Understanding SEBI’s relaxation of Pricing Norms and Open Offer obligations for Preferential Issues by Stressed Companies

– Milind Anand & Suvam Kumar

SEBI has recently amended its Issue of Capital and Disclosure Requirements Regulations, 2018 (‘ICDR Regulations’) and Substantial Acquisition of Shares and Takeovers Regulations, 2011 (‘SAST Regulations’) with the objective of relaxing the pricing guidelines and open offer obligations for preferential issues by companies having stressed assets. SEBI came out with a consultation paper on April 22, 2020 whereby it had proposed certain changes in the ICDR and SAST regulations to relax certain norms for the stressed company and invited public comments to such a proposal. The amendment has been brought after considering all the public comments received. Despite having similarity with the consultation paper there are deviations on several points namely:-

• The amendment has added a list of person to whom the preference issue shall not be made.
• The amendment has done away with the requirement of the approval of the resolution for the preferential issue and the exemption from open offer by the majority of minority shareholders as proposed in the consultation paper.

• It has added a new condition that the proceeds of the preferential issue shall not be used for the repayment of loans taken from promoters, group of promoters or group companies.

• The amendment introduces a new regulatory body of statutory auditor and audit committee, whereby they shall ensure and certify that all the compliances have been met under the new regulation.

Amendment in the ICDR regulations:-

The amendment has introduced a new section 164A. The new section opens another window for the stressed company to undertake preferential allotment of shares by pricing the preferential issues at not less than the average of the weekly high and low of the volume weighted average prices of the concerned equity shares quoted on a recognized stock exchange during the two weeks preceding the relevant date of issue. This helps the company to avoid the onerous obligation under Regulation 164(1) which requires that the price of the preferential issue shall not be less than average of the weekly high and low for a period of twenty-six weeks and average of the weekly high and low for two weeks preceding the date of preferential allotment. The amendment tends to truncate the gap between the price at the starting of the twenty-six week and the price at present when the company intends to raise funds. This wide gap increases the price of issue which is often higher than the current market price. Hence, the investors abstain from investing in the company which pushes the stressed company into insolvency or bankruptcy.

The amendment has also laid down an objective test for the determination of the stressed company. A stressed company is a company which meets any two of the following conditions:-

1. The issuer company has made a disclosure of defaults relating to payment of  interest,  repayment  of  principal  amount  on  loans  from banks, financial institutions, and  listed and unlisted debt securities in terms of SEBI Circular dated November 21, 2019 and such default is continuing for a period of at least 90 calendar days.   
2. There is an inter-creditor agreement in terms of the RBI Prudential Framework for Resolution of Stressed Assets dated 7 June 2019; and
3. The credit rating of financial instruments (listed or unlisted), credit instruments/ borrowings (listed or unlisted) of the listed company has been downgraded “D.

Furthermore, the amendment has laid down other additional conditions which shall be satisfied by the issuer company to benefit under the Regulation 164A. These are:

• The preference issue shall be made to the person who is not a promoter or part of the promoter group on the date of board meeting.
• The allotment shall be locked in for a period of three years from the last date of trading approval as opposed to the one year lock in period imposed under the pre amended ICDR Regulations.
• The proceeds of the preferential issue shall not be used for the repayment of loans taken from promoters, group of promoters or group companies.
• There is also a requirement of disclosure of proposed use of proceeds in the explanatory statement.
• The issuer company shall make arrangements for the monitoring the use of proceeds of the issue.

The amendment also includes a class of persons who are disqualified from becoming the investors in preferential issue.

Amendment in SAST regulations:-

The amendment has introduced a new proviso to regulation 3(2) which allowed a shareholder holding 25% or more of the shares or voting rights of a company to increase their participation up to 10%. However, this limit increase is only authorized via a preferential issue of shares. The relevant provision of the SAST Regulation provides that shareholders can increase their shares or their voting rights in a company, up to a certain threshold, in order to consolidate their shareholding.Any increase in voting rights beyond the authorized threshold will result in a mandatory open offer, in accordance with rule 3 (2) of the takeover regulation. The threshold was raised from 5% to 10%, via a preferential issue, only for the financial year 2020-21.

SEBI has also relaxed the provision on voluntary open offer. Previously, a shareholder holding 25% or more of the shares or voting rights was authorized to make a voluntary open offer but only if he had not acquired any share in the company by way of the progressive acquisition during the 52 previous weeks. This condition has been relaxed until March 31, 2021.

Analysis:

The amendment bought by the SEBI in the ICDR and SAST regulations to relax the pricing norms and open offer obligations for the stressed company is a positive move during the pandemic to infuse funds in the financially stressed company in order to revive them. Stressed company usually witness continuous falling prices due to their financial distress. The situation becomes even worse in a financial lockdown situation Covid-19. Therefore, determination of price on the basis of average of weighted volume average price over a period of 26 weeks would discourage an investor from investing since there would be a huge difference between the price at the beginning of 26 week and the current price when the company wants investors to infuse funds. This would imply that he would have to pay a price greater than the current market price of the share, which is highly detrimental and hence the stressed company goes into perpetual financial distress and can even turn out bankrupt.

Though the amendment has awarded relief against the onerous obligations of pricing norms under Reg. 164(1) and has relaxed the obligations of stressed company to make open offer, there are certain pertinent questions which the amendment fails to address. These are:

• Exclusion of promoters from the benefits of new norms: – The amendment has excluded the promoters from getting benefit under the amended guidelines. The status quo of promoters being disqualified to make any new investment under the new norms might result in serious implications as the company will be at risk of turning insolvent if the company is not able to find investors. In contrast if the promoters are included in the list the company would be able to impregnate capital at less harsh floor price it will be regarded as a positive move to tide over the crisis situations and infuse funds
• Onerous compliances/requirements to qualify as a stressed company: – The amendment has laid down a strict test for classifying a company as stressed. The test laid down becomes onerous for such companies who, despite being in financial distress and in need of urgent funds, could not satisfy the test due to practical difficulties in entering into an inter-credit agreement or failure on the part of credit rating agency to downgrade the credit rating of such company. Therefore, such a strict test for qualification of stressed company should be relaxed.
• Non applicability to non-stressed companies: – By bringing businesses around the nation to a standstill the Covid-19 pandemic has added on to the burden of stressed as well as non-stressed companies. The exclusion of non-stressed companies reveals the limited scope of these relaxations.
• Extension of the lock-in period: – The amendment remains silent on the reason behind the extension of lock in period from a period of one year to three years. The extended lock in period could be cumbersome for many investors who tend to make short term investment and earn profits. Longer lock in period might disincentives such investors from making investment in the company.

Suggestions and conclusion

The relaxed pricing norms and exemption from open offer obligations is certainly expected to provide relief to the financial stressed companies with respect to stabilizing the infusion of funds into the company and reviving them. At the same time, it also encourages investors to invest in the stressed company with favorable price valuations and without meeting onerous obligations. However, the amendment invites criticism on above four points highlighted above. Therefore, SEBI should consider making relaxations in the pricing norms for the all the companies given the surrounding financial disruptions and stress amid Covid-19 pandemic.

This article is authored by Milind Anand and Suvam Kumar. Milind Anand is a student of law at National University of Study and Research in Law, Ranchi and Suvam Kumar is a student of law at National Law Univerisity Jodhpur.