M&A Takeover Code

Acquisitions have gained momentum in the Indian markets recently, though the acquisitions had been a part, however miniscule, of the Indian markets since 1980s. In 1980s, there was a Listing Agreement, which set the guidelines for the regulation of acquisition. The first legal framework was set up in 1992 in the form of SEBI Act. The Act wanted SEBI to regulate the takeovers and acquisitions in a suitable manner and SEBI responded to the same by enacting the Takeover Regulations in 1994.

In less than a year’s time, SEBI set up a committee headed by Justice P. N. Bhagwati, (Bhagwati Committee), which submitted its report on the amendments to be made to the 1994 regulations in the form of Takeover Regulations, 1997. In all the takeover regulations had been amended 23 times by the time the report for the new regulations was submitted.

The underlying need for the new set was regulations were the recent increase in corporate restructuring in India. The present committee was set up based on the SEBI order dated September 4, 2009 and was headed by Mr. C. Achuthan.

It had been historically seen that even though takeovers and acquisitions impacts a host of stakeholders in the company, there was a lack of unambiguous and clear rules. This led to conflict of interests amongst the various stakeholders and it was also observed that the public shareholders were the largest victim of this ambiguity. The new regulations intend to set this straight and balance the regulations. The fundamental objectives as outlined by the committee are summed as:

• Protect the interest of investors in securities and the securities market
• Balance the conflicting objectives and interests of the various stakeholders
• Provide parity to each shareholder to exit the investment on terms not inferior to those which are applicable for the substantial shareholders
• Provide a transparent legal framework
• To continue the normal course of business of the target company to prevent any adverse effect on the share prices or other financial parameters
• Ensure the fair and accurate sharing of al material information
• To regulate and provide for a fair competition in acquisition of the target company
• To remove the sporadic players who do not have the means of acquiring a company to enter into the competition and influence the bidding process by any means

Salient features of the proposed takeover code

Open offer obligations

Initial trigger

Any acquirer cannot by any means acquire more than 25% of the shares and thereby the voting rights, if it has not made an open offer. In other words, any acquirer looking to acquire more than 25% voting rights would have to make an open offer to all the shareholders.

This step would be beneficial for the minority or public shareholders as they would now get a fair chance to exit their investment at the conditions at least equivalent to that the of the substantial shareholders. This would also allow the institutional investors to increase their holding from the present 15% to 25% without running the risk of making an open offer. This would bring the required capital and as institutional investors do not easily shift their money out of an investment, this rule might be good for the companies.

Another collateral benefit will be for the financial and strategic investors who can invest in companies to provide capital, technology and know-how for growth and value creation without affecting the control of the company. It is obviously important for the incumbent shareholders of the company to ensure such investors do not have shadow control on the company at the expense of the other shareholders.

This rule can have counter-effects as well. For instance, majority of the changes brought about in a company requires the support of 75% of the shareholders and with a single acquirer holding being 24.99% without having to make an open offer, suitable changes might be seriously compromised.

Creeping Acquisition Trigger

Any acquirer holding 25% or more of the voting rights can increase its rights up to 5% in any financial year, without making an open offer. Here again, the acquirer is not allowed to increase its shareholding to be more than the maximum permissible non-public shareholding limit.

The regulation includes clauses to prevent increasing the percentage of voting rights by means of either dilution of shares or issuance of more shares (issued to self).

This would protect the shareholders’ interests and prevent the acquiring company to restructure the target company for its benefit, neglecting the other stakeholders. This would also be a deterrent to the acquiring companies who generally look towards reforming the company post-acquisition.

In all, this would help the cause of strategic acquisitions and bring operational efficiency in the target company, preventing the resting of complete powers in the hands of the acquirer. This rule can also act as a signal as the acquiring company has to make the acquisition slowly thereby allowing the analysis of the shareholding pattern. This would also encourage the acquirers to create more value for the shareholders, though implicitly it would surely increase their costs.

Control Trigger

Regardless of the level of shareholding and acquisition of shares, the acquiring of control over the target company would necessitate the open offer from the acquirer.

This step would be beneficial for the minority or public shareholders as they would now get a fair chance to exit their investment at the conditions at least equivalent to that the of the substantial shareholders.

Indirect Acquisitions

The acquisition of the shares or voting rights which would allow the acquirer to exercise control over the wholly or partially owned company of the target company would be considered as an indirect acquisition. This means that for instance if company A has a controlling voting right over company B and company C acquires the voting rights in company A, then it automatically would get the voting rights of those of company B, and would be considered as an indirect acquisition.

