Mohit Gogia of S&R Associates discusses the Independent Committee Recommendations under the New Takeover Code.The Securities and Exchange Board of India (the SEBI) notified the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the New Takeover Code) on September 30, 2011 that will come into force from the 30th day of its publication in the official gazette and replace the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, as amended (the Existing Takeover Code). The New Takeover Code imposes a mandatory obligation on the board of directors of the target company (the Board) to constitute a committee of independent directors (the Independent Committee) to provide written reasoned recommendations on the open offer to the shareholders of the target company. For providing such recommendations, the Independent Committee is permitted to seek external professional advice at the expense of the target company. However, the New Takeover Code does not specify any guidelines or criteria that the Independent Committee may or may not consider in formulating its recommendations and more importantly whether such recommendations should be focused solely on the offer price being paid by the acquirer..Under the Existing Takeover Code, recommendations by the Board are not mandatory and the Board could if it so desired send its unbiased comments and recommendations to the shareholders, keeping in mind their fiduciary responsibilities as directors to the shareholders. The Existing Takeover Code provides that for any misstatement or for concealment of material information in any recommendations made by the Board to the shareholders, the directors will be liable for action under the existing takeover code and the Securities and Exchange Board of India Act, 1992, as amended (the SEBI Act) and such action may include criminal and significant monetary penalties. However, the New Takeover Code falls short of providing any express consequences for such recommendations made by the Independent Committee nor does it impose any obligation on the Independent Committee to ensure that such recommendations are fair and accurate and not misleading (similar to the obligation on the acquirer and the merchant banker in respect of the contents of the public announcement, detailed public statement, letter of offer, etc.). Accordingly, the extent of liability that may arise on any independent director for making recommendations to the shareholders under the New Takeover Code and the SEBI Act is uncertain and the shareholders may have to file a civil suit such as breach of trust to claim a breach of fiduciary duty by the independent directors..In connection with the fiduciary duties of directors to shareholders, the Supreme Court of India has cited with approval the observation in Pennington’s Company Law 6th Edn. at page 608-09, which states that “directors owe no fiduciary or other duties to individual members of their company in directing and managing the company’s affairs, acquiring or disposing of assets on the company’s behalf, entering into transactions on its behalf, or in recommending the adoption by members of proposals made to them collectively. If directors mismanage the company’s affairs, they incur liability to pay damages or compensation to the company or to make restitution to it, but individual members cannot recover compensation for the loss they have respectively suffered by the consequential fall in value of their shares, and they cannot achieve this indirectly by suing the directors for conspiracy to breach the duties which they owed the company. However, there may be certain situations where directors do owe a fiduciary duty and a duty to exercise reasonable skill and care in advising members in connection with a transaction or situation which involves the company or its business undertaking and also the individual holdings of its members” (emphasis supplied) [See Kamal Kumar Dutta and Another v. Ruby General Hospital Ltd. and Others, (2006) 7 SCC 613; Note 1 (Supra), paragraph 51]. The Supreme Court of India in Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad [AIR 2005 SC 809], has held that a director is only required to act in the principal interest of the company and does not owe any duty to perform so far as individual shareholders are concerned subject to any special arrangement which may be entered into or a special circumstance that may arise in a particular case. Such a fiduciary duty would arise, inter alia, in exceptional situations when the directors take upon themselves the task of advising the shareholders. It was observed by the Supreme Court that “directors may have a fiduciary duty where a takeover bid is made for a company and its directors advice its shareholders whether to accept or reject the bid as they owe a duty to advice honestly”. Although under the New Takeover Code directors are mandatorily required to provide recommendations to the shareholders and are not doing so on their own, courts in India should make clear that in providing recommendations to shareholders in the event of a takeover bid, the independent directors will owe fiduciary duties to the shareholders..By introducing the requirement of a mandatory recommendation from the Independent Committee, the SEBI has adopted a prudent corporate governance practice (particularly in the event of those rare hostile takeovers in India) already followed by many foreign jurisdictions including the United Kingdom and Canada. Such requirement in foreign jurisdictions is also usually supported by the fiduciary duties which directors owe to shareholders. For example, under Delaware State law in the United States (Delaware Law), it is well established that directors must discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interest of the corporation