Foreign firms love India, but here's what gives them cold feet when talking business

India's rapidly growing economy, rise of the middle class, and ever-growing consumer base makes it an attractive destination for foreign investments. However, navigating India's complex regulatory landscape poses significant challenges for foreign investors. This article explores the critical legal considerations and possible roadblocks investors typically navigate from an exchange control law perspective while assessing investment and business opportunities in India.

Downstream investment: Deferment of consideration

In 2023, the Reserve Bank of India (RBI) issued notices to several foreign- owned/controlled companies (FOCCs) for violating foreign direct investment (FDI) norms and deferring part of the consideration payable to resident sellers when making downstream investments. The absence of a specific provision in the extant foreign exchange regulations of India that permit payment of deferred consideration by FOCCs results in a lack of clarity among stakeholders when structuring transactions requiring deferment of consideration. Since earn-out structures, holdbacks, and post-closing adjustments are commonly used in merger and acquisition (M&A) transactions, the absence of a specific provision on deferment of consideration and regulatory uncertainty in such transactions impacts deal timelines.

Approval process: Absence of fixed timelines

Investment in some sectors such as banking, multi-brand retail trading and telecommunication, and investment by an investor, whether directly (or beneficially) from a country sharing land border with India, requires the approval of the Government of India. While the investors have shown inclination to procure such approvals as a pre-condition to making investments in India, the absence of identified timelines to receive these approvals remains a substantial deterrent.

Payment of indemnity: Requirement of regulatory approval  

Indemnity provisions are one of the most negotiated clauses of M&A agreements. For a cross-border M&A deal, the Indian exchange control laws only allow payment of 25% of the purchase consideration as indemnity (payable within 18 months from payment of the full consideration) as long as the total consideration finally paid meets the applicable pricing guidelines. Any indemnity not payable within the said contours in a deal involving a foreign investor and a person resident in India may require the RBI’s approval or an arbitral award/court order for enforcement, leading to a delay in payments.

Cross border escrow arrangements

The foreign exchange regulations prescribe that an escrow arrangement cannot exceed a period of 18 months from the date of the transfer agreement. This period is usually inadequate for deals involving regulatory approvals. While this duration may be extended with approval, the uncertainty of obtaining such approval makes structuring of these transactions cumbersome. The fact that this escrow arrangement is on an interest-free basis also proves detrimental for investors in large deal value transactions.

Reforms expected in Modi 3.0

As India braces itself for another term under Prime Minister Narendra Modi's leadership, the business community anticipates significant reforms in the M&A landscape, especially in respect of foreign investments. Modi 3.0 is expected to build on the foundation of the substantial policy shifts to liberalize the economy under previous Modi terms. Some of the aspects that can be addressed are as follows:

Clear guidelines for FOCCs: Clear guidelines from the RBI in respect of the permissibility of deferred consideration in downstream investment transaction could reduce uncertainties and legal risks, making these transactions more straightforward.

Streamlining approval processes: A key expectation from Modi 3.0 is to further simplify regulatory approval processes for M&A transactions. The introduction of the automatic route for many sectors has already reduced the need for prior Government approval, but additional sectors could be brought under this route. Simplifying procedures and prescribing outer timelines for receiving approvals could expedite transactions and make the investment process more transparent and predictable.

Amendments to foreign exchange regulations: Amendments to foreign exchange regulations that permit payment of indemnity exceeding the 25% threshold in case of breach involving fundamental aspects of the transaction (for example, title to securities), increasing the time period for payment of indemnity under the automatic route, and extending timelines for escrow arrangements for transactions involving regulatory approvals could help to catapult India into a more attractive destination for FDI and a deal-friendly economy.

The Modi 3.0 era is poised to bring significant reforms that could transform the M&A landscape. India Inc. continues to wait with bated breath to see these changes materialize, positioning India's economic resilience and competitiveness to be exhibited on the global stage.