In India, foreign investments through equity instruments (other than share warrants) are regulated in accordance with the terms of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”). A recent amendment to the NDI Rules has clarified that any acquisition of shares by foreign investors pursuant to renunciation of rights by a resident will be subject to the pricing guidelines under the Foreign Exchange Management Act, 1999 (“FEMA”).
Rule 7 of the NDI Rules deals with acquisition of equity instruments (other than warrants) by a person resident outside India in case of a rights issue or bonus issue by an Indian company. It provides that in case of an unlisted Indian company, the rights issue to persons resident outside India will not be at a price less than the price offered to persons resident in India and in case of a listed company, the rights issue to persons resident outside India will be at a price determined by the company, and the general pricing guidelines will not apply.
As per the Companies Act, 2013, in case a rights offer is made, existing shareholders can either accept, decline to subscribe to a rights issue or renounce their subscription right in favour of a third party. This renunciation can be made in favour of an Indian resident or a non-resident.
Prior to the Amendment, Rule 7 also had an explanation stating that the provisions of Rule 7 will also apply in case of subscription to rights shares by a person resident outside India which were renounced by the person to whom they were originally offered. Therefore, the pricing guidelines stipulated in Rule 7 were also applicable in all such cases.
The Department of Economic Affairs, Ministry of Finance, on April 27, 2020 notified the Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules, 2020, which omitted the above mentioned explanation and a new Rule 7A has been introduced which states that ‘a person resident outside India who has acquired a right from a person resident in India who has renounced it may acquire equity instruments (other than share warrants) against the said right as per pricing guidelines specified under Rule 21 of the NDI Rules’ (“Amendment”).
As per Rule 21(2)(a)(ii) of the NDI Rules, unless otherwise prescribed in the NDI Rules, the price of equity instruments of an unlisted Indian company issued by such company to a person resident outside India shall not be less than the valuation of equity instruments done as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a Chartered Accountant or a Merchant Banker registered with the Securities and Exchange Board of India or a practising Cost Accountant. Further, in case of equity instruments of a listed company, the price of such instruments has to be worked out in accordance with the guidelines prescribed by the Securities and Exchange Board of India or as per the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009 in case of a company going through the delisting process.
The Amendment is very important simply because prior to the Amendment, since the pricing guidelines were not applicable and in absence of an explicit prohibition on the same, the non-resident shareholders were able to make significant investments at a value much lesser than the fair market value.
While the Amendment has brought in long awaited change in the pricing guidelines in case of renunciation of a rights offer by resident, it does not cover a situation where an existing non-resident investor renounces a rights issue entitlement in favour of another foreign investor. It is important that these clarifications are given in order to make sure that no acquisition of equity instruments is made at a price lesser than the fair market value.