Regulatory view of ‘control’ puts investors in catch-22

By Harish Kumar and Vikas Gaur, Link Legal India Law Services
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Historically, “control” in corporate parlance has been understood as positive control. As per a 2009 press note from the Department of Industrial Policy and Promotion, control means the power to appoint a majority of directors. However, codification of the term control in subsequent legislation has expanded its scope beyond majority ownership of shares and majority representation on the board. Accordingly, control now includes within its ambit the ability of a person to influence the company’s policy decisions, such as by virtue of management rights or shareholders’ agreements.

Harish Kumar Partner Link Legal India Law Services
Harish Kumar
Partner
Link Legal India Law Services

As control was given a new flavour, it was only a matter of time for the judiciary (and quasi-judicial bodies) to respond to the accruing of certain rights to investors out of various definitive agreements entered into among the company, promoters and investors.

An order by the Securities and Exchange Board of India (SEBI) in 2010, in the matter of Subhkam Ventures, sent shock waves among investors. The order stated that certain minority protection rights, including the right to nominate directors on the board, and affirmative voting rights constituted “control” for the purposes of the takeover regulations.

The Securities Appellate Tribunal (SAT) overturned SEBI’s decision, holding that “control” is a proactive power. The entire investment community then looked to the Supreme Court to settle the question of “control”. However, SEBI and Subhkam Ventures reached an out-of-court settlement so the court had no chance to express its opinion.

Surprisingly, the court, while disposing the appeal, stated that the SAT’s order would not be treated as a precedent in the matter of law. This added further ambiguity on whether the grant of certain rights in investment agreements would be tantamount to the acquisition of control.

Although the Competition Act, 2002, defines control as the ability to control the affairs or management of an enterprise, the Competition Commission of India (CCI) has consistently held that the presence of veto and affirmative rights are determinative of control. In the matter of Century Tokyo Leasing Corporation and Tata Capital Financial Services, the CCI held that affirmative rights envisage a situation of control over the assets of the company.

In the matter of Etihad Airways and Jet Airways (India), the CCI concluded that Etihad’s purchase of a stake in Jet Airways fell within the purview of control, as the effect of definitive agreements, including on the governance structure, established Etihad’s joint control over the assets and operations of Jet.

The juxtaposed views of SEBI and the CCI have created discomfort in the minds of investors. Although the divergent views could be on account of differences of purpose and objective, no jurisprudence on the concept of control can be ignored.

Vikas Gaur Associate partner Link Legal India Law Services
Vikas Gaur
Associate partner
Link Legal India Law Services

The Company Law Committee constituted by the Ministry of Corporate Affairs, in its report dated 1 February 2016, discussed the public consultation relating to the feasibility of limiting the scope of control as defined under the Companies Act, 2013. During the consultation, a demand was made to bring the definition in consonance with the definition of control as per accounting standard 110. While rejecting this demand, the committee emphasized the need for the present inclusive definition in view of the constantly evolving instruments and corporate structuring.

In order to resolve the uncertainties and ambiguities around control, SEBI recently released a discussion paper. The paper states that assessing whether an entity controls a company is straightforward in cases where the rights accrue to an entity through its shareholding/voting rights in the company. However, in cases where rights accrue through contractual agreements, facts and circumstances of the case must be considered. Thus, the definition of control is based on certain defined principles rather than rule-based.

In the light of the aggressive regulatory position, investors are in a catch-22 situation. If they increase their scrutiny over the day-to-day affairs of the company, they run the risk of getting scrutinized themselves. If they structure their rights and position carefully so as to steer clear from deeper involvement in the management of the company, promoters may opportunistically compromise the transparent operations of the company.

In effect, so long as affirmative rights are not participative and are solely protective in nature, they may not be construed as resulting in control. Whether a contractual right has surpassed its passive nature is a question that has to be answered on a case-to-case basis, as every agreement and every right is unique.

Harish Kumar is a partner and Vikas Gaur is an associate partner at Link Legal India Law Services.

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