Doing solid due-diligence for a private equity investment – here are the key steps

PrivateEquityLawyer_AngiraSinghviEvery private equity investor conducts due diligence on a target before the transaction is finalised and the documents are executed. Through this, a third party (and even the target entity itself) is able to know its actual position vis-a-vis the standards in various sectors.

With a legal due diligence, an investor wants to:

– ensure that the information provided by the target (and which forms basis for the investment) is accurate;

– find out any additional information the advisors should have been told, but were not;

– probe into the assumptions in the business plan and evaluate the possibility of achieving the targets set;

– identify the principal risks to the business and chalk out a mitigation plan; and

– conduct a more detailed analysis of the current state of the company.

There are several types of due-diligence, such as legal, financial, operational, and environmental. As lawyers advising on a private equity transaction, your focus area will be on the legal due diligence.

The term ‘legal due diligence review’ (“LDDR”) refers to the evaluation of whether the target entity has compied with various laws in letter and in spirit. This helps in identifying the major legal risks faced by the investor. Let us look at the steps involved in an effective LDDR.

Step 1: Prepare and circulate the LDDR checklist

An LDDR checklist will note all the possible documents needed from the target entity and to sub-divide them, they are typically grouped based on the areas of law.


Image above is from Oliver Tacke’s Flickr account and has been published under a CC BY 2.0 licence.

For example, you will need the incorporation documents of the target, the details of the shareholding and transfers made, the contracts that the company has entered into with third parties, environmental compliances, certificates of payments made under the Payment of Bonus Act and so on. You can accordingly sub-divide the LDDR checklist into main sections such as “General Corporate”, “Shareholding”, “Material Contracts”, “Finance”, “Employment”, and “IPR”. These sections can then be further sub-divided.

For instance, the general corporate information required from the target can include:

–  the company’s certificates of incorporation and commencement of business and the memorandum and articles of association, along with all amendments that have been made so far;

– the addresses of the registered office of the company, other office(s) of the company, and other locations from which the company operates;

– the legal structure of the group of which the company is a member, preferably in the form of an organisation chart, stating the names and addresses of all the companies in the group with the percentages of participating interest and describing the relationship between the company and other affiliated group companies, partnerships, and (un)incorporated business associations within the group;

– a summary of the history of the company;

– a brief description of the company business, for example, the business areas, the main products in each, and geographical presence;

– the details of any alliances entered into or to be entered into by the companies including copies of the agreements;

– the details of any branch, agency, place of business, or any permanent establishment of the company outside India including address, brief description of business carried on and numbers of personnel involved;

– the copies of all documents relating to any scheme, merger, amalgamation or restructuring, asset transfer, or acquisition involving the company or any of the group companies or subsidiaries.

The intention, as you can see, is to obtain as much information as possible.

Step 2: Know all the applicable laws

For an effective LDDR, the legal advisor should be aware of all the laws applicable to the target’s business. It is important to assess whether the target has complied with all thse laws and the consequences of any non-compliance. These consequences may pose risks for the target company and therefore, the investment as well.

For example, if the target is required to obtain a particular license prior to manufacturing a product and if it has not been obtained, there is a risk of having to cease the manufacturing activity. This may lead to immense losses to the target and therefore, the investor. Unless you know that this license was required, you will not be able to assess whether the company has complied with this legal obligation.

It is also important to understand the application of local laws. Land laws, for example, vary from state to state. Depending on the state in which activity is carried on, all applicable local laws should be identified.

Step 3: Review and comprehensively analyse documents

After circulating the LDDR checklist, a representative of the target entity, usually their lawyer or company secretary, will assess the applicability of each point. The relevant documents are then provided to the investor’s legal advisors.

documentsThese documents should be reviewed in detail by the lawyer and all possible outcomes should be analysed. For example, in case of an outstanding term loan shown in the books of the target, you should analyse all the restrictions in the term loan agreement such as whether any further funding (by the investor) is permitted, whether there are restrictions on the payment of dividend to the investor, and whether the charges are enforceable. If these activities require the prior permission of a lender, it may not be easy to recoup the investment. If an outstanding loan is shown in the balance sheet, for instance, all relevant documents should be obtained from the target in order to assess any restrictions on the investment, the enforceability of any charge, and the value of secured assets.

