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Corporate Law-II

Hostile Takeovers

TABLE OF CONTENTS

Serial No. Introduction Research Methodology Hostile Takeover: A Brief Conceptual Explanation Policy Issues Arising In A Hostile Takeover Defences To Hostile Takeovers

Legal Regime For Takeover Regulation Financing Of Hostile Takeovers Case Studies Conclusion Bibliography

Page No. 1 2 3 9 15 22 39 43 55 57

INTRODUCTION On Oct. 10, 2000 Arun Bajoria, a jute baron based in Calcutta, revealed that he had bought 14% of languishing textile maker Bombay Dyeing & Manufacturing and would seek a board seat. Just three days later on October13, Renaissance Estates, a young New Delhi-based construction company, revealed that it had accumulated more than 5% of Gesco, a real-estate spin-off of venerable Great Eastern Shipping Co. and would bid Rs. 27 a share for a 51% stake. Gesco's share price nearly tripled to Rs. 40 a share in the wake of the announcement. Then, in early November, news broke that cigarette maker and hotelier ITC Ltd. had bought 5% of East India Hotels Ltd. since the start of the year. ITC termed the buying ''routine treasury operations.'' Aware of ITC's moves, the Oberoi family, East India's founders, has boosted its stake to 39%, from 36%, in the past few months. Hostile takeovers have finally arrived in India and family run business houses are scurrying for cover. India’s industrial scions have been shaken out of their slumber and suddenly find themselves vulnerable against relatively new and young corporate raiders. Although, since 1994, when the Takeover Regulations were first framed by SEBI, no successful hostile takeover has taken place in India, in the past few years it certainly seems to be picking up and it may not be long before inefficient management coupled with low stock prices make them attractive preys for a hostile bidder. A hostile takeover primarily involves changing the control of the company against the wishes of the incumbent management and the Board of Directors. This throws up a lot of social, legal, and economic issues. The prominent among these are the following which form the subject-matter of this project assignment:  Whether hostile takeovers are always beneficial to the target shareholders?  Whether hostile takeover has a disciplining effect on an inefficient management or does it just destabilise the incumbent management?  Do hostile takeovers always lead to efficient allocation of scarce economic resources?  What is the effect of hostile takeover on the shareholders of the acquiring company?  Whether hostile takeover has adverse consequences on non-shareholder constituencies of the target company?  Whether an active market for corporate control is desirable in India?

4 Research Methodology The aim of the paper is to understand the concept of hostile takeovers, understand the implication from the perspective of not only the shareholders but also other stakeholders in the company. The project seeks to examine if the incumbent management should be allowed to defend the existing control structure against a takeover bid.

Scope and Limitations The researchers have excluded the tax implications of hostile takeovers from the purview of research due to the vast scope of the issue.

Sources of Material Both primary and secondary sources have been used for the purpose of the project. The primary sources are the offer documents filed with SEBI and regulatory agencies of the other countries. The secondary sources, which have been used, are articles, books and websites.

Research Questions The questions, which have been dealt with in, this paper are:  What is a takeover and how is a hostile takeover different from a friendly takeover?  What are the issues arising from the perspective of various stakeholders in the company?  Is there a conflict of interest between the shareholders and the incumbent management?  What are the defences to a hostile takeover?  What is the legal regime for takeovers?  How do courts interpret disputes regarding hostile takeovers?

Style of Footnoting A uniform style of footnoting has been followed throughout the paper.

Chapter I

HOSTILE TAKEOVER: A BRIEF CONCEPTUAL EXPLANATION A takeover takes place when one company acquires control of another company, usually a smaller company than the first company. It may be defined as a transaction or series of transactions whereby a person (individual, group of individuals or a company) acquires control over the assets of another company, either directly by becoming the owner of those assets or indirectly by obtaining the control of the management of the company. 1 The company, which acquires control of another company, is called the ‘acquirer’ (offeror) whereas the company, which is acquired, is called the ‘target’ (offeree). In a case where shares are closely held (i.e. held by a small number of persons) a takeover will generally be effected by agreement with the holders of the majority of the share capital of the company being acquired. Where the shares are held by the public generally, the takeover may be effected: 2 1. By an agreement between the acquirer and the controllers of the acquired company; 2. By purchases of shares on the stock exchange; or 3. By means of a “takeover bid”. A takeover bid is a technique for effecting a takeover or a merger 3: in the case of a takeover, the bid is frequently against the wishes of the management of the target company; in the case of a merger, the bid is generally by consent of the management of both companies. It may be defined as an offer to acquire shares of a company whose shares are not closely held (dispersed shareholding), addressed to the general body of shareholders with a view to obtaining at least sufficient shares to give the offeror voting control of the company. 4 A takeover bid may be undertaken in the form of an offer to purchase shares for cash or of a share-for-share exchange or of a combination of those two forms. In other words, the

Weinberg and Blank on Takeovers and Mergers (London: Sweet and Maxwell, 1999) vol. 1 at 1005. Id. 3 The distinction between a ‘takeover’ and a ‘merger’ is that in a takeover the direct/indirect control over the assets of the acquired company passes to the acquirer, in a merger the shareholding in the combined company will be spread between the shareholders of the two companies. Often the distinction is a question of degree. 4 Supra note 1, at 1006. 2

6 consideration part in a takeover bid may be cash, or shares/debentures of the acquiring company, or the shares of a third company, which has nothing to do with the takeover. 5 A takeover may broadly be classified into two categories: 6 i)

Agreed/Friendly Takeover: where the Board of Directors of the target agree to the takeover, accept the offer in respect of their own shareholdings (which might range from nil or negligible to controlling stake) and recommend other shareholders to accept the offer. The directors of the target may agree to do so right from the start after early negotiations or even after public opposition to the bid (which may or may not have resulted in an improvement in the terms of the proposed offer); or the directors of the target may actually have approached the offeror to suggest the acquisition. In a friendly takeover, the controlling group sells its controlling shares to another group of its own accord. However, as we shall see later, because of Regulation 12 read with Regulation 3(1)(c) of the SEBI Takeover Regulations, 1997 there is no compulsion to make an open offer in a friendly takeover.

ii)

Defended/Hostile Takeover: a takeover bid is hostile if the bid is initially rejected by the target Board. It is sometimes also called ‘unsolicited or unwelcome bid’ because it is offered by the acquirer without any solicitation or approach by the target company. In a hostile takeover the directors of the target company decide to oppose the acquiring company’s offer, recommend shareholders to reject the offer and take further defensive measures to thwart the bid. The decision to defend may be influenced by a number of factors but more often than not it is with the intention of (a) stopping the takeover (which in turn may be prompted by the genuine belief of the directors that it is in interests of the company to remain independent or by a desire of the directors to protect their own personal positions or interests); or (b) persuading the bidder to improve the terms of its offer.

There may be different motives/causes behind launching a takeover bid and it is not necessary, as widely believed, that only poorly performing firms are the potential targets of a hostile bid. 5

Recently, the Bhagwati Committee on Takeover has recommended that the acquirer should be permitted to offer shares of the third company as consideration for shares tendered. This is essentially to increase the flexibility available to the acquirer in funding the offer. See, Sanjeev Sharma and Vivek Sinha, “Bhagwati Panel Draft Proposes Bank, FI Funding of Takeovers”, The Economic Times, April 9 2002, p.1. However, in a merger, it always takes the form of a share-for-share exchange offer, so that the accepting shareholders in the offeree company become shareholders in the offeror company. 6 Supra note 1, at 1009.

7 Bidders seem to pursue companies with strong operating managements as often as they pursue companies that have been clearly mismanaged. 7 In fact bidders seldom seem to be interested in a firm where a turnaround is unlikely. For instance, truly sick companies – or at least those whose problems do not appear to be easily remedied – become indigestible and survive, immune form takeover, precisely because of their inefficiency. A bidders offers a premium, often very high, to acquire a target and a rational bidder will offer such a premium over the market price (and incur notoriously high transaction costs as well) only if it believes that the future value of the target’s stock under different management will exceed the price it offered the target’s shareholders within a relatively brief period. There may be a number of objectives behind mounting a hostile bid. It may be a strategic objective like consolidation/expansion of the raider/acquirer. It may be aimed at achieving ‘economies of scale’/critical mass/reducing costs in a particular product/service market. It may also be aimed at acquiring substantial market share or creating a sort of a monopoly. Following are the primary motive/causes of a takeover: 8 1. Assets at a Discount: this refers to a situation where the offeror can acquire the assets/shares of a target at less than the value, which the offeror or its shareholders place upon them: a process commonly referred by financial journalists as ”acquiring assets at a discount”. The situations in which assets may be available at a discount are:  Where the target has not put its assets to their most efficient use;  Where its directors are unaware of the true value of its assets;  When it has an inefficient capital structure;  Where it has followed a policy of limited distribution of dividends;  Where the shares have a poor market rating relative to its real prospects; or  Where due to any other non-economic reasons, the shares of the target are trading at low prices. 2. Earnings at a Discount: because the offeror can by taking over the target acquire the right to its earnings at a lower multiple than the market places on the offeror’s own profits, a process that can be described as acquiring “earnings at a discount”. 3. Trade Advantage or Synergy: because there is a trade advantage or an element of synergy (i.e. a favourable effect on overall earnings by cutting costs and increase in revenue) in bringing the two companies under a single control which is believed will result in the combined enterprise 7 8

Infra note 21, at 1207. Supra note 1, at 1029-30.

8 producing greater or more earnings per share. This has been found to be one of the biggest drivers of takeovers in the 1990s.9 In a globally competitive environment the companies require a critical mass to be able to survive and prosper and the lexicon of even the most hostile endeavours is filled with sober phrases like synergy, the global marketplace and accretion to earnings etc. This can be achieved either through a ‘horizontal takeover’ 10 or a ‘vertical takeover’11. The factors leading to this improvement in earnings could include:  Economies of scale;  Ensuring raw materials/ sales;  Marketing advantages;  Acquisition of a competitor;  Diversification or reduction of earnings volatility;  Purchasing management. 4. Method of Market Entry: because it represents an attractive way of the offeror entering a new market on a substantial scale. 5. Increasing the Capital of the Offeror: Because the offeror has particular reasons to increase its capital base. These include the acquisition of a company a large proportion of whose assets are liquid or easily realisable instead of making a rights issue and the acquisition of a company with high asset backing by a company whose market capitalisation includes a large amount of goodwill. 6.

Management Motives: Because of motives of the management of one/other of the

Companies, either the aggressive desire to build up a business empire or personal remuneration or the defensive desire to make the company bid- proof. Takeovers perform following important functions in an economy: 12

See, Charles V. Bagli, “The Civilized Hostile Takeover: New Breed of Wolf at Corporate Door”, The New York Times, March 19, 1997, Cf. <http//:www.stern.nyu.edu/adamodar/New_Home_Page/invmgmt/ch15/hostile.htm> 10 Horizontal takeover refers to coming together of two companies producing same, similar or competing products/services. 11 A vertical takeover means coming together of two companies, though engaged in the manufacture or provision of same goods/services but at different points in the supply chain. It includes forward and backward integration. 12 Krishnan Thiagarajan, “Fending off Hostile Raiders -- Whining Corporates may Stifle the Takeover Market”, The Business Line, Nov. 26 2000, p.6.

9  Successful takeovers help realise efficiencies by reallocating capital and corporate assets to more high-value uses; enabling two entities to generate joint operating efficiencies and providing companies access to financial, management and other resources not otherwise available. It unlocks the hidden value of unutilised/underutilised assets by transferring them from inefficient management to an efficient management. This function of takeovers is commonly described as the ‘market for corporate control’.13 The term was coined by Professor Henry Manne in 1965 in his seminal paper on the utility of tender offers and of an active market for corporate control. According to this description 14, there is a market for the rights to manage corporate resources in just the way that there is a market for different kinds of goods and services. Companies are up for auction for those who wish to take control from the existing owners. If bidders attach a higher value to control than the existing owners, then they should be allowed to purchase it. The market in corporate control ensures that companies pass to those who attach highest value to ownership. Michael Jenson and Richard Ruback, vocal supporters of hostile bids wrote in 1983: “The market for corporate control is creating large benefits for the shareholders and for the economy as a whole by loosening control over vast amounts of resources and enabling them move more quickly to their highest-valued use. This is a healthy market in operation …and it is playing an important role in helping the American economy adjust to major changes in competition and regulation of the past decade.” 15 They allow companies to realize the benefit of large-scale operations or to achieve what is called ‘economies of scale’. 13

This view, particularly as embellished by later adherents, emphasized the importance of the threat of hostile takeovers as a management accountability mechanism and as a central feature of a market-oriented model of corporate activity and corporation law. Manne argued that, since capital markets are efficient suboptimal managerial performance would be reflected in reduced share prices. Discounted share prices would invite tender offers by those seeking to profit from replacing incumbent management and realizing a corporation's full economic potential. The existence of a vigorous, properly functioning market for corporate control would immediately benefit shareholders by offering the prospect of stock premiums. Moreover, shareholders would gain over the longer term because the threat of takeover would encourage managerial diligence. Furthermore, the bidder's direct financial appeal to target shareholders made the tender offer a much more potent takeover device than the proxy contest, in which shareholders might only dimly perceive how granting a proxy to insurgents would actually improve their economic welfare, and in which management enjoyed inherent legal and collective action advantages owing to its control of the proxy machinery. In addition to citing the wealth and governance benefits of takeovers to capital providers, Manne touted the purported benefits of takeovers to society in general. He argued that an effectively functioning market for corporate control rechannels corporate assets into the hands of those most able and willing to maximize their value. The result would be a more efficient use of limited economic resources, by which everyone -- not merely shareholders -- would benefit. For the purposes of further discussion we may term Manne’s theory as ‘Disciplinary Hypothesis’. Cf. Lyman Johnson and David Millon, “Misreading The Williams Act”, 87 Mich. L. Rev. 1862, 1878 (1989). 14 See, T. Jenkinson and Colin Mayer, Hostile Takeovers: Defence, Attack and Corporate Governance (London: Mc Graw-Hill Book Company, 1994) at 13. 15 Ibid at 14.

