Last year, the Securities and Exchange Board of India (“SEBI”) clamped down on upside sharing arrangements between promoters or senior management of listed companies on the one hand and private equity investors on the other. Accordingly, the securities regulator amended the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the “LODR Regulations”) to introduce regulation 26(6) as follows:
No employee including key managerial personnel or director or promoter of a listed entity shall enter into any agreement for himself or on behalf of any other person, with any shareholder or any other third party with regard to compensation or profit sharing in connection with dealings in the securities of such listed entity, unless prior approval for the same has been obtained from the Board of Directors as well as public shareholders by way of an ordinary resolution …
Although SEBI does not prohibit upside sharing agreements as such, regulation 26(6) performs two tasks. First, it introduces a great deal of transparency to such arrangements, which have to be disclosed to the shareholders. Second, it confers approval rights to shareholders, that too only to public shareholders (i.e., non-promoters) thereby providing for a veto of the arrangement by a “majority of the minority”. Both these are stated to be in the interests of the public shareholders of listed companies.
The scope and ambit of this provision came up for question recently in a request for informal guidance made by Accelya Kale Solutions Limited (“AKSL”). AKSL is part of the Accelya group of companies, which operates across nine countries. 74.66% shares in AKSL is indirectly held by Accelya Holding (Luxembourg) S.A. (“Accelya Luxembourg”), which is in turn ultimately held by Chequers Capital XV FPCI (“Chequers”), a private equity fund. As part of a global programme, certain senior managers of the Accelya group, including those of AKSL, subscribed to securities of two offshore group companies. In 2014, the global senior managers entered into sale agreements pursuant to which they were to sell those securities in the offshore group companies to Accelya Luxembourg. The payment for the sale was to be made in three tranches. While the first two tranches of payments were made to the selling senior managers in 2014 and 2016, the final tranche was to be paid on the occurrence of an “exit event”, which was when Chequers exits from its investment in the Accelya group. The deferred consideration, i.e. payment for the third tranche, was to be paid in accordance with a value that was linked to the sale consideration as part of the exit event. Such deferred consideration was to be paid to Mrs. Neela Bhattacharjee, the Managing Director of AKSL.
The principal question that arose in the context of the above circumstances is whether the payment of the deferred consideration as aforesaid would fall afoul of regulation 26(6) of the LODR Regulations. In its request, AKSL set out several reasons why regulation 26(6) ought not to be attracted in the circumstances. The first is a timing question. Although the deferred consideration became payable only in 2017, the arrangements were entered into in 2014, i.e. prior to the amendment to the LODR Regulations in January 2017. The second relates to the criteria for computing the profit sharing. Under the arrangements, the payment of the deferred consideration was not linked to the profitability of AKSL, being the listed company, but rather to the performance of the Accelya group as a whole. Hence, there was no “compensation” or “profit sharing” exclusively with respect to AKSL. It is possible to envisage a situation where AKSL performs well, but the group as a whole fails to do so, in which case the managers of AKSL would be limited in their ability to share in the profits of AKSL alone. The third pertains to whose securities are being dealt with as part of the arrangements. Here, it was clear that the payments of the deferred consideration related to sale of securities of certain offshore Accelya group companies, and that there were no “dealings in securities of [the] listed entity”, being AKSL.
Based on the above reasoning laid out by AKSL, SEBI responded favourably by noting that the “‘deferred consideration’ in the application pertains to the third and final tranche of the purchase price of those securities which are not of the listed entity in India. Thus the provisions of regulation 26(6) may not be attracted in the instant case”.
Although it is not entirely clear which of the above three reasons was ultimately accepted by SEBI, the wording of SEBI’s letter suggestions that it is the third, i.e. that the shares whose sale and purchase led to the profit sharing did not pertain to AKSL, the listed company. This suggests that so long as the securities in question do not relate to the listed company, profit sharing arrangements may be permissible. This will allow parties to structure the arrangements so as to involve group companies. Even though the SEBI informal guidance letter is unclear on this point, it would help for parties structuring such transactions to all take into account the second reasoning discussed above, which is to avoid any direct correlation between the performance of the listed company and the profit sharing for the promoters or senior managers.
This informal guidance provides some flexibility to parties to structure upside sharing arrangements through the use of the corporate group structure, which is all too common in the Indian context. If the corporate governance issues relating to distortion of manager incentives is the ultimate reason for the restrictions imposed by regulation 26(6), it remains to be seen if structuring the profit sharing arrangements through shares of a group company will help circumvent the protection conferred upon public shareholders.