NATIONAL LAW SCHOOL OF INDIA UNIVERSITY, BANGALORE

MBL II YEAR ANNUAL EXAMINATION (29TH JULY) 2020

PAPER I - INVESTMENT LAW

QUESTION : 2

(a) Explain the definition and nature of “securities” for the purpose of applicability of
SEBI Regulations.
(b) Distinguish between the ‘issue of securities in public offer’ and ‘offer for sale.’

ANSWER : 2

(A) Nature of Securities for the purpose of applicability of SEBI regulations

A “security” is a financial instrument (investment product) that represents fractional

ownership position in a publicly-traded company as stock, a creditor relationship with
governmental body or a company as a bond, or rights to ownership as represented by an
option. A security is a tradable, negotiable financial instrument that represents some type
of financial value. Ironically, securities are the most insecure type of instruments that there
are and this is why, the world over, we can only find inclusive definitions of securities.

A security is nothing more than an instrument in writing evidencing ownership of an asset.

“Security” in this sense means converting an illiquid asset into an easily transferable one
through the process of “Securitization”. The Black’s Law Dictionary defines the word
“securities” to mean “stocks, bonds, notes, convertible bonds, warrants or other documents
that represent a share in a company or a debt owned by a company or government entity”

Securities with participatory rights are referred to as equity securities (ownership

instruments), while securities with promised returns are referred to as debt securities (debt
instruments). A combination of both is commonly termed as hybrid securities. The
ownership rights in corporate bodies are commonly known as stocks and shares or equity.
The debt instruments may be debentures, notes, commercial paper, bonds etc. Let us
examine some of these instruments. Securities not only accord their holder with contractual
rights, as may be agreed between the issuing entity and the investors, but there are several
statutory rights provided under various statutes to the holders of securities. A well-defined
set of statutory rights and liabilities accruing from securities increases investor confidence
leading to greater marketability.

As enunciated earlier, the formal definition in India is found in Section 2(h) of the
Securities Contracts (Regulation) Act which lends an inclusive definition, comprising all
shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of
a like nature in or of any incorporated company or other body corporate; Derivatives;
Special Purpose Instruments; Government Securities; and such other instruments as may be
declared by the Central Government to be securities; and rights or interests in securities. In
Sudhir Shantilal Mehta vs CBI, [2009] 13SCR682, it was observed by Supreme Court that,
the definition of ‘securities’ is an inclusive one. It is not exhaustive. It takes within its
purview not only the matters specified therein but also all other types of securities as
commonly understood.
 (B) Issue of security for public offer (IPO) vs. offer for sale (OFS)

1. Definitions:

IPO : An initial public offering (IPO) is the first time a company issues shares to the
public. This is when a private company decides to go ‘public’. In other words, a company
that was privately-owned until then becomes a publicly-traded company. Before the IPO, a
company has very few shareholders. This includes the founders, angel investors and
venture capitalists. But during an IPO, the company opens its shares for sale to the public.
As an investor, you can buy shares directly from the company and become a shareholder.

OFS : A private company launches an initial public offering (IPO) for additional funding.
The company sells shares to outside investors so that it can gain access to funds for various
purposes. This includes growth and expansion of the company. However, the company’s
financial problems do not end with an IPO. Sometimes, a company may need additional
capital to meet its goals. That’s the time such companies can opt to go for an Offer for Sale
(OFS).

2. Basic Principles :

IPO : There are different investor categories when it comes to IPOs. This includes:

a. Qualified Insititutional Buyers (QIBs)

b. Non Institutional Investors (NIIs)
c. Retail Individual Investors (RIIs)

The allocation of shares differs for all the above groups in an IPO. As an individual
investor, you come under the last category. As an individual investor, you are allowed to
invest in small lots worth Rs 10,000-15,000. You can apply for a maximum of Rs 2 lakh in
an IPO. The total demand for shares in the retail category is judged by the number of
applications received. If the demand is less than or equal to the number of shares in the
retail category, you are offered a full allotment of shares. When the demand is greater than
the allocation, it is known as oversubscription. Many times an IPO can be over-subscribed
five times over. This means that the demand for shares exceeds the supply by five times. In
such cases, the shares in retail category are offered to investors on the basis of a lottery.
This is a computerised process that ensures impartial allocation of shares to investors.

