Deal Aware

Hostile Takeovers of Business Development Companies and Closed-End Funds: SEC takes a U-Turn

Keywords: hostile takeover, Business development companies, SEC, Closed-end funds

(Amar Singh is a II year, B.A. L.LB student at Gujarat National Law University, GNLU)

INTRODUCTION:

When one company acquires another against the target company’s wishes, it is termed as a hostile takeover. This can be accomplished in either of 3 different ways:

Toehold acquisition: an offer to buy stock from the existing shareholders, or
Tender offer: buying majority of shares from the open market, or
Proxy fight: shareholders of the target are convinced to assign their voting rights to the acquiring company so that it can boot out the management opposing the takeover and take control.

While there are various defences available to ward off a hostile takeover until recently one of them called the “Control Share Statute” under U.S. state corporate laws which is a powerful statutory anti-takeover defense was unavailable to Business Development Companies (“BDC”) and Closed-End Funds (“CEF”) which were regulated under the Investment Company Act of 1940 (“1940 Act”).

On 27th May 2020 the Securities Exchange Commission (“SEC”), which is the federal agency of United States Government, reversed its decade-old stance by withdrawing its 2010 no-action letter that prevented BDCs and CEFs regulated under the 1940 Act to exercise the Control Share Statute.

The 2010 letter (“Boulder Letter”) had stated that the SEC staff believed such a statute would be,

“inconsistent with the fundamental requirements of Section 18(i) of the 1940 Act that every share of stock issued by a fund ( A fund is a company under Section 2(8) of the 1940 Act) be voting stock and have equal voting rights with every other outstanding voting stock.”

CIRCUMSTANCES LEADING TO THE ISSUE OF THE BOULDER LETTER:

Section 18(i) of the 1940 Act, as amended states that every share of stock issued by a registered investment company shall be a voting stock with equal rights. A defensive measure that limits the voting rights attached to a share potentially implicates the share voting requirements in Section 18(i) of the 1940 Act. A Control Share Statute generally prohibits an acquirer of “control shares” from voting its control shares unless or until its voting rights are reinstated by a vote of the disinterested shareholders.

In a 2007 opinion, the U.S. District Court for the District of Maryland, inter alia applied the terms of the Maryland Control Share Acquisition Act (“MCSAA”) to shares acquired by a stockholder after the fund had opted in to the statute. In a 2009 speech, however, the director of the SEC’s Division of Investment Management expressed the view that a closed-end fund’s reliance on control share statutes “constitutes a denial of equal voting rights and may violate the fundamental requirement that every share of fund stock be voting stock.” Subsequently, the Boulder letter was issued.

CRITICISM OF THE BOULDER LETTER:

Recently, the Investment Company Institute submitted a report (“the ICI Report”) to the SEC that criticized the Boulder Letter’s stand on the issue. The ICI Report stated that the letter misreads the plain language of Section 18(i) because it pertains to the voting rights of each share of stock, rather than the voting rights of a particular stockholder.; The use of defensive measures, including a control share statute that impact the voting rights of a particular stockholder does not change the stock’s voting rights and thus, does not violate Section 18(i) of the 1940 Act.

In addition, if a disinterested shareholder vote restores an investor’s ability to vote control shares, or that investor sells or otherwise reduces his holdings below the applicable statutory threshold, that investor would again be permitted to vote on all his shares, and none of these events would change the voting rights of those shares. The ICI Report also argued that enabling the use of such takeover defenses to prevent activist shareholders from taking control of a fund for their own benefit at the expense of the fund and the other shareholders furthers the purposes of the 1940 Act.

REVERSAL OF SEC's STAND AND WITHDRAWAL OF BOULDER LETTER:

In 2018, SEC Chair Jay Clayton issued a statement noting that the “staff statements are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties” and stating that the SEC’s divisions and offices “have been and will continue to review whether prior staff statements and staff documents should be modified, rescinded or supplemented in light of market or other developments.” Without commenting specifically on the several arguments that have been raised since 2010 regarding the Boulder Letter, in the statement the SEC staff announced that based on this review, as well as market developments since the Boulder Letter’s issuance and recent feedback from affected market participants, the Boulder Letter shall be withdrawn effective immediately.

The Statement also provides that the SEC staff:

“would not recommend enforcement action to the Commission against a closed-end fund under Section 18(i) of the 1940 Act for opting in to and triggering a control share statute if the decision to do so by the board of the fund was taken with reasonable care on a basis consistent with other applicable duties and laws and the duty to the fund and its shareholders generally.”

