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.

SEBI’s Recent Securities Markets Announcements

Last week, SEBI took certain decisionsin the form of minor reforms to the securities markets, both primary and secondary.

As part of a process that began nearly 3 years ago, SEBI has further liberalized the process for dilution of promoter shareholding in listed companies, since a deadline of June 2013 has been set to ensure minimum level of public shareholding in listed companies. This time, some measures have been adopted to make the “offer for sale through stock exchange mechanism” more efficient. While such measures may make such options more attractive, it is not clear if SEBI’s objective can be achieved within the timeframe given that several companies are yet to comply with the minimum public shareholding norms. It looks likely that SEBI’s enforcement mechanism and its determination in ensuring compliance will be put to rigorous test in a few months.

Some changes have also been suggested to SEBI’s Takeover Regulations that were promulgated in 2011. Several of them are clarificatory in nature or intended to address discrepancies or the lack of clarity that was experienced ever since the new regulations came into effect. However, one of the long standing critiques of the Takeover Regulations pertaining to their lack of appropriate fit with the delisting process has not been addressed in this round despite assurances from SEBI to relook at this issue.

Another announcementthat came last week relates to the implementation of the curbs imposed on acquisition of shares by employee trusts in the secondary markets. SEBI’s decision and rationale were analyzed previously (here). Therefore, now any form of employee stock option or share purchase scheme must necessarily involve the issue of new shares from the company.

Mandatory Offers and Creeping Acquisitions

The Securities and Exchange Board of India (SEBI) passed an orderunder the SEBI Takeover Regulations of 1997 (that existed prior to October 2011) in relation to the shares of Khaitan Electricals Limited (the Target Company). In this order, the SEBI whole time member directed the promoters of the company to make an open offer to the other shareholders on account of certain acquisitions of shares by them in 2006-2007. Along with the open offer consideration, the promoters have been directed to pay interest at the rate of 10% per annum from June 16, 2007 to the date of payment of the consideration.

The key facts of the case are summarized in the gist of the show cause notices issued by SEBI to the relevant promoters of the Target Company:

... consequent to the acquisition of shares [by the promoters] on March 12, 2007, there was increase in their pre-acquisition shareholding (as on March 11, 2007) of -

(a) [Khaitan Lefin Limited (KLL), one of the promoters], individually, from 10,73,415 shares (10.52%) to 19,73,415 shares (17.16%) in the Target Company and KLL failed to make a public announcement to acquire shares in accordance with provisions of regulation 10 read with regulation 14(1) of the Takeover Regulations, 1997 within 4 working days from March 12, 2007;

(b) The promoter group, collectively, from 26,34,639 shares (25.83%) to 39,34,639 shares (34.21%) and the acquirers collectively failed to make a public announcement in accordance with the provisions of regulation 11(1) read with regulation 14(1) of the Takeover Regulations, 1997 within 4 working days from March 12, 2007.

Given these facts, two primary legal issues arose for consideration.

First, whether an acquisition by a single promoter of more than 15% shares will trigger an open offer requirement under Reg. 10 although the promoter group as a whole already held more than 15%. In other words, whether can be independent obligations under Reg. 10 (for individually crossing the 15% threshold) and under Reg. 11(1) (for collectively activating the creeping acquisition trigger of 5% additional shares) in respect of the same set of acquisitions.

Second, in the case of a creeping acquisition, what is the precise timing to be considered for the acquisition of 5% additional shares? Specifically, whether a dilution of shares during the period ought to be taken into account or netted off while considering the 5% limit.

The SEBI order holds against the promoters on both the issues, thereby mandating them to make an open offer.

On the first issue, the SEBI order reasons as follows:

11. Thus, the obligation to make public announcement under regulation 10 gets triggered when the acquisition of the acquirer, individually or collectively alongwith persons acting in concert with him, would cross the threshold limit of 15%. Thus, if individual acquisition of any person in a group (acting in concert) breaches the threshold limit of 15%, such acquirer is under obligation to make public announcement under regulation 10. In my view, there is no ambiguity in the language of regulation 10 with regard to the obligation of an acquirer whose acquisition increases his individual shareholding beyond threshold limit of 15% and no other interpretation can be given to it. …

…

14. … The intent and object behind the obligation with regard to public announcement under regulation 10, 11 and 12 is common. Regulation 10 does not exempt an acquirer from this obligation when he individually breaches the threshold of regulation 10 but his shareholding collectively with persons acting in concert with him is beyond the threshold prior to his individual acquisition as sought to be contended by the noticees. In my view, therefore, no interpretation can be taken in violation of the language of the regulations or to defeat the intent and object thereof.

