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Indias M&A Regulatory Environment Amalgamation: Mergers and De-mergers Acquisitions Delisting Process
Section 1
The Indian M&A environment is a highly regulated one with several pieces of legislation as well as institutions exerting control over the process
The Indian M&A environment is a strongly regulated by the following major pieces of legislation/bodies: The Companies Act, 1956 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (The Takeover Code) The Monopolies and Restrictive Trade Practices Act, 1969 The Foreign Exchange Management Act, 1999 The Foreign Investment Promotion Board (FIPB) The Reserve Bank of India The Income-tax Act, 1961 Competition Act, 2002 (not yet operative) Mergers, amalgamations, de-mergers, acquisitions of business units or divisions, are all governed by The Companies Act Acquisitions of shares in listed Indian companies is governed by The Takeover Code
The following slides briefly outline the regulatory implications of each of these key segments of domestic Indian M&A activity Note however, that the slides outline key implications in a very broad and simplistic manner The specifics of each transaction invariably require much more detailed and in-depth analysis of various regulatory provisions, particularly The Companies Act and The Takeover Code
Indian M&A
Amalgamations
Acquisitions
Merger
De-merger
Asset Purchase
Stock Purchase
Amalgamation: Merger/De-merger
Governed by Companies Act, 1956 High Court approval process 69 months timeline Results in outright sale/purchase Target ceases to exist Valuation, pricing regulated Largely stock transactions No major minority shareholder issues Pooling accounting (2) Bankers / Accountants / Lawyers play prominent role
Asset Acquisition: governed by Companies Act, 1956 Stock Purchases: Governed by Takeover Code No High Court approval process 34 months timeline Could result in outright sale/purchase Target neednt cease to exist (1) Largely cash transactions/offers Minority shareholder issues Tender offer open for 20 days Pooling/Purchase Bankers play more prominent role in determining method of purchase, price
Notes 1. Although delisting is possible in the event of a 100% stock acquisition 2. Goodwill written off over 5 years
The Companies Act governs all forms of amalgamations including mergers and spinoffs.
Indian Companies Act governs the law relating to formation, constitution, regulation, management and liquidation of Indian Companies
Section 81/81(1A)Provisions regarding approval for issue of securities and preferential allotment
Sections 391394AProvisions regarding the manner and process of executing mergers, acquisitions, amalgamations, de-mergers, or any re-organization or arrangement
(1)
The Companies Act governs all forms of amalgamations including mergers and spinoffs.
Indian Companies Act governs the law relating to formation, constitution, regulation, management and liquidation of Indian Companies
Section 81/81(1A)Provisions regarding approval for issue of securities and preferential allotment
Sections 391394AProvisions regarding the manner and process of executing mergers, acquisitions, amalgamations, de-mergers, or any re-organization or arrangement
(1)
The single most critical piece of corporate legislation affecting domestic M&A activity is The Takeover Code
SEBI, the prime regulator for capital markets, was setup to protect the interests of the retail investor and to promote the development of and regulate the securities market SEBI (Disclosure and Investor Protection) Guidelines, 2000Instituted to regulate capital market issuances. Chapter XIII specifically deals with Preferential Allotment of Securities SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (Takeover Code) Instituted to govern the acquisitions in listed companies with the objective of providing protection to minority shareholders SEBI (Prohibition of Insider Trading) Regulations, 1992Instituted with the objective of preventing insider trading and for investor protection SEBI (Delisting of Securities) Guidelines, 2003Instituted with the objective of providing the regulatory framework for delisting of securities, with the objective of protecting the interest of minority shareholders Listing AgreementContractual agreement between the companies and the Stock Exchanges they are listed on Clause 40A specifies minimum public holding in listed entities, excluding founders/promoters Clause 49 specifies Corporate Governance requirements for listed entities Securities Contracts (Regulations) Act, 1956Provides a framework for functioning of various entities in the capital markets
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Government/ RBI
Competition Act, 2002Instituted to prevent practices having adverse impact on the competitive environment (Not yet operative) Foreign Investment Promotion Board (FIPB)Regulates and approves the foreign investments being made in India in various industries. Requirement to take an approval from existing JV partner/technology transfer/trademark agreement for setting up new JV under Press Note 1 (2005 Series) Foreign Exchange Management Act, 1999Instituted to facilitate external trade and payments and for promoting the orderly development and maintainance of foreign exchange market in India. Provides for procedures for taking approvals, including RBI approval, for financial transactions between residents and non-residents
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Section 2
