M&A activity caught in legal bind

Recent developments in the Ranbaxy deal have heightened debate over the issue of conducting due diligence of operations of listed companies and whether an adverse development could lead to an open offer under the Sebi (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations”) being aborted.
The initiation of legal proceedings for discovery of documents from Ranbaxy had sent the media into a spin about whether the development would enable Dai-ichi to back off from the agreement with Ranbaxy promoters and whether the open offer to the public would still stand. Of course, the agreement had always been announced as being a binding one and the ongoing dispute that Ranbaxy had with the UFDA too was public knowledge.
Yet the stock price crashed and then shot back up after the promoters clarified that the agreement was a binding one — that is a separate telling story of how informed investment decisions are in India.
However, this experience has thrown up a larger issue that is plaguing M&A activity in India. In an earlier edition (Without Contempt – November 5, 2007), this column spoke about problems with the drafting of the Sebi (Prohibition of Insider Trading) Regulations, 1992 (“Insider Trading Regulations”), which prohibits communication or counseling of unpublished price-sensitive information.
The Insider Trading Regulations also provide that in a charge of violation, it shall be a valid defence to show that the dealing in securities was “as per” the Takeover Regulations.
The scope of the term “as per” has been a subject matter of immense ambiguous debate among law practitioners and M&A investment bankers. A general consensus among practitioners is that a transaction that would trigger an open offer under the Takeover Regulations would be exempt from the prohibition on communication or counseling of information since no one can be reasonably expected to execute such a large control-based transaction without conducting due diligence.
If the acquirer in question were itself a listed company, it would be fastened with an even higher standard and duty of care to ensure that it conducts due diligence since its board of directors would owe a public obligation to shareholders to ensure that their company is only making an informed investment and not taking a shot in the dark.
What has thrown a bigger cat among the pigeons is a recent decision of the Securities Appellate Tribunal (“SAT”) upholding Sebi’s refusal to permit an acquirer to withdraw an open offer. In that case, the acquirer was a pledgee of a listed company’s shares and had to enforce the pledge.
Consequently, it came to acquire more than 15 per cent shares of the listed company, and therefore had to make an open offer (Disclosure: the acquirer was represented by this author’s firm). The acquirer had made the open offer on the basis of publicly available information, which included the fact that the listed company was not in good financial shape.
After invoking the pledge and taking control, the board of directors of the listed company discovered that fantastic amounts of money had been siphoned out of the listed company by the former management and promoters. An audit was commissioned and all the material was placed at Sebi’s doorstep, seeking withdrawal of the open offer. A pledgee, naturally being on hostile terms with the pledgor in an enforcement situation, would not be able to conduct any special due diligence before enforcing the pledge.
Sebi rejected the application for withdrawal on the sole ground that the acquirer ought to have conducted due diligence before invoking the pledge and that in any case it was public knowledge that the listed company was financially weak. It is another matter that the former management is not being investigated or prosecuted by the regulator despite the strength of the teeth of the audit findings by the new board of directors. The acquirer argued that it was equally an investor and needed to be protected from fraud, and that a company being weak was quite different from the company being defrauded by its promoters.
The argument was that one could take an informed call on company being weak, but since it was discovered after the open offer was announced that the company was being defrauded in a big way, Sebi ought to use its powers under the Takeover Regulations that enable Sebi to permit such an application for withdrawal. The SAT has agreed with Sebi’s argument that due diligence had to be conducted and acquirers should not be allowed to be relieved of bad bargains.
The controversy will travel in appeal. But for now, acquirers are in a fix. At one end is a prospect of being accused of violating the Insider Trading Regulations (in non-hostile takeovers), and on another is the prospect of being stuck despite acute fraud (in hostile situations). Whoever said M&A activity in India is a walk in the park?
The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own
Somasekhar Sundaresan / New Delhi July 21, 2008, 0:56 ISTwww.business-standard.com


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