May 4, 2011

No RBI Approval for Cash and Share Escrow

The Reserve Bank of India (“RBI”) vide a circular dated May 2, 2011 (“Circular 58”)1 has made it permissible for non-residents to open cash and / or share escrow accounts either  independently or together with residents and vice versa, without the requirement of a prior approval of the RBI. This is a welcome change for foreign investors looking at investing into India as it provides greater flexibility in structuring foreign private equity investments and M&A’s in India and exit strategies in connection therewith.

Background

Prior to Circular 58, although RBI specifically permitted opening and maintaining of escrow accounts for acquisition, transfer of shares, convertible debentures through open offers, delisting, and exit offers in accordance with the regulations and guidelines issued by the Securities Exchange Board of India (“SEBI”)2, the circulars issued by RBI from time to time made no mention of escrow arrangements for FDI related transactions, other than the aforementioned. The  uncertainty as to whether an RBI approval was required for such escrow accounts was seen as an impediment  in the structuring of transactions involving staggered execution / closing of transactions contingent on the fulfillment of certain crucial conditions by the issuer company or the transferor, as the case may be. Therefore, escrows to facilitate such transactions were often maintained outside India to facilitate the commercials of the transaction. Circular 58 has now made it possible to set up and maintain such escrow accounts for FDI related transactions in India without any delay.

Circular 58

Circular 58 permits AD Category-I banks to open and maintain escrow accounts on behalf of residents and / or non-residents for the purpose of keeping shares or purchase or subscription money / consideration in an escrow for a maximum period of 6 months; an escrow for a period more than 6 months shall require RBI approval. The cash accounts are required to be maintained in Indian rupees. Therefore, in case of non-residents, the cash escrow accounts may be in the form of non-resident ordinary accounts.

In case of share escrow accounts, in the event the shares are in physical form such accounts can be opened with a AD Category-I banks and in the event the shares are in dematerialised form, such accounts can be opened with a SEBI authorised depositary participant. It is important to note that while Circular 58 refers to securities and shares interchangeably, equity shares, compulsorily and mandatorily convertible preference shares and debentures should fall within the purview of securities dealt with by the said circular.

Circular 58 requires that the cash escrow account maintained with the AD Category-I bank shall be non-interest bearing and fund and non-fund based facilities shall not be permitted against the balances in such cash escrow accounts. To elaborate, the balances in the cash account can neither be used by the AD Category-I bank to provide any form of financing to a third party nor for providing any non-fund based facilities such as letter of credit or guarantees against the balances in the account. The obligation to ensure compliance with the KYC requirements shall be that of the relevant AD Category-I bank. Further, it has been clarified that for the purposes of reporting of the investment such as filing of the FC-TRS in case of a secondary investment, or for calculation of 180 days for the purpose of issuance of shares, in case of primary investment, the date of transfer of consideration into the bank account of the issuer company or the transferor, as the case may be, shall be considered.

The permitted credits / debits to the cash escrow account are:

(a)     amounts remitted by  non-resident investor towards the issue of shares / securities or purchase of shares / securities from Indian company or resident transferor, as the case may be; and

(b)     amounts deposited by a  resident towards the purchase of shares / securities from a non-resident transferor.

There is a clear authorisation to repatriate the funds in the escrow account in the event of failure of the transaction for which the escrow arrangement was maintained. The repatriation of funds shall be at the then prevailing exchange rate with the non-resident required to bear any forex risk. Circular 58 further requires that the terms and conditions of the escrow are to be clearly laid down in the escrow agreements, share purchase agreement, conditions of issue, etc. presumably to ensure that the discretion to repatriate the funds does not lie with the escrow agent.

Analysis and implications

Despite the short duration permitted for maintaining an escrow account opened in accordance with the requirements set out above, Circular 58 is a positive step towards attracting foreign investment into India and for structuring exit strategies. The said circular facilitates the structuring of private equity and M&A transactions involving staggered payouts dependent on the fulfillment of certain crucial conditions by the issuer company or the transferor. The circular also permits the repatriation of any balance funds in the escrow account upon the completion of the transaction for which the escrow account had been put in place; thereby, providing for the flexibility to adjust the valuation of the transaction in the event of non-fulfillment of any of the conditions of the transaction. Consequently, an investment where the price per share is dependent on the outcome of a target company’s EBITDA over a stipulated period may be now structured in a manner where part of the consideration is paid upfront to the promoter by the acquirer / investor and the balance consideration structured as variable component is deposited in an escrow account in India which can be released to the promoters by the escrow agent upon achievement of target EBITDA. From an acquirer / investor’s perspective, such type of escrow arrangements incentivize the promoters to perform better even after they have sold the target company to the acquirer / investor and from a promoter’s perspective, he gets the security for the balance consideration since the same is in an escrow account. Accordingly, such escrow arrangement results in a win-win situation for both the acquirer / investor and the promoters.

