1

DAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITY

VISAKHAPATNAM, A.P., INDIA

PROJECT TITLE

Buy back of Shares as “Poison Pill” in Takeover of Companies – A Critical Analysis

SUBJECT
Corporate Law - II

NAME OF THE FACULTY

Dayananda Murthy Sir

Name of the Candidate U.UPENDRA

Roll No. 2016112
Semester VIII

1|Page
2

RESEARCH METHODOLOGY

This project is purely Doctrinal and based on primary and secondary sources such as websites,
books, journals and internet sources. The referencing style followed in this project is BLUE
BOOK 19th Edition's format of citation. This Research process deals with collecting and
analyzing information to answer questions. The Research is purely descriptive in its boundaries
of the topic

2|Page
3

ACKNOWLEDGEMENT

I would sincerely like to put forward my heartfelt appreciation to our respected professor,
Dayananda Murthy Sir for giving me a golden opportunity to take up this project. I have tried
my best to collect information about the project in various possible ways to depict clear picture
about the given project topic.

3|Page
4

CONTENTS

INTRODUTION……………………………………………………………………………05

HOSTILE TAKEOVERS …………………………………………………………………..06

INDIAN LEGAL AND REGUALATORY FRAMEWORK………………………………08

DEFENCES TO HOSTILE TAKEOVERS ……………………………………………….10

POISON PILL……………………………………………………………………………...11

BUYBACK OF SHARES AS TAKEOVER DEFENCE …………………………………...13

HISTORY OF HOSTILE TAKEOVER ACTIVITY IN INDIA……………………....……15

CONCLUSION…………………………………………………………………..…………17

BIBLIOGRAPHY…………………………………………………………………………..18

4|Page
5

Introduction:

Companies worldwide have realized the importance of being present and to be operating
transnational. That is why many firms tend to expand globally through Mergers &
Acquisitions. A takeover bid is an acquisition of shares carrying voting rights in a company
in a direct or indirect manner with a view to gaining control over the management of the
company. Such takeovers either take place through friendly negotiations or in a hostile
manner. When the takeover takes place in a hostile manner, i.e. against the wishes of the target
company, the target company often adopts certain measures to prevent or discourage the acquirer
from taking over the target company. In practice, these defenses often also serve as leverage that
target companies could use in negotiating higher offers. Most of these defenses have evolved
over the past 50 years. Some of them are required to be approved by the shareholders before they
are carried out while others are not.

To avoid being the target of a hostile takeover by a larger firm, a corporate board might adopt a
defensive strategy called a shareholder rights plan. It is also called as “Poison Pill “.The poison
pill is the most powerful defense against hostile takeovers. Such plans allow existing
shareholders the right to purchase additional shares at a discount, effectively diluting the
ownership interest of any new, hostile party.

Takeovers in India are primarily governed by the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011 ("Takeover Code"). It defines an Acquirer as "any person who,
directly or indirectly, acquires or agrees to acquire whether by himself, or through, or with
persons acting on concert with him, shares or voting rights in, or control over a Target
Company". Further, Regulation 3 permits such Acquirers to make a public announcement of an
open offer for acquiring shares which will entitle the Acquirers to acquire more than 25 percent
of the voting rights of the Target Company. It can be perceived that the Takeover Code does not
present any statutory barriers to a hostile takeover. There is no provision in the Takeover Code
which draws a line between a friendly and hostile takeover. The key import of the regulations
under the Takeover Code is that nowhere do they contain onerous prescriptions for hostile
takeovers which may defeat the purpose of such a bid.

