The Securities and Exchange Board of India ("SEBI"), in its recent informal guidance to Renaissance Jewellery Limited ("Renaissance Informal Guidance"), has introduced a rather novel but somewhat contentious interpretation of Regulation 37 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 ("LODR Regulations"). In a nutshell, the informal guidance is in relation to an exemption from the requirement of obtaining an 'observation letter' or a 'no-objection letter' from the relevant stock exchanges on the draft scheme of arrangement, involving merger of an 'indirect' wholly owned subsidiary with its listed parent company.

While Regulation 37 of the LODR Regulations requires a listed entity desirous of undertaking a scheme of arrangement or involved in a scheme of arrangement to file the draft scheme of arrangement with the relevant stock exchange(s) for obtaining an 'observation letter' or a 'no-objection letter', before filing such scheme with any court or tribunal, it creates a carve-out from such a requirement for schemes involving the merger of a 'wholly owned subsidiary' ("WOS") with its listed parent entity.

Factual Matrix

Renaissance Jewellery Limited ("List Co"), a public limited company with its shares listed on the BSE Limited and National Stock Exchange of India Limited, sought to merge its unlisted WOS, N. Kumar Diamond Exports Limited ("NKDEL") and a subsidiary of NKDEL, House Full International Limited ("HFIL") with itself. NKDEL held ~55% of the paid-up share capital of HFIL and the remaining shareholding of HFIL was held by the List Co.

Given that the List Co did not hold the entire paid-up share capital of HFIL directly, the List Co requested SEBI to provide its interpretative letter on whether the proposed merger of NKDEL and HFIL with the List Co would qualify for the exemption available under Regulation 37 of the LODR Regulations.

SEBI's View

Interestingly, SEBI adopted a liberal approach while examining the applicability of the exemption provided under Regulation 37 of the LODR Regulations and noted that the List Co not only held ~45% of the paid-up share capital of HFIL directly but also that the balance ~55% of the paid-up share capital of HFIL was held by the List Co indirectly through NKDEL.

Accordingly, SEBI took the view that HFIL can be categorised as a WOS of the List Co in terms of the LODR Regulations and the exemption under Regulation 37 of the LODR Regulations will be available for the proposed merger of HFIL and NKDEL with the List Co.

While SEBI did expressly clarify in its letter to the List Co that the current interpretation expresses the view of Division of Issues and Listing (SEBI) solely from the perspective of enforcement and will not affect the applicability of any other law or requirements of any other regulations, guidelines and circulars issued / administered by SEBI, the approach adopted by SEBI in this letter will have to be analysed in light of its interplay with other laws and authorities.

Analysis

Until now, the construct of a company being categorised as a WOS of another company was understood as being limited to the entire paid-up share capital of the former being directly held by the latter. Given that the Companies Act, 2013 ("2013 Act") does not provide a definition of WOS, it may be argued that despite the express qualification of SEBI in its letter to the List Co, the view expressed by SEBI in the instant case may be used by other companies (specifically unlisted companies) to seek similar relaxations from the Regional Director and Registrar of Companies in terms of Section 233 of the 2013 Act. Section 233 of the 2013 Act provides for a fast track merger process for a WOS merging with its holding company.

Additionally, the view expressed in this case also becomes relevant from the perspective of the SEBI Circular on Schemes of Arrangement by Listed Entities dated 10 March 2017 ("SEBI Scheme Circular"), read with the recently issued SEBI circular dated 3 January 2018 which amended the SEBI Scheme Circular. According to the recent amendment, the SEBI Scheme Circular shall not apply to a merger of a WOS or its division (demerger/ hive-off) with its parent company.

In consideration of the aforesaid reasoning of SEBI, it is likely that several companies may seek exemption from the requirements of the LODR Regulations and the SEBI Scheme Circular for a merger involving an unlisted company with a listed entity even for cases in which a listed entity does not directly hold even a single share in the unlisted company but indirectly holds the entire share capital of the unlisted company.

It may also be noted that the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations 2004 ("ODI Regulations") categorises 'wholly owned subsidiaries' as a company whose entire capital is held by the Indian party. As such, the ODI Regulations do not expressly clarify that the entire capital is to be held 'directly' by the Indian party.

While we note that a word or expression defined in one statute cannot ordinarily be used to interpret the same word or expression in another statute, SEBI's reasoning in the instant case may still however be used to further an argument for a company to be categorised as a WOS under ODI Regulations if its entire capital is held indirectly by an Indian party.

Having said that, if the view adopted by SEBI to categorise a WOS in the Renaissance Informal Guidance is employed to interpret the Companies (Restriction on Number of Layers) Rules 2017 ("Layering Rules"), then it may lead to significant ambiguities and complexities as the Layering Rules exclude layers comprising of WOS while determining the maximum number of permissible layers of subsidiaries that may be set-up by companies.

Khaitan Comment

The view adopted by SEBI in the instant case is indeed laudable and a welcome departure from the otherwise strict interpretation of the law to adopt an approach that was cognizant of the facts at hand. SEBI's view seeks to avoid the rigour of Regulation 37 of the LODR Regulation for mergers of companies that are part of the same group. However, this may lead to several unwarranted ambiguities while interpreting the 2013 Act and other statutes as highlighted above.

In wake of this informal guidance issued by SEBI despite the express qualification recorded therein, it may be the appropriate time for lawmakers to categorically define a 'wholly owned subsidiary', particularly from the perspective of the 2013 Act and the Layering Rules so as to abort the rise of any unwarranted interpretation that may be harnessed from this informal guidance.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com