M&A Takeover Code

Acquisitions have gained momentum in the Indian markets recently, though the
acquisitions had been a part, however miniscule, of the Indian markets since 1980s. In
1980s, there was a Listing Agreement, which set the guidelines for the regulation of
acquisition. The first legal framework was set up in 1992 in the form of SEBI Act.
The Act wanted SEBI to regulate the takeovers and acquisitions in a suitable manner
and SEBI responded to the same by enacting the Takeover Regulations in 1994.

In less than a year’s time, SEBI set up a committee headed by Justice P. N. Bhagwati,
(Bhagwati Committee), which submitted its report on the amendments to be made to
the 1994 regulations in the form of Takeover Regulations, 1997. In all the takeover
regulations had been amended 23 times by the time the report for the new regulations
was submitted.

The underlying need for the new set was regulations were the recent increase in
corporate restructuring in India. The present committee was set up based on the SEBI
order dated September 4, 2009 and was headed by Mr. C. Achuthan.

It had been historically seen that even though takeovers and acquisitions impacts a
host of stakeholders in the company, there was a lack of unambiguous and clear rules.
This led to conflict of interests amongst the various stakeholders and it was also
observed that the public shareholders were the largest victim of this ambiguity. The
new regulations intend to set this straight and balance the regulations. The
fundamental objectives as outlined by the committee are summed as:

a) Protect the interest of investors in securities and the securities market

b) Balance the conflicting objectives and interests of the various stakeholders
c) Provide parity to each shareholder to exit the investment on terms not inferior
to those which are applicable for the substantial shareholders
d) Provide a transparent legal framework
e) To continue the normal course of business of the target company to prevent
any adverse effect on the share prices or other financial parameters
f) Ensure the fair and accurate sharing of al material information
g) To regulate and provide for a fair competition in acquisition of the target
company
h) To remove the sporadic players who do not have the means of acquiring a
company to enter into the competition and influence the bidding process by
any means

Salient features of the proposed takeover code

Open offer obligations

Initial trigger

Any acquirer cannot by any means acquire more than 25% of the shares and thereby
the voting rights, if it has not made an open offer. In other words, any acquirer
looking to acquire more than 25% voting rights would have to make an open offer to
all the shareholders.

This step would be beneficial for the minority or public shareholders as they would
now get a fair chance to exit their investment at the conditions at least equivalent to
that the of the substantial shareholders. This would also allow the institutional
investors to increase their holding from the present 15% to 25% without running the
risk of making an open offer. This would bring the required capital and as institutional
investors do not easily shift their money out of an investment, this rule might be good
for the companies.

Another collateral benefit will be for the financial and strategic investors who can
invest in companies to provide capital, technology and know-how for growth and
value creation without affecting the control of the company. It is obviously important
for the incumbent shareholders of the company to ensure such investors do not have
shadow control on the company at the expense of the other shareholders.

This rule can have counter-effects as well. For instance, majority of the changes
brought about in a company requires the support of 75% of the shareholders and with
a single acquirer holding being 24.99% without having to make an open offer,
suitable changes might be seriously compromised.

Creeping Acquisition Trigger

Any acquirer holding 25% or more of the voting rights can increase its rights up to
5% in any financial year, without making an open offer. Here again, the acquirer is
not allowed to increase its shareholding to be more than the maximum permissible
non-public shareholding limit.

The regulation includes clauses to prevent increasing the percentage of voting rights
by means of either dilution of shares or issuance of more shares (issued to self).

This would protect the shareholders’ interests and prevent the acquiring company to
restructure the target company for its benefit, neglecting the other stakeholders. This
would also be a deterrent to the acquiring companies who generally look towards
reforming the company post-acquisition.

In all, this would help the cause of strategic acquisitions and bring operational
efficiency in the target company, preventing the resting of complete powers in the
hands of the acquirer. This rule can also act as a signal as the acquiring company has
to make the acquisition slowly thereby allowing the analysis of the shareholding
pattern. This would also encourage the acquirers to create more value for the
shareholders, though implicitly it would surely increase their costs.

