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-Aarushi Kapoor†
In furtherance of the release of SEBI Discussion Paper on Review of Delisting Regulations pursuant to Open Offer, SEBI has recently agreed to revise the delisting norms to streamline mergers and acquisitions. These revisions seek to address the directionally contradictory transactions under the current SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (‘Takeover Regulations’) and SEBI Delisting Regulations, 2021 (‘Delisting Regulations’). Addressing the directionally contradictory transactions is expected to promote the ease of doing business by diluting the stringent convolutions.
The article makes an attempt to exhaustively understand the inter-relation amongst Takeover Regulations, Delisting Regulations and Securities Contract (Regulation) Rules, 1957 in the light of the revamped solution offered under the abovementioned discussion paper, with a specific emphasis on the pros and cons of doing away the reverse book building process. The article attempts to explore the challenges which propelled the revision and amendments to the existing regulations. It seeks to analyze the current sequencing of the compliance as required under the Takeover Code and the Delisting Regulations. After the careful scrutiny, it brings forth the proposed new solution of doing away with the procedural setbacks and lacunas and accordingly discusses the intricacies of the amendments. Furthermore, it analyses the implications of new solutions proposed with special emphasis on the removal of the reverse book building process. It dives further into the questions if doing away with process of reverse book building process is perfectly aligned to the concerns which prompted their arrival. It critically examines the utility of the process of the reverse book building and enumerates the after effects post removal of the same.
Current Framework governing Mergers and Acquisitions
The current framework for listing and delisting is governed by the convergence of three legislations, namely Takeover Regulations, Securities Contract (Regulations) Rules, 1957, (‘SCRR’) and Delisting Regulations. Under Regulation 3 and 4 of Takeover Regulations, if the acquirer has agreed to acquire shares carrying voting rights upto 25 percent or more, or control over the listed company, then a mandatory open offer to acquire the shares held by all the shareholders, other than the acquirer, has to be made. But, there is a possibility that, pursuant to such direct or indirect acquisition of shares, the acquirer may cross 75 per cent of the shareholding control. However, under Rule 19A of SCRR, this limit of 75 percent is the current maximum non-public shareholding that any acquirer can hold. In order to maintain the minimum public shareholding of 25 percent for all the listed companies, SCRR, mandates that such an acquirer, who has possibly crossed the threshold of maximum non-public shareholding, is required to bring this non-public shareholding to 75 percent or less than 75 percent within a period of 12 months.
This attempt to bring down the shareholding of the acquirer is imperative for complying with the delisting regulations. There might be a situation wherein despite becoming the majority shareholder, an investor wants to go ahead with delisting so early. This may be due to uncertain financial constraints of the company, a proposed arrangement or amalgamation, lack of compliance with the regulatory framework of stock markets, a company filing for insolvency or lack of market capitalization. In such a situation, until and unless this minimum shareholding of 25 percent would not be achieved by reducing the maximum non-public shareholding below 75 per cent, the said company cannot be delisted. Regulation 8(1B)(i) of the SEBI (Delisting of Equity Shares) Regulations, 2009, prohibits any attempt of reaching the required threshold of 90 per cent for delisting (as per Regulation 17 of the SEBI (Delisting of Equity Shares) Regulations, 2009) unless the company is compliant with above mentioned norms.
Tussle Between Takeover Regulations, Delisting Regulations and SCRR
These compliances are likely to complicate and confuse the investors in the secondary market. The investors would have to navigate three contradictory bodies of law and put into force, three effective public transactions.; In other words, even if pursuant to an open offer, an acquirer achieves the shareholding of 90 percent, he would not be in the position to pursue delisting, but instead would have to compulsorily reduce the shareholding down to 75 percent and then again achieve the 90 percent shareholding for delisting. The three-step ladder which has to be compulsorily followed, despite being redundant and repetitive, has been explained with the help of the following example:
For instance, an open offer is triggered either through direct or indirect acquisition by an incoming acquirer who happens to acquire more than 49 percent from an existing shareholder, then in such a situation, the following compliances would be triggered:
● Firstly, the acquisition of shares under Takeover Regulations may cross the threshold limit of 75 per cent of the shareholding;
● Secondly, the provisions of SCRR, in such a case would require the acquirer to reduce its holding below 75 per cent within 12 months; and
● Thirdly, despite there being a possibility of the shareholding getting extended up till 90 percent (with the 75 percent mark being already crossed); the acquirer under Delisting Regulations is not permitted to delist unless the shareholding is brought down to 75 per cent.
The three-step compliance is enough to complicate a simple transaction and hence, deter the investors from enjoying the fruits of ease of business in India.
In order to link the inconsistent Takeover Regulations and Delisting Regulations, an attempt to introduce Regulation 5A in the Takeover Regulations was made in 2015. It entails a renewed sequence. Under this regulation, the acquirer at the time of making an open offer under the Takeover Regulations has to declare its intention to delist upfront. Upon the declaration of intention, delisting can be directly successful if such open offer results in the acquisition of 90 percent of the shareholding in the listed company, at a price determined by the process of reverse book-building, without seeking to reduce the shareholding to 75 percent under the SCRR. Even if shareholding beyond 90 percent cannot be acquired, the acquirer could then pursue the obligations of the open offer under the Takeover Regulations.
