SEBI proposes 25 % votings rights as threshold level to trigger 'control' under Takeover Code

Last week, the SEBI, in its board meeting had considered and approved the proposal for initiation of public consultation process regarding the introduction of brightline tests for acquisition of ‘control’ under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 ("Takeover Code”). The SEBI noted that multiple regulators apply the test of control from di􀁹erent perspectives and arrive at di􀁹ering results which may lead to ambiguity.

In pursuance of the SEBI Board meeting, a discussion paper has been released seeking public comments for proposals related to Brightline Tests for Acquisition of ‘Control’ under the Takeover Code.

In the discussion paper, the SEBI has proposed to amend the definition of control to define it as: (a) right or entitlement to exercise at least 25% 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 company.

I. Current position:

At present, an open o􀁹er is triggered when an entity buys minimum 25 per cent shares in a listed target. However, in some cases, an entity acquires less than the threshold (i.e., 25% of shares) to avoid open o􀁹er obligation, yet gains a say in the management of the target company.

Presently, ‘control’ has been defined, by way of an inclusive definition, under various laws in India and internationally. The salient features of definition of ‘control’ are as under: 

The right to appoint a majority of directors

The right to control the management

The right to control the policy decision

Such rights may be exercised by a person, directly or indirectly. The rights may accrue by virtue of shareholding, management rights, shareholder agreements, voting agreements or in any other manner. However, in case of contractual agreements, assessment of acquisition of control becomes complex and requires consideration of facts. It has been represented to SEBI to amend the definition of control, thereby shi􀁺ing it from a principle based definition to rule based definition, in order to avoid multitude of opinions. In a given scenario multiple regulators may all be applying the test of control from di􀁹erent perspectives and arriving at di􀁹ering results which may lead to ambiguity and confusion in the market 

II. SEBI’s Proposal:

In view of the same, SEBI, in the Discussion paper, has proposed following two options to identify bright lines for control:

Option 1:- Framework for Protective Rights

The Board has proposed to introduce illustrative list of protective rights which would not amount to acquisition of control. SEBI has proposed various example which will not consider as controlling in any manner for the purpose of Merger and Acquisition deals. This include the appointment of Chairman/ Vice Chairman, observer, Covenants specified by Lenders, Commercial Agreements, Veto/ A􀁹irmative Right etc.

Option 2:- Adopting a numerical threshold

The SEBI has proposed to amend the definition of control to define it as: 

(a) right or entitlement to exercise at least 25% 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 company.

III. Pros and Cons of the above two options:-

Investor having the protective rights would continue to be a public shareholder and acquisition of the said rights would not amount to acquisition of ‘control’ under the Takeover Regulations, 2011. However, this only being an indicative list, acquisition of other rights would be examined on the basis of the facts and circumstances of the case. In case such rights are deemed to be participative in nature, it would amount to acquisition of ‘control’ and necessitate an open o􀁹er under regulation 4 of the Takeover Regulations, 2011. However, this approach may lead to further complexities in assessment of control and lead to ambiguity in interpretation.

The acquisition of control through other means such as special rights, etc. would not necessitate an open o􀁹er requirement under the Takeover Regulations. It would reduce the uncertainty in the assessment of acquisition of ‘control’ and bring clarity. Further, the extent of influence by the investor over the board of directors would also be ascertainable in all cases