Family succession through a trust in a listed company can silently become a tripwire that triggers an open offer obligation for the promoter family. Succession planning in a listed company cannot be done the way it is done in an unlisted one.
Skipping SEBI’s prescribed exemption route for transferring promoter shares to a trust entails strict liability for penalties and an open offer obligation that only becomes more complicated over time.
Promoter and listed companies that have already triggered this tripwire may still correct it, but no solution fits all, and the outcome depends on the facts, the corrective steps taken, and how they are taken.
Background
Family trusts have increasingly become a common tool for promoter families of listed companies to plan succession. A trust lets a family consolidate its shareholding in one vehicle, avoid the uncertainties of intestate succession or contested wills, and pass control to the next generation in an orderly way rather than leaving it to chance.
An individual promoter typically settles a private trust and transfers shareholding in the listed company into it, with trustees and beneficiaries drawn from individual promoters, their immediate relatives, or lineal descendants, and the trustees administering the holding for the benefit of the beneficiaries. To the family, this looks like pouring the same water into a different glass: no outsider enters, no change in control, and the exercise feels entirely internal and non-commercial.
What is often missed is that a listed company carries obligations that exist for the protection of the wider investing public, obligations that travel with the shares and the attached voting rights, regardless of how privately, informally or non-commercially they move within a promoter’s family.
Structured the wrong way, a succession-planning exercise concerning a listed entity can trigger consequences the promoter/family never intended and never even contemplated.
SEBI’s Regulations provide for a strict prior-approval framework delineating a specific procedure for transfers of promoter/promoter group shares to a trust, and the latter’s entry into the shareholding pattern as a promoter/promoter group.
A number of listed companies’ promoters have followed SEBI’s procedure for years, which has since been tested and reaffirmed across a considerable body of regulatory jurisprudence, leaving no excuse of good faith, convenience, or harshness of the law open to the doers of such Trust-related transfers/transactions.
And yet, our independent research shows that some listed companies’ promoters still structure transfers of promoter shares to a trust without taking SEBI’s prior approval.
SEBI has not left this to the promoter family’s own judgment. It has built a specific, prior-approval procedure for exactly this kind of transfer, and that procedure is where the analysis must begin.
The Trusted Route: How Promoters Can Transfer Their Shares to a Trust
Regulation 11 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”), read together with SEBI’s circular of December 22, 2017, now consolidated as Chapter 8 of the Master Circular for Substantial Acquisition of Shares and Takeovers dated February 16, 2023 (“Master Circular”), prescribes the procedure through which a promoter or promoter group may transfer its shares to a trust.
It provides that before transferring shares to a trust, a promoter or promoter group must seek exemption under Regulation 11 from the SEBI from the open offer obligation. Further, the trust deed of such trust must satisfy the conditions prescribed under Chapter 8 of the Master Circular. The governing idea is that the trust must be, in substance, a mirror image of the promoters’ existing holding, so that there is no real change in ownership or control.
To meet this standard, the trust deed and accompanying undertakings are expected to confine trustees and beneficiaries to individual promoters and their immediate relatives or lineal descendants, with no layering; prohibit any transfer, assignment, or encumbrance of beneficial interests, and any delegation of trustee powers outside the trustee group; direct that on dissolution, assets pass only to beneficiaries or their legal heirs; require disclosure to the stock exchanges within two days, with a copy to SEBI, of any change in trustees, beneficiaries, or control; treat ownership and control as vesting in both trustees and beneficiaries for securities law purposes; require annual, auditor-certified compliance confirmation; and show that the transferor has been disclosed as a promoter for at least three years prior to the transfer, except in cases of inheritance.
The regulatory position is clear: If a promoter wishes to transfer shares to a trust, the trust must first obtain SEBI’s exemption under Regulation 11 and continually satisfy the conditions Chapter 8 prescribes. There is no route available outside this one. Whether the Regulatory position or posture is reasonable or not is not a matter for discussion here. The law, as prescribed, must be followed, even if it is perceived as harsh. That said, a few ostensible reasons why this legal provision exists are set out below:
- A trust is not recognised as a category under the “promoter group” definitions in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018. Therefore, it cannot assume it steps into an existing promoter’s position simply because the family regards it as a continuation of the same ownership; its acquisition of shares is assessed as that of a new and distinct acquirer.
- A trust does not fall within the meaning of “qualifying person” under Regulation 10 for the general exemption from open offer obligation for inter se transfers between qualifying persons, even if the trustees and beneficiaries of such trust are qualifying persons.
