JUSTICE P.N.BHAGWATI COMMITTEE REPORT ON TAKEOVERS

PREFACE

1. 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.
2. 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. This Report and the SEBI Regulations for Substantial Acquisition of Shares and Takeovers do not deal with the subject of mergers and amalgamations.
3. 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. It is for this reason that substantial acquisition of shares in a listed company and change in control o f a listed company have both been addressed in this Report.
4. 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 utilisation 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.
5. 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.
6. 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.
7. 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.
8. 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.
9. A Committee was therefore set up by SEBI in November 1995, under the Chairmanship of Justice P.N. Bhagwati, former Chief Justice of India, to review the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1994. The terms of reference of the Committee were :
• to examine the areas of deficiencies in the existing Regulations; and
• to suggest amendments in the Regulations with a view to strengthening the Regulations and making them more fair, transparent and unambiguous and also protecting the interest of investors and of all parties concerned in the acquisition process.
10. The Committee was constituted with wide representation from the Chambers of Commerce and Industry, Investors Associations, Stock Exchanges, Merchant Bankers, Institute of Chartered Accountants and Legal Experts.

The members of the Committee were as follows:

Justice P.N. Bhagwati - Chairman

Chambers of Commerce & Industry were represented by

Sh. Adi Godrej, representing Confederation of Indian Industry (CII)

Sh. Bipin Jhaveri, representing Associated Chambers of Commerce and Industry (Assocham)

Sh. Rajendra S. Lodha, representing Federation of Indian Chambers of Commerce and Industry (FICCI)

Investors Associations were represented by

Prof. M. D. Limaye, representing Lokmanya Seva Sangh

Prof. Manubhai Shah, representing Consumer Education and Research Centre (CERC).

Merchant Bankers were represented by

Sh. Udayan Bose, Chairman, Lazard Creditcapital Ltd.

Sh. Shitin Desai, Vice Chairman & Managing Director, DSP Merrill Lynch Ltd.

Sh. Nimesh Kampani, Chairman, J.M. Financial & Investment Consultancy Services Ltd.

Stock Exchanges were represented by

Sh. Kamal Kabra / Sh. M.G. Damani (President, The Stock Exchange, Mumbai)

Legal Experts were represented by

Sh. J.R. Gagrat of Gagrat & Co.

Sh. R.A. Shah of Crawford Bayley & Co.

Sh. Shardul Suresh Shroff of Amarchand Mangaldas & Suresh A. Shroff & Co.

Institute Chartered Accountants of India was represented by

Sh. Y.M. Kale / Sh. T. S. Vishwanath (President, Institute of Chartered Accountants of India (ICAI))

SEBI was represented by Kum. D.N. Raval, Executive Director

Sh. Pratip Kar, Executive Director and Member Secretary.

11. The Committee was to submit the report within 3 months; however, considering the preparatory work required to be done including the need to have interaction with various market participants and industrialists etc. before framing the regulations which is of vital importance to the market place and the economy, the Chairman, SEBI had extended the period from time to time and the last such extension requires the report to be finalised and submitted before January 31, 1997.
12. The Committee held a number of meetings and deliberated extensively on all the provisions of existing Regulations, and on the issues which came up before SEBI in the course of administration of the Regulations over the past two years or so, keeping in view the imminent scenario in the corporate sector following the economic reforms. In order to gather the views of all the members of the Committee and to look at the process of substantial acquisition of shares and takeovers closely from all angles, some members of the Committee prepared papers on specific topics in the Regulations for Substantial Acquisition of Shares and Takeovers namely definitions, applicability of the Regulations, disclosures, the procedural details of an offer and penal provisions. The Committee also had the benefit of views of important market participants, industrialists who have made acquisitions of companies, intermediaries professionally involved in corporate takeovers, and financial and investment institutions who also have crucial role to play in the area of takeovers as they, as a group, hold more than 30% of the voting rights in a large number of listed companies. The Committee also invited several eminent financial journalists who have been writing on the subject of takeovers, for their views. The names of all those persons who gave their views in writing to the Committee and those who made submissions before the Committee are given in the annexure to this Report.
13. The Committee examined the principles and practices and the regulatory framework governing takeovers in as many as 14 countries. The Committee noted that the regulatory framework in these countries had evolved over a period of time drawing extensively upon the corporate culture and practice in these countries. Without an appreciation of these factors, a mere comparison of the procedures, regulatory requirements and various quantitative limits in these countries would be meaningless and would only be an exercise in pedantry. It was important to go behind these regulatory requirements and quantitative limits to discover their raison de etre and understand the fundamental principles on which these regulations are predicated. While the practices and procedures vary from country to country, the principles and the concerns - cardinal among which are equality of opportunity to all shareholders, protection of minority interests, transparency and fairness - have remained more or less common. It would therefore be far more rewarding to devote attention to these principles and concerns rather than to attempt a simplistic adaptation of the practices and procedures prevailing in other countries where the corporate culture is different. The latter exercise may prove to be neither useful nor appropriate; the former would be more satisfactory.
14. The Committee had decided to submit a draft Report to SEBI and requested SEBI to circulate it widely with a view to eliciting public reaction and response. The Committee noted with satisfaction that the Report had become a subject matter of intense debate among companies, industrialists, chambers of commerce, professional bodies, academic circles, market participants, investor associations and the media. This was only a measure of the significance attached to the area of takeovers especially in the wake of economic reforms. As was proposed in the draft Report, the Committee met again to deliberate on the feedback received by SEBI. The Report has also been informally discussed with Government and clarifications on various issues were provided to Government and their views considered and taken into account. This final Report incorporates the changes considered and accepted by the Committee.
15. The Report of the Committee is presented in two parts. The first part contains the recommendations of the Committee based on which the new Regulations have been framed. The newly framed Regulations are given in the second part