owners of capital with preferential rights
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Among the fruits of India’s economic liberalization, a renewed interest by foreign investors and the consequent flow of overseas funds has been especially welcome. The shadow of the erstwhile nationalized, government-controlled economy, however, still looms, and not quite in the background. This is reflected in India’s uneasy relationship with foreign funding.
We want it, but on our own, very specific terms. A number of policies have been formulated to encourage foreign direct investment, which indicates a commitment by the foreign investor to take an active role in the management and growth of the investee company. A number of policies specifically aim to discourage speculative investments. While the intention behind such policies is commendable and undoubtedly in the interest of Indian entrepreneurs/companies, it is also indisputable that these very policies can at times end up having unforeseen side effects, discouraging foreign investors without speculative intentions and preventing the flow of much-needed funding to Indian companies.
A recent circular (New Circular) dated 8 June 2007 issued by the Reserve Bank of India (RBI) has fuelled the debate to a new pitch. Through the New Circular, RBI has revised its guidelines pertaining to issue of preference shares to foreign investors. Now, only those preference shares that are fully and mandatorily convertible into equity shares within a specified time will be considered a part of the investee company’s share capital—and only such preference shares will be issued to foreign investors under the automatic approval route (that is, without requiring permission from the ministry of commerce). Foreign investments in non-convertible, optionally convertible or partially convertible preference shares are now considered to be debt finance, that is, akin to a loan, and are required to conform to the stringent guidelines relating to external commercial borrowings (ECBs).
Presumably, the definition of “capital” under the relevant Indian regulations will be amended to reflect the New Circular. Capital, as originally defined in the relevant Indian regulations, includes equity shares, preference shares, convertible preference shares and convertible debentures.
The problem with optionally convertible preference shares was probably the perception that redeemable preference shares potentially permit unfettered outward flow of foreign exchange through repayment and dividend payments to foreign investors. However, the effectiveness of the provisions of the New Circular is already being questioned.
In this regard, the basic nature of the instrument called “preference shares” becomes all important. Simply put, preference share capital under the Companies Act, 1956, means that part of the share capital of the company that (a) in relation to dividends, carries/will carry a preferred right to be paid a fixed amount or an amount calculated at a fixed rate and, (b) carries or will carry, on the winding up of a company, a preferential right to be repaid the amount of the capital paid up (in relation to equity shareholders).
It is worth considering some of the advantages that non-convertible preference shares offer to Indian companies/promoters accessing foreign funds.
Contrary to equity shares, redeemable preference shares allowed Indian companies to access capital without any equity dilution of the existing Indian equity shareholders. Further, such redeemable preference shares could be allotted to foreign investors without offering them any voting rights or control in respect of the Indian company. There is a prescribed limit on the maximum dividend that can be paid, so preference shares could not work as an instrument for unfettered outflow of the profits of Indian companies. Also, there has never been any guaranteed payout of dividends on preference shares since, under Indian laws, dividends can be paid only out of distributable profits.
In addition to the favourable features set out above, redeemable
We want it, but on our own, very specific terms. A number of policies have been formulated to encourage foreign direct investment, which indicates a commitment by the foreign investor to take an active role in the management and growth of the investee company. A number of policies specifically aim to discourage speculative investments. While the intention behind such policies is commendable and undoubtedly in the interest of Indian entrepreneurs/companies, it is also indisputable that these very policies can at times end up having unforeseen side effects, discouraging foreign investors without speculative intentions and preventing the flow of much-needed funding to Indian companies.
A recent circular (New Circular) dated 8 June 2007 issued by the Reserve Bank of India (RBI) has fuelled the debate to a new pitch. Through the New Circular, RBI has revised its guidelines pertaining to issue of preference shares to foreign investors. Now, only those preference shares that are fully and mandatorily convertible into equity shares within a specified time will be considered a part of the investee company’s share capital—and only such preference shares will be issued to foreign investors under the automatic approval route (that is, without requiring permission from the ministry of commerce). Foreign investments in non-convertible, optionally convertible or partially convertible preference shares are now considered to be debt finance, that is, akin to a loan, and are required to conform to the stringent guidelines relating to external commercial borrowings (ECBs).
Presumably, the definition of “capital” under the relevant Indian regulations will be amended to reflect the New Circular. Capital, as originally defined in the relevant Indian regulations, includes equity shares, preference shares, convertible preference shares and convertible debentures.
The problem with optionally convertible preference shares was probably the perception that redeemable preference shares potentially permit unfettered outward flow of foreign exchange through repayment and dividend payments to foreign investors. However, the effectiveness of the provisions of the New Circular is already being questioned.
In this regard, the basic nature of the instrument called “preference shares” becomes all important. Simply put, preference share capital under the Companies Act, 1956, means that part of the share capital of the company that (a) in relation to dividends, carries/will carry a preferred right to be paid a fixed amount or an amount calculated at a fixed rate and, (b) carries or will carry, on the winding up of a company, a preferential right to be repaid the amount of the capital paid up (in relation to equity shareholders).
It is worth considering some of the advantages that non-convertible preference shares offer to Indian companies/promoters accessing foreign funds.
Contrary to equity shares, redeemable preference shares allowed Indian companies to access capital without any equity dilution of the existing Indian equity shareholders. Further, such redeemable preference shares could be allotted to foreign investors without offering them any voting rights or control in respect of the Indian company. There is a prescribed limit on the maximum dividend that can be paid, so preference shares could not work as an instrument for unfettered outflow of the profits of Indian companies. Also, there has never been any guaranteed payout of dividends on preference shares since, under Indian laws, dividends can be paid only out of distributable profits.
In addition to the favourable features set out above, redeemable
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