- A trust as a structure is an opaque vehicle. Its trustees and beneficiaries can be changed without any public disclosure, and that is why who actually controls a trust is not something the market can verify. A trust also cannot be categorised as a natural person, company, firm, or other artificial juridical person or entity, and is therefore not captured within the promoter group definition or within Regulation 10(1)(a)(iii) of the Takeover Code Because of this opaque structure and the absence of any express recognition, inclusion of a trust in the promoter/promoter group needs to be examined on its own footing.
Taken together, these reasons show why the regulatory policy has been structured so that transfers to a trust require prior scrutiny rather than being assumed compliant. A promoter cannot transfer shares to a trust without inducting the trust into the promoter group, for which exemption under Regulation 11 must be applied for and obtained. If this route is not followed, and shares are transferred or the trust is inducted without exemption, the open offer obligation under the Takeover Code will be triggered.
This also aligns with the broader objective underlying the Takeover Code, which is to prevent alien entities/corporate raiders from stepping into the position of a promoter and/or changing control unchecked. A trust that could be inducted into the promoter group without scrutiny, and whose trustees or beneficiaries could change without disclosure, is capable of doing exactly that, and the Regulation 11 route exists to prevent it.
The Relentless Habit of Regulatory Arbitrage
The problem arises when promoters attempt to bypass SEBI’s prescribed procedure. This is regulatory arbitrage: the trust ends up holding promoter shares within the promoter or promoter group without ever undergoing the prior scrutiny Regulation 11 requires.
Our review of recent regulatory filings indicates that certain companies have inducted trusts directly into the promoter and promoter group without obtaining prior exemption under Regulation 11. These companies have, though, made disclosures to the stock exchanges of the induction itself, possibly on the assumption that disclosure is a substitute for prior exemption. It is not, and the difference matters.
Disclosing that a trust has entered the promoter group tells the market what has already happened, after the fact. It does not tell SEBI, before the event, that the trust satisfies the Chapter 8 conditions, that its trustees and beneficiaries are properly confined, or that its induction does not amount to a change in control. Disclosure is a record of the transaction, not a substitute for the scrutiny and approval that was meant to precede it. There may well be other companies that have gone further, inducting trusts into the promoter group without making even this disclosure, leaving no public record of the transaction at all.
The reasons behind this may, in many cases, be bona fide, a genuine belief that a trust settled for the family is simply a continuation of existing promoter ownership. But that does not change the legal position. When the prescribed procedure is not followed in the particular manner required, it constitutes a clear departure from the law.
It may not attract SEBI’s attention today. But it is likely to come under scrutiny – possibly when such promoters attempt to transfer a more substantial shareholding to the trust after three years, in the hope of obtaining the general exemption under Regulation 10 (that would have been available had the trust been inducted through an exemption obtained under Regulation 11). That benefit will not simply come to the persons in default of the exemption provisions of Regulation 11. Instead, this is where an observation or query is more likely to arise, bringing the transaction squarely under the regulator’s enforcement radar.
Defences That Do Not and Won’t Hold
Where promoters and trusts have proceeded without the Regulation 11 exemption, and the position is later questioned by SEBI/Exchanges, a familiar set of arguments may follow: that the transfer was made in good faith, that the requirement was simply not known, that the structure was set up on external advice, that no wrongful gain resulted, or that disclosure was made to the exchanges and was publicly known; no investor loss, etc. Most of these have been tested before the regulator, and each has, in substance, failed to displace liability once the underlying contravention is established.
In Mooldhan Advisory Systems Pvt Ltd v. SEBI (May 30, 2018), the Securities Appellate Tribunal (“Tribunal”) upheld penalties for failure to make an open offer even where the breach was said to be unintentional and based on erroneous professional advice, holding that such factors may affect the quantum of penalty but do not affect whether the violation occurred. In Arbutus Consultancy LLP v. SEBI (April 5, 2017), the Tribunal held that informal or technical arguments about promoter history, cannot be used to dilute the open offer obligation once it has arisen.
Nor does correcting the position after the fact resolve matters. In Karvy Financial Services Ltd v. SEBI (April 26, 2018), the Tribunal held that a post-facto exemption application under Regulation 11, filed after the acquisition has already taken place, cannot undo the open offer obligation or remedy the default. In Mrs. Sangita Sethi v. SEBI (March 2, 2020), the Tribunal held that even a delayed open offer, made only once the position is questioned, does not erase the original contravention of Regulation 3 or Regulation 4, as applicable. In Kunal Pradeep Savla v. SEBI (April 13, 2018), the Tribunal held that the obligation to make an open offer does not depend on when SEBI acquires knowledge of the violation, and delay on SEBI’s part does not by itself absolve the acquirer of the statutory obligation to make an open offer. However, as held by the Supreme Court in SEBI v. Sunil Krishna Khaitan (July 11, 2022), such delay on SEBI’s part must itself be reasonable, and in the absence of any limitation period prescribed under the SEBI Act, SEBI is required to exercise its powers within a reasonable time.
