Non Compete Fee: Is SEBI going too far for investor interest

In a recent Securities Appellate Tribunal (SAT) judgment SEBI directive to include non-compete fee in offer was turned down. E-Land Fashion China Holdings Limited, the appellant appealed to SAT with regards to SEBI directive to amend its offer letter by adding the Rs. 15/- of non-compete fees to the offer price of Rs. 60/- per equity shares offered to the equity shareholders of the target company Mudra Lifestyle Limited.

Non-Compete fee or Control premium is an amount over and above the agreed purchase price paid to the promoters of a target company preventing them from engaging, whether directly or indirectly, in the similar business for an agreed ‘non-compete’ period. It is often a case that the promoters are hands on with the business and know each and trade secrets. They have the right contacts in that particular business and are usually repertoire of high end technical / commercial information. Therefore, in order to protect the interests of the acquirer and also of the small shareholders who decide to stay with the company, a non-compete fee is paid to the promoters for not engaging in similar business for a period of time. Such, amount is not added to the price offered to the ordinary shareholders of the company, unless it is more than 25% of the offer price as mandated in Regulation 20 (8) of SEBI (SAST) Regulations, 1997, or simply Takeover Code.

However, a contrarian view can also be taken with regards to non-compete fee or control premium. It can be argued that it is a way of benefiting a large shareholder for the control over the target company, denying other shareholders the same benefit. Even SEBI Takeover Advisory Committee in its report dated July 19, 2010 suggested that such payment would not be fair on the minority shareholders of the target company, as the benefit should accrue to the company not only to a particular group of shareholders.

Coming back to the case, it was argued on the behalf of the SEBI that since the original promoter still hold 18.8% of the post offer shareholding and will have the right to appoint two directors, jointly select two independent directors and will select one Joint Managing Director, it can be presumed that they will be in the joint control of the target company.

The counter arguments provided by the representatives of the appellant focused on decided cases of Tata Tea Ltd. and Cementrum IBV and the fact that the directors of a company can also resign from their directorships. It was urged that the outgoing seller have managerial as well as financial capability to compete with the target company and to avoid such eventuality such non-compete fee is paid to the promoters.

The Tribunal concurred with the views of the appellant and held such payment to be valid and not to be added to the offer price. Defending its view, following logic was propounded by the Tribunal:

“It is the case of the appellant which is not disputed by the Board that Mr. Murarilal

Agarwal and Mr. Ravindra Agarwal are family members who were earlier promoters

of Bombay Rayon Fashions Ltd. which was carrying on business similar to that of the

target company. They separated from that company and promoted the target company and built it up as a strong competitor in the Indian textiles business with the assistance of Mr. Vishwambharlal Bhoot. The promoters have more than 20 years of experience in textiles business and have extensive knowledge of the market and intimate knowledge of the target company’s business, employees, suppliers, customers, systems and technological know-how. In this background, they are capable of offering competition to the target company. The appellant, on the other hand, belongs to the South Korea based E-Land Group of Companies which has limited operating experience in the textile manufacturing industry in India. Having taken over the target company, it would like to take the benefit of the knowledge and expertise of the promoters in managing such a business in India and it is for this reason that they are being associated with the target company. In this background, we are satisfied that the promoters have the capability of building a strong business from scratch and as a result of their understanding of the market they have the ability to compete with the business of the target company. If they were to do that, it would neither be in the interest of the target company nor in the interest of its shareholders. We are further satisfied that the payment of non-compete fee in the instant case is not an attempt on the part of the appellant to reduce the cost of acquisition to discriminate against the public shareholders.”

