Foreign investors into India have often found that when they seek to enforce customary contractual rights in investment agreements, such as option rights, guarantees and indemnities, they have been hamstrung by the ability of the Indian counterparty to contend that such rights are in contravention of the Foreign Exchange Management Act, 1999 (FEMA) and the regulations issued by the Reserve Bank of India (RBI).

It is in this context that the recent Delhi High Court judgment in the case of Cruz City I Mauritius Holdings v. Unitech Limited, MANU/DE/0965/2017, is relevant, in that it categorically strikes down the defence that an arbitral award is not enforceable on the ground that certain provisions of the contract pursuant to which the award was issued were allegedly in contravention of the FEMA regulations.

Cruz City 1 Mauritius Holdings (Cruz City) filed a petition in the Delhi High Court for enforcement of an arbitral award rendered under the rules of the London Court of International Arbitration (Award). This required Unitech Limited (Unitech) and Burley Holding Limited (Burley), a wholly owned subsidiary of Unitech, to pay Cruz City the pre-determined purchase price of all of Cruz City’s equity shares in a joint venture (incorporated in Mauritius) pursuant to:

  1. A “put option” exercised by Cruz City against Burley.
  2. A keepwell agreement (which was in the nature of a guarantee) whereby Unitech was to make the necessary financial contribution in Burley to enable it to meet its obligations.

Unitech argued that the Award was not enforceable since it was contrary to FEMA and consequently violated ‘public policy’. The key arguments on the alleged contravention of FEMA raised by Unitech are as follows:

  1. The Award directed Unitech to comply with the provisions of the keepwell agreement to make payment against the delivery of shares of the joint venture and, in effect, directed Unitech to make an overseas investment. Unitech alleged this was not permissible under the FEMA overseas direct investment regulations and the FEMA guarantee regulations, without prior RBI approval.
  2. The Award required purchase of shares, pursuant to the exercise of the “put option”, to be made on an “assured return basis” (i.e. principal + 15% IRR) without valuation of the shares at fair market value, which was not permissible under the prevailing FEMA regulations.

The Delhi High Court dismissed Unitech’s arguments and held as follows:

  1. The ‘public policy’ defence is to be construed narrowly, and foreign awards will only be held unenforceable if they contravene the basic rationale, values and principles which underpin Indian laws. A contravention of specific provisions of FEMA, even if established, was held to be insufficient to invoke the defence of public policy against enforcement of the Award. According to the Court, such an alleged contravention is not synonymous with contravention of the fundamental policy of India. 
  2. Unlike the erstwhile Foreign Exchange Regulation Act, 1973 (FERA), which sought to invalidate foreign exchange transactions which contravene FERA, FEMA permits foreign exchange transactions subject to reasonable restrictions and/or approval of the RBI, on a case by case basis. This distinction between FERA and FEMA has also found mention in the recent Bombay High Court decision in Vitol S.A. Vs Bhatia International Limited [2015 (1) Bom CR 100].
  3. The Court held that the requirement for regulatory approval would not in itself restrict enforceability. As such, the contractual remedy would be enforceable subject to obtaining RBI approval and the RBI would not allow repatriation of funds if the same is found to be in violation of FEMA regulations. This view was also taken by the Supreme Court in the context of a guarantee invocation in its recent judgment in IDBI Trusteeship Services Limited v. Hubtown Limited [(2017) 1 SCC 568].
  4. The Court observed that Unitech had provided certain categorical representations to the effect that the transactions contemplated under the agreement were in compliance with the applicable regulations and were legally enforceable against it. The Court also took note of certain disclosures made by Unitech in the Annual Report to evaluate the bona fides of the arguments advanced by Unitech. In light of the representations provided by Unitech in the agreement and statements made in its Annual Report, the Court held that Unitech could not be later allowed to resist enforcement of these transactions on the grounds that the same are in contravention of FEMA.
  5. The “put option” was exercised by Cruz City on account of a failure by Unitech to commence construction of an underlying project within a specified timeframe and not with an objective to exit with an assured return. In this context, the Court observed that the RBI circulars, which prohibit optionality clauses granting assured returns, would not be applicable in cases where a foreign investor exercises the option as a remedy for breach. However, it may be noted that the relevant RBI circulars in relation to optionality clauses do not draw such a distinction between optionality clauses exercised for breach vis-a-vis those exercised for ensuring an assured return. Since the RBI is the ultimate arbiter in relation to exchange control matters, it remains to be tested if the RBI’s view would be consistent with the Delhi High Court’s decision in this regard.

Key Takeaways 

  1. If parties enter into a contract intending it to be enforceable, it is no longer open to parties to allege as an afterthought that a contract or an arbitral award stemming from a contract is not enforceable on account of certain contractual provisions allegedly being in contravention of FEMA. Such contracts would remain enforceable subject to regularizing compliance with FEMA (including by obtaining the relevant approvals from the RBI). Having said that, parties need to be mindful of the fact that the RBI has traditionally been conservative in granting approvals on account of the potential foreign exchange loss arising from enforcement of such provisions.
  2. In case of a dispute surrounding the enforceability of contracts between foreign investors and domestic entities, since Courts have reviewed representations and covenants of the parties specified in the agreement as well as statements made in the Annual Report to determine the bona fides of the parties, parties need to ensure that:
  • The FEMA implications of the contractual protections have been duly considered and vetted.
  • The contracts incorporate appropriate representations and warranties whereby the Indian parties acknowledge that their obligations are enforceable under Indian laws (including exchange control laws) and provide appropriate covenants that in case any approvals are required, it would be incumbent on the Indian parties to obtain the same.
  • In an existing or expected dispute resolution proceeding, given the Court’s approach to place reliance on statements/disclosures made in the Annual Report and any other regulatory filings, parties should ensure that all public filings and disclosures reflect a consistent position to the arguments canvassed in the course of litigation.

On the basis of this judgment and the other recent judgments cited above, it is clear that the FEMA defence has not found favour with the courts, which have sought to enforce the contractual obligations of the parties and ensure investor protection. This is a welcome step towards aligning Indian practice on enforcement of contracts to the laws of other jurisdictions, which emphasise the importance of giving effect to the stated intentions of contracting parties in the contract, even where one or more of the parties subsequently look to resile from their obligations.

* The author was assisted by Megha Krishnamurthi, Associate