The consistent thread running through these decisions is that no excuse would redress the departure from an established, prescribed procedure. Where shares were transferred without following the prescribed procedure, the contravention exists on that fact itself.
Strict Liability Under the Takeover Code for Such Violations
As discussed, if an exemption under Regulation 11 is not obtained before promoter shares are transferred to a trust or that trust is inducted into the promoter group, the open offer obligation under the Takeover Code is triggered.
Once that obligation is triggered and not discharged, the consequence is strict liability. Section 15H provide that an acquirer who fails to make a public announcement of an open offer, or who fails to make other disclosures required under the Takeover Code, shall be liable to a penalty.
The Supreme Court in SEBI v. Shriram Mutual Fund (May 23, 2006) held that penalties under Chapter VI-A of the SEBI Act (which includes Section 15H), are civil in nature and attract strict liability: once a contravention is established, a penalty must follow, mens rea is not an essential ingredient, and only the quantum of penalty remains a matter of discretion.
Further, Regulation 32 of the Takeover Code gives SEBI a wide set of remedial directions it may issue in the interests of investors and the securities market. These include directing the acquirer to make an open offer, mandating a reduction in shareholding, ordering disgorgement of any wrongful gain, and directing payment of interest to shareholders for loss suffered on account of the delay.
Regulation 32 also makes clear that these directions operate without prejudice to SEBI’s separate power to impose monetary penalties or initiate prosecution under the SEBI Act, so a remedial direction and a penalty under Section 15H are not alternatives to each other, both may apply to the same.
The Remedy to the Malady?
Given that the regime imposes strict liability, there is no assured immunity for a promoter who has transferred shares to a trust and inducted it into the promoter group without the Regulation 11 exemption. The contravention exists as a matter of fact once the underlying transfer and induction have taken place, and the violation does not efface itself just because the promoter later acts in good faith.
That said, how such a situation is regarded going forward depends significantly on what the promoter does once the gap is identified. A promoter who takes corrective remedial steps, addressing the open offer obligation, correcting the trust’s compliance position, being transparent with the exchanges and SEBI, and generally trying to put its own house in order and tow the line of good governance, stands in a materially different position from one that conceals or suppresses the situation, allows it to continue, or builds further complication on top of an uncorrected induction.
No single solution fits every case. What is appropriate depends on the facts and circumstances, including the structure of the original transaction, the quantum of shares transferred, whether control genuinely changed at the point of induction, the circumstances surrounding the creation of the trust, composition and stability of the trust, the adequacy of past disclosures, whether further transfers followed the initial induction, and the promoter’s conduct through the entire chain of events. All of this calls for a detailed, fact-specific assessment rather than a standard or templated response.
Further, settlement under the SEBI (Settlement Proceedings) Regulations, 2018 can also be considered as one available route, generally more meaningfully pursued once the underlying obligation has actually been addressed rather than in its place. Settlement operates on its own set of criteria, assessed on its own footing by SEBI, having regard to factors such as the nature of the default, whether corrective action was taken and how promptly, and the extent of cooperation shown. Although settlement does not, by itself, retrospectively validate what was otherwise non-compliant, it may help achieve an amicable closure in appropriate cases.
Takeaway
As already discussed, a number of companies have already inducted trusts into the promoter group without obtaining the Regulation 11 exemption. Because these inductions sit in public shareholding patterns and stock exchange disclosures, this may well prove to be a ticking time bomb.
Enforcement in matters of this kind rarely proceeds case by case, in isolation. It tends to arrive in waves. One or two matters are taken up, findings are made, and those findings then become the reference point against which an entire category of similar structures is examined.
There is no way to say with certainty when such a wave will arrive, but the underlying facts are already on record, and identifying them is, at its core, a data exercise rather than an investigation, comparing promoter and promoter group shareholding against Regulation 11 exemption orders on file.
This is well within reach of a technology-driven review, and SEBI is one of the discerning regulators that has, in the past, launched targeted drives against a particular pattern of violations once identified, offering little respite to those caught in it; this may be the next one it takes up.
This is exactly why acting now matters more than it might appear to. A company that reviews its position today, identifies any violations of the Takeover Code, and takes the warranted corrective steps stands apart from one that waits.
A company that waits for an enforcement drive to arrive will be judged alongside everyone caught in it, losing the benefit of having acted first and the more favourable treatment that early correction can bring.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
The views expressed in this article are solely those of the author in her personal capacity and are based on her understanding of the applicable legal and regulatory framework. They do not necessarily represent the views, policies or practices of organisation with which the authors is associated.
