IPO Lock-in on ESOP Shares

SEBI
recently issued an informal guidance to clarify that in the case of an IPO only
shares held by employees of the company or other qualifying group entities
(such as a holding company) are entitled to exemption from the one-year lock-in
period on pre-existing share capital. Specifically, employees who are no longer
in employment of the company at the time of the IPO would be subject to the
one-year lock-in even though they received shares upon exercise of employee
stock options (ESOPs) granted to them while in employment.
A request
for informal guidance was made by MCX Exchange to SEBI. It had two ESOP plans
under which shares were allotted to its employees and that of its holding
company Financial Technologies India Limited (FTIL) (which subsequently ceased
to be the holding company). The request specifically pertained to the
interpretation of Regulation 37 of the SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 (the “SEBI Regulations”) that imposes a
one-year lock on all pre-existing share capital of a company undertaking an IPO,
where one of the exemptions relates to equity shares allotted to employees
under ESOP schemes. What is determinative is the definition of “employee” and
whether that includes past employees. The specific questions raised for SEBI’s
guidance were as follows:
– Whether
the employees of the Company who have received shares pursuant to the ESOP
schemes and who have ceased to be the employees of the Company as on the date
of the allotment of shares pursuant to the IPO would be considered as “employees”
for the purposes of exemption from the one year lock-in under proviso (a) to
Regulation 37 of the SEBI Regulations;

Whether the existing employees and ex-employees of FTIL, which was an erstwhile
holding company of the Company, who had received shares pursuant to ESOP 2006,
would be considered as “employees” for the purposes of the exemption from the
one year lock-in under proviso (a) to Regulation 37 of the SEBI Regulations[.]
SEBI, in
its informal
guidance letter
, answered both questions in the negative. After examining
the definition of “employee” in Regulation 2(1)(m), it observed:
As
per the above definition, any person who ceased to be in the employment of
the company as on the date of allotment of shares pursuant to the IPO
is
not considered as employee and hence the shares held by them would not be
considered for the purpose of exemption from one year lock-in … In other
words, such shares held by ex-employees have to be locked in …
This is
consistent with SEBI’s previous
informal guidance
on a similar issue relating to Firstsource Solutions
Limited, which was approach advanced by MCX in the present case.
As for
the second issue, SEBI observed as follows:
The
definition of the ‘employee’ under Regulation 2(1)(m) as discussed above,
covers employees of the issuer, holding company, subsidiary or material associate
of the issuer and director of the issuer. Accordingly, the employees and
ex-employees of FTIL (which is a[n] erstwhile holding company of the issuer)
would not be considered as ‘employees’ for the purpose of exemption from one
year lock-in …

This might appear to be somewhat harsh to the
ex-employees of the company, but there is some rationale as it is the continued
employment that confers the benefit of free transferability without lock-in.
However, the continuing employees of the erstwhile holding company suffer an
even harsher situation as the change in their position is not on account of any
matter within their control, but due to corporate restructuring that severs the
parent-subsidiary relationship between their employer and the issuer.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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