Tuesday, July 25, 2017

Activism through Directors Elected by “Small Shareholders”

Recent news reports (here, here and here) have highlighted a shareholder proposal that has been initiated in preparation for the annual general meeting of Alembic Limited to be held on 28 July 2017. The shareholder in question is Unifi Capital Private Limited who is said (though not verified) to be holding 3% shares in Alembic. The proposal involves the election of a “small shareholder” director for which Unifi Capital put forward the name of Mr. Murali Rajagopalachari. Although the company has since withdrawn the item from the agenda for the shareholders meeting, the developments have raised the possibility that activist investors could potentially use the “small shareholder director” route in order to get their voice heard by resistant boards. Proxy advisory firm IiAS has a detailed memo on the impact this episode will have on shareholder activism. In this post, I outline some of the issues pertaining to the “small shareholder director” and conclude that its utility is likely to be limited, if at all, as a tool of shareholder activism.

Background and Purpose

The concept of a “constituency director” is not novel, either in India or elsewhere. Such a director’s election is attributable to a predefined constituency. A nominee director (proposed by a controlling shareholder or private equity investor) is a paradigmatic instance of a constituency director. Similarly, in the Indian context, directors nominated by banks through powers set forth in specific banking legislation are another example. However, the idea of small shareholders as a distinct constituency electing directors is not common around the world, and India appears to be an honourable exception in providing for a director to be elected by small shareholders.

To be sure, the concept of small shareholder director existed even under the Companies Act, 1956, although it was introduced into the legislation by way of an amendment in the year 2000. It is presently contained in section 151 of the Companies Act, 2013 (the “Act”). The idea seems to be premised on the need to provide representation and a voice to the small shareholders who are otherwise passive and apathetic. While it has been on the statute book for a decade and a half, it has hardly been used. Given that its potential use as a tool for shareholder activism has been highlighted, it is useful to consider some of the other features and issues surrounding the concept.

Election of a Small Shareholder Director

The bar for the election of a small shareholder director has been set quite high. Rule 7 of the Companies (Appointment and Qualification) of Directors Rules, 2014 (the “Rules”) provides that the lower of 1,000 shareholders or one-tenth of the total number of shareholders of a listed company may propose the election of a director. Alternatively, a listed company may, of its own accord, opt to have the small shareholders elect a director. The Companies Act, 2013 in section 151 defines “small shareholders” as those holding shares of nominal value of not more than Rs. 20,000.

It would certainly be a tall order for an activist investor to garner the support of such a high number of small shareholders. It not surprising at all, therefore, to find that small shareholdings could be “created”, as reported in the Alembic case. This can be done by orchestrating sales of shares to several small shareholders so as to generate the constituency required for the election of such a director. While it is not clear as to who has been behind the process of disaggregating the shareholding of the company, both an activist investor as well as incumbent management (or promoter) may indulge in the process, which will lead to an all-out proxy war. Whether the artificial creation of such constituencies in the run up to the election of a small shareholder director is legally permissible is an interesting question. On the one hand, it may be argued that there is nothing illegal about such disaggregation of shareholdings, as long as the sales and purchases of shares are otherwise legitimately carried out. But, on the other, the question arises as to whether this amounts to vote manipulation. A similar effort in Hong Kong in the context of a scheme of arrangement was clamped down by a court in the case of Re PCCW Limited ([2009] HKCU 720). But, the exercise of powers under section 151 neither involve court approval nor are they through a scheme of arrangement, thereby creating a legal vacuum regarding the legitimacy of such an approach.

In any event, such directors are to be elected by way of a majority of small shareholders, with no other shareholders eligible to vote for the purpose. Moreover, such election ought to be conducted through a postal ballot.

