Legal Aspects of Private Equity & Venture Capital Kandivali Study Circle Meeting 2 nd March, 2014

Transcription

1 Investment Regimes Legal Aspects of Private Equity & Venture Capital Kandivali Study Circle Meeting 2 nd March, 2014 Ankur Srivastava Managing Partner 7/24/2014 1

2 Private Equity: the Indian landscape Regulatory Framework Establishment of a New Private Equity Fund Institutionalisation, Value creation model Governance Structure of Private Equity Funds Funds Terms Due Diligence 7/24/2014 2

3 Key Regulations governing PE in India PE SEBI RBI FIPB TAX SEBI (AIF) Reg SEBI (Investment Advisors) Reg SEBI (FVCI) Reg SCR Act, 1956 SEBI (SAST) Reg SEBI(DIP) Guidelines, 2000 SEBI Act, 1992 FEMA, 1999 Transfer or Issue of Security by a Person Resident Outside India, Regulations, 2000 Consolidated Policy Investment Approvals Press Notes FDI IT Act, 1961 DTAA - Singapore - Mauritius - Cyprus - Netherlands - Others 7/24/2014 3

4 FUND FORMATION 7/24/2014 4

5 Definition of Alternative Investment Fund (AIF) AIF Regulations endeavor to extend the perimeter of regulation to unregulated funds with a view to systemic stability, increasing market efficiency, encouraging formation of new capital and consumer protection. AIF means any fund established or incorporated in India in the form of a trust or a company or a LLP or a body corporate whicha) is a privately pooled investment vehicle which collects funds whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors; and b) not covered under mutual fund regulations or collective investment scheme regulations or any other regulations to regulate fund management activities. 7/24/2014 5

6 Structuring Options Trust Investors Investors Units Trustee Scheme Management Services Investment Manager Designated Partner LLP Management Services Investment Manager Portfolio Companies Portfolio Companies Investors Company Management Services Investment manager Class A Class B Portfolio Companies 7/24/2014 6

7 Structural Alternatives Trust LLP Company the person who reposes or declares the confidence is called the Settlor ; the person who accepts the confidence is called the trustee ; the person for whose benefit the confidence is accepted is called the beneficiary ; the subject matter of the trust is called trust property ; the beneficial interest or interest of the beneficiary is the right against the trustee as owner of the trust property; and the instrument, if any, by which the trust is declared is called the instrument of trust. The concept of LLP was recently introduced in India under the Limited Liability Act, 2008 ( LLP Act ). An LLP is a hybrid form of a corporate entity, which combines features of an existing partnership firms and a limited liability company (i.e. the benefits of limited liability for partners with flexibility to organize internal management based on mutual agreement amongst the partners). The functioning of a LLP shall be governed by the limited liability partnership agreement. A Company is created under the (Indian) Companies Act as a separate legal entity that has privileges and liabilities that are distinct from those of its members. The control of the company is determined by a board of directors which is elected by the shareholders. Separate classes of securities could be issued to different shareholders that shall determine their rights and obligations (as distinct from other classes) from both the voting perspective as well as from a distribution perspective. 7/24/2014 7

8 Structural Alternatives Trust LLP Company The Trustee manages the entities involved. In practice this responsibility is outsourced to an investment manager vide an investment management agreement. The liability of the contributors is limited to the extent of any unpaid commitment. The aforesaid liability is driven by contractual terms and governed under the Fund documents. The LLP itself has to manage the entities. In practice, this responsibility may be outsourced to an investment manager vide an investment management agreement. Section 27(3) of the LLP Act, a partner would not be personally liable, either directly or indirectly, for an obligation incurred by the LLP, whether contractual or otherwise, solely by reason of being a partner of the LLP. The board of directors manages the entities involved. In practice this responsibility is outsourced to an investment manager vide an investment management agreement. a shareholder/ member can be required to pay the amount remaining unpaid on shares held by him. Accordingly, as opposed to contractual obligations for contributors in a trust structure, the liability of the investor is statutory in case of a company structure. 7/24/2014 8