The SEC staff cautioned that any inquiry into the application of Section 18(i) of the 1940 Act to a fund’s decision to opt in to a control share statute would be based on the facts and circumstances. In this regard, the SEC staff reminded market participants that any actions taken by a board of a fund, including with regard to control share statutes, should be examined in light of:

the board’s fiduciary obligations to the fund,
applicable federal and state law provisions, and
the particular facts and circumstances surrounding the board’s action.

The 27th May 2020 statement adopts the position that the SEC staff “would not recommend enforcement action to the Commission against a closed-end fund under Section 18(i) of the 1940 Act for opting in to and triggering a control share statute if the decision to do so by the board of the fund was taken with reasonable care on a basis consistent with other applicable duties and laws and the duty to the fund and its shareholders generally.”

The statement also requests inputs as to whether the SEC staff should recommend that the SEC take an additional action to provide clarity regarding the applicability of the 1940 Act to a closed-end fund’s decision to opt in to a control share statute.

CONCLUSION:

For BDCs and CEFs this is good news since now they can freely utilize the defense available to them under the state laws which they were previously hesitant to use since the SEC staff statement though not binding did have an effect on the willingness of the board to rely on the Control Share Statutes.

-by Amar Singh

Efficacy of the Demerger Route and its impact on Shareholder Value

Keywords: Demerger, Companies Act 2013, Company Examples, Corporate restructuring

Keywords: Demerger, shareholder value, corporate, corporate restructuring, Jio Demerger

(Dhruv Thakur is a IV year, B.B.A.LL.B student at Gujarat National Law University, GNLU)

INTRODUCTION:

Companies have now figured out that a diversified business model under one listed entity fails to attract the required valuation. In the previous decade, India witnessed a trend where companies rambled diversification drives beyond their central businesses. However, in today’s era, there is a clear inclination towards value unlocking by demerging business units which indicates many of them have now realized that the diversified business model does not work well in terms of stock valuations and fundraising compared to companies which stayed focused on their core businesses. But the question is whether in the last few years demergers have created value for shareholders? Before diving into that it is important to get familiarized with the fundamental idea behind a demerger.

DEFINITION AND RATIONALE OF A DEMERGER:

A Demerger is essentially separation of one or more units of a company to either be liquidated or form a new company independent from the original one. Primarily, demergers are a form of corporate restructuring the objective behind which is to promote specialization. Sections 230 to 240 of Chapter XV of the Companies Act, 2013 (hereinafter ‘CA, 2013’) read with the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 are the applicable provisions in case of a demerger. The term ’demerger’ is not defined under the CA, 2013 per se but explanation to Section 230 (1) allows for division of shares of different classes as a route for the readjustment of share capital. Section 2 (19AA) of Income Tax Act, 1961 (hereinafter ‘IT Act’)defines a demerger as-

“Demerger”, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956, old act), by a demerged company of its one or more undertakings to any resulting company…”

However, it was held by the High Court of Delhi in the matter of Indo Rama Synthetics Ltd. that the definition under the IT Act was only for the mere purpose of making sure that the demerger was tax neutral, irrespective of whether it fulfills other conditions as regarded by the IT Act.

The rationale behind pursuing demergers is based on the many benefits if offers, which works as motives for a company to initiate the process. It allows a specific division or unit to grow as a separate and focused entity, thereby increasing its efficiency and effectiveness.

To illustrate better, Reliance Jio Infocom Ltd. (hereinafter ‘RJI’) which had three primary undertakings namely (a) digital services business, (b) optical fibre business, and (c) tower infrastructure business went for an NCLT approved demerger process in 2019. It transferred the optical fibre business to a newly formed company ‘Jio Fibre Pvt Ltd.’ and the tower infrastructure business to an existing company ‘Reliance Jio Infratel Pvt Ltd’. However,the digital services business was retained with the original company (RJI).

Each of the three undertakings do have a distinct strategy, separate industry specific risks and operate inter alia under differentiated market dynamics. Even the competition involved in each of the businesses is different from the other two. Hence, segregation of the company by a demerger will incorporate enhanced focus of each of the undertakings and help exploit varied opportunities in their respective fields. Here’s a link to RJI’s composite scheme of arrangement.

Further, in a few cases of family owned companies, demergers are also used to give effect to family partitions, for instance the division of Ambani Group in 2013 between Anil and Mukesh Ambani, splitting up Reliance Industries Ltd. into four distinct entities.

WAYS TO GIVE EFFECT TO A MERGER:

Agreement between the promoters

Under this case a company may hive off its undertaking to a new resulting company. This new company formed due to the demerger issues shares of the resulting company to shareholders of the parent company as consideration. The assets and liabilities pertaining to the undertaking which has been demerged will be transferred to the new resulting company.

