Deciphering Stock Exchange’s Observation in giving NOC to Draft Schemes of Arrangement - MMJC

Introduction

Regulation 37 of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘SEBI LODR’) mandates every listed entity desirous of undertaking a scheme of arrangement or involved in a scheme of arrangement under sections 230–234 and section 66 of Companies Act, 2013 to file the draft scheme of arrangement with the designated stock exchange(s) for obtaining the no-objection certificate, before filing such scheme with National Company Law Tribunal.

The designated stock exchange’s approach for granting the no-objection certificate is based on certain parameters identified by the stock exchanges. Designated stock exchange may issue an observation letter pursuant to which it shall direct modifications or omissions to be done in the respective scheme(s) filed with it or give mandates to adhere to specific provisions and circulars as specified by designated stock exchanges. It may also direct to incorporate its observations or comments in the scheme.

However, in certain circumstances Stock Exchanges may reject and return the scheme absolutely or subject to compliance of certain conditions. In this article, we shall study the list of schemes rejected by stock exchange and the reasons for rejecting the schemes.

Schemes rejected by the stock exchanges on repeated grounds:

• The stock exchange has rejected schemes on various occasions owing to breach of the Fit and Proper Status. Compliance with ‘fit and proper status’ is checked only when companies involved in scheme of arrangement are SEBI registered intermediaries. The reason of such rejections are as follows:
  • The scheme was rejected due to the chargesheet filed by the Economic Offence Wing against the Managing Director of the company proposed to be merged and the ongoing investigation into their ‘fit and proper’ status under the Securities and Exchange Board of India (Intermediaries) Regulations, 2008¹. Given the potential legal ramifications and the uncertainty surrounding the Managing Director’s future, it was deemed necessary to assess the potential impact on the businesses of the Transferor, Transferee companies, and the proposed scheme of arrangement. This clarity was essential to ensure investors could make informed decisions regarding the viability and potential risks associated with the merger.
  • In another case the scheme was rejected owing to ongoing prosecution proceedings against the directors on the board of the Transferor Company and Transferee Company. Stock exchanges also directed the company to examine the impact of the proceedings on the scheme, companies, and investors.

Schemes rejected by the stock exchanges due to other miscellaneous reasons–

• The entities involved in scheme of arrangement have not meet the minimum public shareholding requirement under SEBI (LODR) and para (A)(3)(b) of Part – I of SEBI Master Circular dated 20^th June 2023². Further, SEBI advised to file fresh application by complying with the SEBI Circular.
• Draft scheme was not in compliance with clause III(A)(1)(a) of Annexure I of the SEBI Circular No. CFD/DIL3/CIR/2017/21³, i.e. the equity shares to be allotted by the Transferee company to the shareholders of the transferor companies was not sought to be listed, basis which SEBI has returned the draft scheme, and the company was advised to re-submit the same after ensuring compliance with the provisions mentioned in the circular.
• The draft Scheme was contingent upon the successful completion of a concurrent scheme, the timeline for which is currently uncertain. As a result, stock exchange decided to defer approval of the draft Scheme until the outcome of the concurrent Scheme is determined or until it receives NCLT approval.
• The Company executed a Slump Sale Agreement on September 6, 2023, and subsequently approved a Scheme of Amalgamation on September 25, 2023. The Scheme was contingent upon the successful completion of the Slump Sale. However, the Stock Exchange returned the Scheme as the Slump Sale condition precedent was not fulfilled at the time of applying for the No Objection Certificate under Regulation 37 of the SEBI (LODR).
• The Scheme for reduction of share capital between a company and its shareholders was rejected because incomplete information was submitted at first instance and even after repeated emails being sent for same by regulatory authorities.
• One of the companies to the scheme of merger had not applied for registration as NBFC under Section 45-1A of the RBI Act, 1934 and was wrongfully disclosing in its financial statement regarding having applied for registration as an NBFC. Further, the company was conducting NBFC activities without holding a certificate of registration issued by RBI, which is in violation of Reserve Bank of India Act, 1934. In view of the aforesaid, SEBI returned the draft scheme.
• SEBI has rejected the scheme basis the unresolved complaint of another company against the captioned scheme before the Hon’ble High Court, Kerala. SEBI has returned the scheme and has advised to re-submit the same upon resolution of the complaint and disposal of the case.
• The rationale of the scheme was based on the fact of the company having negative retained earnings however by the time the scheme of merger came for consideration before the stock exchange, the negative retained earnings had progressed to positive retained earnings owing to significant profits because of which the justification for the proposed scheme was no longer warranted and hence rejected by the exchange.
• As per NSE’s standard operating procedures dt: December 20, 2022⁴, draft scheme shall be filed within 15 days of approval of Scheme by the Board of Directors of the company but the same has been filed after 15 days which is in non-compliance of SEBI Standard Operating Procedures. Consequently, the scheme has been rejected.

Key Learnings for Successful Filling of Schemes with BSE

• Address any outstanding legal proceedings, financial instability, or unresolved disputes before filing a scheme.
• Conduct a thorough due diligence process to identify and address potential risks and issues.
• Keep abreast of any changes in SEBI guidelines to avoid non-compliance.
• Ensure strict adherence to SEBI regulations, particularly those related to minimum public shareholding, disclosure requirements.
• Reduce the risk of rejection, companies should strive to structure schemes independently, without making them contingent upon other transactions or schemes. This eliminates uncertainties and potential delays that could hinder approval.
• Companies should conduct a thorough analysis of the fit and proper status of their promoters, directors, and other key personnel. This involves assessing factors like legal ongoing proceedings, past legal records, financial history, and any potential conflicts of interest
• Assurance on Compliance with the SEBI Mater Circulars is a pre-requisite to mitigate the risk of rejection due to regulatory non-adherence.
• Companies should provide complete and accurate disclosures in their applications to stock exchanges. This includes details about the scheme, rationale for the merger, financial projections, and any potential risks or uncertainties.
• Avoiding Misleading / wrong information to Stock Exchange as along with rejection it can also lead to legal consequences.
• Ensuring that the Rationale for undertaking the scheme matches the current facts, situations, and circumstances.

Conclusion

In hindsight, study of the cases rejected by the stock exchange is crucial to anticipate the observations or reasons for rejection when preparing to file a scheme of arrangement. Study of these reasons would help stakeholders draft schemes in a better manner. In navigating the grounds behind scheme rejections by stock exchanges, it becomes evident that these decisions are not merely regulatory hurdles but essential safeguards for market integrity. By scrutinizing schemes thoroughly, stock exchanges aim the mitigation of risks, promotion of accountability and prevention of contingencies among other things.

This article has been published on Taxmann. The link for the same

https://www.taxmann.com/research/company-and-sebi/top-story/105010000000024474/deciphering-stock-exchanges-observation-in-giving-noc-to-draft-schemes-of-arrangement-experts-opinion