Government Plugs Rights Issue Abuse By Non-Residents 
(Photographer: Mike Kane/Bloomberg)

Government Plugs Rights Issue Abuse By Non-Residents 

In a move that will plug cheaper acquisitions by non-residents via the rights issue route, the government has amended the FEMA (Foreign Exchange Management Act) rules to introduce pricing restrictions.

If a resident Indian does a rights issue renunciation in favour of a non-resident, such an acquisition cannot happen below fair market value, as per the new provision under Foreign Exchange Management Rules.

As per company law, existing shareholders can either accept, decline to subscribe to a rights issue or renounce their right in favour of a third party. For listed companies, the board can determine the rights issue price, and it’s usually lower than the current trading price to encourage subscription. For unlisted companies, as per RBI guidelines, the rights issued to persons resident outside India should not be at a price less than the price offered to persons resident in India.

But the regulations didn’t prescribe the pricing for acquisitions done pursuant to a renouncement.

The new provision is an attempt by the government to address, what’s commonly called, ‘designed rights issue’, experts told BloombergQuint.

This is how such issues would work. Let’s say there’s a joint venture with the non-resident holding 70 percent and Indian partner 30 percent. The company would announce a rights issue, the non-resident would participate first to the extent of 70 percent, the Indian shareholder would renounce it’s 30 percent in favour of the foreign partner who would then subscribe to it at the rights issue price.

In a rights issue where pricing guidelines weren’t specifically applicable and given the lack of an explicit prohibition on this kind of practice, the non-resident shareholders were able to make significant investments at a price lesser than fair market value, Vaibhav Kakkar, partner at L&L Partners, told BloombergQuint.

Ideally, any fresh investment by the foreign partner should’ve come at fair market value. But companies would announce rights issues and subvert the pricing guidelines via the renunciation route. That arbitrage is now being plugged to say that if the foreign partner is acquiring shares because the Indian partner has renounced his right, the acquisition has to be done at fair market value.
Vaibhav Kakkar, Partner, L&L Partners

The renunciation can be done in favour of third-parties as well. There too, no pricing restrictions were mandated under the FEMA Rules.

If the renunciation was in favour of a non-resident who was not an existing shareholder, there was always the open question on whether the rights issue route with its pricing flexibility has been used to get in new shareholders, Vivek Gupta, partner at KPMG India, said. This raised questions on compliance with substance of the law. This amendment now ensures that moneys coming in through renunciation are fairly priced, he said.

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