The concept of promoter and promoter group of a listed company finds a mention in the SEBI regulations, and assumes significance as it impacts a wide range of M&A transactions involving listed companies. After closing in a change in control deal, one needs to follow the conditions prescribed in Regulation 31A of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations), to re-classify the outgoing promoter. The conditions in Regulation 31A are onerous, cumbersome, and not in consonance with the way the transacting parties and market participants think. We will also explain below how Regulation 31A is not in consonance with the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Regulations), and does not reflect the realities of deal making and therefore, needs a change.
In this piece, we argue that key substantive changes are required to make the current Regulation 31A more pragmatic.
- Outgoing promoters continuing in executive positions
1.1 Analysis of the current framework: SEBI should allow outgoing promoters to be de-classified even if such persons continue as key managerial persons (“KMP”) for a limited time, say two years since deal closure. This will bring the regulatory framework in line with global M&A transaction structures. It will also give flexibility to the transacting parties since it will ensure that the outgoing promoter is involved in the transition process, without the regulatory overhang of “classification”. As of now, if the outgoing promoter holds a KMP position even for a few months, such outgoing promoter continues to be classified as a promoter of the company. This creates two major issues: (i) it creates confusion in the minds of the general public as to who is calling the shots in the company; and (ii) if the outgoing promoter has a small stub of shareholding left (say 8%), it will still be counted as “promoter shareholding”, making it difficult to comply with the minimum public shareholding norms (currently requiring the public to hold at least 25%)(MPS Norms). The key question, therefore, is why doesn’t the regulation allow simplicity in deal making?
1.2 Suggestion: Re-classification of an outgoing promoter should be allowed even if he/ she continues to hold a KMP position for not more than two years, due to any:
(a) change in control deal where an open offer is triggered; or
(b) change in control deal where no open offer is triggered, say deal implemented under Regulation 164A of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations)[1];
provided that the following conditions are met:
(i) the new acquirer, by the terms of the contract, should be in sole control of the listed company. Such a disclosure should be made where the contents of the transaction documents are summarised in mandatory disclosures; and
(ii) the sellers/ outgoing promoters should be allowed to continue as KMP for a limited period (not more than 2 years), without being required to be classified as “promoters” or “co-promoters” or “promoter group”.
This exemption can be included under Regulation 31A(10) of the LODR Regulations, which contains other exemptions related to re-classification of promoters.
2. Aligning ‘control’ under the Takeover Regulations and the LODR Regulations
2.1 The key point here is that a dichotomy in the concept of control is not required. The idea behind aligning the concept of control under both the regulations is to bring in consistency, which would strengthen the regulatory framework and benefit all market participants.
2.2 Regulatory Framework: The key terms of the existing regulatory framework are summarised below:
(a) The term ‘promoter’[2] is defined under the ICDR Regulations essentially as the person directly or indirectly in control of the listed company while the term ‘promoter group’[3] essentially means a person who is controlled by or related to the promoter.
(b) The Takeover Regulations define control to include “the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner”.[4] The Takeover Regulations also clarify that a director or officer of a listed company will not be considered to be in control of such listed company, merely by virtue of holding such position.
(c) Both Regulation 16(1)(a) of the LODR Regulations and Regulation 2(1)(i) of the ICDR Regulations, define the term ‘control’ to mean the same as ‘control’ under the Takeover Regulations.
2.3. Issue: The LODR Regulations prescribe additional conditions (see paragraph 2.4 below) when considering re-classification of promoters, which are over and above how:
(a) promoter and promoter group are defined under the ICDR Regulations, and
(b) control is defined under the Takeover Regulations.
This approach/ thinking is therefore contradictory and needs an immediate change.
