The Share Holder Agreement (SHA) between Indian entity and foreign entity in majority of cases of transfer of share to foreign entity provides for exit option for foreign investor, which may ex facie violate provision of FEMA, 1999. The foreign arbitration award requires remission of money to an entity outside India, it ex facie appear that RBI’s power under the FEMA, 1999 cannot be negated.

In Srm Exploration Pvt. Ltd. vs N & S & N Consultants S.R.O. , 2012, the Hon’ble Delhi High Court held following:

  1. We have perused the provisions of FEMA, 1999 Section 3 thereof prohibits dealing in or transferring of any foreign exchange save as otherwise provided therein or under the Rules & Regulations framed thereunder without general or special permission of RBI. We are unable to find any provision therein voiding the transactions in contravention thereof. We may mention that the predecessor legislation to FEMA namely FERA 1973 vide Section 47 prohibited entering into any contract or agreement directly or indirectly evading or avoiding any operation of the said Act or any provision thereof. However, Sub Section (3) thereof also provided that such prohibition shall not prevent legal proceedings being brought in India for recovery of a sum which apart from the provision of FERA would be due. However, the legislature while re-enacting the law on the subject has chosen to do away with such a provision. We are of the view that the same shows a legislative intent to not void the transaction even if in violation of the said Act. Thus, we are of the opinion that the plea of the appellant Company in this regard is without any force.

The RBI Circular No.-86 dated 9th January, 2014 issued under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 states following with regard to exit option of Foreign Investor:

………………………………………

  1. b) After the lock-in period, as applicable above, the non-resident investor exercising option/right shall be eligible to exit without any assured return, as under:

(i) In case of a listed company, the non-resident investor shall be eligible to exit at the market price prevailing at the recognised stock exchanges;

(ii) In case of unlisted company, the non-resident investor shall be eligible to exit from the investment in equity shares of the investee company at a price not exceeding that arrived at on the basis of Return on Equity (RoE) as per the latest audited balance sheet. Any agreement permitting return linked to equity as above shall not be treated as violation of FDI policy/FEMA Regulations.

………………………………..

In terms of above circular optionality clauses granting assured returns on FDI appears to be prohibited. It is doubtful whether the said circular would be applicable to cases where a foreign investor founds its claim in breach of contract. Plainly, if an investment is made on representations which are breached, the investor would be entitled to its remedies including in damages.

 The RBI Circular No.-4 dated 15th July, 2014 issued under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 amended certain provision of The RBI Circular No.-86 dated 9th January, 2014 with regard to exit option of Foreign Investor:

“                                                                                                  Annex 2

c.f. Annex to
A.P.(DIR Series) Circular No. 86 dated January 9, 2014

Earlier condition

Revised condition

Para 2(b)

(ii) In case of unlisted company, the non-resident investor shall be eligible to exit from the investment in equity shares of the investee company at a price not exceeding that arrived at on the basis of Return on Equity (RoE) as per the latest audited balance sheet. Any agreement permitting return linked to equity as above shall not be treated as violation of FDI policy/FEMA Regulations.

Note: For the above purpose, RoE shall mean Profit After Tax / Net Worth; Net Worth would include all free reserves and paid up capital.

(iii) Investments in Compulsorily Convertible Debentures (CCDs) and Compulsorily Convertible Preference Shares (CCPS) of an investee company may be transferred at a price worked out as per any internationally accepted pricing methodology at the time of exit duly certified by a Chartered Accountant or a SEBI registered Merchant Banker. The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreement and shall exit at the price prevailing at the time of exit, subject to lock-in period requirement, as applicable.

(ii) In case of an unlisted company, the non-resident investor shall be eligible to exit from the investment in equity shares, Compulsorily Convertible Debentures (CCDs) and Compulsorily Convertible Preference Shares (CCPS) of the investee company at a price not exceeding that arrived at as per any internationally accepted pricing methodology on arm’s length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant Banker.

The guiding principle would be that the non-resident investor is not guaranteed any assured exit price at the time of making such investment/agreements and shall exit at the fair price computed as above at the time of exit, subject to lock-in period requirement, as applicable.


All the above provision of RBI under FEMA relates to the transfer of shares per se from foreign investor back to the Indian entity if same is under put option. However, in majority of SHA such transfer of share back to Indian Entity is under damages clause in case of breach of agreement. It is a fair commitment of Indian investee in the SHA in relation to an investment and a downside protection of an investment of foreign investor, rather than an assured return or exit price.

It can be appreciated, the transfer of share back to Indian investee through damages clause of SHA and its award through foreign arbitration appear to be intentional to bypass the RBI guidelines for assured exit price. This circumstances appear to violate common rule i.e. the rule which prohibits one to accomplish indirectly, what the law forbids doing directly.

In Venture Global Engineering v. Satyam Computer Services Ltd., the Hon’ble Supreme Court went by the shareholders’ agreement (SHA) which expressly provided that the laws in force in India including the Companies Act would apply. This was held to be in the nature of a non-obstante clause which “would override the entirety of the agreement including sub-section (b) which deals with the settlement of the dispute by arbitration.

In recent judgment of Hon’ble Delhi High Court in case of NTT DOCOMO INC vs Tata Sons Limited, it was held that:

  1. As far as the Award itself is concerned, the interpretation placed by the AT on the clauses of the SHA was consistent with the intention of the contracting parties and not opposed to any provision of Indian law. There is nothing in the SHA as interpreted by the Award that renders it void or voidable under the ICA or opposed to either the public policy of India or the fundamental policy of Indian law. The AT’s interpretation of the various provisions of the FEMA and the regulations thereunder have also not been shown to be improbable or perverse. What was invested by Docomo was US $ 2.5 billion and what it will receive in terms of the Award is only 50% of that amount. The Court finds that no ground under Section 48 of the Act is attracted to deny the enforcement of the Award.

In another recent judgment of Hon’ble Delhi High Court in case of Cruz City 1 Mauritius Holdings vs Unitech Limited it was held that:

  1. The reliance placed by Unitech on the RBI circulars dated 09.01.2014 and 14.07.2014 is also misplaced. In terms of RBI’s circular dated 09.01.2014 optionality clauses granting assured returns on FDI are proscribed. However, it is doubtful whether the said circular would be applicable to cases where a foreign investor founds its claim in breach of contract. Plainly, if an investment is made on representations which are breached, the investor would be entitled to its remedies including in damages. The aforesaid circulars proscribe assured return instruments brought in India under the guise of equity. However, in the present case, Cruz City is only seeking to enforce its obligations against Burley, an overseas entity.
  2. Even if it is accepted that the Keepwell Agreement was designed to induce Cruz City to make investments by offering assured returns, Unitech cannot escape its liability to Cruz City. Cruz City had invested in Kerrush on the assurances held out by Unitech and notwithstanding that Unitech may be liable to be proceeded against for violation of provisions of FEMA, the enforcement of the Award cannot be declined

 

The obvious parting comment can be that foreign arbitral award cannot be contested on the ground of FEMA, 1999 violation if the SHA do not stipulate same and the payment back to investor for transfer of share is set as damages under the SHA.

Rajni Sinha

Advocate, Bombay High Court

7738080174

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