The Supreme Court has clarified that the purchase of shares or compulsorily convertible debentures (CCD) by a foreign investor in a real estate company does not violate the Foreign Exchange Management Act (FEMA) regulations, in a ruling that could help soothe investors’ concerns and boost inflows of foreign direct investments in the real estate sector.
The ruling came on a petition by IDBI Trusteeship Services Ltd, on behalf of Dutch government-backed financial institution FMO, against Mumbai-listed developer Hubtown Ltd. IDBI Trusteeship had approached the apex court after the Bombay High Court, in June last year, ruled that FMO’s investment of Rs 418 crore was made in a manner not compliant with foreign investment guidelines. It had also said that FDI in the real estate sector can be made only via equity instruments, not debt, and that offshore investors can’t seek legal remedy for their assured-return investments.
A division bench of the Supreme Court comprising Justice Kurian Joseph and Justice Rohinton F Nariman, earlier this week, set aside the high court order and directed it to finish the case within a year. It also asked Hubtown to deposit Rs 418 crore in the high court within three months. IDBI Trusteeship, as the debenture trustee, had sought to enforce the corporate guarantee and recover FMO’s investment of about Rs 532 crore that included interest.
FMO had entered into an agreement to invest in Hubtown, earlier known as Ackruti City Ltd, in 2009. The money was invested to buy shares and CCDs—debentures that must be converted into equity by a predetermined time—of Hubtown group company Vinca Developer Pvt Ltd. Hubtown owned 90% while FMO held 10% of Vinca. At the time of investment, FMO held three CCDs in Vinca with a conversion period of five years from December 2009. After conversion, FMO’s stake in Vinca was to rise to 99%.
Vinca used the money to buy Optionally Convertible Debentures (OPCD) issued by Hubtown’s wholly owned subsidiaries Amazia Developers and Rubix Trading, which were constructing real estate projects. These OPCDs had a fixed annual interest rate of 14.5%. IDBI Trusteeship was the trustee of the debentures issued by Vinca, Amazia and Rubia.
In 2012, after Amazia and Rubix defaulted on payment in respect of OPCDs, IDBI Trusteeship issued notices asking them to fully redeem all the debentures at par. The next year IDBI Trusteeship approached the high court, where it didn’t get a favourable verdict. It was then that IDBI Trusteeship moved the top court.
Senior counsel Abhishek Manu Singhvi, who represented FMO in the case, said that there was no question of any infraction of FEMA regulations because the funds had gone to purchase equity shares of Vinca in the form of fully convertible debentures and that there was no question of any illegality in the said transaction.
However, Hubtown counsel Aspi Chinoy argued that there was a clear breach of FEMA Regulations and that the high court was correct in saying that the court cannot help enforce such illegality.
The Supreme Court agreed with FMO and IDBI Trusteeship. In its 48-page judgment on 15 November, the division bench said FMO’s investment in Vinca for purchase of shares and CCDs doesn’t violate FEMA regulations. It added that payment under the said guarantee is to the debenture trustee, an Indian company, for and on behalf of Vinca, another Indian company, so that prima facie there is again no infraction of FEMA regulations.
Hubtown will now have to deposit Rs 418 crore in the Bombay High Court and the court will ascertain the rights of FMO over the sum deliver its final ruling within a year on the entitlement rights.
Boost to investors
The top court’s decision comes as a welcome boost to foreign investors in the real estate sector, many of whom have been unable to exit their investments due to disputes with developers.
The real estate sector had received a large amount in funding from foreign investors and private equity funds before and during the peak years of 2007-08. But the economic slowdown and market volatility that followed led to a delay in project construction and prompted developers to defer plans for public share sales. Investors got stuck in such projects and in several cases got embroiled in legal disputes with developers.
In 2009, for instance, real estate-focused private equity firm Sun Area Property Partners invested around Rs 235 crore in Mumbai-based developer Rustomjee's flagship company Keystone Realtors. In 2011, the investor alleged fraud and mismanagement of funds by the company. The two sides fought in various judicial forums before settling the matter in 2013.
Similarly, in December last year, Gurgaon-based developer BPTP Ltd agreed to buy back the stake held by JP Morgan and Apollo Global for Rs 693 crore ($105 million) following a long-drawn arbitration.
“This will go a long way in the transition of India from ‘incredible India’ to ‘credible India’,” said VP Singh, partner—litigation and dispute resolution at law firm AZB & Partners. “The judgment is a shot in the arm for structured FDI in the real estate sector. It is far reaching as it gives a signal to investors that courts will positively enforce contracts, especially when the money has been invested in India without any specific prohibition by the Reserve Bank of India.”
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