Qualification of a Small Shareholder Director

The Rules provide that the person proposed as a small shareholder director must satisfy all the requirements for appointment as a director, and ought not to be disqualified under section 164 of the Act. Moreover, the small shareholder director may be considered an independent director if the requirements under section 149(6) and (7) are satisfied. This issue may come to the forefront in case of the appointment of a person who is put up by a significant shareholder such as an activist investor (as experienced in the Alembic case). Questions could arise whether the board could have the discretion to determine the suitability of the person for appointment as a director even if she otherwise satisfies the qualification criteria. At one level, if the election by the constituency of small shareholders is to act as an investor protection mechanism, the board must be left with a fait accompli once a person is elected to the board by the small shareholders. On the other hand, section 178 of the Act provides for a broader role for the Nomination and Remuneration Committee regarding the composition of the board as a whole, and as to the qualifications and competencies of individual directors. The topical question would be whether the Nomination and Remuneration Committee can exercise power under section 178 to determine the suitability of a person proposed to be a small shareholder director. Arguably, this will come within the ambit of the Committee’s roles and responsibilities, although how this will interact with the minority’s choice of director to represent their interests is unclear. Only a test case will determine how a conflict (or an apparent one) between the appointment of a small shareholder director (under section 151) can be reconciled with the terms of reference of the Nomination and Remuneration Committee to shape the composition of the board (under section 178).

These issues are not merely within the hypothetical realm. Take a case where a company has just the minimum number of independent directors as required by the Act. If a person proposed by the small shareholders for appointment under section 151 does not satisfy the “independence” requirements, her appointment to the board will bring the number of independent directors below the statutory minimum, thereby resulting in non-compliance. Can the board (or the Nomination and Remuneration Committee) in such circumstances refuse to facilitate the appointment of such a person as a small shareholder director? Alternatively, will it be under any form of compulsion to appointment the small shareholder director, and follow that up with the appointment of additional independent directors to bring about the requisite balance and to comply with the independence requirements? Companies that face activism through the small shareholder route will have to prepare for such scenarios.

Whose Interests to Serve?

Like the case of nominee directors, there could be considerable ambiguity if the small shareholder director is required to serve two masters, namely the company (as an entity) on the one hand and the small shareholders (collectively as the constituency) on the other. While the Act makes provision for the election of the small shareholder director, it does not explicitly lay out the roles, responsibilities, duties and liabilities of such director. In that sense, the small shareholder director is no different from other directors, and will be foisted with the array of duties under company law as applicable to all directors. While there is some level of segmentation among the director body when it comes to appointments, which creates a specific mode of appointment for the small shareholder director, no distinction exists in relation to the roles and responsibilities. The small shareholder directors’ duties are like that of other directors. Hence, such a director, once appointed by the small shareholders, cannot simply advance the interests of her constituents at the cost of the broader interests of the company and other shareholders. Directors’ duties under Indian law (albeit under common law and not expressly in statute) are owed to the company and not to individual shareholders. Hence, while the small shareholders are entitled to appoint a director, ostensibly protect and advance their interests, in the end the director so appointed cannot prefer the interests of the constituents over and above the broader interests of the company. Individuals being proposed for election as small shareholder directors must be fully cognizant of the unenviable position they are likely to be placed in. Discharge of such a role will require a great deal of sophistication and experience.

Impact on Shareholder Activism

What motivated this post was the enthusiasm displayed by the media and commentators regarding the use of the small shareholder director provision in the Act to stimulate greater shareholder activism. The excitement surrounding the Alembic case is emblematic of the euphoria, even though in that case the proposal itself may not be put to vote at the shareholders’ meeting. Given that the Indian company legislation is somewhat rare in providing for small shareholder directors, the possibility of its use as a tool of shareholder activism cannot be ruled out. At the same time, there are considerable limitations with its design and operation.

At the outset, as discussed earlier, the bar has been set too high for the proposal and election of small shareholder directors. Several aspects of the appointment and role of such director suffer from considerable ambiguity. Even assuming an appointment is successful in a given case, the small shareholder director is only one among several directors, and cannot affect the outcome of a board decision. Such director can be privy to information placed before the board, and can express views and opinions and seek to convince other directors on matters being discussed, but would not be in a position to veto any decision. To that extent, the utility of such a position is to make the voice of various stakeholders (including the electorate consisting of small shareholders) heard and to infuse a higher level of transparency in board decision-making.