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Business reorganizations such as mergers and de-mergers, are carried out with the approval of the jurisdictional state High Court The High Court process typically takes around 69 months
Section 391-394 of the Companies Act, 1956 (Companies Act) deal with Schemes of Arrangement (in common terms, mergers). The term merger has not been legally defined under the Companies Act Typically, a simple merger/Scheme of Arrangement eventually provides for: Transfer and/or vesting of the target company division or the target company assets into the acquiror company Restructuring of capital: issuing of new securities in line with a share exchange ratio Prior to this, several steps occur leading to the transaction nearing completion must occur: Approval of the Board of both Companies to the Scheme and the share-exchange ratio based on the valuation report of the independent valuation experts hired by each Company Communication of Board decision to Stock Exchanges in case of listed companies Obtaining Fairness Opinion, in case of listed companies Approval of Stock Exchanges where the target and acquiror (if listed) are listed Scheduling of a High Court appointed dates for both sets of shareholders Sanction of the Scheme of Arrangement by both target and acquiror shareholders, creditors, with each Company requiring at least 75% of its shares outstanding to vote For the transaction Transfer of employees on same or similar terms and conditions of service Continuation of legal proceedings pending by or against the transferor company Implementation through a Court scheme under Sections 391394 of the Companies Act Sanction of the relevant High Courts
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Amalgamation/Scheme of Arrangement
Amalgamation
Merger of one or more companies with another company
For mergers/amalgamations/ Schemes of Arrangement, acquiror stock is often used to effect the transaction Once 75% of target shares outstanding are exchanged for shares of acquiror, merger takes effect and target company is dissolved
Amalgamating Companies
Amalgamation Merger: A Court approved process (as per Sections 391-394 of Companies Act). Basic requirements are prescribed under section 2(1B) of the Income Tax Act Merger of one or more company(s) With another company To form one resultant company so that; (i) All assets of target company becomes property of acquiror company; (ii) All liabilities of target company become liabilities of acquiror company; (iii) Shareholders of not less than 75% in value (other than shares already held) of target company become shareholders of acquiror company by virtue of the merger (iv) At this point, Target Company, in effect, ceases to exist
Income Tax Implications (Conditioned on above being effected)
Amalgamated Company
Stamp duty implications on M&As in most states of India Sales tax implications depending upon the merger arrangement Dealing with dissenting shareholderstarget company ceases to exist
No capital gains tax implications for either the Company or the shareholders of the Company No tax implications of business profit Depreciation benefits available to amalgamated company (resulting company) in respect of depreciation of assets that belonged to the transferor company prior to amalgamation Amalgamated Company, in prescribed business areas, is permitted to carry forward losses of prior year and/or unabsorbed depreciation (of the amalgamating company) on satisfaction of certain conditions, which include: Amalgamated company holds the assets (atleast 3/4th in book value of assets of the amalgamating company for 5 years minimum)
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De-merger
Transfer of undertaking pursuant to shareholders approval and a scheme of arrangement under section 391- 394 of the Companies Act
Tax Implications De-merger
As per Income Tax Act
BEFORE DE-MERGER
Shareholders
Tax breaks are available only if demerger is in accordance with section 72(A) and other provisions of Income tax Act. Benefits are: No capital gains tax implications on the Company being de-merged or the shareholders of the Company Accumulated losses and unabsorbed depreciation available in respect of the assets of demerged undertaking are available to resultant undertaking Stamp duty may be payable depending upon the regulations of the State where the Company is registered No Sales tax implications
De-merger has been defined in section 2(19AA) of Income tax Act, to mean transfer, pursuant to a Scheme of Arrangement under Sections 391 to 394 of the Companies Act, by a de-merged company of its one or more undertakings to any resulting company in such a manner that: i) All the property of the undertaking, being transferred by the demerged company, immediately before the de-merger, becomes the property of the resulting company by virtue of the de-merger. ii) All the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the de-merger, become the liabilities of the resulting company by virtue of the de-merger. iii) The property and the liabilities of the undertaking or undertakings being transferred are transferred at book value. iv) The resulting company issues, in consideration of the de-merger, its shares to the shareholders of the de-merged company on a proportionate basis. v) The shareholders holding not less than three-fourths in value of the shares in the de-merged company (other than shares already held immediately before the de-merger) become shareholders of the resulting company or companies by virtue of the de-merger. vi) The transfer of the undertaking is on a going concern basis.
