This article is written by Aabir Shoaib, pursuing Diploma in General Corporate Practice: Transactions, Governance and Disputes from Lawsikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).
Table of Contents
Introduction
Overseas Direct Investment (ODI) is now a catchphrase in this age of globalization. It can be seen during the last few years that the trend of investing in firms overseas is expanding year upon year. Many Indian residents and companies are investing in or purchasing stakes in foreign companies. Money invested by way of donation to the capital or subscription to the Memorandum of Association of a foreign entity, or purchase of equity securities of a foreign entity either by market purchase, private placement, or stock exchange, excluding portfolio investment, is referred to as ‘Overseas Direct Investment’ and this generally signifies a long term interest in the foreign entity.
It is important to note that Foreign Direct Investment (FDI) is regarded as a significant non-debt financial resource for economic development, especially in a developing country like India. FDI flows into India have increased steadily since liberalisation and have become an essential element of foreign investment because it infuses long-term sustainable capital into the economy and contributes to the transfer of technology, corporate strategy sector development, greater innovation, contestability, and job creation, along with other benefits. As a result, the government of India encourages and supports FDI in order to augment indigenous capital, technology, and skills in order to drive economic growth and development.
Unlimited company in India
An unlimited company is defined under Section 2(92) of the Companies Act, 2013. An Unlimited Company means a company not having a limit on the liability of the members of the company, that is, the shareholders. As there is no limit on the liability of the members of the company, if and when the company is unable to pay off its liabilities and debts in a full-fledged manner and it decides to initiate the process of liquidation/winding up, the creditors of the company will have right to recover their payments by asking for the personal assets of the shareholders to be sold in order for the payments to be made to the creditors.
Naturally, unlimited companies are riskier and put the shareholders at much greater risk in case of an adverse situation since there is no limit on the liability of the members regardless of their percentage of shareholdings. However on the bright side, in the case of a company having unlimited liability the creditors have higher chances of recovering their money so it becomes easier to get credit from creditors. This also makes the company realise the value of its assets given that they could lose all of them anytime. Additionally, the management decisions of the company are crucially operated and evaluated at every step thereby significantly reducing their chances of getting the business into potential risks.
Foreign Direct Investment/Overseas Direct Investment in India
‘Foreign Direct Investment’ or FDI, or an overseas direct investment in India is referred to as an investment made through capital instruments by a person residing outside India in an unlisted company registered in India or in ten per cent or more of a listed Indian firm’s post-issue paid-up equity capital on a fully diluted basis.
If a pre-existing stake by a person residing outside of India in capital instruments of a public company drops below ten per cent of the fully diluted post-issue paid-up equity capital, the investment will be classified as FDI. The entire number of shares that would be outstanding if all feasible sources of conversion were used is referred to as a ‘fully diluted’ basis.
The government has developed an FDI policy framework that is transparent, dependable, and easy to understand. This framework is enshrined in the Circular on Consolidated FDI Policy, which could be modified on a yearly basis to assess and stay consistent with regulatory changes that occur during the interim. The Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce & Industry, Government of India, issues consolidated FDI policy circulars, press notations, and press releases, notified by the Department of Economic Affairs (DEA), Ministry of Finance, Government of India, as amendments to the Foreign Direct Investment Policy.
Regulations applicable to Overseas Direct Investments
Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations promulgated via Section 6(3), Clause (a) of the Foreign Exchange Management Act, 1999 govern transactions in respect of Overseas Direct Investments. (Refer FEMA.120/RB-2004 notification issued July 7, 2004, for more details.)
Direct investment by residents in joint ventures and totally owned subsidiaries based overseas is allowed under the aforementioned provisions. Any investment in joint ventures and wholly-owned subsidiaries may be made via the Automatic Route (without seeking Government of India approval) or the Approval Route (subject to Government approval).
The Reserve Bank of India (RBI) has the authority under Section 6(3) of the Foreign Exchange Management Act, 1999 to prohibit, restrict, or control transactions by imposing required restrictions. Section 11 of the FEMA Act also authorises the RBI to make directions to ensure that the terms of the Act, as well as the rules, regulations, notices, and directions issued thereunder, are followed.
Most importantly, only ‘Authorised Dealers’ covered under the definition of Section (1) of Section 10 of FEMA, registered with the Reserve Bank of India can undertake Overseas Direct Investments. The Indian party/Resident Individual is required to route all transactions relating to a specific overseas Joint Venture (JV) or Wholly Owned Subsidiary (WOS) through only one branch of an Authorized Dealer. This branch would be the designated ‘Authorised Dealer’ for that Joint Venture or Wholly Owned Subsidiary, and all transactions and communications relating to the investment in that particular entity would be reported only through this designated Authorized Dealer branch.
