Last week, the FIPB (Foreign Investment Promotion Board) deferred a decision on Vodafone's proposal to acquire Hutch-Essar. Vodafone, the UK-based mobile giant, wants to buy a controlling stake in Hutch-Essar for over $11 billion, and the FIPB nod is needed for the deal to be completed. The Board is delving deep into the transaction, even as different Ministries and the central bank are said to be studying if the structure of shareholding violates the norms of FDI (foreign direct investment).

To know more about the weird turns in the wireless world, Business Line connected with Mr George Vivek Durai, Partner, IndoJuris Law Offices, Bangalore. Mr. Durai focuses on mergers and acquisitions, real estate and technology law. His experience in the telecom, technology and media sectors includes assisting in domain name disputes, advising on patent strategy, drafting online trading rules for a stock exchange, and negotiating the procurement of a telecom network.

Excerpts from the interview:

First, some light on the foreign investment laws currently in focus.

The legal framework for regulating foreign investments in India is governed by the Foreign Exchange Management Act, 1999 or FEMA and more specifically by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (also known as FEMA 20, since it was notified by Notification No. FEMA 20 of 2000) in relation to the issue or transfer of shares in an Indian company to an individual residing outside India or a company incorporated outside India.

What is commonly referred to as the FDI Policy consists of the FDI Scheme, which forms part of FEMA 20, and the Press Notes issued from time to time by the Ministry of Commerce and Industry. Press Note 5 of 2005 governs the current policy on FDI in telecom services. Under this, the FDI limit was raised from 49 per cent to 74 per cent however investment up to 49 per cent was under the automatic route while that between 49 per cent and 74 per cent required FIPB approval.

How is the 74 per cent reckoned?

Press Note 5 is quite elaborate in clarifying how the 74 per cent stake is to be computed. By way of background, before the FDI ceiling was raised, a typical structure for foreign investors to invest in the telecom sector was through the `holding company' route.

The foreign company would hold 49 per cent of the equity of the holding company and the Indian partner 51 per cent. This holding company would then enter into a joint venture with the foreign company to establish the telecom services company, where the foreign company would hold 49 per cent. However, under the above structure Indians would have to control and manage the holding company. The foreign investor would thus have a 74 per cent economic interest, directly and indirectly, in the joint venture company that would obtain the licence to provide telecom services.

Press Note 5 specified that the 74 per cent ceiling was on the `total composite foreign holding' thus clarifying that a similar structure of indirect equity interest would not be allowed to breach the specified ceiling.

The Press Note was fairly elaborate on what constituted the total composite foreign holding investments by FIIs, NRIs, FCCBs, ADRs, GDRs, convertible preference shares as well as proportionate foreign investment in Indian promoters/investment companies including their holding companies. The Press Note concluded that 74 per cent foreign investment can be made directly or indirectly in the operating company or through a holding company. It also stated that the remaining 26 per cent can be owned by resident Indian citizens or an Indian company (that is, companies in which the FDI does not exceed 49 per cent and the management is with the Indian owners).

The FIPB has asked the parties to clarify their shareholding in HEL. What really is the issue?

It has been alleged that the 74 per cent ceiling has been breached. Vodafone had filed an application with the FIPB on February 22, 2007 with regard to its proposed foreign direct investment, and the FIPB is as a matter of course examining the details of the shareholding pattern.

The direct shareholding in HEL as per media reports, appears to be: Approximately 52 per cent is held by subsidiaries of HTIL, Essar Group companies comprising Essar Communications (India) Limited, Essar Com Limited, Essar Telecom Investments Limited and Essar Teleholdings Limited hold approximately 33 per cent, approximately 12.26 per cent is held by Centrino Trading Company Private Limited, ND Callus Info Services Private Limited companies controlled by Asim Ghosh and Analjit Singh respectively and 2.74 per cent is held by IDFC. News reports indicate that 22.02 per cent of the Essar group holding is foreign shareholding since that is held by a Mauritius incorporated company. If this is true the foreign shareholding would be 74 per cent.

However, filings by the HTIL with the SEC, in reporting the proposed transaction, state that HTIL's direct and indirect equity interest in HEL is 66.9848 per cent. This indicates that in addition to the approximate 52 per cent shareholding that I referred to earlier, an additional approximately 15 per cent is held by HTIL indirectly. These filings also state that the remaining approximately 33 per cent is held by Essar Teleholdings Limited and its affiliates.

Centrino Trading Company Private Limited and ND Callus Info Services Private Limited both obtained bank loans to finance their purchase of shares in Telecom Investments India Private Limited. HTIL provided credit support for those loans in the form of a standby letter of credit and in return both companies granted HTIL options, valid for 10 years, to subscribe at par value for fresh shares representing up to 97.5 per cent and 97 per cent, respectively, of its enlarged share capital.

These options are exercisable by HTIL at any time at par. If HTIL exercises these options and in the event Indian law changes so as to permit HTIL to own more than 74 per cent, it also has call options on the entire shareholding of their direct holding companies. So the question really is, are these minority shareholders holding HEL shares in arrangement with HTIL so as to circumvent the provisions of Indian law as laid down in FEMA 20 read with Press Note 5 of 2005.

Number 2, is such an arrangement prohibited under Press Note 5? Because you know, it is possible they might be in compliance with the letter but not the spirit of the law.

If the shareholding of these entities is found to be part of the "total composite foreign holding" referred to in Press Note 5 (although I don't see how they would be brought under that umbrella without amending Press Note 5) HEL would have violated FEMA because the FDI in HEL would be 89.03 per cent as against the ceiling of 74 percent.

This is also a separate question for the Department of Telecommunications to examine in its capacity as a telecom licensing authority. So this is as much a concern for HTIL (for the transaction to go through) as much as it is for Vodafone (in its capacity as incoming owner of the licensee).

There have also been reports about the FIPB having approved the investment structure last year.

Well, the company says the investment structure was approved by the FIPB. But neither they nor their shareholder entities have been very forthcoming with complete details on the shareholding structure and arrangements and therefore that piece of information is not very useful. What we do know is that the FIPB on July 14, 2006, took on record and approved the increase in foreign equity in HEL from 49 per cent to 68.09 per cent.

However, details about this approval and the information provided by HTIL to the FIPB at that time have not been made public.

Are there any lessons to learn from this?

As I mentioned earlier, the company and shareholders while defending themselves, have made very little information public. This is true of a large number of Indian companies and has to do with a natural inclination for secrecy as well as regulatory and tax concerns.

So this gives rise to a lot of speculation. Promoters and investors who wish to adopt (and be known for) best practices should start with transparency in their shareholding and investment structures. On a general note, part of the blame lies with the Government well known for issuing Press Notes that have a tendency to confuse.

What do we know about the deal in question?

According to Hutchison Telecommunications International Limited HTIL's SEC (Securities and Exchange Commission of the US) filings, the proposed transaction involves the sale of 100 per cent shares in CGP Investments (Holdings) Limited, a Cayman Islands subsidiary of HTIL) by Hutchison Telecommunications International Limited (HTIL), a company incorporated in the Cayman Islands, to Vodafone International Holdings B.V., a subsidiary of Vodafone Group Plc. HTIL is a Stock Exchange of Hong Kong-listed company with ADSs listed on the New York Stock Exchange. It appears unlikely that the transaction involves any transfer of shares in the Indian company, that is, i.e. Hutchison Essar Limited (HEL).

D. Murali