The issue of whether put options, exits at assured returns and guarantee arrangements between Indian and foreign parties are enforceable under the provisions of the Foreign Exchange Management Act, 1999 (FEMA) has received much regulatory and judicial attention lately. The dispute between Tata Sons and NTT Docomo heard by the Delhi High Court was being watched very closely until the case was recently settled. However, earlier this week, the Delhi High Court issued its judgment in another case that might potentially pave the way for enforcement of the aforementioned arrangements by foreign parties against Indian parties, and that the provisions of FEMA and related regulations may not come to the rescue of the Indian parties.
In Cruz City 1 Mauritius Holdings v. Unitech Limited, an investor Cruz City sought to enforce a foreign arbitral award against Unitech (an Indian company) and its wholly owned subsidiary Burley Holdings Ltd. (a Mauritius company). By way of a Shareholders’ Agreement (SHA), Cruz City had invested in Kerrush Investments Limited (a Mauritius company) which, through its downstream subsidiaries in India, was to undertake some real estate projects. Under the SHA, Cruz City was entitled to exercise a put option by which it could call upon Burley to purchase its shares in Kerrush at a “post tax IRR of 15% on the capital contributions made by Cruz City in the event commencement of construction of [a specified real estate project] was delayed before the specified period”. Under a separate Keepwell Agreement entered into between Cruz City, Burley and Unitech, Burley agreed to undertake obligations under the SHA in relation to the put option, and Unitech in turn agreed to make sufficient funds available with Burley so as to enable Burley to undertake its obligations towards Cruz City.
In 2010, due to delays in the specified real estate project, Cruz City exercised the put option. Due to the failure by Burley and Unitech to comply with the same, Cruz City initiated an LCIA arbitration and obtained an award against them. When that award was sought to be enforced before the Delhi High Court, Unitech (amongst other objections) raised issues pertaining to the fact that the enforcement of the arbitral award, being impermissible under FEMA, was contrary to public policy. These contentions were rejected by the Delhi High Court, although it clarified that any payments to be made by Unitech would be subject to the provisions of FEMA, including where required based on permissions from the Reserve Bank of India (RBI).
In arriving at this conclusion, the Delhi High Court was largely concerned with the scope of the “public policy” exception under section 48 of the Arbitration & Conciliation Act, 1996. At the outset, the Court addressed the question “whether violation of any regulation or any provision of FEMA would ipso jure offend the public policy of India”. After considering the relevant case law, the Court concluded that “the width of the public policy defence to resist enforcement of a foreign award, is extremely narrow. And the same cannot be equated to offending any particular provision or a statute.” It went on to note:
96. It plainly follows from the above that a contravention of a provision of law is insufficient to invoke the defence of public policy when it comes to enforcement of a foreign award. Contravention of any provision of an enactment is not synonymous to contravention of fundamental policy of Indian law. The expression fundamental Policy of Indian law refers to the principles and the legislative policy on which Indian Statutes and laws are founded. The expression "fundamental policy" connotes the basic and substratal rationale, values and principles which form the bedrock of laws in our country.
97. … One of the principal objective of the New York Convention is to ensure enforcement of awards notwithstanding that the awards are not rendered in conformity to the national laws. Thus, the objections to enforcement on the ground of public policy must be such that offend the core values of a member State's
national policy and which it cannot be expected to compromise. The expression "fundamental policy of law" must be interpreted in that perspective and must mean only the fundamental and substratal legislative policy and not a provision of any enactment.
Distinctions were made between the policy framework of the Foreign Exchange Regulation Act, 1947, which was restrictive in nature, and its successor legislation FEMA, which is more permissive in nature. However, the role of the RBI is not in any way undermined, as the Court notes below:
107. Having held that a simpliciter violation of any particular provision of FEMA cannot be considered synonymous to offending the fundamental policy of Indian law, it would also be apposite to mention that enforcement of a foreign award will invariably involve considerations relating to exchange control. The remittance of foreign exchange in favour of a foreign party seeking enforcement of a foreign award may require permissions from the Reserve Bank of India. There may also be a question whether the initial agreement pursuant to which a foreign award has been rendered required any express permission from RBI. However, as indicated earlier, the policy under FEMA is to permit all transactions albeit subject to reasonable restrictions in the interest of conserving and managing foreign exchange. India has not accepted full capital account convertibility as yet. Thus, there are transactions for which permission may not be forthcoming. Whereas certain transactions are permitted under FEMA and regulations made thereunder without any further permissions; other transactions may require express permission from the RBI. However, these considerations can be addressed by ensuring that no funds are remitted outside the country in enforcement of a foreign award, without the necessary permissions from the Reserve Bank of India. This would adequately address the issue of public interest and the concerns relating to foreign exchange management, which FEMA seeks to address.
Based on its broader ruling on the inability to use FEMA as a defence against enforcement of the award against Unitech, the Court examined some of the specific facts and circumstances of the case. First, it was found that reading the SHA and the Keepwell Agreement together, Unitech only had a payment obligation to fufill its commitment to stand behind Burley, and it had no compulsion to purchase the shares of Kerrush, which could instead be purchased by Burley (which is a foreign company and hence not subject to restrictions under FEMA such as pricing norms).
Second, Unitech’s plea that Cruz City’s investment was in breach of FEMA was rejected by the Court. Interestingly, the Court’s rationale involved relying on the representations and warranties made by Unitech under the Keepwell Agreement that its obligations are valid and legally enforceable. In other words, having made detailed representations and warranties regarding the enforceability of its obligations, Unitech cannot be heard to rely the falsity of its own representations to contend that the obligations are not enforceable.
Third, the Court found that Unitech’s obligations under the Keepwell Agreement, being in the nature of a guarantee of the obligations of its subsidiary, Burley, are within the purview of the Foreign Exchange Management (Guarantees) Regulations, 2000 as they specifically permit an Indian company to provide a guarantee on behalf of a wholly owned subsidiary.
Finally, the argument that assured return clauses are unenforceable was not accepted either by the Court. This was on the ground that the assured return was not absolute and unconditional, but was capable of being invoked only in specific circumstances (such as when a project has been significantly delayed). In that sense, the assured return was possible only in the event of certain contingencies and not otherwise (such as when a project is completed on schedule). However, the Court did not venture into a detailed discussion or analysis of the pricing norms under FEMA and related regulations that has typically stood in the way of clauses relating to assured returns.
In all, the decision of the Delhi High Court in this case seems to favour the enforcement of contractual obligations undertaken by the parties. It eliminates the ability of Indian parties to rely on FEMA as a means to renege on such obligations, and hence provides some relief to foreign investors seeking such clauses. Ultimately, however, since the payment obligations of Unitech would be subject to the approval of the RBI, it might be that the ball would be largely in the RBI’s court in such instances. If history is anything to go by, the RBI has consistently adopted a strict stance, in which case the outcome in such situations remain uncertain.