Validation of options provided to non-residents

The notification issued by the Securities and Exchange Board of India (SEBI) on 3 October 2013 provided much needed clarity on the validity of contracts relating to right of first refusal, tag-along and drag-along rights, and options to buy or sell securities contained in shareholders agreements or articles of association of companies. A criticism levelled at this notification was that it only addressed the validity of such contractual rights in the domestic context, and did not validate these contractual rights in arrangements between foreign investors and Indian investee companies.

An amendment to the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (FEM Regulations), followed by a notification from the Reserve Bank of India (RBI) on 9 January 2014, partly addresses this concern of foreign investors.

Eligible instruments

The amendment to the FEM Regulations (FEM amendment), together with the RBI notification, permits Indian companies to issue equity shares and mandatorily and compulsorily convertible preference shares and debentures with “optionality clauses” to persons resident outside India (collectively called “instruments” below). The transferability of these instruments is subject to a minimum lock-in period of the higher of the period prescribed under the FEM Regulations or the foreign direct investment (FDI) scheme, or a lock-in period of one year.

The RBI notification further recognizes that these “optionality clauses” will provide the foreign investor an option to exit by obliging Indian companies to buy back such instruments. Notably, as such buybacks must take place at the prevailing price, the foreign investor would be denied an assured return.

Siddharth Hariani is a partner and Aditya Bhargava is a senior associate at the Mumbai office of Phoenix Legal.