue.
- Secondly, announcement of special dividend at Rs. 20 per share would though be considered as substantial alienation of assets, it falls within the ordinary course of business and past practices at the same time. Mindtree has declared special dividend 4 times in the past ten years. Also, the declaration of special dividends was not in retaliation to the takeover bid by L&T, but to celebrate its 20 years of operation and crossing revenues of billion dollars a year.
- Lastly, the declaration of dividends is pending approval from the shareholders in its AGM, not violating Regulation 26 of the Takeover Code.
In this manner, none of the moves of Mindtree to prevent the takeover could be considered as legally invalid.
THE LEGALITY OF L&T'S MOVES
An analysis of L&T’s moves depicts the sharp-witted tactics employed by it in order to takeover Mindtree. In a normal scenario, when a company tries to acquire another, it can offer to gain control if it owns 25 per cent stake of the company it is trying to acquire. However, L&T did not own 25% ownership of the company. So, L&T used a loophole in the Takeover Code to pursue the takeover.
It used Regulation 3(1) along with Regulation 4 and 6 of the Takeover Code, which entitles L&T to make an open offer to acquire public shareholding in the company. As per this provision, those with a 25% stake or more cannot take over a company unless an open offer has been made to acquire shares of a company with a public announcement.
However, the Takeover Code also says whether or not one holds shares or voting rights in the company, one is not eligible to take control unless a public announcement of an offer to acquire those shares is made. This allowed L&T to make an open offer, without owning 25% stake in Mindtree.
Moreover, the CCI granted its approval required under Section 5 of the Competition Act, 2002; and Regulation 18(11) of the Takeover Code. Therefore, it can be said that all the moves of L&T are legally valid, even though the anomalies in the Takeover Code have been utilized for its own benefit.
An analysis of L&T’s moves depicts the sharp-witted tactics employed by it in order to takeover Mindtree. In a normal scenario, when a company tries to acquire another, it can offer to gain control if it owns 25 per cent stake of the company it is trying to acquire. However, L&T did not own 25% ownership of the company. So, L&T used a loophole in the Takeover Code to pursue the takeover.
It used Regulation 3(1) along with Regulation 4 and 6 of the Takeover Code, which entitles L&T to make an open offer to acquire public shareholding in the company. As per this provision, those with a 25% stake or more cannot take over a company unless an open offer has been made to acquire shares of a company with a public announcement.
However, the Takeover Code also says whether or not one holds shares or voting rights in the company, one is not eligible to take control unless a public announcement of an offer to acquire those shares is made. This allowed L&T to make an open offer, without owning 25% stake in Mindtree.
Moreover, the CCI granted its approval required under Section 5 of the Competition Act, 2002; and Regulation 18(11) of the Takeover Code. Therefore, it can be said that all the moves of L&T are legally valid, even though the anomalies in the Takeover Code have been utilized for its own benefit.
CONCLUSION
In this battle of legal acumen, both the companies employed various tactics to achieve their goals. But Mindtree lost the battle ultimately getting taken over by L&T. While the strategy of L&T can be appreciated, at the same time, it reflects the violation of corporate ethics and governance due to lacunae in the governing law. Hostile takeovers have certain adverse effects, such as reduction in company value, affecting employees’ morale which might turn into animosity towards the acquirer and so on.
Post Mindtree’s hostile takeover SEBI had introduced the ‘DVR Framework’ which permitted issuance of shares with differential voting rights in order to protect companies (especially startups) from hostile takeovers by enabling promoters to retain voting rights in excess to their share capital. Although introduction of DVR Framework by SEBI in order to protect companies from such threats could be admired, it should be noted that this does not solve the underlying issue.
The underlying issue is anomaly in the Takeover Code and there being no protective mechanisms preventing hostile takeovers within the code itself. Therefore, SEBI should definitely amend the Takeover Code by rectifying the existing inconsistency and inserting requisite safeguards.
Post Mindtree’s hostile takeover SEBI had introduced the ‘DVR Framework’ which permitted issuance of shares with differential voting rights in order to protect companies (especially startups) from hostile takeovers by enabling promoters to retain voting rights in excess to their share capital. Although introduction of DVR Framework by SEBI in order to protect companies from such threats could be admired, it should be noted that this does not solve the underlying issue.
The underlying issue is anomaly in the Takeover Code and there being no protective mechanisms preventing hostile takeovers within the code itself. Therefore, SEBI should definitely amend the Takeover Code by rectifying the existing inconsistency and inserting requisite safeguards.
-By Pranshu Gupta
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