Securities tribunal gives boost to private equity investors

A recent ruling by the Securities and Appellate Tribunal (SAT) saying the veto rights of shareholders do not classify control over the company is all set to change the way investment agreements are drafted between companies and private equity or venture capital entities.

In a landmark judgment last week, the tribunal has shot down the stand of markets regulator Securities and Exchange Board of India (Sebi) that said veto rights constituted “control” of the company under Regulation 12 of the Takeover Regulations.

 Legal experts said this order has come as a major relief to investors who were wary of seeking such rights for fear of triggering the open offer regulations. The order has put to rest a lot of related ambiguities too, they added.

The case goes back to 2007 when private equity firm Subhkam Ventures, through a preferential allotment, acquired more than 15 per cent in MSK Projects thereby triggering an open offer. It filed an open offer draft document with Sebi under Regulation 10 of the Takeover Regulations, mentioning that it was only a financial investor and the acquisition would not lead to any change in the control of the company. Sebi, however, wanted the open offer to be made under Regulation 12 (change in control) along with Regulation 10. This was challenged by Subhkam Ventures at SAT, which based on the facts of the matter, ruled that “Regulation 12 does not get triggered and Sebi was not justified in making the appellant (Subhkam Ventures) incorporate this regulation in the letter of offer”.

Lawyers who deal with private equity and venture capital players said the agreements between private equity and venture capitalist entities and companies are standard in form and such ambiguities are common, so this order would set to rest a lot of issues. “This order should benefit and bring certainty to those venture capital and private equity investors who have made investments in companies on similar terms and conditions,” said Vishal Gandhi of Gandhi & Associates.

According to law firm Nishith Desai Associates, “The order brings much relief to financial investors who have been uneasy about seeking such rights in listed companies for fear of triggering the requirement to make an open offer and also the implications of being regarded as persons in ‘control’ over the company”.

Sebi’s stand in the case stemmed from the fact that the shareholder agreement between Subhkam Ventures and MSK Projects gave the former rights to veto certain business decisions, appoint a nominee on the board of the company and quorum rights (meaning Subhkam nominee should be present at the board meetings).

SAT, in its judgement, has said the provisions of the veto rights do not give control to Subhkam Ventures.

“On the contrary, it only enables (Subhkam) to safeguard its investment and interest of the shareholders in general,” it said.

Gandhi, however, cautioned that the order has still left some of the important issues unresolved. "The larger question is that if the investors are not in control and if the promoters are unable to take a decision due to the investors exercising their rights, then can one say that the promoters are in control? And, if neither the investors nor the promoters are in control, then who really is in control?" asked Gandhi.

The answer to this may be found by examining other related provisions of the shareholders agreement that specify the consequences of the exercise of a veto right by the investors, he adds.

"This ruling will help in the overall growth of the PE industry," says Vishal Tulsyan, director & CEO, Motilal Oswal Venture Capital Advisors. "One major concern was that rights of the PE player was getting diluted. This will no more be the case," he added.

Sebi has an option to approach the Supreme Court on the SAT ruling. However it is not yet known whether it will do so.