Recent Relaxations in the Capital Market Regulations: A Brief Analysis
Indian companies, across sectors, are currently facing a serious challenge, in the wake of the COVID-19 pandemic, and require funds to tide over the present economic crisis.
While there are various methods for raising capital, preferential allotment has been the most preferred route (especially for listed companies) to raise funds from investors on private arrangement basis as it involves lesser regulatory formalities and helps companies receive investment in a relatively short span of time.
However, listed companies are required to comply with, among others, the pricing norms set out under Regulation 164 of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations).
The manner for determining the issue price for preferential allotment of equity shares of a listed company depends on whether the company’s equity shares are frequently traded[1] or not.
In case of a listed company whose shares are frequently traded, the issue price cannot be less than the higher of the average of the weekly high and lows of the volume weighted average prices of the related equity shares during (a) 26 weeks or (b) 2 weeks, preceding the relevant date (being the date 30 days prior to the date on which the meeting of shareholders is held to consider the proposed preferential issue).
In addition to the pricing norms, an investor proposing to invest in a listed company has to be mindful of the open offer norms set out under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code) which would trigger in the case of the following acquisitions: (a) 25% or more equity shares or voting rights in a listed company, and/or (b) control of a listed company. Further, acquisition beyond 5% equity shares or voting rights in a financial year by a person holding 25% or more but less than 75% voting rights attracts the open offer requirement.
While several listed companies (especially stressed companies) were looking to raise capital from potential investors so as meet their funding requirements and in some cases, to arrive at a resolution plan with the lenders outside the insolvency and bankruptcy framework, the pricing norms and the mandatory open offer norms were acting as deterrents in the fundraising plans of these listed companies – especially in view of the falling stock prices on account of the economic impact caused by COVID-19.
In order to help listed companies tide over the liquidity crisis created by the COVID-19 pandemic, the Securities and Exchange Board of India (SEBI) has notified a series of relaxations/reforms.
We have, in this article, set out our analysis of various reforms and relaxations announced by SEBI.
On 22 June 2020, SEBI notified the much awaited relaxations in the pricing norms for preferential allotment and the mandatory open offer rules[3].
Increase in creeping acquisition limit for promoters
The Takeover Code permits a person holding 25% or more but less than 75% voting rights in a listed company, to acquire an additional 5% voting rights in a financial year without triggering the open offer requirement. Any acquisition beyond 5% in a financial year by such shareholder would trigger the mandatory open offer requirement.
In order to encourage promoters to infuse capital in listed companies, SEBI amended the Takeover Code[2] to increase the creeping acquisition limit for promoters from 5% to 10% without making an open offer to the public shareholders.
However, additional acquisition (beyond 5% but up to 10%) must be made:
- during the financial year 2020-21; and
- by way of preferential allotment of equity shares (and not by way of market purchase).
Relaxations for stressed listed companies
On 22 June 2020, SEBI notified the much awaited relaxations in the pricing norms for preferential allotment and the mandatory open offer rules[3]. However, these relaxations are available in respect of investments in such listed companies which qualify the criteria of stressed company (Eligible Stressed Company)[4] as prescribed by SEBI.
A new Regulation 164A has been inserted in the ICDR Regulations to allow an Eligible Stressed Company who shares are frequently traded to make a preferential allotment of equity shares at a price which can be determined on the basis of 2 week average of the weekly high and low of the volume weighted average prices of the related equity shares quoted on a recognised stock exchange.
At the same time, a new Regulation 10 (2B) has been inserted in the Takeover Code to provide an exemption from the open offer norms set out under Regulation 3(1) (i.e., acquisition of 25% or more shares or voting rights) and Regulation 4 of the Takeover Code (i.e., acquisition of control) to investors investing in an Eligible Stressed Company by way of preferential allotment pursuant to Regulation 164A of the ICDR Regulations.
This exemption from open offer would also be applicable to an Eligible Stressed Company with infrequently traded shares provided that such Eligible Stressed Company complies with other conditions set out in Regulation 164A and the price of equity shares to be allotted on preferential basis is determined as per Regulation 165 of the ICDR Regulations (i.e., after taking into account the valuation parameters including book value, comparable trading multiples, and such other parameters as are customary for valuation of shares of such companies).
However, the relaxed pricing norms as set out in Regulation 164A (and consequent exemption from open offer rules) has certain riders, including that the preferential allotment cannot be made to the promoters/promoter group entities and/or certain other categories of persons including undischarged insolvent, wilful defaulters and fugitive economic offenders.
Any allotment made pursuant to Regulation 164A shall be locked-in for a period of three years. Additionally, the resolution for such preferential allotment must have the blessings of the majority of minority shareholders (i.e., public shareholders excluding the proposed investor) of the relevant Eligible Stressed Company. In case an Eligible Stressed Company does not have any identifiable promoter, then the resolution must be approved with 3/4th majority of the shareholders.
The proceeds of such preferential issue cannot be used for repayment of loans, if any, taken from the promoters/promoter group/group companies. Further, in order to monitor the use of proceeds, a monitoring agency (which should be a public financial institution or a scheduled commercial bank, not related to such Eligible Stressed Company) would need to be appointed by the relevant Eligible Stressed Company.
The pricing norms for preferential allotment and mandatory open offer requirements have often proved to be roadblocks in the resolution of stressed entities outside the IBC framework.