The application of the circular in case of the primary issuance may be limited, given the requirement of issuance of shares / securities by companies only upon receipt of the subscription money, as also the constraints posed by the inability of the company to cancel its shares after issuance (other than by way of buy back or a reduction of capital, both having various requirements to be fulfilled prior to the same being undertaken under the provisions of the Companies Act, 1956). In case of secondary purchase, however, the said circular has opened up many structuring opportunities for investors. 

Circular 58 has, however, not provided any clarity on the opening of escrow accounts for facilitating post-transaction escrow structures for the purposes of specific indemnification (typical in case of tax-related indemnities) or for setting aside some portion of the consideration for certain contingent third party claims, etc. and a clarification in this regard would be helpful. 

 

_____________________

1 http://rbidocs.rbi.org.in/rbiadmin/scripts/NotificationUser.aspx?Id=6369&Mode=0

2 http://www.rbi.org.in/scripts/BS_CircularIndexDisplay.aspx?Id=3549

 

- Priyadarshani Sherchan & Simone Reis

You can direct your queries or comments to the authors

 

 

Management by Trust in a Democratic Enterprise: A Law Firm Shapes Organizational Behavior to Create Competitive Advantage, Global Business and Organizational Excellence, Sep 2009

NDA: A different approach by Shyamal Majumdar, Business Standard, July 23, 2009.

A law firm head spends his time studying organisational behavior.

Nishith Desai: Honoured with the title of "Prof. Yunus Social Business Pioneer of India" - 2010 by The Grameen Lab and the Wockhardt Foundation

Legal 500: Ranked in Tier 1 for Tax, TMT and Investment Funds

Nishith Desai: Featured in the Lex Witness publication ‘Witness Hall of Fame: Top 50’ - August 2010

 

>>>

Tax Return Mandatory Even When No Tax Is Payable In India, VCCircle, Aditi Mukundan & Abhay Sharma, April 29, 2011

Use of Trusts in Succession Planning, Legal Era, Hanisha Amesur & Abhay Sharma, April 2011

Trade Unions Act and State Laws Provide Legal Protections to Trade Unions in India, SHRM India, Vikram Shroff & Akshay Bhargav, March 2011

Intellectual Property (IP) Diligence, Legal Era, Gowree Gokhale & Prerak Hora, March 2011

Doing Business in India

Joint Ventures in India

Mergers & Acquisitions in India

Dispute Resolution in India

Real Estate Investment

>>>

New Consolidated Foreign Direct Investment Policy, April 7, 2011

FCPA issues with a special focus on India, March 14, 2011

Economic incentives for doing business in the US – Federal & State incentives - (Tax & Non Tax incentives), Feb 17, 2011

>>>

 

Welcome to connect with us at interesting conferences, seminars and events.

>>>

 

Introducing NDA Dialawgue and Deal Destination.

Siddharth Shah on CNBC TV - 18: Cairn – Vedanta deadlock: Should a third party step in ?, April 08, 2011

Nishchal Joshipura on CNBC TV - 18: To exempt or not to exempt?, April 8, 2011

Siddharth Shah on CNBC TV - 18: SmartLink move not smart enough for shareholders, April 01, 2011

Nishith Desai on CNBC TV 18: Chasing black money!, Feb 12, 2011

>>>

 

Click here to view Hotline archives.

Funding Real Estate Projects - Exit Challenges, April 28, 2011

Real Estate in India - A Practical Insight, March 22, 2011

>>>

Hero to ride without its 'Pillion Rider', March 15, 2011

Piramal - Abbott Deal: The Great Indian Pharma Story, Aug 05, 2010

>>>

 

Our email newsletters – Hotlines are very popular for their insights and analysis. Sign-up to receive Hotlines on the following – Tax, CorpSec, HR, Dispute Resolution and our regular updates such as M&A Labs, IP, Pharma, Media, Telecom Updates and Budget and Policy Analyses.

 

Please visit www.nishithdesai.com to access our Research online.

 

Unsubscribe

 

Feedback

Disclaimer: The contents of this hotline should not be construed as legal opinion. View detailed disclaimer.

This Hotline provides general information existing at the time of preparation. The Hotline is intended as a news update and Nishith Desai Associates neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this Hotline. It is recommended that professional advice be taken based on the specific facts and circumstances. This Hotline does not substitute the need to refer to the original pronouncements. 

This is not a Spam mail. You have received this mail because you have either requested for it or someone must have suggested your name. Since India has no anti-spamming law, we refer to the US directive, which states that a mail cannot be considered Spam if it contains the sender's contact information, which this mail does. In case this mail doesn't concern you, please unsubscribe from mailing list.