Every country that seeks Foreign Investment in a global and competitive market has to ensure that, its laws/ regulations are in sync with the ground realities and expectations of the global and domestic business community, while keeping in mind the national interest. This article seeks to study specific FEMA regulations, specifically those regulations where escrow accounts may have a role to play, with the intent of suggesting modifications/ alternatives basis transactional experience of the author, for simplifying connected transactions.
While the primary focus of this article is on escrows in cross border deals and examines the need for escrows due to singular focus on seamless exchange of consideration, some views have also been shared on matters incidental to cross border transactions. The attempt is to review specific provisions of various regulations inter alia, the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("Non-Debt Rules"); the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019; Foreign Exchange Management (Deposit) Regulations, 2016 ("Deposit Regulations" / "FEMA 5(R)"); and inter alia the Master Direction - External Commercial Borrowings, Trade Credits and Structured Obligations ("ECB Master Directions") issued by the Government of India / Reserve Bank of India ("RBI" / "Regulator") in accordance with the powers conferred under the Foreign Exchange and Management Act, 1999 ("FEMA"). This article attempts to look for ways in which certainty could be infused in some of the existing regulations set out below. Also, this article attempts to provide alternate views for helping parties better manage specific Capital Account transactions – to help commercial enterprises attract more investments in an ever growing and competitive market economy.
Deposit Regulations & Escrows:
One of the main benefits of an escrow account in capital account transactions is, to help assuage any concerns of the buyer (re. financial risk) and to facilitate the payment mechanism. Escrow, as a payment mechanism, ensures that the transfer of consideration, as adumbrated under share purchase agreement or underlying transactional documents, is adhered. Despite this benefit, it appears that, escrows are still underutilised as a risk mitigator in the Indian market.
To facilitate ease of access to escrow as a mechanism, it is suggested that, point 2 of Schedule 5 of the Deposit Regulation may be amended to permit other escrows accounts as well – more particularly specified in this article. Considering that the RBI has already delegated various supervisory functions to AD Banks, it would only be appropriate that the supervision of the below mentioned escrow accounts (opening, operation, and closing) also be delegated to Authorized Dealer Category-I Banks (AD Cat-I Banks).
Escrow For ODI Transactions (Under General Permission):
The extant Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004 ("FEMA 120") read with Master Direction – Direct Investment by Residents in Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Abroad ("ODI Regulations") doesn't allow any deferral for payment of consideration nor does it allow for opening of escrow accounts in India for any ODI transaction under general permission. While RBI may be open to welcome applications (reviewed/ scrutinised by an AD Bank) for seeking permission for allowing such deferral or escrow account opening within India or outside, it would certainly facilitate and expedite such transactions, if general permission is already in place (with required caveats/ conditions for better regulation). This would help save precious time otherwise spent in the drafting, review and approval of such applications to RBI.
The RBI could consider allowing, under general permission, deferral of consideration, as well as the option of keeping part of the total consideration in an escrow account within India for ODI transactions. The said deferral/ escrow could mirror the guidance for escrows under FDI transactions with the exception that: (a) escrow account be allowed to be opened for a period of 3 years (from the date of opening); (b) Indian Party (as defined in the ODI Regulations) is in compliance with Regulation 6 of the FEMA 120 dated July 07, 2004 (as amended from time to time); (c) no credit facilities be availed against the balance in the said escrow account; and (d) escrow be non-interest bearing.
Escrow Account For External Commercial Borrowing ("ECB") Transactions:
The extent ECB Master Direction in Para 7.5 (Security for raising ECB) and more particularly Point (iii) (b) thereof (Creation of Charge over Financial Securities) seems to allow the opening of Rupee Accounts also in the form of escrow accounts or debt service reserve accounts (DSRA) for servicing/ securing ECB loan payments.
