The Hubtown Case: Supreme Court on the FDI Policy

[The following guest post is contributed by Tanavi Mohanty, who is a corporate
lawyer practising in Mumbai]
The decision of the Bombay High Court in the summary suit of IDBI
Trusteeship Services Limited (ITSL)
v. Hubtown Limited (Hubtown),
better known as the Hubtown case has received a lot of attention for being the Bombay
High Court’s pioneering judgment which unearthed a colourable structure
deployed by a non-resident investor to wriggle out of the foreign exchange laws
and ensure an assured return on its investment in India. The judgment was
briefly discussed in an earlier
on this Blog as well. Recently, a ruling of
the Supreme Court
, which disposed off an appeal on the Bombay High Court’s
decision, has brought the issue to the forefront again. This is particularly
because the Supreme Court came to a different conclusion from that of the
Bombay High Court.
The transaction in question involved a two-pronged investment structure.
In the first step, the investment was by FMO, a Netherlands based non-resident
investor in Vinca Developer Private Limited (Vinca), by way of
subscription to equity shares and compulsorily convertible debentures (CCDs)
and, in the second step, the investment was by Vinca in its wholly owned
subsidiaries, Amazia Developers Private Limited (Amazia) and Rubix
Trading Private Limited (Rubix) by way of subscription to optionally
partially convertible debentures (OPCDs).
The structure is alleged to be illegal because it is designed to
provide FMO an assured return at the rate of 14.5% on its investment of INR 418
crores in India, in violation of the Indian foreign exchange laws which
prohibit non-resident entities from investing in instruments that provide a
guaranteed rate of return. The structure is questionable because of two
principal features: (i) a clause in the articles of association of Vinca giving
a veto right to FMO with respect to matters relating to the OPCD document, and
(ii) a stipulation in the investments documents executed for FMO’s investment
in Vinca that the investment amount be specifically invested by Vinca in OPCDs
of Rubix and Amazia.
In a summary suit filed by the debenture trustee, ITSL, for
enforcement of rights under the corporate guarantee provided by Hubtown for
securing due payment by Amazia and Rubix (Guarantee),
the courts dissected the investment structure and observed that the summary
suit, if decided in favour of ITSL, would validate the illegal structure. The
rationale was that the guarantee, although prima facie a contract
amongst Indian parties, was still a part of the entire (allegedly illegal)
transaction involving FMO’s investment.
The Bombay High Court in its judgment dated May 5, 2015 held that
the investment structure is a colourable device to circumvent the foreign
exchange laws, and the Guarantee as a part of the entire transaction was
unenforceable. As regards the principal issue of Hubtown’s leave to defend, the
court found that Hubtown raised triable
in its defence, and therefore, granted an unconditional leave to
Hubtown to defend the suit.  
A division bench of the Supreme Court, while disposing off the
appeal in its judgment dated November 15, 2016, evaluated the terms of the
guarantee on a standalone basis, and examined the defences raised by Hubtown in
further detail. Upon analysis, the Supreme Court disagreed that Hubtown had
raised any substantial defence to ITSL’s claim in the suit, and placed
Hubtown’s defence in the realm of plausible but improbable, which is a
departure from the finding of the Bombay High Court that Hubtown raised triable
Further, in light of an amendment to the Civil Procedure Code, the
court granted Hubtown a conditional leave to defend the suit, requiring Hubtown
to deposit the principal sum of INR 418 crores or provide adequate security for
the said sum, within 3 months from the date of the judgment. The court also
ordered for an expeditious trial of the suit, within 1 year from the date of
the judgment. The Supreme Court relied on the fact that the Guarantee per se was not an illegal instrument and
the invocation of the Guarantee, including the default in payment or the obligation
to pay by Hubtown, were admitted facts.
While the Supreme
Court’s judgment has reversed the finding of the Bombay High Court, thereby
brightening the spirits of the foreign investor community, it has failed to express
any definitive view on whether a non-resident entity can indirectly secure
assured return on its investment in India by routing the investment through an
Indian entity which in turn invests through otherwise impermissible debt
instruments. It is also unclear if the said investment structure devised by FMO
is legally compliant and permissible under Indian law.
As long as these questions remain unanswered, the judgment does
little to provide solace to non-resident investors looking to employ varied
investment structures, and lends ambiguity to Indian exchange control laws.
– Tanavi Mohanty

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.

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