2. Demerger under the scheme of arrangement

Similar to the amalgamation process, in this case approval from the NCLT, under CA, 2013 is mandatory. Provisions governing this route are Sections 230-232 of the CA, 2013. However, this route is only permissible if the Memorandum of Association (hereinafter ‘MoA’) and Articles of Association (hereinafter ‘AoA’) of the company allow for such a process. If not, then the first step would be to amend the AOA of the company by passing a special resolution in the general meeting.

3. Demerger under voluntary winding up and the power of liquidator

After the split of the original company into various companies, the original company can go for voluntary winding up under Section 270 of the CA, 2013. Original company may transfer or sell its workings to the resulting companies.

DEMERGERS AND SHAREHOLDERS' VALUE:

Demergers benefit the shareholders of the company by providing them shares of the applicant company (which is going for the demerger) as well as the resulting company (company segregated from applicant company), which in turn divests better opportunities to participate in the management, decision making process, operations and profits.

But is shareholder value in practice enhanced by demergers and spin-offs? It depends and needs to be carefully examined, as with everything else in life. It is a well-known fact that one of the major objectives behind demergers is to increase the shareholder value. Disposal of any undertaking, will replace cash and/or securities for assets. The benefits to shareholders are mightily dependent on the reaction of the stock market. The typical situation is where the subsidiary is in a high rated sector (rated highly by the market) and the seller is outmoded. Then as an inevitable result demerger unlocks the hidden value for shareholders who receive a part in the demerged equity.

To give an example, in 2016 Crompton Greaves through a court approved process demerged its consumer product business into a separate listed company ‘Crompton Greaves Consumer Electrical’. Consequentially, shareholders of Crompton Greaves were issued shares in the resulting company, The result of the arrangement was a 57% combined return of both original and resulting undertaking since its record date on March 16, 2016.

CONCLUSION:

Well, ideally shareholders of the demerged undertakings do reap the benefits of higher focussed businesses with management accountability driving the intrinsic value of each company, propelling their respective share prices higher than had they remained a combined entity. And spin-offs are usually preferred over IPOs by investors due to their assets being better known and better positioning of incentives due to the parent company’s wish for the progeny to succeed. That being said, have spin-offs underachieved after being demerged?

A few definitely have. All things considered, one thing is for certain, be it Crompton Greeves 2016 demerger (57% combined return) or Reliance Jio Infocom’s 2019 demerger, the value generated for shareholders is positively reflected in the market price of the demerged and resulting corporate entities where the split in undertakings is well defined and better thought out.

Fundamental Framework for Takeovers of Listed Entities

Keywords: M&A, takeover, PAC, Creeping acquisition, open offer, public announcement

[Anjana Ravikumar is a III Year B.B.A.LL.B student at Gujarat National Law University (GNLU)]

INTRODUCTION

Since the advent of globalization, the doors of the Indian economy have been open for overseas investors. To compete on a global platform, companies have to continuously amplify the scale of their business. Mergers and Acquisitions (“M&A”) pave the way for a suitable option to capture the opportunities created by such policies.

BACKGROUND

One of the earliest takeovers in India can be traced back to the acquisition of Pukhuri Tea Co. Ltd. by Bishnauth Tea in 1965. However, the waves of corporate deal-making swept the Indian landscape during the 1980s, which witnessed tentative reforms under the Rajiv Gandhi administration. The first hostile takeover attempt was made out by the London based industrialist, Swaraj Paul in 1983.

A takeover is an acquisition of control of a registered company through the purchase or exchange of shares. A Merger on the other hand involves the amalgamation of two or more companies either through the exchange of shares or the formation of a new company. Thus, while mergers involve an amalgamation through mutual consent of the companies, acquisitions or takeovers may either be friendly or hostile. Further, in an acquisition, the target company is engulfed by the acquirer and hence ceases to exist, while in a merger it is the fusion of two or more companies into one new entity.

Takeovers have been associated with propelling economic efficiency. However, it has a tendency for being exploited as a weapon, at the disposal of corporate raiders with massive capital resources, often prejudicial to the interests of retail investors. To prevent such exploitation and encourage the growth of the securities market, SEBI was established in 1992 as a regulatory body.

Subsequently, the SEBI (Substantial Acquisition of Shares and Takeover [SAST]) Regulations, 1997 were formulated; incorporating the suggestions of the PN Bhagwati Committee. These were substituted by the SEBI (Substantial Acquisition of Shares and Takeover) Regulations in 2011 (hereinafter “Takeover Code”). based on the recommendations of the Takeover Regulations Advisory Committee (“TRAC”) headed by Mr. C. Achuthan.