On the second issue, the promoters argued that the amount of increase in the shareholding due to creeping acquisition must be computed as of the last date of the financial year, i.e. March 31, and that intermediate divestments and dilution must be netted off. This argument was not accepted by SEBI, which adopted the following reasoning:

21. … If the argument of the noticees is accepted, an acquirer may acquire any percentage of shares in a financial year and by the end of that financial year he may reduce it to 5% by sale of holding or otherwise. This is not the intention of the regulation which, since inception, had put a limit on percentage of creeping acquisition and did not allow netting of acquisition and disinvestment for determining the percentage of increase. …

22. I, therefore, am of the view that for the purpose of availing creeping benefit under regulation 11(1), the gross acquisition of the acquirer should not be more 5% in a financial year that starts on April 1st and ends on March 31st. Further, if at any point of time, in that financial year, the acquisition breaches the threshold of 5% creeping acquisition, the obligation to make public announcement is triggered at that time itself. Regulation 11(1) does not allow an acquirer to wait till end of the financial year after such breach.

…

24. In my view, from the definition of the word 'acquirer' under regulation 2(1)(b) and the provisions of regulation 11 of the Takeover Regulations, 1997 it is clear that the obligation to make public announcement is triggered on the date of agreement to acquire or acquisition of shares or voting rights, as the case may be. Thus, the shareholding shall be calculated and reckoned taking into account the shareholding of the acquirer immediately prior to the acquisition. I, therefore, hold that the shareholding of the acquirers as on the date of the acquisition of additional shares should be taken into account to determine whether the acquisition entitles the acquirer to exercise more than 5% voting rights in the Target Company in a financial year ending on March 31st. Further, the 5% increase in the financial year has to be calculated on gross basis without netting the dilution and/or divestment and acquisition. Accordingly, the arguments of the noticees in this regard also cannot hold good.

SEBI’s order is consistent with the text and intent of the 1997 Regulations. Although the facts of the present case gave rise to some issues that required a detailed consideration, the order merely buttresses the position adopted by the Regulations.

The legal difficulties emanating from the above discussion have been partially addressed in the 2011 version of the Takeover Regulations. The first issue regarding the mutual exclusivity of the initial trigger by individual acquirers (now standing at 25%) and the creeping acquisition trigger by the promoters collectively would continue to operate even under the 2011 Regulations, and to that extent SEBI’s order in the present case would continue to be relevant. As far as the second issue on computation of creeping acquisition limits is concerned, the position has been expressly clarified in the 2011 Regulations in Reg. 3(2) Explanation whereby the limit would be computed on a gross basis (without netting off dilutions). In that sense, SEBI’s order seems to suggest that the introduction of this explanation does not change the legal position, but rather clarifies something that was even previously the intention of the Takeover Regulations.

Should Government Companies Be Exempt From the Takeover Regulations?

Today’s Business Standard carries a reportindicating that SEBI is in the process of considering a general exemption to the Government from making a mandatory open offer under SEBI’s Takeover Regulations 2011. This comes in the wake of two specific exemptions granted by SEBI this year in the case of IDBI Bank and IFCIwhereby the Government was given special dispensation from making an open offer when it increased its stake in the companies due to conversion of securities into equity shares.

Currently, under the 2011 Regulations, SEBI has the power to grant exemptions on a case-by-case basis, which it has exercised in the two cases mentioned above. But, any grant of blanket exemptions to the Government would be a retrograde step. There is no compelling reason for the Government to be treated on a special footing compared to private acquirers because the Regulations are in the end analysis concerned with the protection of minority shareholders in a listed company. By creating such an exemption, SEBI would be discriminating against shareholders of government companies, as they would lack an exit opportunity through an open offer that is available to shareholders in non-government companies.

Moreover, the grant of such dispensation to the Government does not augur well in terms of ensuring compliance with securities regulation in the interest of investors. The Government ought to be setting an example by undertaking the obligations under securities regulation such as the Takeover Regulations and paving the way for ensuring compliance by private acquirers, thereby protecting the interests of minority shareholders in public listed companies. This method of carving out special provisions for government companies, that began with the lower minimum shareholding of 10% rather than the larger 25% limit for other companies, stands no reason when judged against the purpose of the Takeover Regulations, which is to provide an equal exit opportunity to minority shareholders when there is a change in control of the company.

