June 2, 2011
In an unpublished letter dated March 18, 2011, the Securities and Exchange Board of India ("SEBI") has taken the view that put and call option arrangements and rights of first refusal are not enforceable in India. Although the law on this question is far from settled, the view taken by SEBI may potentially impact several public M&A transactions in India where such clauses are frequently included in transaction documents. Please note that this discussion is based on an unpublished letter and that the analysis should therefore not be taken to be final law on the subject.
The controversy surfaced against the backdrop of the proposed acquisition by UK-based Vedanta Resources Plc and Twin Star Energy Holdings Limited (along with other "persons acting in concert") ("Acquirers") of a majority stake in Cairn India Limited ("Target"). The promoters of the Target, Cairn Energy Plc and Cairn UK Holdings Limited ("Sellers"), held 62.36% of the Target. Under a Share Purchase Deed dated August 15, 2010 ("Agreement"), the Acquirers proposed to acquire 51% of the voting capital of the Target. The remaining 10.63% stake was to be retained by the Sellers, subject to a right of first refusal in favor of the Acquirers. The Agreement also contained put and call arrangements in relation to a portion of the shares of the Target.
India’s Takeover Code requires an acquirer who crosses certain prescribed ownership thresholds in a listed company to make a mandatory tender offer to the shareholders of the company for at least 20% of the company’s shares. Accordingly, the Acquirers made an offer to the shareholders of the Target.
In the letter of offer dated April 2011 ("Letter of Offer"), the Acquirers disclosed that SEBI, in a letter dated March 18, 2011, had informed them that in SEBI’s view, the put and call option arrangements and the right of first refusal (included in the transaction documents) did not conform to the [Indian] Securities Contracts (Regulation) Act, 1956 ("SCRA"). In particular, SEBI took the view that the contractual clauses did not comply with the requirements of a spot delivery contract or a contract of derivatives under the SCRA.
The Letter of Offer mentioned that, consequently, the Acquirers and Sellers had agreed (with SEBI) that the put/call options and the right of first refusal in the Agreement would not be exercisable or enforceable.
Spot Delivery Contracts/Derivatives
Broadly speaking, Indian law prohibits contracts for the purchase and sale of securities unless the securities are derivatives traded on an exchange, or spot delivery contracts (where the payment of price and delivery of securities both occur on the same day as the date of the contract, or on the next day).
The SEBI View
In its letter to the Acquirers, SEBI reportedly took the view that put/call option arrangements and rights of first refusal do not conform to the requirements of a spot delivery contract or those of a derivatives contract. To SEBI, such contractual clauses are therefore illegal.
The view taken by SEBI cannot be termed as a settled legal position. In September 2010, only a few months after a single judge of the Bombay High Court held that rights of first refusal in shareholders agreements were unenforceable against public companies, a division bench of the court held that such rights were enforceable so long as they did not conflict with the articles of association of the company. However, in neither case was the court concerned with the question of whether rights of first refusal were spot delivery contracts or derivative contracts under the SCRA.
Although SEBI’s view is certainly one to keep in mind while drafting the next shareholders agreement, the question of whether put/call arrangements and rights of first refusal are enforceable under Indian law is far from finally settled.
 Broadly, the put/call arrangements contemplated the sale of the residual stake of the Sellers in the Target in two equal tranches.
 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2008, as amended.
 Letter No. CD/DCR/TO/BV/OW/9093/2011.
 Western Maharashtra Development Corporation v. Bajaj Auto, (2010) 154 CompCas 593 (Bom).
 Messer Holdings Limited v. Shyam Ruia, (2010) 159 CompCas 29 (Bom).
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