Arbitration In IndiaCommercial Agreements & Contracts In IndiaEnforcement of Foreign Award granting a put option subject to challenges under FEMA

August 18, 20200
With industrialization and growth in commercial activities, the need for the development of efficient methods of dispute resolution has also increased. Alternative dispute resolution methods including arbitration are preferred more in international trade as compared to litigation.
One of the reasons for opting for the arbitration is the easier enforceability of an arbitral awards in a foreign country. The Convention on Enforcement of Foreign Arbitral Awards, 1958, or the New York Convention (“New York Convention”) is a noteworthy milestone in international commercial arbitration. The New York Convention has globally attempted to standardize the rule for enforcement of awards passed by arbitral tribunals in foreign countries. By being a signatory to the New York Convention, nations have agreed to recognise and enforce arbitral awards passed in other member nations.
However, in India, even after the gradual development of arbitration laws, it is still quite challenging to enforce foreign awards in certain cases, as regulatory laws are often used as a defence against enforceability of such awards.
Arbitration awards can be challenged in India if their enforceability results in violation of provisions of the Arbitration and Conciliation Act, 1996 (“the Act”). In recent years, the enforceability of foreign award granting put option has been challenged in Indian Courts taking Indian securities and foreign exchange laws as a defence. Nevertheless, Indian Courts have time and again taken a progressive approach by enforcing the foreign awards despite there being regulatory objections.
This article aims at discussing the objections raised under FEMA on the enforcement of foreign arbitral awards granting a put option and how Indian Courts have responded to such objections.
A put option is a type of optional clause which is included in the shareholder agreement to give the shareholder a right, not an obligation, to sell his securities, assets, bonds or stocks, to the investee company on occurrence or non-occurrence of certain events. Thereby, it obliges the investee company to buy such shares.
The price or value of securities may be fixed by the agreement or be left for future determination by an expert. The term ‘put’ means that the owner of the share has the right or option to “put his share up for sale”. The put option clause acts as a means to exit the investment.
Put options are of three kinds:
1. In the time money (ITM): A put option is in the time money, if its strike price is above the current price of the shares.
2. Out of the money (OTM): A put option is out in the money, if its strike price is below the current price of the shares.
3. At-the-money (ATM): A put option is at the money if its strike price is the same as the current price of the shares.
On exercise of a put option by a shareholder, the value or price of the shares is paid back to him. On non-compliance on the part of the investee company, subject to valid exercise, the aggrieved party or the shareholder may seek relief and enforce the performance of such clause.
Foreign investors, often, rely on put options to end their investment in the investee company by obligating the investee company to buy-back their shares. In this way, investors liquidate their investment and protect the value of their investment as an initial public offering is not always the most feasible mechanism, while liquidation or voluntary winding-up proceedings may be time consuming. Further, through this, the investee company’s obligation to buy-back their shares can be fulfilled through strict regulatory measures.
The exercise of the put option clause must be in compliance with the regulatory procedures and laws of the investee country. The put options are quite popular in international commercial practice, however, in India, they face several regulatory obstacles under Indian securities and foreign exchange control laws.
However, the enforceability of foreign awards granting put option has been going through a progressive change by amending the regulatory laws and judicial interpretation, as discussed in detail herein below.
In India, foreign exchange is regulated by the Foreign Exchange and Management Act, 1999 (“FEMA”).  The Reserve Bank of India (“RBI”), being a controlling and enforcement authority under FEMA, it issued the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (“Regulations 2020”) to regulate the transfer or issue of securities by a person residing outside India.
Regulations 2020 provided for a basic framework with respect the kind of Indian companies who could issue securities to a person resident outside India and the mechanism through which shares of the Indian companies could be transferred to or by the non-resident. According, as per Regulations 2020, Indian companies could issue equity shares or preference shares/debentures to only such non-residents as provided under the Foreign Direct Investment Scheme.
