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Combating Hostile Takeovers

Written by: Kumar Sumeet - 5th year Student, Symbiosis Law School
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The two terms - ‘mergers’ and ‘acquisition’ represent the ways by strategies used by companies to buy, sell and recombine businesses. In the present day when there exists cut throat competition in every sphere, not all mergers and acquisitions are consensual and peaceful. The concept of takeovers without consent have, therefore been ideally termed “hostile takeovers”. no consented The history of hostile takeovers can be traced to 1980’s, with the US Supreme Court for the first time sat in judgment over the anti-takeover provisions of the Illinois Business Take-Over Act and pronounced them as invalid in their landmark ruling in Edgar vs. MITE Corp.

There was a time some 2 decades back when hostile acquirers struck terror in the hearts of corporate boards.. If wealthy dealmakers wanted to take over a company in a hostile acquisition, bite it into pieces, and then spin those pieces off for a profit, there wasn’t much that the board of a company could do to stop the massacre. It was at that time that ‘poison pills’ and other anti takeover strategies were conceptualized. The anti=take over strategies developed during that era quickly transformed the takeover law and fortified the pre-emptive defenses of companies.

When an acquirer takes the control of a company by purchasing its shares without the knowledge of the management it is termed as a hostile takeover. Thus, when an acquirer silently and unilaterally, makes efforts to gain control of a company against the wishes of the existing management, such act amounts to hostile takeover. Hostile takeover is an attempt by outsider to wrest control away from an incumbent management.

Defenses against Hostile Takeovers-Shark Repellents

There are several ways to defend against a hostile takeover. The most effective methods are those where there exist built-in defensive measures that make a company difficult to take over. These methods are collectively referred to as "shark repellents".

The classic ‘poison pill strategy’ (the shareholders’ rights plan) is the most popular and effective defense to combat the hostile takeovers. Under this method the target company gives existing shareholders the right to buy stock at a price lower than the prevailing market price if a hostile acquirer purchases more than a predetermined amount of the target company’s stock.

The purpose of this move is to devalue the stock worth of the target company and dilute the percentage of the target company equity owned by the hostile acquirer to an extent that makes any further acquisition prohibitively expensive for him. ‘White Knight’ is another type of defense mechanism. In this case, a third company makes a friendly takeover offer to the company facing a hostile takeover. This is a common tactics in which the target company finds another company to enter the scene and purchase them out and away from the company making the hostile bid. The several reasons why the companies prefer to be bought out by the third company could be -- better purchase terms, a better relationship or better prospects for long-term success. At times these ‘white knight’ companies only help the target company improve the deal terms with the hostile bidder. A very good example is of Severstal which acted as a ‘white knight’ in the Arcelor-Mittal deal, and causing a 52.5 % increase in the Mittal offer.

Some other types of defenses which are available to the targeted company are:
# Pac-Man Defense – wherein a target company thwarts a takeover bid by buying stocks in the acquiring company, then taking the bidder company over.

# Staggered Board:-It is used generally in combination with ‘Shareholder’s Rights’ plan and is considered most effective. This method drags out the takeover process by preventing the entire board from being replaced at the same time. The directors are grouped into classes, each group stands for the election at each annual general meeting. It prevents entire board from being replaced at one go.

# Golden Parachute is a tactics which works in the manner that it makes the acquisition more expensive and less attractive. It is provision in a CEO's contract, which is worded such that the CEO gets a large bonus in cash or stock if the company is acquired.

Indian Legal and Regulatory Framework

Any takeover in India needs to comply with the provisions of SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997 (“Takeover Code”). It is important to understand the various terms associated with the takeover and there meaning explained in the Takeover Code.

The term ‘Target company’ refers to is a listed company, whose shares or voting rights are acquired/being acquired or whose control is taken over/being taken over by an acquirer either directly or by acquiring control of its holding company or a company which is controlling it, which is not a listed company.

As per regulation 2(1)(b), the term “acquirer” means any person who, directly or indirectly, acquires or agrees to acquire control over the target company, or acquires or agrees to acquire control over the target company, either by himself or with any person acting in concert with the acquirer. The term acquirer has been given a wide meaning as the definition takes into account not only substantial acquisition of shares by a person, but also takeover of control of the company.

As regards the term “control”, there is no exhaustive definition. It is dependent on the circumstances of the case which determines who has control over the organization. However the term control shall include:
1)The right to appoint majority of the directors or,
2) To control the management or policy decisions exercisable by a person or persons acting individually or in concert directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

An explanation was inserted in the definition of the term “control” vide SEBI (Takeovers) Second Amendment, Regulations, 2002. The explanation provides that transfer from joint control to sole control over a company is not to be considered as change in control if it has been effected in accordance with regulation 2(1)(e), i.e., through inter se transfer of shares among promoters.

The Takeover Code makes it difficult for the hostile acquirer to just sneak up on the target company. It forewarns the company about the advances of an acquirer by mandating that the acquirer make a public disclosure of his shareholding or voting rights to the company if he acquires shares or voting rights beyond a certain specified limit. However, the Takeover Code does not present any insurmountable barrier to a determined hostile acquirer.

