Earlier last year, on May 5, 2015, the Bombay High Court, in its ruling in IDBI Trusteeship Services Limited (Plaintiff) v. Hubtown Limited (Defendant), dealt with the legalities of a foreign investment structure that involved compulsory convertible debentures (CCDs) issued by an Indian company (IndCo) to a foreign investor, the proceeds of which were in turn were used by the IndCo to invest in optionally partially convertible debentures (OPCDs) of two other Indian companies (Operating Companies) operating in the construction development sector. The Operating Companies thereafter were to invest the funds received out of the issuance of the OPCDs in real estate construction projects compliant with the Foreign Direct Investment Policy of India (FDI Policy).
The Plaintiff was appointed as the debenture trustee in respect of the OPCDs. Under the transaction documents and the debenture trust deed, the Defendant was required to make agreed fixed payments including the interest payments to IndCo and for the purpose of securing the returns as agreed in the transaction documents, the Defendant executed an unconditional, absolute and irrevocable deed of guarantee (Guarantee) in favour of the Plaintiff, which gave the Plaintiff a right to invoke the Guarantee for the benefit of the IndCo in the event of a default by the Operating Companies.
Since the IndCo failed to meet the obligations as agreed, the Plaintiff issued a certificate of demand for enforcing the Guarantee. The issues under consideration before the Hon’ble Bombay High Court inter alia involved evaluation of the investment made by the foreign Investor being compliant with the FDI Policy. The Defendant alleged the investment structure to be in violation of the FDI Policy as only specific securities were permitted in the real estate sector and guaranteed / assured returns to the foreign investor in the nature of the downstream investment made into the Defendant were not permitted. Further, the Defendant alleged that the Plaintiff is using the process of the court to violate the public policy.
In the said ruling, the Bombay High Court saw the transaction as a whole regardless of its two-pronged structure, i.e. (i) foreign investment in Indco; and (ii) Indco’s investment in Operating Companies. The High Court, in the summary suit filed by the Plaintiff, had declined to validate the transaction due to the presence of assured returns in the downstream investments and found the investment structure as a colourable device to evade the foreign exchange laws [see end note 1]. Essentially, the High Court held that the foreign owned/controlled entities must follow all aspects of foreign investments regulations including, inter alia, types of investment instruments.
However, on November 15, 2016, the Supreme Court disposed off this issue with a different conclusion in IDBI Trusteeship Services Limited v. Hubtown Limited, Civil Appeal No. 10860 of 2016. The Apex Court held that the Guarantee per se was not an illegal instrument and the invocation of the Guarantee, including the default in payment or the obligation by the Defendant, were admitted facts. The Supreme Court also evaluated the aspects of the unconditional leave given to the Defendant to defend the suit at the detriment of the Plaintiff and held that the defence is doubtful and designed to deviate from the contractual obligations under the Guarantee. The Supreme Court found that the investment in itself is not in violation of the FDI Policy as both legs of the investment i.e. the investment in the CCDs and the OCPDs are permitted under law. The Reserve Bank of India would, in any case, review the repatriation of proceeds by the foreign investor and will not permit such repatriation if, there is a violation of the FDI Policy, at that point in time.
As the Supreme Court has reversed the Bombay High Court’s order, it has revivified the spirits of the foreign investors which have been finding the Indian investment regulations very restrictive in terms of modes of investment and enforcement of contractual obligations. The famous Tata-Docomo issue also deals with enforcement of contractual obligations in the light of the restrictions laid down by FDI Policy.
However, the Apex Court has not expressed its definite views on the fact that whether a non-resident investor 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. The Apex court has, in this ruling, only decided upon triability of the issues raised by Plaintiff and has directed the Defendant to deposit the entire amount under the Guarantee in order to proceed with the defence in the summary suit for enforcing its rights under the deed of Guarantee executed in respect of OPCDs.
- Note: Indian foreign exchange laws prohibit non-resident entities from investing in instruments that provide a guaranteed rate of return.