IMPORTANT TERMINOLOGIES:

Persons acting in concert (“PACs”):

According to Regulation 2(1)(q) of the Takeover Code, PACs are persons who, in furtherance of a common objective or purpose of substantial acquisition of shares, voting rights, or gaining control over the target company. The same is done pursuant to a formal or informal agreement or an understanding which is pertaining to either directly or indirectly co-operating in acquiring, agreeing to acquire shares, voting rights or control of the target company. The question regarding whether two persons constitute PACs is to be answered based on an analysis of the facts and circumstances of the case.

The scope of PAC has been broadened to include a new class known as deemed PACs under regulation 2(1)(q)(2) of the latest Takeover Code. Deemed PACs include promoters, immediate relatives, trustees, a collective investment scheme and its company, venture capital fund, and its sponsor and asset management company. However, deemed PACs will be considered after the abovementioned PACs as acting in concert.
Acquirer

An acquirer is defined under regulation 2(1)(a) of the Takeover Code. Any person who by himself or through or with PACs, directly or indirectly acquires or agrees to acquire, shares, voting rights or control of the target company is called an acquirer. An acquirer may be a natural person, a corporate entity, or any other legal entity.

DISCLOSURE REQUIREMENTS:

To ensure that the price discovery of shares of the target company takes place in an informed manner, several disclosures have been made mandatory under Chapter V of the Takeover Code. The disclosures required are:

Disclosure of acquisition and disposal: It is required for all acquirers to disclose acquisitions of 5% or more voting rights of the target company within two working days after such acquisition. The disclosure must be made to every stock exchange where the shares of the company are listed and to the registered office of the target company. The same does not apply to a scheduled commercial bank or a public financial institution.

Continual disclosures: If any acquirer along with his PACs holds shares or voting rights entitling him to exercise 25% or more of voting rights in the target company, he is required to disclose the same. Further, every promoter along with his PACs is required to disclose their aggregate shareholding and voting rights in the form as specified in the Regulations.

Disclosure of encumbered shares: The promoter along with his PACs shall disclose details regarding any shares encumbered by them or any release or invocation of such encumbered shares to the stock exchange and the target company’s registered office within seven working days.Disclosure requirements thus, seek to protect the interest of the public stakeholders by ensuring transparency.

OPEN OFFER:

An open offer under the Takeover Code is an offer made by an acquirer to the shareholders of the target company inviting them to tender their shares at a particular price. It provides an exit option to the shareholders of the target company during a change in control or substantial acquisition of shares in the target company. Thus, open offer provides the public shareholders an opportunity to withdraw their investment when there is a change in the management or promoter shareholding.

The Takeover code stipulates clearly that not just direct but even indirect acquisitions of shares, voting rights or control will trigger an open offer. Indirect acquisition is defined under regulation 5(1) of the Takeover Code. It includes any acquisition of shares, voting rights in or control over any company which enables the acquirer and PACs, to exercise or direct the exercise of control over or voting rights in the target company. Such acquisition is made without attracting the obligation to make an announcement of public offer.

To protect the economic interests of the exiting shareholders of the target company, it has been made mandatory for the offer to be at the best possible terms for the shareholders. To ensure the same, the Takeover Code prescribes the timing, minimum offer size, price discovery mechanisms, etc. An open offer may be:

Mandatory Open Offers: The Takeover Code prescribes certain circumstances under which an acquirer is obliged to issue a mandatory tender offer to the existing shareholders of the target company to acquire at least a minimum of 26% of its shares. The triggers/ circumstances include:

Initial Trigger – When the acquirer along with his PACs plans to acquire shares which allows them to exercise 25% or more of the voting rights in the company.
Consolidation Trigger – When acquirer and PACs together hold 25% or more of shares or voting rights but it is less than the maximum permissible limit of non-public shareholding in a target company.
Control Trigger – When an acquirer gains control over the target company, irrespective of shares owned.
Trigger on Indirect Acquisition – When an acquirer indirectly acquires the ability to exercise voting rights or control over target company as specified in initial, consolidation, or control triggers.

Voluntary Open Offer: A voluntary offer is made by an existing shareholder or an acquirer who holds no shares. Under Regulation 6 of the Takeover Code, a voluntary offer is to be made when the acquirer and PACs exercise a minimum of 25% or more of voting rights but less than the maximum limit of non-public shareholding in the target company. Voluntary offers have to be made for a minimum of 10% of the total shareholding of the target company.

Competing Offer: The Takeover Code under Regulation 20 permits third parties to make offers to the shareholders providing exit opportunities while the acquirer’s open offer subsists. This creates orderly competition among acquirers.

PROCEDURE OF AN OPEN OFFER:

The major steps involved in the open offer process are as follows:

CREEPING ACQUISITION:

· Covered under Regulation 3(2) of the Takeover Code, Creeping Acquisition is a means to facilitate the consolidation of shares, voting rights, or control in the company by persons already holding or controlling a substantial number of shares.