The said provision doesn't explicitly state anything about what conditions will govern the opening, operation or closing of such escrow or DSRA accounts, but needless to say, if the Overseas Lender is not allowed to be a named party to the escrow agreement/ DSRA agreement then exclusive control of the ECB borrower over such accounts may frustrate the purpose of allowing such escrow / DSRA accounts.
Having said this and considering that, guidance regarding opening, operation and closing of escrow accounts (where a non-resident is a named party) is covered by the Deposit Regulations, an amendment to the said Deposit Regulations may be considered. This point can be addressed by incorporating a written provision explicitly allowing Overseas Lenders/ Overseas Security Trustee to be named party in such an escrow/ DSRA account agreements thereby removing the ambiguity on whether an Overseas Lender / Overseas Security Trustee can be a named party to such an escrow or DSRA agreement in connection with ECB transactions. This can further be fortified by allowing the AD Banks to check if it is a bonafide transaction and allow such escrows/ DSRA if it is compliant with the regulations.
Such an escrow/ DSRA where the Overseas Lender / Overseas Security Trustee is allowed to be a named party has the following advantages:
- Improves confidence of the lender: Lender gets visibility and control on the borrower's receivables thereby ensuring timely repayable of loan.
- Removes the requirement of the Borrower to share regular proofs of payment receipts if all the payments are routed to/ through the said escrow/ DSRA account.
- Opens up access points within global debt markets for domestic corporates.
Account Bank Construct To Facilitate Trade Payments:
Another illustration of how account bank account (sometimes referred to as trade escrow account) could reshape age-old payment mechanism is by deployment of Trade Account Bank structure. Trade (international or domestic) is something that will always continue in some shape or form – it is the author's view that maybe escrows/ account bank construct could play a role here as well. The payment mechanisms e.g. Letter of Credit, Standby Letter of Credit, Bank Guarantees etc. could be replaced by trade escrows.
Those who are unable to secure such non-fund based facilities from their bankers, could provide required payment assurance to their counterparties through this mechanism.
Therefore, where "A" USA supplies goods to "B" India, which goods are then sold by "B" India to "C" India (after value addition by "B" India) – the payment to "A" USA can be assured through an account mechanism as well. This can be addressed if the Regulator, under general permission, allows account bank accounts to be opened by AD Cat-I Banks in the name of "B" India.
Permitted Credit: (a) Deposit by "C" India against invoices raised; and/ or (b) Deposit by "B" India.
Permitted Debits: (a) Payment to "A" USA; and/ or (b) Payment to current account of B India (in India).
Parties to the Account Bank Agreement shall be "A" USA; "B" India; and the Account Bank (i.e. any AD Cat-I Bank that could also review the trade documents and release payment after checking compliance with the regulations governing such trade payments.
Such account bank structure may help a new trader or start-up in the place of "B" India – who may not easily find a banker to support any Factoring or LC/ SBLC requirement. There is also the possibility that "C" India may not want to acknowledge assignment of rights by "B" India to any banker.
A simpler variation to the above construct may be possible if "C" India happens to be a group company or subsidiary of "A" USA. Also, if permitted, a similar construct could be explored for export related transactions. It seems that, one of the main benefits for the Indian party in such instances could be the reduction of cost of funds, which may in turn help price the goods or services better.
Escrow Period For FDI Transactions:
The objective of law/ regulation, in this context, is to facilitate or augment genuine business requirements, keeping in line with the best interest of the nation. It will certainly help if a study is undertaken to see what other variations of escrows could genuinely help balance both the commercial/ business needs of the market and the objectives that foreign exchange regulations aim to achieve.
In this regard, it may be said that, RBI's Authorised Persons Directive Circular 58 of 2011 (May 02, 2011) was certainly a good step towards liberalising the conditions and granting general permission for 6 (six) months for opening escrow accounts with a non-resident entity/person as a named party (the said six months began from the date of opening of escrow account). Circular 58 was superseded by the Deposit Regulations. The Deposit Regulations also allows another escrow of 18 months (from the date of the Transfer Agreement (SPA) - with a non-resident entity/person as a named party.
