The In-House Lawyer

Inder Mohan Singh (left), Siladitya Chatterjee (centre) and Arya Tripathy (right) examine the term ‘control’ in Indian law and consider whether there is a need for reform

The term ‘control’, with respect to companies, may be defined in various ways, including, with reference to shareholding, voting rights, right to appoint directors on the board, management rights, veto rights etc. A layman’s understanding of the term would be the ability to control the management and policy of a company, whether by holding a majority of shares or by having majority representation on the board of directors of the company or by any other means.?

In light of the vast number and variety of legislations required to effectively regulate companies, and the multifarious subjects that they cover, the term ‘control’ has been given various meanings depending on the domain of the concerned legislation. The multiplicity of definitions of the term has at times created uncertainty and ambiguity in the corporate world and among the investor community. In India, the term ‘control’ finds its place in a number of legislations and regulations, which may be broadly categorised as follows:

1. Companies Act 1956 (the 1956 Act);
2. Regulations of the Securities and Exchange Board of India (SEBI);
3. foreign direct investment (FDI) policy;
4. Competition Act 2002 (as amended from time to time); and
5. Proposed new statutes/amendments to existing legislations.

This article examines the existing definitions of ‘control’ under various statutes, including the context in which the term has been used, the intent behind a particular way of defining the term and the adequacy of such definition in light of their context. Further, any proposed amendments to the term have also been sought to be covered. The objective of this article is to understand whether the widely differing definitions of the term ‘control’ are sufficient in themselves or whether a certain degree of uniformity or harmonisation in the definition is desirable.

CONTROL UNDER THE COMPANIES ACT 1956

The 1956 Act is the basic law governing the formation, operation and liquidation of companies in India. The 1956 Act uses the term ‘control’ in various contexts. Section 4 of the 1956 Act defines ‘holding’ and ‘subsidiary’ companies where one criterion is that a holding company should be able to control the composition of the board of directors of the subsidiary (s4(1)(a)) and it also explains when the composition of the board of directors of a company will be deemed to be controlled by another company (s4(2)). Such a control over the composition of a company’s board is exercised by another company if the latter company, by exercise of some power at its discretion without the consent or concurrence of any other person, can appoint or remove the holders of all or the majority of the directorships (s4(2)). Section 239 empowers an inspector to carry out an investigation into affairs of related companies whose directorships are held by the employees or nominees of those having the control and management of the first-mentioned company. Section 247 of the 1956 Act states that investigation of the ownership of a company can be done for the purpose of determining the true persons who are or have been able to control or materially to influence the policy of the company. Control also appears in the context of s398 whereby an application can be made to the Company Law Board (CLB) by a member complaining that a material change has taken place in the management or control of the company.

On a perusal of above sections, it is apparent that the term ‘control’ is used in the 1956 Act in a variety of contexts and hence a uniform definition of the term would not suffice for this statute. Rather, the term may need to be interpreted differently for each provision or section of the 1956 Act in which it appears, to ensure that the motive and rationale behind the concerned provision is given effect to.

CONTROL UNDER SEBI LAWS

The Securities and Exchange Board of India Act 1992 (the 1992 Act) established the SEBI to protect the interests of investors and to promote and regulate the securities market in India. Sections 11 and 11A of the 1992 Act empower the SEBI to take various steps in furtherance of the aforesaid objectives, including by introduction of regulations to govern the issue of securities, regulation of stock brokers and other intermediaries, regulation of substantial acquisition of shares, promotion of investor education, prohibition of insider trading etc. While the 1992 Act itself does not have a separate definition for the term ‘control’, various regulations and guidelines made under the 1992 Act have defined the term ‘control’.

While some SEBI regulations have their own tailor-made definition of ‘control’ depending upon the specific needs of those regulations, the definition as appearing in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997 as amended from time to time (the 1997 Code) has been adopted or referred to in several other regulations of the SEBI.

