FDI and the “Control” Question

Eons ago, an English judge remarked that “public policy” is
an unruly horse and once you get astride it you will never know where it will
carry you. Lately, corporate India has been left to contend with another unruly
horse in the form of the concept of “control”, whose scope and meaning have
been stretched in different directions without the requisite precision, often
altering according to time and situation. This is now playing out in the form
of the seeming quest for the ideal definition of “control” in the context of
the foreign direct investment (FDI) policy in India.
The concept of control arises in several different contexts
in corporate transactions. For instance, it is used to determine whether a mandatory
open offered requirement arises under the SEBI Takeover Regulations.  It also arises in the context of competition
law and the merger control regime. Of immediate relevance is the fact that it
arises in determining whether the control of an Indian company is in foreign
hands so as to decide whether the relevant FDI norms have been complied with,
especially in certain sensitive sectors.
The concept of control was primarily introduced in the FDI
policy in 2009 while dealing with the question of downstream investments by
Indian companies that were owned or controlled by foreign investors (although
the Reserve Bank of India followed suit with its guidelines on the matter only
about a month ago).  Under that policy,
the key test applied to determine whether one company (say A) controlled
another (say B) was to consider whether Company A had the ability to appoint a
majority of its directors on Company B. 
Such an ability to appoint a majority of directors can arise in two
ways. First, it can arise if Company A owns a majority of equity shares in Company
B.  Second, it can arise if Company A has
additional rights in the articles of association of Company B  (or possibly in a shareholders agreement),
which conferred it with the ability to appoint a majority of the directors.
This was an objective test, with sufficient clarity to determine whether there
was control or not in a given situation.
On the other hand, the Takeover Regulations promulgated by
the Securities and Exchange Board of India (SEBI) carry a wider definition of
control. It includes the ability of Company A to “control the management or policy
decisions” of Company B, which may arise directly or indirectly, including by
virtue of the shareholding, management rights, shareholders agreement or the
like. This is arguably subjective in nature, and could encompass situations
such as negative veto rights and other protective provisions where Company A may
not necessarily have the intention to exercise any control over the functioning
of Company B, but may unwitting be caught within the web of the provision.
After a reconsideration of the existing policy on the
definition of control under the FDI regime, the government has decided to
expand the definition of control under that the regime in order to bring it in
line with the Takeover Regulations. In other words, and objective definition of
control under the FDI regime has given way to a more subjective definition.
As we have seen
on this Blog, such a subjective definition of control is not
without its fair share of problems. These have manifested themselves in the
working of the Takeover Regulations, and have also resulted in litigation in
the form of the Subhkam case, although resolution finally turned out to be elusive
in that case.

Although this is a contentious issue, the
introduction of such a subjective condition in the FDI policy is only likely to
result in greater ambiguity and uncertainty. In deciding specific cases, it is
possible that regulators may exercise discretion differently in somewhat
similar cases, perhaps with the ability to build up a justification for the
same. This would add to the complexity in the implementation of the FDI policy.
Reasonable minds can differ on the extent to which the definition of control
should be widened, but one thing is clear that there ought to be greater
objectivity and clarity to the definition so as to reduce  the level of 
discretion and ambiguity. 
The current
policy change, however, appears to be moving in a different direction. There is
no sign that the unruly horse will be reined in anytime soon.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.


  • NIce post, Uma. My professional role stops in a specific case stops me from writing a full piece on the subject, but I just wanted to add another aspect / perspective. Whether or not one is in control of another will always remain a mixed question of fact and law. Since it involves an element of law, the purpose of the law for which it is being interpreted would also count. Therefore, control for competition law purposes would be determined in the context of whether the element of control could impact competitive behaviour in the market while for takeover regulations purposes, it would need to be in the perpsective a higher control i.e. corporate control / control over management policy.

  • This is a minor comment on the last paragraph. Do you believe that the FDI policy should address the ambiguity that may arise on account of defining 'control' within FDI framework or seek to eliminate uncertainty in defining it in the larger (and often overlapping)context of commercial laws in India. My two cents on it is that the problem arises when both co-exist in a definition or a concept. A good start would be to eliminate one (preferably ambiguity) and let courts (when they decide) to ask explicit questions and reduce uncertainty. Am I making sense ?

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