Control Trigger

Regardless of the level of shareholding and acquisition of shares, the acquiring of

control over the target company would necessitate the open offer from the acquirer.
This step would be beneficial for the minority or public shareholders as they would
now get a fair chance to exit their investment at the conditions at least equivalent to
that the of the substantial shareholders.

Indirect Acquisitions

The acquisition of the shares or voting rights which would allow the acquirer to
exercise control over the wholly or partially owned company of the target company
would be considered as an indirect acquisition. This means that for instance if
company A has a controlling voting right over company B and company C acquires
the voting rights in company A, then it automatically would get the voting rights of
those of company B, and would be considered as an indirect acquisition.

There are provisions whereby based upon the conditions as outlined below, the
acquisition can be treated as a direct acquisition (company C has directly acquired
company B):

In case of the following:

 the proportionate net asset value of the target company as a percentage of the
consolidated net asset value of the entity or business being acquired; or
 the proportionate sales turnover of the target company as a percentage of the
consolidated sales turnover of the entity or business being acquired; or
 the proportionate market capitalisation of the target company as a percentage
of the enterprise value of the entity or business being acquired;

being more than 80% on the basis of the most recent audited financial statements, the
acquisition would be treated as a direct acquisition.

For the purpose of calculating the market capitalisation of the target company the
volume-weighted average market price of such shares on the stock exchange for a
period of sixty trading days preceding the earlier of, the date on which the primary
acquisition is contracted, and the date on which the intention or the decision to make
the primary acquisition is announced in the public domain, as traded on the stock
exchange where the maximum volume of trading in the shares of the target company
are recorded during such period, shall be used.

A lot of acquisitions used to be conducted in the name of acquisition of some sort of

business, whereas the underlying motive was to control companies like B as explained
above. This regulation would make it necessary for the acquiring companies to look
into the interests of the stakeholders. Again as in a direct acquisition, the acquirer has
to make an open offer which can be costly, thereby deterring them from acquisition.

Voluntary Open Offer

Shareholders holding 25% or more of voting rights have the right to make an open
offer to acquire more shares (and thus voting rights), up to the minimum public
shareholding limit. Conditions have been set here to safeguard the interests of the
various shareholders:
If the acquirer or any person acting in concert with it, has in the preceding 52 weeks
acquired shares of the target company, without reaching the limit of making an open
offer, cannot exercise the right to make the open offer presently

During the open offer period the acquirer cannot acquire shares by any other means.
Again any related person, who has acquired shares exercising this clause, cannot
acquire further shares for a period of six months from the completion date, without
making a further open offer. Here the acquirer has the right to acquire shares (making
a competing offer) if any other person has made an open offer.

The regulation here gives the acquirer the liberty to increase its shareholding and at
the same time safeguard the stakeholders’ interests. It also allows them to compete in
case of similar steps being taken by other substantial stakeholders of the company.
This would bring in transparency in the system and allow the minority shareholders to
take a decision regarding their investment.

Offer Size

General Rule

The open offer as per the regulations would be for 100% of the outstanding shares as
of the last day of the tendering period, provided where the target company has issued
the depository receipts and the acquisition of only those shares can be done against
which the receipts have been issued by the target company.
This would be useful or the shareholders of the target company but could be a
deterrent for the acquiring company. The increased open offer size from 20% to 100%
would surely be an attractive clause for the private equity players and the foreign
capital. Though capital flow might increase, the cost for the acquiring company is
going to increase due to the additional cost of funding by private equity or other
players.