Under the SEBI (Merchant Bankers) Regulations 1992, the SEBI (Portfolio Managers) Regulations 1993 and the SEBI (Registrars to an Issue and Share Transfer Agents) Regulations 1993, ‘control’ is defined in a narrow sense whereby controlling interest is an interest, whether direct or indirect, to the extent of at least 51% of voting rights in the body corporate.1 This specific definition of ‘control’ has been adopted in light of the fact that these regulations set up a regulatory regime for market intermediaries and their operations have a potential effect upon the investors in specific and the market in general.

However, as already pointed out, a number of SEBI regulations have adopted the definition of ‘control’ as it appears in the 1997 Code. The SEBI (Buyback of Securities) Regulations 1998, the SEBI (Issue of Sweat Equity) Regulations 2002, the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009 (SEBI ICDR 2009) and the SEBI (Delisting of Equity Shares) Regulations 2009 all incorporate the definition of ‘control’ as it appears in the 1997 Code.2 Under the SEBI (Delisting of Equity Shares) Regulations 2009, a company seeking delisting of securities has to disclose the persons who are in control of the company by means of a public announcement.3 Under the SEBI (Buyback of Securities) Regulations 1998, buyback of securities from the promoters or persons in control is prohibited.4 In the SEBI (Credit Rating Agencies) Regulations 19995, the SEBI ICDR 20096 and the SEBI (Issue of Sweat Equity) Regulations 20027, ‘control’ is used to define terms like associate, group, persons acting in concert and promoters and imposes restrictions on the dealings of these players.

In light of the large number of SEBI regulations that have adopted the definition of ‘control’ as provided in the 1997 Code and the critical importance of the takeover regulations in protecting interests of the minority/public shareholders, it is imperative to examine the definition of ‘control’ from the 1997 Code and relevant judicial pronouncements on the same.

Regulation 2(1)(c) of the 1997 Code defines ‘control’ to include the right to appoint the 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.8 Regulation 12 states that, irrespective of whether there has been acquisition of shares or voting rights, no acquirer shall acquire control over a company without making public announcement to acquire shares.9 Acquisition in the context of Regulation 12 includes direct or indirect acquisition of control over companies whether listed or unlisted and whether in India or abroad.10

Regulation 2(1)(c) defines ‘control’ only in terms of a right11. As per the 1997 Code, the term ‘control’ has been identified with:

1. the right to appoint majority directors; or
2. the right to exercise control over the management or policy decisions of the company.

How can such control be exercised The regulation does not provide a clear answer to this. It gives only certain illustrative instances like by virtue of:

1. shareholding; or
2. management rights; or
3. shareholders agreements; or
4. voting agreements; or
5. in any other manner.

Due to the open-ended nature of this definition, the term ‘control’ has been a bone of contention and subject to interpretation in various decisions of the Securities Appellate Tribunal (SAT) and the SEBI as briefly narrated below.

In Rhodia SA v Securities and Exchange Board of India [2001], the SAT held the acquirer to be in control on the basis that the acquirer had veto right over certain matters that had been described by the parties as ‘major decisions on structural and strategic changes’. Hence, as per this decision, a say over major decisions on structural and strategic changes by veto rights would amount to control. But in Sandeep Save v Securities and Exchange Board of India [2002], the SAT observed that there was no change in control despite the presence of veto rights in favour of the foreign body corporate as it had only two nominee directors on the board of directors of the target company and the board composition did not suggest a change in control. Further, in In Re NRB Bearings India Ltd [2003], the SEBI overlooked the foreign acquirer’s veto rights over some matters, including amendments to the organisational documents, declaration of dividends, alteration in share capital, entry into joint ventures, technology transfer etc and held that since the foreign acquirer had only nominal representation on the target company’s board, there was no ‘change in control’ of the target company.

