The Supreme Court recently had an occasion to
render an interesting decision (Nirma Industries Limited vs. SEBI
((2013) 33 Taxmann.com 333(SC), dated 9th May 2013) on the Takeover
Regulations. It examined the very rationale of the Regulations. In
particular, the question was when could a person taking over a listed
company avoid an open offer? More specifically, having already paid the
promoters for acquiring the controlling interest in a company, can the
acquirer avoid paying the public for their shares? Can the acquirer be
allowed to withdraw if he later finds that the value of the shares was
substantially lower than he was supposedly aware of?
This
decision has drawn a lot of controversy and criticism. It has been said
that the acquirer, having already suffered by getting over valued
promoters shares, should not be made to suffer again by being required
to acquire shares of the public. Partly this owes to certain peculiar
facts and legal interpretation on certain issues which the Court upheld.
Partly also because it is said that the law creates certain hurdles and
then punishes the acquirer for not being able to cross them. But mainly
on certain substantive grounds. I respectfully differ with contrary
views on certain aspects and submit that the Supreme Court has rightly
required the acquirer to comply with its obligations to the public. The
few areas of legal ambiguity have also been rightly interpreted by the
Court.
The facts are indeed peculiar and on a first glance raise
certain sympathy too. To summarise, certain lenders (collectively
referred herein as “Nirma”) granted certain loans to the promoters of a
listed company (“the Company”) against security of shares of the
Company. When there was default in repayment, Nirma exercised the pledge
and acquired the shares. This resulted in trigger of requirement of
open offer which Nirma initiated. However, on later investigation, Nirma
found that there were allegedly serious misappropriations, etc. in the
Company. Nirma applied to SEBI for grant of exemption from making an
open offer or other alternate reliefs. SEBI refused. The Securities
Appellate Tribunal (“SAT”) upheld this decision. On appeal, the Supreme
Court too upheld the decision. Now, let us consider the background of
the law, then the more detailed facts, the decision of the Supreme Court
and the areas of contention.
What do the Takeover Regulations provide?
The
Takeover Regulations, since their inception, are based on a particular
concept. Whoever acquires a listed company (control or substantial
shares in it) ought to also acquire further shares from the public. The
principle behind this is that members of the public invest in the shares
of such company based on the existing promoter group. If another group
replaces the existing group, the public should have a chance to exit
with them. The other objective is to provide the public shareholders an
opportunity to sell their shares at least at the same price as the
exiting promoters. Curiously, despite several rounds of amendments, the
public shareholders are given step-fatherly treatment in one important
aspect. While the Promoters can sell 100% of their shares at a
particular price, the public shareholders cannot. Only 26% (earlier 20%)
of the share capital needs to be acquired from the public.
What happened in this case?
Nirma
lent a certain sum of money to promoters (“the Promoters”) of the
Company against pledge of shares of the Company. The promoters
defaulted. Nirma exercised the pledge and acquired the pledged shares
that triggered the open offer requirements. Nirma made an open offer at
the prescribed price to the public. However, because of findings of
multiple audits, Nirma realised that there were allegedly huge
misappropriations, understatement of liabilities, etc. Consequently, the
value of the shares was far lower than the open offer price.
Nirma
requested SEBI that it should not be required to make the open offer to
the public. Alternatively, the open offer could be at a lower than the
prescribed price nearer to the actual valuation if the alleged
misappropriations, etc. were factored in the valuation.
SEBI
rejected this request. Nirma appealed to SAT which too rejected it.
Nirma appealed to the Supreme Court, which also dismissed the appeal on
grounds discussed in the succeeding paragraphs.
Grounds why Supreme Court rejected the plea for exemption
Nirma
raised several contentions. One set of them was on legal issues. It
contended that SEBI did have general powers to grant exemption that SEBI
said it did not have. The other set of contentions was that if SEBI had
powers, the facts of the case had enough merits that SEBI ought to have
granted the exemption. The Supreme Court rejected both the contentions.
The first contention was that SEBI did have generic powers to
grant exemption. The specific grounds listed in the Regulations were, it
was contended, not exhaustive and, further, SEBI did not have power to
grant exemption on grounds similar to the specified ones but had broader
powers. The Regulations provided for three grounds for withdrawal of
open offer. First was that statutory approvals for making of the open
offer were refused. Second was that the sole acquirer, being a natural
person, had died. The third clause was “such circumstances as in the
opinion of the Board merits withdrawal”.
The contention of Nirma
was that (since the first two grounds did not apply here) SEBI had wide
and unrestricted powers under the residuary powers under the third
ground. SEBI, however, contended that its powers were ejusdem generis
the earlier powers. The present circumstances were not such that could
place pari materia with the earlier grounds and hence exemption could
not be considered.
