INDIAN UPDATE – New Takeover Regime Provides Clarity for Indirect Acquisitions in India and Overhauls Old Regime
- New regulations overhaul the Indian takeover regime, increase transparency, and represent a significant improvement.
- One of the key changes is the new principle-based treatment accorded to “indirect” acquisitions, where a substantial acquisition of shares, voting rights or control of a target company occurs indirectly through the acquisition of shares or control of an intermediate holding company or other entity, either to accomplish a global acquisition or for other reasons.
- The 2011 Regulations provide clear and specific guidance on the fact that both direct and indirect acquisitions of voting rights and/or control in a target company will trigger mandatory tender offer obligations.
- It is expected that the new regime will create a transparent framework for takeover activity involving indirect acquisitions and mitigate uncertainty.
The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“2011 Regulations”), which will come into effect on October 23, 2011, has overhauled the Indian takeover regime. One of the key distinctions between the incumbent regime manifested under the SEBI Takeover Regulations, 1997 (“1997 Regulations”) and the 2011 Regulations is the detailed, principle-based treatment accorded to “indirect” acquisitions, where a substantial acquisition of shares, voting rights or control of a target company occurs through the acquisition of shares or control of an intermediate holding company or other entity, either on account of a global acquisition or otherwise.
This article provides an overview of the evolution of indirect acquisitions and briefly examines the timing and pricing requirements for tender offers triggered on account of indirect acquisitions. Key differences in approach between the earlier 1997 Regulations and the new regulatory framework have also been highlighted, together with illustrations on market practice and the regulatory treatment of indirect acquisitions.
Legislative History of Indirect Acquisitions
The concept of indirect acquisitions was not covered by the SEBI Takeover Regulations, 1994 and was only introduced in the 1997 Regulations pursuant to the recommendation of the Bhagwati Committee in 1997. Accordingly, at the time of its introduction, sub-paragraph (b) of the Explanation to Regulations 10 and 11 of the 1997 Regulations provided for: “(b) indirect acquisition by virtue of acquisition of holding companies, whether listed or unlisted, whether in India or abroad.” Although the Bhagwati Committee (Reconvened) did not make a recommendation in this regard, by an amendment in 2002, SEBI deleted the word “holding”, presumably to widen the scope of the Explanation to cover indirect acquisitions through all companies whether holding companies or otherwise.
The concept of indirect acquisitions appeared to have been introduced into the regulatory framework almost as an afterthought and this lack of clarity led to much debate and differing regulatory viewpoints on account of varying case law.
Triggers for Indirect Acquisitions Under the 1997 Regulations
Under the 1997 Regulations, voting rights triggers and the control triggers applied equally to indirect acquisitions of companies listed in India. Voting rights triggers were applied either through the “proportionate” test or the “effectuality” test, subject to the “chain principle”:
(i) Proportionate test: a pure mathematical test wherein the indirect shareholding of the acquirer is determined on the basis of a pro rata calculation of the shareholding of the intermediate company in the target company and the acquirer’s shareholding in the intermediate company; and
(ii) Effectuality test: which depends on whether the acquisition of shares/voting rights/control in or over the intermediate company by the acquirer has had any effect on how all or part of the shares of the target company held by the intermediate company are voted, where the voting rights held by the intermediate company in the target company are in excess of the voting rights triggers.
The control rights trigger in an indirect acquisition was tested by the Supreme Court of India in the landmark Technip case, wherein the effectuality test was given preference over the proportionality test and the “chain principle” (which was first propounded by the Bhagwati Committee in 1997) was declared law. Under the chain principle an open offer would become necessary only if the intermediate company’s shareholding in the subsidiary amounted to a substantial part of its total assets or if the purchaser’s primary objective for acquiring the intermediate company was to gain control of the subsidiary.
The 1997 Regulations also permitted an acquirer a leeway of up to 3 months after consummation of the parent acquisition for a public announcement of an open offer for the indirectly-acquired target company.
Treatment of Indirect Acquisitions by the TRAC
Rejecting the chain principle recommended by the Bhagwati Committee in 1997 and endorsed subsequently by the Supreme Court in 2005, the Takeover Regulations Advisory Committee (“TRAC”) constituted by the SEBI in its 2010 report recommended that all indirect acquisitions which resulted in the ability to exercise voting rights in excess of the existing voting rights, triggers or control over a target company would trigger a mandatory open offer. Accordingly, open offer obligations would be triggered irrespective of whether the target company represented a material or substantial component of, or the raison d’etre of the primary acquisition.
Moreover, with a view to prevent direct acquisitions from being disguised as indirect transactions, the TRAC recommended that where the target company was a “predominant part of the business” of the entity being acquired, such indirect acquisition would be treated on par with a direct acquisition for all purposes under the proposed new takeover regulations. An objective test in this regard was established with a view to determining what would constitute a “predominant part of the business”. The TRAC recommendations on indirect acquisitions were accepted by the SEBI and finalized in terms of the 2011 Regulations, which have been described in greater detail below.
What constitutes an Indirect Acquisition Under the 2011 Regulations?
The 2011 Regulations provide clear and specific guidance on the fact that both direct and indirect acquisitions of voting rights and/or control in a target company will trigger mandatory tender offer obligations. Accordingly, an indirect acquisition under the 2011 Regulations is one where the acquirer acquires the ability to exercise or direct the exercise of such percentage of voting rights in or control over the target company that would trigger the initial, consolidation or control triggers.
The initial threshold trigger for a tender offer is the acquisition of 25% or more of the shares or voting rights of the target (as opposed to 15% or more earlier) or the acquisition of more than 5% shares or voting rights in any financial year where the acquirer already holds between 25% and 75% of the shares or voting rights. A schematic representation of these thresholds is set out below:
Further, as before, any acquisition of “control” over the target gives rise to a tender offer obligation irrespective of whether or not the same is accompanied with an acquisition of shares or voting rights.
Categories of Indirect Acquisitions
Transactions that trigger one or more of the thresholds described above would be subject to tender offer obligations under the 2011 Regulations, and may be categorized into one of the following categories:
(i) If the proportionate net asset value, sales turnover or the market capitalization of the target as a percentage of the consolidated net asset value, sales turnover or market capitalization of the entity or business being acquired is in excess of 80% on the basis of the most recent audited annual financial statements, then the indirect acquisition is treated as a direct acquisition under the 2011 Regulations for all intents and purposes and the provisions in relation to direct acquisitions (including without limitation timing, pricing and other process) apply to such acquisition (“Deemed Direct Acquisitions”); and
(ii) If the 80% threshold is not met, the acquisition is treated as an indirect acquisition under the 2011 Regulations and certain distinct provisions in relation to inter alia timing and pricing apply (“True Indirect Acquisitions”).
The TRAC noted this issue in its deliberations and recommended a two-tiered categorization based on the materiality criterion with a view to avoid the risk of transactions being structured as indirect acquisitions merely to avoid the price computation methodology and the open offer process prescribed for direct acquisitions.
Timing of the Public Announcement for Indirect Acquisitions
The 2011 Regulations envisage an initial public announcement followed by a more detailed public statement of the tender offer. For True Indirect Acquisitions, the 2011 Regulations provide that a public announcement (which is to be summary document) may be made within 4 working days of the “Relevant Date”, being the earlier of the date on which the primary (direct) acquisition is contracted and the date on which the intention or decision to make the primary acquisition is publicly announced. The detailed public statement however, need only follow not later than 5 working days of the completion of the primary acquisition. Given that global acquisitions may run on a different track subject to varying commercial considerations and regulatory provision, this timescale provides for flexibility in the event of non-completion of the primary acquisition on account of commercial or other considerations.
Deemed Direct Acquisitions are however not provided this benefit with the public announcement required to be made on the Relevant Date, and the detailed public statement required to be made not later than 5 working days of the public announcement. Deemed Direct Acquisitions are therefore likely to proceed au parallel with the primary acquisition.
Despite the fact that the 1997 Regulations also permitted the acquirer a leeway of up to 3 months after consummation of the parent acquisition for a public announcement of an open offer for the indirectly-acquired target company to be made, the biggest commercial driver for an early open offer was the lack of price protection. In such a scenario, the acquirer would not typically be in a position to launch the open offer until the primary acquisition had been consummated, and the market price of the target company could potentially witness a significant upturn before the open offer could be eventually announced. Moreover, the acquisitions between the two dates (date of announcement of the primary acquisition and the eventual date of public announcement) might have fallen outside the relevant look-back period, which would result in even an actual acquisition not getting factored into the computation of the minimum offer price.
Pricing of the Tender Offer
(i) General Determination of Tender Offer Price
In terms of Regulation 8 of the 2011 Regulations, the tender offer price for a True Indirect Acquisition is to be the highest of:
(a) The highest negotiated price for the shares of the target (subject to the price attribution rules described below);
(b) The volume-weighted average price paid or payable for any acquisition by the acquirer in the 52 weeks immediately preceding the Relevant Date;
(c) The highest price paid or payable for any acquisition by the acquirer in the 26 weeks immediately preceding the Relevant Date;
(d) The highest price paid or payable for any acquisition by the acquirer between the Relevant Date and the date of the public announcement in respect of the target;
(e) The volume-weighted average market price of the target’s shares for the 60 day period immediately preceding the Relevant Date on the stock exchange where the maximum trading occurs during such period (only where such shares are frequently traded); and
(f) The price determined after taking into account Price Attribution (see point (ii) below).
Further, in the event the offer price is incapable of being determined under any of above parameters, then the offer price is to be the fair price of shares of the target to be determined by the acquirer and the manager to the open offer taking into account valuation parameters including, book value, comparable trading multiples, and such other parameters as are customary for valuation of shares of such companies.
In the author’s view, with respect to the parameters outlined in (b) and (c) above, the principles detailed by the Supreme Court in the Zenotech case (as outlined below) would continue to hold true even under the 2011 Regulations, given the lack of anything to the contrary in the 2011 Regulations.
In the Zenotech case, the shareholders of Zenotech Laboratories Limited (“Zenotech”) were aggrieved with the open offer price offered to them by Daiichi Sankyo Company (“Daiichi”), which had indirectly acquired control of Zenotech vide its acquisition of Ranbaxy Laboratories Limited (“Ranbaxy”). The SAT examined whether when determining the offer price payable as on January 19, 2009, Daiichi was obligated under Regulation 20 of the 1997 Regulations to find out whether it, or any “persons acting in concert” with it on that date, had paid any price for acquisition to the shareholders of Zenotech during the 26 week period prior to June 16, 2008. Given that Ranbaxy had become a subsidiary of Daiichi on October 20, 2008, the SAT ruled that it was “deemed to be acting in concert” with Daiichi from such date. Accordingly, Ranbaxy, which had paid Rs. 160/- per share to the shareholders of Zenotech during January 16 and January 28, 2008 (i.e., the 26 weeks prior to June 16, 2008), was held to be acting in concert with the Daiichi, as on the material date on which the offer price for indirect acquisition was to be calculated (i.e., January 19, 2009). Daiichi was thus directed by the SAT to revise its offer price to the shareholders of Zenotech from Rs. 113.62/- per share to Rs. 160/- per share.
