Poison pills give immunity from hostile takeovers

While the term takeover is not formally defined, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (takeover code), defines acquisition as “directly or indirectly, acquiring or agreeing to acquire shares or voting rights in, or control over, a target company”. In Pramod Jain v SEBI, the Supreme Court held that “where management of the target company is unwilling to negotiate with an acquirer, the acquirer can directly approach the shareholders by making an open offer, which is called a hostile takeover. A hostile takeover helps to unlock the hidden value of the shares and puts pressure on the management to work efficiently. On the other hand, it has the potential of unduly upsetting the normal functioning of a target company”.

A promoter shareholding of around 50 per cent prevents a hostile takeover. A bid will likely succeed if the promoter shareholding is significantly below 50 per cent and the acquirer offers an attractive price.

The first hostile takeover was in 1983, when Lord Swaraj Paul acquired substantial stakes in two family-held companies. Though the long-fought legal battle over the takeover went in his favour, he sold his investments. The first successful hostile takeover in 1998 saw Indian Cements Limited (ICL) make an open offer for the shares of Raasi Cements Limited at a significantly higher price than that at which they traded. ICL acquired more than 80 per cent of the shares. More recently, Larsen & Toubro took over Mindtree Limited in India’s second hostile takeover. Currently, Adani’s AMG Media Networks Limited is attempting a hostile takeover of New Delhi Television Limited (NDTV). Adani has since acquired a 64% stake in NDTV (including promoter shareholding, vide a separate deal. As hostile bids increase, the poison pill strategy should be a significant company defence.

This strategy makes shares unattractive to the hostile acquirer. In a hostile takeover, the shareholders of the company, except the hostile bidder, are offered its shares at a discounted price. This dilutes the stake of the hostile bidder and increases the cost of acquisition. The poison pill or preferred share purchase rights plan was first approved by the Delaware Supreme Court in Moran v Household International, Inc. The court upheld a plan issuing the company’s stock to its shareholders, except the hostile acquirer, at a discount. The action was lawful in Delaware and helped prevent opportunistic takeovers.

In India, the takeover code requires the disclosure of the acquisition or disposal of a shareholding of 2% or more of the shares or voting rights by anyone holding 5% or more of the shares of the company. While these disclosures can alert a company to a hostile acquirer, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (regulations), bar the preferential issue of shares or the exercise of warrants at a large discount by prescribing minimum or floor prices.

The takeover code does not allow a company to make changes to its capital structure once the hostile acquirer makes an open offer. Under regulation 26, the company cannot issue or allot any unissued securities carrying voting rights during the offer period. An exception is a change to the capital structure made by a special resolution. As the acquirer must own a 25 per cent shareholding before making an open offer, the acquirer can easily defeat such a resolution. This renders the poison pill nugatory. The company may, during the offer period, issue or allot shares on terms that are pre-set on conversion of convertible securities issued prior to the public announcement of an open offer. As already stated, however, the regulations, set a prescribed minimum price and such conversion is therefore of little assistance to the company.

The lack of defences, such as preferred share purchase rights, hinders promoting shareholders trying to prevent hostile bids. Putting provisions such as the poison pill and principles-based standards in the takeover code and removing legal obstacles would provide powerful tools against such bids.

In the USA, the poison pill has been successful against hostile takeovers, including that of Netflix by the corporate raider, Carl Icahn. As the Indian market matures and closely held or promoter-driven family businesses give way to large corporations, regulators should look again at defences against hostile takeovers such as preferred share-purchase rights.

Soumya De Mallik is a partner and Prithviraj Chauhan is a senior associate at HSA Advocates. Himanshu Seth, an associate, also contributed to the article.