On 11 April 2017, the Hon’ble High Court of Delhi (High Court), pronounced its judgment in a case where the enforcement of a foreign arbitral award was opposed inter alia on the ground that the enforcement of the said award would be contrary to the public policy of India as it violated the provisions of the Foreign Exchange Management Act, 1999 (FEMA).

Factual Background

In 2008, Mauritius-based Cruz City 1 Mauritius Holdings (Cruz City) entered into a Shareholders’ Agreement (SHA) dated 6 June 2008 with Cyprus-based Arsanovia Ltd. and Mauritius-based Kerrush Investments Ltd. (Kerrush) under which Cruz City and Arsanovia Ltd. agreed to invest in Kerrush, which in turn, agreed to invest in a real estate project captioned as ‘Santacruz Project’ in India. On the same date, Cruz City also entered into a Keepwell Agreement with India-based Unitech Limited (Unitech) and Mauritius-based Burley Holdings Ltd. (Burley), a wholly owned subsidiary of Unitech.

Unitech and Burley, although not parties to the SHA, signed the SHA for confirmation of certain obligations accepted by them. Under Clause 3.9.2 of the SHA, Cruz City was entitled to exercise a ‘put option’ to call upon Arsanovia and Burley, to purchase all equity shares of Kerrush held by it, at the purchase price that yield a post tax IRR of 15% on the capital contribution made by Cruz City (Put Option).

Owing to delays in commencement of the construction of the Santacruz Project beyond a specified period, Cruz City exercised the put option under the SHA. However, the put option was not honoured and accordingly, Cruz City moved the London Court of International Tribunal (LCIA) under the SHA as well as Keepwell Agreement. The LCIA Tribunal passed an award in favour of Cruz City and inter alia directed Unitech and Burley to pay Cruz City the purchase price for the shares held by Cruz City in Kerrush against delivery of all such shares (Award).

In view thereof, a petition for the enforcement of the said Award was filed by Cruz City before the High Court.

Main Submissions on Behalf of Unitech

The enforcement of the Award was opposed by Unitech inter alia on the following grounds:

  • FEMA, being an enactment of exchange control laws in replacement of the Foreign Exchange Regulation Act, 1973 (FERA), would form a part of the public policy of India. Therefore, the enforcement of the Award would be contrary to the public policy of India in terms of Section 48(2)(b) of the Arbitration and Conciliation Act, 1996 (Arbitration Act) as it contravened the provisions of FEMA for the following reasons:
  • The obligation under the Keepwell Agreement was in the nature of a guarantee issued by Unitech on behalf of Burley, which was not permissible under the Foreign Exchange Management (Guarantees) Regulations, 2000.
  • The SHA was structured to ensure a pre-determined return on equity which was prohibited under FEMA as it amounted to Foreign Direct Investment (FDI) on an assured return basis. Reliance was placed on RBI circulars dated 9 January 2014 and 14 July 2014 to contend that a foreign investor could exit the investment made in India only at a valuation as on the date of exit. Further, as per the Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000, the shares of Kerrush could only be purchased at the fair market value of such shares.
  • The Award effectively directed Unitech to invest in the shares of Kerrush, which could not be made without valuation of the shares by a Category-I Merchant Banker/Investment Banker. Thus, the Award was in violation of the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.
  • The Award in as much as it directs Unitech to make payment against the delivery of shares of Kerrush, in effect, directs Unitech to make an investment in Kerrush, which was not permissible without the approval of the Reserve Bank of India (RBI).
  • Cruz City had not claimed any relief that Unitech purchase its shareholding in Kerrush. Consequently, no notice was issued to Unitech either from Cruz City or the Arbitral Tribunal in respect of any claim against Unitech. Therefore, the Award was beyond the relief claimed by Cruz City and without notice to Unitech and hence, its recognition and enforcement ought to be declined in terms of Sections 48(1)(b) and 48(1)(c) of the Arbitration Act.

Main Submissions on Behalf of Cruz City

  • The Award did not require Unitech to purchase the shares of Kerrush but only to pay the purchase price in accordance with Unitech’s obligations under the Keepwell Agreement.
  • Violation of FEMA would not amount to a violation of public policy under Section 48(2)(b) of the Arbitration Act. In any case, there was no violation of FEMA in entering into the Keepwell Agreement.
  • Further, the question whether any permissions from the RBI were required for remitting of the money recovered from Unitech in the enforcement of the Award, would be a question to be addressed after the amount awarded had been recovered.
  • Unitech was precluded from raising any plea to the effect that the Keepwell Agreement was illegal or that the approval of the RBI had not been obtained since, under the Keepwell Agreement, Unitech had expressly represented that the transactions were in compliance with all applicable laws.
  • Unitech was also precluded from raising the objection that it was not given an opportunity to present its case on the principles of res judicata since it was open for Unitech to raise these issues before the Court in the United Kingdom (UK), wherein it had challenged the Award or before the Arbitral Tribunal.

