27 Natl LSCH India Rev 17

DATE DOWNLOADED: Sat Mar 9 08:13:52 2024
SOURCE: Content Downloaded from HeinOnline
Citations:
Please note: citations are provided as a general guideline. Users should consult their preferred
citation format's style manual for proper citation formatting.
Bluebook 21st ed.

Afra Afsharipour, Corporate Governance and the Indian Private Equity Model, 27 NAT'l
L. SCH. INDIA REV. 17 (2015).
ALWD 7th ed.

Afra Afsharipour, Corporate Governance and the Indian Private Equity Model, 27 Nat'l
L. Sch. India Rev. 17 (2015).
APA 7th ed.

Afsharipour, Afra. (2015). Corporate governance and the indian private equity model.
National Law School of India Review, 27(1), 17-48.
Chicago 17th ed.

Afra Afsharipour, "Corporate Governance and the Indian Private Equity Model,"
National Law School of India Review 27, no. 1 (2015): 17-48
McGill Guide 9th ed.

Afra Afsharipour, "Corporate Governance and the Indian Private Equity Model" (2015)
27:1 Nat'l L Sch India Rev 17.
AGLC 4th ed.

Afra Afsharipour, 'Corporate Governance and the Indian Private Equity Model' (2015)
27(1) National Law School of India Review 17
MLA 9th ed.

Afsharipour, Afra. "Corporate Governance and the Indian Private Equity Model."
National Law School of India Review, vol. 27, no. 1, 2015, pp. 17-48. HeinOnline.
OSCOLA 4th ed.

Afra Afsharipour, 'Corporate Governance and the Indian Private Equity Model' (2015)
27 Nat'l L Sch India Rev 17 Please note: citations are provided as
a general guideline. Users should consult their preferred citation format's style
manual for proper citation formatting.
-- Your use of this HeinOnline PDF indicates your acceptance of HeinOnline's Terms and
Conditions of the license agreement available at
https://heinonline-org-dsnlu.knimbus.com/HOL/License
-- The search text of this PDF is generated from uncorrected OCR text.
-- To obtain permission to use this article beyond the scope of your license, please use:
Copyright Information
NLSIR
CORPORATE GOVERNANCE AND THE
INDIAN PRIVATE EQUITY MODEL
-Afra Afsharipour*
Abstract Private Equity (PE) firms have long invested in Western firms
using a leveraged buyout (LBO) model, whereby they acquire a company that
they can grow with the ultimate goal of either selling it to a strategic buyer or
taking it public. Unable to undertake the traditional LBO model in India, PE
investors in Indian firms have developed a new model. Under this Indian PE
Model, PE firms typically acquire minority interests in controlled companies
using a structure that is both hybridized from other Western investment models
and customized for India's complex legal environment. As minority sharehold-
ers in controlled firms, PE investors in India have developed several strategies
to address their governance concerns. In particular, PE investors in India have
focused on solutions to address local problems through the use of agreements that
govern (i) the structuring of minority investments, (ii) investor control rights, and
(iii) exit strategies. Nevertheless, recent governance and regulatory difficulties
highlight the continuing uncertainty surrounding the Indian PE model.
I. INTRODUCTION
India's economic growth over the past decade has attracted unprecedented
foreign direct investment (FDI). Much of this FDI has consisted of investments
by private equity (PE) firms. In 2005-2012, PE firms were responsible for over
Afra Afsharipour is a Professor of Law at the University of California, Davis School of Law.
An earlier version of this article was distributed as NSE working paper W P/8/2013, sponsored
by the National Stock Exchange of India Ltd. The article has benefited from the comments
of Sandip Bhagat, Anupam Chander, Puneet Gupta, Radhika Iyer, Patricia A. Seith, Diego
Valderrama, Umakanth Varottil, and participants at the 2012 Northern California International
Law Scholars Workshop, the 2011 Law and Society Annual Meeting, and an anonymous
reviewer. The author acknowledges the institutional support of UC Davis School of Law, and the
library staff at UC Davis School of Law. The author thanks Khushi Desai, James Lee, Alexander
Tran and Eric Zaarour for research assistance. The author can be contacted at aafsharipour@
ucdavis.edu. Copyright © 2015 by Afra Afsharipour
NATIONAL LAW SCHOOL OF INDIA REVIEW 27 NLSI REv. (2015)
$50 billion of total FDJ.' In 2014 alone, PE investment accounted for 53% of the
$29 billion FDI inflow into India.2 PE firms, including Western PE firms, have
become active investors in many sectors of India's economy.
PE firms have long been important investors in Western markets. In the

United States and other Western economies, PE firms traditionally seek to
acquire companies that they can grow and improve with the ultimate goal of
either selling the company to a strategic buyer or taking the company public via
an initial public offering (IPO). 3 In implementing this model, PE buyers tend to
acquire companies through the use of leverage. In a typical PE-sponsored lever-
aged buyout (LBO), the company's assets are used as collateral for the debt and
4
its income is used to service the debt.
While the traditional PE model has been successful in developed economies,

transplanting the LBO model to India is difficult due to various legal constraints.
Accordingly, PE firms in India have developed an alternate model that is both
hybridised from other investment models in the West, such as venture capital
(VC) investments, and customised for India's complex regulatory and governance
environment. 5 Thus, rather than engaging in traditional LBOs, PE firms primar-
ily engage in minority investments in promoter-controlled firms. 6 For example, a
2015 report by Bain & Company indicated that over 90% of PE investment deals
7
in 2014 consisted of minority stake deals.
Like other Asian countries, concentrated ownership dominates the Indian cor-
porate landscape.8 Because of the ownership structure of Indian firms, controlling
shareholders (i.e., promoters) play an important and pervasive role in Indian cor-
porate governance. 9 Indian company founders or promoters have generally wel-
Bain & Company, INDIA PRIVATE EQUITY REPORT (2013).

2 Bain & Company, INDIA PRIVATE EQUITY REPORT (2015).
3 Afra Afsharipour, Transforming the Allocation of Deal Risk Through Reverse Termination Fees,
63 VANDERBILT LAW REVIEW 1161, 1170 (2010).
4 Jeffrey Blomberg, Private Equity Transactions: UnderstandingSome Fundamental Principles, 17
BUSINESS LAW TODAY 51, 51-52 (2008).
5 Rustom Kharegat et al., Private Equity in India, KPMG 3 (2009).
6 Bain & Company, INDIA PRIVATE EQUITY REPORT 1 (2011). Reports indicate that minority invest-
ments have decreased somewhat. According to a recent McKinsey report, while in 2006-
2007 only 13% of Indian PE investments by value were control investments, in 2013 2 9 %
of such investments were control investments. Vivek Pandit, Private Equity in India: Once
Overestimated, Now Underserved, McKinsey Insights (February 2015), available at http://www.
mckinsey.com/insights/financial services/private equity in india.
7 Bain & Company (2015), supra note 2, at 31.
Rajesh Chakrabarti, William Megginson & Pradeep K. Yadav, Corporate Governance in India,
20 JOURNAL OF APPLIED CORPORATE FINANCE 59 (2008); Lee Kha Loon & Angela Pica, Independent
Non-Executive Directors: A Search for True Independence in Asia, CFA INSTITUTE CENTRE. FOR
FINANCIAL MARKET INTEGRITY CODES, STANDARDS, AND POSITION PAPERS (2010), available at http://
www.cfapubs.org/doi/pdf/10.2469/ccb.v2OlO.nl.1.
9 The concept of "promoter" has specific legal significance in the Indian context. Promoters
in India are typically controlling shareholders, but can also be those instrumental in a public
VOL. 27 CORPORATE GOVERNANCE & THE INDIAN PRIVATE EQUITY MODEL 19
corned the involvement of PE investors in providing funding and strategic advice

to their companies. Nevertheless, the dominance of promoters exposes PE inves-
tors in India to the typical corporate governance concerns faced by minority
shareholders. In fact, PE investors in India often list corporate governance as a
primary area of concern. 0
As minority investors in controlled firms, PE firms in India confront the

corporate governance concerns that permeate the Indian environment. As cor-
porate law scholars have long recognized, the nature of corporate governance
concerns differ based on the ownership structure of firms." While for publicly
owned firms with diverse ownership the governance concern is primarily about
the agency costs of management vis-h-vis shareholders, for firms with controlling
shareholders the "fundamental concern that needs to be addressed by governance
arrangements is the controlling shareholder's opportunism."' 2 In controlled firms,
minority stockholders are often concerned with self-dealing transactions and
other types of expropriation or extraction of wealth (tunneling) by majority stock-
holders. 3 But minority shareholders generally have limited power under corporate
offering or those named in the prospectus as promoters. Section 2(69) of the Companies Act,
2013 defines a "promoter" as "a person who (a) who has been named as such in a prospectus or
is identified by the company in the annual return referred to in section 92; or (b) who has control
over the affairs of the company, directly or indirectly whether as a shareholder, director or other-
wise; or (c) in accordance with whose advice, directions or instructions the Board of Directors of
the company is accustomed to act. Section 2(27) of the Companies Act, 2013 defines control as
"the right to appoint majority of the directors or to control the management or policy decisions
exercisable by a person or persons acting individually or in concert, directly or indirectly, includ-
ing by virtue of their shareholding or management rights or shareholders agreements or voting
agreements or in any other manner." See also Regulations 2(1)(za), Securities and Exchange
Board of India (Issue of Capital and Disclosure Requirements) (August 26, 2009), available at
http://www.sebi.gov.in/guide/sebiidcrreg.pdf.
Bain & Company (2015), supra note 2, at 36.
For an overview of the differences between controlled and non-controlled companies, see
Lucien A. Bebchuk & Assef Hamdani, The Elusive Quest for Global Governance Standards,
157 UNIVERSITY OF PENNYSLYVANIA LAW REVIEW . 1263, 1281-85 (2009). See also John Armour
et al., What is Corporate Law?,THE ANATOMY OF CORPORATE LAW: A COMPARATIVE APPROACH 31
(R. Kraakman et al. eds., 2d ed., 2009); Ronald J. Gilson & Jeffrey N. Gordon, Controlling
Controlling Shareholders, 152 UNIVERSITY OF PENNYSLYVANIA LAW REVIEW 785 (2003).
Bebchuk & Hamdani, supra note 11, at 1282. See also Gilson & Gordon, supra note 11; Ronald
J. Gilson, Controlling Shareholders and Corporate Governance: Complicating the Comparative
Taxonomy, 119 HARVARD LAW REVIEW. 1641 (2006).
See, e.g., Simon Johnson et al., Tunneling, 90 AMERICAN ECONOMIC REVIEW 22 (2000) (defining
tunneling as the "transfer of resources out of a company to its controlling shareholder (who
is typically also a top manager)"). There is also some concern that the prevalence of pyrami-
dal ownership by family business groups with considerable economic power can affect voting
by minority shareholders and even institutional investors, due to such shareholders' business
ties with the group. See Tarun Khanna & Yishay Yafeh, Business Groups in Emerging Markets:
Paragons or Parasites?, 45 JOURNAL OF ECONOMIC LITERATURE 331-73 (2007); Yishay Yafeh &
Assaf Hamdani, InstitutionalInvestors as Minority Shareholders 1, 3 (October 10, 2011) (unpub-
lished manuscript), available at http://ssrn.com/abstract-1641138.
law to affect the activities of the controlling stockholder through contesting con-
4
trol, voting rights, or pressuring the board of directors.
Given somewhat limited protections for minority shareholders under Indian