More importantly, while the small shareholder director is an important tool for the protection of “small” shareholders, necessary care and caution must be exercised to ensure that the position is not used by one or more large institutional investors who have an axe to grind with the management or promoters. Without appropriate checks and balances, the small shareholders may end up acting as pawns in larger corporate battles amongst groups of influential shareholders (such as a large institutional investor and the promoters). This will end up compromising the interest of passive retail shareholders rather than protecting them, which was the reason for the small shareholder director in the first place.

Insolvency & Bankruptcy Code: Arbitral Proceedings and Bona Fide Dispute

[Guest post by Puneet Dinesh, is a IV year student at the National Law University, Delhi. He can be reached at puneetdin@gmail.com.]

The Insolvency and Bankruptcy Code, 2016 (the ‘Code’) has given rise to some interesting legal questions. As previously discussed on this Blog (here and here), the interpretation of the term ‘dispute’ under section 5(6) of the Code has arisen multiple times before the National Company Law Tribunal (‘NCLT’). In this post, I intend to cover the aspect concerning a dispute raised by way of an arbitral proceeding.

The scheme of an insolvency proceeding under the Code initiated by an operational creditors run as follows. The operational creditor, upon the occurrence of a default, delivers a notice to the corporate debtor under section 8 of the Code. A period of ten days is provided for the debtor to respond to the notice proving the existence of a ‘dispute’. In this regard, section 5(6) defines the meaning of the term ‘dispute’:

"dispute" includes a suit or arbitration proceedings relating to—

(a) the existence of the amount of debt;

(b) the quality of goods or service; or

(c) the breach of a representation or warranty;

The existence of an arbitral proceeding is sufficient to stall the entire proceedings under the Code. In order to determine whether an arbitral proceeding exists or not, it would be necessary to refer to the Arbitration and Conciliation Act, 1996 (the ‘Arbitration Act’). Section 21 of Arbitration Act provides that ‘the arbitral proceedings ...commence on the date on which a request for that dispute to be referred to arbitration is received by the respondent’. Further, section 3(2) of the Arbitration Act provides that ‘the communication is deemed to have been received on the day it is so delivered’. Reading sections 21 and 3(2) in conjunction, an arbitral proceeding is commenced the moment the debtor sends a written communication requesting the reference to arbitration, which is received by the creditor. Therefore, all that a corporate debtor needs to do to stall the proceedings under the Code is to merely send an email requesting for arbitration, and any efforts of the creditor to resort to protection under the Code is instantaneously stalled.

The interesting question that emerges here is to ascertain if the NCLT can scrutinize any abuse of process by the debtor in seeking to stall insolvency proceedings. Section 9(5) of the Code confers power on the NCLT to admit or reject the application by the operational creditor on listed grounds. Section 9(5) as it stands is extremely formalistic and provides limited flexibility for the NCLT to adjudicate.

In these circumstances, it would be useful to analyse analogous situations in other legislation where courts or other adjudicating authorities have had to ascertain the existence of a dispute, and standards they have employed to determine whether such dispute was bona fide. Indian courts have faced similar questions under the Arbitration Act. Section 8 of the unamended Arbitration Act, which provided for reference of disputes to arbitration was extremely formalistic requiring the courts to refer the matter, except when formal conditions provided in the Act were not met. The parallel between these two provisions has not gone unnoticed before the tribunal. The National Company Law Appellate Tribunal (‘NCLAT’) in Kirusa Software Pvt. Ltd. recently observed:

It may be helpful to interpret Sections 8 and 9 and the jurisdiction of the Adjudicating Authority being akin to that of a judicial authority under Section 8 of the Arbitration & Conciliation Act, 1996 amended up to date, which mandates that the judicial authority must refer the parties to arbitration.

