COMPANY. I i GAUTAM GANDOTRA. Introduction. SEBl's Delisting Regulations

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2 COMPANY LAW Going Private Deals GAUTAM GANDOTRA Introduction I I I i.~ J 1. There are times when the promoters of a listed entity do not find it viable to continue to keep their entity listed on the Stock Exchanges and want to "take their company private", i.e., delist the company from the Stock Exchanges. There could be lot of reasons for this, namely, the stock market price may not be really reflective of the intrinsic value of the company's stock; market is not generally appreciative of the company's business model; the stock might have become illiquid or the promoters might be feeling that they would be better off by managing the company in a more private set-up than being publicly traded. The requirement of making various public disclosures along with the cost of running a publicly traded company with infrequently traded or illiquid stock could also add to the decision of taking the company private l. In this article, the author has briefly dealt with the key issues relating to the voluntary (and not compulsory) delisting process, for example, requirement of obtaining approvals,' price discovery through the reverse book building process,squeeze out of remaining shareholders, etc. The author would like to clarify that this article does not deal with all the finer nuances of the entire process of delisting. SEBl's Delisting Regulations 2. The regulations governing the process of delisting of a company in India are the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009("Delisting Regulations"). Under the Delisting Regulations, September 16 to 30, Taxrnann's Corpol'ate Professionals Today. Vol / 189

3 COMPANY LAW _._... --_._ a company cannot be delis ted pursuant to an offer launched by the acquirer. 2 ("Delisting Offer") unless, inter alia, (i) the company has been listed for a period of at least three years on an Indian Stock Exchange; and (ii) delisting exercise is not pursuant to a buy-back or preferential allotment of shares by the company. Kick-starting the process 3. The delisting process gets kick-started when the acquirer sends a proposal to delist the company in the form of a letter to the Board of Directors and then the Board of Directors considers and approves of the proposal in a meeting and then calls for a meeting of the shareholders to approve the delisting proposal. Approvals required prior to making public announcements 4. The following approvals should be obtained prior to making the public announcements ("PAS")3 for the Delisting Offer 4 : 4.1 Board's approval - As mentioned above, the Board of Directors of the company needs to approve of the proposal for delisting received by it from the acquirer and recommend the delisting proposal to the public shareholders of the company for their approval. 4.2 Shareholders' approval - Shareholders have to approve of the Delisting Offer by a special resolution. This resolution could be passed by way of a postal ballot following the rules applicable to the postal ballot process. In addition, the public shareholders (i.e., non-promoter shareholders) who vote, the votes cast in favour of the Delisting Offer should be at least twice the votes cast against it. This means that unless the non-controlling shareholders agree to the delisting proposal, the company will not be able to take itself off the Stock Exchanges. Therefore, the promoters/ controlling shareholders of the company cannot force their decision of delisting the company on the public shareholders. 4.3 Stock Exchange's approval- An in-principle apprpval from the Stock Exchanges, where the company is listed, would be required after the special resolution is passed. It is important to bear in mind that if the public shareholders do not approve of the special resolution as mentioned at paragraph (b) above, then the in-principle approval of the Stock Exchanges will also not come through, as the delisting proposal would be considered to have failed. Recently, in the year 2010, this has happened in the case of proposed delisting of Kennametal India Limited. 4.4 RBI's approval - Approval of the Reserve Bank of India ("RBI") would be required, which is a routine approval in such deals. 4.5 Other approvals - Based on specific facts, one would have to consider if other approvals are required. For example, approval from Foreign Investment Promotion Board, Ministry of Information and Broadcasting, Cabinet Committee of Economic Affairs, Competition Commission of India, etc. When are delisting offers made? 5. As a matter of market practice, delisting offers are made after obtaining all the required approvals from the regulators. This is because in the event the acquirer makes a Delisting Offer prior to receipt of all the regulatory approvals and thereafter there may be a delay in obtaining any of such approvals, the public shareholders might demand interest for delay in payments to be made to them or SEBImight direct the acquirer to pay interest to the public shareholders as a result of delay in obtaining approvals. The Delisting Regulations do not have any provision which allows the acquirer to postpone the timelines for making payments to public shareholders who have tendered their shares in the Delisting Offer, even if the delay in obtaining such approvals is not attributable to any wilful default or failure or negligence on the part of the acquirer. All this puts the acquirer at a risk to bear higher cost of taking the company off the Stock Exchanges. For 190/ September 16 to 30, ]nxlilann's CorpDrate PrlJfe~iSlonalsTnrJay " Vol Id