company law, PE investors in India have devised various contractual protections
to address the corporate governance challenges prevalent in India due to the own-
ership structure of most Indian firms. Accordingly, PE investors have focused
their strategies and shareholders' agreements on several major issues: (i) structur-
ing of minority investments, (ii) investor control rights, and (iii) exit strategies.
The strategies used by PE firms also reflect their ongoing concerns regarding the
governance of Indian firms. While recent reforms in Indian company law may
address some of these concerns, these reforms also generate other uncertainties
with respect to PE investments in Indian firms.
This article proceeds as follows. Section I provides an overview of the general

state of PE investments in Indian firms. Section II then addresses the Indian PE
model, explaining why undertaking traditional LBOs is impracticable in India.
Part II explores some of the challenges PE investors face in implementing minor-
ity investments in Indian firms. Part III then explores the structure of PE invest-
ments in Indian firms and chronicles the contractual methods through which PE
investors have addressed some of these challenges via provisions in their share-
holders' agreements. Part III also examines the difficulties that PE investors con-
tinue to face in designing and enforcing shareholders' agreements.
II. PRIVATE EQUITY INVESTMENTS IN INDIA
India's economy has undergone significant transformations since 1991. 5 India's

rapid economic growth, together with its economic liberalisation, has attracted
global attention. Foreign investors have rushed to direct capital into India. Indian
firms and entrepreneurs have generally welcomed and advocated for the rise in
inbound foreign investment, including investments from PE firms. 6
PE activity in India surged in the first half of the last decade. Some of the
world's most prominent PE firms have set up local offices in India. Firms such as
Goldman Sachs, Warburg Pincus, Blackstone, Carlyle, KKR, and TA Associates
have undertaken multi-million and even billion dollar transactions in India.
14 See Bebchuck & Hamdani, supra note 11, at 1281-83.

For an excellent account of India's economic transformation, see Arvind Panagariya, INDIA: THE
EMERGING GIANT 107 (2008).

Dhammika Dharmapala & Vikramaditya S. Khanna, Corporate Governance, Enforcement, and
Firm Value: Evidence from India, 29 (Olin Working Paper No. 08-005, Univ. of Michigan Law
& Economics, 2011), available at http://ssrn.com/abstract-1105732; see also Umakanth Varottil,
A Cautionary Tale of the Transplant Effect on Indian Corporate Governance, 21National Law
School of India Review. 1, 8-9 (2009).
However, unlike in the West where PE firms generally undertake buyouts, in

India, PE firms have generally undertaken minority investments.
Part A below provides an overview of the trends in PE activity in India over

the past decade. Part B provides a brief overview of India's foreign investment
regime. Since many PE firms investing in Indian companies are foreign PE firms,
they must ensure that their investments comply with the country's foreign invest-
ment rules.
A. An Overview of India's PE Activity
Despite the attractiveness of the potential of the Indian market, PE investments

into India have fluctuated widely over the past several years.' 7 These fluctuations
are due to the country's economic and political uncertainty, as well as regulatory
uncertainty, such as the recent 2012 controversy regarding India's fluctuating tax
policies. 8 PE investments into India experienced significant growth in 2006-2010,
but dipped considerably after 2008. 9 The past year has seen some recovery. For
example, India's total PE deal value in 2014 grew 28% from 2013 levels to $15.2
billion, inching closer to the 2007 peak levels.20 Further, in 2014 the number of
exits increased by 14% from 2013, although the exit value decreased by 22%.21
Table 1 summarises the value of PE investments in Indian firms as well as the
value of exits from such investments.
Anita Raghavan, India's Private Equity Industry Shakes Off its Doldrums, NEW YORK TIMs
(April 6, 2015) available at http://www.nytimes.com/2015/04/07/business/dealbook/indias-pri-
vate -equity-industry- shakes- off-its -doldrums.html
Bain & Company (2013), supra note 1.
19 KPMG, Returns from Indian Private Equity, KPMG Report 11 (2011); Slowdown in PE contin-
ues; quarterly investment dips 34% to below $1.9-B, THE VENTURE INTELLIGENCE BLOG (July 8,
2012) available at http://ventureintelligence.blogspot.in!2012 07 01 archive.html.
20 BAIN & COMPANY (2015), supra note 2, at 16.
21 /d
Table 1: Annual PE Investments into and Exits from Indian Firms
Billions
20
18 17.1
16 14.8 15.2
14
12 1 1.8 m Investments
10 9.3
1 0 Exits
6 4.5 1 5.3
2 3.7 13.5 "
4 -12.6 2. 2.1
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Bain & Company (2015)
PE activity in 2015 appears to follow the positive trends of 2014. The first
quarter of 2015 saw 130 PE deals worth $2.77 billion - the best performing first
quarter since 2011.22 Despite the increase in PE deals, exit activity remains slug-
gish and almost 50% of total exits happened through strategic deals valued at
23
$584 million across 12 deals.
Overall, the initial exuberance of Western PE firms for investing in India

has tempered.24 PE firms have typically become much more stringent in choos-
ing Indian target companies.2 5 Moreover, India's recent economic struggles along
with significant regulatory uncertainty have meant that PE firms must place an
even greater emphasis on managing corporate governance and exit strategies.
Given the history of the value of exits thus far, PE firms fear being unable to
exit companies and also fear that target companies will seek to block any exit.
Accordingly, PE firms are screening the management of target companies much
more closely, attempting to build stronger ties with them on the front end, and
are then structuring tougher contractual provisions in their deals.
In order to understand the strategies that PE firms use to address the afore-
mentioned issues, it is first necessary to understand the Indian PE Model.
22 PRICEWATERHOUSECOOPERS INDIA, MONEYTREE INDIA REPORT (2015).

23 Id.
24 See Boby Kurian & Reeba Zachariah, Global Private Equity Biggies Put India Story on Hold,
TIMES OF INDIA, July 26, 2012,http://timesofindia.indiatimes.com/business/india-business/Global-
private-equity-biggies-put-India-story-on-hold/articleshow/ 15155080.cms.
25 BAIN & COMPANY, INDIA PRIVATE EQUITY REPORT (2012).
B. The Regulatory Framework for Investments by PE Firms
Investments by PE firms in India are governed by a complex set of federal

laws, and a variety of regulators including the Securities and Exchange Board
of India (SEBI), the Reserve Bank of India (RBI) and the Foreign Investment
Promotion Board (FIPB). For purposes of this article, the complex regula-
tory structure governing fund establishment and formation are not addressed.26
Needless to say, both domestic and foreign PE and venture capital funds are sub-
ject to extensive regulation related to fund structuring and licensing.
Indian PE fund structuring underwent a major shift in 2012 with the pas-
sage of SEBI's Alternative Investment Fund (AIF) Regulations, 2012 to regu-
late private pools of capital. Prior to passage of the AIF regulations, PE funds
in India operated under a variety of complex regulatory systems. 27 An AIF can
be set up as a trust (the most commonly used structure), a company, a limited
liability partnership, or a body corporate.28 The AIF Regulations cover a broad
range of funds so that every fund established in India for the purpose of pooling
money from investors, whether Indian or foreign, on a private basis for investing
it further falls under the umbrella of the regulations, unless specifically excluded.
PE funds generally fall within category II of the AIF regulations, and are not
excluded from such regulations.
The general rules of Indian company law and the exchange control regu-
lations govern the investments made in India by foreign PE firms. The Foreign
Exchange Management Act, 1999 (FEMA) and the rules promulgated thereun-
der, regulate foreign investments into India. Foreign PE investments can be made
through several regimes, including foreign direct investment (FDI), foreign port-
folio investment (FPI) or foreign venture capital investment (FVCI).2 9 SEBI grants
some benefits to funds that register as a Foreign Venture Capital Investor (FVCI)
under the SEBI (Foreign Venture Capital Investors) Regulations 2000 (FVCI
Regulations). 30 The FVCI regulatory framework "attracts foreign investors while
allowing India to maintain control over issues such as investor qualifications and
3
debt to equity ratios."1'
26 For an overview of fund regulation, see Siddharth Raja & Ashwini Vittalachar, Private Equity
in India: Market and Regulatory Overview, Private Equity and Venture Capital Global Guide
2015/16 (2015), available at global.practicallaw.com/8-504-2425.
27 Existing venture capital funds that were registered under SEBI's 1996 Venture Capital Fund
Regulations were grandfathered in. For details of this scheme, see Nishith Desai Associates,
Funds Hotline: Alternative Investment Funds Regime (May 24, 2012) (on file with author).
28 See Rupinder Malik, Sidharrth Shankar & Vatsal Gaur, India, GETTING THE DEAL THROUGH:
PRIVATE EQUITY (TRANSACTIONS) 226 (2013).
29 See Nishith Desai Associates, PRIVATE EQUITY AND PRIVATE DEBT INVESTMFNTS IN INDIA
7 (April
2015).
30 See Raja & Vittalachar, supra note 26.
31 Kelly Fisher & Sophie Smyth, US Private Equity Investments in Emerging Economies, 12
JOURNAL OF INTERNATIONAL BUSINESS AND LAW 223, 235 (2013).
PE firms have invested in a variety of Indian companies, although various

exchange control norms may limit the potential targets for foreign PE firms and
the ability of funds to undertake buyouts. Investments by foreign PE firms may
be governed by India's FDI rules. FDI generally does not require regulatory
approval and falls under the "automatic route" of the RBI.3 2 Nevertheless, unless
the company operates in a sector in which 100% FDI is allowed, various sectoral
caps may apply. Accordingly, the PE fund may not be able to acquire 100% of
the shares of such a company without approval from the FIPB, which may not
always be forthcoming. Moreover, FDI is prohibited in certain sectors, such as
gambling or betting.
III. THE INDIAN PRIVATE EQUITY MODEL

