BEFORE THE SECURITIES APPELLATE TRIBUNAL
MUMBAI
Appeal No. 27 of 2011
Date of decision: 24.05.2011 E-Land Fashion China Holdings Limited
Walker House, 87 Mary Street,
George Town, Grand Cayman
KY1-90005, Cayman Islands.
…… Appellant
Versus Securities and Exchange Board of India
SEBI Bhavan, Plot No. C-4A, G Block,
Bandra Kurla Complex, Bandra (East),
Mumbai – 400 051. …… Respondent
Mr. Soli Cooper, Senior Advocate with Mr. Arka Banerjee and Mr. Aditya Mehta,
Advocates for the Appellant.
Mr. Kumar Desai, Advocate with Ms. Daya Gupta and Ms. Harshada Nagare,
Advocates for the Respondent.
CORAM : Justice N.K. Sodhi, Presiding Officer
P. K. Malhotra, Member
S.S.N. Moorthy, Member
Per : Justice N.K. Sodhi, Presiding Officer
The short question that arises for our c onsideration is whether the appellant is
liable to pay to the public sh areholders the non-compete fee that has been paid to the
outgoing promoters of the company that has be en taken over. Facts are not in dispute
and these may first be noticed.
- The appellant is a limited liability company incorporated and registered under
the laws of Cayman Islands and ha s its corporate office in Hong Kong. On 2
October 15, 2010 it entered into a share subs cription agreement with Mudra Lifestyle
Limited – a company registered under th e Companies Act, 1956 and it shall be
referred to hereinafter as th e target company. The promot ers of the target company
namely, Mr. Murarlilal Agarwal, Mr. Ra vindra Agarwal and Mr. Vishwambharlal
Bhoot (hereinafter collectively referred to as promoters) were also a party to this
agreement. The appellant agreed to subs cribe to 1,20,00,000 equity shares of the face
value of Rs.10 each of the target company at a price of Rs.60 per share. On the same
day that is, October 15, 2010 the appellant also executed a share purchase agreement
with the promoters whereby it agreed to acquire their shares up to the higher of 1 crore
equity shares or such number of equity sh ares as would, together with the shares
subscribed to under the share subscription agreement, constitute 51 per cent of the
share capital of the target company s ubject to a maximum of 1,24,75,139 shares at a
price of Rs.75 per share inclusive of a non-compete fee of Rs.15 per share. The
appellant also executed on the same day a shareholders agreement with the target
company and the promoters to regulate their respective rights as shareholders of the
target company and their respective respons ibilities regarding the management and
business of that company. Upon the consummation of the transactions described in the
aforesaid three agreements, the shareholding of the appellant in the target company
shall be a minimum of 51 per cent and a maximum of 67 per cent of the post equity
share capital of the target company. Since the equity shares acquired by the appellant
through the aforesaid agreements were in excess of 15 per ce nt of the voting rights in
the target company, the provi sions of Regulations 10 an d 12 of the Securities and
Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 1997 (hereinafter called the takeover code) got triggered. Accordingly,
the appellant made a public announcem ent on October 21, 2010 to acquire up to
95,98,094 equity shares amounting to 20 per cent of the emerging voting capital of the
target company at a price of Rs.60 per share. It is common case of the parties that the
shares of the target company are listed on the Bombay Stock Exchange Limited (BSE)
and the National Stock Exchange of India Limited and are frequently traded on both
these stock exchanges and most frequently traded on the BSE. The appellant claims 3
that it determined the offer price of Rs.60 per share in terms of Regulation 20(4) read
with Regulation 20(8) of the takeover code and that the said price is justified being the
highest of all the four parameters prescrib ed in Regulation 20(4). As the payment of
non-compete fee of Rs.15 per share paid to the promoters under the share purchase
agreement is equal to 25 per cent of the offer price of Rs.60, the same was not added
to the offer price in terms of Regulation 20( 8) of the takeover code. After the public
announcement, the appellant filed in terms of Regulation 18(1) of the takeover code a
draft letter of offer with the Securities a nd Exchange Board of India (for short the
Board) through its merchant banker, SBI Capital Markets Ltd. (merchant banker).
