Buy-back ought not to trigger an open offer

WITHOUT CONTEMPT

The Sebi (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations”) are in for significant amendments, thanks to governmental attention to falling stock prices. Last fortnight, Sebi issued a press release to state that one could buy up to 5 per cent shares in a financial year in a listed company even if one’s holding were above 55 per cent.

The Takeover Regulations today impose an obligation to make an open offer upon purchase of a single share by anyone holding more than 55 per cent. Actual amendments to the Takeover Regulations are still being drafted, but it appears from Sebi ‘s press release that a far-reaching change in connection with buy-back of shares is on the cards.

Under Indian company law, any company may buy back its shares. Shares so bought back are required to be extinguished, thereby increasing the earnings per share (after a buy-back, the profits would be distributed over fewer shares), thereby enhancing shareholder value.

A buy-back of shares by a listed company has to comply with regulations made by Sebi for the purpose. Sebi permits two routes for a buy-back – tender offer and market purchases. In a tender offer, all shareholders have a right to participate on a proportionate basis, while in an open market buy-back promoters are prohibited from selling in the market when the company is buying shares in the market.

When a company buys back shares, a necessary consequence would be an increase in percentage shareholding in the hands of shareholders who continue to hold shares. Let’s say the total share capital of a company comprises 100,000 shares. A shareholder holding 50,000 shares before the buy-back would have held a 50 per cent stake. If the company were to implement a 10 per cent buy-back, the same 50,000 shares would represent a 55.55 per cent shareholding on a contracted base of 90,000 shares.

Sebi has passed numerous orders clarifying that an involuntary increase in percentage shareholding pursuant to a buy-back would not trigger an obligation on the continuing shareholders to make an open offer. This is but logical because there would be no positive acquisition of shares to trigger an open offer. Besides, in a given situation, more than one person could end up triggering an open offer owing to such involuntary hike in percentage stake. Moreover, since Sebi regulations prohibit promoters from participating in an open-market buy-back, the percentage stake of the promoters is bound to go up.

However, the Sebi press release indicates that Sebi would treat an involuntary increase of above 5 per cent in percentage shareholding as a trigger for an open offer obligation. Sebi’s press release states that if the increase in shareholding percentage is within 5 per cent in a year pursuant to a buy-back, there would be an automatic exemption from open offer obligations. However, where the increase is in excess of 5 per cent , one would have to approach Sebi for an exemption.

According to an internal policy position among Sebi officials (this is made known only to exemption applicants), if the percentage shareholding increases by more than 5 per cent pursuant to a buy-back, Sebi would oppose an exemption. Exemptions endorsed by the expert panel formed under the Takeover Regulations and precedents of orders passed by Sebi’s wholetime members have been opposed during exemption hearings on this basis.

It is therefore reasonably expected that when the Takeover Regulations actually get amended, an obligation to make an open offer would be imposed if a shareholder’s stake were to rise by more than 5 per cent.

Such a blanket provision would be unfair. It is true that promoters in control of the company could use their control to expend company money to buy back shareholders and enjoy the consequential hike in stake. However, should Sebi desire to impose an open offer obligation pursuant to a buy-back, Sebi ought to correspondingly remove the ban on promoters participating in the buy-back.

There is another legislative option. Sebi could make it mandatory that the promoters refrain from voting on buy-back proposals, both at the level of the board decisions and at shareholder meetings, if their stake were to go up beyond 5 per cent. If the rest of the shareholders and the board were to implement the buy-back without the promoters voting, then an involuntary increase of any level of percentage holding of the promoter ought not to result in an open offer.

Imposing an open offer obligation pursuant to an involuntary increase in shareholding is a tricky measure that requires careful consideration. Knee-jerk amendments could lead to unintended consequences.

As for the government’s push to encourage people holding more than 55 per cent to freely buy shares of up to 5 per cent to boost market sentiment, until the Takeover Regulations are actually amended, relying solely on the Sebi press release could have disastrous consequences for acquirers.

The Takeover Regulations still prescribe an open offer if a person holding more than 55 per cent were to acquire a single share. If one were to buy a single share in excess of 55 per cent before the regulations are amended, a public shareholder could move court to enforce his right enshrined in delegated legislation pursuant to Parliamentary mandate. Press releases will not help a court ignore the explicit letter of the law.

The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.

somasekhar@jsalaw.com