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Sunday, August 29, 2010

Company Law - Role of Takeover Regulations in Protecting Minority Interests: A Comparative Study between India and UK

Takeover of companies is a well-accepted and established strategy for corporate growth. International experience of takeovers and mergers and amalgamations has been varied. Nonetheless, one of its important lessons is that, its appeal as an instrument of corporate growth has usually been the result of an admixture of corporate ethos of a country, shareholding pattern of companies, existence of cross holdings in companies, cultural conditions and the regulatory environment. 

In India, however, "the market" for takeovers has not yet become significantly active, though following economic reforms, there is now a discernible trend among promoters and established corporate groups towards consolidation of market share, and diversification into new areas, albeit in a limited way through acquisition of companies, but in a more pronounced manner through mergers and amalgamations. The latter course is outside the purview of SEBI and constitutes a subject matter of the Companies Act, 1956, and the courts of law, and there are well laid down procedures for valuation of shares and protection of the rights of investors.

In common parlance, a takeover bid is generally understood to imply the acquisition of shares carrying voting rights in a company in a direct or indirect manner with a view to gaining control over the management of the company. Generally speaking, there cannot be a change in the control of a company simpliciter, unaccompanied by acquisition of shares, though there have been cases before SEBI where management control has changed from one group of persons to another without any overt acquisition of substantial quantities of shares. It would therefore be correct to state that, takeover or gaining control over a company, as opposed to pure investment, is the most common leitmotif for substantial acquisition of shares. Such takeovers could take place through a process of friendly negotiations or in a hostile manner in which, the existing management resists the change in control.

In a market driven economy, where free competition should thrive without relying on the protective hand of bureaucratic intervention, it is important that such critical processes as substantial acquisition of shares and takeovers, which can significantly influence corporate growth and contribute to the wealth of the economy through rational allocation and optimal utilization of resources, take place within the orderly framework of regulations and that such a framework should be one which comports with principles of fairness, transparency and equity, and above all with the need to protect the rights of the shareholders. 

Need for Regulations in Corporate Control Market and the Relevance of CG
Mergers and TOs (takeovers) are dynamic corporate events and all the various permutations and combinations of the moves of the relevant parties and the resulting outcomes cannot be envisaged. For the market for corporate control to perform efficiently in the sense of effective utilization and management of corporate resources that will ensure improved performance of companies after the consolidations take place, it ought to take place within the orderly framework of regulations. Here comes in the relevance of CG. Thus, it is important that such critical processes like substantial acquisition of shares and TOs, which can significantly influence corporate growth and contribute to the wealth of the economy through rational allocation and optimal utilization of resources, take place within the orderly framework of regulations. The regulations have to be so devised that they outline the principle, which could be the guiding lights for the unexpected events that could crop up later. The major objectives of any framework of regulations governing TOs are perceived to be:
  1. Protection of stakeholders’ (particularly, the shareholders') rights and interests.
  2. Allowing a free, fair transparent and equitable market for corporate control.
  3. Curbing malpractices in such transactions.
It transpires from the above discussion of conceptual issues that for the CG mechanism to be effective, adequate and appropriate, the regulations designed to control the market for corporate control under the general set of rules of CG ought to be more expansive in the sense that not only the shareholders but all the stakeholders should be taken care of.

The first attempts at regulating takeovers were made in a limited way by incorporating a clause, viz. Clause 40, in the listing agreement, which provided for making a public offer to the shareholders of a company by any person who sought to acquire 25% or more of the voting rights of the company. This allowed for the passive participation of shareholders of the company that is being taken over, in the takeover process. But the clause used to be easily circumvented and its basic purpose frustrated by the acquirers, simply by acquiring voting rights a little below the threshold limit of 25% for making a public offer. Besides it was also noted that it was possible to acquire control over a company in the Indian context with even holding 10% directly. There was therefore a case for lowering of the threshold from 25%. In 1990, even before SEBI became a statutory body, Government, in consultation with SEBI, amended Clause 40 by -
  • Lowering the threshold acquisition level for making a public offer by the acquirer, from 25% to 10%;
  • Bringing within its fold the aspect of change in management control under certain circumstances (even without acquisition of shares beyond the threshold limit), as a sufficient ground for making a public offer;
  • Introducing the requirement of acquiring a minimum of 20% from the shareholders;
  • Stipulating a minimum price at which an offer should be made;
  • Providing for disclosure requirements through a mandatory public announcement followed by mailing of an offer document with adequate disclosures to the shareholders of the company; and
  • Requiring a shareholder to disclose his shareholding at level of 5% or above to serve as an advance notice to the target company about the possible takeover threat.
These changes helped in making the process of acquisition of shares and takeovers transparent, provided for protection of investors’ interests in greater measure and introduced an element of equity between the various parties concerned by increasing the disclosure requirement. But the clause suffered from several deficiencies - particularly in its limited applicability and weak enforceability. Being a part of the listing agreement, it could be made binding only on listed companies and could not be effectively enforced against an acquirer unless the acquirer itself was a listed company. The penalty for non-compliance was one common to all violations of a listing agreement, namely, delisting of the company's shares, which ran contrary to the interest of investors. The amended clause was unable to provide a comprehensive regulatory framework governing takeovers; nonetheless, it made a positive beginning.