Section 8: Dispute and its bona fide nature

Section 8 of the Arbitration Act, as interpreted through landmark decisions such as P. Anand Gajapathi Raju and Pinkcity Midway Petroleums have consistently guarded against judicial interference at the reference stage. However, in a recent decision the Delhi High Court in M/S Fenner (India) Ltd. vs M/S Brahmaputra Valley ventured into finding whether there was a valid ‘dispute’ in the first place. While it is arguable whether an adjudication of the existence of the dispute (and the extent thereof) is permitted under section 8, the decision also makes observations to the effect that a dispute must be a bona fide dispute in the first place. In making reference to several provisions of Code of Civil Procedure, 1908 (‘CPC, 1908’) the court made some important observations with regard to the dispute being one with bona fide motive. While the NCLT is not bound by the procedure laid down by CPC, 1908, section 424 (2) of the Companies Act, 2013 vests the tribunal with the same powers of a civil court. Although the nature of section 8 of the Arbitration Act and section 9(5) of the Code are vastly different in their subject-matter, it is useful to bear in mind that the court under section 8 with similar formalistic powers as section 9(5) attempts to navigate through the ‘intention’ of the dispute raised.

Section 9 of Arbitration Act: Commencement of Arbitration

As previously noted, an insolvency proceeding under the Code can be brought to a complete halt by the debtor by merely sending a notice of arbitration. In theory, it is possible that the debtor does not intend to participate in the arbitration proceeding and exercises this option as a dilatory tactic. Can the tribunal examine whether the debtor truly intends to commence arbitration?

In this regard, useful parallels can be drawn from the jurisprudence under section 9 of the Arbitration Act. Section 9 empowers the court to grant interim relief ‘before or during’ the arbitral proceedings. The looming concern was that parties may attempt to seek interim relief even before the commencement of an arbitral proceeding without intending to commence arbitration in the first place! Sundaram Finance (1999) caught on to this mischief early on and held that the parties must show a manifest intention to arbitrate while seeking a relief through section 9 of the Act. Later, the Supreme Court in Firm Ashok Traders (2004) extended Sundaram Finance’s logic to hold that ‘....the Court may also while passing an order under Section 9 put the party on terms and may recall the order if the party commits breach of the terms’. Even apart from section 9, nothing in the Arbitration Act confers such a power on the court. All this was read into section 9, given the ‘… scheme in which Section 9 is placed’. While both these cases serve as classic examples of judicial legislation, in the current analysis, it serves as suitable examples regarding the implicit powers the court has exercised to verify the bona fide conduct of the parties in the proceeding.

Winding up of Company: IBA Health on Bona Fide Nature of Dispute

The courts interpretation under winding up cases also provides some guidance in this regard. While the Companies Act, provided for winding up ‘if the company is unable to pay its debts’, the court in IBA Health v. Info-Drive Systems (previously covered here) held that if there is a bona fide dispute regarding the debt, the creditor cannot file a winding up petition. This is one more instance, wherein the court implicitly read in the bona fide nature of the dispute to check if the parties engage in abuse of process. This post highlights that through multiple instances, the court implicitly required the parties to engage in good faith without a specific legislative mandate. In Kirusa Software, NCLAT made a passing reference in this regard:

(Dispute) must be raised in a court of law or authority and proposed to be moved before the court of law or authority and not any got up or malafide dispute just to stall the insolvency resolution process.

It is hoped that the scheme of the Code which seeks to create a time bound insolvency resolution process is protected by developing internal mechanisms to check such abuse of process by corporate debtors. In the absence of clarity in the legislation, much will depend on the jurisprudence developed by the adjudicating authority, and the analogous circumstances discussed above will likely provide some guidance.

- Puneet Dinesh

Monday, July 24, 2017

Section 26 of the Arbitration and Conciliation (Amendment) Act 2015: A Case of Misinterpretation

[Guest post by Aishwarya Singh, IV Year B.A., LL.B. (Hons.), Jindal Global Law School]

A recent post on this Blog had discussed the conundrum surrounding the applicability of the Arbitration and Conciliation (Amendment) Act, 2015 (“Amendment Act”). The post discussed the conflicting judgements of High Courts regarding the applicability of the amendment to applications filed under section 34 of the Arbitration and Conciliation Act, 1996 (“1996 Act”) for setting aside the arbitral award, when the arbitral proceeding has been commenced before the Amendment Act came into force. The present post discusses the growing trend amongst High Courts to hold that the amendment will be applicable to section 34 proceedings, even if the related arbitral proceedings commenced before the Amendment Act came into place. This post argues that a substantive right accrues to a party to be governed by the pre-amendment regime when the arbitration proceedings have been commenced prior to the amendment. Such an accrued right cannot be taken away unless the legislature provides expressly in the Amendment Act pointing to the contrary.