· Under this provision, acquisition of voting shares in a listed company; without public announcement; in excess of 25%, is permissible provided that the acquisition is limited to 5% in one financial year.

· Every financial year, an additional 5% voting rights can be acquired by an acquirer with PACs. However, this additional acquisition via creeping acquisition can only extend up to a total shareholding of 75% of the share capital.

· Beyond this 75% limit, a public announcement is mandatory. The 5% limit is to be calculated by aggregating all purchases, without including the aggregate sales.

EXEMPTIONS FROM OPEN OFFERS:

The exemptions applicable to open offers are dealt with under Regulation 10 and 11 of the Takeover Code. Circumstances under which a company is exempt from the issue of open offer include:

1. Inter se Transfers: Inter se transfers occur between immediate relatives, between a company and its subsidiaries, holding company and other subsidiaries of such holding company are exempt from the obligation of issuing open offer. Transfer to PAC for three years or more, prior to the proposed acquisition is also exempted.

Regulation 10(1)(a)(ii) of the Takeover Code provides for inter se transfer amongst promoters which can be exempted only if the said promoter holds shares for at least three years, prior to such acquisition. Inter se transfers are exempt from the obligation of open offer since there is no change in ownership per se.

2. Trusts: The transfer of shares to trusts are exempt from the obligation of open offer under the following conditions:

Such transfer shall not affect the ownership or control of shares or voting rights in the target company.
The trust is a mirror image of the promoter holding such shares.
Only individual promoters, immediate relatives, or lineal descendants can be the beneficiaries of the trust.
The beneficial interest shall not be transferred, assigned, or encumbered.
After dissolution, the assets can be transferred only to beneficiaries or their legal heirs.
The trustees cannot transfer or delegate their powers.

3. Intermediaries: The transfer of shares in return for services rendered are exempt from the obligation of open offer. Intermediaries include underwriters, stockbrokers, merchant bankers, registered stock marker, and scheduled commercial banks acting as an escrow agent.

4. Insolvency and Bankruptcy: The acquirers of distressed companies are not obliged to make an open offer. The acquisitions of Bhushan Steel by Tata Steel is one such acquisition under IBC which was exempted from open offer obligation.

5. Disinvestment: Defined under Regulation 2(g) of the Takeover Code, disinvestment is the direct or indirect sale by the Central/State Government or by a government company of shares, voting rights or control over a target company, which is a public sector undertaking. Acquisition of shares during disinvestment is exempt from the obligation of open offer.

6. Investment Funds: Alternate Investment Funds and Venture Capital Funds are exempted from making an open offer, when their investments cross the threshold which triggers an open offer.

7. Buyback of shares: If the buyback of shares results in an increased shareholding of the promoter, it will not trigger an open offer.

8. Forfeiture of shares: Increase in voting rights of existing shareholders due to forfeiture of partly paid shares and non-payment by defaulting shareholders does not necessitate the issue of an open offer.

9. Acquisition under the SARFAESI Act, 2002: The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) vests in banks the power to auction properties of borrowers who default the loan payment.

Asset Reconstruction Companies acquiring financial assets from banks and other financial institutions are duty-bound to return them upon recovery of the amount. Such acquisitions under SARFAESI Act, therefore, fall within the ambit of exemption from open offers.

Acquisitions by way of transmissions, inheritance, succession, rights issue, and exchange of shares also fall within this exemption. When the company is unsure about the exemption of a proposed transaction, it may seek informal guidance from SEBI through an application. Further, SEBI also has the discretionary power to grant exemptions for specific transactions, in the interest of the stakeholders of the company though not provided for in the code.

PUBLIC ANNOUNCEMENT:

When the acquirer acquires voting rights of the target company, in excess of limits prescribed under Regulation 3 and 4 of the Takeover Code, the acquirer is required to give a Public Announcement of Open offer to the shareholders of the target company.

It contains details about the offer, the acquirer(s)/PAC, the transaction which triggered the open offer or the underlying transaction details of selling shareholders (if any), the target company, and the price and mode of payment. It is the first announcement made by the acquirer disclosing details of the intention to acquire the shares of the target company from existing shareholders through an open offer.

Public Announcement is issued on behalf of the acquirer, by the Manager to the offer, in the format as provided under Regulation 15(1) of the Takeover Code. The Takeover Code also prescribes a specific timeline for Public Announcement. Public announcements are essential to safeguard the interests of the shareholders.

