August 19, 2012

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"Opportunities and Beyond– New Takeover Code

- Dharmesh Kotadia, Partner [ MDP & Partners ]

Dharmesh Kotadia

Takeover Code, as widely known in the markets for the Securities Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (Old Takeover Regulations) has been replaced by a new version.

The Securities and Exchange Board of India (SEBI) vide its order dated September 4, 2009 had constituted the Takeover Regulations Advisory Committee (TRAC) to examine and review the Old Takeover Regulations and suggest the suitable amendments. The TRAC had submitted its report to SEBI in July 2010 and most of the recommendations of the TRAC were approved by SEBI in its Board Meeting held on July 28, 2011.

The SEBI has notified the Securities Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (New Takeover Regulations) on September 23, 2011 effective on and from the 30th day of the notification i.e. October 22, 2011 replacing the Old Takeover Regulations. It applies to all direct and indirect acquisition of shares or voting rights in, or control over the target company.

The initial threshold for trigger of the open offer is increased from 15 percent to 25 percent of the voting rights.

This has given much head room for the private equity players to acquire more shares/voting rights in a target company effectively having more say in the target company. It has also helped midcap and small companies to have access to more capital for growth and expansion from strategic and financial investors. The new open offer trigger limit is in line with the international practices. But at the same time it has been a challenge for promoters whose shareholding in a target company is around 25 percent. An investor holding up to 24.9 percent in a target company can with the help of few other investors block the special resolution floated by the promoters.

Will this create a nuisance value or in fact help better governance, remains to be seen.

Under the New Takeover Regulations, the open offer will have to be made for 26 percent of the voting rights as against 20percent of the voting rights under the Old Takeover Regulations. The SEBI did not accept the proposal of the TRAC to make the open offer mandatory for 100percent of the voting rights which would have immensely benefited foreign investors. SEBI instead has played a balancing act. By increasing the offer size to 26 percent, it has created a level playing field for all potential investors and in addition to the 25 percent voting rights, the acquirer will have acquired 51 percent of the voting rights of the target company resulting in control over the target company.

One of the other major changes in the New Takeover Regulations is the inclusion of the non-compete fee in the offer price. Though this be done with the intention of providing equal treatment to all shareholders of the target company, the promoters with their due expertise in running the operations of the target company should be treated differently because subsequent to their exist from the target company, they can pose greater challenge for the management of the target company with all the insider information and knowledge of the target company. The payment of non-compete fee to such promoters was more of a reality.

The other important change is allowing the creeping acquisition of maximum 5 percent per financial year up to the maximum permissible non-public shareholding as prescribed under the Securities Contract (Regulations) Rules, 1957 ("SCRR") which is 90 percent for public sector companies and 75 percent for every other listed company. The promoters holding 55 percent of the voting rights in a target company can now consolidate by acquiring shares or voting rights up to the maximum permissible limits without triggering open offer.

With regard to the definition of control, SEBI has continued with the current definition by not accepting the suggestion of the TRAC to expand the scope of control which goes with the ability of a person to control. This may be due to the pending litigation on the definition of control. Any change in control of a target company regardless of the level of shareholding and acquisition of the shares has been brought under the ambit of open offer

The New Takeover Regulations do not give liberty to the shareholders of a target company to waive the requirements of making an open offer in case of a change of control of such target company.

The New Takeover Regulations also deal with the indirect acquisition of a target company through the acquisition of shares or voting rights in or control over any company or other entity. This is a good step and provides clarity in case of indirect acquisition. This has brought the control over a target company through foreign companies, bodies corporate, limited liability partnership under the ambit of takeover regulations. It further provides that all indirect acquisitions, where the value of the target company (based on proportionate net asset value, sales turnover or market capitalization) over the value of the entity or business (consolidated net asset value, sales turnover or market capitalization) being acquired is more than 80 percent, shall be regarded as direct acquisition for the purposes of the New Takeover Regulations and the compliance with the open offer requirements is mandatory.

The acquirer or PACs holding voting rights of 25 percent or more but not exceeding maximum permissible non-public shareholding can make a voluntary offer for acquiring shares subject to compliance with following conditions, (a) The acquirer or PACs should not have acquired shares of target company otherwise than through open offer in preceding 52 weeks; (b) The acquirer should not acquire any shares of the target company during offer period otherwise under the open offer; and (c) The acquirer or PACs will not be eligible to acquire shares of the target company save and except through another voluntary offer, competing offer or through bonus issue or stock splits. In case of voluntary open offer, the acquirer may decide at the offer size which shall be a minimum of 10 percent of the voting rights with an ability of increase the size of the open offer to 26percent within 15 working days in case of a competing offer being made.

Under the New Takeover Regulations, the open offer should be made to all shareholders other than acquirer, PACs and parties to the underlying agreements including their PACs. If as a result of open offer, promoter shareholding exceeds the maximum permissible limit, the promoters would be required to bring down their holding below the permissible maximum non-public shareholding and within the time permitted as required under the SCRR. Further, in such cases, voluntary delisting offer cannot be made for a period of 12 months from the date of completion of offer period.