5|Page
6

Hostile Takeovers

The term “Hostile Takeover” is defined as when a company puts a bid on a target firm, which is
being opposed by the management of the targeted company which furthermore advises its
shareholders not to sell to the acquiring firm Also, if a bid is placed for the shares of the target
company without informing its board and is directly aimed to the shareholders, the term hostile
takeover is also applied. The bid or offer could be suggested towards the shareholders with or
without the consent or negotiations from the management of the targeted firm. Furthermore,
there is a thin line between what is characterized as a hostile bid or a normal bid, since it
sometimes occurs that a friendly or normal bid if you, develops into a hostile bid. However,
hostile bids and offers are generally directly aimed at the shareholders of the targeted
company in hope of gaining control over the company without the consent from the board
of directors of the targeted firm.1

A hostile takeover primarily involves changing the control of the company against the
wishes of the incumbent management and the board of directors. This throws up a lot of
social, legal & economic issues this chapter to tries throw light on all those issue.2

Following are the primary motive/causes of a takeover

1. Assets at a Discount: this refers to a situation where the offeror can acquire the assets/shares of
a target at less than the value, which the offeror or its shareholders place upon them: a process
commonly referred by financial journalists as” acquiring assets at a discount”. The situations in
which assets may be available at a discount are:

Where the target has not put its assets to their most efficient use;

 Where its directors are unaware of the true value of its assets;
 When it has an inefficient capital structure;
 Where it has followed a policy of limited distribution of dividends;

1
Weinberg and Blank. Takeovers and Mergers (London: Sweet and Maxwell, 1999) Vol. 1 at 1005.
2
Samim Zarin, “Mergers & Acquisitions: Hostile takeovers and defense strategies against them.”

6|Page
7

 Where the shares have a poor market rating relative to its real prospects; or
 Where due to any other non-economic reasons, the shares of the target are trading at low
prices.

2. Earnings at a Discount: because the offeror can by taking over the target acquire the right to
its earnings at a lower multiple than the market places on the offeror’s own profits, a process that
can be described as acquiring “earnings at a discount”.

3. Trade Advantage or Synergy: because there is a trade advantage or an element of synergy

(i.e. a favorable effect on overall earnings by cutting costs and increase in revenue) in bringing
the two companies under a single control which is believed will result in the combined enterprise
producing greater or more earnings per share. This has been found to be one of the biggest
drivers of takeovers in the 1990s.3

4. Method of Market Entry: because it represents an attractive way of the offeror entering a
new market on a substantial scale.

5. Increasing the Capital of the Offeror: Because the offeror has particular reasons to increase
its capital base. These include the acquisition of a company a large proportion of whose assets
are liquid or easily realizable instead of making a rights issue and the acquisition of a company
with high asset backing by a company whose market capitalization includes a large amount of
goodwill.

According to Weinberg and Blank a takeover may be achieved in the following ways:

 Acquisition of shares or undertaking of one company by another for cash.

 Acquisition of shares or undertaking of one company by another in exchange of shares or

other securities in the acquired company.

 Acquisition of shares or undertaking of one company by a new company in exchange for its
shares or other securities

 By acquisition of minority held shares of a subsidiary by the parent.

 Management buyouts.

3
Charles V. Bagli, “The Civilized Hostile Takeover: New Breed of Wolf at Corporate Door”, The New York Times

7|Page
8

Indian Legal and Regulatory Framework

Any takeover in India needs to comply with the provisions of SEBI (Substantial Acquisition of
Shares and Takeover) Regulations, 1997 (Takeover Code). It is important to understand the
various terms associated with the takeover and there meaning explained in the Takeover Code.

The term 'Target company' refers to is a listed company, whose shares or voting rights are
acquired/being acquired or whose control is taken over/being taken over by an acquirer either
directly or by acquiring control of its holding company or a company which is controlling it,
which is not a listed company.

As per regulation 2(1) (b), the term acquirer means any person who, directly or indirectly,
acquires or agrees to acquire control over the target company, or acquires or agrees to acquire
control over the target company, either by himself or with any person acting in concert with the
acquirer. The term acquirer has been given a wide meaning as the definition takes into account
not only substantial acquisition of shares by a person, but also takeover of control of the
company.

As regards the term control, there is no exhaustive definition. It is dependent on the

circumstances of the case which determines who has control over the organization. However the
term control shall include:

1) The right to appoint majority of the directors or,

2) 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.

An explanation was inserted in the definition of the term control vide SEBI (Takeovers) Second
Amendment, Regulations, 2002. The explanation provides that transfer from joint control to sole
control over a company is not to be considered as change in control if it has been effected in
accordance with regulation 2(1)(e), i.e., through inter se transfer of shares among promoters.

