Since March 2010, the Department of Industrial Policy and Promotion in the Government of India has issued regular updates to its policy on foreign direct investment (FDI). These updates are issued biannually—on March 31 and September 30. Therefore, and as expected, on September 30, 2011 the Government issued its September update with a press release highlighting key changes.
Six changes were highlighted in this update. These changes related to (i) permitting FDI under controlled conditions in apiculture (beekeeping), (ii) exempting FDI in construction development activities in the education sector and in old-age homes from conditions that apply to FDI in other construction activities, (iii) broadening the definition of industrial parks (where 100% FDI is permitted) to cover facilities that conduct research and development in bio-technology, pharmaceuticals and life-sciences), (iv) allowing up to 26% FDI in terrestrial FM radio (up from 20%), (v) clarifying the rules that apply when converting pre-incorporation and other expenses into equity; and (vi) permitting residents to pledge shares to non-residents in connection with external commercial borrowings by Indian companies and allowing banks in India to open rupee denominated non-interest bearing escrow accounts, to hold shares acquired from residents or to hold money being paid to purchase shares from residents.
While these changes are welcome, another change—one that was not highlighted in the accompanying press release—is likely to cause a kerfuffle.
Like earlier updates, this September update continues the provision that only three types of instruments can be used for FDI: (i) equity shares, (ii) fully, compulsorily and mandatorily convertible debentures, and (iii) fully, compulsorily and mandatorily convertible preference shares.
However, this September update then expressly goes on to state that these instruments cannot have "in-built options of any type" to qualify as FDI. "Equity instruments issued/transferred to non-residents having in-built options or supported by options sold by third parties would lose their equity character and such instruments would have to comply with the [current rules applicable to external commercial borrowings]."
This new language is likely to cause a lot of confusion on two counts. First, there is little clarity on the types of transactions that will be affected by the phrase "options of any type." For instance, would a common restriction on transfer of the shares (such as a right of first refusal or a drag along right) amount to a prohibited option. Second, there is also little clarity on the period to which the restriction relates. In other words, is this restriction a 'clarification' of an old rule that applied to instruments issued before October 1, 2011 or is this a new restriction that will only apply to instruments that are issued after October 1, 2011?
Given the common use of such shareholding-related restrictions in FDI transactions, one can only hope that the Government of India or the Reserve Bank of India issues prompt clarifications on the scope and effect of this latest "update."