The Takeover Code, vide Regulation 23, also imposes a prohibition on the certain actions of a target company during the offer period, such as transferring of assets or entering into material contracts and even prohibits the issue of any authorized but unissued securities during the offer period. However, these actions may be taken with approval from the general body of shareholders.

However, the regulation provides for certain exceptions such as the right of the company to issue shares carrying voting rights upon conversion of debentures already issued or upon exercise of option against warrants, according to pre-determined terms of conversion or exercise of option. It also allows the target company to issue shares pursuant to public or rights issue in respect of which the offer document has already been filed with the Registrar of Companies or stock exchanges, as the case may be.

However this may be of little respite as the debentures or warrants, contemplated earlier must be issued prior to the offer period. Further the law does not permit the Board of Director, of the target company to make such issues without the shareholders approval either prior to the offer period or during the offer period as it is specifically prohibited under Regulation 23.

During a takeover bid, it may be critical for the Board to quickly adopt a defensive strategy to help ward of the hostile acquirer or bring him to a negotiated position. In such a situation, it may be time consuming and difficult to obtain the shareholders’ approvals especially where the management and the ownership of the company are independent of each other.

The Takeover Code is required to be read with the SEBI (Disclosure & Investor Protection) Guidelines 2000 (“DIP Guidelines”), which are the nodal regulations for the methods and terms of issue of shares/warrants by a listed Indian company. They impose several restrictions on the preferential allotment of shares and/or the issuance of share warrants by a listed company. Under the DIP guidelines, issuing shares at a discount and warrants which convert to shares at a discount is not possible as the minimum issue price is determined with reference to the market price of the shares on the date of issue or upon the date of exercise of the option against the warrants. This creates an impediment in the effectiveness of the shareholders’ rights plan which involves the preferential issue of shares at a discount to existing shareholders.

The DIP guidelines also provide that the right to buy warrants needs to be exercised within a period of eighteen months, after which they would automatically lapse. Thus, the target company would then have to revert to the shareholders after the period of eighteen months to renew the shareholders’ rights plan.
Without the ability to allow its shareholders to purchase discounted shares/ options against warrants, an Indian company would not be able to dilute the stake of the hostile acquirer, thereby rendering the shareholders’ rights plan futile as a takeover deterrent.

Also, the FDI policy and the FEMA Regulations have provisions which restrict non-residents from acquiring listed shares of a company directly from the open market in any sector, including sectors falling under automatic route. There also exist certain restrictions with respect to private acquisition of shares by non-residents, under automatic route, is permitted only if Press Note 1 of 2005 read with Press Note 18 of 1998 is not applicable to the non-resident acquirer. This has practically sealed any hostile takeover of any Indian company by any non-resident.

However, for the poison pill strategy to work best in the Indian corporate scenario certain amendments and changes to the prevalent legal and regulatory framework are required. Importantly, a mechanism must be permitted under the Takeover Code and the DIP Guidelines which permit the issue of shares/warrants at a discount to the prevailing market price. These amendments would need to balance the interests of the shareholders while allowing the target companies to fend off hostile acquirers.

Possibilities in India
The DIP Guidelines do not stipulate any pricing restrictions on the issue of non-convertible preference shares, non-convertible debentures, notes, bonds and certificates of deposit. Thus, companies may consider structuring a poison pill in place whereby backend rights which permit the shareholders to exchange the rights/shares held for senior securities with a backend value as fixed by the Board, are issued to existing shareholders when the hostile acquirer’s shareholding crosses a predetermined threshold.

As most takeovers are carried out through borrowed funds, the use of backend rights reduces the profitability of the takeover because of the mounting interest rates on borrowings; thus deterring the hostile acquirer and more importantly sets the minimum takeover price, which is the price at which the shares have been exchanged for senior securities.

Another method is where a company puts a provision in its Articles of Associations to the effect that a hostile acquirer who succeeds in taking control of that company and/or its subsidiaries is prohibited from using the company’s established brand name. A live example is of the Tata companies who have put in place a an arrangement with the Tata Sons holding entity, whereby any hostile (or otherwise) acquirer of any of those entities is not permitted to make use of the established “Tata” brand name.

As a consequence, the bidder might be able to take over the target Tata company but will be shortchanged as it will not be entitled to a significant bite of its valuation — the valued brand name!!

Hostility is usually perceived when an offer is made public that is aggressively rejected by the target firm. Consequently, perceptions of hostility are closely linked with takeover.

negotiations that are far from completion. Often firms engage in confidential negotiations before there is a public announcement of a bid or an intention to bid. In some cases, the first public announcement is of a successfully completed negotiation, which would be perceived to be friendly, even if the early stage private negotiations would have seemed hostile if they had been revealed to the public. In other cases, private negotiations break down and one of the parties decides that public information about the potential bid would enhance its bargaining position.

Indian companies need to shift from desperate defensive play to getting ready on the offensive. The reason for utilizing the poison pill defense is to protect shareholder value and interest while stalling entities such as asset strippers that do not have the best interest of the company in mind or add any value to it. However, companies need to ensure that this defense is not misused by errant management. The need today, obviously, seems not to do away with poison pills, but a change in the attitude and approach of the management towards the poison pills. Not all hostile takeovers are bad; so long as the shareholders reserve the power to exercise the poison pills and take an informed decision, the pills and hostile takeovers can do more good than harm.

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