A recent decision of the
Securities Appellate Tribunal (‘SAT’) has perhaps for the first time reversed a
SEBI Order refusing to grant an exemption from an open offer. Such exemption, as
will be explained later, is a discretionary one from the otherwise mandatory
open offer under the SEBI Takeover Regulations. This decision is in the case of
Dr. Arvindkumar B. Shah (HUF) v. SEBI, (2010) 104 SCL 559 (SAT-Mum.). To me, it
is also an important and perhaps controversial precedent of SAT deciding on the
merits of SEBI’s decision in such a case.
To briefly review the
relevant law and scheme of the Regulations as relevant to the present case, it
may be recollected that the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997 (‘the Regulations’) require an open offer to be
made by certain persons typically in certain cases of acquisition of shares of
listed companies. Such persons, generally stated, are required to offer to
acquire at least 20% of the shares held by the public. This is usually when they
make substantial acquisition of shares. This open offer is mandatory though
there are certain statutorily exempted acquisitions. However, between these two
extremes, a mechanism has been provided to grant discretionary exemption on a
case-to-case basis. The mechanism involves a Takeover Panel which is really an
independent committee that reviews each application and renders its
recommendation to SEBI. SEBI then considers the recommendation and then applies
its own discretion again and grants or rejects exemption (irrespective of the
recommendation).
In the light of this scheme
of Regulations, let us consider, first very broadly, the facts of the present
case.
The applicant company sought
to set up a plant to manufacture certain pharmaceutical products. For this
purpose, a large amount of funds was to be raised from lenders who made it a
condition of their lending that a sum of Rs.50 crores shall also be raised as
equity. The company had various alternatives of raising the equity in the form
of rights issue, preferential issue, etc. At the end, in consultation with the
Promoters, the company decided to issue shares on a preferential basis to the
Promoters and persons acting in concert. Essentially, the important consequence
was that post such preferential issue, the holding of the Promoters and persons
acting in concert (referred to together as ‘Promoters’ herein) would increase
from 25.32% to 45.91%. Regulation 11 of the Regulations provide that an acquirer
holding 15% or more of shares or voting rights can, to simplify a little,
acquire further shares only up to 5% in a financial year. Clearly, the acquirers
would in the normal course be required to make an open offer if the acquisition
was of more than 5% of the shares.
The company obtained the
required approvals under the Companies Act, 1956, which particularly required
approval of the shareholders by way of a special resolution through a postal
ballot. In the postal ballot, only about 10% (in number) of the shareholders
sent in their votes but of those who so voted, 99.10% voted in favour of the
resolution.
The Promoters then applied
to the Takeover Panel for exemption from the open offer. The Panel, after due
consideration, recommended grant of exemption. SEBI, however, considered the
matter and refused to grant the exemption.
The main reasons cited by
SEBI were that, firstly, the company could have raised the funds through a
rights issue where all the shareholders could have benefited. If the
shareholders did not subscribe, then of course, the Promoters could subscribe
and cover up the shortfall. Secondly, if an exemption was granted, the public
shareholders would lose the benefit of an exit. Thirdly, SEBI stated that
usually it grants exemption in such cases if the company is a sick/turnaround
company and the infusion of funds is under a Corporate Debt Restructuring (CDR)
package or similar situation. In view of this, SEBI refused to grant the
exemption.
The company appealed against
this decision to the SAT. The SAT allowed the appeal and granted the exemption.
Firstly, the SAT found fault
in SEBI’s view that the company could have raised the funds by a rights issue.
The SAT felt that SEBI should not advise a company on which alternative it could
use to raise funds. It observed, :
“The whole-time member has
found fault with the target company for not raising the funds through a rights
issue as, according to him, the method of preferential allotment denied to the
shareholders an equal opportunity in the fund raising exercise. He appears to be
of the view that since the shareholders had been denied that opportunity, they
be given an exit option through an open offer by declining the exemption. He is
totally wrong in his approach and perception of the shareholders’ interests.
First of all, it is not for the Board to advise or insist on any company as to
how and in what manner it should raise its further equity capital when the law
gives the aforesaid three options to a company . . . . the target company and
its shareholders had considered the option of the rights issue for raising the
equity and for good business reasons and without jeopardising the interest of
the shareholders abandoned this option . . . . Since time was of the essence,
the target company had to choose the quickest way without sacrificing the
interests of its shareholders to raise the necessary funds including the equity
of Rs.50 crores which was a pre-disbursement condition imposed by the banks. We
agree with the learned counsel for the appellants that preferential allotment
was not only the quickest but also the surest method of raising equity. The
option of rights issue if resorted to would have consumed good bit of the 30
months that were available with the target company to start commercial
production. Apart from the delay which that process would have caused, there was
no certainty that the target company would be able to raise Rs.50 crores through
that method. Even in the best case scenario of full subscription in the rights
issue at 1 : 1 ratio, the total money that could be raised would have been Rs.36
crores only leaving a deficit of Rs.14 crores for the project.”
