Shareholder Exits and Regulatory Hurdles

India is positioning itself as an attractive hub for foreign investments. Gradual liberalisation in its foreign direct investment policy has seen interest from foreign shareholders. However, India is an exchange controlled jurisdiction. Broadly speaking, transactions between residents and non-residents are governed by the provisions of the Foreign Exchange Management Act, 1999 and framework thereunder (“FEMA”). Foreign investors, while making investments, also seek clarity on issues that they may face to exit their investments easily. Exit clauses in shareholder agreements can usually be triggered by investors pursuant to efflux of time or upon the occurrence of certain events. However, at the time of performance, an investor may face resistance on the ground that such clauses are invalid under the Indian regulatory regime. We have outlined below some hurdles that foreign investors face while seeking enforcement of exit clauses and their treatment by Indian courts.

An argument that is commonly seen being raised by the Indian counter party is that FEMA prohibits compliance with certain exit clauses and other obligations between parties. FEMA prescribes pricing guidelines which have to be complied with when shares are to be sold or bought from Non-Resident Investors to or by Indians.  Therefore, where the payment obligation to the investor under the exit clause entails payment higher than the fair market value (“FMV”) of the shares, it is often argued that such clauses are void.

However, schematically, FEMA provides for both, the general and special permission of the RBI. While transferring shares at FMV is allowed under “general permission” route, a party may also apply to the RBI for “special approval” to transfer the shares at a price above FMV. The Bombay High Court in Videocon Industries Ltd. v. Intesa Saupaolo SPA[1], interpreted the phrase “with the general or special permission of the Reserve Bank of India” as not mandating prior permission, and that contracts were not invalid for want of permission. Therefore, it is open for parties to apply to the RBI post-facto for permission to transfer shares at price higher than FMV, and such transfers are not per se prohibited.

Another argument also deployed under FEMA is that exit clauses provide parties with an “assured return” which is prohibited. In Cruz City 1 Mauritius Holdings vs Unitech Limited [2], a put option clause provided for payment of the investment amount plus a 15% IRR (internal rate of return), if construction of a project was delayed. The counterparty failed to make payment upon such delay, and an award was made for damages. The Court upheld the award and rejected the argument that the clause provided for an assured return which was impermissible under FEMA, holding that “Cruz City had no assurance of exit at a pre-determined return… in the event the execution of the project was commenced on schedule.

Similarly, in NTT Docomo Inc. vs. Tata Sons Limited[3], the Delhi High Court upheld an arbitral award which awarded damages on the basis of a clause promising the investor the higher of (i) the fair value of the shares or (ii) 50% of the purchase price. The investor was awarded the 50% purchase price, which was higher than the FMV of the shares. The Court held that 50% purchase price was in the nature of “downside protection” rather than an assured return. Significantly, the Court held that FEMA had no applicability in the case because the award was one of damages, which is not regulated by FEMA. In a first, when the foreign award was being enforced in India, RBI sought to intervene in the matter. However, the Court rejected RBI’s intervention application.

Despite the above judgments (or perhaps because of them) a public interest litigation was filed in the Calcutta High Court (Sanjib Kumar Dan vs. the Union of India and Ors)[4] seeking a clarification that assured returns on equity investments are illegal and in the alternative, issuance of guidelines to “curb the menace of assured return on equity investment” (sic). The petition was dismissed as misconceived on the basis that there was sufficient guidance in place.

The issue on FEMA violations impeding contractual promises has also been tested in the Supreme Court in Vijay Karia and Ors. v. Prysmian Cavi E Sistemi Srl and Ors.[5] It was argued that enforcement of a foreign award (which directed sale of shares to a non-resident entity at a discount) would inter alia violate FEMA. The Supreme Court, while affirming the decision in Cruz City, held that: (i) breach of a provision of an enactment (FEMA) would not amount to a violation of the fundamental policy of Indian law, and (ii) even if there was such a violation, it could not be used to resist the enforcement of a foreign award since RBI could always post-facto condone such breach or require that the sale take place at fair market value.

While the ruling in Vijay Karia is encouraging qua FEMA, parties may advance arguments under other legislations, such as the Securities Contracts (Regulation) Act, 1956 (“SCRA”). In Edelweiss Financial Services vs Percept Finserve Pvt Ltd and Anr[6], an arbitral award was passed holding that a put option was unenforceable as it was either a forward contract or a derivative contract, both illegal under the SCRA. The Bombay High court set aside the award and held that put options are enforceable as they are contracts of sale which come into existence only after the exercise of such option, therefore not being either a forward or derivative contract. An appeal is pending against this decision before a division bench of the Bombay High Court.

Recently, the Bombay High Court in BanyanTree Growth Capital LLC v. Axiom Cordages Limited & Ors.[7], held that a put option was valid under both the FEMA and SCRA regimes and enforced an award granting the petitioner damages for the respondents’ failure to honour the said put option. The Court followed the decisions in Vijay Karia, Cruz City and Edelweiss, and inter alia held that: (i) merely because a contract contained a put option in respect of securities, it could not be termed as a contract in derivatives and contrary to the provisions of the SCRA, (ii) the put option clause was not in the nature of an assured return  since it could only be invoked on the occurrence of certain contingencies and (iii) since the put option price at the time of exercise of the put option was less than the fair market value of the put securities, the transaction was permissible under the FEMA framework. Aside from FEMA and SCRA objections, the respondents also argued that the underlying agreement was insufficiently stamped and required to be impounded before it could be acted upon, including for the purposes of enforcement of the award. This argument too was rejected, inter-alia since it was never made before the arbitral tribunal. This is the first consolidated judgment considering objections under FEMA, SCRA, and stamping laws while considering the enforcement of a foreign award.

Given the above jurisprudence, Indian Courts appear to be largely adopting a pro-exit approach.


[1] 2014 SCC Online Bom 1276
[2] (2017) 239 DLT 649
[3] (2017) 241 DLT 65
[4] WP 6949 (W) of 2019
[5] 2020 SCC OnLine SC 177
[6] 2019 SCC OnLine Bom 732.
[7] Commercial Arbitration Petition Nos. 475 and 476 of 2019

Date: July 23, 2020