The Companies Bill, 2012, is on the anvil and the word is that it is likely to be taken up in the budget session. This piece attempts to highlight some of the key changes under the Bill that private equity investors should look out for.
Buy-back: It is customary for investment agreements to contain exit-related provisions for private equity investors, notable amongst which is the obligation on the part of the promoters and the target company to cause a buy-back of the investor?s shares on or before the defined time lines. Under the Companies Act, 1956, while a cooling off period of one year had been prescribed between two successive buy-backs authorised by the board of directors, a dominant interpretation under the Act permitted a buy-back of up to 10% of the paid up equity capital and free reserves of the company by way of a board resolution, immediately followed by another buy-back of up to 25% of the total paid up equity capital and free reserves by way of shareholders? resolution. However, under the Bill, no buy-back shall be allowed for a period one year from the date of a preceding buy back, irrespective of who authorised such buy back (i.e. board or shareholders, as the case may be). This could have an impact of reducing the ability of a target company to give a timely exit to private equity investors in a staged manner even in cases where the company may be sitting on surplus cash.
Restrictions on multi-layered structures: The Bill limits the ability of a company to make investments through not more than two layers of investment companies, unless otherwise prescribed and subject to two specific exceptions: (i) allowing Indian companies to acquire offshore companies, which, in turn, has subsidiaries beyond two levels; and (ii) in cases where a company needs to have more than two layers of investment companies in order to comply with law. Similarly, the Bill also preserves the right of the central government to limit the number of subsidiaries that certain classes of holding companies will be able to have.
The restriction on a company having multiple subsidiaries/investment companies (placed with a view to curb diversion of funds through a web of complex corporate structures) is set to hurt infrastructure companies the most as the commercial realities of this sector often require infrastructure players to adopt structures containing multiple subsidiaries.
Usually, private equity investors have preferred to take exposure at the level of the holding company so as to derive economic value from the entire group as a whole, as against any particular arm/ investment vehicle within the group. If this restriction is not implemented practically by the government (by not providing exceptions for genuine corporate structures), it may hurt the ability of infrastructure companies to lure private equity investors – since investors may not be able to derive the same amount of economic value from a single investment at the holding company level as they would have, under the Act.
Definition of ?listed company?: The Bill now defines a ?listed company? to mean a company which has ?any of its securities? listed on any recognized stock exchange. Consequential implications arising from this definition are very interesting!
For example, a large number of companies in the real estate sector have listed their non-convertible debentures (NCDs) on the stock exchange. Going by the definition of a ?listed company? under the Bill, each of these companies would qualify as a ?listed company?. Does this mean that such companies (regardless of what status they enjoy in their articles of association) would need to comply with all the obligations and compliances of a ?listed company?, such as provisions in relation to appointment of independent directors, audit committee and a nomination and remuneration committee? The definition of ?listed company? also has the potential to stir a fresh debate on the applicability of the Securities Contract Regulation Act, 1956 to such private companies (that may have issued NCDs).
Depending on how these questions ultimately get addressed, private equity investors should consider these aspects at the time of evaluating their investments in companies which have listed a class of securities on a stock exchange.
Positives: While the Bill poses some challenges, certain positives also deserve a mention. The Bill has granted statutory recognition to contracts or arrangement between two or more persons in respect of transfer of securities of a public company, putting to rest contradicting judicial precedents on this aspect. Through this change, provisions such as tag and drag along rights, ROFO and ROFR commonly found in investment agreements have been granted legitimacy, providing much needed relief to private equity investors who rely on such contractual protections. The Bill has also sought to grant greater protection to non-executive directors by making them liable only in respect of such acts of omission/ commission by the company which had occurred with their knowledge, attributable through board processes, and with their consent or connivance. This in-built protection should make it easier for private equity investors to nominate directors on boards of their portfolio companies, as it attempts to define the scope of liability of independent directors.
Sidharrth Shankar is a partner and Vatsal Gaur is an associate with J Sagar Associates. Views are personal