and for the benefit of its shareholder owners [See North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92, 99 (Del. 2007)]. Under Delaware Law, there are two main components of fiduciary duties of directors: (i) duty of care; and (ii) duty of loyalty. A Board’s judgment is entitled to the presumption that it was formed in good faith and done to further the interests of the corporation and a shareholder will first have to rebut this presumption and show that a director breached one of the above duties..The fiduciary duty of loyalty under Delaware Law requires a director to act in good faith for the best interests of the corporation and not in his/her own interests. In the context of a takeover, the duty of the directors is to ensure that the maximum fair value is offered to the shareholders. Under duty of care, a director’s fiduciary responsibility is to perform his/her duties with the diligence of a reasonable person in similar circumstances. In the context of a takeover bid, it is important that the board members fulfill their fiduciary duties by making informed decisions [See Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985)]. For this purpose, directors are entitled to rely and act on the advice of experts (that may include corporate officers and employees, bankers and lawyers). However, the end responsibility for such decision lies on the director and not the experts. To meet its fiduciary duties to shareholders in the context of a takeover, the Board typically obtains a fairness opinion from an investment banker which certifies that the price offered by the acquirer is not, “not fair” and the reasons of determining the fairness and confirms that such price is within the range of similar prices in the same industry..With a mandatory obligation being imposed by the New Takeover Code on independent directors of the target company to make recommendations to the shareholders, the SEBI has made clear its intent of requiring the independent directors to play a more active role in such scenarios and accordingly the recommendations made by the Independent Committee should be made in a responsible manner taking into account the fiduciary duties owed to shareholders. It will be interesting to see if the SEBI and the courts in India require the Independent Committee to follow a practice similar to other foreign jurisdictions to ensure that the recommendations of the Independent Committee are well informed and in the best interest of the target company and its shareholders. Certainly while providing its recommendations, the Independent Committee must not act with any malafide intent and must truly and reasonably believe that at the time what they did was in the best interest of the company..Mohit Gogia is lawyer working at S&R Associates. The views expressed in this note are those of the author and may not reflect the view or position of S&R Associates.
Mohit Gogia of S&R Associates discusses the Independent Committee Recommendations under the New Takeover Code.The Securities and Exchange Board of India (the SEBI) notified the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the New Takeover Code) on September 30, 2011 that will come into force from the 30th day of its publication in the official gazette and replace the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, as amended (the Existing Takeover Code). The New Takeover Code imposes a mandatory obligation on the board of directors of the target company (the Board) to constitute a committee of independent directors (the Independent Committee) to provide written reasoned recommendations on the open offer to the shareholders of the target company. For providing such recommendations, the Independent Committee is permitted to seek external professional advice at the expense of the target company. However, the New Takeover Code does not specify any guidelines or criteria that the Independent Committee may or may not consider in formulating its recommendations and more importantly whether such recommendations should be focused solely on the offer price being paid by the acquirer..Under the Existing Takeover Code, recommendations by the Board are not mandatory and the Board could if it so desired send its unbiased comments and recommendations to the shareholders, keeping in mind their fiduciary responsibilities as directors to the shareholders. The Existing Takeover Code provides that for any misstatement or for concealment of material information in any recommendations made by the Board to the shareholders, the directors will be liable for action under the existing takeover code and the Securities and Exchange Board of India Act, 1992, as amended (the SEBI Act) and such action may include criminal and significant monetary penalties. However, the New Takeover Code falls short of providing any express consequences for such recommendations made by the Independent Committee nor does it impose any obligation on the Independent Committee to ensure that such recommendations are fair and accurate and not misleading (similar to the obligation on the acquirer and the merchant banker in respect of the contents of the public announcement, detailed public statement, letter of offer, etc.). Accordingly, the extent of liability that may arise on any independent director for making recommendations to the shareholders under the New Takeover Code and the SEBI Act is uncertain and the shareholders may have to file a civil suit such as breach of trust to claim a breach of fiduciary duty by the independent directors..In connection with the fiduciary duties of directors to shareholders, the Supreme Court of India has cited with approval the observation in Pennington’s Company Law 6th Edn. at page 608-09, which states that “directors owe no fiduciary or other duties to