Rajat Sethi and Sarangan Rajeshkumar†
On June 15, we had written about a proposed preferential issue by PNB Housing Finance to certain entities belonging to the Carlyle Group, General Atlantic, Ares SSG, and Salisbusry Investments (a company controlled by Mr. Aditya Puri, the former CEO of HDFC Bank).
A proxy advisor issued a report asking public shareholders to vote against the proposed investment. The report argued that the price at which Carlyle will be investing in the company belied the company’s true value. As an alternative to a preferential issue, the report suggested that the company should have considered a “rights issue” in which all shareholders will be entitled to participate.
In our previous article, we considered a “rights issue” and a “preferential issue” from the perspective of certainty in funding, disclosure obligations, approvals and timelines and pricing.
The debate has since focused on whether the proposed preferential issue required a report of a registered valuer and whether such a report was in fact procured. On June 18, the SEBI issued a letter to PNB Housing Finance stating that the proposed resolution for shareholder approval of the preferential issue is ultra vires the articles of association of PNB Housing Finance (the PNB Articles), and should not be acted upon until PNB Housing Finance undertakes the valuation of shares as prescribed under Article 19(2) “from an independent registered valuer as per the provisions of applicable laws”. On an appeal filed by PNB Housing Finance to the SAT, the SAT held, in an interim order, that since electronic voting had already commenced, it would not be fair to stay the shareholder vote. Accordingly, it permitted the shareholder vote to go ahead, but ordered that the results not be disclosed and kept in a sealed cover. The matter is now listed before the SAT for final disposal on July 12.
The legal framework
The relevant legal framework for considering the narrow question currently under review is, in the context of the proposed preferential issue, Article 62(1)(c) of the Companies Act, the proviso to Rule 13(1) of the Companies (Share Capital and Debentures) Rules (the Share Capital Rules), Regulation 164 of the SEBI ICDR Regulations, and Article 19(2) of the PNB Articles.
Article 62(1)(c) of the Companies Act requires the price for a preferential issue to be determined by a valuation report of a registered valuer (defined under the Companies Act). However, the Share Capital Rules provide that the “price of shares to be issued on a preferential basis by a listed company shall not be required to be determined by the valuation report of a registered valuer.” The proposed price for the preferential issue in the present case is in compliance with the SEBI pricing formula – as per the pricing formula under the SEBI ICDR Regulations, the minimum price for the preferential issue as of the relevant date was INR384.60 and the proposed price for the preferential issue is INR390.
The proposed price for the preferential issue is therefore in compliance with the relevant provisions under Companies Act and the SEBI regulations.
The issue is whether Article 19(2) of the PNB Articles, which starts with notwithstanding language, imposes an additional requirement for the price of the preferential issue to be determined by the report of a registered valuer.
The Registered Valuer Report
While the requirement for a report from a registered valuer under Article 62(1)(c) has been rendered inapplicable to listed companies by the Share Capital Rules, there is arguably no such limitation on Article 19(2) of the PNB Articles and a strict reading of the PNB Articles requires a report from a registered valuer. There may be an argument to the contrary that if the Companies Act requirement relating to a registered valuer report has been specifically removed for listed companies, then Article 19(2) should not be read in such a manner as to conflict with the scheme under the Companies Act.
In terms of Section 6 of the Companies Act, the provisions of the Companies Act will have effect notwithstanding anything to the contrary contained in the articles of association of a company. Further, any provision in the articles that is repugnant to the provisions of the Companies Act is void. However, the articles of association of a company can impose additional requirements on a company that go beyond the provisions of the Companies Act.
As a factual matter, as per the responses provided by PNB Housing Finance to the stock exchanges, there is a valuation report provided by its statutory auditor and a registered valuer report provided by the lead investor. Whether these would satisfy the requirement of Article 19(2) of the PNB Articles remains to be finally determined. The SEBI concluded that the provisions of the PNB Articles were not complied with and the decision of the SAT is awaited.
“Independent” Registered Valuer?
It is relevant that the SEBI, in its communication of June 18 to PNB Housing Finance, stated that PNB Housing Finance should have obtained a report from an “independent registered valuer as per the provisions of applicable laws”. Article 19(2) does not use the word “independent” nor does the Companies Act or the rules thereunder. Perhaps the point the SEBI is seeking to make is that the valuation report needs to be provided by an independent firm and not the company’s statutory auditors.
If the argument is to be made based strictly on the basis of the PNB Articles, there is no requirement of an “independent” registered valuer report since the word “independent” is not used in Article 19(2). In fact, there is no requirement of a registered valuer report for listed companies under the SEBI Regulations or the Companies Act and its rules. If the view is that the existing legal framework in relation to preferential issues by listed companies needs to be strengthened through the introduction of an independent registered valuer report, then the legal framework will need to be amended.
The last word on this matter is yet to be spoken.
† Rajat Sethi is a partner and Sarangan Rajeshkumar is an associate at S&R Associates. The authors are based in the firm’s Mumbai office.