This departure from the stand taken in Rhodia was reiterated in Subhkam Ventures (I) Private Ltd v The Securities and Exchange Board of India [2010] where the SAT observed that every fetter of any nature in the hands of any person over a listed company cannot result in ‘control’ over the company. The SAT stated that what is contemplated for a ‘change in control’ under the 1997 Code is a proactive control and not a reactive control. A proactive control would mean a power by which an acquirer can command the target company to do what they want it to do. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. Hence, the SAT opined that affirmative/veto rights given to the private equity investor enabling it to block certain decisions in the management of the company would not amount to ‘control’ in the absence of a positive right to take such decisions.

However, the SEBI has appealed against the aforesaid judgment of the SAT in the Supreme Court and the Supreme Court’s decision is awaited. Till such time as a final decision is given by the Supreme Court, the meaning and scope of the term ‘control’ under the 1997 Code shall remain a grey area.

CONTROL UNDER FDI POLICY

The FDI policy of India aims at achieving increased foreign investment and at the same time maintaining a supervisory structure that would regulate the quantum and usage of the investments that flow in. This is done with the objective of maintaining transparency, simplicity, clarity and predictability (Paragraph 1.1.1 of the Consolidated FDI Policy (the FDI Policy), effective from 1 April 2011, Circular 1 of 2011). The FDI Policy, issued by the Department of Industrial Policy and Promotion and the Ministry of Commerce and Industry, provides the regulatory regime for investments by foreign residents in any entity in India, where investment is usually understood as financial contribution to the capital of an enterprise or purchase of shares in the enterprise. (Paragraph 1.1.2 of the FDI Policy 2011). The FDI Policy defines the term ‘control’. It provides that the foreign investment through an investing company would not be considered for calculation of the indirect foreign investment in case of Indian companies which are ‘owned and controlled’ by resident Indian citizens and/or Indian companies, which are owned and controlled by resident Indian citizens (Paragraph 4.1.3(ii)). A company is considered as ‘controlled’ by resident Indian citizens if the resident Indian citizens and Indian companies, which are owned and controlled by resident Indian citizens, have the power to appoint a majority of its directors in that company (Paragraph 2.1.7). An entity is considered as ‘controlled’ by non-resident entities, if the non-residents have the power to appoint a majority of its directors (Paragraph 2.1.8).

If an investing company is either owned or controlled by non-residents, the entire investment by the investing company into the subject Indian company would be considered as indirect foreign investment (Paragraph 4.1.3(ii) of the FDI Policy). The same meaning of ‘control’ is used while laying down guidelines for transfer of ownership or control of Indian companies in sectors with FDI caps from resident Indian citizens to non-resident entities (Paragraph 4.2.2).

Thus, it appears that ‘control’ is defined under FDI regulations with the purpose of ensuring that the indirect foreign investment is taken into account for calculation of sectoral caps only when majority of the board of the concerned investing company can be appointed by the non-resident investor. The definition of ‘control’ under the FDI regulations is thus narrower than that found under SEBI regulations.

CONTROL UNDER COMPETITION LAW

The term ‘control’ plays an important role in the competition law regime. The Competition Act 2002 succeeded the Monopolies and Restrictive Trade Practices (MRTP) Act 1969. Under the MRTP Act 1969, the term ‘control’ was used to define vital concepts like ‘group’ (s2(ef)), ‘associated person’ (Explanation to s2(ef) of MRTP Act 1969) and ‘interconnected undertakings’ (s2(g)). Under the MRTP Act, it generally meant the position that is held by a person, directly or indirectly, even without having a controlling interest, to control the policy of another person (s2(g)). The concept of ‘control’ under the MRTP Act 1969 facilitated the identification of companies under the same management and companies that were part of the same group or interconnected undertakings or associated companies. This was done to trace and check the monopolistic and restrictive trade practices that may be undertaken by such entities.

The Competition Act 2002 (the 2002 Act), as amended from time to time, provides for a detailed regulatory framework to assess the anticompetitive effects of any merger, acquisition, amalgamation and any other form of combination. The 2002 Act defines ‘acquisition’ as directly or indirectly acquiring or agreeing to acquire:

1. shares, voting rights or assets of any enterprise; or
2. control over management or control over assets of any enterprise. (s2(a) of the 2002 Act).

