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Brightline test for Control

Finsec Law Advisors

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SEBI has recently issued a discussion paper containing proposals to overhaul the definition of ‘control’ within the Takeover Regulations, 2009. Control is presently defined as the right to appoint majority of the directors or to control the management or policy decisions of a company. Determination of control is straightforward where these rights accrue simply based on shareholding in the company. However, as the definition also takes into account whether these rights are accruing through other arrangements, including by virtue of their management rights, shareholders agreements or voting agreements, ‘control’ has become a complex and contentious issue. Some are of the view that, by only providing broad contours of what would constitute control, there is vast scope for interpretation and a multitude of opinions. In this light, SEBI has proposed two possible options for revising the definition of control.

Adopting a numerical threshold: One option proposed by SEBI is to overhaul the definition of control entirely and base the new definition on a numerical threshold of 25%, irrespective of whether there is de facto control, and the ability to appoint a majority of the non-independent directors. The concern with this approach is that it may lead to instances where persons not in control are incorrectly adjudged to be in control while others who have control, through means other than shareholding, are left unaffected. This may undermine the intent behind the Takeover Regulations and the requirement of making an open offer on acquiring control. For the sake of simplicity of understanding and ease of working, changes to securities law cannot be made with shortcuts in reasoning.

Framework of Protective Rights: One of the concerns with the present definition is that protective rights being given to financial investors are often being interpreted as amounting to ‘control’. In this light, without overhauling the definition, SEBI proposes to create a list of protective rights that would not amount to control and may be bestowed upon investors, who have invested atleast 10% in the target company, without triggering an open offer obligation. This would include rights such as the right to appoint a non-executive chairman without a casting vote, certain veto/ affirmative rights in regard to decisions which are not part of ordinary course of business, etc. This option may be explored further, keeping in mind the need to avoid rigidities, as contentious issues faced by investors seeking protective rights are addressed by it. As any list of protective rights that do not amount to control cannot be exhaustive, SEBI may also consider instituting an approval mechanism where other contentious protective rights can be decided upon on a case to case basis.