Such moves could give rise to governance implications in a broader sense. For example, there is already a dispute over the governance matters in Coal India Limited between the Government, which is the controlling shareholder, and a minority shareholder, which has also resulted in litigation that is pending before the Indian courts. Such matters could also be significant in the context of the government disinvestment programme where the limitation of protection to minority shareholders in listed companies substantially owned by the Government could impact the success (or otherwise) of such programme.

It would therefore be preferable for SEBI to exercise the power of exemption on a case-by-case basis as per the current practice. That would not only provide the flexibility to deal with specific circumstances such as those that arose in the IFCI and IDBI Bank cases, but at the same time it would require SEBI to apply its mind to individual cases rather than to deal with them on an overall basis as proposed.

Interpreting the Takeover Regulations

With the current Takeover Regulations (that came into effect in October 2011) being fairly recent, they are being subjected to interpretation during the course of their functioning. SEBI this week issued two sets of informal guidance in the context of one takeover.

The firstpertains to whether an acquirer holding less than 25% can make a voluntary offer and then acquire shares in the market during the course of the offer so as to cross that limit. SEBI’s response is in the affirmative, as Reg. 22(1) (which prevents completion of acquisitions before completion of the public offer) applies only to acquisitions under an “agreement” and not through open-market purchases. While this approach is consistent with the scheme of the regulations, it could be subjected to abuse by acquirers in the manner detailed in the company’s letter to SEBI.

The secondrelates to the size of a competing offer, and whether that ought to have a minimum of 26% similar to an original offer. SEBI confirmed that this was not necessary in view of the specific provisions of Reg. 20(2).

Although the two sets of informal guidance deal with technical (and somewhat minor) details, they can make a significant difference in a takeover scenario, particularly one where there is an element of hostility between and acquirer and promoters, or between competing acquirers. The previous versions of the Takeover Regulations had built up a significant body of interpretation through orders of the court, the Securities Appellate Tribunal and SEBI. That looks set to continue under the new dispensation as well. Since litigation during the course of a takeover can result in considerable delays that may be disastrous to investors due to adverse price movements in the interim, speedy decision-making is of the essence.

The Concept of Control under the Indian Competition Act: an analysis (Part II)

(This is a continuation of a post contributed by Avirup Bose)

In an earlier post I discussed the importance of understanding the concept of ‘control’ while analyzing the probable anti-competitive effects of a merger especially in a partial stock ownership context. The discussion was in the background of an order of the CCI dated May 17, 2012, which basically held that if a company has a convertible security holder who can convert its convertible securities into almost 100 per cent of the firm’s share capital anytime, it cannot but be deferential to such security holders views about the affairs and management of the company and this amounts to control by such security holder for the purposes of the Act. Let us examine below how certain other jurisdictions deal with such situations.

The aforesaid position was the basis of the conclusion of an order of the erstwhile U.K. Monopolies and Mergers Commission (the “MMC”) (the predecessor to the U.K. Competition Commission) relating to the leveraged buy-out of the consumer products division of Stora (which included the Wilkinson Sword wet shaving business) by a number of Swedish investors, banks and financial houses along with the Gillette Company (“Gillette”, the world’s leading supplier of wet shaving products)[i]. The MMC had to decide if the holding by Gillette of a number of rights and interests in Swedish Match NV, the buyout vehicle for the Wilkinson Sword division (“Wilkinson”), including 22 per cent of non voting convertible loan stock amounted to control or material influence[ii] over the affairs of Wilkinson. The MMC in its analysis of the main components of the possible influence of Gillette on Wilkinson included the facts that the non-voting loan stock could convert to ordinary shares in the event of a stock exchange listing, a sale of equity in certain circumstances, possible winding up of the company, certain pre-emption rights over the sale of equity or assets of the company[iii]. Although the MMC accepted Gillette’s arguments that it had no voting rights or board representation and no right to attend shareholders meetings or receive internal information it concluded that a “prudent Wilkinson board would be bound constantly to take into account the fact that Gillette was a major shareholder of its parent, the Swedish Match NV (holding 22 percent non-voting convertible loan stock), was its largest creditor and had important rights in relation to significant decisions affecting the future of the company, notwithstanding the limits to Gillette’s rights.”[iv] Given the abovementioned perceived influence Gillette had over the business of its leading competitor, Wilkinson, the MMC concluded that the transaction would be anti-competitive and against public interest. The MMC’s conclusion that the mere existence of certain non-voting rights of an investor can give rise to the ability to influence corporate policy and decisions resonates with the conclusion of the CCI in the order referred above.

