Directors nominated by the foreign partner in a subsidiary firm will be treated as appointees of the foreign firm, they feel.
Directors nominated by the foreign partner in a subsidiary company would be treated as appointees of the foreign firm, even though the investing company is controlled and owned by Indian residents, is the consensus among officials and experts on the new guidelines.
According to Press Note 2 of 2009, downstream investments of companies in which Indian residents have over 50 per cent beneficial stake and the right to appoint a majority of directors will not be considered as Foreign Direct Investment (FDI). And, so, they will not have to conform to the restrictions associated with FDI.
Experts say this clause will allow foreign companies to direct their investments to sensitive sectors (with FDI limits and other prohibitions) through Indian-owned and controlled companies. And, concern is being expressed that foreign companies, through downstream investments of their Indian partner, can take over control of the subsidiary firm’s board.
Government officials maintain this is not possible. “Why will the Indian majority partner allow its foreign partner to have more board members in the subsidiary companies?” an official asked.
Investments experts are still puzzled at the implications of the new foreign investment guidelines, but insist that the agreement between two companies is a mutual prerogative. “Commercial considerations are independent of actual practical execution of guidelines for any company to follow,” said Apurva Mehta, associate director, advisory services, KPMG.
Thus, if Indian company ‘I Co’, which has ownership and control by Indian residents, undertakes downstream investment in subsidiary company ‘Sub Co’, it will not be considered as foreign investment. Assume I Co has five directors, of whom two are nominated by the foreign partner.
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Suppose Sub Co has seven directors, of whom two are nominated by the foreign investor, while the others are the same directors on I Co. Effectively, then, Sub Co will have four foreign partner-nominated directors, while the other three come from the Indian firm. Sub Co will be treated by the government as if it is controlled by the foreign company, as a majority of its board is nominated by the latter.
Officials say the two foreign-nominated directors from I Co will be considered as foreign directors in Sub Co as well. But, they insist, such a situation is “unlikely and presumptuous”, as the Indian partner will not allow control of Sub Co to go away from them.
According to Akash Gupt, executive director, PricewaterhouseCoopers, a scenario where minority shareholders get control of a subsidiary company may not be in the spirit of the FDI policy. “Control should be proportionate to the liquidity stake,” he said.
In sectors such as media, where the ministry of information and broadcasting has specified that control of companies will have to be with the Indian partner, the majority of the board of directors will continue to be from the latter, irrespective of the foreign investment.
But, experts maintain, nothing stops the Indian partner from asking its foreign partner to manage operations of the subsidiary company on its behalf. “The Indian partner, while holding control and ownership of the subsidiary, can ask the foreign partner to bring its best practices and technology and use it for managing operations of the subsidiary company.
This does not violate any norms,” said a Delhi based investment expert.