OFS : An Offer for Sale is a mechanism where promoters in a listed company sell their
shares directly to the public in a transparent manner. This mechanism was first introduced
in the market by SEBI in 2012. Through this process, promoters in public companies can
sell their shares and reduce their holdings from publicly-listed companies. This is a simpler
way for public companies to sell shares and get capital compared to other options such as
follow-on public offering (FPO).An FPO is a process where an already listed company
issues additional shares to investors.
 3. Strategy

IPO :
i. To raise capital for growth and expansion
Every company needs money to increase its operations, create new products or pay off
existing debts. Going public is a great way to gain this much-needed capital for a company.

ii. Allowing owners and early investors to sell their stake to make money
It is also seen as an exit strategy for initial investors and venture capitalists. A company
becomes liquid through the sale of stocks in an IPO. Venture capitalists sell their stock in
the company at this time to reap returns and exit from the company.

iii. Greater public awareness

IPOs are ‘star-marked’ in the stock market calendar. There is a lot of buzz and publicity
around these events. This is a great way for a company to publicise its products and
services to a new set of customers in the market.

OFS :

In an OFS, promoters of a company dilute their stake by selling their shares on an

exchange platform. Anyone including retail investors, companies, Foreign Institutional
Investors (FIIs) and Qualified Institutional Buyers (QIBs) can bid on these shares.

List of investors who can participate in OFS

1. Retail investors
2. Insurance companies
3. Mutual funds
4. Qualified institutional buyers (QIBs)
5. Non Resident Indians (NRIs)
6. Foreign Portfolio Investors (FPIs)
7. Trusts, HUFs, Body Corporates

4. Pros & Cons of IPO

Pros:

a. First-mover advantage
This is especially true when reputed companies announce an IPO. You get a chance to buy
the company’s shares at a much lower price. This is because once the company’s shares
reach the secondary market, the share price may go up sharply.

b. High returns
If the company has a potential to grow, buying shares in an IPO can be benefit you. Strong
fundamentals of the company mean that it has a good chance of growing bigger. This can
be advantageous to you as well. You stand a chance to earn good returns over the long-
term.

c. Listing gains
When a company gets listed on the stock market, it may be traded at a price that is either
higher or lower than the allotment price. When the opening price is higher than the
allotment price, it is known as listing gains. Generally, investors expect an IPO to perform
well on listing due to factors such as market demand and positive bias. However, this does
not always happen. It is possible for a stock price to drop by the end of the first trading day
too. In reality, listing gains may not actually result in good returns for the investor in the
long term. So, if you are a trader interested in quick returns, it may be suitable. But for
long term investors, it is important to identify a company that can offer high returns five or
even ten years down the line.

Cons :

An FPO is generally a lengthy process. The company is required to issue a new prospectus,
which is then submitted to the Securities and Exchange Board of India (SEBI). Following
that, the company has to hire managers to take care of the sale. The sale of shares can last
anywhere between three and five days.

On the other hand, an OFS is much simpler. There is no requirement for the company to
file any formal paperwork. In addition, the sale of shares typically takes only a single
trading day.

5. Pros & Cons of OFS

Pros:

a. Discount
Retail investors are generally offered a discount on the floor price when they buy shares
through OFS. The discount is around the range of 5% in these offerings. The discounted
price is one of the key benefits of investing through OFS for retail investors.

b. Minimal paperwork
The entire process of OFS is a system based bidding platform. As a result, there is minimal
paperwork required from the investor. This makes OFS a simple and less time consuming
process.

c. Cost effective
When you place your bids under OFS, there are no additional charges applicable. Only the
regular transaction and Securities Transaction Charges (STT) which are already levied for
equity investments are applicable. This makes OFS a cost effective way of investing in
equities.