While examining the draft letter of offer, the Board indicated to the merchant banker
that it was inclined to a dd the non-compete fee of Rs .15 per share payable to the
promoters under the share purchase agreement to the offer price in the light of the fact
that the promoters after the acquisition con tinue as co-promoters with the appellant
and queried as to why this should not be done. In response to the Board’s query, the
merchant banker and the legal advisors of the appellant met the officers of the Board
to clarify as to why the non-compete fee should not be added to the offer price. It was
pointed out that such an addition would be bad-in-law and contrary to the provisions
of the takeover code and the earlier decisions of this Tribunal. The merchant banker
then filed detailed written submissions before the Board in this regard. The Assistant
General Manager, Corporation Finance Department, Divisi on of Corporate
Restructuring acting on behalf of the Board did not accept the plea of the merchant
banker on behalf of the appellant and issued directions to the latter, the relevant part of
which are reproduced hereunder:
“4. Offer Price & Financial Arrangements
a. You are advised to add the non comp ete fee to the offer price in the
instant open offer because of the following facts and circumstances:
i. Promoters are still continuing as promoters with the holding of
18.8% (post offer shareholding) with the certain rights and
obligations.
ii. The Promoters shall have the right to appoint 2 (Two) members on
the Board of Directors of target company and 2 (Two) independent
directors of the Target Company shall be jointly selected by the
Promoters and the acquirer.
iii. Promoters shall have the right to appoint 1(one) Joint Managing
Director of the Target Company (“JMD”). The JMD nominated by 4
the Promoters shall be resp onsible for production and
development.
iv. The Board shall not have the power to change the role, powers and
duties of the Promoter JMD as stated above.
v. For a period of 3 (Three) years fr om the date of allotment of the
Investor Shares to the Acquire r (the “Lock-in Period”), the
Promoters shall not be entitled to tr ansfer the shares held by them
in the Target Company, without the prior written consent of the
Acquirer, provided that this restri ction shall not apply to the Free
Flat Shares which shall be freel y transferable by the Promoters
subject to satisfaction of certain conditions.
vi. The Promoters have a right of firs t offer in any sale of shares by
the Acquirer.
vii. The Promoters have a full tag along right or pro rata tag along right
(as applicable) in any sale of sh ares by the Acquirer subject to the
satisfaction of certain conditions.
viii. The Promoters have a put option on the Acquirer for a period of 6
(Six) months after the 3 rd anniversary of the Completion Date
whereby they may require the Acquirer to acquire all the shares
held by them in the Target Company. This put option of the
Promoters shall survive any termination of the SHA.
ix. The rights conferred on the pr omoters under the SPA along with
the disclosure of the intention to be the co-promoters of the target
company, exhibits that the promoters are still in the joint control of
the target company. In such a sc enario, it is not likely that the
promoters would be willing to sepa rate themselves from the target
company and offer competition.
x. Therefore, you are advised to add the non compete of Rs.15/- to
the instant open offer price of Rs.60/- and revise the open offer
price to Rs.75/- (i.e. Rs.15 + Rs.60).
b. In view of aforesaid revised o ffer price vis-à-vis offer size
(inclusion of non compete fee to the offer price), you are advised
to update the escrow account as per Regulation 22(7) of Takeover
Regulations.
…………………………………………………………………”
Feeling aggrieved by the aforesaid directi ons, the appellant has filed the present
appeal. - We have heard the learned se nior counsel on behalf of the appellant and
Shri Kumar Desai, Advocate on behalf of the Board. Before we deal with the
respective contentions of the parties, it is necessary to refer to the non-compete clause
as contained in the share purchase agreem ent and the same is reproduced hereunder
for facility of reference:
“6A. NON-COMPETE
6A.1 For a period which is the later of (a) 3(three) years from the Share
Sale Closing Date, and (b) 2(two) years from the date upon which
the aggregate shareholding of the Promoters falls below 5% (five)
percent of the total Share Capital of the Company as on the Share
sale Closing Date, (the “Non-Compete Period”), the Promoters
hereby undertake to the Purchaser that they shall not, and shall
5
ensure that none of their Affiliates shall, singly or jointly, directly
or indirectly, for their own account or as agent, employee, officer,
director, consultant, or shareholde r or equity owner of any other
Person, engage or attempt to enga ge or assist any other Person
(including their Relatives and non- dependant children) to engage
in the Business.
6A.2 The Promoters further undert ake that during the non-Compete
Period, they shall give-up, part with and/or cease and desist from
carrying on in India any activity or business which is same as that
of the Business in India. During the Non-Compete Period, the
Promoters undertake that any ve nture or investment, whether
directly or indirectl y, in the Business shal l only be undertaken,
carried on, implemented, or he ld through the Company or its
subsidiaries, unless the Purchaser gives prior written consent to the
Promoters to do otherwise.
