SEBI’s Covid-19 Pill For Stressed Companies – Respite Or Conundrum?
On April 22, 2020, the Securities and Exchange Board of India released a consultation paper proposing certain regulatory relaxations for listed companies facing financial stress. The relaxations proposed by SEBI seek to enable stressed companies to tide over the current distressed market situation, by raising capital through preferential allotment in a less stringent regime.
The relaxations contemplated are largely two-fold:
- A reduction in the relevant time period for determining the price of a preferential issue under the SEBI ICDR Regulations from 26 weeks to two weeks. So, this means that the current economic realities reflected in the “2-week spot price”, rather than the historic performance over the last 26-weeks, will be the basis for a further issue of shares; and
- An exemption from the open offer requirements under the SEBI Takeover Regulations for such preferential issuances.
However, these relaxations are not open to all issuers. The concerned company will first have to fulfil the specific eligibility criteria for stressed companies encapsulated in the consultation paper. Without a doubt, this is a welcome move by SEBI and should be implemented immediately. This article sets out some additional opportunities to promote entrepreneurship and risk-taking, the hallmarks of India’s promoters, and employers.
Narrow Ambit: Issuances To Promoters
The relaxations proposed under the consultation paper only apply to preferential issuance of shares by stressed companies to persons or entities that are not part of its promoter group. The infusion of capital by promoter group entities will continue to attract both the pricing guidelines and the open offer requirements prescribed under the applicable regulations. Further, any bilateral share purchase by an investor by way of a secondary market sale, including a potential buyout, will continue to trigger an open offer obligation under the takeover regulations, if the relevant thresholds are met.
The rationale for excluding infusions of capital by the promoter group remains paradoxical given the safeguard of the ‘majority of minority’ rule for shareholder resolutions concerning any transaction covered by the relaxations.
Not only does this exclusion constrict the pool of available sources of funds for stressed companies, but it also places promoters squarely between the hammer and the nail.
On one hand, promoters risk losing control of the stressed company due to the infusion of capital by a new investor, granting such investor 25 percent or more shareholding in the company. On the other, they also risk the company being declared insolvent or pursued under personal guarantees if no new investor is identified and the continued application of open offer requirements renders them financially unable to make the required capital infusion. (This can be potentially be addressed under Regulation 11 of the Takeover Regulations which grants discretionary powers to SEBI to grant exemptions upon an application being made for this purpose. However, given that the company is under financial stress, the timelines for granting exemptions under this regulation may prove disastrous.)
Preferential allotments made to entities forming part of the promoter or promoter group of the stressed company may also be brought within the framework of eligible allottees, provided that the ‘majority of minority’ rule continues to apply to such transactions as well. This will ensure that the public shareholders decide the fate of the proposed capital raising, which is perhaps the most equitable outcome and permitted by SEBI for related party transactions anyway.
When the need of the hour is to save a company, a blanket ban on any source of capital seems excessive and prevents promoters to stretch themselves for a workaround.
The exclusion of secondary market transfers from the relaxations prevents potential acquirers from taking advantage of the stress situation of the company and attempting a hostile takeover through the acquisition of shares from shareholders, other than the promoter group. Such takeovers are particularly attractive to the public shareholders, regardless of the past performance of a distressed target, as it provides an opportunity for them to assess if they wish to exit. For the acquirer, economies of scale and cost savings are possible. In our view, in addition to extending the relaxations to the secondary market, use of shares or other securities as acquisition currency should also be encouraged, so that the target can be absorbed in a larger group, and mitigate the risk of business failure. Such large acquisitions would require approval not only from lenders, but also shareholders of the acquirer, and thus be closely scrutinised anyway from a governance standpoint.
Acquisition Of ‘Control’ Not Exempted From Open Offer Requirement
The exemption from the open offer requirement under the consultation paper has been granted only for transactions involving the acquisition of 25 percent or more shareholding in a company. Any acquisition of control—without meeting the numerical threshold of 25 percent—continues to be subject to completion of an open offer.
This leaves the pie half-baked at both ends as any incoming investor in a distressed company would look to change its management.
Indeed, the Reserve Bank of India insists upon a change in control for its asset classification norms. Such an investor often requires board seats, deep changes in management, and some affirmative voting rights over the affairs of the company which would allow it to acquire de facto control over the company. All of this should be permitted to allow capital to be infused. Here the consultation paper takes a very simplistic view that someone would rescue a sinking ship but retain the captain.
Do Present Circumstances Merit Greater Relaxation?
Since the relaxations proposed under the consultation paper apply only to stressed companies, the riders attached to the relaxations must be viewed with a pragmatic lens, so that the full medicine of rescue capital can be applied and the patient can recover. The riders and conditions make it very challenging for distressed companies to undertake a simple transaction where public shareholders—through the majority of minority rule—are the ultimate deciding force. This just increases the cost of capital for our issuers, who are competing against similarly placed businesses in South Asia for capital, that too in times of an ongoing pandemic.
Bharat Anand is Partner, Saurav Bhaumik and Ranjini Gogoi are Associates, at Khaitan & Co LLP. Views are personal and do not constitute legal / professional advice of Khaitan & Co. For any further queries or follow up please contact us at firstname.lastname@example.org.
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