Protecting crown jewels

India has done well to follow in the footsteps of Germany, France and Australia among others by introducing provisions to safeguard its businesses

It was a pandemic aftermath waiting to happen. It has been said that the economic consequences of Covid-19 would result in one of the worst depressions in living memory. Given that it is almost certain that businesses will be under stress, many will need additional funding to survive, others may need to be sold off and some others simply liquidated. In a country like India where many of the largest Indian business houses are highly leveraged, these consequences would likely happen sooner than elsewhere. And it is only logical that when businesses are so stretched and facing dire consequences, they would either raise additional capital or be sold very cheap. The most logical question then would be whether the government would allow its national assets to be sold cheap, particularly to a government which may not be considered an ally.

Germany, France, Australia and several other countries have recently introduced provisions to safeguard their national interests. These lay down that the acquisition of assets requires prior government approval to ensure that these are not acquired by foreign investors at less than fair price. It is only logical and welcome that India has followed suit. Press Note (PN) No. 3 dated April 17, 2020, provides that non-residents based out of countries that share land borders with India can invest in India only under the government approval route. Since investments from Pakistan and Bangladesh in India are already regulated, this leaves investments from Nepal, Myanmar, Bhutan, Afghanistan and, of course, China to be covered by the PN. The PN (which needs to be formally notified to be effective) interestingly, brings out the concept of beneficial ownership and provides that an investment made by a person or entity which is beneficially owned by a resident of prohibited countries would be regarded as investment made by residents of those countries. Given that Chinese entities already have substantial investments in India and also that Chinese entities have investments in PEs and other entities that have investments in India, the PN poses interesting issues, which are best clarified.

Logically, investments from Hong Kong should be covered by the PN since Hong Kong is a special administrative region of China, albeit with a limited autonomy. This needs to be clarified. Also, given that several Indian citizens are residents of Hong Kong, they need to be exempted from the purview of the PN.

The PN would cover not only new investments but also the transfer of existing or future foreign direct investment (FDI). As such, if an Indian entity held wholly or partly by an investor covered by the PN issues further shares — say, on a rights basis — the covered investor will not be able to make investments except with prior approval of the government. The concept of beneficial ownership is quite interesting and, while it is welcome, it is new and the term itself is not defined. This term is recognised under tax laws but that is a narrow definition.

For the purposes of the PN, one needs to look at the intention of the investments that are sought to be covered. Also, there is no de minimis quantum of interest that a resident of the covered country can hold. For example, if a foreign investor is a joint venture with 80 per cent American shareholding and 20 per cent Chinese holding, would the investment be covered by the PN? Similarly, global private equity (PE) funds might have Chinese investors as limited partners. Should the PN cover investments by such PEs too? If that is done, we may encounter significant bureaucratic delays and that may defeat the very purpose of the PN. Under the Know Your Customer guidelines issued by the Reserve Bank of India, a passive investor cannot be regarded as a beneficial investor, except if the 25 per cent shareholding level is breached. Under the Companies Rules, a 10 per cent holding is regarded as constituting significant influence. It would be appropriate for the government to come out with guidelines in this regard.

Finally, the PN applies to the FDI investments. A substantial portion of investments coming into the country is under the FPI or foreign portfolio investment route. It would be appropriate to consider whether those investments too should be covered and, if so, amend the PN appropriately or come out with specific instructions by theSecurities and Exchange Board of India. Similarly, one needs to consider investments in limited liability partnerships or LLPs.

The author is CEO, Dhruva Advisors LLP