Put options were not considered legal under FEMA and even Regulations 2020 did not permit the put option clauses. Thereafter, RBI through its Notification No. FEMA. 294/2013-RB dated 12 November 2013 (“2013 Notification”), provided that –
“Further, shares or convertible debentures containing an optionality clause but without any option/right to exit at an assured price shall be reckoned as eligible instruments to be issued to a person resident outside India by an Indian company subject to the terms and conditions as specified in Schedule I.”
Subsequently, in accordance to Circular RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 dated 9 January 2019 (“2014 Circular – I”), rendered that –
“optionality clauses may henceforth be allowed in equity shares and compulsorily and mandatorily convertible preference shares/debentures to be issued to a person resident outside India under the Foreign Direct Investment (FDI) Scheme. The optionality clause will oblige the buy-back of securities from the investor at the price prevailing/value determined at the time of exercise of the optionality so as to enable the investor to exit without any assured return.”
Henceforth, through the 2013 Notification and the 2014 Circular -I amendments were made in Regulations 2020 which allowed the optionality clause but without any option to exit. By 2014 Circular – I, optionality clauses were allowed in shares to be issued to a person resident outside India but such shares would have to oblige the buy-back at the price prevailing or value determined at the time of exercise of the optionality. Further, the optionality clause including the put option shall be subject to other conditions provided in the circular.
RBI through Circular RBI/2014-15/129 A. P. (DIR Series) Circular No. 4 dated 15 July 2014 (“2014 Circular – II”), revised the pricing guidelines applicable to issue and transfer of shares having optionality clauses. Thus, the exercise of a put option would be subject to the revised pricing guidelines.
Subsequently, by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (“Regulations 2017”) and now by Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“Non-debt Rules”) further attempts were made to relax the laws. These amendments have substantially liberalized the enforceability of put options.
Further, even the recent amendments of RBI via Regulations 2017 and Non-debts Rules impose certain pricing and other regulatory restrictions on the enforcement of put options. In accordance to Regulation 10(7) of the Regulations 2017,
“A person resident outside India holding capital instruments of an Indian company containing an optionality clause in accordance with these Regulations and exercising the option/ right, may exit without any assured return, subject to the pricing guidelines prescribed in these Regulations and a minimum lock-in period of one year or minimum lock-in period as prescribed in these Regulations, whichever is higher”
Similar clause has also been incorporated in the Non-Debt Rules.
The primary obstacles that arise is when a put option is exercised at a price above or below the fair market value of share set under FEMA Regulations. If it is the case, then the put option is considered in violation of the Indian foreign exchange and securities laws and are considered illegal. Another obligation deployed against put option is that they provide the foreign investors with an “assured return” which is prohibited under FEMA.
The 2013 Notification, 2014 Circular – I and II,  along with Regulations issued by the RBI and Non-Debt Rules prohibiting exits at assured returns have become the basis for challenge to the enforcement of certain foreign awards.
International, as well as domestic arbitral awards, are enforced as per the Act. India, being a signatory to the New York Convention, facilitates the enforcement of foreign awards subject to the official recognition and provisions of the Act.
Article V of the New York Convention provides for limited grounds to challenge the enforcement of a foreign award. Article V is incorporated into the Act through Section 48 which replicates the grounds set out in Article V. If a foreign award is found to be in violation the provision, the award would be considered illegal and would be prohibited to be enforced in India.
An arbitral award may be refused to enforce if the aggrieved party proves that –
1. The arbitral agreement is not valid, or
2. Due process of law has been violated, or
3. The arbitrator exceeded his authority, or there is an irregularity in the composition of Arbitral Tribunal or proceedings, or a
4. Award was set aside in the country where it was made, or
5. Award is contrary to the public policy of India. In such cases, the Courts have to check whether the enforcement of arbitral awards is in contravention with provisions of Indian law or public policy of India.  However, the ground of public policy can only be taken if,
a. The making of the award was induced by fraud or corruption or was in violation of Section 75 or Section 81 of the Act; or
b. The award is in contravention with the fundamental policy of Indian law; or
c. It is in conflict with the most basic notions of morality or justice.
