-FOREIGN DIRECT INVESTMENTS- (BENEFICIAL INTEREST) INTERPRETATION AND IMPLEMENTATION OF PRESS NOTE 3 (2020 SERIES)

By notification of Press Note 3 (2020 Series) on April 17, 2020, the Government of India has attempted to curb the opportunistic takeover of the Indian entities by neighboring jurisdiction, which shares land borders with India, due to their feeble position owing to COVID-19 pandemic. Though the Press Note has not named any specific jurisdiction, yet this move is unambiguously aimed at Chinese Investments, which have seen a steep rise in Indian markets. The Statement on country-wise FDI equity inflows published by Department for Promotion of Industry and Internal Trade (“DPIIT”) shows that FDI equity inflow of USD 2,378.71 million (equivalent to INR 15,112.07 crore) has been received from China during the period April 2000 to March 2020[1]. Further, the increase of the shareholding percentage of People’s Bank of China in HDFC Bank to over 1% during the COVID-19 pandemic, has also compelled the Government to take the recourse of stricter norms in FDI policy in order to safeguard domestic markets from hostile acquisitions.

The legal framework, as notified by the Government of India vide the above Press Note and consequent amendment in the Foreign Exchange Management (Non-Debt Instruments) Rules 2019 (“NDI Rules”), has already been discussed in our previous article “Investments from China require Government Approval- Fair Dealing is a Key” which may be accessed at https://www.acumenjuris.com/images/upload/2525040407074904Investments%20from%20China%20requires%20Government%20Approval-%20Fair%20Dealing%20is%20a%20Key.pdf

Without re-iterating the amended provision, this article seeks to cover the interpretation and implementation of the Press Note 3 (2020 Series) with a set of diverse transactions.

I. Interpretation of the term ‘Beneficial Owner’

 As per the revised FDI regime, where the beneficial owner of the Investment in India is situated or is a citizen of a country which shares a land border with India (“Restricted Country”), such investment shall be made under the Government route. However, the Government of India has not defined the term “Beneficial owner”. The question arises is:

Whether any trivial investment in India from such will fall under the ambit of approval category or there is a certain threshold defining the criteria of beneficial ownership?

While issuing the Press Note, the Government has not defined the term “beneficial owner” of the investment. Also, the said term can neither be found in FDI Policy nor in the NDI Rules (including its predecessor, Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000/2017).

Resorting to the popular/ dictionary meaning of the term “beneficial owner”, which means that “individual or entity that enjoys the benefit of owning an asset, regardless of whose name the title of the property or security is in”.

Relating to the concept of investment, here the asset shall be treated akin to the security (shares, compulsorily convertible preference shares/ debentures), which shall be allotted by the investee entity to the investing party (individual or body corporate) pursuant to the investment, who then becomes the beneficial owner of such security. At times, instances are seen where the securities are registered in the name of say Mr. A (Indian resident), however, the benefits accruing out of such security, like dividends, surplus, etc are enjoyed by Mr. B (Chinese resident). In that event, Mr. B shall be considered as the beneficial owner of the security issued to Mr. A. Hence, any prospective investment in respect of the securities held by Mr. A for the benefit of Mr. B shall entail the approval of the Government of India.

Moreover, some schools of interpretation recommend taking the reference of the term “beneficial owner” with its identical term “beneficial interest” from the Companies Act, 2013 read with the Companies (Management and Administration) Rules, 2014. Section 89(10) of the Companies Act, 2013 presents an inclusive definition of the term “beneficial interest”, which provides that “beneficial interest in a share includes, directly or indirectly, through any contract, arrangement or otherwise, the right or entitlement of a person alone or together with any other person to (i) exercise or cause to be exercised any or all of the rights attached to such share, or (ii) receive or participate in any dividend or other distribution in respect of such share”[2].

It can be observed that this definition is very much in line with the popular meaning of the term “beneficial owner” and seeks to connote a broad interpretation to include any form of interest attached in relation to the subject shares.

One of the most prominent and noteworthy similarities in the meaning of “beneficial owner” as defined in the Companies Act, 2013 and the popular meaning is that none of the said definitions provide any specific quantum or ceiling to categorize beneficial ownership in the share. In other words, it can be deduced that the concept of beneficial ownership lies even in case of 1 share i.e. (quoting the above example) even if Mr. A hold 1 share for the benefit of Mr. B, the former shall be considered as the registered owner and the latter shall be classified as a beneficial owner in respect of that 1 share. Consequently, the required declarations shall be required to make by both the parties to the company.

Further, it is ought to be considered that had the Government intended to limit the concept of beneficial ownership up to the certain threshold, it would have certainly defined the term while issuing the press note or at any time thereafter, however, there has not been any notification or circular by the Government in this respect for narrowing the criteria of adjudging the beneficial owner of the investment.

Thus, on the basis of implication drawn from the popular meaning, Companies Act, 2013 and the intention of the Government in this respect, it is inferred that the Press Note seeks to include any form of investment from the Restricted Country, be it trivial or large, in the mandatory approval zone.

II. Applicability on the existing investments

 The Press Note requires that investments in India by the persons of Restricted Country shall be under Government Route. However, it is silent on past investments, if any received from such a country. The question arises is:

 What will be the scenario if the Indian entities already have investment from Restricted Country? Whether only future investment shall entail the approval, or the Indian company has to seek post-facto approval for all such investments or both?

