Foreign investments into India to acquire equity instruments (other than share warrants) i.e., equity shares, convertible shares/debentures of an Indian company are primarily regulated in terms of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”). A recent amendment to these Rules has clarified that any acquisition of shares by foreign investors pursuant to renunciation of rights by a resident will be subject to FEMA pricing guidelines. We have analyzed below the rationale for the said amendment and certain consequent fallouts.
Rule 7 of the NDI Rules inter-alia permits existing foreign investors of an Indian company to acquire securities through rights issue subject to certain conditions thereunder. The conditions inter alia include the offer being compliant with the provisions of the Companies Act, 2013 and the price at which instruments are being issued in case of a rights issue being (i) not less than the price offered to persons resident in India, in case of an unlisted Indian company and (ii) as determined by the company, in case of a listed Indian company.
Earlier, an explanation to the said Rule clarified that these conditions would apply to a foreign investor acquiring securities pursuant to renunciation of a rights issue as well. This meant that a foreign investor, not even being an existing shareholder, could acquire securities under the renunciation route at the applicable rights issue price. As one would know, the Companies Act, 2013 does not prescribe any valuation norms for a rights issue and the board of directors of a company (“Board”) is free to determine the same. This provided leeway to parties to circumvent the pricing guidelines otherwise applicable to foreign investors under the NDI Rules.
The Department of Economic Affairs, Ministry of Finance, on 27 April 2020 notified the Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules, 2020 (“NDI Amendment”) which inter alia amended Rule 7 of the NDI Rules. The NDI Amendment has omitted the aforesaid explanation and further a new Rule 7A has been inserted which states that ‘a person resident outside India who has acquired a right from a person resident in India who has renounced it may acquire equity instruments (other than share warrants) against the said rights as per pricing guidelines specified under rule 21 of these rules’.
The NDI Amendment curbs the practice of foreign investors being able to acquire securities of an Indian company in breach of FEMA pricing guidelines using the renunciation route.
Fallouts and Unaddressed Issues
The NDI Amendment would imply that, if existing foreign shareholders in an Indian company were to acquire securities of such company, a portion comprising of their rights issue entitlement and remaining portion being part of renunciation in terms of new Rule 7A, differential pricing treatment could apply where the pricing under rights issue is different from the pricing arrived at on the basis of Rule 21 of the NDI Rules. This could be an important aspect to be considered both from a commercial and a tax standpoint.
Further, the new Rule 7A relates only to renunciation of rights by a resident. It does not cover a situation where an existing foreign investor renounces a rights issue entitlement in favor of another foreign investor. It needs to be clarified whether in such cases NDI pricing guidelines would apply or the acquisition can be consummated at the prevailing rights issue price.
Section 62(1) of the Companies Act, 2013 which deals with rights issue provides that where a shareholder to whom an offer is made has declined the same, the Board of the company may dispose of them in such manner which is not dis-advantageous to the shareholders and the company. This is not a case of renunciation, but the Board’s prerogative to dispose of a portion of securities not being taken by the entitled shareholder. In such a case, the Board may even determine to dispose of such portion of securities to an existing foreign investor. The NDI Amendment does not address this scenario and therefore the question remains open if pricing guidelines under NDI Rules would apply in such cases.
It will be in good order for these aspects to be clarified by the authorities.