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Citation: 13 Student Advoc. 219 2001

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 TAKEOVERS AND BUY BACK
Vijayendra Pratap Singh*

Introduction
After the Companies (Amendment) Ordinance, 1998 via S. 77A,
introduced the concept of buy back there were some doubts as to it's impact
on the (Substantial Acquisition of Shares and Takeovers) Regulations, 19971
as amended in 1998. This prompted the Securities Exchange Board of India
to ask the Bhagwati Committee to look into the interplay between the two
legal regimes. The Committee's recommendations are still awaited in this
regard. The present paper will endeavour to examine this interaction and see
if the passive increase in the holding of the management or an acquirer due to
the buy back merits an exemption under the Takeover Code, 1997.
Before embarking on such an enterprise one should see how the buy
back makes the promoter/management fall within the ambit of the Takeover
Code, 1997. Buy back is the process by which a company purchases its own
shares from shareholders out of the amount in its free reserves. This was not
permitted earlier as there was abundant scope for manipulation and speculation
with respect to the shares so bought back. But now in the changing scenario
brought about by liberalisation this was permitted under a regulated framework.

Need and Advantages of buy Backs

The company undertakes a buy back if it is not viable to invest the money
in its free reserves for adequate returns i.e. there are no other avenues. Also
this amount cannot be distributed, as dividends to the shareholders as it would
not be wise to do so in the long run.2 Therefore buy back may seem an
attractive option whereby the extra resources of the company can be returned
to the shareholders without a negative impact. In addition to this there is also
an increase in the return on networth and earnings per share.3 Further, such
* V Year, B.A. LL.B. (Hons.), National Law School of India University, Bangalore.
1. Hereinafter Takeover Code, 1997.
2. Declaring a high dividend in one year increases the expectation of a similar if not higher dividend
next year. As it may not be possible to replicate or better the performance always, it could cause the
price to fall on account of non-fulfillment of expectation.
The other avenues mainly used in investing the companies reserves and surpluses could be inter
alia investing in new plant and machinery, lending from them in the manner prescribed by law . But
these decisions are largely dependant on the market and may not be wise or possible at all points of
time.
3. The number of claimants for the profits/dividends are reduced by the number of shares bought back
and extinguished.
220 Student Advocate [2001

use of the reserves would make the company less attractive to a prospective
raider. It may result in an increase in the promoter's holding as well. The
increase is brought about on account of the fact that the shares bought back
are extinguished leading to an increase in the holdings of those who did not
participate or participated to a level proportionately below the percentage of
buy back.4 At times this increase can result in the 15% limit' being transgressed
or could lead to a consolidation of the holding of the promoter beyond the
creeping limit.6 Thus the sledgehammer mechanism of the Takeover Code
would be triggered unless an exemption is provided against its application.

Buy Backs V. Reduction of Capital

Reduction of capital is another way by which a company can either pay
off any paid up capital which is in excess of the wants of the company or
reduce or extinguish the liability on any of its shares'. But from the focus of
the present paper this strategy has certain shortcomings, which will be
explained next. First and foremost the Court has discretion to sanction the
scheme for reduction of capital as prescribed under Ss. 100-104 of the
Companies Act, 1956. This requirement is not present under the (Buy Back of
Securities) Regulations, 1998. Hence under the Regulations the buyback can
be sought as a matter of right as long as the requirements thereunder are met
i.e. it is not contingent on the approval of SEBI. Furthermore, the reduction
of capital should be authorised by the articles of association of the company.8
These requirements make reduction of capital a less favoured method to counter
a takeover bid when compared to buy back.

Methodology of the Code in Accommodating Subsequent Market

Developments
Before this paper goes on to make a case for an exemption in such cases,
it will define the parameters by which one can judge the suitability of such an
exemption. The Bhagwati Committee too in its Report recognized that it would
be impracticable to devise regulations in such detail as to cover the entire
range of situations, which could arise in the process of substantial acquisition

