Can a foreign-owned and controlled Indian companies (FOCC) invest in an Indian company through optionally convertible instruments such as optionally convertible debentures (OCDs) and optionally convertible preference shares (collectively, OCIs) of another Indian company? The ambiguity around investment by an FOCC into an Indian company through OCIs emerges from foreign exchange regulations not directly dealing with this issue in the process of the evolution of forex regulation since its commencement.
Two regulations are important for this discussion: (1) OCI subscription by a non-resident entity (NR) is considered as external commercial borrowing (ECB), and (2) entire downstream investment by an FOCC is treated as part of the total foreign investment. Downstream investment means only investment through a capital instrument in another Indian company, and capital instrument means only equity shares and compulsorily convertible debentures/preference to the exclusion of OCIs. As per the ECB framework, ECBs can only be obtained from an NR.
One view could be that FOCCs cannot subscribe to OCIs because: (1) these are not capital instruments, and what a foreign entity cannot do directly it also can’t do indirectly by routing investment through its Indian subsidiary; and (2) forex regulations state that “[an] Indian entity which has received indirect foreign investment shall comply with the entry route, sectoral caps, pricing guidelines, and other attendant conditions as applicable for foreign investment”.
The proponents of this view could argue that “other attendant conditions” would mean that the forex regulations as applicable to an NR would be applicable to an FOCC, so if a foreign entity cannot subscribe to OCIs without it being considered as ECB, it would be the situation for an FOCC. However, can such a restriction on an Indian company (although an FOCC) be read into forex regulations when it doesn’t provide for it, and when ECB regulations provide that ECBs can be procured only from NRs?
The second view could be that investment by an FOCC through OCIs is allowed in any Indian entity, even if foreign investment in such an entity is prohibited or restricted. The question is, could regulators have intended this consequence? For instance, taking this view, a foreign entity could possibly own 100% of a B2B e-commerce company with such company having substantially invested in OCIs in a B2C e-commerce entity.
A third view could be somewhere between the first and second, i.e. an FOCC can subscribe to OCIs of an Indian entity only if it complies with sectoral restrictions, entry routes, and pricing guidelines. In IDBI Trusteeship Services Limited v HubTown Limited, the Supreme Court considered a structure where an FOCC invested in OCDs of an Indian entity that were secured by a corporate guarantee from Indian obligors. The defendant argued that the suit for the enforcement of the corporate guarantee should be summarily rejected since OCD subscription was illegal.
The Supreme Court overruled the Bombay High Court judgment, which summarily rejected the suit holding the transaction to be a colourable device, structured specifically to enable the foreign investor to secure assured return on its investment, which is otherwise not allowed, by making the FOCC only a nominal recipient of the returns from the OCDs.
It is unclear whether the Supreme Court, while overruling the high court judgment, has upheld the structure to be legal, as the court decided the issue of disposal of summary suit under the Code of Civil Procedure rather than deciding on the merits, and observed that even if there was a triable issue (i.e. structure not being legal) the defendants were entitled to defend the suit only upon deposit of the principal debt amount with the court since their actions it doubted the defendant’s good faith and the genuiness of the triable issue.
It is also noteworthy that in this case, the OCD investee did not attract any sectoral restrictions. The high court had rejected the defendant’s contention that under forex regulations, an FOCC cannot subscribe to OCDs which should be considered as ECBs. With this high court decision being set aside, and the Supreme Court not ruling on this issue, the fate of this opinion remains unclear. Given the situation, it will perhaps require a decisive judgment or a clarification from the regulators to see which view will be reckoned as conclusive. Until then, treatment of an investment by an FOCC in OCIs will remain like the mysterious mythological character, Narasimha – who was neither animal nor human, and acted in a way that no one had foreseen!
Akshay Nagpal is a partner and Niharika Choudhary is an associate at L&L Partners. The views expressed are personal and intended for general information purposes. They are not a substitute for legal advice.
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