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SEBI Proposes Changes In Norms For Delisting Of Subsidiaries, Protection Of Debenture Holders

Listed subsidiaries may be exempted from reverse book building if they become subsidiary under the scheme of arrangement.

The logo of Securities and Exchange Board of India (SEBI) is pictured on the door handle of a corference room at the market regulator hearquarters in Mumbai, India. (Photo: BloombergQuint)
The logo of Securities and Exchange Board of India (SEBI) is pictured on the door handle of a corference room at the market regulator hearquarters in Mumbai, India. (Photo: BloombergQuint)

The Securities and Exchange Board of India has approved many changes at its board meeting for delisting of listed subsidiaries under a scheme of arrangement, enhanced disclosures relating to forensic audit and measures for further strengthening the role of debenture trustees.

A major change relates to the delisting regulations, according to which a listed subsidiary will be exempted from reverse book building process if it fulfils the prescribed criteria. Listed entities will now also be required to disclose information on initiation of forensic audit by a third party to the stock exchanges without any application of materiality.

Here are the key proposed changes....

Delisting Of Listed Subsidiaries

The Companies Act, 2013, allows listed companies to enter into a scheme with their creditors or any class of members which may involve a compromise, arrangement or amalgamation with another entity. Any such scheme can also result in corporate debt restructuring or reorganisation of the entity’s share capital through consolidation or division of shares.

SEBI has proposed that delisting of listed subsidiaries will now be exempted from the reverse book building requirement if it becomes a wholly owned subsidiary of its parent under a scheme of arrangement.

To be sure, reverse book building is one of the price discovery mechanisms applied to determine price of shares while delisting a company. Public shareholders make bids at the price at which they are willing to sell their shares. The offer price is then determined after a closing date on the basis of prices which are above or equal to a predetermined price.

To claim exemption from this requirement, a listed holding and subsidiary company must be in same line of business. Further, the listed holding-subsidiary relation must have existed for at least a minimum period of three preceding years. Additionally, the votes cast by public shareholders favoring the delisting must be at least twice the number of votes cast against it. Both companies must also ensure that:

  • The scheme of arrangement does not violate or limit any applicable securities law or requirement stipulated by a stock exchange.

  • A listed entity must submit the draft scheme of arrangement with the stock exchanges for obtaining their observation or no-objection before filing it with the National Company Law Tribunal for its approval.

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Bhakta Patnaik, head of capital markets practice at Trilegal, welcomed the proposed changes. The stipulation that both entities should be in the same line of business will ensure that investors are able to give due importance to the consolidated value and not have to figure out the split between two listed entities while calculating their consolidated value, he told BloombergQuint.

Many delisting offers have failed in the past for non-acceptance of the price determined through reverse book building process by the public shareholders, Harish Kumar partner at L&L Partners, told BloombergQuint. The proposal would invariably avoid this risk and will ensure complete exit of the public shareholders compared with the standard delisting process where shareholders have full discretion to not accept the delisting offer, he said.

Dhruva Advisors’ Vaibhav Gupta explained that the proposed move will enable a cashless consolidation of shareholding while providing the public shareholders with access to enhanced liquidity, especially for companies which don’t have wide trading. It will be interesting to see if the restrictions on future restructuring by listed parent companies for three years as originally proposed in SEBI’s march consultation paper is also introduced, he said.

Gupta pointed out that the proposed changes may also have a tax impact on the shareholders of both entities.

The swap of shares will be taxable for the public shareholders based on the fair value of the shares of parent company which are received by them. There will also be other tax considerations around availability of grandfathering benefits of January 2018 price, applicable tax rate if securities transaction tax is not paid on the swap transaction, as well as treaty issues for non resident shareholders
Vaibhav Gupta, Partner, Dhruva Advisors

Safeguarding Debenture Holders

With an intent to further safeguard the interests of debenture holders, SEBI has proposed changes requiring debenture trustees to carry out independent due diligence of assets of a company which are being offered as a security against the debentures.

Debenture trustees will now be required to monitor the asset cover offered as a security, become a party to the inter-creditor agreement between lenders and the issuer and also obtain a mandatory certificate from auditor on a half-yearly basis.

SEBI’s proposal comes at a time when debenture trustees of leading listed entities have locked horns with issuers on the sufficiency of asset cover. For instance, IDBI Trusteeship, the trustee of debentures issued by Rural Fairprice Wholesale Ltd., a future group entity, questioned the adequacy of security cover offered by the retailer. The Bombay High Court had initially restricted the trustee from selling the pledged shares. Similar dispute also arose between the debenture trustee of Avantha Holdings which finally led to the sale of Ballarpur Industries’ pledged shares.

Explaining the rationale behind the proposals, L Vishwanathan, partner at Cyril Amarchand Mangaldas, said the changes announced by SEBI will make resolution of stress more effective. Until recently, the market regulator treated debt instruments as investment rather than credit extended by the market. Its regulations were also inconsistent with certain accepted parameters, he said.

The final regulations must provide for an enabling framework for undertaking collective action rather than piecemeal individual enforcement, conditions that are not restrictive to participate in a resolution process which protects value for all creditors and aligns the conditions for collective action by permitting decision-making in accordance with thresholds in the inter-creditor agreement
L Vishwanathan, partner, Cyril Amarchand Mangaldas

Forensic Audit Related Disclosures

A listed entity may undergo a forensic audit if a creditor, regulator, stock exchange or certain other party seeks to investigate its financials to discover any illegal activity. SEBI has observed that there are certain gaps in availability of information relating to forensic audit of listed entities due to lack of timely disclosures.

To address this shortcoming, SEBI has proposed an amendment which would require listed entities to make a disclosure about initiation of any forensic audit by a third party along with the reasons for such audit. Further, listed entities may also have to submit final forensic report after its receipt by the listed entity in certain cases.

Harish Kumar explained that warranting submission of forensic audit report will enable regulators to initiate appropriate actions for alleged wrong doings.

However, an immediate disclosure on mere initiation of the forensic audit, that too without any materiality threshold or reaching a stage of any conclusive finding may otherwise adversely impact the market sentiments resulting in unwanted fluctuations in the share price of listed entities, he said