10  It is widely believed that hostile takeovers help in policing the management conduct in widely held public corporations. It has a disciplining effect on the incumbent management as the threat of a hostile takeover keeps them on their toes to perform efficiently and deliver goods to the shareholders. 16  Moreover, they help identify undervalued assets and permit shareholders to realise the true value of their investments. Hostile takeover threat can trigger far-reaching changes in corporate strategy resulting in significant gains to the shareholders. Many have claimed that without a hostile takeover the inertia that exists within many large organizations would have prevented such efficiencyenhancing (and consequently, shareholder value enhancing) restructurings from taking place. 17 According to Weinberg and Blank a takeover may be achieved in the following ways: 18  Acquisition of shares or undertaking of one company by another for cash.  Acquisition of shares or undertaking of one company by another in exchange of shares or other securities in the acquired company.  Acquisition of shares or undertaking of one company by a new company in exchange for its shares or other securities  By acquisition of minority held shares of a subsidiary by the parent.  Management buyouts. Chapter II

POLICY ISSUES ARISING IN A HOSTILE TAKEOVER

From a Target Shareholder’s Perspective: From a policy perspective it is important to understand that in a large public company, as the separation between ownership and management/control widens, the interests of the 16

This view received a qualified endorsement in Edgar v. MITE Corp., 457 US 624, 643 (1982). Justice White’s majority opinion describes the hostile tender offer in the following terms: the effects of allowing the Illinois Secretary of State to block a nationwide tender offer are substantial. Shareholders are deprived of the opportunity to sell at a premium. The allocation of economic resources to their highest valued use, a process that can improve efficiency and competition, is hindered. The incentive the tender offer mechanism provides incumbent management to perform well so that stock prices remain high is reduced (emphasis added). Later we will see as to what extent this claim is sustainable. 17 Supra note 14, at 39. 18 Supra note 1, at 2009.

11 controllers/managers of the company and that of the shareholders increasingly tend to diverge. 19 In the field of takeovers the interests of shareholders of a company are that 20  The company should takeover another company only if in doing so it improves its own profit earning potential, measured by earnings per share, and  The company should agree to takeover if and only if the shareholders are likely to be better off with the consideration offered, whether cash/securities of the other company, than by retaining their shares in the original company. On the other hand, the interest of the controlling shareholders or promoters or the board may be as varied as the number of companies but more often than not controllers of a company are more concerned with their personal benefits, saving their jobs and earnings and in the process they pay scant attention to the interests of shareholders. Modern theory of corporation has a strong tilt in favour of shareholders and benefit to the shareholders is considered as a benchmark against which the performance of powerful corporate management must be assessed. Global research, especially studies in countries like US and UK where market for corporate control is sufficiently developed, has shown that hostile takeovers promote efficiency, increase shareholder wealth, and result in greater corporate accountability. 21 Following are the findings with respect to impact of takeovers on target shareholder returns: 22

In A Successful Takeover •

All studies reveal that target company stockholders end up with huge increments in wealth in comparison to the market value of their holdings before the takeover activity.

•

The wealth increment can be attributed to the premium paid by the acquiring company, which has ruled around 30 per cent on average in the last few decades.

• 19

Premiums as high as 100 per cent have also prevailed.

On the other hand in a private company where shares are closely held and most of the time persons in managerial positions are the same people who hold substantial shares in the company and therefore, interests of the shareholders/owners and the management/the board tend to converge. 20 Supra note 1, at 1022. 21 John C. Coffee, Jr., “Regulating the Market for Corporate Control: a Critical Assessment of the Tender Offer’s Role In Corporate Governance”, 84 Colum. L. Rev. 1145 at 1148 (1984). 22 Prabhavathi Rao, “Hostile Takeovers-Sharks on the prowl”, Analyst, May 1998, Cf. <www. icfaipress.org/archives/Analyst/1998/may/cover-Hostile Takeovers Sharks on the prawl.htm>

12 •

Premiums have been inching upwards with time. For instance, premiums in the 1980s were nearly twice the amount in the 1960s, averaging in the 50 to 60 per cent range.

•

Typically, when information about a potential takeover trickles in or rumours pervade the stock markets, the market price of the target company stock moves upwards. The stock price improvement begins before the takeover is announced, even one month in advance.

•

The pattern of share price movements differs in the case of a takeover by tender offer and by a merger agreement. Share prices tend to be more buoyant in the case of a tender offer as compared to a merger. For instance, in the case of a tender offer, the share price may be 50 per cent higher than the pre-offer price. Whereas, in a merger it could be just 30 per cent higher. This variance could be attributed to factors like competition and multiple bids, which are fairly common in a tender offer as against a merger deal, which involves just one party.

Though in India, market for corporate control has hardly begun to develop and after the Takeover Regulations were framed by SEBI in 1994, there has not been a single successful hostile takeover, quite a few unsuccessful attempts have been made in the last two-three years. Prominent among these are India Cements Ltd.’s bid for Raasi Cements Ltd., which ended in a negotiated sale of promoter’s stake in the company; the raid by Abhishek Dalmia led Renaissance Estates Ltd. on Gesco corporation – a real estate division of Great Eastern Shipping Company and the attempt to takeover Nusli Wadia promoted Bombay Dyeing Ltd. by the jute baron Arun Bajoria. In all these attempts the shares of target companies appreciated by 30% to 100% after the news of takeover attempt became public. In such scenario shareholders, especially minority, obviously stand to gain by tendering their shares to the acquirer or selling the shares in the market when prices are still ruling high in the wake of a takeover bid. Therefore, it is beyond doubt that hostile takeovers are in the interests of shareholders of the target company and from a shareholder-centred perspective hostile takeover should be promoted or at least should largely be left unregulated and let the market forces determine restraints, if any, on hostile takeovers. From Other Stakeholders’ Perspective: A company's responsibility is not restricted only to its shareholders. There are other stakeholders as well - for instance the employees, customers, lenders, etc. besides the shareholders. And they

13 are as important as the shareholders and it is not necessary that what is in the interest of shareholders is also in the interest of other stakeholders. It has been observed through empirical studies that takeovers, more so when it is hostile, leads to substantial policy changes in the form of changes in control, asset disposals and restructuring of operations.23 This also involves employee lay-offs, reconstituted board, and new faces in the management positions24. A hostile takeover may have the effect of disrupting local

economies by snapping the local supply and demand chain and harming resident nonshareholders dependent on corporate activity. There is, therefore, nothing that ensures that what is in the interests of the shareholders is in the interest of other stakeholders â&#x20AC;&#x201C; employees, pensioners, creditors, suppliers etc. If employees cannot be sure that when control changes occur they will be adequately rewarded for past investments that they have made, in, for example, training then they may be unwilling to undertake it in the first place. For example, the decision of a skilled employee to work for a particular company is an investment decision because he decides to invest his human capital in the specific activities of the company. He will expect the investment to pay off in time: he will want to be rewarded financially, to be promoted and to have continuous employment unless he fails to perform his prescribed duties (he may also have other expectations, such as his pension rights increasing with inflation). Ex ante, such contracts can be mutually beneficial to the employee and the shareholder alike. However, ex post, it can be value maximizing for shareholders to break that implicit contract, for example by raiding the pension fund or laying off skilled workers. Hostile bids, it could be argued, present an opportunity for one set of shareholders (who, collectively, may have honoured the implicit contracts) to be replaced by a single shareholder who may, in the short-term at least, see the opportunity to increase the profits by breaking the implicit contracts.25 Implicit Contract Theory Once employees and other stakeholders cease to trust shareholders, they will enter into implicit contracts, and an environment of suspicion and distrust will tend to emerge. Stakeholders will insist upon detailed explicit contracts, and, since, negotiating explicit contracts can be costly, 23

Supra note 14, at 15. It is also pertinent to note here that though the Board and the management are under an obligation to act in the best interests of the company, a shareholder is under no such obligation and more often than not his or her vote will be determined by personal benefits and other extraneous considerations which may not necessarily be in the best interests of other constituents of the target company. 25 Supra note 14, at 15. 24

14 stakeholders may demand premiums on such contracts. In essence, once there is a fear that corporations cannot be trusted; there will be a decline in corporate loyalty, which will affect even those corporations, which have never violated implicit agreements. Thus, the threat of hostile takeovers acts as an unfavourable externality on an economy, and results in welfare losses to society. 26 There may be various other transaction costs that may push companies towards establishing business relationships upon implicit agreements, which are usually long-term and based upon mutual trust. German and Japanese companies typically rely upon implicit contracts, reinforced by long-term relationships, which build up trust between the parties involved. 27 Disputes are often resolved without recourse to courts, with each party being aware of the value of continuing relationship, which would be jeopardized by opportunistic or unreasonable behaviour by any one party.28 Hostile bids may lead to breakdown of such trust-based relationships. In most cases, a hostile bidder (who introduces a new management team) will have had no pervious business relationship with any of the upstream or downstream companies, and so will not be able to reap the potential benefits of implicit contracting.29 Worse still, if hostile bids are widespread in an economy, it may be impossible for any companies to enter into the kind of long-term relationship outlined above, build implicit contracts, however much the management teams of each company would like to build such relationships. The reason is clear: if the incumbent management team is vulnerable to a hostile bid, it cannot commit any potential hostile bidder to honouring the implicit contracts and not breaking the trust between the two parties. As a result, contracts will have to be more explicit, fewer companies will rely upon 26

Supra note 14, at 16. Supra note 14, at 17. 28 Id. 29 However, researchers are of the view that implicit contract theory should not be taken too far to restrict or over-regulate the phenomena of hostile takeovers. A newly established company will and does take sometime to build the kind of implicit relations discussed above, similarly a new management team may also build, of course after sometime, the kind of relationship it thinks most suitable for achieving its objectives. There is no denying the fact that it may involve disruption of some existing relationships but at the same time it will also involve building up of new ones, which may offset any adverse impact that may have been brought about in the economy as a whole as a result of the takeover. Strictly speaking no corporate structure is permanent and corporate restructuring is but inevitable to keep the economy growing. Winding-ups or shut downs also involve some displacements and social costs but it is thought desirable because the costs to the society of running an inefficient or loss making unit is greater than the costs of shutting it down. Similarly, where the benefits to the society (and not only to the shareholder) of a hostile takeover are greater than its costs to the society, it must be allowed. 27

15 verbal assurances and trust, and the benefits of long-term relationships between companies will be less apparent. Hostile takeovers, according to this view, again impose an externality on the corporate sector as a whole.30 Likewise, if managers do not expect to reap the benefits of long-term high-risk strategies because raiders compete the gains away, then they will choose safer, short-term strategies. Therefore, unless managers and the employees are granted some measure of protection against the hostile raiders, it may be difficult to generate in them a long-term loyalty and vision for the company. With the Damocles’ sword hanging over their head they may be happy to choose low-risk and short-term strategies which will neither be in the interest of the shareholders nor in the interest of other stakeholders. Therefore, from a non-shareholder perspective hostile takeover may have harmful effects on constituencies other than shareholders and that calls for strict regulation of hostile takeovers, as is being done in most of the states of the United States. In the US the view has slowly but steadily gained ground that hostile takeovers bring plant closings or transfers, employee layoffs, lost tax revenues and charitable contributions from local firms, disruption of established supplier and customer relationships, and other vaguely articulated economic and social dislocations 31 and in response many states have moved to enact anti-takeover legislations to protect non-shareholder interests.32 In Unocal Corp. v. Mesa Petroleum Co.,33 the Delaware Supreme Court clearly 30

Supra note 14, at 17. The author concludes by saying that “while the threat of a hostile bid may provide an important incentive for the incumbent management of companies to be efficient, and to pursue policies that are in their shareholder’s interests, the existence of such hostile bids may have more widespread implications for the way in which business relationships are conducted in an economy. When the threat of a hostile takeover exists it may be impossible to establish and maintain long-term relationships built upon trust and confidence, which may result in less efficiency. 31 Lyman Johnson and David Millon, “Misreading The Williams Act”, 87 Mich. L. Rev. 1862, 1886 (1989). 32 Some states explicitly authorize target company boards to take into account the impact of a takeover on non-shareholders. Minnesota, for example, states that "a director may, in considering the best interests of the corporation, consider the interests of the corporation's employees, customers, suppliers, and creditors, the economy of the state and nation, community and societal considerations, and the long-term as well as short-term interests of the corporation and its shareholders including the possibility that these interests may be best served by the continued independence of the corporation." Wisconsin's statute declares that Wisconsin corporations "encompass, represent and affect, through their ongoing business operations, a variety of constituencies including shareholders, employees, customers, suppliers and local communities and their economies," and states further that it is intended "to promote the welfare of these constituencies" and to "allow for stable, long-term growth of resident domestic corporations." Connecticut has recently passed a takeover law that empowers something called a Connecticut Partnership Compact -- including representatives of labour and citizen groups, as well as of business and the legislature -- to impose conditions on certain post-takeover transactions for the benefit of various non-shareholder interests. Cf. Lyman Johnson and David Millon, supra note 31. 33 493 A.2d 946 (Del. 1985).

