Measuring the Independence and Performance of the Independent Director

by Mr Suraj Choudhary (B.A., LL.B (Hons.) 2009, JGLS

The inclusion of independent directors on the Board of Directors is considered integral to the corporate governance framework. In India, most of the companies are closely held by promoter groups from the same family. The average promoter shareholding in BSE 500 companies is estimated to be over 50%. Hence, in order to counter the dominance of promoters and business families, and to safeguard the interest of all other stakeholders, it has become critical to have an independent voice in the Boardroom.

In India, the concept of independent directors was first introduced through voluntary guidelines issued by the Confederation of Indian Industry (“CII”). In 2000, the recommendations provided in the Kumar Mangalam Birla Committee Report prompted the Securities Exchange Board of India (“SEBI”) to include clause 49 in the Listing Agreement, which made appointment of independent directors sine qua non for listed companies or companies intending to be listed; the Listing Agreement has no application to companies that do not intend to be listed.

The Companies Act, 2013, (the “Act”) has introduced the concept of mandatory independent directorship, thereby requiring all companies, irrespective of whether they are listed, non-listed, public or private companies. Section 149(6) of the Act has defined the term ‘independent director’ in relation to a company. Accordingly, an independent director means a director other than the managing director or a whole-time director or nominee director.

An independent director should have or have had no direct or indirect pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year. To make the definition more stringent, pecuniary relationships with group companies within the same promoter group are also be included as a parameter for determining the directors’ independence.

The Act proposes to limit the tenure of independent directors to two terms of five years each. The Act mandates at least 1/3rd of the total number of directors should be independent directors in a listed company.

The Act also provides that the performance evaluation of the independent directors shall be done by the entire board of directors, excluding the director being evaluated and a report of performance evaluation would be prepared. This report will determine whether the term of appointment of the concerned director should be extended.

Lacunae and Suggestions

The remuneration paid to the independent directors by the company is a key factor that may give rise to an inherent conflict of interest. It is important that the remuneration package of the directors is tapped as a potential instrument for maintaining independence of independent directors. This may be done by linking remuneration with the performance of the company. An independent director’s ability to act independently from management is directly proportional to the remuneration offered to him.

The existence of exclusive and capped compensation would add little or no value to the object behind the provisions enactment and would prove as a hindrance in the way of the directors seeking to add value to the company by exerting over and above what is required by them. Independent directors may also be reluctant to disturb the collegiality and conviviality of collective decision-making, thereby precluding themselves from effectively discharging their roles. After a thorough scrutiny, it emerged that Satyam’s board of directors had unanimously approved a proposal to acquire two firms promoted by Raju’s family — Maytas Infra and Maytas Properties. The Serious Fraud Investigation Officer (“SFIO”) concluded that the independent directors were kept in the dark by A. Ramalinga Raju. Some of the independent directors later stated the approval for Maytas was not unanimous because it was subject to certain conditions.

Quick on the heels of the Satyam imbroglio, came the scandal where the very whistle blowers of corporate governance were found guilty of insider trading. One such case is that of Mr. V.K. Kaul, an independent director in a pharmaceutical major, who was found guilty of insider trading by the Securities Appellate Tribunal (“SAT”).

Further, the Act provides for two terms to change the composition of the boards which leaves room for persons, who have been on the Board for long tenures, to potentially serve further two terms as independent directors of the company. Therefore, the changes that the Act seeks to bring in independent functioning of the Board will come into effect ten years down the road in listed companies, which already have independent directors on their Boards. Moreover, the one year provided to companies to appoint independent directors is too short, and may prevent thoughtful appointments in the first tenure.

In India, we place an unrealistic expectation from our independent directors which needs to be tempered in the face of current laws. Relying overly on a singular metric as the key gate keeper may not safeguard stakeholders' interests. We continually need to remind ourselves that the only role of the independent director is to make sure that the rights of the minority and small shareholders is not abused and that is what he should be judged for.

It is also suggested that the requirement of performance evaluation for directors be made mandatory. The importance of performance evaluation of independent directors is such that the Standing Conference of Public Enterprises (“SCOPE”), the apex body of public sector undertakings (“PSU”), is developing a matrix for rating the performance of independent directors in PSUs. Such evaluation report of the independent director may be based on his attendance and contribution to the board/committee meetings and such appraisal may be placed before the nomination committee for taking a decision for re-appointment. This process of critical analysis of the performance of independent directors will not only enable the directors to focus more on their area of weaknesses but it will also build on their strengths enabling them to add value to the company.

