India: RBI On Downside Protection – Are We Set For Course Correction?

Last Updated: 1 June 2017
Article by Amitabh Sharma

The article analyses two landmark judgments, NTT Docomo Versus Tata Sons and Cruz City Versus Unitech delivered by two coordinated benches of Delhi High Court. It delves upon the courts taking a view on the regulatory autonomy of RBI in dealing with foreign exchange remittance between JV ventures parties, especially in the context of 'put option', damage/indemnity payouts.

Hitherto, the RBI, quite literally had the last word on the interpretation of the provisions of law and policy involving issues around foreign exchange. In that context, the judgment of Delhi High Court in the Docomo Case that RBI will be bound by the determination of a foreign Arbitral Tribunal that no permission of RBI is required for remittance of damages payout from a resident to Non-resident entity, assumes greater significance. The Delhi High Court Judgment in the Docomo Case, by disallowing RBI to intervene purely on technical grounds has come tantalizingly close to almost impinging on the regulatory autonomy of RBI in interpreting and deciding matters involving Foreign Exchange in FDI transactions. Unless overruled by a superior court or better still if RBI acquiesces with the judgment in the Docomo Case, it seems that the regulatory compass under which RBI governs the FDI regime is all set for a major course correction!

Is it 'fait accompli' for the RBI? Whether RBI has any legal remedy against the Foreign Arbitral Tribunal and Single Judge 's determination in Docomo Case, of RBI's powers? Seems that the dust has just not settled yet on the legality of downside protection on an inbound equity investment...

Enforceability of Foreign Awards

Recently, in two separate landmark judgments, two coordinate benches of the Delhi High Court refused to decline the enforceability of Foreign Arbitral Awards on the ground of it being against the fundamental policy of Indian law. The Delhi High Court, in both these Single Judge's judgments, NTT Docomo v. Tata Sons Limited (Docomo Case) and Cruz City v. Unitech (Unitech Case), while passing the judgment decree in favour of the foreign party(ies), not only disallowed the invocation of 'fundamental policy of Indian law' to thwart the foreign Arbitral Awards' enforceability, but also examined at length some fundamental issues pertaining to Indian Foreign Exchange laws and policy irking the foreign investors involved in the cross-border Mergers & Acquisitions (M&A) landscape. The Delhi High Court tested the legality of shareholders' agreements (SHA) and delved into issues like, 'put option', 'assured returns', 'downside protection' in view of the restrictions under the foreign exchange law and policy. It also examined in detail, issues around breach of representations and warranties and ensuing damages/indemnity arising in cross border M&A transactions. In the Docomo case, while disallowing the Reserve Bank of India's (RBI) intervention application (in the Execution Suit proceeding), the Single Judge held that there are no statutory requirements in India which mandate that RBI must necessarily be heard in proceedings involving enforcement and validity of an Arbitral Award resulting in a remittance of foreign exchange to a non-Indian entity outside of India. "The mere fact that a statutory body's power and jurisdiction might be discussed in adjudication or an Award, will not confer locus standi on such body or entity to intervene in those proceedings," held the Single Judge.

RBI – The Last Word on FDI

Hitherto, the RBI, quite literally had the last word on the interpretation of the provisions of law and policy involving issues around foreign exchange. In that context, the judgment of Delhi High Court in the Docomo Case that RBI will be bound by the determination of a foreign Arbitral Tribunal that no permission of RBI is required for remittance of damages payout from a resident to Non-resident entity, assumes greater significance. The Delhi High Court Judgment in the Docomo Case, by disallowing RBI to intervene purely on technical grounds (as The Arbitration and Conciliation Act, 1996 does not allow a 'third party' to intervene in Execution proceedings/Compromise decree) has come tantalizingly close to almost impinging on the regulatory autonomy of RBI in interpreting and deciding matters involving Foreign Exchange in FDI transactions. Unless overruled by a superior court or better still if RBI acquiesces with the judgment in the Docomo Case, it seems that the regulatory compass under which RBI governs the FDI regime is all set for a major course correction!

