[Divya Rau is a fourth year law student in Jindal Global Law School]
The Department for Promotion of Industry and International Trade (DPIIT) released Press Note 3 (2020 series) on 17 April 2020. The Press Note alters para 3.1.1 of the Consolidated FDI Policy, 2017. The Press Note provides that any non-resident entity in a country sharing a land border with India can invest in India only by obtaining prior government approval. India shares a border with seven countries — China, Afghanistan, Pakistan, Bangladesh, Myanmar, Bhutan and Nepal. The revised position alters the eligibility criteria of the Consolidated FDI Policy 2017, wherein similar restrictions were previously only applicable to Bangladesh and Pakistan. The main aim of the Press Note is to ‘curb opportunistic takeovers/acquisitions’ of Indian companies, in light of the COVID 19 pandemic, where share prices have fallen in several companies.
Further, the Press Note covers all instances where the beneficial ownership of the FDI is located in a neighbouring country or with a citizen of a neighbouring country. This rule applies to any direct or indirect transfer of ownership of any existing FDI in an Indian entity, in order to target transfer of ownership through complex structures that may circumvent the spirit of this rule. The Press Note will only take effect after the requisite amendments to Rule 6 of the FEMA (Non-Debt Instruments) Rules 2019 are carried out. The Press Note has received mixed reactions, which has largely been perceived as a means to maintain a check on FDI from China, although the Press Note does not explicitly mention China.
The Press Note does not define the term ‘beneficial owner’, which raises concerns. Where an investment entity is situated in a country which is permitted to invest through the automatic route, but the beneficial owner is in a neighbouring country or a citizen of a neighbouring country, such investment now requires mandatory approval from the government prior to such FDI. This indicates that the Press Note may impact countries beyond the seven border-sharing nations. Section 89 of the Companies Act, 2013 deals with the distinction between legal owners and beneficial owners, irrespective of the magnitude of shareholding. Section 89 read with rule 9 of the Companies (Management and Administration) Amendment Rules 2018 states that a person who holds or acquires beneficial interest in the share of a company becomes a beneficial owner. Beneficial interest, defined under section 89(10) of the Companies Act 2013, in a share includes, “directly or indirectly, through any contract, arrangement or otherwise, the right or entitlement of a person alone or together with any other person” to exercise rights attached to such share or receive dividend or other distribution.
According to section 90, which mentions significant beneficial owner (“SBO”) and not beneficial owner, a person who holds at least 25% beneficial interest in a company is a SBO. However, rule 2(e) of the Companies (Significant Beneficial Ownership) Rules 2019 (“SBO Rules”) prescribes a 10% threshold, in terms of shareholding, voting or dividend. The SBO Rules also provide that a person who holds beneficial interest should not be in the register of members. As section 90 states that the threshold is 25% or as ‘may be prescribed’, it is the threshold under the SBO Rules that is considered as the appropriate threshold. The 10% threshold in the SBO Rules should be taken as the ‘prescribed’ threshold referred to in Section 90. Further, according to section 90(1), the definition of SBO includes a person who exercises ‘significant influence’ or ‘control’ over the concerned company. Further, section 2(fa) of the Prevention of Money Laundering Act 2002, defines ‘beneficial owner’ as “an individual who ultimately owns or controls a client of a reporting entity or the person on whose behalf a transaction is being conducted and includes a person who exercises ultimate effective control over a juridical person”.
A cause for concern is the extent or degree of influence or control to be exercised by a person to be considered to have beneficial ownership, or whether only objective criteria will be considered for the purposes of this Press Note such as shareholding or voting rights. In addition, the position for a person who holds less than 10% of beneficial interest in the shares of a company but has rights attached to shares or investor rights such as first refusal, anti-dilution rights, etc., is uncertain. It also may lead to the conclusion that any transfer of beneficial ownership requires mandatory government approval, which significantly increases regulatory control, especially where the holding transferred is minimal in nature and not a cause for concern. This could have a chilling effect and impact investor sentiment due to increased regulatory burden and inevitable delays in gaining approval, impacting bona fide investments. It is unclear whether ‘beneficial owner’ in the Press Note refers to SBO, and the government must clarify the same.
On 11 April 2020, the People’s Bank of China (PBOC) increased its stake to 1.01% from 0.8%, through the FPI route in Housing Development Finance Corporation (HDFC), whose shares have fallen by 41% since the beginning of February. Several reports have attempted to paint this investment as a trigger for the revised rule. Previously, China was permitted to invest in India through the automatic route in most sectors with the exception of sixteen sensitive sectors including defence and national security, amongst others. Although the investment in HDFC was through the FPI route, FDI investment has received scrutiny from the government through this Note, as FDI is more likely to result in change in control or management of a company.
The economic impact, particularly on the startup environment, is unknown. Chinese investors have been active in the startups like Flipkart, Paytm and Big Basket amongst others. As of February, FDI from China was estimated to be $6.2 billion, with $4 billion invested in Indian startups. It is important to note that 18 of India’s 30 tech unicorns have received funding from China. Startups across India have benefitted significantly from Chinese investments, which could now be under increased regulatory scrutiny due the revised rule. This Press Note indicates the intention of the Indian government to keep a closer check on investments from neighbouring countries, especially China, and to evaluate such investments on a case by case basis. It is also likely to impact additional investments in Indian companies where investors already have pre-existing investments, as they will henceforth require government approval. The government requires a few months to approve investments through the approval route, which may be further delayed due to increased number of FDI approvals that will be required under this rule.
India’s revised rule in the FDI policy is reflective of global concerns of Chinese investors purchasing assets at low prices due to the pandemic. The Note does not prohibit FDI from certain countries, but merely regulates such FDI. In Australia, a review board has been instituted to evaluate all investment proposals in order to detect and regulate the sale of distressed corporate assets. On 25 March 2020, the European Commission issued new FDI guidelines, in light of the pandemic. The new guidelines confer on member states the power to review investments on the ground of security and public order and to be alert in order to avoid the sale of “Europe’s business and industrial actors”. It directs all member states to make “full use” of their current screening regulations to analyse the risks to critical sectors. With protectionist measures being adopted globally, India is no different. However, the European Commission’s new guidelines applies to FDI from all countries. India’s approach has specifically targeted neighbouring states, as the automatic route continues to be available to other countries, subject to sectoral limits under the FDI Policy. It is impossible to predict the impact of such protectionist regimes post the pandemic, and whether the Indian government will be able to meet the regulatory burden and effectively keep a check on FDI.
– Divya Rau