LEGALIZATION OF OPTIONS IN INDIA
1.
BACKGROUND
It is common to incorporate ‘put’ / ‘call’
options; ‘right of first offer’ / ‘right of first refusal’ and tag / drag along
rights (all of them collectively referred as “Options”) in the investment agreements. However, the issue of enforceability
of Options has always been a challenge before an Indian court due to lack of
clarity under the company law and the objections raised by the Indian
regulators i.e. Reserve Bank of India and (“RBI”) and Securities Exchange Board of India (“SEBI”). Some of the recent changes seem to have brought clarity in
the legal positions and Indian investment regime. Please see below our
observations with regards to these recent changes.
2.
NEW
COMPANIES ACT
Indian courts under Section
111-A of the Companies Act, 1956 have at several occasions held that
enforcement of Options are contrary to the principle of ‘free transferability’ of shares of a public limited company.
New
Company Law: The new Companies Act, 2013 (“2013Act”) under Section 58(2) specifically
provides that any contract or arrangement between 2
(two) or more persons in respect of transfer of securities shall be enforceable
as a contract. Section 58 of 2013Act has been notified in September 2013 and
hence Options under the investment agreements are now enforceable.
3.
SEBI
NOTIFICATION
Supreme Court in its judgment[1]
has held that Securities Contract (Regulation) Act, 1956 (“SCRA”) is also applicable to unlisted public companies. According to SEBI, SCRA permits derivatives contract (i.e. Options) only if they are entered into on the stock exchanges and any other private agreement is in violation of Section 18A of the SCRA. Based on the above, SEBI has at several occasions requested parties to delete these Option clauses in investment agreements.
Amendment Notification: SEBI vide notification
dated 3 October 2013 has now permitted contract of pre-emption rights
including but not limited to right of first refusal or tag-along or drag along
rights or such other pre-emptive rights contained under the shareholders
agreements or articles of association of companies or other body corporate.
SEBI has also permitted clauses for purchase or sale of securities pursuant to
exercise of an option contained therein to buy or sell the securities
under certain specified circumstances as provided in the notification.
However, this new
permissible legal regime applies only prospectively and does not “affect or
validate any contract which has been entered into” prior to the date of the
notification. Hence, all the investment agreement executed before this SEBI
notification will not be entitled to the benefit of this amendment unless the investment
agreement is appropriately amended.
4.
RBI
NOTIFICATION
RBI in past has been objecting to inclusion
of Options in investment agreements when such investment is done by a
non-resident as it viewed Options as secured mode of exit to a foreign investor
within a specific period of time. RBI believed such assured exit was primarily
defeating the spirit of equity instrument and making them parallel to debt
instruments. Debt instruments are governed under the Foreign Exchange
Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 (“Borrowing Regulations”) which lay down strict
conditions such as end-use restriction of the loan, ceiling on the interest
payment, etc. RBI viewed Options in equity instruments as a method of getting
around the Borrowing Regulations.
Amendment Circular: Vide a circular
dated 9 January 2014, RBI has now permitted inclusion of Options in
investment agreements subject to certain conditions laid down in the circular.
The key conditions are as follows:
- Minimum lock-in period of 1 (one) year or a minimum lock-in period as prescribed under Foreign Direct Investment Regulations, whichever is higher; and
- Foreign investor exercising Options shall be eligible to exit without any ‘assured return’.
5.
MHCO
COMMENTS
In the last 6 (six) months, the regulatory
bodies and the government has provided much needed clarity on Options. The
changes are very welcome and will encourage investors, more particularly,
foreign investors to see India as a favourable investment option again.
Enforceability of Options will provide a boost to the foreign investment in
India. This is because the changes will induce confidence amongst foreign
investors in terms of securing their exit and otherwise making India a
favourable investment destination for foreign investors yet again.
(The views expressed in this
update are personal and should not be construed as any legal advice. Please
contact us directly on +91 22 40565252 or contact@mhcolaw.com for any
assistance)
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