1 Introduction

1.1 In recent times we have seen the re-emergence of PIK (or payment in kind) structures in Indian PIPE deals. These are compulsorily convertible bonds where the interest component can be PIK-ed, capitalised and paid as equity shares at the option of the investor. Investors obviously enjoy the extra 'equity' bang for their buck, while the issuer gets to conserve coupon cash.

1.2 In this article, we examine in brief the regulatory regime here in the context of compulsorily convertible debentures ("CCDs") being issued by an Indian listed company to a non-resident QIB.

1.3 A non-resident investor can invest in an Indian company by way of subscribing to CCDs. Under India's exchange control laws, the conversion price for the CCDs cannot be less than the fair market value of the underlying equity security as determined on the date of issuance of CCDs, in accordance with exchange control rules. However, for private investment in public equities ("PIPE"), the conversion price is determined with deference to the regulations issued by the Securities Exchange Board of India ("SEBI"). The SEBI regulations apply at the time of issuance of the CCDs and, in doing so, also determine the conversion price and timeline. However, SEBI regulations could also impact whether the investor can elect to PIK the coupon on the CCDs and receive that as an additional equity kicker.

2. Key Considerations

While the Indian foreign exchange regulations as well as SEBI regulations explicitly deal with CCDs, their issuance and conversion, they do not provide granular colour on PIK-ing the coupon. This leaves the following questions to be answered:

2.1 Conversion price for the PIK

2.1.1 As mentioned above, the conversion price for CCDs being issued by an Indian listed company is determined SEBI regulations. For example, for issuance to QIBs (not exceeding five in number) the conversion price cannot be less than the 10day VWAP (volume weighted average price) of the listed shares preceding the 'relevant date'. The relevant date being thirty days prior to the date on which shareholders meet to approve the preferential allotment. Let us call this the "SEBI Regulatory Price".

2.1.2 Exchange control and SEBI Regulations are clear that the CCDs cannot convert at below this SEBI Regulatory Price. However, they do not provide that granularity for PIK conversion. Therefore, it might be prudent to retest the SEBI Regulatory Price as of the CCD conversion date to ensure that PIK conversion is not less than the higher of the two.

2.2 Shareholders' consent

Preferential issue of securities by any company requires the approval of its shareholders. For listed entities, the notice for such shareholder approval is required to be accompanied by details required by SEBI regulations including, the maximum number of securities to be issued to the investor (i.e. maximum dilution). Investors rightfully ask for getting the shareholder approval upfront for the conversion of the CCDs as well as the PIK. There is a case to be made that if the maximum number of securities to be issued (including the PIK) is specified and approved by the shareholders prior to issuance of the CCDs, then no separate shareholder approval for PIK conversion is necessary.

2.3 Tax implications

It is worth examining with your tax advisors whether coupon expensing is an option available where the PIK is converted.

3. Conclusion

These are some of the reasons investors do retain flexibility that PIK conversion is at their election. This means that in a down market investors can elect to cash out the coupon, and in an up-market they get to PIK convert it.

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