Cons:

a. Limited reservation for retail investors

As per SEBI guidelines, a minimum of 10% of the offer is supposed to be reserved for
retail investors. In case of PSUs, this may go up to 20%. However, this is far lesser than
the 35% reservation for retail investors in the case of IPOs.

b. Limited bidding window

The issue period for an OFS does not exceed more than a single trading day. In
comparison, an FPO can stay open for anywhere between 3-10 days. The issuing company
has to inform the stock exchanges two banking days prior to the OFS. That’s why it is
important to be updated to avoid losing out on a good investment opportunity.

QUESTION : 6
Write a short note on any FOUR of the following
a) Minimum subscription
b) Connected Person in Insider Trading
c) Greenshoe Option
d) ‘Right to renounce’ in Rights issue
e) Anchor Investor

ANSWER : 6

I. Minimum subscription

Minimum subscription is the term which is used to represent the amount of the issue which
has to be subscribed or else the shares can't be issued if it is not being subscribed.
Company which is offering the shares to the public then they set a specific amount for the
subscription which can be taken by the public in order to issue the shares.

The minimum subscription which is required for a company to utilize funds as follows:-

1. Infrastructure company won't have to have the requirement of 25% of its securities as
public offer.

2. If the infrastructure company offers the requirement for the shareholders in that case Rs.
1 lakh can be waive off.

3. Infrastructure companies which are having public issues for them minimum subscription
of 90% is not necessary and it should be given by the alternate source through that fund is
coming to the company.

4. Infrastructure company can keep the issue open for 21 days only which would give the
sufficient amount of time to get the funds for their issues.

II. Connected Person

The clause 2(1)(d) of the SEBI regulations define “connected person” to mean:

(i) any person who is or has during the six months prior to the concerned act been
associated with a company, directly or indirectly, in any capacity including by reason of
frequent communication with its officers or by being in any contractual, fiduciary or
employment relationship or by being a director, officer or an employee of the company or
holds any position including a professional or business relationship between himself and
the company whether temporary or permanent, that allows such person, directly or
indirectly, access to unpublished price sensitive information or is reasonably expected to
allow such access.

(ii) Without prejudice to the generality of the foregoing, the persons falling within the
following categories shall be deemed to be connected persons unless the contrary is
established, -
(a) an immediate relative of connected persons specified in clause (i); or
(b) a holding company or associate company or subsidiary company; or
(c) an intermediary as specified in section 12 of the Act or an employee or director
thereof; or
(d) an investment company, trustee company, asset management company or an
employee or director thereof; or
(e) an official of a stock exchange or of clearing house or corporation; or
(f) a member of board of trustees of a mutual fund or a member of the board of
directors of the asset management company of a mutual fund or is an employee
thereof; or
(g) a member of the board of directors or an employee, of a public financial institution
as defined in section 2 (72) of the Companies Act, 2013; or
(h) an official or an employee of a self-regulatory organization recognised or
authorized by the Board; or
(i) a banker of the company; or
(j) a concern, firm, trust, Hindu undivided family, company or association of persons
wherein a director of a company or his immediate relative or banker of the
company, has more than ten per cent. of the holding or interest;

It is intended that a connected person is one who has a connection with the company that is
expected to put him in possession of unpublished price sensitive information. Immediate
relatives and other categories of persons specified above are also presumed to be connected
persons but such a presumption is a deeming legal fiction and is rebuttable. This definition
is also intended to bring into its ambit persons who may not seemingly occupy any position
in a company but are in regular touch with the company and its officers and are involved in
the know of the company’s operations. It is intended to bring within its ambit those who
would have access to or could access unpublished price sensitive information about any
company or class of companies by virtue of any connection that would put them in
possession of unpublished price sensitive information.