To take another example, agreements that reflect the business of the target need to be obtained and evaluated. Often, agreements have not been entered into and some times, such contracts have been entered into with related parties. This can be seen from the corporate details provided by the target. If there are any related party agreements, you should check whether all the required provisions have been complied with.

Since the LDDR is an investigative activity, it is important to keep your eyes and ears wide open. Often, attempts are made to hide information that may be detrimental to an investment. A glaring example is the Ranbaxy transaction. Important information was concealed during the due diligence and as a result, the joint venture party incurred losses. You may need to request the target for clarifications and seek further information backed by documents before you are satisfied on all the issues.

Step 4: Think about what can be done to mitigate risk

After the review of all the documents, you will often notice that further action is required to mitigate the investors’ risks. Usually, they belong to the following categories:

(i) obligations that have to be fulfilled as a condition precedent to closing the investment;

(ii) representations and warranties backed by indemnity;

(iii) creation of escrows; and

(iv) conditions subsequent.

For instance, after the review of loan documentation, you may conclude that prior permission is required before additional funding is brought in. It is your duty to make your client aware of this stipulation and then include it among the conditions precedent to closing the transaction.

Similarly, if the target is facing litigation with respect to an event prior to the investment, the investor should not be required to bear its costs. The amount of potential loss should either be set aside in an escrow or adequate representations and warranties backed by indemnity should be stipulated in the transaction documents.

Step 4: Draft and finalise the LDDR report

The outcomes of an LDDR exercise are usually set out in a report. Depending on your understanding with the client, it may either be a long form report or a report setting out only the main issues.

You should bear in mind that the report should be structured in a manner that all sections are classified and organised in the order of importance. Issues should be clearly identified and all risk mitigation solutions should be clearly set out.

In my next post, I will discuss the transaction documents in a typical private equity investment.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.


The four types of laws that all private equity lawyers must know

PrivateEquityLawyer_AngiraSinghviTo advise on private equity investments and their structure, lawyers need to be aware of the many laws that affect transactions. Let us look at the four major categories of laws that can regulate a private equity transaction.

1. Foreign investment laws

When investment flows in from countries located outside India for investment in some business activity and not merely stock or trading, the amount is treated as foreign direct investment (“FDI”) and the investment needs to comply with applicable regulations. Many private equity funds are based out of tax havens such as Mauritius and the British Virgin Islands and FDI is routed through such jurisdictions.

Every year, some time in the months of April or May, the Ministry of Commerce and Industry issues an FDI policy, governing areas such as the kind of instruments that may be issued, sectors in which investment may be freely made, and the procedure of issue. The policy is reviewed every year and changed if necessary.

Depending on factors such as the business sector, the nature of the instrument, and the intended percentage of shareholding, FDI can fall under the automatic route or the government route. Under the automatic route, the investor can directly invest into the target company without obtaining any prior approval from the government. Under the “government route” or the “approval route”, prior approval is required from the Foreign Investment Promotion Board. For example, prior government approval is necessary in mining, coal and lignite, and real estate unless some prescribed conditions are complied with.

The Foreign Investment Promotion Board is housed in the Department of Economic Affairs of the Ministry of Finance.

The Foreign Investment Promotion Board is housed in the Department of Economic Affairs of the Ministry of Finance.

Structure of the target: FDI investment into a company or a venture capital fund (not being a trust) is most straightforward because there are fewer restrictions and the investment is permitted through the automatic route. While investors may prefer investing in trusts and LLPs to take advantage of tax and operational benefits, additional structures are required for an FDI investment.

Types of instrument: Indian companies can issue equity shares; fully, compulsorily, and mandatorily convertible debentures; and fully, compulsorily, and mandatorily convertible preference shares under the automatic route subject to the pricing guidelines or the valuation norms prescribed by the regulations under the Foreign Exchange Management Act, 1999 (“FEMA”).