Option/Right to Exit

by Ms. Preksha Malik (B.A., LL.B. (Hons.) 2009 , JGLS

In January 2014, the Reserve Bank of India (“RBI”) permitted option/right to exist clauses in foreign direct investment (“FDI”) instruments by a notification amending the Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000 (“FEMA 20”). The welcomed step by RBI was in light of the clearance granted to call and put options and pre-emptive rights by Securities and Exchange Board of India (“SEBI”) through the notification dated 3^rd October 2013.

The Foreign Exchange Management Act, 1999 (“FEMA”) is the Act governing FDI in India, with RBI and Central Government as the regulatory authorities. Under Section 6(3)(b) and Section 47 of FEMA, RBI notified FEMA 20, which governs the nature of instruments that can be validly issued or transferred by a person resident outside India. Prior to the notification dated 6^th January 2014, FDI instruments with call and put options and pre-emptive rights, including tag-along, drag-along, right of first refusal and right of first offer, were treated as debt rather than equity and did not qualify as valid FDI instruments. In other words, instruments with optionality clauses would attract External Commercial Borrowing (“ECB”) Regulations rather than FDI Regulations and be subject to greater regulatory requirements. However, the clearance for option/right to exit clauses in FDI instruments was made subject to certain requirement and pricing guidelines, which were clarified in RBI notification dated 9^th January 2014.

The highlights of the January notifications are:

• Optionality clauses have been permitted for equity, compulsorily and mandatorily convertible preference shares and compulsorily and mandatorily convertible debenture.
• Minimum lock-in period requirements have been imposed, with the minimum lock-in period being one year or minimum lock-in period as prescribed under FDI Regulation, whichever is higher.
• The exit shall not be at an assured price.
• The regulations apply prospectively.
• RBI prescribed exiting pricing guideline for instruments with optionality clause issued/transferred under FEMA:
• Non-Resident + Listed Equity + Optionality clause
• Exit at market price.
• Non-Resident + Unlisted Equity + Optionality clause
• Exit at not more than Return on Equity based price as per the last audited balance sheet.
• Compulsorily Convertible Debentures (“CCDs”) and Compulsorily Convertible Preference Shares (“CCPs”) + Optionality clause
• Exit at price as per any internationally accepted pricing methodology duly certified by CA/Merchant Banker.

The acceptance of option/right to exit clauses by RBI is rooted in incentivizing FDI in India. Although, the acceptance came with the introduction of a dual scheme for without and with option instruments, the hitch in the notified dual scheme is magnified in case of unlisted equity that stipulates entry and exit at a price determined by Discounted Cash Flow (“DCF”) in case of without options, however limits the exit price to Return on Equity (“ROE”) in case of options. The scheme mandates a person resident outside India to enter at a price not lower than the estimated value of the entity, however, the exit price is limited by the book value of the entity. The scheme notified although approved option/right to exit clauses in case of unlisted companies, the financial unprofitable pricing guidelines have nullified the approval.

The acceptance of optionality clauses for equity, CCD and CCPS is a sign of a more liberalized FDI regime with a drawback of the dual pricing scheme. However, the present drawback with optionality clauses would be dealt with once the proposed FDI guidelines based on accepted marketable practices repeal all the existing pricing guidelines. The validation of optionality clauses coupled with the proposed pricing guidelines is expected to pump more FDI in India, thus benefiting the economy.

Foreign Direct Investment - Indian Civil Aviation Sector

by Parvati Parkkot, B.A., LL.B. (Hons.), 2009 JGLS

The civil aviation sector has benefitted economies and communities around the world. By providing connectivity, it enables the growth of economies, tourism, social development, as well as access to markets on a global platform. This sector is solely responsible for 56.6 million jobs and over USD2.2 trillion of global Gross Domestic Product (“GDP”). Currently, the Indian civil aviation sector (“Indian Sector or Sector”) is the 9^th largest aviation market. Presently, around 85 international airlines and 5 Indian airlines cater to the needs that arise from the Indian Sector. According to studies, India is likely to become the 3^rd largest aviation market by the year 2020. It is predicted that the “Indian Sector will cater to 336 million domestic and 85 million international passengers with projected investment to the tune of USD120 billion”.

The fast expansion of the Indian Sector can be attributed to the economic reforms and the progressive liberalization of the Foreign Direct Investment policy (“FDI policy”) pertaining this Sector. The FDI policy regulates any foreign direct investment made in India. As per the circular issued by the Department of Industrial Policy and Promotion (“DIPP”) in 2012, amending the Consolidated FDI policy of 2012, a foreign airline is permitted to invest up to 49% in the paid-up capital of Indian companies operating scheduled and non-scheduled air transport services through the Government approval route (“Amendment”). This Amendment has triggered a series of investment by foreign airlines into the Indian Sector.

The Amendment was approved by the cabinet due to the dire need of equity infusion into Indian airlines that were going through a severe lack of funds, needed for its operations. All key players in the Indian Sector welcomed the Amendment permitting investments by foreign airlines, because of the multifaceted crisis that the Indian Sector is currently suffering due to the increase in taxes on jet fuel, rise in airport fees, unaffordable loans, lack of infrastructure and aggressive competition. It was predicted that this Amendment in the policy would give a boost to the Indian Sector that was hit by a bane of financial struggles. The opening up of the Indian Sector to investments by foreign airlines has led to an influx in foreign investment, as discussed further in this article.

FDI Policy on Civil Aviation

The FDI Policy contains various provisions for the procedure to make investments in India and also provides the maximum limit of investments.

• Present FDI Policy pertaining to the Indian Sector
• The Amendment issued by DIPP permits foreign airlines to invest up to 49% in the paid-up capital of an Indian company operating scheduled and non-scheduled air transport services on the following conditions.
• It has to be made under the Government Approval Route
• The 49% limit will include FDI and Foreign Institutional Investor investment.
• Investments made must be in accordance with the relevant regulations of the Securities and Exchange Board of India, such as the Issue of Capital and Disclosure Requirements Regulations, the Substantial Acquisition of Shares and Takeovers Regulations, and any other applicable rules and regulations
• A Scheduled Operator’s Permit will only be granted to a company that is (a) registered and has its principal place of business within India, (b) whose Chairman and at least two-thirds of the directors are citizens of India, and (c) the substantial ownership and effective control of which is vested in Indian nationals.
• All foreign nationals that are likely to be associated with a company engaging in air transport as a result of such investment must be cleared from a security aspect prior to his/her deployment.
• Clearance from the relevant authority in the Ministry of Civil Aviation must be obtained for importing any technical equipment into India as a result of such investment.
• Implications of Amendment in FDI Policy.
• This relaxation in the FDI policy allows influx of equity into the Indian Sector but at the same time ensures that majority ownership of the airline company remains in the hands of Indian citizens.
• Indian companies are allowed to invest in more than one Joint Venture (“JV”) with international players, as is evident from the fact that Tata Sons have been permitted to set up a low-cost carrier with Air Asia and a full-service carrier with Singapore Airlines.
• FDI allows international players to tap into India’s quota of seats to any destination as determined by the bilateral agreement between India and that country.

Financial Arrangements to Facilitate Entry of Foreign Investors into the Indian Sector

One of the main reasons behind the success of the Indian Sector is the various business partnerships between independent airline companies. This has made the Sector highly consumer-friendly by becoming more accessible and more efficient.  Cooperation between airlines has led to “greater choice, lower fare and improved service quality”. Financial arrangements between airlines provide for co-operation between airlines.

• Strategic Alliances. Foreign Airlines can enter into strategic alliances with Indian airlines by investing in the equity of the Indian airlines. An example is the Jet-Etihad deal, discussed further in this article.
• Mergers. Under this arrangement, two or more airlines combine in order to form a new airline. Until the passing of the Companies Act, 2013 this method was not a commonly adopted method as the Companies Act, 1956 permitted a foreign company to merge into an Indian company, but the vice versa was not permissible.
• Joint Venture with Indian Company. Under this arrangement, a separate business entity is formed which is jointly owned by a foreign airline and at least one of the Indian companies which operates scheduled and non-scheduled air transport services. This can be done in a two-way JV where a foreign airline will hold at most 49% of equity of the joint venture and the Indian airline will hold the remaining stake, or a three-way joint venture where the foreign airline will hold at most 49% of equity of the joint venture while the remaining two Indian owners of the joint venture hold the remaining stake of equity.

Drawbacks of Investing in India

One of the biggest concerns while investing in India is the rampant presence of corruption amongst government officials and the requirement of lengthy procedural approvals from various Government officials. Moreover the increasing budget deficit, and slow growth rate of India’s GDP are major causes of worry for foreign investors. India is infamous for its uncertain political climate and because of this there is a concern of unwarranted changes in policy if a different party comes to power. Despite these drawbacks the three deals discussed in the next section are a testament to the optimism that the Amendment will stand the test of time.

Major Deals in the Civil Aviation Sector

Following the Amendment, several significant deals have taken place in the Indian Sector. This has helped give the Indian Sector a new lease on life. Three major deals that have been approved by the Government are the (a) Jet-Etihad deal, (b) the three-way JV between Tata Sons, Air Asia and Telestra, and (c) the two-way JV between Tata Sons and Singapore Airlines.

Strategic Alliance between Jet Airways and Etihad Airways.

Etihad Airways, an Abu Dhabi based airline, picked up 24% stake in Jet Airways for INR 2058 crores. Naresh Goyal, a non-resident Indian (“NRI”), will hold a 51% stake in the airline, in part through his holding company, Tailwinds, registered in the Isle of Man, while the remaining 25% will be publicly held. DIPP ruled that Mr. Goyal’s personal shares will not be treated as an FDI despite his NRI status, however he needs to restructure the holding pattern to ensure that the shares held by Tailwinds and Etihad do not exceed 49% of the total number of shares.

Joint Venture between Air Asia, Tata Sons and Teletra Tradespace.

Air Asia entered into a JV with Tata Sons and Telestra Tradespace. While Air Asia will hold 49% of the shares, Tata Sons and Telestra will hold 31% and 20% shares respectively. Air Asia has invested INR 81 crores in the JV. The new company, called Air Asia India, will be a low-cost domestic carrier.

Joint Venture between Tata Sons and Singapore Airlines.

The Foreign Investment Promotion Board cleared a JV between Tata Sons and Singapore Airlines. Singapore Airlines is investing USD 49 million and will have a 49% stake in the venture, with Tata Sons holding the rest.

Cashing Potash

by Mr. Shivam Sinha, B.A., LL.B (Hons.), 2009 JGLS

Introduction

“Cartel is an agreement among competitors not to sell their product below a fixed price that will generate monopoly profits for the parties to the agreement.”

Another definition provided by Competition Commission of India (“CCI”) is “Cartels are agreements between enterprises (including association of enterprises) not to compete on price, product (including goods and services) or customers. The objective of a cartel is to raise price above competitive levels, resulting in injury to consumers and to the economy. For the consumers, cartelization results in higher prices, poor quality and less or no choice for goods or/and services.” Cartels are formed to maximize profit and maintain market standing. There has been a cartel operating in potash market which has come to light recently as it has affected the global potash trade. Though cartels are not harmful every time, but in this particular scenario, they are.

Potash Cartel

The main stakeholder in this cartel operating in Canada is Potash Corp., which is the largest manufacturer of potash in the world. Mosaic and Agrium, together with Potash Corp. have formed a firm called Canpotex that exports nearly 35% of the total potash exports in the world. This works as a cartel for them and on similar lines works Belarussian Potash and Co., which is the firm used by Belarus and Russia (second largest exporters of potash in the world i.e. 30%). This can be termed as ‘conscious parallelism’ i.e. “decisions by competitors to charge same price, to adopt the same pricing system or to engage in some other kind of conduct, the most troublesome case being what has come to be called ‘oligopoly pricing’ or the consciously parallel decisions of a few dominant sellers in an industry to maintain the same high noncompetitive price.”

Potash market has been working as a duopoly i.e. two firms operating and dominating the market. The combined market share of the two geographic markets sums up to 70% of the total global exports. Recently, there has been decline in the demand of potash around the world, the cartels have reduced the production and escalated the prices approximately to the tune of 400% since 2008 in order to maintain domination and profit.

Establishing the Antithetical Relationship

“Under a competitive scenario, the price of potash would decline from $574 in 2011 to $217 by 2015 and would subsequently increase to $488 by 2020. With an unchanged Canadian cartel policy, the price of potash will steadily increase from $574 in 2011 to $734 in 2020. On average under the current cartel scenario the price of potash would be doubled or $321 more expensive per ton than under the competitive scenario from 2011 to 2020”

In view of the above, it is evident that the formation of the aforementioned cartels has severely affected the prices of the potash worldwide and will continue to do so if left unchecked. Cartels are antithetical to competition. They prove to be a roadblock in the efficient working of the market. 

The price differences between competitive scenario and cartel scenario shows the extent of exploitation by the Canadian firm, Canpotex. Since Canada has no antitrust provisions with regard to exporting norms, it has not paid any heed to this situation. Moreover, due to a recent refusal of a takeover bid, Canadian Government has fueled concerns worldwide as it refused BHP Billiton (an Australian firm) to buy Potash Corp. This acquisition (if allowed) would have affected the cartel in place and would have led to effective competition that would result in heavy loss of revenue which Canada has been generating through this industry.  Canada seems to have given a green light to such practices and by ignoring the effects being caused worldwide. As per Section 45 of Canadian Competition Act “No person shall be convicted of an offence under subsection (1) in respect of a conspiracy, agreement or arrangement that relates only to the export of products from Canada”. The law clearly protects any such establishment in place and there seems to be no solution until amendments are made.

Indian Scenario

India is an agrarian economy since time immemorial and even today when India is among the fastest growing economy in the world, 72% of India’s population is in the agriculture sector which accounts for 21% of India’s GDP (gross domestic product). Being an agrarian country, fertilizers are imported at large scale and subsidies are also provided on the same. The global potash cartel which is centered in Canada, Russia and Belarus, has resulted in steep rise of potash price import. This increase in prices has majorly affected the developing countries such as India since it has been striving hard to become self-sufficient in food production.

“CUTS, a consumer advocacy firm, have appealed to the competition watchdog to undertake an investigation under Section 19 of the Competition Act. Under the Competition Act, the CCI can initiate action for an act taking place outside India that has or is likely to have an appreciable adverse effect on competition in India vide Section 32 of the Competition Act (applying the effects doctrine) against the global potash cartel.” India will be majorly affected if steps are not taken to breakdown these cartels it is still at a developing stage and requires potash on a large scale.

“There is no international competition law prohibiting export cartels but competition law can be used by large developing countries to mitigate the cost of international anti-competitive cartels or transactions that victimize them.”

India can use its extra territorial reach under Section 32 of the Competition Act in order to rectify the situation at hand but India is in an uncertain position as it cannot utilize domestic laws in place for preventing such activities. This is because neither  can it initiate any action for imposing sanctions without risking further increase in the prices of potash nor can it cut down its imports as it requires potash in large quantities for sustenance.

Further, owing to such non-substitutable needs it recently got into a deal with Canpotex for 1.1 million ton of potash to be delivered in 2014. This dependency has led to protracted existence of such cartels.

“Indian competition law allows the CCI to take action even if such events are not taking place on Indian soil, and this could become a beacon case. Competition law is a relatively new tool in many developing countries and international cooperation between the competition authorities of those countries is still in its infancy, but the attempt by Potash Corp. to eliminate the potential competition and reinforce its grip on a world market so crucially important for agriculture may be the trigger that will spur China and India into action, singly and jointly. If this happens, it could be the beginning of a new era for the governance of world markets.”

If it would have been a competitive scenario, the benefits would have been universal. India would save a lot on its potash imports which could be used efficiently for other developments in the country.

Conclusion

Cartels are a hindrance in free trade and result in exploitation. It is a moral and ethical wrong-doing which proves to be a contrary to the notions of development “Global food demand is expected to increase by up to 80 per cent in the next 40 years as the world's population reaches 10 billion people. That means food production must rise by nearly 2 percent annually, about double the current production rate, and fertilizer will be needed in abundance.”

In the presence of such cartel and absence of any competitive characteristics, exploitation of the one in need is bound to take place. There is an urgent requirement for setting up a global competition body overlooking such scenarios which have little or no solution in domestic laws and cannot be subjected to scrutiny by other nations. It can be adequately established from the scenario above that cartels are major hurdle towards fair competition and can be regarded as antithesis of competition.

Ongoing Coal Scam Proceedings: The Environmental Angle

by Ms. Kudrat Dev, B.A., LL.B. (Hons.) 2009, JGLS

In the latest coal block allocation scam, the Central Government has been accused of causing a loss of INR 1.86 lakh crores to the national exchequer due to the arbitrary allocation of coal blocks. The Report of the Comptroller and Auditor General of India (CAG) noted that private players were granted mining licenses arbitrarily without a competitive bidding process. With filing of several Public Interest Litigations (PILs), the Supreme Court will rule on the issue of allocation of the coal blocks. However, the pertinent question is whether the allegations of abuse of power and arbitrariness against the State have overshadowed the important question of sustainable development.