AND OBSTACLES FACED BY INVESTORS
PE firms in India broadly undertake two types of deals: "growth" deals,

where a PE fund buys a minority stake in a company, but does not get involved
in the day-to-day management; and "buyouts," where a PE fund buys an own-
ership stake and runs the business as well. PE firms generally have the option
of investing in private companies, public companies (both listed and unlisted),
and private companies that are subsidiaries of public companies. The structural
impediments to LBOs-such as the prohibition on using leverage in such deals,
a practice that is widely used elsewhere, which makes returns more attractive-
bolster the predominance of minority investments. Thus, the vast majority of PE
firms in India undertake "growth" deals with minority investments in public or
private companies."
For PE firms, such minority investments can present significant challenges

given India's complex legal environment. Part A below explains why PE firms
investing in Indian companies have generally been unable to use the traditional
leveraged buyout (LBO) model that is commonly used in the West. A PE firm's
status as a minority investor can cause friction with the Indian promoter. Part
B discusses some of the problems that PE firms have faced when dealing with
promoters. In addition to corporate governance challenges related to promoter
control, the Companies Act generally imposes greater requirements, particularly
corporate governance requirements, on public companies and their subsidiaries.
Indian securities regulation prescribes even more rigorous norms for public listed
companies. Thus, PE firms face significant obstacles when investing in listed
companies in India. Part C discusses additional legal issues faced by PE firms
investing in listed companies.
32 Reserve Bank of India (RBI), Master Circular on Foreign Investments in India (Master Circular
No.15/2012-13) (2012).
See Bain & Company (2011), supra note 6, at 5-8, 20.
A. Challenges for the Traditional Private Equity Model
Due to India's complex legal framework and restrictions, PE firms investing in

Indian companies have generally been unable to use the traditional LBO model
that is commonly used in the West. Part 1 below provides a brief overview of the
traditional LBO model. Part B then examines the legal and regulatory hurdles to
an LBO of an Indian company.
(a) The TraditionalPrivate Equity Model
In the West, PE firms are typically privately-held partnerships that acquire and
"take private" publicly-traded companies so that the shares of public investors
will be bought out and the company will be de-listed from the stock market. PE
firms rarely use their own cash as the only currency for the acquisition consid-
eration. More typically, PE acquisitions are structured as LBOs in which the PE
firm completes the acquisition using significant debt financing from a consortium
of lenders. In a PE-sponsored LBO, the seller's assets are used as collateral and
the seller's cash flows are used to service the debt.34 In order to service this debt,
the company's management is then required to "adhere to strict, results-oriented
financial projections" and to "operate the company within tight budgetary and
35
operational constraints".
() Corporate governance in PE acquisitions
In connection with their significant ownership stake, PE firms are often heav-
ily involved in the governance of the acquired firm. A principal question in cor-
porate governance is: Who controls the board of the company? In general, the PE
owner directs all aspects of the board of directors of an acquired company. Not
only does the PE owner select the vast majority of the company's board of direc-
tors, the general partners of the PE fund often serve as board members with sig-
nificant involvement in devising and executing the company's strategic plan, with
a focus on improving the company's financial performance. In addition to board
representation, the PE owner typically exercises control over many aspects of the
board's decision-making process through the use of shareholder agreements. It is
common for PE investors to negotiate an ability to veto key decisions, including
the following: amending the articles of incorporation; changing the nature of the
business; change in control transactions; issuing securities; engaging in non-arm's
length transactions; replacing the CEO; incurring debt; and approving the budget.
Under most PE shareholder agreements, an effective veto can be established by
requiring shareholder approval for certain actions and by requiring that those
actions be approved by a super-majority of the board. Shareholder agreements
See Jeffrey A. Blomberg, Private Equity Transactions: Understanding Some Fundamental

Principles,17 Bus. L. TODAY 51, 51-52 (2008).
15 Brian Cheffins & John Armour, The Eclipse of Private Equity, 33 DEL. J. CORP. L. 1, 9 (2008).
may also include other important provisions such as transfer restrictions (which
prohibit transfers of target securities for a particular time period and transfers in
excess of specified percentages), tag-along rights (i.e., the right of a shareholder to
transfer securities to a person who is purchasing securities from another holder),
and drag-along rights (i.e., the right of a shareholder to require other holders to
transfer securities to a person who is purchasing in excess of a specified percent-
age of securities from such shareholder).
(ii) PE exit strategies
PE funds have contractually limited lifetimes-typically around 10 years.

Accordingly, a PE firm must manage the acquired company with exit strategies
in mind in order to realise its investment as soon as possible. In the West, PE
firms generally have two exit options: (i) an IPO of the company; or (ii) a sale
of the company to a strategic buyer or another financial buyer.36 In connection
with these exit strategies, PE firms often seek specific contractual rights in the
shareholder agreement such as demand and piggyback registration rights (which
may include the right to force an IPO), put rights, or mandatory redemption
37
provisions.
(b) Legal Challengesfor Use of the TraditionalPE Model in India
In addition to regulations regarding fund structuring and licensing, PE firms

in India face a host of regulations related to the structure of their investments
in their portfolio companies. These various regulations place significant hurdles
that make both buyouts and traditional LBOs exceedingly difficult to undertake
in India.38 The following sections discuss some of these hurdles.
36 See Afra Afsharipour, Transforming the Allocation of Deal Risk Through Reverse Termination
Fees, 63 VANDERBILT LAW REVIEW 1161, 1170 (2010).
17 See Darian M. Ibrahim, The (Not So) Puzzling Behavior of Angel Investors, 61 VANDERBILT LAW
REVIEW 1405, 1415-16, (2008); Gordon Smith, The Exit Structure of Venture Capital, 53 UCLA
LAW REVIEW 315, 348-354 (2005).
In addition to the legal restrictions discussed in this section, market conditions also present
challenges for PE firms seeking to undertake traditional LBOs. PE firms often undertake LBOs
by leverage or debt that is issued and serviced by the target company. Thus, financing an LBO
requires access to a deep debt market. However, India's corporate debt market is small and mar-
ginal compared to the corporate bond markets in developed countries. For a full discussion, see
Vikramaditya Khanna & Umakanth Varottil, Developing the Market for Corporate Bonds in
India (Nationall Stock Exch. of India Ltd., Working Paper No. 6, 2012), available at http://www.
nseindia.com/research/content/WP 6 Mar2012.pdf.
() Legal and regulatory restrictionson LBOs
PE firms looking to undertake traditional Western-style LBOs face significant

restrictions from both regulatory rules and provisions of the Indian Companies
39
Act.
The Reserve Bank of India (RBI) prohibits Indian banks from granting loans
for the purchase of shares in an Indian company.40 Several RBI Master Circulars
mandate that domestic banks cannot grant loans to any borrowers that use the
equity or debt of the company as collateral.4' Moreover, the RBI strongly lim-
its a bank's total exposure to the capital markets. 2 Given these restrictions, a
PE investor will be unable to use the shares of a target company as collateral in
order to finance an LBO by raising debt in India.
In addition to the RBI restrictions, a Press Note by the Foreign Investment

Promotion Board (FIPB), India's highest authority regulating foreign invest-
ment in India, has placed several roadblocks to leveraging debt for the purchase
of an Indian company.4 3 The FIPB prohibits foreign investment companies from
borrowing from Indian banks to purchase the securities of an Indian company.
It also requires foreign PE firms to obtain permission from the FIPB for estab-
lishing a foreign-owned holding company in India. Moreover, it mandates FIPB
approval if the foreign-owned holding company decides to purchase the shares of
an Indian company.
The provisions of the Indian Companies Act present additional obstacles for
traditional LBOs as companies are not allowed to leverage their assets to raise
investments. The Companies Act, 1956, as well as the new Companies Act, 2013,
prohibit public companies (which include private companies that are subsidiaries
of a public company) from providing financial assistance to any person for the
purchase of their shares.44 Thus, a traditional LBO where debt is raised by using
39 See Narendra Chokshi, Challenges Faced in Executing Leveraged Buyouts in India: The
Evolution of the Growth Buyout (Apr. 2, 2007) (unpublished manuscript), available at https://
www.stern.nyu.edu/sites/default/files/assets/documents/uat 024317.pdf.
40 See Chokshi, supra note 39, at 15; Archana Rajaram & Amrita Singh, India, in PRIVATE EQUITY:
FUND FORMATION AND TRANSACTIONS IN 42 JURISDICTIONS WORLDWIDE 217, 219 (Casey Cogut ed.,
2009) (discussing debt-financing structures). In December 2013, the RBI released a Discussion
Paper on "Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair
Recovery for Lenders: Framework for Revitalizing Distressed Assets in the Economy" which
explores allowing PE firms to conduct LBOs of distressed companies. See James Crabtree, India
Central Bank Invites Buyout Groups to Clean Up Bad Debts, FINANCIAL TIMES (Dec. 17, 2013).
41 Reserve Bank of India, Master Circular on Exposure Norms, RBI/2012-13/68 DBOD. No.Dir.
BC.3/13.03.00/ 2012-13 (2012); see Chokshi, supra note 39, at 15 (noting that banks cannot make
loans to industrial, corporate or other borrowers).
42 Reserve Bank of India, Discussion paper on Regulation of Off-Balance Sheet Activities of Banks,
DBOD. BP. No. 12048/21.04.141/2009-10 (2010).
41 Foreign Investment Promotion Board, Press Note 9 (1999).
44 See § 77(2) , the Companies Act, 1956 and § 67(2),the Companies Act, 2013.
NATIONAL LAW SCHOOL OF INDIA REVIEW 27 NLSI REV. (2015)
the company's assets as collateral is not permitted for public companies. This
45
restriction applies to all public companies, whether listed or unlisted.
Since the restrictions in the Companies Act do not apply to a private com-
pany, a listed public company could conceivably delist its securities and convert
itself into a private company prior to being acquired via an LBO. However, the
delisting and conversion processes are not simple, and are subject to both sig-
nificant shareholder and regulatory approvals. 46 Delisting is considered an "oner-
ous" and often unsuccessful process as it requires the separate approval of a 2/3
majority of a company's shareholders. 47 Furthermore, the votes cast in favour of
the resolution by public shareholders should be at least two times the votes cast
by public shareholders against the resolution.48 In addition, under SEBI's rules,
in order to delist a company two thresholds must be met (A) the shareholding of
the acquirer together with the shares tendered by public shareholders must reach
90 per cent of the total share capital of the company and (B) at least 25 per cent
of the number of public shareholders, holding shares in dematerialised mode as of
the date of the board meeting which approves the de-listing proposal, have par-
ticipated in the reverse book building process; although this requirement is not
applicable to cases where the acquirer and the merchant banker demonstrate to
the stock exchanges that they have delivered the letter of offer to all the public
49
shareholders.
In 2015, SEBI amended the Delisting Regulations in order to address concerns