Exception for Voluntary Open Offer

A voluntary offer other than the 100% offer can be made, for at least 10% of the
representing shares, to the limit that the maximum non-public shareholding is not
exceeded. The conditions implied here are that in case a competing offer is made, post
the voluntary announcement, the latter has the right to increase the number of shares
to such levels as it doesn’t exceed the maximum non-pubic shareholding limit, within
the 15 days of the announcement of the competing offer. In case of increase in the
offer size the creeping acquisition trigger rules would be upheld.

The rules of no allowing an acquirer to acquire further shares if a portion has been
within the preceding 52 weeks as outlined above and the non-acquisition of shares by
means other than the open offer, are upheld here.

This would reduce the timing of declaration of the offers and also make the process
streamlined instead of being prolonged for a longer period of time. This would allow
the acquiring firms to focus on the project thereby reducing the operational costs
substantially. This would also prevent non-competent players from making offers and
extending the buffer period to make arrangements for the acquisition thereby not
allowing the presently capable acquirer to move ahead with the acquisition.

Public Shareholding

If an acquirer who is making an open offer but not under the creeping acquisition
trigger rules, would have the right to declare upfront at the time of the public
announcement of the open offer, the intention of delisting the target company, in case
the total shareholding of the acquirer exceeds the delisting threshold.

The condition here is that in case any shareholder doesn’t agree or accept the offer,
would have the right to make the acquirer to purchase the shares at the offer price at
any time within a period of 12 months from the 15th business day from the date on
which the shares are delisted from the stock exchanges.

For any convertible instruments held by anyone, in addition to the preceding

paragraph provisions, the holder may compel the acquirer in converting the
instrument into shares on an accelerated basis.

This gives more liberty to the shareholders and also the acquiring companies can be
sure of the price which needs to be paid in any time in future (with conditions).

If such an intention to delist is not stated upfront, or the response to the open offer is
such that the public shareholding could fall below the minimum level required under
the listing agreement but remains above the delisting threshold, the acquirer would be
required to either bring its holding down to ensure compliance by the target company
with the listing agreement, or proportionately reduce both its acquisitions under the
agreement that triggered the open offer and the acquisitions under the open offer. If
the open offer in question is a competing one, then the option of proportionate
reduction would not be available.

This would prevent the asymmetry of information amongst the various stakeholders
and prevent the acquirer to benefit from such events.

Exemption from Open Offer Obligations

Exemptions have been streamlined and classified on the basis of the specific charging
provision from which exemptions would be available, with conditions for eligibility
for such exemptions. Some of the areas where changes have been recommended
include increase in voting rights due to buy-back of shares, schemes of arrangement
that do not involve the target company, certain inter se transfers, corporate debt
restructuring and rights issues.

The summaries of the various conditions under which the open offer exemptions are
made are given as:
 a) Acquisitions which has taken place due to transfer of shares amongst
qualifying parties which would include immediate relatives, promoters for
more than 3 years in the target company, 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 holding
company, other holding 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 parties being exclusively held by the same persons, persons
acting as concerts for the acquirer for at least the last 3 years, shareholders
acting as concert in the target company for the last 3 years and any equity
share capital owned by them in the same proportions, where the concert and
other information has ben declared as under the rules of the Listing
Agreement.

There are conditions which have been set for the above to take place.

The acquisition price per share shall not be higher by more than twenty-five per cent
of the volume-weighted average market price for a period of sixty trading days
preceding the date of issuance of notice for the proposed inter se transfer as traded on
the stock exchange where the maximum volume of trading in the shares of the target
company are recorded during such period. Moreover the transferor and the transferee
should have complied with the applicable disclosure requirements as given in the
Listing Agreement.

b) Acquisitions which have been made under the normal course of business by an
underwriter using an underwriting arrangement as provided under the SEBI
Act, 1992; a stock broker registered with the Board on behalf of his client in
exercise of lien over the shares purchased on behalf of the client under the
bye-laws of the stock exchange where such stock broker is a member; a
merchant banker registered with the board or a nominated investor in the
process of market making or subscription to the undersubscribed portion of
issue; any person acquiring shares pursuant to a scheme of safety net; a
registered merchant banker acting as a stabilisation agent.