DETAILED PUBLIC STATEMENT (DPS):

The DPS is the second announcement made by the acquirer and the PACs disclosing all relevant information regarding the open offer. It enables the shareholders to make an informed decision regarding the open offer. Under Regulation 13(4) of the Takeover Code, a DPS shall be published by the acquirer through the manager to the offer within a maximum of five working days from the date of Public Announcement. Regulation 15(2) of the Takeover Code provides the format for the Detailed Public Statement.

LETTER OF OPEN OFFER (LO):

After the publication of Detailed Public Statement (DPS), within 5 days, the acquirer through the manager of the offer is required to file a draft letter of offer with SEBI. SEBI is required to revert with its comments on the LO within 15 working days. SEBI oversees that the disclosures contained in the LO are adequate and in conformity with the Regulations. Once approved by SEBI, it is dispatched to the shareholders of the target company as on an identified date.

While the PA and the DPS are made by the acquirer to inform the public of an exit opportunity available to them, the LOO is an offer made by the acquirer to the identified shareholder of the target company to purchase their shares.

CONCLUSION:

Although not all corporate takeovers may be deemed beneficial to the economy, an overwhelming majority of them are economically justifiable and are not mere opportunistic managerial power-grabs. SEBI has constantly strived to curb undesirable practices and protect the interests of investors to encourage mergers and takeovers.

The new Code based on the suggestions of the TRAC has relied on court rulings, International Takeover Codes, and sound statistical analysis to plug all loopholes. It aims to provide clarity by simplifying and aligning with internationally accepted practices.

The ever-evolving public M&A landscape continues to throw new challenges for SEBI to address. However, the new Takeover Code presently is at par with any foreign code on mergers and acquisitions and continues to ensure a systematic and transparent mechanism for takeovers in India.

-By Anjana Ravikumar

L&T’s Hostile Takeover of Mindtree: A Battle of Legal Acumen

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:

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.

In this background, it becomes essential to discuss the legality of Mindtree’s moves to avert the takeover; and L&T’s moves to pursue the same.

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.

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.

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.

-By Pranshu Gupta

Material Adverse Change (MAC), a bail out from M&A deals during Covid-19 in India?

Keywords: Covid-19, M&A, MAC, Cross-border

(Dhruv Thakur is a IV year, B.B.A.LL.B student at Gujarat National Law University, GNLU)

INTRODUCTION:

The world is facing the challenges transpired due to a global pandemic, and it has already manifested into an economic crisis as evinced by International Monetary Fund. This is surely expected to bring hard-hitting and drastic blows to the M&A scenario. As globalization faces the risk of an impending doom this can especially affect cross border transactions.

Material Adverse Change (MAC) clause is a protective measure which divests the right to either party to terminate the agreement in case of a material change of events or a development which adversely affects the feasibility of the transaction or the company. In these circumstances, as a resort to repudiate transactions, it wouldn’t be unlikely to see the invocation of MAC Clauses in Merger/Investment Agreements.

MAC is available as a recourse from the signing of the agreement to the completion of the transaction. This is usually one of the most rigorously negotiated clauses but is hardly enforced. With respect to ongoing transactions, the most significant aspect of MAC clauses is their specific wording which will determine if COVID-19 can be taken into consideration or not. Buyers/Investors like to keep the scope of MAC clauses broad whereas the sellers like it as narrow as possible.

CAN COVID-19 SET-OFF MAC?

In scenarios where the signing of the agreement is complete, it is pertinent to note whether “acts of God” (force majeure) or “pandemics” “changes in financial/political/market conditions” are specifically excluded, in which case it would be difficult for the Investor to utilise the MAC clause. However, if not excluded, then to determine the materiality threshold, guidance needs to be taken from the specific wording of the MAC clause.

Usually, courts have deemed a high bar for the occurrence of a MAC event and interpreted MAC clauses narrowly, stating that MAC is any change or event which will render it impossible for any reasonable party to enter into such transactions. There is an evident lack of structured guidelines by the courts.

Indian laws also stipulate that anything that makes it impossible or prevents a prudent person from the fulfillment of their obligation due to turbulent circumstances can be deemed as MAC. Regulation 23(1) (c) of the SEBI Takeover Code, enunciates that the parties under a contract can withdraw from the obligations, if for reasons beyond the reasonable control of the parties it becomes impossible to meet the conditions stipulated therein. Further, courts have also stressed upon the direct correlation between materiality and duration period of the change. It essentially means the development should have durational significance which is a concept even US Court’s Judgements rely upon, which is the assessment of the long-term impact caused by the event.

CROSS BORDER IMPLICATIONS:

Further, most importantly Cross-border transactions are in a rocky boat due to the supply chain being hampered. To elucidate, a major challenge to cross border transactions is that governments across the world are using lockdowns as a countermeasure against COVID-19 which has hampered the cross-border supply chain for goods and services due to constraints on movement of labour and sealed borders. Cross border transaction agreements usually carry a MAC provision for risks and costs which includes a situation of a change in law, post entering the agreement.