Hence, it is first essential to briefly outline the process of coal block allocation:

First, the applications received by the Ministry of Coal, are checked for eligibility and completeness and are thereafter sent to the administrative Ministry/State Government concerned for their evaluation and recommendations.  After receipt of recommendations of the administrative Ministry/State Government concerned, the Screening Committee considers the applications and makes its recommendations.  Based on the recommendations of the Screening Committee, the Ministry of Coal determines the allotment. The Screening Committee (chaired by the Secretary, Ministry of Coal) plays the most crucial role as it makes recommendations for or against the final allocation to a particular applicant. The decision is made on the basis of several criteria including: “satisfaction level of coal requirement”, “assessed (coal) requirement” of the applicant preparedness and investment made by the applicant.  However, ‘environmental clearance(s)’ as such, are not a determinative factor or a pre-requisite for allocation of coal blocks. 

Recently, the Supreme Court ordered the Ministry of Environment and Forest to submit a report on the environmental clearances that have not been obtained by the coal block allottees under consideration which would influence the decision to de-allocate coal blocks. Hence, even though late in the day, the “environmental angle” has come into some light in the ongoing proceedings. Moreover, around INR 145,000 crores had been spent on projects linked to coal blocks under question which are now held up due to various problems including environmental clearances.

In view of the above, environment clearances should become a very strong factor (if not a decisive factor) in allocation of coal blocks by the Screening Committee. This seems like the correct approach because: (a) it follows an approach that is leaning towards sustainable development which is the need of the day in light of extreme depletion of mineral resources coupled with lack of ecological restoration and (b) it cuts short the process of first allocating coal blocks to allottees who do not have the required environmental clearances and later finding out another suitable applicant for allocation. In this way, different ministries (in this case, the Ministry of Coal in addition to the Ministry of Environment and Forest) and different organs of the government could collectively serve as multiple check-points for sustainable development to the extent possible to ensure that deviation from sustainable development does not go unnoticed and can be corrected efficiently as well as effectively.

Development of Foreign Direct Investment in Retail

by Ms. Shreya Gupta, 5^th Year B.A., LL.B. (Hons.), JGLS

Foreign Direct Investment (“FDI”) in retail has been a much-debated topic in India wherein arguments favoring and contradicting FDI in India within the retail sector have been advanced. Until 2011, the Central Government was opposed to opening up the retail sector to foreign investors. However, realizing that the lack of cold storage infrastructure and other logistics will result in wastage of perishable items, and that most of the retailers in India are small shops which do not have the resources to build the back-end infrastructure, the Central Government relaxed its stance considerably. These concessions are explained below, however, it is the author’s opinion that even though 100% investment is allowed in cold storage and related infrastructure, it is unlikely that many foreign investors will invest unless there are real possibilities for organized retail.

Single-Brand Retail Trading (“SBRT”) and Multi-Brand Retail Trading (“MBRT”) in India has undergone tremendous changes pursuant to three notifications issued by the Department of Industrial Policy and Promotion (“DIPP”) in January 2012, September 2012 and August 2013.

The Notification passed in January 2012 made changes with regard to the SBRT regime in India. These changes are as follows:

•     Increased threshold limit for FDI from 51 % to 100% through the approval route. Foreign brands like Nike, which has up till now held stores in India through franchise outlets, can now actually hold 100% of its Indian business. It is to be noted that this relaxation has been made subject to a few conditions-:
•    Where the FDI is greater than 51%, 30% of the products are required to be sourced from small-scale industries, artisans and craftsmen. The upper limit for determination of these industries has been stipulated as USD 1 million of investment. This value is determined at the time of installation.
•    Approval is required to be taken through the government route. Application has to be made to the Secretariat of Industrial Assistance of DIPP, while mentioning the categories proposed are to be sold under the SBRT regime. DIPP processes the applications, which are followed by the approval of Foreign Investment Promotion Board.

In September 2012, the Central Government issued another notification permitting 51% of FDI in the MBRT sector, subject to the following conditions:-

1.      50% of the FDI brought in the first 3 years is required to be invested in the back-end infrastructure.

2.      30% sourcing is mandated from small-scale industries, with a maximum investment at the time of installation be USD 1 million.

3.      Minimum amount brought in by foreign investors is prescribed as USD 100 million.

4.      MBRT outlets can only be set up in cities with a minimum population of 1 million.

5.      These outlets are required to get approval through the government approval route.

Even after incorporating the above changes, applications were not received from many foreign investors who were willing to invest in SBRT and MBRT in India. Subsequently, the Union Cabinet went on to approve changes relating to SBRT and MBRT and issued a notification on August 1, 2013 to the following effect:

SBRT Up to 49% via automatic route (only the details regarding product categories made to the Reserve Bank of India).  Paves way for foreign brands that are ready to come through Joint Ventures (“JVs”) with an Indian resident holding. Above 49% requires government approval.