The Supreme Court on appeal however overruled the decision of the SAT and held that the tribunal had erred in proceeding on the basis that the material date for Ranbaxy and Daiichi to be acting in concert was the date of the public announcement for the Zenotech shares (i.e., January 19, 2009). The Supreme Court was of the view that for the purposes of the application of the pricing norms under the 1997 Regulations, it would not be material for the acquirer and the other person, who had acquired the shares of the target company on an earlier date, to be acting in concert at the time of the public announcement for the target company. The relevant time in this behalf would be the time of purchase of shares of the target company and accordingly, the only material aspect for determination was whether the other person was acting in concert with the acquirer at the time of purchase of shares of the target company.
(ii) Price Attribution
An interesting issue that was hitherto part of the regulatory haze in the case of a negotiated price of an indirect acquisition pertained to the quantum of the price at the primary acquisition level which would have to be included in the open offer price with respect to the Target. This resulted in acquirers disclosing the basis (or the lack thereof) on which the open offer price had been arrived at in a roundabout manner. For instance, in the India Carbon and the Tata Teleservices (Maharashtra) Limited open offers in 2009, the acquirers stated that the underlying transaction documents which triggered the primary acquisition contemplated composite consideration with no specific value or consideration being allocated or ascribed for the indirect interest held in the Indian target company. However, in the Thomas Cook open offer in 2008, the acquirer chose to mention, “by way of abundant caution”, that the consideration paid for 100% of TCIM (an intermediate entity) would amount to the acquirer indirectly paying Rs.107/- per equity share (also the offer price) of the target company. The disclosure for the Williamson Tea open offer in 2005 also contained similar language with the acquirer stating that the price paid for the intermediate entity would ultimately amount to indirectly paying Rs. 140/- per equity share (the offer price was Rs. 145/- per equity share) for the Indian target company if all the other assets of the intermediate company were not taken into account. The acquirer further maintained that this price would have been lower if the assets of the intermediate company had been taken into account.
The SEBI was concerned about whether the tender offer price for the target was artificially suppressed and this often led to regulatory second guessing of the value attributed to the Target’s shares and had, in some instances, called for an independent valuation. On the other hand, Acquirers were wary that they might be overcharged for what could have been an unintended or incidental acquisition resulting from a primary (often global) acquisition. This issue has now largely been laid to rest by the 2011 Regulations which adopt the recommendations of the TRAC and provide objective guidelines to tackle such a situation.
Thus, Regulation 8(5) provides that where the proportionate net asset value, sales turnover or the market capitalization of the target as a percentage of the consolidated net asset value, sales turnover or market capitalization of the entity or business being acquired is in excess of 15% on the basis of the most recent audited annual financial statements, then the acquirer shall mandatorily be required to compute and disclose the per value share of the target taken into account for the primary acquisition in the tender offer letter together with a detailed description of the computation methodology adopted.
In any event, such a description has been included in open offer documents for a number of years. For instance, in the Insilco open offer in 2002, the percentage proportion of the revenues, assets and net profit of the target company in the business of the entity being acquired was considered. Information based on similar parameters was also disclosed in the Ciba India open offer in 2009 and the Rhodia Speciality open offer in 2011. Whilst the percentage attributed to the Indian operations in each of these scenarios was fairly low, there have also been instances where the Indian operations constituted a substantial proportion of the business being acquired. For instance, in the Widia open offer in 2003, the proportion of the revenues, assets and net profit of the target company in the businesses being acquired was 19%, 29% and 42%, respectively. The Disa India open offer in 2005 is also noteworthy insofar as it contained a disclosure stating that the income from operations of the target company constituted “less than 10.0% of the total income from operations” on a consolidated basis of the entity being acquired. Separately, in both Ciba India and Rhodia Speciality, no specific due diligence was carried out on the target company. However, in Widia, a “limited due diligence” was conducted on the target company though this process did not include a financial diligence.
