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Home / Opinion / Are Options Under FEMA Really Enforceable?

Are Options Under FEMA Really Enforceable?

By Abhinav Surana, Sumitava Basu, Kanika Mathew
16 May 2017

Abhinav Surana & Sumitava Basu

Exit clauses with downside protection have been a common demand of foreign investors/partners dealing with
Indian firms. While the Reserve Bank of India (RBI) had allowed options a few years ago under the Foreign
Exchange Management Act (FEMA), it had specified that upon exercise of such an option, the exit should be
without any ‘assured return’.

However, enforceability of such clauses/an arbitral award for enforcing such clauses has been a subject matter
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of dispute – in some cases the Indian party tries to prevent its enforceability by citing violation of FEMA
provisions and in the Tata-Docomo case (where the parties had consented), the RBI raised an objection.
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In the Tata-Docomo dispute, the Delhi High Court upheld the enforceability of the award against Tata. In the
Cruz City I Mauritius Holdings versus Unitech case, the Delhi High Court allowed enforcement of an arbitral
award requiring Unitech to honour its obligation pursuant to exercise of a put option.

Going by these recent judgments, the FEMA violation

argument may not be sufficient defence anymore for the
Indian party to avoid honouring its obligations.

Kanika Mathew, Associate, Juris Corp

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The Unitech case

Cruz City had invested in Kerrush Investments Ltd (a Mauritius company) which, through its downstream
subsidiaries in India, were to undertake some real estate projects in Mumbai. Under the shareholders’
agreement (SHA) entered by Cruz City at the time of investment, Cruz City was entitled to exercise a put
option (in a specified event) pursuant to which Burley (a 100% subsidiary of Unitech) was obligated to
purchase its shares in Kerrush at a specified IRR. Under a separate agreement, Burley agreed to undertake
obligations under the SHA in relation to the put option, and Unitech, in turn, agreed to make sufficient funds
available with Burley to enable Burley to undertake its obligations towards Cruz City.

Cruz City exercised its put option and moved to the London Court of International Arbitration (LCIA) for
enforcement of the same, which gave the award in favour of Cruz City. At the time of enforcement of the award
before the court, Unitech (amongst others) argued that the award was not enforceable since it was contrary to
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FEMA (as it obliged Unitech to honour the put option with an ‘assured return’) and consequently violated
‘public policy’ of India.
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The court dismissed Unitech’s arguments and held that the ‘public policy’ defence is to be construed narrowly
and contravention of specific provisions of FEMA cannot be held to be against public policy. As regards the
argument for violation of FEMA, it held that these issues can be addressed by ensuring that no funds are
remitted outside the country in enforcement of a foreign award, without the necessary permissions from the
RBI.

The court also drew a distinction between the put option with assured return versus put option as a remedy for
breach. The put option was exercised by Cruz City because of a failure by Unitech to commence construction
of an underlying project within a specified time frame. In this context, the court observed that it is doubtful if the
RBI regulation, which prohibits optionality clauses granting assured returns, would be applicable in cases
where a foreign investor exercises the option as a remedy for breach.

The Tata-Docomo case

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Briefly, in 2009, NTT Docomo (Docomo) and Tata Teleservices Ltd (Tata) entered in an arrangement wherein
Docomo purchased around 26.5% in the joint venture entity. As per the agreement between the parties,
Docomo had the right (upon Tata’s failure to achieve certain milestones) to require Tata to either find a buyer
or purchase itself Docomo’s shareholding at the fair market value (FMV) or 50% of the acquisition price (half
acquisition price), whichever is higher. Once, Docomo enforced its sale option, Tata sought the RBI’s
permission as the half acquisition price was higher than the maximum permissible price under the FEMA.
However, the RBI declined the same.

Things changed after Cyrus Mistry was removed as Tata group chairman and Ratan Tata stepped in as interim
chairman and the parties agreed to settle the case. However, the RBI filed an application for opposing the
enforceability of award as being violative of FEMA.

The court while allowing enforcement of the award against Tata, held as follows:
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The court held that in absence of RBI being a party to the dispute, it cannot challenge its
enforcement. The court thus refused to accept the submission of the RBI that since the award
contemplates the provisions of FEMA and its applicability, it is imperative that the RBI be
conferred locus standi to intervene the enforcement proceedings.

The court clarified that the payment by Tata to Docomo falls under ‘damages’ (as against a
sale consideration) and the RBI’s apprehensions about this being an ‘assured return’ under
FEMA is not sustainable. Since the sale price is less than the purchase price, the court endorsed
the view that this is more in the nature of a downside protection and not an ‘assured return’.
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The court, therefore, concluded that the RBI cannot refuse permission for transfer of funds
from Tata to Docomo.

The road ahead

The recent judicial trend suggests that the courts are becoming increasingly sensitive to the rights and
interests of foreign investors and the need to protect them against abuse by resident entities who exploit the
law to circumvent their payment obligations. The recent judgments mentioned above and the IDBI Trusteeship
Services Ltd versus Hubtown Ltd case are clear indicators of the same.

While the appeal from the Unitech judgment by Unitech or by the RBI in Tata-Docomo case (in case it is held
to have locus standi), cannot be ruled out, overall, these developments signal positive signs and will provide
comfort to the foreign investors/partners while dealing in India. Hopefully, the regulator’s stand will also change
in line with the approach of the court.

Abhinav Surana is partner, Sumitava Basu is senior associate and Kanika Mathew is associate at law firm
Juris Corp.

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