DEMYSTIFYING THE CONUNDRUMS OF HOSTILE TAKEOVER WITH DVR MECHANISM
Author: Avik Sarkar, IV Year of B.A.,LL.B, from K.L.E Society's law college, Bengaluru.
In developing countries such as India, startups play a very significant role in boosting the economic growth of the country. The startups are looked into as the future of the country. But of late it has been observed that startups are apprehensive of raising capital and going for expansion. It is speculated that this change in behavioral pattern is due to the fear of hostile takeovers, one of them being the takeover of Mindtree by L&T.
This paper thoroughly discusses the takeover of Mindtree by L&T along with a potential solution to prevent hostile takeovers by using the mechanism of DVR. It has been speculated that the DVR mechanism will ameliorate the position of the promoters, thereby helping to channelize their focus towards the expansion and growth of the company.
The concept of corporate takeovers has become quite normal in the contemporary world compared to that of hostile takeovers. Especially, in a country like India where the promoters of a business keep the management of the company in their hands, a hostile takeover seems to be an equivalent to the rarest of the rare cases. In a simplified understanding, as opposed to friendly takeovers, hostile takeovers are situations where one company (“Acquirer”) is inclined towards controlling a stake in another company (“Target”), against the wishes of the target company. Hostile takeovers can be executed in the following ways.
The acquirer directly approaching the shareholders of the Target company. By displacing the management of the Target to get the acquisition approved. 2019 is looked into as a landmark year in the M&A space of India as the first-ever hostile takeover occurred in the form of L&T acquiring Mindtree.
The seed for Mindtree’s downfall was planted from the time when café coffee day started incurring losses. One must be thinking that how is that even possible? But, V.G Siddhartha who was the founder of Café Coffee Day was also the holder of the majority stake equivalent to 20.4% in Mindtree. And due to his debts in Café Coffee day, he was the first one to sell his 20.4% so that he could repay his debts and absolve himself from all the liabilities. On the contrary, the promoters of Mindtree themselves had only 13.32% of the stake, thereby making them a low hanging fruit for the takeover.
This was followed by an order to purchase a further 15% stake before an open offer for buying 31% voting shares in consonance with the requirements under regulations 3(1) and 4 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeover) Regulations, 2011.
As per reports, L&T has acquired 60% share of voting rights in Mindtree. It happened after foreign portfolio investor Nalanda Capital sold its entire 10.61% stake in the company.
Therefore, for L&T, who entered into a share purchase agreement (“SPA”) with Siddhartha, Mindtree has been an addition to their IT services portfolio along with L&T’s two listed technology firms, L&T Infotech Ltd. and L&T Technology Services Ltd. With this L&T had a golden opportunity to shed its ‘construction company’ tag and play the chasing game with Infosys and Tata Consultancy Services.
Defence opted by Mindtree
There were many impressive defences that were opted by Mindtree in order to save itself from the hostile takeover. Some of them are as follows:
Mindtree highlighted the difference between the work cultures of both the companies.
It tried to buy back its own shares but later on scrapped their plan.
Declaration of special dividends which is also known as the ‘poison pill’ defence so that it could win over its shareholders' trust. Through this action, the company had thrown a lot of questions as it was stated that the company was not adhering to the SEBI rules and regulations.
Till date, there has been a lot of discussions with regards to the defence that would help companies fight against future hostile takeovers.
Differential voting rights—a need for the hour
DVR is normally seen as an alternative to the prevalent rule of one share one vote. Here, different shares have different weightage. They can be broadly classified into two types, i.e., Superior Voting Rights (SR) and Fractional Voting Right (FR). DVR is a very attractive gambit for all the promoters to ward off the potential chances of a hostile takeover. And, therefore, the promoters have the freedom to raise capital without diluting control. Tata Motors uses the same mechanism of DVR in their company.
According to Section 43(a)(ii) of the Companies Act, 2013 a company limited by shares to have equity share capital with differential rights as to voting or dividend in accordance to rule 4 of the Companies (Share Capital & Debenture) Rules, 2014.
According to rule 4 of the Companies (Share Capital & Debentures) Rules, 2014:
1. The issue of DVR must be in accordance with the Articles of Association (AOA) of the Company.
2. Issue of DVR is approved by an ordinary resolution at the General Meeting. If a company has more than 200 members, then it is required to pass the resolution through postal ballot.
3. Shares with DVR shall not exceed 26% of the total post-issue paid-up equity share capital including equity shares with differential rights issued at any point of time. There is no limitation on the amount of superior or inferior voting right attached to the equity share, which means a company may issue DVR which have voting rights more than 26 %, but total post-issue paid-up equity share capital shall not exceed 26% including shares with DVR issued at any point of time.
4. Consistent track record of distributable profits for the last three years
SEBI guidelines with regards to DVR
The relaxation allowed by SEBI to issue DVR is given keeping in mind that it has to protect the interests of minority shareholders. Thus, SEBI has tried to create an equipoise by safeguarding the interests of minority shareholders once the company becomes public. According to the framework the unlisted companies are restricted from issuing DVR’s and thereby allowing only tech companies to come out with an IPO in which the promoter group is not permitted to hold SR exceeding Rs 500 crore. The IPO has to comprise only ordinary shares and further issue of SR is not permitted in any form. The guidelines ensure that the shares are only used for the limited purpose of raising capital without losing out on the majority voting power. SR shall be given weightage equivalent to 10 votes per share. The SR shares shall comprise of a “sunset clause” wherein they will convert into ordinary shares after five years of issue. The provision looks to provide growth in companies in terms of operations, profitability, caters to the needs of the investors, thereby ensuring stability in management.
The above-mentioned framework by SEBI prima facie looks very attractive to start-ups who are in their nascent stage. SEBI’s framework for SR shares provides enough protection to the promoter of a company in the event of a hostile takeover. It will also help the promoters of the company to channelize their focus into the growth of the company without having the fear of losing considerable control of it. On the contrary, SEBI’s framework has raised apprehensions that public investors may be wary about investing in a company that has a large proportion of DVR shares.