As mentioned above, one of the grounds to refuse enforcement of foreign awards is when the foreign award is found to be contrary to the public policy of India which includes the violation of any Indian laws. This ground is used as a defence against the enforcement of put option when it is in violation of provisions of FEMA or SEBI.
With the aim to minimise the interference with the enforceability of a foreign award, amendments were made to Section 48 in 2015, which deleted the ground “contrary to the interest of India”.
More so, even the India Courts have clarified that the power to refuse the enforceability of a foreign award is discretionary, and Courts may allow an award even if it is contrary to the provisions of Section 48 of the Act.
The Indian Courts have followed the principle of “least interference” in several cases while determining the enforceability of the foreign arbitral awards under Section 48 of Act.
The Supreme Court in the case of Renusagar Power Co. Ltd. v. General Electric Co., 1994 Supp (1) SCC 644, had categorically held that,
“provisions of the New York Convention do not postulate refusal of recognition and enforcement of a foreign award on the ground that it is contrary to the law of the country of enforcement and the ground of challenge is confined to the recognition and enforcement being to the public policy of the country in which the award is set to be enforced”.
Thereafter, in Ssangyong Engineering & Construction Co. Ltd. v. National Highways Authority of India, AIR 2019 SC 5041, the Supreme Court limited the scope for intervention in the enforcement of arbitral awards and noted that interpretation of the term ‘public policy has been narrowed down by the 2015 Amendment.
The Supreme Court, in Shri Lal Mahal Ltd. v Progetto Grano Spa (2014) 2 SCC 433, laid down that any interference on the merits of the decision of the foreign arbitral tribunal is untenable as it is not permitted under the New York Convention, and the expression ‘public policy of India’ should be construed narrowly.
Following is a judicial trend of cases pertaining to the issue of enforcement of the foreign arbitral awards granting put option despite the violation of Indian laws:
1. Shakti Nath and Others v. Alpha Tiger Cyprus Investment Ltd.& Others (2017 (5) ARBLR 112)
In this case, dispute arose pertaining to the foreign investors right, under the shareholder agreement, to require the Indian promoters to acquire their shares in case of failure to comply with certain conditions. An award was passed in favour of the foreign investors.
The award was challenged by the Indian promoters on the ground that the award was an attempt by the foreign investors to enforce their put option rights under the agreement which was in violation of Notification and Circulars issued by the RBI that explicitly prohibited foreign investors from receiving an assured exit price on the sale of their shares.
With regard to the allegation on enforcement of put option rights through arbitral award, the High Court of Delhi observed that
“The Arbitral Tribunal examined the Respondents’ claim as one for damages. The directions issued by the Arbitral Tribunal did not touch on the aspect of exercise of put option by the Respondents. With the Respondents not exercising the option of the “put option” but claiming damages for breach of the contract under Section 73 of the ICA, the question of any violation of RBI Circular No. 4 of 2014 in relation to exercise of “put option” did not arise. There is, therefore, no merit in the contention of the Petitioner that the impugned Award, if implemented, would lead to violation of FEMA/ RBI guidelines or any of the circulars thereunder.”
Thus, the Court held that award awarding damages for breach of a put option does not violate foreign exchange or RBI guidelines. 
2. Cruz City 1 Mauritius Holdings v. Unitech Ltd. (2017) 239 DLT 649
In this case, the dispute pertained to the exercise of a put option by the petitioner due to delay in commencement of construction of a real estate project. An arbitral award was passed in favour of the petitioners which was challenged by the respondents. Respondents contended that the award is contrary to the public policy of India as it contravenes the provisions of FEMA.
The High Court of Delhi, while enforcing the award held that the defense of public policy is to be balanced while enforcing the foreign awards and it shall be exercised only when it offends the core values of national policy which cannot be compromised.
Further the Court laid down that, “The expression “fundamental policy of law” must be interpreted in that perspective and must mean only the fundamental and substantial legislative policy and not a provision of any enactment.”
