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Relevance Of Right Of First Refusal (ROFR) Clause In Investment Transactions: A Glance At Phonepe Acquisition Of Indus Os

The Right Of First Refusal is one of the most important rights when it comes to the negotiation of a shareholders' agreement between an investor and the company's founders or promoters. Any investor who is taking the risk of undertaking investment will need to have certain rights in his favor to have a fool-proof assurance of the safety of his hard-earned money and therefore, ROFR enables the investor to conditionally restrict the promoters of the company from selling equity of the company to a third party.

In simple terms, the ROFR clause issuer (Promoters) binds himself by law to first offer his share to the ROFR holder (Investor) for purchase, after the issuer has done negotiating a price with a third party. The concerned shares can only be offered to the third party in case the ROFR holder denies purchasing the shares at the price negotiated by the third party.[i]

Relevance Of ROFR

The legality of the ROFR clause was ambiguous in the past when it was challenged in the case of Western Maharashtra Development Corporation v. Bajaj Auto[ii], the court held that any kind of restriction which is imposed on the transferability of the shares will be against Section 111A of the Companies Act, 1956. However, the judgment was overruled in the case Messer Holdings Limited v. Shyam Madanmohan Ruia[iii], and it stated that any agreement which is done with an objective of pre-emption and is entered into freely by the parties will legally restrict the free transferability of shares.

Later, in the appeals of the aforementioned case of Bajaj Auto, it was decided by the court that under Section 58 of the Companies Act, 2013 even the public companies have the power to enter into private agreements between two or more parties concerning the transfer of shares which can include provisions like ROFR. The Bombay High Court also stated that the language written in the new act makes it explicit and vivid that the public companies also have the right of arranging private shareholding agreements of pre-emption.

As a final nail to the coffin, the regulatory body of Securities and Exchange Board of India vide a notification issued on 3rd October, specified the manner according to which parties can enter into agreements for the sale of shares. The sub-clause (c) read as, contracts for pre-emption including the right of first refusal, or tag-along or drag-along rights contained in shareholders agreements or articles of association of companies or other body corporate .[iv]

The relevance of the ROFR can be traced from the very fact that it stands completely valid and legal when it is tested on the principles of the Indian Contract Act provided that it has been drafted and executed according to the law. When it comes to the drafting of the clause, the parties should ensure that it is not against Section 27 of the Indian Contract Act, 1872 by the way of containing covenants that are negative or restricts the parties from the freedom of trade provided by the law. Moreover, at the time of execution, the parties should ensure that the clause is being exercised following the terms which are mutually decided by the parties through the agreement which contains the ROFR.[v]

ROFR rights are being used predominantly in the present era of the digital revolution in almost all transactional contracts and might also include consideration that is not limited to shares and can include things like assets, livestock, and in some cases even properties.[vi] Therefore, it can be said that a ROFR clause holder has the power to ensure management compatibility, maintain family control in some cases, or can even protect the other shareholders in a company from an interloper who can be harmful to their interest.[vii] As a result, it allows the investor to not only use the right strategically for commercial profit but also to protect the company from an outsider.

Phonepe Acquisition Of Indus OS

The current tussle in the corporate world regarding the acquisition deal of India's second-largest fintech company PhonePe and Indus OS (Samsung-backed 5 years old startup) has become a classic example of how the ROFR clause can become a disaster if it is not used strategically.

The aforementioned deal is a straightforward transaction where PhonePe wants to acquire 90% of the stake in the company from its present holding of 32%. Since the takeover is a friendly transaction between the companies, Indus OS also wants the same deal which is valued at approximately $60 million by the fintech company. However, the deal is hindered by two of the major minority stakeholders of Indus OS, namely, Affle Global and Ventureast[viii].

Conflict & Role of ROFR
Affle Global, a minority stakeholder of Indus OS has an approximate stake of 23% in the company. As soon as PhonePe proceeded with the acquisition transaction by the way of executing an alleged term sheet, Affle Global triggered the ROFR rights of their investment agreement with Indus OS. According to the agreement, the shares of the founders of Indus OS have to be first offered to Affle Global after a price has already been negotiated with a third party and Indus OS can proceed only if Affle Global rejects to purchase the shares at the offered price.

At the current time, the acquisition is still facing trials in the Singapore Court of law as both the companies have filed legal proceedings against one another, while recently PhonePe has also appealed to the Securities and Exchange Board of India to interfere as according to them there has been a side-dealing by Vneutreast and Affle Global which has been done deliberately in bad faith to scramble the aforementioned acquisition deal of PhonePe and Indus OS.[ix]

Conclusion And Takeaways
It is a known fact that a boilerplate clause like ROFR might not avoid all the probable future disputes between the founders and the investors but what is known is to draft these clauses with clear, descriptive and precise use of words and terms. As seen in the case of PhonePe acquisition of Indus OS, any startup company like Indus OS shall negotiate these rights with utmost seriousness and foresightedness because it might seem like a small right while building an investment relation of the company with the investors but when the time comes, this small right can become the reason for the founders to have a profitable exit from the company.

From the founder's point of view, these rights can be negotiated along with a lock-in period to make the investor vested in the business for a long time. While from an investor's point of view, the clause of ROFR can also be clubbed with Tag-Along Rights (TAR) for the maximum benefit and security of their investment. So, in this way, the investor can either purchase the stake of the founders through ROFR or otherwise can force the third party who is purchasing the stake of the founders to also purchase the investor's stake on the same commercial terms and provide him a profitable exit.

References & Sources:
  1. Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613, (2012).
  2. Western Maharashtra Development Corpn. Ltd. v. Bajaj Auto Ltd. . | Bombay High Court | Judgment | Law | CaseMine, , (last visited Jun 26, 2021).
  3. Messer Holdings Limited v. Shyam Madanmohan Ruia | Bombay High Court | Judgment | Law | CaseMine, , (last visited Jun 26, 2021).
  4. 1380791858733.pdf, , (last visited Jun 26, 2021).
  5. Percept D'Markr (India) Pvt. Ltd vs Zaheer Khan & Anr, (2006).
  6. Walker - 2000 - Rethinking Rights of First Refusal.pdf, , (last visited Jun 26, 2021).
  7. Id.
  8. ETtech Exclusive: PhonePe's Indus OS deal in a legal tangle - The Economic Times, , (last visited Jun 27, 2021).
  9. Rucha Joshi, PhonePe's Battle With Ventureast and Affle Over Indus OS Deal, TimesNext (2021), (last visited Jun 27, 2021).

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