Zee-Sony Deal: The Non-Compete Fee Twist

The proposed merger will result in Zee shareholders owning 47.07 % in the merged company and Sony India promoters at 52.93 %, according to Zee's filing with the stock exchange.

Interestingly, while shareholders of both the listed and private companies will see their holdings diluted, Subhash Chandra's stake will remain at 3.99%—the current holding in the listed entertainment major.

The filings say Chandra will be given shares of the merged company in order to maintain that shareholding level. This will be done by the promoters of Sony India and in consideration of a non-compete agreement.

A separate media statement by Zee Entertainment adds that - "According to the term sheet, the promoter family is free to increase its shareholding from the current 4% to up to 20%, in a manner that is in accordance with applicable law". No further details have been disclosed yet.

Non-Compete Fees

Non-compete fees are hardly unusual in M&A transactions. But they're viewed differently by securities regulations and company law.

Under SEBI's Takeover Regulations, in the event of an acquisition of 25% or more voting rights in a company or a change in control, a mandatory tender offer must be made by the acquirer to shareholders of the target company to purchase at least 26% of total shares.

The open offer price must be the same as the acquisition price. And that price includes non-compete fees or such paid to promoters or controlling shareholders.

The principle being that the same price must be paid to all exiting shareholders—be it a promoter or a public shareholder participating via an open offer.

Given that the preliminary deal proposal indicates shareholders of Sony India will own over 52% of the merged company—the transaction does result in change in control.

But, since it is being done via a scheme of arrangement for merger, SEBI's takeover regulations will not apply.

Mergers are governed by company law—which makes no objection to non-compete fees as part of the merger agreement or alongside it.

But mergers do need shareholder and creditor approval: 75% of the votes cast must be in favour of the merger resolution to pass.

They also need approval from the company law tribunal. That process also involves approval of regulators such as Securities and Exchange Board of India and tax authorities.

Mohit Saraf, managing partner of Saraf & Partners law firm, said both the securities regulator and public shareholders may frown at the non-compete consideration.

"As it reads, it's Sony’s promoters who are transferring shares to Zee’s promoters from their kitty. I’m not sure if SEBI will allow this non-compete premium. The regulator may view this as an intrinsic part of the merger transaction."

Saraf told BloombergQuint that even if Sony India promoters are compensating Zee Entertainment promoters one can take a view that the merger ratio isn't in favour of Zee shareholders because the promoter got an extra-sweet deal.

He expects that even if the non-compete agreement is not put to a shareholder vote, as it is a promoter to promoter transaction, it could be opposed by the regulator and it may give Zee Entertainment's public shareholders leverage to improve the merger ratio in their favour.

Nothing there, says Sandeep Parekh, managing partner at Finsec Law Advisors, when asked if the non-compete agreement will pose a hurdle.

Parekh said neither Zee Entertainment's public shareholders nor SEBI will have any substantive legal grounds to oppose the non-compete agreement.

Amit Tandon, founder and managing director of proxy advisory firm IiAS said, "As a firm we don’t like non-competes. We will of course wait and read the small print."

"But you need to put it in context as this is coming out of Sony's share," he said. "It is Sony’s way of showing respect to Subhash Chandra, acknowledging his role as a doyen of India’s media industry."