50
related to the complexities of the delisting process and to make delisting easier.
Key changes to the 2009 Delisting Regulations include reductions in statutory
15 § 2(71), Companies Act, 2013 defines a public company as a company which is not a private
company. A private company is defined under Section 2(68) of the Companies Act, 2013 as a
company which by its articles restricts the right to transfer its shares; limits the number of its
members to two hundred, and prohibits any invitation to the public to subscribe for any secu-
rities of the company. Under the Companies Act, a public has more reporting and compliance
obligations than a private company. See Vinod Kothari & Aditi Jhunjhunwala, Finally Some
Exemptions to Private Companies, INDIACORPLAW BLOG (June 9, 2015), available at http://indi-
acorplaw.blogspot.com/2015/06/lenders-empowered-to -take -control-over.html.
46 The delisting of listed securities is governed by the Securities Contracts (Regulation) Rules, 1957
and the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009,
and various amendments thereto.
I See Vikramaditya S. Khanna & Umakanth Varottil, Regulating Squeeze Outs in India: A
Comparative Perspective 11-12 AMERICAN JOURNAL OF COMPARATIVE LAW (Forthcoming 2015);
NUS Law, Working Paper No. 2014/009, 2014), available at http://papers.ssrn.com/sol3/papers.
cfm?abstract id-2479678.
41 See Securities and Exchange Board of India, The Securities and Exchange Board of India
(Delisting of Equity Shares) Regulations, 2009, (June 10, 2009), available at http://www.sebi.gov.
in/acts/delisting2009.pdf.
49 Securities and Exchange Board of India, The Securities and Exchange Board of India (Delisting
of Equity Shares) (Amendment) Regulations, 2015, (March 24, 2015), available at http://www.
sebi.gov.inlcms/sebi data/attachdocs/1427261684807.pdf.
51 See Rachit Gupta, Delnsting made easier: SEBI amends the deltsting norms, PSA E-Newsline,
April 27, 2015 available at http://www.psalegal.com/upload/publicationassocFile/
ENewslineApril20l5.pdf.
timelines, new thresholds for a successful delisting, changes in pricing mecha-

nisms and providing for stock exchange platforms for delisting. In addition, the
amendments place additional responsibilities on the board of directors of the
company proposed to be delisted, including a determination by the board that the
delisting is in the interest of the shareholders.5
(ii) Challenges with exits through public offerings
India's complex set of regulations and its recent economic turmoil also limit a
PE firm's exit opportunities. 2 In the West, IPOs are often a preferred method of
exit for PE investors. Similarly, PE investors often seek IPO exit rights in share-
holders' agreements with Indian portfolio companies. PE investors may choose to
exit in an IPO pursuant to an offer for sale. Under Regulation 26(6) of the SEBI
(ICDR) Regulations, 2009, an offer for sale may be made if the equity shares
have been held by the sellers for a period of at least one year prior to the filing of
the draft offer document with SEBI5 3
Over the past several years, PE firms have struggled to use IPOs as an attrac-
tive exit as India's IPO market experienced a significant slow-down. 4 However,
there are some indications of an upward trend for PE-backed IPOs in 2015. As of
the Spring of 2015, SEBI had already approved 10 IPOs and was said to be exam-
ining an additional 14 IPOs, with most involving PE-backed companies. 5 5 Given
fluctuations in the global economy, however, it is still too early to say whether
IPOs will become the dominant mode of exit.
While shareholder agreements often include an IPO as an exit right for PE

investors, the ability of PE investors to demand an IPO is significantly limited
56
and the enforceability of such rights has not been tested in the Indian courts.
PE investors who seek to push an IPO over the objections of a promoter will face
51 Securities and Exchange Board of India, The Securities and Exchange Board of India (Delisting
of Equity Shares) (Amendment) Regulations, 2015, (March 24, 2015), available at http://www.
sebi.gov.inlcms/sebi data/attachdocs/1427261684807.pdf.
52 Market factors as well as the legal limitations discussed play an important role in exiting. If the
company's operations are located solely in India, an IPO in Indian markets would be most lucra-
tive. However, if the company operates predominantly overseas or has a major export aspect to
its business, an offering in foreign capital markets is likely to be more profitable.
51 Securities and Exchange Board of India, The Securities and Exchange Board of India (Issue of
Capital and Disclosure Requirements) Regulations, 2009, (August 26, 2009), available at http://
www.sebi.gov.in/guide/sebiidcrreg.pdf.
54 Raja & Vittalachar, supra note 26; India's New Wave of Private Equity Investment, KNOWLEDGE#_
WHARTON (April 25, 2014), available at http://knowledge.wharton.upenn.edu/article/
indias -new-wave -private -equity-inve stments/.
55 Rajesh Mascarenhas, Sneha Shah and Baiju Kalesh, India Inc. plans to raise Rs 25,000
crore in FY16: Investor appetite for mid-caps reignites the primary market, ECON. TIMES,
Apr. 27, 2015, available at http://articles.economictimes.indiatimes.com/2015-04-27/
news/61577936 1 ipo-market-inox-wind-rural-electrification-corp.
56 Malik, Shankar & Gaur, supra note 28.
difficulty since "the offer document needs to be signed by all the directors of the
company, and therefore despite contractual obligations to provide such an exit
(even if placed on the promoters of the target), the promoters and other directors
could always cite their fiduciary duties towards the company as a ground for not
causing an IPO, should they feel that causing an IPO is not aligned with their
57
fiduciary duties towards the company."
A number of SEBI regulations add complexity to a public market exit and

make it clear that PE investors engaged in a buyout of an Indian company
may not be able to exit cleanly through an IPO. 5 8 According to the SEBI's list-
ing requirements, Indian companies must identify the promoters of the list-
ing company for purposes of minimum contributions and the promoter lock-in.
Furthermore, the Companies Act, 2013 includes significant disclosure require-
ments for promoters in a company's offering prospectus. Promoters are also
subject to a certain lock-in of their shares. SEBI's guidelines stipulate lock-in
requirements on promoters' shares to ensure that the control and management
of the company is consistent after the public offering. The minimum contribu-
tion of 20% that promoters make will be locked in for three years. If the pro-
moters' contribution is over 20%, the additional contribution is locked in for one
year. Moreover, a PE firm's pre-IPO shares may be locked in for a year (and even
longer if the PE firm is deemed a promoter) after the date of allotment in the
59
public issue.
(c) Investing in Listed Companies
Even if not undertaking a buyout, PE investments in publicly-traded or listed

companies-private investments in public equity, known as PIPE transactions-
can be quite complicated. PE investors need to be cautious when receiving
non-public information; moreover, such transactions can be subject to the SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter,
"Takeover Code").
() Due diligence issues in PIPEtransactions
Prior to committing capital, PE firms conduct extensive due diligence on target

companies. Indian law, however, has long imposed major obstacles on an inves-
tor's ability to perform this due diligence on a listed company.60 Since required
57 Id.
51 For an overview of capital markets transactions in India, see Zia Mody, Securities Regulation in
CAPITAL MARKETS ININDIA (Rajesh Chakrabarti and Sankar De, eds., 2010).
59 See Nishith Desai Associates, supra note 29, at 29. The one year lock-in period is not applicable
to foreign venture capital investors (FVCIs) that are registered with SEBI so long as such funds
have owned the issuer's securities for at least one year.
60 Tarun M. Stewart & Cyril S. Shroff, Investing in Indian PIPEs, 10 JOURNAL OF PRIVATE EQUITY
87, 88 (2007) (discussing challenges to effective due diligence).
disclosures are limited and do not include financial projections or future business
plans, PE firms often approach the target's management to request access to cur-
rent financial, operational, and legal data of the company.
PE firm have been extremely cautious because due diligence investigations

of listed companies are covered by the provisions of the SEBI's insider trading
regulations. 6' During due diligence, the PE investor may obtain unpublished,
price-sensitive information. The insider trading regulations generally restrict per-
sons that obtain this information about a listed company from buying or selling
securities of that company. A non-exhaustive list of information that is price-sen-
sitive includes periodic financials, intended declaration of dividends, stock issu-
ance or repurchase plans, expansion plans, a proposed merger or consolidation,
or a sale of assets or business units. A PE firm receiving any of this information
could be at risk of being considered an "insider" covered by the regulations, thus
62
limiting its ability to perform a successful due diligence investigation.
SEBI's insider trading regulations underwent a significant overhaul in May

2015 when the SEBI (Prohibition of Insider Trading) Regulations, 2015 (New
Regulations) came into force. 63 The regulations generally expanded the scope of
compliance and restrictions with respect to trading based on unpublished infor-
mation, including prohibiting communication to any person of unpublished price
sensitive information with respect to a company or securities, listed or proposed
to be listed. Despite their expanded scope, the new regulations do provide some
relief for PE investors. The new regulations provide an exception for communi-
cations for all legitimate purposes, performance of duties or discharge of legal
obligations. 64 Nevertheless, the exception provided by the new regulations may
not fully satisfy PE investors. Under the new regulations, in the case of divul-
gence of unpublished information where the board of the company believes the
access to be in the best interest of the company but where there is no open offer,
the price-sensitive information needs to be disseminated to the public two trading
days before the transaction. Experts in India have commented that such dissem-
ination may lead to speculative trading and may adversely impact the pricing of
65
the transaction.
61 Umakanth Varottil, Legal Hurdles to Private Equity Investments, INDIACORPLAW BLOG (May 20,
2008), available at http://indiacorplaw.blogspot.com/2008/05/legal-hurdles-to-private-equity.html
(discussing SEBI's takeover regulations).
62 Umakanth Varottil, SEBI Reforms Part 1: Inisder Trading, INDIACORPLAW BLOG (Novembery
20, 2014), available at http://indiacorplaw.blogspot.com/2014/11/sebi-reforms-part-1-insider-trad-
ing.html.
63 Securities and Exchange Board of India, The Securities and Exchange Board of India
(Prohibition of Insider Trading) Regulations, 2015, (January 15, 2015), available at https://www.
clpindia.in/doc/Annexureo20l.pdf.
64 See Cyril Shroff, Indian Update New Insider Trading Laws in India: How
much is too much? XBMA (April 22, 2015) available at http://xbma.org/forum/
indian-update -new-insider-trading-laws -in-india-how-much-is -too -much!.
65 Id.
(ii) Takeover regulations and PIPE transactions
The Takeover Code applies to the acquisition of shares in a public listed com-
pany that would take the investor's ownership in such a company over certain
specified percentages, and to the acquisition of "control" over the company,
whether or not any shares are being acquired. The Takeover Code requires PE
firms that acquire a substantial number of shares or voting rights of a listed com-
pany to make a mandatory offer, along with significant disclosures, to the public
shareholders of that company.
The Takeover Code underwent significant amendments in late 2011, in part to

