SAT, Control, the Takeover Code and SEBI

In cases of Share Subscription and Shareholders Agreements (SSA and SHA) providing for reserved matters, veto rights, affirmative rights and other protective provisions to the investors, what exactly amounted to control under the Takeover Code in SEBI’s eyes was by and large a rather grey area. The SAT ruling in the matter of M/s Shubhkam Ventures (I) Pvt. Ltd. V. SEBI, delivered on January 15, 2010, has given a very liberal interpretation to what amounts to control in Shareholder agreements and has put SEBI in a very tight corner.

Prior to the ruling, the capital markets regulator had a very wide approach and almost all forms of veto rights, affirmative rights, covenants and reserved matters were taken as amounting to control. There was no clarity as to how much reasonable protection afforded to such investors (via SSA and SHA) was acceptable without triggering off Regulation 12 of the Takeover Code. The norm was that an entity was always embroiled in making an open offer both under Regulations 10 and 12.

In the Shubhkam case however, SAT has culled out attraction of Regulation 12 in cases where there is an acquisition of voting rights under a SHA mainly on the point that there were no veto rights provided to the nominee director of the investor/ appellant. In this case the investor/ appellant acquired 17.90% of the post preferential allotment paid up capital and the Investor group’s shareholding became 24.26% in the target company. SAT ruled out application of Regulation 12 relying upon broadly two arguments, namely:

• Repeated iterations by the investor group that it was merely a financial investor in the target company and was not a promoter of the company and that the investor did not acquire any control or management of the company inspite of acquiring shareholding.
• That the affirmative vote provided to the nominee director of the investor coupled with the exhaustive list of reserved matters did not amount to control as it was in the nature of passive protection afforded to the investor.

SAT however did not appreciate the impact of the reserved matters on big decisions of the target company (as opposed to the daily running of the company) and that taken together with the affirmative vote of the nominee director it does put the investor in the company’s driving seat. Secondly, the mere non-mention of the word, ‘veto’ does not reduce the amount of control. What happens if the nominee director’s affirmative vote is not there? Obviously the decision taken by the other members pertaining to the reserved matter will fall through.

Relying on this judgment alone, it will simply be a drafting issue to take such cases out of the ambit of Regulation 12. No one will print ‘veto’ in any SHA or SSa, but will simply provide exhaustive reserved matters coupled with an affirmative vote to investor nominees. The present ruling fails to recognise exercise of tacit control by use of affirmative voting rights, though in the said order itself there is recognition that the powers conferred on the nominee director will control the whims and fancies of the promoters. The main issue is the tribunals assertion that control is always pro-active and is tied up with veto rights as against an affirmative vote.

Basically SEBI needs to appeal and at the same time provide some clarity to the market. It may consider issuing a clarification enumerating what kinds of veto/ affirmative voting rights/ covenants and reserved matters are acceptable and do not amount to control for the purposes of Regulation 12. Further since the Committee is already out for a review of the Takeover Code, it is good that this area of uncertainty has been thrown up in the Shubhkam case.