2.4. Analysis: Simplicity and consistency in regulatory approach is key. Regulation 31A(3)(b) of the LODR Regulations prescribes various conditions that are required to be met for the outgoing promoter to be eligible for re-classification, which are extracted below:
“(b) the promoter(s) seeking re-classification and persons related to the promoter(s) seeking re-classification shall not:
(i) together, hold more than ten percent of the total voting rights in the listed entity;
(ii) exercise control over the affairs of the listed entity directly or indirectly;
(iii) have any special rights with respect to the listed entity through formal or informal arrangements, including through any shareholder agreements;
(iv) be represented on the board of directors (including not having a nominee director) of the listed entity;
(v) act as a key managerial personnel in the listed entity;
(vi) be a ‘wilful defaulter’ as per the Reserve Bank of India Guidelines; and
(vii) be a fugitive economic offender.”
When we examine these conditions in the context of the ICDR Regulations and the Takeover Regulations, it is evident that:
(a) The shareholding threshold for re-classification under the LODR Regulations is only 10% while under Regulation 3(1) of the Takeover Regulations, open offer obligation is triggered at 25%. Both these regulations prescribe certain consequences based on the presumption that the person is in control since he/ she holds a specified level of shareholding. SEBI should have a consistent approach and should increase the shareholding threshold under the LODR Regulations to 25% i.e. till an outgoing promoter continues to hold at least 25% equity, such a person should not be forced to be classified as a promoter or promoter group.
(b) The condition in Regulation 31A(b)(ii) deals with direct or indirect control without reference to shareholding. Any instances of control that are not covered under Regulation 31A(b)(i) will be covered by this condition.
(c) Therefore, in light of the conditions in Regulations 31A(b)(i) and (ii) which cover all instances of control, the conditions set out in Regulations 31A(b)(iii), (iv) and (v) are redundant and contrary to the concept of control under the Takeover Regulations.
(d) We have examined the conditions under Regulations 31A(b)(iii), (iv) and (v) in the context of the Takeover Regulations in more detail below:
(i) Regulation 31(A)(b)(iii) – Special rights in relation to a listed entity does not necessarily imply control over the listed entity. In Subhkam Ventures (I) Private Limited v. SEBI[5] (Subhkam),the Hon’ble Securities Appellate Tribunal had held that veto rights granted to an investor for the protection of his/ her/ its investment did not amount to acquisition of control by the investor. There are various instances of listed companies giving special rights to public institutional shareholders where such shareholders are not in control of the listed company.[6] Other judgments too have followed the Subhkam principles and have correctly laid down that the overhang of protective covenants should be done away with as these covenants do not grant control.
(ii) Regulation 31(A)(b)(iv) – The right to appoint a single director or a nominee director does not grant control to a person. The standard for determining control is clear – the person should have the right to appoint the majority of directors to be considered to be in control.
(iii) Regulation 31(A)(b)(v) – Acting as a KMP does not necessarily grant control to a person. The Takeover Regulations clarify that any officer merely by virtue of holding office cannot be considered to be in control. Please also see our suggestions in paragraph 1 above to simplify the approach rather than applying a vague criterion.
(e) SEBI’s contradictory approach to control under the Takeover Regulations vis-a-vis de-promoterisation under the LODR Regulations creates a regulatory gap, which makes it difficult to implement a M&A deal closure. The selling shareholders/ outgoing promoters should be reclassified irrespective of their balance shareholding (if it’s less than 25%), and if by the terms of the contract they are no longer in control of the company. However, due to the additional conditions under the LODR Regulations, such selling shareholders/ outgoing promoters may not be de-promoterised, which results in non-compliance with MPS Norms. This forces the acquirer to either carry out further corporate actions, diluting their investment value by selling shares at a loss or paying penalties for non-compliance. While, contractually, the burden of selling at a loss may be put on the outgoing promoters, the question is, whether this is the ideal way to implement M&A deal closure? Obviously, not.