16 specified that the Board is under a duty to evaluate the likely "effect on the corporate enterprise," which includes the discretionary power to weigh "the impact on 'constituencies' other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally) to justify any defensive tactic."

Chapter III

DEFENCES TO HOSTILE TAKEOVERS In a takeover battle if the board/management chooses to reject a bid it may have to take effective defensive measures in order to stall the raider from carrying out the takeover operation. These defence mechanisms may be put in place after the bid has been made or may have been there prior to the bid having been made. 34 The most obvious case for defence is that by rejecting an initial bid, the board may be seeking to receive a higher offer or inviting a competitive bidder. By mounting a vigorous defence, the board may be able to fetch a better price for surrendering its stake in the target. Defence may also be raised on the ground that the companyâ&#x20AC;&#x2122;s net worth is much more than the bidder had calculated. This may be the case when the management of the target company has some privileged and commercially sensitive information, which, if released, would increase the market value of the firm. By mounting such a defence, management may be able to increase the market value of the target firm to such an extent that the bid fails, or, even if the bid succeeds, secure a higher price for their shareholders. 35 Another reason for mounting a defence may be the managementâ&#x20AC;&#x2122;s genuine belief that the company is better off by remaining an independent entity. Finally, the acceptability or rejection of a takeover bid and the extent of its regulation also depends upon the social and political philosophy of a country. For example, in UK the accountability of management to the shareholders is paramount. 36 The companies are expected to 34

Apart from purely defensive strategies that may have been built into the companyâ&#x20AC;&#x2122;s by-laws, there are certain other barriers to takeover, which may not exactly be in the league of defences to hostile takeovers. But nonetheless they do pose considerable difficulties to the potential acquirer. These barriers may be categorised into structural and technical barriers. The structural barriers basically result from underlying structure of the economy, including such diverse factors as the distribution of wealth, market size, the role of financial institutions, the political & legal system and socio-cultural environment found in different countries. The tendency of companies to remain private constitutes by far the greatest structural barrier to a hostile bid. Moreover even in case of listed companies, if the substantial shareholding is concentrated in a few hands/families and dispersed among public, mounting a hostile bid may prove difficult. State ownership often presents an additional source of structural barriers. Financial institutions commanding substantial voting rights either through direct equity holding or through proxies can often thwart a hostile bid if they decide to support the incumbent management. On the other hand technical barriers are the brainchild of the companies themselves. Through internal regulations such as restricting voting rights, issuing shares with weighted voting rights, giving more powers to incumbent management etc. companies seek to limit the ability of a potential predator to mount a successful hostile bid for a company, or to increase the cost of making such a bid. Cf. Jenkinson & Mayer, supra note 14, at 35 Supra note 14, at 43. 36 Supra note 14, at 18.

18 pay out a large proportion of their earnings as dividend payments in order to avert the threat of a hostile bid and they frequently cite the takeover threat as a serious impediment to investing, particularly, in R&D related projects.37 On the other hand, companies in other EU countries are not so shareholder-centric. Shareholders are clearly one interest group, but many others exist: workers, the existing management, suppliers, providers of finance other than shareholders (like banks and financial institutions), and other related companies. Such groups are often referred to as stakeholders in a company – those who are involved in the day-to-day operations and who in most EU countries have a right to play a part in the process of running and controlling the company. 38 Of course, in a country like India where an active market for corporate control is still to develop, the question of corporate accountability either to shareholders or to other stakeholders has hardly received any significance worth mentioning. In the pre-liberalisation era, India’s giant industrial houses, most of them family-controlled, enjoyed the government-conferred monopoly status upon them and they hardly bothered to increase shareholder value. Equally guilty have been Indian banks and financial institutions, which held substantial stake in large public companies but they largely remained passive onlookers and never questioned management/board’s decision even if the decision went against their own interests as a shareholder in the company. Post-liberalisation era, due to increasing competition from foreign and some new aggressive domestic players, has brought about some welcome changes in the area of corporate accountability. A healthy return to shareholders is increasingly being recognised as an important benchmark of corporate success. Therefore, in India it is highly desirable that a healthy market for corporate control is allowed to develop. The most commonly adopted defence strategies to hostile bids are: 1. Staggered Board39

This defence involves an amendment of the by-laws of the company to create a staggered board of directors. A staggered board is a board whose members are elected in different years or in other words only part of the board comes up for election each year. Implementation of a staggered board may cause an acquirer to have to wait for several years or at least till the next 37

Id. Supra note 14, at 18. 39 Meredith M. Brown and Paul S. Bird, “Introduction to Hostile Takeovers”. Cf. <www.debevoise.com/memos/memo001128d.html> 38

19 annual general meeting before it controls the board of directors. Because the acquirer would not control the board initially, the acquirer would not have the power to change management or the corporation's business plan. As with the other pre-tender offer defences, courts will allow amendment of the charter to create a staggered board of directors provided the amendment is allowed under the governing corporation law and the amendment was made for a valid business reason. 2. Poison Pills. A defensive tactic, which originated in the US and is mainly employed in the US. A poison pill is a shareholder rights plan that encourages a would-be acquiring company to talk to target’s directors before seeking to acquire more than a certain percentage of the target’s stock, because not doing so will result in substantial economic harm to the acquirer as the rights held by it will become void, and all other shareholders will be able to buy shares of the target at half price. 40 A rights plan can be adopted without shareholder approval and the directors authorize the rights to be distributed as a dividend to target’s shareholders. These rights can be redeemed by the Board of Directors or exercised. If they are exercised, the resultant preferred stock might be convertible into ordinary shares at an extremely attractive price – essentially raising the cost of the bid. Such pills are referred to as ‘flip-overs’. Alternatively, the rights might be purchased by the issuing firm at a large premium over the issue price, with the large shareholder excluded form the repurchase. These are known as ‘flip-ins’. 3. Buyback of Shares  Open market repurchases  Self-tenders Critics of the buyback strategies argue that the discriminatory effects on target shareholders will defeat value-increasing bids41. Open market purchases tend to distort shareholder preference and defeat value increasing bids. In a model given by Bradley and Rozenweig the result of open market purchases is that it amounts to a special dividend payout to selling shareholders that

Mark R. Wingerson and Christopher H. Dorn, 1992 Columb. Bus. L. Rev. 223. Jeffrey N. Gordon and Lewis A. Kornhauser, “Takeover Defence Tactics: A Comment on Two Models”, 96 Yale L. J. at 295 (1986). 41

20 distorts shareholder choice.42 However self-tenders can be defended on the ground that buyback creates an auction for the companies’ resources among competing management teams. 43 Proponents argue that they tend to defeat value-decreasing offers and not value increasing ones 44. The critics however argue that if the target finances the self-tender through the sale of special synergy assets the bidder may simply withdraw its bid. 45 Self-tender is not like an auction process. Target management is spending the shareholders’ money and not its own funds.

4. Crown Jewels These are precious assets of the target often termed as Crown Jewels, which attract the raider to bid for the company’s control. On facing a hostile bid the company sells these assets at its own initiative leaving the rest of the company intact and hence removes the incentive for which bid was offered. Instead of selling the assets, the company may also lease them or mortgage them so that the attraction of free assets to the predator is suppressed. By selling these jewels the company removes the inducement that may have caused the bid. 5. White Knights: After coming to know of an initial hostile bid other rival bidders also enter the battle often offering higher bids than the initial bidder. Among the rival bidders whose bids are recommended by the target company are classified as ‘white knights’ 46 or this expression is also used to refer to a an acquirer whom the target, faced with a hostile bid, approaches to save it from being taken over by the initial bidder.47 However, this is not exactly a defence strategy by the incumbent management because a white knight may successfully defend the target company from the initial 42

The model offered by them is: consider a target firm with 200 shares outstanding, trading at $40 a share prior to the bid, and thus valued by the market at $8000. The acquirer values the firm at a minimum of $10000 and makes a two-tier offer, front loaded bid of $60 for the first 100 shares and $40 for the remaining shares. According to the model prevailing market value of target shares will increase to reflect the expected value of a tendered share, $50. Target management then defends with an open market repurchase of 120 shares at $50, which reduces the value of the firm by $6000 as a result of the outgo. The bid is withdrawn and the value of the firm to $2000, or $ 25 a share. The bidder will then present a revised offer bid at around $25, substantially below the earlier $50. This leads to a distortion of the shareholder decision and defeat of a value-increasing bid. Thus the conclusion that the remaining shareholders will have financed the premium received by the lucky open market sellers. 43 Supra note 41, at 297. 44 Supra note 41, at 297. 45 The inherent contradiction with this line of argument is that it assumes that hostile takeovers are motivated because of synergies, which exist between the companies. This however has been examined earlier in the paper as being not entirely true. This model fails to explain the ‘bust-up’ takeovers. 46 Supra note 14, at 32. 47 For example, in Renaissance Estates Ltd.’s bid to takeover Gesco, the promoters of Gesco had roped in Mahindras as a ‘white knight’ to save them from being taken over.

21 hostile bid but in most cases the company is still taken over, albeit by the white knight. Realistically, the target’s choice is between ravishment by the hostile bidder or a hastily arranged shotgun wedding with the ‘white knight’. Only advantage is that it raises the offer/bid value. It may also be that the white knight may offer some positions to the incumbent management in the merged entity. However, it is only lesser of the two evils. Even if the management of the target firms are able to retain their jobs (and this is not frequently the case), control is generally ceded to the acquiring company. White knight enters the fray when a hostile suitor raids the target company. The regulation 25 of SEBI Takeover regulations allows the entry of a White Knight to offer a higher price than the predator to avert the takeover bid. (With the higher bid offered by the white knight, the predator might not remain interested in acquisition and hence the target company is protected from the raid.) Alcan of Canada had bought the shares in Indian Aluminium Company at Rs.200, which was higher than Sterlite’s offer in 1998. Thus Alcan emerged as the White Knight in this deal. 6. Golden Parachutes This defense requires management to arrange employment contracts between the management and key employees to increase their post employment compensation in the event of a hostile takeover.48 When golden parachutes are created for management and key employees, a corporation becomes less attractive to the acquirer because generous payments to departing management and employees could financially deplete the corporation. 7. Greenmail A targeted share repurchase, or greenmail, is the buyback of the shares owned by a particular shareholder of the target who has made or threatened a takeover bid 49. The greenmail payment is typically at a premium over the prevailing market price. A large block of shares is held by an unfriendly company, which forces the target company to repurchase the stock at a substantial premium to prevent the takeover. The critique of this theory is that the management, which has mismanaged the target’s assets, pays greenmail in order to perpetuate its ability to exploit the targets. According to this view greenmail should be prohibited because it decreases shareholders’ wealth and discriminates unfairly. 8. Corporate Restructurings:

48 49

Supra note 40, at 226. Supra note 40, at 227.

22 Asset disposals announcement by the target firm that parts of its existing business will be sold off, e.g., sale of subsidiaries, the disposal of holdings in other companies, sale of specific assets such as land or property, de-merging of completely unrelated businesses, decision to concentrate on core businesses and hiving off non-core interests etc 50. By doing so the target seeks to make the company less attractive for a potential acquirer. 9. Legal/Political defences Where the target firms seek the intervention of the regulatory bodies or indulge in political lobbying to repel the hostile bidder51. This might be in the form of an appeal to the competition regulatory bodies that the resultant entity would violate the anti-trust norms. But these strategies rarely succeed often resulting in delays and increase in the costs of the bid both to the bidder and the target. However, in countries like India, political/legal interventions can cause considerable delays which can either frustrate the initial bidder leading it to withdraw or costs may escalate so much due to delay that the bidder may be forced to withdraw on prudent economic considerations. 10. Joint Holding (or) Joint Voting Agreement Two or more major shareholders may enter into an agreement for block voting or block sale of shares rather than separate voting. This agreement is entered into with the cooperation and blessings of target Companyâ&#x20AC;&#x2122;s management who likes to have a control. 11. Interlocking shareholdings or Cross Shareholdings Two or more group companies acquire shares of each other in large quantity or one company may distribute shares to the shareholders of its group company to avoid threats of takeover bids. If the interlocking of shareholdings is accompanied by joint voting agreement then the joint system of defense is termed as "Pyramiding", which is the safest device or defense. 52 12. Defensive Merger The directors of a threatened company may acquire another company for shares as a defensive measure to forestall the unwelcome takeover bid. For this purpose, they put large block of shares of their own company in the hands of shareholders of friendly company to make their own company least attractive for takeover bid. 50

Supra note 14, at 32. Stephen Lofthouse, â&#x20AC;&#x153;Competition Policies As Takeover Defencesâ&#x20AC;?, [1984] JBL 320. 52 Supra note 51, at 324. 51

23 13. Pac-Man Strategy This is nothing but a counter bid. The target company attempts to takeover the hostile raider. 53 This usually happens when the target company is larger than the predator or is willing to leverage itself by raising funds through the issue of junk bonds.

Id.