Ultimately, the Court referred to various Indian and foreign decisions to conclude that the width of the public policy defense to resist enforcement of a foreign award is extremely narrow. The Court held that the ground of violation of the provisions of FEMA would not warrant declining enforcement of a foreign award. Importantly, however, the Court clarified that the remittance of foreign exchange in favour of a foreign party pursuant to the enforcement of such award would still be subject to receipt of the requisite permission, if any, from the RBI under FEMA.
The Court also refused that the exercise of the put option clause, in this case, amounted to an assured return and held that Cruz City had no assurance of exit at a pre-determined return.
3. NTT Docomo Inc. v. Tata Sons Limited, (2017 (4) ARBLR 127 (Delhi))
In this case, the RBI challenged the enforcement of the foreign award on the ground that the award is in contravention of the provisions of FEMA. The Award stated that there were modes of performance of the put option obligation that would not require any special permission from the RBI.
The High Court of Delhi rejected the RBI’s contentions and held that there is no provision in the law that permits the RBI to intervene in a petition seeking enforcement of an arbitral award to which the RBI is not a party.
Further, the Court allowed the enforcement of award as it contemplated payment for damages instead of enforcing the put option hence was not violating any provision of FEMA.
4. Vijay Karia v. Prysmian Cavi E Sistemi SRL & Others (2020 SCC SC 177)
In this case, the Supreme Court affirmed the earlier decisions of the High Court of Delhi and allowed the enforcement of a foreign award transferring securities from an Indian resident to a non-resident of India at a price below the fair market value.
The challenge was on the ground that the foreign exchange regulations require the transfer of securities be made at fair market value, not at the lessor value, thus, the objections were raised that the award was in contravention of FEMA and against the public policy of India. It was pointed out that FEMA aims at managing foreign exchange, unlike FERA which focused on policing.
The Supreme Court observed that the violation of FEMA can be rectified by seeking ex post facto permission from the RBI to condone the violation, thus, these awards cannot be held to be illegal or void.
The Court while commenting on violation of the fundamental policy of Indian law held that a breach under FEMA can never be held to be a violation of the fundamental policy of Indian law. 
The Court further held that –
“the important point to be considered is that the foreign award must be read as a whole, fairly, and without nit-picking. If read as a whole, the said award has addressed the basic issues raised by the parties and has, in substance, decided the claims and counter-claims of the parties, enforcement must follow”.
5. Banyan Tree Growth Capital LLC v. Axiom Cordages Ltd, Commercial Arbitration Petition No. 476 of 2019, dated 30 April 2020
Recently, the High Court of Bombay relied on the decision of Cruz City and Vijay Karia and observed that put options providing exit to foreign investors do not violate the provision of FEMA. It held that unlike its predecessor, it aims at managing the foreign exchange transaction.
It was further held that a put option providing exit to a foreign investor which is triggered in the event that the promoters of the investee company are unable to conduct an IPO or merger of the investee company, would not amount to an assured exit.
Thus, the Court held no objections under FEMA can become a ground for holding the put option agreement unenforceable and definitely will not be violation of public policy of India so as to render the enforcement foreign award granting put option void.
For a long time, it has been a challenging task for foreign investors to prove the validity of put option and to enforce arbitral awards allowing put option in India. However, post 2013 amendments made in FEMA and recent judicial pronouncements, there has been a progressive change in foreign exchange laws and their interpretation, which has made the enforcement of such clauses possible India in several cases.
Judiciary had adopted the narrow approach of public policy in furtherance of the pro-enforcement and pro-arbitration regime. The position is also in accordance with Article 51 of the Constitution of India that bestows a duty to encourage compliance of international law and treaty obligation, thereby need to encourage settlement of international disputes by arbitration.
Thus, it is settled that enforcement of arbitral awards cannot be restricted based on the objections raised under foreign exchange law. Nonetheless, RBI retains its regulatory powers and can step in to regulate remittance of monies pursuant to enforcement of a foreign award.
This approach of Indian Courts has resulted in substantial relief for foreign investors and it may attract more foreign investments in future.
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