Management of Indian companies with foreign stakes under lens

NEW DELHI: Indian companies having foreign stakes will now face a much closer scrutiny of their management and decision-making structures as the government decides to tighten the rules to determine who controls them.

The department of industrial policy promotion ( DIPP), the nodal department responsible for FDI policy, is looking to design the control definition on the lines of the one in the Sebi's takeover code, a government official told ET.

Under the present definition in the FDI policy, control is defined as the ability to appoint majority of directors. This definition does not take into account indirect ways of exercising control such as lien over voting rights and share purchase agreements, giving room to investors to skirt norms via quasi-equity instruments.

In contrast, the definition on control in the takeover code and the proposed Companies Bill take into account these two instruments, commonly used globally by corporates to exercise control.

The DIPP has initiated fresh discussions with the finance ministry and Sebi to finalise what should be the conditions wherein one entity is said to 'control' another, an issue that became important after British telecom major Vodafone's $11.1 billion buyout of Hutchison Essar in 2007.

Vodafone had in its application to the FIPB said that it had bought 52% stake in Hutchison but its notice to overseas stock exchanges said that it had purchased 67% stake. This was because the company had also acquired indirectly 15% controlling interest, prompting the Foreign Investment Promotion Board (FIPB) to direct the DIPP to review the FDI policy.

The finance ministry, which houses the FIPB, has repeatedly pitched for a clear and stringent definition of control in the FDI policy since 2009 to ensure clarity of ownership in sensitive sectors, more so as investments from some countries have national security implications.

The new FDI policy says that a company having more than 50% foreign equity or controlled by a foreign company would be considered foreign company and all investments of such Indian company would be considered foreign investments. Such a foreign owned or controlled company has to comply with sectoral FDI caps and is not allowed to invest in sensitive sectors.

However, under the current definition of 'control' in the FDI policy a company could escape restriction if it did not appoint the majority of directors but the foreign investor otherwise exercised control over the Indian company through quasi-equity instruments and other routes available. A wider definition of control would make it difficult for foreign investors to avoid restrictions by exercising indirect influence over the Indian company.

Experts, however, caution against excessive scrutiny of ownership structures and shareholder agreements.

"Control definition under the Sebi takeover code is very wide and certain terms are ambiguous...Unless an advance ruling kind of window is provided to foreign investor for upfront determination of control based on specific facts and agreements with Indian parts, there would litigation risk," said Akash Gupt, executive director, PwC.