3 February 2017

SUPREME COURT APPROVES STRUCTURED INVESTMENTS

Supreme Court of India in its recent judgment of IDBI Trusteeship Vs Hubtown Limited (HubTown Case) seems to have approved that foreign investments in structured investments indirectly providing assured returns will be now permitted even though otherwise prohibited under the Foreign Direct Investments in India (FDI).
Brief facts of the HubTown Case are as follows:

• In 2009 and 2010, a non-resident foreign entity, Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden NV (FMO) invested in equity shares and Compulsorily Convertible Debentures (CCDs) of Vinca Developer Private Limited (Vinca). Upon conversion of the CCDs in Vinca, FMO would be entitled to 99% of the equity of Vinca which in turn will further entitle FMO to 99% of the voting and economic rights of Vinca.
• These monies invested by FMO in Vinca were used by Vinca to purchase Optionally Partially Convertible Debentures (OPCDs) bearing a fixed rate of interest in its wholly owned subsidiaries Amazia Developers Private Limited (Amazia) and Rubix Trading Private Limited (Rubix). IDBI Trustee Limited (IDBI) was appointed as a debenture trustee in relation to the OPCDs for the benefit of the Vinca. Further, corporate guarantee was executed by Hubtown Private Limited (HubTown) in favour of IDBI to secure the OPCDs.
• Amazia and Rubix defaulted in payment of interest in relation to the OPCD's and accordingly IDBI as debenture trustees on behalf of Vinca invoked the aforesaid corporate guarantee. In view of the default, IDBI filed a summary suit against HubTown before the Bombay High Court.
• HubTown submitted before the Bombay High Court that the investment structure was a `colourable and artificially structured transaction.` The transaction was so structured that:
  • FDI amount received by Vinca from FMO`s investment in Vinca (by way of equity shares and CCDs) would be directed towards Amazia and Rubix against issue of OPCDs bearing a fixed rate of return at 14.5% per annum which was prohibited under the existing FDI laws.
  • On conversion of the CCDs, FMO would become the owner of Vinca and thereafter be entitled to the amount received by Vinca by way of the fixed rate of return from Amazia and Rubix.
  • FMO through its Nominee Directors could solely deal with the OPCDs and IDBI.
  HubTown submitted that if the entire transaction is looked at as a whole, it clearly shows that the purpose of the transaction was to enable FMO to secure a fixed rate of return on its FDI investments in townships/construction of housing, which is in violation of FEMA Regulations as FDI investments do not permit fixed rate of return in equity investments.
• Based on the aforesaid submissions of HubTown, the Bombay High Court vide an Order dated 8 May 2015, held that the above transaction through Vinca to Amazia and Rubix was a colourable device structured only to enable FMO to secure repayment (through Vinca) of its FDI amount and its interest thereon, and is in violation of FEMA Regulations and the FDI Policy which only permitted FDI in townships/real estate development sector to be made in the form of equity and precluded any assured return thereon as it is the case herein. Accordingly, Bombay High Court granted HubTown to unconditionally defend the summary suit which otherwise is not permitted under Civil Procedure Code, 1908 if the claim amount is undisputed.
• This order was challenged before Supreme Court. The Supreme Court held an entirely different approach and viewed the transaction at every individual stage contrary to the Bombay High Court, which viewed the transaction as a whole. The Supreme Court concluded that none of the stages of the transaction, if viewed distinctively, would violate the FDI Policy or FEMA Regulations.
• In view of the facts and circumstances of the given case, the Supreme Court stated that FMO`s investment in Vinca (an Indian Company) is itself not violative of FEMA Regulations. Furthermore, payments under the corporate guarantee is made for and behalf of Vinca to IDBI (an Indian Company), thus no violation of FEMA Regulations.
• Once FMO becomes a 99% holder of Vinca (post conversion of CCDs), at that stage FMO may utilise the funds received pursuant to the overall structure agreement in India. If this is the case, there is no breach of FEMA Regulations. Lastly, at a stage when FMO wishes to repatriate such funds, RBI permission would be necessary. However, if RBI permission is not granted, then again there would be no violation of FEMA Regulations as the funds would remain within the Indian economy itself.
• This being the case, the Supreme Court concluded that IDBI needs to be protected. HubTown would be granted leave to defend the suit only if it deposits in the Bombay High Court the principal sum invested by FMO in Vinca within a certain specified period.

MHCO COMMENT:

This Judgement is a landmark development in the life of structured investments in India and lays down the future approach which the Courts will be adopting in comprehending similar transactions. However, the order of the Bombay High Court was more admissible to the facts and circumstances of the given case, since it did not bypass the underlying intention with which FMO invested in Vinca i.e. to receive a fixed rate of return on its investments which is in violation of FDI Policy and the FEMA Regulations.

(The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or contact@mhcolaw.com for any assistance.)