The definition is similar to the definition of ‘acquirer’ under the 1997 Code.

Further it defines ‘combination’ in Regulation 5 by laying down various thresholds (in terms of assets and turnover of the acquired and acquiring entities), which, when triggered, would require a scrutiny by the Competition Commission of India. Regulation 5(b) states that a ‘combination’ would result if there is an acquiring of control by a person over an enterprise when such person has already direct or indirect control over another enterprise engaged in production, distribution or trading of similar or identical or substitutable goods/services and the thresholds (in terms of assets and turnover of the acquired and acquiring entities) are also triggered (s5(b) the 2002 Act). For this purpose, ‘control’ is defined to include controlling the affairs or management by:

1. one or more enterprises, either jointly or singly, over another enterprise or group;
2. one or more groups, either jointly or singly, over another group or enterprise (Explanation (a) to s5 of the 2002 Act).

The question arises as to whether the definition of ‘control’ as provided in the 2002 Act would suffice for an effective analysis of a combination that involves ‘acquisition of control’ and subsequently facilitate identification of the adverse anticompetitive effects of the proposed combination. The 2002 Act is silent on what instances would amount to a control over the affairs or management of a company and this is likely to create an ambiguity.

In addition to this, it may be noted that ‘acquisition’ as defined in the 2002 Act includes acquisition of control (over management or assets of the enterprise) and this definition is similar to the definition of ‘acquirer’ in the 1997 Code. This may imply that the meaning of ‘control’ as it appears in the 1997 Act may be referred to while scrutinising any acquisition under the 2002 Act. But does it mean that the Competition Commission of India (CCI) would be guided by the ongoing debate that prevails over the meaning of ‘control’ under the takeover law It is yet to be seen how the CCI interprets the term ‘control’ in such cases.

PROPOSED LAWS/AMENDMENTS

Control under the Companies Bill 2009

It is noteworthy that the Companies Bill 2009 (the 2009 Bill) had defined the term ‘controlling interest’. ‘Controlling interest’ meant the largest voting power a member may exercise in a general meeting of a company, whether directly or indirectly, and either alone or in association with their relatives, bodies corporate or firms controlled by such person or their relatives (s2(1) of the 2009 Bill). Further the term ‘control’ was used in defining several concepts like ‘promoter’ (s2(1)(zzq)) and ‘subsidiary company’ (s2(1)(zzzi)). These definitions have been made simpler in contrast to the definitions provided under the 1956 Act. For instance, ‘promoter’ is defined as a person who has been named as such in a prospectus or who has control over the affairs of the company, directly or indirectly whether as shareholder, director or otherwise (s2(1)(zzq) of the 2009 Bill). This definition of ‘promoter’ is similar to the definitions under the 1997 Code and the SEBI ICDR 2009. Similarly, ‘associate company’ is defined as a company that has significant influence over another company and significant influence connotes control of at least 26% of total voting power, or of business decisions under an agreement (s2(1)(f)).

However, the 2009 Bill was placed before the Parliamentary Standing Committee and an amended version of the 2009 Bill has been prepared consequent to the committee’s recommendations. The Standing Committee received several recommendations to the effect that the definition of ‘controlling interest’ as present in the 2009 Bill was at variance with the definition of ‘control’ in the 1997 Code and the same should be aligned with the definition in the 1997 Code. It has been reported that the latest draft of the 2009 Bill as prepared by the Ministry of Corporate Affairs (post incorporation of the recommendations of the Parliamentary Standing Committee) has in fact defined ‘control’ on the lines of the 1997 Code, ie ‘control’ is 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 light of the same, the Ministry of Company Affairs may also modify the definitions of ‘promoter’, ‘associate company’ and ‘subsidiary company’ in the revised draft of the Companies Bill.

