1. Background & Objective

1.1  Given the recent unprecedented events, various regulators in the country are deliberating upon updating the prevailing laws and regulations to, amongst other things, help Indian corporates tide over these difficult times. A recent example of such initiatives are the amendments introduced by the Securities and Exchange Board of India (“SEBI”) to the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“SEBI ICDR Regulations”) and SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SEBI Takeover Regulations”), by SEBI’s notifications dated June 22, 2020 (collectively, the “Amendments”).[1]

1.2  Following a consultation paper issued by SEBI earlier in April 2020 in this regard[2], the Amendments introduce certain relaxations in respect of pricing of preferential issues and exemption from an open offer obligation for acquisitions in companies having ‘stressed assets’. It was observed that, typically, listed companies having ‘stressed assets’ experienced a progressive fall in their share price, and that lack of funding at such a crucial stage could lead to a major disruption in the functioning of the operations of such companies. Accordingly, these Amendments have been introduced with the aim of assisting listed companies that are facing financial stress and need imminent funding, in raising capital through preferential allotment under a more liberalized regime.

2. Overview of the Amendments

2.1 Relaxation in pricing: Pursuant to the Amendments, SEBI has inserted Regulation 164A in the SEBI ICDR Regulations, which provides that the pricing of any preferential allotment undertaken by a listed company having ‘stressed assets’ would be based on the average of weekly high and low of the volume weighted average price for two weeks preceding the relevant date[3]. Considering the steady decline in the share prices of such companies, the price determined by applying the original criteria may no longer be representative of the prevailing market price of the stock and accordingly, not be a commercially viable proposal for any potential investor. This mechanism is similar to the prevailing pricing norms applicable to Qualified Institutional Placements.

2.2  Exemption from open offer: In addition to the above, SEBI has introduced Regulation 10(2B) in the SEBI Takeover Regulations, which provides that any acquisition of shares or voting rights or control pursuant to a preferential allotment undertaken per Regulation 164A of the SEBI ICDR Regulations (as referred to above) shall be exempted from making an open offer under: (i) Regulation 3(1), which provides for a mandatory open offer to public shareholders in case of acquisition of 25% or more of the voting rights in the listed company; and (ii) Regulation 4, which provides for a mandatory open offer to public shareholders in case of acquisition of direct/indirect control over the listed company.

2.3  Objective criteria for determining whether a company has ‘stressed assets’: The exemptions under the Amendments can only be availed by listed companies that satisfy any two out of the following three conditions:

i. The company has made disclosure of defaults on payment of interest/repayment of principal amount on loans from banks/financial institutions /NBFC SI and listed and unlisted debt securities for two consequent quarters in terms of SEBI circular dated November 21, 2019 and such default is continuing for ninety (90) days;

ii. Existence of inter-creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 dated June 07, 2019;

iii. The downgrading of credit rating of the listed instruments of the company to “D”.

2.4 Additional eligibility conditions. The issuer company undertaking a preferential issue under Regulation 164A of the SEBI ICDR Regulations would need to ensure compliance with the following conditions:

i. Eligible allottees: Allotments can only be made to persons/entities not forming part of the promoter and promoter group of the company.

ii. Majority of minority approval: Any such preferential issue is required to be approved by the majority of minority shareholders of the company (i.e., the promoters, the promoter group, and any proposed allottee in the preferential issue that already holds specified securities in the company are not counted for this purpose). In a situation where the company does not have an identifiable promoter, the votes cast in favour of the resolution would need to be at least three times the number of the votes, if any, cast against it.

iii. Lock-in: Allottees will be subject to a three-year lock-in as against a one-year lock otherwise imposed under the SEBI ICDR Regulations for preferential allotments

iv. Restrictions on proceeds of preferential issue and monitoring the use of proceeds: The proceeds of such preferential issue shall not be used for any repayment of loans taken from promoters/ promoter group/ group companies and shall be disclosed in the explanatory statement sent for shareholder resolution. Further, the company would be required to appoint a monitoring agency for monitoring the use of such proceeds, and the audit committee of the company would also need to monitor the utilization.

v. This preferential allotment shall be subject to other condition such as negative list of allottees not eligible for this exemption and certification by the statutory auditors.

3.  Viewpoint

i. These Amendments are positive steps and an incentive that will ease rules for equity financing to ‘stressed’ listed companies and at the same time result in an increase in interest from investors given that they will no longer be burdened with an open offer obligation under the SEBI Takeover Regulations. The Amendments would incentivize bailout transactions by making them cost-efficient for acquirers.

ii. While critics could argue that the Amendments deprive the public shareholders an exit route when there is substantial acquisition of shares or change in control; in the greater scheme of things, the revival of a stressed listed company could, in turn, be beneficial for minority shareholders given that, after all, such an infusion will only improve the long-term equity value for all shareholders.

iii. These Amendments also raise the following pertinent questions

(a) Why are the promoters excluded? There is no apparent rationale for the exclusion of promoter and promoter group from availing the benefits under the Amendments. It remains to be seen whether SEBI would relax this further in the months to come since this is anyways subject to approval of public shareholders. If the purpose of this amendment is revival of stressed companies, it makes one wonder why does the inclusion of promoters not achieve this objective. While one can argue that a promoter seeking to infuse funds into the stressed company can make an application to SEBI seeking an exemption from open offer, depriving of him of pricing benefits would be a deterrent.

(b) Is the acquirer also exempted from getting classified as promoter? Not yet. It remains to be seen if SEBI provides guidance on whether such investors are also exempted from being classified as a ‘promoter’ of the listed company which is an important element given that financial investors could be vary of the proposition of being classified as a ‘promoter’ of a ‘stressed company’.

(c) Is this exemption from open offer also applicable to creeping acquisition? No, it only applies to acquisition under Regulation 3(1) of the Takeover Regulations. However, a separate notification by SEBI on June 16, 2020 permits creeping acquisition up to 10% per financial year (as against 5% earlier) on account for preferential issue. This benefit has been granted till March 31, 2021.

Interestingly, the Amendments provide an effective cure to ‘stressed’ listed companies. This is indeed positive. However, prevention is better than cure and one does wish that these Amendments should be extended to companies that are likely to be categorized as ‘stressed’ by providing certain objective parameters. This flexibility would, after all, only aid in capital infusion in a cost-efficient manner and, ultimately, help the stakeholders.

Please note that this article is generic and is for discussion purposes only. It should not be construed as legal advice from AZB in any manner whatsoever. You are requested to seek appropriate legal advice before entering into any transaction.  

Authors:

Vaidhyanadhan Iyer, Senior Partner
Vasudha Asher, Senior Associate
Farah Titina, Associate   

Footnotes:

[1] (1) Securities And Exchange Board of India (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations, 2020; and (2) Securities And Exchange Board of India (Substantial Acquisition of Shares And Takeovers) (Second Amendment) Regulations, 2020.
[2] SEBI consultation paper on Preferential issue in companies having stressed assets dated April 22, 2020.
[3] As against higher of (a) the average of the weekly high and low of VWAP of the related equity during 26 weeks preceding the relevant date, or (b) the average of the weekly high and low of VWAP of the related equity shares during the 2 weeks preceding the relevant date.