The judgments of the Delhi HC in Cruz City and SRM Exploration, discussed in Part 1, appears to ignore the earlier decision of the SC in Dropti Devi v Union of India, where the SC held (in the context of prosecution under the Conservation of Foreign Exchange and Prevention of Smuggling Activities Act) that the legislative objectives of FERA and FEMA are identical, namely, preservation of the foreign exchange resources of the country.
In NTT Docomo v Tata Sons Limited, Delhi HC was faced with a similar question, i.e. whether enforcement of a foreign arbitral award could be denied on the grounds that such enforcement would be in violation of FEMA. In this case, disputes arose between the Japanese company NTT Docomo Inc and Tata Sons Limited, in relation to the former’s investment in an Indian joint venture company, TTSL. The June 2016 arbitral award entitled NTT Docomo to exercise its right under the shareholders agreement to have its shares under the joint venture bought by Tata Sons at a price which was equal to 50% of its original investment. The enforcement of the award was objected to by Tata Sons (though it later entered into a settlement with NTT Docomo) and also by the RBI (which had filed an impleading application) on the ground that enforcement of the award would constitute a violation of FEMA and related regulations since the shares were to be sold/ purchased at a predetermined rate. In this context, Delhi HC held that the RBI had no standing to challenge the enforcement of the settlement agreement. The court also held that since the award was in the nature of damages, no FEMA provision had been violated. Further, given the nature of the award, no special RBI permission was needed for the remittance.
On the RBI’s lack of standing, Delhi HC observed: “The fact that the legislature did not intend this is evident when a comparison is made with the provisions for mergers and amalgamations under the Companies Act, 1956 (as it stood prior to its amendment in 2015). Section 394 thereof envisaged notice being issued to the central government by the Company Court in order to give it an opportunity to be heard in those proceedings. There is no such statutory requirement that where the enforcement of an arbitral award might result in remitting money to a non-Indian entity outside India, or to an account of a party outside India, RBI has to necessarily be heard on the validity of the Award. The mere fact that a statutory body’s power and jurisdiction might be discussed in an adjudication order or an award will not confer locus standi on such body or entity to intervene in those proceedings.”
Vijay Karia Judgment – Violation of NDI Rules condoned?
In Vijay Karia v. Prysmian Cavi E Sistemi SRL (“Vijay Karia”), the SC considered whether a foreign award by which a non-resident would have to purchase shares from a resident, at a discounted value, would violate the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”), and would thereby violate the ‘fundamental policy of Indian law’ under Section 48(2) of the Arbitration Act.
The appellants contended that as the foreign award provided for transfer of shares from a resident to a non-resident at a price that is less than the fair value of the shares, the foreign award violated the pricing guidelines stipulated under Rule 21 of the NDI Rules, and the award was accordingly rendered unenforceable as it violated the fundamental policy of Indian law, under Section 48(2) of the Arbitration Act.
The SC rejected the appellant’s argument and held that non-compliance with NDI Rules would not make the award unenforceable. The SC held that FEMA, unlike FERA, refers to the nation’s policy of managing foreign exchange instead of policing foreign exchange, the policeman being RBI under FERA. It was highlighted that as Section 47 of the FERA was not mirrored in FEMA, as a result of which transactions that violate FEMA cannot be held to be void. In this regard, the SC also agreed with the reasoning adopted by the Delhi HC in Cruz City, which held that there is a material distinction between the fundamental policy of exchange control under the FERA regime and the FEMA regime.
Significantly, the SC also noted that – “if a particular act violates any provision of FEMA or the Rules framed thereunder, permission of Reserve Bank of India may be obtained post facto if such violation can be condoned. Neither the award, nor the agreement being enforced by the award, can, therefore, be held to be of no effect in law. This being the case, a rectifiable breach under FEMA can never be held to be a violation of the fundamental policy of Indian law”.
Whilst the SC’s view proceeds on the basis that the ‘fundamental policy of Indian law’ should be interpreted narrowly, the SC does not specifically address whether a circumvention of law (i.e. FEMA) by obtaining a favourable arbitrable award would be violative of public policy.
Bombay HC’s view on pricing guidelines for put options – Is the legal position settled beyond doubt?
In relation to the pricing guidelines for foreign investments into India, one aspect that assumes relevance is the price at which a foreign investor can exit, by exercising his put option right and divesting his shareholding in the Indian investee company.
It is pertinent to note that as per Rule 21(2)(c) of the NDI Rules, the price of equity instruments of an unlisted Indian company, transferred from a non-resident to a resident shall not exceed the valuation of equity instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis, duly certified by a Chartered Accountant/ SEBI-registered Merchant Banker/ Cost Accountant.