Convertible instruments get converted into equity after a specified period of time. A prescribed conversion formula determines the value of that instrument or the equity shares to be issued. Unless they are compulsorily convertible, they do not fall within the category of permitted instruments under the automatic route.

All other instruments (including optionally convertible instruments) are considered debt and require compliance with the Reserve Bank of India’s guidelines on external commercial borrowing.

The price or conversion formula at the time of conversion of a convertible capital instrument should be determined at the time of its issue according to any internationally accepted pricing methodologies and on arm’s length basis for unlisted companies. For listed companies, a valuation has to be made under the Securities and Exchange Board of India( Issue of Capital and Disclosure Requirements) Regulations.

In order to use the automatic route, the instruments need to be fully paid up and comply with the pricing norms, failing which, the government’s prior approval is required.

Reporting of the investment: The FDI policy requires that any amounts received by the target entity against capital should be reported to the Reserve Bank of India. An amount received against the transfer of existing shares should be reported by filing Form FC-TRS. An amount received against the issue of new shares should be reported by filing Form FC-GPR.

Business sector: FDI policy restricts the level of investment in certain sectors. In such sectors, investment above a certain percentage of the total shareholding requires the prior approval of the government. In some sectors, even indirect shareholding or control is not permitted. For example, in defence production, air transport services, ground handling services, asset reconstruction companies, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecommunications, and satellites, no transfer is permitted that may result in ownership or control by foreign entities.

2. Laws governing listed companies

Acquisition of shares: Ordinarily, shares are freely transferrable in listed companies (unless there are agreements to the contrary). Some provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations”) however, can hinder the acquisition of shares in a company.

Any acquisition of shares or voting rights that will give the acquirer (or persons acting in concert with the acquirer) 25 per cent or more of the voting rights in the target company can only go forward after the acquirer makes a public announcement of an open offer to acquire at least 26 per cent of the voting shares from the public shareholders of the target.

The Takeover Regulations also lay down norms that apply to acquisitions where the acquirer already holds or controls a substantial amount of shareholding in the target company. Further, under Regulation 4 of the Takeover Regulations, irrespective of the acquirer’s shareholding or voting rights in the target company, it shall not acquire control over a target company without making an open offer for acquiring shares.

The term ‘control’ is significant for private equity transactions because investors tend to insist that their active consent should be taken before any main action affecting the company is taken, such as any future financing, entering into any agreement above a certain value, appointment of directors, deciding upon agenda of board and shareholders’ meeting, restrictions on sales and company assets, and sale of shares to third parties. Even when they have a minority stake in the company, they insist upon such rights and often, this list is so wide that it may be interpreted as exercising control over the company.  According to the SEBI, an agreement that incorporates such a condition would give the private equity firm ‘control’ over the company even though its shareholding is not high enough to trigger the Takeover Regulations.

In addition to the requirement of having to make an open offer, the target company and its board of directors become subject to a few other obligations. For instance, during the offer period, no person representing the acquirer (or any person acting in concert with him) can be appointed as a director on the board of directors of the target company.

If the private equity investor decides to acquire the entire public shareholding resulting in the delisting of the company, even more regulations apply in the form of the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009 (“Delisting Regulations”). The company must be listed for a period of at least three years and the delisting cannot result from a buy-back or preferential allotment of shares by the company.

3. Insider trading regulations

It is an offence under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 to ‘deal in securities’ while in possession of unpublished price-sensitive information, that is, any information that, if published, is likely to affect the price of the securities of a company. The Companies Act, 2013 has also introduced provisions on insider trading. Section 195 of the Act, which applies to unlisted companies also, lays down punishments of imprisionment and hefty fines for their contravention.

4. Other company law aspects

Since private equity investments are usually made in companies, a detailed understanding of the Companies Act, 2013 (“Act”) is necessary before advising on transactions. Some of the important provisions are discussed here.

Layered investment: Investments through more than two layers of investment companies, preffered by private equity investors because of their tax efficiency, are not permitted under the Act.

