Abstract: –
India has emerged as a key destination for foreign direct investment (FDI), particularly in the mergers and acquisitions (M&A) sector, as evidenced by record inflows reported by the Reserve Bank of India (RBI) and rankings in the UNCTAD World Investment Report 2023. However, uncertainty surrounding regulatory frameworks for downstream investments by foreign-owned or controlled companies (FOCCs) poses significant challenges. In 2023, the RBI issued notices to several FOCCs for allegedly violating FDI norms related to deferred payment of consideration for their investments, raising questions about regulatory interpretations. The RBI’s actions have left stakeholders in a state of ambiguity, as there are no explicit provisions in Indian FDI regulations regarding deferred purchase consideration for downstream investments. This lack of clarity disrupts transaction structures, extends timelines, and causes delays in statutory reporting requirements. The prevailing interpretations of the regulations vary, with some stakeholders advocating for a total prohibition on deferred consideration, while others argue for its allowance under the established 18–25 rule. This paper explores the implications of regulatory uncertainty on FOCC transactions, highlighting three interpretations of deferred consideration: complete prohibition, conditional deferral under the 18–25 rule, and unrestricted deferral. It argues that a ban on deferred consideration hinders essential transaction mechanisms, such as post-closing price adjustments, holdbacks, escrows, and earnouts, which are vital for M&A activities. The discussion emphasizes that allowing deferred consideration for downstream investments, while adhering to the 18–25 rule, aligns with regulatory goals and promotes ease of doing business. It calls for the RBI to issue clear guidelines to mitigate existing uncertainties, enhance consistency in transaction structuring, and attract greater foreign investment. Ultimately, a transparent regulatory framework is essential for fostering investor confidence and facilitating economic growth in India’s evolving M&A landscape.
Keywords : –
Foreign-owned or controlled companies,Deferred Payment, Downstream Investments, FDI Norms, RBI Regulations, 18–25 Rule, M&A Activity, Regulatory Uncertainty
Overview of the Topic : –
India has established itself as a premier global hub for foreign direct investment (FDI) and has continued to be a significant contributor to the realm of mergers and acquisitions (M&A) sector.[1] As reported by data that has been periodicallyrecorded by the Reserve Bank of India (RBI), which also functions asthe central bank of India, FDI inflows into India reached their highest level during the financial year of 2021–2022.[2] Further, the ‘World Investment Report 2023 by UN Trade and Development (UNCTAD)’ highlighted that, on a global scale, India has ranked as the eighth largest recipient of foreign direct investment in 2022.Moreover, India stood as the third-largest recipient of foreign direct investment in ‘greenfield projects’ (i.e., new initiatives) and held the position of the second-largest recipient for foreign direct investment in international project finance transactions.[3]Despite the global economic downturn, India’s M&A activity reached the highest level it has in the past ten years in 2023, as was reported in the ‘M&A Report 2023’ that was released by Bain & Company.[4] However, in this context, the ongoing uncertainty regarding regulations surrounding downstream investments, specifically by‘FOCCs’ which are called ‘foreign owned or controlled companies’ in India, coupled with the cautious stance adopted by most stakeholders following the Reserve Bank’s actions, has remained a significant challenge for foreign investors looking for investment opportunities in the country.[5]
In the year 2023, a prominent newspaper that specialises in financial news in India had reported that the Reserve Bank of India (RBI), which not only serves as the country’s central bank but also oversees adherencewith regulations governing foreign exchange control in India, had given out certain notices to several companies for violating specific FDI norms. The question then arose as to what the exact nature of these violations was?It was found that these FOCCs had deferred a portion of the consideration owed for their downstream investments in other Indian companies.[6]
Up until recently, most legal practitioners and authorized dealer banks, also known as AD Banks, which are the financial intermediaries that are responsible for routing foreign investment transactions under the relevant applicable laws, had prominently held the opinion thatFOCCs were allowed to defer a specific portion of the consideration due for their investments in other companies in India.[7] As such, the recent incidents have resulted in numerous investment and acquisition transactions that are structured through FOCCs being left in a state of utter uncertainty.
