The Mumbai-based India Rising Fund (IRF), the venture fund for investment in the defence sector in India, the first of its kind and also the only one to be registered with the Sec-urities and Exchange of India, is caught in a quag-mire of interpretation iss-ues, i.e. whether their investment proposal is subject to sectoral caps.
The defence sector, hitherto jealously guarded, was opened to the private sector at the turn of the century – permitting 100 per cent participation in manufacture of arms and ammunitions, with 26 per cent FDI permissible, both subject to licensing, by the Ministry Industry in consultation with the Ministry of Defence.
All cases involving FDI require FIPB approval, and the FIPB in assessing the proposal can verify the antecedents and credentials of the investors. There are other requirements based on security concerns such as only Indian residents directors should constitute the majority on the Board, a three year lock-in for the FDI, and prior permission from FIPB/Government for transfer of foreign shares even after the lock-in expires.
Against this backdrop, IRF sought FIPB approval for raising Rs.550 crores from international investors. The purpose was to participate in small and medium defense enterprises (SMEs), particularly in order to ensure fulfilment of offset obligations.
SMEs play an important role in the non-lethal equipment sector and forays are being made in the weaponry field.
In order to maximize offset off-take, the weaponry sector needs technology – and funds. As on date, there are 6000 SMEs registered with the Defence Ministry and these SMEs can leverage major deals, e.g. aircraft orders where components can be sourced indigenously.
The FIPB clearance for IRF was finally issued in February 2009, reportedly delayed on grounds of percei-ved potential conflict of interest, and revert from the port of final call – the Defence Ministry.
It appears that the app-roval was made subject to a provision pertaining to appr-oval for all down-stream investments being subject to FDI limits. IRF reportedly sought deletion of this provision in view of the implications under Press Notes 2 & 4 of 2009 having come into force, which completely changed the context in which the approval was sought for in view of the recent Press Notes (PN) 2 & 4/99.
IRF claims to be owned and controlled by Indian individuals and companies and the investments made in the Fund are not by way of shares, but units denominated into rupees, and therefore not subject to sectoral caps.
The matter has got embroiled in a controversy because the Department of Economic Affairs (DEA) is believed to have taken a position that such interpretation would render existing FDI limits under PN 2/2002 effectively redundant.
This is not the first occasion on which PNs 2 & 4 have locked horns on extant FDI guidelines.
For one, these Press Notes have made an important departure from the earlier approach in which Foreign Institutional Investors and Foreign Direct Investment were subjected to different treatment. Even then, there were contradictions stem-ming from Press Note 2/2000 in which FDI/NRI investments were clubbed in one category.
Yet some sectors contin-ued to exclude NRI from FDI, e.g., airlines It cannot be that sectoral caps will not apply if the investments are not “shares’ or the structure of the business entity is not limited by shares, e.g. in the yet untested LLPs.
In my column of March 30, 2009, I had expressed appreciation for PN 4/09 had put at rest the interpretational problem in relation to downstream investment by foreign companies, which is defined to mean an indirect foreign investment by an Indian company in another Indian company for which no permission is required, in cases where the ownership and control of the investing entity is in Indian hands.
In permitting such investments in the automatic route Clause 4.1 of PN 2/09 clarifies that Indirect Foreign Investment, in an Indian company, would include FDI, FII NRI investments, ADRs, GDRs, FCCB et al.
If a new instrument is used for investment, there should be no reason for interpreting otherwise Clause 5.2, the exempting provision of the policy, does not make any sector specific exclusion.
Going by the strict rules of interpretation, the later policy would prevail over an earlier one i.e the 2009 Press Notes would prevail over the earlier ones specific to the defence sector. But interpretative rules also provide that a specific law override the general.
While there is no prejudice if the foreign investment thresholds for the defence sector are raised from 26 per cent to 49 per cent, if the other tests are satisfied – security concerns should not be hyped or ignored. Will the FIPB be able to provide the right solution?
Kumkum Sen is a partner at Rajinder Narain & Co., and can be reached at kumkumsen@rnclegal.com
