JUSTICE P.N.BHAGWATI COMMITTEE REPORT ON TAKEOVERS

Applicability of the Regulations

3 Applicability of the Regulations
(Reference: Part II of the Report, Chapter I, Regulation 3)

3. 1 In the course of administering the Regulations, SEBI had been granting exemptions from the applicability of the Regulations in a number of cases in exercise of the powers granted to it under regulation 4 of the existing Regulations. Exemptions were also granted by SEBI under Clause 40 (A & B) of the listing agreement. Very often acquisition of shares or voting rights may become necessary in commercial and business interests as described later, and all such cases of transfer of shares among two set of persons may not result in a takeover and the interest of shareholders may not be jeopardised. It stands to good reason that such cases merit exemption from the requirement of making mandatory public offers. With the experience gained by SEBI in dealing with applications for exemption, it should be possible to enlist the types of transactions for which exemptions could be granted under the Regulations. The Regulations may be made inapplicable in the first place for such cases, so that the need to approach SEBI for seeking exemptions would not arise in such cases.

3. 2 The Committee felt that delineating the circumstances in which Regulations will not be applicable would mean greater transparency besides minimising the exercise of discretionary power. At the same time, the Committee also recognised that in a dynamic and developing securities market, there would always be situations, all of which cannot be covered even by delineating circumstances in the widest possible terms. The use of discretionary power in residual cases cannot be totally avoided but may be guided by the recommendations to be made by a Panel to which reference has been made in para 3.3.5 of the Report.

The Committee recommends that

SEBI should appoint a Panel comprised of experts and officers of SEBI and the recommendations of the Panel may be taken into account by SEBI while considering exemptions in cases which would not be covered by the circumstances specifically enumerated in the Regulations. (Reference : Part II of the Report - Regulation 4)

While laying down the situations where the provisions of the Regulations regarding public offers will not be applicable, the Committee restricted itself to only those situations in which SEBI has granted exemptions in the past.

3.3 It was brought to the notice of the Committee that the cases in which exemptions have been granted broadly fell into one of the following two categories :

• acquisition through preferential issue for consolidation of holdings by foreign collaborators, Indian promoters and also, consequent upon induction of foreign collaborators for technology transfer etc.
• acquisition by way of transfer of shares inter se among group companies, promoters, state level financial institutions and promoters in joint and assisted sector projects, foreign collaborators and Indian promoters, split in family and consequential regrouping of shareholding among branches of the family and corporate restructuring plans.

It was also brought to the notice of the Committee that while firm allotment in public issues and preferential offers should continue to be permitted, it should be ensured that these routes are not used to bring about change in control without appropriate disclosures and proper consent of the shareholders. Similarly, in the case of rights issues the exemption from the applicability of the requirement to make a public offer should normally be restricted to the extent of the entitlement of a shareholder. At the same time, if a shareholder passively crosses the threshold limit of a public offer under the Regulations, or were allotted additional shares within the limit of the acquisitions permitted in any period of twelve months, he should not be required to make a public offer. Further, if the persons presently in control of the company have disclosed in the rights letter of offer that they intend to acquire additional shares beyond their entitlement if the issue is undersubscribed, they should be permitted to do so as long as there is no change in control.

The Committee therefore recommends that

• the requirement to make a public offer be exempted for acquisitions made under firm allotment in public issues and preferential offers, with full disclosure as to who the allottees are and the consequences, if any, on the control of the company; acquisitions by the shareholder pursuant to rights issue to the extent of his entitlement and additional entitlement subject to certain conditions; inter se transfers among group companies within the definition of group in the MRTP Act; inter se transfer among promoters and foreign collaborators, among relatives, among government companies, among state level financial institutions and private co-promoters in joint sector projects; acquisitions pursuant to schemes of arrangement or reconstruction including amalgamation or merger or demerger under any law or Regulation, Indian or foreign; acquisition of shares by market makers during the course of market making, acquisition of shares by financial institutions in the ordinary course of their business in view of the special role in the Indian context or as pledgees. (Reference : Part II of the Report - sub-regulation 1 of Regulation 3)

3.31 Rights Issues

The Committee reconsidered the need to exempt fully all acquisitions made through a rights issue and noted that while there was a case for exempting acquisitions made through rights issues, this could also be prone to misuse and it may be possible for persons presently in control of the company to hand over control through a combination of unattractive pricing and rights renunciation in favour of the acquirer.

The Committee recommends that

• instead of fully exempting rights issue as was proposed in the draft Report, apart from acquisitions made by a shareholder pursuant to an application made to the extent of his entitlement, additional allotments within the limit of the acquisitions permitted in any period of 12 months and additional allotments to the persons currently in control of the company, provided he had disclosed in the letter of offer that he intends to take up additional shares if the issue is undersubscribed, be excluded. (Reference : Part II of the Report - clause (b) of sub-regulation (1) of Regulation 3)

3.32 Preferential Offers

Companies adopt the preferential offer route in varied situations for the purpose of consolidation of stake by the existing Indian or foreign promoters, induction of foreign collaborators with foreign technology, gaining management control of the company, injection of fresh funds for turning around sick companies. At present, SEBI has been granting exemption on case to case basis under the powers granted to it under regulation 4 of the existing Regulations.

