Introduction When you hear of the word
‘control’ what comes to your mind? It could be some sort of degree of
rigidness or a rule associated with a school/an office/a formal place or
even a remote control or the control key on your keyboard. It can have
multiple meanings but the most common one is to have the power to
influence another person’s actions or the course of events. The Black’s
Law Dictionary, 6th Edition defines control as the ‘power or authority
to manage, direct, superintend, restrict, regulate, govern, administer
or oversee’. In the case of
State of Mysore vs. Allum Karibasappa,
AIR 1974 SC 1863, the Supreme Court held that the word “control”
suggests check, restraint or influence. Control is intended to regulate
and hold in check and restrain from action. Again in
Shamrao Vithal Co-op. Bank Ltd vs. Kasargod Pandhuranga Mallya,
AIR 1972 SC 1248, the Court held that the word ‘control’ is synonymous
with superintendence, management, or authority, to direct restrict or
regulate. Control is exercised by a superior authority in exercise of
its supervisory power.
However, when we speak of control in the
field of corporate law in India, there are numerous meanings and there
is no uniformity. Often, this causes regulatory uncertainty and
ambiguity and leads to interpretation issues. More often than not, the
interpretation of the term ‘control’ has been the subject matter of
widespread debate. Recently, it has been in the limelight on account of
certain sensitive sectors in India, such as, telecom, aviation, defence,
etc. Let us examine the diverse meanings of this term under various
Regulations and the issues ensuing from the same.
Companies Act, 1956
The
Companies Act, 1956, (the “Act”) which currently is the mother statute
for corporate law in India, interestingly does not define this very
important term. However, section 4 of the Act which defines a holding
company and a subsidiary, states that the composition of a company’s
(i.e., a subsidiary) board of directors shall be deemed to be controlled
by another company (i.e., a holding company) if the holding company can
exercise power at its discretion, without the consent of any other
person, to appoint/remove all or a majority of the directors of the
subsidiary. If such a control exists then holding-subsidiary
relationship is deemed to exist. Thus, the ability to control the
composition of the board or the power to appoint or remove the majority
of the board renders one company as a subsidiary of another. The Delhi
High Court in Oriental insurance Investment Corp. Ltd, 51 Comp.
Cases 487 (Del) has held that this power may be enjoyed by virtue of
being a majority shareholder or from certain special rights which are
conferred by the Articles of Association of a company. The judgment in
the case of Velayudhan (M) vs. ROC, 50 Comp Cases 33 (Ker) is on similar
lines. It is the control of the second variety, i.e., control because
of special rights, which is often a matter of debate.
While the
Act is silent on a general definition of the term, the Rules issued
under the Act are one step better. The Unlisted Public Companies
(Preferential Allotment) Rules, 2003 issued u/s. 81(1A) of the Act
define the term to 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. Thus, it is a very wide definition on the lines of the Takeover
Code (explained below). The definition is relevant under the Rules for
ascertaining who is a Promoter.
SEBI Takeover Regulations
This
is one Statute which has witnessed the maximum debate over “what
constitutes control”? The SEBI Takeover Regulations of 1997 as well as
those of 2011 both define this very important term. The definition of
the term in the 2011 Regulations includes:
(a) the right to appoint majority of the directors; or
(b)
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/management rights/
shareholders’ agreements or voting agreements or in any other manner:
However,
a director or officer of a company shall not be considered to be in
control over such company, merely by virtue of holding such position.
Here the decision of the SAT in the case of Ashwin K. Doshi vs. SEBI, 40
SCL 545 (SCL) is relevant. The SAT held that just because a company is
professionally managed does not mean that nobody has control over the
company. Even competent professional managers are given policy decisions
by those in control. Hence, it is a question of fact.
The right to appoint directors must be one which empowers a person to appoint a majority of the board of directors. In Ram Prasad Somani vs. SEBI,
69 SCL 168 (SAT), it was held that appointment of 5 out of 14 directors
could not tantamount to gaining of control over a company since they
were in minority.