Other jurisdictions may disagree. Under U.S. antitrust law the HSR Regulations requires that only parties to acquisitions of any voting securities or assets would be required to file appropriate notification under the U.S. pre-merger notification program and it exempts from such notification process any acquisitions of convertible securities, but requires reporting in advance of their conversion.[v] The Statement of Basis and Purpose of the HSR Regulations discusses the antitrust significance of convertible securities:

“From an antitrust standpoint, reporting at conversion is more useful.  It is true that before conversion, convertible voting securities may confer upon their holder the power to influence, either directly or   indirectly, the management of the issuer. But the conversion price attached to convertibles may make conversion economically unattractive. And the measurement of the potential voting power conferred by convertibles is highly speculative, since conversions by other holders may dilute the potential voting power of the person holding the convertibles. So although a substantial holding of convertible voting securities may give the holder some power to influence management, this power is far less significant than the ability actually to vote securities. At conversion a more accurate picture of voting power in the hands of the owner or holder of those securities can be calculated.[vi]” (Emphasis added)

However, under Indian competition law an analysis of what amounts to control in the merger analysis context is perhaps of less significance than in other jurisdictions. As Prof. Umakanth had rightly pointed out that the CCI’s analysis as to what amounts to ‘control’ under the facts of the transaction between the Reliance Industries and the TV18 Group of companies seemed unnecessary since the CCI ultimately derived jurisdiction through section 5(a) of the Act which applies when there is an acquisition of control, shares, voting rights or assets of an enterprise by another. Hence, the mere acquisition of shares (which includes in its definition convertible securities) or assets (which may or may not vest control upon the acquirer) could trigger a merger analysis under section 5 of the Act. However an instance where an analysis to what amounts to control over the acquired entity is important is where control over the acquired entity is being derived without any share or asset acquisition, such as through a contract. Some of such instances have been summarized by the U.K. Office of Fair Trading (OFT) in its Substantive Assessment Guidance:

“The OFT may also consider whether any additional agreements with the company enable the holder to influence policy. These might include the provision of consultancy services to the target or might, in certain circumstances, include agreements between firms that one will cease production and source all its requirements from the other. Financial arrangements may confer material influence where the conditions are such that one party becomes so dependent on the other that it gains material influence over the company’s commercial policy (for example, where a lender could threaten to withdraw loan facilities if a particular policy is not pursued, or where the loan conditions confer on the lender an ability to exercise rights over and above those necessary to protect its investment, say, by options to take control of the company or veto rights over certain strategic decisions).” (para 2.10)

Finally, the CCI’s interpretation of what amounts to ‘control’ under the Act has been described to be at odds to the interpretation of the term ‘control’ under the [Indian] Takeover Code[vii]. As per the CCI the mere acquisition of convertible instruments would trigger a merger analysis under section 5 of the Act while obligations under the Takeover Code arises only when such convertible instruments are actually converted to voting rights beyond the prescribed thresholds. In my opinion the purpose of the Takeover Code and the Act are different and that may be a key in understanding the conceptual differences in the acquisition of shares and control under the Act on one hand and the Takeover Code on the other. The primary aim of the Takeover Code is fair and equal treatment to all shareholders in an acquisition or merger scenario[viii]. The triggering of the obligations under the Takeover Code is dependent on the acquisition of voting rights because the basis of these obligations is to provide the minority shareholder with a quantifiable exit option. This exit price can be more precisely calculated at the time of conversion of the convertible instruments into shares carrying voting rights. On the other, as explained above, completion law has to account for the imprecise ways in which an acquirer can influence and control the management decisions of its rival and cause appreciable anti-competitive effect on the markets to the detriment of the common public. What matters under the Takeover Code is if the acquirer has actual control over the company and hence the stress on voting rights so that a quantifiable exit price can be determined for the minority shareholders while what matters under competition law is the acquirer’s mere ability to control rather than the actual exercise (or the intended exercise) of control.