There are provisions whereby based upon the conditions as outlined below, the acquisition can be treated as a direct acquisition (company C has directly acquired company B):

In case of the following:

• the proportionate net asset value of the target company as a percentage of the consolidated net asset value of the entity or business being acquired; or
• the proportionate sales turnover of the target company as a percentage of the consolidated sales turnover of the entity or business being acquired; or
• the proportionate market capitalisation of the target company as a percentage of the enterprise value of the entity or business being acquired;

being more than 80% on the basis of the most recent audited financial statements, the acquisition would be treated as a direct acquisition.

For the purpose of calculating the market capitalisation of the target company the volume-weighted average market price of such shares on the stock exchange for a period of sixty trading days preceding the earlier of, the date on which the primary acquisition is contracted, and the date on which the intention or the decision to make the primary acquisition is announced in the public domain, as traded on the stock exchange where the maximum volume of trading in the shares of the target company are recorded during such period, shall be used.

A lot of acquisitions used to be conducted in the name of acquisition of some sort of business, whereas the underlying motive was to control companies like B as explained above. This regulation would make it necessary for the acquiring companies to look into the interests of the stakeholders. Again as in a direct acquisition, the acquirer has to make an open offer which can be costly, thereby deterring them from acquisition.

Voluntary Open Offer

Shareholders holding 25% or more of voting rights have the right to make an open offer to acquire more shares (and thus voting rights), up to the minimum public shareholding limit. Conditions have been set here to safeguard the interests of the various shareholders:

If the acquirer or any person acting in concert with it, has in the preceding 52 weeks acquired shares of the target company, without reaching the limit of making an open offer, cannot exercise the right to make the open offer presently

During the open offer period the acquirer cannot acquire shares by any other means. Again any related person, who has acquired shares exercising this clause, cannot acquire further shares for a period of six months from the completion date, without making a further open offer. Here the acquirer has the right to acquire shares (making a competing offer) if any other person has made an open offer.

The regulation here gives the acquirer the liberty to increase its shareholding and at the same time safeguard the stakeholders’ interests. It also allows them to compete in case of similar steps being taken by other substantial stakeholders of the company. This would bring in transparency in the system and allow the minority shareholders to take a decision regarding their investment.

Offer Size

General Rule

The open offer as per the regulations would be for 100% of the outstanding shares as of the last day of the tendering period, provided where the target company has issued the depository receipts and the acquisition of only those shares can be done against which the receipts have been issued by the target company.

This would be useful or the shareholders of the target company but could be a deterrent for the acquiring company. The increased open offer size from 20% to 100% would surely be an attractive clause for the private equity players and the foreign capital. Though capital flow might increase, the cost for the acquiring company is going to increase due to the additional cost of funding by private equity or other players.

Exception for Voluntary Open Offer

A voluntary offer other than the 100% offer can be made, for at least 10% of the representing shares, to the limit that the maximum non-public shareholding is not exceeded. The conditions implied here are that in case a competing offer is made, post the voluntary announcement, the latter has the right to increase the number of shares to such levels as it doesn’t exceed the maximum non-pubic shareholding limit, within the 15 days of the announcement of the competing offer. In case of increase in the offer size the creeping acquisition trigger rules would be upheld.

The rules of no allowing an acquirer to acquire further shares if a portion has been within the preceding 52 weeks as outlined above and the non-acquisition of shares by means other than the open offer, are upheld here.

This would reduce the timing of declaration of the offers and also make the process streamlined instead of being prolonged for a longer period of time. This would allow the acquiring firms to focus on the project thereby reducing the operational costs substantially. This would also prevent non-competent players from making offers and extending the buffer period to make arrangements for the acquisition thereby not allowing the presently capable acquirer to move ahead with the acquisition.

Public Shareholding

If an acquirer who is making an open offer but not under the creeping acquisition trigger rules, would have the right to declare upfront at the time of the public announcement of the open offer, the intention of delisting the target company, in case the total shareholding of the acquirer exceeds the delisting threshold.

The condition here is that in case any shareholder doesn’t agree or accept the offer, would have the right to make the acquirer to purchase the shares at the offer price at any time within a period of 12 months from the 15^th business day from the date on which the shares are delisted from the stock exchanges.

For any convertible instruments held by anyone, in addition to the preceding paragraph provisions, the holder may compel the acquirer in converting the instrument into shares on an accelerated basis.

This gives more liberty to the shareholders and also the acquiring companies can be sure of the price which needs to be paid in any time in future (with conditions).