In cross border transactions, generally the parties have a predetermined jurisdiction that they would be subjected to, essentially meaning that any relief would not be provided to the injured party, in case the change in law falls outside of such predetermined jurisdiction. Although, principally the restrictions are the same across all jurisdictions since the entire global economy is combating COVID-19.

Hence, attempt must be made to diligently scrutinize the MAC provision, placing the restrictions apropos the lockdown under its ambit. Consequently, it becomes imperative to carefully evaluate the MAC provision as there may be scenarios where a change in law in one particular jurisdiction is not contemplate a change in law in another one.

However, in case ambiguities still persist, the affected party can terminate the agreement for the cross-border transaction, the availability of which heavily rests upon on how the MAC clause under the agreement has been worded. Therefore, it is essential that the MAC provision is devised with utmost attention to detail and a precise materiality threshold in order to solicit the same to a COVID-19 like situation, and it can help steer clear of cumbersome & expensive litigation.

In cross border transactions where the agreement has not been executed yet, more than anything else, both parties must clearly define the risk allocations amongst themselves and resort to eloquent drafting of the provisions with regards to the COVID-19 pandemic, which successively may assist both the parties to mitigate the adverse effect of the pandemic.

CONTEMPORARY SCENARIO:

In India, even after nearly 100 days since the first positive case regrettably, Covid-19 still has a strong grasp over some major metropolitan cities (surely durational implications are expected) and even if pandemics are specifically excluded from MAC, the situation can still fall under events which have industry-wide implications, acts of god or events of nationwide economic impact. Further, now that the Indian Ministry of Finance has already issued an office memorandum declaring that COVID-19 can be treated as a natural calamity, it can thus constitute ‘act of god’. Even the Indian Supreme Court in a 2018 landmark judgment clarified constituents required for being declared force majeure as:

the events must be beyond the reasonable control of the parties,
best efforts have been undertaken to mitigate force majeure event
that the same was unforeseeable by the parties and,
that the event actually rendered the performance impossible or illegal.

Hence, any impact due to COVID-19 has scope to be covered under the MCA as a force majeure event.

However, ultimately the burden of proof is on the one invoking it and instituting an MAC is an extremely subjective mechanism which all boils down to facts & circumstances of each case. What stays imperative in every scenario for triggering the MAC clause is a cautious & diligent evaluation of the specific wording of the MAC clause and lastly to take all possible measures to mitigate the impact of COVID-19 upon the ability to fulfill the obligations under a contract.

Defensive Strategies against Hostile Takeovers

Keywords: Hostile Takeover, M&A, Takeover Defenses, Cross-border M&A

(Kanisqa Agarwal is a IV year B.B.A.LL.B student at Gujarat National Law University, GNLU)

We have witnessed a rise in shareholder activism over the years in India which has developed a fertile ground for hostile takeovers. Hostile takeovers account for a huge proportion of global deal activity over the last two decades. It is only a matter of time before this trend percolates down to India markets.

The COVID-19 pandemic has wreaked havoc on the world economy and has financially distressed many companies. These dire circumstances bring in the added risk of Hostile Takeovers. It is recommended for companies to consider relevant defenses against such opportunistic activism.

Defenses against Hostile takeover can be broadly classified into:

Preventive measures to be applicable before the open offer/bid comes into effect i.e. Pre-offer Defenses;
Reactionary measures applicable after the open offer / bid i.e. Post-offer Defenses.

PRE-OFFER DEFENCES

Shark repellent / Embedded Defences

This strategy involves defenses embedded in the Charter documents of the Company. This category of strategies is largely untested in Indian courts. It can be adopted by incorporating certain amendments in the company charter documents which become active only when a takeover is attempted.

Poison Pill

A Poison Pill can exist, among other forms, as a customized shareholders rights plan. This strategy includes a rights issue i.e. shareholders can purchase shares of the company at a considerable discount or through a two-for-one scheme.

This issue is only triggered if a particular shareholder/shareholder group purchases a specific percentage of equity, by the virtue of which they become a potential takeover bidder. The bidder is excluded from exercising their rights in such an issue. This exercise makes the hostile takeover very tedious and expensive as it would dilute the shareholding of the bidder.

The rights issue can only be introduced and rescinded by the Board and thus the potential takeover bidder has to engage in negotiations with the Board. The negotiations may lead to an agreement on an acquisition price which is mutually acceptable to the parties or the takeover fail altogether if the management of the target company is keen to retain its control and the acquirer withdraws altogether.

