In a recent order, the Securities Appellate Tribunal (“SAT”) for the first time expanded on the scope and applicability of Regulation 8(7) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SAST Regulations”). This Order comes from a case involving Diageo PLC (“Diageo”) and United Spirits Ltd. (“USL”), where Securities and Exchange Board of India (“SEBI”) had on June 26, 2019, directed Diageo to make additional payments to shareholders who had tendered their shares in the 2012 Open Offer. However, the SAT by its order on July 26, 2023,^[i] has set aside SEBI’s order. In this article, we examine the scope and applicability of Regulation 8(7) of SAST Regulations and the major findings of SAT.

Background

1. In 2012, the acquirer, Relay BV, along with Diageo who was one of the persons acting in concert (“PAC”) had signed a deal to acquire 53.4% shareholding through a series of transactions, including a 27.4% stake by way of a combination of preferential allotment, stake of Promoters (through Share Purchase Agreement (“SPA”) dated November 9, 2012), and the balance 26% through a mandatory open offer.
2. Since large quantities of the promoter shares of USL to be acquired were pledged to various banks, it was agreed between the acquirers, PACs and the promoters of USL that the sale consideration would be paid into an escrow account, which would be used to pay off the dues of the banks to ensure release of their pledges. Post transfer of amount into the escrow account the banks released their pledges/ security claims and the shares were transferred to the acquirer.
3. This triggered an Open Offer obligation under SAST Regulations. On November 9, 2012, a Public Announcement for Open Offer (“2012 Open Offer”) was made by the acquirer and PACs at Rs. 1440/- per share. During the tendering period 58,668 shares were acquired by the acquirer.

The Agreement which was alleged to be within the realm of Regulation 8(7) of SAST Regulations

4. In 2007, ICICI Bank U.K. Plc (“ICICI – UK”) had lent to a Mauritius-based company named Watson Ltd (“Watson”), in which Dr. Vijay Mallya, a part of the promoter group of USL at that time, had some interest. This loan remained unpaid until 2013, and ICICI – UK demanded repayment. During this period, Standard Chartered Bank, UK (“SC”), stepped in to refinance Watson’s loan, enabling them to repay the outstanding USD 135 million to ICICI – UK. This new loan from SC was secured with a valuable security package, but notably, no shares of the Target Company/USL were included in this security package.

5. SC, a key banking partner of the Diageo Group, was aware of the USL takeover. At the request of SC, a Diageo group company called Diageo Holdings Netherlands BV (“DHN”) agreed to provide additional security to SC.

6. On July 4, 2013, DHN and SC executed a Backstop Guarantee Commitment Agreement where DHN agreed to sign a Backstop Guarantee in favour of SC for the loan given to Watson. The said agreement stipulated as a condition precedent that SC should have a full security package, and that Dr. Vijay Mallya and Watson should provide a counter indemnity to DHN.

7. Thereafter, on August 5, 2013, DHN executed a Backstop Guarantee in favour of SC. This Guarantee could be invoked by SC only if Watson defaulted, and SC could not encash the other components of the security package and recover its dues within the specified timeline.

8. On May 5, 2015, SC recalled the loan as it fell due. Watson defaulted in repayment. SC issued a notice for enforcing the pledge of certain shares that were part of the security package. On January 29, 2016, DHN made payment of USD 14,09,70,651 to SC under the Backstop Guarantee since SC had invoked the pledged shares. As on date Watson is liable to pay DHN a sum of USD 135 million plus interest and costs.

The SEBI Order and the events leading to the SEBI Order

The intrigue in this case was sparked by a former SEBI official’s television interview in September 2015, where he asserted that the 2012 Open Offer’s price should have encompassed the amount paid under the Backstop Guarantee. Soon thereafter, SEBI forwarded the interview transcript to Diageo and the Merchant Banker to the 2012 Open Offer (“JM Financial”) seeking their comments. Post replies and personal hearings of Diageo, SEBI by its Order dated June 26, 2019, held that if the Backstop Guarantee had not been provided, the acquirers could not have acquired the shares of USL. SEBI held that the Backstop Guarantee should be considered under Regulation 8(7) as an additional payment, impacting the acquisition price for the 2012 Open Offer. By the said Order SEBI directed that the net liability (i.e. payment under the Guarantee minus the value recovered through collaterals), shall be considered to be part of the acquisition price of the shares under Regulation 8(7) and 8(10) of SAST Regulations and the difference, as and when ascertained, would be payable to the shareholders who tendered shares in the 2012 Open Offer.

Findings of SAT

The core issue before SAT was whether the Backstop Guarantee dated August 5, 2013, in which DHN made payment to SC pursuant to their invocation of the pledged shares which were part of the security package would be covered under Regulation 8(7).

• SAT held that the purpose for introduction of Regulation 8(7) was that the price paid for the shares of the Target Company may not be always reflected in the SPA and could be hidden through layers of agreement. Regulation 8(7) takes into account any condition made to the seller in any manner which is incidental, contemporaneous or collateral or otherwise. The intention is to calculate the appropriate price offered to the shareholders.
• SAT observed that when the 2012 Open Offer was made the Backstop Guarantee was not in existence and was a different and distinct agreement which had nothing to do with the SPA. Therefore, the Backstop Guarantee is neither incidental, contemporaneous or collateral to the SPA.
• Further, SAT rejected SEBI’s finding and said that there was nothing on record to substantiate the finding that if the Backstop Guarantee had not been given, the acquirers would not have been able to acquire the shares of USL, since the loan given by ICICI – U.K. and later refinanced by SC had no collateral security of shares of USL, therefore, the Backstop Guarantee had nothing to do with the acquisition of control of the Target Company, USL under the SPA.
• The alleged violation of Regulation 8(10) was rejected by SAT on the limited ground that, the repayment of the loan by DHN to SC did not lead to any additional acquisition of shares within the 26 week period specified in Regulation 8(10).

Analysing the scope and applicability of Regulation 8(7):

It is pertinent to note the historic reasons for the said provision, which were also recorded by the Hon’ble Supreme Court in the matter of I.P. Holding Asia Singapore Pvt. Ltd. & Anr v. SEBI.^[ii] The erstwhile 1997 SAST Regulation had no provision for a situation where a non-compete fee was paid by the acquirers to the outgoing promoters/ management. Generally, in case of a non-hostile takeover, the acquirers would restrict outgoing promoters/ management from immediately starting a competing business and /or poaching the customers of the Target Company, by paying them a non-compete fee as consideration.

Pursuant to the recommendations of the reconvened Bhagwati Committee, the 1997 SAST Regulations were amended^[iii] and Regulation 20(8) was added, which provided that if payment was made to a person other than the Target Company by way of a non-compete fee arrangement, then to the extent that the same was in excess of 25% of the offer price, the same would be added to the offer price. Therefore, to the extent that such non-compete fee was up to 25% of the offer price, the same was deemed to be a fair separate consideration paid and payable only to the outgoing promoters/ management and therefore, was not required to be added to the offer price payable to all the other shareholders. However, when the SAST Regulations were substituted in 2011, this exemption was deleted.

The current Regulation 8(7) is extracted as follows: –

” 7) For the purposes of sub-regulation (2) and sub-regulation (3), the price paid for shares of the target company shall include any price paid or agreed to be paid for the shares or voting rights in, or control over the target company, in any form whatsoever, whether stated in the agreement for acquisition of shares or in any incidental, contemporaneous or collateral agreement, whether termed as control premium or as non-compete fees or otherwise.”

Regulation 8 (7) provides that for determining the open offer price, the price paid would include the price paid for shares, voting rights or control of the Target Company in any form whatsoever, whether stated in the agreement for acquisition of shares or in any incidental, contemporaneous or collateral agreement, whether termed a control premium or as non-compete fees or otherwise. The Control Premium mentioned in the said Regulation is a special premium that is often paid by the acquirer to the outgoing promoters / management if their shareholding is large enough to be considered as a controlling block. This premium also used to be paid only to the outgoing promoters and not to the retail shareholders. The words “or otherwise” must be interpreted ejusdem generis, as being an agreement to pay something similar to a “non-compete fee” or a “control premium”.

Therefore, only Agreements for payment of control premium, non-compete fees or similar additional payments of price to the outgoing promoters/ management, are considered as incidental, contemporaneous and/or collateral to the main share purchase agreement.

Conclusion

SAT in consideration of the facts of the case and the scope of Regulation 8(7) has rightly held that the Backstop Guarantee which was envisaged after the completion of 2012 Open Offer can never be deemed to be payment of any price of the shares acquired under the SPA and the said Guarantee cannot amount to any incidental, contemporaneous or collateral agreement qua the SPA within the meaning of Regulation 8(7).

The SAT’s verdict highlights the necessity of precisely evaluating the applicability of regulatory provisions in intricate financial arrangements during open offers. Thresholds and timelines are core to the SAST Regulations and serve as important warnings and triggers. The SAT decision underscores the importance of considering the timing, intent, and nature of agreements within the regulatory framework, thus ensuring a fair and transparent process in substantial share acquisitions. This case serves as a notable precedent for future interpretations of Regulation 8(7) in similar contexts.

Footnotes:

[i] https://sat.gov.in/english/pdf/E2023_JO2019353_24.PDF

[ii] I.P. Holding Asia Singapore Pvt. Ltd. & Anr V. SEBI (2015) 2 SCC 68

[iii] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers)(Second Amendment) Regulations 2002 available at: http://www.sebi.gov.in/cms/sebi_data/commondocs/takeoveramend2002_p.pdf