individual members of their company in directing and managing the company’s affairs, acquiring or disposing of assets on the company’s behalf, entering into transactions on its behalf, or in recommending the adoption by members of proposals made to them collectively. If directors mismanage the company’s affairs, they incur liability to pay damages or compensation to the company or to make restitution to it, but individual members cannot recover compensation for the loss they have respectively suffered by the consequential fall in value of their shares, and they cannot achieve this indirectly by suing the directors for conspiracy to breach the duties which they owed the company. However, there may be certain situations where directors do owe a fiduciary duty and a duty to exercise reasonable skill and care in advising members in connection with a transaction or situation which involves the company or its business undertaking and also the individual holdings of its members” (emphasis supplied) [See Kamal Kumar Dutta and Another v. Ruby General Hospital Ltd. and Others, (2006) 7 SCC 613; Note 1 (Supra), paragraph 51]. The Supreme Court of India in Sangramsinh P. Gaekwad v. Shantadevi P. Gaekwad [AIR 2005 SC 809], has held that a director is only required to act in the principal interest of the company and does not owe any duty to perform so far as individual shareholders are concerned subject to any special arrangement which may be entered into or a special circumstance that may arise in a particular case. Such a fiduciary duty would arise, inter alia, in exceptional situations when the directors take upon themselves the task of advising the shareholders. It was observed by the Supreme Court that “directors may have a fiduciary duty where a takeover bid is made for a company and its directors advice its shareholders whether to accept or reject the bid as they owe a duty to advice honestly”. Although under the New Takeover Code directors are mandatorily required to provide recommendations to the shareholders and are not doing so on their own, courts in India should make clear that in providing recommendations to shareholders in the event of a takeover bid, the independent directors will owe fiduciary duties to the shareholders..By introducing the requirement of a mandatory recommendation from the Independent Committee, the SEBI has adopted a prudent corporate governance practice (particularly in the event of those rare hostile takeovers in India) already followed by many foreign jurisdictions including the United Kingdom and Canada. Such requirement in foreign jurisdictions is also usually supported by the fiduciary duties which directors owe to shareholders. For example, under Delaware State law in the United States (Delaware Law), it is well established that directors must discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interest of the corporation and for the benefit of its shareholder owners [See North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92, 99 (Del. 2007)]. Under Delaware Law, there are two main components of fiduciary duties of directors: (i) duty of care; and (ii) duty of loyalty. A Board’s judgment is entitled to the presumption that it was formed in good faith and done to further the interests of the corporation and a shareholder will first have to rebut this presumption and show that a director breached one of the above duties..The fiduciary duty of loyalty under Delaware Law requires a director to act in good faith for the best interests of the corporation and not in his/her own interests. In the context of a takeover, the duty of the directors is to ensure that the maximum fair value is offered to the shareholders. Under duty of care, a director’s fiduciary responsibility is to perform his/her duties with the diligence of a reasonable person in similar circumstances. In the context of a takeover bid, it is important that the board members fulfill their fiduciary duties by making informed decisions [See Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985)]. For this purpose, directors are entitled to rely and act on the advice of experts (that may include corporate officers and employees, bankers and lawyers). However, the end responsibility for such decision lies on the director and not the experts. To meet its fiduciary duties to shareholders in the context of a takeover, the Board typically obtains a fairness opinion from an investment banker which certifies that the price offered by the acquirer is not, “not fair” and the reasons of determining the fairness and confirms that such price is within the range of similar prices in the same industry..With a mandatory obligation being imposed by the New Takeover Code on independent directors of the target company to make recommendations to the shareholders, the SEBI has made clear its intent of requiring the independent directors to play a more active role in such scenarios and accordingly the recommendations made by the Independent Committee should be made in a responsible manner taking into account the fiduciary duties owed to shareholders. It will be interesting to see if the SEBI and the courts in India require the Independent Committee to follow a practice similar to other foreign jurisdictions to ensure that the recommendations of the Independent Committee are well informed and in the best interest of the target company and its shareholders. Certainly while providing its recommendations, the Independent Committee must not act with any malafide intent and must truly and reasonably believe that at the time what they did was in the best interest of the company..Mohit Gogia is lawyer working at S&R Associates. The views expressed in this note are those of the author and may not reflect the view or position of S&R Associates.
