Sebi, vide a notification dated October 3, 2013, permitted the usage of preferential rights in the deal pacts, subject to adherence with other laws like Indian exchange control regulations issued by Reserve Bank of India (RBI). The said notification overwrites the decade-old notification dated March 1, 2000, which clarified Sebi's stance that the contracts with preferential rights cannot be enforced under the Securities Contracts (Regulation) Act, 1956 (SCRA).
The regulator has pumped-in a good booster that provides legal enforceability to such clauses in the deal agreements. Be it foreign investment, a private equity or a venture capital investment, the priority for investors is to protect the credentials of the investment amount, its returns and its recovery along with a pre-determined exit plan. Typically, investments are sought to be protected while writing the deal pact through inclusion of certain preferential clauses therein. For instance, a private equity investor may wish to exit at the end of the fifth year at an agreed valuation.
Although the deal pacts can virtually capture all the possibilities and the corresponding remedies for either party, their enforceability in the Indian context has been challenged in the past and a few preferential clauses like call-and-put options for facilitating exits have been held to be void by the Sebi.The regulator permits the use of pre-emption rights including the right of first refusal, or tag/drag-along rights in the shareholder agreements and/or articles of association of companies. The contracts for purchase or sale of securities pursuant to an option also find place in the subject change.
Right of first refusal (ROFR) provisions prevent shareholder from being able to sell his shares to a third party unless he has presented to the other shareholders the terms of the proposed third-party sale and the other shareholders have declined to purchase the shares that the selling shareholder desires to sell. A tag-along right gives a shareholder the right (but not necessarily the obligation) to exit along with the exiting shareholder, usually at the same price and terms. Similarly, a drag-along right gives the exiting shareholder the right to force the other shareholder(s) to exit, once again, usually on the same price and terms.
A put option gives the right to either party to offload its securities at a specified price. On the other hand, a call option allows an investor to buy securities at a particular price. For making the call-and-put options enforceable, Sebi has prescribed that the underlying securities ought to be owned by the selling party to such contract for a minimum period of one year prior to the date of entering into such contract. The market regulator also prescribed that the exercise price of such call-and-put options is to be determined in accordance with the applicable pricing guidelines under laws in force like the Indian exchange control regulations. The Companies Act, 2013, also follows the above intent by specifically permitting enforceability of such contracts under Sec 58(2).
Notably, Sebi's move is prospective from October 3, 2013, and hence, questions remain open on enforceability of contracts executed earlier. Nevertheless, the subject move reflects the regulator's commitment to improve the investor environment in India and will certainly provide a boost to M&As and private equity investments.
The author is executive directorM&A tax practice, PwC India
With inputs from Abhijeet Shah, associateM&A tax practice, PwC India