Fundamental Policy of Indian Law – Relevance under FERA Vs FEMA

In the Unitech Case, the Single Judge meticulously navigated through the provisions of both the old and new foreign exchange legislations, namely the Foreign Exchange Regulation Act, 1973 (FERA) and the Foreign Exchange Management Act, 1999 (FEMA), thus narrowing down the applicability of 'public policy' argument in the current day context. The Delhi High Court analysed a catena of judgments including Renusagar Power Co. Ltd. v. General Electric Co.; Life Insurance Corporation of India v. Escorts Ltd. to deduce how the argument of 'public policy' cannot anymore be used to stall the enforcement of a foreign Arbitral Award in the current liberalized economic environment.

Given the policy, legal and economic milieu in which Renusagar case came up before the Supreme Court, it was correctly held that a violation of any provision of FERA would fall foul of the public policy of India. However, under the new dispensation of exchange law provisions under FEMA, the Delhi High Court astutely did not succumb to the temptation of falling for such a dated reasoning. The Delhi High Court in Unitech Case concluded by stating that there has been a paradigm shift in the Foreign Exchange law and policy; the focus has now shifted from prohibiting transactions (from FERA era) to a more permissible and enabling environment (under FEMA). The fundamental policy of FEMA is to manage not to prohibit foreign exchange transactions. The High Court of Delhi thus held that declining enforcement of a Foreign Award because it vitiates the fundamental public policy of India as it may be requiring a particular regulatory compliance or may be violating a provision of FEMA, would not be warranted. It ruled, "a simpliciter violation of any particular provision of FEMA cannot be considered synonymous to offending the fundamental policy of the Indian law." Indeed, even for the skeptics of Indian judiciary, this judicial leaning towards creating a more conducive and facilitative FDI regime through interpretational inventiveness is a very welcoming sign.

Judicial Interpretation of Risk Protection Clauses in FDI Transactions

What is even more encouraging for the votaries of a liberalised economy is that the Single Judges in both the judgments did not just stop at negating the applicability of 'public policy' in challenging the Foreign Arbitral Award, but they went on to examine in detail, the provisions of the shareholder's agreement in the two cases giving rise to the claims of damages/indemnity vis-a-vis the concepts of assured return and down side protection in international M&A deals. The 'put option', a standard risk protection clause for salvaging the economic value of the investments by selling the securities to the other side often at a pre-determined valuation/price in the M&A deals, was discussed in-depth in the backdrop of assured returns/ down side protection. The Delhi High Court in the Unitech Case held that a 'put option' provided to a non-resident (Cruz City) by another non-resident (Burley, an overseas subsidiary of Unitech) back-stopped by the resident Indian parent entity i.e., Unitech, cannot be held as an illegally structured FDI transaction ensuring an "assured return" at a "predetermined rate", and thus is not violating FEMA. Having examined the provisions of the Shareholders Agreement and a "Keepwell Agreement" (akin to equity backstopping/guaranteeing arrangement by parent entity to de-risk the breaches of primary obligations of its subsidiaries to the other parties under the terms of SHA), the Court held that FEMA does not prohibit any 'put option' given to the non-resident entity (Cruz City) by another non-resident entity (Burley). Displaying interpretative ingenuity, the Delhi High Court held that both Unitech and Burley had breached the obligation under the Keepwell Agreement and that Cruz City was indeed entitled to recover from Unitech a sum equal to the 'put option' price by way of damages for the breach of contract, under the terms of Keepwell Agreement.

The Delhi High Court squarely rejected the contention that the provisions of the SHA read with the Keepwell agreement provided an assured return, thus violating FEMA provisions. It held that such restrictions under the foreign exchange policy and law would not be applicable to cases where the foreign investor initiates a damage claim based on a breach of contract. If the FDI has been brought into the country based on specific representations and warranties and such representations and warranties are breached, the foreign investor would be entitled to its remedies under law, including in damages. 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", the Single Judge came out very strongly against Unitech. It termed Unitech's contention that the SHA was a device to circumvent the provisions of FEMA, and all its representations were false and illegal, as 'plainly dishonest', and thus held that permitting it to prevail on such contentions to resist the enforcement of the Award would plainly amount to "rewarding dishonesty and would be manifestly unjust."

Judicial Determination of Docomo Exit Clause

In the Docomo Case, the High Court of Delhi yet again judiciously set out the difference between transactions prescribing assured returns/downside protection on equity instruments and an exit arising out of a breach of a representation by way of a damages claim. The fundamental questions that arose in the Docomo Case was whether the stop loss protection provided to NTT Docomo is legal under the provisions of FEMA? Or in other words, whether Tata's obligation to find a buyer or buyers of the sale shares (and thus guaranteeing NTT Docomo an exit at the minimum of 50% of its investment value by way of damages/indemnity payments), is violative of FEMA? The High Court of Delhi held that Tata could have lawfully performed its obligations to find a buyer at any price, including at a price above the shares' market value, through finding a non-resident buyer. Tata's failure to find such a buyer is a breach, thus entitling Docomo to damages arising out of Tata's non-performance of its obligation under the provisions of the SHA.

The Delhi High Court while adjudicating on RBI's intervention application in the Docomo Case, having reviewed a long series of internal correspondence and file notes between RBI and the Ministry of Finance, probed RBI for taking ambivalent stands on the sticky issues of assured returns/downside protection. While on the one hand, India has been taking fast strides to evolve as a truly liberalised economy, it is somewhat dampening to see such bureaucratic log jam in fast tracking decisions on the fundamental issue of downward protection provided to foreign investors in the cross border M&A transactions.

The internal notes on the RBI files (as exhibited in the Docomo Case) seem to suggest that RBI has indeed been in favour of allowing protection against downside losses to NTT Docomo and other such entities in cross-border equity deals keeping in view the FDI inflow in the country and maintaining the sanctity of contracts. RBI further proposed to the Ministry of Finance to let RBI follow similar principle of downside protection in other cross border M&As, going forward. However, the Ministry of Finance seems to have taken a contrarian view and has advised RBI that such down side protection, technically not being in conformity with the FEMA regulations because of the absence of an enabling framework, cannot be allowed.

Risk Protection Clause in FDI – Is Regulatory Certainty in Sight?

While it is heartening to see the judiciary taking a pragmatic view on the issue of the enforceability of a Foreign Arbitral Award and granting reliefs to the foreign investors in the form of damages for the breaches of representations and warranties and obligations by the Indian parties, the fundamental issue remains far from being resolved. The central issue regarding whether the RBI would eventually allow what is understood in international M&A parlance as 'downside protection', remains unresolved. Relief for foreign investors in terms of successfully arguing and defending the claims for repatriation of foreign exchange outside India before the arbitral tribunal and Indian courts would still largely be dependent on the ingenuity of contracts, how lawyers have structured the exits around damages/indemnities arising out of breaches by the Indian party of the representation and warranties, instead of acknowledging contractual remedies for downside protection under the letter of law and policy. It is about time to set the course right, rather than skirting the issue.