4. If a company seeks to buy back shares upto 8% and does not participate in the offer, then its
holding would increase in percentage terms with respect to the total shareholding left after the buy
back. Thus now the holding of the promoter would be calculated on 92% remaining shares rather
than on 100% - prior to the buy back.
5. Limit under R. 10 of the Takeover Code, 1997 needed to trigger it.
6. R.1 Iof the Takeover Code, 1997.
7. S. 100 of the CompaniesAct, 1956
8. Ibid.
Vol. 13 Takeovers and Buy Back 221

of shares and takeovers.' Thus it arrived at a set of 'general principles' to

guide the interpretation and operation of the Takeover Code, 1997, especially
in circumstances not covered by the Code. These principles are:10
1. Equality of treatment and opportunity to all shareholders.
2. Protection of interests of shareholders.
3. Fair and truthful disclosure of all material information by the acquirer in
all public announcements and offer documents.
4. No information should be furnished by the acquirer and other parties to
an offer exclusively to one group of shareholders.
5. Availability of sufficient time to shareholders for making an informed
decision.
6. An offer to be announced only after most careful and responsible
consideration.
7. The acquirer and all other intermediaries professionally involved in the
offer to exercise highest standards of care and accuracy in preparing the
offer document.
8. Recognition by all the persons connected with the process of substantial
acquisition of shares that they are bound to be limitations on their freedom
of action and on the manner in which the pursuit of their interests can be
carried out during the offer period.
9. All parties to an offer to refrain from creating a false market in securities
of the target company.
10. No action to be taken by the target company to frustrate an offer without
the approval of the shareholders.
Therefore these 'general principles' can be termed as the ten
commandments to be used while interpreting the Takeover Code, 1997. These
commandments have to be considered and would serve as guidelines in
interpreting the any ambiguity or doubt. Furthermore, these commandments
are particularly relevant with respect to the buy back, as they are not explicitly
covered by the Code."

9. Report ofthe Committee on SubstantialAcquisitionofShares andTakeovers underthe Chairmanship

ofJustice P.N. Bhagwati, 1997- hereinafter the Report.
10. Para 1.2 of the Report.
11. The law regarding the buy back is later in time then the legal regime regarding takeovers.
222 Student Advocate [2001

A Brief for the Exemption of Buybacks

The (Buy Back of Securities) Regulations, 1998 (Regulations hereinafter)
involve only one company and therefore there is no acquirer and target
company distinction present here. Further the management is the same after
the buy back but only with a stronger holding. Therefore the need for a public
offer for 20% is not required, as the shareholders do not experience a change
in the management. 12 Thus the need for a public offer is obviated. In case a
group of shareholders is not happy with the increased shareholding of the
promoter(s), they can offer their shares in the buy back and get the buy back
price in return.' 3
Furthermore, the Regulations provide for accountability, transparency
and equality. These three aspects adequately safeguard the interests of the
investor. This is clear from the fact that they are informed at every stage of the
process. " The disclosures include inter alia the need for the buy back, method
of buy back, maximum amount required for the buy back, sources from which
the buy back would be financed, the basis of arriving at the buy back price
and the number of securities the company intends to buy back. The investor
is further protected by the obligations imposed on the promoter to not only
disclose whether he would also tender shares in the buyback but also to mention
his holdings and dealings in the shares of the company over the 6 months
preceding the passing of the special resolution." These mandates ensure that
to increase his holding and control over the company the promoter does not
wrongly use the shareholders' money. In case of buy back through the open
market, it is permitted only on exchanges with electronic trading facility and
requires the company to give information to the exchange on a daily basis of
shares bought back.

12. The Takeover Code, 1997 seeks to facilitate an exit of shareholders that are uncomfortable with the
new management that the acquirer may bring in with him. Another reason could be that the
shareholders subscribe to the share capital only on the basis that the present management is in
place.
13. Usually the buy back price is slightly higher than the market price. This would provide for an
attractive exit option for the shareholders not comfortable with the increased holding of the
management or growth options in future. An exception to this is the Reliance offer, which was at
a price lower than the market price. In such cases the poor response will curtail the increase in
holding.
14. The Regulationsseek to inform the shareholders before they vote on the special resolution authorising
the buy back (R.5 r/w Schedule 1), thereafter at the time of the public announcement (R. 8(1) r/w
Schedule 2, then through the letter of offer (R. 8(4) r/w Schedule 3) and finally after the buyback
is over (the particulars are disclosed under R. 19).
15. R. 7(6) of the Regulations,see also R. 15(6) with respect to buy back through the open market.
Vol. 13 Takeovers and Buy Back 223

