Protecting Your Investments in India

For foreign companies engaged in business operations or investments within India, it is of utmost importance to possess a thorough understanding of – and to have meticulously organised their investments in accordance with – the provisions outlined in the Foreign Exchange Management Act, 1999 (FEMA) and the associated rules and regulations. This is because any inflow or outflow of funds into or out of India falls under the purview of FEMA.

Certain sectors, such as atomic energy and railways, are strictly prohibited for foreign investment. Others, such as e-commerce, trading and real estate, are subject to specific conditions. Conversely, sectors such as manufacturing and software development allow for complete foreign ownership without any prerequisites.

Should any undertaking involving acquisitions, joint ventures, venture capital, private equity or similar transactions contravene the provisions of FEMA, they could potentially encounter challenges when attempting to divest from their investments and repatriate funds from India. It is worth noting that even guarantees issued by Indian parties in favour of foreign investors or business partners might prove ineffective and unenforceable if not compliant with FEMA.

Here are a few critical errors to avoid, taking into account not only FEMA but also the Companies Act, 2013.

Committing to assured returns in contracts for the sale and purchase of shares is a significant blunder. According to FEMA, Indian parties cannot guarantee assured returns to foreign investors. This is particularly crucial for venture capital and private equity funds that often specify a predetermined liquidation preference based on their investment value. The law explicitly disallows assured returns on put options, for instance. Additionally, there are minimum and maximum prices for subscription and sale of equity-linked instruments, with some exceptions for non-resident transactions.

Failing to integrate the terms of a joint venture agreement or shareholders’ agreement into the articles of association of the joint venture company can have repercussions. If these terms are not part of the articles of association of the joint venture company, they are not legally binding on it and cannot be enforced against it. This could lead to an unfavourable scenario, where even if a shareholder breaches the shareholders’ agreement, the joint venture company cannot be compelled to act in accordance with its terms. The only recourse would be to initiate legal action against the breaching shareholder.

Many parties assume that once a liquidated damages clause is included, it will be enforced as written. However, this assumption does not hold true in India. Recent Supreme Court judgments indicate that courts require parties to demonstrate the actual losses suffered, unless proving such losses is difficult or impossible, even when relying on a liquidated damages clause.

Frequently, foreign investors or business partners rely on guarantees from Indian counterparts. Nonetheless, this approach could prove detrimental, as guarantees provided by Indian parties outside the scope of FEMA’s Guarantee Regulations might be rendered null and void from the outset, making them unenforceable. Specific circumstances exist under which an Indian partner may offer a guarantee; for instance, a guarantee might be permissible in relation to an overseas joint venture, provided that the overseas joint venture itself complies with FEMA regulations from the outset.