It is not very often that courts in India have had the occasion to interpret and rule on the Foreign Direct Investment (FDI) Policy of the Government of India. Earlier this month, the Bombay High Court issued its ruling in IDBI Trusteeship Services Ltd. v. Hubtown Ltd., which relates to the legalities of a foreign investment structure that involved compulsory convertible debentures (CCDs) issued by an Indian company to a foreign investor the proceeds of which were in turn used by the Indian company to invest in optionally convertible debentures (OCDs) of two other companies operating in the construction development sector. The specific issues in question relate to the permissibility of assured returns to the foreign investor and the nature of downstream investments. Sandip Bhagat, et. al., discuss the facts, issues and decision in an article on The Firm.
Here, I propose to highlight some of the key implications of this judgment that may be of wider relevance:
1. The Bombay High Court has demonstrated its willingness to view the transaction as a whole by transcending beyond the form and into the substance. In other words, although the transaction involved two stages of foreign investment into a holding company, which in turn invested in two operating companies, the court effectively viewed the transaction as a whole and not in separate parts. The openness to re-characterizing the transaction may cause some amount of uncertainty in structuring foreign investments. Moreover, the reliance of the Court in doing so on judgments of the Supreme Court relating to aspects such as taxation and cases involving fraud leaves the debate somewhat open.
2. The implications of the judgment on downstream investments are categorical in that foreign owned/controlled investment companies in India must follow all aspects of foreign investment regulations (including types of investment instruments such as equity shares or CCDs). This enhances the compliance requirements of downstream investments.
3. In essence, the Court declined to validate the transaction due to the presence of an assured return. This will have to be considered in the context of pronouncements by the Reserve Bank of India (RBI) of its intention to liberalize greater flexibility in the pricing of instruments, including an assured return, in the context of optionality clauses, as discussed here.
In any event, this does not appear to be the final word as the Court was only determining whether there are triable issues in a summary suit that require further adjudication. The hearing in the suit is to follow.