Title of the project- Buyback of Shares: a corporate business responsibility

Submitted byName- Ananya Pratap Singh Class- BBA, LLB (2011-16) (Div-C) Roll No. 35 Semester-5th Of Symbiosis Law School, NOIDA Symbiosis International University, PUNE In September, 2013 Under the Guidance of Prof. (Dr.) S.N. Ghosh (Course in-charge Company Law) Symbiosis Law School, NOIDA Symbiosis International University, PUNE
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CERTIFICATE

The project entitled Buyback of Shares: a corporate business responsibility submitted to the Symbiosis Law School, NOIDA for Company Law I as part of internal assessment is based on my original work carried out under the guidance of Prof. (Dr.) S.N. Ghosh from July to October. The research work has not been submitted elsewhere for award of any degree.

The material borrowed from other sources and incorporated in the thesis has been duly acknowledged.

I understand that I myself could be held responsible and accountable for plagiarism, if any, detected later on.

Signature of the candidate Date:

ACKNOWLEDGEMENTS

With my deepest appreciation, I would like to thank Prof. (Dr.) S.N. Ghosh & Prof. Meenakshi Kaul for providing me the opportunity to undertake a research work on Buyback of Shares: a corporate business responsibility. I would like to thank them for providing me all the necessary help in completing this project. Without their help, it would be very difficult for complete the project on time. I would like to thank Symbiosis Law School, Noida, for providing me an excellent environment which helped in my project. I would also like to thank my parents and my classmates for helping me, in one way or the other, for the success of this project.

Index

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Content Introduction Object of the study Research Methodology Literature Review Issues Raised in Research Issues advanced (i) Mode of Issuance of corporate repurchase of shares (ii) Importance of Anti- Dilution provisions (iii) Analysis of SEBI (Buy Back Of Securities) Amendment Regulations, 2013 In Relation To the Existing Regulations and the Companies Act, 2013 (iv)Restriction on Repurchase of Shares in India (v) Extent of Corporate repurchase of shares in the favour of shareholders.

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7.

Conclusion

Introduction
Buy- back of shares1 is a significant financial strategy with multiple faces and has become a common event in global financial market. It is a double edged sword which can be used in two ways vis-a-vis for the benefit of the investors (shareholders), as claimed by companies and for filling the pockets of company and its shareholders. In repurchase of shares, the corporation utilised its surplus of excess cash flow to repurchase its own shares from the shareholders, generally at premium. The most prominent reason corporate repurchase of shares is to display the financial stability of a corporation and its confidence on itself. In view of proposed benefits of this corporate repurchase, both to the company and as well as the shareholders and to reframe the cobweb of price rigging and manipulation of the promoters, the Government of India appointed a working group for keeping a check on Companies Act in 1996. The recommendations given by this working group included the corporate repurchase. In India, the corporate repurchase of shares was introduced in 1998 and has grabbed the attention of all major corporate entities. Since then there has been a spate of amendments of corporate repurchase of shares. The legal position then was that a company was prohibited, under section 77 of the companies Act, 1956, to buy its own shares unless a reduction of capital is effected in pursuance of section 100-104 or section 402 of the Act. Currently buyback of shares is allowed in India.

Working of Corporate Repurchase Share capital plays a very critical role in both listed and unlisted companies. Share capital can be of two types i.e. equity share capital or preferential share capital. The share capital of a company has to be subscribed by one or more persons. After the share of a company has been allotted to the subscribing members, the subscribers have no right over the money gone as proceeds of the shares subscribed. All that the shareholder has is the right to vote at the general meetings of the company or the right to receive dividends or right to such other benefits which may have been prescribed. The only option left with the shareholder in order to realise the price of the share is to transfer the share to some other person.

