Flexible options for business deals

Nov 01 2013, 20:45 IST
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SummaryPermitting the use of rights to privilege in shareholders’ agreements will give a fillip to India’s investment climate

The Securities and Exchage Board of India (Sebi) has provided an impetus to deal-making in India by permitting usage of preferential rights like right of first refusal, tag/drag-along rights as well as call-and-put options. Such rights are a privilege to either party as they ensure that the respective interests are protected and not diluted because of any unilateral action. The regulator’s decision will align the flexibility of the deal pacts in India with globally-accepted standards.

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

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