Foreign investment in India is governed by the Foreign Exchange Management Act, 1999, read with the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000, as amended from time to time. The regulatory framework and instructions issued by the Reserve Bank of India (RBI) are compiled in the form of a master circular released on 1 July every year.
The above provisions also govern the pricing of fresh issue of shares (including rights issue) or transfer of shares. As the shares are issued by a company, such issuance is further governed by the Companies Act, 2013, and the rules under it. The juxtaposition of price of shares which are issued and allotted to non-residents on the exercise of right of renunciation by existing shareholders (including non-resident shareholders) is analysed below.
The Companies Act
Section 62(1)(a) of the Companies Act, 2013, deals with rights issues, which involve the offer by a company to its existing shareholders to subscribe to further shares at the price mentioned in the offer letter. As no guidelines are provided to determine the price in case of a rights issue, it can be inferred that no pricing restriction applies, unlike the case of a preferential issue, where the share price is required to be determined by the valuation report of a registered valuer and the shares cannot be issued at a price lower than the price determined by the valuation report.
One of the inherent rights of existing shareholders is the right to renounce the offer of further shares in favour of any other person, unless the articles of association of a company have specifically taken away such right. As renunciation is merely passing of the offer from an existing shareholder to another person, such person can only accept the offer on the same terms and conditions as were offered to the one who renounced the offer.
Foreign exchange regime
The master circular does not specifically reproduce the language of the circulars which it consolidates, and due to this, it does not specifically mention rights of residents and non-residents in relation to the renunciation of rights shares. To get clarity on this aspect, it is therefore necessary to examine the language of the circular which provided for renouncement of rights shares, dated 3 December 2003.
The 2003 circular inter alia provides (a) general permission is available to Indian companies to issue rights shares; (b) rights shares purchased by a person resident outside India will be subject to the same conditions (including restrictions in regard to repatriability) as are applicable to the original shares against which rights shares are issued; (c) both non-residents and residents may renounce the shares offered either in full or part in favour of a person named by them.
As may be seen from the above, the renunciation of rights shares by both resident and non-resident shareholders is recognized, however, there is no clarity as to the price at which such renounced shares can be issued to a non-resident especially in light of pricing guidelines applicable in case of fresh issuance of shares, rights shares and transfer of shares.
The way forward
The key question that arises is whether the exercise by a non-resident of rights to subscribe to shares of an Indian company is to be treated as transfer of shares or fresh issuance of shares. Neither the master circular nor the 2003 circular clarifies that.
However, the RBI seems to have advised in some cases of listed companies that the renunciation of rights entitlement by a resident to a non-resident is akin to transfer of shares by way of sale. In this context, it is important to note that in case of listed companies, rights entitlements are also traded on stock exchanges, unlike the case of unlisted companies and private companies.
Further, if renunciation of rights entitlement is treated as transfer, then in addition to the pricing guidelines, RBI or Foreign Investment Promotion Board (FIPB) approval will also be required.
On one hand, the Companies Act gives the freedom for a person to subscribe to rights shares which are renounced without distinguishing resident or non-resident, and on the other hand, the foreign exchange rules do not throw enough light on the issue of pricing and permission.
It seems that unless the views of the regulator (RBI) are codified and clarified by means of a circular or clarification, the RBI or FIPB will need to be approached on a case-to-case basis for pricing and allotment of shares to a non-resident in whose favour right of renouncement has been exercised.
Bhavin Gada is an associate partner and Manendra Singh is an associate at Economic Laws Practice. Tanya Chib, an associate, helped with research and input. This article is intended for informational purposes and does not constitute a legal opinion or advice.
109 A Wing, Dalamal Towers
Free Press Journal Road
Nariman Point, Mumbai – 400 021, India
Tel: +91 22 6636 7000
Fax: +91 22 6636 7172
Mumbai | New Delhi | Ahmedabad | Pune | Bengaluru | Chennai