ANTI-DILUTION RIGHTS AND OPEN OFFER OBLIGATIONS: A REGULATORY PERSPECTIVE

This post is authored by Dewansh Raghuwanshi and Samyak Jain, 4th year BA LLB (Hons.) students at NLIU, Bhopal.

1. INTRODUCTION

The complexities of Indian takeover regulations have uncovered a major dilemma  that is the regulation of an acquirer’s anti-dilution rights and his mandatory open offer obligations under the   SEBI (Substantial Acquisition of Shares and Takeovers) Regulations [SEBI (SAST) Regulations].  The anti-dilution right offers  protection to investors, by enabling them to buy more shares and  neutralize dilution from new issuances, thus preserving a percentage of shares owned. On the contrary, “anti-dilution rights can possess negative implications” where an investor’s pre-determined shareholding percentage must be capped by an open offer to all public shareholders.

This interplay raises a key regulatory question: Suppose an investor holds 25% of voting shares in Company ABC, and because of new shares issued at a relatively low rate, his stake gets diluted to 23%. To restore his stake, he exercises his anti-dilution rights, acquiring more shares to return to 25%. Does this make him liable to launch an open offer?

The difficulty in distinguishing  between a genuine increase in control from a revised one that nullifies dilution has grave consequences for regulatory obligations and even business segments. In this writing piece, author tries to resolve  this puzzle by  analysing the legal and regulatory scope of anti-dilution rights and open offer triggers. In particular, author focuses  on the element that  whether the exercise of anti-dilution rights – when the investor’s percentage stake within the company stays static – amount to an acquisition for the purposes of triggering open offer obligations?

2. DISENTANGLING ANTI-DILUTION ADJUSTMENTS FROM INCREMENTAL ACQUISITIONS

In determining whether an anti-dilution right exercised to retain an existing shareholding needs an open offer notice, one must consider statutory construction approaches and the overarching regulatory intentions. One key tool is the rule of expressio unius est exclusio alterius, which asserts that mentioning certain conditions or clauses explicitly negates other unspecified conditions or clauses. Under   Regulation 3 of the SEBI (SAST) Regulations, open offer obligations stem from an acquisition that leads to some increase in voting rights or control. The fact that the SEBI (SAST) Regulations define conditions in the context of “acquisition” and prescribe measures for an increase beyond a set threshold suggests that measures aimed solely at preserving an existing shareholding percentage are not intended to be covered under the SEBI (SAST) Regulations.

Another important rule is ejusdem generis which recommends that a common term that follows after enumerating specific items be understood to refer to that class of items. Due to regulations containing forward-looking provisions that categorically list transactions triggering an open offer—such as incremental acquisitions that increase the level of control—anti-dilution measures, which merely restore the pre-dilution value, should not be interpreted as falling within the same category.

Furthermore, the  golden rule of interpretation, which is intended to prevent outcomes that are absurd or impractical, supports the view that penalizing an investor for protecting their investment against dilution would be counterintuitive to the regulation’s purpose.

In this case the balance of the purpose of the open offer regime is to safeguard unfavourable shareholders from being overrun by the major shareholders of the company. Legislative history and advisory committee reports make it clear that the focus was on significant changes in control. The result is that when an investor exercises his anti-dilution rights to just return to his previous percentage without further increasing his net control, there has been no acquisition for purposes of the regulations.

3. IMPLICATIONS FOR INVESTORS AND CORPORATE GOVERNANCE

The factors that are outlined above from a practical perspective support the conclusion that, a distinction between an acquisition that increases level of control and, one which merely preserves an investor’s existing percentage, is important for investor protection as well as corporate governance. If an investor has significant ownership, for example of 25%, then, issuance of new equity could result in dilution of key shares, thus, undermining his influence over the company. This and other forms of investment are protected by anti-dilution rights, which enable an investor to purchase shares without the need to invest additional capital and restore ownership percentage to its ideal value.

