In the wake of the covid-19 pandemic and its economic consequences, the private equity and venture capital industry has seen a major downturn. The pandemic has also increased the focus on exit options available to investors under their existing investment contracts.
Most investment contracts provide for an exit for the investors in accordance with defined timelines, which may include such matters as a listing on a stock exchange; a strategic sale of either the portfolio company or its assets; a sale to an institutional investor or other private equity or venture capital funds; a promoter buyout or a company buyback, and drag-along rights granted to the investor. Exit rights may be obligatory or on a best-effort basis, and the drag-along rights may be excisable at will or in accordance with agreed timelines. Some contracts provide for an exit at market value, others set out an expected return on investment.
Regulatory changes introduced by the government in a press note dated 17 April 2020 restricted fresh funding or additional funding from certain countries without prior governmental approval and reduced the options available to companies to find third party acquirers for existing investors.
It is uncommon to find force majeure provisions in investment contracts. The absence of such a clause means that the investment contract does not contemplate circumstances where parties would be excused from performance on the occurrence of circumstances beyond their control. However, section 56 of the Indian Contract Act, 1872 (act), provides for circumstances under which a contract can be frustrated and performance can be avoided if it becomes reasonably impossible. The government issued clarification through an office memorandum dated 19 February 2020 in relation to its public procurement manual, in which it stated that the covid-19 pandemic could be considered as a force majeure event wherever appropriate. However, this would apply only to those government contracts that incorporate a force majeure clause. The benefit of such a provision would not be available to transactions where the manual is not applicable. Further, in cases such as Standard Retail Pvt Limited v GS Global Corp and Ors and Halliburton Offshore Services Inc v Vedanta Limited the courts have not excused performance of contracts solely because of the pandemic.
While the issues surrounding put options and assured returns continue, the question of whether section 56 of the act applies to the exit obligations under investment contracts has also arisen. In order to be protected under section 56 of the Act, the defaulting party needs to establish that the performance is impossible and not merely difficult or economically unfeasible. Landmark cases upholding this principle are Satyabrata Ghose v Mugneeram Bangure & Co and Alopi Prasad and Sons Ltd v Union of India. Courts have also held that they will not apply the doctrine of impossibility to assist a party who does not want to fulfil his contractual obligations and relies on literal impossibility to resile from them. In Energy Watchdog and Ors v Central Electricity Regulatory Commission and Ors the Supreme Court approved the approach of the English case of The Sea Angel, in which it was stated that the application of the doctrine of frustration requires a multi factorial approach. Factors that have to be considered before a party can establish frustration include the terms of the contract itself; its matrix or context; the parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, at the time of the contract; the nature of the supervening event, and the parties’ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances. The application of the doctrine can be difficult, but mere expense, delay or onerousness is not sufficient. There has to be a break in identity between the original contract and its performance in the new circumstances.
The applicability of section 56 of the act to exit rights would also depend on the intent as set out in the investment contracts, especially if there are many such contracts. Factors, other than the pandemic, that may be considered include: (i) whether the exit rights are obligatory; (ii) whether there is a remedy in the event that no exit is provided; (iii) whether there has there been a breach; (iv) whether there are exit rights fundamental to the execution of the contract, especially where more than one investment contract exists; (v) whether the current adverse circumstances amount to a hardship, a temporary event, or something that make the performance of the exit rights impossible, and (vi) whether the enforcement of exit rights would cause regulatory or statutory non-compliance or challenge.
Ekta Bahl is a partner and Sanjana Shrivastava is a senior associate at Samvad Partners.
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