6A.3 The Promoters undertake that during the non-Compete Period, they
shall not divulge or disclose to any Person any information (other
than information available to the public or disclosed or divulged
pursuant to an order of a cour t of competent jurisdiction or
required under applicable Laws) relating to the business, including
but not limited to the identity of clients, finance, contractual
arrangements, business or methods.
6A.4 The Promoters covenant and agree that during the non-Compete
Period, they will not, directly or indirectly:
(a) attempt in any manner to solicit from any client/customer,
except on behalf of the Company, business of the type
carried on by the Company or to persuade any Person which
is a client/customer of the Company to cease doing business
or to reduce the amount of business which any such
client/customer has custom arily done or might propose
doing with the Company whether or not the relationship
between the Company and such client/customer was
originally established in whole or in part thro ugh his or its
efforts; or
(b) employ or attempt to employ or assist anyone else to employ
any Person as an employee or a consultant (including the
Key Employees) who is in the employment of the Company,
or was in the employment of the Company at any time
during the preceding 12 (twelve) months; or
(c) otherwise interfere in any manner with the contractual,
employment or other relationshi p of any Person (including
the Key Employees) who is in the employment of the
Company, or was in the employment of the Company at any
time during the preceding 12 (twelve) months.
6A.5 The Promoters acknowledge and agree that the above restrictions
are considered reasonable for th e legitimate protection of the
business and the goodwill of the Company. The Promoters further
agree that the Purchase r has agreed to invest in the Company and
to acquire the Sale Shares from the Promoters relying on this
covenant of the Promoters.
6A.6 In lieu of the Promoters’ covenant under this Section 6A, the
Parties agree that out of the to tal Purchase Price, Rs.15 (Rupees
6
Fifteen Only) shall constitute the non-compete fee for each Sale
Share acquired by the Purchaser from the Promoters.”
It is not in dispute that the promoters continue to hol d a minority stake of 18.87 per
cent in the target company and by reason of the aforesaid agreements executed
between the parties they have a right to appoint two members on the board of directors
of the target company and two independent di rectors therein shall be jointly selected
by the promoters and the acquirer. The prom oters also have the right to appoint one
joint managing director of the target company who shall be responsible for production
and development. From these facts the Bo ard has concluded that the promoters are
still in joint control of the target company and it is not likely that they would offer any
competition. It is strenuously argued on behalf of the appellant that the approach of the
Board is wholly erroneous and contrary to la w and that it is not justified in directing
the appellant to include the non-compete fee in the price o ffered to the shareholders.
It is urged that the outgoing sellers are capable of providing competition to the
business as they have the managerial as we ll as financial resources to compete with
the target company and that they could any time resign from the board of directors and
offer competition to the target company whic h has been taken over by the appellant.
The argument is that it is to avoid such an eventuality that the non-compete clause has
been put in the agreement to prevent the promoters from offering any competition.
Shri Kumar Desai, learned counsel for the Board, on the other hand, argued that the
promoters are still continuing to hold a minor ity stake of 18.87 per cent in the target
company and that they have two memb ers on the board of directors and two
independent directors that are jointly sel ected by the promoters and the acquirer. He
further pointed out that the promoters al so have the right to appoint one joint
managing director who shall be in charge of production and deve lopment. He also
referred to the agreements which give the promoters a right of first offer in any sale of
shares by the acquirer. In view of these provisions contained in the agreements, the
learned counsel for the Board contended that the promoters who are still in the joint
control of the target company are not likel y to disassociate themselves from it and
offer competition to the target company and in this background the Board was justified
7
in advising the appellant to add the non-compete fee of Rs.15 to the open offer price of
Rs.60 that has been offered to the sharehol ders. Having heard the learned counsel for
the parties, we are clearly of the view that all the issues that are now sought to be
raised by the respondent sta nd answered in favour of th e appellant in an earlier
decision of this Tribunal in Tata Tea Ltd. vs. Securities and Exchange Board of India
and anr. [2010] 103 SCL 140. This is what the Tribunal has observed in that case –
“6. The recommendations made by the Bhagwati Committee clearly
recognize the legitimacy of the non-co mpete fee payable to the outgoing
sellers. Regulation 20(8) based on these recommendations puts a cap on
such payments so that an acquirer could not reduce the cost of acquisition
through public offer thereby depriving the public shareholders of their
legitimate dues. When examining the validity of the non-compete fee, the
question to be addressed is whether the outgoing sellers are capable of
providing competition to the business alone or in association with third
parties and not whether the busine ss was dependent on the outgoing
sellers. When an acquirer take s over a business from the outgoing
seller(s), it is obvious that the sellers have sp ecific 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 ag reement with the promoter sellers
if he feels threatened by a lurking fear of compet ition from them. It is
neither for the Board and not even for this Tribunal to analyse the threat
perception of the acquirer. We ar e of the view that a non-compete
agreement would then protect not onl y the target company but also its
continuing shareholders. An acqui rer has a right to protect his
investment/business from competition by a seller of the business and this
right is a long standing customary el ement in business sale transactions
and is even recognised by law. Secti on 27 of the Contract Act recognises
that non-compete agreements are not in restraint of trade if the restrictions
placed are reasonable. The Law of C ontract (Treitel, Sweet & Maxwell)
11th Edition at page 455 after relyi ng on Connors Bros. Ltd & Ors. vs.
