Indian 'Treasury Stock'

Published on Sat, Oct 25 17:09, Updated at Mon, Oct 27 at 16:18

Source: CNBC-TV18
Well let's move on to the next story - which came to us 2 weeks ago, when we were discussing
Reliance's decision to reclassify some treasury stock, from the promoter and persons acting in
concert category to the public category. That transaction is still an enigma, but then so is the
concept of treasury stock in India. Reliance has it, M&M has it, and ICICI bank had it and now so
does the King of Good Times. Yet legally, treasury stock is not allowed here.

What is treasury stock? It's a company owning it's own stock - either by way of a merger or a
buyback. The company can reissue the stock on a future date. But in India as per company law, a
company or its subsidiaries cannot hold it's own shares. So how come all these Indian companies
have treasury stock? Isha Dalal travels back in time to understand how India’s own home grown
version of treasury stock came to be.

Delhi High Court, 1996

Shardul Shroff, partner in India’s leading law firm Amarchand Mangaldas was on the verge of
making corporate history.

Client, telecom Solutions Company Himachal Futuristic or HFCL had merged with Himachal
Telematics through a court approved merger scheme
But what the court approved, the Department of Company Affairs did not!
Post merger, HFCL wound up in possession of a subsidiary that held HFCL shares. That was a
violation of Section 42 of the Companies Act, and DCA was crying foul. But HFCL’s lawyers had
a case to make.

Shardul Shroff, Partner, Amarchand Mangaldas

Suppose you have purchased shares in the market or purchased it in a bid, the cost of acquisition
gets frozen in your schedule of investments. But the market cap or market value may be higher. If
those shares were put to sale, the shareholders will benefit. And that is the logic that courts
accept by asking a company to create an independent trust for the purposes of holding those
shares temporarily and liquidating them over time so realization value is accruing to benefit of
shareholders

And that's how the desi version of 'treasury stock' was born. In the last 10 years there have been
2 formats of holding this treasury stock that have been legitimised. Each with an accompany set
of rules on how the stock is held, how it's classified, how it votes and when it's sold.

Type 1, is the HFCL type

Wherein HFCL's subsidiary Trade Invest ended up with 30 lakh shares of HFCL because of the
merger. As per court directions Trade Invest then became trustee of those shares for the benefit
of HFCL shareholders. The shares had to be held for 8 years , after which they could be sold and
the proceeds shared by HFCL's shareholders. And while they shares were held in trust, they had
no voting power.

Shardul Shroff, Partner, Amarchand Mangaldas

They suspend the right to vote because of the bar in law that you cannot use a subsidiary’s rights
in a holding company and vote on them. Because you are in control of that subsidiary. So you are
voting as a company on your own shares. And that is not permissible
Type 2 is the ICICI Bank case. In 2002 when ICICI merged with it's subsidiary ICICI Bank, the
merged entity ended up with its own stock. Almost 16% of it. All held by a Trust, specially created
for the purpose. Because of the ownership separation, these shares retained their full voting
rights

Amrish Shah, Executive Director, PwC

These shares have full voting rights, full dividends, right to participate in meetings. Treated like a
normal shares. Because in India these are not held by the company- so like any other registered
shareholder

But Type 2 comes with a twist. Is the Trust's shareholding classified as 'public' or 'promoter &
persons acting in concert'.
That depends on who controls the trust ? For instance in the case of the United Spirits - Shaw
Wallace merger of 2006. A USL Benefit Trust was created to hold 2.28% of United Spirits stock.
The trust was run independently, that is it could vote as it pleased in shareholder meetings.
Which is why it was classified as public shareholding and not promoter and persons acting in
concert.

Shardul Shroff, Partner, Amarchand Mangaldas

if you’re an independent trustee, then you’re not dependent upon or acting in concert unless the
trust itself embeds a principal that you’ll vote with us or vote with the promoters or vote in
accordance with decision of the board. That would normally not be put because people don’t want
insider angle to come into play

Yet that does exist for some companies - such as Reliance, where the Petroleum Trust holds a
7.2% stake in Reliance. The trust was created when Reliance Petroleum merged into it's parent
company Reliance. And the trustees of Reliance have an agreement to vote along with the
promoter group. Which is why the Trust is classified under the 'Promoter and persons acting in
concert' category

Lawyers say in the spirit of corporate governance it's best to have an independent trust. But that's
just about which way the trust votes. What about how long it lives? Well trusts cannot go on
indefinitely and the so called ‘treasury stock’ too can be held only for a defined period.

Amrish Shah, Executive Director, PwC

it needs to be a definite period you cant have an undefined term for a trust under the Indian trust
act. They generally keep a reasonable period of 3-5 years

Ajay Bahl, Partner, AZB & Partner

It is at the end of the day a mandate given to trustees as to how they must operate. If the deed
say that all stock must be sold in seven years and proceeds distributed, so be it. If it provides that
income must accrue and be distributed periodically that would be the case

Eventually shareholders stand to gain more from the sale of treasury stock over a period of time
than it's extinguishment at the time of merger. For companies too, this can come in
handy...especially in tough times like these...when any other kind of share sale is difficult.

Amrish Shah, Executive Director, PwC

if they have a stock in a trust, it is freely priced. In a preferential allotment you have to follow at
least the 2 weeks or 26 weeks average price. And in today’s market if I have to follow a 26 week
average, I might not be able to get anyone to put in the funds. Because even 26 weeks is too
high. But I might be able to use the stock.
Use the stock to realize a higher value for the company's shareholders. And that's the only reason why the Delhi
High Court allowed for this desi version of treasury stock to be created in 1996. In Mumbai Isha Dalal.