Restrictions on transfer of shares: Unlike its predecessor, the Act allows shareholders of ‘public’ companies to enforce restrictions on the transfer of securities. Private equity investors therefore, can freely stipulate conditions on the transfer of shares such as drag-along rights, tag-along rights, and right of first refusal (all of which will be explained in detail in a later post on transaction documents). The Act only protects these conditions as if they are a contract between private persons, and so, to bind the company, it may be advisable to incorporate these provisions into the articles of the company.

Differential voting rights: The Act also contains provisions relating to different classes of shares. Barring a few situations, private companies cannot issue preference shares with voting rights.

Representation on the board: In order to safeguard their investment, private equity investors usually nominate one director to the board of the target company. As their legal consultant, you should be able to advise the investors about the consequences of such an appointment. A director who becomes ‘aware’ of any contravention by way of his participation or receipt of information and does not object to such contravention can be subject to prescribed punishments. Such liability extends to non-executive directors as well.

Amendments to a company’s articles: The articles of a company are amended following a private equity investment to reflect the amended understanding amongst shareholders. You should verify whether the current articles of the company contain any provisions that may only be altered after following procedures that are more restrictive than those applicable in the case of a special resolution, and that these procedures are complied with at the time of the closing. Such provisions may also be inserted in the articles to protect the interests of the investor in its capacity as a minority shareholder.

Apart from these major laws that are essential to advice on private equity transactions, some other laws are important at the stage of conducting due diligence over the target. Let us look at those laws in a later post on conducting due diligence.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.



All you need to know about drafting put and call option clauses

Drafting_for_Business_Deepa_Mookerjee.jpg“Call options” and “put options” are used frequently in shareholders agreements. As you know very well by now, a shareholders agreement specifies the rights and obligations of shareholders and sets out the manner in which the company will be governed. We have already seen some vital clauses used in these agreements such as condition precedent clauses and restrictions placed on the transfer of shares. Let us now look at “call” and “put” options.

Simply, a call option is a right but not an obligation to purchase shares at a specified price, on the happening of a specified event. If A and B are two investors in a joint venture company, A may have a call option over twenty-six per cent of the shares held by B, which he can exercise once the limit on foreign direct investment (“FDI”) is raised. This means that once the FDI cap is raised, A has a right to purchase twenty-six per cent of the shares held by B. If A exercises this right, B cannot decline to sell the shares to A.

A put option on the other hand, is a right but not an obligation to sell shares upon the occurrence of a specified event at a specified price. If A has a put option over twenty-six per cent of his own shares in the company that he can exercise once the company is insolvent, it means that if the company declares insolvency, A can sell his shares to B. Once A exercises his put option, B cannot decline to purchase A’s shares.

Junior lawyers should understand these mechanisms well because they can be used in a shareholders agreement in various scenarios. To think that call and put options are only useful in an FDI limit scenario or an insolvency situation (as discussed above), would be incorrect. Let us first go through some scenarios to understand how they may be useful.

Versatile options

Assume that there are two shareholders in a joint venture company – A and B. You are representing ‘A’. A comes to you with a simple question – what if B commits a material default of the provisions of the shareholders agreement and is unable to cure the defect or default? What are the options available to A?

PutAndCallOptions_ShareholderAgreementsYou can tell A that he can either ask for a mechanism by which he can sell his shares and exit the company (a put option) or a mechanism by which he can insist that B exits (a call option), when the material default occurs. The latter mechanism means he can continue in the company and ask B to exit. If you know these mechanisms well, you can give your client two options – either continue in the company and buy the other party’s shares (by exercising the call option) or sell his shares and exit the company (by exercising the put option).

Take another scenario. Suppose your client would like to continue as a shareholder in the company only if the company generates a certain amount of revenue after a specified period (say five years). If not, your client would like to exit. If you know what a put option is, you can simply suggest that your client include a put option over his own shares.

These two mechanisms can therefore be used throughout shareholders agreements to address different scenarios and the various needs of your client. There are some points that you should keep in mind while drafting them.

