India has been one of the hot destinations for global financial investors, and private equity and venture capital investment has been the most popular route for foreign investments in India. What is of paramount importance for these financial investors is their exit and they have been looking for ways to structure their exit at an assured return around various loopholes and interpretations of the Indian regulations.
The Reserve Bank of India (RBI) and other regulatory authorities, which were not in favour of any guaranteed return linked exit option, have now woken up and understood the need for such exit options. This column focuses on put option as an exit option for foreign investors, the regulatory framework related to this and the option’s future in India.
The relevant legal framework is broadly set out in the Securities Contracts (Regulation) Act and the Foreign Exchange Management Act (FEMA).
In 2013, the Securities and Exchange Board of India (SEBI) issued a notification which provided that its prior approval was not required for exercise of an option (to buy or sell securities) contained in shareholders’ agreements or companies’ articles of association, subject however to a lock-in of one year, compliance with pricing guidelines, and settlement of contract by actual deliveries.
The RBI followed in the footsteps of SEBI and amended the relevant FEMA regulations, to allow optionality clauses in equity investment agreements with a foreign investor, provided it is without any assured return.
While these moves were appreciated by financial investors, the non-availability of assured return linked exit remains a concern.
To address this, the RBI in its bi-monthly monetary policy statement of 3 February 2015 sought to offer foreign investors some protection against downside risks of their equity investments by permitting an assured return but at an appropriate discount over the sovereign yield curve through an embedded optionality clause or in any other manner. However, this was not followed by any formal guidelines or notifications from the RBI.
Another important but unresolved issue is whether assured exit options given in the past will automatically get amended or be required to be amended to be in line with the new policy, as the new RBI notifications required all existing contracts to comply with their requirements. But what if the Indian party refuses to amend the previous assured return linked exit option and tries to benefit from the situation?
There have been many instances where Indian promoters have structured transactions to indirectly provide an assured return to foreign investors, which they themselves have subsequently challenged as being violative of Indian laws.
In IDBI Trusteeship Services Limited v Hubtown Limited (2015), Bombay High Court held that the guarantee of an assured exit price when foreign investors invested in compulsorily convertible debentures (CCDs) was violative of the extant foreign direct investment (FDI) policy. The court noted that the CCDs were a colourable device to circumvent the FDI policy.
Recently, Docomo instituted LCIA arbitration after Tata failed to pay assured return to Docomo upon the exercise of a put option by Docomo, allegedly because the RBI denied its permission for the payment. The tribunal awarded damages to Docomo for Tata’s failure to honour its contractual obligation.
It appears that the tribunal has sought to bypass the RBI regulations by giving Docomo the relief of the assured return but styling it as compensation for breach. The award may be challenged on various grounds including the following: (1) breach cannot be established as Tata was bound by the RBI regulations, which will override the contract; and (2) the tribunal cannot grant indirectly what it cannot grant directly.
India’s highest court has yet to deal with this issue. Everyone will be watching to see whether the Supreme Court will uphold the view of Bombay High Court in the IDBI case or the view taken by the arbitral tribunal in the Tata-Docomo case. Another interesting angle here for global investors is to see whether Indian courts will honour this foreign arbitration award or strike down its enforceability on the ground of public policy.
Outside all the legalese and court cases, what is really the need of the hour is that the present government clarifies India’s stand and maybe allow commercial parties to decide their own rules of the game.
Manish Gupta is a partner and Ashish Ahluwalia is an associate at Link Legal India Law Services.