The Committee debated on whether preferential issues, which are approved by the shareholders under Section 81 (1A) by passing special resolution, should at all attract the regulations, as it is the very body of shareholders whose interest the takeover regulations seek to protect which has given consent to the preferential issue. Besides, as preferential issue helps infusion of fresh capital into the company, it is largely in the general interest of all shareholders and also SEBI Guidelines for Preferential Issues have neutralised any economic advantage to any person acquiring shares through preferential allotment on terms more favourable than the market. There is also a need to differentiate between the acquisition of shares through the primary market and the secondary market. The Committee also noted that market participants with whom the Committee discussed this issue, overwhelmingly favoured exclusion of preferential issue from the ambit of the Regulations, provided it does not lead to change in control.

Following suggestions received on the draft Report and also on its own, the Committee deliberated on the possibilities of misuse of this exemption route to circumvent the regulatory provisions for public offer. The Committee ultimately decided to exempt preferential issue of capital made with express consent of the shareholders to whom full disclosures about the proposal including the likely changes in the control of the company, if any, has been made by way of explanatory statement to the notice to the general meeting in which the proposal is being put up for shareholders approval.

The Committee also examined whether the exemption of preferential offer discourages competitive offers. The Committee, however, noted that the company is required to notify the stock exchange upon passing of the board resolution approving the public offer and thus, the proposal of preferential offer becomes publicly available information and that preferential offer, per se, does not debar a serious acquirer from making a bid on the company.

The Committee recommends that

• the acquisition of shares covered under section 81 (1A) of the Companies Act be exempt from the applicability of the regulations subject to full disclosure in the notice for the extraordinary general meeting called for consideration of preferential issue, including identity of the acquirer and consequent changes in shareholding pattern and control of the company etc. (Reference : Part II of the Report - clause (c) of sub-regulation (1) of regulation 3).

3.33 Market Makers

The Committee recommends that

• Acquisition of shares in the ordinary course of business by a registered market maker of a Stock Exchange in respect of shares for which he is the market maker during the course of market making be exempt. (Reference : Part II of the Report - sub-clause (ii) of clause (f) of sub-regulation (1) of regulation 3).

3.34 Indirect acquisition

The Committee had noted that there exists a lacuna in the existing regulations which would allow persons to acquire indirect control of a listed company by acquiring the holding company or a set of investment companies which has block holding and which may be unlisted, because the scope of the Regulations apply only to acquisitions of shares in listed companies. The Committee thought it fit to clarify by way of an explanation that acquisition of an unlisted company would not be exempted if by virtue of such acquisition, or change in control of the unlisted company whether in India or abroad, there is brought about a change in control of the listed company or acquisition of control over the voting rights of the listed company.

The Committee recommends that

• concept of indirect acquisitions be brought in. This has been done in the definition of acquirer in clause (b) of sub regulation (1) of regulation (2); in the definition of persons acting in concert in sub clause (1) of clause (e) of sub regulation (1) of regulation (2); further while excluding unlisted companies from the purview of the Regulations in clause (k) of subregulation(1) of regulation 3.

3.35 Chain principle

Occasionally, a person or group of persons acquiring statutory control of a company (which need not be a company to which the Regulations apply) will thereby acquire control of a second company because the first company itself holds a controlling block of shares in the second company, or holds shares which, when aggregated with those already held by the person or group, secure or consolidate control of the second company. The Committee felt that an offer should be made in these circumstances if -

• the shareholding in the second company constitutes a substantial part of the assets of the first company; or one of the main purposes of acquiring control of the first company was to secure control of the second company.

The Committee recommends that

• indirect acquisition of control of a company should require compliance to the Regulations and this needs to be clarified by way of suitable explanation. (Reference : Part II of the Report - Explanation to clause (k) of sub-regulation (1) of regulation 3 and Explanation to Regulations 10 and 11).

3.36 Residual Cases and Takeover Panel

While the Committee has attempted to enlist as many circumstances as possible where a public offer should not be required to be made, there might still be residual cases where SEBI may be required to exercise its discretion whether to grant exemption or not. To help SEBI in this task, the Committee thought it desirable to set up a Panel.

The Committee recommends that

• SEBI may be vested with power to grant exemption in residuary cases and for this purpose SEBI shall set up a Panel. The Panel would be recommendatory in nature. Any order granting or refusing exemption passed by the Board shall be a reasoned order and shall be published. This, procedure, while bringing transparency, would also serve to create precedents and help develop jurisprudence on the subject through case law. (Reference : Part II of the Report - clause (l) of sub-regulation (1) of regulation 3 and Regulation 4)

3.37 Reporting of Exemptions to Stock Exchange and SEBI

The Committee recommends that

• in order to ensure transparency in the transaction and assist in the monitoring, all the exempted transactions should be subject to reporting requirements to the concerned stock exchanges in advance of the proposed acquisition and to SEBI. (Reference : Part II of the Report - sub-regulation (3) and (4) of Regulation 3)