Hereinafter, repurchase of shares

But there are certain provisions in the companies act which allow the shareholders to sell their shares directly to the company and such provisions are termed as buy back of shares. Buy back of shares can be understood as the process by which a company buys its share back from its shareholder or a resort a shareholder can take in order to sell the share back to the company. In India, repurchase of stock is commonly known as buyback of shares. There are three methods of share repurchase: 1. Repurchase tender offer: Here the firm specifies the number of shares it proposes to buyback, the fixed price it would pay and the time period for the offer would be open for the shareholders to tender their shares. For example in the year 2000, Bajaj Auto made tender offer to buy its shares at Rs. 400 per share, when the shares were trading at around Rs. 300 per share. 2. Open market repurchase: Here the firm buys from the market at the prevailing market price. For example in March 2008, Madras Cements completed its buyback offer, amounting to Rs. 67 crores, within two months of making the open offer. 3. Targeted repurchase: Here the firm buys shares from a select group of investors. For example the Great Eastern Shipping Company bought shares from select investors to protect itself from a hostile takeover bid led by the Abhishek Dalmia group.2

Object of the study

In my research project, I have critically examining the hypothesis that Whether the motives of corporate business entities to do corporate repurchase (buyback) of shares is in favour of shareholder or it is only a financial strategy and Is buy back of share act as a double edged sword.

Research Methodology
My research methodology requires gathering relevant data from the specified documents (specified in literature review) in order to analyze the material and arrive at a more complete understanding of how corporate repurchase of shares is used as tool to enhance net profit of a
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Thomas Francis, FT, & Patil R.R., R.R.T, Is Buy back of shares a double edged sword, Vol.No.1, Issue No. 9, ISSN 2277-1166.

company and its various impacts on shareholders. In my research project, I have shed light on the following questions through my research: 1. How does a company issue buy back of shares? 2. How important were factors such as Anti- Dilution provisions, Book value of Equity per share, return on capital employed (ROCE) & Earnings per share (EPS) in corporate repurchase? 3. What are the ways in which buy back of shares take place (special reference to the new amendment Act, 2013). 4. What are the restrictions imposed on Buyback of shares and loopholes in it. 5. What is the status of contingent or unascertained claims of creditors arising out of capital reduction? 6. To what extent buyback of shares is in favour of shareholders.

Literature Review
This section provides a brief review of the extensive academic literature on share repurchase, emphasizing those articles, research papers, journals that are most relevant to the current study. Apart from that, several research papers and journals that are being referred while my researches are: 1. N. Stern, Leonard, LNS & Boudry, Walter I, WIB, Investment Opportunities and Share Repurchases Version 08 September 2009. 2. Grullon, Gustavo, GG, & L. Ikenberry, David, DLI, What Do We Know About Stock Repurchases? Journal of Applied Corporate Finance, Spring Vol.13.1. 3. Thomas Francis, FT, & Patil R.R., R.R.T, Is Buy back of shares a double edged sword, Vol.No.1, Issue No. 9, ISSN 2277-1166. 4. Manor Paulsen, Lars, LMP Do share buybacks create value for the shareholders?,Candmerc Finance & Strategic management, Copenhagen Business School. 5. Mishra, A.K., AKM, An Empirical analysis of share Buy Backs in India.

6. Padmashree, P.M., PMP & Nigam, N.S., NSN, Buy Back of shares by a company: An analysis, Manupatra. 7. A. Woronoff, Michael, MAW, & , A. Rosen, Jonathan, Understanding Anti-Dilution Provisions in Convertible Securities, 2005, Volume 74,Issue 1,Article 4.

Issues Raised in Research

1. Mode of Issuance of corporate repurchase of shares. 2. Ways in which buy back of shares take place (special reference to the new amendment Act, 2013). 3. Restrictions imposed on Corporate repurchase of shares. 4. Extent of Corporate repurchase of shares in the favour of shareholders.

Issues advanced
1) Mode of Issuance of corporate repurchase of shares
Repurchase of shares or other specified securities can be done through various sources which have been illustrated under sub section 5 of section 77A, they are as follows:a) From the existing security holders on a proportionate basis or b) From the open market, through ; i) stock market ii) book building process c) From odd lots, that is to say where the lot of securities of a public company, whose shares are listed on a recognised stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange; or d) by purchasing the securities issued to employees of the company under a scheme of stock option or sweat equity.

