[The following guest post is contributed by Tanavi Mohanty, who is a corporate lawyer practising in Mumbai]
The decision of the Bombay High Court in the summary suit of IDBI Trusteeship Services Limited (ITSL) v. Hubtown Limited (Hubtown), better known as the Hubtown case has received a lot of attention for being the Bombay High Court’s pioneering judgment which unearthed a colourable structure deployed by a non-resident investor to wriggle out of the foreign exchange laws and ensure an assured return on its investment in India. The judgment was briefly discussed in an earlier post on this Blog as well. Recently, a ruling of the Supreme Court, which disposed off an appeal on the Bombay High Court’s decision, has brought the issue to the forefront again. This is particularly because the Supreme Court came to a different conclusion from that of the Bombay High Court.
The transaction in question involved a two-pronged investment structure. In the first step, the investment was by FMO, a Netherlands based non-resident investor in Vinca Developer Private Limited (Vinca), by way of subscription to equity shares and compulsorily convertible debentures (CCDs) and, in the second step, the investment was by Vinca in its wholly owned subsidiaries, Amazia Developers Private Limited (Amazia) and Rubix Trading Private Limited (Rubix) by way of subscription to optionally partially convertible debentures (OPCDs).
The structure is alleged to be illegal because it is designed to provide FMO an assured return at the rate of 14.5% on its investment of INR 418 crores in India, in violation of the Indian foreign exchange laws which prohibit non-resident entities from investing in instruments that provide a guaranteed rate of return. The structure is questionable because of two principal features: (i) a clause in the articles of association of Vinca giving a veto right to FMO with respect to matters relating to the OPCD document, and (ii) a stipulation in the investments documents executed for FMO’s investment in Vinca that the investment amount be specifically invested by Vinca in OPCDs of Rubix and Amazia.
In a summary suit filed by the debenture trustee, ITSL, for enforcement of rights under the corporate guarantee provided by Hubtown for securing due payment by Amazia and Rubix (Guarantee), the courts dissected the investment structure and observed that the summary suit, if decided in favour of ITSL, would validate the illegal structure. The rationale was that the guarantee, although prima facie a contract amongst Indian parties, was still a part of the entire (allegedly illegal) transaction involving FMO’s investment.
The Bombay High Court in its judgment dated May 5, 2015 held that the investment structure is a colourable device to circumvent the foreign exchange laws, and the Guarantee as a part of the entire transaction was unenforceable. As regards the principal issue of Hubtown’s leave to defend, the court found that Hubtown raised triable issues in its defence, and therefore, granted an unconditional leave to Hubtown to defend the suit.
A division bench of the Supreme Court, while disposing off the appeal in its judgment dated November 15, 2016, evaluated the terms of the guarantee on a standalone basis, and examined the defences raised by Hubtown in further detail. Upon analysis, the Supreme Court disagreed that Hubtown had raised any substantial defence to ITSL’s claim in the suit, and placed Hubtown’s defence in the realm of plausible but improbable, which is a departure from the finding of the Bombay High Court that Hubtown raised triable issues. Further, in light of an amendment to the Civil Procedure Code, the court granted Hubtown a conditional leave to defend the suit, requiring Hubtown to deposit the principal sum of INR 418 crores or provide adequate security for the said sum, within 3 months from the date of the judgment. The court also ordered for an expeditious trial of the suit, within 1 year from the date of the judgment. The Supreme Court relied on the fact that the Guarantee per se was not an illegal instrument and the invocation of the Guarantee, including the default in payment or the obligation to pay by Hubtown, were admitted facts.
While the Supreme Court’s judgment has reversed the finding of the Bombay High Court, thereby brightening the spirits of the foreign investor community, it has failed to express any definitive view on whether a non-resident entity 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. It is also unclear if the said investment structure devised by FMO is legally compliant and permissible under Indian law.
As long as these questions remain unanswered, the judgment does little to provide solace to non-resident investors looking to employ varied investment structures, and lends ambiguity to Indian exchange control laws.
- Tanavi Mohanty