Bombay High Court Pronounces on FDI Policy

It is not very often that courts in
India have had the occasion to interpret and rule on the Foreign Direct
Investment (FDI) Policy of the Government of India. Earlier this month, the
Bombay High Court issued its ruling in IDBI
Trusteeship Services Ltd. v. Hubtown Ltd.
, which relates to the
legalities of a foreign investment structure that involved compulsory
convertible debentures (CCDs) issued by an Indian company to a foreign investor
the proceeds of which were in turn used by the Indian company to invest in
optionally convertible debentures (OCDs) of two other companies operating in
the construction development sector. The specific issues in question relate to
the permissibility of assured returns to the foreign investor and the nature of
downstream investments. Sandip Bhagat, et. al., discuss the facts, issues and
decision in an article
on The Firm.
Here, I propose to highlight some
of the key implications of this judgment that may be of wider relevance:
1. The Bombay High
Court has demonstrated its willingness to view the transaction as a whole by
transcending beyond the form and into the substance. In other words, although
the transaction involved two stages of foreign investment into a holding company,
which in turn invested in two operating companies, the court effectively viewed
the transaction as a whole and not in separate parts. The openness to re-characterizing
the transaction may cause some amount of uncertainty in structuring foreign
investments. Moreover, the reliance of the Court in doing so on judgments of
the Supreme Court relating to aspects such as taxation and cases involving
fraud leaves the debate somewhat open.
2. The
implications of the judgment on downstream investments are categorical in that
foreign owned/controlled investment companies in India must follow all aspects
of foreign investment regulations (including types of investment instruments
such as equity shares or CCDs). This enhances the compliance requirements of
downstream investments.
3. In essence, the
Court declined to validate the transaction due to the presence of an assured
return. This will have to be considered in the context of pronouncements by the
Reserve Bank of India (RBI) of its intention to liberalize greater flexibility in
the pricing of instruments, including an assured return, in the context of
optionality clauses, as discussed here.

In any event, this does not appear
to be the final word as the Court was only determining whether there are
triable issues in a summary suit that require further adjudication. The hearing
in the suit is to follow.

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.


  • IMPROMPTU (sharing own sporadic thoughts, with the aim of ‘common good’)
    All said but nothing seemingly done worth a mention, the quality of legal drafting of private contract agreements, between two parties, in as foolproof a manner as possible/ ideally expected of, – in the sense of satisfying and safe guarding the individual rights and interests of NOT just either one of but both the parties, has deplorably come to be demonstrated to be a thing of the past. Apart from the largely noted deficiency in drafting, another root cause, -as may be readily gathered from wisdom gained in hindsight/past experience – has been the large number /enormity and complicity of laws, rules and regulations governing, impacting, impinging on a transaction intended to be covered in any such agreement . All the more so, should that happen to do anything with the rules and regulations, systematically framed and brought into force by the regulatory authorities,- as opposed to/distinct from legislative bodies, -who rightly or wrongly are regarded to be competent and suitably equipped, hence vested with powers, to frame such rules, etc. The speed / frequency with which that is being done , more often than not ‘impulsively’, – without giving much conscious thought / intelligent consideration to the pros and cons of doing so, from the viewpoint of the stakeholders / vested interests in particular, the public at large in general, for whose ultimate benefit such an exercise is aimed to work / be implemented.
    In any view, one honestly feels that, keeping in focus the serious problems/far reaching unpleasant consequences and controversies faced with even otherwise,- by reason of the increasingly attached relevance /preference to ‘substance’ , over the ’form’, unduly so, – in the realm of tax legislation and administration, there must be good reasons why that ought not to be extended and applied to a matter in which the dispute and its resolution / settlement is principally confined to the two contracting parties.
    (May be contd. )

  • Dear Uma,

    Thank you for your brief analysis of the case. I refer to point 2 of your analysis, i.e.

    "2. The implications of the judgment on downstream investments are categorical in that foreign owned/controlled investment companies in India must follow all aspects of foreign investment regulations (including types of investment instruments such as equity shares or CCDs). This enhances the compliance requirements of downstream investments."

    Please can you let me know your rationale for the above inference. I was wondering if an alternate reading of the case was possible. In support, I refer to the following extracts from the judgement (please see [] portion):

    Extract from pleadings:

    18. Apart from the above main submission the Defendant has also submitted as follows:
    (i) Relying upon (a) Chapter 3, paragraphs 3.10, 3.10.1 and 3.10.2 of the FDI Policy,(b) Chapter 4, paragraphs 4.1.1, 4.1.2 and 4.1.3 of the FDI policy, and (c ) Chapter 6, paragraph 6.2, 6.2.11 of the FDI Policy, [it is submitted that an Indian Company, which has received foreign direct investment, can employ its funds downstream viz. moving funds into its subsidiaries only by making investments in the form of Equity Capital or compulsorily and mandatorily convertible preference shares or debentures]. Vinca therefore could only have subscribed for convertible debentures of Amazia and Rubix and consequently, Vinca's investment in Amazia and Rubix in the form of OPCDs does not satisfy the definition of capital in clause 2.1.5 and is in clear violation of the FDI policy for downstream investments made by an Indian Company in which there is any foreign investment.

    Extract from ruling:

    33. However, I must also state that [I do not find substance qua the following defences raised by the Defendant]:

    33.2 [That under the provisions of the FDI Policy, an Indian Company which has received foreign direct investment can utilise its funds downstream only for making investment by way of equity instruments (i.e. in the form of equity capital or compulsorily and mandatorily convertible preference shares or debentures);]

    33.3 [That Investment by an Indian Company in OPCDs issued by subsidiary (also an Indian Company) would amount to an external commercial borrowings.]

    In light of the above, could it be inferred that court ruled that an investment by a FOCC need not comply with FDI norms (as per para 33.2) and further, an investment by FOCC into debt instruments, such as OCD, would not require compliance with ECB regulations. Thus leading to the general inference that FOCC entities in India are not required to comply with FDI norms to the extent of the foreign entity itself.

    Please do let me know your thoughts on the above.

  • @Rahul. Thanks for your pertinent observations. Although, the Court specifically rejected the contention of the defendants that all downstream investments must be made only in equitable instruments, the overall implication of the judgment could suggest otherwise due to the conclusion, albeit arrived at by applying a different legal principle. In effect, what the Court has done is to look at the substance of the transaction by disregarding the form. If a foreign investor cannot invest in OPCDs directly, then it cannot do so indirectly either by interposing an Indian investment company. In this analysis, the type of instrument that the Indian investment company obtains by way of a downstream investment becomes important, not as a technical matter of compliance with the FDI policy, but rather when considering the substance of the transaction.

  • @umakanth – thank you for sharing your thoughts. I agree that the overall impact may be as you envisage it. A related thought then, is whether the court would have given the same ruling if the 14.5% assured return wasnt a part of the terms of the OPCDs. Basically, my submission is that the court didnot seem to have a problem with the OPCDs per se, but with OPCDs having fixed return. So for example, in the same case, if there was no fixed return, but the OPCDs would be redeemed based on acceptable RBI valuation (i know this is commercially not viable, but assuming so for a moment), then the court may have been fine with the FOCC subsidiary investing in OPCDs. Would this be stretching the principle a bit much? As always, your views on this would be much appreciated.

  • Thanks, Rahul. As you mention, the fact that the OPCDs carry an assured return seems to have weighed heavily in the mind of the Court. To that extent, it is possible that OPCDs without assured return may have elicited a different outcome. In all, the implications of the judgment are that a lot would depend on the facts of each case (which seem to have played an important role here too), and the entire investment structure and instruments may have to be looked at as a whole.

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