2) Importance of Anti- Dilution provisions3

Anti-dilution provisions are designed to protect holders of convertible securities against dilution from a large variety of corporate events, including, among others, stock dividends and splits, cheap issuances of additional common stock, and distributions of cash or property. 4 These provisions are complex5 and can have significant economic consequences;6 yet they have been subject to little systematic thought.7 Even the most experienced practitioners often poorly understand how common anti-dilution provisions work. This lack of understanding is partially due to the complexity of these provisions, exacerbated by their mathematical nature, which is off-putting to many lawyers.8As a result, many practitioners mechanically rely on precedent without examining the consequences of using provisions that make sense in one context but not in another. Indeed, anti-dilution provisions are often rigorously examined only after they have been triggered, generally when an issuer is not succeeding and, as a consequence, tensions (and emotions) are heightened. 9 The dearth of analysis is somewhat surprising, given that convertible securities have been widely used for over half a century, and commentators have long recognized the need for a clearly articulated theory to understand these clauses.' As Professor David Ratner has noted, "Any presentation which helps to clarify the basic problems and the relevant choices in this arcane subject is welcome."'

A. Woronoff, Michael, MAW, & , A. Rosen, Jonathan, Un derstanding Anti-Dilution Provisions in Convertible Securities, 2005, Volume 74,Issue 1,Article 4. 4 For example, imagine a security that is initially convertible into a single share of common stock. If the issuer effects a two-forone stock split (doubling the number of shares outstanding), and no adjustment is made to the number of shares delivered upon conversion, all else being equal, the value of the convertible security is cut in half. 5 Stanley A. Kaplan, Piercing the Corporate Boilerplate: Anti-Dilution Clauses in Convertible Securities, 33 U. Chi. L. Rev. 1, 3 (1965) ("Customary anti-dilution clauses are long and complex, presenting intricate problems of draftsmanship which may often deter penetrating examination."). 6 Stephen I. Glover, Solving Dilution Problems, 51 Bus. Law. 1241, 1242 (1996) ("[T]he scope of the dilution protection included in equity rights documents can have a significant impact on value .. "). 7 David A. Broadwin, An Introduction to Antidilution Provisions (Part 1), Prac. Law., June 2004, at 27, 28 (citing Glover, David L. Ratner, Dilution and Anti-Dilution: A Reply to Professor Kaplan, 33 U. Chi. L. Rev. 494 (1966)); see also Marcel Kahan, Anti-Dilution Provisions in Convertible Securities, 2 Stan. J.L. Bus. & Fin. 147, 148 n.3 (1995) ("Few articles have examined anti-dilution provisions." (citing William W. Bratton, Jr., The Economics and Jurisprudence of Convertible Bonds, 1984 Wis. L. Rev. 667; Richard M. Buxbaum, Preferred Stock-Law and Draftsmanship, 42 Cal. L. Rev. 243 (1954); George S. Hills, Convertible Securities-Legal Aspects and Draftsmanship, 19 Cal. L. Rev. 1, 20-39 (1930); Kaplan, supra note 2; William A. Klein, The Convertible Bond: A Peculiar Package, 123 U. Pa. L. Rev. 547 (1975))). The universe of scholarly articles is not much broader than those listed by Broadwin and Kahan. The other significant contributions to the area include James M. Irvine, Jr., Some Comments Regarding "Anti- Dilution" Provisions Applicable to Convertible Securities, 13 Bus. Law. 729 (1958). 8 Howard Darmstadter, The Arithmetical Lawyer, Bus. L. Today, Nov.-Dec. 2000, at 16, 16. 9 Walter Kuemmerle, Note on Antidilution Provisions: Typology and a Numerical Example (Harvard Bus. Sch., Case No. 9-805024, 2004)

Despite the desirability of doing so, commentators have had difficulty in formulating a theory that can reconcile the variance among the many types of anti-dilution clauses. This project work contends that the scope and extent of different types of anti-dilution provisions can generally be understood as a rational response to the nature and level of the information barriers 10 and agency cost11 typically confronted in particular circumstances, mechanisms to address these issues.
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and the existence or absence of other