The Takeover Code makes it difficult for the hostile acquirer to just sneak up on the target
company. It forewarns the company about the advances of an acquirer by mandating that the

8|Page
9

acquirer make a public disclosure of his shareholding or voting rights to the company if he
acquires shares or voting rights beyond a certain specified limit. However, the Takeover Code
does not present any insurmountable barrier to a determined hostile acquirer.

The Takeover Code, vide Regulation 23, also imposes a prohibition on the certain actions of a
target company during the offer period, such as transferring of assets or entering into material
contracts and even prohibits the issue of any authorized but unissued securities during the offer
period. However, these actions may be taken with approval from the general body of
shareholders.

However, the regulation provides for certain exceptions such as the right of the company to issue
shares carrying voting rights upon conversion of debentures already issued or upon exercise of
option against warrants, according to pre-determined terms of conversion or exercise of option. It
also allows the target company to issue shares pursuant to public or rights issue in respect of
which the offer document has already been filed with the Registrar of Companies or stock
exchanges, as the case may be.4

However this may be of little respite as the debentures or warrants, contemplated earlier must be
issued prior to the offer period. Further the law does not permit the Board of Director, of the
target company to make such issues without the shareholders’ approval either prior to the offer
period or during the offer period as it is specifically prohibited under Regulation 23.

During a takeover bid, it may be critical for the Board to quickly adopt a defensive strategy to
help ward of the hostile acquirer or bring him to a negotiated position. In such a situation, it may
be time consuming and difficult to obtain the shareholders' approvals especially where the
management and the ownership of the company are independent of each other.

The Takeover Code is required to be read with the SEBI (Disclosure & Investor Protection)
Guidelines 2000 (DIP Guidelines), which are the nodal regulations for the methods and terms of
issue of shares/warrants by a listed Indian company. They impose several restrictions on the
preferential allotment of shares and/or the issuance of share warrants by a listed company. Under
the DIP guidelines, issuing shares at a discount and warrants which convert to shares at a
discount is not possible as the minimum issue price is determined with reference to the market

4
https://taxguru.in/sebi/sebi-takeover-code.html last acessed on 28th march,2020

9|Page
10

price of the shares on the date of issue or upon the date of exercise of the option against the
warrants. This creates an impediment in the effectiveness of the shareholders' rights plan which
involves the preferential issue of shares at a discount to existing shareholders.

The DIP guidelines also provide that the right to buy warrants needs to be exercised within a
period of eighteen months, after which they would automatically lapse. Thus, the target company
would then have to revert to the shareholders after the period of eighteen months to renew the
shareholders' rights plan.

Without the ability to allow its shareholders to purchase discounted shares/ options against
warrants, an Indian company would not be able to dilute the stake of the hostile acquirer, thereby
rendering the shareholders' rights plan futile as a takeover deterrent. Also, the FDI policy and the
FEMA Regulations have provisions which restrict non-residents from acquiring listed shares of a
company directly from the open market in any sector, including sectors falling under automatic
route.

DEFENCES TO HOSTILE TAKEOVERS

In a takeover battle if the board/management chooses to reject a bid it may have to take
effective defensive measures in order to stall the raider from carrying out the takeover
operation. These defense mechanisms may be put in place after the bid has been made or
may have been there prior to the bid having been made. The most obvious case for defense
is that by rejecting an initial bid, the board may be seeking to receive a higher offer or
inviting a competitive bidder. By mounting a vigorous defense, the board may be able to fetch
a better price for surrendering its stake in the target. Defense may also be raised on the ground
that the company’s net worth is much more than the bidder had calculated. This may be the
case when the management of the target company has some privileged and commercially
sensitive information, which, if released, would increase the market value of the firm. By
mounting such a defense, management may be able to increase the market value of the target
firm to such an extent that the bid fails, or, even if the bid succeeds, secure a higher price for
their shareholders. Another reason for mounting a defense may be the management’s genuine
belief that the company is better off by remaining an independent entity.5