The Tribunal had the similar view in earlier cases of Tata Tea Ltd. and Cementrum IBV. In the case of Tata Tea Ltd the Tribunal had held “When an acquirer takes over a business from the outgoing seller(s), it is obvious that the sellers have specific knowledge of that business and have access to and are in possession of crucial trade secrets of the target company which if disclosed or misused would be detrimental to and could cause irreparable harm to the target company and its continuing shareholders and by virtue of their association with that business, they (out going sellers) are capable of offering competition to the business being taken over. In such cases, it would be legitimate for the acquirer to enter into a non-compete agreement with the promoter sellers if he feels threatened by a lurking fear of competition from them. It is neither for the Board and not even for this Tribunal to analyse the threat perception of the acquirer. We are of the view that a non-compete agreement would then protect not only the target company but also its continuing shareholders.”

Therefore, in all above cases, it was held by the Tribunal that non-compete fees is valid given the position of the promoters in the market and the law which mandates it. SEBI though have the right to vet the offer in terms of Regulation 18 of Takeover Code and suggest changes which should be carried out by the acquirer. However, it must tread carefully while deciding whether non-compete fees should necessarily added to the offer price for the benefit of the ordinary shareholders. It is an unalterable fact, that in many cases it is the promoter’s ingenuity that gets his business to new height and same ingenuity can be used against the company when he sold out, and instead of benefiting the ordinary shareholder it would only harm the existing holders, who in good faith acquired the company. It is up to the SEBI for not going too far in name of investor protection and let the investors decided themselves what is good for them.

© Tarun Mitra

May 27, 2011

References:-

1.      SEBI (SAST) Regulations, 1997

2.      SEBI Takeover Advisory Committee Report

3.      E-Land China Holdings Ltd. V. SEBI (2011)

4.      Tata Tea Ltd V. SEBI and anr. (2009)

5.      Cementrum IBV V. SEBI and anr. (2008)

6.      The Mint, “Promoter buyouts: non-compete payments on a different footing”, October 18, 2009

7.      The Economic Times, “ Non-Compete Fee: SAT Rejects Sebi Directive” May 26, 2011

Star-Zee Distribution Alliance: A Challenge to Competition Law

The Mint, New Delhi edition on Tuesday, May 24, 2011 reported that the Star TV and Zee Network are joining hands for distribution of their television channels. Both the networks, which have in their portfolios television channels with the highest viewer ship in the country, presently distribute channels through their own respective joint ventures, Zee Turner Limited and StarDen for Zee Network and Star TV respectively. This proposed joint venture between two top television companies could have serious impact on the Cable TV industry of the country; it would not only affect the Cable TV distributors and DTH operators but also the local Cable TV operators and the end consumers.

This proposed joint venture, poses a serious challenge to the Competition law, as there is clear cut absence regarding the status of the joint ventures in the Act. Although, the Act talks about the cartels, but proviso to subsection (3) of Section 3 of the Competition Act, 2002 provides that:

“Provided that nothing contained in this sub-section shall apply to any agreement entered into by way of joint ventures if such agreement increases efficiency in production, supply, distribution, storage, acquisition or control of goods or provision of services.”

Which will clear cut provide a defense to the companies to claim that their JV is in nature of “increasing efficiency” of distribution, as Mint reports quoting an unnamed Zee TV executive “move should be seen in view of the growing piracy of broadcasters’ signals as well as the monopoly of large cable networks in some markets such as Punjab and Tamil Nadu. Some states are monopolized by a single operator and we find it hard to collect subscription fees”. It is an open secret that cable TV signals are being pirated and in many instances mafia controls the cable TV operations, however by making the consumer pay by their nose is any solution.

Such move will only lead to cartelization by the broadcasters to increase the revenues. Such cartel will not only squeeze cable TV operators but also increase the subscription rate, which will give no leeway to the consumer to seek recourse.

The report further states other broadcasters might also join this joint venture, making it near monopoly situation in the market. Further, it is also believed, as the report states, that the both companies are scrambling to declare their JV before June 1^st, when the Combination regulations comes into force, thereby bypassing the law.