3) Analysis of SEBI (Buy Back Of Securities) Amendment Regulations, 2013 In Relation To the Existing Regulations and the Companies Act, 2013 13
The Securities and Exchange Board of India [SEBI] has issued SEBI (Buy back of Securities) Amendment Regulations, 2013 [hereinafter referred to as "New Regulations"] vide notification No. LAD-NRO/GN/2013- 14/16/6348 dated 8th August, 2013 amending the existing SEBI (Buy back of Securities) Regulations, 1998 [hereinafter referred to as "Regulations"/ "Old/Earlier Regulations"]. Also, recently the Companies Act, 2013[hereinafter referred to as "Companies Act"] has been passed by the Rajya Sabha. Considering the above New Regulations, Regulations and the Companies Act, 2013 an analysis has been done discussing the various provisions. The changes have been discussed point wise as follows: 1. Ceiling prescribed for buy back from open market: Regulation 4 of the Regulations state that a company may buy-back its shares or other specified securities from the existing security-holders on a proportionate basis through tender offer or from the open market offer. The existing regulations do not prescribes any cap on the amount on buy back of securities. However, with the issue of new regulations, a provision has been added to Regulation 4 which provides that buy-back offer from the open market shall not

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George G. Triantis, Financial Contract Design in the World of Venture Capital, 68 U. Chi. L. Rev. 305, 307 (2001). Michael Klausner & Kate Litvak, What Economists Have Taught Us About Venture Capital Contracting 4 (Stanford Law Sch. John M. Olin Program in Law and Econ., Working Paper No. 221, 2001), available at http://papers.ssrn.com/abstract=280024. 12 Dilution arising from information barriers essentially occurs at the time the investment in the convertible security is made and dilution arising from agency costs occurs at the time of the subsequent action. Thus, different mechanisms are needed to protect against these different sources of dilution. 13 Retrieved from ,The Gazette of India, SECURITIES AND EXCHANGE BOARD OF INDIA (BUY BACK OF SECURITIES) (AMENDMENT) REGULATIONS, 2013 issued by SECURITIES AND EXCHANGE BOARD OF INDIA at New Delhi the 8th day of August 2013

