The cardinal objective of estate planning is to always balance continued creation of wealth for economic growth and security, with adequate measures to ensure preservation of that wealth – during one’s lifetime.
In the wake of several stringent regulations like the Insolvency and Bankruptcy Code 2016 (and subsequent amendments in 2017 and 2018), the Fugitive Economic Offenders Ordinance 2018, stricter enforcement of provisions under the Companies Act, 2013, the Income Tax Act, 1961, the Securities Exchange Board of India, 1999 (Sebi), and the persistent rumours of an ‘estate duty’ or inheritance tax in India – an equally unprecedented wave of proactive and innovative estate planning tactics by promoter families can be observed.
These legislative changes have also introduced nuanced issues and risks that come with ownership as well as management of family businesses/ companies.
Of particular interest to promoters, are the measures available to shield shares of listed companies – the ‘crown jewels’ - from liabilities, claims and disputes.
An added burden for such promoter families is to ensure proper inter-generational transfer of such substantial wealth between family branches and / or generations, during their lifetime, as well as after.
In an effort to “ring-fence” such shares of listed companies, promoters and their families overwhelmingly turned to the use of private family trusts as tools of wealth management and protection.
They were however, faced with a peculiar question that persisted without a verified answer for several years (specifically until December 2017), viz. – what is the exact impact of the Securities and Exchange Board of India (Substantial acquisition of shares and takeovers) Regulations 2011 (Takeover code), on any transfers of listed shares to a private family trust in India?
This article seeks to broadly cover the approach used by Sebi and promoters alike in relation to this question over the last few years, until the ultimate release of a clarificatory circular in December 2017, by Sebi (circular).
It also examines the conditions laid down in the circular and how they shall impact any future transfers of listed shares into trusts.
Impact Of The Takeover Code
Briefly, under the takeover code, promoters have a requirement to make an ‘open offer’ to the public shareholders of the target company upon a substantial acquisition of shares or voting rights or acquisition of control of the target company, directly or indirectly.
The thresholds for triggering an open offer (amongst other requirements), are as follows:
(a) Any acquisitions resulting in entitlement of 25% or more of voting rights;
(b) After an initial acquisition of 25% in (a) above, acquisition of voting rights exceeding 5% in any financial year; and
(c) Regardless of the level of shareholding, any acquisition of ‘control’ in the target company.
The takeover code, however, provides a list of certain transfers that fall under the ‘general exemption’ route (subject to complying with certain conditions), for which an open offer shall not be triggered.
Such transfers include, inter-alia, inter-group transfers, transfers between immediate relatives or promoters, transfers pursuant to transmission, succession or inheritance, etc.
Transfers that are not covered under this categorical list, require a ‘specific exemption’ from Sebi - or risk triggering an open offer.
The question that arose albeit on a case to case basis, was whether the transfer of any shares of a listed company to a private trust warranted an open offer on the prima facie ‘trigger’ of any of the above thresholds.
Furthermore, even if it could be argued that in a particular case, (a) and (b) above were not triggered - owing to the wide definition afforded by Sebi to the term ‘control’, the universal question remained whether an open offer was being triggered under (c) above.
Against this uncertainty, two schools of thought emerged.
Under one school, it was argued that promoters in some cases were eligible to benefit under the general exemption route.
It was reasoned that although a substantial transfer of shares had indeed occurred, in effect, the control continued to vest in the same promoter group, as there was no change in the ultimate beneficial ownership of the promoters exercising voting rights in the target company.
Further, an argument could be made that an open offer was not necessitated at all, since such transfer was simply a part of an internal succession planning exercise resulting in a mere reallocation of the family’s existing shareholding in the target company, amongst the same or different family promoters.
Under the opposing school however, it was contended that any and all transfers of listed shares, would require a specific exemption order from Sebi.
Clarity Brought By The Circular
After observing an increased traction in promoter families transferring or proposing to transfer shares of listed companies to trusts, Sebi issued the circular in 2017, clarifying their position on the issue, as well as formally streamlining the procedure and requirements for ‘fast-tracking’ an application for approval of transfer of listed shares to a private trust.
The circular directs any promoter proposing to transfer listed shares to a private trust, to seek a specific exemption from Sebi.
Drawing from the numerous exemption orders that have been granted on a case to case basis over the years, Sebi has now listed several provisions that must be expressly provided in the trust deed executed by the parties, including, inter alia, the following:
(a) That the trust is a mirror image of the promoter's holdings;
(b) That the trust's beneficiaries and trustees should only include individual promoters, their immediate relatives or their lineal descendants;
(c) That the beneficial interest of the beneficiaries has not been and will not be transferred, assigned or encumbered;
(d) That the assets will be distributed only to the beneficiaries of the trust or to their legal heirs on dissolution of the trust; and
(e) That the powers of trustees cannot be transferred or delegated to any person(s) other than themselves, i.e. a co-trustee.
The trust deed must additionally capture the following undertakings:
(a) That the trustees and indirectly the beneficiaries are vested with control or ownership of shares or voting rights for the purposes of Sebi, and the regulations thereunder;
(b) That any change in trustees or beneficiaries or change in ownership and control of shares would be disclosed within two days;
(c) That the trust shall confirm, on an annual basis, that it is in compliance with the specific exemption order passed by Sebi and get its compliance status certified from an independent auditor;
(d) The transferors must have been promoters of the target company for over a period of three years (except for holding on account of inheritance);
(e) There must be no layering in terms of trustees / beneficiaries; and
(f) The trust deed must not limit the liability of any trustees or beneficiaries in relation to the Sebi Act, 1992 and the regulations thereunder.
In addition to the above, Sebi has also clarified vide various informal guidance notes, that a (sub) trust cannot be included as a beneficiary of such trust which is acquiring shares of the target company.
Further, an institutional or professional trustee company cannot be appointed as a trustee of such a trust.
It is pertinent to note that the circular merely states that compliance therewith, shall expedite the approval of an application for specific exemption and should not be interpreted as a circular carte blanche, i.e. to mean that by virtue of satisfying the above requirements of the circular, Sebi shall necessarily grant a specific exemption.
With the December 2017 circular now clarifying Sebi's position on how they shall view any prospective transfers to private trusts, it remains to be seen whether Sebi intends to review any transfers made prior to the issuance of the circular and how such transfers shall be viewed.
This space should be closely tracked to understand whether Sebi shall, in the future, expect post-facto approvals of such transfers previously effected under the general exemption route.
Trusting The Trust: Only A Matter Of Time
Even prior to the circular, using a private trust for housing shares of listed companies had become increasingly popular amongst promoter families.
With Sebi's position on transfer of shares to a private family trust now clarified, as well as streamlined for efficient promoter restructuring - using a trust remains highly advisable for promoters of listed companies to achieve a pre-emptive “ring-fencing” of assets from creditors/liabilities, the return of potential estate-duty in India, familial and matrimonial discord alike.
With the ever-evolving legal landscape of India, it has become all the more crucial to embark on a journey of estate planning and protection, sooner rather than later.
As perfectly encapsulated by Winston Churchill – "Let our advance worrying become advance thinking and planning".
Haigreve Khaitan is a partner and Virja Dange is an associate at Khaitan & Co.