When is a person a Promoter of a listed company? When is he
not? What are the liabilities and disabilities of a Promoter that a person
connected with a listed company should know? Would a mere executive director
be a Promoter? Would a financial or strategic investor be a Promoter? Would
relatives of an existing Promoter be considered as Promoters? Would a
significant shareholding be the deciding factor? Would holding more shares
than the Promoter make a person a Promoter? These issues are of general
interest but they have come into sharper focus in the light of a recent
decision of the Securities Appellate Tribunal (“the SAT”) in the case of
Subhkam Ventures (I) Private Limited v. SEBI – Appeal No, 8 of 2009, order
dated 15th January 2010. In this decision, the SAT has considered a situation
where the issue was whether a private equity investor holding significant
quantity of shares and having certain rights was a ‘Promoter’.
Being a Promoter is a status that, in recent times, creates
more obligations than rights or advantages. The term Promoter, as we will see
in more detail later on, is really a result of being in control of a company.
However, it is a result and the fact that a person may be a promoter does not
give any right of control. Once a person is a Promoter, he faces several
handicaps – for example:-
1. if shares are allotted to him on a preferential basis,
lock-in period is higher.
2. he cannot increase his holding beyond a general
percentage (this restriction is for any significant shareholder but in
practice, would apply mainly to Promoters).
3. he cannot be granted ESOPs.
4. he will be counted for restriction on the number of
non-independent directors.
In addition, there are many disclosure requirements of his
holdings, his share pledges, etc. The irony is that though the Promoter in
India is in de facto and generally de jure control of a company, there are no
specific provisions holding the Promoter directly responsible. However, there
is a general provision holding a ‘person in control’ responsible for violation
by companies but it is a general provision and there is nothing specific
holding Promoters responsible for non-compliance or violation of laws.
Thus, there are sound reasons for a person to be hesitant
at being classified as a Promoter. Non-executive independent directors would
by definition not be Promoters and thus, they can avoid this categorisation.
The problem may be difficult for other non-executive directors, particularly
those who are nominees of the Promoters though not part of the Promoter Group.
There is a unique category of persons who are ex-promoters.
These include persons who have handed over control of the company to a new
Promoter but continue to hold significant shares. A category that is also not
infrequent is when a Promoter Group partitions and one branch gets control of
the company while the other holds shares but does not participate in control.
In an old case involving the Modi family/Modipon Limited
(Appeal No. 34/2001),
the Securities Appellate Tribunal held on the facts that a brother and his
group who were originally part of the Promoter Group were no more part of the
current Promoter Group, since they had separated and did not participate in
control.
However, recently, a more significant problem is faced by
persons who are significant investors in a company such as private equity
investors or similar financial investors. The category of ex-promoters may, on
facts, also fall in this group since they often retain significant holding and
also have certain contractual rights of representation and share decision
making power.
Would such persons be deemed to be in “control” of a
company or in joint control with the “main” Promoters?
The SAT had to consider a typical case and thus, we now
have the benefit of fairly detailed principles that have been laid down in
this decision. It must be clarified that SAT, in this case, had to decide
whether a person had acquired “control” and it can be seen that this issue is
substantially identical in determining ‘whether a person is a Promoter’. This
is because a person becomes a Promoter if he acquires “control”.
The facts of the case were that Subhkam, that has been
described as a private equity investor (“the PE Investor”), took a significant
24.26% stake in a listed company. As required under the Takeover Regulations,
for a person taking a 15% or higher stake, it made an open offer for another
20% shares. The terms of acquisition of shares by the PE Investor in the
listed company were that the PE Investor had certain rights. The significant
ones worth highlighting include the right to nominate a director, right of
consultation for appointment of certain senior officials, and a veto power in
the taking of certain specified acquired decisions. The issue was whether, by
virtue of such rights, the PE Investor had control and was thereby a Promoter.
Interestingly, the agreement giving the PE Investor such
rights specifically stated that the PE Investor was not a Promoter or in
control of the company.
The issue arose in a peculiar context. Subhkam had made an
open offer and in the draft letter of offer, it had specified itself only as a
financial investor. It specifically did not make an open offer under
Regulation 12 of the Takeover Regulations, which is attracted when a person
acquires control. However, SEBI, after much discussions, directed it to make
an open offer under Regulation 12 also. This direction was the subject matter
of appeal.
Incidentally, Regulation 12 requires open offer to be made by a person acquiring control in a listed company, irrespective of any acquisition of shares by him.
The SAT meticulously analysed important provisions of the agreement and also in the process, laid down important principles of determination of when a person is said to be in control of a listed company.
It is worth considering the exact wording of the definition of “control” under the SEBI Takeover Regulations:-
“control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner;
The SAT considered the above definition and observed:-
“This definition is an inclusive one and not exhaustive and it has two distinct and separate features: i) the right to appoint majority of directors or, ii) the ability to control the management or policy decisions by various means referred to in the definition. This control of management or policy decisions could be by virtue of shareholding or management rights or shareholders agreement or voting agreements or in any other manner.” Having considered the above, the SAT then went on to give a detailed description of what constitutes control and under what circumstances:-
“Control, according to the definition, is a pro-active and not a reactive power. It is a power by which an acquirer can command the target company to do what he wants it to do. Control really means creating or controlling a situation by taking the initiative. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. In that event, the acquirer is only reacting rather than taking the initiative. It is a positive power and not a negative power. In a board managed company, it is the board of directors that is in control. If an acquirer were to have power to appoint a majority of directors, it is obvious that he would be in control of the company but that is not the only way to be in control. If an acquirer were to control the management or policy decisions of a company, he would be in control. This could happen by virtue of his shareholding or management rights or by reason of shareholders agreements or voting agreements or in any other manner. The test really is whether the acquirer is in the driving seat. To extend the metaphor further, the question would be whether he controls the steering, accelerator, the gears and the brakes. If the answer to these questions is in the affirmative, then he alone would be in control of the company. In other words, the question to be asked in each case would be whether the acquirer is the driving force behind the company and whether he is the one providing motion to the organization. If yes, he is in control but not otherwise. In short, control means effective control.”
Having laid down what constitutes control, it examined the rights of the PE Investor in light of the agreement. It particularly stated that grant of rights to a significant investor can be expected since he would be likely to safeguard his investment. It held that having one nominee on the Board does not amount to having control.
The SAT analysed the provisions that give “veto rights” under certain circumstances to the PE Investor. If the company proposed to take certain acts as described in the agreement, which are typically significant and out of the normal course of business, the affirmative vote of the PE Investor was necessary. Would such a right mean that the PE Investor had acquired control? The SAT held that it did not. It observed:-
“The list of matters provided in clauses 9(a) to 9(o) are not in the nature of day to day operational control over the business of the target company. So also, they are not in the nature of control over either the management or policy decisions of the target company. These provisions merely enable the acquirer to oppose a proposal and not carry any proposal on its bidding… The mere fact that any such amendment requires an affirmative vote from the appellant is again indicative of the fact that it wants to protect its investment and that the basic structure of the company is not altered without its knowledge and approval. By no stretch of logic, can such an affirmative vote confer control over the day to day working of the company.”
Accordingly, the SAT held that the PE Investor had not acquired control and therefore was not required to make an open offer under Regulation 12. Curiously, the PE Investor would have held, if the open offer to acquire 20% was wholly successful, 44.26% shares, that would have been far more than the holding of the Promoters.
The decision was of course on facts. Often, depending upon situations, resulting also from the bargaining power of the investee company, the rights obtained may be more or less. The answer may be different. However, the general principles laid down by SAT can surely help in resolving situations such as these that are relatively quite common.