The SEBI Act enacted in 1992, empowered SEBI to regulate substantial acquisition of shares and takeovers, and made substantial acquisition of shares and takeovers a regulated activity for the first time. The SEBI Regulations for Substantial Acquisition of Shares and Takeovers were notified by SEBI in November 1994. Clause 40(A & B) of the listing agreement also remained in force. The Regulations preserved the basic framework of Clause 40 (A & B) by retaining the requirements of - initial disclosure at the level of 5%, threshold limit of 10% for public offer to acquire minimum percentage of shares at a minimum offer price and making of a public announcement by the acquirer followed by a letter of offer. But the Regulations did make a significant departure from Clause 40(A & B) by dropping "change in management" simpliciter as a ground for making a public offer. On the other hand, several new provisions were introduced enabling both negotiated and open market acquisitions, competitive bids, revision of offer, withdrawal of offer under certain circumstances and restraining a second offer in relation to the same company within 6 months by the same acquirer. These provisions were used later by some acquirers to launch hostile and competitive bids. Additionally, the Regulations enhanced the level of investor protection in several ways. Being statutory in nature, violation of its provisions attracted several penalties. These inter alia included SEBI’s right to initiate criminal prosecution under section 24 of the SEBI Act, issue directions to the person found guilty not to further deal in securities, prohibit him from disposing of any securities acquired in violation of the regulations, or direct him to sell shares acquired in violation of the Regulations and take action against the concerned intermediary who is registered with SEBI. The SEBI Act also empowered SEBI to adjudicate fines as penalties for certain violations of the Regulations. Indeed, there have already been a number of instances, where SEBI has initiated penal action against the acquirers under these provisions for violation of the Regulations. 

The process of substantial acquisition of shares and takeovers is complex. SEBI has now gained considerable experience and insight into the complexities in this area through the administration of the Regulations and Clause 40 A & B of the listing agreement. It has also helped SEBI focus attention on certain areas in the regulatory framework which not only required clarity but also needed to be addressed specifically. For example, the provisions for open market acquisition of shares, competitive bid and revised offer in the Regulations allowed hostile takeovers and competitive offers to be launched, and the consequent revision of offers to take place for the first time in the Indian market; nonetheless, these offers demonstrated with certain degree of acuity, the deficiencies in the existing provisions. These needed to be specifically addressed in the extant Regulations to make the regulatory framework more comprehensive and equitable.

Regulations in corporate control market after 1991
The policy and regulatory framework governing mergers and acquisitions has evolved over the 1990s. In 1992, government created the SEBI with powers vested in it to regulate the Indian capital market and to protect investors’ interests. SEBI also took over the functions of the office of the Controller of Capital Issues (CCI). In November 1994, with a view to regulating the TOs, SEBI promulgated the Substantial Acquisition of Shares and TOs Regulations. The SEBI regulations on TOs were modeled closely along the lines of the UK City Code of TOs and Mergers. The Indian regulations have borrowed substantial concepts from and procedures from the UK code, e.g., the term "persons acting in concert", the compulsory requirement of making a public offer on acquisition of a particular level of shares, the emphasis on following the spirit, rather than the letter, and so on. However, the essential difference is that the Indian TO regulation is a law while the UK City Code is not (Thakur (1996)).

The 1994 TO Code was observed to be inadequate in handling the complexity of the situation. Hence, a committee chaired by Justice P.N. Bhagwati was appointed in November 1995 to review the 1994 TO Code. The committee’s report of 1996 formed the basis of a revised TO Code adopted by SEBI in February 1997. The revised TO Code provides for the acquirer to make a public offer for a minimum of 20% of the capital as soon as 10% ownership and management control has been acquired. The creeping acquisitions through stock market purchases over 2% over a year also attracted the provision of open offer. However, acquisitions by those owning more than 51% ownership do not attract the provisions of the code. The price of the public offer is to depend on the high/low price for the preceding 26 weeks or the price for preferential offers, if any. In order to ensure compliance of the public offers, the acquirers are required to deposit 50% of the value of offer in an escrow account. Furthermore, the acquirer has to disclose sources of funds.

Some more amendments to the code were announced by the government in October 1998. These amendments include revision of the threshold limit for applicability of the code from 10% acquisition to 15%. The threshold limit of 2% per annum for creeping acquisitions was raised to 5% in a year. The 5% creeping acquisition limit has been made applicable even to those holding above 51%, but below 75% stock of a company.

Current regulations, by making disclosures of substantial acquisitions mandatory, have sought to ensure that the equity of a firm does not covertly change hands between the acquirer and the promoters. Moreover, the right of the existing management to withhold transfer of shares under Section 22A of the SCRA, dealing with free transferability and registration of listed securities of companies has been withdrawn in the recently introduced Depository Regulations Act, 1996, with effect from 20.9.1995. However, under Sections 250 and 409 of the Companies Act, target companies can shelter against raiders if the proposed transfer prejudicially affects the interests of the company.

Buyback of shares has been recently introduced and the TO code will not include companies that are planning offers under the buy-back norms. However, TO defense mechanisms as poison pills for incumbent management as in US and UK are not allowed under the current regulations.

Objectives of the takeover regulations
The main objective of the regulations governing TOs is to provide greater transparency in the acquisition of shares and the TO of ownership and control of companies through a system based on disclosure of information. Instead of discovering that the management of the company one owns has covertly changed hands, resulting in huge gains for the promoter, a shareholder could now expect to be informed each time, and at what price a firm’s equity changed hands. Moreover, if the shareholder had less faith in the new owners, he could sell the shares without incurring a loss, since SEBI regulations stipulate that a buyer must make a public offer to buy shares at the same price at which the acquisition is made. The current regulations on TOs in India seem to have taken a liberal view towards TOs. TOs are thought to play an important role in building corporate synergy, in raising shareholder value and in keeping companies on their toes.

