The Reserve Bank of India (RBI) is soon expected to notify the Foreign Exchange Management Act, or Fema rules on the definition of “owned or controlled”. The nod from the Cabinet Committee on Economic Affairs is awaited. In fact, it has been the subject of many court cases on matters of foreign ownership, taxation, transfer of shares and residency status.
The issue in India has come up because no longer can mere foreign shareholding of a company be used to determine the extent and control of an Indian company. Control has two aspects: de facto control and de jure control. Merely using a shareholding threshold of 25 per cent or 50 per cent foreign ownership to define an Indian company as a foreign-controlled company is looking at it purely from a de jure control perspective – a narrow legal view that doesn’t take into account the other aspects and rights accorded to shareholders.
On the contrary, de facto control looks at whether the foreign owner has any direct or indirect influence on strategic decisions taken at the shareholder or the board level, and in the operating day-to-day management. For a proper determination of control, one needs to go beyond the form and look at substance, which translates to recognising de facto control, and not merely restricting the evaluation to de jure control. The concept of de facto control is not just about influencing the composition of the board of directors, but also influencing other powers of the board and management. Positive and negative consents, veto rights, contingent control, put and call options, among others are all examples of control features incorporated into the shareholders’ agreement that goes beyond the current shareholding.
The RBI has taken a step in the right direction to raise the issue of de facto control and notify it in the foreign direct investment policies. Other regulations – the Companies Bill, 2012 and the Securities and Exchange Board of India (Sebi) takeover code – seem to recognise the de facto control aspect. The Companies Bill, 2012, pending in Parliament, says: “‘Control’ shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders’ agreements or voting agreements or in any other manner”. The Sebi takeover code paraphrases the same definition of control as that of the Companies Bill.
Many countries such as the US, Canada and Australia recognise the de facto control feature. In legislation where national security or public interest is involved, de facto control is considered. Increasingly, court rulings are looking into de facto control. In India, as sectors such as retail, aviation, defence and nuclear power are opened up to foreign ownership, it is de facto control that needs to be considered.
At the end, the true test of control is whether majority shareholders of the Indian company have strategic and operational freedom to take decisions independent of the foreign shareholder.
(Source: Extracts from an Article by Mr. Shriram Subramanian in Business Standard dated 29-06-2013.)
