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by Nandish Vyas and Pranati Ishwar
Whilst the noted work ‘The Anatomy of Power’ (John Kenneth Galbraith, 1983) is written in the context of establishing that there are different sources of power which enable the imposition of will, and that different types of power can be obtained through such different sources, the examination of the anatomy and composition of “power” which has been undertaken in the book is a necessity, which is also entirely relevant to the manner in which the concept of “control” is defined in Indian laws and regulations, and the manner in which such definitions are interpreted by courts and regulatory authorities.
At a very broad level, an overview of the various definitions and the judicial interpretations in India in relation to the definition of “control” would suggest that the law-makers and the courts have deliberately avoided providing a precise and exhaustive definition to the term “control”. Whilst this approach is entirely appropriate (given that the question of whether or not “control” is acquired often requires a detailed factual examination), the outcome of this approach has been that no clarity has emerged even at a broad and non-specific level, as to what nature or quantum of control should be regarded as trigger points for the applicability of various legislations. Particularly, with respect to securities and economic regulations such as the Takeover Code and the Competition Act, there has been a cloud of mystery surrounding the view which the regulator will ultimately take, which has led to significant uncertainty regarding this crucial concept.
In this context, it is first necessary to examine whether at all there can be different levels of control exercised over an enterprise, which achieve a distinct and different result or outcome as regards the management and affairs of an enterprise. In the view of the authors, “control” can be possibly be classified into the following levels, each of which has a distinct and different effect:
Level 1: Ability to have an influential voice in decision making, without any ability to either direct, or block, decision making
Level 2: Ability to block decision making only through the form of negative control, such as veto rights or a particular quantum of shareholding (in such situations, a different person or group has the ability to control day to day management of the enterprise)
Level 3: Ability to effectively exercise control by virtue of being the largest shareholder, typically amongst a dispersed body of shareholders (a classic example of ‘de facto control’)
Level 4: Clear positive control possessed by the person on account of factors such as majority shareholding, ability to appoint the majority of the board of directors, and consequently the ability to manage day-to-day affairs of any enterprise on an ongoing basis (often, the actual control achieved by virtue level 3 and level 4 could be almost identical)
Level 5: Ability to exercise absolute and unfettered control (e.g. over 75% ownership without any fetters on control such as negative control, etc.)
Interestingly, several commentaries on the subject do not even recognize level 1 and level 2 as being types of control, and refer to the range of control as being within de facto control to absolute control – in other words, falling within level 3 to level 5. Further, even de facto control is recognized as being exercisable by an existing management. However, there could be a few cases in which it can be argued that control of the nature described in level 2 can potentially amount to having control over a target enterprise (discussed in greater detail later).
As indicated above, divergent judicial views have been arrived at with respect to the term “control”. For example, in 2001, in Rhodia SA v. SEBI, the Securities Appellate Tribunal (“SAT”) held the acquirer in question to be in control as it had veto rights on “major decisions on structural and strategic changes”. In the Sandip Save case (2002), SAT took a view that rights acquired by IDBI in relation to a listed company, which included a reasonably wide set of matters which required the prior consent of IDBI, did not amount to an acquisition of control, on the basis that the parties did not have the ‘intention’ that IDBI would control the company, and that IDBI had never actually interfered in the management of the company. More recently, in 2010, in the widely publicized SAT decision in Subhkam (now virtually rendered redundant by the Supreme Court), it was held that the acquisition of only positive or proactive power to direct over a company would amount to an acquisition of “control”, and that the acquisition of a negative or reactive power would not qualify as an acquisition of control, since the definition of control required the acquirer to be in the ‘driving seat’. The SAT analyzed an extensive set of negative rights in the Subhkam case, and held that they were only provided for the purposes of protecting the investment and did not amount to providing day to day control or management control to the acquirer.
However, whilst SAT appears to have liberalized its view over a period of time, there is a continued lack of clarity with respect to the scope of “control” even today, on account of the much more stringent views of SEBI on the subject, the specific observation of the Supreme Court in the Subhkam appeal to the effect that the SAT decision in Subhkam should not be regarded as a precedent, and the recent CCI decision relating to the acquisition of shares of holding companies of Network 18 group by a trust, of which Reliance Industries Limited was the beneficiary. Specifically, an element of concern in the Network 18 decision is that the CCI appears to have observed that acquisition of a right to convert debentures into equity shares at a later stage itself amounts to conferring the ability to exercise ‘decisive influence’ over the management and affairs. Whilst in the said case, control over the target could have been acquired at a later point in time upon conversion of the securities, the effect of the observation of the CCI is to subtly broaden the scope of the definition of control, since the acquirer was construed as having already acquired control – or ‘decisive influence’ – over the target, by acquiring securities which could have resulted in acquisition of control over the target at a later date.
