SEBI allows put-call options for M&A deals, investor’s tag-along and drag-along rights

Securities market regulator Securities and Exchange Board of India (SEBI) has permitted put and call options in share transactions and M&As related to public limited companies in the country. In a notification issued on Thursday, it also gave its nod to contracts having right of first refusal, tag-along and drag-along rights which are common in preferential allotments and specifically linked to a typical private equity transaction.

Firms have used such arrangements while striking deals and forming joint ventures in the past, but the market regulator was against such agreements. Its objection to these arrangements, particularly put and call options, was that these were in the nature of derivative contracts but not tradable.

The regulator had called for deletion of such clauses in deals such as the one between Cairn and Vedanta and more recently in the deal involving Diageo and United Spirits.

The industry has been demanding clarity on the same as such contracts are common in deals as conditional clauses to protect the interest of the parties.

A person or company holding the put option has the right to sell stake back to the JV partner or the promoter of the firm (in case the holder of such option is an investor) at a pre-determined price. Under a call option, the person or company holds the right to buy shares held by the other party.

Tag-along and drag-along rights are more common in private equity deals. Under a tag-along clause the investor has a right to sell shares at the same conditions as the selling shareholder (which could be the promoter of the firm). The drag-along clause allows the investor to also get the other party (say the promoter of the firm) to sell shares in the event it is divesting its holding.

Such clauses protect the interest of investors if the promoter wants to exit or if the investor is keen on moving on while bringing in say a strategic investor who may like to buy the whole company instead of a small stake of the investor.

In its notification, SEBI has permitted contracts for pre-emption, including right of first refusal, tag-along or drag-along rights contained in the shareholders agreements or articles of association of companies. SEBI has also permitted contracts containing an option for purchase or sale of securities subject to a few conditions.

It has said the title and ownership of the underlying securities are to be held continuously by the selling party to such a contract for a minimum period of one year from the date of entering into the contract.

According to the market regulator, the price or consideration payable for the sale or purchase of the underlying securities pursuant to exercise of any option contained therein, should be in compliance with other laws in force and the contract has to be settled by way of actual delivery of the underlying securities.

SEBI said the contracts permitted under this notification shall be in accordance with the provisions of Foreign Exchange Management Act, 1999. Further, this notification shall not affect or validate any contract which has been entered into prior to the date of this notification.

This notification supersedes the earlier SEBI notification, i.e., S.O.184 (E) dated March 1, 2000, in line with the proviso to section 58(2) of the Companies Act, 2013 which states that “any contract or arrangement between two or more persons in respect of transfer of securities shall be enforceable as a contract".

Now, the RBI needs to give its green signal to such contracts to ensure that the companies striking such deals are free of any regulatory roadblock in enforcing such clauses. The central bank was opposed to such agreements as it feels such transactions provide guaranteed returns to one side and is akin to debt instrument.

(Edited by Joby Puthuparampil Johnson)

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