c) Acquisitions made by an acquirer who has made public announcements of an

open offer, provided the acquirer and the seller are same throughout the stages
of acquisition and that the full disclosures have been made in the public
announcement and in the letter of offer.

d) Acquisitions which are pursuant to a scheme, made under Sec 18 of SICA Act;
of arrangement involving the target company as a transferor company or as a
transferee company, or reconstruction of the target company, including
amalgamation, merger or demerger, pursuant to an order of a court or a
competent authority under any law or regulation, Indian or foreign; in cases of
target company not taken as given in the preceding point, provided the cash
and cash equivalents in the consideration paid are less than 25% of the total
consideration, and after implementation of the scheme at least 33% of the
voting rights in the target company are with the same persons as pre-scheme
implementation.
 e) Acquisition pertaining to the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002, or to the SEBI Act,
1992.

f) Acquisitions by way of transfer, succession or inheritance.

g) Acquisition of preferred stocks with voting rights as under the Companies Act,
1956.

The following conditions would allow the exemption from initial trigger and the
creeping acquisition trigger.

a) Acquisition of shares of a target company not involving a change of control

over target companies, pertaining to the corporate debt restructuring

b) Acquisition of shares in a target company in the ordinary course of business

by a consortium of scheduled commercial banks or public financial
institutions, pursuant to invocation of pledge or other security interests,
provided no member of the consortium acquires shares in excess of the
threshold of voting rights

c) Acquisition of shares in a target company in excess of the threshold of voting

rights, if there is a pledge to retransfer the shares to the pledger

d) If the voting rights amount has been reduced within 90 days of the acquisition

The following would allow exemptions from the creeping acquisition trigger:

a) acquisition of shares by any shareholder of a target company pursuant to a

rights issue provided the acquirer has not renounced any of the entitlements in
such rights issue, and the price at which the rights issue is made is not higher
than the ex-rights price of the shares of the target company

b) increase in voting rights in a target company of any shareholder pursuant to

buy-back of shares, provided, such shareholder has not voted in favour of the
resolution authorising the buyback of securities, in the case of a shareholder
resolution, voting shall be by way of postal ballot, where a resolution of
shareholders is not required for the buy-back, such shareholder, in his capacity
as a director, or any other interested director has not voted in favour of the
resolution, the increase in voting rights does not result in an acquisition of
control by such shareholder over the target company. In case these are not
met, the shareholder would need to reduce the holding to below the threshold
limits.

c) acquisition of shares in a target company by any person in exchange for shares

of another target company

d) acquisition of shares in a target company from state-level financial institutions

or their subsidiaries or companies promoted by them, by promoters of the
target company
 e) acquisition of shares in a target company from a venture capital fund or a
foreign venture capital investor registered with the Board by promoters of the
target company

As per the new regulations SEBI would continue to have the power to grant
exemption from making an open offer and would continue to have the power to give
relaxation from strict compliance with the procedural requirements along with making
the previously mandatory reference optional.

The Board may for reasons recorded in writing, grant exemption from the obligation
to make an open offer for acquiring shares under these regulations subject to such
conditions as the Board deems fit to impose in the interests of investors in securities
and the securities market provided that the target company board of directors has been
superseded by governmental authorities and the same provides a transparent process
of transfer of the company. Also the exemptions given by SEBI would be needed to
be published.

Offer Price

The minimum price has been fixed as the highest of the following:

 the negotiated price under the agreement that attracted the open offer;
 volume-weighted average price paid by the acquirer and persons acting in
concert in the preceding fifty-two weeks;
 highest price paid by the acquirer or persons acting in concert with him during
the preceding twenty-six weeks;
 sixty trading day volume weighted average market price (for frequently traded
shares)

To compute the offer price for indirect acquisitions, in addition to the above
parameters, any higher price paid during the period between contracting of the
primary transaction and the public announcement has also to be considered.