R. 4 goes on to state that irrespective of
shares/voting rights in a target company, an acquirer who acquires,
directly or indirectly, control over such target company, must make a
public announcement for an open offer for the shares of such target
company. This applies even if there is no acquisition of shares –
Swedish Match AB vs. SEBI, 42 SCL 627 (SAT).
Thus, the Takeover
Code imbibes the definition under the Companies Act, i.e., power to
appoint majority of the directors but also goes forth to include various
other facets. The right to control the management or policy decisions
of a company renders a person as being in control of that company. These
rights typically arise by virtue of Shareholders or Share Subscription
or Voting Agreements. Hence, under the Takeover Regulations it is not
necessary for a person to be a majority shareholder. He could even be a
minority shareholder but by virtue of certain Agreements he could be in
control. Such an issue typically arises in the case of private equity
investors or venture capitalists. Any PE/FDI Investment may carry a veto
right or an affirmative vote or special rights for the Investor. Thus,
without the consent of the investor, the company cannot carry out
certain substantial decisions, e.g., corporate reorganisation, starting a
new line of business, borrowing in excess of a limit, etc. The PE has
power to stall a decision of the company. However, in most cases, he
does not have power to carry out a decision on his own behest. Thus, if
he refuses the company cannot go ahead but if he proposes and the
company refuses then he cannot proceed on his own. A question often
asked is that, does the grant of such special rights make the investor a
person in control of the company? This is a question of fact. For
instance, the Securities Appellate Tribunal in the case of SEBI vs
Sandip Save, 41 SCL 47 (SAT) after examining various powers given to
IDBI under a lending agreement held that IDBI was not in control over
the company. This was also the question in the case of Subhkam Ventures (I) (P.) Ltd. vs. SEBI, 99 SCL 159 (SAT). Here, the SAT explained the situation with the help of very interesting metaphors as follows:
“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 alone would he 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 organisation. If yes, he is in control but not otherwise. In short, control means effective control.”
On this basis and on an examination of the facts, the SAT held that the investor did not have control over the target company. SEBI contested it before the Supreme Court. There an interesting mutual consent agreement was arrived at between the parties. The Supreme Court’s Order in SEBI vs. Subhkam Ventures, Civil Appeal No. 3371 /2010 states that certain facts changed after the SAT Order. Accordingly, the Court, by consent, disposed of the appeal filed by SEBI by keeping the question of law open and it is also clarified that the order passed by the SAT will not be treated as a precedent. This leaves the all-important question yet open for interpretation. Some of the recent high-profile foreign takeovers/joint ventures have reportedly run into a roadblock with the SEBI on similar grounds. SEBI has questioned whether the grant of special investor protection rights to the foreign investor results into a sharing of management control with the Indian promoters?
SEBI has once again indicated its aversion to special rights, veto powers and other preemptive rights in favour of Private Equity Investors in listed companies. In Kamat Hotels Ltd, Clearwater Capital Partners (Cyprus) was given certain affirmative voting rights. SEBI has taken a stand that this tantamount to control under the Takeover Code. Clearwater has filed an appeal against SEBI’s decision to SAT.
The Takeover Code, 1997 contained R. 12 which provided for a change of control not triggering an open offer. Thus, in cases where a special resolution was passed for change of a control by way of a postal ballot resolution of the shareholders, then the same did not attract an open offer by the acquirer of the control. It applied to an offer triggered only by change of control and not one which was accompanied by acquisition of substantial shares. These were known as the White-wash Provisions. These provisions were resorted to when control was sought to be transferred without increasing shareholding above the threshold limits.
The 2011 Regulations have deleted these provisions. SEBI’s Takeover Regulations Advisory Committee (TRAC) in its Report stated that although whitewash provisions are in principle not undesirable, the time is not yet ripe to introduce them in India. Hence, it suggested that the same not be retained under the 2011 version of the Code. Accordingly, they were dropped. Further, earlier cessation of joint to sole control did not amount to a change of control. However, now the same would be treated as a change of control.
The Takeover Code also contains an express provision for an indirect acquisition of control. For instance, acquiring control over an unlisted company which in turn controls a listed company, thereby acquiring indirect control over the listed company.
