Over the last few years, there has been considerable debate in Indian corporate legal circles around the interpretation of the term ‘control’ as defined under the SEBI (SAST) Regulations, 2011 ( “Regulations”). To those unaware of this issue, the question, simply put, is this: if an investor seeks to invest in an Indian listed entity (“Target”) and as a part of its investment terms requests for and obtains, certain contractual rights that are not available to other shareholders of the Targets (“Special Rights”), would such Special Rights amount to acquisition of ‘control’ of the Target by the investor for the purposes of the Regulations? The genesis of such debate may owe its origins to conflicting definitions of ‘control’ by Indian courts and legislators or interpretations of ‘control’ by Indian regulators but that would not be the focus of the current post. Nonetheless, there is no exhaustive definition of ‘control’ and recognising its impact on deal making and M&A in the public space in India, India’s securities markets regulator, the Securities and Exchange Board of India (“SEBI”) in March of 2016 initiated the process to define ‘control’ by proposing certain bright line tests (“BLTs”).
If Special Rights are ‘Control’
To appreciate this question better, some basic concepts under the Regulations may need to be analysed. If the acquisition of Special Rights is indeed acquisition of ‘control’, then the investor may be classified as a ‘promoter’ of the Target. This, in turn, would mean that an investor would be recognised by the law as a person in the day to day control of/ person in charge of the affairs of the Target. This would further cast various duties on an investor, which may not be commensurate to the level of risk or involvement that an investor may wish to subject them-selves to in the context of its investment in the Target. Additionally, the Regulations may also require an investor to make an open offer for the purchase of shares held by the public shareholders of the Target, in the manner set forth in the Regulations (“Open Offer”). The Open Offer process is detailed and broadly involves notices to be provided to shareholders, minimum number of shares to be acquired by an acquirer, the engagement of a merchant banker, allowing tendering of shares by the shareholders, payment there-for and filing of relevant documents with SEBI during and after the process.
Therefore, and in the context of the current discussion, if an investor’s acquisition of Special Rights is indeed deemed to be indicative of ‘control’, then the investor may end up being classified as a ‘promoter’ and may be required to undertake an Open Offer. Needless to add, this would be irrespective of underlying commercial considerations of the transaction at hand, including the percentage of ownership of the Target that may be acceptable to the investor or the implications of being in ‘control’ of the Target as opposed to being invested in the Target.
Based on various industry representations and feedback on this issue, SEBI proposed two approaches to conveniently identifying or bright-lining ‘control’. SEBI’s first approach is to identify certain Special Rights as protective and to expressly exclude them from the purview of ‘control’. For a Special Right to be ‘protective’, it has to be primarily aimed at protecting the investment of the investor whilst ensuring that it does not limit the Target from conducting its business on a day-to-day basis. It has also been suggested that Special Rights (not amounting to ‘control’) may be granted subject to certain criteria, including a minimum percentage of investment in the Target and obtaining the public shareholders’ approval thereto. As such, SEBI has prescribed certain rights that it deems to be protective in nature and which do not amount to exercise of ‘control’. Alternately, SEBI has also suggested a ‘quantitative’ test whereby ‘control’ would be determined on the basis of the right to exercise at least 25% of the Target’s voting rights. It has also suggested that a Special Right to appoint the majority of non-independent directors would be construed as ‘control’.
What Would Work in the Indian Context
BLTs have been historically criticised for their inability to appreciate factual nuances, for addressing legal issues in a convenient /over-simplified manner and subsequently, for not always being equitable. Conversely, adopting fine-line tests or balancing tests (“FLTs”), whereby various aspects concerning the matter are examined and then legal principles are applied, may result in the introduction of excess objectivity and delay. Further, given the Special Rights that are typically sought by investors in the Indian scenario and Indian deal dynamics, a standalone BLT or a pure FLT may not be the most effective and efficient method to determine ‘control’. As such, whilst the SEBI initiative to define ‘control’ has been long due, it will be interesting to see how ‘control’ stands finally determined.
(A detailed version of this article was first published by the International Institute for the Study of Cross-Border Investment and M&A in March of 2016. Given the significance of this topic, this article has been re-presented in the blog format for the ease of our readers. For the said detailed version, please see this link.)