Deal Talk
September 02, 2024
Deal Making Insights – Lessons from Proxy Advisory Firms
Introduction:
Companies, undertaking
business operations in India, are obliged to
comply with the Companies Act, 2013 (‘CA
2013’), which requires them to
undertake operations and make decisions through
two means- (a) board decisions and (b) shareholder
decisions. Matters like inspection
of books of accounts, making political contributions,
related party transactions, borrowing of money,
appointment of key managerial persons and managing
director, approval of financial statements,
approval of a merger/ amalgamation/ reconstruction
etc. require approval from the majority
of the board of directors as a board resolution. Matters like reduction
of share capital, amendment to charter documents,
buy back, preferential allotment of shares,
private placement, issue of stock options, scheme
of arrangement etc. require a shareholders majority
vote in addition to a board resolution to undertake
such activity. Shareholders majority
under CA 2013 is of two types:
(a)
Ordinary Resolution: A resolution
approved by more than 50% of the shareholders by
value (voting in person/ proxy/ electronic means).
E.g., appointment of directors, approval of financial
statements, declaration of dividends; and
(b)
Special Resolution: A resolution
approved by more than 75% of the shareholders by
value (voting in person/ proxy/ electronic means).
E.g., reduction of share capital, buy back of shares,
amendment to charter documents.
The shareholders in
a listed entity can be broadly segregated into
three buckets – promoters, institutional
investors, and retail investors. Therefore,
for the purposes of any shareholders resolution,
these shareholders would be eligible to vote.
However, historically the turnout of retail
investors has been substantially lower as compared
to the other two buckets given that (i) their
interest in the company is focused on financials
as compared to governance and (ii) retail investors
are dynamic investors and keep changing based
on the market position of the company. As per
latest data available on the BSE, the average
voter turnout for top 20 listed companies in
the general meetings was approximately 80%,
with maximum votes being cast by the institutional
investors and promoters. In cases of listed
companies which are not closely-held by the
promoters, the institutional investors have
a huge role to play in shareholders vote, given
that the turnout of retail investors would be
significantly lower, and the promoter shareholding
is not high enough to have control over shareholders’
decisions. While institutional
investors play such a huge role in determining
the faith of shareholders’ resolutions,
they usually have investments in a number of
companies which makes it difficult for them
to exercise independent diligence in deciding
their position in a shareholders’ resolution.
This is where the proxy advisors come into the
picture to help institutional investors in their
decision making with respect to shareholders’
resolutions. Proxy advisors are
person/ entities defined under Regulation 2(p)
of the SEBI (Research Analyst) Regulations,
20141
which provide advice to institutional investors
or shareholders of a company, in relation to
exercise of their rights in the company including
recommendations on public offer or voting recommendation
on agenda items. Proxy advisors provide
advice to the institutional investors and other
shareholders by examining the documents of the
company in relation to their shareholder resolutions
and other factors specific to each company.
However, to maintain a transparent system, proxy
advisors publicly present and disclose their
voting guidelines, where they mention the factors,
they will take into consideration while determining
their voting position with respect to an agenda. The power of falling
foul of the voting guidelines can be seen in
the multiple shareholders’ resolutions
which failed upon proxy advisors advising to
vote against such agenda. Few key examples of
them include the withdrawal of delisting plans
by Vedanta Limited in 2021 where the proxy advisors
had voted against the proposal of delisting
citing undervaluation concerns. In 2019, Tata
Motors withdrew a proposed salary hike for top
executives after proxy advisors (IiAS and SES)
opposed it due to the company's financial struggles,
reflecting their commitment to fiduciary duty
and financial prudence. It may be possible
that different advisors provide different advice
in accordance with their analysis and voting
guidelines. It then becomes critical how the
shareholders in their prudence vote in a meeting.
For e.g., in the recent ITC De-merger plans,
IiAS had advised against the proposed demerger
of ITC’s hotel business, stating there
is a lack of complete value unlocking for shareholders,
while InGovern and SES had raised no concern
over the same proposal. The plan was approved
by the shareholders. For deal making, these
voting guidelines also help in understanding
the chances of a particular structure or agenda
item in the deal passing the check of proxy
advisors and therefore helps in predicting the
voting sentiment of institutional investors
and thereby allow for higher deal certainty.
Relevant voting guidelines for
deal making:
1.