Takeover Code
The SEBI (Substantial Acquisition of Shares and Take-overs) Regulations, 1994 aim at making the take-over process transparent, and also protect the interests of minority shareholders. The first competitive bid and the first hostile bid in terms of the regulations were launched in 1995-96. While the launching of these bids marked the maturing of the process of take-overs, these bids highlighted the need to strengthen the regulations. SEBI approved the modified takeover code based on the recommendations of the Bhagwati Committee chaired by former Chief Justice P.N. Bhagwati. 

Under the revised code, a mandatory public offer of 20 per cent purchase will be triggered off when the threshold limit of 10 per cent equity holding is crossed. This will, however, not apply to consolidation by those in control, who can purchase 2 per cent of shares per annum as long as their total holding is below 51 per cent. The pricing of public offers would have to satisfy certain conditions. To discourage frivolous attempts, acquirers will have to deposit a certain value of cash and assets in an escrow account. The escrow deposit would be higher for conditional public offers, unless the acquirer agrees to acquire a minimum 20 per cent even when the full condition is not met. This mandatory acquisition could be at a lower price to be specified in the conditional offer 

Substantial Acquisition of Shares and Takeovers
  • Definitions of 'acquirer' and 'persons acting in concert' have been amplified to cover direct as well as indirect acquisitions. The definition of "control" would be modified to safeguard shareholders' interest.
  • Mandatory public offer is triggered off when the threshold limit of 10 per cent is crossed and there is change in control.
  • For the purpose of consolidation of holdings, acquirers holding not less than 10 per cent but not more than 51 per cent are allowed 'creeping acquisition' upto 2 per cent in any period of 12 months. Any purchase for a holding more than 51 per cent will have to be in a transparent manner, through a public tender offer.
  • An acquirer, including persons presently in control of the company, should make a public offer to acquire a minimum of 20 per cent in case the conditions for mandatory public offer mentioned earlier are valid.
  • SEBI would not be involved in the pricing of offer. Pricing will be based on the parameters such as the negotiated price, average of the high and low price for 26 weeks period before the date of the public announcement, highest price paid by the acquirer for any acquisition during the 26 weeks period before the date of the public announcement, and the price for preferential offers, if any. Use of discretion by SEBI will be reduced to the bare minimum.
  • The concept of 'Chain Principle' has been introduced requiring a public offer to be made to shareholders of each company when several companies are acquired through acquisition of one company.
  • Disclosure requirement has been strengthened, requiring disclosure of additional details on financial arrangements for implementing the offer, future plans of the acquirer for the target company etc. Disclosure of misleading information will be deemed a violation attracting penal action. Non-exercise of due diligence will also attract penalties.
  • Conditional offer has been allowed subject to either a minimum mandatory acceptance of 20 per cent with differential pricing; or, with a deposit of 50 per cent of the value of the offer in cash in the escrow, in cases where the bidder does not want to be saddled with the 20 per cent acquisition.
  • The obligations of the board of the target company have also been spelt out. During the offer period, the board is precluded from inducting any person belonging to the acquirer or transfer shares in his name until all the formalities relating to the offer are complete.
Relevance of Clause 40 A & B of the Listing Agreement
SEBI has enforced public offer relying on Clause 40 A and B of the Listing Agreement where takeover has been evidenced through changes in management control, though the acquisition of shares has been less than the threshold limit of 10%. The Regulations should, as far as possible, be comprehensive and self-contained and SEBI should not have to rely on outside rules and regulations to implement its objective. Clause 40 A & B of the listing agreement may be replaced by a clause requiring compliance with the SEBI Regulations on Takeovers.

Timing of public announcement of offer
  • The public announcement of offer is made not later than four working days of the agreement.
  • In case of acquisition of securities (including GDRs / ADRs) which would entitle the acquirer to voting rights at a later date, the public announcement be made not later than four working days before conversion, or exercise of option, as the case may be leading to acquisition of shares with voting rights exceeding the threshold limit.
Public announcement of offer
Under the existing provisions, an acquirer is required to make public announcement in atleast one national English daily and in regional language newspaper of the place where the shares of the company are listed and most frequently traded. It has been the experience of SEBI that acquirers pay lip service to compliance with these provisions by releasing the public announcements in obscure dailies with very limited circulation. This defeats the very purpose of releasing public announcement as it hardly comes to the notice of any shareholder. Fairness and equity also demand that the Board of Directors of the target company should know about the impending takeover from the acquirer. It should be an obligation for the acquirer to inform the Board of the target company about his intention. Another important point is that the announcement of substantial acquisition of shares or takeover of a company by an acquirer is a market sensitive information and should become publicly available through communication to the stock exchanges as well. 

An issue which often came up before SEBI in the course of administering the existing Regulations was when an offer could be said to have been made. Related to this was the issue whether the public announcement of an offer would constitute an offer or could be considered merely as a declaration of intention to make an offer. There have been several cases before SEBI in which the acquirers have sought to withdraw their offers after making the public announcement on the basis of a contention that public announcement by itself does not constitute an offer. These issues need to be clarified.