provide greater flexibility to investors, including PE firms.66 For example, under
the pre-2011 rules, investors could not acquire 15% or more of a listed Indian
company without making a mandatory offer for an additional 20% of the out-
standing public shares (Open Offer). Pursuant to the advice of the Takeover
Regulations Advisory Committee (TRAC), the revised code increased this 15%
trigger to 25%.67 In addition, acquirers holding 25% or more voting rights in the
target company can acquire additional shares or voting rights up to 5% of the
total voting rights in any financial year, up to the maximum permissible non-pub-
lic shareholding limit (generally 75%). However, a mandatory open offer is trig-
gered by creeping acquisition of more than 5% voting rights in a financial year
by an acquirer who already holds 25% or more voting rights in the target com-
pany. These changes were designed in part to enable the PE industry to enter into
transactions of a more reasonable size.68
Other accompanying changes may also alter the predominance of minor-

ity investments by PE funds. For example, a key change in the Takeover Code
is to increase the size of the mandatory offer from 20% to 26% of the public
shares. 9 Thus, acquirers proposing to acquire 2 5% or more of the target com-
6
pany will have to make an open offer to acquire an additional 26% of the pub-
lic's shares. These changes may enable PE funds that are willing to comply with
due diligence and disclosure requirements to obtain a majority stake or to take
over an Indian company that has a founder/promoter who holds less than 50% of
the company's outstanding shares. 70 Of course, PE investors will need a greater
66 Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 2010, Report of the Takeover Regulations Advisory Committee Under the
Chairmanshipof Mr. C. Aghuthan.
67 Id.
68 Somasekhar Sundaresan, Insider Track on the Takeover Code in IVCA, REPORTING ON INDIAN
PRIVATE EQUITY & VENTURE CAPITAL 5 (2010); Prashant Mehra, What is the Impact of Changes
to Takeover Rules?, REUTERS (July 20, 2010) available at http://in.reuters.com/article/2010/07/20/
idINIndia-50260620100720.
69 Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers)
Regulations, 2011.
7 Dilip Maitra, Barbarians at the Gate, DECCAN HERALD (July 27, 2010) available at http://www.
deccanherald.com/content/83782/barbarians-gate.html.
amount of capital to complete an offer. Some analysts predict that the increase
in the size of the mandatory offer will benefit foreign PE investors who can raise
capital overseas at a lower cost.
One significant impact of the Takeover Code for PIPE transactions is the
definition of "control" under the code. When a PE firm acquires rights in listed
companies (e.g., veto rights on key decisions), the PE firm may have obtained
"control" over the company, triggering the mandatory offer requirements. This
is largely due to the SEBI's adoption of an expansive interpretation of the term
"control." The Takeover Code defines "control" in a broad, inclusive manner,
as including: "the right to appoint the majority of the directors or to control the
management or policy decisions exercisable by a person or persons acting indi-
vidually or in concert, directly or indirectly, including by virtue of their share-
holding or management rights or shareholders agreements or voting agreements
or in any other manner." Thus far, it remains up in the air whether a PE fund
with certain veto powers or influence on strategic decisions has "control" and
7
must, therefore, conduct a mandatory offer. '
The new Takeover Code no longer allows PE investors to pay promoters

up to a control premium as a non-compete fee. Thus, all shareholders must be
offered the same price per share by the PE investor. Analysts have argued that
this change overlooks the fact that promoters are knowledgeable about the day-to-
day operations and management of the company, and that if promoters depart the
company without a non-compete agreement, a major threat to the interests of the
PE acquirer and the company exists.
The Takeover Code also imposes disclosure obligations on PE investors. Under

the Takeover Code, disclosures are required to be made in the following cases: (i)
an acquirer along with persons acting in concert (PACs) acquires 5% or more of
the shares of the target; (ii) any 2% change (increase or decrease) in such acquir-
er's shareholding in the target; (iii) annual disclosure of aggregate shareholding
by every person along with PACs holding 25% or more of the voting rights in
a target; and (iv) annual disclosure of aggregate shareholding by the promoters
along with PACs.72
B. Promoter Control of Indian Firms
The vast majority of PE investments in India are minority stakes in com-

panies. In addition to the restrictions on LBOs discussed above, the traditional
71 Vishal Shah & Smit Sheth, Proposed Takeover Norms Could Be a Game Changer, REUTERS
(December 23, 2010), available at http://blogs.reuters.com/india-expertzone/2010/12/23/
new-takeover-regulations- could-be -a-game -changer/.
72 See Nishith Desai Associates, PUBLIC M&As IN INDIA: TAKEOVER CODE DISSECTED 12 (August
2013) available at http://www.nishithdesai.com/fileadminluser upload/pdfs/Ma%20Lab/
Takeover%2 0 Code%20Dissected.pdf
family-controlled ownership structure of Indian firms has resulted in the small

ownership stake of PE investors. Such minority investments are not without risks
and frictions with promoters.
Cultural conditions play an important role in the predominance of minority

investments by PE firms. Traditionally, India's business owners pass on busi-
nesses to family members. 71 Management, which often includes company found-
ers, is usually unwilling to cede control of their businesses to PE investors.74 The
desire to retain control has resulted in more minority investments.
The predominance of promoter-controlled family-owned companies in India

combined with the perception that some companies lack professional manage-
ment, transparency, and modern management systems have led to governance
concerns among PE investors.75 Since investments usually involve a minority
stake, PE firms have limited influence over the company's direction and may
experience roadblocks in their attempts to drive fast growth. Family dynam-
ics and relationships may add to the problem, and contribute to issues about the
adaptability of the firm. 76 Moreover, the management information that a fam-
ily-owned company provides to its foreign PE may be subpar compared to the
information that PE firms receive from management in the West.
The corporate governance of Indian firms can result in friction between PE

investors and promoters. PE managers face the dual task of discovering the right
company at the right valuation that also understands the value of a PE partner-
ship. Some promoters have viewed PE firms simply as a source of capital rather
than as an influx of capital plus expertise as well as knowledge of best business
practices. In other words, promoters expect PE firms to be passive investors on
the sidelines while PE investors seek to play a pivotal role in guiding the busi-
ness. Since management focuses on getting the most money for the sale of a
stake in their business, valuation has often been the overriding consideration in
choosing a PE investor to the exclusion of other considerations. In India's initial
PE boom, the growing pools of PE capital led to fierce competition among PE
firms. Consequently, the target company's management often held the bargaining
power and dictated the terms of investments.
71 Afra Afsharipour, Corporate Governance Convergence: Lessonsfrom the Indian Experience, 29

NORTHWESTERN JOURNAL OF INTERNATIONAL LAW & BusINEss , 335, 362-63 (2009).
4 Bain & Company (2011), supra note 6, at 20.
75 Ambayat Shruti, M&A and PE deals face slowdown as policy paralysis bites,
FINANCIAL EXPRESS (April 7, 2012), available at http://archive.financialexpress.com/
news/m-a-and-pe-deals-face-slowdown-as-policy-paralysis-bites/933711.
I Stephen Aldred & Michael Flaherty, Bain, TPG's Lillput woes a warning on India invest-
ing, REUTERS, (May 18, 2012), available at http://in.reuters.com/article/2012/05/18/
india-buyout-idUSL4E8G318Y20120518.
The Lilliput Kidswear controversy is a prime example of PE concerns regard-

ing corporate governance.7 In 2010, Bain Capital and TPG Capital invested
roughly USD 86 million for a 45% stake in the Indian clothing company. By
2011, tensions between Bain!TPG and Lilliput's founder Sandeep Narula reached
a fevered pitch. Narula eventually moved to court to prevent the PE firms'
interference in the day-to-day activities of Lilliput and actively sought to pre-
vent Bain or TPG from exiting their investments .8 By 2012, the firms valued
their investment in Lilliput at zero and accused Lilliput of accounting fraud.
Eventually, the two sides reached a settlement in late 2012, with TPG and Bain
selling back their stakes in the company to Narula with zero returns and Narula
withdrawing his case against them.
IV. THE INDIAN PRIVATE EQUITY MODEL:

STRUCTURE, CONTROL AND EXIT
Given some of the challenges they face as minority investors, PE investors

have used innovative structures to protect their interests. As minority investors in
companies with significant majority shareholder control, PE firms are often con-
cerned about how to address the corporate governance issues and majority-mi-
nority shareholder agency costs that arise in Indian firms.7' These concerns are
increasingly being reflected in the terms of the shareholders' agreements between
PE investors and the investee company. Section A summarises the types of struc-
tures used by PE investors, as well as their potential benefits and shortcomings.
Section B then analyses some of the innovations used by PE firms in sharehold-
ers' agreements to address their corporate governance concerns.
A. The Structure of Private Equity Investments into Indian Firms
A variety of structures are employed in PE investments and acquisitions.80

According to PE consultant Bain & Co., while straight equity purchases were
often the norm, the use of convertible instruments has increased significantly
I Shruti, supra note 75.

71 Aldred & Flaherty, supra note 76.
71 While for publicly owned firms with diverse ownership, the governance concern is primarily
about the agency costs of management vis-a-vis shareholders, for firms with controlling share-
holders, the "fundamental concern that needs to be addressed by governance arrangements is
the controlling shareholder's opportunism." For an overview of the differences between con-
trolled and non-controlled companies, see Bebchuk & Hamdani, supra note 11. In controlled
family-owned entities, various family members often serve in the executive management or on
board positions. Thus, the minority shareholders of controlled entities are often concerned about
self-dealing transactions and other types of expropriation or extraction of wealth (tunnelling) by
majority stockholders. See, e.g., Johnson et al., supra note 13 (defining tunnelling as the "trans-
fer of resources out of a company to its controlling shareholder (who is typically also a top
manager)").
80 Raja & Vittalachar, supra note 26.
over the past several years.8' In general, PE funds tend to invest using either
equity or equity-linked instruments such as fully and compulsorily convertible
preference shares ("CCPS") and fully and compulsorily convertible debentures
("CCD").8 2 PE investors use these instruments to: (i) obtain dividend and/or liq-
uidation preferences; (ii) achieve disproportionate voting rights on their invest-
ments in return for the strategic value that the foreign investor will add; and (iii)
achieve potential liquidity in overseas markets and more flexibility in terms of
exit options.83
According to experts, the recent trend in PE investment structures is for the