III. Greenshoe option

In any Initial Public Offer (IPO) of a company, the biggest challenge, once the IPO is
subscribed and the shares are listed in the Stock Exchanges, is to maintain the price of the
shares listed, i.e., to maintain the issue price. Regulation 45 of the SEBI (Issue of Capital &
Disclosure Requirements) Regulations, 2009 (ICDR Regulations) contains the provision
relating to implementation of Green Shoe Option in
the public offerings. There are three parties involved in the mechanism of GSO, viz.,
1. the issuer-company;
2. the Stabilization Agent who would be usually one of the Merchant Bankers,
and
3. The lender, usually one of the pre-issue holder/promoter of the issuer company
who holds significant portion of the shares.

The GSO is an option vested in the issuer of securities wherein the issuer can opt for
over allotment of shares beyond the issue size to the investing public. The purpose of
going in for GSO is that the company intends to ensure that share price on the Stock
Exchange does not fall below the issue price. A company can issue only 15% of the
total number of shares of the IPO.
Example of Greenshoe Options
A well-known example of a greenshoe option at work occurred in the Facebook Inc. (FB)
IPO of 2012. The underwriting syndicate, headed by Morgan Stanley (MS), agreed with
Facebook, Inc. to purchase 421 million shares at $38 per share, less a 1.1% underwriting
fee. However, the syndicate sold at least 484 million shares to clients – 15% above the
initial allocation, effectively creating a short position of 63 million shares.

If Facebook shares had traded above the $38 IPO price shortly after listing, the
underwriting syndicate would’ve exercised the greenshoe option to buy the 63 million
shares from Facebook at $38 to cover their short position and avoid having to repurchase
the shares at a higher price in the market. However, because Facebook’s shares declined
below the IPO price soon after it commenced trading, the underwriting syndicate covered
their short position without exercising the greenshoe option at or around $38 to stabilize
the price and defend it from steeper falls.

IV. Anchor Investor

Anchor investors are institutional investors who are offered shares in an IPO a day before
the offer opens. As the name suggests, they are supposed to ‘anchor’ the issue by agreeing
to subscribe to shares at a fixed price so that other investors may know that there is demand
for the shares offered. Each anchor investor has to put a minimum of ₹10 crore in the
issue.

SEBI introduced the concept of anchor investors in IPOs in 2009. Book built IPOs are
supposed to have a 50 per cent reservation for qualified institutional buyers (QIBs). Up to
30 per cent of the total issue size can be allotted to anchor investors. No merchant banker,
promoter or their relatives can apply for shares under the anchor investor category. In
offers of size less than ₹250 crore, there can be a maximum of 15 anchor investors, but in
those over ₹250 crore, SEBI recently removed the cap on number of anchor investors.
Now, there could be 10 additional investors for every extra ₹250 crore allocation, subject
to minimum allotment of ₹5 crore per anchor investor.

The anchor investor can’t sell his shares for at least 30 days after the allotment. This rule
ensures that investors who want to flip shares on listing, do not use the ‘anchor’ route.
Anchor investors can bid for shares at anywhere within the price band declared by the
company. If the price discovered through the book building process is higher than the price
at which shares were allotted to anchor investors, then these investors have to bring in
additional funds to make good the shortfall. But if the book built price is lower, the excess
amount is not refunded to them.

Today, many have a complex structure and are not necessarily profitable at the net level —
Sadhbhav Infrastructure Projects, Adlabs Entertainment and Café Coffee Day are
examples. In such cases, the anchor investors can guideother investors.

Unlike analysts, brokerages or investment bankers who may put out reports on an IPO,
anchor investors have their own skin in game. They have actually subscribed to the shares
at the published price. As the anchor portion of an issue is usually taken up by serious
institutions such as mutual funds, insurance companies and foreign funds, their valuation
signals can be useful. If the issue has problems, say, of corporate governance, or asks for a
stiff price, the issue will face a tepid response from anchor investors.

Prabhat Dairy’s offer failed to draw anchor investors as the price was at a sizeable
premium to listed peers and there were challenges in growing the business. In the case of
Adlabs Entertainment IPO too, anchor investors had bid at the lower end of the price band.
In the public issue which opened a day later, poor retail response forced the company to
lower its price band to get subscribed.