If such an intention to delist is not stated upfront, or the response to the open offer is such that the public shareholding could fall below the minimum level required under the listing agreement but remains above the delisting threshold, the acquirer would be required to either bring its holding down to ensure compliance by the target company with the listing agreement, or proportionately reduce both its acquisitions under the agreement that triggered the open offer and the acquisitions under the open offer. If the open offer in question is a competing one, then the option of proportionate reduction would not be available.

This would prevent the asymmetry of information amongst the various stakeholders and prevent the acquirer to benefit from such events.

Exemption from Open Offer Obligations

Exemptions have been streamlined and classified on the basis of the specific charging provision from which exemptions would be available, with conditions for eligibility for such exemptions. Some of the areas where changes have been recommended include increase in voting rights due to buy-back of shares, schemes of arrangement that do not involve the target company, certain inter se transfers, corporate debt restructuring and rights issues.

The summaries of the various conditions under which the open offer exemptions are made are given as:

• Acquisitions which has taken place due to transfer of shares amongst qualifying parties which would include immediate relatives, promoters for more than 3 years in the target company, a company, its subsidiaries, its holding company, other subsidiaries of such holding company, persons holding not less than fifty per cent of the equity shares of such holding company, other holding companies in which such persons hold not less than fifty per cent of the equity shares, and their subsidiaries subject to control over such qualifying parties being exclusively held by the same persons, persons acting as concerts for the acquirer for at least the last 3 years, shareholders acting as concert in the target company for the last 3 years and any equity share capital  owned by them in the same proportions, where the concert and other information has ben declared as under the rules of the Listing Agreement.

There are conditions which have been set for the above to take place.

The acquisition price per share shall not be higher by more than twenty-five per cent of the volume-weighted average market price for a period of sixty trading days preceding the date of issuance of notice for the proposed inter se transfer as traded on the stock exchange where the maximum volume of trading in the shares of the target company are recorded during such period. Moreover the transferor and the transferee should have complied with the applicable disclosure requirements as given in the Listing Agreement. 

• Acquisitions which have been made under the normal course of business by an underwriter using an underwriting arrangement as provided under the SEBI Act, 1992; a stock broker registered with the Board on behalf of his client in exercise of lien over the shares purchased on behalf of the client under the bye-laws of the stock exchange where such stock broker is a member; a merchant banker registered with the board or a nominated investor in the process of market making or subscription to the undersubscribed portion of issue; any person acquiring shares pursuant to a scheme of safety net; a registered merchant banker acting as a stabilisation agent.

• Acquisitions made by an acquirer who has made public announcements of an open offer, provided the acquirer and the seller are same throughout the stages of acquisition and that the full disclosures have been made in the public announcement and in the letter of offer.

• Acquisitions which are pursuant to a scheme, made under Sec 18 of SICA Act; of arrangement involving the target company as a transferor company or as a transferee company, or reconstruction of the target company, including amalgamation, merger or demerger, pursuant to an order of a court or a competent authority under any law or regulation, Indian or foreign; in cases of target company not taken as given in the preceding point, provided the cash and cash equivalents in the consideration paid are less than 25% of the total consideration, and after implementation of the scheme at least 33% of the voting rights in the target company are with the same persons as pre-scheme implementation.

• Acquisition pertaining to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, or to the SEBI Act, 1992.

• Acquisitions by way of transfer, succession or inheritance.

• Acquisition of preferred stocks with voting rights as under the Companies Act, 1956.

The following conditions would allow the exemption from initial trigger and the creeping acquisition trigger.

• Acquisition of shares of a target company not involving a change of control over target companies, pertaining to the corporate debt restructuring

• Acquisition of shares in a target company in the ordinary course of business by a consortium of scheduled commercial banks or public financial institutions, pursuant to invocation of pledge or other security interests, provided no member of the consortium acquires shares in excess of the threshold of voting rights

• Acquisition of shares in a target company in excess of the threshold of voting rights, if there is a pledge to retransfer the shares to the pledger

• If the voting rights amount has been reduced within 90 days of the acquisition

The following would allow exemptions from the creeping acquisition trigger:

• acquisition of shares by any shareholder of a target company pursuant to a rights issue provided the acquirer has not renounced any of the entitlements in such rights issue, and the price at which the rights issue is made is not higher than the ex-rights price of the shares of the target company

• increase in voting rights in a target company of any shareholder pursuant to buy-back of shares, provided, such shareholder has not voted in favour of the resolution authorising the buyback of securities, in the case of a shareholder resolution, voting shall be by way of postal ballot, where a resolution of shareholders is not required for the buy-back, such shareholder, in his capacity as a director, or any other interested director has not voted in favour of the resolution, the increase in voting rights does not result in an acquisition of control by such shareholder over the target company. In case these are not met, the shareholder would need to reduce the holding to below the threshold limits.