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be made for 15% or more of the paid up capital and free reserves of the company. In this regard, clause 68 of the Companies Act, 2013, recently approved by Rajya Sabha provides that the buy-back of securities shall be limited to 25% of total paid-up capital and free reserves. Provided that in case of buy-back of equity shares it is 25% of total paidup equity capital in a financial year. 2. Lock in period on further buy-back : The existing regulations do not provide for any lock in period between two buy back offers. However, the new regulations has issued a sub-regulation 4 after sub-regulation 3 of Regulation 4 which provides that no offer of buy-back shall be made by any company within a period of one year from the date of closure of the preceding offer of buy back. The Companies Act, 2013 in this regards also provides that no offer of buy-back shall be made within a period of one year from the date of closure of preceding offer of buy-back. 3. Minimum Buy Back limit: The newly introduced sub regulation 3 of Regulation 14 of the new regulations provides that atleast 50% of the amount set aside for buy-back shall be utilized for buying back shares or other specified securities. There was no such limit prescribed in the existing regulations. Further, the Companies Act, 2013 is also silent with respect to such limit. 4. Public Announcement (PA): Regulation 15(d) of the said regulations provided that the PA shall be made at least 7 days prior to the commencement of buy back. However, the new regulations has modified the said regulation and provides that the PA shall be made within 7 working days from the date of passing the resolution authorizing buy-back. It is to be noted that there is no such condition relating to the same has been provided in the Companies Act, 2013. 5. Filing of copy of PA with SEBI: The regulations provided that copy of PA shall be filed with SEBI within 2 days of making such announcement. The same has now been modified and the companies shall now be required to ensure that copy of PA shall be filed with SEBI simultaneous with the issue of public announcement. 6. Submission of information pertaining to buy-back : Regulation 15(i) in the regulations provided that the company shall submit the information pertaining to buy-back on daily basis to Stock Exchange and publish the same in a national daily on a fortnightly basis. However, as per the amended regulation (i) of Regulation 15, the company shall be
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required to submit the information regarding the shares or securities bought back to stock exchange on daily basis in specified form and the stock exchange shall upload the same on its website. Further, newly inserted sub regulation (ia) of Regulation 15 provides that the company shall upload the information regarding the shares or other securities boughtback on its website on a daily basis. 7. Period of buy back offer: The newly inserted sub regulation (k) of Regulation 15 provides that the buy-back offer shall open not later than seven working days from the date of public announcement and shall close within six months. No such condition was prescribed under the existing regulations. However, the Companies Act, 2013 provides that the buy-back shall be required to be completed within a period of 1 year from the date of passing of resolution authorizing buyback. 8. Buying back physical shares/ specified securities: Regulation 15A has been inserted in the new regulation which deals with buy-back of physical shares or other specified securities. Following are some of the key points: 1) a separate window shall be created by the stock exchange, which shall remain open during the buy-back period, for buyback of shares or other specified securities in physical form. 2) Before proceeding with buy-back, verification of the identity proof and address proof needs to undertaken by the broker. 3) the price at which the shares will be bought back shall be the volume weighted average price of the shares or other specified securities bought-back, other than in the physical form, during the calendar week in which such shares or other specified securities were received by the broker No such conditions were prescribed in the earlier regulations. Neither there is any provision relating to same in the Companies Act, 2013. 9. Escrow Account : New Regulation 15B has been inserted which provides that before opening of the buy-back offer, the company shall create an escrow account towards security and shall deposit 25 % of the amount earmarked for the buy-back in such escrow account. No such condition was/is there either in the regulations or Companies Act, 2013. 10. Extinguishment of Certificates : The newly inserted sub regulation 3 of Regulation 16 provides that the company shall be required to extinguish and physically destroy the security certificates so bought back during the month in the presence of a Merchant Banker and the
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Statutory Auditor, on or before 15th day of the succeeding month. Further, the company shall ensure that all the securities bought-back are extinguished within seven days of the last date of completion of buyback. Earlier there was no such provision under the regulations. The Companies Act, 2013 however, provides that the certificates shall be extinguished within 7 days of the last date of completion of buy-back. 11. Restriction on dealing in Shares or specified securities: Regulation 19(1)(e) has been modified so as to specifically mention the period during which the promoters or the person shall be restricted to deal in shares or specified securities. As per the said regulation, the promoter or the person shall not be allowed to deal in the shares or other specified securities of the company in the stock exchange during the period or off- market, including inter-se transfer of shares among the promoters during the period from the date of passing the resolution relating to buyback. As per the earlier regulations, such restriction was for during the period when buy back offer is open. No such condition as prescribed in the Companies Act, 2013. 12. Raising of further capital: As per the newly inserted Regulation 19(1)(f ), the company shall not raise further capital for a period of 1 year from the closure of buy-back offer, except in discharge of its subsisting obligations. However, as per the Companies Act, 2013, a period of 6 months has be prescribed for the purpose of raising further capital except by way of bonus issue or in discharge of its subsisting obligation. The amendments made to the existing legal framework of Buy Back Regulations have been done considering the overall interests of the various stakeholders. However, there are certain provisions in the new regulations which are in conflict with the recently passed Companies Act, 2013 and will require some kind of clarification.

3) Restriction on Repurchase of Shares in India

Some of the features in government regulation for buyback of shares are:

1. A special resolution has to be passed in general meeting of the shareholders 2. Buyback should not exceed 25% of the total paid-up capital and free reserves 3. A declaration of solvency has to be filed with SEBI and Registrar Of Companies 4. The shares bought back should be
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extinguished

and

physically

destroyed;

5. The company should not make any further issue of securities within 2 years, except bonus, conversion of warrants, etc. These restrictions were imposed to restrict the companies from using the stock markets as short term money provider apart from protecting interests of small investors.

4) Extent of Corporate repurchase of shares in the favour of shareholders.