- Avirup Bose

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[i] Stora/Swedish Match/Gillette, CM. 1473 (March 1991)

[ii] Section 26(2) to (4) of the U.K. Enterprise Act, 2002 (the “Enterprise Act”) recognizes three degrees of control, acquisition of each of which can give rise to a merger analysis. These three degrees are: (a) de-jure or legal control (that is a controlling interest), (b) de-facto control (that is, control over commercial policy) and (c) material influence (that is, ability to materially influence commercial policy). Although such degrees of control are not provide under the Act yet the analysis of the CCI of the term control in the order discussed above comes closest to the concept of what is referred as ‘material influence’ under the Enterprise Act.

[iii] These investor rights can be typically found under any investment agreement in India and can be reasonably expected to be present in an agreement relating to a transaction of the nature between the Reliance Industries and the TV18 group of companies.

[iv] Ibid, at para 1.6

[v]  16 C.F.R. §§ 801.32 & 802.31

[vi] Rules, Regulations, Statements and Interpretations under the Hart-Scott Rodino Antitrust Improvements Act, 1976, Chapter I, Sub-Chapter H, p. 30.

[vii] Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011

[viii] Justice P.N. Bhagwati Committee Report on Takeovers 1997, Preface, para ix

The Concept of Control under the Indian Competition Act: an analysis (Part I)

(The following post is contributed by Avirup Bose, who holds law degrees from the West Bengal National University of Juridical Sciences and the Harvard Law School and is qualified to practice law in India and the U.S. Avirup has worked in the New York office of Weil Gotshal & Manges and in the New Delhi office of S&R Associates. He has also briefly worked at the Mumbai office of Trilegal. He can be reached at avirup.s.bose@gmail.com)

The Competition Commission of India (“CCI”) in a recent order dated May 17, 2012,[i] while approving a transaction between the Reliance Industries and the TV18 group of companies gave an interesting interpretation to the term “control” under the [Indian] Competition Act, 2002, as amended (“Act”)[ii]. The CCI held that the subscription of convertible securities (in the given case, Zero Coupon Optionally Convertible Debentures (ZOCDs)) with an option to convert such convertible securities into equity shares of the company confers upon such holder the “ability to exercise decisive influence over the management and affairs” of the acquired company and therefore amounts to control for the purposes of the Act. For a detailed analysis of the order refer to the discussions in the blog post by Prof. Umakanth, dated May 31, 2012.

The order provides an interesting opportunity for discussing why control is necessary for analyzing the competitive effects of a merger under any competition law regime. This is primarily because through a merger previously independent competitors can co-ordinate their price and output decisions to the possible detriment of the customers if such decisions are not sufficiently constrained by competition from rivals. In the context of merger analysis, a noted authority on antitrust law, sums up stating that: “[f]or antitrust purposes,….[a]ll that matters is that what used to be separate businesses pursuing independent profit motives have now been combined into one common ownership structure that gives the businesses a joint profit motive.”[iii] Therefore who controls the decision making of such common ownership structure is an important element for analyzing the probable anti-competitive behaviour of the post-merger entity. So if A acquires a rival firm B the determination of who controls the management and corporate decisions of the merged entity is important but also simple. However, the problem arises when A acquires only a part of the share capital of firm B or does so only for a passive investment purpose. For example in transaction referred to in the aforesaid order between Reliance Industries and the TV18 group of companies the subscription of the ZOCDs (without any voting rights) by a trust established for the benefit of Reliance Industries Limited could be perceived as granting the acquirer a mere financial interest and no corporate control over the affairs of the TV18 group of companies. The CCI thought differently and we shall discuss the reasons below.

One of the key elements in any merger analysis is to evaluate if any proposed transaction will create a corporate structure which will not be sufficiently constrained by competition from other rivals. When a firm acquires full ownership of its rival firm, the acquiring firm’s unilateral pricing incentives are affected by the fact that it now controls its erstwhile competitor. For every customer that the acquiring firm would lose for a give increase in the price of its products may now be directed towards its merged partner. This allows the acquiring firm to recapture some of the profits that would be otherwise lost absent the merger. However, when firm A acquires only a partial financial interest in a rival firm B, its rivals incentive to compete may remain unaffected thereby effectively constraining any anti-competitive pricing or output decisions of Firm A or the rival firms may tacitly cooperate to create a market concentration that leads to oligopolistic co-ordination. In these latter situations the degree of control or influence that  Firm A has over the managers of Firm B, how such partial ownership may translate into control or influence, and how this influence may translate into competitive effects is the most vital aspect of the transaction’s merger analysis[iv].