However, as it is stated earlier, that the law regarding to Joint Ventures is vague and can form a grey area in the Competition Act. But if this joint venture happens, it will surely will one of the greatest challenges to the emerging field of Competition law in the country.

© Tarun Mitra

May 25, 2011

References:-

1.      The Mint, “Star, Zee to join hands for distribution”, May 24, 2011

2.      Competition Act, 2002

3.      The Competition Commission of India (Procedure in regard to transaction of business relation to combination) Regulations, 2011

  

All Poor are equal, but some Poor are more equal than others

“Poverty and deprivation get covered as events” writes P. Sainath in his critically acclaimed and bestselling book ‘Everybody loves a good drought stories from India’s poorest districts’ “Yet, poverty is about much more than starvation deaths or near famine conditions. It is the sum total of a multiplicity of factors… Hunger-again just one aspect of poverty-is far more complex here. It is more low level, less visible and does not make for the dramatic television footage that Somalia and Ethiopia do.” Off late, with release of movies like Slumdog Millionaire and with tourist coming here solely for the purpose of clicking the deprived class, the poverty and the poor has seen massive dramatization in India and the world. But when it comes to counting them for the purpose of their welfare, the whole task becomes much more complicated as understanding the poverty as a process in India.

The Central Government on Thursday May 19^th, 2011 approved the proposal of head counts of poor in the country, for the sole purpose of better targeting of the numerous welfare schemes it operates. First such census was done in the year 1992 to count the number of families below poverty line. This time it would be a paperless exercise using handheld devices manufactured by Bharat Electronics Limited. Apart from counting rural poor, which used to be done earlier, this time urban poor would also be enumerated. The Ministry of Rural Development, Housing and Urban poverty alleviation, which is the nodal ministry to conduct this exercise, along with Registrar General of India would jointly conduct this exercise. A new methodology for determination of poor would be used, according to Business Standard “The new methodology for the rural census would divide the rural poor into three sections. One set of the population would be included in the BPL category, while another set of people — the economically affluent but socially deprived — would be excluded from the BPL category. A third set of the population would be enumerated on the basis of seven socio-economic parameters. The methodology for the rural census would consider the economic conditions of the family and attach only moderate importance to factors like social backwardness. The urban population would be enumerated on the basis of three criteria — residential status, social vulnerability and occupational vulnerability.” However there is a catch, for the first time religion and caste would come into picture, that is, the religion and caste of those counted would also be determined.

Although this mammoth exercise of determination and labeling of poor would be undertaken by the Ministry of Rural Development, Housing and Urban poverty alleviation along with Registrar General of India. But those who will get benefits would be only identified by the Plan Panel. As report in Mint says, “While the Planning Commission estimates the number of poor in the country, the ministry of rural development identifies the poor. The processes used by the two are different: the Planning Commission estimates poverty based on consumption, while the BPL census uses socio-economic characteristics such as household assets.” Therein lays the anomaly. Though data would be determined on a different basis, the information from it would be extracted from it using totally different criteria.

This only shows serious lacunae in Government policy making at the highest echelons of the governance. The editorial in the Mint bluntly puts it like this,” On the list of this government’s most serious lapses in policymaking, this one should rank somewhere near the top. The below poverty line census, due to its methodology approved on Thursday, will identify more poor households than officially estimated. But, because the government has also decided that the official estimates will serve as a ceiling, the additional poor families will not benefit from poverty alleviation schemes. In other words, the government will pick and choose who is to be officially poor and who isn’t. India has always had trouble with the ways and means of defining poverty and identifying the poor. But Thursday’s decision says something about the government’s confusion over the political handling of poverty. It is almost as if the aam aadmi’s government was telling some of its votaries: “You may be poor, but you ain’t poor enough”.”