PE firm to invest using a combination of equity and convertible preference shares
or convertible debt. PE investors often subscribe to a combination of converti-
ble instruments and a small number of equity shares so that they can vote in a
shareholder meeting of the equity shareholders and exercise veto rights. The con-
vertible instruments would then convert upon achievement of certain agreed-upon
performance milestones-a useful feature "in cases where there is a mismatch
between the valuations of the target company as ascribed by the promoter and the
84
private equity investor."
(a) Equity securities
Some PE investors obtain equity, i.e., common stock, in exchange for their
investment in the company. Equity shares are the same ordinary equity shares
held by the company's promoters. When PE firms invest in equity shares, their
shares have the same rights as the existing shares of the company and have no
special rights on the assets or the earnings of the company. Thus, if the company
goes bankrupt, common shareholders are paid after debt holders, preferred share-
holders, and other creditors of the company.
(b) Convertiblepreference shares
In addition to, and at times in place of, the use of equity common stock, PE
investments into Indian companies can be structured through the issue of com-
pulsorily convertible preference shares (i.e., preferred stock) or fully convertible
debentures that are convertible into equity based on a specified conversion ratio
upon maturity. Such preferential instruments get paid ahead of equity instruments
Bain & Company, INC., INDIA PRIVATE EQUITY REPORT (2010).
82 Any investment instrument which is not fully and mandatorily convertible into equity is consid-
ered to be external commercial borrowing ("ECB") which is subject to significant limitations.
See Nishith Desai Associates (2015), supra note 29, at 9-10; Raja & Vittalachar, supra note 26.
According to experts, the need to comply with stringent ECB guidelines makes instruments that
are not fully and mandatorily convertible in nature "not suitable" for PE investors. See Malik,
Shankar & Gaur, supra note 28, at 233.
83 Vaibhav Parikh, Private Equity Fund Investments in Indian Companies in 1735 PLI/CORP 249,
282-83 (2009) (noting different ways to structure PE investment).
84 Malik, Shankar & Gaur, supra note 28, at 226.
if the company winds up, and they also enjoy the right to receive preferential
dividend.85
Under Indian company law, convertible preference shares have no voting

rights, with limited exceptions. Under Section 47 of the Companies Act, 2013,
preference shareholders only have voting rights on resolutions placed before the
company which directly affect the rights attached to their preference shares and,
any resolution for the winding up of the company or for the repayment or reduc-
tion of its equity or preference share capital.8 6 PE investors generally overcome
such voting obstacles through the use of shareholders' agreements (to which the
company is also usually a party) that confer rights and impose obligations beyond
those provided by company law. Section JJJ.B below provides an overview of
the control provisions typically included in such agreements.
Mandatorily convertible preference shares are treated on a par with equity for
purposes of FDI sector caps. Furthermore, only mandatorily convertible pref-
erence shares can be issued to foreign PE investors under the FDI scheme.88
Adding to this hurdle, the RBI has prescribed that the dividend payable on all
convertible preference shares issued to non-resident parties cannot be in excess
of 300 basis points over the prime lending rate of the State Bank of India on an
annual basis.8 9
One of the advantages of the preference share to a PE firm is avoiding the

mandatory offer requirements of the Takeover Code. 90 This means that the PE
firm can cash out part of its existing stake prior to acquiring more equity and
exceeding the 5% or the 25% threshold limit.
(c) ConvertibleDebt
Under convertible debt instruments, the debt holder receives interest from
the company until the maturity date, after which the debt converts into equity
shares. Mandatorily convertible debt is treated the same as equity for deter-
mining an FDI sector cap. On the other hand, optionally convertible or
15 Under Indian company law, a preference share by definition gets a preference over the other
shareholders as to dividends and recovery of capital in the event of liquidation. See Section 43,
the Companies Act, 2013.
86 Under Section 47 of the Companies Act, if dividends are not declared on compulsory convertible
preference shares for two consecutive years, then such shareholders have the same voting rights
as that of the equity shareholders.
Umakanth Varottil, Shareholders Agreements: Clauses and Enforceability, INDIACORPLAW BLOG
(December 31, 2010), available at http://indiacorplaw.blogspot.com/2010/12/shareholders-agree-
ments-clauses-and.html.
8 Supra note 72.
89 Stewart & Shroff, supra note 60, at 93.
90 Shraddha Nair, Private Equity Firms Prefer Convertibles to Direct Equity, MINT (June 7, 2010),
available at http://www.livemint.com/2010/06/07223811/Private-equity-firms-prefer-co.html (dis-
cussing exit from investment in parts as typically a PE investment has a one-year lock-in period).
non-convertible debentures will be construed as debt, and foreign investors will

need prior approval from the FIPB and the RBI to invest via these instruments
(RBI, 2007a).9' Moreover, investment in optionally convertible or non-converti-
ble debentures will require compliance with the restrictive guidelines for external
commercial borrowings (RBI, 2007b).92 Thus, a foreign PE investor must always
invest in fully and compulsorily convertible instruments.
(d) Warrants
Warrants are instruments that can be converted into equity shares at the con-
venience of the holder by paying a conversion price. Outstanding warrants are not
taken into consideration for evaluating FDI sector caps. This is the primary rea-
son why foreign PE firms use warrants, i.e., as stopgap instruments to ensure that
the investment does not exceed the sector caps. At the same time, warrants retain
the right to acquire the underlying equity shares within a specified timeframe in
the hope that the regulatory regime might change.
Warrants have their own limitations. Most obviously, a warrant is only a right
to subscribe to shares at a later date, meaning that investors do not get any of the
rights attached to shares (e.g., dividends, voting rights). A warrant makes sense
only when used as a stopgap arrangement, with the investor obtaining compen-
sation via other contractual arrangements with the company. If the company that
the PE firm invests in chooses to have an IPO prior to any changes in the FDI
sector caps, the investor would effectively have to forfeit the shares underlying
the warrants. This is due to the SEBI's requirement that all convertible securities
outstanding in a company should be converted into equity shares prior to an IPO.
Therefore, warrants can be extremely risky.
In July 2014, the RBI issued a circular under which the issuance of warrants
by Indian companies to foreign investors would be permitted under the automatic
route. Under these new rules, in order for such warrants to be permissible, the
pricing of the warrants, a price conversion formula to be determined upfront and
also 25% of the consideration amount to be received upfront, with the balance
of the consideration towards fully paid up equity shares to be received within 18
months. According to experts while the RBI's revised regulation "has opened the
possibility for structuring PE investments through warrants," whether it will be
an attractive and feasible option remains to be seen.93
91 Reserve Bank of India, Foreign Investments in Debentures Revised Guidelines, RBI/2006-

2007/435 A.P. (DIR Series) Circular Number 74 (2007).
92 Reserve Bank of India, Foreign Investments in Preference Shares Revised Guidelines,
RBI/2006-2007/434 A.P. (DIR Series) Circular No. 73 (2007).
93 Raja & Vittalachar, supra note 26.
B. Control and Exit Rights in the Indian Private Equity Model
In order to address their governance concerns as minority investors, PE firms

typically insist on shareholders' agreements with specific contractual provisions
to protect their interests. Many of the provisions of the shareholders' agreements
found in Indian PE deals mirror those found in VC deals in the United States,
where control and exit rights are central issues in the deal. 94 Both types of deals
use similar forms of instruments. PE and VC transactions involve negotiations
over board representation and staged financing, the use of protective provisions
to maintain control over their investments, and the possible use of exiting through
specific rights of exit.
These attributes in shareholders' agreements in India include liquidation

preferences, conversion rights, anti-dilution protections, voting and informa-
95
tion rights, share transfer restrictions (particularly with respect to promoters).
In addition, PE investors in India often seek the right to appoint representatives
on the company's board of directors, as well as on board committees. Given that
governance and regulatory problems may jeopardise the investment, PE inves-
tors often include extensive provisions relating to exit rights. PE investors usually
make minority investments in the form of equity investments with put/call rights
to existing shareholders (usually the promoters) and buybacks by the company
over time.
(a) Control rights in shareholders' agreements
In India, shareholders' agreements typically give PE investors as minority

shareholders rights such as:
1. a board seat and veto rights over certain transactions;
2. pre-emption rights to participate in future financing rounds by the
company;
3. restriction on sales (e.g., right of first offer, right of first refusal) and
co-sale or tag-along rights;
4. anti-dilution price protections for down rounds (where the company's
valuation has dropped);
5. drag-along rights (although courts in India are opposed to forced sales
and these rights, though contractually agreed to, may ultimately not be
enforced);
94 Jesse M. Fried & Mira Ganor, Agency Costs of Venture Capitalist Control in Startups, 81 NEW
YORK UNIVERSITY LAW REVIEW 967, 987 (2006).
95 Malik, Shankar & Gaur, supra note 28, at 229-230.
6. arbitration clause (especially as litigation is a weak enforcement mech-

anism in India) with neutral country arbitration.
The following sections address a few of these provisions, along with the
impact of the Companies Act, 2013 on such provisions.
(b) Board representation
Shareholders' agreements typically include provisions on the maximum num-

ber of directors on the board, the number of nominee directors from each party,
who will be the chairperson of the board meeting, the quorum required for a
board meeting, whether the chairperson will have a casting vote, and other such
matters pertaining to the board. PE investors in India often require the right to
appoint at least one nominee director on the board of the company. The share-
holders' agreement will also provide that the quorum cannot be constituted unless
such nominee director is present at board meetings, and the investor as a share-
holder is present at shareholder meetings.
The passage of the Companies Act, 2013 raises some important issues for such
nominee directors, who are not considered to be independent directors under the
Companies Act. Under the Act and the rules promulgated thereunder, directors
are charged with significantly increased duties and responsibilities. Section 166
of the Companies Act, 2013 includes a broad sweeping provision codifying the
duties of directors. According to the Act a director of a company must:
* act in accordance with the articles of the company, subject to the pro-
visions of the Act;
* act in good faith in order to promote the objects of the company for
the benefit of its members as a whole, and in the best interests of the
company, its employees, the shareholders, the community and for the
protection of environment.
* exercise his duties with due and reasonable care, skill and diligence
and exercise independent judgment.
* not involve in a situation in which he may have a direct or indirect
interest that conflicts, or possibly may conflict, with the interest of the
company.
* not achieve or attempt to achieve any undue gain or advantage either
to himself or to his relatives, partners, or associates and if such
96 Section 149(6), the Companies Act, 2013, for a definition of Independent Director.
director is found guilty of making any undue gain, he shall be liable to

pay an amount equal to that gain to the company.
* not assign his office and any assignment so made shall be void.
If a director commits a breach of the duties outlined, such director can

be fined a minimum of Rupees 100,000 up to Rupees 500,000. Overall, the
Companies Act imposes significant duties on directors, and in case of failure
to perform such duties, gives recourse to members and depositors to file class
action suits against them. However, the 2013 Act also grants reasonable immu-
nity to an independent director or a non-executive director not being a promoter
or key managerial personnel, whereby such a director will be held liable only
(a) in respect of such acts of omission or commission by a company which had
occurred with his knowledge, attributable through board processes, and with his
97
consent or connivance or (b) where he had not acted diligently.
(c) Protective provisions and Voting Rights
In the West, VCs usually receive specific veto rights over major decisions. 98
These "protective provisions" are important to help VCs protect themselves from
forced exit, whether through business combinations or forced IPOs, through the
use of protective provisions.99 Protective provisions are complementary when the
VC has board control and are more important when it does not.' Protective pro-
visions only create a right to block unfavourable transactions, i.e., they protect
against opportunistic entrepreneurial behaviour but are not an affirmative grant
of power.' The most common protective provisions include VC consent for
business combinations and acquisitions, amendment of the corporation's char-
ter, redemption of common stock, payment of common stock dividends, issuance
of more preferred stock, a significant change in business conducted, and incur-
rence of debt. VCs also typically negotiate for a catch-all provision in addition
to the list of provisions that explicitly require their consent. The catch-all provi-
sion allows VCs to veto any action that materially modifies their rights under the
company.
Similar to Western VC investors, PE investors in Indian firms rely on protec-

tive provisions in their shareholders' agreements.0 2 Often, if the PE investor has
invested through the use of compulsorily convertible preference shares or fully
convertible debentures, the shareholders' agreement will include provisions to
97 Section 149(12), the Companies Act, 2013.
91 See Robert P. Bartlett, III., Venture Capital, Agency Costs, and the False Dichotomy of the
Corporation,54 UCLA LAW REVIEW 37, 53 (2006).
99 Smith, supra note 37, at 346-47.
100 Ibrahim, supra note 37, at 1415.
101 Brian J. Broughman, The Role of Independent Directors in Startup Firms, 2010 UTAH LAW.
REVIEW 461, 987 (2010).