24 Chapter IV

LEGAL REGIME FOR TAKEOVER REGULATION City Code on Takeovers and Mergers54 The City Code on Takeovers and Mergers is the governing code for acquisitions of controlling shares in public companies in England. 55 Enacted in 1968, the Code ensures fair and equal treatment for all shareholders by establishing rules for the conduct of bids and the acquisition of controlling blocks56. In particular, the Code requires equality of treatment of shareholders of the 54

This section of the paper has been influenced by Weinberg and Blank on Takeovers and Mergers, (London: Sweet and Maxwell), 1999 and 2001 Colum. Bus. L. Rev. 683. The position in Britain is different from that in European Union. In EU the governing law is the Thirteenth Directive of the European Commission. Article 9(1) of the Thirteenth Directive reads: The board of the offeree company shall abstain from completing any action other than seeking alternative bids which may result in the frustration of the bid, and notably from the issuing of shares which may result in a lasting impediment to the offeree obtaining control over the offeree company, unless it has the authorisation of the general meeting of the shareholders given for the purpose during the period of acceptance of the bid. The obligation to refrain from frustrating action is triggered as soon as the target board is informed of the acquirer's intent to make a bid. Thus, target management is limited to acting in the shareholders' interests. While the language of the rule is strong, it does not amount to complete passivity. Management is explicitly permitted to seek alternative bids. Excluding the search for "white knights" from the prohibition has two distinct results. First, it reinforces the idea that the company belongs to the shareholders, with management acting as their agents. Second, by allowing management to search for more attractive bidders, they are able to maximize shareholder value while also considering the welfare of stakeholders. The imposition of shareholder primacy into Continental control transactions would not limit management's ability to consider the welfare of the company as a whole when proposing alternative bidders; it only means that shareholders must ultimately make the decision. It is completely permissible for management to provide shareholders with a range of options. The prohibition of frustrating actions, as contemplated under the Thirteenth Directive, is not absolute. Article 9(1) specifically contemplates the adoption of defensive measures in order to maintain independence. However, such defensive measures cannot be used to entrench management. Defensive tactics are permitted as long as shareholders, at a general meeting, authorize them after the announcement of the bid, ensuring that shareholders receive and consider the offer. The Thirteenth Directive recognizes that the greatest risk of self-serving behaviour by management is during the transfer of control, but also that corporate independence is not unrelated with shareholder interests. In contrast to the City Code, which prohibits defensive measures absolutely, under this formulation of the rule, adoption of defensive measures is allowed under certain conditions. In general, the prohibition against frustrating action will serve to enhance the development of a European market for corporate control. The prohibition on defensive measures immediately serves to make takeovers more likely by reducing the cost of acquisition. Increasing vulnerability to takeovers has two beneficial effects on shareholder wealth: (1) it increases the probability of receiving a premium over market value for holdings, and (2) it induces managerial efficiency. By reducing the cost of acquisition and placing the choice to tender in the hands of shareholders, management is forced to increase operational efficiency, eliminating the potential for outside gain or risk replacement. Thus, shareholder wealth should increase as the takeover premium and company efficiency both rise. Moreover, the incentive to monitor performance increases, causing security prices to more accurately reflect true value. See 1995 Colum. Bus. L. Rev. 495. 55 Scott Mitnick, 2001 Colum. Bus. L. Rev. 683. 56 Id.

25 same class, limitation on actions by the target board, and disclosure requirements. 57 The success of the Code is particularly interesting considering the fact that it does not have the force of law. The Takeover Panel, a self-regulatory body consisting of representatives from the Bank of England, the financial institutions and industry, administers it. 58 Penalties include public censure, and violations may influence access to public securities markets. The provisions for conduct have been very successful in maintaining orderly markets and shareholder protections.

Two significant features of the Code - the mandatory bid rule and the prohibition against defensive measures provide the model for the Thirteenth Directive and for domestic takeover laws adopted by European countries during the last five years. 59 The mandatory bid provision, laid out in Rule 9, requires a partial acquirer to launch a bid for all remaining shares at a price equivalent to the highest price paid in the previous twelve months. The mandatory bid rule is triggered when voting power (a) crosses 30 percent, or (b) if acquirer holds 30 to 50 percent of voting power and acquires an additional 1 percent in twelve months. This means that when control of a company is acquired through tender offer, private transaction, or on the open market, the remaining shareholders will be allowed to exit the corporation at the best price offered. The second major provision of the City Code, found in Rule 21, prohibits management from taking actions that might “frustrate” a bid. 60 This prohibition on frustrating actions precludes most defensive measures. Additionally, the rule becomes effective upon a bid or “even before the offer if the board of the offeree company has reason to believe that a bona fide offer is imminent.” Falling within the prohibited actions are issuance of shares (authorized or unauthorized), options or convertible securities, selling assets, or entering into contracts outside the ordinary course of business. As a result, it is very difficult for the board to adopt defensive measures that would deter a bid (the prohibition focuses on effect not intent). Rule 21 embodies the philosophy that shareholders own the company and the board manages it; consequently, it is the shareholders that should decide on whether or not to sell the company. However, the Code does allow management to search for subsequent bidders, white knights, on the view that such attempts do not frustrate the change of control they simply provide options for shareholders.

Id. Supra note 55. 59 Supra note 55. 60 Supra note 55. 58

26 The Code has encouraged the development of a dynamic control market. Hostile takeovers tend to be successful - with nearly 65 percent of bids resulting in a change of control. 61 Moreover, nearly 25 percent of bids are contested, resulting in auction settings that maximize shareholder value.62 It is also worth noting that the Code has not completely limited the management's ability to defend against bidders. It has simply shifted the implementation of defensive measures from post bid to pre bid period (though they must also have legitimate business purposes). Common tactics include placing a block of shares in friendly hands or placing assets outside a bidder's reach.63 The key to using a pre-planned defensive measure is that it must not be "triggered" by the bid. General Principles of the Code:64  All shareholders of the same class of an offeree company must be treated similarly by an offeror.  During the course of an offer or when an offer is in contemplation, neither an offer nor the offeree company nor any of their respective advisers may furnish information to some shareholders, which is not available to all shareholders. This principle does not apply to furnishing of information in confidence by the offerree Company to a bonafide potential offeror or vice versa.  An offeror should only announce an offer after the most careful and responsible consideration. Such an announcement should be made only when the offeror had every reason to believe that it can and will continue to be able to implement the offer. Responsibly in this connection also rests on the financial adviser to the offeror.  Shareholders must be given sufficient information and advice to enable them to reach a properly informed decision and must have sufficient time to do so. No relevant information should be withheld from them.  Any document or advertisement to shareholders containing information or advice from an offeror or the bidder or the offerree company or their respective advisers must, as is the case with a prospectus, be prepared with the highest standards of care and accuracy.  All parties to an offer must use every endeavour to prevent the creation of a false market in the securities of an offeror or the offerree company. Parties involved in offers must take care that statements are not made which may mislead shareholders or the market. 61

Supra note 55, at 692. Supra note 55, at 694. 63 Supra note 55, at 696. 64 Supra note 1, at 9013-14. 62

27  At no time after a bonafide offer has been communicated to the board of the offeree company or after the board of the offeree company has reason to believe that a bonafide offer might be imminent, may any action be taken by the board of the offeree company in relation to the affairs of the company without the approval of the shareholders in the general meeting which could effectively result in the shareholders being denied an opportunity to deice on its merits.  Rights of control must be exercised in good faith and the oppression of a minority is wholly unacceptable.  Directors of an offeror and the offeree company must always in advising their shareholders act only in their capacity as directors and not have regard to their personal or family shareholdings or their personal relationships with the companies. It is the shareholders interest taken as a whole, together with those of employees and creditors, which should be considered when the directors are giving advice to shareholders. Directors of the offeree company should give careful consideration before they enter into any commitment with an offeror or anyone else, which would restrict their freedom to advise their shareholders in the future. Such commitments may give rise to conflict of interest or result in the breach of directors’ fiduciary duties.  Where control of a company is acquired by a person or persons acting in concert, a general offer to all shareholders is normally required. A similar obligation may arise is the control is consolidated. Where an acquisition is contemplated as a result of which a person may incur such an obligation, he must, before making the acquisition, ensure that he can and will continue to be able to implement such an offer. Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 SEBI regulations called the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 65 deal extensively with the rights of shareholders. One of the goals of the regulations is to protect the small shareholders in the event of a hostile takeover. Mandatory Bid Rule When changes of control occur, minority shareholders usually have little knowledge or influence over the transaction. The mandatory bid rule protects shareholders from abusive tactics by 65

Hereinafter referred to as the Takeover Code.

28 involving them in the sale of control. It functionally prohibits the use of two-tier discriminatory offers during the acquisition of control and it prevents expropriation from minority shareholders by allowing them to sell.

The mandatory bid rule eliminates the ability of acquirers to affect a two-tier discriminatory transaction by ensuring minority shareholders an equitable price. Upon the change of control, it is the minority shareholders, not the acquirer, who determine the size of the acquisition. After the adoption of the mandatory bid rule, controlling shareholders can no longer sell their stakes at the same premium because the acquirer may also be forced to purchase the rest of the company (at a significant cost). In the U.K., acquirers must offer minorities the highest price paid in the previous 12 months, ensuring that they receive the same price as control blocks acquired during that period. 66 In contrast, minority shares in France may be bought for less than controlling shares (though the price usually still includes some premium). Since controlling shareholders will only sell if they are compensated for the private benefits they previously received, under a mandatory bid regime acquirers will not be able to distribute the ex ante control premium among shareholders pro rata. Adoption of a mandatory bid rule will therefore raise the price of such transactions by forcing acquirers to pay all shareholders a uniform premium, similar in size to that which previously would have been paid only to the controlling shareholders. The effect is to substantially raise the level of synergy or efficiency gains that an acquirer contemplates. However, by raising the cost of the transaction, the provision may actually decrease the number of transactions. British targets are significantly more likely to be entirely acquired (100 percent) in a single transaction than targets in any other country. Moreover, full acquisition of public targets in the U.K. is equally as frequent as the smaller investments. The increased likelihood of full acquisition in the U.K. implies that the return on British targets must be considerably greater than that of any other country.

The greater return on British acquisitions is attributable to the reduction in

transaction costs and the structure of capital markets. Even if the mandatory bid rule has the effect of increasing the cost of acquisitions, its effect appears to be countered by the prohibition on defensive measures; effectively, the decision between a full acquisition and the purchase of a stake is determined by the acquirer to a far greater extent in the U.K. than in any other country.

City Code on Takeovers and Mergers.

29 Under the SEBI Takeover Code any person acquiring 15% or more of the voting capital of the company or securing the control of the management of the company by acquiring or agreeing to acquire, irrespective of the percentage of the voting capital, the securities of the directors or other members who control or manage the company, has to make an offer to the remaining shareholders of the company to acquire from them an aggregate minimum of 20% of the total shares of the company at a price not lower than the average of the highest weekly prices prevailing during the preceding 26 weeks or a negotiated price, whichever is higher. This is the mandatory bid rule in order to enable shareholders who did not tender in the pre-takeover stage to sell. The policy behind fixing the price at which the offer will be made is to prevent two tier pricing in which those who tender later may have to sell at a price which does not reflect the true value of their holding and to ensure that the management may not strike a deal with the acquirer in which the management may sell the controlling stake at a premium and later the minority may have to sell at a lower price in a freezeout after the takeover is successfully completed. The public offer has to be made by the merchant banker appointed by the acquirer not later than 4 working days of entering into an agreement for acquisition of shares or voting rights or deciding to acquire shares or voting rights exceeding the respective percentage specified therein. To ensure that the information regarding the offer is available to all the shareholders the public announcement shall be made in all editions of one English and Hindi national daily in wide circulation and a regional language daily with wide circulation at the place of the stock exchange where

the

target

company

are

most

frequently

traded.

The content of the Public Announcement of Offer should include the following: •

The paid up share capital of the target company, the number of fully paid up and partly paid up shares;

•

The total number and percentage of shares proposed to be acquired from the public, subject to minimum as specified in sub-regulation (1) of Regulation 21;

•

The minimum offer price for each fully paid up or partly paid up share;

•

Mode of payment of consideration;

30 •

The identity of the acquirers and in case the acquirer is a company or companies, title identity of the promoters and/ or the persons having control over such company(ies) and the group, if any, to which the company(ies) belong;

•

The existing holding, if any, of the acquirer in the shares of the target company, including holdings of persons acting in concert with him,

•

Salient features of the agreement if any, such as the date, the name of the seller, the price at which the shares are being acquired, the manner of payment of consideration and the number and percentage of shares in respect of which the acquirer has entered into the agreement to acquire the shares or the consideration, monetary or otherwise, for the acquisition of control over the target company as the case may be;

•

The highest and the average price paid by the acquirer or persons acting in concert with him for acquisition, if any, of shares of the target company made by him during the twelve month period prior to the date of public announcement;

•

Provided that where the future plans are set out, the public announcement shall also set out how the acquirers propose to implement such future plans;

•

The 'specified date' as mentioned in Regulation 19; the date by which individual letters of offer would be posted to each of the shareholders;

•

The date of opening and closure of the offer and the manner in which and the date by which the acceptance or rejection of the offer would be communicated to the shareholders;

•

The date by which the payment of consideration would be made for the shares in respect of which the offer has been accepted;

•

Disclosure to the effect that firm arrangement for financial resources required to implement the offer is already in place, including details regarding the sources of the funds whether domestic i.e from banks, financial institutions, or otherwise or foreign i.e from Non-Resident Indians or otherwise.

