Legal Alert - Use of Put and Call Option by Foreign Investors

Legal Alert

USE OF PUT AND CALL OPTION BY FOREIGN INVESTORS

Reserve Bank of India (“RBI”) vide its Notification dated November 12, 2013 (“Notification”)has amended Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (“FEMA Regulations”). The amendment to the FEMA Regulation has also been clarified by the RBI vide its A.P. (DIR Series) Circular No. 86, dated January 09, 2014 (“Circular”). As per the said Notification and the Circular, foreign investors can use ‘Put and Call’ options in their investment agreements.

Recently, Securities Exchange Board of India (“SEBI”) had allowed the use of put and call option in the investment agreement. However, the confusion on the use of the same was still persisting as RBI had not allowed it specifically. Earlier, RBI had in some instances taken an adverse view on put and call option, and treated equity instruments with call/ put options on par with debt instruments. The view was based on the fact that guaranteed return on exit made the instrument more like a debt instrument. However, with the aforesaid Notification, RBI has now cleared the confusion and expressly allowed use of put and call option in the investment agreements of foreign parties investing in India.

The Notification has amended Regulation 5(1)(i) of FEMA Regulations to include put and call options in a the investment agreements . As per the said amendment, companies can issue shares and convertible debentures containing call or put option, however companies are restricted from fixing the option price/exit price at the time of issuing such shares or convertible debenture.  As per RBI, the same shall be decided at the time of exercising the option. Notification also provides the formula for calculating the option/exit price.

Further, RBI has amended Regulation 9(1) of FEMA Regulations to provide for a minimum lock-in period. It provides that option can be exercised only after the expiry of a lock-in period of one year or a minimum lock-in period provided under FEMA Regulations, whichever is higher.

The amendment to Regulation 9(1) of FEMA Regulations provides the mechanism to calculate the option/exit price. It states that in case of a listed company the option price shall be the market price determined by recognised stock exchange. In the case of an unlisted company, the option price shall not exceed the price calculated on the basis of Return of Equity as per the latest audited balance sheet. The said Notification defines Return of Equity as the ‘profit after tax’/net worth. Net worth would include all free reserves and paid up capital.

In case of convertible preference shares or debentures, the option price shall be calculated on basis of internationally accepted pricing standards prevailing as the time of the exit. The pricing standards shall be certified by a Charted Accountant or a merchant banker registered with SEBI. The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreement and shall exit at the price prevailing at the time of exit, subject to lock-in period requirement, as applicable.

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DISCLAIMER

This legal alert has been prepared by Sarthak Advocates & Solicitors. It is meant to be merely an informative summary and should not be treated as a substitute for considered legal advice. We welcome your comments and suggestions. For any comments, suggestions or further clarifications, please contact us at:

  

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