Approval of Special Rights to Shareholders
|
Deal-making Factor
|
Many investors look to structure
their transactions in such a way that they
also have certain rights over the listed
company (such as a board seat) to ensure
value protection of their investment. Additionally,
the promoters of a listed company also seek
additional rights as compared to the public
shareholders to ensure they can exercise
control over the listed entity. However,
as per the SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2018 (‘ICDR’)
all shareholders of the same series of a
class shall be treated equally. In order
to provide the flexibility to investors
for structuring non-control rights and to
the promoters for structuring control rights,
SEBI through Regulation 31B of SEBI (Listing
Obligations and Disclosure Requirements)
Regulations, 2015 (‘LODR’)
allows for special rights to shareholders
of a listed company subject to such rights
being approved by a special resolution (i)
at the time when they are granted and (ii)
every five years from the date of granting
such rights
|
|
IiAS
|
IiAS in its general stance will advise
to vote AGAINST any special
rights. Will generally analyze on a case-to-case
basis and advise AGAINST
resolutions where:
a set of shareholders
have board nomination rights disproportionate
to their shareholding or if these rights
are embedded in permanency and continue
even if the shareholding levels drop; when identified
individuals (usually promoters) have
board permanency or are necessarily
required to form quorum for board, board
committee and/or shareholder meetings
and they are not subject to retirement
by rotation; identified/named
individuals are permanently appointed
as Managing Director, Whole-Time Directors,
or Chairperson; investor/investor
nominee directors are given veto power
on board decisions.
IiAS will generally not support any special/
overriding powers to an individual or a
group, and will require complete disclosure,
where any discrepancy or insufficiency will
be raised as a concern.
|
|
SES
|
SES will generally advice to vote
AGAINST the resolution
unless:
controlling
shareholder is widely held or if the
special rights are for non-promoter
Institutional Investors/Lenders as a
safeguard; the director
proposals are based on merit, regardless
of investor affiliation; there is no
right to nominate Board committee members.
Additionally, SES will recommend voting
against special rights irrespective of where
such rights are being enshrined in the articles
of the company or merely being enforced
through an agreement.
|
|
Insights for deal-making
|
While structuring transactions which
have a rights package for the investor or
the promoters in the listed company, the
following shall be considered:
the rights
are provided through provisions in AoA; the rights
package shall be in proportion to the
shareholding that the investor or the
promoter holds in the target entity
(ideally most of these special rights
such as board appointment right can
be linked to a minimum shareholding
level that a shareholder has to maintain
to be able to exercise this right); the board nominee
shall not be made party to all committees
of the board and only key committees
which are of important nature for the
concerned shareholder who is being granted
the special right; the board nominees
shall not be permanently appointed to
the position of a chairman, whole time
or managing director; the board nominee
selected by such shareholder with special
right shall have relevant experience
and also be fit for the concerned board; there is no
grant of a veto power, but only sufficient
safeguard of interests is observed.
|
2.
Issuance of Preferential Allotment to investors
by a listed company
|
Deal-making
|
An investor may choose to acquire shares
in a listed entity either as (a) a secondary
purchase by acquiring shares from an existing
shareholder or (b) a primary purchase where
the investor is issued shares by the target
company. One of the most common methods
for investors to make primary investments
in target company is a preferential allotment.
Preferential allotment is an issue of shares
to any person/entity other than the existing
shareholders, under Section 62 of CA 2013
and ICDR. Preferential allotment requires
a special resolution.
|
|
Voting Guidelines by IiAS
|
IiAS will generally advice to vote
FOR resolution of a preferential
allotment, on a case-to-case basis, upon
review of factors such as:
(i) whether the issuance is to promoter/non-promoter
(ii) whether the investor is in the nature
of financial/strategic
(iii) extent of dilution
(iv) urgency of funds
(v) Debt levels of the company and available
cash
(vi) Return of the capital employed
IiAS will also recommend voting for preferential
issues for companies in financial services
sector as these have high capital requirements
for meeting Basel III guidelines, absorbing
credit losses and organic growth. While
IiAS recognizes that a public issue is typically
costlier and time consuming, IiAS views
excessive dilution of existing shareholders
by the promoter group as a concern unless
companies are undergoing a debt restructuring
program or are in urgent need of funds.
|
|
Voting Guidelines by SES
|
SES will in the normal course of action
advice to vote AGAINST
proposals for preferential issue and/or
private placement of shares and/or convertible
securities due to their dilutive effect
on the shareholders unless:
(i) compelling reasons/justifications
for the preferential issue have been disclosed;
or
(ii) such investment is being made by
a strategic investor which may be positive
for the company; or
(iii) where the company adequately explains
as to why a rights issue is not a feasible
option.