9 Background and Purpose AIF Regulations notified on 21 May 2012 pursuant to the SEBI board meeting dated 2 nd April 2012 Need Prior to AIF Regulations, only VCFs, mutual funds, portfolio managers and collective investment schemes were regulated No comprehensive legal framework for regulating various categories of non-retail private pools of capital such as private equity, real estate funds, etc. Main objective of the erstwhile VCF regulations is not fully served and the restrictions/conditions imposed thereunder constrain various types of funds in meeting their commercial goals Main Objectives To regulate the unregulated funds such as PE funds, real estate funds, etc. and to have better stability and efficiency of the capital market To eliminate regulatory gaps & create a level playing field To ensure certain governance practices & investor protection To encourage new capital formation To ensure transparency in the operations of funds To ensure appropriate channeling of corpus of the funds 7/24/2014 9

10 VCF Regulations are repealed Applicability to Existing VCFs Existing VCFs continue to be regulated by the VCF Regulations until the existing fund or scheme managed by the fund is wound up may seek reregistration under AIF Regulations subject to approval of 2/3 of their investors by value Existing VCFs not to raise any fresh funds post the notification of AIF Regulations except commitments already made by investors as on date of the notification Existing funds not registered under the VCF Regulations not allowed to float any new scheme without registration under AIF Regulations schemes already floated by such funds allowed to be governed till maturity by the contractual terms, except that no rollover/ extension or raising of any fresh funds is allowed Existing funds not registered under the VCF Regulations may seek exemption from the Board from strict compliance with the AIF Regulations 7/24/

11 Key Changes Registration Registration with SEBI is compulsory for all AIFs Registration in any one of the categories (Category I, II or III) No change of category without SEBI approval 6 months window period for registration of existing funds extendable up to a maximum of 12 months by SEBI Certificate of registration to be valid till the AIF is wound up Eligibility Criteria Charter documents should prohibit from making any invitation to public to subscribe its securities Key investment team to have adequate experience At least one key personnel to have a minimum of 5 years experience and relevant professional qualification Investment Strategy Any material alteration to the fund strategy can be made only with the consent of at least 2/3 of unit holders by value 7/24/

12 Key Changes Investment in AIF Each scheme to have a corpus of at least INR 200 million Minimum investment by an investor is INR 10 million minimum investment by investor who is employee/director of the AIF/Manager is INR 2.5 million Manager/Sponsor to have continuing investment of a minimum of 2.5% of the corpus or INR 50 million, whichever is lower for Category III AIF, continuing investment to be a minimum of 5% of the corpus or INR 100 million, whichever is lower Cap of a maximum of 1,000 investors in any scheme of AIF Minimum tenure 3 years Investment by AIF Co-investment in an investee co. by Manager/Sponsor not to be on terms more favourable than those offered to the AIF No investment in associates except with approval of 75% of investors by value Un-invested portion of the corpus may be invested in liquid MFs or bank deposits or treasury bills, CBLOs, CPs, CODs etc. till deployment of funds AIF may act as Nominated Investor as specified under SEBI (ICDR) regulations, 2009 There are Category specific conditions also 7/24/

13 Key Changes Listing Close ended AIF units may be listed subject to a minimum tradable lot of INR 10 million Listing is permitted only after final close of the fund/scheme Investor Friendly Regime Manager/Sponsor to appoint of a custodian registered with SEBI for safekeeping of securities if the corpus is more than INR 5000 million SEBI to be informed of any change in the Sponsor, Manager or designated partners or any other material change in the information provided at the time of application for registration The Sponsor/Manager to act in a fiduciary capacity towards the investors and to disclose them all conflict of interests More transparency and disclosure of information on financial, risk management, operational, portfolio and transactional information Valuation procedure and methodology for valuing assets to be disclosed to the investors Any significant change in the key investment team to be intimated to all investors 7/24/

