In this blog, the author has discussed the proposed relaxation from pricing and open offer requirements will bring a sigh of relief for stressed companies to find investors and thereby make fundraising easier in the current economic scenario.
In the wake of the Covid-19 pandemic, unprecedented measures such as a nationwide lockdown had to be taken by the Government. With the economy coming to a standstill, most of the companies are currently facing a major setback in terms of diminishing cash flows and growth forecasts. At this moment, one of the most viable options available to a company for raising capital is through “equity financing”. The most common method of seeking equity funding has been through the “preferential allotment” route. However, with the current market situation, the pricing mechanism and open offer obligations linked to preferential allotment may not be favorable for companies in distress. Taking this into consideration, on 22 April 2020, the Securities and Exchange Board of India (“SEBI”) issued a consultation paper on the pricing of preferential issues and exemption from open offer obligations for companies having stressed assets.
Current Legal Framework
As per the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”), the pricing of equity shares is to be calculated on the basis of the “volume-weighted average price” approach. The price which is to be allotted to the shares is to be not less than the weighted average price of weekly high and low for a period of twenty-six weeks or for a period of two weeks, whichever is higher.
Further, the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 mandates the acquirer to make a Mandatory Tender Offer (“MTO”) to the shareholders to acquire a minimum of twenty-six percent of the shares.
The Indian Capital Market Regulator recognized the distressed state of companies that are in a dire need of fund infusion to avoid insolvency or bankruptcy. SEBI also noted the fact that listed companies having “stressed assets” face a progressive fall in their share price. Owing to the current slowdown in the economy, there is a wide gap between the price at the beginning of the twenty-six weeks and the current price when funds are required to be raised. Due to the continuous downfall of the stock market, the volume-weighted average price for twenty-six weeks is ought to be higher than the average price for two weeks. Therefore, the pricing guidelines in the ICDR Regulations will make it very difficult for such distressed companies to raise capital through the conventional preferential allotment route.
Additionally, the requirement to make an MTO is an added financial burden for the incoming investor thereby creating difficulties for the stressed company.
A move in the right direction, SEBI’s consultation paper proposes to bring about changes in the pricing regime for companies having stressed assets and along with that, introduces exemptions for such companies with regard to the open offer norms.
§ It has been proposed that the price determined for preferential allotment by “stressed” companies should not be less than the average of the weekly high and low of the volume-weighted average prices of the equity shares during the two weeks preceding the relevant date.
§ Further, it has also been proposed that the acquirer of a “stressed company” shall be exempted from making an open offer even if the acquisition is more than twenty-five percent in the company by way of preferential allotment.
Further moving in the right direction of safeguarding the interests of minority shareholders, the consultation paper states that these exemptions shall only be available if the preference issue is made to entities that are not part of the promoter/promoter group on the date of the board meeting to consider the issue. Another added safeguard is that the pricing mechanism and open offer exemption as stated in the paper must be approved by the majority of minority shareholders.
Further, the allotted shares shall have a lock-in period of three years from the latest date of trading approval granted by the stock exchange, as opposed to the existing one-year time period.
The exemptions introduced by SEBI apply only to companies in distress and therefore, it becomes imperative to have clarity on the categorization of a “stressed entity”. In this regard, the consultation paper lays down three criteria and a company to qualify as a stressed entity must comply with at least two of the three below mentioned criteria.
§ A listed company that has made disclosure of defaults on payment of interest/repayment of principal amount on loans from banks or financial institutions and listed and unlisted debt securities for two consequent quarters;
§ Existence of Inter-creditor agreements in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019;
§ Downgrading of credit rating of the listed instruments of the company to “D”.
SEBI’s consultation paper is certainly a move in the right direction for companies in distress. It recognises that unprecedented times, such as now, demands easement of onerous pricing mechanism and open offer norms in order to easily raise capital through the preferential allotment route. It is pertinent to note that stock prices may not always reflect the actual underlying value of the company. Especially in the current scenario, where the stock market has been gradually at a downfall, a twenty-six week timeline is ought to present a much higher valuation than a two week timeline. MTO obligations create further difficulties for the incoming investor since it is in addition to the infusion the investor already makes in the stressed company. Therefore, this exemption will make it easier to raise capital thereby coming to the aid of companies facing financial stress.
SEBI’s consultation paper is a welcome step in clearing the regulatory hurdles which dissuade investors to infuse funds in entities under dire financial stress. However, the capital market regulator may have adopted a peculiar criteria for selection of companies for providing this exemption. The approach that seems to have been embraced is that a company “must” default before availing the benefit of raising funds without hurdles. Here, it is imperative to highlight that most of the companies are in dire need of funding to “avoid” becoming a stressed entity. In this regard, the benefits of a less onerous route of preferential allotment should ideally be not restricted to entities which qualify as a “stressed entity” as per SEBI’s parameters. A reasonable approach that could have been taken was to determine the status of the company as a stressed entity based on financial statements. This approach would have come in recourse of companies desperately in need of funds to avoid distress and not just companies struggling to come out of it.
Another interesting point to note here is that SEBI should, in general, consider reforming the law governing pricing of preferential allotment. The pricing mechanism introduced in the consultation paper should be a norm rather than an exception. Presuming shares are well traded in the capital market, an ideal approach would be to consider the most recent price of a share to determine the mandatory floor price.
The proposed relaxation from pricing and open offer requirement will bring a sigh of relief for stressed companies to find investors and thereby make fund raising easier in the current economic scenario. However, taking a stringent approach in terms of qualifying entities as a “stressed entity” could leave out a lot of companies which are on the verge of becoming distressed. Therefore, it is suggested that the capital market regulator should consider making this relaxation available for all companies and not just stressed companies. SEBI shall be accepting public comments on this proposal till May 13 2020. The above proposals, if and when, materialise into a set of concrete amendments will ease the process of raising capital through the preferential allotment route in the midst of the current stock market meltdown.
1. Securities and Exchange Board of India, Consultation Paper – Preferential Issue in Companies having Stressed Assets (April 22, 2020).
2. Dhruva Advisors LLP, SEBI Proposes Measures to Ease Fundraising by Financially Stressed Companies, Regulatory Alert (April 27, 2020) https://dhruvaadvisors.com/insights/files/Regulatory_alert_SEBI_Consultation_Paper_27042020.pdf.
3. BDO India, SEBI Proposals for Ease of Fund Raising by Listed Companies, Alerts (April 25, 2020) https://www.bdo.in/en-gb/insights/alerts-updates/regulatory-alert-sebi-proposals-for-ease-of-fund-raising-by-listed-companies.
4. Henil Shah, Proposal for Relaxation in Pricing Norms for Preferential Issue and Making an Open Offer, Vinod Kothari Consultants (April 28, 2020) http://vinodkothari.com/2020/04/sebis-proposal-to-aid-financially-stressed-companies/.
Symbiosis Law School, Pune
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