The focus is that the issuance shall
be beneficial for the company rather than
an individual or an entity. Additionally,
SES generally recommends that for the purposes
of raising capital, the company should undertake
a rights issue as compared to a preferential
allotment. However, in cases where the price
of equity shares offered to select persons
under preferential issue is significantly
higher than the market price of the share
or higher than the price arrived at as per
the ICDR pricing formula, it may take a
lenient view and recommend voting FOR of
the resolution.
SES will also consider the dilution caused
as a result of the preferential issues made
during a period of 12 months, and if the
dilution caused over a period of 12 months
is significant, then the company should
explain as to why rights issue was not feasible.
However, in case of financially distressed
company or any other apparent reason where
rights issue is clearly not practically
feasible, then, SES may take a lenient view.
|
|
Insights for deal-making
|
Based on the positions taken by IiAS
and SES, an investor planning to acquire
shares of a target company through preferential
allotment shall keep the following points
in consideration:
(a) There should be sufficient explanation
for the need of capital being raised as
part of the preferential allotment;
(b) The company shall reflect detailed
reasons on why preferential issue was undertaken
as compared to a rights issue given that
preferential allotment would lead to a dilution
whereas rights issue to existing shareholder
would avoid dilution of the shareholders;
(c) The investors shall also verify the
extent of dilution that has taken place
in the last 12 months by other investments
in the target entity as if there is a significant
dilution in the last 12 months, the proxy
advisors might take a negative position
with respect to the agenda.
|
3.
Issue of Warrants
|
Deal-making Factor
|
Another instrument for structuring which
is used by promoters and investors alike
are warrants issued by a listed entity.
Issuance of warrants is governed under the
ICDR which states that at least 25% of the
conversion price in case of warrants shall
be paid upfront, and rest upon conversion
of the options attached with the warrants
into equity shares. Additionally, as per
ICDR, warrants can have a maximum tenure
of 18 months.
|
|
IiAS
|
IiAS will generally advice to vote
AGAINST the resolution
for issuance of warrants. As per IiAS, warrants
issued to promoters give them the option
to ride the stock prices of the company
for 18 months. Additionally, a promoter
might decide not to subscribe to the remaining
25% at the end of 18 months, which could
have material implications on the long-term
plans of the company. They will advise voting
FOR the resolution only
if:
The exercise
period is less than 18 months, and the
upfront payment is more than 25%; Made to government-controlled
entities, non-promoter shareholders
or technical collaborators; Issued at a
significant premium to the market price; Confirmation
from the company that the allottee will
pay the remaining amount irrespective
of the market price prevailing on the
date of exercise; The company
offers the same terms of issuance to
both promoters and non-promoter shareholders; Granted to
an institution or a listed company; The promoters
have a track record of completely subscribing
to warrants issued in the past.
|
|
SES
|
Will generally advice to vote
AGAINST the resolution if the issue
is of Naked Warrants i.e., not attached
with non-convertible debentures, unless:
|
|
Insights for deal-making
|
When structuring a transaction involving
warrants being issued by a listed entity,
in case such warrant issuance is to a promoter
the following considerations shall be considered:
The issue is
attached to non-convertible debentures; The exercise
period is shorter, there is significant
premium and there is more than 25% upfront
payments; The terms of
the warrants are consistent with the
warrants previously issued to promoters/non-promoters; Past track
record of the promoters with respect
to conversion of warrants held by such
promoters; There are justified
reasons including urgency, and experience
of the company in issuing Warrants.
|
4.
Issue of Debt Instruments/ non-convertible
debentures on a Private Placement Basis
|
Deal-making Factor
|
Issue of non-convertible debentures /
debt securities on a private placement basis
under Section 42 of CA 2013 requires a special
resolution.
|
|
IiAS
|
Will generally advice to vote
FOR the resolutions unless such
issuance is not within borrowing limits
of the company.
|
|
SES
|
Will generally advice to vote only after
a case-to-case analysis considering borrowed
amount to the size and operations of the
company and will not raise concerns where
sufficient reasons are provided.
|
|
Insights for deal-making
|
Investors structuring their transactions
through debt instruments shall ensure that
the target company is within the borrowing
limits and the issue size shall be in-proportion
to the size and operations of the company
and shall not be significantly huge comparatively.
|
Conclusion:
In conclusion, Proxy Advisors have become instrumental
in the realm of deal-making, primarily by serving
as a vital check on transaction structures to safeguard
shareholder interests. Their role in scrutinizing
deals has ensured that proposals detrimental to
shareholders do not go unchecked, thereby promoting
transparency and accountability in corporate governance.