Under the new law, minority shareholders will have no choice but to surrender their shares if the company wants to buy them out. But the new law is a bitter pill for investors such as P.H. Ravikumar. The former CEO of the National Commodity & Derivatives Exchange Limited (NCDEX) has shares in chemicals company Schenectady Herdillia, and the old law let him enjoy tax-free dividends even after the company got itself delisted in from stock exchanges in 2009. But under the new law, if Schenectady Herdillia wanted to buy him out, he would have to sell. The new bill is a bane for investors. Rather than protecting minority shareholders, it gives more power to corporate. Companies don't take the decision to list on an exchange lightly. They have a responsibility towards minority shareholders. Many critics of the new law argue that it favours listed multinational companies, letting them delist easily and become 100 per cent private. Generally, when minority shareholders have balked at buybacks, it has been over the price. Usually, the discounted cash flow method - in which all future cash flows are estimated at present value - is used to determine the price. It remains to be seen whether and how this may change under the new law, and whether it tips the scales in favour of minority shareholders. But one thing is clear: the new law helps companies buy out minority shareholders without risking years of legal battle. Until now, the only way companies could become 100 per cent privately owned after delisting was by reducing their share capital. Basically, a company could squeeze out minority shareholders by opting for a capital reduction to buy out dissident shareholders and extinguish their shares. The new law makes the process a cakewalk by comparison. There are plenty of cases in the courts, of companies fighting to buy out minority shareholders. Among them is Cadbury India Ltd, which delisted in 2003. The delisting price was Rs 500 per share. Over the years, Cadbury has raised its buy-back price to Rs 1,900. Court-appointed valuer Ernst & Young came up with a value of Rs 2,014 per share, which was rejected by shareholders who wanted Rs 2,500 then. Today, minority shareholders are asking for Rs 3,000 per share. The
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case for capital reduction has dragged on in the Mumbai High Court, as the company and minority shareholders have been unable to agree on the buy-back price. Just last week, on August 5, the Rajasthan High Court ruled in favour of RayBan Sun Optics India Ltd for capital reduction by cancelling minority shareholders' shares, which accounted for 6.68 per cent of the total equity share capital. Incidentally, the capital reduction price of Rs 137 per share is below the delisting price of Rs 140 announced in 2008. The courts maintain that valuation is an art and not a science, and the mere fact that the price is not acceptable to objectors should make no difference, unless it is found that price paid to minority shareholders is unfair and inequitable. In the case of RayBan, the court saw nothing wrong in the valuation method that determined the price of Rs 137, as against some objectors' demand of Rs 293. "The new act will bring down these legal delays," says Parikh of Verus Advocates. The new Companies Bill of 2012 is certainly a boon to corporate India, as many companies that delisted years ago and want to become 100 per cent privately owned will now be able to do so easily. For example, Bharti Telecom, which has a 43.5 per cent stake in Bharti Airtel, could be a beneficiary and buy back five per cent of its shares, which are held by minority shareholders, to become 100 per cent privately owned. It is over a decade since Bharti Telecom delisted from domestic bourses by offering shareholders Rs 96 per share.

Conclusion
In my opinion for corporate, the new Companies Act is a boon. It makes a clear provision for companies that can buy out minority shareholders without any opposition from them. This saves lot of time. As per law, reduction of capital is a domestic affair to be decided by the majority. Even the Companies Act of 1956 leaves it to the company to decide for itself the extent and mode of reduction, but bearing in mind that it takes care of the interest of creditors and minority shareholders, so as to see that it is fair, just and equitable. The new act will bring down these legal delays but it nowhere suggests that it is unfair to minority shareholders. With the courts being vigilant, shareholder interests will always be of the utmost importance, and it will not be easy for companies to get away with murder. There must be stricter regulations, and companies should be penalised for delisting. After a company delists, if another group company seeks to be listed, the group should be required to explain clearly the reasons for both delisting and listing. The Securities and Exchange Board of India has toughened buy-back and listing norms (the minimum non-promoter holding should be 25 per cent). But it should also bring down creeping acquisition levels for companies from five per cent a year down to one or two per cent, which may act as a deterrent if companies have plans to delist. It may be a while before the regulator

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comes out with stringent norms. But it is clear that the Companies Act, 2005 is a boon to corporate India. It will be interesting to see how companies such as Cadbury use the new law.

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