While Point 2(d) of Schedule 5 of the Deposit Regulation allows parties to an escrow agreement to approach RBI (through AD Banker) to seek an extension for any period beyond 6 months, no such explicit provision has been made for seeking extension of a period beyond 18 months (in Point 2(e) of Schedule 5 of FEMA 5(R)). It is humbly submitted that, such explicit language allowing parties to make an application be considered for addition in in Point 2(e) of Schedule 5 of FEMA 5(R) by the Regulator in their next review.
Such restrictions on period of escrow (i.e. maximum period of 6/ 18 months) is dehors the laws of countries like United Kingdom, USA, Singapore, or the EU. It is not a practice in any of the top 10 free market economies. If the objective is to be at par with the global competition, maybe one could try to mould the capital account regulations in line with the practice prevalent in these jurisdictions. Many parties in M&A transactions seek 2 to 7 years deferral of consideration for addressing taxation or capital adjustment clauses in their underlying transfer agreements. Some parties prefer making an application to the regulator, while other mould their transfer agreements around the present construct of 18 months.
Alternatively, the Regulator could consider allowing the period of 18 months to commence from the date of opening of escrow account because invariably there will always some time lag between the execution of the actual Transfer Agreement and the opening of the escrow account. The parties have to address several conditions precedent (CPs) before they begin to address the payment mechanism (escrow). This may help give some immediate relief while the overall period enhancement from 18 months to 3 years can be deliberated.
Noting the intent behind the original framework, perhaps the meter clock could be reset by the Regulator with relative ease. The time of opening of an escrow account may be an easy update, as the Regulator has already allowed the seller to give an indemnity undertaking for 25% of the total consideration for a period of 18 months from the date of receipt of full consideration. Any indemnity undertaking without assurance of escrow behind it, may easily run into litigation. This can be addressed by mutually acceptable contractual provisions of SPA and Escrow. [Regulation 9(6) of the Non-Debt Rules: "In case of transfer of equity instruments between a person resident in India and a person resident outside India, an amount not exceeding twenty five percent of the total consideration… (iii) may be indemnified by the seller for a period not exceeding eighteen months from the date of the payment of the full consideration, if the total consideration has been paid by the buyer to the seller] [Emphasis added]
It is suggested that, if the aforesaid is not possible, then in the least, the Regulator may consider substituting the word "or" with "and/ or" at the end of Regulation 9(6)(i) and (ii) of the Non-Debt Rules.
Escrow For Earmarking More Than 25% Of Total Consideration And Remittance Under General Permission Of Indemnity Payment Pursuant To Court Order:
The Regulator's guidance on payment of Fair Market Value (FMV) in capital account transactions, while being helpful, could be further deliberated basis the commercial realities prevalent. The objective is to protect the interest of the resident party, but if the objective is also to augment investor confidence, then maybe an additional proviso could be considered in connection herewith. Perhaps the Regulator could, under general permission, allow payment (clawback or otherwise) of more than 25% of the total consideration where the investor has obtained a court order and an AD Banker has satisfied itself of the bonafide nature of the transaction.
Considering that buyers and sellers in M&A transactions are quite commercially mature and savvy, it is suggested that escrows/ deferral of consideration or clawback of consideration should be subject to contractual agreement. In this context, the Regulator could consider allowing more than 25% to be deferred for a period of 3 years. Further, a consequential review of the Pricing Guidelines may also be undertaken.
Also, it is observed that, several investors do not prefer the approval route on account of the time required in making an application, and the time required to get a definitive answer,. It is humbly submitted that maybe the time for review/ approval could be defined e.g.: rejection/ approval decision be conveyed with some rational within 20 working days from the date of submission of the application through an AD. Breach of law should always be prohibited; but liberty for deal structuring (sans opaqueness) should be allowed.
