A unique opportunity to investors to acquire "control" of Stressed Companies by infusing capital at current valuations without the obligation of making an open offer...
The Securities and Exchange Board of India (SEBI) has recently announced a slew of changes to key SEBI regulations such as SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations) and SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 (Takeover Regulations), aimed primarily at facilitating fundraising for companies with stressed assets (Stressed Companies).
The recent experience shows that the cash-strapped companies have been constrained to raise fresh capital due to the pricing framework under the ICDR Regulations which required to take into account historical trading prices of 26 weeks. These relaxations for preferential issues by Stressed Companies are a welcome relief as it will help such Stressed Companies to attract investments at more current prices.
The above changes also afford a unique opportunity to investors to acquire "control" of Stressed Companies by infusing capital at current valuations.
Relaxations in preferential allotment by companies with stressed assets
The amendment to ICDR Regulations1 now allows Stressed Companies to undertake preferential allotment at a price which is not less than the average of the weekly high and low of the volume weighted average price (VWAP) of the shares during the 2 weeks immediately preceding the relevant date, subject to compliance with the prescribed conditionalities. The amendment specifies objective parameters to determine companies which are eligible to be categorized as Stressed Companies.
The preferential issue can only be made to persons or entities which are not part of the promoter or promoter group as on the date of the board meeting to consider the preferential issue. The proposed allottees should also meet the prescribed eligibility criteria which includes not being a 'willful defaulter', undischarged insolvent, disqualified to act as a director, declared as a fugitive economic offender, etc.
Also, the preferential issue is required to be approved by majority of public shareholders of the Stressed Company. Further, the shares allotted to an investor pursuant to such preferential issuance are subject to a mandatory lock-in of 3 years.
The Takeover Regulations have also been amended to include an exemption from making an open offer upon acquisition of shares, voting rights or control of a Stressed Company by way of a preferential issue undertaken in compliance with the above framework.2
Turning crisis into opportunity
The onslaught of COVID-19 has caused business disruption across all sectors. Most companies have a crying need of additional capital to sustain business operations. There are many listed companies which are currently under stress.3 In this situation, the Stressed Companies usually find it extremely challenging to tap into traditional sources of funds to rescue themselves. This can worsen the situation and deepen the crisis.
Also, in the wake of temporary suspension of the Insolvency and Bankruptcy Code 2016 (IBC), the Stressed Companies cannot go under the corporate insolvency resolution process (CIRP) for resolving stress for the time being. In any case, given the experience of delays in the completion of the CIRP process, concomitant litigations, requirement of approval from the committee of creditors and national company law tribunal and overall uncertainty of emerging as a successful bidder, the takeover of Stressed Companies through the IBC is a sub-optimal option compared to takeover through infusion of primary capital pursuant to this new framework. These relaxations also allow the investors to take control over Stressed Companies without the additional obligation of providing an exit to the public shareholders of Stressed Companies by launching an open offer under the Takeover Regulations.
It is axiomatic that there is a sharp correction in the share prices of Stressed Companies as soon as the stress is publicly known. The existing pricing framework under the ICDR Regulations has been a hindrance in finding interested investors to takeover such Stressed Companies as the issue price for shares has to take into account 26-week historical price which is invariably higher than the current prices. Also, the exemption from the pricing framework and the open offer requirement was hitherto only available for companies whose resolution plan has been approved under IBC. Now, since the Stressed Companies can avail such relaxations even prior to going into insolvency, the investors should take a liking to this route for structuring takeovers.
Additionally, the promoters lose complete control of the Stressed Company once the moratorium is imposed and the CIRP process is commenced under the IBC. The amendment can help promoters in onboarding a strategic or a financial investor without ceding complete control of the company. The promoters would like to restructure their businesses by availing this opportunity and avoid putting their fate in the hands of the creditors as is the case under the IBC framework. So, at the end of the day, it is a win-win situation for the company, the promoter(s) and the investor(s).
This new framework presents an opportunity for the takeover of Stressed Companies by third-party investors or white knights through infusion of fresh capital at corrected lower prices while avoiding the requirement of making an open offer to the public shareholders. However, before undertaking any transactions under this framework, the importance of undertaking thorough due diligence and negotiating appropriate package of protective rights which are permissible within the SEBI framework cannot be overstated.
Also, whilst there are certain onerous conditions like the 3-year lock-in requirement on the investor, this in itself should not be a major dissuading factor for an investor who has a medium to long term investment strategy. If one looks at the overall advantages of the current relaxations, arguably, they do substantially outweigh the challenges imposed by these conditions.
We expect an uptick in distressed acquisitions of public listed companies as the new framework is a much smoother and time-efficient process to takeover a Stressed Company as opposed to going through the long drawn CIRP process under the IBC.
1 SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations, 2020 2 SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2020 3 "Overall, more than 270 listed companies as on date have their debt instruments/loans rated as D and therefore can be construed as stressed in nature." See https://www.outlookindia.com/newsscroll/new-sebi-norms-to-give-more-fundraising-flexibility-to-stressed-firms/1886509
Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.
Partner - Khaitan & CO
Prasenjit Chakravarti is a Partner in the Corporate and Commercial Practice Group in the New Delhi office. With over 14 years in the profession, Prasenjit advises domestic and international corporate clients on a range of legal, regulatory and governance related issues concerning foreign investment (both inbound and outbound), joint ventures and strategic alliances, acquisitions and other business transactions, financial and technical collaborations, commercial, corporate and securities laws. Prasenjit is part of Firm’s German Desk, which regularly advises on a wide variety of transactions in the Indo-German corridor.
Principal Associate, Khaitan & Co
Nitish Goel is a Principal Associate in the Corporate and Commercial Practice Group in the New Delhi office at Khaitan & Co.