At its essence, this situation revolves around a lack of clarity in regulations. Without a clarification from the RBI, especially without an explicit provision in Indian FDI norms with regards to the deferral of purchase consideration for downstream investments, the stakeholders have been left to formulate their own interpretations with regard to the matter in discussion.[8] Previously, stakeholders had adopted a general interpretation of the applicable law regarding the deferral of purchase consideration for downstream investments.[9] However, that view has shifted following the RBI’s issuance of notices, which reflected a deduced regulatory stance on the aforementioned matter. This uncertainty with regard to the regulations to be followed is not only affectingstructures of various deals and transactions and extending previously decided timelines, but also resulting in delays in these timelines. M&A practitioners have observed that statutory reporting requirements for downstream investments involving deferred consideration are being delayed because the relevant Authorized Dealer Banks (AD Banks) are reluctant to approve filings due to the prevailing regulatory ambiguity.[10]
A blanket prohibition on deferred consideration in downstream investments merits reconsideration, as it does not align with the intent with which the Indian FDI norms that are applicable to FOCCs were drafted, in addition this lacks commercial practicality.[11]
[1] Cross-border ventures: India’s pivotal role in global investment flows (2024) ARC Group. Available at: https://arc-group.com/india-cross-border-ventures/ (Accessed: 19 September 2024).
[2]FDI in India: Foreign Direct Investment Policy of India (2024) Invest India. Available at: https://www.investindia.gov.in/foreign-direct-investment#:~:text=In%20FY%202014%2D15%2C%20FDI,inflows%20stands%20at%20%2444.42%20Bn. (Accessed: 19 September 2024).
[3]World investment report 2023 | unctad (2023) United Nations Trade and Development. Available at: https://unctad.org/publication/world-investment-report-2023 (Accessed: 19 September 2024).
[4]Singh, K. and Chandrashekhar, V. (2023) M&A in India: How Long Can This Hotspot Buck the Global Downturn?, Bain & Company. Available at: https://www.bain.com/insights/india-m-and-a-report-2023/ (Accessed: 20 September 2024).
[5]Lala, P. and Mukherjee, R. (2024) Downstream investments by foccs: Practical challenges and conundrums, Downstream Investments by FOCCs: Practical Challenges and Conundrums | Trilegal Quarterly Roundup: Jan – Mar 2024. Available at: https://trilegal.com/magazine/downstream-investments-foccs-practical-challenges-and-conundrums-insights-issue-11.html (Accessed: 20 September 2024).
[6]Dubey, A. and Sarkar, S. (2024) Deferred consideration by ‘foreign owned or controlled’ Indian companies – regulatory overhang, International Bar Association. Available at: https://www.ibanet.org/deferred-consideration-by-foreign-owned-or-controlled-indian-companies-regulatory-overhang#:~:text=Indian%20FDI%20norms%20ordinarily%20apply,not%20to%20share%20transfers%20between (Accessed: 20 September 2024).
[7]Menezes, A. (2024) Deferred consideration for foccsindia – legal perspective, King Stubb&Kasiva. Available at: https://ksandk.com/corporate/navigating-deferred-consideration-for-foreign-owned-and-controlled-companies-foccs-in-india-legal-perspective/#:~:text=The%20RBI%20appears%20to%20hold,deferred%20consideration%20since%20early%202022 (Accessed: 21 September 2024).
[8]Dubey, and Sarkar, supra note, 6.
[9]Chowdhury, P.R. and Pera, P. (2022) Exploring the latest whims of the RBI, Lexology. Available at: https://www.lexology.com/library/detail.aspx?g=9ac2b174-8376-49f4-be8f-8248332123cb (Accessed: 21 September 2024).
[10]Menezes, supra note, 7.
[11]Chandrashekar , K., Joshipura, N. and Joshi, K. (2022) DOWNSTREAM INVESTMENTS – A REGULATORY CONUNDRUM, Nishith Desai Associates. Available at: https://nishithdesai.com/SectionCategory/33/Regulatory-Digest/12/77/RegulatoryDigest/8308/1.html (Accessed: 21 September 2024).