Over the past 20 hours, we at Lexygen have received innumerable calls and emails seeking our view on the corrigendum issued yesterday by the Department of Industrial Policy and Promotion (“DIPP”) deleting a paragraph of the Consolidated FDI Policy 2011 issued in early October (“FDI Policy”) which prohibited Indian companies from issuing shares under the FDI route “with in-built options”. While the corrigendum has been universally welcomed by the PE/VC community, one question that I have been getting asked repeatedly is as to whether this really means that put and call options can now be considered kosher once again, and whether transaction documents can now revert to including put/call option clauses in favour of foreign investors. This column is a reaction to, and a product of, my discussions with these various querists.
Many of us have followed with interest the put/call options drama unfolding in the Indian PE/VC arena over the past several months. While the issue has been receiving a lot of coverage over the past 3-4 months, some of us have been casting anxious glances over our heads for a much longer time now at this potentially lethal sword dangling dangerously over numerous PE/VC deals. While many readers may be familiar with the issue, for the sake of setting the context, let me begin by giving a very brief background summary.
Background to the Issue
The options controversy started when, a few months ago, the Reserve Bank of India (“RBI”) served notices to some Indian companies questioning the “put/call option” clauses contained in shareholders’ agreements entered into by such companies with foreign investors, despite the applicable laws of India then containing no prohibitions on such clauses. The RBI had taken the position in those notices that the inclusion of any sort of option clauses in shareholders’ agreements with foreign parties effectively amounted to raising foreign debt (external commercial borrowings, or “ECB”s) disguised as equity infusion.
This controversy came to a head in October when the DIPP issued the FDI Policy in which it specifically introduced language stating that any equity infusions by foreign parties with “in-built options of any kind” would be treated as ECB and would have to comply with the stringent restrictions under the ECB Regulations. This new paragraph in the FDI Policy effectively made any sort of option clauses impossible to include in PE/VC transaction documents. This had caused a fair amount of anxiety amongst the PE/VC investor community, as also amongst strategic investors, as it took away a very important downside protection to such investors investing in Indian companies. This move to prohibit options clauses in FDI transactions has been widely been assailed as retrograde, and fears have been vociferously expressed that this move could adversely affect FDI inflows into India, thereby exacerbating an already difficult deal environment.
Implications of the Corrigendum – Will RBI Buy In?
The scheme and structure of the foreign investment laws in India is that while the RBI has been vested with powers under the FEMA to make regulations for the implementation of foreign investment into Indian companies and to administer the same, the broader policy decisions with respect to foreign investment are made by the DIPP. Therefore, the regulations made and administered by the RBI need to be in conformity with the principles of foreign investment policy laid down by the DIPP. The RBI frequently also takes inputs from time to time from the DIPP and the Ministry of Finance on matters of policy with respect to foreign investment.
While, of course, it is not very easy to read the crystal ball with respect to regulatory intent on this issue, by looking at the background and sequence of events, one can get some firm pointers as to the regulatory thinking on this issue. It is worth noting that it was only very recently (after years of investment of several billions of dollars into India with such option clauses) that the RBI started raising objections as to the validity of these options. Quite clearly, it appears that there was a fair amount of discussion between the RBI and the DIPP on this issue, and it would seem that it was in recognition of, and to address, the lack of legal backing for the RBI’s position that the FDI Policy (issued in early October) specifically included paragraph 188.8.131.52 which stated that no “in-built options” could be a part of any FDI into Indian companies.
In other words, it clearly appears to me that the regulator and policy-makers concluded that there was no legal backing (prior to October, 2011) for the RBI to take the position that options to foreign investors are not permitted, and hence, decided to include paragraph 184.108.40.206 in the FDI Policy to give this position legal/policy backing. And yesterday, by issuing a corrigendum specifically to delete this paragraph, the DIPP has taken away this short-lived policy backing to the RBI’s position.
Given this background and sequence of events, it would be a reasonable conclusion to reach, in my view, that the very fact that the DIPP chose to issue a specific corrigendum deleting paragraph 220.127.116.11 in its entirety barely a month after issuing the FDI Policy (which had introduced this prohibition for the first time ever) makes it abundantly clear that the regulatory position and thinking has changed after further consideration of the issue, perhaps after joint discussions between RBI and DIPP, taking into account the widespread backlash from industry.
The DIPP would not, in my view, have reasonably spent the time and effort to formally announce a deletion of that paragraph in such a short span of time unless it wanted to send a clear and reassuring message that it had concluded that such a restriction/prohibition on options was undesirable in the interests of India attracting more FDI.
Having said the above, it is possible that the RBI may continue to question such options in FDI deals notwithstanding the corrigendum. In my view, however, in the absence of a further change or clarification in the FDI Policy by the DIPP, or in the FEMA Regulations by the RBI, any attempt by RBI henceforth to question such put and calls options in FDI deals would be a weak one in law.
The foreign investment policy intent has been made abundantly clear by the DIPP in amending the FDI Policy to remove paragraph 18.104.22.168 in its entirety. The most logical and reasonable conclusion in the circumstances is that the policy-maker has considered the matter further and has arrived at an informed policy choice that the formal deletion of paragraph 22.214.171.124 from the FDI Policy is necessary and desirable in the interests of the Indian economy. Given this clearly demonstrated policy directive from the DIPP, I would think that the RBI should not raise this issue again in FDI transactions till such time as put and call options continue to be not prohibited by the FDI Policy of India.