A
De-merged Company
AFTER DE-MERGER
Shareholders
A^
B
De-merged Company
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Slump Sale has been defined under section 2(42C) of the Income Tax Act as: transfer of one or more undertakings as a result of sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales Stamp duty implications depending upon the State where the registered office of the Company is located
Transfer of an undertaking, under section 293 of Companies Act, for a lump-sum consideration without assigning values to individual assets/liabilities
Mechanics BEFORE SALE OF UNDERTAKING Shareholders
Transfer of division for a consideration (networth of the undertaking is computed considering both assets and liabilities) Report by an accountant regarding computation of net worth of the company Slump Sale involves selling a division (assets and liabilities of that division) or creating a subsidiary of an existing division by transferring the division into a New Company Cash or shares of the new company can be issued as consideration
Taxation
A
Company
Capital gains implications to transfer company, as per section 50B of Income Tax Act If assets are transferred at tax written down value, then no capital gains tax implications Period of holding of undertaking before the de-merger will affect the rate of taxation Transfer of inventory is not considered a separate sale transaction Depreciation benefits are available to the acquiror company on assets acquired Carry forward of losses allowable to acquiror company
B
Company
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Different shareholding levels assume significance since shareholders can pass certain resolutions only with the minimum support of certain percentage of shareholders Decisions, other than day to day decisions, can be passed only by way of special resolution; thus a shareholder holding 25%+ can effectively block the special resolutions
< 10%
Can prevent acts which are ultra vires the Company or illegal and can approach the Central Government to sue management for oppression of minority shareholders or mismanagement of the Company Can sue management for oppression of minority shareholders and mismanagement of the Company Can block special resolutionsthe passing of which requires prior notice to be given to members, and votes cast in favour of the resolution be at least 3 times the votes cast against it Can pass an ordinary resolutionwhich governs most matters and covers: Adopting the annual accounts matters relating to the capital structure of the Company Issues relating to the appointment of auditors and their remuneration Issues relating to the appointment of directors including the Managing Director, their remuneration and permission for exercise of certain powers Matters associated with the voluntary dissolution of a Company
> 50%
> 75%
Can pass a special resolution. Some of the decisions requiring a special resolution are: Change in the Memorandum and Articles of Association of the Company Approval for the commencement of a new business Alteration of the rights of holders of special classes of shares Any scheme of arrangement under Section 391-394 Specific issues regarding the dissolution of a Company Issue of shares to other than the existing shareholders Buyback of shares and reduction of capital
100%
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Step
Appoint Investment Bankers to examine prospects, valuation Identify Target, prepare presentation for Board of Directors File Notice of Board of Directos meeting with Stock Exchange (assumes listing) Begin negotiations with Target, preparation of a Scheme of Arrangement Board of Directors to approve draft Scheme of Arrangement, with valuation and other transaction details included Approved Scheme of Arrangement filed with High Court/s High Court/s to provide date for shareholders meeting EGM for acquiror shareholders: 75% of shares outstanding must vote For transaction EGM resolutions with vote filed with the Registrar of Companies Chairman/MD must file EGM, report with High Court within 7 days of EGM concluding Company to seek High Courts confirmation of Scheme of Arrangement High Court sanctions presented Scheme of Arrangement Approved Scheme to be filed with Registrar of Companies within 30 days of High Court order Allotment of shares Transaction fully executed
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Pre-Board Approval
Weeks
10
Weigh Structuring Options & Tax Impact & finalize structure Company to provide information to bankers to complete valuation
Appoint PR Agency
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Post-Board Approval
Weeks
Begin negotiations with target, conduct Analyst Roadshow
10
11
12
13
14
15
16
17
18
19
20
21
22
After Stock Exchange approval, Draft Scheme of Arrangement filed with High Court
Send a copy of the application made to the concerned High Court, to the Central Government, Dept. of Company Affairs
Send notice for the General Meeting to every shareholder along with explanatory statements
20
Weeks
Extra-ordinary General Meeting of shareholders 75% of shares outstanding must vote for transaction EGM resolutions to be filed along with explanatory statement with Registrar of Companies Forward to the Stock Exchanges, 3 copies of the notice of the meeting and a copy of the proceedings of the General Meeting
