Assured returns, unassured consequences: The Supreme Court’s approach to FEMA and compensatory damages in foreign awards

The petitioners, who were non-resident investors, had entered into Share Purchase Agreements (SPA) with the respondents for the sale of their shares in Haldia Coke and Chemicals Private Limited. The SPAs included negotiated exit rights. On the respondents’ failure to pay the exit consideration, the petitioners initiated arbitration in Singapore, administered by the Singapore International Arbitration Centre (SIAC). The arbitral tribunal granted an award entitling the petitioners to damages along with interest for breach of the SPAs.

The petitioners sought enforcement of the foreign award before the Madras High Court. On expected lines, the respondents challenged the enforcement on the ground that the SPAs guaranteed a return to the petitioners at a price far above the fair market value, rendering them illegal, and that enforcement of the foreign award was opposed to the public policy of India under Section 48(2)(b) of the Arbitration and Conciliation Act, 1996.

Even though the Madras High Court reiterated that a mere violation of the Foreign Exchange Management Act, 1999 (FEMA) did not amount to a breach of public policy, it reasoned that the receipt of damages equivalent to the entire unpaid sale consideration under the SPAs would require prior RBI approval. In doing so, the Madras High Court departed from the Delhi High Court’s approach in NTT Docomo Inc. v Tata Sons Limited (2017),² which had permitted enforcement of a foreign arbitral award without such approval in a similar context involving damages for breach of a put-option agreement alleged to be in violation of FEMA.

Ultimately, the Madras High Court upheld the foreign award but directed that its enforcement be made subject to obtaining prior approval from the RBI, if required.³

While hearing the special leave petition, the Supreme Court issued notice to the RBI seeking its views on whether such approval was necessary and, if so, at what stage. The RBI’s affidavit, with relevant portions reproduced verbatim in the judgment, clarified that compensatory damages are in the nature of current account transactions and enabled under the Indian foreign exchange regime, and that “payment of such compensatory damages without any transfer of equity instruments does not fall under the purview of the RBI.” This was despite the RBI’s observation that the original investment, which carried an internal return rate (IRR) of 24%, contravened the pricing guidelines under FEMA.

Relying on the RBI’s position, the Supreme Court held that no prior approval was required and concluded that there was “no impediment in law” to enforcing the foreign award.

This case also marks another instance of the Supreme Court seeking RBI’s views in a special leave petition arising from a judgment enforcing a foreign award. The RBI was impleaded in Nine Rivers Capital Limited, a matter currently pending before the Supreme Court that involves similar issues of assured returns and violation of FEMA in the context of a foreign award to purchase shares.⁴

Under the Indian foreign exchange regime, a ‘capital account transaction’, i.e., a transaction which alters the assets or liabilities in India of non-residents, requires prior RBI approval unless specifically permitted under the Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 (Capital Account Transaction). In contrast, ‘current account transactions’ do not require prior RBI approval unless specifically prohibited or restricted under the Foreign Exchange Management (Current Account Transactions) Rules, 2000 (Current Account Transaction).

The Supreme Court’s ruling clarifies that even when a claim for damages arises pursuant to a breach of a share purchase transaction, such payments qualify as a Current Account Transaction and, therefore, do not require prior RBI approval.

This provides certainty in structuring cross-border transactions, where, so far, a delay in claims for compensatory liquidated damages due to the requirement of prior RBI approval has been a vital consideration in commercial negotiations (both security and non-security related). The judgment provides certainty for not only transaction documents and shareholder arrangements but also extends to a wider range of international commercial arrangements, such as cross-border supply contracts, where risk allocation depends largely on the enforceability of such compensatory damages clauses.

Drawing extensively from the RBI’s affidavit, the Supreme Court affirmed the position in NTT Docomo that compensatory damages payable to non-residents for breach of exit clauses do not require prior RBI approval. This is because the damages under an arbitral award represent a ‘measure of loss’ rather than payment for the shares themselves.

However, both the RBI’s stance and the Supreme Court’s ruling apply where payment of compensatory damages is not accompanied by any transfer of underlying equity instruments – a distinction that could raise the following practical concerns: