The Government of India, Ministry of Commerce and Industry, on 18th April 2020, through its Press Note No. 3 (2020 Series) (“Press Note”), subsequently followed by a gazette notification dated 22nd April 2020 making amendment to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“FEMA NDI Rules”), reviewed the Foreign Direct Investment (“FDI”) policy for curbing opportunistic takeovers/acquisitions on Indian Companies due to the COVID-19 pandemic.
The gazette notification has substituted the earlier provisos to Clause (a) to Rule 6 of FEMA NDI Rules with three new provisos, clarifying that any entity resident outside India, may subscribe, purchase or sell equity instruments of an Indian company, provided that where such entity is of a country sharing land borders with India, will now require prior approval of the Indian Government and this approval requirements shall also apply to transactions where the beneficial owner of the investment (whether directly or indirectly) is from any such country. The actual text of the amendment to proviso to Rule 6(a) of FEMA NDI Rules reads as follows:
“Provided that an entity of a country, which shares land border with India or the beneficial owner of an investment into India who is situated in or is a citizen of any such country, shall invest only with the Government approval:
Provided further that, a citizen of Pakistan or an entity incorporated in Pakistan shall invest only under the Government route, in sectors or activities other than defence, space, atomic energy and such other sectors or activities prohibited for foreign investment:
Provided also that in the event of the transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in the beneficial ownership falling within the restriction or purview of the above provisos, such subsequent change in beneficial ownership shall also require government approval”.
The position earlier was such, that a non-resident entity could invest in India, subject to the FDI Policy, except in those sectors/activities which were prohibited. Restrictions were only there for Pakistan and Bangladesh, as entities incorporated in these two countries had to go through the government approval route for any FDI investment in India.
However, in light of this amendment, investments from countries like China, Nepal, Bhutan, Myanmar and Afghanistan will also come under this government approval route, irrespective of the sector under which the FDI is being made. Additionally, any indirect investment from a non-resident entity sharing land borders with India, is also not permitted through the automatic route and will require government approval.
Enforcement
While the press note read along with the amendment clarifies that the intent of the government is to curb the opportunistic takeovers/acquisitions of Indian companies due to the current COVID-19 pandemic, however, erecting a firewall against neighbouring countries, specially China, may back-fire for Indian companies.
As of December 2019, China’s cumulative investments in India exceed over $8 Billion, spreading over various sectors, primarily technology, manufacturing, renewable energy etc., which previously were covered under the automatic route. Therefore, investments into these sectors required no approval from the government, except few sensitive sectors like defence manufacturing, telecom etc. Considering the present scenario, the time for obtaining an approval from the government by an investor, especially in mid-sized companies in India, whose major capital was to come from China, will suffer great economic hardships.
Also, if we see the enormously high thresholds laid down by the legislature under the Government Route or under the Competition Act, 2002 with respect to takeovers and acquisitions, the intent of the legislature has always been to ensure that the investments made in large size corporates/group companies with huge stakes that would adversely impact the market or affect Indian entities in the same business are approved/monitored by the government. However, in the present scenario, not providing such thresholds and putting a blanket ban on investment, raises a question with respect to the intent of the legislature and at the same time impacts the investments in small/mid-size companies in the market.
Key Challenges and Anomalies
What is a beneficial owner?
The amendment does not clarify what “beneficial ownership” in this context would mean and the method of computation of the same. This would give a wide scope to the authorities to interpret the term “Beneficial Ownership” in the context of foreign investments. It is further pertinent to note that Foreign Exchange Management Act, 1999 (“FEMA”) read along with FEMA NDI Rules does not define the term “Beneficial Ownership”. So, for one to understand this concept, will possibly have to refer to Section 89(10) of the Companies Act, 2013 read with rule 2(e) of Companies (Significant Beneficial Owners) Rules, 2018. This would affect severely the ability of investors to exit at the moment.
How does one ascertain “persons situated in”
The part of the proviso that provides that “…or the beneficial owner of an investment into India who is situated in or is a citizen of any such country…” is vague to say the least. What kind of individuals or corporates are deemed to situated in those excepted countries. Is it that the word situated only applies to corporates and not to individuals?
Delays in Approvals
The other challenge which the entities may face is obtaining the approvals. Presently, the FDI applications seeking approvals of the government may take approximately 6 – 8 months, or may be more, depending upon the ministry/department from which the approval is sought. Therefore, taking into account all approvals which the entities from the neighbouring countries will have to seek for an FDI will drastically increase the volume of applications and may lead to further delay in obtaining the approvals.
No grandfathering of existing transactions
There is no grandfathering for transactions that have already been finalized between a investor falling within the first proviso and an Indian entity – or situations where the money has already been remitted by such investors.
Lack of further funding opportunities
Existing wholly-owned subsidiaries or joint ventures being investee companies of person(s) covered in the first proviso will have no way of receiving further funding given the Government mandate not to lay off, not to do business and continue to pay wages.
In Sum
While it can be appreciated that this amendment however is a step by the Indian Government to curb opportunistic takeovers/acquisitions of Indian companies, implementation of the same will have to be judiciously done, the notification has created a two faced dilemma. On the one hand the investors who are in the process of investment and/or exit would need to defer their plans Indian companies would not have the necessary backing to revive from the financial crunch posed by the pandemic.
Archana Balasubramanian (Partner) with Lalit Munshi (Associate)
COMMERCIAL LAW BLOG 
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