Mumbai: The Bombay High Court has ruled that offshore investors cannot seek legal recourse for their assured return investments in India, a verdict that can impact several foreign investors and their investments in Indian real estate projects.
The ruling pertains to a plea by Dutch government-backed financial institution FMO for recovery of over Rs. 532 crore. FMO has invested in realty developer Hubtown in 2009. The court refused relief to FMO as it was seeking assistance to enforce recovery of its investment and interest in a transaction that was contrary to the foreign direct investment (FDI) regulations.
The court said foreign direct investment (FDI) in real estate can be made only by way of equity, and any debt instrument that includes any fixed return is not permitted. These assured return investments typically happen through structured quasi-debt instruments.
The court observed that the structure of the deal was devised to circumvent the restrictions imposed by FDI regulations.
The ruling is likely to trigger restructuring in several current and future transactions involving FDI in real estate.
Justice SJ Kathawala, while passing the orders also observed that the conduct of FMO in routing the FDI investment through subsidiaries of Hubtown Ltd -Vinca and Amazia -against the issuance of optionally partially convertible debentures (OPCDs), establishes that FMO was aware that no investment could have been made with a fixed return without bearing an equity investment risk.
In the case filed by IDBI Trusteeship Services, on behalf of FMO, against Hubtown as the guarantor, the court has declared that the transaction involving FDI with assured returns was a “colourable device“ and an artificially-structured transaction that violated FDI regulations in India.
The court ruling complicates an issue that has been a cause of endless disputes in the past, with some Indian promoters trying to wriggle out of their commitments under the pretext that the foreign partners cannot claim a fixed return. But the dust had somewhat settled, with the government and the Reserve Bank of India endorsing such deals. Under the circumstances, it remains to be seen how regulators would view the court verdict.
Foreign investors expect the ruling to affect investor sentiment and capital flow towards India. "This will discourage offshore investors from investing in India, it would take their confidence away ," said the CEO of a foreign private equity firm. "The government should be clear with its policies, it just can't leave the policies open for lawyers and advisors' interpretation."
According to regulations, FDI in townships and construction of houses is permitted only through equity or debentures that are compulsorily convertible and instruments with assured returns are prohibited.
"Foreign investors will have to be careful while going into any structured trans actions in context of FDI. Courts have reverberated the regulatory approach to ook at the spirit of the FDI regulations and disregard the form of the transac ion, even though the form of it was technically legit," said Ashish Kabra, senior member with the dispute resolution team at Nishith Desai Associates.
Nishit Dhruva, managing partner of aw firm MDP Partners who is represent ng the Mumbai-based realty developer n the case, said: "Foreign investors cannot use pressure tactics on promoters on he basis of structures that are not legally permissible in India."
ET's email query to FMO did not elicit any response.
Following IDBI's suit, the court's prima acie conclusion was that Vinca was only a nominal recipient of investment and it was routed to its subsidiaries.
"Convenient 'structuring' is increas ngly becoming a thing of the past. Compliance of law in letter and spirit is the way forward, and rightly so. This is the message coming out of various recent investigations, including this judgement,“ said Abhijit Joshi, founding partner of Veritas Legal.
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