Thursday, October 6, 2016

Promoter Upside Sharing Arrangements in Listed Companies: SEBI Comes Down Hard

[The following post is contributed by Amitabh Robin Singh, who is a corporate lawyer practising in Mumbai.

For another perspective on the topic, please see an earlier post on the Blog.]

The Securities and Exchange Board of India ("SEBI") has released a discussion paper ("Paper") to regulate certain arrangements between private equity investors and the promoters/top personnel of a listed investee company. These arrangements are generally called promoter upside sharing arrangements and provide for the private equity investor to share a part of the gains that it makes above a certain threshold with the promoter in a proportion decided among the parties. These agreements are generally based on the internal rate of return (commonly known as IRR) that the private equity investor makes at the time of exit.

For example, it can be agreed that if the private equity investor gets an internal rate of return of more than 50% on its investment, then an agreed proportion of the return which is above 50% will be shared with the promoter as a reward for handling the day to day management of the company in such a manner that the share price has risen enough for the investor to enjoy such returns.

A recent case which may have prompted SEBI to bring this issue under the scanner was the exit of certain investors from PVR Limited ("PVR")[1], which runs a chain of multiplex cinemas. The MD and CEO of PVR signed "Incentive Fee Side Agreements" that were not disclosed to the shareholders or the stock exchanges based on the logic that the payments which may be made to the MD in the future will not be made from PVR's books, hence no disclosure was required. The MD was to receive 20% of the amount received by the investors which was in excess of 30% returns on their investment. Seeing that the relevant SEBI regulations do not allow promoters to receive stock options, it was the opinion of one of the investors in PVR that this arrangement was "in lieu of ESOPs".

Another interesting point on such arrangements is that the total compensation of the promoters may exceed the limits prescribed in the Companies Act, 2013 ("the Act"), i.e., if the remuneration is more than 11% of the net profits of the company or the limits specified in Schedule V of the Act depending on the profitability of the company. However, the Act uses the language "remuneration payable by a public company", and hence such compensation is cleverly placed outside the scope of caps on remuneration.

SEBI is concerned that these promoter upside sharing arrangements, when executed without the approval of the shareholders of the company, may lead to unfair practices and not be in the best interests of investor protection. The promoter may give short term capital appreciation precedence over long-term wholesome growth of the company in anticipation of receiving substantial upside upon the exit of the investor. SEBI uses rather strongly worded language in the Paper saying that "such agreements are not desirable and hence it is necessary to regulate such practices."

SEBI goes on to ponder over two different views on the topic: the first being the comparatively stern position that such arrangements should be totally disallowed in listed companies, while the other being the more benign view, which is that these arrangements should stand scrutiny before the board of directors and shareholders of the listed company.

SEBI has proposed that Regulation 26 (which governs the obligations of directors and senior management of listed companies) of the SEBI (Listing Obligations and Disclosure Requirements), Regulations, 2015 be amended to insert a new sub-regulation 6 which will state that no "employee" of a listed company will be permitted to enter into any arrangement with any "individual shareholder(s)" or any third party relating to profit sharing or compensation without the sanction of the board and the shareholders by way of an ordinary resolution. It may be noted that the broader term "employee" is used here and an inclusive list is provided afterwards mentioning key managerial personnel, promoter, etc. So if the recipient of the compensation does not fall in the legal definition of promoter, key managerial personnel or is not a director of the concerned company, he will still be well within the ambit of the proposed provision.

Interestingly, SEBI has thrown a spanner in the works, by inserting a proviso to the effect that while such existing arrangements may continue, the stock exchanges must be informed of them and shareholder approval by way of an ordinary resolution will be required at the ensuing annual general meeting. If such approval is not procured, then the arrangement will fall away.

This provision may alarm promoters of listed companies who have entered into such arrangements with private equity investors, seeing that they will fear their upside sharing falling away due to no fault of their own, even if they do help the company reach the desired position.

However, the Paper seems to encapsulate a step in the right direction for improving investor protection in the Indian market.

- Amitabh Robin Singh




[1] Facts of the matter have been sourced from various news websites:
http://www.asianage.com/business/sebi-lens-illicit-pe-deals-promoters-545;
http://timesofindia.indiatimes.com/business/india-business/PEs-reward-PVRs-Bijli-for-stock-returns/articleshow/49603297.cms;
http://www.dnaindia.com/money/report-secret-pact-helps-pvr-s-bijli-earn-profits-2142866

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