It has been contended that the aforesaid definition of ‘control’ is likely to ensure a uniform interpretation and application of the term ‘control’ under the SEBI laws and the to-be-enacted companies law. However, it has to be understood that the proposed Bill would need to cover diverse aspects including a company’s incorporation, administration, internal management, accounts, member protection and liquidation. The scope of the Bill is thus vast and it has to be seen whether a uniform definition of ‘control’ would suffice for all purposes.

For instance, Clause 2(zzt) of the 2009 Bill defines ‘public financial institution’ as including any financial institution in which not less than 51% of the paid-up share capital is held or controlled by the central government or by any state government or both by the central government and any state government. Clause 159 of the 2009 Bill permits the board of directors of a company to take certain decisions on behalf of the company by means of resolutions passed at board meetings, including, inter alia, to take over a company or acquire a controlling or substantial stake in another company (Clause 159(3)(j)). Clause 187 of the 2009 Bill empowers the central government to appoint inspectors to investigate and report on the membership of any company and other matters relating to the company, for the purpose of determining the true persons who are able to control or to materially influence the policy of the company (Clause 187(1)(b)). Clause 212 permits a member of the company (who has the right to do so under the Bill) to apply to the CLB when a material change has taken place in the management or control of the company, and such member(s) believes that by reason of such change the affairs of the company will be conducted in a manner prejudicial to the company or any of the members of the company (Clause 212(1)(b)). Clause 216 permits a member or creditor or a class of members or creditors to bring a class action suit to restrain the company from doing certain acts, if such member or creditor is of the opinion that the control or management of the affairs of the company is being conducted in a manner prejudicial to the interests of the company or the members or creditors (Clause 216(1)).

Provisions analogous to the ones in the 2009 Bill mentioned above may be present in the latest draft of the Companies Bill also. It seems dubious to suggest that a uniform definition of ‘control’ is sufficient to engulf within its ambit all these diverse situations.

TAKEOVER REGULATIONS ADVISORY COMMITTEE REPORT

The Takeover Regulations Advisory Committee (TRAC) was of the opinion that the existence of control in a listed company is a question of fact or at best a mixed question of fact and law, which needs to be answered on a case-to-case basis. It recognised that any blanket provision whereby a right to say ‘no’ is in all circumstances deemed to either constitute control or not is liable to misuse. It observed that acquisition of de facto control and not just de jure control should expressly trigger an open offer obligation. An investor could acquire de facto control through a variety of mechanisms such as through veto rights. The TRAC thereby recommended that the definition of ‘control’ should be modified to include ‘ability’ in addition to ‘right’ to appoint majority of the directors or to control the management or policy decisions. It was also stated that clarification needs to be issued to the extent that a director or officer of the target company should not be regarded as being in control merely by virtue of holding such position.

However on 28 July 2011, the SEBI in its meeting clarified that, while most of other recommendations of the TRAC be incorporated in the new takeover code, the definition of ‘control’ as occurring in the extant 1997 Code should be retained in the new takeover code.

The SEBI had notified the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 2011 on 23 September 2011. The same has retained the definition of ‘control’ as present in the 1997 Code, while accepting some other recommendations of the TRAC. The new code shall become effective after 30 days from the date of the notification.

CONCLUSION

The definition of ‘control’ under the takeover regulations needs to be clarified to ensure that a climate of certainty prevails over when an investor would be required to make an open offer to shareholders. More specifically, it is standard practice for private equity investors to insist on veto/affirmative rights in shareholder agreements in order to protect their investment and the takeover laws need to clarify whether such veto rights would amount to a ‘change in control’ or not. In this respect, the decision in Shubkam was a step in the right direction, as it clearly asserted that the mere ability to block/veto management decisions does not itself amount to ‘control’ and hence acquiring such veto rights would not trigger an open offer requirement under the 1997 Code. However, the said decision is now under appeal in the Supreme Court and hence the ambiguity remains. Meanwhile, the SEBI has decided to retain the existing definition of ‘control’ in the new takeover regulations, thereby losing out on an opportunity to define the term ‘control’ with greater clarity and precision.

