Wednesday, February 3, 2016

Easing Investor Exit in the Construction Development Sector: A Loss for Domestic Infrastructure?

[The following guest post is contributed by Abhinav Kumar, who is a 5th Year, B. A. LL. B (Hons.) student at NLU, Jodhpur]

The Department of Industrial Policy and Promotion (“DIPP”) issued Press Note 12 (“PN12”) in November, being the last of the 2015 series. Titled “Review of FDI policy on various sectors”, PN12 brought sweeping changes to the FDI regime pertaining to around 15 sectors, including construction development, defence and single brand retail. While the changes brought about by PN12 were hailed as an investor-friendly in the background of liberalization of the overall FDI regime, this post will discuss the possible adverse effects of the changes wrought with respect to investor exits in the construction development sector.

Real estate – that is, dealing in land and immoveable property with the intention of earning profit – has traditionally remained off-limits for foreign investors. However, the “construction development” sector, comprising development of townships, residential/commercial premises, roads, bridges, hotels, resorts etc. was opened up to 100% FDI under the automatic route by DIPP Press Note 2 of 2005. The regime pertaining to construction development was further liberalized by DIPP Press Note 10 of 2014 (“PN10”).

Under PN10, the conditions prescribed for investor exit were as follows. The investor was permitted to exit either on completion of the project, or after the development of “trunk infrastructure”, which was defined as defined as roads, water supply, street lighting, drainage and sewerage. The ostensible purpose behind the introduction of the trunk infrastructure condition was to prevent speculative investments by foreigners without any proper intention to develop the land. It was additionally provided that the Foreign Investment Promotion Board (“FIPB”) would consider proposals for investor exit even before the completion of the project or development of trunk infrastructure on a case-to-case basis. In other words, the investor could not exit before at least completing trunk infrastructure without FIPB approval.

These conditions have undergone a complete overhaul under PN12. The first, general condition – that the investor shall be permitted to exit either on completion of the project or after the development of trunk infrastructure – has been retained [as Paragraph 6.2.11.2(A)(i) of the FDI Policy, hereinafter referred to as “Para (A)(i)”]. However, a new set of conditions has been introduced thereafter vide Paragraph 6.2.11.2(A)(ii) [hereinafter referred to as “Para (A)(ii)”], the text of which is reproduced as follows:-

Notwithstanding anything contained at (A)(i) above, a foreign investor will be permitted to exit and repatriate foreign investment before the completion of the project under automatic route, provided that a lock-in period of three years, calculated with reference to each tranche of foreign investment has been completed. Further, transfer of stake from one non-resident to another non-resident, without repatriation of investment will neither be subject to any lock-in period nor any government approval.

There are two key takeaways from this insertion. First, notwithstanding the prescriptions of Para (A)(i), a lock-in period of 3 years with respect to each tranche of investment has been introduced. Once the lock-in period has been completed, the investor is permitted to exit the project, even if it is not complete, without the requirement of government/FIPB approval. In fact, the very concept of an FIPB-approved investor exit has been completely done away with. Secondly, the PN10 restrictions on transfer of stake between non-residents have been done away with: it is now provided that such transfers (so long as the investment is not repatriated) are not subject to any lock-in, and do not require government/FIPB approval.

While the second change with respect to transfer of stake is fairly straightforward, the first condition pertaining to investor exit merits a closer look. Under PN10 (ignoring the possibility of a government-approved exit), the minimum that an investor was bound to do before his exit was to develop trunk infrastructure. PN12, however, operates slightly differently in that it lessens investor obligations with respect to development of basic infrastructure prior to an exit. A conjoint reading of Paras (A)(i) and (A)(ii) makes the following position clear: an investor can now exit upon the completion of the project or development of trunk infrastructure; or, due to the presence of the non-obstante clause in Para (A)(ii), he can straightaway exit, even without government/FIPB approval, before the completion of the project, so long as the investment has been locked in for 3 years.

Does the completion of the 3 year lock-in ensure the completion of trunk infrastructure? It appears not, since PN10 – which introduced the concept of trunk infrastructure for the first time – made no time-bound prescription for the development of trunk infrastructure. In other words, the DIPP has never indicated any time period, let alone 3 years, within which it is assumed that trunk infrastructure can be comfortably completed. Further, given the various facets of trunk infrastructure itself – roads, water supply, street lighting, drainage and sewerage – and assuming that the project pertains to, say, a large enterprise such as a township, there is no guarantee that the trunk infrastructure would be completed within 3 years. Thus, the very introduction of the lock-in linked exit option before completion of the project means that the new, lower minimum that an investor has to do before his exit is merely complete the lock-in period, whether or not he completes trunk infrastructure during that time. Therefore, the changes brought in by PN12 essentially signal a win-win for the investor: it is not only permitted to exit before completion of the lock-in if the trunk infrastructure (or the project itself) is completed, but also to leave before even completing trunk infrastructure, so long as it has served out the lock-in period.

In sum, the revised conditions under PN12 have diluted the investor obligations as to development of trunk infrastructure: it may now exit without bringing any tangible benefit to domestic infrastructure, simply by serving out a lock-in period. In its zeal to increase the ease of doing business, the government has gone beyond “striking a balance” between domestic interest and ease of investment: the scales are clearly tilted in favour of investor convenience. Therefore, it is hoped that the government introduces, or rather, re-introduces, certain minimum development obligations for investors even within the lock-in period, so that domestic infrastructure is assured at least some gains from foreign investment.

- Abhinav Kumar

2 comments:

vswami said...

OFFHAND
Easing exit of investor is one thing; but not the same as easing exit by 'promoter' , particularly in construction of 'residential' and 'commercial ' complexes. The most must- -be -of -utmost concern is that the new regulatory law for realty sector, -implicitly, if not explicitly for anyone to readily take a note, more so a conscious note of- is seen to lend scope for such 'exit ' by promoter.

Anonymous said...

The conclusion provided by this article is not entirely correct because:

1. In the RE industry, if there is a large project, such large projects are typically split into phases. Apart from a few investors who have the appetite/ ability to stay invested for a very long period, most investors limit their investment to one specific phase. The revised policy, considering the above, has limited the requirement of 'trunk infrastructure' development to that specific phase and not the entire project. Hence, there is no question of exit through transfer of other parts of the project and obtaining undue benefit.

2. If one were to analyse the history of the FDI policy restrictions in the C&D sector, we can observe that the previous policies had placed obligations on both the NR investor and the developer to comply with the FDI policy conditionalities. This meant that the investor had to put all necessary efforts to ensure development of 'trunk infrastructure' before exit. However, this was found impractical in the India RE sphere, since NR investors did not have the wherewithal to step into the shoes of the developer (in case the developer was unnecessarily delaying the development of the project). Hence, the policy now has been revised to place all the obligations only on the resident developer. This was made with the intent to give the benefit of doubt to the investor that in case 'trunk infrastructure' has not been developed in a project and the investor can reasonably demonstrate that he was not the reason for it, he can obtain an exit.

3. Moreover, if any particular project/ phase of a project cannot have the trunk infrastructure developed within 3 years, it is most probably a bad investment for RE investors or even worse (i.e.write-off situation), except in very rare cases. Hence, exit by investors will anyway not lead to excessive foreign exchange outflow than the original investment. Net-net, there would only be a loss for the investor.

The changes to the FDI policy, in my view, will serve for the betterment of the RE investment sector.