The Probity Of Delisting In A Downturn
Is India’s prevailing delisting regime adequate to protect the interests of minority shareholders, asks Umakanth Varottil.
The delisting of a company in a bear market presents a paradox. Where, as in an economic downturn, there is a perception that the market price of the company is not reflective of the true value of its businesses, the share price may cease to be an accurate indicator of the company’s worth. This offers a compelling justification, among others, for the managers and promoters to extricate the company from the stock market. However, when it comes to making a delisting offer to the public shareholders, the very same market price blemished as not reflecting the company’s true value becomes the primary benchmark for compensating the exiting public shareholders.
Timing Is Everything
Delisting offers tends to generate opportunistic behaviour on the part of the promoters, as they hold the reins to the timing of a delisting offer. They can not only choose an opportune moment when the market price of the shares is substantially lower than the intrinsic value of the company, but they can spring a surprise on the minority shareholders who will be cornered into reacting within a relatively short span of time. This makes the delisting process inherently imbalanced in favour of the promoters.
Given this scenario, it is not surprising that promoters of certain Indian companies have embarked upon delisting their companies in the wake of the pandemic-led slump in the stock markets. Leading the pack is Vedanta Resources Ltd., the promoter of Vedanta Ltd. holding 51.06 percent of its shares, which has offered Rs 79.6 per share to the public shareholders in a delisting offer. The price represents 9.9 [ercent over the prevailing price on the date of the announcement but is at a substantial discount to the historical price as well as the book value of the company. News reports indicate that the delisting of companies such as United Spirits and Adani Power might follow suit, perceptibly driven by a similar rationale.
A question arises whether the prevailing delisting regime is adequate to protect the interests of the minority shareholders.
The issue is not so much about whether these companies ought to be delisted. Rather it is about whether the choice of timing by the promoters will lead to short-changing the minority shareholders.
In that sense, one needs to consider whether the existing legal mechanisms in the form of the SEBI (Delisting of Equity Shares) Regulations, 2009, preserve the ability of exiting shareholders to claim the price they deserve.
Protective Mechanisms In Decision-Making
To be sure, SEBI’s delisting regulations do offer various forms of protection to the public shareholders. At the outset, the board of directors of the company must approve the delisting offer. More specifically, the board must satisfy itself, and certify, that “the delisting is in the interest of the shareholders”. Besides this, customary fiduciary duties under company law impose this obligation anyway. Delisting offers epitomise the conflicts between the interests of the promoters and the minority shareholders. Understandably, therefore, the independent directors of the company ought to don the mantle of protecting the interests of the minority shareholders.
At the same time, the delisting regulations also suffer from some glaring inadequacies. For example, unlike SEBI’s regulations governing takeovers, there is no regulatory requirement either for the board to constitute a committee of independent directors or for the directors to make recommendations to the shareholders as to the delisting offer. This arguably makes the role of the independent directors in a delisting rather inchoate and limits the ability of minority shareholders to hold directors—both independent and otherwise—accountable for their actions and omissions. Despite the regulatory gaps, one hopes that directors of the current delisting cohort will nevertheless utilise these devices of their own accord.
Shareholders too enjoy certain self-help mechanisms. While the delisting requires a special resolution through postal ballot, there is an additional majority-of-the-minority requirement. The votes cast by public shareholders in favour of the delisting proposal must be at least twice the number of votes cast by public shareholders against it. Apart from decision-making through voting, public shareholders can determine the success (or failure) of a delisting offer by other means. For the offer to be successful, the promoter must have been able to raise its post-offer shareholding to 90 percent of equity shares, and at least 25 percent of the public shareholders holding shares in the demat mode must have participated in the process. Hence, through these labyrinthine checks and balances, shareholders have the ability to spurn unattractive offers. However, as seen later, there are several impediments in the actual exercise of shareholder power in delisting offers.
The SEBI delisting regulations are unique in that they rely solely on the reverse book building process as a means to discover the delisting price. Public shareholders make bids at the price at which they are prepared to sell their shares. At the time of bidding, they only have access to a floor price prescribed by regulation. Promoters must fix their offer at a price higher than the floor, and in declining market conditions such a price tends to be at considerable divergence with the true value of the company. While the reverse book building mechanism appears attractive at a superficial level as the public shareholders fix the price themselves, this could create distortions for several reasons.
First, the lack of a price cap, and hence a range, allows public shareholders to bid at any higher price as they wish, thereby creating a wide gulf in the pricing of bids. Second, a small group of shareholders owning a significant number of shares could demand an unduly high price, thereby holding the other shareholders to ransom. Such an attitude could chill a delisting, even if offered at a generally acceptable price. Third, and conversely, a group of arbitrageurs who may have purchased shares in the lead up to the delisting announcement may seek to bid at an unduly low price to profit for themselves at the expense of the long-term shareholders. Fourth, the reverse book building process assumes a high level of information and sophistication among the public shareholders that would allow them to make educated bids, especially as to price. However, information asymmetry between the promoter and public shareholders is writ large in a delisting that reduces the likelihood of proper price discovery.
The promoters and management are privy to not only a more accurate value of the company in its current circumstances but also to the future value they propose to extract after the delisting.
During two previous consultations, SEBI has acknowledged some of these challenges to the reverse book building process but has sought to make suitable adjustments rather than to jettison it. For example, in 2018 it added that if the reverse book built price is unacceptable to the promoter, it may make a counteroffer to the public shareholders, but at a floor price pegged to the book value of the company as certified by a merchant banker. If book value is a floor for a counteroffer, it is unclear why such a floor cannot be prescribed for the original offer, as that could have saved a failed round of price discovery.
As for other possibilities, SEBI could require promoters to support their indicative price with an independent valuation report stating that such price is “fair and reasonable” to the shareholders. Such a measure, reinforced last year by the SGX in Singapore, will ensure that the information asymmetry that public shareholders suffer from is minimised by reliance on a gatekeeper, being the independent financial adviser. Finally, contingent price mechanisms would augur to the benefit of minority shareholders as well. For instance, if the company’s value raises substantially in the aftermath of delisting, the by-then exited public shareholders could stake a claim to share in that value as well. Such a contingent pricing mechanism is not alien to the Indian securities market, as SEBI stipulated the same in the 2015 Essar Oil delisting case, although the contingency therein was known beforehand at the time of delisting. This will ensure that minority shareholders are not victims of canny timing for delisting.
The likely wave of delisting generated by the present economic environment is bound to test the decision-making and price discovery processes under the SEBI regime. However, it may also provide an opportunity to recalibrate the regime to balance the interests of the company, management, promoters, and public shareholders.
Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.