MBRT 30% sourcing requirement can be fulfilled from micro, small- and medium-scale industries which have a total investment in plant and machinery equal to or more than USD 2 million at the time of engagement. The state has discretion to choose which city it wants to permit a MBRT outlet.

Despite these changes in FDI policy, there have been a lower number of invitations from foreign investors to invest than one would have been expected. India has a complex regulatory environment which makes it one of most difficult places in the world to do business as is evidenced by the fact that India ranks 134th on the World Bank’s “Ease of Doing Business” Index in 189 countries.

India’s maze of byzantine regulations have given India a name as an unfriendly destination for foreign investment and India must enhance its image before the rest of the world so a change in investor-oriented policies can actually bring the desired level of  foreign investment. Allowing foreign retailers’ entry into India markets, in which they could not earlier make inroads, is a step ahead in the right direction.

The SEBI (Foreign Portfolio Investors) Regulations, 2014: What’s New?

by Mr. Jayant Malik, B.A., LL.B. (Hons.) 2009, JGLS

The SEBI (Foreign Portfolio Investors) Regulations, 2014 (“FPI Regulations”) came into effect on January 7, 2014, repealing the SEBI (Foreign Institutional Investors) Regulations, 1995 and rescinding the Securities and Exchange Board of India (“SEBI”) Circulars issued on Qualified Foreign Investors (“QFI”). It covers the registration of foreign portfolio investors and provides an operating framework for overseas institutional investors.

The most significant change that has taken place is the creation of a new class of investors known as Foreign Portfolio Investors (“FPI”) which encompasses Foreign Institutional Investors (“FII”), their sub-accounts and QFIs.

FPIs have been divided into three categories in Regulation 5 of the FPI Regulations. Category I FPIs include governments and government-related entities such as central banks, government agencies, sovereign wealth funds or multilateral organizations or agencies. Category II FPIs include regulated broad-based funds and persons, unregulated broad-based funds whose investment managers are appropriately regulated, university and pension funds and university-related endowments already registered with SEBI as FIIs or sub-accounts. Category III FPIs includes other investors who do not fall within Category I or II.

The second change is in the eligibility criteria for FPIs given under Regulation 4 of the FPI Regulations. In addition to the requirements to be fulfilled under the FII Regulations, 1995, Regulation 4 of the FPI Regulations has included the following criteria for an applicant to fulfil in order to be eligible as an FPI:

• The applicant should be a resident of a country whose securities market regulator is a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding (Appendix A signatories) or a signatory to a bilateral Memorandum of Understanding with SEBI.
• If the applicant is a bank, it should be a resident of a country whose central bank is a member of the Bank for International Settlements.
• The applicant should not be a resident in a country identified in the public statement of Financial Action Task Force as,
• A jurisdiction having strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply; or,
• A jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the Financial Action Task Force to address the deficiencies.

In addition, Regulation 4 of the FPI Regulations provides that all applicants must be legally permitted to invest in securities outside the country of their incorporation, establishment or place of business (a requirement which was earlier confined to university funds, endowments, foundations and charitable trusts).

Regulation 21 of the FPI Regulations specifies that, in addition to the securities and derivatives that FIIs were permitted to invest in, FPIs are permitted to invest 

• Treasury bills
• Rupee denominated credit enhanced bonds
• Security receipts issued by asset reconstruction companies
• Perpetual debt instruments and debt capital instruments, as specified by the RBI from time to time
• Rupee denominated bonds or units issued by infrastructure debt funds
• Indian depository receipts
• Such other instruments specified by the Board from time to time

The FPI Regulations have been enacted with the aim of simplifying the entry of foreign investors into India. The FPI Rules are expected to come into effect from June 1, 2014 which would further clear the air on any doubts about FPIs in India.

The increase in the number of instruments that FPIs can invest in is expected to encourage investors to view India as a country that is foreign investor-friendly.

