The (Un?)Enforceability of Investor Rights in Indian Private Equity
30 Pages Posted: 3 Jun 2019 Last revised: 1 Jul 2020
Date Written: May 14, 2019
While Private Equity (“PE”) funding is a preferred vehicle for corporate growth in India, due to the ubiquitous role played by company promoters, extant laws, and a complex regulatory and compliance environment, PE funds prefer to take up a minority shareholding in Indian companies. As a result, PE funds invest in Indian companies in exchange for participation in the company’s profits either through equity or convertible preferred stock or convertible debt. The PE fund typically also requires a number of investor control rights negotiated as part of the investment, keeping in mind concerns related to minority shareholding in India.
While these contractual rights typically do not interfere with the day-to-day management of the company, they serve as a check and balance against promoter opportunism. These rights include provisioning for the investor to participate in the governance of the company through board nomination, quorum requirements and veto powers. Investors may also require downside protection in the form of anti-dilution and pre-emptive exit rights and preferred payments upon liquidation.
However, the nature of these investor control rights are departures from the default provisions under Indian company law. These rights, which are borne out of a contractual arrangement between the investor and the company/promoters, are also subject to Indian contract law under which, contracts in variation of applicable law are void. Additionally, due to excessive delays in the Indian judiciary, any disputes that may arise are not referred to the courts, but are privately arbitrated or settled. Consequently, the enforceability of these contracted rights have never been tested in court.
This paper seeks to qualitatively identify the investor control rights typically negotiated by PE funds using a sample of 158 privately held Indian companies which have received investments from non-Indian PE funds in the last five years. This paper will go on to analyse the limitations that Indian corporate and contract law place upon parties’ freedom to contract, thus raising the question as to whether the rights negotiated by PE investors are enforceable at all. It is hypothesized that some of these rights may not be enforceable in their customary form.
This is a draft paper scheduled for publication with the University of Pennsylvania Journal of International Law. This paper would not have been possible without the funding support received from the JGU Research Grants Committee (Grant No JGU/RGP/2018/013). The author is also immensely grateful to Ms Chinar Gupta, Ms Ishita Malhotra, Mr Soumil Desai, Mr Nikhil Kapoor and Mr Dhananjay Salkar, all students of the JGLS Class of 2019, for their research assistance.
Keywords: Corporate Law, Corporate Finance, Private Equity, Venture Capital, Company Law, Investment Agreement, Shareholders Agreement
JEL Classification: K12, K22, G24, G34
Suggested Citation: Suggested Citation