Where FDI Does Not Fall (Clawback Terms Of SPA, Subject To Pricing Guidelines Being Adhered):
A minor proviso could be added in Point 2(b)(ii) (read with Point 8) of Schedule 5 of FEMA 5(R) to also allow debits in the escrow account for partial/ complete remittance of funds in the said account for clawback, or otherwise where there is no failure/ non-materialisation of FDI transactions; but just partial or complete clawback is proposed in line with (a) the provisions of Transfer Agreement and (b) Point 9(6) of the Non-Debt Rules. Suggest that an explicit provision will be helpful here.
Escrows For LLP/ Invit/ REITs:
Since general permission has been granted by RBI for Non-Resident (NR) – Resident (R) transfer of shares of an Indian Company, as clarified in Schedule 5 of FEMA 5(R), granting similar general permission for allowing escrow accounts in connection with transactions involving shares/ units of LLPs/ INVIT/ REITs may be considered by the Regulator. Note: There seems to be no rationale provided in the current regulations for differential treatment towards these entities.
Also, it will be helpful if the definition of "Capital Instruments" under FEMA 5(R) is revised to help ensure proper cross referencing with "Equity Instruments" under Non-Debt Rules and the definition of equity instruments (or capital instruments) be modified to also include LLP/ INVIT/ REIT for such escrows.
With the increase of FDI inflow in India, one may need to consider the associated reporting requirements. It is suggested that, the next step in making the process of investment easier could be in relation to the reporting of such FDI transactions.
It is suggested that the following points be considered in the next review of Reporting Guidelines:
FC-TRS ó DI Interface: The Form FC-TRS interface be modified/ updated to automatically capture Foreign Owned and Operated Company ("FOCC") investments i.e.: when FOCC buys a resident company's shares from a non-resident. This will address the additional requirement of filing Form DI which one would file after the Form FC-TRS is reported. Alternatively, it could be suggested that, maybe the RBI could explicitly state in the Master Direction on Reporting that when a FOCC buys shares of an Indian company from a non-resident, no Form DI will have to be filed by the FOCC.
FC-TRS and FC-GPR: Form FC-TRS (for transfer of shares) and FC-GPR (for allotment of shares) could be revised to all add the consent letter or extract of SPA/ SSA requirements therein. Possibly, a field in the Form to add comments, if any could also help. This modification of the Form will remove few physical pages that need to be printed and signed by the parties. Retaining requirement of attaching the following documents would certainly be supported by the market: valuation reports, board resolutions of the parties involved, and a no-objection certificate (NOC) (i.e. on-behalf payment/ Nominee etc.).
FC-TRS: An express provision could be included in the Form FC-TRS reporting guidelines to allow one seller to undertake FC-TRS filing for all other sellers, when all of these sellers are selling the capital instruments of the same Indian company to the same buyer.
Single Window For FDI/ ODI/ ECB Application:
With due regard to the nature of structured transactions, it would certainly be helpful if the RBI could consider opening a single window for receiving, reviewing and approving (or rejecting) various applications under approval route for FDI/ ODI/ ECB transactions. If possible, maybe a scanned copy of the client application, along with the covering letter of the AD Banker to such single-window will help expedite the application and review process. Even a dedicated and specialised single department/ team within RBI - addressing such FDI/ ODI/ ECB applications will help process the applications and possibly bring more clarity for the parties involved and their respective deal structures. Also, with all due respect to the citizens' charter, perhaps the number of days for such review could be crystalised at 20 working days, this will help avoid follow-up/ queries from clients or AD Banks.
Standalone Master Direction For Escrow/ Trust Retention Account/ Account Bank/ DSRA:
While there are several touch points in the FEMA guidelines for addressing escrows, it be suggested that a standalone Master Direction on Escrow/ Trust Retention Account/ Account Bank/ DSRA could be circulated for better and uniform understanding of all market participants. This could be similar to other Master Directions such as the Master Direction on Foreign Investment.
