Promoter Exits in India: A Real Leash Reined by the Market Watchdog?
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Most Indian listed companies are run by promoters who are a set of persons and/ or families having effective control over a listed company. The Securities and Exchange Board of India (SEBI), the securities market regulator, has historically been wary of investor protection issues that may arise between promoters of listed companies and public shareholders. This is evident by the fact that SEBI, in the past year itself, has restricted promoters from changing the objects of an issue as stated in the issue prospectus (unless shareholder approval is obtained) and barred promoters of companies undergoing compulsory delisting from receiving shareholder benefits and being appointed as directors of other listed companies.
The term ‘promoter’ has been defined under Section 2(69) of the Companies Act, 2013 and Regulation 2(1)(za) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 to broadly mean persons having ‘control’ over a company. The shareholding pattern of listed companies is primarily classified into two categories viz. promoter and public. Entry into the promoter club has never been barred (as anyone who gains control over a listed company, irrespective of shareholding, is categorized as a ‘promoter’) and formal guidelines for exiting the promoter club did not exist until September 2015.
SEBI introduced provisions relating to promoter reclassification into public shareholders under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Norms). Regulation 31A of the Listing Norms deals with disclosures and conditions for reclassification. Regulation 31(A)(5) of the Listing Norms requires a listed company to obtain shareholders’ approval for the reclassification of its exiting/ selling promoter into a public shareholder occurring due to control being established over the listed company by an incoming promoter/ acquirer via (i) an open offer in accordance with the Indian takeover code or (ii) in any other manner. In addition, the exiting/ selling promoter is required to, inter alia, have no more than ten percent shareholding in the listed company, and abandon any special rights vis-à-vis the listed company, established through formal or informal arrangements.
For those who may be less familiar with the concept of an ‘open offer’, it is a procedure required to be undertaken to acquire control over a company by triggering thresholds prescribed under the Indian takeover code. The open offer procedure requires the incoming promoter/ acquirer to provide an exit option to the existing public shareholders of the listed company by offering to buy their shares – after giving numerous disclosures and assurances in the open offer documents under the regulatory scrutiny of SEBI. The expression ‘in any other manner’ would appear to refer to methods such as court-blessed schemes of arrangements or reconstruction and Reserve Bank of India regulated strategic debt restructuring schemes that can facilitate the establishment (and replacement) of control over a listed company. These schemes are exempt from open offer obligations under the Indian takeover code as they already involve regulatory/ judicial oversight and/ or approval of shareholders.
Interestingly, SEBI through its recent informal guidance letters, has allowed existing promoters holding nil or minimal shares to exit without obtaining shareholders’ approval – this appears to be in sync with the Listing Norms (Regulation 31A(5) requires approval of shareholders only when the promoter is being ‘replaced’).
Despite SEBI’s efforts to streamline promoter reclassifications, there appear to be certain lacunae. It appears odd and to an extent, even counter-intuitive, for the law to (a) require shareholders’ approval in relation to reclassification of exiting/ selling promoters into public shareholders pursuant to an open offer, when in fact the law already provides the shareholders with full information/ disclosures about the transaction (triggering such change in control) coupled with a fair option to exit the listed company (in case of ‘open offer’) and an opportunity to approve/ decline such replacement when put to vote (in case of ‘any other manner’) and (b) allow an existing promoter with nil or minimal shareholding to exit the listed company without shareholder blessing.
Delving into this apparent lacuna, a scenario may be envisaged wherein shareholders show reluctance to give their approval for reclassification after the exiting/ selling promoter has transferred the entire stake to the incoming promoter/ acquirer (the earliest this transfer may take effect under law based on the open offer procedure is twenty-five working days after the signing of the acquisition agreement). This would essentially translate into a situation wherein the exiting/ selling promoter may continue having legal obligations as a ‘promoter’ along with the incoming promoter/ acquirer despite not holding any shares. From a M&A transaction perspective where ‘conditions precedents’ are at the heart of any acquisition agreement, the shareholders’ approval for reclassification being made a condition precedent for the share transfer to occur may not be feasible, as a shareholding of less than ten percent by the exiting/ selling promoter is a prerequisite for seeking reclassification.
An escape from the aforesaid situation can perhaps be found, oddly, through a literal interpretation of Regulation 31A(2)–(3) of the Listing Norms coupled with a reading of the recent SEBI informal guidance letters. Through this route existing promoters can seek reclassification by approaching the stock exchanges – without shareholders’ approval. As such, to obviate the need for obtaining shareholders’ approval under Regulation 31A(5) of the Listing Norms or on being refused such shareholders’ approval, the literal law seemingly allows the exiting/ selling promoter to approach the stock exchanges under Regulation 31A(2)–(3) of the Listing Norms to seek reclassification – without obtaining shareholders’ approval. It should be acknowledged however that this approach ostensibly defeats the spirit of Regulation 31A(5) of the Listing Norms, which requires the exiting/ selling promoter to obtain shareholders’ approval.
On a related note, Regulation 31A(5) of the Listing Norms provides for “re”classification i.e. changing the status of a shareholder from ‘promoter’ to ‘public’ and not “de”classification i.e. a situation where the exiting/ selling promoter sells the entire shareholding to the incoming promoter/ acquirer. However, on perusal of certain recent transactions triggering an open offer, it can be seen that exiting/ selling promoters are adopting the approach of obtaining shareholders’ approval despite having transferred or agreed to transfer their entire shareholding to the incoming promoter/ acquirer. This approach seemingly blessed by SEBI (considering, open offers are overseen by SEBI) and reflecting its “once a promoter, always a promoter” psyche is, respectfully, preposterous and needs correction before a precedent is etched.
Having been established with the task of protecting the interests of public investors and the development of the Indian securities market – has SEBI, in its sincere effort, baked half-hearted guidelines on promoter exits?
Malek-ul-Ashtar Shipchandler and Gaurav Malhotra are corporate lawyers at Shardul Amarchand Mangaldas & Co. All views are personal.