The Anomaly That’s Section 395
The opening up of the economy has created a boom in corporate restructuring. Mergers, amalgamations, reconstructions and takeovers are common strategies. Faster and wider, the law is being evolved and interpreted under the Companies Act, the SEBI Takeover Code, to provide flexibility to companies and protection to minority investors. 

Part VI of the Companies Act deals with schemes of reconstruction and mergers (Sections 391 & 394). The relatively unknown anomaly in this Part is Section 395, which envisages schemes of takeover of the entire shares of one company by another. The effect of this exproprietary provision is the total dilution of a class of members holding less than 10 per cent. In a recent decision of the Delhi High Court, the application of this Section has been severely criticised as being violative of Article 19 of the Constitution. 

A rambling, lengthy provision, Section 395 requires acceptance of the acquirer’s offer by 90 per cent shareholders of the target company within four months, following which the acquirer has to give notice to the dissenting shareholders for acquisition of their shares on the said terms. The dissenting shareholders are bound to accept the offer, unless interdicted by the Court. 

The Section provides partial protection in a situation where the acquirer holds more than one-tenth shares in the target company. Effectively, that renders a 90 per cent acceptance impossible. The solution offered by the Section is the requirement of a special resolution, minus the offeror’s shares. 

The Delhi High Court has described Section 395 as operating in its own orbit, impervious to the gravitation of other provisions in the chapter. It is significant that the analogous provision in the revamped English Companies Act has been segregated from reconstruction etc and regrouped with takeover provisions. The legislature, when devising the operation of these laws in various fields, has clearly not applied its mind to this.
In the instant case, AIG (Mauritius) Vs Tata Televentures, AIG had 7.2 per cent in the target company, Tata Cellular, in which the other non-Tata partners were bought out by Tata Industries Limited. Tata Televentures made a bid to acquire the target company, in which AIG was the only non-Tata shareholder. In the meanwhile, the target company proceeded to amalgamate with AT&T and Grasim, resulting in BATATA (now Idea Cellular). But AIG’s shareholding in Tata Cellular remained a discordant note, hence this stratagem. 

There are very few Indian leading cases on this Section. But the clear view is that, minority interests notwithstanding, a deadlock against majority decisions should not be sustained in law. In 1957, the Madras High Court had held in an obiter that the analogous provision in the old Act is not ultra vires the Constitution.
What is more relevant is the decision of Bugle Press by the Court of Appeals, UK, which struck down the purchaser’s offer on the premise that 90 per cent of the majority shareholders who accepted the offer, in fact, constituted the acquirer. The Court opined that it could not lend its approval to a takeover on such terms, under the perfunctory guise of the legal provision. It also expressed the need for guidelines in the Section for the exercise of the Court’s discretion. To this, the Delhi High Court adds that the objective of the invocation ought to be deducible from the Section’s wordings, on which it is silent. While the Sebi Takeover Code imposes various prohibitions to safeguard minority interest against majority abuse, there is no objective guidance available to the Court under this exproprietary takeover. 

In the instant case, the presence of AIG was a greater irritant, and once the corporate veil was pierced, the acquirer and the seller’s identity were the same. Legally, the Tata group could have excluded AIG in the BATATA merger scheme, where complete transparency would have been observed. To press Section 395 into use in what the Delhi High Court describes as “incestuous transactions” cannot be countenanced.
The Court has imposed costs on the respondents, while upholding AIG’s case. Had the case involved a quoted company, the penalty would have been more onerous. It is important that Section 395 gets a relook in the next amendment to the Companies Act.

Balance to be struck between the rule of the majority and the rights of the minority
The fundamental principle defining operation of shareholders democracy is that the rule of majority shall prevail. However, it is also necessary to ensure that this power of the majority is placed within reasonable bounds and does not result in oppression of the minority and mis-management of the company. The minority interests, therefore, have to be given a voice to make their opinions known at the decision making levels. The law should provide for such a mechanism. If necessary, in cases where minority has been unfairly treated in violation of the law, the avenue to approach an appropriate body for protecting their interests and those of the company should be provided for. The law must balance the need for effective decision making on corporate matters on the basis of consensus without permitting persons in control of the company, i.e., the majority, to stifle action for redressal arising out of their own wrong doing.

Minority and ‘Minority Interest’ should be specified in the substantive Law
  • At present, in case of a company having share capital, not less than 100 members or not less than 1/10th of total number of members, whichever is less or any member or members holding not less than 1/10th of issued share capital have the right to apply to CLB/NCLT in case of oppression and mismanagement. In case of companies not having share capital, not less than 1/5th of total number of members have the right to apply.
  • To reflect the interest of the "Minority", a 10% criteria in case of companies having share capital and a 20% criteria in the case of other companies is provided for in the existing Act. In Section 395 of the Act, the dissenting shareholders have been put at the limit of 10% of shares. Thus Minority could be defined as holding not more than 10% shares for the limited purpose of agitating their rights before the appropriate forum.
  • Oppression is defined in section 397(2). It is defined as conducting the company’s affairs in a manner prejudicial to public interest or in a manner oppressive to any member or members. Mis-management has been defined in section 398(1) of the Act, as conducting the affairs of the company in a manner prejudicial to public interest or in a manner prejudicial to the interests of the company.
Representation of minority interests
While the Committee feels that the concept of independent directors would provide an objective scrutiny of management, operations and decision making, the Boards of the companies could also incorporate the concept of representation of specific minority shareholders group. It was observed that the existing Act provided an option to company to adopt proportionate representation for the appointment of directors but this option was rarely used. A view was expressed that the applicability of the provisions of Section 265 (existing Act) could be made mandatory. The specific minority appointed director/independent director could also play an important role in investor protection. The Committee view was that the existing option may be retained.