If the investor’s stake was diluted to 23% due to some event, then restoring the holding back to 25% does not demonstrate an increase in control after that adjustment. This restores his stake without giving him additional control. From a corporate governance perspective, the key challenge is to ensure that such measures do not result in the exercise of open offer obligations that are meant to benefit public shareholders when there is a sincere increase in control. Open offer requirements are meant to assist minority shareholders in attempting to relinquish shares when there is a substantial increase in ownership of control or capture beyond a certain level; imposing these obligations to anti-dilution changes would defeat the economic rationale behind such restrictions.

Further, if the regulatory interpretations and statutory provision are applied consistently with the aim of the anti-dilution mechanism, the above action should not be viewed as a fresh acquisition. The action should be classified as a continuation of the investor’s original position, preserving the economic and voting power without altering the overall control dynamics. This distinction is crucial because inappropriately triggering the open offer obligation could create issues in the company’s capital structure and impose excessive regulatory challenges to investors.

4. REGULATORY EXEMPTIONS AS A SHIELD FOR ANTI-DILUTION ADJUSTMENTS

Given the potential regulatory complications surrounding anti-dilution rights, it becomes important to contemplate the regulatory exemptions granted by the SEBI (SAST) regulations. For instance, if the changes described above are deemed controversial as an acquisition, it can be said that there is a legal framework that provides a way out of undue regulatory restrictions.

There is a possibility under SEBI (SAST) Regulations that will allow the Board through  Regulation 11(1) to exempt any party from ceaseless open offers, if the acquisition was done in exercise of Anti-dilution rights. The party ready to acquire should make a detailed representation on the transaction and reasons for exemption. This approach ensures that undue hurdles on investment and stability in the primary market are formulated. However, the difficulty posed against the  acquirer under the  Regulation 11 (4), is the  deposition of a non-refundable fee of five lakh rupees along with the exemption application.

Moreover, SEBI’s discretionary authority under the SEBI (SAST) Regulations strengthens investor safeguards concerning anti-dilution adjustments. Within the bigger regulatory picture, open offer obligations aim to protect minority shareholders when there is a legitimate transfer of control. On the other hand, anti-dilution rights are simply a remedy correcting the adverse impact of dilution on an investor’s proportionate shareholding. Keeping this in mind, SEBI can allow certain relaxations in open offer requirements where additional acquisition would not result in a further increase in control, as it has done in the matter of Educomp Solutions Limited & in the matter of Prima Industries Limited.

It is suggested that an acquirer can make such an adjustment only after proactively seeking relief by applying to the Board and giving full detail of the remedial nature of the transaction. SEBI may, at its own discretion, refer it to a panel for independent confirmation. The SEBI order, which is also published on its website, will enhance transparency and will act as a safeguard for investors. This regulatory tool can act as a self-corrective measure to guard an investor exercising anti–dilution rights from the unforeseen consequence of having to make an open offer in order to maintain the purpose of the anti-dilution measure whilst not increasing the burden on the acquirer.

5. CONCLUSION

The examination of anti-dilution rights in accordance with the SEBI (SAST) Regulations highlights an important difference between acquisitions that enhance control and those that simply revert an investor’s shareholding to pre-dilution levels. Principles of statutory interpretation indicate that anti-dilution adjustments ought not to activate open offer responsibilities, since they do not change control dynamics. Although SEBI holds discretionary power under Regulation 11(1) to grant exemptions for such acquisitions, the procedural challenges outlined in Regulation 11(4) create a compliance burden for investors. Providing specific exemptions, as demonstrated in previous SEBI decisions, is a welcome step as it can guarantee regulatory clarity while upholding investor rights in Anti-Dilution mechanism also. Going forward, active collaboration with SEBI and clear disclosures can assist in reducing regulatory uncertainty in these transactions.

This is particularly significant in an era where new equity is increasingly issued and investors issue novel contracts to protect their interests. Balancing the need for robust regulatory measures while preventing anti-dilution clauses from being wrongly viewed as participation in the exercise of open offer obligations helps to achieve regulatory sanity. It ensures the rights of investors while asserting the fundamental reason behind insisting on open offers: mitigating the risk to minority shareholders with the increased control. Supporting this argument enables greater stability and predictability in regulation which is the cornerstone of proper functioning of a fair and efficient capital market.