The New Takeover Regulations differentiate in case of the offer price for indirect acquisition. The offer price for the direct acquisition is highest of the following: (a) Highest negotiated price under the agreement triggering the open offer; (b) Weighted Average Price of shares acquired by the acquirer or the PACs during 52 weeks preceding the date of the public announcement;(c) Highest price paid for any acquisition by the acquirer or PACs during 26 weeks preceding the date of the public announcement; (d) In case of frequently traded shares, volume weighted average market price for sixty trading days immediately preceding the date of public announcement and in case of shares not frequently traded, the price determined by the acquirer and the manager based on the valuation of the shares arrived as per customary valuation parameters.

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

In case the acquirer holds any convertible instrument of Target Company, conversion price thereof will be one of the criterions for determining offer price. The offer price will now include the payment of non-compete fees/control premium or similar payments in any form. If acquirer or PACs have acquired any share during offer period at a price higher than the offer price, the offer price will stand revised to that price. If acquirer acquires any shares at a price higher than the offer price during 26 weeks post tendering period excluding the acquisitions under an open offer, delisting regulations or open market purchases, acquirer will be required to pay difference between offer price and that price to all shareholders whose shares were accepted in the open offer, within 60 days from the date of such acquisition.

The New Takeover Regulations have streamlined the number of exemptions from making the open offer. A few of the available exemption are as follows:

Inter-se Transfer of shares amongst the following qualifying persons, (a) Immediate relatives (spouse of a person,and includes parent, brother, sister or child of such person or of the spouse); (b) Persons named as promoters in the shareholding pattern filed by the target company for not less than 3 years prior to the proposed acquisition; (c) A company, its subsidiaries, its holding company and other subsidiaries and persons holding at least 50 percent of the equity shares of such companies and other companies and its subsidiaries.; (d) PACs and shareholders (who have been PACs) for not less than 3 years prior to the proposed acquisition, and disclosed as such pursuant to filings under the listing agreement; (e) any company in which the entire equity share capital is owned by such shareholders in the same proportion as their holdings in the target company without any differential entitlement to exercise voting rights in such company.

These exemptions are subject to the following conditions, (a) In case of the frequently traded shares, the acquisition price per share shall not exceed 25 percent of volume weighted average market price for a period of 60 trading days preceding the date of issuance of notice for proposed inter se transfer on the stock exchange where the maximum volume of trading in the shares are recorded; (b) In case of the infrequently traded shares, the acquisition price shall not exceed 25 percent of the price determined by the acquirer and the manager based on the valuation of the shares arrived as per customary valuation parameters; (c) The benefit of exemption will be available subject to the transferor(s) and transferee(s) having complied with disclosure requirements.

pursuant to a Scheme, (a) Scheme under Section 18 of Sick Industrial Companies (Special Provisions) Act, 1985; (b) Scheme of arrangement, merger or demerger involving the target company, pursuant to an order of a court; (c) Scheme of arrangement, merger or demerger not involving the target company pursuant to the order of a court, provided components of cash in the consideration should not exceed 25 percent of total consideration paid under the scheme; and at least 33 percent of the voting rights of the combined entity after implementation of the scheme is held by the same persons who held the entire voting rights before the implementation of the scheme;

Other exemptions include acquisition of voting rights or preference shares carrying voting rights arising out of the holding of preference shares in a target company and acquisition of shares pursuant to rights issue or pursuant to buyback is exempt provided, in the case of buyback, the shareholding is reduced such that the voting rights fall below the threshold limits within 90 days of the increase in the voting rights.

The New Takeover Regulations provides for certain disclosure and filing requirements in case of acquisitions falling under the exempted category.

If the open offer is triggered due to an acquisition agreement and the conditions stipulated in such agreement have not been met which for no fault of the acquirer, the acquirer can withdraw the open offer provided the agreement is rescinded.

Under the New Takeover Regulations, not only the material assets of the target company but the material assets of its subsidiaries shall also not be disposed of for a period of two years from the open offer unless the same was mentioned in the open offer or the shareholders of the target company consents to such transaction by passing a special resolution through postal ballot.

A recommendation on the offer by the board of directors of a target company has been made mandatory and such recommendations shall be published at least two working days before the commencement of the tendering period in the same newspapers where the public announcement of the open offer was published, and simultaneously, a copy of the same shall be sent to SEBI, Stock Exchange and manager to the offer.

The New Takeover Regulations provide that anything done or any action taken or purported to have been taken including actions such as exemption granted by the Board, investigation commenced or show cause notices issued under the Old Takeover Regulations prior to its repeal shall be deemed to have been done under New Takeover Regulations. Any rights, obligation or liability acquired or incurred under the Old Takeover Regulations will remain unaffected as if the regulations were never repealed.

Any open offer for which public announcement has been made under the Old Takeover Regulations will be required to be continued and completed under the Old Takeover Regulations.

The New Takeover Regulations have seen the light of the day and are aimed at bringing transparency, fair disclosures, and effective competition among acquirers and to benefit the shareholder at large.

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