In case the offer price cannot be determined by the above factors the acquirer and the
manager of the open offer should fairly value the company using various parameters
likes book value, comparable trading multiples, and any other company specific
parameters. In case certain financial parameters of the target company, like
proportionate net asset value or sales turnover or market capitalisation exceeds 15%
value of the target entity or business, the price has to be computed by the acquirer and
the methodology for the same has to be made public.

In case of indirect acquisitions of the target company, the offer price would stand
increased at the rate of 10 % per annum calculated on a pro-rata basis for the period
from the date of the primary transaction being announced in the public domain until
the date of actual detailed public statement in respect of the target company. Such
revised offer price would be payable to all shareholders who tender their shares in the
open offer.
The control premium if any paid has to be included in the calculation for the total
price. If the dates on which the corporate actions like rights issue, bonus issue, stock
consolidation, stock splits, payment of dividends, de-mergers, or reduction of capital
fall prior to 3 days before the start of the tendering period, the price paid has to be
reduced or adjusted as required, provided that no adjustment shall be made for
dividend declared with a record date falling during such period except where the
dividend per share is more than fifty per cent higher than the average of the dividend
per share paid during the three financial years preceding the date of the public
announcement.

The addition of control premium into the price paid would allow the equal distribution
of the premium earned by the target company to all the shareholders.

The offer price for partly paid up shares shall be computed as the difference between
the offer price and the amount due towards calls-in-arrears with interest, if any,
thereon.

In cases of exchange rate being involved, the conversion would take place at the rate
which prevailed on the date of the public announcement of the offer.

Though there are doubts whether the Indian financing environment can cope with
such a requirement, this will lead to further development of capital markets in India
with new financing structures and instruments like acquisition-related equity raising,
issuance of convertible debt instruments, and will also promote the usage of other
non-cash considerations like exchange of equity.

Mode of payment

The offer price may be paid in the form of cash or securities like shares, convertibles,
secured debt instruments of the acquirer or of persons acting in concert with him or a
combination of these modes. To ensure that the equity shares given in consideration
for the open offer are liquid, eligibility conditions have been stipulated. However, if
shares of the target company carrying more than 10 % voting rights have been
acquired for cash in the preceding 52 weeks, shareholders to whom the open offer is
made may opt to receive the offer price only in cash.

The mode of payment of consideration may be altered in case of revision in offer

price subject to the condition that the component of the offer price to be paid in cash
prior to such revision is not reduced.

As the shareholders have been provided with options to accept payment in cash or by
way of securities, or a combination thereof, the pricing for the open offer may be
different for each option subject to compliance with minimum offer price
requirements provided, the detailed public statement and the letter of offer should
contain justification for such differential pricing. If the securities are being provided
as consideration, the value of the same should be taken as the volume-weighted
average market price for the period of sixty trading days.
The given parameters have removed a lot of ambiguity from the pricing of the
securities and that of the target company. It also provides ample regulations to
safeguard the interest of the shareholders and also prevents any sort of premium to be
received by the substantial shareholders.

Conditional Offers

An acquirer can make an open offer conditional as to the minimum acceptance level
and during the time of offer neither the acquirer nor any party acting on its behalf can
acquire any shares.

Competing Offers

An acquirer having made a voluntary offer is permitted to switch to a normal full-

sized offer when a competing offer is made. Within 21 business days from expiry of
the offer period, any competing acquirer would be free to negotiate and acquire the
shares tendered to the other competing acquirer, at the same price that was offered by
it to the public. However, the holding cannot increase beyond the maximum permitted
non-public shareholding.

Any acquirer needs to declare the intention of acquisition within 15 days of the public
announcement by the first who has declared and this competing offer would not be
regarded as a voluntary open offer under any circumstances.

Competing offers cannot be made in case the initial offer pertains to a case of
disinvestment, or the initial open offer has been relaxed by the SEBI under sub-
regulation (2) of regulation (11) of the takeover code.