It is an established rule that unless expressly notified, any amendment is prospective in nature. Hence, the Indian entities, which already have investments from Restricted Country(ies) are not required to obtain post-facto approval for regularizing their existing investments. However, in case such entities are anticipating receiving investment from their existing investors from the Restricted Country, such investment shall entail the prior approval of the Government of India.

Further, the transfer of ownership in any security, from the existing shareholder (belonging to the Non-Restricted Country) to person (including existing shareholder, belonging to the Restricted Country) shall also attract the approval requirement.

III. Direct and Indirect Investments

The Press Note talks only about the investment and does not demarcate between “Direct” and “Indirect” Investment. The question arises is:

Whether the Government seeks to include any form of investment- direct or indirect?

By using the term ‘investment’, the Government has amplified its supervisory powers by implied including every form of investment in its ambit, whether direct or indirect, in its arena of assessment.

For eg. XYZ Ltd (Indian Company), the wholly-owned subsidiary of ABC Company (Chinese entity), proposes to make an investment in PQR Ltd (another Indian Company). This form of investment shall come under the category of indirect investment (or Downstream Investment) and hence, the proposed investment shall require to be examined by the Government of India.

IV. Indirect Acquisitions where the beneficial owner is from China or any other Restricted Country.

The approval is required when the beneficial owners of the investments are situated in or are the citizens of Restricted Country. However, instances may occur, where the shareholder of the Indian company, being a body corporate (belonging to a Non-Restricted Country) is acquired by a person based in the Restricted Country (may or may not be an existing shareholder of Indian Company). The question arises is:

Whether the Acquirer/ Indian company is required to obtain the approval of the Government of India before proceeding for acquisition which is resulting in the vesting of beneficial interest to a person belonging to a Restricted Country?

Let us analyze this issue with the help of an example.

ABC LLC (USA Company) and PQR Co. (Chinese Company) are the shareholders of XYZ Ltd (Indian Company). PQR Co. proposes to acquire ABC LLC.

As per the press note, the approval of Government of India is required before executing the proposed acquisition since PQR Co. will be the shareholder of the XYZ Ltd in respect of the shares held by ABC LLC and the beneficial interest (along with the registered ownership) in such shares shall stand transferred in the name of PQR Co.

Another example can be quoted as follows:

Among other shareholders, ABC LLC (USA Company) is one of the shareholders of XYZ Ltd (Indian Company). Another company (which is not a shareholder of XYZ Ltd) proposed to acquire ABC LLC.

In this case, it is to be noted that pursuant to the proposed acquisition, PQR Co. will become the shareholder of ABC LLC and the beneficial interest (along with the registered ownership) in the shares of XYZ Ltd shall stand transferred in the name of PQR Co. Thus, the approval of the Government of India shall be entailed before such acquisition.

Further, the approval requirement shall also hold valid even there is an investment (instead of acquisition) by PQR Co. in ABC LLC since it results in indirect transfer of ownership of XYZ Ltd to PQR Co. through ABC LLC in respect of the proportionate holding held by ABC LLC.

It is ought to be considered that % shareholding by ABC LLC in XYZ Ltd is irrelevant for the purpose of assessing the approval requirement.

Practically, we observe that the proposed transaction is basically a subject matter of two parties, PQR Co. and ABC LLC. In the case of closely-held companies, the proposed acquisition is expected to be in the knowledge of XYZ Ltd and thus, XYZ, being an Indian company can familiarize the non – resident parties of the approval requirements before the proposed acquisition/ investment takes place. However, in case, ABC LLC Ltd is a widely held company, XYZ Ltd cannot be assumed to have any acquaintance of the anticipated transaction resulting in the change of beneficial ownership in favour of the person belonging to Restricted Country and hence, the PQR Ltd would be under the obligation and responsibility to obtain the required approval from the Government of India.

The above is only an example of an indirect acquisition with a single company involved in the middle, however, there can be an acquisition where there is a chain of companies involved between the Indian company being acquirer and the Acquirer from the Restricted Country.

Therefore, considering the complexity involved, it is advised to closely assess each transaction for the acquisition of the Indian Company or any of its shareholder entity for any beneficial interest of the Restricted Country.

Authors: I Abhishek Bansal, Partner (abhishek.bansal@corpacumen.com) I Laxmi Sinha, Senior Associate (laxmi.sinha@corpacumen.com) I ACUMEN JURIS I

Practice Areas: I Corporate & Commercial I Acquisitions & Investments I Arbitration & Dispute Resolution I

Disclaimer- This Article is for information purposes only, and the views stated herein are personal to the author, and shall not be rendered as any legal advice or opinion to any person, and accordingly, no legal opinion shall be rendered by implication.

The Article does not intend to induce any person to omit, commit, or act in any particular manner, and that you should seek legal advice before you act on any information or view expressed herein. We expressly disclaim any financial or other responsibility arising due to any action taken by any person on the basis of this Note.

[1] https://dipp.gov.in/sites/default/files/FDI_Factsheet_March20_28May_2020.pdf

[2] Inserted by The Companies (Amendment) Act,2017 - Amendment Effective from 13th June 2018