2.5 Suggestions: We suggest that:
(a) Re-classification be permitted in all cases where post the M&A deal closure, the outgoing promoter is not in control of the listed entity, holds less than 25% shareholding and does not fall within the definition of promoter and promoter group. This also helps in maintaining conceptual consistency across regulations;
(b) The conditions for permitting re-classification under Regulation 31A(3)(b) of the LODR Regulation be aligned with the provisions and jurisprudence under the Takeover Regulations and the ICDR Regulations; and
(c) Specifically, the shareholding threshold under Regulation 31A(3)(b)(i) of the LODR Regulations be increased to 25% and Regulations 31A(3)(b)(iii), (iv) and (v) be deleted or appropriately amended as suggested above.
3. Automatic re-classification of outgoing promoters should not be permitted
3.1 Automatic re-classification as a promoter is contrary to the legal obligations under the Takeover Regulations and goes against the interests of the market participants, especially, the retail shareholders.
3.2 Regulatory Framework: After the outgoing promoter has been re-classified from the promoter to the public category, the outgoing promoter is required to comply with the conditions under Regulation 31A(4) of the LODR Regulations. If the outgoing promoter fails to comply with these conditions, then the outgoing promoter is automatically re-classified as part of the promoter and promoter group.
The automatic re-classification will happen if:
(a) Conditions without any time limit: At any time, the outgoing promoter acquires (i) 10% shareholding in the company; (ii) control of the company; or (iii) any special rights in the company; and
(b) Conditions with a time limit: Within three years from re–classification, the outgoing promoter is (i) represented on the board of the company (including by a nominee); or (ii) appointed as a KMP.
3.3 Issue: Automatic re-classification of an outgoing promoter as a promoter of a listed company is contrary to the obligation to make an open offer under clear provisions of the Takeover Regulations. Factually, you can either be in control or you can’t be in control of a company. There can’t be a grey area that requires “automatic” promoter classification.
3.4 Analysis: Currently, if the outgoing promoter either:
(a) acquires 10% shareholding or any special rights in the company at any time, or
(b) is represented on the Board of the company or appointed as a KMP, within three years from re–classification,
then the outgoing promoter would be automatically re-classified as the promoter of the listed company.
The question that needs to be asked at this stage is whether the outgoing promoter has acquired control by virtue of these actions. After having sold the company, it is far-fetched to believe that the outgoing promoter has once again actually acquired control (i.e. he is the one calling the shots to run the company), since it would imply that the new promoter, who has sole control, has willingly given controlling rights to the outgoing promoter. In the unlikely scenario that the outgoing promoter actually manages to regain control, he/she would be obligated to make an open offer under the Takeover Regulations.
It is more likely that even if the outgoing promoter acquires 10% shareholding or any special rights in the company at any point, he/ she has not actually acquired any control. In such a scenario, classifying the outgoing promoter as a promoter and promoter group of the company is incorrect. This also contradicts the concept of acquisition of control under the Takeover Regulation and the definition of promoter and promoter group under the ICDR Regulations.
3.5 It is clear law that if a public shareholder seeks to be classified as a promoter of the company, such public shareholder would need to make an open offer under Regulation 4 of the Takeover Regulations, read with Regulation 31A(5) of the LODR Regulations. Automatic reclassification contradicts this clear legal obligation.
3.6 Suggestion: Regulation 31A(4) attempts to solve a problem that does not exist and should be done away with completely.
*The author was assisted by Arnav Shah, Principal Associate
For further information, please contact:
Gautam Gandotra, Partner, Cyril Amarchand Mangaldas
gautam.gandotra@cyrilshroff.com
[1] It’s a route under which, if certain specified conditions are met, no open offer is required to be made.
[2] Regulation 2(1)(oo) of the ICDR Regulations.
[3] Regulation 2(1)(pp) of the ICDR Regulations.
[4] Regulation 2(1)(e) of the Takeover Regulations.
[5] Subhkam Ventures (I) Private Limited v. SEBI, Appeal No. 8 of 2009.
[6] SEBI has already proposed amendments to increase disclosure and approval requirements in relation to special rights in SEBI’s Consultation Paper on Strengthening Corporate Governance at Listed Entities by Empowering Shareholders – Amendments to the SEBI (LODR) Regulations, 2015 dated February 21, 2023.