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24
25
26
27
28
29
30
31
32
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34
35
Report of the Chairman to be filed with the High Court within 7 days of EGM Petition and affidavit to be prepared and approved by the Companys solicitors, Company to present petition to the Court for confirmation of the Scheme of Arrangement Petition comes up for hearing by court which requires Company to give 21 day notice to Dept. of Company Affairs Courts to sanction the Scheme of Arrangement Certified true copies of the orders of the High Courts approving the Scheme of Arrangement will be filed with the Registrars of Companies within 30 days of obtaining the copy of the order RBI approval to be obtained for issue and dispatch of shares under FEMA
Effective Date
Allotment of Shares
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Section 3
Acquisitions
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ACQUISITIONS
Stock acquisitions generally occur without any High Court approvals and in a more expedited manner A typical stock acquisition takes between 34 months to be executed Various provisions of The Takeover Code trigger Tender Offers that the Acquiror must make These Tender Offers are usually in cash with a minimum price set by The Takeover Code, 1997 Key Acquisition Benchmarks: 0% 14.99%: No restrictions Above 15%: Tender Offer for at least 20% 15% - 55%: 5% annual stake enhancement through preferential issuance / open market purchase / buy-back 55% - 75%: 5% annual stake enhancement through open market in normal segment on stock exchanges Promoters holding less than 75% / 90% of the capital of the company can make a voluntary tender offer to consolidate its holding
SEBI (Substantial Acquisition & Takeover) Regulations, 1997 (The Takeover Code), governs acquisitions of stocks in listed Indian companies An Acquirer may begin purchasing stock without any requirement of a Tender Offer until a 15% ownership (all thresholds refer to Shares Outstanding) threshold Once this is reached, or if control is acquired at a holding below 15%, the Code requires the holder to launch a Tender Offer for a minimum of a further 20% of the shares outstanding in the Target At this point, assuming the Acquirer has a 35% stake in the Target, it may do one of several things:
Gain control (no other shareholder at 35%): if the initial offer is for change of control, otherwise another offer Not gain control and simply retain his interest at 35% Increase its stake by increments of less than 5% within a fiscal year, and can go up to 55% through
market normal segment on the stock exchanges i.e. not though bulk deals / preferential allotments / negotiated transaction
Increase its stake by increments more than 5% within the fiscal year: if so, he is again required by the Code to
launch another Tender Offer for at least 20% of the shares outstanding
Begin a full merger/amalgamation process if he is keen on realizing synergies and confident of shareholder /
High Court approvals Each of these Tender Offers may be for stakes larger than 20% at the Acquirer's sole discretion. The minimum price and size are however regulated by The Takeover Code Any acquisition beyond 75% would mandate a tender offer for minimum of 20% and depending on the market capitalization of the Target, Acquirer can hold up to 75% / 90%
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ACQUISITIONS
Shares may be acquired either by way of block deal with select shareholders, tender offer (to all the shareholders), or through open market purchases Acquisition of a stake in a listed Indian company requires compliance with key regulations Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997 (the Takeover Code) of Securities and Exchange Board of India (SEBI) The Takeover Code stipulates requirement, depending upon the nature and quantum of the acquisition, of making an offer to purchase shares from the public shareholders, including The minimum number of shares for which the offer is to be made The minimum price at which the shares must be acquired In the event the public shareholding in the Indian Company falls below the specified 10%, then The acquirer has to make an offer to buy out the outstanding shares remaining with the shareholders, resulting in de-listing of the Company, or for delisting the company process prescribed under delisting guidelines needs to be followed The acquirer has to divest, through an offer for sale or by a fresh issue of capital to the public, to keep the public holding at the prescribed levels and prevent a delisting FIPB and/or RBI approval may be required in specific cases
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ACQUISITIONS
Issuance of a public announcement is a prerequisite for proceeding with any transaction under Regulation 10, 11 or 12 For Regulation 10 & 11, Acquisition means & includes: Direct acquisition in a listed company Indirect acquisition by virtue of acquisition of companies, whether listed or unlisted, whether in India or abroad Open Offer may be made under any or combination of Regulation 10, 11 and 12