QUESTION : 4

DGL Infra Ltd., which is part of the promoter group of BGL Limited (the target
company), made certain acquisitions of shares in the target company between 2017
and 2018 that caused it to breach the creeping acquisition limits under the SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations, 2011. Subsequently,
on January 20, 2019, Mr Desouza, Director of DGL, made a ‘voluntary open offer’
for Rs. 91 per share, which represented a 20% premium over the prescribed floor
price. Upon making the public announcement, Mr Desouza filed the draft public offer
document with SEBI for its comments. There was an exchange of correspondence
that ensued between SEBI and Mr Desouza that primarily related to his prior trigger
of the mandatory offer requirements due to its breach of the creeping acquisition
limits. Due to this, there had been a delay of almost 14 months in SEBI’s clearance of
the offer documents. After SEBI conveyed comments on March 24, 2020, the next day
there was nation-wide lockdown announced due to COVID 19 pandemic, which also
resulted in the offer unviable and uneconomic to Mr Desouza in light of unforeseen
COVID 19 crisis. Mr. Desouza wanted to withdraw the offer. Explain the position of
law in the light above facts and advice Mr. Desouza can withdraw the voluntary open
offer made by him on January 20, 2019.

ANSWER : 4

The given case is slightly similar to a recent Supreme Court judgement, but in the case I
am now quoting is different from the question above where the scenario of the
“natural disaster” is absent.

The Supreme Court in the matter of SEBI v. M/s. Akshya Infrastructure Private
Limited has considered the question of whether an open offer for purchase of shares of the
target company, voluntarily made through a public announcement, can be permitted to be
withdrawn if such an open offer has become uneconomical.

The acquirer, M/s Akshya Infrastructure Private Limited, is a part of the promoter group of
the target company, MARG Limited. It had made several acquisitions, between 2006-2010,
in excess of the 5% creeping acquisition limit under the SEBI (SAST) Regulations, 1997.
Though in breach, the acquirer made a voluntary open offer in October, 2011, scheduling
the tendering period to commence from December, 2011. Due to certain reasons, the
acquirer expressed its desire in March, 2012 to withdraw the open offer. SEBI's
comments on the draft letter of offer were received by the acquirer in November, 2012,
after a delay of 13 months from filing, without any reference to the acquirer's request to
withdraw the open offer. SEBI's comments, in effect, mandated that the open offer fructify
after incorporating its suggestions on the same.

Appealing against SEBI's directions, primarily on the ground that the delay rendered the
open offer unviable and academic, the acquirer obtained a favourable ruling from SAT on
the issue. In appeal from SAT's decision, SEBI placed before the Supreme Court various
arguments hinging on various provisions of the SEBI (SAST) Regulations, 1997 and an
earlier Supreme Court decision in Nirma Industries & Anr. v. SEBI to state that no special
dispensation was accorded to voluntary open offers, under the law, in respect to their
withdrawal.

Taking cognisance of various arguments, some interpretative, the Supreme Court rapped
SEBI on the knuckles for its delay of 13 months in giving its comments on the draft letter
of offer, but declined to make the delay, or economic unviability of the open offer, a
valid ground for relief to the acquirer. In the absence of such a ground in the exempting
provision of the SEBI (SAST) Regulations, 1997, the Supreme Court ordered the
setting aside of SAT's decision and the implementation of SEBI's directions to make
the offer.

Analysis :

The reasoning given by the top court is: If, on the ground of fall in prices, a public offer
is allowed to be withdrawn, it could lead to frivolous offers being made and
withdrawn. This would adversely affect the interests of shareholders of the target
company and the integrity of the securities market, which is wholly contrary to the
intent and purpose of the SEBI (Substantial Acquisition of Shares and Takeovers)
Regulations, 2011.

However, a new ground inserted under Regulation 23(1)(c) for withdrawal of open
offer offers some flexibility as far as commercial transactions are concerned.