The Madras High Court in New Tirupur Area Development v. Hindustan Construction Co. Ltd. and the Bombay High Court in Rendezvous Sports World v. BCCI and recently in Wind World Ltd v. Enercon Gmbh have held that the Amendment Act will be applicable to section 34 applications by virtue of section 26 of the Amendment Act, even when the arbitral proceedings have commenced prior to the amendment. Section 26 of the Amendment Act states:

Nothing contained in this Act shall apply to the arbitral proceedings commenced, in accordance with the provisions of section 21 of the principal Act, before the commencement of this Act unless the parties otherwise agree but this Act shall apply in relation to arbitral proceedings commenced on or after the date of commencement of this Act.

The High Courts in the abovementioned judgements have sought to divide section 26 in two parts, holding that “to the arbitral proceedings” has a different meaning to “in relation to arbitral proceedings”: thus, the phrase “in relation to arbitral proceedings” includes court proceedings, while the former is limited to only proceedings before the arbitral tribunal. Hence, the Amendment Act is prospectively applicable only with respect to the arbitral proceedings and the Amendment Act will be applicable to court proceedings such as section 34 applications.

The said distinction has led two major consequences, which are: (1) cases pending in the court prior to the date of Amendment Act will be governed by the amended provisions because of the limited interpretation of the term “to the arbitral proceedings” and (2) cases filed in the court following the amendment, which are connected to the arbitral proceedings that have commenced prior to the amendment will be governed by the amended provisions. As a consequence, now there is no distinction between the abovementioned categories of court proceedings which are connected to the arbitration proceedings that had commenced prior to the Amendment Act and the cases initiated in the court which are connected to the arbitral proceedings that have commenced or may commence after the Amendment Act.  

The distinction between the two phrases results from the reliance of the said High Courts on an earlier judgement of the Supreme Court in the case of Thyssen Stahlunion GmBH v. Steel Authority of India where the court was interpreting the phrase “in relation to arbitral proceedings” under section 85(2), the repeal clause of the 1996 Act. Section 85(2) also comprised two parts. But, in both parts, the expression used was “in relation to arbitral proceedings: so it was not confronted with the exact question facing the High Courts today under the Amendment Act. The Supreme Court held that the expression “in relation to arbitration proceedings” includes not only arbitral proceedings but also court proceedings relating to the arbitral proceedings. It is respectfully submitted that the said High Courts while adopting the conclusion of the Supreme Court regarding the interpretation of phrase “in relation to arbitral proceedings” have failed to take into consideration the reasoning of the court in arriving at the said interpretation. The Supreme Court was faced with the question of the applicability of the provisions of the Arbitration Act, 1940 (“1940 Act”) which had been repealed “in relation to arbitration proceedings” which had commenced prior to the enactment of the 1996 Act. The following conclusions of the court are relevant:

22. 1. The provisions of the old Act (Arbitration Act, 1940) shall apply in relation to arbitral proceedings which have commenced before the coming into force of the new Act (the Arbitration and Conciliation Act, 1996).

2. The phrase ―in relation to arbitral proceedings cannot be given a narrow meaning to mean only pendency of the arbitration proceedings before the arbitrator. It would cover not only proceedings pending before the arbitrator but would also cover the proceedings before the court and any proceedings which are required to be taken under the old Act. for the award becoming a decree under Section 17 thereof and also appeal arising thereunder.

5. Once the arbitral proceedings have commenced, it cannot be stated that the right to be governed by the old Act for enforcement of the award was an inchoate right. It was certainly a right accrued. It is not imperative that for right to accrue to have the award enforced under the old Act some legal proceedings for its enforcement must be pending under that Act at the time the new Act came into force.