For the purposes of ODIs, FEMA and RBI, company incorporated in India, a body created by an Act of Parliament, a partnership firm registered under the Indian Partnership Act 1932, a Limited Liability Partnership (LLP) incorporated under the LLP Act, 2008, and any other entity in India as may be notified by the Reserve Bank is all considered Indian Parties. When more than one of these companies, bodies, or entities invests in a foreign Joint Venture or Wholly Owned Subsidiary, the combination is known as an “Indian Party.”
In case an Indian Party wants to make an overseas direct investment from India, it may make bona fide overseas direct investment in any bona fide activity but Real Estate (as defined in Notification No. FEMA 120/RB-2004 dated July 7, 2004) and banking as these are prohibited sectors for FDI. The term “real estate business” refers to the buying and selling of real estate or the trading of Transferable Development Rights (TDRs), but it does not include the development of townships, the construction of residential/commercial premises, roads, or bridges.
In a recent case, Standard Chartered Bank has been fined Rupees 100 Crore involving illegal share distribution as the Enforcement Directorate’s Adjudicating Authority (AA) penalised Standard Chartered Bank, Tuticorin-based Tamilnad Mercantile Bank, and others for violating provisions of the Foreign Exchange Management Act (FEMA).
Standard Chartered Bank (SCB) was fined 100 Crore by the AA, while Tamilnad Mercantile Bank (TMBL) was fined 17 crores and MGM Maran, the then chairman and director of TMBL, was fined 35 crores. According to the Enforcement Directorate, the AA held SCB guilty of contraventions of the provisions of FEMA for opening the SCB Project Windmill escrow account without prior permission of the RBI.
Conclusion
In a nutshell, the investment made through capital instruments by a person residing outside India in an unlisted company registered in India; or in ten per cent or more of a listed Indian firm’s post-issue paid-up equity capital on a fully diluted basis is referred to as ‘Foreign Direct Investment’ or FDI.
An unlimited corporation is one in which the responsibility of the members of the company, i.e. the shareholders, is unrestricted. Because the members’ liability is unlimited, if and when the company is unable to pay off its liabilities and debts in a timely manner and decides to initiate the process of liquidation/winding up, the company’s creditors will have the right to demand that the personal assets of the shareholders be sold in order for the payments to be made.
In India, the Reserve Bank of India reserves the right to prohibit, restrict, or control transactions by placing certain restrictions under Foreign Exchange Management Act, 1999 such as transfer or issue of any foreign security by a person resident in India; transfer or issue of any security by a person resident outside India; transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India; any borrowing or lending in rupees in whatever form or by whatever name called; any borrowing or lending in rupees in whatever form or by whatever name called between a person resident in India and a person resident outside India; deposits between persons resident in India and persons resident outside India; export, import or holding of currency or currency notes; transfer of immovable property outside India, other than a lease not exceeding five years, by a person resident in India; acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a person resident outside India; giving of a guarantee or surety in respect of any debt, obligation or other liability incurred either by a person resident in India and owed to a person resident outside India; or by a person resident outside India.
This Act also empowers the Reserve Bank of India to issue directions to ensure that the Act’s terms, as well as the rules, regulations, notices, and directions issued thereunder, are followed, and that only ‘Authorised Dealers’ registered with the Reserve Bank of India can engage in Overseas Direct Investments. The investment shall be considered as FDI if a previous stake by a person residing outside of India in capital instruments of a public company falls below ten per cent of the fully diluted post-issue paid-up equity capital. A fully-diluted basis refers to the total number of shares that would be outstanding if all possible sources of conversion were utilised. An Indian Party may make bona fide overseas direct investment in any bona fide activity but Real Estate and banking are the prohibited sectors for FDI. The term “real estate business” refers to the buying and selling of real estate or the trading of Transferable Development Rights (TDRs), but it does not include the development of townships, the construction of residential/commercial premises, roads, or bridges.
Foreign Direct Investment (FDI) is viewed as an important non-debt financial resource for economic development, particularly in developing countries like India. Since liberalisation, FDI flows into India have steadily increased and have become an important component of foreign investment because it infuses long-term sustainable capital into the economy and contributes to technology transfer, corporate strategy sector development, greater innovation, contestability, and job creation, among other things. As a result, the Indian government encourages and supports foreign direct investment (FDI) in order to supplement indigenous capital, technology, and skills and drive economic growth and development.
References
- https://www.mca.gov.in/MinistryV2/classification+and+registration+of+companies.html
- https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join:
https://t.me/joinchat/J_0YrBa4IBSHdpuTfQO_sA
Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.
