SEBI has been continuously streamlining the regulatory architecture governing schemes of arrangements under Sections 230-232 of the Companies Act, 2013 (“Companies Act”) and Regulations 11, 37 and 94 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR”) involving listed companies with the introduction of the SEBI Circular dated March 17, 2017 (“SEBI Scheme Circular”). SEBI vide its Circular dated November 3, 2020 (“Amendment Circular”), has introduced further changes to the SEBI Scheme Circular. The Amendment Circular is brought into effect for all schemes of arrangement submitted to the Stock Exchanges on or after November 17, 2020. Changes introduced under the Amendment Circular are as follows:
1. Independent view from Committee of Independent Directors
The Amendment Circular has introduced a new requirement of obtaining a report from the Committee of Independent Directors recommending the draft Scheme, taking into consideration, inter alia, that the scheme is not detrimental to the interests of the shareholders of the listed entity.
The rationale appears to be that Independent Directors should be tasked with the responsibility to adequately deliberate on scheme proposals and give their considered views for the benefit of the public shareholders to take informed investment decisions. SEBI believes that a mere board approval to the scheme has not proved to be adequate to protect the interests of minority shareholders. Therefore, to ensure that that the scheme is not detrimental to the interest of the shareholders, the approval must be supplemented by an express certification from the Committee of Independent Directors. Whilst there is no denying the fact that such a move (at least on principles) will be in the interest of the minority shareholders, there are certain larger practical challenges for the Audit Committees and the Independent Directors that need deeper deliberations.
The concept of a Committee of Independent Directors is not alien to SEBI regulations – Regulation 26 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 already has a provision for a Committee of Independent Directors to provide reasoned recommendation to an open offer. SEBI has authorised such Committee of Independent Directors to seek external professional advice at the expense of the target company. However, in the absence of specific guidance from SEBI, it appears that the scope of the report under the Amendment Circular is much wider (it is not a mere recommendation) wherein they would have to effectively determine that the scheme will not be detriment to the interest of the minority shareholders. This would impose a significantly higher burden upon the Committee of Independent Directors, given how subjective a determination of what is “detrimental to the interest of shareholders” could be. Independent Directors, at the end of the day, are non-executive directors with no role to play in the day-to-day affairs of the company, and their involvement with the business of the company is limited to their participation in the Audit Committee and Board Meetings. Their ability to review and supervise the day-to-day business operations of the company is limited by design of the Companies Act and LODR. One needs to ask if the Independent Directors will have adequate data, information, knowledge of a company’s business and other resources to prepare such a report? The Committee of Independent Directors would be required to act with extreme caution and care as they would be exposed to legal liability if their report is misleading or inaccurate.
Interestingly, this change appears to be a part of an emerging trend of the Regulator relying more on the institution of Independent Directors – the recently published SEBI Consultation paper on Review of SEBI (Delisting of Equity Shares) Regulations, 2009 has also introduced a new proposal to mandate the Committee of Independent Directors to provide their reasoned recommendations on the proposal for delisting.
Further, the composition of the ad-hoc ‘committee of independent directors’ needs further clarity. For instance, will two Independent Directors constitute a valid quorum for such a committee, irrespective of the total number of Independent Directors? Also, the sequencing of recommendations on the scheme by the Audit Committee and by the Committee of Independent Directors and, finally by the entire Board would also require appropriate guidance from the SEBI.
There are enough checks and balances already in place under the current regulatory framework. Under the SEBI Scheme Circular, the Audit Committee is required to submit a report recommending the draft scheme, taking into consideration, inter alia, the valuation report. By composition, two-thirds of the members of Audit Committee are Independent Directors and, therefore, the additional requirement of a report from a ‘Committee of Independent Directors’ on the same draft scheme appears to be a duplication of efforts. Should the Independent Directors, who are part of the Audit Committee, also form part of this committee? Further, to protect the interest of the minority shareholders, SEBI mandates listed companies to obtain approval from the majority of the minority shareholders in certain specific instances - schemes involving (a) promoter/ promoter group and their related parties etc.; (b) merger of an unlisted entity which results in reduction in voting share of pre-scheme public shareholders by more than 5%; and (c) transfer of whole or substantially the whole of undertaking of the listed entity for non-equity shares’ consideration. Separately, even under the Companies Act, leaving aside the NCLT sanction and obtaining no-objections from other regulatory authorities, shareholders’ approval threshold prescribed for schemes is the most onerous one for any corporate transaction – majority in number of shareholders representing 3/4th of the value of outstanding shares.
Instead of providing for an additional report from a ‘Committee of Independent Directors,’ a pre-requisite to obtain approval of the scheme from majority of the Independent Directors would have sufficed to achieve the desired objective.
2. Enhanced scrutiny prescribed for the Audit Committee
SEBI has further enhanced the scope of scrutiny of the scheme by the Audit Committee. In addition to recommending the Scheme to the Board of Directors after taking into consideration the valuation report, the Audit Committee is now required to also comment on the following:
- Need for the merger/demerger/amalgamation/arrangement;
- Rationale of the scheme;
- Synergies of business of the entities involved;
- Impact on the shareholders; and
- Cost benefit analysis.
