Inter Se Promoter Exemption for Takeovers: Computation of Holding Period

A few days ago, SEBI made public its informal guidance issued to Weizmann Forex Ltd. on October 25, 2012. In this case, the target company became listed only in 2011 due to a corporate restructuring process. The question was whether certain shareholders can avail of the exemption for inter se promoter transfer by taking into account the promoter holdings in the previous company from which the business was restructured into the target. Qualifying for the exemption requires that both the transferor and transferee should have been disclosed as promoters of the target company for at least 3 years. SEBI adopted a purposive interpretation to answer in the affirmative thereby making the exemption available in that case even though the parties did not technically satisfy the condition.

Facts

The relevant facts can be gathered from the company’s requestto SEBI. Weizmann Forex Ltd., the target company was previously an unlisted company with the name Chanakya Holdings Ltd. As part of an overall restructuring of the Weizmann group, which involved many other legs that are not directly relevant for our present purposes, the forex business of Weizmann Ltd. (the demerged company), being a listed company, was demerged into Weizmann Forex Ltd. (the resulting company). As part of this restructuring process, Weizmann Forex’s shares were listed on the stock exchanges. The promoters of Weizmann Forex intend to transfer certain shares of Weizmann Forex among themselves and hence approached SEBI for informal guidance.

Under Reg. 10(1)(a)(ii) of the SEBI Takeover Regulations, there is an exemption from a mandatory open offer for transfer of shares inter se among qualifying persons being “persons named as promoters in the shareholding pattern filed by the target company in terms of the listing agreement or [the takeover] regulations for not less than three years prior to the proposed acquisition.”

In the present case, none of the proposed transferors of shares were able to satisfy the requirement of being named as promoters in Weizmann Forex as they acquired shares in that company only under the restructuring process. However, if their shareholding in the demerged company (Weizmann Limited) were taken into account for the purpose of computation of the 3-year period, they would satisfy the requirement. Similarly, the transferees too were unable to satisfy the 3-year period of being named as promoters in Weizmann Forex. While one of the transferees held shares for a 3-year period across the two companies (similar to the transferors), the other transferee did not satisfy the 3-year period across two companies (on a combined basis) either.

The issue for SEBI’s consideration was whether, given these facts, the proposed transfer of shares among promoter was exempt from the mandatory open offer requirements under Reg. 10(1)(a)(ii).

SEBI’s Informal Guidance

In interpreting the Takeover Regulations, SEBI considered the 3-year holding period of the transferors and transferees by looking at their holdings on a combined basis in Weizmann Ltd. and Weizmann Forex Ltd. even though they may not have satisfied the requirement strictly with reference to Weizmann Forex Ltd., which is the target company.

Moreover, as far as the transferees are concerned, SEBI’s guidance goes one step further. Even though one of the transferees has not satisfied the 3-year holding period requirement, the exemption has been made available to it. SEBI reasons as follows: “The condition of 3 years shareholding by the transferees prior to the proposed acquisition would be deemed to be fulfilled in case all the transferees collectively hold shares for a period of 3 years prior to the proposed acquisition provided the other conditions for availing the exemption are fulfilled.”

Analysis

In interpreting the Takeover Regulations, SEBI had adopted a purposive approach in making the exemption available to the parties, as opposed to a literal or technical approach that may have denied this facility to the parties. By taking into accounting the shareholding of the parties in the demerged company, necessary consideration has been placed on the demerger transaction, which is essentially a restructuring of businesses and shareholdings as opposed to a complete transfer or sell-out of the business. In other words, it is considered a purely internal group restructuring.

Such an approach is not unusual. For instance, the Income Tax Act, 1961 considers such demerger transactions (provided certain other conditions are satisfied) as a restructuring (rather than a pure sale) and confers certain benefits in terms of exemptions from capital gains tax. More specifically, for the purpose of computing the holding period, the period of shareholding by a shareholder in the demerged company will be considered at the time of sale of shares in the resulting company. The present interpretation of SEBI brings the holding period under the Takeover Regulations on par with such a regime, which is understandable in the context of restructuring transactions and the purpose of the holding period for purpose of exemption under the Takeover Regulations. The only difference is that the Income Tax Act expressly provides for such treatment, while under Takeover Regulations it is only by virtue of the interpretation adopted by SEBI in this case.

However, in the case of the transferee, to the extent that SEBI finds that all the transferees may collectively satisfy the holding period requirement, it is perhaps providing a fairly liberal reading. This seems to suggest that where there is a group of transferees, it might be sufficient if one or more of the transferees satisfy the holding period requirement, and it is not necessary for each one of them to satisfy it. This might provide greater options to structure transfers that may avail of the inter se promoter exemption. At the same time, it may be argued that this is too much of a stretch of the Regulations, and could be subject to potential misuse.