Right of share holders to be informed through correct disclosures
The risks of investors can be reduced / minimized through adequate transparency and disclosures. The law should indicate in clear terms the rights of members of the company to get all information to which they are entitled in a timely manner. The financial information and disclosures to be provided to shareholders should not be in excessively technical format but should be simple to understand. This will enhance the credibility of the company and will help the shareholders to take an informed and conscious decision in respect of their investments. Besides, statutory information, which would be regulated through law, the information could also be made available through other means like print, electronic media, company website etc. A regime of stringent disclosure norms should be provided for in case of companies accessing funds through public offers. There should be adequate and deterrent penalties in law against wrong disclosures. 

Right of minority to be heard
Once the principle of protection of "Minority Interest" is recognized in the Act, there would also be a need to put in place an appropriate mechanism for ensuring that such provisions relating to "Minority Interest" do not obstruct the Board or the management from performing their functions genuinely in interests of the company. The Board and the management should, therefore, be protected from undue and unjustified interference from unscrupulous shareholders acting in the guise of investors’ rights.

Rights of minority shareholders during meetings of the company
Sometimes, the meetings of the company are so organized so as to deprive the minority of an effective hearing. The procedures to be prescribed under the Act should safeguard against such behaviour by the company. There should be extensive use of postal ballot including electronic media to enable shareholders to participate in meetings. 
Rights in case of Oppression and Mismanagement
There are adequate provisions in the existing Act to prevent Oppression and Mismanagement. Minority, represented by specified number of members or members holding requisite percentage of equity capital are entitled to approach Courts/Tribunals for protection of their interests. The quasi-judicial body is empowered to order a number of remedial measures for regulation of the conduct of company’s affairs. These measures, inter-alia, include purchase of shares or interests of any members of company by other members; termination, setting aside or modification of agreements relating to managerial personnel; setting aside of transactions relating to transfer, delivery of goods etc, or any other matter for which Court/Tribunal feels that provisions should be made. The Court/Tribunal is also empowered to appoint such number of persons as necessary to effectively safeguard interest of the company. 

Rights of minority shareholders during mergers/ amalgamations/ takeovers
  • As per existing provisions of the Act, approval of High Court / Tribunal is required in case of corporate restructuring (which, inter-alia, includes, mergers/amalgamations etc.) by a company. The Scheme is also required to be approved by shareholders, before it is filed with the High Court. The scheme is circulated to all shareholders along with statutory notice of the court convened meeting and the explanatory statement u/s 393 of the Act for approving the scheme by shareholders.
  • Though there may not be any protection to any dissenting minority shareholders on this issue, the Courts, while approving the scheme, follow judicious approach by mandating publicity about the proposed scheme in newspaper to seek objections, if any, against the scheme from the shareholders. Any interested person (including a minority shareholder) may appear before the Court. There have been, however, occasions when shareholders holding miniscule shareholdings, have made frivolous objections against the scheme, just with the objective of stalling or deferring the implementation of the scheme. The courts have, on a number of occasions, overruled their objections.
  • It is, therefore, felt that there should be specific provision in the Act to put a limit (either according to a minimum number of persons or according to a minimum percentage of shareholding) for entitling any body to object such a scheme. It would also be appropriate to provide for acquisition of remaining 10% shares in a company, of which 90% has been acquired by an acquirer. Such acquisition of 10% shares should be as per Rules to be framed by Central Government. The Committee has also made recommendations separately in para 19 of Chapter X, concerning a threshold limit for maintainability of objections by barring minority shareholders with insignificant stake from obstructing schemes of arrangement.
  • In case of Takeovers, as per SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997, SEBI has powers to appoint investigating officer to undertake investigation, in case complaints are received from the investors, intermediaries or any other person on any matter having a bearing on the allegations of substantial acquisition of shares and takeovers. SEBI may also carry out such investigation suo moto upon its own knowledge or information about any breach of these regulations. Under section 395 of the Act, a transferee company, which has acquired 90% shares of a transferor company through a scheme or contract, is entitled to acquire shares of remaining 10% shareholders. Dissenting shareholders have been provided with an opportunity to approach Court/Tribunal. This scheme of things appears to be fair and should be continued.
  • In sum :-a) In order to object a scheme of amalgamation by investors, a limit shall be determined either according to the minimum number of members or according to the minimum percentage of shareholding; b) The provision of section 395A which were incorporated in the Companies (Amendment) Bill, 2003 for acquisition of remaining shares may be considered as a basis for developing an appropriate framework in this regard.
Fair valuation as a means of safeguarding minority interests
  • There should be recognition of principle of valuation of shares of a company through an independent valuation mechanism as means of safeguarding minority interests. The independent valuer should be appointed by Audit Committee where such a Committee is mandated or by the Board in other cases. The shareholders should have the right to approach the Court / Tribunal if they perceive the process to be unfair. In such cases, the Tribunal should be empowered to appoint an independent valuer. These principles for valuation of shares could also applied in case of companies that have delisted and have a shareholder base of 1000 or more.
  • Further, this Committee has recommended that a company that has delisted from all the Stock Exchanges in India and has a shareholder / depositor base of 1000 or more should be mandated to give one buy-back offer within a period of three years of delisting. The Committee feels that such an offer, taken in the background of the recommendations of ensuring fair valuations of shares, would also serve to protect minority interests.
  • Class Action/Derivative suits
  • In case of fraud on the minority by wrongdoers, who are in control and prevent the company itself bringing an action in its own name, derivative actions in respect of such wrong non-ratifiable decisions, have been allowed by courts. Such derivative actions are brought out by shareholder(s) on behalf of the company, and not in their personal capacity (ies), in respect of wrong done to the company. Similarly the principle of "Class/Representative Action" by one shareholder on behalf of one or more of the shareholders of the same kind have been allowed by courts on the grounds of persons having same locus standi.
  • Though these principles have been upheld by courts on many occasions, these are yet to be reflected in Law. The Committee expresses the need for recognition of these principles.
Bidders need to be aware of various rules by which they have to abide. The Takeover Code, the Rules governing Substantial Acquisitions of Shares, the rules relating toInsider Dealing Disclosures obligations, the UKLA Listing Rules and AIM Rules and other disclosure obligations are all relevant and need careful consideration.