6. If a narrow meaning of the phrase ―in relation to arbitral proceedings is to be accepted, it is likely to create a great deal of confusion with regard to the matters where award is made under the old Act. Provisions for the conduct of arbitral proceedings are vastly different in both the old and the new Act. Challenge of award can be with reference to the conduct of arbitral proceedings. An interpretation which leads to unjust and inconvenient results cannot be accepted.”

The court further observed:

28. Section 85(2)(a) is the saving clause. It exempts the old Act from complete obliteration so far as pending arbitration proceedings are concerned. That would include saving of whole of the old Act up till the time of the enforcement of the award. This (sic Thus) Section 85(2)(a) prevents the accrued right under the old Act from being affected. Saving provision preserves the existing right accrued under the old Act. There is a presumption that the legislature does not intend to limit or take away vested rights unless the language clearly points to the contrary. It is correct that the new Act is a remedial statute and, therefore, Section 85(2)(a) calls for a strict construction, it being a repealing provision. But then as stated above where one interpretation would produce an unjust or an inconvenient result and another would not have those effects, there is then also a presumption in favour of the latter.

The Supreme Court chose to provide an expansive interpretation to phrase “in relation to the arbitral proceeding” holding that court proceedings in relation to arbitral proceedings under the 1940 Act cannot be governed by the 1996 Act because: (1) a right accrues to the party to have all the aspects of enforceability of award (including appeal) to be governed by the 1940 Act when the arbitral proceedings are commenced under the 1940 Act; and (2) the court also stated that an interpretation that the court proceeding in relation to arbitral proceedings commenced under the 1940 Act will be governed by the 1996 Act would lead to confusion and hardship as there is a significant difference in both the Acts, the changes brought about by the 1996 Act may not have been in contemplation of the parties when they entered into the arbitration agreement. The same situation will occur if the Amendment Act is to be applied to court proceedings, when the arbitral proceedings were invoked before the Amendment Act came into place. The Amendment Act changes the parameters of setting aside the arbitral award under section 34 and staying the execution of the same under section 36, and hence it substantively affects the accrued right of the parties.

In the judgement of Ardee Infrastructure Pvt. Ltd. v. Ms. Anuradha Bhatia & Ors., the Delhi High Court has accordingly held that that the amended provisions would not be applicable to ‘court proceedings’ related to arbitral proceedings commenced prior to the amendment, unless they were merely ‘procedural’ and did not affect any ‘accrued right. The amendments to sections 34 and 36 affect accrued rights of the parties. It is submitted that the interpretation adopted by the Delhi High Court is the correct interpretation and in line with the reasoning of the Supreme Court in Thyssen Stahlunion GmBH. It is superfluous to assume that by virtue of the usage of the phrase “in relation to arbitral proceedings”, the legislature intended to allow application of the Amendment Act to court proceedings, especially in the light of the precedent that a statute cannot take away a substantive right (which includes the right to appeal) except by an express provision or by necessary implication. The conundrum regarding the application of the Amendment Act may soon come to an end as the decision of the Bombay High Court in Rendezvous Sports World has been challenged and is pending adjudication in the Supreme Court.

- Aishwarya Singh

Friday, July 21, 2017

Holding Period and Corporate Veil in a Takeover Offer

[Guest post by Vaneesa Agrawal, who is Partner, Suvan Law Advisors. She can be reached at info@suvanlaw.com.]

Last week Supreme Court of India issued a significant judgement in the matter of Laurel Energetics Pvt. Ltd. v. SEBI, Civil Appeal No. 5675 of 2017 on the issue of the interpretation of Regulation 10 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”).


Indiabulls Real Estate Ltd. (“IBREL”) is a listed company. Laurel Energetics Pvt. Ltd. (“Appellant”) is Wholly Owned Subsidiary of Nettle Construction Pvt. Ltd., which in turn is wholly owned by one Mr. Rajiv Rattan. Rattan India Infrastructure Ltd. is the target company (“Target Company”) in the present case.

