FDI into the Indian market is governed by the Foreign Exchange Management Act, 1999 (FEMA). A few statutory bodies bring out notifications time and again to amend or clarify the Indian position on FDI related aspects. One such vital aspect, which has been tried to be clarified up to an extent by the RBI, is of the validity of put options in Shareholders' Agreements containing provisions for assured returns on investments when the investor (in this case, foreign) wishes to exit its investment. This clause usually kicks in after a fixed amount of time, specified in the clause itself.

The RBI, in 2014, came out with two notifications, the end result of both being that although put options were deemed to be valid under FEMA, any provision for assured return was held to be void. The investor could only exit by selling its securities at a Fair Market Value (FMV) decided by internationally approved valuation standards.

In October 2020, the Department for Promotion of Industry and Internal Trade of the Ministry of Commerce and Industry came out with a Consolidated FDI Policy where, again, the same position was explained by the government. Under Annexure 1, in clause 1.1, it is stated "after the lock-in period and subject to FDI Policy provisions, if any, the non-resident investor exercising option/right shall be eligible to exit without any assured return, as per pricing/valuation guidelines issued under FEMA from time to time." The same has been repeated in Section 1, clause 2.4 of Annexure 2 with the addition that the FMV would be decided in accordance with pricing/valuation guidelines issued by the RBI.

All this theoretically clarifies the position of such clauses under Indian law to be per se invalid. However, the courts, while placing due importance to the RBI guidelines, has adopted a slightly different approach which has led to the creation of a very strong, and legally approved, loophole of 'downside protection'.

Downside Protection is a fairly simple concept. They are techniques and mechanisms that try to mitigate any losses caused to the investor through his investment. It always depends on the occurrence of an event that is harmful to the interests of the investor.

It is compensatory in a way and as the name suggests, tries to protect the investor if the investment goes wrong beyond a certain extent (as specified in the shareholders' agreement). If the investor inserts such a condition in the shareholders' agreement, it can easily escape the restrictions put in place by FEMA vis-�-vis assured return, through technicalities.

What is even funnier is that such condition might be the occurrence of an event which, even though is harmful to the investor, is part of the daily business of the company and such risks are expected to be taken by a shareholder. For example, a put option might trigger an exit (subject to time constraints) with an assured return of 20% if the share price drops below 10% from the day when the investor first purchased that company's shares.

Whether downside protection can serve as a kind of exception to the rules around assured return clauses and the extent of such exception can be understood through some landmark judgements given by Indian courts. In Cruz City 1 Mauritius Holdings v. Unitech Limited, a put option called for payment of the investment amount plus a 15% internal rate of return in the event that a project's completion was delayed. After such delay, the counterparty did not make payment, and damages were awarded.

The claim that the clause offered for an assured return, which was unlawful under FEMA, was rejected by the Court, which upheld the judgement, saying that "Cruz City had no assurance of exit at a pre-determined return in the event the execution of the project was commenced on schedule."

In NTT Docomo v. Tata Sons, the shareholders' agreement stated that the Indian company would be obligated to find a suitable buyer for the foreign investor's shares at a set price if the joint venture between the parties did not meet certain performance targets based on investee's representations and warranties. Later, the Indian corporation argued that the "no assured return rule" prevented them from fulfilling its promises. The foreign investor did, however, receive a favourable arbitral award in its favour. The Court held that the exit option was in the nature of "downside protection" rather than an assured return.

Even in Shakti Nath v. Alpha Investments Ltd., the court deemed the assured return clause in the particular case to be in the character of damages after distinguishing between "put option provisions giving assured returns" and "damages" clauses. Therefore, India only permits downside protection in the form of contractual violation.


Downside protection seems to have attained the assent of the higher judiciary, directly or indirectly, as an exception to the RBI notifications under FEMA that concern fixed price put options. It gives foreign investors a way to protect their investments, which continue growing at rapidly, by circling around legal restrictions. All it takes is to add a simple, convenient condition or contingency in the put option.

Also, considering that almost all landmark decisions holding such put options legal were challenges to arbitral awards, an arbitration clause would be ideal, if the parties were to take an extra-prudent approach. One thing, however, must be noted; the cases above do not approve 'assured return' clauses per se. If the clause is of the nature of damages, only then does this exception come into play. The result, therefore, is that a lot of it depends on the phraseology used in the shareholders' agreement.

Now the question of whether the loophole of 'downside protection' needs to be fixed or not, is a more philosophical question, but considering the direction that India aims to go towards, where more FDI is envisioned and encouraged, ensuring the validity of 'assured return' clauses will definitely help in the longer run. So, the loophole might just be a necessary evil.

End-Notes:

• https://rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=9106
• https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020.pdf
• https://indiankanoon.org/doc/58509699/
• https://indiankanoon.org/doc/124111275/
• https://indiankanoon.org/doc/23496190/