Private equity (PE) investors are typically long-term investors who work with management to build value in an enterprise, as they are looking for a high valuation at the time of exit. When making an investment the PE investor conducts due diligence to gauge the risks involved and ascertain the fair value of the enterprise, and also seeks a wide range of representations and warranties from the company and its promoters.
The Companies Act, 2013, seems to have made an impact on the way PE deals will be executed as the language used in sections 42 and 62 of the act and the compliance requirements introduced by rule 13 of the Companies (Share Capital and Debentures) Rules, 2014, are incongruous in that the rules make no distinction between public issuance and private equity placements.
For a PE fund, an investment decision usually involves both legal and financial due diligence followed by one-on-one negotiations with the company’s promoters. An understanding between them is generally crystallized in a memorandum of understanding or term sheet, succeeded by a share subscription or share purchase agreement coupled with a shareholders agreement. In practice, the promoter/management of the company typically issues a “disclosure letter” regarding the warranties in the above agreements, and often also agrees to indemnify the fund for acts done prior to its entry.
SECTIONS 42 AND 62
Under section 42 of the act, “private placement” is defined to mean “any offer of securities or invitation to subscribe securities to a select group of persons by a company (other than by way of public offer) through issue of a private placement offer letter and which satisfies the conditions specified in this section”. Under section 42(1), a company may make a private placement by issuing a private placement offer letter. This letter has to be addressed specifically to persons whose names are recorded prior to making the offer and is not transferable. Further, such an offer cannot be made to more than a total of 200 persons in a financial year.
Section 62 deals with “further issue of share capital”, and section 62(1)(c) specifically deals with “issue of shares on preferential basis” subject to certain conditions, to any persons.
The explanation to rule 13(1) defines “preferential offer” to mean “an issue of shares or other securities, by a company to any select person or group of persons on a preferential basis and does not include shares or other securities offered through a public issue, rights issue, employee stock option scheme, employee stock purchase scheme or an issue of sweat equity shares or bonus shares or depository receipts issued in a country outside India or foreign securities”.
In terms of rule 13(1), for the purposes of section 62(1)(c), shares may be issued by any company in any manner, including by way of a preferential offer, to any persons and such an issue must comply with conditions laid down in section 42 of the act. Rule 13(1) refers to both a “select person” and “group of persons”, while section 42 uses the expression “select group of persons”.
According to one view, if a “preferential offer” (including by way of a private placment) is being made only to a select person, then section 42 need not be complied with as that section defines “private placement” as any offer of securities or invitation to subscribe securities to a “select group of persons”.
According to another view, despite this definition, section 42 needs to be complied with as rule 13(1) also imposes an obligation to comply with section 42. Thus, section 62 seems to suggest that, a “preferential offer” includes a “private placement” under section 42 even to a single allottee.
The stringent provisions prescribed under section 42 were introduced in the aftermath of the Sahara episode, which involved a private placement to investors who were not well informed. Unfortunately, the language lacks the desired precision and poses practical challenges, especially in the case of a one-to-one private placement to a “well-informed investor” that has conducted a due diligence.
By using both “select person” and “group of persons” in the definition of preferential offer under section 62, confusion has arisen as to whether section 42 needs to be complied with in both these cases or just in the case of “select group of persons”. A company’s legal advisers may take the view that a private placement offer letter needs to be issued even to a select person. However, the issuance of such a letter would place such an investor in a disadvantageous position since it would involve, for example, disclosure of “management’s perception of risk factors”. This is likely to cause discomfort to the investor, in light of the warranties given by the company and promoters and related indemnities.
Disclaimer: This article was first published in the June 2014 issue of the India Business Law Journal magazine. It has been authored by Suhail Nathani, who is a partner and Yogesh Chande, who is an Associate Partner at Economic Laws Practice (ELP), Advocates & Solicitors. Manendra Singh, who is an Associate assisted with research They can be reached at firstname.lastname@example.org, email@example.com or firstname.lastname@example.org for any comment or query. The information provided in the article is intended for informational purposes only and does not constitute legal opinion or advice. The contents of this article/update are intended for informational purposes only and do not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.