102 Malik, Shankar & Gaur, supra note 28, at 229-230.
provide the PE investor with voting rights from day one at general meetings on
an as-converted-to-common stock basis. With respect to voting rights, for exam-
ple, a shareholders' agreement can specify matters that will require the consent
of both promoters and PE investors in general meetings, such as changes in the
capital structure of the company, fresh issue of capital, amendment of the memo-
randum and articles of the company, and a change in the auditors. Investors also
require that the shareholders' agreement include provisions that provide the inves-
tor information rights, including the right to inspect records and premises, and to
conduct an independent audit. 03
Recently, PE firms have introduced new deal technologies in shareholders'

agreements to further address corporate governance issues. PE firms, wary of
Lilliput-like fiascos and eyeing favourable investment opportunities in other mar-
kets, have insisted on more stringent protective provisions. In particular, firms are
looking for anti-bribery clauses, insurance against unauthorised use of funds, and
mandatory arbitration in Singapore. In addition, PE acquirers are also pursuing
third party insurance for tax matters and other representations and warranties. PE
firms typically have a representative on the company's board, and recently have
sought protections such as indemnity for their own board members against alle-
gations of wrongdoing or control of important committees, such as the audit or
compensation committees. 0 4 Given the challenges faced by PE firms in deals
such as Lilliput, analysts expect that PE investors will introduce even greater cor-
05
porate governance in target companies.
One concern with the level of voting rights that PE investors have under a
shareholders' agreement is whether such control will mean that a PE investor can
be construed as a promoter under the statute's broad definition of promoter and
0 6
control.
(d) Investor Rights and Share Transfer Restrictions
Some of the most commonly negotiated-for rights in PE investments in India

include share transfer restrictions on the sale or disposition of shares by the pro-
moters such as a right of first offer (ROFO), right of first refusal (ROFR) and
tag-along rights. Under the Companies Act, 2013, such restrictions on transfer
are now permitted in all public companies. Section 58(2) of the Companies Act,
2013 stipulates that "any contract or arrangement between two or more persons in
13 Malik, Shankar & Gaur, supra note 28, at 230.

104 Deepti Chaudhary & Harini Subramani, PE Firms Widen Indemnity Clause Scope, MINT
(February 20, 2012), available at http://www.livemint.com/2012/02/20003959/PE-firms-widen-
indemnity-claus.html?d 1.
15 Rajesh Naidu & Suraj Sowkar, Investors Should Not Base Their Investment Decisions Only on
Private Equity Bets, ECONOMIC Tims(Mar. 5, 2012), available at http://articles.economictimes.
indiatimes.com/2012-03-05/news/31124315 1 pe-players-pe-investments-pe-firms.
106 Supra note 9 regarding definition of promoter; See also Raja & Vittalachar, supra note 26.
respect of transfer of securities shall be enforceable as a contract." Thus, there is

greater possibility for PE investors in public companies to enforce share transfer
restrictions such as rights of first offer or refusal.
() Exit options for PE investors
For PE investors, a smooth exit from the investment is imperative in deter-

mining the investment's overall success. Exit can be achieved via various means
such a sale of securities by the PE investor into the stock markets in the case of
listed securities, an IPO by the Indian company, a strategic sale to another oper-
ating company, or a private sale to another investor (in the case of both listed
and unlisted securities). Some of the most common exit mechanisms used by PE
investors in India to address exit are similar to those found in VC investment
agreements in the West. For example, VC agreements typically involve contrac-
tual rights of exit such as redemption rights, which require the company to repur-
chase shares as specified in the contract.
(e) Buybacks
In India, PE investors negotiate for several alternative exit mechanisms in their

shareholders' agreements. These mechanisms include a buyback by the company
of the PE firm's stake or a put option against the company's promoters. In gen-
eral, a company buyback of shares is less attractive than a put option due to sig-
nificant restrictions placed on buybacks under the Companies Act. Under Section
68 of the Companies Act, 2013, a company can only buy back up to 25% of its
paid-up equity share capital in a single year. Moreover, a buyback can only be
made from either free reserves or proceeds of a fresh issue of securities. Section
68 also requires the affirmative vote of a special resolution of the shareholders
unless the buy-back is 10% or less of the total paid-up equity capital and free
reserves of the company.' Given these limitations, in general, PE investors
prefer to negotiate for the right to put their shares to the company's promoters.0 8
(9 Put Options
While put options are often negotiated, they are not without risk. In the case
of foreign PE investors, exit options such as put options are subject to Indian
pricing guidelines for the transfer of shares from non-resident entities to resi-
dent Indian entities or vice versa. Under Indian exchange control laws, the price
at which securities may be transferred from a resident to a non-resident entity
10A Special Resolution is one where the votes cast in favor of the resolution (by members who,
being entitled to do so, vote in person or by proxy, or by postal ballot) is not less than three
times the number of the votes, if any, cast against the resolution by members so entitled and vot-
ing. See Section 114, the Companies Act, 2013.
o Raja & Vittalachar, supra note 26.
should be at or above the "fair value" calculated in accordance with the pre-
scribed rules. The fair value issue does not present significant hurdles for foreign
PE firms if the company is doing well; however, if the company is doing poorly,
the application of the pricing guidelines results in a lower than expected return
for the PE firm. 09
For many years, the enforceability of put options was under significant debate
due to the "stringent securities legislation that has been supported by strict judi-
cial interpretation.""' 0 For example, in 2010, the SEBI outlawed all forward con-
tracts"', and in 2011, in two cases involving the shares of listed companies, the
SEBI unequivocally ruled that put and call options are invalid and unenforceable,
2
and will not be given effect by the regulator.1
SEBI's interpretations regarding put options came under attack by Indian cor-
porate law experts who argued against a fragmented regulatory regime which
unnecessarily restricted the investors' ability to enter into protective contracts.
Both scholars and markets participants advocated for the recognition of pre-emp-
tion rights and options in investment agreements." 3
After years of uncertainty, both SEBI and the RBI indicated that such put
options would be permissible, subject to certain conditions. In the fall of 2013,
SEBI issued a notification which allowed contracts for pre-emption, including
right of first refusal, tag-along or drag-along rights contained in the shareholders
agreements or articles of association of companies, as well as contracts contain-
ing an option for purchase or sale of securities." 4 Under SEBI's new rules such
options are subject to three conditions intended to continue to curb speculation in
5
securities:
19 If the put option is on a non-resident entity, such as a non-resident affiliate of the promoter, pric-
ing restrictions would not apply.
11 Umakanth Varottil, Investment Agreements in India: Is there and "Option", 4 NUJS LAW REVIEW
467, 467 (2011).

Securities and Exchange Board of India, Order Disposing of the Application Dated April 7, 2010
Filed by MCX Stock Exchange Limited, 56-57 (September 23, 2010), available at www.sebi.gov.
inlcmorder/MCXExchange.pdf (Last accessed on July 15, 2013).
1 Letter of Offer to the Shareholders of Cairn India Limited(April 8, 2011), available at http://
www.sebi.gov.in/takeover/cairnlof.pdf (Last accessed on July 15, 2013); and Securities and
Exchange Board of India, Letter addressed to Vulcan Engineers Limited (May 23, 2011), avail-
able at http://www.sebi.gov.in/informalguide/Vulcan/sebilettervulcan.pdf (Last accessed on July
15, 2013).
113 Varottil, supra note 110, at 492-493.
114 SEBI Press Report No.: 98/2013 available at http://www.sebi.gov.in/sebiweb/home/list/4/23/0/0/
Press-Releases; Securities and Exchange Board of India, Notification No.: LAD-NRO/GN/2013-
14/26/6667(October 3, 2013).
15 Umakanth Varottil, SEBI Notification on Pre-Emption Rights, Put and Call Options,
INDIACoRPLAW BLOG (October 4, 2013), http://indiacorplaw.blogspot.com/2013/10/sebi-notifica-
tion-on-pre-emption-rights.html.
(i) the title and ownership of the underlying securities is held continuously
by the selling party to such contract for a minimum period of one year
from the date of entering into the contract;
(ii) the price or consideration payable for the sale or purchase of the under-
lying securities pursuant to exercise of any option contained therein
complies with all applicable laws; and
(iii) the contract is settled through actual delivery of the underlying
securities.
SEBI's notification was not retrospective, and thus did not legitimate or affect
agreements which had been entered into prior to the date of the notification.
Moreover, SEBI's rules mandated compliance with the pricing guidelines under
foreign exchange laws prescribed by RBI (Transfer or Issue of Security by a
Person Resident outside India) Regulations, 2000, SEBI Takeover Code, 2011, etc.
Following SEBI's move, the RBI also issued a notification relating to options
and convertible instruments."6 The amended RBI regulations now provide that
equity shares, fully and mandatorily convertible preference shares and debentures
containing an optionality clause can be issued to foreign investors, subject to cer-
tain conditions." 7 These conditions provide that:
(i) such instruments must be subject to a minimum lock-in period of one
year or such higher lock-in period as prescribed under FDI regula-
tions. The lock-in must be effective from the date of allotment of such
shares/ debentures;
(ii) such instruments cannot include an option or exit right at an assured