•

Provision for acceptance of the offer by person(s) who own the shares but are not the registered holders of such shares;

•

Statutory shares approvals, if any,

31 â&#x20AC;˘

Approvals of banks or financial institutions required, if any;

â&#x20AC;˘

Whether the offer is subject to a minimum level of acceptance from the shareholders.

If the public offer results in the public shareholding being reduced to 10% or less of the voting capital of the company, or if the public offer is in respect of a company which has public shareholding of less than 10% of the voting capital of the company, the acquirer

a) Within a period of 3 months from the date of closure of the public offer, make an offer to buy out the outstanding shares remaining with the shareholders at the same offer price, which may result in delisting of the target company; or

b) Undertake to disinvest through an offer for sale or by a fresh issue of capital to the public, which shall open within a period of 6 months from the date of closure of the public offer, such number of shares so as to satisfy the listing requirements.

The letter of offer shall stale clearly the option available to the acquirer under sub-regulations mentioned above. Where the number of shares offered for sale by the shareholders are more than the shares, agreed to be acquired by the person making the offer, the acquirer is required to accept the offers received from the shareholders on a proportional basis, in consultation with the merchant banker, taking care to ensure that the basis of acceptance is decided in a fair and equitable manner and does not result in non -marketable lots. The acquirer is to ensure that the letter of offer is sent to all the shareholders (including Non-Resident Indians) of the target company, whose names appear on the register of members of the company as on the specified date mentioned in the public announcement, so as to reach them within 45 days from the date of public announcement. The date of opening of the offer shall be not later than the 60th day from the date of public announcement. The offer to acquire shares from the shareholders shall remain open for a period of 30 days The only reason for the existence of an open offer requirement in the Securities and Exchange Board of Indiaâ&#x20AC;&#x2122;s takeover regulations is to protect small investors and ensure that they get a fair deal. An acquirer is required to make an open offer to buy 20 per cent of the public shareholding. Since investors and regulators cannot be expected to unravel complex acquisition deals, it was decided that the average market price of the previous 26 weeks would form the basis of the offer.

32 The takeover code provides for white knights. Regulation 29 provides that any person, other than the acquirer who has made the first public announcement, who is desirous of making any offer, shall, within 21 days of the public announcement of the first offer, make a public announcement of his offer for acquisition of the shares of the same target company. Such a bid will be termed as a competitive bid. Upon the making of a competitive bid the acquirer has the option to a. Revise the offer; or b. Withdraw the offer, with the prior approval of the Board. It has to make the counter offer within fourteen days of the announcement of the competitive bid(s) or the earlier offer on the original terms shall continue to be valid and binding on the acquirer who had made the offer except that the date of closing of the offer shall stand extended to the date of closure of the public offer under the last subsisting competitive bid. Regulation 26 provides that irrespective of whether or not there is a competitive bid the acquirer who has made the public announcement of offer may make upward revisions in his offer in respect of the price and the number of shares to be acquired, at anytime upto seven working days prior to the date of the closure of the offer. Regulation 27 (1) provides that no public offer, once made, shall be withdrawn except under the following circumstances: a. The withdrawal is consequent upon any competitive bid; b. The statutory approval(s) required have been refused; c. The sole acquirer, being a natural person, has died;

A Critical Evaluation of the Takeover Code and Bhagwati Committee Report Takeover Code 1. The present Code does not provide for a level playing field between a potential acquirer and a promoter. A potential acquirer can acquire upto 15% stake without making any announcement and in any period of time while an existing promoter can have creeping acquisition of only 5% without triggering an open offer. This essentially means that the

33 existing promoters are at a disadvantage when it comes to consolidating their holding in the company to ward off any takeover bid. On the other hand, a predator can acquire 15% stake in the target company without incurring any disability imposed by the Code.

2. The â&#x20AC;&#x153;object and purpose of acquisition'', required to be disclosed in open offers is usually sketchy. It would be in the larger interest of minority shareholders for the Takeover Code to stipulate that the acquirer render with greater clarity the object and purpose of acquisition, particularly future plans, if any, both in the public announcement and the letter of offer. For instance, in its bid to takeover GESCO, the letter of offer by Renaissance Estates (part of AH Dalmia group) merely stated that â&#x20AC;&#x153;the reason for the offer is to effect substantial acquisition of shares/voting rights in GESCO. Renaissance believes that the recent stock price of GESCO did not reflect its true intrinsic value. A substantial acquisition of shares in GESCO accompanied by a change in control would unlock the intrinsic value of the shares for all shareholders.'' Had it not been for the unlocking of value, the takeover bid itself would not have been made at all. 3. Financing plan/options: The acquirer must spell out his/her financing plan in unambiguous terms. As per the provision in the Takeover Code, money has to be pooled in an escrow account (which is returnable in the case of a failed bid). In a competitive hostile takeover environment, the escrow mechanism may itself not be a deterrent for the acquirer to overreact and lay down a weak financing plan for the takeover. In such cases, the Takeover Committee has to decide the circumstances under which SEBI may have the power to intervene in the matter.

4. Disposal/sale of assets: The Takeover Code provides that an acquirer is required to make a disclosure both in the public announcement and the letter of offer that he has no intention of disposing of or otherwise encumbering the assets of the target company in the two succeeding years, except in the ordinary course of business. The Code further adds that if the acquirer fails to make this disclosure either in the public announcement or the letter of offer, he shall be debarred from disposing of or otherwise encumbering the assets of the target company.

34 But this provision, made to protect shareholders' interests, has hardly served any purpose and is unlikely to do so in future because the Code does not prevent the acquirer to indulge in stripping of assets of the target company if he/it has disclosed in the offer letter and the public announcement that it reserves the right to do so. The disclosure by Renaissance Estates Ltd. in the GESCO Corporation bid provides an example. The letter of offer stated: “On obtaining control over GESCO, REL (Renaissance Estates Limited) would have access to material information, based on which it would explore the possibilities of further increasing shareholder value through various means, which may include selling or encumbering the assets of GESCO, in the ordinary course or otherwise, in the succeeding two years from the date of offer disclosure.” Now, strictly speaking this disclosure fails to comply with the requirement of the Code because it discloses an intention to dispose the assets, though circumscribed by the requirement of increasing the shareholder value. This disclosure, as it stands today, has no value at all for the GESCO shareholders to reach an informed decision on whether to accept the offer or not because the disclosure entices the shareholder with a promise to increase shareholder value notwithstanding that it may involve selling of assets of the acquired company. However, in its latest recommendation to SEBI the Bhagwati Committee constituted to review the Takeover Code has suggested that disclosures made in the offer document should include an undertaking not to strip substantial assets except with the prior approval of the shareholders of the target company and any non-compliance of this requirement may attract action from SBEI. 67 Although, this is likely to arrest the apprehensions of shareholders but it may also lead to litigation on the question of what constitutes “substantial assets”. Therefore, it would be prudent for the market regulator to include an explanation clarifying the expression “substantial assets”. A minimum market value (of assets) may be prescribed and any disposal of assets the value whereof exceeds the prescribed minimum without prior shareholder approval will attract penal liability.

See, Sanjeev Sharma and Vivek Sinha, “Bhagwati Panel Draft Proposes Bank, FI Funding of Takeovers”, The Economic Times, April 9 2002, P.1. In the US such provisions are popularly known as ‘Business Combination Statutes’. These statutes, subject to certain exceptions, prevent hostile tender offerors from completing defined "business combinations" -such as mergers, consolidations, substantial sales of assets, and liquidations -- for periods of three to five years after acquisition of control through a successful tender offer. The effect is to prevent a hostile bidder from using its power of control to engage in the post-takeover "bust-up" transactions that typically motivate takeovers.

35 5.Consolidation of holdings: Regulation 11 (1) of the Takeover Code provides that "no acquirer who together with persons acting in concert with him has acquired, in accordance with the provisions of law, 15% or more but less than 75% of the shares or voting rights in a company, shall acquire either by himself or through or with persons acting in concert with him additional shares or voting rights entitling him to exercise more than 5% of the voting rights, in any period of 12 months, unless such acquirer makes a public announcement to acquire shares in accordance with the regulations". From the above provision an important question arises as to whether consolidation is permitted once an acquirer has acquired 15%? As per a clarification issued by SEBI: "An acquirer who is having 15% or more but less than 75% shares or voting rights of a target company, can consolidate his holdings upto 5% of the voting rights in any period of 12 months". This means, an acquirer can first acquire 15% shares and then instead of making a public offer as per Regulation 10 of the Takeover Code, can choose to consolidate his holdings through the creeping route by adding 5% to his holding every year and can thus raise his holdings up to 75%. Strictly speaking, an acquirer can follow this route to raise his holdings up to 75% over a period of time despite the requirement under Regulation 10 to make a public offer for further acquisition once the acquirersâ&#x20AC;&#x2122; holding touches 15%. Regulation 10 provides that "no acquirer shall acquire shares or voting rights which (taken together with shares or voting rights, if any, held by him or by persons acting in concert with him), entitle such acquirer to exercise 15% or more of the voting rights in a company, unless such acquirer makes a public announcement to acquire shares of such company in accordance with the Regulations". As per this regulation, an acquirer is required to make a public announcement for further acquisition in terms of the takeover code when his holdings touch the trigger point of 15%. However, an acquirer can take shelter under the consolidation provisions prescribed under Regulation 11 (1) of the Takeover Code and may not make public offer for acquiring further shares and instead can follow the creeping route. To avoid the scope for litigation, the Takeover Code should be amended, and in the Regulation 11(1) the expression "15% or more" should be replaced by "more than 15%". This will ensure that the acquirers cannot escape the requirement of making an open offer under regulation 10 once their holding reaches the 15% ceiling.

6. Consolidation of holdings by promoters: The benefit of creeping acquisition should preferably be available only to promoters/persons having control over the company and persons of other categories should not have the benefit of creeping acquisition at par with promoters. Alternatively, promoters may be permitted to consolidate their holdings at a rate higher than 5%, if not completely removing this limit, at least for raising their holdings up to 51%. One can appreciate this argument when historical reasons for lower promoters holdings are looked at: 68 As per listing guidelines prevailing before repeal of the Capital Issues Control Act, the promoters were required to offer at least 60% of issued capital of the company to public, thereby limiting promoters' holding only up to 40%. As per joint sector norms, the promoters were not permitted to have more than 25% shareholding as 26% shares were required to be held by the state government promoted institutions and 49% shares were required to be offered to the public. In the companies promoted by MRTP houses, in certain circumstances, the promoters were not permitted to have more than 25% of the paid-up share capital, without the approval of the central government. It was difficult for promoters to mobilise promoters' contribution as very little disposable funds could be generated due to high incidence of tax. Now that the tax rates have been rationalised and reduced, the promoters can reasonably be expected to generate investible funds. Promoters were not permitted to consolidate their business at par with global practices and were not encouraged to expand in the chosen business line. In the quest for growth, promoters had no other choice but to set up factories for whatever product they could get the licence. The criteria for the same was anything but economic, and promoters had no choice either in the case of the product or the location. In view of these factors and historical reasons, SEBI should seriously consider giving an opportunity to the promoters to raise their holdings up to at least 51% without triggering the takeover code or at least raise the 5% limit to 10% for consolidating holdings up to 51%, rather than treating the promoters on par with any other acquirer.

T P K Rustagi, â&#x20AC;&#x153;Takeover Code Should Not Treat Promoters And Acquirers On Parâ&#x20AC;?, The Indian Express (Bombay Edn.), 13 Dec. 2000, p.8.

37 SEBI can also consider permitting only the promoters to avail the creeping acquisition route under Regulation 11 and acquirers other than promoters should be required to make a public offer once their holdings touch 15%, as per Regulation 10.

Bhagwati Committee Report- A Critique. The P. N. Bhagwati Committee constituted to review the Takeover Code proposes to recommend disclosure at three stages -- 5 per cent, 10 per cent and 14 per cent of equity -- vis-a-vis the current requirement at the 5 per cent level. By introducing a three-stage disclosure mechanism, the target company management could try to indirectly stifle the `market for corporate control' in three ways:69 First, by making disclosure mandatory especially at the 10 per cent and 14 per cent levels, the target company aims to make the cost of acquisition high (even prohibitive) for the acquirer. It is but natural that the disclosure at these levels would cause too much speculative interest in the stocks of the target company - market will be anticipating a takeover due to rising stake in the target company - which is likely to drive the price expectation way beyond the levels the acquirer may have contemplated. Second, while the acquirer has to make his intentions known to the target company, the latter can conserve its resources till the 10 per cent level and test the seriousness of the potential hostile bidder before entering the market. The target company can also drive the acquisition price to higher levels through `market operations', making the acquisition as unattractive as possible for the acquirer. Finally, even with a single-stage disclosure, say at 5 per cent, the target company has adequate safeguards in place to mount a takeover defence against the hostile acquirer, such as creeping acquisition, making a competitive bid, a white knight rescue, a buyback and even a preferential offer. Even in the US market, where the takeover market is fairly mature, the various Committees have only actively solicited for a `lower threshold' of disclosure, and not a multi-stage disclosure. Under Rule 13D of the Williams Act, as soon as an acquirer has accumulated 5 per cent of the target company's equity, he has to file a schedule 13D declaration disclosing the size of his 69

Krishnan Thiagarajan, â&#x20AC;&#x153;Fending off Hostile Raiders -- Whining Corporates may Stifle the Takeover Market, The Business Line, Nov. 26 2000, p.6.