As regards equality of treatment and opportunity to all shareholders, the

announcements are made to all the present shareholders. Further 'all those
shareholders whose names appear in the Register of Members and even those
waiting to get their names so registered, as on the specified date can participate
in the offer.16 Also, under R. 4(2) the exclusion of negotiated deals from the
process of buy back ensures that no information is made available to one
group of shareholders. The aspect of equality of shareholders is further
demonstrated by the fact that a specific formula is used to compute acceptances
per shareholder in the" event of more shares being tendered in the offer than
sought to be bought back. This ensures minimum discretion in the hands of
the management in picking and choosing the shares to be bought back.
Thereby giving equal treatment to all participating shareholders.
The Regulations also allow for the offer to be announced only after most
careful and responsible consideration. This includes a declaration to the effect
that the company is able to implement the offer and is given by the merchant
banker only when firm arrangements or monies, to fulfill obligations is in
place.' Further, to ensure that only serious offers take place, withdrawal of
the offer after its announcement or submission of the draft letter is prohibited.19
Further, any violation by the acquirer company or any of the intermediaries,
of any obligations imposed on them, are dealt with severely by the Regulations.
This would ensure that the acquirer and all intermediaries professionally
involved in the offer exercise the highest standards of care and accuracy in
preparing the offer document. Therefore due diligence needs to be strictly
adhered to by them in fulfilling their obligations under the Regulations. As a
further safeguard, to ensure against the offer jeopardizing the very existence
of the company i.e. by putting an undue strain on its resources, the Regulations
and the Companies Act mandate the filing of a declaration of solvency.20 All
these factors show that a buy back offer is the culmination of a careful and
well considered process, if it does not want to fall foul with the regulatory
framework.
Another aspect of the Regulations is that they give the shareholders
enough time to make the decision on the issue of participating in the offer.
This decision is made possible by the availability of all material and relevant
facts that would facilitate it, as explained before. This information would be

16. R. 8(2) of the Regulations.

17. R. 9(3) of the Regulations.
18. R. 20 of the Regulations.
19. R. 19(l)(d) of the Regulations.
20. R. 8 and S. 77A(6) of the Act - for a period of one year after the offer.
224 Student Advocate [2001

useless if the shareholders are not given sufficient time to consider it and
arrive at an informed conclusion. The Regulations seek to facilitate this through
R. 9, which mandates that the letter of offer is sent to shareholders so as to
reach them before the opening of the offer. Further the Regulations require
the offer to be open to the members for a period of not less than 15 days and
not exceeding 30 days. 2 ' Therefore there exist sufficient scope for the
shareholder to make an informed decision.
Finally, the Regulations seek to prevent any scope for insider trading
with respect to unpublished information relating to the buy back. This helps
curb the tendency towards creating a false market in the shares of the company,
which are to be bought back.2 2 In addition to this, the promoter is prohibited
from dealing in the shares of the company in the stock exchange during the
period of the offer. 2 3 This helps prevent the scope for manipulation of the
market, alongwith the disclosure of the promoter's holding in the previous 6
months. If these preventive aspects do not work then the promoter can be
disciplined through punitive aspects as well. He can be prosecuted under
(Prohibition of Fraudulent and Unfair Trade Practices Relating to the
Securities Market) Regulations, 1995 or the (Insider Trading) Regulations,
1995.24 These restrictions are justifiable as all persons connected with the
buy back process should recognise that they are bound to be limitations on
their freedom of action and on the manner in which the pursuit of their interests
can be carried out during the offer period.

Conclusion
Thus in the light of the above submissions, one can conclude that buy
back if carried out under the Regulations, does not offend the ten
commandments of takeovers. In fact, it further reinforces them by its letter
and spirit. Therefore using these principles one can reasonably conclude that
buy back deserves an exemption under the Takeover Code, 1997. Further an
explicit exemption as per the explicit exemption in R.3 of the Takeover Code,
1997 should be given, to do away with the need for the Panel to adjudicate
on this issue. This would allow the Panel to not only concentrate on other
relevant matters saving time, effort and money but also minimise the chances
of there being any contradictory jurisprudence in this regard in future. This is

21. R. 9(1) of the Regulations.

22. A false market exists as the party not having the unpublished information regarding the buy back,
is unaware of the true market value of the shares. Therefore R. 4(3) seeks to prevent this from
happening.
23. R. 19(1)(c) of the Regulations.
24. R. 25(2) of the Regulations.
Vol. 13 Takeovers and Buy Back 225

necessitated by the fact that the creeping acquisitions limit.under the Code
has not proved to be an effective defence in hostile takeovers. The Indian
industry would do well to canvass for this exemption as a defence against
moves to remove the incumbent management. This method has the advantage
of involving present shareholders and their participation in the process will
make it more transparent and democratic. Such a development has the
advantage of empowering the shareholders, as it will make the management
more responsive to their needs and aspirations. Non- performing managements
will be forced to review their attitude and performance, thus infusing Indian
industry with the professional outlook it requires to survive in an unprotected
environment.