Regulation 10 Substantial Acquisition of Shares Open Tender offer under Regulation 10 needs to be made if the Acquiror (along with the PAC) decides to acquire, directly or indirectly, more than 15% of the shares outstanding in a concerned target company Once an entity has acquired a 15% stake in target, individually or as part of a group, the entity must make a tender offer for a minimum of 20% of the shares outstanding (not including shares already owned)
Regulation 11 Consolidation of Holdings Open Tender offer under Regulation 11 (1) needs to be made by Acquirer alongwith the Person Acting in Concert if: Acquirer and PAC already hold >15% but <55% of the Voting Capital of Target Company Want to exceed the creeping limit of 5% in a financial year Offer under Regulation 11 (2) needs to be made if the Acquirer alongwith PAC want to exceed 55% shareholding in the Target Company (other than 5% creeping acquisition from open market in one financial year up to 75%)
Regulation 12 Acquisition of Control Open Tender offer under Regulation 12 needs to be made by the Acquirer and PAC if they want to acquire control over a Target Company Offer needs to be made irrespective of: Whether or not there has been any acquisition of shares or voting rights in a target company Whether the control is acquired directly or indirectly This regulation is not applicable if the change in control takes place pursuant to a special resolution passed by the shareholders in a general meeting
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ACQUISITIONS
If shares of the company are frequently (1) traded It shall not be less than the highest of the following: 1. 2. 3. 4. The Negotiated Price under an agreement, if any, triggering the code Highest Price paid by the Acquirer during the 26-week period prior to the date of public announcement for acquiring shares of Target Company, including by way of allotment in a public or rights issue The Price paid by the Acquirer under a preferential allotment at any time during the 26- week period up to the date of closure of the offer The Average of the weekly high and low of the closing prices of the shares of the target company as quoted on the most frequently traded stock exchange during 26 weeks preceding the date of the public announcement(2) The Average of the daily high and low prices of the shares of the target company as quoted on the most frequently traded stock exchange during 2 weeks preceding the date of the public announcement(2)
5.
If the shares of the company are not frequently (1) traded, then it shall not be less than the highest of 1. 2. 3. 4. The Negotiated Price under an agreement, if any, triggering the code Highest Price paid by the Acquirer during the 26-week period prior to the date of public announcement for acquiring shares of Target Company, including by way of allotment in a public or rights issue The Price paid by the Acquirer under a preferential allotment at any time during the 26- week period up to the date of closure of the offer Other parameters including return on net worth, book value of shares, EPS, price earnings multiple vis--vis the industry average. In such cases, it is advisable to get valuation from a chartered accountant in line with the Supreme Court decision in HLL Tomco case
Notes 1. Shares are said to be frequently traded on the stock exchange when the annualized trading turnover in that share in the preceding 6 calendar months prior to the month in which public announcement is made is more than 5% of the number of listed shares. 2. In case the public announcement of offer is pursuant to acquisition by way of a firm or preferential allotment, the average prices are calculated with reference to the 26 week period preceding the date of board resolution which authorized the firm or preferential allotment
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ACQUISITIONS
The Tender Offer shall be made to acquire a minimum of 20% of the voting capital of the target company 15 days after the closure of the offer Tender Offer under Regulation 11(2A) (i.e. consolidation of holding beyond 55%) can be for a minimum of 20% of the voting capital of the company Such other lesser percentage of the voting capital of the company, assuming full subscription to the offer, enable the acquirer, to increase its holding to the maximum level possible (75% or 90%), meeting the requirements of minimum public shareholding The offer can also be made conditional upon minimum level of acceptances from the shareholders. In such a case, the acquirer will have to deposit in the escrow account in cash a sum of 50% of the consideration payable under the public offer and also agree to cancel the MOU. Such conditionality should be mentioned in the Public Announcement will not work if offer is triggered pursuant to preferential allotment
To be made latest with 4 working days of decision which triggers the Offer. In case of indirect acquisition or change in control, within 3 months of consummation of acquisition or change of control or restructuring of the parent company holding shares or control over the target company in India. Not later than 4 working days prior to exercise of any warrants, conversion of convertible securities or exchange of GDR/ADRs into shares.