In 2011, the board of directors of IBREL framed a demerger scheme by which the power business of the company was to be demerged and would vest in the Target Company. The aforesaid demerger was sanctioned by Delhi High Court and an Information Memorandum (IM) in terms of the listing agreement was filed by the Target Company, pursuant to which it was listed on BSE & NSE on 20 July 2012. The Appellant acquired 18% of the equity shareholding of the Target Company at a price of Rs. 6.30 per share sometime in July 2014. On 20 October 2015, Laurel and Arbutus Consultancy LLP along with various other entities, who were persons acting in concert (“PACs”), made a public announcement under Regulation 15(1) of Takeover Code, when an open offer was made for the acquisition of 35,93,90,094 equity shares of the Target Company from the equity shareholders of the Target Company at the price of Rs. 3.20 per share.

By a letter dated 04 December 2015, the Securities and Exchange Board of India (“SEBI”) observed that the exemption provisions contained in Regulation 10 would not apply to the 2014 acquisition, as a result of which the price of Rs. 3.20 per share was not accepted and the higher price of Rs.6.30 was stated to be the amount to be paid to the equity shareholders of the Target Company. By a letter dated 5 May 2016, containing SEBI's Order, SEBI stated:

It has been observed that the acquisitions made through inter se transfers amongst promoters on July 9, July 10, 2014 September 5, 2014, and October 20, 2014, were not exempted from open offer obligations. You are advised to revise the Offer Price accordingly. Further, along with the consideration amount, you are advised to pay a simple interest of 10% per annum from the scheduled date of payment of consideration based on these triggering dates to the actual date of payment of consideration to the shareholders who were holding shares in the Target Company on the date of violation and whose shares are accepted in the Open Offer, after adjustment of dividend paid, if any. You are also advised to enhance the financial arrangements and the amount maintained in the escrow account in terms of the revised Offer Price and the revised Offer Size, if any.

An appeal against the SEBI communication was dismissed by Securities Appellate Tribunal (“SAT”) holding that Regulation 10 did not exempt the acquisitions of 2014, as a result of which the price payable per share necessarily became Rs. 6.30 instead of Rs. 3.20 per share. SAT’s order has been analyzed on this Blog here.

Appellant’s Threefold Arguments

1.     Object of the Regulation: Regulation 10 must be construed taking into account its object. When this is done, it is clear that the promoters of IBREL were the same right from the date of its incorporation, and  they continued as such even after the demerger into the present Target Company. The Regulation should be read in accordance with the object sought to be achieved, which is that where there is stability in the company and the promoters in that company do not change for a period of three years or more, inter se transfers between them at prices agreed to between them should be exempt from the Takeover Code. At no point of time have the promoters of the power business of IBREL and now of Target Company ever changed. Therefore, the object of the regulation is that promoters should not keep changing, and if on facts it is found that the same set of promoters continue, such cases should be exempted.

2.   Committee Reports: The Appellant sought to reply upon Reports of Achuthan Committee and Bhagwati Committee to show that the object of Regulation 10 is not to penalize persons who had remained in control of a particular business entity, notwithstanding that it may ultimately change form. Had no demerger taken place, it would be clear that the promoters of IBREL, having been promoters for over three years, would be exempt from the Takeover Code, in which case the 2014 purchases could not be taken into account for the purpose of the present open offer.

3.        Supreme Court Precedents: Various judgments hold that a mere change in form from a partnership firm into a limited company would not necessarily lead to the conclusion that, under various State Rent Acts, a sub-tenancy had taken place. These judgments would apply on the facts of the present case in as much as, at no point of time, have the promoters of the power business of IBREL and now of Rajiv Rattan ever changed.

SEBI’s Arguments:

1.     A well-reasoned SAT judgment ought not to be interfered with unless found to be perverse under 15-Z of the SEBI Act.

2.     It is not possible to go to the object of a provision when the language of the said provision admits of no doubt.

Applicable Provisions of the Takeover Code


2(z) “target company” means a company and includes a body corporate or corporation established under a Central legislation, State legislation or Provincial legislation for the time being in force, whose shares are listed on a stock exchange;”

General exemptions.