38 holdings with the target company, with each exchange on which the stock is traded and with the Securities and Exchange Commission. 70 In India too, instead of making the disclosure at the 5, 10 and 14 per cent levels, stringent disclosure practices need to be in place on the lines of the recommendations made by the Takeover Committee. As soon as the 5 per cent threshold is reached, the acquirer must be called upon to notify the target company, its regional stock exchange, the BSE, the NSE (and even SEBI, though this has not been recommended) which must put this information on their web sites to provide for widest possible dissemination. The committee has also decided not to redefine “change in control”. The reason given is that there could be a situation where control may change but the same management is retained or the owner may decide to change the management by sacking the board. As regards board being retained, “Control” is defined in Regulation 2(1)(c) to include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements in any other manner”. It is clear that the person in control of the company cannot sack the board unless approved by an ordinary resolution in a general meeting. The exception being directors appointed by proportional representation, a director appointed by central government under Sec 408 or by the FIs referred to in notes under Sec 255 of the Companies Act; none of whom can be removed through the ordinary resolution route. If the shareholders vote out the board, there is no question of an open offer. Control should be defined in terms of having a particular percentage of voting rights in the general meeting, say for example, 30% or more and if the person who is in control holds such voting rights, he can very well get the board removed by getting an ordinary resolution passed.

Outright Acquisition Of 51 Or 100 Per Cent There is also a growing demand among sections of Corporate India for an outright acquisition of 100 per cent equity, or at least 51 per cent, when an acquirer crosses the 15 per cent threshold. The Takeover Code now calls only for a minimum offer of 20 per cent for an acquirer crossing the 15 per cent threshold. Though prima facie, this suggestion has merit, the pros and cons have to be debated at greater length before it is introduced. Some of the points in favour of a mandatory 100 per cent or 51 per cent acquisition are as follows:

Lyman Johnson and David Millon, “Misreading The Williams Act”, 87 Mich. L. Rev. 1862, 1874 (1989).

39  In the case of a minimum offer size of 20 per cent, while the promoters can sell their entire equity stake in a friendly offer, the minority shareholders have to be satisfied with a proportional acceptance of equity shares by the acquirer. The proportional acceptance leads to shareholders being saddled with shares in companies whose prices fall sharply after the takeover bid. Even in a hostile offer, the minority shareholders may be constrained by this low minimum offer requirement of 20 per cent.

 The minimum offer size of 20 per cent may leave the scope for some frivolous offers. However, this is balanced to a large extent by the escrow mechanism, which has kept at bay several non-serious bidders. Further, the Committee is also toying with the idea of prohibiting the original bidder from withdrawing the offer once an offer has been made. The rationale behind this proposal is that an acquirer while making any bid for a company should be fully prepared for the consequences. 71 The arguments that can be advanced against the 100 per cent acquisition are:

 In a country like India, where financing options from banks and financial institutions are virtually absent, a 100 per cent acquisition will make a takeover offer too onerous for an acquirer. So, strictly, the UK City Code on Takeovers, which provides for 100 per cent acquisition, or the Williams Act of the US may not be strictly applicable in India. Making the takeover offers too onerous may end up killing the takeover market in India, leaving it open to cash-rich Indian and foreign companies. However, the Takeover Committee has now proposed to allow banks and financial institutions to finance takeovers and the RBI has given a positive response to this suggestion.72  The requirement of 100 per cent acquisition by a bidder in a target company in which a good chunk of equity is with financial institutions (FIs) may prove a non-starter and discourage the growth of the takeover market. FIs have been either neutral observers or have favoured incumbent managements in takeover battles. Unless they become active participants, lending transparency to the takeover process (being aware of the internal workings of the target company), the market for corporate control will never take off.  If the Takeover Committee feels a 100 per cent acquisition desirable, it can be introduced only with adequate checks and balances. In hostile takeovers, in order to encourage genuine bidders, the bidder must be allowed to retract his offer if it fails to generate the required number of acceptances. At the same time, to ensure that the bidder does not 71 72

Supra note 67. Supra note 67.

40 destabilise existing managements, the Code must indicate the minimum level of acceptance of offer (say, 20 per cent) by bidders, even where it fails to generate the desired response.

Chapter V

FINANCING OF HOSTILE TAKEOVERS Section 77 of the Companies Act prohibits Companies from giving financial assistance for the acquisition of its shares.73 The rationale behind such provision is that the persons lending credit to a Company are entitled to rely upon the existence of the issued capital of the Company (subject to any loss which may occur or may have occurred in carrying on the business of the Company) as a cushion against the possibility of the company being unable to pay its debts. Restriction on the buyback of shares has the dual effect of protecting shareholders from controlling shareholders controlling less shareholding votes (it may be a promoter or a member of the Board) who could use the funds of the company or its subsidiaries to make themselves irremovable, and of protecting the creditors and other persons dealing with the Company who might be prejudiced by what would in effect amount to a reduction in the capital of the company authorised neither by the shareholders nor by the Courts. S 77 is often regarded as an extension of the protection given to shareholders and creditors against erosion of the Company’s capital. However section 77 was provided to counteract the abuses that were likely to arise where someone acquired control of a company in circumstances where he was not able to provide funds necessary to acquire control either from his own resources or borrow on his own credit. And where he needed to rely on the funds of the company over which it had gained control in order to help him finance that purchase. In UK the Greene committee report described the situation in the following manner: 74 “A syndicate agrees to purchase sufficient shares to control a company, the purchase money is provided by a temporary loan from a bank for a day or two, the syndicate’s nominees are appointed directors and immediately proceed to lend to the syndicate out of the company’s funds (often without security) the money required to pay off the bank. Thus in effect the company provides for the purchase of its own shares…the practise is open to the gravest abuse. There is a general prohibition on providing financial assistance to acquire its own shares”.

73 74

Section 151 of the English Companies Act, 1985. Supra note 1, at 2092.

The prohibition applies both to direct and indirect assistance and it need not be assistance given to the purchaser of shares himself. Therefore for example liability can’t be avoided by interposing a third party between the company and the purchaser through whom the financial assistance passes. Nor presumably would it be allowable for the company by providing finance to relieve the purchaser of some other independent liability thus freeing it to purchase the company’s shares. The financial assistance must be given “for the purpose of” or “in connection with” the acquisition of shares.75 Under S.77-B of the Companies Act it is not lawful for a company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of reducing or discharging any liability incurred by a person for the purpose of the acquisition of the shares in that company. 76

Meaning of Financial Assistance In Charter House Investment Trust Limited v. Tempest And Diesels Ltd77, A Ltd agreed to submit as tax loss as part of a transaction whereby B Ltd. was to sell its shares in A Ltd. to C. C resisted this surrender by claiming that the transaction involved “financial assistance” being given to B by A Ltd for the purpose of purchase of shares of A Ltd. It was decided that the true nature of the transaction did not involve the giving of financial assistance: that the surrender of the tax loss constituted a part of the consideration to be paid by A Ltd. For the financial assistance of various kinds being given to it by B Ltd., rather than being financial assistance given by it in respect of acquisition of its shares. In coming to this conclusion, Justice Hoffman, suggested the approach to be taken in determining the nature of the transaction for these purposes: “One must examine the commercial realities of the transaction and decide whether it can properly be described as the giving of financial assistance by the company, bearing in mind that the section is a penal one and should not be strained to cover transaction where not fairly within it…it is necessary to look at the transaction as a whole to determine whether it constituted the giving of

The corresponding Provision under English Law is narrower because it excludes the expression “in connection with” acquisition of shares. The liability must have been incurred for the purpose of acquisition of shares. 76 S. 151(2) of the English Companies Act, 1985. 77 [1986] BCLC 1.

43 financial assistance…. this must involve a determination of where the net balance of financial advantage lay.” Any guarantee or security provided by the target before or after the acquisition of shares in the target by the offeror, to support the borrowings of the offeror will be financial assistance. But in a hostile takeover such issue will never arise because the target having rejected the bid offer will never agree to provide any kind of financial assistance to the acquirer. However post acquisition of shares the question of financial assistance to the acquirer may arise and in that case prohibition contained in section 77 will apply. If the lending of money is part of the of the ordinary business of the company, there will be no contravention of s.77 of the Companies Act if money is in fact lent by the company in the ordinary course of business. The lending must, must however take place in the ordinary course of business and this means that the particular loan in question must be ordinary or normal with respect to the size of the loan, the duration of the loan, the security for the loan and the type of customer to whom the loan is made. Weinberg and Blank are of the opinion that in a takeover situation the provision of financial assistance to facilitate the takeover will probably never be protected because a takeover would be in the nature of a “one off” situation, and therefore not in the ordinary course of business. 78 However, the researchers are of the opinion that this is not necessarily so because amount raised to finance a takeover may have to be repaid over a period of time. For example, the acquirer raises loan from the bank to finance the takeover and agrees to repay the bank over a period of six months. After the takeover of Target Company there is nothing to stop the acquirer from getting financial assistance from the target company or dispose some of its assets to repay the bank loan and in that case the prohibition should be attracted. A takeover may be a ‘one-off’ situation but money raised to finance it can be extracted form the target company over a period of time to give it a colour of assistance given in the ordinary course of business. In this context it is pertinent to point out that the Bhagwati Committee on Takeover Regulations has noted that the regulations do not have substantive and explicit provisions to cover situations where after the public offer the acquirer proceeds to strip the assets of the company. This phenomenon is similar to the “bust-up” takeover wave of 1980s in the United States wherein the acquirer after taking over the target swiftly moved to sell the assets of the company piece by 78

Supra note 1, at 2100.

44 piece to realise quick profits. To remedy this the Takeover Committee has recommended that disclosures made in the offer document should include an undertaking not to strip substantial assets except with prior approval of the shareholders of the target company and any non compliance of this may attract penal action from SEBI. 79 Exemptions A Public Company may only provide financial assistance in the form of a loan as part of its ordinary course of business, or by way of employee share schemes, or through loans to employees to purchase shares, if the company has net assets which are not reduced by providing this financial assistance or, if they are reduced, the financial assistance is provided out of distributable profits. Net assets for this purpose means the amount by which the aggregate of the company’s assets exceeds the aggregate of its liabilities (taking the amount of both assets and liability to be as stated in the company’s accounting records immediately before the financial assistance is given). Further, it is not a prohibited transaction for a company to distribute its assets by dividend lawfully made. The requirement that the dividend be “lawfully made” excludes the possibility of offeror obtaining from target immediately after a successful takeover, an unusually larger dividend, thus providing itself with sufficient funding to repay any loan made for the purpose of accomplishing the takeover.

Supra note 67.

Chapter VI

CASE STUDIES CASE STUDY 1: India Cements’ Acquisition of Raasi Cements Though the India Cements Limited (ICL) acquired the Hyderabad-based Raasi Cements Ltd. (RCL) in a negotiated deal for Rs. 140 crore, the deal could be reached only after three months long "hostile takeover" bid mounted by the ICL over RCL. Dr B V Raju, the chief promoter agreed to sell his entire 32 per cent holding in RCL at Rs. 286 per share. A careful study of the events that took place before the deal was reached gives an insight into the issues involved in a hostile takeover deal. In order to thwart the hostile takeover, Mr. Raju had challenged the SEBI's takeover code in the Andhra Pradesh High Court arguing that the takeover code does not give the promoters any chance to defend it. However, after an initial stay, the Andhra Pradesh High Court vacated its earlier stay against the takeover proceedings. When looked at the takeover bid from target shareholder’s point of view, between October 1997 to March 1998, the RCL stock rose by a whooping 318 per cent. In contrast, during the same period the ICL stock fell by 46.36 per cent. On the other hand when the sale was agreed upon, the Raasi scrip crashed to Rs 181 from Rs 187 at the closing on the BSE while India Cements’ share improved to Rs 63.15 from Rs 57.60. The movement in RCL scrip can be explained by the fact that the shareholders of RCL expected a high premium on their shares if the hostile bid turned out to be successful but when it ended in a negotiated deal the share prices fell because shareholders lost the opportunity to make some quick bucks. Though generally, the share price of the target company should remain high even if the initial bid has failed on the expectation of a fresh tender offer from other bidders. But when the bid has ended in a negotiated deal, there is no possibility of a fresh offer and expectation of a high premium is naturally dashed pulling the share price down. However, what explains the downward movement in the share price of ICL when the hostile bid was on and subsequent rise in its prices when the target was acquired in a negotiated deal? How and in what manner would the acquiring company's shareholders (ICL in this case) benefit? This is a function of the synergies in production; marketing and distribution expected from the takeover and the future growth strategies of the acquirer. The possibilities of sales enhancement,

46 greater market share, operating economies and improved management would all decide the rewards to the acquiring company’s shareholders in the future. The initial downtrend in the ICL stock can probably be explained due to some apprehension in the market that the ICL may be willing to pay too high a premium, which may not be offset by the gains that may accrue due to synergy of operations and management between the two companies. Now it is worthwhile to investigate into the possible reasons that may have triggered the hostile bid by ICL against RCL. Depressed Stock Prices Make An Easy Prey 80 Due to general economic recession prevailing in the last 2-3 years, the demand for cement has been very sluggish which has been reflected in the depressed stock prices of major cement manufacturers. This has resulted in bringing down the P/E ratios of several cement scrips to just 6 or 7. At these abysmally low prices, several cement companies with capacities of around one million tonne can be acquired for Rs. 150-200 crore. Hence predators find it more reasonable and attractive to launch a takeover bid rather than going in for expansion. For example, setting up a 1 million tonne plant would roughly cost around Rs.400 crores. RCL has a capacity of 1.6 million 80