price;
(iii) the exit price must be determined as follows:
16 Foreign investors holding put options in the securities of Indian companies are subject to the
Foreign Exchange Management Act, 1999 and RBI regulations. The RBI previously viewed such
put options as constituting an external commercial borrowing (ECB) which is subject to sig-
nificant restrictions. In addition, in September 30, 2011, the Indian Government stated that all
investments in equity securities with in-built options or those supported by options sold by third
parties would be considered as ECBs. After an uproar from industry experts, the Government
reversed its stance by deleting the relevant clause regarding options within a month. See
Umakanth Varottil, Revised FDI Policy: Options Outlawed, INDIACORPLAW BLOG (Oct. 2, 2011),
available at http://indiacorplaw.blogspot.com/2011/10/revised-fdi-policy-options-outlawed.html;
Umakanth Varottil, Reversal of FDI Policy on Options, INDIACoRPLAW BLOG (Oct. 31, 2011),
available at http://indiacorplaw.blogspot.com/2011/10/reversal-of-fdi-policy-on-options.html.
17 Reserve Bank of India, Foreign Direct Investment- Pricing Guidelines for FDI instruments
with optionality clauses RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular
No. 86 (January, 09 2014) available at http://rbidocs.rbi.org.inlrdocs/NotificationlPDFs/
APDIR0901201486EN.pdf.
a.In case of listed company, at the market price determined on the floor
of the recognized stock exchanges;
bIn case of unlisted equity shares, at a price not exceeding that arrived
on the basis of return on equity;
c.In case of preference shares or debentures, at a price determined by a
Chartered Accountant or a SEBI registered Merchant Banker per
any internationally accepted methodology.
In 2015, the RBI indicated that it would consider greater flexibility with
respect to the pricing of options in order to better meet FDI needs and to pro-
vide greater protections to investors against downside risks."8 In its February
2015 statement, the RBI stated that "With a view to meeting the emerging needs
of foreign direct investment in various sectors with different financing needs and
varying risk perceptions as also to offer the investor some protection against
downside risks, it has been decided in consultation with the Government of India
to introduce greater flexibility in the pricing of instruments/securities, includ-
ing an assured return at an appropriate discount over the sovereign yield curve
through an embedded optionality clause or in any other manner. Guidelines in
this regard will be issued separately.""' 9
(z) Enforceability of shareholders' agreements
One of the most significant legal challenges for PE investments in Indian firms
is the lack of clarity regarding the enforceability of the rights and obligations set
forth in shareholders' agreements. 20 In fact, "[t]he process of enforceability of
legal rights in India is among the slowest" in the world, with recent World Bank
reports placing India near the bottom of all countries surveyed (186 out of 189) in
2
ease of enforcing contracts.' '
Shareholders' agreements in the context of PE investments have gained popu-

larity only in the last few years in India. Indian courts have not had many oppor-
tunities to address the validity and enforceability of the various types of rights
and clauses contained in such agreements. Given that litigation in India can take
18 Umakanth Varottil, Pricing of Options to Foreign Investors, INDIACORPLAW BLOG (Feb. 9, 2015),
available at http://indiacorplaw.blogspot.com/2015/02/pricing-of-options-to-foreign-investors.html.
119Reserve Bank of India, Sixth Bi-Monthly Monetary Policy Statement, Press Release
2014-2015/1619 (February 03, 2015) available at: https://www.rbi.org.inlscripts/BS
PressReleaseDisplay.aspx?prid-33144.
120 Sidharrth Shankar & Shantanu Jindel, Towards an Investor Friendly Regime, FINANCIAL
EXPRESS (May 12, 2015), available at http://www.financialexpress.com/article/fe-columnist/
towards-an-investor-friendly-regime/71505/.
121 Id.; World Bank, DOING BUSINESS 2015: GOING BEYOND EFFICIENCY (2014).
a significant amount of time 22 , the parties involved usually provide for arbitration
23
as the dispute settlement mechanism in the shareholders' agreement.
In its one landmark decision on shareholders' agreements, the Supreme Court

of India made explicit that the terms and conditions of a shareholders' agreement
are not binding on the Indian company unless they are incorporated into the arti-
cles of association. 24 Accordingly, PE firms must push to have the agreement
terms written into the articles of association. Despite this decision, lower Indian
courts still disagree over whether there is complete freedom of contract when the
provisions of shareholders' agreements appeared to be inconsistent with the tenor
of company legislation. 25 However, in a 2010 case, the Bombay High Court rec-
ognised rights inter se among shareholders in a case where the validity of a right
of first refusal in a shareholders' agreement was called to question. 26 While the
Bombay High Court's decision provides some relief to PE investors regarding the
enforceability of their rights under shareholders' agreements, it does not have the
same force of precedent as a decision of the Indian Supreme Court.
Some provisions typically included in PE shareholders' agreements have

proved particularly challenging under Indian law. For example, non-compete
agreements with founders and management beyond the term specified in the
contract are void and unenforceable. This may result in PE firms retaining the
27
management rather than the typical U.S. practice of replacing the management.
Moreover, the Bombay High Court has declared unenforceable provisions of a
shareholders' agreement curtailing the rights of directors if they are not included
in the company's articles. The court also held that the shareholders can dictate
terms to the directors only by the amendment of the articles of association.
V. CONCLUSION
Unable to undertake the traditional LBO-based PE model in India, PE inves-

tors in Indian firms have developed their own Indian PE Model. The Indian PE
model is designed to address the regulatory and corporate governance challenges
prevalent in India. Investors have relied on a hybridised and customised model
1 John Armour & Priya Lele, Law, Finance and Politics: The Case of India, 43 LAW & Soc'Y
REVIEW 491 (2009).
123 Siddharth Raja & Neela Badami, Private Equity India in GETTING THE DEAL THROUGH: PRIVATE
EQUITY (2012).
124 See VB. Rangaraj v. VB. Gopalakrishnan, (1992) 1 SCC 160 : AIR 1992 SC 453; See also
Vishal Gandhi, Certain Legal Aspects in PRIVATE EQUITY AND VENTURE CAPITAL INVESTMENTS IN
INDIA 2-3 (2008).
125 Varottil (2010), supra note 110. See, e.g., VB. Rangaraj v. VB. Gopalakrishnan, (1992) 1 SCC
160 : AIR 1992 SC 453; Shanti PrasadJain v. Kalinga Tubes Ltd., AIR 1965 SC 1535; Mafatlal
Industries Ltd. v. Gujarat Gas Co. Ltd., (1999) 97 Comp Cas 301 (Guj); Pushpa Katoch v. Manu
MaharaniHotels Ltd., (2006) 131 Comp Cas 42 (Del).
126 Messer Holdings Ltd. v. Shyam Madanmohan Ruia, (2010) 159 Comp Cas 29 (Born).
127 Ketan Kothari, Investments in India Risks & Mitigation Strategies in OUTLOOK ON INDIA 2010:
DELIVERING ON THE PROMISE IN TURBULENT TIMES 337, 347 (2010).
48 NATIONAL LAW SCHOOL OF INDIA REVIEW 27 NLSI REv. (2015)
to address the restrictions related to investment structure, investor control rights,

and exit strategies. Some of these strategies-such as the use of protective pro-
visions-have proven to be successful. Recent reforms in Indian company law
and regulations may certainly be of benefit to PE investors, allowing for greater
possibility for better structuring PE investments and less opportunity for minor-
ity oppression. Nevertheless, continuing concerns regarding the enforceability of
contracts will continue to hamper PE investments in Indian firms.

27 Natl LSCH India Rev 17

Uploaded by

Copyright:

Available Formats

27 Natl LSCH India Rev 17

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

27 Natl LSCH India Rev 17

Uploaded by

Copyright:

Available Formats

DATE DOWNLOADED: Sat Mar 9 08:13:52 2024

SOURCE: Content Downloaded from HeinOnline

Bluebook 21st ed.

ALWD 7th ed.

APA 7th ed.

Chicago 17th ed.

McGill Guide 9th ed.

AGLC 4th ed.

MLA 9th ed.

OSCOLA 4th ed.

PE firms have long been important investors in Western markets. In the

While the traditional PE model has been successful in developed economies,

Bain & Company, INDIA PRIVATE EQUITY REPORT (2013).

corned the involvement of PE investors in providing funding and strategic advice

As minority investors in controlled firms, PE firms in India confront the

Given somewhat limited protections for minority shareholders under Indian

This article proceeds as follows. Section I provides an overview of the general

II. PRIVATE EQUITY INVESTMENTS IN INDIA

India's economy has undergone significant transformations since 1991. 5 India's

14 See Bebchuck & Hamdani, supra note 11, at 1281-83.

EMERGING GIANT 107 (2008).

However, unlike in the West where PE firms generally undertake buyouts, in

Part A below provides an overview of the trends in PE activity in India over

A. An Overview of India's PE Activity

Despite the attractiveness of the potential of the Indian market, PE investments

Table 1: Annual PE Investments into and Exits from Indian Firms

Source: Bain & Company (2015)

Overall, the initial exuberance of Western PE firms for investing in India

22 PRICEWATERHOUSECOOPERS INDIA, MONEYTREE INDIA REPORT (2015).

B. The Regulatory Framework for Investments by PE Firms

Investments by PE firms in India are governed by a complex set of federal

PE firms have invested in a variety of Indian companies, although various

III. THE INDIAN PRIVATE EQUITY MODEL

PE firms in India broadly undertake two types of deals: "growth" deals,

For PE firms, such minority investments can present significant challenges

A. Challenges for the Traditional Private Equity Model

Due to India's complex legal framework and restrictions, PE firms investing in

(a) The TraditionalPrivate Equity Model

() Corporate governance in PE acquisitions

See Jeffrey A. Blomberg, Private Equity Transactions: Understanding Some Fundamental

(ii) PE exit strategies

PE funds have contractually limited lifetimes-typically around 10 years.

(b) Legal Challengesfor Use of the TraditionalPE Model in India

In addition to regulations regarding fund structuring and licensing, PE firms

() Legal and regulatory restrictionson LBOs

PE firms looking to undertake traditional Western-style LBOs face significant

In addition to the RBI restrictions, a Press Note by the Foreign Investment

In 2015, SEBI amended the Delisting Regulations in order to address concerns

timelines, new thresholds for a successful delisting, changes in pricing mecha-

(ii) Challenges with exits through public offerings

While shareholder agreements often include an IPO as an exit right for PE

A number of SEBI regulations add complexity to a public market exit and

(c) Investing in Listed Companies

Even if not undertaking a buyout, PE investments in publicly-traded or listed

() Due diligence issues in PIPEtransactions

Prior to committing capital, PE firms conduct extensive due diligence on target

PE firm have been extremely cautious because due diligence investigations

SEBI's insider trading regulations underwent a significant overhaul in May

(ii) Takeover regulations and PIPE transactions