While the proposed Companies Bill may adopt the definition of ‘control’ from the takeover regulations for the sake of uniformity and harmonisation, this in itself would not be adequate for the purposes of the companies law. A generic definition of ‘control’ will not suffice for all the provisions where the term ‘control’ has been used in the Companies Bill. It is the duty of the legislators to consider the context in which the term ‘control’ appears in the various provisions of the Companies Bill and limit the meaning of ‘control’ for each such provision depending upon the intent and rationale of that particular provision. While this may necessitate a detailed reconsideration of each provision in the Companies Bill using the term ‘control’, it would go a long way in removing the ambiguity associated with the usage of this term.

The FDI regulations define ‘control’ in a narrow sense in terms of ability to appoint majority of directors of the investing company. Since a robust inflow of foreign direct investment is heavily dependent on clear and unambiguous law and policy, the existing definition may be retained as it is concise and easily comprehensible.

By Inder Mohan Singh, partner, Siladitya Chatterjee, associate and Arya Tripathy, associate, Amarchand & Mangaldas.

E-mail: inder.mohan@amarchand.com;

siladitya.chatterjee@amarchand.com;

arya.tripathy@amarchand.com.

The views expressed are those of the authors and do not reflect the official policy or position of Amarchand Mangaldas.

1. Explanation to Regulation 2(ad) of SEBI (Merchant Bankers) Regulations 1992, while defining ‘change in control’ in relation to a merchant banker; Explanation to Regulation 2(ad) of SEBI (Portfolio Managers) Regulations 1993, while defining ‘change in control’ in relation to a portfolio manager; and Explanation to Regulation 2(bc) of SEBI (Registrars to an Issue and Share Transfer Agents) Regulations 1993, while defining ‘change in control’ in relation to a registrar to an issue or a share transfer agent.
2. Regulation 2(1)(d) of SEBI (Buy Back of Securities) Regulations 1998; Regulation 2(1)(d) of SEBI (Issue of Sweat Equity) Regulations 2002; Regulation 2(2) of SEBI (Delisting of Equity Shares) Regulations 2009; Regulation 2(1)(i) of SEBI ICDR 2009.
3. Schedule I under Regulation 10(2) of the SEBI (Delisting of Equity Shares) Regulations 2009.
4. Regulation 15 of SEBI (Buyback of Securities) Regulations 1998.
5. Regulation 2(1)(b) defining ‘associate’, Regulation 2(1)(m) defining ‘group companies’ under SEBI (Credit Rating Agencies) Regulations 1999.
6. Regulation 2(za) defining ‘promoter’ under SEBI ICDR 2009.
7. Regulation 2(b) defining ‘associate’ under SEBI (Issue of Sweat Equity) Regulations 2002.
8. Regulation 2(1)(c) of the 1997 Code.
9. Regulation 12 of the 1997 Code.
10. Explanation to Regulation 12 of the 1997 Code.
11. Regulation 2(1)(c) of the 1997 Code.
12. Section 2(1)(b) of the 1997 Code defines ‘acquirer’ as any person who, directly or indirectly, acquires or agrees to acquire shares or voting rights in the target company, or acquires or agrees to acquire control over the target company, either by themselves or with any person acting in concert with the acquirer.

In Re NRB Bearings Ltd [2003] SEBI Order (29 May 2003) No CO/33/TO/05/2003

Rhodia SA v Securities and Exchange Board of India [2001] Appeal No 36/2001 (7 November 2001)

Sandeep Save v Securities and Exchange Board of India [2002] SAT Order (27 November 2002); Appeal No 22/2002; Application No 17/2002

Subhkam Ventures (I) Private Ltd v The Securities and Exchange Board of India [2010] SAT Order (15 January 2010); Appeal No 8/2009