Preposterous policy view from SEBI on QIPs and Public Shareholding

The Securities and Exchange Board of India has issued an informal guidance relating to the Listing Agreement and the SEBI (Disclosure and Investor Protection) Guidelines ("DIP Guidelines") that defies all logic and reason.

Clause 13.A.1.1(b) of the DIP Guidelines, which governs private placements to qualified institutional buyers, provides that a listed company ought to be in compliance with the prescribed minimum public shareholding requirements of the Listing Agreement in order to effect a qualified institutional placement ("QIP").

Clause 40A (vii) and clause 40A(viii) of the Listing Agreement provides that where the public shareholding in a company falls below the minimum level of public shareholding on account of supervening extraordinary events such as the implementation of a scheme of arrangement, public shareholding ought to be restored, in consultation with the stock exchange, to the prescribed minimum level through one of the following methods:

(a) Issuance of shares to public through prospectus;

(b) Offer for sale of shares held by promoters to public through prospectus;

(c) Sale of shares held by promoters through the secondary market; or

(d) Any other method which does not adversely affect the interest of minority shareholders.

A listed company that had undergone a Scheme of Arrangement by merging another company into itself faced a fall in public shareholding and therefore desired to effect a QIP to restore public shareholding to the prescribed level. Since the DIP Guidelines required a company to be compliant with the Listing Agreement in order to be able to transact a QIP, the company sought an informal guidance from SEBI to confirm that it could indeed effect a QIP as a means of increasing public shareholding.

Since the very purpose of the QIP was to restore public shareholding to the minimum level, upon completion of the QIP, the company would be compliant with the Listing Agreement. SEBI has taken an unsustainable technical view. In an informal guidance, SEBI has said that a status of compliance with the Listing Agreement is a condition precedent to the eligibility to effect a QIP. Since the company in question is not compliant before the QIP, it did not matter that the QIP would be the transaction that would ensure compliance with the prescribed level of public shareholding. SEBI has ruled that the company would not be allowed to transact a QIP and has held that the company is ineligible under the DIP Guidelines.

SEBI's view is not just amusing but also clearly violative of the purpose behind the DIP Guidelines. It is settled law that not just "guidelines", but even other forms of securities laws made under the SEBI Act, as indeed regulatory law, have to be purposively construed, and not strictly construed on the lines of fiscal statute. The purpose of the Listing Agreement is to ensure that every company has a minimum public shareholding at a prescribed level. The stock exchanges are empowered to have a dialogue with the company and work out the means of attaining the prescribed level of public shareholding. In this case, the stock exchange and the company had agreed that the public shareholding would be restored, among others, by means such as QIP, which would only increase the shares held by the public.

SEBI's informal guidance is contrary to the spirit of the DIP Guidelines and the Listing Agreement, each of which constitutes regulatory law formulated by SEBI. If a company seeks to comply with the prescribed level of minimum public shareholding, it is rather strange that SEBI should disallow the means of ensuring such compliance. So long as the QIP would push the company towards compliance with the salutary provisions prescribing minimum public shareholding, the purpose behind the law would have been achieved. The purpose behind the DIP Guidelines is to regulate private placements of securities within the parameters of the law. The QIP, in this case, would have promoted and furthered the cause of getting the company to comply with the law. However, SEBI, in its wisdom, has treated an eligibility clause in the Listing Agreement, on the lines of a condition of grant of a tax exemption, and by a narrow interpretation, has promoted the continued non-compliance with the Listing Agreement. This is a travesty.

Such a position would result in similarly-placed companies being forced to go in for public offerings, or sale of shares by promoter-shareholders. There is no reasonable object in the securities laws that would support forcing the adoption of such a mechanism. The right course for SEBI would have been to clarify that so long as the QIP results in the public shareholding level becoming compliant, the eligibility clause in the DIP Guidelines would not come in the way of the QIP.

An opportunity has been lost. It is not too late for SEBI to rectify this position and issue a correction in its view.

- Somasekhar Sundaresan

Post Script:-

Informal guidance letters contain the following disclaimer:-

"This letter does not express a decision of the Board on the question referred."

While this line is to pre-empt such interpretative letters being treated as "orders" that can be challenged before the Securities Appellate Tribunal, it makes a mockery of the Informal Guidance Scheme itself. The question it raises is that if the position taken by SEBI is actually not a decision of SEBI, of what value at all is it? It is a waste of time and energy for all concerned including SEBI?