Seeking More Clarity On Few Points:
Subscription of Share Warrants of unlisted India companies:
The explanation (i) under the definition of the term "equity instruments" re. Non-Debt Rules seems to state that: "Share Warrants" are those issued by an Indian company in accordance with the regulations by the Securities and Exchange Board of India. This is also captured in Point 4.4.1 of the Master Direction – Foreign Investment in India. Though Point 4.1 of the same Master Direction also reads as follows: An Indian company is permitted to receive foreign investment by issuing capital instruments to the investor. The capital instruments are equity shares, debentures, preference shares and share warrants issued by the Indian company.
It is suggested that the Regulator may please consider adding an express provision to allow unlisted Indian companies to issue share warrants to non-residents.
Purchase of shares of unlisted Indian company by NRI/OCI on Repatriation basis:
While the market has interpreted that an NRI may buy shares of an unlisted Indian company on repatriation basis, maybe an explicit provision could be added in Regulation 12(1) (under Chapter V) as well as in Schedule III of the Non-Debt Rules to ensure presence of explicit general permission allowing NRI to purchase of shares of an unlisted Indian company as well.
NB: Point 7.3.1 of the Master Direction on Foreign Direct Investment confirms that NRI can hold (and therefore sell) shares of Indian company on repatriation basis]
NB: Point 4.1 of the Consolidated FDI Policy states as follows: "…In case the buyer is an NRI, the payment may be made by way of debit to his NRE/FCNR (B) accounts. However, if the shares are acquired on non-repatriation basis by NRI, the consideration shall be remitted to India through normal banking channel or paid out of funds held in NRE/FCNR (B)/NRO accounts."
Definition of 'listed Indian company':
Considering that unlisted companies can also list their debt instruments, it is submitted that, if possible, the Regulator may consider revisiting the definition of listed Indian company and keep the reference to companies whose debt instruments are listed under a separate heading - as pricing/valuation of unlisted companies may be impacted in other transactions in case an incorrect interpretation is drawn.
The Regulator has been helpful in ensuring that best practices in capital account transactions are adopted. However, given that the aforesaid regulations are issued under specific powers granted to Regulator under FEMA, it is befitting that the law/ regulation governing such FDI/ODI/ECB transactions are all encompassing, specific, and explicit. As certainty continues to be the mother of repose, it will be helpful if there is less room kept for interpretation, as it will help all parties concerned in the long run. It is recommended that a wider consult with other market participants (including on-ground transaction managers) to help simplify the regulations (by end user) with explicit elaboration of requirements may be equally helpful in attracting more foreign investments in India.
The views expressed here are shared to evoke further review and discussion from a wider group, including transactional lawyers and on-ground transaction managers. One hopes that popular opinion on these points will help move the discussion in the right direction. The objective is to help commercial transactions, ensuring: (a) they remain within the legal framework, and (b) that the regulations are in step with the market requirement.
Author is a lawyer with cross border transactional banking experience of more than 10 years
The views are personal and do not reflect the views of any organisation or firm.
 NB: Non-Debt Rules and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 were issued by the Central Government.
 Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000.
 See – Point 2(d) and (e) of Schedule 5 of Deposit Regulations for specifics on which two escrow accounts are permitted.
 Inter alia, addressing taxation or capital adjustment clauses in their underlying transfer agreements.
 FEMA 5(R) was issued first on April 01, 2016. Please see Point 2 (d) of Schedule 5 of FEMA 5(R).
 Please see Point 2 (e) of Schedule 5 of FEMA 5(R).
 FED Master Direction No. 11/2017-18.
 FED Master Direction No. 11/2017-18.
 See – Regulation 2(ag) of Non-Debt Rules: "listed Indian company" means an Indian company which has any of its equity instruments or debt instruments listed on a recognised stock exchange in India and the expression "unlisted Indian company" shall be construed accordingly.