‘Ordinary Course of Business’ in Investment Agreements: Is it Useful Defining the Phrase?

It is quite common to notice the phrase ‘ordinary course of business’, used across various investment and acquisition agreements. The phrase is used in VC/PE shareholder agreements to allow promoters/founders of investee companies the flexibility to operate without obtaining investors’ consent. Activities or business decisions that are in the ‘ordinary course’ are usually exempt from the requirements of obtaining investors’ permission. In acquisition and subscription agreements, the phrase is used across warranties to provide generic exemptions to the warrantors. Depending on the language of the warranty used, it could either be beneficial for the warrantors or the investor seeking the warranty. Often the phrase is defined with such subjectivity that it defeats the purpose of having a definition in the first place. In this context, it may be useful to understand the legal connotation of the phrase ‘ordinary course of business’, as understood by Indian Courts and possibly revisit the practice of defining the phrase.

Indian Courts have discussed the phrase “ordinary course of business” at length. The mere fact of an activity being mentioned in the charter documents is not sufficient to establish that the activity was carried out in the ordinary course. But, mentioning an activity in the charter documents does help in establishing certain bonafides of a related transaction. It appears that for determining if a transaction is in the ordinary course – volume of transactions and degree of frequency would be more helpful.

If an activity is carried out in the ordinary course, it can be demonstrated from company’s historical practices – frequency of undertaking such activity, volume of such transactions and the amount of money and resources invested by the company in undertaking such activity(ies). While frequency, volume etc., are all guiding factors, one of the true tests is determining whether carrying on of such operations is continuous and is done with a view to earn profit. Reliance can also be placed on the proximity of such transactions with the business and the distinguishing factor of any such transaction. To conclude that a transaction has been carried out in the ordinary course of business, it is also necessary to establish the nexus of such transaction with the primary business activities. However, a systematic activity carried on over a period of time, even with low volumes, would amount to carrying on of business in the ordinary course. To consider an activity as business there must be an identified course of dealing with a profit motive. Industry specific practices may also be relied upon, along with the past practices, to determine ‘ordinary course of business’.

As we can see from the above; there is no decisive test or straight jacket formula to determine whether an activity is in the ordinary course of business. Each activity would have to be assessed considering the determining factors laid down by the Courts:

  • such activity should be permitted under the charter documents;
  • the activity should not be a one-off transaction, and regular frequency of the activity should be demonstrable;
  • there should be a sequence of similar transactions carried on by the company in the past;
  • the activity should be akin to general industry standards; and
  • the activity should be a source of income for the business.

Given the volume of existing jurisprudence on the subject and the inherent subjectivity in the criteria set out by Courts, it may be worth considering the prudence of even defining ‘ordinary course of business’ in investment agreements. It may be better to leave the phrase open for interpretation as per law and offer founders / promoters the freedom to operate the business in the ‘ordinary course’ coupled with approval requirements for certain material actions. Additionally, a more objective and desirable approach would be to place monetary thresholds on business decisions and actions as the yardstick for obtaining investor consent. In this approach, the promoters cannot take any decisions which may have a monetary impact on the business or incur expenditure in excess of the monetary threshold without investor’s approval. Of course, the exact figures or range of permissible expenditure would depend on the size of the business, the industry vertical and a host of other factors which need to be considered on a case to case basis. The exact monetary threshold itself can be worked out in various permutations such as; a single transaction, cumulative transactions, quarterly or annually etc. But, the monetary threshold as opposed to relying on a subjective definition of ‘ordinary course of business’ in documents may probably be a better approach to the issue. Further, it will also enable the investors to exercise a more objective degree of oversight on the investee business. Lastly, in the unlikely scenario of a litigation, it would be relatively easier to demonstrate compliance or non-compliance of the relevant contractual provision. This assumes greater significance in a jurisdiction like India where contractual disputes could linger for years within the judicial system.

Ajay Joseph (Partner, Veyrah Law) and Arun Mohanty (Principal Associate, Veyrah Law)

Views expressed above are for information purposes only and should not be considered as a formal legal opinion or advice on any subject matter therein.

 

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