Decision of the High Court

The High Court rejected the objections raised by Unitech against the enforcement of the Award and decided the issues as follows:

On whether Unitech was required to purchase the shares of Kerrush

  • The premise that the Award requires Unitech to purchase the shares of Kerrush is fundamentally flawed. The Arbitral Tribunal having found that Unitech had breached the its obligations, directed it to pay the purchase price. The Award only seeks to enforce Unitech’s obligations undertaken under the Keepwell Agreement. There is no stipulation in the Award that the shares must be delivered only to Unitech. Although, the Award requires Burley and Unitech to pay the purchase price, it does not require that the delivery of shares of Kerrush be made to Unitech and not Burley.
  • The payment of purchase price for the shares of Kerrush by Unitech would be on behalf of Burley which is in conformity with the obligations that were undertaken by Unitech in the Keepwell Agreement.

On violation of FEMA ipso jure being in conflict with Public Policy

  • The objections to enforcement on the ground of public policy must be such that offend the “core values of a member State's national policy and which it cannot be expected to compromise”.
  • A simpliciter violation of any particular provision of FEMA cannot be considered synonymous to offending the fundamental policy of Indian law. The expression “fundamental policy” must mean only the fundamental and substratal legislative policy and not a provision of any enactment.
  • There has been a material change in the fundamental policy of exchange control as enacted under FERA and as now contemplated under FEMA. The objective of FERA was to ensure that the nation does not lose foreign exchange essential for economic survival of the nation whereas under FEMA, the focus had shifting from prohibiting transactions to a more permissible environment.
  • The enforcement of a foreign award will invariably involve considerations relating to exchange control or remittance outside the country for enforcement of foreign award or the initial agreement pursuant to which award required permission of RBI. However, these concerns can be addressed by ensuring that no funds are remitted outside India from RBI, which addresses the issue of public interest and foreign exchange.
  • Thus, the High Court held that the question of declining enforcement on the ground of a simpliciter violation of any provision of FEMA cannot be considered synonymous to offending the fundamental policy of Indian Law but, any remittance of money recovered from Unitech in enforcement of Award would necessarily require compliance of regulatory provision and/or permissions.

On whether the Award violated the provisions of FEMA

  • The Award does not contravene the Foreign Exchange Management (Guarantees) Regulations, 2000 since Regulation 5 specifically permits the giving of guarantees in certain circumstances, including by a company in India for and on behalf of a wholly owned subsidiary. In the instant case, Burley is a wholly owned subsidiary incorporated by Unitech in Mauritius and, therefore, it was entitled to give guarantees for Burley’s business to stand as surety for obligations undertaken by Burley within the limits prescribed in the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.
  • Unitech cannot take the argument that Burley has no business and therefore, Regulation 5 (b) of the Foreign Exchange Management (Guarantees) Regulations, 2000 would not be applicable since it is not bonafide, a complete afterthought and runs contrary to the express representations made by Unitech in the Keepwell Agreement.

On whether the SHA provided an assured return

  • The Put Option was not an open ended assured exit option and could be exercised only within a specified time and was contingent on the Santacruz project not being commenced within the prescribed period.
  • RBI only restricts assured return instruments brought in India under the guise of equity. However, in the present case, Cruz City is only seeking to enforce its obligations against Burley.
  • Even if it is accepted that the Keepwell Agreement was designed to induce Cruz City to make investments by offering assured returns, Unitech cannot escape its liability as Cruz City had invested in Kerrush on the assurances held out by Unitech. Hence, even if Unitech may be liable to be proceeded against for violation of provisions of FEMA, the enforcement of the Award cannot be declined.

On whether Unitech was precluded from raising the plea that it was unable to present its case

  • The principle of res judicata is applicable only where the issue/controversy is finally considered and decided by a ‘court of competent jurisdiction’ and the question whether the award will be recognised/enforced in India cannot be adjudicated by any other forum in any country except the courts of India.

Khaitan Comment

This judgment rendered by the High Court may have far reaching consequences for other pending disputes on similar issues. The High Court came down heavily on Unitech and observed that it must ‘bear the consequences of violating the provisions of law, but cannot be permitted to escape their liability under the Award’. The message is that parties representing that the transaction is in compliance with all applicable laws cannot be permitted to derogate from their obligations under the contract in the garb of an alleged violation of a provision of law at a later stage. Further, this again reflects the approach of the courts in India to not interfere in the arbitral proceedings and awards.