FDI Policy
The Consolidated FDI Policy (CFDIP) states that an investment by an Indian company ultimately owned and controlled by resident Indian citizens would be treated as a domestic investment and in other cases as a downstream/indirect foreign investment. Hence, it becomes to understand what constitutes control under this Policy. A company is considered as controlled by resident Indian citizens, if ultimately the resident Indian citizens have the power to appoint a majority of its directors in that company. Thus, the FDI policy defines control in a very narrow manner and does not factor in the power to control policy decisions or management decisions by virtue of an shareholders’ agreement. However, the CFDIP provides that in the case of those sectors which require FIPB approval for any FDI, any shareholders’ agreement which has an effect on appointment of Directors, veto rights, affirmative votes, etc., would have to be filed with the FIPB at the time of seeking approval. It will then consider all such clauses and would decide whether the investor has ownership and control due to them. Thus, if any courier company (where FIPB approval is required) wants to get PE funding, it would also have to get the Shareholders’ Agreement approved by the FIPB. Such a provision does not apply in sectors under the Automatic Route.
The FIPB has asked for control provisions to be re-worked in the case of shareholders’ agreements in sensitive sectors, such as, defence. For instance, in the proposals of M/s EADS Deutschland GmbH, Germany & Larsen & Toubro Limited, Mumbai, M/s Telecom Investments India Private Limited, etc., certain control provisions in favour of the foreign investors were asked to be diluted.
Although this definition of control has been a part of the FDI Policy since 2009, the RBI has only recently notified this under the FEMA Regulations. Recently, the Department of Industrial Policy and Promotion, which drafts the CFDIP, is reported to have moved an amendment to widen the definition of control and to bring it in sync with the definition under the Takeover Regulations. The idea is to focus on de facto rather than de jure control.
Companies Bill, 2012
What the Companies Act omits, the Bill seeks to rectify. The current position of the Act being silent on the definition of control is sought to be corrected by cl. 2(27) of the Bill. It states that 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 proposed definition is almost in sync with the Takeover Code except for one small difference – while the Code starts with the word “includes”, the Bill starts with the words “shall include”. Although it may be argued that the difference is only semantic, it is submitted that the Code is wider in scope than the Bill because of the absence of “shall”.
Competition Act, 2002
The Explanation to s.5 of the Competition Act, 2002 defines the term control for the purposes of determining whether an acquisition or a merger would be a combination under the Act. Control is defined to include controlling the affairs or management by—
(a) one or more enterprises, either jointly or singly, over another enterprise or group;
(b) one or more groups, either jointly or singly, over another group or enterprise;
The Competition Commission of India (Procedure in regard to the Transaction of Business relating to Combinations) Regulations, 2011 provide that transfer of joint to sole control would not be an exempt trans-action and would require a prior clearance from the Competition Commission of India (CCI). The CCI has been quite explicit in its orders of what constitutes a control. By its Order dated 04-10-2012 in response to a Notice for clearance filed by Tata Capital Ltd and Century Tokyo Leasing Corporation, the CCI has held granting of special rights such as affirmative vote, right to appoint key managerial personnel, approval of business plans, etc., tantamount to transfer of sole to joint control and hence, trigger the Competition Act.
Again by its Order dated 9th August 2012 in response to a Notice for clearance filed by SPE Mauritius Holdings Ltd, the CCI has held that each of the persons in joint control have a right to veto / block the strategic commercial decisions of a company. Careful scrutiny of Agreements is required to distinguish mere investor protection rights from rights resulting in joint control. It held that positive consent for opening new offices or hiring / termination of key management personnel, employees drawing a salary > $30,000, etc., cannot be considered as mere minority investor protection rights. It is a case of joint control by two persons.
Accounting Standards
Control is also relevant under the Accounting Standards issued by the ICAI and notified by the NACAS under the Companies Act. Here there is a very absorbing angle to the tell. 4 different Accounting Standards define the term ‘control’ in 3 different ways. Let us briefly look at these:
