FACILITATING FOREIGN DIRECT INVESTMENTS IN INDIAN BUSINESS AND INDUSTRY
FACILITATING FOREIGN DIRECT INVESTMENTS IN INDIAN BUSINESS AND INDUSTRY
Generally in India, security for project finance is created over the following asset types: immovable property; movable fixed assets; current assets; shares; assignment of rights in project and insurance contracts; and a charge over the project bank accounts. The charge over immovable property is typically created by executing an indenture of mortgage or by undertaking a deposit of title deeds for the property. On the other hand, security over movable assets (both fixed and current) is created by executing a deed of hypothecation. Security over shares is created via a pledge, which requires possession to be transferred by way of deposit of the share certificates, or if the shares are in dematerialized form, by recording the same with the depository of shares. An assignment of rights (such as rent receivables) arising out of project contracts is done via a deed of assignment. The charge over immovable property, movable property and an assignment of rights can be clubbed together under a single indenture.
Lenders typically have security over real property, plant, machinery and equipment. If the land leasehold property, permission may be required from the lessor for the creation of charge. If the security is created via an indenture of mortgage, it is necessary to register the same with the local registrar of companies (RoC). The charge created over movable/immovable properties is also required to be registered with the Central Registry Of Securitization Asset Reconstruction and Security Interest of India (CERSAI)
Security may be taken over receivables without the express consent of the debtors. However, such charge over receivables or other current assets (which is a floating charge) crystallizes into a fixed charge only upon occurrence of an event of default.
Typical project financing security package involves the creation of security over the project specific bank accounts. The procedure to be followed in this case mirrors that of any other movable assets. A notice of such a charge is given to the bank.
Security over shares is a prevalent for of security creation in India. Typically, a pledge agreement is entered into with a power of attorney to enforce the pledge which is also executed by the pledger upfront. If the shares are in certified form, the share certificates are physically deposited along with a share transfer form. If the shares are in dematerialized form, certain forms (indicating the agreement number, closure date of the pledge, quantum of shares pledged, etc.) will be required to be submitted at the relevant share depository.
In India, stamp duty on security documents varies from state to state. In some states, stamp duty is uncapped, whereas in others the liability is capped. Additionally, all indenture of a mortgage must be registered with the local registrar of assurances. In some states, a mortgage created via a deposit of title deeds is also compulsorily registrable; however, in most states such registration is optional (viz., powers of attorney and affidavits) are required to be notarized by a notary public, at a nominal charge.
The time taken to register a mortgage with the local registrar of assurances may vary drastically, depending on the efficiency of the local bureaucracy. Similar to stamp duty, registration fees payable also vary from state to state, as some states have ad velorem charges whereas others have capped limits. Filing/ registration with the RoC and AERSAI are required to be done online and is neither time-consuming nor expensive.
For the creation of security over freehold land, no consents or regulatory approval is required unless it has been reserved for a specific purpose (such as forest land, coastal land) by the government. If the land over which the security is created is leasehold in nature, typically prior consent of the lessor would be required. However, with respect to pipelines (once embedded in the earth), the land over which pipelines for the transport of petroleum, minerals or gas are laid are not transferred to the borrower, who merely acquires the rights of a user over the land. Such right of way may also be assigned to the lenders.
The “trust” structure is recognized and the tights and obligations of the security trustee is typically recorded in a security trustee agreement. Such security trustee agreements grant the trustee the right to sue, on behalf of all the lenders cumulatively, for the enforcement of the security and to apply the proceeds to the claims of all lenders. A security is trust is recognized in India, so the security trustee can sue for the enforcement of the security and can apply the proceeds to the claims of all lenders. There is also no bar on any lender suing for enforcement independently.
