Legal quirks: When control overtakes ownership

The Jet-Etihad airline deal has put the spotlight on the C-word. With several definitions of control under different laws, business partners are known to try and get control disproportionate to their level of ownership in a business. The Jet-Etihad deal is an example.

Corporate lawyers and investment bankers involved in cross-border merger and acquisition (M&A) deals say lack of uniformity in the definition of control in Indian regulations make foreign investors wary. It also flags issues around corporate governance practices at the board level, say proxy advisory firms.

Under Indian law, broadly speaking, ‘control’ emanates from ownership of a majority of the voting shares in a company. However, the Foreign Exchange Management Act, which governs FDI-related M&A deals, and the Companies Act, 1956, do not provide a specific definition of the term. 

The Companies Act treats ownership of majority stake and ability to control the composition of the board of directors as giving rise to control. The new companies Bill takes a broader view, more in line with the takeover regulations of the Securities and Exchange Board of India (Sebi).

According to Arindam Ghosh, partner, Khaitan & Co, a Mumbai-based law firm, certain Sebi regulations define the term in a very narrow sense, to mean at least 51 per cent direct or indirect voting rights. 

On the other hand, certain regulations adopt the much broader definition provided in the takeover code. Sebi’s takeover regulations recognise a situation where a minority business partner could have control by acting in concert with other shareholders or the management.

Sebi’s Takeover Regulations Advisory Committee said the issue should be seen on a case-by-case basis. It said the definition of control should be modified to include ‘ability’ in addition to the ‘right’ to appoint a majority of the directors or to control the management or policy decisions. 

The issue of ‘positive’ (i.e. ability to push through or initiate certain actions) and ‘negative’ (i.e right to hold back a company from carrying out certain decisions) controls an investor enjoys has been the subject matter of many legal disputes.

Reading between the lines
“Control has always been a contentious issue and subject to Sebi’s discretion and assessment,” says Abhishek Pandey, vice-president, Resurgent India Ltd, an M&A advisory firm. The issue of negative control remains a grey area, not addressed fully by the takeover code, he adds.

According to Falguni Shah, partner, M&A Tax, KPMG India, the definition under the takeover code goes beyond prima facie control through ownership and composition of the board of directors.

What it essentially means is that even if a stakeholder does not have the ability to appoint a majority of the directors, rights such as appointment of a chief executive or positive control on certain functions might put the stakeholder in “control”

of the company, says Shah.

Many corporate lawyers say the foreign direct investment (FDI) policy has a less tight definition of foreign control, limited to the ability to appoint a majority of directors. “This provides ample room for investors to get around sectoral caps and curbs, such as investing indirectly or via quasi-equity instruments,” says a cross-border M&A consultant. 

For instance, if a company has less than 50% FDI and is controlled by Indians, then further downstream investments by such a company will not be considered foreign investment.

No thresholds
Unlike in some countries, India prescribes no threshold for ‘control’ to be triggered. The picture is mixed when one scans international takeover laws. 

The threshold in Hong Kong is 30 per cent or more, 20 per cent in Australia, 30 per cent in Britain, 33 per cent or more in Malaysia, 30 per cent or more in Singapore and 50 per cent or more in Indonesia.

Under Australian corporate laws, control means capacity to determine the outcome of financial and operational policy decisions. 

Under American takeover laws, control includes power, direct or indirect, by any means to cause decisions of importance to an entity. “The Indian laws are in line with US and Australian laws,” says Shah.

M&A consultants say uniform legal and regulatory treatment and more clarity on the issue of control is important in an environment where M&A deals are becoming complex and multi-layered, and need to go through multiple regulatory clearances.

According to Shriram Subramanian, founder-head of InGovern Research Services, a proxy advisory firm, deals such as Jet-Etihad, with several levels of control among business partners, do not promote transparent corporate governance practices. 

“This not in favour of minority shareholders, as it gives one set of shareholders, working in cohort with promoters, a disproportionate level of control over decision making within the company,” he says.

Non-uniformity of definitions of control under Indian laws and regulation

* The Companies Act, 1956
No definition of control; broadly control is used interchangeably with ownership,  and ability to appoint  majority member on the board of directors 

* Foreign Exchange Management Act (FEMA and FDI  Policy)
No definition of control ; Under FDI Policy the concept of ownership is used for control

* SEBI regulations and Take Over Regulations Advisory committee (TRAC)
SEBI Regulations define the term control in a narrow sense to mean atleast 51% direct or indirect voting rights; The take over code adopts a broader definition of control. 

The TRAC has recommended that  the definition of control should include "Ability" in addition to "Right" to appoint majority of the directors. 

* The new Companies Bill
Adopts a broader definition of control in line with SEBI.