The principal set of rules is set out in the Takeover Code, which is a non-statutory set of rules issued and administered by the UK Panel on Takeovers and Mergers toensure fair and equal treatment of all shareholders in relation to takeovers. It imposes responsibilities on the parties involved and although it does not have the force of law, non-compliance may result in sanction by the Financial Services Authority and any other regulatory body to which the offending organisation belongs and the withdrawal of the facilities of the market.

The Code applies to offers for all listed and unlisted public companies (and in certain limited circumstances, private companies) considered by the Panel to be resident in the United Kingdom, the Channel Islands or the Isle of Man.

The basis of the Code is a set of General Principles, which are then developed further in the detailed Rules, which seek to apply such principles. The Code itself makes clear that it is the spirit and not the letter of the Code, which is important. The advantage of this structure is that it allows consultation on individual cases as necessary and the flexibility for decisions on interpretation can be made on particular facts. Parties often seek guidance from the Panel Executive.

Whether a bid will be recommended or not, together with whether a competing offer emerges, is a key factor in determining the form and structure of a takeover.

A recommended offer to acquire all of the securities of a company with no intervening competing offer is usually the most straightforward form of takeover with the shortest timetable.

Such a transaction (known as public-to-privates, or take-privates) involves the complexity of both a public takeover and an MBO.

Public-to-privates share a number of general characteristics; a management team and a newly incorporated company (backed by private equity) makes an offer to acquire the listed shares of a target company; the independent directors of the target (i.e. independent and unconnected with the management team, with no continuing role in the bidder or target following the deal) assess and, where appropriate, recommend the offer; significant shareholders of the target give irrevocable undertakings to the bidding team to accept their offer; the funding for the offer normally consists of debt and equity financing; and inherent deal uncertainties (for example volatile share prices and competing bidders) exist. Private equity houses are often involved, keen to inject capital and energy into a company that would otherwise stagnate, enabling the company to drive towards a future exit for its new financial backers. Set out below are the main issues that should be considered prior to and during public takeovers.

Due Diligence
Planning and investigation are key to the success of any bid. For the bidder and for the providers of finance (debt and equity) to commit to an offer, they will need more information than mere discussions with the management team and a review of their business plan. Much of the information relating to listed companies is publicly available (the report and accounts being the primary example), together with the filings from the weighty disclosure requirements a listed company must comply with.

However the more confidential or specialist documentation will have to be requested from the directors of the target in order that a thorough legal, financial and commercial due diligence is undertaken.

Competing Offers
A listed company is at the mercy of potential bidder(s) for most of its life, unlike a private company where it is very difficult to force a sale without the consent of all the shareholders. The shareholders of a listed target must be informed by their board of all events that may affect the value of their shareholding, which include offers made for the company. In the takeover arena a bid can always be challenged by other bids, leading to ‘hostile’ takeovers.

The risk of competing bids means that the outcome of a public takeover can never be guaranteed which is one of the reasons that they are regarded as being higher risk than a standard MBO or private purchase.

Irrevocable Undertakings to Accept the Offer
To alleviate some of the bid uncertainties of a public takeover, the bidder will want to ensure that all members of the management team and significant shareholders of the target are bound to accept the offer to be made by the Offeror. These undertakings can range from being ‘hard’ (a commitment which only falls away upon a rival bid being declared unconditional) to ‘soft’ (the commitment falls away where a better offer is made or the independent directors withdraw their recommendation). Sometimes a shareholder will only agree to the signing of a letter of intent to accept the bid. The Code limits the number of shareholders that can be approached, and in any event the Takeover Panel must be consulted prior to seeking such undertakings. Undertakings are usually obtained at the last moment before making an offer, as giving an undertaking creates a disclosable interest in shares.

The Code specifies a number of circumstances when an announcement about an offer must be made. As well as the obligation to announce immediately after a firm intention to make an offer has been communicated to the target board, the obligation to make an announcement may be triggered by other circumstances including where there are untoward movements in the target share price and the extension of the negotiations beyond the limited group of the bidder and target and their respective immediate advisers (Rule 2.2).

If circumstances arise where an announcement is required but the bidder is unable to issue an announcement of a firm intention to make an offer, the bidder, or target, may instead issue a “holding” announcement that an offer is being considered or that talks are in progress (Rule 2.4). This can only be a temporary measure and a bidder issuing a holding announcement will come under pressure from the Panel to crystallise its intentions as soon as possible.

On a recommended bid, once the bidder’s proposal is accepted, the bid will be announced to the market by a joint announcement by the two companies, setting out the terms of the offer and the target board’s recommendation. Merger agreements between the two companies which are often used in similar situations in the US are not common practice in the UK.

Traditionally in a takeover where the bidder alone funds the consideration, it seeks to gain a 90% acceptance rate before declaring the offer unconditional (to allow it to squeeze out minority interests), but is able to declare its offer unconditional at 50.1%.

Where debt finance is required to fund the consideration, as is usually the case in a public-to-private, the debt provider will have a view as to what figure is required before the offer can become unconditional, the rationale being it does not want to lend money to the bidder where only partial control of the target is gained. A debt provider will often wish to take security over the target assets and will often require that its consent is obtained prior to an offer being declared unconditional unless over 90% acceptances are received (although discussions are often held with the debt provider when over 75% acceptances have been received).

Certain Funds
Where the proposed offer is for cash, or provides that part of the consideration is to be satisfied in cash, the bidder’s financial advisers must confirm in the offer document that the bidder has sufficient resources to satisfy full acceptance of the offer (Rule 24.7).

In particular, where the bid is leveraged, the financial adviser must be sure that the debt financiers will release the consideration funds once the offer becomes wholly unconditional. An analysis must be made of what events enable such debt provider to withhold the money – in reality these will be few in number and specific, e.g. the solvency of the bidder and other matters within the control of the bidder. Generally, all conditions will have been met and funding must have become unconditional. This in turn means that acceptance fees and other fees are incurred before the outcome of the transaction is determined.

The Council of Ministers adopted a common position on June 19, 2000 on the proposed Thirteenth Company Law Directive on Takeovers. Under the codecision procedure, the Directive was sent to the European Parliament for a second reading, where, much to the Commission's dismay, a number of fundamental changes were made on December 13, 2000. The Directive will now be subject to conciliation between Parliament and Council, with the Commission attempting to foster a compromise.

The Directive forms part of the E.U.'s Financial Services Action Plan and is seen as an important element in achieving the target of a single market in financial services by 2005, set by the Lisbon European Summit. Its principal aims are to guarantee legal certainty for take overs by setting minimum guidelines for corporate conduct, and to implement throughout the E.U. an adequate level of protection for minority shareholders and employees. The current draft provides that Member States have four years to implement the Directive into their domestic law.

General principles as at the common position on June 19, 2000
At present, there are wide variations in the regulation of takeovers at national level within the E.U. For example, the Netherlands and Germany do not require a bid to be launched in the case of a transfer of control, and some Member States permit the board of the target company to take defensive measures in the event of a hostile takeover bid without the prior consent of the shareholders.

Once adopted and implemented, it is intended that the Directive will establish certain basic principles in order to tackle potential barriers to cross-border merger and acquisition activity at a time when, to take full advantage of a buoyant economy and the advantages of the single currency, companies are increasingly looking to invest across frontiers. In particular, under the proposed Directive as adopted on June 19, 2000:
• all investors holding the same class of shares must be equally treated, particularly when there is a change of control within the company (currently several Member States do not require a full bid if control is transferred);
• shareholders in the target company must be given enough time and sufficient information to enable them to reach a properly informed decision on the bid (currently some Member States allow the target company to take defensive measures without the prior consent of shareholders);
• the board of the target company must act in the interests of the company as a whole and must not deny shareholders the opportunity to decide on the merits of the offer;
• false markets must not be created in the shares of the target company;
• the bid cannot be announced until the bidder has ensured that it can fulfil in full any cash consideration if offered and that it has taken all reasonable measures to ensure it can fulfil any other type of consideration; and
• a takeover bid should not unreasonably hinder the operation of the target company.
The proposed Directive is designed to give Member States the flexibility to reflect national practice and corporate culture in drafting the detailed rules implementing these general provisions into national law.

Protection of minority shareholders
The proposed Directive as at June 19, 2000 is designed to ensure an adequate level of protection for minority shareholders across the E.U. in the case of a change of company control. To ensure this, Member States are obliged to require that bidders in such cases make a full bid for all the shares at an equitable price. This raises the issue of alternative compensation. A compromise has been found that protects shareholders in the target company without making large takeovers more difficult, by ensuring that, when the compensation offered by the bidder does not consist of liquid securities, alternative compensation has to include some cash as an alternative.

Transparency is a means of ensuring that all parties with an interest in the bid are treated equally. The Directive as agreed on June 19, 2000 therefore lays down obligations regarding information and publication of bids. These obligations, binding on both the target company and the bidder, apply to information that must be supplied to the supervisory authorities, the shareholders and the employees. Member States must ensure that bids are made public without delay and that the supervisory authority is informed of the bid. They may require that the authority is advised before the bid is made public. As soon as it is public, the board of the target company must inform its employees, either through their representatives or directly. An offer document containing the information necessary to enable shareholders in the target company to reach a properly informed decision on the bid must be made public.