However, this revision is a mere sequencing provision that fails to provide a required and desirable framework for establishing a convenient and smooth flow of all the constituent rights and obligations. The uncertainties are not resolved but are only sequenced. That is why, it would be right to conclude that introduction of Regulation 5A was an ‘ineffectual remedy’.
Recommendations of the SEBI Discuss Paper
In order to overcome the instability, SEBI has recently released a discussion paper wherein the need to streamline the operation of Takeover Regulations, SCRR and Delisting Regulations was recognized. The paper was able to contemplate a new solution to address the conundrum of the legal rules and principles. This article makes an attempt to critically analyze the viability and feasibility of solutions proposed therein, by bringing to light the consequences and the implications attached therewith.
The solution can be discussed under the following heads:
(i) Disclosure of Intent to Attempt Delisting Upfront
While making an open offer under the takeover regulations, the acquirer is mandatorily required to state upfront during the first public announcement and detailed public statement, his intention of delisting or retaining the listed securities. however it is important to mention that despite the declaration of intention to delist, the delisting of an entity is contingent upon the promoter’s shareholding reaching 90 percent. This uncertainty to reach 90 percent of the shareholding might result in the prevalence of confusion amongst the shareholders in absentia of clarity. It is because despite the declaration of delisting intent, if the 90 percent threshold is not achieved, then the shares are to be tendered for open offer as against the desired delisting.
(ii) Delisting Price and Takeover Price
The most unique solution is the introduction of a differential pricing system. Ideally, under the current framework, the delisting of the securities is carried at the price, determined by the process of reverse book building executed by the shareholders’ bidding. If such a price is above the floor price as specified, and is acceptable to the promoters of the delisting entity, it ends up becoming the exit price for the shareholders during delisting.
However, under the proposed legal framework, if the acquirer is desirous of delisting then a differential pricing must be proposed by the acquirer. The first price should be an open offer price which should not be lower than the minimum offer price under the Takeover Regulations (‘takeover price’) which would be offered if pursuant to an open offer, the threshold of 90 percent is not met and the second price should be a higher price than the former with a suitable premium reflecting what the acquirer is willing to pay if delisting were successful (‘delisting price’) which would be offered if the threshold of the 90 percent is met. This higher price of delisting is expected to act as an incentive to the shareholders which should encourage them enough to offer their shares to the acquirer. It is an obligation upon the acquirer to offer a premium over the delisting price because without this addition, the shareholders might not deem profitable to offer their shares and hence the whole exercise for delisting may fail . In addition, post delisting, the acquirer would be controlling 90 per cent of the company’s ownership, so such a threshold must therefore command a higher rate of premium. This additional premium paid over the delisting price is technically the cost of acquiring the 90 per cent equity of the company.
As an alternative, even if the acquirer is able to cross the mark of 75 percent, but fails to reach the required threshold of 90 percent of delisting, the nuanced solution provides an additional period of 18 months to make further attempts of delisting by meeting the unmet thresholds.
(v) Doing away with the process of reverse book building
The suggested approach is likely to circumvent the process of reverse book building. The new approach shifts the burden of striking the delisting price on the promoters instead of the shareholders. This might act as a backdoor for the promoters who are inclined to make shareholders exit at their own terms and conditions. A detailed analysis of this implication has been discussed below.
Before making an attempt to understand the implications which are likely to dwell on the regulatory compliances post the reversal of the reverse book building process, it is essential to understand its utility and the primary idea behind its incorporation.
v.(ii) Importance of Reverse Book Building Process
Regulation 17 of the Delisting Regulation, prescribes a reverse book building process as a means to discover the delisting price. According to Regulation 20 of the Delisting Regulations, the public shareholders can quote their bids to determine the exit price. The promoters have the liberty to fix the floor price in accordance with the Takeover Regulations. The regulations sufficiently protect the interests of the shareholders as they are the ones who enjoy the last say in the determination of the final offer price. It protects them from the ill-will of the promoters who may quote a lower price in order to strike a profitable bargain for themselves at the expense of the shareholders.
v.(iii) Relevance of Reverse Book Building Process in light of proposal
Critics and legal experts opine that the proposed solution will be detrimental to the interests of the shareholders. The removal of reverse book building as a method to determine the delisting price would once again leave the shareholders stranded by the exploitative and unconscionable bargain of the promoters. The solution is likely to dilute the concept of reverse book building and, accordingly, it will be the promoter who would suggest the delisting prices. The case of Hamilton v. Nozko is a perfect example to showcase the failure of the promoter driven price determination process in protecting the interests of the minority shareholders during delisting. The Court in the said case did acknowledge the lacuna and directed a more inclusive process of price determination during delisting.
