On October 1, 2011, the Department of Industrial Policy and Promotion (DIPP) altered the way foreign direct investments (FDI) into India are to be structured.
The new policy is nebulous in that it is bereft of all explanations and clarifications, while blandly stating that the only eligible equity and debt instruments through which FDI may come into India are those that are fully mandatorily and compulsorily convertible into equity.
Thus, equity instruments having “in-built” options or supported by options sold by third parties would lose their equity character, which means that such instruments would qualify as debt and would have to comply with the extant External Commercial Borrowing (ECB) guidelines.
Foreign investors have already faced the regulatory ire earlier this year, with several option-backed deals inviting the scrutiny of the Reserve Bank of India and the Securities Exchange Board of India. Both the regulators believe that the put and call options and pre-agreed buy-back arrangement are in the nature of futures or derivative contracts and cannot be executed by non-registered investors.
LEGAL STATUS
The term “options in securities” finds its origin in the Securities Contract Regulation Act (SCRA) that explains it as a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a put, a call or a put and call in securities and goes on to state that all options in securities entered into after the commencement of this Act (of 1956) shall be illegal.
The Central Government then, via a notification in 1969, extended these restrictions to all contracts for securities, barring spot delivery contracts. The only kind of spot delivery contracts are those where the actual delivery of securities and the payment of a price occurs therefore either on the same day as the date of the contract or on the next day.
Although in 2000, the notification was struck off, SEBI swiftly replaced the contents of the notification with its own in the same year.
Thus, while foreign investors were grappling with the fact that any contract of sale or purchase of securities, which is meant to occur in the future, will have no effect unless specifically approved by the SEBI, they will now have to completely eliminate any option tagged on to an investment deal, lest it be considered an ECB.
REMAINING FDI OPTIONS
The only investment transaction that the new law seems to bless is the vanilla investment transaction with no options to safeguard the exit of the foreign investor.
Furthermore, the investor will also have to contend with the law that a company may refuse to register a transfer of shares in the investor's name, if it is contrary to the provisions of “any other law for the time being in force”, thereby including the SCRA, SEBI, RBI mandates and the current FDI policy issued by DIPP.
Inventive structuring may see legal advisors make a nuanced argument that the option attached to a security is an executory contract (contract becoming effective at a future date) and such contracts may be drafted so as to read as spot delivery contracts. Even if this were the case, this would only satisfy the RBI and SEBI. The foreign investor would still have to struggle with his investment being treated as an ECB under the new FDI policy.
It could possibly lead to potential investors moving jurisdiction of shareholder agreements outside India to other destinations that lend themselves to more predictability.
Difficulties in foreseeing the enforceability of shareholder agreements, coupled with the non-harmonisation of political and legislative intent, can have deleterious effects on the general investment climate.
We will have to twiddle our thumbs and wait to see what, if any, rationale the government will offer for the latest change to its FDI policy.
(The author is a partner at Vichar Partners, a Chennai-based corporate and transactional law firm.)