Relaxations for other listed companies
While SEBI had relaxed the creeping acquisition limit for the promoters (for all listed companies) as well as the pricing norms and open offer rules for Eligible Stressed Companies in case of allotment to non-promoter entities, no relaxation was available from pricing norms in respect of the investments to be made (a) by promoters, or (b) in non-Eligible Stressed Companies.
Keeping in mind the representations received from several stakeholders, SEBI further amended the ICDR Regulations[5] to provide temporary relaxations to all listed companies from pricing norms in case of preferential allotment.
By way of the amendments, SEBI has inserted a new Regulation 164B in the ICDR Regulations which stipulates an optional pricing methodology for preferential issue of shares or specified securities and can be availed in respect of preferential allotment to be made till 31 December 2020.
As per the optional pricing method, listed companies (having frequently traded equity shares) can now allot equity shares on preferential basis at a price being not less than higher of the average of the weekly high and lows of the volume weighted average prices of the related equity shares during (a) 12 weeks (as against 26 weeks stipulated under Regulation 164), or (b) 2 weeks, preceding the relevant date. The listed companies would have the option to determine the issue price either as per the existing pricing norms set out in Regulation 164 or in accordance with the revised pricing norms set out in Regulation 164B.
However, a lock-in period of three years would apply in case the preferential allotment is made using the pricing methodology set out in Regulation 164B of the ICDR Regulations. Further, all allotments arising out of the same shareholders’ approval shall follow the same pricing method.
In this way, the relaxations announced by SEBI for stressed listed companies are likely to enable such entities to find friendly investors.
Our thoughts
In view of the complete ban on the initiation of fresh insolvency proceedings in respect of any default arising on or after 25 March 2020 and six months thereafter (which may be further extended to 1 year), the option for resolution of stressed assets under the Insolvency and Bankruptcy Code, 2016 (IBC) would no longer be available in cases where default arises during the aforementioned period of suspension.
The pricing norms for preferential allotment and mandatory open offer requirements have often proved to be roadblocks in the resolution of stressed entities outside the IBC framework. While SEBI had earlier proposed (in the consultation paper issued on 22 April 2020) to exempt the acquisition of 25% or more shares or voting rights from the mandatory open offer norms, the final amendments have provided an exemption from the open offer requirement in case of acquisition of control as well and thus, paved the way for strategic investments in such Eligible Stressed Companies.
In this way, the relaxations announced by SEBI for stressed listed companies are likely to enable such entities to find friendly investors. This would also promote the friendly resolution of stressed assets outside the IBC framework which would, in turn, help the promoters retain the ownership and control of the stressed company, unlike the IBC where the promoters are removed from the position of control of the distressed entities.
Nonetheless, the relaxations/reliefs announced by SEBI are likely to provide some respite and flexibility to the listed companies in attracting ‘white knights’ which would, in turn, spur innovative restructuring and M&A activities in listed companies.
Further, SEBI appears to have taken a leaf from section 29A of the IBC since the relaxations from pricing norms and open offer rules for Eligible Stressed Companies would not be available in case the preferential allotment is made to promoters/promoter entities or wilful defaulters, undischarged insolvents etc.
However, in case of listed companies other than the Eligible Stressed Companies, while temporary relaxations have been granted from pricing norms, SEBI has not provided any relief from the mandatory open offer norms set out under the Takeover Code (other than providing a relaxation in the creeping acquisition limit). This would certainly impact the size and terms of investment which a friendly investor can make in such listed companies. Further, the investment made by non-promoter investors pursuant to the optional pricing norms is required to be locked in for a period of 3 years as against 1 year which would be applicable in case pricing norms set out under Regulation 164 are followed. This condition could also throw a challenge for the listed entities in raising funds from investors.
Nonetheless, the relaxations/reliefs announced by SEBI are likely to provide some respite and flexibility to the listed companies in attracting ‘white knights’ which would, in turn, spur innovative restructuring and M&A activities in listed companies.
Disclaimer: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to herein. This publication has been prepared for information purposes only and should not be construed as legal advice. Although reasonable care has been taken to ensure that the information in this publication is true and accurate, such information is provided ‘as is’, without any warranty, express or implied, as to the accuracy or completeness of any such information.
Authors:
Vineet Aneja
Managing Partner
E: vineet.aneja@clasislaw.com
Dinesh Gupta
Senior Associate
E: dinesh.gupta@clasislaw.com
[1] “frequently traded shares” means the shares of the issuer, in which the traded turnover on any recognised stock exchange during the 12 calendar months preceding the relevant date, is at least 10% of the total number of shares of such class of shares of the issuer:
Provided that where the share capital of a particular class of shares of the issuer is not identical throughout such period, the weighted average number of total shares of such class of the issuer shall represent the total number of shares.
[2] Text of the relevant SEBI notification can be accessed at the following link:
[3] Text of the relevant SEBI notifications can be accessed at the following links:
[4] A listed company would need to satisfy any two of the conditions set out below:
- Such listed company has made disclosure of defaults on payment of interest/ repayment of principal amount on loans from banks / financial institutions/Systemically Important Non-Deposit taking Non-banking financial companies/ Deposit taking Non-banking financial companies and /or listed or unlisted debt securities (in terms of SEBI Circular dated 21 November 2019) in last 90 days;
- There is an inter-creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 dated 7 June 2019; and
- The credit rating of the financial instruments (listed or unlisted), credit instruments / borrowings (listed or unlisted) of such listed company has been downgraded to “D”.
[5] Text of the relevant SEBI notification can be accessed at the following link:
