Bharat Vasani explores the legislative gap between the arbitration act and foreign exchange regulations by examining key judgments on enforcement applications

India is one of the few countries that still has exchange controls and does not have full capital account convertibility. The Foreign Exchange Management Act, 1999 (FEMA), empowers the Reserve Bank of India (RBI) to frame regulations for the enforcement of FEMA. FEMA regulations contemplate prior RBI approval for certain categories of capital account transactions between residents and non-residents.

The enforcement of international arbitration awards in India, where there is going to be a remittance of foreign exchange from a resident to a non-resident, would invariably have FEMA implications. If the award is not in conformity with the FEMA regulations, the question that arises is whether the court, where enforcement action is filed, can decline enforcement on the ground that the award’s enforcement would be contrary to the country’s public policy.

Relevant provisions

Section 48 of the Arbitration and Conciliation Act, 1996, lays down conditions for enforcement of a foreign arbitral award. Under section 48(2), “Enforcement of an arbitral award may also be refused if the court finds that (a) The subject-matter of the difference is not capable of settlement by arbitration under the law of India; or (b) The enforcement of the award would be contrary to the public policy of India.”

Two explanations are provided. First, it is clarified that an award is in conflict with the public policy of India only if: “(i) The making of the award was induced or affected by fraud or corruption or was in violation of section 75 or section 81; or (ii) It is in contravention with the fundamental policy of Indian law; or (iii) It is in conflict with the basic notions of morality or justice.”

Second, “The test as to whether there is a contravention with the fundamental policy of Indian law shall not entail a review on the merits of the dispute … If an application for the setting aside or suspension of the award has been made to a competent authority … the court may, if it considers it proper, adjourn the decision on the enforcement of the award and may also, on the application of the party claiming enforcement of the award, order the other party to give suitable security.”

Section 48 adopts article V of the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards, 1958, to which India is a signatory.

Scope of public policy

The scope of enquiry for the court before which the application for enforcement of foreign award is pending is circumscribed by the conditions for refusal set out in section 48(1) and (2). It is not open to a party seeking to resist a foreign award to assail the award on merits as the enforcing court is not the appellate court.

Further, even if the award debtor has not challenged the award or resisted its enforcement under section 48, the court enforcing the award is duty bound to make an independent enquiry to satisfy itself that: (a) the subject matter of the difference is capable of settlement by arbitration under the law of India; and (b) the enforcement of the award will not be contrary to the public policy of India.

The 2015 amendment to section 48 of the arbitration act has significantly restricted the ground of “public policy” by overruling many previous judgments of the Supreme Court. The amendment was based on the 246th Report of the Law Commission of India, which had recommended various amendments to the arbitration act. The Law Commission had recommended restrictions on the scope of “public policy” in both section 34 and section 48. This was to bring the definition in line with the definition propounded by the Supreme Court in the case of Renusagar v General Electric (1993) where the Supreme Court, while construing the term “public policy” in section 7 of the Foreign Awards (Recognition and Enforcement) Act, 1961, held that an award would be contrary to public policy if such enforcement would be contrary to: (1) fundamental policy of Indian law (2) interests of India (3) justice or morality.

The amendment made to the definition of public policy in 2015 is stricter and does not include reference to “interests of India”, which is vague and capable of interpretational misuse, especially in the context of challenging awards in international commercial arbitration.

Judicial pronouncements

The effect of the 2015 amendments to the arbitration act has been well explained by the Supreme Court in its judgment of 31 August 2017 in the case of HRD Corporation (Marcus Oil and Chemical Division) v Gail (India).

According to that judgment both sections 34 and 48 have been brought back to the position of law contained in the Renusagar case, “where ‘public policy’ will now include only two of the three things set out therein, viz., ‘fundamental policy of Indian law’ and ‘justice or morality’. The ground relating to ‘the interest of India’ no longer obtains. ‘Fundamental policy of Indian law’ is now to be understood as laid down in Renusagar (supra). ‘Justice or morality’ has been tightened and is now to be understood as meaning only basic notions of justice and morality i.e. such notions as would shock the conscience of the court as understood in Associate Builders v Delhi Development Authority”.

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FEMA a fundamental policy?

It may be helpful to first look at the Supreme Court’s landmark decision in the Renusagar case on the scope of “public policy” in relation to enforcement of foreign awards under the Foreign Awards (Recognition and Enforcement) Act. The Supreme Court considered whether an award would fall foul of public policy if its enforcement would involve a contravention of the Foreign Exchange Regulation Act, 1973 (FERA). The court held that FERA was enacted to safeguard the country’s economic interests and any violation of its provisions would be contrary to India’s public policy. In the Associate Builders case, the Supreme Court, while interpreting the term “fundamental policy of Indian law” relied on Renusagar to observe that a violation of the foreign exchange act would be contrary to the fundamental policy of Indian law. However, it must be noted that in the Renusagar case, the Supreme Court held that FERA was enacted to protect the nation’s economic interests and that if enforcement of an award violated FERA provisions it would be contrary to the “interest of India” and not the “fundamental policy of Indian law” (as observed by the Supreme Court in Associate Builders).

Delhi High Court in its judgment on 11 April 2017, in the case of Cruz City v Unitech Ltd, considered whether a violation of FEMA would be contrary to the public policy of India under section 48(2)(b). The court considered the decisions of the Supreme Court in Renusagar and Shri Lal Mahal v Progetto regarding the scope of “public policy” and concluded that enforcement of a foreign award would be refused on the grounds of public policy of India only if it were contrary to: (1) the fundamental policy of Indian law; (2) the interests of India; or (3) justice or morality. The court further held that a contravention of a provision of law was not sufficient to invoke the defence of “public policy” and the expression “fundamental policy of India” referred to the basic and substratal rationale, values and principles which form the bedrock of laws in the country.

The court distinguished Renusagar on the grounds it dealt with a violation of FERA. The court held that FERA and FEMA were based on materially different considerations and took completely different approaches to economic policy. While FERA sought to protect the economic interest of India, FEMA only sought to manage foreign exchange transactions and did not share the same protectionist rationale.

The court noted that the nature of the public policy in question also had to be considered. The permissive nature of FEMA and the overarching public policy consideration in favour of enforcing foreign awards based on India’s international obligations had to be taken into account when weighing whether enforcement of the award would contravene public policy. The court further held that no provision of FEMA had been violated and even if this were the case, Unitech could not escape liability on this ground under the arbitral award, and would be separately liable for any consequences that would follow from a violation of FEMA.

The Cruz City judgment follows the earlier decision of a division bench of Delhi High Court in the 2012 case of SRM Exploration Pvt Ltd v N&S&N Consultants, where the court had held that the deletion of section 47 of FERA from FEMA shows a legislative intent to not make a transaction void even if it is in violation of FEMA. The division bench of Delhi High Court stated: “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 and 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 reenacting 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.”

FERA section 47(3)

Section 47(3) of FERA, relating to “contracts in evasion of the act” (since repealed), stated that: “Neither the provisions of this act nor any term (whether express or implied) contained in any contract that anything for which the permission of the central government or the Reserve Bank is required by the said provisions shall not be done without that permission, shall prevent legal proceedings being brought in India to recover any sum which, apart from the said provisions and any such term, would be due, whether as debt, damages or otherwise, but (a) the said provisions shall apply to sums required to be paid by any judgment or order of any court as they apply in relation to other sums; (b) no steps shall be taken for the purpose of enforcing any judgment or order for the payment of any sum to which the said provisions apply except as respects so much thereof as the central government or the Reserve Bank, as the case may be, may permit to be paid …”

The approach suggested by Delhi High Court in SRM Exploration poses a serious danger in that it may encourage unscrupulous parties to enter into transactions that effectively circumvent applicable FEMA regulations. It could never be the legislative intent to allow an arbitration award to be used as a device to circumvent a statutory provision and in any event, circumvention of law is certainly against the fundamental policy of Indian law. It would therefore be safe to conclude that if the intent of a party is to circumvent FEMA by using the mechanism of an arbitration award, the court should decline enforcement on that ground.

It needs to be noted that in the Cruz City judgment, Delhi High Court has taken a view that “having held that a simpliciter violation of any particular provision of FEMA cannot be considered synonymous to offending the fundamental policy of Indian law, it would also be apposite to mention that enforcement of a foreign award will invariably involve considerations relating to exchange control. The remittance of foreign exchange in favour of a foreign party seeking enforcement of a foreign award may require permissions from the Reserve Bank of India. There may also be a question whether the initial agreement pursuant to which a foreign award has been rendered required any express permission from RBI. However, as indicated earlier, the policy under FEMA is to permit all transactions albeit subject to reasonable restrictions in the interest of conserving and managing foreign exchange. India has not accepted full capital account convertibility as yet. Thus, there are transactions for which permission may not be forthcoming. Whereas certain transactions are permitted under FEMA and regulations made thereunder without any further permissions; other transactions may require express permission from the RBI. However, these considerations can be addressed by ensuring that no funds are remitted outside the country in enforcement of a foreign award, without the necessary permissions from the Reserve Bank of India. This would adequately address the issues of public interest and the concerns relating to foreign exchange management, which FEMA seeks to address.”

The above judgment of Delhi High Court ignores the earlier decision of the Supreme Court in Dropti Devi v Union of India, where the Supreme Court held (in the context of prosecution under the Conservation of Foreign Exchange and Prevention of Smuggling Activities Act) that the legislative objectives of FERA and FEMA are identical, namely, preservation of the foreign exchange resources of the country.

In NTT Docomo v Tata Sons, Delhi High Court was faced with a similar question, i.e. whether enforcement of a foreign arbitral award could be denied on the grounds that such enforcement would be in violation of FEMA. In this case, disputes arose between the Japanese company NTT Docomo and Tata Sons, in relation to the former’s investment in an Indian joint venture company, TTSL. The arbitral award of June 2016 entitled NTT Docomo to exercise its right under the shareholders agreement to have its shares under the joint venture bought by Tata Sons at a price which was equal to 50% of its original investment. The enforcement of the award was objected to by Tata Sons (though it later entered into a settlement with NTT Docomo) and also by the RBI (which had filed an impleading application) on the ground that enforcement of the award would constitute a violation of FEMA and related regulations since the shares were to be sold/purchased at a predetermined rate. In this context, Delhi High Court held that the RBI had no standing to challenge enforcement of the settlement agreement. The court also held that since the award was in the nature of damages, no FEMA provision had been violated. Further, given the nature of the award, no special permission of the RBI was needed for the remittance.

On the RBI’s lack of standing, Delhi High Court observed: “The fact that the legislature did not intend this is evident when a comparison is made with the provisions for mergers and amalgamations under the Companies Act, 1956 (as it stood prior to its amendment in 2015). Section 394 thereof envisaged notice being issued to the central government by the Company Court in order to give it an opportunity to be heard in those proceedings. There is no such statutory requirement that where the enforcement of an arbitral award might result in remitting money to a non-Indian entity outside India, or to an account of a party outside India, RBI has to necessarily be heard on the validity of the Award. The mere fact that a statutory body’s power and jurisdiction might be discussed in an adjudication order or an award will not confer locus standi on such body or entity to intervene in those proceedings.”

This legislative gap or conflict between FEMA and the arbitration act needs to be filled and reconciled as otherwise the provisions of FEMA would become redundant in that two parties to the agreement can enter into a collusive transaction which is not in accordance with the FEMA regulations and obtain an arbitration award. The RBI, which has been vested with the authority to administer FEMA, will have no standing to object to such an award and the award will become final, binding and enforceable in India as if it was a decree of the court.

The earlier judgment in Renusagar will not be of any help as the expression of “interest of India” has been consciously omitted in the 2015 amendments to the arbitration act. As a result, courts will be constrained to adopt the restrictive interpretation of “public policy” in section 48(2) of the arbitration act and violation of FEMA may not be regarded as contrary to the fundamental policy of Indian law as was held by Delhi High Court in the Cruz City case.

Conclusion

There is an urgent need for amendments to reconcile the differences between the arbitration act and FEMA. Both are central statutes covered by the Union List of the seventh schedule of India’s constitution.

Parliament has two choices: It can either amend section 48 of the arbitration act to provide for giving notice to the RBI whenever an international arbitration award would involve remittance to a non-resident. Such notice would require the RBI to examine whether such payment would be in conformity with the FEMA regulations. The RBI should have standing to raise objections before the enforcing court if the award is directly in conflict with the FEMA regulations.

Alternatively, parliament can reintroduce section 47 of FERA in FEMA so that any remittance to a non-resident under a decree granted by the executing court on the arbitration award is subject to final RBI approval under the FEMA regulations.

Amending FEMA is a better option as any amendment of section 48 of the arbitration act providing for issue of notice to the RBI may send wrong signals to the international community that India is not sincere about honouring international arbitration awards and is not an “arbitration-friendly” country.

Until a suitable amendment is introduced in parliament, it is safe to conclude that the final word on this issue has yet to come and arbitral awards in breach of FEMA provisions could be susceptible to challenge.

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Bharat Vasani is the legal adviser to the chairman’s office at Tata Sons.