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Assured Returns on Foreign Direct Investments via Indirect Arrangements

[Jayesh Kumar Singh is a student at National Law University, Jodhpur]

India, the fastest growing economy in the world, is a major destination for foreign direct investment (FDI). As of 31 March 2019, the FDI inflow in India stood at $610 billion. Additionally, India has consistently been ranked among the top 20 countries in the FDI Confidence Index. The FDI in India is majorly governed by the Foreign Exchange Management (Transfer or Issue of Securities by a Person Resident Outside India) Regulations 2017 (TISPRO Regulations) framed under the Foreign Exchange Management Act 2002 (FEMA).

FDI refers to an investment through capital instruments by a non-resident in an unlisted company, or in 10% or more of the post issue fully paid up equity shares of a listed company on a fully diluted basis.[1] The term ‘capital instruments’ includes equity and preference shares, debentures, bonds, share warrants, or any other instrument contributing to a company’s share capital. Unlike equity shares, the returns on preference shares, debentures and bonds are generally fixed in nature. The mandatory requirement of equity-based investments necessitates that all capital instruments providing guaranteed returns shall be compulsorily converted to equity shares sooner or later.

Indian companies are permitted to raise their debt capital from foreign sources only in the form of external commercial borrowings (ECBs). This means that all the partially convertible/non-convertible capital instruments form a part of ECBs. The notifications issued by the Reserve Bank of India (RBI) on FEMA clearly mention that even after grant of optionality, the investors do not have the option or right to exit at an assured price. Although the legislations completely prohibit the investors from earning assured return, investors seek to circumvent the law by inserting certain ‘contingent clauses’ in their shareholders’ agreement (SHA). The guiding principle behind FDIs in India is that such investments shall not guarantee assured returns to the investors and the investors shall exit at the price prevailing in the market.[2]

In this blog, I have attempted to give a brief about the legal framework governing FDIs in India and the ‘no assured return rule’. The first part of the blog deals with colourable structures and indirect clauses formulated to circumvent the rule. The second part deals with the overlap between ‘downside protection’ and the ‘no assured return rule’. Lastly, the conclusion examines the existing position in India on the rule under discussion.

Part I: Colourable structures and indirect clauses

The courts have given varied interpretations to the guiding principle behind FDIs. In IDBI Trusteeship Services Ltd. v. Hubtown Ltd., the conversion of certain compulsorily convertible debentures and equity shares of an Indian company vested 99% shareholding with the foreign investor. Additionally, the Indian company had also invested in two of its wholly owned subsidiaries by subscribing to optionally convertible debentures (OCDs) carrying a coupon rate of 14.5%. When the subsidiaries defaulted, it was held that the foreign investor shall not receive assured returns indirectly on account of a colourable shareholding structure designed to circumvent the restrictions imposed under the FDI policy. Relying on Vodafone International Holdings BV v. Union of India, the transaction was viewed as a whole. Since the Indian holding company was to receive a fixed return of 14.5% from its subsidiaries and that the foreign investor would hold 99% of Indian holding company post conversion, the foreign investor would receive an assured return, which was against the existing law.

In Cruz City 1 Maruti Holdings v. Unitech Limited, the SHA provided that if the real estate projects for which the investment was made do not materialize, then the foreign investor would be entitled to exercise a put option requiring the respondents to purchase the investor’s equity interest at a specified price. Due to delays in the project, the foreign investor elected to exercise the put option and, upon dispute, obtained a favourable arbitral award. The enforcement of the award was challenged by the investee company on the ground of public policy since investors were barred from earning assured returns in India.

The court held that since the put option clause was in the nature of damages upon breach of contract, the FEMA would not be attracted. Further, the ‘no assured return’ rule had not been violated since the return was based on contingent circumstances. Additionally, even if there were a breach of Indian law, it was not significant enough to amount to a violation of public policy. However, the Supreme Court of India had previously held that the FEMA is intended to safeguard India’s economic interests, thereby forming a part of India’s public policy. Thus, if the clause in an SHA specifying assured returns is dependent on an uncertain event and is for a specified limited time, then such a clause cannot be struck down.

Part II: Assured returns vis-à-vis downside protection

Downside protection refers to strategies adopted by corporations to prevent reduction in the value of their investments. In NTT Docomo v. Tata Sons, the SHA provided that if the joint venture between the parties did not meet certain performance targets based on investee’s representations and warranties, the exit option granted to the foreign investor would bind the Indian company to find a suitable buyer for investor’s shares at a fixed price. Later, the Indian company pleaded that it was barred to exercise its obligations under the ‘no assured return rule’. However, the foreign investor obtained a favourable award in its favour. When the RBI tried to preclude the enforcement of the award on the ground of public policy, it was held that the RBI did not have the standing to challenge an award between two private parties, and that the tribunal had correctly found that the obligations could be performed without breaching the guiding principle.

The case should not be interpreted as an approval of fixed-price put option clause per se since a significant part of the reasoning depended on its phraseology in a SHA. The clause, being in the nature of damages arising upon breach of contract, merely offered downside protection to the foreign investor. Even in Shakti Nath v. Alpha Investments Ltd., the court, differentiating between ‘put option clauses providing assured returns’ and ‘damages’ clauses, also declared the assured return in the specific case to be in the nature of damages. Thus, downside protection only in the form of contractual breach is allowed in India. Although the said cases received a similar fate, it shall be kept in mind that in these cases, the central issue was whether the enforcement of a foreign arbitral award granting contractually stipulated sums to the investors would be in violation of the no assured return rule. The court was also obliged to uphold the terms of the New York Convention on the Enforcement of Foreign Arbitral Awards even if the award was in contravention to the national laws.


To summarize the existing position in India, an investor may exit from the investment either through an ‘exit option clause’ or a ‘liquidation preference clause’. Through the liquidation preference clause, an investor may exit upon the happening of specified liquidation events wherein a prudent investor would incorporate all the circumstances which would trigger breach of contract, thereby liquidation. Thus, upon triggering of a ‘liquidation event’, the investor would be entitled to receive either the principle amount or its multiples. If the approach of the courts is to be adopted, then the happening of liquidation events would entitle the investor to receive certain specified sums in the form of damages or downside protection. However, if the liquidation preference clause is not triggered, then the option available to an investor is to exit through the specified ‘exit mechanism’. An investor exit not triggered by a liquidation event shall not guarantee assured returns to the investor.

The foreign investors generally adopt this approach to shield their investments in India. The interpretation given by the courts to the no assured return rule provides legal validity to such an approach. Lawyers can structure exit option for their clients around damages from contractual breach. Additionally, the investors can put in highly probable or certain liquidation events arrived through internal commercial discussions under the liquidation preference clause and seek to obtain downside protection in FDI. Thus, only if there exists a complete restriction on obtaining a specified sum in the nature of downside protection would the foreign investors fail in escaping from the no assured return rule.

[1]TISPRO Regulations, regulation 2 (xvii).

[2]TISPRO Regulations, regulation 10(7)(3).

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