While clause (a) has been omitted, the other three clauses (b), (c) and (d) are exceptions to
the general rule. Clause (b) would permit a public offer to be withdrawn in case of legal
impossibility when the statutory approval required has been refused. Clause (c) again
provides for impossibility when the sole acquirer, being a natural person, has died. Clause
(b) deals with a legal impossibility whereas clause (c) deals with a natural disaster.
SOLUTION:

DGL INFRA LTD. should be allowed to withdraw its voluntary open offer, because
this is a legitimate case and not a frivolous case of making open offers and disturbing the
market by withdrawing them quickly citing adverse financial reasons. The COVID19 is a
natural disaster of a pandemic and this is a legitimate case as per Regulation 23 (1) (C).

QUESTION : 4

Cuba Banana Production Inc., a company registered as per the laws of the United
States of America, had a technology to produce banana on saline water land. They
found and examined the coastal soils of Tamil Nadu and felt interested in acquiring
such fallow lands on the east coast of Bay of Bengal within Tamil Nadu measuring
3000 acres which are registered in the name of 527 fishermen and women. The
project is to produce high-quality banana for 100% export with certification on
quality, content, branding and packaging. They have made a preliminary
investigation to understand the value of such land in India and calculated at 1 lakh
per acre with the development of farming which would require 100% of the land cost.
The farming, processing, packaging and shipment cost would be five times the land
and development cost. It will create employment for 1000 people. For carrying out the
above project, the said US based company has approached you to seek your advice in
on Foreign Direct Investment norms in India concerning its proposed project. Write a
detailed note explaining the sectoral eligibility, mode of entry, issue of capital
instruments, and any other restriction or conditions related to the relevant sector as
per FDI norms.

ANSWER : 4

Major Takeaways from the proposed project :

- Company is based in USA and not some nation like Pakistan which is considered
an enemy state. USA is under the present diplomatic relations, considered a friend.
- They are interested in setting up the project in the state of Tamil Nadu
- No information is given if the people looking to acquire land are composed of NRIs
or people of Indian origin
- They want to acquire land from a community(/es) of fisher-people
- They want to export everything they produce
- They want to set up banana plantations in the saline water lands and they have the
requisite permissions
- They want around 1000 employees

A. Sectoral eligibility

At present, 100% foreign direct investment (FDI) is allowed through the automatic
route into India for the following agricultural activities:

- Floriculture, horticulture, apiculture and cultivation of vegetables and mushrooms

under controlled conditions
- Development and production of seeds and planting material
- Animal husbandry (including breeding of dogs), fish farming, aquaculture, under
controlled conditions
- Services related to agriculture and its allied sectors

Here we need to note that the FDI investment will cover multiple points like plantation
farming and aquaculture where we are dealing with saline lands.

B. Entry/ Land Acquisition

One of the major issues getting in the way of greater investments into the Indian
agricultural sector is issues pertaining to land acquisition in the country. According to the
master circular on acquisition and transfer of immovable property in India by
NRIs/PIOs/ foreign nationals of Indian Origin circulated by the Reserve bank of
India (RBI), foreign nationals of non - Indian origin do not hold the permission to
acquire any immovable property in the country. An exception from this rule is for
property acquired through inheritance from an Indian resident.

Several states have their own laws regarding this issue and may have different guidelines
to adhere to. States like Maharashtra and Karnataka only permit individuals to acquire
agricultural land whereas, other states such as Delhi, Goa, Bihar and Tamil Nadu permit
both individuals and companies to acquire agricultural land for the purpose of
carrying out agricultural activities.

C. Labour

The government of India, under the National Agricultural Policy, promotes private sector
participation in the agricultural sector through the concept of contract farming and land
leasing. This is to allow accelerated technology transfer, capital inflow and assured market
for crop production, especially that of oilseeds, cotton and horticultural crops. The Model
Contract Act of 2018 was recently unveiled in order to protect the interests of the farmers.
The act brings in all services in the agricultural value chain under its gambit including
contract farming. This has made it easy for them to acquire labour and other staff
numbering around 1000.

