Role of the Target’s Board in Control Transactions from a Governance Standpoint

Cyril Shroff, Cyril Amarchand Mangaldas

India is expected to remain one of the fastest-growing economies in the world on the back of favourable demographics and reforms in the legal and regulatory framework. In this article, Cyril Shroff of Cyril Amarchand Mangaldas discusses the evolution of corporate governance within the Indian market.



India has witnessed a progressive surge in M&A activity over the years and this is expected to increase significantly with the projected GDP growth of 7.4 per cent for the coming financial year. India is expected to remain one of the fastest-growing economies in the world on the back of favourable demographics and reforms in the legal/regulatory framework. The volume of cross-border M&A in India totalled US$33.4 billion in 2017, which was up 224 per cent from US$10.3 billion in 2016. The factors currently driving the upward swing in M&A activities in India are sectoral consolidations and the sale of stressed assets pursuant to the new bankruptcy regime. 

Given the increasing relevance of India in the global economy, it is not surprising that corporate governance has emerged as a key consideration from a valuation, growth and investments standpoint for the Indian corporate sector in the past few years. The regulatory framework has made significant strides since 2013 towards prescribing norms for minority protection such as regulation of related party transactions and increased disclosure obligations. The new company law regime introduced in 2013 codified fiduciary duties of boards of directors (which until then were imported into the Indian jurisprudence from common law principles) and introduced the stakeholder model of governance in the Indian legislative framework. There also appears to be a consistent regulatory focus on enhancing governance standards by way of revision/updation of the norms as well as increased regulatory scrutiny. The Securities and Exchange Board of India (SEBI) constituted a committee in June 2017 seeking recommendations for revision of existing listing and disclosure norms to bring in the next phase of corporate governance in India – the committee issued its report in October 2017. Therefore, issues that impact public shareholders of Indian listed companies are at the forefront of governance conversations in India. Per a report issued in November 2017 by IIAS (a key proxy advisory firm in India), 66 resolutions were defeated by shareholders of Indian-listed companies since January 2014. According to IIAS, this was largely attributable to recent changes in the governance framework in India, which have empowered the shareholders by providing them a greater say on critical governance matters.

While recognising a shift in perspective, it cannot be denied that concentrated ownership of controlling shareholders in majority of listed companies is seen, and in some cases rightfully so, as a “nemesis” to the effective implementation of the governance norms in India. Given the overlap in ownership and management in these instances, the very prescriptive norms provided in the regulations are seen to be complied with on a form over substance basis. Added to this, historically low levels of regulatory scrutiny and enforcement action have led to ineffective implementation of the existing governance framework. In this context, the issue of governance and minority protection becomes starker where there are regulatory white spaces. 

It may be argued that one such gap in the Indian regulatory framework is in the takeover/change of a control regime that primarily seeks to protect the minority interests. It does this by requiring a partial exit to be provided to public shareholders through a mandatory tender offer (MTO) for a minimum of 26 per cent of the outstanding capital of the target, at the higher of either the negotiated price, or the price based on trading price for a specified look-back period. Per the current regulatory framework, in a control transaction of a listed company pursuant to sale of shareholding of the exiting controlling shareholder (the most common and commercially favourable structure for controlling shareholder exits), there is no requirement to seek approval of the public shareholders for such change of control. The active involvement of a target’s board is required only at two stages. First, at the time of due diligence, when unpublished price-sensitive information must be shared with the potential acquirer. Prior to the sharing of such information, the board is required to be of an informed opinion that the proposed transaction is in the best interests of the company. The second stage occurs after the trigger of a tender offer requirement: the publication of reasoned recommendations of a committee, formed by the target’s independent directors, on the open offer. 

Neither of these requirements are seen as meaningful interventions by the target’s board, as its approval for undertaking due diligence is, by its nature and expected timing, based on broad preliminary and non-binding terms of the proposal and the recommendation of the target’s independent directors is too far into the transaction process, with the deal having been signed and the only consequence of the recommendation being the extent of tenders in the MTO. 

Thus, in case of a control transaction pursuant to the sale of a shareholding by the controlling shareholder, it may be said that the current regulatory framework, from a governance standpoint, requires:

  • no intervention by the board of the target to actively negotiate, or have a say on, the change of control or the acquisition price; 
  • consideration of only shareholder interest while assessing the impact of the transaction, and not that of any other stakeholders; and 
  • provision of only a partial exit option at the price negotiated by the exiting controlling shareholder to the public shareholders. 

This intuitively may be inconsistent with the governance model that regulatorily and legislatively seems to be developing in India. This model seeks to:

  • have the board, specifically the independent directors, responsible for the interests of the minority/public shareholders; 
  • have equitable treatment of all shareholders; 
  • protect stakeholder interests, with shareholder interest/profit maximisation being one of, but not the only, component fiduciary duties;
  • have increased participation of public shareholders in matters concerning the relationship between listed companies and controlling shareholders; and 
  • presume that the interests of controlling shareholders are not aligned with those of the public shareholders. 

It may be argued that this inconsistency arises not from regulatory intentionality, but from the very nature of control transactions that have the exiting controlling shareholder “go over” the target’s board to negotiate with the incoming controlling shareholder and consequently, make the exit offer to the public shareholders. Therefore, the inconsistency may be resolved by having the target’s board play a more significant and effective role in control transactions.

This appears to find some resonance with the takeover regime in the USA (specifically under the Delaware law) where in case of potential takeover bids, both solicited and unsolicited, the target’s board is expected to act as a vigilant gatekeeper of its company’s interests and act, at all times, as a trustee of the shareholders. While it is recognised that unlike India, most listed companies in the USA have dispersed shareholding and control transactions usually happen with an end goal of taking the company private, the judicial principles developed on the role and responsibilities of the target’s board in such transactions, such as the “Revlon duties” may be relevant guidance for the evolving regulatory framework concerning governance in M&A transactions in India.

It cannot be denied that the concentrated ownership of Indian companies drives the nature of control transactions in India, which are primarily friendly deals negotiated between the controlling shareholders and the acquirers. Such ownership structures also result in the blurring of the line between ownership and management. Consequently, the currently mandated involvement of the target boards in the MTO process is viewed merely as procedural actions with the boards predictably facilitating these transactions. Hostile/unsolicited takeovers are rare in India since the ownership, control and management structures, along with the regulatory framework, are more facilitative towards the incumbent controlling shareholders. Therefore, the target’s board is not expected to watch out for and build in takeover defences or actively consider its role in control transactions with regard to the target’s stakeholders. 

However, given the evolving corporate governance jurisprudence in India, it may not be farfetched to expect a review of the takeover/change-of-control regime to have more holistically value-enhancing transactions. This will require backing of the regulator as well as the markets, as SEBI has always brought in reforms in the takeover and corporate governance regimes through consultative processes. Therefore, the views of the controlling shareholders, as the key constituents, will be very important. Their main concern in moving the regime from being primarily shareholder-controlled to one that is “co-controlled” with the board of the target could be the dilution of their agency to deal with their property in the manner they wish, given that – unlike in the USA – there is no specific jurisprudence in India on controlling shareholders having any fiduciary duties towards minority shareholders. Of course, their concern may be addressed from a practical standpoint, as concentrated ownership and the manner of exercising control usually ensure that boards are aligned with the controlling shareholders. However, with increased scrutiny from proxy advisory firms, growing shareholder activism and focus on fiduciary duties of the board of directors (including related liabilities and enforcement action), it is yet to be seen whether the role of a target’s board in control transactions would remain passive in the long run.

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