1. Be precise about whether your client has a right to sell shares or is under an obligation to purchase shares. Use words such as ‘right’ and ‘obligation’ wisely to ensure that the burden is being placed on the correct party.

2. Specify the amount or percentage of shares that are subject to the call or put option. At the time of enforcement, there should be no confusion on the amount of shares that can be sold or bought.

3. Remember, contractual arrangements can work in many permutations and combinations. For instance, if you are drafting a put option clause, it is not necessary that the shares always need to be sold to the other parties in the shareholder agreement. You can also have a right to sell your shares to a third party of your choice. Similarly, it is up to the parties to decide whether the option should apply to a part of the shares or all the shares that a party holds. As a lawyer, you should advise your client about the most appropriate form of the clause depending upon his or her intentions.

4. As always, the letter of the law plays an important role. For instance, the Reserve Bank of India has made it clear that a non-resident investor should not be guaranteed any assured exit price at the time of making an investment. The exit price must be a fair price calculated according to the prescribed guidelines and at the time of exit. Keep this in mind when you draft a put option for a foreign investor and always know the correct legal position before drafting.

5. Always flesh out the manner in which the clause will work. For instance, if your client has a call option on the shares held by the other party, you should specify the manner in which your client should send a notice to the other party indicating his or her intention to exercise the call option (known as a call option notice), the time period within which the other side must respond (the call option period), the price at which shares will be sold (the call option price), and the maximum time period within which the sale must take place. Specifying these details makes it simpler to execute the sale and implement the clause effectively.

Remember these basic points while drafting. Make sure that you are always clear about what a clause is intended to achieve. Take the time to understand the needs of your client and draft accordingly.

(Deepa Mookerjee is part of the faculty on


An introduction to strategies and risks in private equity for lawyers

PrivateEquityLawyer_AngiraSinghviCommon funding options available to companies include taking loans from banks, commercial borrowings, and issuing equity shares and convertible instruments. Even though the cost of borrowing is perceived to be lower than the cost of equity, companies often prefer not to take loans because among other reasons, loans require security, increase the repayment obligation on the company, and increase its debt-equity ratio.

Another option is to raise equity investment from a closed group of private persons directly. Well known examples of this category of investors, known as ‘private equity funds’ or ‘private equity firms’, include Blackstone, Goldman Sachs, Warburg Pincus, and Carlyle and their investments are called private equity (“PE”) investments. Their objective is to transfer back their shares in the company at a pre-determined rate at the end of a certain investment period and earn a return on these investments. In India, unless the gestation period of the target company’s business is long, this period ranges between three and five years.

In India, private equity investments are mostly made into private or public non-listed companies. While there is no bar, legally or conceptually, to making private equity investments in listed companies, the law governing the acquisition of shares in listed companies above a certain threshold makes them cumbersome.

Since it is aimed at maximising shareholder return in a fixed period, private equity helps in speeding up the process of achieving growth targets. Private equity can also help professionalise some mature companies that earn profits but do not have systems in place with respect to reporting, compliance, and accounting. It can also change the direction of a company and enable it to take calculated risks as opposed to the following the directions of one person. Remember also, that the private equity market is less transparent compared to the market for listed stocks and bonds, and so may offer more opportunities and higher returns.


Even though most PE funds are generalists and invest into all kinds of promising ventures in a variety of sectors, specialised PE funds focusing on particular sectors or a particular strategy of investment, have emerged. Private equity investments can be used for financing start-ups, injecting working capital into a growing company, or acquiring a mature company. It can also be used to strengthen a company’s balance sheet.

– Among all categories of PE investments, venture capital, which is provided to start-ups and early stage growth companies, has the highest risk and the highest potential for returns. The strategy here is to invest in companies that promise a bright future. Their business model typically involves high technology industries such as information technology, healthcare, and green or renewable energy. Companies, if successful, experience higher levels of growth.

– Growth capital is provided to mature companies that have already made it through the early stages and are able to generate constant revenues. Such financing is usually for a major expansion or diversification that the company cannot fund on its own. Recently, on 1 May 2015, Goldman Sachs and Rocket Internet invested USD 100 million into food delivery portal ‘Foodpanda’. The investment is aimed at further expanding Foodpanda’s own delivery activities and improving overall customer experience across global markets.

