Arrangements regarding compensation of promoters and key personnel are quite common in private equity (PE) deals. Structures are devised so as to provide additional compensation subsequent to the original acquisition, instead of providing the entire amount upfront. Depending on one's preference, the stake being acquired and negotiating positions of the parties, which can range from earn-out structures (where additional compensation is granted upon the company achieving certain benchmarks) and staggered acquisitions to non-compete arrangements, there are various structures for doing this.
Some of these structures are even extended to public enterprises where secondary transfers take place between promoters and third-party investors (including PE investors) through either the block window or via off-market transactions. Such transactions are commonly referred to as PIPE (private investment in public enterprises) transactions.
Structures in the form of non-compete arrangements in public enterprises lost their charm with the notification of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (also called 'Takeover Code'). However, for PIPE transactions in listed companies that didn’t trigger an open offer under the Takeover Code, in the absence of any regulations, compensation arrangements with promoters/key personnel could be structured without any obligation such as disclosure etc.—of course, the risk relating to being classified as ‘persons acting in concert’ had to be addressed in such structures.
The Securities and Exchange Board of India (SEBI), on its part, viewed such practices unfair as it did not involve the minority shareholders (particularly retail shareholders), who didn’t get their fair share of the deal. Hence, in October 2016, SEBI issued a consultation paper discussing concerns in relation to compensation agreements. In the paper, it noted that “it is felt that such agreements are not desirable and hence it is necessary to regulate such practices. One view is that there is no place at all for such side agreements in case of listed companies. Another view is that the focus is may be on the principle of disclosure and transparency in governance of listed entities.”
Following on from its board meeting on 23 November, 2016, where it decided to regulate such arrangements, SEBI amended the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Amendment Regulations) on 3 January 2017 to tighten the norms of compensation agreements entered into between promoters, directors and key managerial personnel of listed companies with any shareholder or any other third-party.
It is also interesting to note that SEBI on 22 November 2016 (i.e., a day prior to the 23 November meeting), issued a show-cause notice to PVR Limited in relation to the alleged violations committed by Ajay Bijli, chairman and managing director of the company, of the erstwhile listing agreement and the listing regulations, inter alia, in relation to an incentive fee arrangement entered between him and the PE investors.
The LODR Amendment Regulations provide that no employees (including key managerial personnel, director or promoter) of a listed company will enter into compensation agreements without obtaining board and shareholders' approval.
Further, all such agreements entered into during the last three years (calculated from 3 January 2017), including those which may not be currently valid, are required to be disclosed to the stock exchanges for public dissemination.
As regards the subsisting agreements, in addition to disclosure to the stock exchange, approval of the board and public shareholders is required to be taken in the forthcoming meetings. Further, 'Interested Persons' are not allowed to vote on the same in the general meeting. ‘Interested Person’ means “any person holding voting rights in the listed entity and who is in any manner, whether directly or indirectly, interested in an agreement or proposed agreement, entered into or to be entered into, by such a person/employee/key managerial personnel/director/promoter of such listed entity with any shareholder or any other third-party with respect to compensation or profit-sharing in connection with the securities of such listed entity.”
Although the newly introduced amendments are wide-ranging and cover arrangements entered into by any employee of a company and not just promoters/key managerial personnel, they might lead to peculiar situations in case of existing transactions.
For agreements existing on the date of LODR Amendment Regulations, there may be situations where the promoters become entitled to the payment, or have received part-payment and, subsequently, shareholders do not approve of the transaction. It remains to be seen how these issues will be handled.
Impact on PIPE deals
From SEBI’s perspective, the intention is to enable fair and transparent dealings in public enterprises. While it is a good move from a governance perspective, it can act as a dampener on the frequency of PIPE deals. While promoters will always want some upside, the PE investor would usually prefer earn-out structures, which now will require approval of the public shareholders. There will now be additional structural considerations in such transactions, in addition to issues under the Takeover Code (including issues relating to ‘persons acting in concert’) and Insider Trading Regulations, and they are likely to affect the timelines of the transactions and, in some cases, even their viability. On the flip side, the PE investors may use these amendments forcing promoters to ask for limited upside, instead of living with increased regulatory compliances and contingency of public shareholders’ approval.
Separately, SEBI has extended the same ‘majority of minority’ rule that it has for sanctioning scheme of arrangements, which also seem to be becoming the norm in SEBI regulations relating to structures that may impact minority investors.
Overall, while the LODR Amendment Regulations are sure to increase transparency in dealings of public enterprises, the impact that it will have on PIPE transactions remains to be seen.
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