Takeover Code & Exemptions for Debt Restructuring
Vishal Achanta May 19, 2016
Recently, there has been a spike in the number of ‘bad loans’ in the Indian banking system, in response to which the banking regulator put in place a debt restructuring framework called the Strategic Debt Restructuring (“SDR”) scheme enabling lenders to take control of defaulting corporate borrowers. Two other schemes for debt restructuring are also available to lenders – the Corporate Debt Restructuring (“CDR”) scheme, and the Joint Lenders’ Forum (“JLF”) scheme. These debt restructuring schemes have seen a degree of success.
During a debt restructuring, lenders may take haircuts, but they may also convert loans given to a borrower-company into equity. Converting loans to equity has certain advantages: it gives the company a longer runway to improve its performance without having to make principal and interest repayments, and may also give the lender a chance to unlock the value of the company in a stake sale.
However, taking an equity position in the company results in the lenders’ fortunes being very tightly bound to the fate of the company, and therefore, lenders must ensure that the company performs well. In such situations, even if the lenders gain control over the company, they may not wish to take on the burden of running a large company on a day-to-day basis, and are not always comfortable with showing the company’s management the door. This is driven by practical considerations: stability in top management roles after a lender-led takeover may be desirable from both an optical as well as an operational perspective (though in some cases, lenders may take control for the sole purpose of replacing the extant management).
A loan conversion may therefore result in a situation where the lenders have formed a de facto JV with the management/promoter, with each holding large equity stakes. In these cases, lenders would usually require the extant promoter to show more ‘skin in the game’ i.e., take up more equity in the company to show their commitment to a turnaround, before restructuring the debt. The event of the promoter taking up more equity may, however, become an issue in listed companies due to the rules issued by the Securities and Exchange Board of India (“SEBI”) governing substantial acquisitions of shares and takeovers (“Takeover Code”).
As per the Takeover Code, an acquirer of a listed company’s shares is required to make an ‘open offer’ i.e., offer to buy a minimum of 26% of the company’s shares from public shareholders, so as to offer them an exit, in these situations: (i) when the acquisition of shares/voting rights puts the acquirer in ‘control’ of the company, and (ii) if the acquirer already holds a 25% stake in the company (as a promoter usually would), and subsequently acquires an additional 5% stake in a financial year.
Making an ‘open offer’ is a costly affair (and in the case of a promoter-made open offers in a restructuring context, may shift the dynamics of ‘control’ of the company in a manner undesirable to lenders) – consequently, it could be a roadblock for restructuring packages if
lenders/promoters were required to make open offers in respect of shareholding increases that occur during implementation of restructuring packages, such as (i) loan conversion, or (ii) infusions by the promoter.
Therefore, the Takeover Code exempts lenders who acquire ‘control’ of a company when loans are converted into equity pursuant to restructurings under the SDR scheme from making an open offer. Further, the Takeover Code also exempts persons already in control (this would apply to promoters) who acquire shares pursuant to restructuring under the CDR scheme from making an open offer. Lastly, the Takeover Code also gives acquirers the option of approaching SEBI to obtain a case-specific exemption from making an open offer. However, there are no other exemptions from making an open offer in the context of a debt restructuring.
A recent SEBI order (“re Diamond Power”) now gives comfort that lenders/promoters will be exempted from having to make an open offer when there is an open offer-triggering increase in shareholding pursuant to a JLF restructuring. In re Diamond Power, a company underwent debt restructuring under the JLF scheme (debt restructuring under the JLF scheme was chosen over restructuring under the CDR scheme, since the JLF scheme was perceived to be a speedier method to restructure the debt). As per the terms of the restructuring package, the promoters were required to infuse debt into the company which would later be converted into equity. Upon such conversion, the promoters would trip the Takeover Code’s threshold for making an open offer, and thus, the promoters sought an exemption from having to make an open offer – as mentioned above, the Takeover Code contains no specific exemptions from making an open offer for acquisitions pursuant to a JLF restructuring, like it does for acquisitions pursuant to restructuring under the CDR scheme.
The whole-time member of SEBI reasoned that since (i) the JLF scheme was similar to the CDR scheme, (ii) the promoters were already in control of the company, and (iii) the promoters would be acquiring shares at a price greater than the market price of the scrip and thus would not be gaining an unfair advantage, the promoters could be exempted from making an open offer.
Re Diamond Power was followed by a favourable informal guidance given by SEBI exempting promoters from making an open offer during restructuring under the CDR scheme. Re Diamond Power also stands in contrast to another recent SEBI order where promoters were denied an exemption from making an open offer when asked to infuse funds via warrants by lenders. In that case, the proposed conversion price of the warrants was lower than the price the scrip was trading at, and the proposed infusion was not made under a JLF restructuring – the former seems to have led the whole time member of SEBI to conclude that an exemption from making an open offer would not serve the interest of public shareholders.
The takeaway from the above is that in line with the regulatory trend of making life easier for lenders, SEBI may look favourably upon requests for exemption from making an open offer in a debt restructuring context, while carefully scrutinizing the restructuring package on parameters like pricing and mode of restructuring to ensure that public shareholders are
protected and promoters do not gain an unfair advantage. These points must be kept in mind when putting in place a restructuring package that might require a green light from SEBI.
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