The pandemic has brought the economy at a standstill and the current valuation of the Indian companies has been badly hit, thus, making them an easy target for hostile takeover/acquisition. Suddenly, India wakes up to the news that People's Bank of China (“PBoC”) has raised its stake in India's largest non- banking mortgage provider HDFC Ltd. from 0.8% to 1.01%, according to a regulatory filing. Springing to attention, Government of India (“GOI”) amends its foreign direct investment (“FDI”) policy. China reacts terming this step as discriminatory. The question is whether in today’s liberalized world, is it a step in the right direction or whether it will lead to dispute and how will it be reciprocated.
Understanding the legal issue, Ministry of Commerce & Industry, Department for Promotion of Industry and Internal Trade (“DPIIT”) vide Press Note 3 (2020 series) dated 17th April 2020 (“Press Note 3/2020”) amended the extant FDI Policy as under:
Para 3.1.1: A non-resident entity can
invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited. However, a citizen of Bangladesh or an entity incorporated in Bangladesh can invest only under the Government route. Further, a citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/ activities other than defence, space, atomic energy and sectors/ activities prohibited for foreign investment.
Para 3.1.1: 3.1.1(a) A non-resident
entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited. However, an entity of a country, which
shares land border with India or where
the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route. Further, a
citizen of Pakistan or an entity incorporated in Pakistan can invest, only under the Government route, in sectors/activities other than defence, space, atomic energy and sectors/activities prohibited for foreign investment.
3.1.1(b) In the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction/purview of the para 3.1.1(a), such subsequent change in beneficial ownership will also require Government approval.
It is provided that the proposed amendments shall be effective from the date of Foreign Exchange Management Act (“FEMA”) notification, which is expected anytime.
As evident from above, earlier only entities from Bangladesh and Pakistan were required to seek approval form GOI for any investment in Indian companies whereas the revised position has now brought all the countries which share land border with India under the government route for making any investments. Additionally, it covers cases where the beneficial owner of any such investment is situated in or is a citizen of any such country.
Implications arising out of this amendment:
Albeit the recital of the said Press Note reflects that the amendments have been proposed just to curb opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic, however, the language used in the amended policy is wide enough to bring within its ambit all types of foreign direct investments including additional investments in existing wholly owned subsidiaries or pro-rata increase in existing JVs not resulting in takeover/acquisition. This will definitely create some hardship in terms of process for such neighbour entities where the mere purpose is to be saviour of their own exiting Indian subsidiaries/JVs in such tough times by infusing more funds. It is to be noted that seeking approval from GOI will not be that easy and fast considering COVID situation and also that under government route, each case is assessed separately. Normally, it does take minimum 3-4 months in getting the approval, however, depending upon the sector, it may take long.
Amendments have been made in FDI Policy intending to keep a vigil on any sort of indirect acquisition by entities based in countries sharing land border with India. Any change in the ownership of any entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restricted neighboring countries, will also have to be approved by the GOI. Although the GOI has provided multi-layer protection, practically it may not be easy and will be challenging to identify the end beneficiary. Almost a year back, the Ministry of Corporate Affairs (“MCA”) introduced the Companies (Significant Beneficial Owners) Rules, 2018 (“SBO Rules”), in order to lift the corporate veil and identify the real beneficiaries in case of complex shareholding structures of the corporates wherein the Significant Beneficial Owner (“SBO”) was required to make declaration to the relevant company specifying the nature of its interest, within 90 days of becoming SBO or any change thereof. The SBO Rules define SBO as an individual who holds directly or indirectly greater than or equal to 10% of the shares/voting rights/total distributable dividend in the shares of the company. The said rules cover only those beneficiaries whose holding is more than 10%, leaving beneficiaries holding less than 10% out of its ambit. Also, the deadline to comply with the SBO Rules is still fluid as MCA keeps extending it. Moreover, the declaration/reporting has to be made after the transaction is complete. On the contrary, there is no threshold under Press Note 3/2020. While it seems MCA is still trying to tackle compliance under SBO Rules, time will tell how the government will deal with complex structures pursuant to Press Note 3/2020 where multi-layer and multi-jurisdictional investment is involved. The same is likely to result in encyclopedic legal disclosures to be made by the investors.
It seems India has followed suit after European Union, Australia, Germany, Italy, and Spain tightened rules on foreign investments amid distress valuation due to COVID. However, cogitating that India’s top Start-up companies like Paytm, Ola, Byju's, Zomato, Bigbasket are backed by Chinese giants like Tencent and Alibaba, the FDI policy change may have major impact on future investments as these companies and other startups may be worried about follow- on infusion of funds for the business growth.
It seems like GOI’s move is in the wake of PBoC’s swelled stake in HDFC, however, it is pertinent to note that the said investment is in the form of foreign portfolio investment. It is further relevant to note that GOI, through the Securities and Exchange Board of India (“SEBI”), had recently liberalised Foreign Portfolio Investors (“FPIs”) regime to augment foreign investment into India by issuing Operational Guidelines vide circular dated 5 November 2019 to facilitate implementation of new SEBI (FPI) Regulations, 2019. Changes were also made in Foreign Exchange Management (Non-Debt Instruments) Regulations, 2019, to suit FPIs in terms of structuring their investments and providing easy exit routes. However, it would be, now, interesting to watch SEBI’s reception vis-à- vis FPIs, post change in FDI policy. On plain reading of Press Note 3/2020, it is possible to infer that the same is not applicable to FPIs, however, a more concrete verdict soon from the government will be appreciated.
Clarification from the government over aspects dealt with supra is most awaited. Let’s wait for the fine print in the form a formal FEMA notification when these amendments will be effective. Further, it needs to be seen whether such ringfencing measures are just short term or will live long life.
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Author: Sushma Mathur
BMC Advisors, Advocates
Author: Sonakshi Chaurasia