Connors succinctly states the law as under:-
“A person who sells shares in a company which he controls
may covenant not to compete in respect of the business
carried on by the company. Such a covenant may be valid
if it was in substance the se ller who, through his control of
the company, carried on the business”.
Again, the terms of the non-compete ag reement have necessarily to be
decided between the acquirer and the outgoing promoter sellers and based
as they are, on business consideratio ns, the Board and this Tribunal have
no role to play. However, if they agree to fix the non-compete fee in
excess of 25 per cent of the offer price as determined under sub-
regulations (4) or (5) of Regulation 20 of the takeover code, the amount in
excess of 25 per cent of the offer pr ice shall be added to the offer price
which shall be offered to all the public shareholders. It is common ground
between the parties that in the case before us, the amount of Rs.3 crores
which the appellant as the acquirer has agreed to pay to the promoters as
8
non-compete fee comes to Rs.9.64 per share which is only 6.96 per cent of
the offer price as worked out under Regulation 20(4) of the takeover code.
This is far less than the maximum prescribed by Regulation 20(8) and is in
compliance with the takeover code. We are satisfied that this payment of
non-compete fee is not an attempt on the part of the appellant to reduce the
cost of acquisition to discriminate against the public shareholders.
- We are also in agreement with Shri Janak Dwarkadas learned
senior counsel appearing on behalf of the appellant that the payment and
quantum of the non-compete consider ation is based on strong business
rationale. It is not in dispute that the target company is in possession of a
unique source of water and is engaged inter alia in the business of
sourcing, manufacture, bottling and dist ribution of natural mineral water
and are owners of the “Himalayan” brand, a premium luxury brand of
natural mineral water. It was rightly argued on behalf of the appellant that
the knowledge and expertise of the pr omoters in managing and exploiting
the said source is critical to the operations and the worth of the target
company. The appellant as the acquirer is a new entrant to the business as
a strategic player and hence it requ ires support and not competition from
the promoters to realise its commercial objectives. It is not disputed that
as on the date of the filing of the ap peal, the appellant held 34.29 per cent
of the equity share capital of the ta rget company and being in control of
the target company it was important for it to ensure that the promoters,
who continue to hold a much smalle r stake in the targ et company, do not
compete with it in any manner. A re ference to the non-compete provision
which has been reproduced in the earlier part of our order would show that
it is an obligation that binds not only the promoters but also their affiliates
and, therefore, the obligations are quite extensive. A sum of Rs.3 crores
has been paid as non-compete consideration to the seller promoters for not
competing for a period of one year from the termination of the
shareholders agreement executed on June 1, 2007 and it can be presumed
that during this period the acquirer would stabilize in the business. - Shri Kumar Desai learned counsel appearing for the Board
strenuously contended that the promoter s are on the board of directors of
the target company and hold a minority stake therein and, therefore, in the
very nature of things they could not offer any competition to the business
of the target company. According to the learned counsel, the appellant
was not justified in paying non-comp ete fee to the promoters without
paying the same to the public sharehol ders. Shri Desai referred to the
judgment in Boulting vs. Association of Cinematograph, Television and
Allied Technicians (1963) 2 QB 606 and urged that directors of a
company act as its agents and cannot enter into engagements in which they
have a personal interest c onflicting with the interest of the company. He
relied upon the following words of Lord Cranworth L.C. in Aberdeen
Railway Co. vs. Blaikie Brothers which were quoted in Boulting’s case
(supra):-
“The directors are a body to w hom is delegated the duty of
managing the general affairs of the company. A corporate
body can only act by agents, and it is of course the duty of
those agents so to act as best to promote the interests of the
corporation whose affairs they are conducting. Such agents
have duties to discharge of a fiduciary nature towards their
principal, and it is a rule of universal application, that no
one, having such duties to disc harge, shall be allowed to
enter into engagements in which he has, or can have, a
personal interest conflicting, or which possibly may
conflict, with the interests of those whom he is bound to
protect.” 9
It is true that the directors of a company discharge a fiduciary duty and
cannot allow their own interest to c onflict with that of the company but
such duties cease to exist the moment th ey resign from the directorship of
the company. In the case before us , there is nothing to prevent the
promoters from resigning from the directorship of the target company and
setting up a rival business. It is with a view to safe guard against this
possibility that the appellant as the acquirer ente red into the non-compete
agreement with the promoters with a vi ew to protect the interest of the
target company and its continuing shar eholders. Equally, there is nothing
that prevents the promoters from di vesting their minority stake in the
target company if that were to become necessary.”
