First Notes - 23 March 2016

First Notes - 23 March 2016

SEBI issues a Discussion Paper (DP) on 'bright-line tests for acquisition of control' under SEBI Takeover Regulations, 2011


Regulation 2(e) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SEBI
Takeover Regulations, 2011) defines ‘control’ as follows:
‘control includes the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner:
Provided that a director or officer of a target company shall not be considered to be in control over such target company, merely by virtue of holding such position’. The above definition of control is a principle-based definition rather than rule-based. The assessment of control requires a consideration of the facts and circumstances of each case. 

Control is also defined under other laws in India such as the Companies Act, 2013, Insurance Laws (Amendment) Act, 2015, Consolidated Foreign Direct Investment (FDI) Policy Circular of 2015.

The SEBI has in the past received representations from various stakeholders to seek guidance on the definition of control and to define bright-lines while assessing the various factors leading to contro.

Accordingly, SEBI issued a DP on 14 March 2016 seeking comments from the general public on its proposals defining the bright-line tests for the acquisition of control under the SEBI Takeover Regulations, 2011.
Overview of the DP
The DP broadly lists down two options to determine ‘control’

1. Option 1 - Framework for protective rights: Veto rights not amounting to the acquisition of control may be protective in nature rather than participative i.e. such rights may provide the investor the ability to protect their investments or prevent dilution of their shareholding.  At the same time, the investor should not have the power to exercise control over the day-to-day running of the business or the policy making process.  Rights over decisions involving a significant change in the current business activity or that apply in exceptional circumstances would also be treated as protective rights.

Under option 1, the DP provides an illustrative list of protective rights which would not amount to the acquisition of control. For example:

  • Appointment of the chairman,  vice-chairman, observer provided such individuals do not carry any casting vote or other voting rights.
  • Rights conferred under commercial agreements provided mutual commercial benefit flows from both the sides i.e. not one-sided, the board of the target company approves the decision to enter into such an agreement, has the right to terminate the agreement, and enter into similar agreements with any other party.
  • Veto rights/affirmative rights that are not part of the ordinary course of business or involve governance issues would be considered as protective in nature and would not amount to the exercise of control over the target company.
  • Quorum rights i.e. for meetings involving the matters of veto rights/affirmative rights.  If two meetings are not quorate, the next meeting would be deemed to have quorum despite the absence of the investor nominees.

Under this framework, the DP specifies three conditions to be fulfilled before the above rights can be given and they are as follows:

  • The investor bestowed with the above rights, must invest at least 10 per cent or more in the target company.
  • Every company would be required to formulate a policy defining the parameters that will be ‘material’ or ‘outside the ordinary course of business’ and the same should be disclosed to the shareholders.  Additionally, grants of the protective rights would be subject to obtaining the public shareholders’ approval (majority of minority).  Such rights would also be required to be incorporated in the Articles of Association of a company after obtaining shareholders’ approval.
  • In case of initial public offers, the existing agreements would need to be cancelled/modified or suspended till the approval of public shareholders (majority of minority) is taken post-listing of the shares.

2. Option 2 - Adopting a numerical threshold: Under this approach, the definition of control would be amended such that control is defined as:

a) The right or entitlement to exercise at least 25 per cent of voting rights of a company irrespective of whether such holding gives de facto control and/or 

b) The right to appoint majority of the non-independent directors of a

Advantages and disadvantages of both options highlighted in the DP

The DP highlights the advantages and disadvantages of both the options as follows:

  • Option 1: An investor having protective rights would continue to be a public shareholder and the acquisition of these rights would not amount to an acquisition of ‘control’ under SEBI Takeover Regulations, 2011. However, option 1 only provides an illustrative list of such rights. Therefore, the acquisition of other rights would need to be examined on the basis of the facts and circumstances of each case to assess if definition of control has been met. In case such rights are deemed to be participative in nature, it would amount to ‘control’ and necessitate an open offer under SEBI Takeover Regulations, 2011. However, this approach may lead to further complexities in assessment of control and lead to further ambiguity in the interpretation of the definition of control.
  • Option 2- In case option 2 is adopted, the acquisition of control through other means such as special rights, etc. would not necessitate an open offer requirement under SEBI Takeover Regulations, 2011. Being a numerical threshold, it would reduce the uncertainty in the assessment of the acquisition of ‘control’ and provide clarity. Further, the extent of influence by an investor over the board of directors would also be ascertainable in all cases.

Timelines for receiving public comments

The DP has outlined 14 April 2016 as the last day for receiving public comments.

Our Comment

An assessment of control entails judgment and consideration of the facts and circumstances of each case.  The issuance of the DP is a welcome step by SEBI to put in place specific guidelines to determine control. This could also help to sort out any ‘grey areas’ around the existing definition of control.

Listed companies (meeting the specified threshold) in India are on their way to adopt Ind AS standards from 1 April 2016. Ind AS 110, Consolidated Financial Statements and Ind AS 103, Business Combinations provide a definition of control and explain when rights would be considered as protective rights. Therefore, while drafting the final regulation, SEBI should take into account the guidance given in Ind AS in addition to considering the comments and views sent in by the public. Given that Ind AS standards are principle-based, option 1 would be more closely aligned with Ind AS. However, the requirement of an investor to invest ‘10 per cent or more in the target company’ provides a bright-line.  These conditions should also be principles-based.

The definition of numerical thresholds under option 2 is at variance with the prevailing guidance under Ind AS and other internationally accepted standards such as IFRS and U.S. GAAP. Such a numerical threshold also creates avenues for companies to structure transactions in order to avoid falling under the definition of control. We also believe that the requirement to put existing shareholder agreements to vote post listing may be onerous. An alternative would be to require any changes to existing shareholder agreements necessitated by any changes in the shareholding to be subject to approvals by the shareholders. 

We encourage listed companies to send their views on the DP by 14 April 2016 to SEBI.
To access the full text of the SEBI press release, please click here.  


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