10. (1) The following acquisitions shall be exempt from the obligation to make an open offer under regulation 3 and regulation 4 subject to fulfilment of the conditions stipulated therefor,—

(a) acquisition pursuant to inter se transfer of shares amongst qualifying persons, being,—

(i)    immediate relatives;

(ii)  persons named as promoters in the shareholding pattern filed by the target company in terms of the listing agreement or these regulations for not less than three years prior to the proposed acquisition;

Judgement & Analysis

The Supreme Court dismissed the appeal while upholding the SEBI and SAT orders, providing three-fold reasons:

Lifting of Corporate Veil Not Envisaged

1.        The target company is clearly defined and “means” only Rattan Limited. To go behind Rattan Limited would not only be contrary to the clear language of Regulation 10(1)(a) but would also introduce a concept, namely lifting the corporate veil by the Court, contrary to the Regulation 10(1)(a) itself. Regulation 10 also contains sub-regulation (iii) which, in the circumstances specified, lifts the corporate veil. Sub-regulation (iii) is set out hereinunder:

(iii) a company, its subsidiaries, its holding company, other subsidiaries of such holding company, persons holding not less than fifty per cent of the equity shares of such company, other companies in which such persons hold not less than fifty per cent of the equity shares, and their subsidiaries subject to control over such qualifying persons being exclusively held by the same persons;

A reading of this sub-regulation would show that holding companies and their subsidiaries are treated as one group, subject to control over such companies being exclusively held by the same persons. This shows that it has been statutorily recognized in sub regulation (iii) that in a given situation, namely holding-subsidiary relationship, the corporate veil would be lifted. Moving on to sub-regulations (iv) and (v), it is clear that these two sub-regulations follow the pattern contained in sub regulation (ii) in as much as when it comes to PACs, the period should be not less than three years prior to the proposed acquisition, and disclosed as such pursuant to filings under the listing agreement. Also, when it comes to shareholders of a target company who have been PACs for a period of not less than three years prior to the proposed acquisition and are disclosed as such pursuant to filings under the listing agreement, the corporate veil is not lifted. The difference between sub-regulations (ii), (iv) and (v) on the one hand, and sub regulation (iii) on the other, again shows us that it is impermissible for the court to lift the corporate veil, either partially or otherwise, in a manner that would distort the plain language of the regulation. Where the corporate veil is to be lifted, the regulation itself specifically so states.

Even on Facts 3-year Holding Period Not Complete

2.       Coming back to Regulation 10, it is thus clear that persons named as promoters in the shareholding pattern filed by the Rattan Company in terms of the listing agreement between the two stock exchanges is what is to be looked at. And for this purpose, persons must be promoters of the Rattan Company for not less than three years prior to the proposed acquisition in order that the exemption under Regulation 10 would apply. On the facts of this case, therefore, the information memorandum having been filed on 19 July 2012 pursuant to which listing took place one day later, is the relevant date from which this period is computed. This being the case, three years had not elapsed on 9/10 July 2014, which was the date on which the earlier purchase of shares had taken place.

Precedents Distinguishable

3.     The cited judgements do not advance the Appellant’s case in as much as it is not possible to construe the regulation in the light of its object when the words used are clear. This statement of the law is of course with the well-known caveat that the object of a provision can certainly be used as an extrinsic aid to the interpretation of statutes and subordinate legislation where there is ambiguity in the words used. According to Supreme Court, the literal language of the regulation clear and beyond any doubt. The language of sub-regulation (ii) becomes even clearer when it is contrasted with the language of sub-regulation (iii).

This is a significant judgement from Supreme Court on the relevance of the three-year holding period especially in cases of indirect listing under the process of a corporate restructuring and lifting of corporate veil for the purposes of mandatory takeover offer. Unfortunately, Supreme Court did not delve into an aspect of SAT Order whereby SEBI disowned the view under an Informal Guidance taken by an official of SEBI saying it as “a mistake made by an officer”. The Supreme Court, in my respectful submission, also lost an opportunity to describe the legal status of informal guidance issued by a department of SEBI and to set right the frequent differing views adopted under the Informal Guidance Scheme, creating more confusion than guidance.

- Vaneesa Agrawal