5
Jeffrey N. Gordon and Lewis A. Kornhauser, “Takeover Defence Tactics: A Comment on Two Models”, 96 Yale L. J.
at 295 (1986)

10 | P a g e
11

Staggered Board

This defense involves an amendment of the by-laws of the company to create a staggered
board of directors. A staggered board is a board whose members are elected in different
years or in other words only part of the board comes up for election each year.
Implementation of a staggered board may cause an acquirer to have to wait for several
years or at least till the next annual general meeting before it controls the board of
directors. Because the acquirer would not control the board initially, the acquirer would not
have the power to change management or the corporation's business plan. As with the other pre-
tender offer defenses, courts will allow amendment of the charter to create a staggered board of
directors provided the amendment is allowed under the governing corporation law and the
amendment was made for a valid business reason.6

Poison Pills

A defensive tactic, which originated in the US and is mainly employed in the US. The
expression poison pill comes from the domains of espionage. This refers to back in the days
when agents were instructed to swallow a cyanide pill instead of being captured or as in our case
overtaken. When it comes to the corporate world the effect of the pill is similar. There are
several variations of the pill, but most work roughly in the same way. A poison pill is a
shareholder rights plan that encourages a would-be acquiring company to talk to target’s
directors before seeking to acquire more than a certain percentage of the target’s stock,
because not doing so will result in substantial economic harm to the acquirer as the rights
held by it will become void, and all other shareholders will be able to buy shares of the
target at half price.7 A rights plan can be adopted without shareholder approval and the
directors authorize the rights to be distributed as a dividend to target’s shareholders.

6
Meredith M. Brown and Paul S. Bird, “Introduction to Hostile T akeovers”
7
Robert F. Bruner, The Poison Pill Anti-takeover Defense.

11 | P a g e
12

The board of directors can adopt these pills at any point in time without the shareholders'
approval. On adoption, the rights get attached to the shares and are traded along with the shares.
The rights get detached from the shares and are exercisable only on the occurrence of an event
called the triggering event.

The flip-in pill: The pill, when triggered, gives all existing shareholders other than the
acquirer, the right to buy shares of the firm at a discounted rate. This makes it more
expensive for the acquirer to complete the takeover as more shares are introduced into the
market. It dilutes the value of the shares already held by the acquirer and reduces the percentage
of shareholding of the acquirer.8

The Flip-over pill: The pill gets triggered when an acquirer crosses a threshold level of
shareholding (for example 20%) or makes a bid for a certain amount of shareholding. At
this point, the shareholders, other than the acquirer, get a right to buy shares at a deep
discount in the merged / surviving entity after the merger. This right is exercisable only on
the merger of the target with the acquiring firm. This pill releases its poison when the
acquiring firm acquires all the shares of the target firm and merges with it. The flip-over pill
transfers wealth from the shareholders of the acquiring firm to the shareholders of the target
firm.9

The board of directors can adopt a poison pill at any time in anticipation of a hostile bid or have
one prepared and kept ready to be adopted when a hostile bid is announced. They can also
suspend the application of the pill in case of a friendly takeover. So the poison pill acts
selectively at the discretion of the board.

Buyback of Shares as a Specific Takeover Defense:

Buybacks as a defense is executed through the repurchase by a company of its own shares, to
reduce the number of shares available or to increase the price at which the remaining shares can
be bought, or alter the ratio in favor of the promoter group.
8
D.L.Sunder,The Controversial 'Poison Pill' Takeover Defense: How valid are the Arguments in Support of it?
9
ibid

12 | P a g e
13

Buyback of shares may be employed by the management of a company as a tool to defend

against an unwelcome takeover aiming at one of the following consequences: either the buyback
will alter the percentage of the shares held by a shareholder group which is unlikely to accept the
offer of the potential acquirer, or by raising the price of the shares above the offer price of the
bidder, thus making the takeover more cumbersome.10