Concept of Private Placement under Companies Act, 2013

by Ms. Shreya Gupta, 5th Year B.A., LL.B (Hons.), JGLS

A popular mode of raising funds for unlisted companies is through private placement. A private placement is where the offer of share subscription is made to a limited group of persons who comprise a number less than 50 according to Proviso to Section 67(3) of the erstwhile Companies Act, 1956 (“1956 Act”) as opposed to a public offer where the shares are offered to the public at large. Since private placement involves raising capital from a small group investors, companies raising money through this mode are exempt from the jurisdiction of Securities Exchange Board of India (“SEBI”) and its disclosure requirements.

However, the Sahara case has demonstrated how unlisted companies can circumvent the provisions of private placement to escape SEBI disclosure requirements and investor protection norms to raise money from a large number of people.

Two unlisted companies of the Sahara group - Sahara Real Estate Corporation Ltd. (“SIRECL”) and Sahara Housing Investment Corporation Limited (“SHICL”)- under the garb of raising money through private placement, raised INR 20,000 crores from almost 22 million investors between 2008 and 2011. Their defense was that the offer of subscription was addressed to only close friends and relatives of the promoters and directors of the Sahara group and only they could accept or reject the offer. It was argued that it was not a public offer and hence was exempted from the jurisdiction of SEBI under Section 55-A of the erstwhile Companies Act, 1956 and compliance with its disclosure-related and investor protection norms.

The Supreme Court did not accept Sahara’s arguments. It noted that, by virtue of the Proviso to Section 67(3) of the 1956 Act, any offer made to more than 49 persons is deemed to be a public offer irrespective of the fact that it may be addressed to specific people. The Court held that Sahara had made a public offer under Section 67(3) and therefore the company’s shares were mandatorily required to be listed on any of the stock exchanges The Court was of the view that the offer made by Sahara fell within the purview of SEBI jurisdiction by virtue of Section 55A of 1956 Act.

In the guise of private placement, a large number of people were offered Optionally Fully Convertible Debentures (“OFCDs”) while bypassing all disclosure and investor protection norms. While the Supreme Court has recently passed directions against Sahara to pay back all the investors with an interest of 15%, the 2013 Companies Act has introduced and specifically incorporated provisions relating to private placement in order to prevent another Sahara debacle.

Section 42 of the Companies Act, 2013 allows for private placement of shares and has to be read together with Rule 14 of the Companies Prospectus and Allotment of Security Rules, 2014.

A conjoint reading of the provision and the rule suggests that the new rules allow for private placement of shares to up to 200 people in an aggregate financial year.  This number excludes the qualified institutional buyers such as banks, financial institutions etc. and employees of the company given shares under Employee Stock Option Plans (“ESOPs”).

However, according to Section 42 of the Act, an offer to invitation to subscribe through private placement mode cannot be made to more than 50 persons in one go. If at a single instance it is made to more than 50 people, then irrespective of the fact that payment for securities has been received or not or the company is willing to list its securities on a stock exchange, it will be deemed to be a public offer. This number excludes the securities offered to qualified institutional buyers and employees.

If a company intends to raise capital through a further issue of securities within the limit of 200 persons, Section 62(1)(c) of Act, 2013 will applicable. According to this section, if authorized by a special resolution existing shareholders have a pre-emptive right to purchase the new shares offered which includes the right to renounce the shares in favor of someone else.

According to Rule 14 of the Companies Prospectus and Allotment of Securities Rules, 2014, the value of such offer per person should be a minimum investment size of INR 20,000 of face value of securities.

The procedure set out within the relevant rule and provision is as follows-

• A private placement letter of offer is addressed to specific persons.
• This letter is required to be filed with the Registrar within 30 days
• All money payable is required to be paid through a banking channel and not by way of cash.
• Within 60 days of invitation of offer of shares such shares must be allotted; if unable to so after the expiry of 60 days, the money should be returned within a period of 15 days.
• Within 30 days the letter of allotment of shares should be filed with the Registrar.
• If the money is not repaid within 15 days then interest payable at 12% is imposed.
• Non-compliance with the above provisions will make the company liable to pay a penalty that may extend to the amount of offer or invitation or INR 2 crore, whichever is higher. This amount is payable within 30 days.
• According to the Rule 14 of the Companies Prospectus & Allotment of Security Rules, 2014, minimum investment by each purchaser should be to the tune of INR 20,000.
• Shares must be valued by an independent expert to determine their price.

Although both 1956 Companies Act and 2013 Act allow for private placement, the 2013 Act when supplemented with the Companies Prospectus and Allotment of Securities Rules, 2014 has brought clarity in the provision of private placement in the Act and is a welcome change that is likely to result in transparency and accountability in the system.