India: ‘Objects, They Are A-Changin' - Rethinking Variation In IPO Objects Midst COVID-19

1. INTRODUCTION

The Standing Committee on Finance in its 21st report had highlighted that a company should not be able to freely change the terms of contracts or the objects stated in its initial public offering ("IPO") prospectus after listing of the shares is achieved. The idea behind such restriction was to protect IPO investors who would have invested based on disclosures made in the prospectus, including in relation to the objects or use of proceeds of the IPO. This suggestion, along with certain exceptions, eventually translated into Section 27¹ of the Companies Act, 2013 as amended (the "CA 2013"), which was notified in April 2014.

Since then, many companies have changed IPO objects following this law, reflecting the dynamic nature of businesses and any alterations in assumptions made at the time of stating IPO objects. It is well understood that change in internal or external factors would give genuine reasons to a company to alter the use of IPO money post listing. The issue of variation of objects, however, has become relevant today, when COVID-19 has locked down economies, sent markets into free-fall, and forced listed companies to rethink their business and planned expansion strategies, including in relation to the use of proceeds of their IPOs.

2. VARYING OBJECTS

2.1. What is variation

Section 27(1) of the CA 2013 states that a company shall not vary the objects for which its prospectus was issued unless it obtains consent from its shareholders through a special resolution. While the language appears clear at first glance, it still raises a few questions on its applicability. Questions such as what is meant by 'vary the ... objects for which the prospectus was issued'. Questions are often raised on whether the following would be seen as "variation of the objects":

1. using proceeds for a completely new object;
2. failure to utilize proceeds for an object;
3. changing the amount to be spent for an object;
4. changing the amount for a sub head within an object (with the overall amount spent towards the same object remaining unchanged); and
5. changing the schedule of deployment for an object.

Curiously, the CA 2013 or the relevant rules do not define variation of an object, or lay down a bright-line test. It could therefore be argued that any change in the use of proceeds of the IPO, either in terms of the amount or timing of deployment or the terms of the object itself, would require a shareholders' approval. What is concerning here, is that whilst the language of Section 27(1) of the CA 2013 seems to cover all instances of change (regardless of how insignificant), its real purpose or intent should have been to apply to only 'material' or 'significant' changes. To put the burden of compliance on companies for changes which are truly negligible, could not have been the intent of Section 27(1) of the CA 2013. Therefore, the question remains whether companies should take literal interpretation of Section 27(1) of the CA 2013 and seek shareholders' approval for each and every change, regardless of how insignificant the change is or restrict to approaching the shareholders for their approval only where the change is 'material', despite there being no guidance on how to define 'material'.

Certain instances where companies have taken a shareholders' approval for variation in objects have been listed in the Annexure. These instances range from change in deployment of amounts as little as 0.05% of the IPO proceeds, all the way up to 89% of the IPO proceeds. Shareholder approvals have also been taken for changes in the funds spent on sub-heads within the primary objects.

2.2. Procedure for varying objects

The proviso to Section 27(1) of the CA 2013, gives the Government of India the power to frame rules in relation to the process for obtaining shareholders' approval. Rule 7 of Companies (Prospectus and Allotment of Securities) Rules, 2014, as amended, prescribes the particulars to be included in the notice of the shareholders' meeting for a special resolution (required to be passed through postal ballot) for approving the change in objects. These include the original object, unutilized amount out of proceeds raised, particulars of and reasons for the variation. The notice is required to be published in one English and one vernacular newspaper in the city where the registered office of the company is situated, and also placed on the website of the company.

It should also be noted that the Ministry of Corporate Affairs (the "MCA") has recently relaxed certain procedural requirements for holding general meetings, to ease the compliance burden of companies, due to COVID-19. Through its circular dated April 8, 2020, the MCA has allowed companies, till June 30, 2020, to conduct general meetings by way of video conference or other audio-visual means for matters that are considered unavoidable.² The MCA has also through another circular dated April 13, 2020, allowed companies to send notices for general meetings to shareholders electronically, subject to certain conditions.

2.3. Exit option for shareholders

Once the approval under Section 27(1) of the CA 2013 has been obtained, Section 27(2) of the CA 2013 mandates that all shareholders who have voted against the resolution (the "Dissenting Shareholders") shall be given an exit offer by the promoters or the controlling shareholders (the "Exit Offer Provider") in a manner as specified by the Securities and Exchange Board of India ("SEBI").

In February 2016, pursuant to certain amendments to the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009, SEBI had set out the manner of providing such exit to the Dissenting Shareholders. These provisions were carried over in the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (the "SEBI ICDR 2018") under Regulations 59 (in case of IPOs on the main board) and 157 (in case of further public offers on the main board), read with Schedule XX. Needless to say, these provisions for exit to the Dissenting Shareholders are not applicable in cases where there is no identifiable Exit Offer Provider.

