New control definition to hit foreign private equity
Given the fears that Etihad Airways was actually gaining control of Jet Airways while keeping its share of equity at below the threshold for an open offer, it is natural the government should want to remove any ambiguity as to what constitutes ‘control’ of a company or any change in it. Indeed, while setting FDI caps, the definition of control is also important since there is little point having caps restricting FDI if informal control has already been ceded through other means. The problem with the definition cleared by the Cabinet last week is that it is so ambiguous, it can mean anything depending upon who is reading it. Control, the government press release begins, perfectly sensibly, “include(s) the right to appoint a majority of directors—it is after this that the problem starts. Control, it appears, is also to include the control the management or policy decisions” by way of “shareholder or management rights or shareholder agreements or voting agreements”.
Private equity (PE) deals are the most obvious ones to be hit by this new definition of control—in just the first half of this year, just under $6 billion of FDI came in through this route. Most private equity deals contain clauses to protect the rights of investors—unlike debtors who are protected by law, PE investors can only seek protection through what are called “minority protection rights”. These include, for instance, agreements that say, for instance, that no board meeting can be held without the representative of the PE firm being present—is this ‘control’ or is just the PE investor’s way of ensuring the investee company’s board doesn’t take any decision that could jeopardise the investment? Similarly, it’s pretty standard for PE agreements to say the investor reserves the right to appoint director(s) on the firm’s board—once again, the idea is to protect the investment, not control the company. What will be interesting is whether lenders like banks will be deemed to be in ‘control’ of a company when they put such covenants in place while lending—if they do, under accounting standards, the balance sheets of the firms they are lending to will have to be consolidated with theirs. If that’s not bad enough, think of what happens in case the lender is a foreign bank.