14 Key Changes Certain Discretionary Powers to SEBI In the interest of investors i.power to issue directions regarding transfer of records, documents or securities or disposal of investments i. power to appoint any person to take charge of records, documents and securities Prior approval in case of change of control of AIF/Sponsor/Manager Power to call AIF to file reports with respect to the activities carried on b AIF Power to undertake inspection of books of accounts, records and documents relating to AIF Power to call for information from AIF or its Manager /Sponsor /trustee / investors with respect to any matter relating to its activity as an AIF or for assessment of systemic risk or prevention of fraud Power to direct for winding up in the interest of investors 7/24/

15 Implications Portfolio Managers Portfolio managers providing customized services on one-to-one basis without pooling fund would continue to be governed by the existing PMS Regulations Portfolio managers providing fund management services would be governed by AIF Regulations Portfolio managers who do not deal in funds but only provide advice would not be required to register themselves as an AIF FVCI FVCI Regulations to be retained separately and not subsumed in the AIF Regulations FVCIs allowed to invest in different AIFs such as SME Fund, Social Venture Funds in addition to domestic VCFs FIIs AIF Regulations does not explicitly deal with FIIs investing in India 7/24/

16 Implications VCFs Restriction on VCFs to raise any fresh funds after notification of the AIF Regulations may pose a challenge to existing VCFs which have completed their 1 st round of closing based on commitments received from investors & intend to achieve capital commitment for an amount equivalent to the total size of the fund, as disclosed to SEBI, by way of one or more rounds of closings. The intent behind inclusion of such a restriction is not clear and appears to equate the raising of fresh capital by the VCF under existing schemes to achieve the total fund size with the launch of new schemes Requiring existing VCFs, which are in the process of raising capital to achieve the total fund size, to realign their operations as per the AIF Regulations may be practically difficult & give rise to anomalous situations, wherein VCFs may potentially be governed by two separate regulations in relation to the same set of investors 7/24/

17 Categories of Funds AIF Regulations Particulars Category I AIF Category II AIF Category III AIF Concept Example Invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other socially and economically desirable sectors VCFs, SME funds, social venture funds, infrastructure funds, etc. Incentives / Certain incentives/concessions No specific incentives/ Concessions AIF Regulations might cover be all considered types of funds by the broadly concessions under 3 categories: given by the Government/regulators Government/regulators Tenure Close ended funds with a minimum tenure of 3 years extendable up to 2 years subject to approval of 2/3 of the unit holders by value Leverage Key Investment Restriction No leverage except for meeting temporary funding requirements for not more than 30 days, on not more than 4 times in a year and not more than 10% of the corpus Can not invest more than 25% of the corpus in one investee company Not a Category I or III AIF Employs divers or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives PE funds, debt funds, fund of funds Same as Category I Same as Category I may engage in hedging Same as Category I Hedge funds or funds which trade to make short term returns No specific incentives/ concessions given by the Government/regulators Can be open ended or close ended May engage in leverage subject to consent of the investors and the maximum limit specified by the SEBI Can not invest more than 10% of the corpus in one investee company 7/24/

18 Angel Funds With an aim to encourage entrepreneurship in the country by financing small start-ups, SEBI on 16 th Sept., 2013 notified new norms for angel investors, who provide funding to companies at their initial stages. Angel Funds means a sub category of Venture Capita Fund under category-i AIF that raises funds from Angel Investors and invest as per Regulations. Angel Investor if an individual investor, the person need to have net tangible assets of at least Rs 2 crore and who has early stage investment experience or experience as a serial entrepreneur. In case an investor is a corporate entity, it need to either have a net worth of Rs 10 crore or registered as AIF/ VCF with SEBI. 7/24/