In terms of the SEBI ICDR 2018, the Exit Offer Provider is required to provide an exit offer to the Dissenting Shareholders if:

1. the proposal for change in objects referred to in the company's offer document is dissented by at least 10% of the shareholders voting on the resolution; and
2. the amount to be utilized for the objects for which the offer document was issued is less than 75% of the amount raised (including amounts, if any, earmarked for general corporate purposes).

As is evident from the foregoing, SEBI has taken a more rational approach by adding a materiality threshold in both the limbs of this requirement, perhaps signaling that the term 'variation' itself should be pegged to a reasonable benchmark.

As regards item (i) above, even though the requirement under Section 27(1) of CA 2013 is to have the proposal approved by a special resolution (i.e., 75% of the shareholders present and voting), the requirement to provide an exit to the Dissenting Shareholders will only kick in where at least 10% of the shareholders who are present and voting have rejected the proposal.

In item (ii) above, even though it states that the Exit Offer Provider does not have an obligation to provide an exit offer if 75% or more of the amount raised in the IPO has already been spent on the objects as stated in the company's prospectus, it does not state whether this 75% is supposed to be calculated basis total proceeds (i.e., the aggregate of the fresh issue and the offer for sale) or just the fresh issue component of the IPO. However, due to the fact that the proceeds of the offer for sale go to the selling shareholders and not the company, the intent seems to peg this at 75% of the fresh issue.

2.4. Exit Price

The SEBI ICDR 2018 (under Schedule XX) provides the method for arriving at the exit price to be offered to the Dissenting Shareholders by the Exit Offer Provider, as being the highest of the following –

1. the volume-weighted average price paid or payable for acquisitions, by the promoters of the company or by any person acting in concert with them, during the 52 weeks immediately preceding the relevant date;
2. the highest price paid or payable for any acquisition, by the promoters of the company or by any person acting in concert with them, during the 26 weeks immediately preceding the relevant date;
3. the volume-weighted average market price of shares for a period of sixty trading days immediately preceding the relevant date as traded on the stock exchange where maximum volume of trading takes place during such period, provided such shares are frequently traded; or
4. in case shares are not frequently traded, the price determined by the Exit Offer Provider and the lead managers taking into account valuation parameters including book value, comparable trading multiples, and such other parameters as are customary for valuation of shares of such companies.

The relevant date for the purpose of pricing is defined as the date of the board meeting in which the proposal for change in objects is approved, before shareholders' approval.

Further, Schedule XX of the SEBI ICDR 2018 also lays down the manner for providing an exit to the Dissenting Shareholders', which involves, among other things, appointment of a merchant banker or a lead manager by the Exit Offer Provider, creation of an escrow account for deposit of the exit offer consideration, opening and closing of the tendering period and eventually payment by the Exit Offer Provider to the Dissenting Shareholders who continue to be shareholders of the company as on the relevant date, and tender their shares in the exit offer.

The Dissenting Shareholders have the option to either tender or hold on to their shares, which arguably gives an unfair advantage to investors and, possibly, creates room for unfair play. In addition, even after the entire process has been followed, the Dissenting Shareholders who have tendered their shares have the option to withdraw till the closure of the tendering period, thereby making the entire process infructuous. Till date, there has not been any instance of an exit offer being provided since the provisions came into force.

Also, important to note is that acquisition of shares by the Exit Offer Provider under this process is exempt from the obligation to provide an open offer under Regulation 3 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. Further, in case the exit offer results in a breach of the minimum public shareholding threshold, the Exit Offer Providers must bring their shareholding in compliance with such thresholds.

3. CONCLUSION

Even though the applicability and process for providing an exit offer to the Dissenting Shareholders is clear under the SEBI ICDR 2018, there still exits ambiguity on the applicability of Section 27(1) of the CA 2013, with respect to the requirement of obtaining shareholders' approval for variation in objects. This ambiguity arises out of the disconnect between the language of Section 27(1) of the CA 2013 and the need to take a rational approach when it comes to ascertaining the meaning of 'variation in objects', and the absence of any guidance or bright-line tests under CA 2013 or rules thereunder.

Since the requirement to obtain the shareholders' approval is directly under the CA 2013, SEBI is unlikely to clarify this matter and any clarity in terms of applicability or threshold will have to come by way of an amendment. Some regulatory guidance on this matter through an amendment to the CA 2013 or otherwise would go a long way to assist issuers in achieving their commercial ends, particularly in the "times of COVID-19", which potentially threatens to topple (at the very least) deployment schedules of the proceeds of an IPO.

Annexure

Footnotes

1. Variation in Terms of Contract or Objects in Prospectus (Notified Date of Section: 01/04/2014)

2. For details see - MCA issues relief measures to conduct EGM: Nifty Solution To The Conundrum?, available at: https://induslaw.com/app/webroot/publications/pdf/alerts-2020/Infolex-News-Alert-MCA-issues-relief-measures-to-conduct-EGM-Nifty-solution-to-the-Conundrum-April-2020.pdf

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