Unpacking Regulation 3(3) of the Takeover Code – An Interpretive Journey

The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”) provides two key shareholding triggers, for acquirers along with persons acting in concert (“PACs”), to make a mandatory open offer to public shareholders, namely,

(i) Regulation 3(1): the 25% threshold for new or existing shareholders who are now said to have acquired a substantial stake (“25% Threshold”), and

(ii) Regulation 3(2): the 5% threshold for existing shareholders who already hold 25% in the listed company and acquire over 5% in a financial year (“Creeping Acquisition Threshold”).

In a departure from the previous takeover regulations (“1997 Code”), a new Regulation 3(3) was added by the regulator, ostensibly to address situations where there is an increase of individual shareholding within the PACs, but no change in the aggregate PAC shareholding. The regulation is set out below:

For the purpose of sub-regulation (1) and sub-regulation (2), acquisition of shares by any person, such that the individual shareholding of such person acquiring shares exceeds the stipulated thresholds, shall also be attracting the obligation to make an open offer for acquiring shares of the target company irrespective of whether there is a change in the aggregate shareholding with persons acting in concert.”

The Report of the Takeover Regulations Advisory Committee published in 2010, which first suggested this insertion, did not provide a rationale. We look to demystify this regulation through subsequent jurisprudence.

25% Threshold and Regulation 3(3)

The application of Regulation 3(3) to the 25% Threshold is straightforward, and has been applied by SEBI unambiguously where the PACs together already hold above 25%, but an individual crosses the 25% Threshold.[1]

Acquirers have typically argued, although unsuccessfully, that the breach was inadvertent and resulted in no effective change of control. SEBI has however clarified that the purpose of Regulation 3(3) is to protect investor interests because the acquirer’s individual acquisition grants him substantial control after crossing the 25% Threshold.[2]

Creeping Acquisition Threshold and Regulation 3(3)

The application of Regulation 3(3) to the Creeping Acquisition Threshold raises some questions. There are two possible scenarios relevant here:

(i) The acquirer crossing 5% already holds over 25% individually, as well as collectively with PACs; and

(ii) The acquirer crossing 5% does not hold 25% prior to or after the acquisition, but the aggregate shareholding with PACs is over 25% prior to the acquisition.

In the first scenario, the outcome is clear. The acquirer falls squarely within the scope of Regulation 3(3) when applied to the Creeping Acquisition Threshold, even where the aggregate shareholding of the acquirer and PACs actually fell.[3]

SEBI has surprisingly applied Regulation 3(3) in the second scenario as well. In a recent order in Kesar Petroproducts Limited[4], the promoter company of a listed company transferred 48.16% to two children of an individual promoter. Consequently, each child held under 25% in the target. This transfer caused no change in the overall promoter shareholding or effective control of the target.

SEBI ruled that since (i) the acquirers along with PACs held over 25% in the target; and (ii) the acquisition resulted in the children’s individual shareholding crossing 5%, Regulation 3(3) read with the Creeping Acquisition Threshold was triggered. Ultimately, SEBI did not order a public announcement, relying on its powers to grant exemptions based on the facts and circumstances of the case.

Inconsistent Interpretation

Under the 1997 Code, the Securities Appellate Tribunal (“SAT”) stated that “once an individual becomes a part of a group acting in concert with the intention of acquiring shares, it loses its identity as an individual and takes on the identity of the group as a whole“.[5]

Regulation 3(3), and the jurisprudence thereunder, reverses this rationale. As explained by SEBI in Patel Airtemps, Regulation 3(3) recognises that individuals may exercise control without the support of voting rights held by the larger group of PACs.

However, in Kesar Petroproducts Limited, SEBI has perhaps over-extended this reasoning. SEBI has applied Regulation 3(3) to the thresholds in Regulation 3(2) selectively. While the individual shareholding of the acquirers was considered for the 5% threshold, the collective PAC shareholding was considered for the 25% threshold. By this order, Regulation 3(3) goes from merely clarificatory to creating an additional trigger for open offers for new acquirers where there is no effective change in control or impact on public shareholders. Individuals who acquire 5% without individually holding above 25% pose no control risk to public shareholders.

Conclusion

Until SEBI’s order in Kesar Petroproducts Limited, Regulation 3(3) was applied harmoniously with existing thresholds. The intent of the clause has now taken on a new colour.

Since SEBI exempted the acquirers in Kesar Petroproducts Limited from making an open offer, the order is unlikely to face SAT scrutiny. Accordingly, it remains to be seen whether this reasoning would be upheld in similar cases in the future. In the meantime, intra-group or promoter and family reorganisations, which otherwise do not fall in any of the exemptions available under the Takeover Code, will be most affected.

Authors:

Pranav Atit, Senior Associate
Chitrangda Singh, Associate

Footnotes:

[1] Some examples are the cases of Vakrangee Limited (SEBI, 9 August 2018) and Soma Textiles and Industries Limited (SEBI, 5 July 2016)[1], and the informal guidance in Cybertech Systems and Software Limited (SEBI, 2 January 2017)[1]
[2] Order in the matter of Patels Airtemp (India) Limited, SEBI, 25 July 2018
[3] SEBI has clarified this in an informal guidance in the matter of Capital Trust Limited, SEBI, 1 March 2016
[4] Order in the matter of Kesar Petroproducts Limited, SEBI, 9 March 2020
[5] Sunil Krishna Khaitan & Ors. v SEBI, Securities Appellate Tribunal, 19 June 2013

Date: October 7, 2020