Why veto rights does not mean "control"

Over the last decade, as the private equity (PE) and venture capital (VC) activities have gained traction in India, the definition of what constitutes "control" of a company has emerged as a thorny issue. Market regulator SEBI's stance that veto power to shareholders constitutes "control" and should attract Takeover Code regulations has been viewed as a major irritant by the PE and VC funds, who routinely seek such rights. Now, in a landmark ruling, the Securities Appellate Tribunal (SAT) has overruled SEBI.

What SAT has ruled: The tribunal has shot down the stand of SEBI that veto rights constituted "control" of the company under Regulation 12 of the Takeover Code. SAT has ruled that it is conventional for financial investors to protect their investment and, indeed, the target company itself from the whims and fancies of the promoters who manage the target company.

What was the trigger: The case goes back to 2007 when PE firm Subhkam Ventures, through preferential allotment, acquired more than 15 per cent in MSK Projects, triggering an open offer. SEBI wanted the open offer to be made under Regulation 12 (change in control) of the Takeover Code. Subhkam Ventures challenged this in SAT arguing it was merely a financial investor and there would be "no change in control".

SEBI's stand: SEBI argued that the shareholder agreement between Subhkam Ventures and MSK Projects gave the former rights to veto certain business decisions, appoint a nominee on the board of the company and quorum rights (Subhkam's nominee should be present at board meetings)—all this constituted "control" of the company.

Its implications: Until SAT's recent order, there has been much ambiguity as to whether such veto rights constitute "control" under the Takeover Code. The order thus brings much relief to financial investors who have been uneasy about seeking such rights in listed companies for fear of triggering the requirement to make an open offer and also the implications of being regarded as persons having "control" over the company.

The grey areas: Experts argue that grey areas still remain. For instance, if investors are not in control and if promoters are unable to take a decision because investors are exercising their rights, then logically who is in control?