At this junction, it is imperative to balance the interests of both the shareholders who want a profitable selling price and the promoters who want a reasonable cost price to successfully delist the entity. No doubt, protection of the shareholders’ interest is vital and the process of reverse book building is likely to secure some of their interests, but it is equally worth mentioning the possible and glaring inadequacies that this system is brimming with.
Critical Analysis: Can dilution of Reverse Book Building seriously hamper shareholders’ interests?
At a glance, the provisions of reverse book building may seem good, but it fails to do equitable justice with the commercial interests of the entity. The concept of reverse book building is based on a detailed understanding of the commercial viability and financial health of the company. In order to strike a conscionable bargain that takes into accord the interests of both the shareholders and promoters, the shareholders should possess an adequate amount of information and knowledge. Usually, the public shareholders are not well versed with these aggregates and the sole determinant of their proposed delisting bid is the urge to earn the maximum amount of profit by quoting a higher price.
As a consequence, the shareholders may indulge in opportunistic behaviour through arbitrageurs share purchases which may tend to manipulate the prices. This opens the possibility of bids being entered at exceptionally high prices which may not be acceptable to the promoters and hence, may result in the failure of the delisting process. This was exactly the reason which moved the promoters of INEOS Styrolution to reject the price discovery by shareholders, thereby resulting in the failure of delisting attempt. This unscrupulousness is because of the unchecked behaviour at the end of the shareholders because the delisting regulations only prescribe a floor price and not any ceiling price. This process is equally likely to be get exploited in the hands of promoters who may sell the shares of the listed entity to their related and friendly shareholders, who may act to reduce the bid amount
Furthermore, it is noteworthy to mention that India is the only capital market wherein the concept of the reverse book building process finds its presence. No other jurisdiction of the world prescribes this methodology as a way to determine the delisting price. For instance, the major jurisdictions of the world like the US, UK, Canada and Japan, desist from offering such appraisal rights to the shareholders and even if they do, they subject such rights to a reasonably calculated look-back price or a fair valuation of the stock. Other methods of determination of exit price may include open market purchases negotiated between the shareholders and promoters via a financial intermediary and public tender offers through investment bankers.
Suggestions and Alternatives course of actions
With the pros and cons of the reverse book building process having been discussed already, it is imperative to conclude that criticising the proposed solution of direct delisting on the sole grounds of dilution of reverse book building is erroneous. There are other methods to accord a sufficient amount of protection to the shareholders and protect the interests of the promoters. It is high time for the Indian capital markets to revamp this methodology of balancing the commercial interests of the shareholders and the entities. Therefore, the determination of price by the promoters, if accompanied by certain safeguards, is likely to be a welcome step that would eradicate the ill-effects of the reverse book building process.
It is also suggested that due to the information asymmetry between the shareholders and the promoters, the promoters should be allowed to play a proactive role in efficient price discovery. They not only possess accurate information regarding the intricate value of the company but are also conversant with the future value that the company seeks to extract post delisting. To further remove the possibility of fraud, the determined price should be certified by the merchant banker. In addition, such a price should be approved by the regulatory authorities who have better information about the dynamics of the market in which the entity operates. To further remove the possible shade of red tapism from the said solution, a fixed time could be filled within which this check and balance had to be carried and reverted back. This would definitely reduce the instances of failed daily delisting attempts because the bargain would strike an appropriate and reasonable balance between the two sets of entities.
In addition, there are certain other safeguards under the delisting regulations in order to further protect the interests of the shareholders. In the first place, Section 166 of the Companies Act, 2013 imposes a fiduciary duty on the directors to protect the interest of shareholders. Further, for delisting to be successful, the delisting regulations mandate that a special resolution needs to be passed through the means of a postal ballot by the public shareholders. The votes cast by public shareholders in favour of the delisting proposal must be at least twice the number of votes cast by the public shareholders against it..
That is how after incorporating any of the abovementioned solutions, the balance among the interests of the shareholders, the promoters and the company can be brought close to equilibrium. Revamping the existing regulatory compliances with international practices are likely to add an impetus to the drive of Indian community to attract foreign investment. The combination of the solution as listed down in addition to the compliance with these safeguards is likely to further strengthen the equilibrium between the promoters and the company. The delisting price is despite being determined by either the promoters or the shareholders, must be able to strike an equitable bargain. The proposal to get done away with the process of reverse book building process, no doubt favours one side of the story, but however it is likely to bear fruits. Firstly, it would eradicate the negatives of the reverse book building process and secondly, if balanced against the abovementioned precautionary measures, would result in a predictable price determination thereby reducing the chances of speculations.
Conclusion
As shown above, the concerns of the shareholders after the dilution of the reverse book building process are misplaced. The proposed framework and the current framework jointly are sufficient to provide enough protection to the shareholders. Therefore, direct delisting is a welcoming step that not only promotes the ease of doing business but, at the same time, also protects the capital markets from the possible drawbacks of the reverse book building.
†Aarushi Kapoor is a 4th year student at Hidayatullah National Law University