The definition of ‘control’ has been one of the most debatable issues under Indian corporate law. The Sebi has recently issued a discussion paper that proposes ‘bright-line tests’ for defining control in the context of its Takeover Regulations. Under the existing regulations, any person who acquires a specified percentage of shares or voting rights in a listed company or actual control of such company is required to make an open offer to the public shareholders of the company to acquire their shares (known as the ‘mandatory bid rule’ in other jurisdictions). The primary objective of this rule is to protect minority shareholders by giving them an exit right, in the event of a significant acquisition or change of control. However, the definition of the term ‘control’ under the Indian regime is quite open-ended, which leads to a lot of legal and commercial uncertainty. The Takeover Regulations define control in terms of the right to appoint majority of directors or the right to control the management or policy decisions of the company in any manner. While the existence of a right to appoint majority of the directors can be often ascertained objectively, the position of law on ascertaining whether a person has the right to control the management or policy decisions in any manner is far from settled. Moreover, since the concept of control is also relevant for the purpose of the FDI policy and the Companies Act among other laws which use similar a definition, this uncertainty pervades the Indian corporate law regime in general (albeit the purposes of such laws differ).
In the case of Subhkam Ventures Private Limited versus Sebi, that relates to the definition of ‘control’ under the Takeover Regulations of 1997 which defined the term similarly, the Securities Appellate Tribunal (SAT) disagreed with position adopted by Sebi that affirmative voting rights or AVMs of an acquirer—prevalent in shareholder agreements involving investments in Indian companies—would amount to control over the target company. It held that ‘control’ is a “proactive and not a reactive power…”. The SAT, therefore interpreted the term control as a positive power whereas AVMs in shareholder agreements are typically seen as negative rights that prevent a company from taking certain actions without the prior approval of the AVM holder. The decision of SAT was appealed by Sebi in the Supreme Court, which in an earlier ruling—Technip S.A. versus SMS Holding (Pvt.) Ltd. and Others—had noted that the ability of the acquirer to exert influence over policy matters of the target company was relevant for determining if such acquirer had acquired de facto control. This indicated that acquisition of control required some element of positive action. However, the SC did not say that in so many words. While the Subhkam Ventures matter was pending adjudication before the SC, the Takeover Regulations Advisory Committee (TRAC) panel issued its recommendations for a new Takeover Code in 2010. Although the Panel examined the definition, it decided to leave it largely unchanged, noting that control as a concept was ‘case-specific’ in nature. Before the Subkham Ventures matter could conclude, the parties arrived at a settlement leaving the SC to observe that the earlier SAT order will not have any precedential value.
While one may argue that it may not be possible to define ‘control’ objectively and a factual analysis is required in every case, given that several jurisdictions have done so in the interest of promoting greater certainty in the market, there is no reason why this shouldn’t be considered in the Indian context. A 2012 study on the implementation of the EU Takeover Bids Directive—that gives EU Member States the flexibility to adopt their own definition of control for the purpose of the mandatory bid rule—commissioned by the European Commission, observes that other than Estonia, all 22 member states that were part of the study provide for a specific threshold of voting rights or shares that must be met or exceeded for the purpose of determining control. The study lauds the success of this threshold based approach and notes that Denmark and Spain are the only member states that use a combined approach (like India), i.e., relying on either a numerical threshold or acquisition of actual control.
While there is no evidence to suggest that the public offer rule has been beneficial for the Indian shareholders or the market, what is certain is that the rule definitely increases the cost of acquisitions and may also be said to have a chilling effect on takeover activity. This gets further aggravated by the uncertainty around the definition of control. The Sebi discussion paper rightly recognises the need for objectivity in defining control and proposes two options. Under the first option, the paper prescribes a list of rights which may be taken into account to determine whether the investor has acquired control or not. However, this approach will also require a factual analysis in every case. The second option proposes an even more objective numerical-threshold based approach. Given the existing uncertainty on this issue, the second alternative is a more suitable approach for promoting acquisitions in the market. Having said that, such change will also have an effect on other Sebi regulations (for instance, the regulations governing public issuances) which rely on the definition of control under the Takeover Regulations for defining ‘promoter’, etc. The interaction of Takeover Regulations with such other regulations will also have to be carefully considered before implementing any of the proposed options.