By Invitation. SEBI clears the air on ‘control’ in M&A

For over half a decade, volatile capital markets have reduced public participation in listed Indian companies. This, combined with the current debt situation, suggests that private investment may be the most favourable route for listed companies to access funds for growth.

SEBI, acknowledging the need, and in an attempt to make the regulatory climate more conducive for private investment, has proposed to rework the definition of ‘control’ in the context of mergers and acquisitions by providing a ‘bright-line test.’

Since the Bhagwati Committee, which was set up to review SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1994, a ‘broad’ definition of control has been the preferred approach. It was left open to SEBI to decide whether there has, indeed, been a change in control based on the facts and circumstances of each individual case. However, the proposed bright-line approach comprising objective factors would leave little or no room for varying interpretations, and finally puts to rest regulatory uncertainty on the definition of control.

Current scenario While the current definition of control contemplates a broad and principle-based approach, SEBI has always held the view that affirmative rights in the hands of investors demonstrate control. Accordingly, in the case of Subhkam Ventures, SEBI’s stance was that affirmative rights resulted in acquisition of control by the investor. However, in a subsequent case of Jet-Etihaad, SEBI itself made a volte-face and recognised that investor protection rights or affirmative rights not in the nature of day-to-day management or policy making of a company would not result in acquisition of control.

This was at a time when FDI guidelines, in the context of the airline industry, had restrictions. This differing position has led to regulatory uncertainty around the definition and investors are wary of seeking downside protection rights in listed companies. Recognising the need to build investor confidence, the regulator has now proposed a regime that distinguishes between downward protection rights and control rights (by providing an illustrative list of protective rights that would not amount to acquisition of control over a company).

Such a framework clearly indicates the regulator’s intention to shift from a de facto approach towards control to a more objective approach, devoid of uncertainty.

Control and influence It appears that the regulator is finally coming around to recognising the difference between control (that is, an ability to control policy making and run day-to-day operations) and significant influence (that is, an ability to influence decision making). Other than SEBI’s view in Subhkam, market participants have always held the view that negative control does not result in an acquisition of control (if such negative rights do not in any manner curb the day-to-day management and policies of the company). However, if a de minimis threshold was added to such negative veto in relation to disposal of property, it may result in affecting the day-to-day functioning of a manufacturing company.

Further, the discussion paper also proposes that the threshold for presuming ‘control’ be set at 25 per cent of voting rights, irrespective of whether such holdings result in de facto control. This move shall make the system predictable and transparent without bringing significant departure from the present legal position. It may be noted that acquisition of 25 per cent shares or voting rights currently results in a takeover trigger, irrespective of whether such acquisition of shares or voting rights results in an acquisition of ‘control’. As a result, this change would only bring objectivity without widening the scope of the current legislation. It would also result in a clearer test in the case of indirect acquisitions of control.

Shortcomings To summarise, the discussion paper with proposed amendments to the definition of ‘control’ is indeed a step in the right direction. It will bring an end to a system that is overtly open to interpretation, and fraught with regulatory uncertainty and risk of litigation. However, the paper proposes half measures, such as dropping all rights in unlisted companies at the time of listing. Further, the paper proposes that any downside protection rights to investors shall have to be ratified by a majority of the minority (public) shareholders in a meeting. Such half measures are neither logical nor warranted if a fillip has to be provided to private funding of listed companies.

If the regulator is proposing a regime for the determination of control based on the nature of rights being granted to an investor, it should not be open to subsequent ratification by shareholders as the nature of such rights does not change based on their approval or disapproval, as the case may be.

The writer is Managing Partner, BMR Legal. Kaushik Mukherjee and Murtaza Zoomkawala have also contributed to the article.