(iii) Price Protection
Under the 1997 Regulations, the tender offer price for an indirect acquisition was determined with reference to the price determined as of the date of the public announcement for the primary acquisition and as of the date of the public announcement for the target (whichever was higher). Since the regulations provided for a time period of 3 months from the date of consummation of the primary acquisition for making the public announcement for the target, and because the determination of the tender offer price involves a historical “look-back” of the price of the shares of the target from the date of the public announcement (or the date of the original trigger, whichever is higher), this often resulted in the acquirer having to bear a significant price risk inasmuch as the stock price usually rose significantly during this period. A classic instance of this price imbalance occurred in the Rhodia Speciality open offer, where the highest price payable based on applicable parameters prior to the “global” public announcement was Rs. 211.39, whereas the highest price payable prior to the “Indian” public announcement was Rs. 386.72. Similar price distortions were also witnessed in the Hindustan Oil and the Hughes Software open offers where the difference between the highest price payable prior to the global and Indian public announcements was in excess of 22% and 18%, respectively. This may be contrasted with a situation where price protection was afforded to the acquirer by virtue of simultaneous public announcements for the “global” and “Indian” legs of the transaction, as was the case in the Sparsh, Tata Teleservices (Maharashtra) Limited, and Thomas Cook open offers.
Further, the determination of the “relevant date” under the 1997 Regulations with reference to which a tender offer price was to be calculated proved nebulous, and could potentially result in regulatory intervention causing the acquirer to revise the minimum offer price, often to its detriment. For instance, in the B.P. Amoco-Foseco case, the acquirer was directed by the SAT to make a public announcement to acquire shares from the shareholders of the target company at an offer price which had to be computed by taking the higher of the price arrived on the deemed date of the primary acquisition and the actual date of the public announcement as reference dates. Given that (a) the SAT had denied an open offer exemption to the acquirer and determined the primary acquisition reference date to be March 14, 2000; and (b) the public announcement would be made over a year after March 14, 2000, the acquirer would be forced to make an offer price of around Rs. 226/-, considerably higher than the Rs. 144.02/- it would have otherwise paid under its claimed reference date.
With a view to avoid such a scenario, acquirers had generally chosen to launch their public announcements simultaneously, which was commercially unfeasible since the non- satisfaction of conditions (including the need for regulatory approvals) not relevant for the consummation of the indirect acquisition would not have permitted a withdrawal of the open offer. The TRAC noted this issue in its deliberations and had accordingly recommended “price protection” for the Acquirer, which the 2011 Regulations have put into effect.
Thus, pursuant to Regulation 8(12) of the 2011 Regulations, in the case of all True Indirect Acquisitions (but not in case of Deemed Direct Acquisitions), the acquirer is provided with price protection subject to enhancement of the tender offer price by 10% per annum for the period intervening the Relevant Date and the date of the detailed public statement (provided such period is more than 5 working days).
Other Offer Provisions Applicable to Indirect Acquisitions Under the 2011 Regulations
With the exception of the specific provisions in the 2011 Regulations pertaining to trigger thresholds, timing and pricing requirements for tender offers triggered on account of indirect acquisitions, the rest of the open offer process for indirect acquisitions would follow the same process that is applicable to other types of offers:
(i) Offer Size
Investors who trigger mandatory tender offer obligations as described above would have to make an offer for at least 26% of the fully diluted share capital of the target company.
The provision of escrow for the open offer is to be 25% for the first Rs. 500 crores and 10% for the balance open offer consideration. In some situations, the acquirer would need to provide a higher escrow amount (which may extend up to 100% of the offer price).
(iii) Mode of Payment
The consideration offered in an open offer may be all or part cash, or stock or secured debt instruments listed on a stock exchange in India (not available to global acquirers who are not listed in India). While the 1997 Takeover Regulations also contemplated the option of a cash or kind mode of consideration, the kind option was rarely availed of. The 2011 Takeover Regulations provide greater clarity for structuring stock for stock and, therefore, may make it more commercially appealing.