ENFORCEMENT OF SECURITY
The timelines for enforcing security may depend on the nature of security held by the lender. To illustrate, enforcement of a pledge created over shares, which are in dematerialized form, is relatively simple and does not require a decree of a court of competent jurisdiction. Enforcement of a mortgage may require a decree of the court under the Civil Procedure Code, 1908 or enforcement action under the securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. In a scenario where an insolvent company is subject to proceedings under the IBC, a publicly solicited bid process is undertaken wherein bidders are required to submit resolution plans that are required to be inter alia approved by the committee of creditors. In assets in regulated sectors (e.g. airports, telecommunications, roads) the enforcement process is done through a “substitution” of the defaulting company by an entity nominated by the lenders, with the consent of the relevant regulatory authority.
Under Indian law, a foreclosure suit in respect of a mortgage may be filed by a mortgagee to debar the mortgagor of his right to redeem the mortgaged property in the event that the mortgagor is unable to pay the amounts due to the mortgagee. While foreclosure proceedings may be initiated under the Foreign Exchange Management (Acquisition and transfer of immovable property in India) Regulations, 2018, from transferring any immovable property in India, unless permitted by the Reserve Bank Of India (RBI). Additionally, foreclosure suits may only be filed under the Transfer of Property Act, 1882 by a mortgagee by conditional sale or a mortgagee under an anomalous mortgage. However, if the mortgage creation is by way of an English mortgage, foreclosure suits may not be filed.
BANKRUPTCY AND RESTRUCTURING PROCEEDINGS
The IBC is the primary legislation governing insolvency of corporate entities today. The initiation of a corporate insolvency resolution process (CRIP) against the project company (which would ordinarily last at least 180 days, extendable by another 90 days, exclusive of any time spent in litigation). Accordingly, the project lender will be unable to enforce or exercise any rights in respect of its security during this period.
In the event of a successful CIRP, the IBC permits the resolution plan to provide for, inter alia, the modification and release of pre-existing security interests created by the corporate debtor. In case a successful resolution plan (approved by at least 66% of voting share of committee of creditors and the National Company Law Tribunal (NCLT)) provides for any such modification/release, the project lender will lose its right to enforce its security related rights post approval of the resolution plan.
Under the IBC, “insolvency resolution process costs” and “liquidation costs” are accorded the highest priority. Besides this, the payment of workmen’s dues for the period of 24 months preceding the liquidation commencement date is ranked pari passu with the dues of the second creditors that have relinquished their security interests to the liquidation estate. The IBC also contains protections in favor of creditors against antecedent transactions entered into by the corporate debtor during specified look-back periods (calculated backwards from the insolvency commencement date). Such provisions are equally applicable to transactions relating to security interests created over the assets of the company as well.
Under the IBC, these include transactions that are “preferential” in nature (and pertain to an antecedent liability owed to a creditor, surety or guarantor), those that are “undervalued” (including gifts), those that defraud creditors (which must necessarily pertain to undervalued transactions, which were entered into with the deliberate intention to defraud creditors), and such credit transactions that are “extortionate” in nature.
Further, the Income Tax Act, 1961 provides for transfers or charges to be void against any tax claim where it is created during the pendency of any tax proceeding or outstanding tax demand, without prior permission of the tax department.
While the IBC provides for and governs bankruptcy of individuals, partnership firms, limited liability partnerships and corporate entities in India, the provisions pertaining to bankruptcy of individuals have not yet been made operational. The regime, however, does not extend to the bankruptcy of financial service providers, which continue to be governed under the Companies Act, 2013. The Banking Regulation Act, 1949 governs the winding up of banking companies.
Post the initiation of the CIRP under the terms of the IBC, creditors are prohibited from enforcing their security interests and seizing the assets of a company. However, outside the IBC framework, there are several ways in which a creditor can enforce its security and seize the assets of a project company out of court. To illustrate, a creditor having security by way of an English mortgage has the right to sell such mortgaged property by way of private sale. Similarly, in respect of security by way of pledge, a creditor is entitled to enforce such a pledge without resorting to court proceedings, and to effect the sale of the pledged goods, after having given due notice to the pledgor.
Under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2001, banks, notified financial institutions, asset reconstruction companies, debenture trustees and certain notified NBFCs are conferred with private enforcement rights in respect of their security interests, other than in respect of pledges and liens. However, such rights do no extend to foreign creditors.