4 example, in the recent delisting of UTV Software Communications Limited, the Delisting Offer was made after obtaining approvals from the Stock Exchanges, RBI, Foreign Investment Promotion Board and Competition Commission of India. In the delisting of Nirma Limited, the approval of RBI was obtained prior to the making of PA for the Delisting Offer. In author's personal view, the Delisting Regulations should be amended to allow the acquirer to postpone the timeline for making payments to the shareholders (without having any liability to pay interest for consequential delayed payments), should there be any delay in obtaining approvals from the regulators where the delay is due to reasons otherwise than wilul default or failure or negligence of the acquirer. Pricing in accordance Regulations with the Delisting 6. For a Delisting Offer to be considered successful, i.e., in order to let a company get its shares delis ted, public shareholders have to be provided with an exit opportunity at a price to be discovered in accordance with the Delisting Regulations. Such a process is termed as the" Reverse Book Building" process - essentially, a method of getting public shareholders to voluntarily quote a price at which they are willing to sell their shares. Promoters of the company cannot participate in the Reverse Book Building process. The price at which the maximum number of shares are tendered by the public shareholders is the exit price that ought to be made available to all public shareholders ("Discovered Price"). Therefore, shareholders who hold a majority of the shares within the public shareholding would determine the Discovered Price.s In other words, the smaller the constituency of public shareholders, the greater would be the capacity of a relatively larger shareholder to dictate the price. Before the Reverse Book Building process is started, a floor price has to be computed for such an exercise. If the shares are" frequently traded" on all the Stock Exchanges where the company is listed, the floor price for the Delisting Offer ("Floor Price") would be the higher of the average of the weekly high and low of the closing market prices during a period of: (a) twenty six weeks and (b) two weeks, immediately preceding the date on which the Stock Exchanges were notified of the board meeting in which the proposal for Delisting Offer was first considered. For practical reasons, the Discovered Price will always be more than the Floor Price. This is because the public shareholders would like to make more returns on their investments by tendering the shares held by them at a price that is higher than the Floor Price. The premium of Discovered Price over the Floor Price will vary from deal-to-deal. For example, in the delisting of Atlas Copco (India) Limited, the premium to Floor Price was approximately 75%; in the delisting of BOC India Limited, the premium to Floor Price was approximately 166%; in the delisting of Sulzer India Limited, the premium to Floor Price was approximately 38%. In certain delisting deals, the acquirers even mention certain "indicative price" which is higher than the Floor Price. This is particularly done in those cases where the Floor Price is considered to be so low that there is a risk that public shareholders might not approve of II' the delisting proposal at all. For example, in :; the delisting of UTV Software Communications' Limited the Floor Price was ~ and "1 indicative price was.~ 1,000; in the delisting [ '... of Altas Copco (India) Limited the Floor Price fj was ~ 1,426 and indicative price was ~ 2,250; I' in the delisting of Sulzer India Limited the " Floor Price was ~ 855 and indicative price was fl ~ 870; in the delisting of Nirma Limited the I: Floor Price was ~ 218 and indicative price was II ~ 235. All these deals were successful delisting II deals.! i Under the Delisting Regulations, the acquirer II, 1 I: has an absolute discretion to accept or to reject r I the Discovered Price. If the Discovered Price 1... is acceptable, the acquirer has to make a public q announcement declaring its acceptance of the r.1 Discovered Price. After this, all the shares IJ validly tendered by the public shareholders I' II i Lf September 16 to TaxlTlilnn's CrJr'poI'iltn Pr'oleiiiiional:i Today Vol / 191 I;]. "'.

5 I, >:t f:"','.:, COMPANY LAW -_.._--._...._-_... "..._ " '. rj II [:1 ought to be acquired at the Discovered Price. All public shareholders who have tendered their shares validly have to be paid the same price per share. In other words, one shareholder cannot get more price per share than the other shareholder. Successful Delisting Offers 7. For a Delisting Offer to be successful, the shareholding of the acquirer, including the shares tendered in response to the Delisting Offer, would have to reach the higher of : (a) 90% of the total paid-up share capital of the company; or (b) the aggregate percentage of the pre-delisting Offer shareholding and fifty per cent of the Delisting Offer size. In short, the number of shares tendered by the public shareholders ought to be at least one half of the shares held by them, unless such shares tendered would still not take the aggregate holding to 90% or more. Therefore, for a Delisting Offer to be successful, two features are necessary: (a) the shares tendered ought to be at least one half of the residual public shareholding, subject always to a 90% aggregate holding being reached, and (b) the Discovered Price ought to be acceptable to the acquirer and the same price should be offered to all. Need of an escrow account 8. The acquirer would have to open an escrow account prior to making the PA. The initial escrow amount would be a multiple of the Floor Price and all the outstanding shares of the company held by the public shareholders. On determination of the Discovered Price, the promoter has an obligation to forthwith topup the amount lying in the escrow account to make it sufficient to make payments to all the public shareholders at the Discovered Price. Delisting Regulations allow the escrow to be funded by cash or by a bank guarantee, Typically, ;i the acquirer furnishes a bank guar~ntee in favour 1: of the merchant banker at least one day prior I! to the making of the PA and replaces the bank guarantee with cash prior to making the successful delisting announcement, so that cash can be giveti out to the public shareholders who have validly tendered their shares. As a matter of practice, the merchant banker instructs the escrow agent to pay the money due to the public shareholders by moving the amount lying in the escrow account to the special account6. After all payments have been made to the public shareholders, final approval has to be obtained from the Stock Exchanges to delist the company. Typically, the final approval specifies two dates, i.e., date from which the trading of shares of the company will stop and the date on which the company would be finally struck-off from the exchanges and get formally delisted. Exit offer 9. For a period of twelve months after the company stands delisted ("Exit Offer Period"), the remaining public shareholders have a right to sell their shares to the acquirer at the Discovered Price that was accepted by the acquirer. This right of the public shareholders is a statutory put option, under which they can make the acquirer to purchase the shares tendered by them during the Exit Offer period. Even during the Exit Offer period, the merchant banker instructs the escrow agent to pay the money due to the public shareholders by moving the amount lying in the escrow account to the special account. Squeeze-out of the rest of minority shareholders-possibilities 10. After the company is delisted and the Exit Offer period has also expired, the company could still be left with certain shareholders who did not tender the shares held by them. Such shareholders may become shareholders with a nuisance value. There are no specified procedures for utilizing the statutory provisions in the Companies Act, 1956 (" Act") to squeeze out minority shareholders in an Indian company. of 192 / September 16 to 30, 2012 TiIXIIJallll'[1 COI'plJl'ate Professionals Tor1ay Vol