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ACQUISITIONS
The Timeline indicated is the most elaborate process possible All preparatory work to be completed prior to the Trigger Date by the Acquiror and the Investment Banker
X-4
Date of passing a firm and final resolution by Board/constituted Committee (Trigger Date) Draft copy of Public Announcement submitted to SEBI, Stock Exchanges & Target Public announcement to be published in leading newspapers
In 4 working days from the Trigger Date
X+14
Draft Letter of Offer and due diligence cert. filed with SEBI, Stock Exchange & Target
Not later than 14 days from the Public Announcement
X+35
X+45
X+55
X+63
X+75
X+90
X
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Section 4
Delisting Process
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DELISTING PROCESS
The de-listing offer could either result from provisions of the Takeover Code, wherein due to
the acquisition public holding falls below the prescribed limit in this regard, or could be a voluntary offer driven by desire to de-list
Under Regulation 6 of the De-listing Guidelines, by a prior special resolution,
shareholder(s)/promoter(s) could make an offer under Regulation 5 for voluntary de-listing by using the reverse book building method to determine the price
If the discovered price is unacceptable to shareholder(s)/promoter(s), the Offer can be
withdrawn
Under Regulation 8, in the event of securities being de-listed, the acquiror shall allow a further
period of 6 months for any of the remaining shareholders to tender securities at the same price. Further, the payment for de-listing has to be made entirely in cash
SEBI is in the process of substantially amending the de-listing procedure and it proposes to do
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DELISTING PROCESS
Before making application to the Stock Exchange, Acquirer shall make a Public Announcement (PA)
Price Determination
An exit price shall be determined in accordance with the Reverse Book-building process The Offer shall have minimum floor price which will be the average of 26 weeks traded price on the stock exchange where SubCo is listed (if the stock is frequently traded) 26 weeks shall be calculated from the date of PA If the shares of the company are not frequently traded, then follow the pricing guidelines for infrequently traded shares as per SEBI Takeover Code. The final offer price shall be determined as the price at which the maximum number of shares have been offered
Right of the Acquirer/Promoter
The Acquirer has the option to accept the offer price as determined If the Acquirer does not accept the offer price, It shall not make an application for delisting of securities It shall ensure that public shareholding is brought to the level specified in the Listing Agreement
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DELISTING PROCESS
On determination of the final price, Acquirer shall within 2 working days: Make public announcement of acceptance or not acceptance of the final offer price Communicate to all stock exchanges from where de-listing is sought
Payment Consideration
Where fewer number of shares are accepted compared to the total shares outstanding and public shareholding does not fall below minimum limit specified by the Listing Agreement, the Offer shall be considered failed
Escrow Mechanism
The Acquirer shall deposit in an escrow account, 100% of the estimated consideration based on the minimum floor price and the number of securities required to be acquired
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DELISTING PROCESS
Price Determination
Discovered PriceAn Illustration
The price at which the highest number of shares are tendered is the Exit Price, even if sufficient number of shares required for delisting are tendered at a price lower than the price as discovered Acquirer is free to fix a higher price than the Discovered Price
Discovered Price
Bid Process
Price (Rs.) Quantity
50
Floor Price: Rs.40 Offer Price: Rs.50 Discovered Price (Rs.60) Exit Price: Rs.65 (Subject to Premium)
70 75 55 60 65
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