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Merger and Acquisitions - Future in the Light of Impending Changes in the Takeover Code

India is one among the fastest developing countries with a highly impressive growth story. But to sustain this level of growth there needs to be a favourable environment conducive to development. Subsequently Indian regulators are these days sitting on the edge, recreating and revamping the legal framework for Indian incorporations. Significant alterations have been due from long time. However, owing to the rigidity of Indian legal system, the processes have been outstretched. The business and number of corporate organisations have increased manifold over the years. In this dynamic era, one cannot think of sticking to age-old legal regime. A legislation which is too old will lose its relevance and jeopardise the objective for which it was enacted.

Brief preview on the genesis of the Takeover Code

2. It would be worthwhile to review genesis of the Takeover Code starting from 1990. Briefly, it may be stated as follows:

• In 1990 the Government amends clause 40 of the Listing Agreement according to which threshold acquisition level reduced from 25 per Cent to 10 per cent; change in management control to trigger public Offer; minimum mandatory public offer of 20 per cent; disclosure requirement through mandatory public announcement.

• In 1992 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1992 was notified.

• In 1994 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1994 was notified replacing 1992 Regulations introducing new provisions to enable both negotiated and open market acquisitions and allowing competitive bids.

• In 1995 SEBI sets up committee under former Chief Justice of India P N Bhagwati to review the 1994 Takeover Regulations in order to frame comprehensive regulations.

• In 1997 Bhagwati Committee submits its report on the Takeover Regulations to SEBI.

• In 1997 SEBI accepts Bhagwati Committee report and notified SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 after which it has been time and again being amended to suit the prevailing market conditions in order to facilitate an investor friendly market.

Rationale behind codifying the Takeover Code

3. With the announcement of the policy of globalisation, the doors of Indian economy were opened for the overseas investors. But to compete at the world platform, the scale of business was needed to be increased. In this changed scenario, mergers and acquisitions were the best option available for the corporate considering the time factor involved in capturing the opportunities made available by the globalisation. But soon the predators with huge disposable wealth started exploiting this opportunity to the prejudice of retail investor. This created a need for some regulations to protect the interest of investors which were done through enactment of the Takeover Code and various other ancillary rules and regulations. The major objectives of the Takeover Code can summarised as follows:

Investors having the option of choosing to exit from the company

Tougher requirements for disclosure of material information with respect to the Open Offer enabling the investor to make an informed decision

Effective and efficacious completion of takeover formalities in a timely manner

Key recommendations of the TRAC

4. Key recommendations of the TRAC can be summarized as follows:

4.1 Trigger of the Takeover Code

(i) The threshold for triggering of the Takeover Code has been increased from 15 per cent to 25 per cent.

(ii) The creeping acquisition limit of 5 per cent in one financial year increased from 15 per cent-55 per cent to 25 per cent-75 per cent. Such acquisition can be made in any manner (including through open market purchases, negotiated deals, bulk or block deals, preferential allotment, etc.).

(iii) Acquisition of control over a Target Company would require the acquirer to make an open offer.

4.2 Size of open offer

The size of open offer has been increased from 20 per cent to 100 per cent of the shares of the company.

4.3 Offer price

(i) For direct acquisition - Volume-weighted average market price ('VWAP') for 60 trading days prior to the public announcement to replace average of the weekly high and low of the closing prices of shares for past 26 weeks or 2 weeks. Further, in addition to highest negotiated price between parties and highest price paid by acquirer and PAC during 26 weeks prior to public announcement, VWAP for shares acquired by acquirer and PAC during past 52 weeks also to be considered for determining open offer price.

(ii) For indirect acquisition - New price indicator introduced in the form of highest price paid by acquirer or PAC between date of primary acquisition and date of public announcement for indirectly acquired target company, in addition to the existing price indicators. Further, offer price shall stand enhanced by additional 10 per cent per annum for the period between date of primary acquisition and date of detailed public statement.

4.4 Definition of 'control'

The definition of 'control' to include not only the right but also the ability to appoint majority of the directors on the Board of the target company.

4.5 Deemed direct acquisition - Concept of deemed direct acquisition introduced if the proportionate net asset value/sales turnover/market capitalisation of the indirectly acquired target company as a percentage of the consolidated net asset value/sales turnover/market capitalisation of the directly acquired entity is in excess of 80 per cent, on the basis of the most recent audited annual financial statements.

4.6 Delisting

An acquirer would be required to state upfront in public announcement its intention to delist the target company. If the shareholding of the acquirer is between 75 per cent to 90 per cent after the open offer, the acquirer would be required to either bring his holding down to ensure compliance with the Listing Agreement, or proportionately reduce both his acquisitions under the agreement that triggered the open offer and the acquisitions under the open offer. No requirement to make a separate delisting offer under Delisting Regulations if acquire crosses 90 per cent delisting threshold through the open offer under the Takeover Code.