This strategy is really one in which the target management uses up a part of the assets of the
company on the one hand to increase its holding and on the other it disposes of some of the
assets that make the target company unattractive to the raider. The strategy therefore involves a
creative use of buyback of shares to reinforce its control and detract a prospective raider. But
“buyback” the world over is used when the excess money with the company neither gives it
adequate returns on reinvestment in production or capital nor does it allow the company to
redistribute it to shareholders without negative spin offs.11 68 in new act

In India, buybacks have been considered a legitimate shield against a takeover bid, and this use
of the technique was in fact one of the reasons why section 77A, which permitted buyback of
shares by a company for the first time, was introduced in the Companies Act in 1999. To
understand the legal regime governing buybacks in India and their operation in context of
takeovers, there are three instruments that must be studied: section 77 A of the Companies Act,
the SEBI Takeover Code and the SEBI Buyback Regulations.12

While Indian law has no express provisions regulating buybacks in the specific context of
takeovers, the effect of the three instruments in combination does serve to operate as a check. A
company may purchase its own shares from the existing shareholders proportionately.29 The
buyback must be authorized by the articles30 and cannot exceed 25% of the total paid up capital
and free reserves, as well as 25% of the total paid up equity capital in that year.31 This prima
facie places a restriction on the quantum of shares that may be repurchased. However, this would
in most cases suffice to thwart the bid as in any case, a purchase of 25% of the shares would
greatly increase the value of the remaining shares and also alter the proportion of shareholding
significantly. The most potent protection against abuse of management powers to thwart a

10
A.S.Dalal, ANALYSIS OF TAKEOVER DEFENSES AND HOSTILE TAKEOVER
11
Sakshi Gupta, Regulation of Takeover Defenses: A Comparative Study of Buyback of Shares as a Takeover
Defense
12
ibid

13 | P a g e
14

potentially beneficial takeover offer perhaps is by ensuring that a disclosure of the purpose for
the buyback is made to the shareholders and the same is done with their consent. Section 77 A
addresses this concern by first, providing for a special resolution at a general meeting and
second, by mandating that the resolution for the proposed meeting must contain a complete
disclosure of the material facts as well as the necessity for the buyback , thus making covert
schemes on the part of the management to avoid a takeover difficult.13

However, it must be noted that a buyback can proceed without requiring the assent of the
shareholder where the buyback is up to 10% of the paid up equity capital and free reserves, so
depending on how many shares are already held by a group opposed to the takeover, it seems
that the management can potentially use buyback to avert a takeover bid without taking
shareholder consent. 14

Shark Repellents: To deter hostile takeovers a company may make special amendments to its
legal charter which becomes active only when a takeover is attempted. It is commonly known as
a porcupine provision. These are put in place largely to reinforce the ability of a firm's board of
directors to remain in control. Techniques such as staggered or classified board structures may be
implemented through which only specified directors are re-elected to the board while others have
a fixed tenure, thereby forcing a hostile bidder to wait until the completion of tenure.
Pac-Man Defense: Pac-man defense is a bold move in which the target company prevents a
takeover by buying stocks in the acquiring company and ultimately gaining control of the
acquirer.
Sale of Assets: In a move to make the acquisition less interesting for the acquiring company, the
target company may sell the whole company or the most important assets of the company.
Thereby making the sale less attractive for the acquiring company.
White Knight: Where a hostile takeover seems imminent, the target may seek out other
investors which are friendly to the target company, and sell the company or substantial stocks of
the company to the friendly investor. Such friendly investor is called a white knight.
Greenmail: Similar to blackmail, greenmail refers to the money paid to an hostile entity to stop
or prevent its aggressive behavior. Greenmail is an anti-takeover tool in which the target
13
White, W.L., Pulling the Golden Parachute Ripchord, The Mergers and Acquisitions Handbook,(1987)
14
ibid

14 | P a g e
15

company pays a premium, (known as greenmail), to purchase its own shares back at increased
prices from a hostile acquirer.

