New Delhi: A recommendation by India’s banking regulator that the government probe the extent of foreign ownership in Hutchison Essar Ltd, a cellular company in which Vodafone Group Plc is acquiring a 67% stake could form grounds for questioning Indian corporate law, say legal experts.
The Reserve Bank of India suggested last week that a $11.1 billion (Rs49,000 crore) buyout by Vodafone of Hong Kong-based Hutchison Telecommunication International Ltd’s 67% stake in Hutchison Essar could violate rules that cap foreign ownership in Indian telecom service firms at 74%.
The Vodafone-HTIL deal has come under scrutiny amid allegations that two Indian shareholders—Hutchison Essar chief executive Asim Ghosh and Max India chairman Analjit Singh—are representative shareholders for the Hong Kong seller, taking the foreign equity in the Mumbai-based phone firm beyond the permitted 74%.
Under the current structure, HTIL owns 52%; Ghosh and Singh together about 13%, financier Infrastructure Development Finance Corporation 2% and Essar Group 33%, of which 22% is owned through foreign investment units of the conglomerate.
Newbury, England-based Vodafone is buying the stakes of HTIL, Ghosh, Singh and IDFC.
The 22% foreign stake of Essar, legal experts contend, should be considered Indian, if the 13% owned by Ghosh and Singh is treated as foreign equity on an ‘ultimate ownership’ principle. They point out that while any investment by an Indian company, which has foreign investors on board, is considered foreign-controlled to the extent of overseas investment in it, incoming investment from overseas firms, even when they are owned by Indians, is seen as completely foreign without distinction.
“This will have to be considered by the law ministry. As of now, the proportionate-ownership principle is applied only one way,” said Rohan Phatarphekar, head of the India arm of audit firm Grant Thornton. “If you are incorporated in another country, you are a foreign investor even if you are partly owned by Indians,” he added.
But precedents from other sectors could prove damaging to Vodafone’s case. Under the terms of HTIL’s deal with Ghosh and Singh, the Hong Kong company has an option to buy out the two shareholders at a pre-decided price.
Call options, which are designed to lock in equity for future availability for the foreign partner when it wants to raise its stake, should not be used as a source of indirect funding, Abhishek Tripathi, a Delhi-based corporate lawyer, said. “There have been many cases where the insurance regulator forced companies to rewrite shareholder agreements to remove this anomaly. Indirect funding usually comes with pressure-clauses on Indian partners such as a pre-determined selling price for the stake under option,” he said. In insurance, foreign equity is capped at 26%.
In early 2006, immediately after the government clarified that even minority shareholding by foreigners in Indian companies will count as foreign investment, HTIL had been forced to exit its 49% joint venture with the investment bank Kotak Mahindra Group, which had until then acted as a vehicle for its indirect holding in Hutchison Essar (about 19.5%).
Under the shareholder agreement with Kotak Mahindra, HTIL effectively controlled nearly all of the 19.5% stake the joint venture company had in Hutchison Essar.
HTIL then had to split the 19.5% stake into three parts—7.6% held by Singh, 4.7% in Ghosh’s name and 7.3% absorbed by itself—according to a report submitted to the Hong Kong company’s board by Somerley Ltd, a Beijing-based investment bank.