A study done in the year 2000 of some leading Indian companies (many of them family run business houses) to find out who were the most vulnerable companies gave some revealing insights in which many old economy stalwarts find themselves in an unviable situation and it should serve as a wake-up call for the management of these companies. For decades, the families have run these companies like fiefdoms, giving scant attention to share price and returns to shareholders. Many of these companies' share prices are below their net asset values per share--sometimes drastically so. In the Table it can be seen that barring a few companies like L&T, ACC, Bharat Forge, Madras Cements, Bajaj Auto and Hindalco, the ratio of share price to book value is less than one which means that market value of these companies is lower than their book value and that makes these companies a cheap bargain. That also makes takeovers a cheap way to buy real estate, ships, factories, and dominant, if often poorly run, businesses. The low valuation of these companies, with the average price-earnings (P/E ratio) on the Indian markets ruling at 14, makes many of them potential takeover candidates and encourage predators to launch a hostile bid. Table 1: NamePriceMarket capMarket cap/Price/Market cap/Promoters (Rs)(Rs m)Sales (x)Book Value (x)Cash (x)(%)Crompton Greaves2211260.070.30.330.1Essar Steel620050.100.20.123.0HPCL101341710.110.61.551.0Voltas278970.120.60.628.7Century Textiles2726980.130.50.946.7Ashok Leyland3541680.180.41.151.0Telco78199230.280.50.816.4Sesa Goa428400.370.40.451.0Grasim172158130.370.61.322.8Thermax6815710.410.40.475.0India Cements3752120.440.70.636.8Tata Chem3463250.440.41.132.0BILT5835010.450.40.931.1BHEL101247090.480.71.168.0M&M1611 76890.500.91.112.5Tisco88323610.530.71.918.6Tata Power6475130.550.40.428.1L&T158394820.571.01.98.3ACC88151290.641.42.919.1GESCO256 6000.690.61.514.1Bharat Forge9735700.711.11.042.8Madras Cements390047200.921.33.230.9Bajaj Auto307367421.191.10.933.8Nalco41270611.360.86.687.2Hindalco809603172.971.62.924.7Sou rce: India Infoline. Cf. Anirudha Dutta, “After Bombay Dyeing Who’s Next?” <www.indiainfoline.com/pobl/13oct00.html>

47 tonnes81 and setting up a new plant of same capacity at current prices would entail an outgo of around Rs.550-600 crores. Therefore, it is clear that the market capitalization of most cement stocks was way below the cost of setting up similar capacities. Compare the market capitalization of both RCL and ICL before and after the takeover announcements. The market capitalization of ICL prior to the takeover announcement in October 1997 was Rs. 603.17 cores, which came down to Rs.371.55 crores in March 1998. In contrast, the market capitalization of RCL before the hints of takeover in October 1997 was just Rs.94.62 crores. The subsequent developments on the takeover front helped in bringing this upwards to Rs.230.18 crores in March 1998. The shareholders of no other cement company had such a windfall in terms of value gained considering that bottomlines of most players in the cement industry had been badly hit. 82 Accelerated revenue generation ICL probably also realized that takeover would help in augmenting revenues. Given that in the normal circumstances the gestation period of a new plant is usually 30 months before revenues trickle in, the acquisition route would streamline this gap. In a takeover, the entire process would take around 6 to 8 months before the process is completed and revenues are generated. Enviable Capacity Companies in the cement industry have been aiming at garnering large capacities to remain competitive and ensure future survival and growth. ICL's acquisition of RCL also reveals this trend. The cement industry in the country is in a fragmented state with 59 companies operating with 115 plants. Nine groups make up for 65 per cent of the total capacity – a clear indicator that the consolidation is due.83 ICL had started adding capacities through acquisitions much before the acquisition of RCL. In 1997-98 alone, ICL had added 2.2 million tonnes of fresh capacity through acquisitions and expansions. Its capacity has increased from 1.4 mt in 1989 to 4 mt by early 1998. ICL took over Visakha Cements (0.9 mt) for Rs 380 crore and the public sector Yerraguntla plant (0.4 mt) for Rs.198 crore both in AP. This coincided with the going on stream of ICL's Greenfield plant (0.9 mt) at Adalvoi in Tamil Nadu. RCL has come in as a golden mine for ICL - by dint of 81

In 1997, Gujarat Ambuja had acquired Modi Cement with an installed capacity of 1.5 million tonne for just Rs.166 crore. 82 All the figures mentioned herein have been taken from Prabhavathi Rao, “Hostile Takeovers-Sharks on the prowl”, Analyst, May 1998, Cf. <www. icfaipress.org/archives/Analyst/1998/may/cover-Hostile Takeovers Sharks on the prawl.htm> 83 Rather it has already started slowly. In 1999, the French cement major Lafarge acquired Raymond Cements.

48 acquiring RCL's 2 mt plant, ICL has emerged as the second largest cement maker in the country after ACC (10 mt capacity), tucked with a capacity of 7.5 mt and an enviable 35 per cent market share in South India - to achieve growth. Thus, comfortably for ICL, the acquisition of RCL has led to enhancing capacity without creating new ones. Increased market share ICL could now cash in on its dominant position, especially in the southern market and pursue an aggressive pricing strategy. With the takeover of RCL, ICL would be able to enjoy the benefit of having all its plants in one region, thereby ensuring a substantial market share in the region. Post acquisition, ICL's market share is expected to be 30.77 per cent in Tamil Nadu, 34 per cent in Kerala, 30 per cent in Karnataka and 43 per cent in AP, raising its aggregate market share in the South to 33 per cent from the earlier level of 14 per cent. It would be now easier for ICL to enter the cement deficit regions of Tamil Nadu and Kerala and in consolidating its position in the southern markets. Another interesting factor in ICL's favour is the higher growth in demand for cement in the south as compared to the national average. Prices in the Southern markets are generally known for being steady in comparison to that in the North. Competition has gathered momentum in the Southern market of late what with L&T's 1.75 mt plant's operations on the anvil in Andhra Pradesh, Madras Cements' expansion plans and Gujarat Ambuja's aggressive strategies of late. ICL's moves seem to be in the right direction. Cost Competitiveness of RCL RCL's perhaps most important attraction is its cost effectiveness in comparison to ICL. A look at the statistics reveals as to how RCL is highly cost competitive. For instance, its raw material costs per ton is lower than ICL by nearly 42.16 per cent, power and fuel costs are lower by 24 per cent, and employee cost is a merely a fraction (28.2 percent) of ICL. RCL's only achillesâ&#x20AC;&#x2122; heel seems to be its higher selling and distribution costs - 20 per cent higher than ICL. This could be attributed to its wide distribution network in several states. In comparison, ICL's sales primarily come from Tamil Nadu and Kerala. ICL can also hope to save on logistics per annum post acquisition scenario to the tune of nearly Rs.20 crore. Additionally, the rationalization of various markets between ICL and RCL and by cashing in on ICL's distribution network, the new ICL should be able to realize around Rs.200 per tonne. The benefits of economies of scale, the synergies of the juxtaposed operations would help ICL in realizing stronger cash flows. This should happen thanks to ICL gaining a greater regional foothold and market leadership.

How the shareholders would actually benefit? It is important to note what the shareholders should actually do during such bid offers. Given that the offer generally would be accepted for a small portion, mandatory bid is to offer for 20% of the equity, it would be sensible to offload the shares in the market when the prices are ruling high on the back of takeover news, even though it may be at a discount to the offer price because once bid is accepted share prices will revert back to the normal pre-bid level. Consider the case of RCL. The market price of the scrip at the time of the bid was around Rs.200, in comparison to the offer price of Rs.300. It would not be easy for every shareholder to realize this price. Accepting a certainty of Rs 200 could be more practically appealing to some shareholders as against the uncertain Rs. 300. Balakrishnan, a shareholder evinces interest in such a situation. He explains, "If I submit my shares under the offer and if only part is accepted, the certificate for the balance will come back to me after three months or so. By this time, the market price will fall back to earlier levels of under Rs 100. This is a risk to be evaluated carefully. SEBI can help in this regard by making it compulsory to accept all offerings up to a maximum of say 500 shares per applicant. This will offer relief to small shareholders. For the institutions they can do a negotiated deal outside the offer, with either the existing promoter or the raider at a higher price, which is possible given the circumstances."84 ICLâ&#x20AC;&#x2122;s acquisition of RCL should help in enhancing the shareholder value of ICL shareholders in the long run. This is because the market-share of ICL moves up after the acquisition with the company emerging as the largest cement producer in South India. And given the current wave of consolidation in the cement industry, the open offer also benefits the shareholders of RCL thanks to the attractive offer price. Post-Acquisition Returns to ICL Shareholders Now, it is interesting to have a look at the post-acquisition scenario in order to determine as to whether acquisition of RCL has actually benefited, and, if yes, to what extent, ICL shareholders. After acquiring RCL later, in 1999, ICL also acquired Sri Vishnu Cements Ltd. (1mt. Capacity) â&#x20AC;&#x201C; another Raju promoted company in which RCL already had 49% holding. Therefore, with the acquisition of RCL and its subsequent merger with ICL, ICL also got a 49 % holding in SVCL. For ICL group, Sri Vishnu cost little over Rs. 170 crores. This meant an average price of Rs. 76 84

Supra note 82.

50 per share, though it paid about Rs. 100 per share to the minority shareholders while complying with the takeover code through an open offer. As can be seen in the Table 2 below Post SVCL acquisition the paid equity capital has shown an increase. Though the acquisition spree launched by ICL catapulted it to the top in terms of capacity, alongside ACC, Grasim Industries and Larsen & Toubro, its profitability came under considerable strain and its acquisitions are yet to pay. The acquisitions largely financed by debt coupled with a recession in the market, the company is nowhere near to get the kind of returns for the price (Rs. 300 per share and close to Rs. 400 crores) paid for Raasi Cements. It had a total debt of close to Rs. 1,800 crores as at the end of March 2001. And, its debt-equity ratio is in the vicinity of 2.14:1. As can be seen from the table below, earning per share has shown a steady decline from March 1998, and the decline has been around 40% when compared to the figures in 1996-97 and 199798. What may have acted as a dampener on company's performance, apart from high financial costs, is the cement price trends. In 1999-2000, despite a 15 per cent growth in volumes, prices were flat with periodic moves in either direction. Though prices improved thereafter the company continued its insipid show, as the companyâ&#x20AC;&#x2122;s first quarter results in 2000-1 were not encouraging compared to those in the first quarter of 1999-2000. The operating profit margin declined by 1.4% from 22.8% to 21.4%. Net profit also showed a decline from Rs. 7.4 crores to Rs. 5.7 crores â&#x20AC;&#x201C; a decline of almost 30%. The large debt burden in spite of soft interest continued to take a heavy toll on the companyâ&#x20AC;&#x2122;s profitability and hence shareholder returns and unable to improve its bottomlines ICL was forced to sell its 39.5% stake in SVCL in Jan. 2002. Therefore, what we see in this case is that a (hostile) takeover almost invariably increases target shareholder value but the same may not be true of returns to the shareholders of the acquirer company. If the decision to takeover another company was not taken with prudent economic interests in mind, it may lead to decrease in the wealth of shareholders of the acquiring company.