The Supreme Court noted that Regulation 27 first provides that “No public offer, once made, shall be withdrawn”.
The exceptions to this thus shall be strictly construed. It also held
that the residuary power to grant exemption had to be considered ejusdem
generis the earlier powers. Since such powers conceived of a practical
impossibility of the open offer going further, the residuary power of
SEBI has also to be restricted to those other situations where the there
was similar practical impossibility. It held that the present
circumstances did not have any such practical impossibility. Nirma had
contended that an earlier specific ground that was deleted ought to have
been considered. This deleted ground provided that the open offer could
be withdrawn in case there was a competing bid. However, the Court
rejected this contention too.
The Supreme Court observed as follows:-
“Applying the aforesaid tests, we have no hesitation in accepting the conclusions reached by SAT that clause (b) and (c) referred to circumstances which pertain to a class, category or genus, that the common thread which runs through them is the impossibility in carrying out the public offer. Therefore, the term “such circumstances” in clause (d) would also be restricted to situation which would make it impossible for the acquirer to perform the public offer. The discretion has been left to the Board by the legislature realising that it is impossible to anticipate all the circumstances that may arise making it impossible to complete a public offer. Therefore, certain amount of discretion has been left with the Board to determine as to whether the circumstances fall within the realm of impossibility as visualised under sub- clause (b) and (c). In the present case, we are not satisfied that circumstances are such which would make it impossible for the acquirer to perform the public offer. The possibility that the acquirer would end-up making loses instead of generating a huge profit would not bring the situation within the realm of impossibility.”
Even on the issue whether the facts warranted exemption on generic grounds, if SEBI indeed had such powers, the Supreme Court answered in the negative. The Court held that Nirma’s real reason for seeking withdrawal was for avoiding economic losses. However, such a ground could not be permitted at the cost of the public shareholders. The Court noted that there were several red flags in the Company such as litigations against the Company, etc. and Nirma took the decision to acquire the shares fully conscious of these. Hence, such ground was also rejected.
The other major ground on general legal principles that a fraud vitiated any contract or obligation was also rejected.
The Court also refused to grant downward revision of price nearer to the value had the alleged siphoning off/understatement of liabilities, etc. were taken into account.
Criticism and support of the decision
The decision has been criticised on certain grounds. It was suggested the Court ought to have interpreted the powers of SEBI broadly and not applied the principle of ejusdem generis. Even if this principle was applied, it ought to have taken a broader view and taken into account the deleted ground also. All in all, it should have held that SEBI did have powers to grant withdrawal.
On merits too, criticism was made that the offeror was already subjected to loss on account of having acquired the shares from the promoters through pledge. Forcing the acquirer to suffer further loss was unfair and also resulted in unintended benefit to the public shareholders. The acquirer was victim of fraud and should not have been victimised further.
It is also stated that the law does not permit extensive due diligence by acquirers because of restrictions in Regulations relating to insider trading. In such a situation where an acquirer is handicapped, he should not be forced to carry out an acquisition when later investigation does throw up a fraud that could have been found through earlier due diligence.
It is submitted that while the circumstances were peculiar, the acquirer cannot escape the liability of making an open offer. This was a case where the acquirer acquired control and not merely 3substantial quantity of shares. The directors representing the erstwhile promoters resigned and Independent Directors were appointed. Further, though the acquisition was really in the form of exercise of pledge, it was a conscious act. Though not specified, it appears to me that these shares could have been immediately sold in the market at the then prevailing higher market price. However, the acquirer proceeded to carry out further investigations that revealed the hidden losses.
Further, effectively, the acquirer acquired shares of the erstwhile promoters but did not want to carry out the inevitable next step of acquiring shares of the public. In effect, the promoters did get money through original lending and exercise of pledge. Having acquired the controlling interest, the acquirer could not avoid the open offer that came as a package deal with it.
It is submitted that permitting exemption from making an open offer would have been a bad precedent and opened litigation in future cases where acquirers would come before SEBI on several pretexts seeking exemption and even benefitting from the sheer delay. It would be extremely unfair to allow acquisition of a controlling interest without making the public offer.
One may also recollect that the public shareholders even otherwise suffer from an inequity in takeover of companies. The promoters get to sell all their shares while only 26% (earlier 20%) of the public shareholding is to be acquired under an open offer.
Perhaps what is needed is change in law relating to pledge of shares. It is true that pledges are subject to misuse since an acquisition may be disguised as a pledge. Usually, however, financial lenders are not interested in acquiring control of a company. Thus, there is a case for amending the law to give some relief. For example, an exemption could be granted in cases where pledge is exercised but the shares so acquired are sold by way of auction within a time frame. The acquirer of shares through such sale would be required to make an open offer. If the lender does not sell within the time frame, the lender should be required to make an open offer.