19 Investment In & By Angel Funds An Angel Fund should have a corpus of at least Rs 10 crore and minimum investment by an angel investor should be Rs 25 lakh for maximum 3 years. No Angel Fund scheme have more than 49 investors. The manager or sponsor shall have a continuing interest in the Angel Fund of not less than two and half per cent of the corpus or Rs 50 lakh, whichever is lesser, and such interest shall not be through the waiver of management fees. Investment by Angel Funds is restricted between Rs 50 lakh and Rs 5 crore and only in those companies which are incorporated in India. Angel Funds can invest in companies not older than 3 years and needs to be invested in a firm for at least three years. Investee company needs to be unlisted and with a maximum turnover of Rs 25 crore and this firm may not be related to a group with a revenue of more than Rs 300 crore. The fund must not have any family connection with the investee company. 7/24/

20 Migration from VCF to AIF platform Pros: Allows investment in LLPs Upto 75% allows investment in unlisted equity or debt securities of infrastructure operating entities or SPVs. Balance 25% could be in any manner. The fund can also invest in listed debt securities or securities debt instruments without any restrictions Cons: Offshore investors may require FIPB approval for investment into AIFs including for sectoral relaxation, Legally mandated level of sponsor commitment by the Sponsor which could be locked in for the term of the fund (2.5% of the corpus or Rs. 5 crores,whichever is lower) Legally mandated standard of governance, compliances, disclosures as per the AIF Regulations (Conflict of interest, key person clauses, etc.) Please note that at the time of migration, an existing VCF may make out a case for certain relaxations from certain requirements prescribed for the AIF platform upon making a suitable case for it. 7/24/

21 ESTABLISHMENT OF NEW PRIVATE EQUITY FUND 7/24/

22 Structuring Considerations (co invest / unified / pure offshore play) Complex Exercise Key Elements Fund structure Management structure Carried interest structure/performance participation structuring Objectives Limited liability Tax efficiency Investors no worse off than for direct investments Suitable for all kinds of investors Tax efficient carried interest Marketability Easy to manage 7/24/

23 U.S. tax-exempt investors & Non-U.S. investors U.S. taxable investors CO-INVESTMENT MODEL Offshore Jurisdiction Cayman Co Jersey LLC Cayman Feeder Jersey Feeder Mauritius 100% Master Fund (FDI) Carry Shares Investment Management Arrangement Investment Manager 100% Subsidiary (FVCI) 100% Cyprus based subsidiary (Debt) Cyprus Investment Advisory Arrangement India Indian Investors Portfolio Company Carry Shares 100% Private Trust VCF Investment Management Arrangement Investment Manager / Advisor 7/24/

24 Typical Fund structures - Co-investment Structure Overseas Overseas Investors Tax efficient jurisdiction Co-investment arrangement Offshore Fund Fund management services Management fees Offshore AMC FDI FII / subaccount FVCI Service fee Investment advisory services India AIF Management services Management Fees Domestic AMC / IAC Domestic investors Investee Company 1 Investee Company 2 Investee Company 3 Team in India 7/24/

25 U.S. tax-exempt investors & Non-U.S. investors U.S. taxable investors UNIFIED INVESTMENT MODEL Offshore Jurisdiction Cayman Co Cayman Feeder Jersey LLC Jerrsey Feeder Mauritius 100% Cyprus Master Fund (FDI) 100% Cyprus based subsidiary (Debt) 100% Subsidiary (FVCI) FIPB India Indian Investors VCF Private Trust Portfolio Company 100% Investment Management Arrangement Carry Shares Investment Manager / Advisor 7/24/

26 Typical Fund structures - Unified structure Investors Overseas Tax efficient jurisdiction Offshore Fund FVCI / FDI India Domestic AMC Management services Management Fees AIF Domestic investors Team in India Investee Company 1 Investee Company 2 Investee Company 3 7/24/

27 Key Aspects for Decision Making Co-invest v/s Unified Tax Aspects Regulatory Aspects Commercial Aspects Exposing non-resident to trust tax uncertainty PE risk Residency risk Taxability of management fees / carried interest (income tax and service tax) AOP risk GAAR impact 10 sector restriction in FVCI approval FDI route investment via FIPB approval RBI approval for income repatriation? Foreign investment in restricted sectors Sponsor contribution Differential investment strategy (secondary market, NBFC etc.) Liability issue Pros and cons to be evaluated 7/24/

28 Fund structuring - key issues for consideration Tax & Regulatory Need for India Advisory Company/Limited Liability Partnership Ownership of India Advisory Company and entities Interplay between various entities Jurisdiction for establishing Fund Tax Residency / Permanent Establishment Exit strategies Tax efficiency on profit repatriation Regulatory approvals Carry / Management Fee Sharing Reward planning for Deal team 7/24/

29 Listed NCD structure Overseas India Fund (FII Subaccount) Listed NCDs Investee Co Engaged in restricted sectors (eg: retail, non FDI compliant RE projects, etc Mechanics Offshore Fund to obtain FII sub-account registration and bid for corporate debt limits Investment through subscribing / purchasing NCDs of Indian borrower companies, provided listing is committed to be done within 15 days of such investment NCDs need to be redeemed / bought back by the company, if not listed within 15 days FDI sector specific conditions not applicable No restriction on rate of interest to be paid on NCDs Capital repatriation simple Security of Indian asset Should be possible Jurisdictional analysis for investment so as to minimize India tax incidence on interest / redemption premium WHT at the rate of 21.01% on interest payable on NCDs as per the Act. However WHT could be reduced to 10% if investment through tax efficient jurisdiction Equity type returns mimicked through NCDs 7/24/

30 49:51 Holding Company Structure Foreign Company Mechanics Hold Co. to be held upto 51% by Indian promoters Downstream investment by Hold Co. in I Co. Overseas Multiple layers possible to go in excess of 49% India 49% Hold Co 99.9% 51% Promoters 0.01% Key Aspects Preferable to structure Hold Co as operating cum Investing company Minimal affirmative rights / veto rights and director appointment rights for foreign investor advisable I Co (Operating Co.) Engaged in restricted sectors (eg: retail, non FDI compliant RE projects, etc Potential tax leakage unless exit at Hold Co level Precedents available 7/24/

31 FVCI OCDs Structure Overseas India Interest / Dividends FVCI OCDs Project SPV Mechanics FVCI to invest in OCDs of Project SPV Repatriation by way of interest, redemption etc Implications Investment by FVCI in OCDs under Automatic route - view o FIPB Review 2010 (M/s QAI India Limited) Pricing norms, sectoral caps, interest ceiling prescribed under FDI not applicable ECB Regulations do not apply - Not required to comply with eligible lender, end use, maturity etc Downside protection - Conversion option in case of default; Security possible Tax deductibility of interest as well as redemption premium (subject to tax deduction on actual redemption) 7/24/

32 Liquidation and Cost Step-up Investment of Rs.1000 F Co I Co 1 Land & Bldg. Rs.1000 I Co 2 Mechanics F-Co invests say, Rs 1,000 in I Co-1; subsequently worth Rs 2,000 F-Co has also invested in I Co-2, an operating entity, which has excess cash of Rs. 2,000 F-Co transfers shares of I Co-1 to I Co-2 for Rs 2,000 and avails treaty benefits I Co-1 liquidated and assets (Land & Bldg.) distributed to I Co-2 I Co-2 sells Land & Bldg. for Rs. 2,000 Implications Sale of shares by F-Co Not taxable under Capital gains Liquidation of I Co- 1 Effectively no capital gains. No deemed dividend implications assuming no accumulated profits in I Co 1 Sale of property by I Co 2 No tax since cost for I Co- 2 is Rs (FMV of assets on date of liquidation) Stamp duty implications on liquidation and transfer to I Co- 2 to be considered 7/24/

33 Indian NBFC Mechanics F-Co Foreign Company to invest in an Indian NBFC Equity / CCDs / Listed NCDs Overseas India NBFC to subsequently provide participating loan to the Indian Co. Foreign Company to earn returns through profit participating loan extended by NBFC to Indian Co. Implications Minimum capitalization norms under FDI I Co (Operating Co.) Participating Loan NBFC Regulations Compliance of NBFC regulations NBFC s profit subject to corporate tax Tax leakage and prudential norms to be considered 7/24/

34 Foreign Investment in India Alternative routes Foreign Investments in India FDI FII FVCI Others Indian Co Equity Shares / CCPS / CCDs / Warrants Auto route v. Approval Route NBFC Shares / Convertible Debentures - IPO / Private Placement - Secondary Market NCDs MF Units G-Sec T-Bills SR CPs Indian Co Equity Shares / CCPS / CCDs DVCF/ AIF GDR / ADR / FCCB / FCEB / ECB / QFI Different investment routes necessary to ensure flexibility to make different investments 34 7/24/

35 FDI Investment Instruments Instrument Whether gives Ownership in the Company Whether gives Voting Rights Nature of Return from the Instrument Equity Share Yes Yes Dividend from profits and subject to Transfer of Profits to Reserves Rules Pricing Restrictions Listed: SEBI Guidelines Unlisted: DCF Method Priority upon Liquidatio n III Other consideration s CCPS Yes No Preferential dividend possible Listed: SEBI Guidelines Unlisted: DCF Method II Unpaid dividend to be taken into account at the time of conversion Vote on matters on an as if converted basis CCD (tenure of 18 months for CCDs issued by listed companies) Warrants (issue to foreign investor only with prior permission) No No Interest Listed: SEBI Guidelines Unlisted: DCF Method No No None Listed: To be converted within 18 months Unlisted: No conversion period fixed I Consider taking some equity to take voting rights 7/24/

36 Eligible Instruments Offshore / Domestic Equity Shares Securities Premium Compulsorily Convertible Preference Shares / Debentures Warrants Equity Shares - differential voting / dividend rights Options ECB / Optionally Convertible Preference Sharers / Debentures Loan From NBFC Listed NCDs Combination of the above can be explored 7/24/

37 Exit Routes IPO Preferred exit for PE investors Market-Conditions Dependent Third Party Sale ROFO/ROFR Tag/Co-Sale Drag Competitors Put / Call Options Buy-back Complex Process Non-Resident Investors RBI Pricing Guidelines 7/24/

38 Exit Routes Issues No profits but excess cash in initial years Solutions Buy-back through share premium Complex economic distribution/ Promote structure Extraction of initial capital investment Class A, Class B Convertible Instruments Buy-back through share premium High Corporate Tax Use CCDs (net tax saving - 23%) High DDT Buy-back 7/24/

39 GOVERNANCE STRUCTURE OF PE FUNDS 7/24/

40 Matters of Fund Governance Investor Consent Required Threshold for investor approval Matter 2/3 rd by value A material alteration to the AIF s strategy An extension of up to two years of the tenure of a close ended AIF 75% by value In-specie distribution of assets of AIF at any time, including on winding up of the AIF (subject to conditions specified in the PPM / Contribution Agreement of AIF) Early termination / winding up of the AIF Approving an investment by the AIF in an associate Extending the period for valuation of the investments of a Category I AIF and Category II AIF to one year 7/24/

41 OTHER CONCEPTS 7/24/

42 Carried Interest Carried interest is a profit participation in favor of the general partner, which is typically paid after investors receive a return of their capital, plus a preferred return. Investors generally want the carried interest profit to take into account the fees and expenses, which will happen if net proceeds are run through the waterfall Typically, Carried Interest is first paid through a GP catch-up until the general partner has received its threshold carried interest profit percentage (20% is market), if the fund has a GP catch-up. Afterwards, carried interest is typically 20% of net proceeds of net proceeds, not gross profits Recent developments in US concerning management fee offsets raise concern 7/24/

43 Management Fees The biggest issue in management fees is how much they are? The market seems to be holding steady at 2% with larger investors generally paying lower management fees. Many factors affect the management fees including - Size and sophistication of investors, asset class, investment strategy, the amount of capital raised, the amount of work required for the managers to execute its strategy effectively, etc Most frequently, the management fees is calculated on committed capital during the investment period and then invested capital or a similar defined term after the investment period. 7/24/

44 Other Terminologies Preferred Return / Hurdle Rate: Is basically a minimum annual return that the limited partners are entitled to before the general partners may begin receiving carried interest. The rate is typically around 8%. Clawback: It gives the limited partners the right to reclaim a portion of the general partner's carried interest in the event that losses from later investments cause the general partner to withhold too much carried interest. Drawdown / Capital Calls: It is a contractual right of a fund to demand a portion of the committed capital to it by an investor. It is issued to limited partners when the general partner has identified a new investment and a portion of the limited partner's committed capital is required to pay for that investment. The first year that the private equity fund draws down or "calls" committed capital is known as the fund's vintage year. Contributed Capital: It is the cumulative amount of capital that has been drawn down from the investor. 7/24/

45 Legal Due Diligence Concept No legal definition Due Diligence is the process by which legal, financial and commercial information is evaluated (or collected) about assets or business organisation involved in a transaction to reach an informed judgment by analysing risks associated. Principle Based on Caveat Emptor - Buyer Beware! Risk assessment tool Significant for valuation of the deal! Key risks to which Buyer & Seller are exposed Identifies problems, sometimes even the Seller was not aware of. Common Types : Financial Legal Intellectual Property Business Environ-mental 7/24/

46 Legal Due Diligence Purpose To verify disclosures, representations, and warranties To ascertain conditions precedent for achieving transaction completion To identify legal risk factors and value depletors To obtain suitable indemnities To verify validity of licenses, permits, etc. To ascertain third party consents 7/24/

47 Legal Due Diligence Key Areas Company Constitution & Corporate Secretarial Compliances Banking & Finance Material Contracts Intellectual Property Licenses, Registrations and other Regulatory Approvals Litigation Insurance Real Property Labour and Employment Anti-corruption & Anti-bribery 7/24/

48 Legal Due Diligence Listed Companies Insider Trading Regulations prohibit and regulate the trading of shares by insiders or persons who have access to UPSI about a listed company Prohibition: (i) investee company cannot give UPSI; and (ii) acquirer having UPSI cannot acquire shares of investee company Limitations: Restriction on diligence Approach Insider Trading Regulations applicability exempt for corporate acquirer if acquisition is as per Takeover Code (Investee company still at risk!) Practice to make all information shared by investee company public use of website 7/24/

49 Key Provisions in Shareholders Agreement Governance Rights: Governance rights may include the right to appoint Investor directors, quorum rights, right to nominate key personnel such as CEO, CFO, etc and affirmative voting rights for crucial matters. Exit and Transfer Provisions: Covers promoter lock-in, IPO for exit of Investor, ROFR/ROFO, Tag Along, Drag Along, Put and Call Options. (Covered in detail later in the presentation.) Anti-Dilution- Rights: Price protection for the investor. Most Favoured Investor: Any additional rights given to a future investor should be provided to the present investor Pre-Emption Rights: Right to subscribe to further issue of shares to ensure shareholding percentage can be maintained. Non-Compete and Solicitation: To protect value in company Deadlock: Deadlock is a situation where shareholders cannot agree upon a matter where both their consents are required. Arbitration may not be an effective mode for resolution. 7/24/

50 Share Transfer Restrictions Controversies Basic Principles: Enforceability: AOA: Share transfer restrictions not be enforceable in all situations. In case of private companies, terms of Agreement between Shareholders must be incorporated into the Articles of Association of the Company. Provisions of Articles of Association of a Company cannot fetter its statutory powers, the Companies Act, 1956 overrides any provision contained in the articles or any agreement which is inconsistent with the Act. Public companies are characterized by free transferability of shares and transfer restrictions would be unenforceable vis-à-vis the Company. 7/24/

51 Assessment Form of Company Type of Right Enforceability Private ROFO Public ROFO X Private ROFR Public ROFR X Private Tag * Public Tag * Private Drag Public Drag X Private Put Public Put X Private Call Public Call X *There is doubt (low risk) if private companies that are subsidiaries of public companies may face enforceability as applicable to public companies. 7/24/2014

52 Options Controversies Companies Act Call Options are considered as restriction on free transferability of shares and therefore, unenforceable in public companies (listed and unlisted companies) SCRA and SEBI Call and Put Options in PE transactions may not be treated as spot delivery contracts and may be treated as options in securities not on stock exchange and therefore unenforceable in case of public companies (listed and unlisted companies). SCRA does not apply to private companies Recently SEBI has approved call and put options and affirmative rights as standard inclusions in many shareholders agreements FIPB FIPB had come up with restrictions on options, however, withdrew such restriction RBI RBI has expressed reservations about the validity of put options with fixed returns in FDI transactions and seeks to treat such options as ECB 7/24/

53 Options Controversies Call Options Public companies (listed and unlisted): enforceability is doubtful in view of SCRA and Companies Act. Private Companies: Call options should be enforceable Private Company Subsidiary of Public Company: Position is not clear. In practice, parties are proceeding as if these are enforceable. Is this a correct view? Put Options Public companies (listed and unlisted): unenforceable due to SCRA and RBI reservations treating as ECB Private Companies: Put should be enforceable except for RBI reservations treating as ECB Private Company Subsidiary of Public Company: Position under Companies Act and SCRA is not clear. In practice, parties are proceeding as if these are enforceable. Is this a correct view? RBI may still be an issue. 7/24/

54 Recent important judicial precedents 1. On Treaty entitlement: Positive Rulings: Dynamic India Fund AAR (2012) / Ardex Investments Mauritius Ltd - AAR (2012) relied on Azadi Bachao Armstrong World AAR (2012) buyback of shares exempt under India- Mauriitus tax treaty Moody s Analytics AAR (2012) legal ownership prevails over beneficial ownership; funding by parent entity irrelevant; effective management lies with BOD and not with a person authorised by BOD Castleton Investment Limited AAR (2012) / Smithkline Beecham Port Louis Ltd AAR (2012) Share transfer by Mauritius Co to Singapore Co eligible to treaty benefit E-Trade AAR (2010) - writ petition filed by tax authorities in SC Negative Rulings: Vodafone SC (2012) valid TRC insufficient 7/24/

55 Recent important judicial precedents 2. On indirect transfer: Positive Rulings: Vodafone SC (2012) Not taxable in the absence of specific provisions Moody s Analytics AAR (2012) Capital gains exempt in the hands of Mauritius company Negative Rulings: Sanofi - Aventis AAR (2011) colorable device for tax avoidance 3. Re-characterisation of capital gains: Z Mauritius AAR (2012) - Capital gains on sale of zero coupon CCDs to Indian promoters re-characterised as interest income - Look at approach referred in Vodafone relied on; A Mauritius AAR (2012) - Buy back of shares from selective shareholders shall attract DDT and WHT provisions colourable device to avoid DDT However, in Armstrong World AAR (2012) - Gain arising from buyback of shares from Mauritius company considered as capital gains and treaty benefit granted 7/24/

56 Recent important judicial precedents 4. Others: Castleton Investment Limited (AAR) / Smithkline Beecham Port Louis Ltd (AAR) - MAT provisions shall apply even if foreign company does not have a PE in India departed from its earlier ruling in case of Timken (2010) Credit Suisse (International) Holding AG (AAR) - No capital gain arises upon offshore merger of WOS with its offshore parent in the absence of sale consideration / non-determination of capital gain Orient Green Power Pte Ltd (AAR) - Inter-corporate gift of shares is a strange transaction, unless done for bonafide purpose. Corporate gift would not be considered to be an exempt transfer u/s 47(iii) referred back to AO for further inquiry 7/24/

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