– The strategy behind buyouts is to acquire a stake in a mature, established company with a strong market position in order to exercise influence on it. Privatising a company allows the management to take decisions or adopt strategies that could otherwise be difficult or controversial in a publicly listed company. For example, disposing off an undertaking or a substantial asset of a listed company may be a cumbersome task since the same requires a special resolution to be passed under company law. It is much simpler to pass such resolution after acquiring a stake in a company through which the investor can influence the decisions of the company.


While a private equity investment may appear more appealing than a bank loan, there are risks involved in the transaction.

– The PE investor, even when holding a minority stake, exercises influence over the company and restricts the entrepreners discretion to a large extent.

– The costs of continuous and detailed reporting may be an added burden on the target company.

– There are likely to be restrictions on the transfer of shares of the current shareholders of the company for the benefit of the PE investor;

– The rights of the PE investor at the time of its exit from the company along with its return may often be unduly harsh on the promoters. For example, it may require the promoter to compulsorily sell his shares on terms and conditions agreed upon by the PE investor with a third party purchaser.

– Being pure investors, the interest of a PE investor in the company is limited to the recoupment of their investment.

These concerns, especially the risk of diluted control over the company, may often outweigh the benefits of PE investment.


To ensure a successful PE investment, lawyers advising the parties have to ensure that both investor and the target are well prepared.

– The target company should weigh the limitations that are likely to be placed on the discretionary powers of its current owners against the need for money from the investors. Clients that are not from a professional background must be clearly advised about these consequences.

The main concern of a PE investor is to ensure that it exits the company smoothly and with an acceptable return on its investment. An estimate of this return helps avoid disputes later. The target company should prepare this estimate professionally. This requires clarity on the current business situation as well as the forecast.

A PE investor, prior to investing in the company, always conducts a penetrating due diligence on the target company. The investor will examine every aspect of the company including its governance, compliance, and reporting structures. By ensuring that it is compliant, for example, that meetings are held in time, that books and registers are well maintained, that all filings are made, that proper contracts have been entered into for all activities, and that licenses and registrations have been duly obtained and maintained, the target company can remove uncertainty and delays in the conclusion of a transaction. In fact, the target company should even conduct an internal compliance due diligence on a regular basis.

– Disagreement during the finalisation of transaction documents can be largely reduced if, before entering into a transaction, the framework of the investment is set out in a term sheet. There should therefore be clarity on issues such as the nature and type of instrument (whether a convertible or plain vanilla equity), the structure through which equity will be infused, the exit rights of the investor, restrictions on the transfer of shares of the current shareholders, and the governance of the company. The agreement on these issues can be revised after the reviewing the results of the due diligence.

I will reflect about private equity transactions in greater detail in a few more posts here.

Angira Singhvi is a principal associate with Khaitan Sud and Partners and handles general corporate, joint ventures and private equity investments.

Corporate Lounge

Why SEBI has jurisdiction over GDRs that impact Indian securities markets

DeekshaSinghEarlier this month, the Supreme Court decided on the jurisdiction of the Securities and Exchange Board of India (“SEBI”) in relation to Global Depository Receipts (“GDRs”). Let us take a closer look at GDRs and the Court’s decision in Securities and Exchange Board of India v. Pan Asia Advisors Ltd.

What are GDRs?

GDRs are instruments created by a foreign depository outside India and authorised by a company making an issue of such depository receipts. A depository can be any company, bank, or institution that holds and facilitates the exchange of securities. Depositories issue receipts for the securities deposited with them, which then function as negotiable financial instruments that can be traded on a stock exchange.

Let us look at how this works. Each GDR represents a certain number of equity shares of an Indian company, which are listed on an Indian stock exchange. A local custodian in India holds the underlying equity shares on behalf of the depository. The depository issues these GDRs, which are then listed and traded on the foreign exchanges. The underlying equity shares are not traded on the Indian stock exchange until the GDR holder redeems the depository receipts. Until then, they are merely held by the local custodian.

