Recently, the Supreme Court in the case of IDBI Trusteeship Services Limited v. Hubtown Limited has issued an order that might bring much cheer to the foreign investor community. This case involved, among other things, an interpretation of FEMA Act and regulations thereunder. It came up before the SC as an appeal from a summons for judgment in a summary suit from the Bombay High Court.

The facts are that FMO, a non-resident investor, invested in compulsorily convertible debentures (CCDs) and equity shares of an Indian company, Vinca, such that FMO owned 10% of the total equity shares of Vinca and 3 CCDs. Hubtown, an Indian company owned 49% of the equity shares in Vinca and the individual promoters of Hubtown held the remaining 41%. Upon conversion of the 3 CCDs, FMO would be entitled to 99% of the equity of Vinca. Vinca subscribed to optionally fully convertible debentures (OPCDs) issued by three of Vinca’s subsidiaries, from the amount invested by FMO. The OPCDs issued by all the three subsidiaries carried a coupon to ensure an internal rate of return of 14.75% p.a. to Vinca. To secure the OPCDs and to ensure punctual payment of all their dues to Vinca, Hubtown had issued an unconditional and irrevocable corporate guarantee in favour of IDBI, the debenture trustee to the transaction. When the subsidiaries defaulted in payment of the coupon rate to Vinca, IDBI proceeded to fully redeem all the OPCDs, including the principal amount and unpaid interest thereon. When the subsidiaries failed to pay the amounts due, IDBI sought to enforce the corporate guarantee issued by Hubtown. When Hubtown failed to pay, IDBI filed a summary suit before the Bombay High Court for enforcement of the corporate guarantee.

The Bombay High Court agreed with Hubtown’s defense that FMO could not have directly subscribed to OPCDs under the FDI policy and that Vinca was interposed merely as a nominal recipient of FDI from FMO to circumvent the FEMA regulations and FDI policy. It held that the transaction was a colorable and artificially structured transaction, designed to enable FMO to secure a fixed rate of return on its FDI investments and that it was specifically designed to defeat the FEMA regulations and the FDI policy. Hubtown was granted leave to defend the summary suit on this basis.

The Supreme Court while setting aside the order of the Bombay High Court noted that investment by FMO into Vinca by way of equity shares and CCDs was not violative of FEMA regulations. The court also held that payment under the corporate guarantee to the debenture trustee for and on behalf of Vinca, an Indian company, was also not violative of FEMA regulations. If and when FMO became a 99% equity share holder of Vinca, the court noted that FMO could use the funds received into Vinca to structure its other Indian investments. The court also noted that if FMO intended to repatriate the same, it would have to seek RBI’s permission and if the same was granted by the RBI, there would be no violation of FEMA regulations. It held that Hubtown’s defence was merely “plausible but improbable” and held that it would be granted leave to defend itself only upon depositing the principal amount invested by FMO with the Bombay High Court.

It is important to note that the Supreme Court did not disregard the form of the transaction or lift the corporate veil in the manner that the Bombay High Court erroneously did. Foreign investors who have employed similar structures in their investments in Indian companies would definitely breathe a sigh of relief and Indian promoters who sought to take umbrage under the dubious argument such as the one raised here will no doubt be forced to put their money where their mouth is and honor their commitments.