It is the case of the appellant which is not disputed by the Board that Mr. Murarilal
Agarwal and Mr. Ravindra Agarwal are fam ily 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 extensiv e knowledge of the market and intimate
knowledge of the target company’s busin ess, employees, suppliers, customers,
systems and technological know-how. In this background, they are capable of offering
competition to the target company. The appe llant, on the other hand, belongs to the
South Korea based E-Land Group of Co mpanies which has limited operating
experience in the textile manufacturing industry in India. Having taken over the target
company, it would like to take the benefi t of the knowledge a nd expertise of the
promoters in managing such a business in Indi a 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 in terest of its sharehol ders. 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 disc riminate against the
public shareholders. The aforesaid observati ons made by the Tribunal in the case of
Tata Tea Ltd. (supra) and also in the cas e of Cementrum IB.V. vs. Securities and 10
Exchange Board of India and anr. App eal no. 28 of 2008 decide d on July 8, 2008
squarely support the case of the appellant. - Before concluding, we may take note of an objection raised by the Board in its
reply. It is stated that the impugned communication dated January 28, 2011 by which
the observations of the Board were communicat ed to the appellant is not an ‘order’
within the meaning of Section 15T of the Se curities and Exchange Board of India
Act, 1992 (for short the Act) and, therefore, the present appeal is not maintainable.
Since we have summarily rejected this obj ection in some earlier cases, the learned
counsel for the Board wanted us to take note of this objecti on. After the public
announcement is made, the acquirer is required to file with the Board a draft letter of
offer to the public shareholders containing the requisite disclosures. This draft letter is
filed under Regulation 18(1) of the takeover code. The draft letter of offer is then
examined by the Board and it can require the merchant banker and the acquirer to
make changes therein. If some changes are suggested, the acquirer and the merchant
banker have no choice but to carry out those changes before sending the letter of offer
to the shareholders. This is what the first proviso to Regulation 18(2) of the takeover
code provides:
“Provided that if, within 21 days from the date of submission of the letter
of offer, the Board specifies changes, if any, in the letter of offer (without
being under any obligation to do so), the merchant banker and the acquirer
shall carry out such changes before the letter of offer is dispatched to the
shareholders:
Provided further that……………………………………………”
The word ‘shall’ used in the proviso leaves no room for doubt that whatever changes
are suggested by the Board have to be car ried out by the acquirer and his merchant
banker and it is not open to them to ignor e those suggestions. The word ‘order’ has
been defined in Black’s Law Dictionary (Sixth Edition) to mean “a mandate;
precept; command or direction authoritativ ely given; rule or regulation.” Since
the changes suggested by the Board have to be carried out, the communication through
which those changes are suggested is a comm and or a direction authoritatively given
and, therefore, an order. There would have been merit in the objection raised by the 11
Board if it was open to the acquirer not to co mply with the changes as pointed out by
the Board. But that is not the position. We ha ve, therefore, no hesitation to hold that
the communication from the Board suggesting changes in the letter of offer is an order
within the meaning of Section 15T of the Act and the person feeling aggrieved could
always come up in appeal. The objection is overruled. - For the reasons recorded above, the a ppeal is allowed and the question posed
in the opening part of our order answ ered in the negative. The impugned
communication dated January 28, 2011, in so far as it directs the appellant to include
the non-compete fee in the offer price, is se t aside. The said fee shall not be included
in the offer price. The appellant may now issue the letter of offer to the shareholders in
accordance with law within the next two weeks from today. There is no order as to
costs.
Sd/-
Justice N. K. Sodhi
Presiding Officer
Sd/-
P. K. Malhotra
Member
Sd/-
S.S.N. Moorthy
Member
24.05.2011
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