In a significant regulatory action, the Securities and Exchange Board of India (SEBI) in the matter of Reliance Home Finance Limited (RHFL) vide order dated August 22, 20241, banned Anil Ambani and 24 other entities from the securities market for a period of 5 (five) years.
The decision in the aforesaid order by SEBI stems from the findings of SEBI that Anil Ambani, leveraged his position as Chairperson of the ADA Group and his substantial indirect shareholding in the holding company of RHFL, to orchestrate a fraudulent scheme to siphon off funds from RHFL.
As per SEBI's investigation Chairperson of RHFL i.e., Anil Ambani, with the assistance of key managerial personnel at RHFL, cloaked the diversion of funds as loans to entities linked to him. Despite directives from RHFL's Board of Directors to halt such lending practices, the company's management continued to approve loans to companies with minimal assets, cash flow, net worth, or revenue. Therefore, as per the aforesaid order the only plausible explanation which SEBI could determine is that RHFL's issuance of loans to these entities were part of a fraudulent scheme to divert funds from RHFL to entities linked to Anil Ambani, while concealing the financial ramifications of their actions from the investing public.
SEBI emphasized that Ambani's influence over RHFL's management and policy decisions constituted de facto control.
Understanding De facto Control
The term “de facto controlling influence,” as employed by SEBI, refers to a form of control that exists in practice, even if it is not formally or legally acknowledged. Per Black's Law Dictionary 4th Ed2, “de facto” means “in deed, actually.”
This term describes a situation or state of affairs that must be accepted for all practical purposes, even though it may be illegal or illegitimate. In essence, it signifies actual or existing control that has an effect, despite not being formally recognized. This concept is crucial in understanding how control can manifest in various business scenarios, particularly in the context of corporate governance and regulatory oversight.
De facto control arises not from legal provisions but through contractual or other rights. This can include influence over decisions through participation in policy decisions by virtue of shareholder agreements or other arrangements. Even if such contracts are not outcomes of legal provisions, they still exist and are enforceable, thereby classifying such influence as de facto control. This means that even without formal recognition, the influence exerted can significantly impact the operations and decisions of a company.
The Hon'ble Supreme Court of India had acknowledged the presence of both de facto and de jure control in the definition of “control” provided in SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”) in the matter of ArcelorMittal India Private Limited v. Satish Kumar Gupta & Ors3. The Supreme Court held that control is defined in two parts: de jurecontrol, which includes the right to appoint a majority of the directors of a company, and de factocontrol, which refers to the ability to influence management or policy decisions directly or indirectly. This influence can be exerted through shareholding, management rights, shareholder agreements, voting agreements, or other means.
The relevant extract of the judgment is reproduced herein:
“47. The expression “control” is therefore defined in two parts. The first part refers to de jure control, which includes the right to appoint a majority of the directors of a company. The second part refers to de facto control. So long as a person or persons acting in concert, directly or indirectly, can positively influence, in any manner, management or policy decisions, they could be said to be “in control”. A management decision is a decision to be taken as to how the corporate body is to be run in its day to day affairs. A policy decision would be a decision that would be beyond running day to day affairs, i.e., long term decisions. So long as management or policy decisions can be, or are in fact, taken by virtue of shareholding, management rights, shareholders agreements, voting agreements or otherwise, control can be said to exist.”
This distinction between de facto and de jure control is essential for understanding how influence operates within corporate structures. De facto control can often be more subtle and complex than de jure control, which is more straightforward and legally defined. For instance, a shareholder may not hold a majority of shares but can still exert significant influence over the company's decisions through strategic alliances or agreements with other shareholders. This may lead to situations where the actual control of a company does not align with the formal ownership structure.
In the matter of Reliance Home Finance Limited, SEBI's application of the concept of de facto control highlights its concern and endeavours to addressing the complexities of corporate governance. The regulator's focus on de facto influence allows it to scrutinize situations where control may not be immediately apparent but still has significant implications for the company's operations and stakeholder interests. This approach may assist in deliberating that all forms of influence are considered, promoting a more comprehensive understanding of corporate control.