Staggered Board Defense

The strategy involves adding provisions in the Charter documents of a company restricting the number of directors than can be removed/re-elected in a financial year. Alternatively, the target company can specify classes of directors which are re-elected and specifying others which have a fixed tenure. This drags out the whole process of taking over control.

However, this defense is not really effective in India as directors of Indian Companies can be removed by the shareholders through an ordinary resolution in a general meeting (Section 169 of the Companies Act, 2013).

Brand Pills

Private Companies which are owned and controlled by the promoters own the Brands and/or Critical assets which are licensed or leased respectively to the listed companies.
The listed companies have made provisions in their Charter documents that automatically terminate those license/leasing agreements if the licensee/lessor i.e. the listed company ceases to be in control of the licensee entities. Moreover, an automatic termination of such agreements may not come under the ambit of restrictions imposed by Regulation 26 of the SEBI Takeover Code.

Golden Parachute

If a new acquirer wants to terminate top management personnel, a huge severance package needs to be paid. This additional compensation is referred to as a Golden Parachute.

An apt example of this would be that of the ex-CEO of Walt Disney, Michael Ovitz who had to be paid a severance package $140 million owing to a golden parachute in his employment. An exorbitant Golden Parachute acts as an effective deterrent for potential corporate raiders.

POST-OFFER DEFENSES

Buyback of shares at a huge premium

This strategy entails the target company purchasing its own shares from the open market. This can be done by intimating the stock exchanges, pursuant to Regulation 29(1) (b) & 29(2) of SEBI LODR Regulations, 2015, prior to the consideration of a Share Buyback in an upcoming board meeting. However, Regulation 26(2) of the Takeover Code doesn’t allow buybacks during the open offer period unless a special resolution is passed.

Greenmailing

Sometimes Companies are threatened with open offers to extort a payment from the promoters to dissuade the corporate raid. Greenmail refers to the process of having shares bought back from the acquirer itself at a substantial premium. Some companies incorporate special anti-greenmail clauses in their charter documents that prohibit such payments.

In addition to the greenmail, the acquirer can be made to sign a Standstill Agreement. It is an undertaking whereby the bidder agrees not to acquire more shares of the target accompany within a time certain period.

Asset Restructuring

The Crown Jewels strategy entails disinvesting critical assets of the company in order to make the acquisition seem unappealing to the corporate raider. The targeted company also has the option of purchasing certain assets or undertakings which makes the acquisition undesirable for the bidder or may potentially pose anti-trust issues for it.
A more radical approach to the aforementioned strategy is the Scorched Earth approach which entails selling off most, if not all, properties of appreciable value. However, this would leave the major shareholders of the company in control of a non-appreciating enterprise.

Pacman Defense

The is a bold and counter-aggressive strategy whereby the target company starts a reverse hostile bid on the acquiring company. The target company needs to have deep pockets to pull this off.

White Knight Defense

This is the most commonly used defensive maneuver against Hostile Takeovers in India. It involves getting a promoter-friendly party to buy out the company.

Alternatively, the company can employ a variant of this defense i.e. White Squire approach which involves it making a preferential allotment of equity shares or convertible securities to the friendly party, essentially freezing the minority shareholders.

Prominent instances of the White Knight strategy being used in the Indian context:

British American Tobacco (BAT)-controlled VST Industries employed this strategy by making ITC its white knight to combat a takeover attempt by Radhakishan Damani.
The promoters of Oberoi group’s EIH employed this strategy by getting RIL as its white knight to quash ITC group’s attempt to make an open offer by increasing its stake in VST by acquiring a 14.8% shareholding.
Kalindee Rail Nirman Ltd. employed a white knight strategy as Jupiter Metal attempted a hostile bid to acquire it. In order to fend off the takeover attempt, it approved a preferential allotment of equity shares (24.9% of equity) to Texmaco Rail & Engineering promoted by Saroj Poddar. Texmaco and Kalindee subsequently agreed to merge.
Saroj Kumar Poddar of the Adventz Group also acted as a white knight for Vijay Mallya when Deepak Fertilizer attempted a hostile takeover of UB Group’s Mangalore Chemicals in the form of an unsolicited open offer.
Mahindra Realty acted as a white knight to the Sheth family-controlled GESCO Corporation, when Abhishek Dalmia of the Renaissance Group tried to acquire it.

Regulatory Bottleneck / Litigation

The targeted company sues the corporate raider for violating securities law or anti-trust laws. The Competition Commission of India (CCI) has not yet blocked a merger or an acquisition to this day, and all transactions have been given the green light after a detailed Phase II investigation.

However, it is well within the powers vested in the CCI to do so if the resultant transaction has an appreciable adverse effect on the competition in India

-By Kanisqa Agarwal

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