4.7 Competing offers

The period for making competing offer changed to 15 business days from the date of detailed public statement of open offer. Further, within 21 business days from expiry of the offer period, any competing acquirer would be free to negotiate and acquire the shares tendered to the other competing acquirer, at the same price that was offered by him to the public.

4.8 Non-compete fees

Omitted. Promoters to be paid the same price per share as the public shareholders.

4.9 Open offer process - (i) Timing of public announcement - A summary public announcement on the same day of agreeing to acquire shares or voting rights in, or control over the target company. A detailed public statement within 5 business days from making of the summary public announcement. (ii) Timeline for open offer - 57 business days.

4.10 Obligations of the manager

The manager is free to deal with the shares of the target company after the offer period.The manager shall file a report with the Board within 15 business days from the expiry of tendering period.

Analysis of the recommendations

6. On basis of the recommendations given by the TRAC, an attempt is being made to analyse the impact of the recommendations that would have on each of the stakeholder in the succeeding paras:

6.1 Promoters of the target company

Rise in hostile takeovers of companies in which the promoters have a lower shareholding will be simple. This argument is augmented by the new threshold limits from 15 per cent to 25 per cent.

• Substantial shareholders to benefit from the exemption that is provided in the case of increase in voting rights due to buy-back of shares that happens but this rule is subject to certain conditions. This rule also benefits those who do not participate in any buy-back but end up crossing the threshold for open offer.

• The present Takeover Code permits creeping acquisition only up to 55 per cent but the recommendations permits creeping acquisition of 5 per cent per annum up till 75 per cent for any acquirer who holds 25 per cent or more voting rights in the target company.

• Promoters will now be paid at the same rate for their stake as is paid to other public shareholders of the target company due the abolishment of non-compete fees. This move could severely impact the stake sale done by many promoters in listed companies.

6.2 Public shareholders

• One of the primary intention for creating a Takeover Code is to protect the interest of all the stakeholders and this includes public shareholders as well. TRAC has recommended that the open offer size be increased from the present 20 per cent to 100 per cent. This could be viewed as path breaking because it gives exit opportunity to all the shareholders and not just a handful.

• TRAC urged the Central Board of Direct Taxes to put proposal to the Government for an amendment in the Income-tax Act to exempt capital gains resulting from sale of shares tendered in an open offer.

• By deletion of the concept of non-compete fee, all sort of difference between promoters and public shareholders have been removed. A uniform price is offered to one and all, thus, introducing an equitable treatment to every stakeholders.

• Risk associated with the volatile market conditions will be minimised as the timeline has been shortened for the open offer. Largely the price determined for the open offer at times ends up to be substantially lower than the market prices when the shares are finally tendered.

• One major change envisages is with respect to the accountability of the independent directors. The independent directors have to compulsorily make reasoned recommendations on the open offer. For the public shareholders this is a welcome move as they stand to gain from the experience and wisdom of the independent directors.

6.3 Strategic acquirers

• Increase in the cost for acquiring a listed company on the account of increased open offer size from 20 per cent to 100 per cent.

• Due to the increase in the cost of acquisition the domestic acquirers would find it difficult as the banks would have limitations in providing the finance. Moreover, at the same time foreign entity, wanting to acquire Indian company, would be placed at an advantage as there would be easy access to money outside India.

• Delisting becomes easier as the acquirer can bypass the requirements of the Delisting Regulations and delist the company directly if the acquirer's stake in the target company exceeds the delisting threshold.

• There are newer alternatives to the acquisition as it now also includes their own liquid shares or convertible securities.

6.4 Private equity investors

• The higher trigger option of 25 per cent should see an increment in the volume of private equity investment as now they can increase their stake in listed companies upto 24.99 per cent without having to worry about triggering the open offer requirements

• There is still a lack of clarity on the definition of 'control'. Instances such as when a private equity investor does not have a positive control over the affairs of the company by only getting minority rights. 'Defacto control' provides a better solution here than 'dejure control'.

6.5 Target company

• As mentioned earlier, there is an increase with respect to the

accountability of the independent directors as from now on they have to give compulsorily reasoned recommendations to their shareholders with respect to the open offer explaining whether they are in favour of the open offer or not.

• There is a new requirement for passing a special resolution by

the shareholders of the target company if they wish to dispose off an asset/undertaking within a period of two years from the end of the offer period.

Conclusion

7. TRAC has attempted to simplify the Takeover Code and align it with the international best practices. The report of TRAC sets a benchmark to emulate before any new legislation is introduced since some of the important principles followed by TRAC such as sound statistical analysis, relying on past court rulings, analysing international Takeover Codes, plugging the loopholes based on some of the recent cases, etc., are extremely important for developing a robust legislation which can stand the test of time. If SEBI stamps the recommendations of TRAC with force of law, replacing the extant Takeover Code, then the Report of TRAC will be guiding light for takeover regime in India in the next decade to come as was Bhagwati Committee Report in the previous decade.

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This post first appeared on Dubai Community, please read the originial post: here

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Merger and Acquisitions - Future in the Light of Impending Changes in the Takeover Code

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