Whether Call / Put Options in FDI Transactions are considered as Assured Returns?
In the context of increased liberalisation of various foreign exchange laws in India, the country has seen a surge in the investment from abroad. Whereas, in case of divestments by foreign investors, the Indian foreign exchange laws have not been as liberalised as the foreign investors would have preferred, especially with regards to an assured exit price.
Call and put options are usually investor’s rights included in the agreements executed with the investee company and the promoters where, (a) the investor will be entitled to call upon and purchase the shares of the promoters; or (b) the investor will be entitled to put all its shares and obligate the company/promoters to purchase such shares.
Optionality Clauses permitted in FDI
The Reserve Bank of India has, vide its circular dated January 09, 2014[1], notified that any non-resident may include optionality clauses in respect of its securities. A similar approach has been adopted by the Central Government in formulating the Foreign Exchange Management (Non-debt Instruments) Rules, 2019[2] (“NDI Rules”). Such optionality clauses may obligate the resident shareholders/promoters to provide an exit to non-resident investors. However, the securities issued with such optionality clauses will be subject to lock in restrictions for a period of 1 (one) year or any other greater period as applicable under the NDI Rules.
As per the NDI Rules, upon exercise of such optionality clauses, consequent disinvestment will be subject to the prevailing pricing guidelines[3] (“Pricing Guidelines”). Therefore, even though call options are recognised by Reserve Bank of India, due to the applicability of Pricing Guidelines, non-resident investors cannot implement protective mechanisms to recover their investments if the fair value of shares falls below the price prevailing at the time of its investment.
Despite the above provisions of the NDI Rules, non-resident investors usually tend to include optionality and exit clauses in the agreements executed with the investee companies and its promoters, where upon default of any provisions of such agreements, the investor is entitled to exit the Indian company at a specific agreed price. Inclusion of such clauses has been subject to several interpretations, as analysed further.
Assured Return for Default
In the case of NTT Docomo vs. Tata Sons[4], a non-resident investor which held approximately 26.5% of the shareholding of an Indian company, the Indian shareholder and the Indian investee company executed a shareholders’ agreement whereunder, the parties agreed that the investor had a right to obligate the Indian shareholder to find buyer(s) to purchase the investor’s shares at a price which is the higher of (a) the fair value of those shares as of March 31, 2014, or (b) 50% of the price at which the non-resident investor purchased its shares (“Exit Clause”) if the investee company fails to achieve certain performance indicators (“Default”) within a specific period of time. Since, the investee company failed to achieve the agreed performance indicator, a trigger notice for exercising the above exit right was deemed to be issued. The parties thereafter appeared before the London Court of International Arbitration (“LCIA”) and the LCIA, in its award, obligated the Indian shareholder to pay to the non-resident investor, damages equivalent to 50% of the price invested by the non-resident shareholder and consequently, return the shares to the Indian shareholder. The parties appeared before the Hon’ble High Court of New Delhi for enforcement of the LCIA’s award. The Indian shareholder and the Reserve Bank India (who filed an intervention application) challenged the said award on the ground that the award was violative of the Pricing Guidelines and Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (“FEMA 20”), as to the enforcement of the Exit Clause, since the downward protection of 50% of the investment amount would be construed as an assured return.
However, the Hon’ble High Court of New Delhi, upheld the award of LCIA in the context that the Exit Clause agreed between the parties cannot be considered as an assured return over and above its investment as this was only a downside protection offered to the investor. The court also agreed with the LCIA, that the provisions in shareholders’ agreement state that upon Default, the promoter had the right to find a non-resident purchaser and such sale to a non-resident purchaser would not trigger the pricing guidelines under FEMA 20. The court reiterated the LCIA’s award that transfer of 50% of the investment amount was awarded as damages with regards to the breach committed by the resident shareholder and the return of the shares was a consequent action since the investor would no longer require the shares. The court also rejected the Reserve Bank of India’s application to intervene, as it had no locus standi in a petition for enforcement of a foreign award for damages.
Similarly in the case of Cruz City 1 Mauritius Holdings Vs. Unitech Limited[5] (“Cruz City Case”) where the resident party has committed a default of a provision of the agreement with the investor by not commencing a project within the specified timeline, the Hon’ble High Court of New Delhi held that the put option provided to the investor under the agreement was only triggered due to the failure of the other party to complete the construction of the agreement and cannot be construed as an assured return. In the light of the above the court had held that:
“the Put Option was relevant only if the construction of the Santacruz Project was not commenced within the specified period of two years. Cruz City had no assurance of exit at a pre-determined return under the Keepwell Agreement in the event the execution of the project was commenced on schedule. And thirdly, if Cruz City has been induced to make an investment on a false assurance of the Keepwell Agreement being legal and valid, Unitech must bear the consequences of violating the provisions of Law but cannot be permitted to escape their liability under the Award.”
It is also pertinent to note that the Hon’ble Supreme Court of India, in the case of Vijay Karia vs Prysmian Cavi E Sistemi SRL[6], when discussing if a foreign award can be enforced if such enforcement may violate the prevailing pricing guidelines in the NDI Rules, agreed with the Cruz City Case where it held that the violation of a provision of the NDI Rules cannot be construed to be against the fundamental public policy of the Foreign Exchange Management Act, 1999 (“FEMA”) since the Act is more of a regulatory and liberal law and a mere breach of rectifiable provisions of NDI Rules cannot be construed to be against the public policy.
Conclusion
In light of the above cases, it is pertinent to note that the courts and tribunals have interpreted that in specific instances where there has been a default of the Indian promoters/shareholders of any contractual provisions, consequent call options exercised by non-resident investors could be considered as protective clauses which need not have the intent to make assured returns.
The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal, Hyderabad.
[1] Vide A.P. (DIR Series) Circular No. 86 dated January 09, 2014 issued by the Reserve Bank of India
[2] The Foreign Exchange Management (Non-debt Instruments) Rules, 2019 had superseded Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 which superseded Notification No. FEMA 20/2000-RB, in the year 2017.
[3] As per the prevailing pricing guidelines under NDI Rules, 2019, “the price of securities transferred from a person resident in India to a person resident outside India shall not be less than, (i) the price worked out in accordance with the Securities and Exchange Board of India guidelines in case of a listed Indian company; (ii) the price at which a preferential allotment of shares can be made under the Securities and Exchange Board of India Guidelines, as applicable, in case of a listed Indian company or in case of a company going through a delisting process as per the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009; and (iii) the valuation of equity instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India or a practising Cost Accountant, in case of an unlisted Indian company.”
[4] (2017)3CompLJ526(Del)
[5]2017(3) ARBLR20(Delhi)