6 ..._--_." , -. Upon delisting, the shares would only be taken off from trading on the Stock Exchange, and the remaining shareholders would continue to be shareholders with rights under the Act. Section 395 of the Act provides for acquisition of shareholders who dissent to a scheme or arrangement propounded by a company, provided 90% of the residual minority shareholders have approved of such a scheme. In other words, the company or the promoter could pursue a scheme to acquire all minority shareholders. If 90% of such shareholders support the proposal, the remaining shareholders can be mandatorily acquired. However, in the absence of specific procedural prescriptions on how to avail of this statutory framework, there are not too many successful precedents of majority shareholders even attempting this route. Against this backdrop, certain companies and their majority shareholders have attempted to squeeze out the minority shareholders either by mandatorily effecting a reduction of capitaf (selectively reducing the shares held by minority shareholders as opposed to effecting a reduction in proportion of shareholding of all shareholders) at a fair value, or by consolidating shares into shares of a huge face value, resulting in minority shareh6lders being left with fractional shares, with such shares being acquired at a fair value. Such selective reduction of capital (as mentioned above), has received judicial assent from a division bench of the Bombay High Court in the case of Sandvik Asia Ltd. v. Bharat Kumar Padamsi 8 The Supreme Court did not change this opinion. Conclusion 11. While the deli sting process by itself does not involvecomplications,dealing with a minority of the shareholders who have neither tendered their shares in the reverse book building process nor in the Exit Offer period could become a messy affair. While Bombay High Court's judgment in the case of Sandvik Asia Ltd. (supra) has been much criticized and could be overruled in future, it would be better to have specific procedures under the Act to squeeze out minority shareholders after a company has been delisted. Till the Act is not amended, principles of selective reduction of capital followed in the case of Sandvik Asia Ltd. (supra) may be followed. 1. Delisting was a common phenomenon in the United States in the years 1999 and companies were delisted from NASDAQ the year 2000 and 440 companies were delisted from NASDAQ in the year C.f The acquirer in Delisting Offer would be one or all of the promoters of the listed entity. 3. The key documents involved in the delisting process (apart from the usual documents required for passing the shareholders resolution) are public announcement, letter of offer, bid clim acceptance form and bid withdrawal ~I form. II 4. Besides making applications for obtaining approvals, the acquirer would have to appoint merchant banker, I... j.. escrow agent, registrar and trading member who all have important roles to perform in the delisting process. I Detailed agreements are entered into with each one of these intermediaries. These appointments have to be.' made prior to making the PA. I. 5. It is important to bear in mind that it is not mandatory for all the public shareholders to participate in the ). reverse book building process. If the promoters who have launched the Delisting Offer accept the Discovered l '.}'. Price and make a successful delisting announcement, then the remaining public shareholders who did not tender their shares in the reverse book building process can tender the shares held by them within a period of one i'l' year after the company is delisted. I have briefly dealt with this concept under the head "Exit Offer" below.!~ 6. Special account is an account from which the payments are made by the escrow agent to the public shareholder i.j upon receiving instructions from the merchant banker. The money is moved from the acquirer's account to the escrow ::1:.1. account to the special account and then given to the public shareholders who have validly tendered their shares. 7. Process that can be followed under section 100 of the Act. 8. [2009] 92 SeL 272. fj September 16 to 30,2012 Toxrnalln's Corpor'iJte Prolm;siDliiJls Today.Vol /193!I i. r pj LJ