With the Securities and Exchange Board of India
(SEBI) stepping in to regulate the activities of
Proxy Advisors, there is an increased emphasis on
transparency in their recommendation processes.
This regulatory oversight mandates that Proxy Advisors
provide clear voting guidelines, ensuring that investors
and promoters have a comprehensive understanding
of the factors influencing their recommendations.
By closely monitoring these guidelines, stakeholders
can better structure transactions to align with
shareholder expectations, thereby enhancing the
likelihood of favourable outcomes during shareholder
voting. Ultimately, this increased transparency
and understanding can help in achieving greater
deal certainty, as stakeholders can anticipate and
address potential concerns from shareholders proactively.
As a result, the evolving role of Proxy Advisors,
coupled with regulatory efforts by SEBI, is fostering
a more informed and balanced approach to corporate
deal-making, ensuring that the interests of all
stakeholders are adequately protected.
Author:
Anurag Shah,
Divyansh Bhardwaj
and
Nishchal Joshipura
You can direct your queries or comments to the relevant member.
1https://www.sebi.gov.in/legal/regulations/aug-2021/securities-and-exchange-board-of-india-research-analysts-regulations-2014-last-amended-on-august-03-2021-_34615.html
Disclaimer
The contents of this hotline should
not be construed as legal opinion. View detailed disclaimer.
This hotline does not constitute a legal
opinion and may contain information generated using
various artificial intelligence (AI) tools or assistants,
including but not limited to our in-house tool,
NaiDA. We strive to ensure the highest quality and
accuracy of our content and services. Nishith Desai
Associates is committed to the responsible use of AI
tools, maintaining client confidentiality, and adhering
to strict data protection policies to safeguard your
information.
This hotline provides general information
existing at the time of preparation. The Hotline is
intended as a news update and Nishith Desai Associates
neither assumes nor accepts any responsibility for any
loss arising to any person acting or refraining from
acting as a result of any material contained in this
Hotline. It is recommended that professional advice
be taken based on the specific facts and circumstances.
This hotline does not substitute the need to refer to
the original pronouncements.
This is not a spam email. You have received
this email because you have either requested for it or
someone must have suggested your name. Since India has
no anti-spamming law, we refer to the US directive,
which states that a email cannot be considered spam if
it contains the sender's contact information, which
this email does. In case this email doesn't concern you,
please
unsubscribe from mailing list.
 |
|
We aspire
to build the next generation
of socially-conscious lawyers
who strive to make the world
a better place.
At NDA, there
is always room for the right
people! A platform for self-driven
intrapreneurs solving complex
problems through research, academics,
thought leadership and innovation,
we are a community of non-hierarchical,
non-siloed professionals doing
extraordinary work for the world’s
best clients.
We welcome
the industry’s best talent -
inspired, competent, proactive
and research minded- with credentials
in Corporate Law (in particular
M&A/PE Fund Formation),
International Tax , TMT and
cross-border dispute resolution.
Write to
happiness@nishithdesai.com
To learn more
about us
Click here.
|
|
Chambers
and Partners Asia
Pacific 2024:
Top Tier for Tax,
TMT, Employment,
Life Sciences, Dispute
Resolution, FinTech
Legal
Legal 500
Asia Pacific 2024:
Top Tier for Tax,
TMT, Labour &
Employment, Life
Sciences & Healthcare,
Dispute Resolution
Benchmark
Litigation Asia
Pacific 2023:
Top Tier for Tax,
Labour & Employment,
International Arbitration
AsiaLaw
Asia-Pacific 2023:
Top Tier for Tax,
TMT, Investment
Funds, Private Equity,
Labour and Employment,
Dispute Resolution,
Regulatory, Pharma
IFLR1000
2024: Top
Tier for M&A
and Private Equity
FT Innovative
Lawyers Asia Pacific
2019 Awards:
NDA ranked 2nd in
the Most Innovative
Law Firm category
(Asia-Pacific Headquartered)
RSG-Financial
Times:
India’s Most
Innovative Law Firm
2019, 2017, 2016,
2015, 2014
|
|
|
|
