Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

IBC: Will India’s Foreign Exchange Regulations Discourage Foreign Bidders Of Insolvent Assets?

Conditions are ripe for a clash between one of India’s newest laws - the Insolvency and Bankruptcy Code and RBI’s two-decade old FEMA regulations. And this may impact foreign bidders interested in acquiring distressed assets in India, said lawyers.

Currently, Europe’s ArcelorMittal and joint venture partner Nippon Steel of Japan have bid for Essar Steel Ltd., as has financial investor and Russian bank VTB. Several foreign distressed-asset funds are also in the fray for the many assets in insolvency proceedings.

Restrictions On Foreign Debt

The Reserve Bank of India’s regulations under the Foreign Exchange Management Act govern foreign exchange coming into India, whether via debt or equity.

For foreign investors who propose to infuse funds into an Indian asset by way of debt, there are two ways of going about this:

  • external commercial borrowings
  • investing in debt instruments such as bonds and non-convertible debentures

And both come with regulatory restrictions.

The external commercial borrowing regulations place restrictions on the total foreign debt an Indian company can raise, its cost, and what the funds are spent on - also referred to as end-use restrictions. The loans can only be taken from a prescribed class of foreign lenders.

Bonds, NCDs
On the other hand, only entities registered as foreign portfolio investor or foreign institutional investor can invest in debt instruments like non-convertible debentures or bonds issued by an Indian company. Such foreign investment is capped at an aggregate level. With the limit currently about to be exhausted, the remaining is being auctioned by the government. The auctions are done by the Securities Exchange Board of India.

It’s expected that most resolution plans will include both forms of refinancing the stressed company. If the foreign bidder is unable to fulfill these regulatory requirements, it will need specific approval from RBI and SEBI or both, said lawyers.

The chances of a regulatory relaxation are higher in the case of ECBs than for bonds and NCDs, Nilang Desai, partner at AZB & Partners told BloombergQuint.

Under the ECB route, there is a possibility to apply for relaxation of these restrictions which the RBI may be more inclined to consider on a case to case basis. It could be possible for an applicant to seek a dispensation from the RBI to enhance corporate debt limit for IBC companies but I am not sure that that will be forthcoming,
Nilang Desai, Partner, AZB & Partners

Equity Pricing Problems

Foreign investment in the equity of a stressed company is also governed by RBI and SEBI regulations, especially when it comes to pricing. The problem here is that while regulations may be linked to fair market value, bidders for stressed assets are often looking to buy at below fair market value.

Listed Companies
If the stressed asset is a listed company, then SEBI pricing regulation determines the minimum price at which new shares can be issued. This is linked to current market price. Foreseeing the challenge, the market regulator has clarified that its pricing guideline will not apply to issuance of shares by listed companies undergoing the IBC process.

Unlisted Companies
But RBI has not relaxed its regulations that require a foreign investor to pay fair market value when buying shares of an unlisted company. These continue to apply to companies in insolvency proceedings.

The law seems to be clear that if you are investing at a less than fair value then you require an RBI approval, Abhijit Joshi, founding partner of Veritas Legal told BloombergQuint.

We don’t have an answer right now on how forthcoming the RBI would be with this approval but it is likely that the RBI should be forthcoming since it is a statutory process under the IBC before the NCLT.
Abhijit Joshi, Founding Partner, Veritas Legal

While fair market value is calculated using internationally accepted pricing guidelines, it is possible for a valuer to bring the pricing closer to the reasonable value of the company, said Desai.

But a fair market value that’s more empathetic to bidders may not sit very well with the income tax authorities. "The valuation methodology under FEMA for calculating fair market value might not be accepted under the Income Tax Act, and this could lead to certain tax implications for foreign players," said Saurav Sood, joint partner at Lakshmikumaran & Sridharan. "There are also chances of implication from transfer pricing provisions," he added.

Dilemma For Committee Of Creditors

Most bids for companies in insolvency proceedings are contingent on receiving regulatory approvals. Given the challenge thrown up by FEMA pricing guidelines, its not clear how the committee of creditors will view the problem of a pending RBI approval.

According to Desai, if the CoC views the chances of RBI approval as low, it may well consider a competing bid even if its offers a lower price but comes with a higher chance of regulatory clearance.

On the other hand, Joshi said that there is enough jurisprudence in different segments like reduction of capital, mergers and amalgamation where the issue of such regulatory approvals has been traversed, even if in a different context.

In such circumstances, where companies come together under a court approved process but regulatory approvals are required, typically the regulators follow suit - although they are not obliged.
Abhijit Joshi, Founding Partner, Veritas Legal

Today there is uncertainty but it is temporary, Joshi added.