India's foreign investment regime, governed by the Foreign Exchange Management Act, 1999 (FEMA), maintains a clear prohibition on providing "assured returns" on equity investments to foreign investors. This policy is designed to distinguish risk-bearing equity from fixed-return debt, prevent circumvention of regulations governing external borrowings, and manage foreign exchange outflows. However, while the regulatory text is stringent, Indian courts have adopted a pragmatic and pro-enforcement approach, creating significant and legally recognized pathways for investors to secure their exits.
As per Regulation 9(5) of the Non- Debt Instrument Rules, 2019 (NDI Rules) framed under the Foreign Exchange Management Act, 1999 (FEMA) – "... a person resident outside India holding equity instruments....may exit without any assured return, subject to the pricing guidelines prescribed..."
Whilst the term "assured return" is not defined under FEMA, the Cambridge Online Dictionary defines the terms "assured" as 'certain to be achieved' and "return" as a verb is defined as 'to give a particular amount of profit'.
When so understood, an assured return refers to a guaranteed or pre-determined exit price on an investment or in an agreement, promised to a foreign investor, which at the time of exit ensures a fixed return to the investor. There could be several reasons for the regulator opting for such restrictions, including, lack of full capital account convertibility in India; to ensure that the investment made is a genuine commercial transaction where the investor takes the equity risk, so as to not undertake a disguised debt.
Indian jurisprudence has evolved to address the commercial realities of foreign investment, leading to crucial distinctions that allow for the enforcement of investor exit rights.
a) Assured Return vs Damages for a Breach of Contract
- In the landmark case of NTT Docomo Inc. v. Tata Sons Ltd. 1, the Delhi High Court upheld a foreign arbitral award of damages to Docomo. The shareholders' agreement obligated Tata to find a buyer for Docomo's stake at a price that was higher of the fair market value or 50% of the initial investment. When Tata failed to do so, the arbitral tribunal awarded damages. The Delhi High Court ruled that this payment was not an "assured return" for shares, but akin to damages for Tata's breach of its primary obligation to find a buyer. Further, if Tata was to sell the shares at a price higher than the fair market value, i.e., against FEMA pricing guidelines, it could have done so by selling to a non-resident buyer. The Madras High Court, in GPE (India) Limited v. Twarit Consultancy Services Private Limited, took a contrary view and made it conditional to obtain an RBI approval for remittance of damages while enforcing a foreign award.
b) FEMA Contravention and the "Public Policy" Defence
Indian parties resisting enforcement of arbitral awards often argue that a payout violating FEMA's pricing guidelines is against India's "public policy." The Supreme Court has decisively rejected this defence.
In the case of Vijay Karia v. Prysmian Cavi E Sistemi SRL2, the Supreme Court upheld an arbitral award despite it allowing for an act that goes against FEMA's pricing guidelines. The Supreme Court clarified that a breach of FEMA guidelines is a rectifiable breach that does not contravene public policy. The Court emphasized that FEMA is a statute for managing foreign exchange, not policing it like its predecessor, FERA. This means a violation does not render the underlying contract void, and the RBI can grant post-facto approval to condone it. Therefore, an arbitral award cannot be refused enforcement merely because it directs an act contrary to FEMA's pricing guidelines.
c) Conditional Put Option vs Assured Return
The courts differentiate between an open-ended right to exit at a pre-determined price and a right that is contingent upon specific events.
In Cruz City Holdings v. Unitech Ltd.3, the Delhi High Court enforced an award that allowed the foreign investor to exercise a put option with a 15% IRR. The court reasoned that since the option was exercisable only within a specific timeframe and was contingent on a trigger event (in this case the failure to commence a construction project), it was not an open-ended "assured return." An assured return, the court clarified, is one that can be exercised at the sole discretion of the investor, whereas a conditional option is a protective right against non-performance. This means that assured returns clauses would not be subject to the same aforesaid contingencies as a put option.
d) Structured Transactions: A Step-by-Step Approach
In the case of IDBI Trusteeship Holdings v. Hubtown Ltd.4, the Bombay High Court had invalidated the entire transaction (which broadly involved an (i) FDI leg, (ii) a downstream investment leg and (iii) a provision of security in the form of guarantee leg) by viewing its aggregate commercial effect, which appeared to give a foreign investor an assured return indirectly. However, the Supreme Court overruled this and has provided a clear method of analysis by holding that such structures must be assessed on a step-by-step basis. It held that each stage of the transaction was compliant with FEMA policy including the returns generated through downstream debt instruments within a holding company structure to the foreign equity investor at the top and therefore, was permissible though the commercial effect of the whole transaction resembled an assured return.
Although the Supreme Court has ruled that a contravention of FEMA's pricing guidelines does not automatically violate India's fundamental public policy, the above matters are indicative in nature, and the final determination of a breach depends upon the facts of each case and the manner in which the agreement is drafted. It appears that it has become difficult for Indian parties to evade contractual obligations by citing regulatory hurdles. Simultaneously, it has also created a paradoxical situation where an Indian promoter must technically "breach" an agreement to facilitate a contractually agreed-upon exit for its foreign partner or structure a transaction while noting the following: (i) adopt alternate mechanisms as restrictions that apply to a non-resident investor are not the same for a resident investor; (ii) the manner in which the arrangement is contractually drafted with downside protection and not assured return could provide room for interpretation; (iii) the valuation conducted at the time of exit, and its mechanism; and (iv) repatriation of proceeds in certain circumstances can still be done with specific RBI approval. The regulations are being followed in spirit rather than the letter as there is room for drafting a contract and interpreting the law, when implementing the arrangement between the shareholders.
Footnotes
1. NTT Docomo Inc v. Tata Sons Ltd. MANU/DE/1164/2017.
2. Vijay Karia v. Prysmian Cavi E Sistemi SRL (2020) 11 SCC 1.
3. Cruz City Holdings v. Unitech Ltd. MANU/DE/0965/2017.
4. IDBI Trusteeship Holdings v. Hubtown Ltd. (2017) 1 SCC 568.
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