Harsh Dhiraj Singh

The Securities and Exchange Board of India [“SEBI”] issued a consultation paper [“The paper”] on 22^nd April 2020 with an aim to ease pricing terms for preferential allotment of shares in listed companies having stressed assets. The paper seeks to amend certain provisions in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 [“ICDR Regulations”] and the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 [“SAST Regulations”]. The steps have been seen in a generous light and are now open to suggestions from the public.

This article tries to pan out the significant points that the paper has missed out on, which should have been included in pursuit of the purpose of these relaxations. Keeping that in mind, the article will elucidate as to why this paper has been released in the first place, the changes that have been suggested, and lastly the few, but significant, discrepancies in the suggested changes.

Understanding the Context

The situation unfolded when certain heavily leveraged companies, which were at the brink of bankruptcy, started looking for alternate avenues for fundraising. The conventional means of fundraising i.e. equity capital, involved huge regulatory and compliance costs which would ultimately lead the company to bankruptcy. Moreover, the dwindling prices of their stock due to the ongoing pandemic made it unlikely to be a part of anybody’s portfolio. Such companies then tried to avail funds through preferential allotment of shares by investors. However, the pricing guidelines for preferential issues require the issue price to be not less than the average of weekly high and low prices for 26 weeks preceding the date of such issue. The only exemption from such a pricing method is laid down in Regulation 158 (2) of the SEBI (ICDR) Regulations. It provides exemption in the cases where the preferential issue has been made due to the resolution plan under the Insolvency and Bankruptcy Code, 2016 (IBC).

The problem with the pricing guidelines is reflected in the widened time period of 26 weeks of frequently traded shares. The highs and the lows of such prices were at such extreme levels that it affected the prices of the shares in an unfavourable manner. To solve this wide latency, the regulator (SEBI) has decided to come up with certain guidelines for such companies to manage fundraising through the preferential allotment route.

Changes Proposed in the Consultation Paper

The changes have been proposed in a structural manner; meaning thereby that they have first attempted to introduce objective criteria to determine the scope of ‘stressed companies’ and subsequently clarified their stance on the pricing and valuation of the preferential allotment of shares. The paper states that if a company satisfies any two of three following conditions, it could be classified as a stressed company:

2019. Any listed company that has made disclosure of defaults on payment of interest/ repayment of principal amount on loans from banks / financial institutions and listed and unlisted debt securities for two consequent quarters in terms of SEBI Circular dated November 21, 2019.
2020. Existence of Inter-creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 dated June 07, 2019.

• The downgrading of credit rating of the listed instruments of the company to “D”.

Thereafter, the exemptions in the pricing of the preferential allotment have been stated as follows: Pricing of the preferential allotment to be, “not less than the average of the weekly high and low of the volume weighted average prices of the related equity shares quoted on a recognised stock exchange during the two weeks preceding the relevant date”. The paper further puts three significant conditions to avail the exemption:

1. That the preferential allotment is not to be done to the promoters/promoter groups and;
2. That the resolution for the preferential allotment has to be approved by the majority of minority shareholders.

• The shares preferentially allocated shall be locked in for a period of three years in place of the erstwhile one year lock-in period.

The Criticism

While businesses across the globe are busy tackling the short-run deficiencies, they are also mindful of the fact that this pandemic cannot be classified as a ‘temporary’ event anymore. In all probabilities, the future has hinted towards a multi-quarter recession coupled with the structural changes in management needed to manage the crisis. If all this comes out to be true, which seems highly likely, the SEBI’s consultation paper can be critiqued on various grounds:

i. Short-sightedness in not including non-stressed companies

With dropping sales revenue, investment opportunities, and encumbered operations, the businesses of a majority of the non-stressed companies have also come to a halt. In a few weeks we will be halfway through the year and it can be said with conviction that the pandemic is not yet in control or at least the business sentiment isn’t. The non-inclusion of non-stressed companies in the consultation paper gives us a hint at the narrow scope of relaxations that the pricing changes would bring. The fundraising avenues of many such companies are bound to get limited with the passing of time and such relaxations will be required sooner or later. This argument is evidenced by the impact the 2008 financial crisis had on non-stressed businesses, when regulations were altered without the long-term perspective taken into account. Limited protection to stressed companies left thousands of start-ups and small businesses out of the market. Consequently, this also led to a major blow to some of the ‘major’ job-creating sectors in India. Primary attention has to be given to service sector businesses, which are bound not to strike the perfect post-epidemic recovery unlike the manufacturing sector. The measures announced by the Reserve Bank of India gave a strong impetus to these business but application of these eased down regulatory mechanisms for preferential allotment can be a bonus for these struggling businesses.

ii. Paradox of disallowing Promoter infusion of capital

Historically, the promoters and the investors have been at loggerheads mainly due to the differences in perspective with which they manage their investments. The equity investors have always believed that the promoters act against the common principles of business investment, breach fiduciary duties, and are negligent towards corporate governance measures. This is precisely the root cause behind the insertion of the provisions relating to Oppression and Mismanagement in the Companies Act, 2013. It is also the reason why promoters were disallowed to infuse capital in these stressed companies. But we witness a paradoxical approach by the SEBI, when we see that a requirement of getting majority approval by minority shareholders has also been added as a rider.

If the SEBI removes this restriction, the companies would be able to infuse capital at less onerous floor prices which will ultimately be in consonance with the objective of these relaxations. On the other hand, if the status quo continues, the promoters will be at a risk of losing control of the stressed company due to the infusion of capital by some other investors. These guidelines also put the company at the risk of being insolvent in case it does not find any investor and the promoters continue to stay debarred to invest, following the current guidelines. Disallowing promoter participation and at the same time also inserting a rider about majority approval by the minority does not serve any additional benefit for the companies as well as the regulatory authorities.

iii. Uncertain intentions behind the extended lock-in period of investments

The lock-in period prior to this consultation paper was one year which has been extended to three years. The consultation paper fails to provide any rationale for the extension. In normal circumstances, a lock-in period is provided in order to secure liquidity and stability in the market. However, the paper fails to show how an extended period would help more to resolve the cause. Nevertheless, if the regulator has taken this step keeping in mind the ‘permanent’ and ‘everlasting’ nature of the pandemic, the businesses will fail to understand why they couldn’t do the same while including non-stressed companies in the scope of these relaxations. This paradox will only lead to one conclusion that the regulator has done this to provide a buffer cover to the businesses. If this is so, it highlights the inherent contradiction in the approach of this consultation paper. The business and investor community would expect a clarification in this regard because of the simple reason that the investors would not entertain a change to their detriment for the cause of saving businesses.

Conclusion

The proposed relaxations have certainly given relief to the stressed companies. The guidelines issued with respect to such companies are unequivocal and ensure transparency. The author, however, suggests the above-mentioned three points which may be incorporated in the final guidelines so as to ensure that a more detailed and inclusive outline is prepared during these tough times of COVID-19. The inclusion of non-stressed companies would be completely dependent upon the approach of SEBI. The approach of the regulator, aggressive or defensive, would define the scope of these relaxations and protectionist measures. In so far as the inclusion of promoter led capital infusion is concerned, a clarification is much needed to avoid the theoretical and practical complication in its actual application. Lastly, the extended lock-in period will be against the interests of the investors, provided the rationale behind such extension is detailed out in the final guidelines. The consultation paper is about perfect and inclusions and clarifications regarding such points would only speak of the business sentiment in the country.

The author is a student at the National Law University, Jodhpur.

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