ROFRs, Call, Put: RBI Nod Soon?

ROFRs, drag & tag rights and call & put options are common to most joint venture negotiations and PE investments besides other corporate share purchase agreements. Till recently, they were all considered invalid as they violated the Securities Contract Regulation Act that permitted only spot contracts, some aspects of company law and ran foul of the RBI as well. Company law has changed as has the SCRA and Menaka Doshi reports the RBI is set to give it’s clearance as well.

On October 3rd SEBI removed one big hurdle facing the inclusion of rights such as ROFRs, drag & tag rights and call & put options. It said Shareholder Agreements and Articles of Association can include such rights. It imposed certain conditions on call & put options, but these are benign conditions.  ROFRs, TAG, DRAG, CALL, PUT...APPROVED!
Oct 3, 2013: SEBI Notification Shareholder agreements/ AoA can include
- Pre-emption Rights including RoFR
- Tag/Drag Along Rights
- Call/Put Option ROFRs, TAG, DRAG, CALL, PUT...APPROVED!
Oct 3, 2013: SEBI Notification Conditions on Call & Put Options
- Minimum holding period of 1 year post contract
- Price to be in compliance with all laws
- Contract to be settled by actual delivery of securities
This was good news but this is not enough to give confidence to companies and investors regarding the validity of such rights especially call & put options. That’s because RBI has also opposed call & put options, especially those with an element of fixed return. To RBI, this was debt masquerading as equity. In many deals involving foreign investments in real estate, RBI interpreted the equity investment to be more in the nature of an ECB as the option price guaranteed a fixed return, like debt does. So despite SEBI’s clearance, companies and lawyers are awaiting RBI’s clearance of such rights as well. ROFRs, TAG, DRAG, CALL, PUT...APPROVED!
Oct 3, 2013: SEBI Notification Conditions applicable on Call & Put Options
All such contracts to be FEMA compliant
Prior such contracts not validated ROFRs, TAG, DRAG, CALL, PUT...APPROVED!
RBI Objections Opposed Call & Put options with fixed rate of return
Equity with fixed return is akin to debt
Foreign investment in real estate equity was actually ECB
The good news is that an RBI notification is expected soon. In which RBI will give clearance to call & put options but with a condition- no fixed returns. In order to ensure that, RBI may de-link the option pricing from DCF valuations as DCF valuations many believe can be manipulated. What measure the RBI will allow is not known yet. The regulator wants to enable call & put options as they are a common agreement feature but also wants to safeguard against misuse. ROFRs, TAG, DRAG, CALL, PUT...APPROVED!
RBI  Notification Expected To clear call & put options as long as no fixed return offered
May not allow pricing formula to be linked to DCF