All the activities and the timeline for all the competing offers (including the initial
offer) would be adjusted to the last date of tendering shares for the last competing
offer made.

Completion of the Transaction that Triggered the Open Offer

The acquirer cannot complete the acquisition of shares or voting rights, or take control
of the target company under any agreement attracting the obligation of making an
open offer until the expiry of the offer period. The agreement that attracts an open
offer obligation may be acted upon during the pendency of the open offer provided
100 % of the consideration payable under the open offer is placed in escrow account.

An agreement that triggered an open offer obligation would have to be completed

within twenty-six weeks after the offer period. In case this is not possible due to
certain reasons, the board can decide upon the amount of extension to be given to the
acquirer as they might deem fit in the interest of the shareholders and the securities
market.
Governance Issues

The board of directors of the target company would be required to conduct the
operations of the target company in the ordinary course and consistent with past
practice. Material transactions outside the ordinary course of business cannot be
undertaken during the offer period, either at the level of the target company or at the
level of any subsidiary of the target company without approval of shareholders of the
target company.

This would make the acquiring company to state its intention upfront as it would not
be allowed to sell off the assets which are kind of mandatory for the target company
to function. This would give proper and relevant information with regards to the
intention of the acquiring company and the probable future of the target company.

The target company cannot under the offer period conduct a buy-back of shares, or
bring any changes in the capital structure of the company. Neither may it enter into,
amend or terminate any material contract nor can it accelerate the rights of any related
party as against the normal course of business. The target company cannot also fix
any date for any corporate action from 3 days prior to the start of tendering period to
the end of it.

A committee of independent directors of the target company would be formed to

consider and give its reasoned recommendations on the open offer, which would be
published by the target company. The expenses for the external help if any taken
would be borne by the target company. The suggestions of the committee should be
published at least 2 days prior to the commencement of the tendering period.

This would surely allow more information to the shareholder but would be weakening
the already bleated set of steps which can be taken by the target company to prevent
its acquisition.

No appointment of representatives of the acquirer to the board of directors of the

target company would be permitted unless the acquirer places in escrow account
100% of the consideration under the open offer in cash. Such appointment may be
made only after the deadline for making competing offers expires. This provision
stands nullified in case the offer is subject to a minimum level of acceptance. In case
there is already a relevant member on board, the director in the target company cannot
take part in any discussion related to the acquisition.

These clauses remove to a higher degree the impact of asymmetric information and
also provides for a framework whereby the influencing factor predominant in
emerging countries is taken care of. Increasing the transparency this would not allow
the acquiring companies to influence the decision of the target companies.

Activities and Timelines in Open Offer Process

A normal open offer process would be completed within 57 Business Days from the
date of Public Announcement.
Day 00 - Open offer made
Day 05 - Detailed Public Statement
Day 10 - Draft Offer Letter to SEBI
Day 25 - Comments from SEBI on Draft Offer Letter
Day 32 - Identification of the Shareholders and Dispatch of Letters
Day 34 - Upward revision in offer
Day 35 - Comments by independent directors
Day 36 - Issue of advertisement announcing the schedule of activities for open offer
Day 37 - Date of Opening Offer
Day 47 - Date of Closure of Offer
Day 57 - Payment to Shareholders

The total number of days required for the acquisition process has been reduced
considerable from the present 95 days to 57 days. This would be an attractive factor
for the acquiring companies as longer periods of time increase the cost for them.

The regulations also provide the acquirer the right to declare the intention of selling
away the non-performing assets or those which won’t be useful post-acquisition. This
may allow them to raise the funds required to conduct the acquisition and also bring
operational efficiency.

The excerpts have been taken from the “Report of the Takeover Regulations Authority Committee”, dated July 19, 2010.
The author is a participant at Indian Institute of Managament, Indore

Contact: financeingeneral@gmail.com