The CCI decision in the Network 18 case also leads one to compare the definition of control in the context of the Takeover Code, and the definition set out in the Competition Act. Whilst these definitions are couched in different language, it is likely that a ruling by a higher appellate authority, or the Supreme Court, in the context of either of these definitions, would have persuasive value in the context of the other definition.
Under the Takeover Code, “control” is defined to include the right to appoint majority of the directors or 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. In comparison, the definition contained in the Competition Act is slightly cryptic, and provides that control includes “controlling the affairs or management” of an enterprise.
Whilst the substance of the definitions appears to be similar, there are distinct matters which need to be considered for each of these legislations. For example, a matter which merits detailed consideration for the purposes of the Competition Act is whether a clear test of being “in the driving seat” needs to be applied for testing acquisition of control. In this regard, the authors submit that since the ultimate objective of the merger control law is to prevent a transaction which causes, or is likely to cause, an ‘appreciable adverse effect’ on competition, the test which would need to be logically applied for the purposes of the Competition Act is whether the level of control acquired is of such extent as would enable the acquirer to have the ability to consistently determine the competitive behavior of an enterprise. In this specific context, control in the nature of negative rights is rarely relevant, as such rights only allow a person to prevent certain actions, but can rarely confer the ability to control the behavior of an enterprise, so as to affect market dynamics on an ongoing basis in order to cause an ‘appreciable adverse effect’ in a particular market. More particularly, at least where the investment is made by an investor who is not engaged in the same strategic business as the target, a test of this nature seems to be entirely irrelevant. This issue is of particular significance, since the regulations framed pursuant to the Competition Act now exempt an acquisition of shares in the ordinary course to the extent of 25% of the shares or voting rights of the target enterprise, unless such acquisition results in the acquisition of control over the target enterprise. Therefore, unless clarified, this issue has the potential of resulting in a spate of needless notifications to the CCI.
As regards takeover laws, the question may be slightly more difficult, as one of the primary objectives of the law is to provide a suitable exit opportunity to shareholders in the event that a new person acquires control of the company. Presently, the general practice of limiting rights acquired by an investor, so as not to be construed as acquisition of control, appears to be based (i) on market precedents in which a limited set of rights has been granted to investors (not resulting in a requirement from SEBI to undertake an open offer), and (ii) to some extent, on the principle that rights which could amount to providing control over business items which are in the ordinary course (as opposed to merely certain ‘protective’ rights), would possibly qualify as acquisition of control.
Whilst the way ahead in terms of an ultimate judicial determination of the issue is definitely not clear, in the view of the authors, some principles which could be considered (for the purposes of securities and economic legislations) in the context of this issue are as below.
The introduction of new concepts which are broad in nature does not appear to be assistive in clarifying any ambiguities in the concept of “control” – for example, the ‘decisive influence’ test which seems to be considered by CCI, or the concept of ‘ability’ to control (in addition to the words ‘right to control’) as was sought to be originally included in the definition of ‘control’ in the proposed draft of the new takeover code, appears to only further complicates an understanding of the matter.
Secondly, in cases where only negative rights are acquired pursuant to an acquisition, it must be acknowledged that such acquisition admittedly does not result in the taking away of the de facto management control, or day to day control, from existing hands. It is therefore relevant, to a limited extent, that control over day to day affairs continues to vest in the same hands, as prior to the acquisition.
Lastly, based on the various principles discussed above, whilst it is overly ambitious to attempt to define ‘control’ in precise and exact terms, broad guidelines could at least be formulated to identify certain protective rights, the acquisition of which could be construed as not amounting to acquiring control. The formulation of such guidelines may go a long way in at least identifying transactions which are clearly non-problematic from a regulatory perspective, and in better understanding the anatomy of control for the purposes of Indian regulations.
Nandish Vyas (pictured left) is a Senior Associate and Pranati Ishwar (pictured right) is an Associate at AZB & Partners. The views expressed in this article are the personal views of the authors and do not represent the views of the Firm.