HISTORY OF HOSTILE TAKEOVER ACTIVITY IN INDIA

The concept of takeover without consent termed as hostile takeover. No consented history of
hostile takeover can be traced to 1980s with U.S Supreme Court for the first time sat in judgment
over the anti-takeover provisions of the Illinois Business Takeover Act and pronounced them as
invalid in landmark ruling in Edgar vs. MITE Corp. Hostile takeovers occur rarely even in the
most mature economies, so it then should not be surprising that in India, where the economy was
only liberalized in 1991, a mere dozen or so hostile takeovers have been attempted. The four
cases illustrated below are meant to provide historical context to the current situation and
illustrate some of the political and technical barriers that a foreign hostile acquirer might face
today.

Swaraj Paul’s failed bids for escorts and DCM

In 1983 London-based NRI Swaraj Paul sought to control the management of two Indian
companies, Escorts Limited and DCM (Delhi Cloth Mills) Limited by picking up their shares
from the stock market. While he was ultimately unsuccessful, Paul's hostile threat sent
shockwaves through the Indian business world.

India Cements Limited and Raasi Cements Limited

In 1998, India Cements Limited ("ICL") in its hostile bid for Raasi Cements Limited ("RCL")
made an open offer for RCL shares at Rs 300 per share at the time when the share price on the
Stock Exchange, Mumbai ("BSE") was around Rs. 100. In this case investors felt cheated as the
promoters themselves sold out their stake to the acquirer leaving little room for them to tender
their stake to the acquirer during the open offer. However, ICL also bought out the FIs in the
open offer and thereby increased their holding in RCL to 85%.15

15
https://previewtech.net/hostile-takeover-india-sebi-regulations/ last accessed on 24th March ,2019

15 | P a g e
16

Gesco Corporation

In October 2000, Abhishek Dalmia, made an open offer to acquire 45% of the share capital in
Gesco Corporation at Rs 23 per share at a total. This transaction entered in to a drama of hostile
takeover until the promoters of Gesco Corporation and the Dalmia group announced to have
reached an amicable settlement in the battle for Gesco, with the former buying out Dalmias'
10.5% stake at Rs 54 per share for a total consideration of Rs 16 crore. The Gesco Corporation
takeover drama showed that a bidder with admittedly poor financial resources could drive the
price up of shares only to exit later with a huge profit via a negotiated deal.

Emami and Zandu

In 2008, hostile takeover triggered between Emami and Zandu in May 2008 when Emami
acquired 24 per cent stake in Zandu from Vaidyas (co-founders) at Rs 6,900 per share. Open
offer for further 20 per cent stake followed with co-founders giving in their 18% after 4 months
of futility to save the company. Rs 750 crore was the consideration paid by Emami for a 72 per
cent stake in the company.

16 | P a g e
17

Conclusion

Indian companies need to shift from desperate defensive play to getting ready on the offensive.
The reason for utilizing the poison pill defense is to protect shareholder value and interest while
stalling entities such as asset strippers that do not have the best interest of the company in mind
or add any value to it. However, companies need to ensure that this defense is not misused by
errant management. The need today, obviously, seems not to do away with poison pills, but a
change in the attitude and approach of the management towards the poison pills. Not all hostile
takeovers are bad; so long as the shareholders reserve the power to exercise the poison pills and
take an informed decision, the pills and hostile takeovers can do more good than harm.

Companies are becoming less inclined to use takeover defenses as shown by a study conducted
in the USA only the defense of Golden Parachute is being increasingly adopted as compared to
other defenses. Takeover defenses however play an important role in corporate restructuring.
Most of the takeover defenses that are frequently used by target companies in the US are
restricted by the regulations and acts in India. This kind of corporate synergy requires that the
legal paradigm so adjust itself, so that it is in a position to optimize the benefits that accrue from
such restructuring. Such need has nowhere been more evident than in the case of regulation of
takeovers. The legislature realizing this, has entrusted the job of doing the same to SEBI. SEBI
has endeavored to keep abreast with the market in this regard, as can be seen from the Bhagwati
Committee’s scope of reference. But the time has come for the other substantive law, i.e.,
Companies Act to be a more accommodative towards such defenses. As this would enable
takeovers to facilitate the removal of incompetent management and/or traditionally family owned
companies and increase efficiency in a more competitive global market.

17 | P a g e