The past two to three years have been an exciting time to practise private equity law in India with the government heightening its focus on creating a more navigable terrain for foreign investors. Various amendments to laws governing foreign direct investment (FDI) have been consolidated into the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 (FEMA regulations), introduced in November 2017.
Capital instruments that may be acquired by non-resident investors may be classified as: (1) fully paid-up instruments (i.e. where the acquisition consideration needs to be paid at the time of delivery of the instrument); and (2) partly paid instruments (i.e. where the acquisition price can be paid subsequent to delivery of the instrument). Equity shares, compulsorily and fully convertible preference shares and compulsorily and fully convertible debentures can be issued on a fully paid or a partly paid basis. Warrants are another type of partly paid instruments. In connection with startup companies, the FEMA regulations also permit issuance of convertible notes.
The discussion below focuses on partly paid capital instruments that may be purchased or subscribed to by non-resident investors under the FDI route.
A non-resident investor is permitted to acquire partly paid shares and share warrants under the automatic route (i.e. without government approval), subject to prescribed conditions. However, in the context of share warrants the FEMA regulations state that share warrants are those that are issued in accordance with the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (SEBI ICDR regulations).
The purpose of the above change is unclear. It may be interpreted to suggest that the FEMA regulations only permit non-residents to acquire warrants in listed companies. To the contrary, it may be argued that where necessary, the FEMA regulations spell out provisions which apply differently to listed and unlisted companies and such provisions cannot be expressly spelled out in the case of warrants. Therefore, one may contend that the purpose of including such a restriction is to compel unlisted companies which are issuing warrants to non-residents to also observe restrictions under the SEBI ICDR regulations such as those on pricing, tenure and forfeiture.
Under the FEMA regulations, partly paid shares can be issued by preferential allotment, rights issuance and bonus issuance. Share warrants may only be issued through preferential allotment.
Pricing per the applicable pricing guidelines is determined at the time of allotment of partly paid shares. For share warrants, pricing as well as the price conversion formula is determined upfront at the time of issuance.
For both partly paid shares and share warrants, 25% of the total consideration (face value plus premium) is payable at the time of issuance. For partly paid shares the balance of the consideration must be received 12 months from the date of allotment. However, the issuer need not insist on such payment when the issue size exceeds ₹5 billion (US$75 million). The issuer also needs to appoint a monitoring agency under or in line with SEBI guidelines. For share warrants the balance of the consideration must be received 18 months from the date of allotment.
Partly paid shares are issued at the time of allotment and form part of the share capital from the date of issuance. Shares under share warrants are allotted at the time of exercise of the option to subscribe to shares against the warrant. Unless converted into shares, the consideration received against share warrants appears in the balance sheet under “shareholder funds” and does not form part of paid-up share capital. However, such shares are counted towards the total number of shares on a fully diluted basis.
On non-payment of call money on partly paid shares within 12 months from issuance or non-exercise of warrants within 18 months from the date of allotment of the warrant, the upfront consideration and the instrument will stand forfeited.
Both partly paid shares and share warrants can be transferred freely subject to applicable conditions.
Warrants and partly paid shares are effective methods of implementing a deferred payment structure and along with deferred consideration and liberalized post closing indemnity provisions provide foreign investors with several deal structuring options.
Apurva Jayant is a partner and Vishakha Panchangam is an associate at Luthra & Luthra Law Offices. The views expressed here are personal. They are intended for general information purposes and are not a substitute for legal advice.
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