Sebi permits put & call options in M&A deals

Until RBI too validates the use, uncertainty could prevail say experts

The Securities and Exchange Board of India (Sebi) has permitted listed companies to use options, which give an entity the rights to sell or purchase a security at a future date, in M&A (merger and acquisition) transactions. Sebi has also allowed use of other popular preferential clauses such as ‘right of first refusal, tag along and drag along’.

The markets regulator on Thursday amended the Securities Contracts Regulation Act (SCRA), which originally prohibited use of these clauses.

Sebi’s move will permit India Inc’s long-awaited wish to incorporate put and call options clauses in their share purchase agreements.

Put and call options are the most popular exit mechanism in M&A transactions.

Earlier, the use of such clauses was turned down by Sebi on the ground that they weren’t perceived to be valid derivative contracts as they weren't traded on the stock exchanges.

Some of the famous instances where Sebi had objected to the use of put and call options is the Cairn and Vedanta deal, MCX-SX and the recent deal between Diageo and United Spirits.

Earlier this year, the law ministry had cleared a proposal by Sebi to allow put and call options by listed firms.

“Not only have call and put options been made valid, pre-emption rights such as right of first refusal, tag along right or drag along rights are also made valid without any restriction on the minimum period after which these rights can be exercised like in the case of call and put option,” said Lalit Kumar, partner, J Sagar Associates.

A right of first refusal in M&A deals give an entity the first right to purchase shares whenever they are offered for sale. Tag-along gives the right to a minority shareholder to sell if a majority stakeholder also sells its stake, while drag-along clause forces a minority shareholder sell stake with a majority shareholder. Experts have said the new norms will benefit both domestic and foreign corporates and institutional investors such as private equity (PE) and foreign institutional investors (FIIs). It will also ease the burden on IPO-bound companies. “These options were valid in private limited companies. However, when these companies were taken for IPO, specially to provide an exit to a PE, Sebi used to insist deletion of such clauses from the shareholders’ agreement. Now with this notification, these can continue and be enforced even after the company is listed after the IPO,” said Kumar.

Sebi said the put and call options to be exercised will have to be held continuously for at least one year from the date of the contract. Also, the pricing of the options will have to be in compliance with all the rules.

Experts, however, have said there could be some uncertainty till the time the Reserve Bank of India (RBI) also permits use of these clauses.

“The validity of put/call option arrangements as per Sebi's notification is subject to exchange control regulations and since RBI has expressed its discomfort with respect to such option arrangements in case of cross border deals, unless a similar notification is issued by RBI to validate these option arrangements, this relaxation may not provide adequate comfort to parties to a cross border deal,” said Nishchal Joshipura, partner M&A and private equity, at Nishith Desai Associates.

“Perhaps, just like SEBI, RBI will also clarify that put option exercised after one year from the date of the contract will be valid and not treated as external commercial borrowing,” said Kumar.

Experts said that the contracts entered prior to October 3 will not be affected or validated by Sebi's notification, which come into effect today.