D. Issue of capital instruments

a. An Indian company is permitted to receive foreign investment by issuing capital

instruments to the investor. The capital instruments are equity shares, debentures,
preference shares and share warrants issued by the Indian company.

1. Equity shares: Equity shares are those issued in accordance with the provisions of
the Companies Act, 2013 and will include equity shares that have been partly paid.

2. Partly paid shares: Partly paid shares issued on or after July 8, 2014 will be
considered as capital instruments. Partly paid shares that have been issued to a
person resident outside India should be fully called-up within twelve months of
such issue. Twenty five percent of the total consideration amount (including share
premium, if any), shall be received upfront. The time period of 12 months for
receipt of the balance consideration need not be insisted upon where the issue size
exceeds rupees five hundred crore and the issuer complies with Regulation 17 of
the SEBI

3. Share warrants: Share warrants issued on or after July 8, 2014 will be considered as
capital instruments. At least twenty five percent of the consideration shall be
received upfront and the balance amount within eighteen months of issuance of
share warrants

4. Debentures: Debentures are fully, compulsorily and mandatorily convertible

debentures.

5. Preference shares: Preference shares are fully, compulsorily and mandatorily

convertible preference shares.
 b. Issue of Securities:

The capital instruments should be issued within 180 days from the date of receipt of the
inward remittance received through normal banking channels including escrow account
opened and maintained for the purpose or by debit to the NRE/FCNR (B) account of the
non-resident investor. In case, the capital instruments are not issued within 180 days from
the date of receipt of the inward remittance or date of debit to the NRE/FCNR (B) account,
the amount of consideration so received should be refunded immediately to the non-
resident investor by outward remittance through normal banking channels or by credit to
the NRE/FCNR (B) account, as the case may be.

c. Pricing of shares

Price of shares issued to persons resident outside India under the FDI Policy, shall not be
less than –

1. the price worked as per SEBI guidelines, as applicable, where the shares of the company
are listed on any recognised stock exchange in India;

2. the fair valuation of shares done as per any internationally accepted pricing methodology
for valuation of shares on arm’s length basis, duly certified by a Chartered Accountant or a
SEBI registered Merchant Banker where the shares of the company are not listed on any
recognised stock exchange in India

3. the price as applicable to transfer of shares from resident to non-resident is –

4. where shares of an Indian company are listed on a recognized stock exchange in India,
the price of shares transferred by way of sale shall not be less than the price at which a
preferential allotment of shares can be made under the SEBI Guidelines, as applicable,
provided that the same is determined for such duration as specified therein, preceding the
relevant date, which shall be the date of purchase or sale of shares.

5. where the shares of an Indian company are not listed on a recognized stock exchange in
India, the transfer of shares shall be at a price not less than the fair value worked out as per
any internationally accepted pricing methodology for valuation of shares on arm’s length
basis which should be duly certified by a Chartered Accountant or a SEBI registered
Merchant Banker.

However, where non-residents (including NRIs) are making investments in an Indian

company in compliance with the provisions of the Companies Act, as applicable, by way
of subscription to its Memorandum of Association, such investments may be made at face
value subject to their eligibility to invest under the FDI scheme.

d. Exit from foreign direct investment with optionality clauses for the unlisted Indian
companies

In case of an unlisted company, the non-resident investor shall be eligible to exit from the
investment in equity shares, Compulsorily Convertible Debentures (CCDs) and
Compulsorily Convertible Preference Shares (CCPS) of the investee company at a price
not exceeding that arrived at as per any internationally accepted pricing methodology on
arm’s length basis, duly certified by a Chartered Accountant or a SEBI registered Merchant
Banker.

The guiding principle would be that the non-resident investor is not guaranteed any assured
exit price at the time of making such investment/agreements and shall exit at the fair price
computed as above at the time of exit, subject to lock-in period requirement, as applicable.