There are certain mechanisms that are available to companies to achieve a restructuring of its debts, outside of the formal insolvency regime provided for under the IBC, including the cramdown of its dissenting financial creditors. On February 12, 2018, the RBI had issued a circular titled “Resolution Of Stressed Assets- Revised Framework” (which resulted in an overhaul of all previous restructuring schemes issued by the RBI), under which lenders were obligated (either singly or jointly) to formulate a resolution plan which may provide for the change in ownership or restructuring of the corporate debtor, the moment there is a default in the company’s account. However, the said circular was struck down by the Supreme Court of India on April 2, 2019. The RBI Governor has, on April 4, 2019, issued a statement stating that the RBI will take necessary steps, including issuance of a revised circular, as may be necessary, for expeditious and effective resolution of stressed assets.
In July 2018, a large majority of Indian banks have also entered into the Inter-Creditor Agreement for Resolution of Stressed Assets as part of Project Sashakt upon recommendations of the Sunil Mehta committee. Under the framework, the lead lender shall be authorized to formulate the resolution plan, which shall be presented to the other lenders for their approval. The decision-making shall be by way of approval of majority lenders, that is, the lenders with 66% share in the aggregate exposure. Once the resolution plan is approved by the majority, it shall be binding on all the lenders that are a party to the inter-creditor agreement.
Under the IBC, upon the initiation of the CIRP against the corporate debtor, it is the resolution professional that takes on the role of the management of the company, and the powers of the board of directors remain suspended during this period. In terms of section 66(2) of the IBC, directors may be held personally liable to make contributions to the assets of the corporate debtor (on an application made by the resolution professional to the NCLT), if such director knew or ought to have known that “there was no reasonable prospect” of avoiding the commencement of the CIRP against the corporate debtor under the terms of the IBC, and did not exercise the due diligence in minimizing the potential loss to the creditors during this period.
Separately under Section 66(1) of the IBC, such persons who are knowingly party to the carrying on of the business of the company during its CIRP or liquidation, in a manner that demonstrates their intent to defraud the creditors of the company, or for any other fraudulent purpose, may be held liable to make contributions to the assets of the corporate debtor (on an application made by the resolution professional to the NCLT).
FOREIGN INVESTMENT AND OWNERSHIP RESTRICTIONS
The foreign ownership of an Indian project company is subject to the Foreign Exchange Management Act, 1999 (FEMA) and the rules and regulations made thereunder. The Maser Direction on Foreign Investment in India read with the Foreign Exchange Management (Transfer or Issue of a Security by a Person Resident Outside India) Regulations, 2017 (FEMA Regulations, 2017) empowers the RBI to prohibit, restrict or regulate the transfer or issue of any security by a person resident outside India. FEMA Regulations, 2017 provides: (i) the limit of foreign investment in each sector in India which cannot be exceeded; and (ii) the entry routes for foreign investment in various sectors, which may be either automatic or with government approval. FEMA Regulations, 2017 also lists out the prohibited activities, which include real estate, agricultural activities, atomic energy and railway operations.
Further, from a tax perspective, where any taxpayer, including a foreign company, acquires any property, i.e. shares or other instruments which are characterized as security, then it must acquire such share or security at a “fair market value” as determined in accordance with a prescribed rule for valuation. If the consideration paid is less than such fair market value, then the difference would be subject to tax in the hands of the foreign investor as “income from other sources” at the rate of 40% (plus applicable surcharge and cess) in hands of a company or 30% (plus applicable surcharge and cess) in case of other investors.
There are several bilateral and multilateral investment treaties entered into by India with various countries in order to promote trade and commerce within the country. India also has comprehensive Double Taxation Avoidance Agreements (DTAA) with 88 countries, out of which 85 are presently in place. The Income Tax Act, 1961, provides for relief for two types of taxpayers. One is for taxpayers who have paid the tax to a country with which India has signed a DTAA, while the other is for taxpeyers who have paid tax to a country with which India has not signed a DTAA. The rates differ from country to country. However, there are no treaties providing explicit protection to a foreign entity from restrictions on exchange control.