The SAT also pointed out the
risks of uncertainty and costs to the company in a rights issue. It observed, :
“There was also no certainty that all the share-holders would participate in the rights issue. The average market price of the share of the target company during the last six months was around Rs.1.89 and it could at the most offer shares to the shareholders in a rights issue at Rs.1.39 per share, if not lower. It is axiomatic that unless the target company offers the shares at a price lower than the market price, the shareholders would not participate. If the option of rights issue had been adopted, the existing shareholders would have paid at the most at the rate of Rs.1.39 per share, whereas the Promoters to whom preferential allotment has been made have paid Rs.2.25 per share. Has the preferential allotment not added value to the company and in turn enhanced the shareholders’ value. There is yet another reason why the target company did not pursue the rights issue option. This process causes not only uncertainty and delay but also involves extra cost. The appellants pointed out and which fact has not been disputed on behalf of the Board that the total cost of the rights issue would have been close to Rs.56 lakhs and the target company could ill afford at that point of time to spend this amount on this exercise as it had recently wound up its project at Haridwar and was operating at low margins.”
The SAT also held that the prescribed procedure for obtaining approval for the preferential allotment by a postal ballot as prescribed under the Companies Act, 1956, was duly followed in letter and spirit. There was due disclosure of the facts and the relevant and prescribed majority duly approved the resolution. It said that the shareholders were the best judge of their interests and if they have approved something, their judgment cannot be interfered with.
The SAT also rejected the argument of SEBI that an exit route should have been provided to the shareholders through an open offer. The SAT observed :
“We also do not agree with the whole-time member that, in the circumstances of the present case, the shareholders of the target company should have been provided with an exit route by requiring the appellants to make a public of-fer. There has been no change of management or control over the target company consequent upon the preferential allotment as notified to the shareholders. This is also not a case where a rank outsider had acquired a large chunk of shares in the company and was seeking exemption from the takeover code. Such an acquisition or change in management or control over the target company brings with it an element of uncertainty and the takeover code provides that in such an eventuality the existing shareholders be provided with an exit route by requiring the acquirer to make a public offer. In the case before us, there was no element of uncertainty and there was no change of management or control and we are satisfied that the shareholders of the target company did not get affected in any manner by the acquisition.”
At the end, after reversing SEBI’s Order and allowing the exemption, the SAT further observed that in an earlier case on similar facts, SEBI had granted exemption. Thus, SEBI should have granted exemption in the present case too. It observed, “It must be remembered that it is in public interest that a statutory regulator like the Board should be consistent in its approach as that would send the right signals to the capital market and would also insulate the Board from the charge of discrimination.”
While this decision will act as a precedent in future cases and also act as deterrent in arbitrary or inconsistent Orders of SEBI, I respectfully submit that some aspects of this decision of SAT require reconsideration.
Firstly, SAT has, in my opinion, substituted its own judgment in place of the clearly discretionary approval process of SEBI. This is not a case where SEBI has levied, say, a penalty using its discretion whether or not to levy a penalty. It was considering a case of grant of approval which is a concession or benefit given to the Promoters/ other allottees in the present case. SAT also has not found any patent error of fact or law on the face of the record.
Secondly, it may be recollected that till 2002, the Regulations allowed for exemption from open offer to preferential allotment provided certain conditions particularly relating to disclosures were complied with. This exemption has been consciously dropped as a matter of policy. Thus, it could be fair to accept that normal preferential allotment ought not be granted exemption, even if the other formalities in law were duly complied with. With due respect, this decision may indirectly lead to a situation that all allotments through preferential allotments in similar cases of need for fund raising should be exempted. This would make a nullity of the conscious amendment to the law.
Thirdly, the ground that SEBI should be consistent in its Order is of course an advisable and fair ground generally to avoid being seen as arbitrary. However, in cases of grant of discretionary exemption, it is submitted, with respect, that it would mean rigidity and exemptions being taken for granted.
Though not directly on the point, it may be recollected that the Supreme Court (in SEBI v. Saikala Associates Ltd., Civil Appeal No. 3696 of 2005 with Civil Appeal No. 4640 of 2006, decided on April 21, 2009) on the limits and nature of appellate power of the SAT had held that the SAT could not travel beyond the statutory powers in terms of exercising its discretion. The Court observed, “When something is to be done statutorily in a particular way, it can only be done that way. There is no scope for (SAT) taking shelter under a discretionary power”.
To conclude, an appellate window is now open, apparently for the first time, for refusal to grant exemption from open offer by SEBI. However, one trusts that the spirit of discretionary approvals is not defeated by it becoming it mandatory.