Clearly, this puts additional compliance burden on the already heavily over-burdened Audit Committee. Again, this change is in line with the overall trend of relying more on the recommendation of the Independent Directors and the Audit Committees rather than the entire Board. The Audit Committee would need to undertake a cost-benefit analysis – tax-related costs, stamp duty, consultant costs, price adjustment mechanisms etc., to determine whether such costs are acceptable in view of the overall objective of the transaction in the short or long term. Whilst this exercise should be the responsibility of the CEO/CFO of a listed company, the Audit Committee will have to now consider and comment upon these aspects as well which could result in the Audit Committee’s role becoming more executive in nature rather than the non-executive role designed under the Companies Act.
3. Obligation of the Stock Exchange to provide a no-objection letter
Earlier, Stock Exchanges had the flexibility to issue an observation letter or a no-objection letter on the draft scheme. Thereafter, SEBI would issue a comment letter upon receipt of the observation letter or no-objection letter from the Stock Exchanges. The requirement of an observation letter has been done away with.
Now, Stock Exchanges would need to issue a no-objection letter to SEBI on the draft scheme in co-ordination with each other, instead of providing their observations on the scheme. Consequently, the SEBI would issue a comment letter upon receipt of no-objection letters from all the Stock Exchanges. The burden of examining and approving a draft scheme of arrangement has been placed primarily on the Stock Exchanges. SEBI will now issue a no-objection letter only upon receipt of a similar no-objection letter from the Stock Exchange.
This is a welcome move and will lead to better coordination between the Stock Exchanges and SEBI while issuing their ‘no-objection’ to the draft scheme. This will also ensure that Stock Exchanges forward draft schemes to SEBI only after they have completed their review that the draft scheme is in conformity with the applicable SEBI regulations.
4. Valuation report from a registered valuer
Under the SEBI Scheme Circular, all listed entities were required to submit a valuation report obtained from an independent chartered accountant. Under the Companies Act, a valuation report is required to be obtained from a registered valuer. This amendment appears to be technical in nature and aligns the SEBI Scheme Circular with the requirements of Section 247 of the Companies Act. This will also enable a registered valuer who may or may not be a chartered accountant to issue valuation report with respect to scheme of arrangement. This change is also in line with the increasing acceptance by regulators of the registered valuer framework in conducting valuation exercises.
Further, the Amendment Circular has also rectified the clause referencing of the Companies Act wherein the definition of “substantially the whole of the undertaking” has now been linked to Section 180(1)(a)(ii) of the Companies Act (which defines the expression ‘substantially the whole of the undertaking’), instead of Section 180(1)(a)(i) (which defines the term ‘undertaking’).
5. Additional conditions for seeking relaxation in listing conditions
The Amendment Circular has rightly increased the time limit from 45 days to 60 days for ensuring that the steps for listing of specified securities are completed, and trading in securities is commenced post the receipt of the NCLT order.
Further, certain additional disclosures are now required to be made by the entity seeking listing of its specified securities on the Stock Exchanges. The list of disclosures to be given for public advertisement has been significantly extended to include host of details that will offer greater transparency and facilitate public shareholders to take more informed decisions. .
6. Repealing provisions for listing of Equity Shares with Differential Rights
The SEBI Scheme Circular provided that listed entities may make an application to SEBI to seek relaxation from complying with the provisions of Rule 19(2)(b) of the Securities Contracts Regulation Rules, 1957, for listing of shares with differential voting rights on the Stock Exchanges pursuant to a scheme, subject to fulfilment of certain conditions. The Amendment Circular has repealed those provisions. This appears to be in line with the amendments notified in the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018, LODR, the SEBI (Buy-back of Securities) Regulations 2018, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011, and the SEBI (Delisting of Equity Shares) Regulations 2009.
The Amendment Circular seeks to introduce an enhanced level of transparency and disclosure for the benefit of the public shareholders in relation to schemes of arrangement. To that extent, the changes appear to be in the right direction. However, when viewed in the larger context of the overall compliance responsibility on already heavily burdened institutions of Independent Directors and the Audit Committees, it also ends up casting a one more onerous burden on them. The institutions of Independent Directors and the Audit Committees are already under a threat with the rise in number of resignations tendered by Independent Directors during in the last 24 months (a record 1,393 independent director posts were vacated in 2019 – double the number of exits in the previous two years, and another 567 resigned from January – August 2020). The need of the hour is to provide them protection from harassment by the law enforcement agencies for various technical violations by the companies. SEBI has consistently shied away from creating an institution of lead Independent Director. Without an office and staff in the listed companies and bereft of other supporting infrastructure to discharge their ever-increasing duties and responsibilities under various laws and regulations, SEBI seems to be turning them into what one would say “soldiers without the sword.