A differential price for acceptance of payment in cash or stock is permissible. Where the underlying agreement to acquire shares provides for payment in cash, or acquisitions made in the 52 weeks preceding the date of the public announcement have been paid for in cash, and such shares constitute more than 10% of the voting rights in the target company, a cash option is required to be provided to the shareholders. However, if the requisite corporate approvals for a stock for stock offer are not received prior to the commencement of the tendering period, the acquirer will have to pay the consideration in cash.
(iv) Withdrawal of Open Offer
In addition to the grounds currently existing under the 1997 Regulations for withdrawal of an open offer (i.e., non-receipt of statutory approvals and death of sole acquirer), the 2011 Regulations provides that an open offer may be withdrawn where the underlying triggering transaction fails for reasons outside the reasonable control of the acquirer and such agreement is rescinded, subject to full disclosure in the open offer documents.
Under the 2011 Regulations, an open offer may be completed within 57 business days from the date of the public announcement (as opposed to the 95 calendar days under the 1997 Regulations). A snapshot of a typical open offer timeline under the 2011 Takeover Regulations is enclosed at the end of this article.
Unlike the earlier 1997 Regulations, the 2011 Regulations provide for a detailed and clear framework for indirect regulations by (i) categorizing such acquisitions on the basis of the proportionate net asset values, sales turnover and market capitalization of the target to the consolidated net asset values, sales turnover and market capitalization of the business being acquired; and (ii) providing a separate framework for dealing with each such category. The events giving rise to the creation of a legal tender offer obligation in the context of an indirect acquisition have been clearly spelt out. It is also expected that the comprehensive norms surrounding pricing and price attribution will create a transparent framework for takeover activity involving indirect acquisitions and mitigate uncertainty. In light of the above, in the author’s view, the 2011 Regulations represent a significant improvement over the 1997 Regulations in the area of indirect acquisitions.
|Appointment of Merchant Banker||Prior to X|
|Public Announcement (PA)||X|
|PA to Target Company||X+1|
|Provision of Escrow||Y- (<) 2 working days|
|Detailed Public Statement||X+ (<) 5 working days (or within 5 working days of completion of the primary acquisition in case of a “pure” indirect acquisition) = Y|
|Filing of Draft Letter of Offer with SEBI||Y + (<) 5 working days|
|Making of Competing Offer(s)||Y + (<) 15 working days|
|Appointment of Acquirer Nominees to the Board of the Target Company (Optional)||After Y + 15 working days (subject to 100% open offer consideration being deposited in escrow in cash and open offer being non-conditional and no competing offer)|
|Completion of underlying transaction giving rise to the open offer subject to meeting 100% open offer escrow cash deposit requirement (Optional)||After Y + 21 working days|
|Receipt of Comments from SEBI||Y + (<) 20 working days|
|Specified Date||10 working days prior to Z|
|Despatch of Final Letter of Offer||Y + (<) 27 working days|
|Last Date for Upward Revisions (Optional)||(>) 3 working days prior to Z|
|Ban on Acquirer/PAC to acquire or sell shares of the target company until expiry of the tendering period commences.Target Company prohibited from fixing any record date for a corporate action lying between this date and the date of expiry of the tendering period.||Z – 3 working days to Z + 10 working days|
|Comments on the Offer by Committee of Independent Directors||2 working days prior to Z|
|Issue of advertisement announcing the schedule of activities||Z – 1 working day|
|Commencement of tendering period||Y + (<) 32 working days = Z|
|Closure of tendering period||Z + 10 working days|
|Completion of all open offer requirements including payment to shareholders||Z + (<) 20 working days|
|Issue of Post Offer Advertisement||Z + (<) 25 working days|
|Filing of Report with SEBI by Merchant Banker||Z + (<) 25 working days|
|Release of Escrow||Not earlier than Z + 50 working days|
|Completion of underlying transaction giving rise to the open offer without meeting 100% open offer escrow cash deposit requirement||Not before Z + 20 working days and not after (Z + 20) + 26 weeks|