The GDR holder may redeem the GDRs and obtain the underlying equity shares. The terms of the redemption will depend on the terms of the deposit agreement between the issuer, the GDR holder, and depository issuing the GDRs. The GDR holder however, should be eligible to hold the underlying equity shares according to the foreign exchange laws in India, namely, the Foreign Exchange Management Act, 1999 and the regulations made under it, in order to redeem the GDRs and obtain the underlying equity shares.

In India, the Ministry of Company Affairs has issued the Companies (Issue of Global Depository Receipts) Rules, 2014 (“GDR Rules”) to govern the issue of GDRs. The GDR Rules provide that any GDR issue must comply with the GDR Rules and the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993, which was notified by the Ministry of Finance.

SEBI v. Pan Asia Advisors Ltd. – the facts

In this case, issued GDRs were all converted into the underlying equity shares of the issuing companies, which were then sold in large deals to several buyers, such as stock brokers. The stock brokers would in turn sell the shares to other investors.

After investigation, the SEBI found that the issuing companies, the lead manager to the GDRs, the foreign institutional investors (“FIIs”), and the stock brokers were all acting as a group. They were able to maintain the share price of the company through these transactions. No information was communicated to outside investors who may have paid a high price based on the issuance of GDRs by the companies and large holdings maintained in them by FIIs.

SEBI held that this was an instance of market manipulation and exercising its quasi-judicial function, passed an order restraining the parties from participating in the capital markets.

The Securities Appellate Tribunal (“SAT”) overturned the SEBI’s ruling on the ground that SEBI does not possess jurisdiction to regulate GDRs. SEBI appealed the matter. The issue was whether the SEBI has the jurisdiction to initiate action against the lead managers to the GDRs issued outside India.

The Supreme Court’s decision

The Supreme Court of India

The Supreme Court of India

The Supreme Court looked at the process involved in a GDR issuance. It recognised that while the deposit of the ordinary shares with the custodian takes place in India, the actual issue and trading of the GDRs takes place outside India.

Since the GDR does not come into existence unless the underlying shares are issued, Indian law does apply. This also leads to the conclusion that GDRs would fall within the definition of “securities” under section 2(h) of the Securities Contracts (Regulation) Act, 1956 (“SCRA”).

The Supreme Court then looked at the powers of the SEBI under the Securities and Exchange Board of India Act, 1992 (“SEBI Act”) and the SEBI (Prohibition of Fraudulent and Unfair Trade Practice Relating to Securities Market) Regulations, 2003. After finding that the SEBI has extensive powers to protect the interests of investors in the securities markets, the Supreme Court noted that the alleged actions of the parties involved in the transactions adversely affected the Indian securities markets. It observed that “… the violation complained of by the appellant is with reference to such of those provisions contained in SEBI Act, 1992 vis-`-vis the underlying shares of GDRs. Therefore, we are unable to see any violation of exercise of its jurisdiction since the underlying shares of GDR were created and dealt with as well as traded in the stock market of Indian Territory.

It further relied on the case of GVK Industries Limited v. Income Tax Officer and stated that in order to proceed “in exercise of any extra territorial aspect, which has got a cause and something in India or related to India and Indians in terms of impact, effect or consequence would be a mixed matter of facts and of law, then the Courts have to enforce such a requirement in the operation of law as a matter of law itself.

So with regard to the limited question of jurisdiction, the Supreme Court concluded that the SEBI has jurisdiction over GDR issues that impact the Indian securities markets. It sent the matter back to SAT for a decision on the merits of the case.

The specific facts of the case could have affected the Supreme Court’s decision. This transaction in question was not just a GDR issue. A series of allied transactions allegedly caused adverse consequences for Indian investors. The scope of this judgment may therefore be somewhat limited. However, it serves to clarify that just because a GDR issue is carried out entirely outside India does not mean that it is outside the SEBI’s territorial jurisdiction.

Deeksha Singh is part of the faculty at