An important element of the Directive is the obligation on Member States to appoint one or more supervisory authorities. These bodies have wide powers of investigation and decision. In the case of cross-border takeovers, the Directive establishes which supervisory authority is competent and which country's law is applicable to a particular bid. In general, the rules of the target company's Member State of origin pertain, but the Directive also establishes a legal framework for cases where this cannot be applied.

Protection of shareholders' interests
As well as the obligation to inform shareholders and employees, under the Directive as agreed on June 19, 2000 the board of the target company is obliged to act neutrally and may not take any action--other than seeking alternative bids--which may cause the bid to fail without first getting the prior authorisation of a general meeting of shareholders during the period of acceptance of the bid.

To allow sufficient time for a general meeting to be called, the Directive provides for an acceptance period (to be specified in the offer document) of not less than two weeks and not more than 10 weeks from the date when the offer document is published. Member States may modify the length of this period in specific appropriate cases.

History of the proposed Directive
The first proposal for the Directive was presented in 1989 and amended in 1990. The amended proposal included detailed provisions, such as the obligation to launch a full bid for 100 per cent of a target company's shares once a person acquired shares with more than one-third of the voting rights. The object of this was to ensure that minority shareholders were not excluded from the opportunity to sell their shares at an attractive bid price. Further detailed rules were proposed in areas including the publication of bids, the contents of offer documents and the revision of bids, and the general principles governing the conduct of takeovers.

In 1996, the Commission replaced previous proposals with a suggested framework directive which approached the issue in a different way. The framework directive established the same general proposals to govern the conduct of takeovers as were featured in the previous proposal, but omitted the detailed provisions which aimed to harmonise how these principles should be applied. Under the draft framework directive, Member States' own rules on takeovers were required to respect a number of principles (including, for example, the requirement for the board of the target company to act in the interests of the company as a whole and not to deny shareholders the opportunity to decide on the merits of the offer).

The Directive was further amended in 1997, when the European Parliament decided that insufficient attention had been paid to the interests of employees. New rules were inserted requiring employees of target companies to be kept informed of bids, and for the offer document to be made available to them. The rules on disclosure with regard to shareholders were widened to cover employees, and management was required to take into account employment concerns when considering the interest of the company as a whole.

Some key changes made by the European Parliament on December 13, 2000
The Parliament voted to amend the Directive's key principle that the management of companies targeted for takeover must consult with shareholders before putting defensive measures in place. The Directive already permitted Member States to allow the board of the offeree company to increase the share capital during the period for acceptance of the bid on condition that prior authorisation had been received from the general meeting not more than 18 months before the beginning of acceptance of the bid. However, the Parliament has strengthened the hand of companies facing a hostile bid by allowing boards greater room for manoeuvre. National supervisory authorities with responsibility for takeover supervision may, in conformity with national law, adopt guidelines for any other permitted defensive measures. Member States can also opt for one of the following models:
• The board must obtain previous authorisation by the competent supervisory authority for defensive measures other than those provided for in the Directive and in the Directive as amended. However, the competent supervisory authority may, upon request from holders of securities representing at least 1 per cent of the voting rights, forbid defensive measures if they are not covered by the Directive or guidelines drawn up by national supervisory authorities.
• In any event, holders of securities may also arrange for the courts to determine whether the limits of the room for manoeuvre have been wilfully exceeded, and whether the company is entitled to claim compensation from members of the board.
• In any event, all defensive measures which have the prior authorisation of the general meeting of shareholders given for this purpose, during the period of acceptance of the bid, are permissible and in particular cannot be forbidden by the competent supervisory authorities.

Frits Bolkestein, European Commissioner for the Internal Market, described the changes as "deeply disappointing". They could allow managements to put "poison pill" defences in place and to act in their own, potentially narrower interests, rather being obliged to act in the interests of the target company's shareholders as a whole. The fundamental changes from the text agreed by the Council could put adoption of the Directive at risk.

Workers' rights to information on takeover were strengthened by various amendments, including one which requires the board of an offeree company to consult with worker representatives (or the workers themselves in the absence of representatives) before drawing up the document setting out its opinion on the bid, the reasons on which it is based, and the effects of its implementation on all the interests of the company (including employment).

U.K. reaction to the Directive
Lawyers involved with the conduct and regulation of takeovers in the United Kingdom do not for the most part welcome the proposed Directive because they feel that it is likely to create extra litigation and delay without giving anything much back in return. Those responsible for the Directive were much influenced by the quick and flexible system of takeover self-regulation offered by the U.K. Takeover Code. It is not without irony that just before the common position was adopted on the Directive, the Financial Services and Markets Act 2000 received Royal Assent and established the Financial Services Authority as the statutory body with responsibility for takeover regulation. The Panel's future effectiveness and authority has been severely affected as a result.

Sir David Calcutt Q.C., chairman of the Takeover Panel, commented in the Panel's annual report for 1999-2000: 
"Although well-intentioned, there is little to commend the Directive. But it does contain damage-limitation provisions, which should, subject to the manner of implementation by the U.K. government; help to maintain the benefits of the Panel's non-statutory system of regulation. The Directive would allow the U.K. to retain an administrative system of bid regulation. The courts would be able to dismiss purely tactical litigation, thereby continuing the approach adopted by the Court of Appeal in the Datafin case in 1986. The implementing legislation could also provide that the supervisory authority could not be sued for damages and could ensure that the implementation of the Directive did not create new grounds of litigation between the parties. These provisions should minimise the scope for litigation."

Julian Harris Senior Information Officer, Institute of Advanced Legal Studies, London

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