Government’s Concern With Neighbouring Countries’ Directors

Prior government approval will now be required if individuals from neighbouring countries want to be directors on board of Indian companies. This direction is, however, silent on the why. The requirement has been mandated by the Ministry of Corporate Affairs. And is another one in a series of changes introduced since April 2020 for countries sharing a land border with India.

This is an extension of amendments introduced earlier in the foreign direct investment policy and series of other regulatory changes concerning investments from China and other land bordering countries, said Vaibhav Kakkar, partner at Saraf & Partners.

Currently also, he said, the government as part of security clearance process for FDI applications in certain sensitive sectors like broadcasting, civil aviation etc., monitors persons who are on board of Indian companies.

To recap, it all started with revisions to the FDI policy two years ago. Referred to as press note 3 (PN3), the amendment moved all investments from China, Hong Kong, Pakistan, Bangladesh, Nepal, Myanmar, Bhutan and Afghanistan under approval route. Since then, fresh FDI from these countries or transfer of existing ownership to a beneficiary from these countries has required government approval.

At the time, preventing opportunistic takeovers of vulnerable Indian businesses, in light of the Covid-19 pandemic, was given as the reason for the policy change.

The legislation was the outcome of the geopolitical scenario, said Harshita Srivastava, leader-private equity and M&A practice at Nishith Desai Associates. Be that as it may, PN3 applications seemed to have moved only since last year, Srivastava says while sharing the practical experience of businesses so far.

One common thread across rejections is the most talked-about, obvious one- high degree of Chinese ownership, several lawyers told BQ Prime on the condition of anonymity.

Of course, that’s not the reason you get on paper, said one of the lawyers. You get told that the investment will not generate enough employment or there’s not enough technical know-how that the investor is bringing. To be clear, the same lawyers also said not all applications with Chinese beneficial ownership have been rejected. And subsequent investments by PN3-approved investors have been quicker.

While stakeholders were navigating through all of this, in the last few months, several process requirements have been made mandatory under company law. All of these are a subset of April 2020 change to the FDI policy-

• Private placement of shares to entities from neighbouring countries requiring prior government approval.

• Disclosure under share capital and debentures rules: Acquirer of shares, debentures or convertible securities needs to disclose if its PN3 compliant.

• Declaration under companies’ incorporation rules: Subscribers and directors of a newly formed company to disclose if they are approved as per PN3.

• Mergers, restructurings resulting in allocation of shares to an entity from a neighbouring country—needs to be disclosed before company law tribunal if PN3 approval is in place.

• And last week, the government directed that director appointments from neighbouring countries will require prior clearance from the Ministry of Home Affairs.

While the intended objectives of the MCA are not clear, one theory that’s been circulating is that dummy companies have been set up with Chinese individuals as directors to and run operate companies in India and also on the premise that getting work visa is relatively easier, said Rudra Pandey, partner at Shardul Amarchand Mangaldas & Co.

According to Srivastava, requirement for directors could’ve been prompted by Chinese entities acquiring ‘control’ over Indian companies, one of which is through board and management rights.

The recent notification is consistent with the intent of PN3, said Ravindra Bandhakavi, head of private equity practice at Cyril Amarchand Mangaldas. The April 2020 changes to the FDI policy brought in through PN3 had grandfathered existing investments, he explained.

The notification seems to cover both fresh appointments and re-appointments of directors, Bandhakavi said.