A closer scrutiny of the Unitech judgment reveals that while the High Court of Delhi upheld the enforceability of the Foreign Arbitral Award and made Unitech liable for honouring its obligation by way of damage payout (for the breach of its obligations), the High Court still left the issue of repatriation of funds outside India open ended where it said that the ultimate remittance of funds from Unitech to overseas would still be subject to necessary permission from RBI. Even in the Docomo Case the High Court of Delhi fell short in giving clear instructions to RBI for straightaway allowing the damages payment sans any further clearance from RBI. The High Court of Delhi has taken on record the Consent Terms between NTT Docomo and Tata Sons whereby both the NTT Docomo and Tata Sons have undertaken to obtain all the requisite statutory permissions and clearances. It will be interesting to see how the RBI now proceeds in this matter, and whether it would allow the remittance of damages payment from Tata to NTT Docomo without any further ado. Interestingly, the High Court has instructed that the payment of damages from Tata to NTT Docomo and the incidental share transfer between NTT Docomo and Tata Sons shall be administered through the modalities of form FC-TRS (a statutory form under the provisions of FEMA for transaction of securities between a resident and a non-resident). It is noteworthy that the form FC-TRS does not have any flexibility to allow or accommodate any payouts other than towards consideration for buying/selling of securities between a resident and non-resident.

Any indemnity/damages payment from a resident to non-resident under the provisions of FEMA would normally require permission from RBI, so it will be interesting to see whether RBI reaffirms its authority by sitting again in judgment on the issue of repatriation of funds (damage payout) from Tata to NTT Docomo. Not only Docomo but the entire investment community is watching with bated breath as to what steps RBI will take pursuant to the order in Docomo Case – the question is would RBI resort to technical infirmities arising out of incapability of the form FC-TRS to permit transfer of damages payouts amongst others, thus allowing the 'form over the substance' argument come in the way of fund transfer? Or would RBI, riding on the facilitative Judgment of the Single Judge of the Delhi High Court, acquiesce and allow, without exercising regulatory superintendence, damage payouts to NTT Docomo? Or would RBI allow, but having affirmed its regulatory powers by granting a special permission to let Tata make the damage payouts?

Supremacy of RBI's Regulatory Powers - Is the Tussle Over?

Docomo Case has far reaching ramifications for the RBI – not only it disallows and sets a precedent that RBI cannot intervene in the enforcement of an Arbitral Award that might result in remitting money to an non-Indian resident entity outside India, it also judicially concludes that, RBI, just as any other entity, be bound by an (Foreign) Award interpreting the scope of its powers or any of its regulations subject to it being upheld by a court when challenged by a party to the Award (which RBI is not). The Single Judge in Docomo Case has also alluded to Arbitral Tribunal's decision that "since the sum awarded to Docomo was in the nature of damages and not the sale price of the shares, the question of having to seek the special permission of RBI did not arise." It concurred with the views of Arbitral Tribunal that the Arbitral Award (for payment of damages) would not require any RBI permission and the Award will be enforceable and "RBI will be bound by such determination of the Arbitral Tribunal and cannot refuse permission." Not only RBI but even the M&A lawyers community in India long held the view that any damages/indemnity payouts from a resident to a non-resident entity would be subject to RBI's clearance.

There are some fundamental questions that would still need to be answered. Whether a foreign Arbitral Tribunal has the jurisdiction to determine the regulatory ambit of RBI in matters of (Indian) foreign exchange and policies? Whether the foreign Arbitral Tribunal has the locus standi to conclude that no RBI permission is required for remittance of damages payout from a resident to Non-resident entity? Is it 'fait accompli' for the RBI? Whether RBI has any legal remedy against the Foreign Arbitral Tribunal and Single Judge 's determination in Docomo Case, of RBI's powers? Technically it is open for the RBI to challenge the order passed by the Single Judge (on RBI's Intervention Application) by way of an Appeal before the Division bench of the Delhi High Court by pleading that RBI was a proper and necessary party to the proceedings and the Single Judge has passed a Judgment Decree in contravention to the settled principles of foreign exchange laws as it prevails. Further, another legal remedy which RBI can exercise is to file a Writ Petition under Article 32 of the Constitution of India before the Supreme Court and invoke its inherent and supervisory jurisdiction to check and correct the alleged illegality regarding the determination of RBI's powers. It can also argue that since the enforcement of Award would finally entail overreaching FEMA policy, the Supreme Court will have necessary jurisdiction to address such illegality.

Seems that the dust has just not settled yet on the legality of downside protection on an inbound equity investment...

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