The provisions of the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 applies in relation to land acquisitions by the government for public purpose and compensation paid thereof. The Indian Constitution also grants the government the right to compulsorily acquire any property for a public purpose, upon payment of compensation. The rights on the projects undertaken through Public Private Partnerships (PPP) are automatically transferred to the concessioning authority at the end of the concession period.
GOVERNMENT APPROVALS/ RESTRICTIONS
Each infrastructure sector in India has one or more regulators that exercise jurisdiction over the particular sector. For example, the Airports Authority of India (AAI) and the Directorate General of Civil Aviation (DGCA) regulate the airports/aviation sector, while the roads sector is regulated by the National Highway Authority of India (NHAI) or the Ministry of Aviation and Ministry of Road Transport and Highways (MORTH), amongst others. Concession agreements or power purchase agreements, for example, may also be entered into with state-specific utilities/agencies.
Security documents are required to be filed and registered with certain authorities.
The government retains sovereign rights over ownership of natural resources, and the right to use such natural resources shall be subject to the terms of the licenses granted by the government. Land and licenses in respect of natural resources cannot be directly held by a foreign entity; however, it may be held by an Indian entity owned and/or controlled by such foreign entity, subject to the foreign investment thresholds specified by the government.
Royalties are payable for the extraction or export of natural resources, the amount for which will depend on the manner in which such concession was obtained and in accordance with the stipulations set out under the applicable law. Further, income tax is payable on income from extraction or export of natural resources.
Capital account transactions (which alter assets and liabilities), unless specifically permitted by the RBI or under FEMA, are prohibited. Specified routes are available for equity investment, borrowings, etc. Taxes on foreign currency exchange transactions would be levied depending on whether it results in income or deemed income in India. The actual transaction of foreign currency exchange may also be subject to the Goods and Services Tax (GST).
Tax is levied on remittances and repatriation of investment returns, levied by way if Income tax or capital gains tax, depending of the nature of the return. No tax is levied on the shareholder in the Indian project company for distribution of dividends under the law currently in force. However, the Indian company distributing dividend is subject to additional dividend distribution tax at the rate of 20.56% (including applicable surcharge and cess). Capital gains would be taxed as short term or long term depending on the period of holding the asset. Long-term capital gains arising on the sale of shares is generally taxable in the hands of a foreign investor at the rate of 10% (plus applicable surcharge and cess). Short-term capital gains would be taxed at the rate of 40% (plus applicable surcharge and cess). However, a lower rate of 30% is applicable on short term capital gains in the case of a foreign portfolio investor. Further, the short-term capital gains may be taxed at 15% only, if the gains are realized upon sale of the security on the stock exchange and the securities transaction tax paid, as prescribed.
Onshore and offshore foreign currency accounts are no permitted under applicable law, except in limited circumstances, as set out in the Foreign Exchange Management (foreign currency accounts bu a person resident in India) Regulations, 2015. For instance, an Indian project company receiving foreign investment under the foreign direct investment (FDI) route is permitted to open and maintain a foreign currency account with an authorized dealer in India, provided that the Indian project comoany has impending foreign currency expenditure. In the instance referred to hereinabove, the account is required to be closed immediately after the requirements are completed and is not permitted to be operational for more than six months from the date of the opening of such an account.
In addition to restrictions on declaration of dividend under the financing documents, the Companies Act, 2013 permits declaration of dividend only out of the profits of the Indian company and after maintaining reserves for depreciation. The payment of such dividend will be subject to the taxes mentioned above.
Depending on the nature and size of the project, project developers will be required to seek environmental clearances, approval of the resettlement and rehabilitation plan, consent to establish and operate, forest clearances and wildlife clearances, amongst others.
Any procurement by project companies may be governed by the terms of the bid documents and the subsequent concession agreements that may be signed by such a project company. That being said, in certain instances, additional taxes or duties may also be levied (for instance- the recently introduced safeguard duty on the import of solar panels from certain countries).
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