Significant Changes in Primary Security Issuances Loom in India: The New Takeover Code and the ICDR Second Amendment Notification

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Contributed by Subhayu Sen, Senior Associate, Khaitan & Co

The introduction by the Securities and Exchange Board of India (SEBI) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the 2011 Takeover Code) and the SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment) Regulations, 2011 (the ICDR Amendment) has brought about significant changes in substantive, procedural and disclosure norms governing corporate acquisitions and capital issues in India. While the 2011 Takeover Code has replaced the earlier regulations governing acquisitions of shares and voting rights of listed companies (the 1997 Takeover Code), the ICDR Amendment has introduced significant changes in the eligibility parameters and other procedural amendments governing primary security issuances. This article examines the relevant regulations in the 2011 Takeover Code and the provisions of the ICDR Amendment that could significantly impact the established structures of raising capital in India.

The Exemption Norms in the 2011 Takeover Code

The 2011 Takeover Code offers exemptions from its applicability to acquisitions of shares and voting rights effected through certain processes. Such processes include acquisitions through a rights issue, acquisitions by underwriters registered with SEBI pursuant to an underwriting agreement, increases in shareholdings or voting rights consequent to a buy–back arrangement subject to certain conditions, etc. However, the exemption afforded to acquisitions of shares and voting rights through a rights issue has been substantially amended when compared to the corresponding provisions in the 1997 Takeover Code. The exemptions from the applicability of the 1997 Takeover Code were available to acquisitions of shares pursuant to a rights issue by “persons in control” of the company. The proviso to regulation 3(1)(b) of the 1997 Takeover Code stated that a person in control of a company could acquire shares beyond their entitlement if the issue was undersubscribed without triggering the 1997 Takeover Code, subject to the condition that the intention to do so had been disclosed in the letter of offer. This regulation 3(1)(b) was often utilized as a valuable tool to increase the promoters’ stake in a company without going through the process of an open offer. The 2011 Takeover Code has not retained the benefit afforded by regulation 3(1)(b) of the 1997 Takeover Code to the promoters of a company, but has extended this benefit to any shareholder. Regulation 10(4) of the 2011 Takeover Code states that any shareholder holding 25% but less than the maximum permissible non-public shareholding can acquire shares in a rights issue beyond his entitlement subject to the conditions that (1) he should not have renounced any of his entitlement; and (2) certain pricing guidelines apply. Regulation 10(4) of the 2011 Takeover Code has deprived promoters from acquiring additional shares in a company at the rights issue price without being forced to make an open offer. By contrast, Regulation 3(1)(b) of the 1997 Takeover Code allowed consolidation of the promoters' holdings in a company, which was often of benefit to the company, its employees, and its shareholders, as well. In addition, it seems that this amendment would significantly reduce the number of rights issues by Indian companies as a mode of fundraising, as SEBI currently allows fundraising avenues, such as qualified institution placements that do not contemplate vetting of the document by SEBI and consequently reduce the timelines and the risk of a possible takeover.

Eligibility Criteria for a Company Proposing to Offer Shares Under Regulation 26(1) of the ICDR Amendment

SEBI allows a financially-sound company to list its equity shares without a mandatory minimum allotment to qualified institutional buyers (QIBs). QIBs are banks, financial institutions, funds, etc. who are deemed to be informed investors, and their participation in an issue lends confidence to the public at large about the company. Regulation 26 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (SEBI ICDR) enumerates the tests for identifying a “financially strong company,” and companies that do not meet these tests must allot at least 50% of the issue size to QIBs. One of the tests for determining a “financially strong company” is that the company has a track record of distributable profits in terms of section 205 of the Companies Act, 1956, for at least three out of the immediately preceding five years. The ICDR Amendment has now mandated that this test must be applied on a standalone, as well as on a consolidated basis. The rationale behind this amendment seems to be logical as the financial projections of a company are ordinarily on a consolidated basis. However, practically, an issuer company may be undertaking certain business ventures through subsidiaries that have a higher break-even period or that are not as successful a venture financially due to various other considerations, which may be unrelated to the current business and the future prospects of the issuer company. A suggested amendment to the regulations should be that in the event the company is proposing to infuse the issue proceeds into such subsidiaries, the test of a track record of distributable profits should be applied on a consolidated basis. This would ensure that the public money is not infused into an unsuccessful venture and that the return on the investment is not adversely affected.

Amendment of the Standard Due Diligence Certificate to Be Submitted to SEBI by the Merchant Banker

A merchant bank acting as lead manager of an issue must submit a due diligence certificate to SEBI along with the draft offer document. This due diligence certificate contains certain confirmations regarding the disclosures in the offer document and the procedure for fundraising. The ICDR Amendment, along with the SEBI Circular dated September 27, 2011, has introduced an additional clause in the standard due diligence certificate, which states that the merchant bank responsible for determining the price of the shares offered in an issue must disclose the price information of issues managed by that merchant bank in the last three years. The price information for such past issues shall include the issue price, the percentage change in price as of the listing date, and the change in price of the shares 10, 20 and 30 days after the listing date. Due to volatile market conditions and uncertain economic situations, on numerous occasions stock prices of companies have not performed as expected. Nonetheless, it is common for merchant banks and issuer companies to receive complaints from investors aggrieved at the declining value of their investments and alleging aggressive pricing of issues. SEBI has been stern on inflated valuations and projections by merchant banks, and this amendment seems to be the consequence. The price of shares in an issue is often not the prerogative of the merchant banks and is dependent on various factors such as the strength and reputation of the promoters of the issuer, the pricing clause in a shareholders’ agreement where the issue involves a selling shareholder, etc. Consequently, the pricing details of past issues may not be an accurate reflection of the performance of the merchant banks. Thus, this particular amendment does not seem to address the issue it proposes to solve. However, the merchant banks are required to disclose the basis for the determination of the issue price of securities in an issue in the offer document. The basis for the issue price must be categorized by qualitative and quantitative factors, which include the qualitative strengths of the company, the earnings per share of the company’s shares for the last three years, the return on net worth, the net asset value, and comparison with peers on these parameters. Consistent with the practice of stringent obedience to the promises made in the section of the offer document entitled "Objects of the Issue," the qualitative and quantitative factors identified for price discovery should be questioned post issue. However, any procedure introduced to allow such questioning should be rigorously monitored to avoid arbitrary and possibly baseless allegations.


The 2011 Takeover Code is truly a long stride towards regulating acquisitions in India. Unfortunately, the change mandated by the ICDR Amendment discussed in this article is seemingly unnecessary and may potentially elongate preparations for the process. 

Subhayu Sen is a Senior Associate with Khaitan & Co ( and has been associated with their Capital Markets team for over five years. His responsibilities include leading transactions in the nature of public issues and private placements.

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