• acquisition of shares in a target company by any person in exchange for shares of another target company

• acquisition of shares in a target company from state-level financial institutions or their subsidiaries or companies promoted by them, by promoters of the target company

• acquisition of shares in a target company from a venture capital fund or a foreign venture capital investor registered with the Board by promoters of the target company

As per the new regulations SEBI would continue to have the power to grant exemption from making an open offer and would continue to have the power to give relaxation from strict compliance with the procedural requirements along with making the previously mandatory reference optional. 

The Board may for reasons recorded in writing, grant exemption from the obligation to make an open offer for acquiring shares under these regulations subject to such conditions as the Board deems fit to impose in the interests of investors in securities and the securities market provided that the target company board of directors has been superseded by governmental authorities and the same provides a transparent process of transfer of the company. Also the exemptions given by SEBI would be needed to be published.

Offer Price

The minimum price has been fixed as the highest of the following:

• the negotiated price under the agreement that attracted the open offer;

• volume-weighted average price paid by the acquirer and persons acting in concert in the preceding fifty-two weeks;

• highest price paid by the acquirer or persons acting in concert with him during the preceding twenty-six weeks;

• sixty trading day volume weighted average market price (for frequently traded shares)

To compute the offer price for indirect acquisitions, in addition to the above parameters, any higher price paid during the period between contracting of the primary transaction and the public announcement has also to be considered.

In case the offer price cannot be determined by the above factors the acquirer and the manager of the open offer should fairly value the company using various parameters likes book value, comparable trading multiples, and any other company specific parameters. In case certain financial parameters of the target company, like proportionate net asset value or sales turnover or market capitalisation exceeds 15% value of the target entity or business, the price has to be computed by the acquirer and the methodology for the same has to be made public.

In case of indirect acquisitions of the target company, the offer price would stand increased at the rate of 10 % per annum calculated on a pro-rata basis for the period from the date of the primary transaction being announced in the public domain until the date of actual detailed public statement in respect of the target company. Such revised offer price would be payable to all shareholders who tender their shares in the open offer.

The control premium if any paid has to be included in the calculation for the total price. If the dates on which the corporate actions like rights issue, bonus issue, stock consolidation, stock splits, payment of dividends, de-mergers, or reduction of capital fall prior to 3 days before the start of the tendering period, the price paid has to be reduced or adjusted as required, provided that no adjustment shall be made for dividend declared with a record date falling during such period except where the dividend per share is more than fifty per cent higher than the average of the dividend per share paid during the three financial years preceding the date of the public announcement.

The addition of control premium into the price paid would allow the equal distribution of the premium earned by the target company to all the shareholders.

The offer price for partly paid up shares shall be computed as the difference between the offer price and the amount due towards calls-in-arrears with interest, if any, thereon.

In cases of exchange rate being involved, the conversion would take place at the rate which prevailed on the date of the public announcement of the offer.

Though there are doubts whether the Indian financing environment can cope with such a requirement, this will lead to further development of capital markets in India with new financing structures and instruments like acquisition-related equity raising, issuance of convertible debt instruments, and will also promote the usage of other non-cash considerations like exchange of equity.

Mode of payment

The offer price may be paid in the form of cash or securities like shares, convertibles, secured debt instruments of the acquirer or of persons acting in concert with him or a combination of these modes. To ensure that the equity shares given in consideration for the open offer are liquid, eligibility conditions have been stipulated. However, if shares of the target company carrying more than 10 % voting rights have been acquired for cash in the preceding 52 weeks, shareholders to whom the open offer is made may opt to receive the offer price only in cash.

The mode of payment of consideration may be altered in case of revision in offer price subject to the condition that the component of the offer price to be paid in cash prior to such revision is not reduced.

As the shareholders have been provided with options to accept payment in cash or by way of securities, or a combination thereof, the pricing for the open offer may be different for each option subject to compliance with minimum offer price requirements provided, the detailed public statement and the letter of offer should contain justification for such differential pricing. If the securities are being provided as consideration, the value of the same should be taken as the volume-weighted average market price for the period of sixty trading days.

The given parameters have removed a lot of ambiguity from the pricing of the securities and that of the target company. It also provides ample regulations to safeguard the interest of the shareholders and also prevents any sort of premium to be received by the substantial shareholders.

Conditional Offers

An acquirer can make an open offer conditional as to the minimum acceptance level and during the time of offer neither the acquirer nor any party acting on its behalf can acquire any shares.

Competing Offers

An acquirer having made a voluntary offer is permitted to switch to a normal full-sized offer when a competing offer is made. Within 21 business days from expiry of the offer period, any competing acquirer would be free to negotiate and acquire the shares tendered to the other competing acquirer, at the same price that was offered by it to the public. However, the holding cannot increase beyond the maximum permitted non-public shareholding.

Any acquirer needs to declare the intention of acquisition within 15 days of the public announcement by the first who has declared and this competing offer would not be regarded as a voluntary open offer under any circumstances.

Competing offers cannot be made in case the initial offer pertains to a case of disinvestment, or the initial open offer has been relaxed by the SEBI under sub-regulation (2) of regulation (11) of the takeover code.

All the activities and the timeline for all the competing offers (including the initial offer) would be adjusted to the last date of tendering shares for the last competing offer made.

Completion of the Transaction that Triggered the Open Offer

The acquirer cannot complete the acquisition of shares or voting rights, or take control of the target company under any agreement attracting the obligation of making an open offer until the expiry of the offer period. The agreement that attracts an open offer obligation may be acted upon during the pendency of the open offer provided 100 % of the consideration payable under the open offer is placed in escrow account.

An agreement that triggered an open offer obligation would have to be completed within twenty-six weeks after the offer period. In case this is not possible due to certain reasons, the board can decide upon the amount of extension to be given to the acquirer as they might deem fit in the interest of the shareholders and the securities market.

Governance Issues

The board of directors of the target company would be required to conduct the operations of the target company in the ordinary course and consistent with past practice. Material transactions outside the ordinary course of business cannot be undertaken during the offer period, either at the level of the target company or at the level of any subsidiary of the target company without approval of shareholders of the target company.

This would make the acquiring company to state its intention upfront as it would not be allowed to sell off the assets which are kind of mandatory for the target company to function. This would give proper and relevant information with regards to the intention of the acquiring company and the probable future of the target company.

The target company cannot under the offer period conduct a buy-back of shares, or bring any changes in the capital structure of the company. Neither may it enter into, amend or terminate any material contract nor can it accelerate the rights of any related party as against the normal course of business. The target company cannot also fix any date for any corporate action from 3 days prior to the start of tendering period to the end of it.

A committee of independent directors of the target company would be formed to consider and give its reasoned recommendations on the open offer, which would be published by the target company. The expenses for the external help if any taken would be borne by the target company. The suggestions of the committee should be published at least 2 days prior to the commencement of the tendering period.

This would surely allow more information to the shareholder but would be weakening the already bleated set of steps which can be taken by the target company to prevent its acquisition.

No appointment of representatives of the acquirer to the board of directors of the target company would be permitted unless the acquirer places in escrow account 100% of the consideration under the open offer in cash. Such appointment may be made only after the deadline for making competing offers expires. This provision stands nullified in case the offer is subject to a minimum level of acceptance. In case there is already a relevant member on board, the director in the target company cannot take part in any discussion related to the acquisition.

These clauses remove to a higher degree the impact of asymmetric information and also provides for a framework whereby the influencing factor predominant in emerging countries is taken care of. Increasing the transparency this would not allow the acquiring companies to influence the decision of the target companies.

Activities and Timelines in Open Offer Process

A normal open offer process would be completed within 57 Business Days from the date of Public Announcement.

Day 00 - Open offer made

Day 05 - Detailed Public Statement

Day 10 - Draft Offer Letter to SEBI

Day 25 - Comments from SEBI on Draft Offer Letter

Day 32 - Identification of the Shareholders and Dispatch of Letters

Day 34 - Upward revision in offer

Day 35 - Comments by independent directors

Day 36 - Issue of advertisement announcing the schedule of activities for open offer

Day 37 - Date of Opening Offer

Day 47 - Date of Closure of Offer

Day 57 - Payment to Shareholders

The total number of days required for the acquisition process has been reduced considerable from the present 95 days to 57 days. This would be an attractive factor for the acquiring companies as longer periods of time increase the cost for them.

The regulations also provide the acquirer the right to declare the intention of selling away the non-performing assets or those which won’t be useful post-acquisition. This may allow them to raise the funds required to conduct the acquisition and also bring operational efficiency.

 

The excerpts have been taken from the “Report of the Takeover Regulations Authority Committee”, dated July 19, 2010.