The NDI Rules also provides that the “guiding principle shall be that the person resident outside India is not guaranteed any assured exit price at the time of making such investment or agreement and shall exit at the price prevailing at the time of exit”. Hence, basis the express wording of the NDI Rules, a foreign investor cannot be entitled to receive any assured return at the time of exit, and the consideration payable to the foreign investor (upon exercise of the put option) cannot exceed the fair value of the shares, at the time of exit.
In this context, reference may be made to an interesting decision of the Bombay HC in Banyan Tree Growth Capital LLC v. Axiom Cordages Limited(“Banyan Tree”), where the HC, in the context of a challenge to a foreign arbitral award, considered whether a put option right available to a foreign investor was compliant with the pricing guidelines under the FEMA Framework.
In Banyan Tree, the put option deed provided that upon exercise of the put option by the foreign investor, the promoters of the investee company would provide valuation certificates from a CA/ auditor, specifying the fair value of the put securities. The put option deed also provided for a 15% yield upon exercise of the put option, stating that if the 15% yield amount exceeds the fair value of the put securities, only an amount equivalent to the fair value would be remitted to the foreign investor. The balance amount (being the difference between the 15% yield and the fair value) was to be deposited with a nominee at an account in India, as would be requested by the foreign investor.
The Bombay HC held that as only the fair value of the put securities would be remitted to the foreign investor upon exercise of the put option, this was not in violation of the FEMA Framework. Further, it was held that for repatriating the excess amount that had been deposited in the nominee’s account, additional compliances stipulated under the FEMA Framework would be required. Based on the SC judgment in IDBI Trusteeship Services Limited v. Hubtown Limited, it was also observed that repatriation of such excess funds may require prior RBI permission.
As the FEMA Regulatory Regime specifically prohibits assured exit returns for a foreign investor, it can be argued that the Banyan Tree judgment does not take note of the cardinal principles enshrined in Sections 3 and 4 of the FEMA, as per which a foreign security cannot be transferred except as provided under the FEMA Regulatory Regime. Hence, we will have to wait for a final word from the SC, on enforceability of put option clauses that provide assured returns to a foreign investor, at a price that is above the fair value of the put securities.
This legislative gap or conflict between FEMA and the Arbitration Act needs to be filled and reconciled as otherwise the provisions of FEMA would become redundant, since two parties to the agreement can enter into a collusive transaction that is not in accordance with the FEMA Regulatory Regime and obtain an arbitration award. The arbitration award may involve transfer of foreign exchange/ securities that is not compliant with the FEMA Regulatory Regime. The RBI, which has been vested with the authority to administer FEMA, will have no standing to object to such an award and the award will become final, binding and enforceable in India as if it was a decree of the court.
The earlier judgment in Renusagar will not be of any help as the expression “interest of India” has been consciously omitted in the 2015 Amendment to the Arbitration Act. As a result, courts will be constrained to adopt the restrictive interpretation of “public policy” in Section 48(2) of the Arbitration Act and violation of FEMA may not be regarded as contrary to the fundamental policy of Indian law as was held by Delhi HC in the Cruz City case, and by the SC in Vijay Karia.
There is an urgent need for amendments to reconcile the differences between the Arbitration Act and FEMA. Both are central statutes covered by the Union List of the seventh schedule of India’s constitution. Parliament has two choices: It can either amend Section 48 of the Arbitration Act to provide for giving notice to the RBI whenever an international arbitration award would involve remittance to a non-resident, or wherever a foreign award would involve transfer of securities between a non-resident and a resident.
Such notice would require the RBI to examine whether such payment/ transfer of foreign exchange would be in conformity with the FEMA regulations; and whether such transfer of securities between a non-resident and a resident complies with the pricing guidelines set out under the NDI Rules. The RBI should have standing to raise objections before the enforcing court if the award is directly in conflict with the FEMA Regulatory Regime.
Alternatively, Parliament can reintroduce Section 47 of FERA in the FEMA, so that any remittance to a non-resident under a decree granted by the executing court on the arbitration award is subject to final RBI approval under FEMA. Amending FEMA is a better option as any amendment of Section 48 of the Arbitration Act, providing for issue of notice to the RBI may send wrong signals to the international community that India is not sincere about honouring international arbitration awards and is not an “arbitration-friendly” country.
 (2012) 7SCC 499.
 (2020) 11 SCC 1.
 2020 SCC OnLine Bom 781
 (2017) 1 SCC 568.