More than Rs. 612, 000, 000,000/- (Rupees Six Hundred Twelve Billion) is spend annually by the Government on welfare of poor and how much actually reaches them is the mystery of the millennium. As it is no state secret that government programs for welfare of poor are usually not in sync with actual requirement and often the money flows out through the bureaucratic leakages. If they are not, the schemes provide incentives for diverting the resources meant for poor, for example, in National Rural Employment Guarantee Scheme (or loot if you prefer) monies are given for digging up pits and filling them up and calling it work.

 

Now if to this determination of poor, if we add in the factors of religion and caste, instead of a portable solution to this chronic problem, it would only provide a heady cocktail to the political parties, dry gunpowder which can be lightened up by smallest spark. Further, Supreme Court in many occasions has pulled up Plan Panel for putting a ceiling on the number of poor in the country as if putting a ceiling would end India’s poverty problem. The Mint reports that in one such instance the Honorable Court observed,” The bench made the critical remarks while dealing with a PIL filed by Peoples Union for Civil Liberties (PUCL) complaining about large scale corruption and irregularities in the PDS mechanism of the country. Questioning the plan panel rational in fixing 36% as the percentage of BPL families in the country, the bench said, “It is astonishing as to how you can fix 36% people in the BPL category in 2011 by relying on the 1991 census data… How can you fix such a limit when the per capita income varies from state to state?... The bench also questioned the Commission for fixing the per capita daily income of Rs. 20 in urban areas and Rs. 11 in rural areas to determine the BPL category…How can you justify fixation of this meager amount when even in the rural areas the amount is not enough”, further the Bench also extolled Deputy Chairman of Plan Panel to file a comprehensive affidavit in this regard. Now with such arbitrariness in determination and selection, isn’t the government is playing with the taxpayer’s money.

Milton Friedman once quipped about government spending,” There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government.” With such anomaly at the highest level which in fact will direct expenditure of billions of rupees, done with arbitrary manner, is it worthwhile to ask, whom the government is trying to please, itself by claiming poverty is down, its finances by claiming they are doing things efficiently or the electorates by providing benefits to chosen few and beating its chest to the rest about reduction in poverty.

“All animals are equal, but some animals are more equal than others” writes George Orwell in his famous book ‘Animal Farm’, today a poor might say, “All poor are equal, but some poor are more equal than others.”

© Tarun Mitra

References:-

1.      Mint, “Quick Edit | Uncommon incertitude”, May 20, 2011

2.      Mint, “UPA courts trouble with BPL census”, May 20, 2011

3.      Business Standard, “Cabinet approves BPL census”, May 20, 2011

4.      Mint, “SC slams govt over fixing BPL criteria”, April 20, 2011

I am not here, but I did not die

While changing the template of my blog, I have observed one thing; since 2009 when I started regular posting, my posts have progressively decreased. This story is same across by photo blog. Many times you might have seen the I write apologizing myself for not writing at all, or even trying to reason out for the same. But today it might not be the case.

My last post was on the 25th day of March 2011, it was a poem which I wrote a year back and which I feel is haunting me presently, anyhow, but the point is, even there it was not something fresh I wrote, it was from my records and I just pasted it. It is true for many of my posts, especially poetry, where I have shared something I wrote long back and stumbled upon them as I didn't have anything new to share. Even the last story I wrote was in November 2009, almost a year and half back. I am not apologizing for not writing, neither reasoning out my fallacies. One thing I have learned from the churns and twists of my life is that nothing is certain, especially when one sees certainty, at the very immediate moment the most uncertain thing happens, washing away everything, leaving a clean slate.

It is on this clean slate that new stories are started, and it is on this slate old memories are shared. It is from this clean slate I wish to venture again. In this new venture, there might be lack of continuity and again the same thing might be repeated once again. But as it is the human nature to try and to think, this wheel won't stop. From now on, many of you might find the contents boring as there would be more business and law items, but as I said the wheel must keep turning. Otherwise it will rust in the sands of time.

In conclusion, I must say, even though I might not be writing lately but:

I am not here, but I did not die.

Regards

Tarun Mitra