This brings us to the crux of the question that in my view the CCI attempted to analyze in the aforesaid order. How does one determine if a transaction is solely for investment purpose or otherwise?[v]The term ‘investment’ has not been defined under the Act, however, under the U.S. antitrust law, the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR Regulations, the U.S. equivalent to section 6 of the Act) provides that an acquisition made ‘solely for an investment purpose’ is when the acquirer has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.[vi] If the acquiring firm is investing in the share capital of the rival firm such intention can be evidenced by the lack of veto rights, quorum requirements at board and committee meetings etc[vii]. However, when the acquiring firm subscribes to convertible securities without any voting rights, how does one analyze lack of an intention to control the business decisions of the acquired firm. In the context of the transaction between Reliance Industries and TV 18 group of companies, the CCI perceived the ability of the acquiring firm to convert the ZOCDs anytime within ten years from the date of subscription, into 99.99 per cent of the fully diluted equity share capital of the acquired firms to confer upon the acquirer the ability to exercise decisive influence over the management and affairs of the acquired firms[viii]. If a company has a debenture holder who can convert its debentures into almost 100 per cent of the firm’s share capital anytime, it cannot but be deferential to such debenture holders views about the affairs and management of the company.

Another interesting issue regarding partial stock ownership in rival firms that needs to be made in the passing (although it definitely merits a much more elaborate discussion) is the fiduciary obligation of the directors nominated by the acquiring firm to the board of directors (“Board”) of the acquired firm. A partial equity ownership interest usually entitles the acquirer to appoint one or more directors to the Board of the acquired firm. The appointed directors of the acquirer will owe their fiduciary obligations to the shareholders of the acquired firm which would require such directors to act solely in the interest of the acquired firm and ignore the impact of its actions on the acquiring firm, even though the acquiring firm may have a large financial interest in the acquired firm. To avoid such conflicts the investment agreements between the acquirer and the acquired firms usually require that certain specific pre-determined corporate actions (‘reserved matters’) can only be adopted at a shareholder meeting of the acquired firm’s shareholders where the acquiring firm as a shareholder can vote according to its economic interests. However, items on reserved matters list should be properly scrutinized before the consummation of the transaction such that it does not raise anti-competitive issues or at-least be neutral from a competition perspective. Also, the manner in which the acquirer and its nominated directors deal with any confidential information relating to the acquired firm that such directors may become privy to in their capacity as members of the Board of the acquired firm is also a sensitive issue from a merger analysis perspective to determine anti-competitive behaviour.

In a subsequent post, I shall discuss how the issue of control and partial stock ownership is dealt in certain other major antitrust jurisdictions of the world and if they bear any resemblance with the interpretation of the CCI in the order discussed above.

- Avirup Bose

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[i] CCI order No. C-2012/03/47, dated May 28, 2012.

[ii] For a detailed discussion on how the term ‘control’ has been defined under other statutes and regulations of India, See Sandip Bhagat et al., India: Defining Control, International Financial Law Review (IFLR), June 10, 2010.

[iii] Einer Elhauge and Damien Geradin, Global Competition Law and Economics, (Hart, 2011), p. 913

[iv] What amounts to effective control depends on the facts of a particular case. The U.S. Department of Justice and the Federal Trade Commission has brought complaints and entered into consent orders under the U.S. Clayton Act limiting partial stock acquisitions for as low as ten (10) per cent of holding of voting stock (Medtronic Inc. 63 Fed. Reg. 53, 919, 53, 920 (1988)

[v] An acquisition of shares or voting rights solely as an investment that does not entitle the holder to more than 25 per cent of the total shares or voting rights of the acquired firms are ordinarily not required to be filed for pre-merger approval to the CCI. See Regulation 4 and Schedule I(1) of the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011, as amended (“Regulations”). The term ‘investment’ is not defined under the Act or the Regulations.

[vi] 16 C.F.R. § 801(1)(I)

[vii] For a discussion on whether such affirmative rights amounts to control under the Takeover Code, see the transcript of a discussion titled, Subhkam Settled; Private Equity Unsettled, November 26, 2011 at www.moneycontrol.com.

[viii] CCI order No. C-2012/03/47, dated May 28, 2012, para. 15.