To any foreign investor looking into an opportunity to invest in India, one of the primary
concerns is the time required to set up a legal entity in India and how simple / difficult it is
to get various registrations / approvals, if any, and the compliance regime of the country.
Indian Government had been proactively involved for past few years to improve India’s
standing in ease of doing business and has achieved remarkable success in doing so. In a
bid to simplify the existing compliances with respect to the Foreign Direct Investment, the
Indian Government came out with major changes with the policies which seeks to revamp
regulations to regulate investment in India by a Person Resident Outside India.

E. Restrictions/ conditions

Agriculture is covered under the automatic route and there aren’t many restrictions or
conditions as such. No prior approval is required for FDI under the Automatic Route. Only
information to the RBI within 30days of inward remittances or issue of shares to Non-
Residents is required. RBI has prescribed a new form, Form FC-GPR (instead of earlier
FC-RBI) for reporting shares issued to the Foreign Investors by an Indian company.

QUESTION : 5
Xenon India Ltd., a company registered under Companies Act, 2013, having it
registered office at Bengaluru. Xenon is engaged in the business of manufacturing
printer cartridges and refills. In the year 2017, Xenon Ltd. listed its specified
securities on Bombay Stock Exchange issued under a public offer for issuance of fresh
securities and offer for sale of shares of existing shareholders constituting 25.8% of
the total paid-up capital of the company. The present market capitalisation of the
company is Rs. 1400 cr. Xenon Ltd. is in the process of expanding its installed
capacity at one of its manufacturing units, and for the same, it requires Rs. 100 Cr. of
capital financing. Due to COVID Crisis Xenon was not able to go for public offer.
Hence, Mr Anand Mehta, one of the Managing Director of the company, has
identified four (4) promoters of the company (all person resident in India) who are
ready to finance the expansion of capital against the issue of Compulsory Convertible
Debentures with 7-year maturity through private placement. Mr Anand Mehta has
approached you on June 19, 2020, for legal advice to structure the mode of
investment and guide the future course of action. Explain the law related to the above
transaction and the process to be followed.

ANSWER : 5

Analysis :
Compulsorily Convertible Debentures (“CCDs”) or Compulsorily Convertible Preference
Shares (“CCPS”) are instruments which mandatorily convert into equity shares of the
issuing company on the conditions decided mutually at the time of issuance of the
instruments. CCDs generally have a lower rate of interest than NCDs. CCDs are
considered as capital instruments and investment in CCDs may be made under the FDI
route.

While interest payments on CCDs is permissible, due to RBI guidelines on pricing, the
price/ conversion formula has to be determined upfront at the time of issuance, and the
price at the time of conversion cannot be lower than fair market value. Further, instruments
issued with optionality clauses will not considered to be FDI compliant, unless they
comply with RBI guidelines in this regard, including, inter alia, minimum lock-in of 1
year, and obtaining exit only according to the prevailing market price. The prevailing intent
is that foreign investors subscribing to instruments with optionality clauses should not be
guaranteed an exit price.

The FA, 2017 introduced thin capitalization rules within the ITA (“Thin Capitalization
Norms”) to curb companies from enjoying excessive interest deductions, while effectively
being akin to an equity investment. This move would have a significant impact on
investments into India through the debt route – both in respect of CCDs and NCDs which
are widely used methods for structured finance into India.

However,

a. CCDs have to be issued pursuant to the RBI’s pricing guidelines which prescribe
for internationally accepted pricing methodologies
b. Creation of security interest is not permissible either on immoveable or movable
property
c. an NBFC carrying on the business of acquisition of shares and securities must
satisfy the following requirements:
1. at least 80% of its total assets is in the form of investment in equity shares,
preference shares, debt or loans in group companies
2. at least 60% of its total assets is invested in equity shares of group
companies (including CCPS/CCDs with a maturity period of maximum 10
years)
3. it does not trade its investment in shares, debt or loans, except for the purposes
of disinvestment or dilution
4. it does not carry on any other financial activity except bank deposits, money
market instruments, government securities, loans to and investments in debt
issuances of group companies or guarantees issued on behalf of group
companies
5. it has a minimum asset size of INR 100 crore
6. it accepts public funds