Saturday, March 14, 2009

Another Case Of Regulatory OverReach under the Take Over Code?

In a recent adjudicating order, Adjudicating Order No.VSS/AO-27-2009, that may be viewed here, SEBI found that the Directors of a "Non Promoter Controlled Company", Matra Realty Limited were obligated to disclose their share holdings pursuant to the Disclosure law in the Take over Code. The SEBI found that the Directors were "persons having control over the company" within the meaning of relevant regulations [6(3) & 8(2)] and therefore were required to disclose their share holding to the company. It seems to me that this is yet another case of regulatory overreach. Conceding that the relevant provisions of the take over code distinguish between promoters and persons having control over the Company; the expression, "persons having control over the company" cannot in the context of the take over Code disclosures mean Directors of the Company. Let us therefore analyse this latest juridical wisdom that comes from the regulator.

The adjudicating officer found that the expression "control" is defined inclusively in the Take over Code. Regulation 2(1)(c) defines Control as:

“control” shall 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 or in any other manner.

Thus Control includes the right to a) appoint majority of directors b) (the right to) control the management or policy decisions. Further such right(s) are exercisable bby a person acting individually or in concert. And lastly, such right(s) of Control as above stated were tracable to (should emanate from) such sources as their share holding, management rights, share holders Agreements, voting agreements or analogues thereof. Again here, the sources of the right to exercise control are inclusive.

The adjudicating officer found that the above definition meant:

"any person who controls the management of a company either individually or collectively with other persons or controls or influences the policy decisions, by virtue of his position can be said to be in ‘control’ over the affairs of the company... a Director is one of the controller of companies affairs. The Board Of Directors is the brain of the Company. When the Board functions, the Company is said to function. Thus the functioning of the Company is totally controlled by the Board..."

Further, having analysed the share holding pattern, he finds that the Directors and PACs were the largest share holders in the Corporation as they held 13.75% together with their PACs as of 2004.

"In view of the foregoing", he finds that the Directors are "in control" of the Corporation and having not disclosed, finds them not compliant with the law.

Thus the analysis seems to rest on two main premises: Firstly, the Directors had control over the Company by virtue of their position. Secondly, they were the single largest share holders of the Company, taken together with their PACs.

If this is the case, the analysis is faulty;

even conceding that the definition of control is inclusive and that the sources from which Control rights emerge is (also) inclusive, the analogues are to be considered ejusdem generis to the more particular words used in the definition. The sources of Control rights that the definition speaks of are :

a) share holding b) share holding agreements 3) voting agreements 4) management rights. So, the analogues, applying ejusdem generis, should only include Control rights that are "contractual" in orgin.

Directors of a Company, in contrast, receive their power/right to manage the corporation from the Companies Act. The Companies Act mandates that there should be a Board Of Director and articulates the powers of the Board (See for e.g. Section 291/292 of the Companies Act that speak of "Powers of the Board"). Their source of "Controlling power" (or Controlling Rights, leaving aside the jurisprudential difference between "Power" and "Right"), is the Statute and therefore those rights have a "in rem" origin rather than "in personam" origin that Contractual rights have. Consequently , the Control that they exercise over the Corporation pursuant to the powers under the Companies Act cannot be read in the understanding of control that we have under the Take Over Code. ( because the illustrative sources of Control rights in the Take Over code are only Contractual in origin).

Finally, the reliance of the adjudicating officer on the share holding of the Directors and the PACs taken together being the largest was incorrect.

It is clear that the powers that the Board exercised over the Company were traced to or emanated from their position/status as Directors ofthe Company. The source of the power to control the management or policy decisions emanated from their position as Directors. The source of that power/right was NOT their share holding. So,it need not have figured in the analysis at all. (indeed if the control rights emanated by virtue of them being the largest share holders, Control as understood in the take over Code is triggered. See, the definition of "Control" above. But the Right/Power of taking Management decisions emanates from the Statute as we saw earlier).

A case of regulatory overreach (again)?