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posted 1 year ago
“What happens when an unstoppable force meets an immovable object?” The Joker – the iconic villain from The Dark Knight – used these words to describe the impasse that he and his nemesis Batman had reached. Believe it or not, similar impasses exist in the world of business as well; and when two parties in a joint venture (JV) fail to reach an agreement on critical matters, it is commonly referred to as a deadlock.
A deadlock in a JV can arise due to several factors. For instance, when there is a split view between board members with equal representation, at the shareholder level where members exercise equal voting rights, when minority shareholders exercise “veto” or “affirmative voting” rights to block a move by the majority shareholder, or when there is lack of quorum on crucial meetings, especially those for resolving “reserved matters” or “affirmative vote matters”.
What are “shoot-out” mechanisms?
Broadly, a “shoot-out” entails structuring a call/ put option in a manner where one party initiates the process by issuing a notice setting out timelines and the price for buying/ selling shares of/ to the other party. This eventually culminates into exit of one party from the JV. There can be several variants of shoot-outs – “Russian Roulette” and “Texas Shoot-out” being two of the more commonly known options.
Imagine a JV between party A and party B where a deadlock has arisen. One party – let us assume A – tells the other party, B, via a notice that it wishes to sell its shares to B or buy B’s shares at a specified price and within a timeline indicated in the notice sent by A. Consequently, there is a mandatory sale and purchase between the parties leading to one party exiting the JV. This is “Russian Roulette”. In a Texas Shoot-out, also colloquially referred to as the highest sealed bid, A tells B that it wishes to purchase B’s shares at a specified price and within a timeline indicated in the notice. B can either accept that offer or make an alternative offer to buy A’s shares at a higher price. If B chooses the alternative, A and B would consequently submit their bids in a sealed envelope to an independent third party and the highest bidder prevails, getting the right to buy out the other party.
Shoot-out mechanisms, including its variants discussed above, are considered quite frequently in western jurisdictions. Proponents of the shoot-out mechanism argue that there is an inherent fairness in the process which virtually compels one party to propose a reasonable and fair price for the shares.
“Shoot-out” mechanisms – Indian perspective
In JVs involving an Indian party and an offshore party, however, these “shoot-out” mechanisms are far from a viable option. The central reason for this is that the pricing regime in the case of transfer of shares by a resident shareholder to a non-resident shareholder is skewed in favour of the resident shareholder. When a resident shareholder seeks to transfer its shares to a non-resident shareholder, the fair market value of the shares determined as per the foreign exchange laws acts as the “floor” price, i.e. the lower limit. In contrast, when the non-resident shareholder seeks to transfer shares to a resident shareholder, the same fair market value of the shares acts as the “cap”, i.e. the maximum price. Any share purchase transaction between a resident and non-resident party in deviation of these pricing norms will necessitate prior approval from the Indian regulatory authorities, which may be denied, delayed and/ or conditioned.
Let us assume that in the above example, A is a non-resident entity while B is a resident party and the fair market value of the JV (a private limited company) is ₹ 100 per share. A deadlock has occurred in the JV. If A were to send a notice to B setting out the price at which the “shoot-out” would play out, it would need regulatory approval to complete a transaction of selling its shares to B at a price above ₹ 100 per share (fair value). However, B is at an unfair advantage here as it can set any price above ₹ 100 per share for sale of its shares to A, without prior approval.
Deadlock resolution – Alternative mechanisms
In light of the above, the fundamental question is then what is the ideal deadlock resolution mechanism in the Indian context? Here are a few options and suggestions to avoid and/or resolve an impasse.
What if the JV Agreement is silent and there is a deadlock?
In such a scenario, especially if the deadlock is persistent, the relationship between the parties could suffer irreparable damage. Where a JV party acts unreasonably or oppressively, and/or the deadlock is pretty much an artificially engineered deadlock for ulterior motives, the party at the receiving end should consider approaching judicial authorities to seek appropriate recourse. The nature of relief will really depend on the facts and circumstances of each case. In some instances, Indian judicial authorities have permitted buying/ selling of shares by one party to the other, or even ordered winding up of the JV. However, as it is evident, there is a degree of uncertainty in this option.
With the global economy still grappling with the impact of the COVID-19 pandemic, the way we do business is also undergoing a paradigm shift. Unforeseen obstacles and newer hurdles may be around the corner. Therefore, it is better to spell out the deadlock resolution mechanism in the JV agreement or at the very least, factor in some of the suggestions enumerated above. Options like shoot-outs that work in other jurisdictions are not practical options in the Indian context. Parties must weigh in the options as per the facts, circumstances and dynamics of each JV, and carefully craft the provisions in discussions with experts.
Khaitan & Co – Prasenjit Chakravarti and Sonakshi Sharma
The content of this document does not necessarily reflect the views / position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at [email protected].
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