51 Table 2:85 Financial Performance of India Cements Ltd. Account of ICL for 1998-99 incorporate results of RCL w.e.f. April 1, 1998. Mar. 1996 Net Sales (Rs. 687.6

Mar. 1997 712.8

Mar. 1998 782.6

Mar. 1999 1137.1

Mar. 2000 1168.4

Crores) Operating

161.5

178.2

196.8

278.3

289.8

Profits OPM (%) EPS (Rs.) Cash Profits Paid-up Equity

20.4 80.7 118.0 64.3

21.8 81.7 130.7 64.3

21.7 53.8 104.0 64.3

20.6 50.4 119.9 125.0

20.6 42.9 127.6 138.4

(Rs.Cr.) Shareholder

418.2

466.6

487.2

630.1

742.9

Funds

CASE STDY 2: Northrop Grumman Inc.â&#x20AC;&#x2122;s Open Offer to Takeover TRW Inc. 86 On March 3 2002, Northrop Grumman Corp., a Los Angeles-based defence contractor, launched a hostile bid to acquire TRW Inc. for $5.9 billion, after TRW's board earlier in the day had rejected an unsolicited offer made 10 days ago. On Feb. 21 Northrop had made an unsolicited offer of $ 47 per share to the TRWâ&#x20AC;&#x2122;s Board, which was rejected by the TRW Board. Northrop made the open offer to the TRW shareholders at the same price of $ 47 in Northrop shares for each TRW share. On the same date Northrop announced an exchange offer for all outstanding shares of TRW Inc. Each share of TRW common stock may be exchanged for a number of shares of common stock of Northrop Grumman equal to $47 and this exchange offer was open till March 29 (later extended till April 12, 2002). At the same time Northrop also announced that if its succeeds in its bid to acquire TRW, it plans to immediately spin off or sell the company's automotive business, which accounts for 60% of sales and a large amount of its debt thus making it clear that Northrop is more interested in

Source: The Business Line at <www.blonnet.com/iw/2001/01/07/stories.html> All the information in this case study is derived from the official website of Northrop Grumman <Corporation at www.northropgrumman.com> 86

52 TRW's space and defense electronics business, considered one of the premier operations in the industry. Northrop Grumman Corporation is an $18 billion, global defense company with its worldwide headquarters in Los Angeles. It provides technologically advanced, innovative products, services and solutions in defense and commercial electronics, systems integration, information technology and nuclear and non-nuclear shipbuilding and systems. The acquiring company gave following reasons87 for its bid against TRW: i) A business combination of Northrop Grumman and TRW has the potential of offering enhanced value to the shareholders of both companies. Strategically, Northrop Grumman and TRW are an excellent fit. TRW's space and systems expertise is complementary to Northrop Grumman's strengths in electronics and systems integration, and, together, will create a third major contributor to the nation's satellite and missile defense requirements. This is an attractive segment of the defense marketplace that has been slated to receive considerable U.S. Government funding in the years ahead, and the combined company will have a significant footprint in this strategic area. ii) Northrop Grumman's proposal offers TRW shareholders more certainty than the proposed alternative by TRW's board of directors. iii) A combination of TRW with Northrop Grumman offers TRW shareholders the opportunity to participate in our growth plans going forward. However, TRW’s Board, as expected, rejected the open offer terming it as ‘financially inadequate’88 and grossly undervaluing TRW's businesses and opportunities; recommended TRW Shareholders to reject the Northrop Grumman offer and announced a strategic plan to enhance shareholder value. A Special Meeting of Shareholders was set for April 22, 2002 to decide on the acceptance or rejection of the offer as required under Ohio takeover law. The Table 3 below shows the current market price of TRW’s shares and 52 weeks high and low prices. According to the current market price the offer was certainly low but the percentage change in the latest closing price was 41.4%, which is very high and 52-week change is also 87

These reasons broadly fit into our theoretical assertion that a hostile bid can be made against a wellmanaged company as well and the reasons can be synergy of operations and the growth potential. 88 On the other hand Northrop maintained that its $47per share offer is 22 percent above the average trading price for TRW stock for the last 12 months and four percent over the highest closing price for the last year. As on March 1, the closing price for TRW share was $ 50.05.

53 38.2%. It shows that in the last 12 months TRWâ&#x20AC;&#x2122;s shares had appreciated considerably and 52week range was $27.43 to $53.00. Therefore, 52-week average price will be around $40 per share and in that case Northrop was probably right in contending that the offer price is 22% above the 12-month average trading price. The Table 4 shows payment of dividend by TRW Inc. Taking 40 dollars as the average trading price in the past 12 months, the annual dividend declared in 2001 comes to $1.05, which translates into an annual return of around 2.5% on TRW shares. Table 3: Trading Statistic of TRW as on 16/04/2002 Price & Volume Recent Price

$52.38

Trade Date

4/16/2002

52-Week High

$53.00

52-Week Low

$27.43

52-Week Change

38.2%

YTD High (highest intra-day price this calendar year)

$53.00

YTD Low (lowest intra-day price this calendar year)

$34.74

YTD Change (the % change in the latest closing price)

41.4%

Volume (10-Day Average)

1,215,000

Table 4: Dividend Payment by TRW

Dividend Summary, TRW Inc. Declared

Ex-Date

Record

Payable

Amount

Type

12/12/2001

2/6/2002

2/8/2002

3/15/2002

$0.175

Regular Cash

10/24/2001

11/7/2001

11/9/2001

12/15/2001

$0.175

Regular Cash

7/25/2001

8/8/2001

8/10/2001

9/15/2001

$0.35

Regular Cash

4/25/2001

5/9/2001

5/11/2001

6/15/2001

$0.35

Regular Cash

12/13/2000

2/7/2001

2/9/2001

3/15/2001

$0.35

Regular Cash

10/25/2000

11/8/2000

11/10/2000

12/15/2000

$0.35

Regular Cash

7/26/2000

8/9/2000

8/11/2000

9/15/2000

$0.33

Regular Cash

4/26/2000

5/10/2000

5/12/2000

6/15/2000

$0.33

Regular Cash

1/26/2000

2/9/2000

2/11/2000

3/15/2000

$0.005

12/8/1999

2/9/2000

2/11/2000

3/15/2000

$0.33

Regular Cash

10/27/1999

11/9/1999

11/12/1999

12/15/1999

$0.33

Regular Cash

Rights Redemption

54 7/28/1999

8/11/1999

8/13/1999

9/15/1999

$0.33

Regular Cash

4/29/1999

5/12/1999

5/14/1999

6/15/1999

$0.33

Regular Cash

12/9/1998

2/10/1999

2/12/1999

3/15/1999

$0.33

Regular Cash

10/21/1998

11/10/1998

11/13/1998

12/15/1998

$0.33

Regular Cash

7/22/1998

8/12/1998

8/14/1998

9/15/1998

$0.31

Regular Cash

4/29/1998

5/6/1998

5/8/1998

6/15/1998

$0.31

Regular Cash

12/10/1997

2/11/1998

2/13/1998

3/15/1998

$0.31

Regular Cash

10/22/1997

11/12/1997

11/14/1997

12/15/1997

$0.31

Regular Cash

7/23/1997

8/6/1997

8/8/1997

9/15/1997

$0.31

Regular Cash

4/30/1997

5/7/1997

5/9/1997

6/15/1997

$0.31

Regular Cash

12/11/1996

2/12/1997

2/14/1997

3/15/1997

$0.31

Regular Cash

10/23/1996

12/10/1996

11/8/1996

12/9/1996

10/23/1996

11/6/1996

11/8/1996

12/15/1996

$0.31

Regular Cash

7/24/1996

8/7/1996

8/9/1996

9/15/1996

$0.275

Regular Cash

5/1/1996

5/15/1996

5/17/1996

6/15/1996

$0.005

Rights Redemption

4/24/1996

5/15/1996

5/17/1996

6/15/1996

$0.275

Regular Cash

12/13/1995

2/7/1996

2/9/1996

3/15/1996

$0.275

Regular Cash

2-for-1 Stock Split

Till March 29, which was the closing date for the exchange offer announced by the Northrop less than 2% of the shares were tendered for exchange. Probably, shareholders were hoping for a competitive bid or an improvement in offer price. On this basis TRW Board claimed that shareholders agree with the Board that the offer was grossly inadequate. Here, it is to be noted that the Board had not rejected the Northrop offer outright. Rather, it had contended that the offer was inadequate and thus leaving scope for a negotiation at a higher price and also leaving open the door for a competitive bidder to enter with a higher offer. Faced with a poor response from TRW shareholder Northrop on April 14, 2002 revised its bid offer to $53 and extended the exchange offer deadline till May 3, 2002. Northrop CEO explained the increase as being driven by improved economic conditions of TRW and positive developments in the defence industry and he also urged TRW shareholders to vote in favour of the offer at the Special Meeting scheduled for April 22. Meanwhile, Northrop had also sent letters to employees and shareholders of TRW urging them to vote for the acceptance of the tender offer at the Special Meeting as required under Ohio takeover law. While the Special Meeting was still being awaited by both the parties, TRW on 17 th April again rejected the amended offer of Northrop at 53 dollars per share saying that the enhanced offer still

55 undervalues the business of the company. 89 At the same time the Board said that it was willing to negotiate with any interested buyer and also offered to share non-public information with interested parties including Northrop.90 This clearly shows that TRW was looking to raise the bid offer to fetch a higher price and was not averse to being acquired by another party. Interesting to note in this takeover battle is the fact that the TRW Board did not seek to raise any of the usual defences, which the corporations in the US are so used to doing to thwart a hostile bid.

Arindam Nag & Karen Padley, â&#x20AC;&#x153;TRW rejects Northrop bid, says itâ&#x20AC;&#x2122;s undervaluedâ&#x20AC;?, Economic Times, April 19, 2002. 90 Id.

56 CONCLUSION The broad policy question this paper seeks an answer to is whether hostile takeover needs to be restricted or promoted or it should be left untouched with minimum set of regulations. The answer depends upon whether benefits to the society of a hostile takeover outweigh its costs. There are certain advantages and disadvantages of a hostile takeover and it may be difficult to categorise it into a strict mould in order to say that hostile takeover should be promoted or discouraged. It is a widely shared belief that hostile takeovers allow the shareholders of the target company realise the best price of their investment or in other words it promotes economic efficiency by transferring the control of corporate resources from an inefficient management to an efficient one. While it is true that hostile takeovers are value-maximising to the target shareholders; some hostile takeovers may promote efficiency, some may result in a misallocation of economic resources, and some may be neutral in terms of economic efficiency. After all market behaves on the basis of past records and future expectations and therefore, when a company makes a bid for another share price of the target generally rises in anticipation of more profits and greater shareholder returns from the company under the new management. But, there is no guarantee that the new management would not mismanage and hence, if mismanaged, the reallocation of resources may not be promoting efficiency. Moreover, it is not necessary that only poorly managed companies become takeover targets; even well-managed companies may be the targets of a hostile takeover, this is especially true when the primary purpose of takeover is consolidation, business synergy and to achieve growth in size and volumes. When a well-managed company is acquired by another equally well-managed company, the takeover may be neutral in terms of economic efficiency. Secondly, the proponents of hostile takeover zealously argue that hostile takeover has a disciplining effect on inefficient managements and therefore, an active market for corporate control is not only desirable but it should be promoted. However, this disciplinary hypothesis â&#x20AC;&#x201C; namely, that poor stock market performance implies poor management - also has its limitations. Poor stock prices may be due to a number of non-economic reasons and something else may be occurring on an industry-wide basis, or on a narrower basis within a portion of that industry, that precludes an inference of managerial failure based solely on below average stock performance. For example, an overproduction in the world steel market coupled with low demand has caused share prices of steel company to fall steeply, however, it does not imply that TISCO is a poorly managed company and hence a potential takeover target.

57 Further, bidders seem to pursue companies with strong operating managements at least as often as they pursue companies that have been clearly mismanaged and a bidder’s search will be biased in favour of industries in which it already operates. Since firms within the industry have greater knowledge about each other’s properties, products and prospects, this certainty of information enables the bidder to pay a higher premium to emerge as the winning bidder. This may result in the displacement of a competent management of the target after acquisition. In such situations the Disciplinary Effect of hostile takeover has no consequence. Therefore, it is appropriate to say that the market for corporate control has a disciplinary effect, but the scope of that effect tends to be more limited than neo-classical economic theory has made it out to be. As a consequence, a public policy toward hostile takeovers that seek to promote them in the interests of economic efficiency and greater shareholder returns may have to contend with the dangers of increased industry consolidation and oligopolistic market. Now, the question arises whether the conclusion drawn above varies form country to country and can it be something different in case of India? In the specific Indian context, we have a long history of family run business houses which tend to pay scant regard to improving returns to shareholders and vast economic assets are lying underutilised under their control, it may be desirable to allow a regulated but not restricted market for corporate control to operate in order that old blue-chip companies are run in accordance with sound management principles and the influence of corporate families are reduced on the running and management of the company. What should be guarded against is the notorious US-style ‘bust-up’ takeovers and the impact of hostile takeovers on non-shareholder constituencies must also be kept in mind.

BIBLIOGRAPHY Articles: 1. Barry D. Baysinger and Henry N. Butler, “Antitakeover Amendments, Managerial Entrenchment, and the Contractual Theory of the Corporation”, (71), Va. L. Rev., 1985. 2. E. Norman Veasey, “The New Incarnation of the Business Judgment Rule in Takeover Defences”, (11), Del J of Corp L, 1986. 3. Geoffrey Miller, 1998 Columb. Bus. L. Rev. 51. 4. John C. Coffee, Jr., “Regulating the Market for Corporate Control: A Critical Assessment of the Tender Offer’s Role in Corporate Governance”, 84 Colum. L. Rev. 1145 (1984). 5. Jeffrey N. Gordon and Lewis A. Kornhauser, “Takeover Defence Tactics: A Comment on Two Models”, (96), Yale L.J. 1986. 6. Lucian Arye Bebchuk, “Towards Undistorted Choice and Equal Treatment in Corporate Takeovers”, (98), Harv. L. Rev., 1985. 7. Mark R. Wingerson and Christopher H. Dorn, 1992 Columb. Bus. L. Rev. 223. 8. Ronald J. Gilson,“Unocal Fifteen Years Later (And What We Can Do About It)”, 26 Del. J. Corp. L. 491. 9. Scott Mitnick, 2001 Colum. Bus. L. Rev. 683. 10. Stephen Lofthouse, “Competition Policies As Takeover Defences”, JBL, 1984. Books: Weinberg and Blank on Takeovers and Mergers, (London: Sweet and Maxwell,1999). T. Jenkinson and Colin Mayer, Hostile Takeovers: Defence, Attack and Corporate Governance (London: Mc Graw- Hill Book Company, 1994).

59 Websites:

1. Meredith M. Brown and Paul S. Bird, “Introduction to Hostile Takeovers”, <www.debevoise.com/memos/memo001128d.html> 2. “The Civilized Hostile Takeover: New Breed of Wolf at Corporate Door”, <http://www.stern.nyu.edu/~adamodar/New_Home_Page/invmgmt/ch15/hostile.h tml> 3. Anirudha Dutta, “After Bombay Dyeing: Who’s Next?”, <www.indiainfoline.com/pobl/13oct00.html>