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SEBI ruling on Cairn deal may hit mergers and acquisitions of listed companies
April, 20th 2011

Securities and Exchange Board of India's recent directive to Vedanta Resources and Cairn Energy to drop the put and call options, and pre-emption right clauses from their original deal agreement is likely to impact the future of mergers and acquisitions of listed companies in India.

The capital market regulator's directive in the $9.6-billion Cairn-Vedanta deal will make both foreign and domestic companies apprehensive about the enforceability of put and call options and pre-emption right clauses that are common in share purchase agreements of companies and private equity investors , industry experts said. Such clauses are inserted in most negotiated transactions to protect investor interest and allow the acquirer further consolidate holding.

In a put option, the option holder or investor has the right, not obligation, to sell his shares back to the company or promoter. Similarly, in a call option, the investor or holder has the right, not obligation, to buy shares held by the company or promoter.

There has been a long debate on the transferability of shares in Indian courts, without any final verdict. "It's an area of ambiguity. The law has developed piecemeal. Ideally, clarity should be brought through legislative intervention," said Suhail Nathani, partner, Economic Laws Practice.

The Cairn-Vedanta contract had built-in clauses to ensure Vedanta got more shares from Cairn Energy if the open offer to buy 20% from shareholders of Cairn India got a lukewarm response. The put and call options could have seen Cairn sell another 10% of its residual stake to Vedanta in two equal tranches.

However, Sebi notified Vedanta that the put and call options exercisable by Cairn and Vedanta, and a pre-emption right exercisable by Vedanta, must be removed from the agreement. With put and call options and pre-emption right, the clause assumes the nature of forward contracting and violates Indian securities regulations, Sebi said.

"The recent Sebi directive will become an issue because every practitioner and banker will take note of it. This is perhaps the first formal word from the regulator on such clauses in share sale pacts and it's a major step as a regulatory intervention," said Shardul Shroff, managing partner, Amarchand Mangaldas. "This absolutely goes to the root of validating of the option," he said.

Share purchase agreements that are commercial contracts and not speculative in nature must be allowed to have put and call options and the regulator must amend its ancient norm, legal experts said. In countries such as the UK, put and call options are legally allowed.

"The prohibition on forward contracts in securities is moored in a different century and is a residue of an era when the mark of a villain in a Hindi movie was a person wearing dark glasses and from a time when speculation was a horrible word," Sandeep Parekh, founder of Finsec Law Advisors, said. "This primitive law should be done away with, particularly since it stands in the way of a modern shareholders' agreement, which often provides for a call or a put option or a right-of-first-refusal clause," he said.

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