In line with changes introduced by Securities and Exchange Board of India (“SEBI”)vide notification dated October 3, 2013[1] and provisions of Section 58 of the Companies Act, 2013 (“2013 Act”), which came into force from September 12, 2013, the Reserve Bank of India (“RBI”) vide notification published in Official Gazette dated December 30, 2013[2] (“Notification”)amended the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (“Regulations”)to permit Indian companies to issue shares and debentures with call and put conditions to persons resident outside India. Post the changes made by the RBI, all the three relevant regulatory authorities’ viz. SEBI, Ministry of Company Affairs (“MCA”)and RBI have introduced the relevant regulatory framework for issuance of instruments with call and put options attached to them, subject to conditions. We have, in this alert, summarized the key changes introduced by RBI and the related impact.
Issuance of shares/ debentures
Prior to the aforesaid Notification, under the Foreign Direct Investment Policy dated April 5, 2013[3] (“FDI Policy”), an Indian company could issue only equity instruments or instruments compulsorily convertible into equity to a person resident outside India. RBI viewed options as providing the ability to assure fixed rates of return to the investor and hence, as carrying debt like characteristics. RBI had in the past even issued show cause notices seeking clarity on such provisions in the agreements.
Vide the Notification, RBI has now recognized shares or convertible debentures, containing optionality clauses, issued by an Indian company to a person resident outside India, as an eligible instrument under exchange control regulations. This recognition by RBI is, however, subject to the condition that exit cannot be provided at an assured price and the same will be subject to pricing norms specified in the Notification.
Conditions for the exit
a) Lock-in period
RBI has prescribed a minimum lock-in period of 1 year for such shares and debentures that have call and put options attached to them. However, for sectors where specific lock-ins are prescribed in the FDI Policy, this lock-in of 1 year is required to be extended to the minimum lock-in prescribed under the FDI Policy for such sectors.
b) Pricing
Listed company
In case of an Indian company listed on a recognized stock exchange, such call and put option can be exercised at the market price determined on the floor of the recognized stock exchanges.
Equity shares of an unlisted company
In case of equity shares of an unlisted Indian company, such call and put option can be exercised at a price not exceeding the price arrived on the basis of the Return on Equity (“RoE”) as per latest audited balance sheet. Parties have been permitted to include clauses for providing return based on RoE in the inter se agreements. Such agreements would be considered to be in compliance with the FDI Policy. RoE has been defined to mean ‘Profit after Tax/ Net worth’ and the term Net worth has been defined to include all free reserves and paid up capital. It is not however clear whether the latest audited balance sheet would refer to the immediately preceding 12 months or last financial year.
Preference shares and debentures
In case of preference shares or debentures, the price for exit is required to be determined as per an internationally acceptable pricing methodology at the time of exit. Such pricing will be required to be duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.
The fundamental concept for the exit under option clauses is that the RBI has mandated that for the purpose of determining the price for providing exit to the non-resident investor, the Indian party shall not guarantee any assured exit price at the time of making of such investment / entering into of the agreement. The exit price would be determined based on the mechanism prescribed above at the time of the exit
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