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With the Securities and Exchange Board of India (SEBI) making their stand clearer on the put/ call options in the Cairn Vedanta deal/Vulcan Engineering, and the Reserve Bank of India (RBI) indicating that they may consider such options as external commercial borrowing, has opened a can of worms and has definitely created a lot of uncertainty which could affect foreign direct investment. This article summarizes the views of the regulator and analyses some of the issues involved.
First, RBI raised concerns on viability of options and was proposing to recharacterise the same as “guarantees”. Then SEBI says no ‘option’ for public companies – Cairn Vedanta deal/Vulcan Engineering. Finally Department of Industrial Policy and Promotion (DIPP) said such ‘option’ would be treated as debt and not equity investment (both listed and unlisted), and shortly thereafter retracted.
With this increasing trend in views taken by various regulators on put/call options, the signals are somewhat unclear. In this turbulent economy, where investors are looking for stability and uniformity, the regulator should be providing a uniform view on where this issue lies so that investors can structure their investments accordingly.
The issue of put/call option came up in the Cairn Vedanta deal where SEBI directed the parties to that pre-emption rights and the put/call option be removed from the share purchase agreement dated August 15, 2010. SEBI’s view was that such arrangement was violative of Notification No. SO 184(E) dated March 1, 2000 as it was not in conformity with the requirements of spot delivery contract or a derivative contract under Section 18A of the SCRA. Prior to the above notification, the Central Government had issued a notification in 1969 which prohibited all contracts or contracts for cash or hand/special delivery. The 1969 notification was rescinded by the above 2000 notification which did not bring about any substantial changes.
SEBI’s view on put/call option arrangements was further substantiated in an interpretative letter dated May 23, 2011 issued to Vulcan Engineering Limited (“VEL”) wherein it clarified that put/call options were not valid under the SCRA as: (i) the put/call option would be exercisable at a future date and therefore, the transaction would not qualify as spot delivery contract as defined in Section 2(i) of the SCRA; and (ii) the put/call option would not qualify as a legal and valid derivative contract in terms of Section 18(A) of the SCRA as it was exclusively entered into between two parties and was not a contract traded on stock exchanges and settled on the clearing house of the stock exchange.
Another contradiction on this issue is the Government of India notification of June 27, 1961 which said that specified contracts of pre-emption or similar rights contained in the promotion or collaboration agreements or in the articles of association of limited companies, as contracts to which SCRA would not apply.
Finally, the division bench of Bombay High Court in Messer Holdings Limited v/s Shyam Madanmohan Ruia upheld that pre-emption rights/private arrangements inter-se shareholders were not violative of the requirements of free transferability under Section 111A of the Companies Act, 1956. However, the issue on enforceability in relation to put/call option was not dealt with by the High Court considering that an option being a contingent event and exercisable on the happening of certain pre-identified event and as such, may not resemble a pre-emption right. One might conclude, based on the above judgement, that put/call arrangement is a private arrangement between shareholders and hence are not violative.
Another issue that still remains unresolved is the controversy surrounding internationally accepted provisions relating to exits (including put/call options) from a foreign exchange control perspective.
On October 1, 2011, DIPP came out with a clarification that equity instruments issued to non-residents and having in-built options or supported by options sold by third parties would lose their equity character and would be treated as debt. DIPP’s view was suggestive of the fact that since ‘equity’ shares are by their very nature risk capital and if it was being backed by put/call options having a certain specified return then, it would essentially mean that the investor was assured with not only return of capital but also a certain specified interest rate. After receiving views from all quarters, DIPP issued a notification retracting its earlier position on put/call options. Recently, it appears that RBI has once again taken a disapproving view on put/call options.
Typically put and call are used in a shareholders agreement to address various types of situations. One of the trigger events could be a default of the shareholders agreement, failure to meet certain obligation, provisions relating to deadlock resolution mechanisms, material breach of obligations of parties, where there is an ability to buy or sell at the fair market value. The RBI has stipulated pricing guidelines (discounted case flow method) in relation to any transfer of shares between residents and non-resident. In case of a sale from a non resident to a resident the pricing guideline acts as a ceiling. So long as the pricing is within the confines of the stipulated guidelines there appears to be no need for any regulatory interventions in such transactions. Unfortunately, the RBI has not issued any formal guidance on the subject and one has to determine its intention from the show cause notices/directions given on case to case basis. Does this mean that the joint venture partners would need to approach Indian courts and ask for only damages or specific performance? Will this hinder or delay the exit opportunities available to the investors.
Given the global crises, and the need of the country to raise foreign capital, in our view, the right regulatory intervention in the right direction will give a real fillip to investments into India and as well as invigorate the economy.
Vineetha M.G. (pictured left) and Yogesh Bhattarai (pictured right) are Partners at AZB & Partners. The views expressed in this article are the personal views of the authors and do not represent the views of the firm.