The concept of "de facto controlling influence" as articulated by SEBI plays a vital role in the landscape of corporate governance in India. It emphasizes the importance of recognizing the various ways in which control can manifest, beyond just formal ownership structures. By understanding both de facto and de jure control, stakeholders can better navigate the complexities of corporate decision-making and ensure that their interests are adequately represented. This nuanced understanding is essential for fostering a transparent and accountable corporate environment, ultimately benefiting all participants in the market.
Jurisprudence
The concept of de facto control is not new and has been acknowledged in various legal contexts. For instance, the Apex Court has recognized it in cases such as Vodafone International Holding vs. UOI & Ors.4, and Raghuvanshi Mills Ltd Bombay vs. Commissioner of Income Tax5.
The Apex Court's judgment in the ArcelorMittal6 case is a notable example where the Court analyzed and accepted the existence of de facto control. It is evident from the judgment in ArcelorMittal7 case that the definition of “control” provided in the Takeover Code aligns with SEBI's broader interpretation of control, ensuring that all forms of influence, whether legally recognized or not, are considered when assessing the actions and responsibilities of individuals in corporate governance.
The relevant extract of Regulation 2 of Takeover Code is reproduced herein:
“(e) “control” includes the right to appoint a majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding, management rights, shareholder agreements, voting agreements, or in any other manner.”
Therefore, SEBI's use of the phrase “de facto controlling influence” in its order against Anil Ambani is consistent with this established jurisprudence. It highlights that control within a corporate entity can be exerted through various mechanisms, not limited to formal legal rights. This inclusive definition of control ensures that all forms of influence, whether legally recognized or not, are considered when assessing the actions and responsibilities of individuals in corporate governance.
Implication
While SEBI's recognition of de facto control is consistent with established legal principles, it may have certain negative implications. One potential issue is the ambiguity and subjectivity involved in determining de facto control. Unlike de jure control, which is clearly defined by legal rights and formal agreements, de facto control relies on practical influence, which can be more challenging to quantify and prove.
This ambiguity can lead to increased regulatory scrutiny and potential disputes, as parties may contest SEBI's findings of de facto control. Additionally, the broad interpretation of control may deter investors and stakeholders who fear being held accountable for actions based on perceived influence rather than formal legal rights. This could impact investment decisions and corporate governance practices, potentially stifling innovation and growth.
The recognition of de facto control has significant implications for corporate governance. It underscores the importance of acknowledging actual control and influence, regardless of formal legal recognition. This approach ensures comprehensive oversight and accountability in the securities market. By recognizing de facto control, regulatory bodies like SEBI can address and mitigate risks associated with undisclosed or informal control structures that may lead to fraudulent activities or mismanagement. This proactive stance could result in maintaining the integrity of the financial system and protecting the interests of investors.
Conclusion
SEBI's use of the phrase “de facto controlling influence” aligns with established legal principles and jurisprudence. It underscores the importance of recognizing actual control and influence in corporate governance, regardless of formal legal recognition. This approach ensures comprehensive oversight and accountability in the securities market, thereby protecting the interests of investors and maintaining the integrity of the market.
However, the potential negative impacts of adjudication based on de facto influence, such as ambiguity and increased regulatory scrutiny, must be carefully managed to balance regulatory objectives with fostering a conducive environment for investment and corporate growth.
Regulatory bodies must strive to clarify the parameters of de facto control to minimize confusion and ensure that businesses can operate effectively while adhering to necessary compliance standards. This balance is vital for promoting a healthy investment climate that encourages growth and innovation while safeguarding the interests of all stakeholders involved.
Footnotes
1. Order bearing reference No. WTM/AN/CFID/CFID_1/30660/2024-25
2. As per Black Law Dictionary, Revised Fourth Edition by the Publishers Editorial Staff, 6-1971 the term de facto means “DE FACTO. In fact, in deed, actually. This phrase is used to characterize an officer, a government, a past action, or a state of affairs which must be accepted for all practical purposes, but is illegal or illegitimate”
3. Civil Appeal No. 9582 of 2018
4. 2012 SCC OnLine SC 77
5. 1960 SCC OnLine SC 240
6. Civil Appeal No. 9582 of 2018
7. Supra
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