An Indian Company is permitted to borrow overseas funds from "Recognised Lenders" under the RBI guidelines on External Commercial Borrowings (ECB). ECB is generally considered to be under Approval route since the agreement between the lender and borrower has to be submitted to the RBI to obtain Loan Registration number (LRN) before the funds can be utilised. Further various conditions like recognised lender, eligible borrower, repayment period, restrictions on end-use, ceiling on interest cost etc. has to be adhered to and complied with. The Indian Company is also required to file Form ECB-2 with the RBI every month reporting specified financial transactions taken place during the month.
It may so happen that the Indian company who has borrowed funds from the recognised lender is either not in a position to repay the borrowing or for any other reasons wishes to issues Equity shares in lieu of the ECB. We therefore analyse herewith whether such conversion is permitted and if at all under what conditions.
The Indian Companies have been granted general permission for conversion of ECB into Equity shares or fully compulsorily and mandatorily convertible preference shares ("Equity Shares"), subject to the following conditions and reporting requirements:
Automatic or Approval route:
The activity of the Indian company is covered under the Automatic Route of the Foreign Direct Investment (FDI Policy) or if the company is engaged in the sector that requires Government permission, permission will need to be obtained by the company seeking the conversion;
Sectoral cap:
The foreign equity in the Indian Company, after conversion of ECB into equity, is within the sectoral cap of equity shares, if any, as defined under the FDI Policy. One will therefore have to look at the sector in which the Indian Company is operating and check if there is any sectoral cap on the percentage of foreign equity in that sector. In case of such sectoral cap, the percentage of foreign equity in the Indian Company should not exceed this sectoral cap after effecting the conversion of CB into Equity shares;
Consent from Lender:
Such conversion shall be with the lender's consent and without any additional cost.
Pricing guidelines:
Price per share at which the ECB is converted into Equity shares in the Indian Company shall not be less than fair value of the shares done by Merchant Banker or Chartered Accountant as per any internationally accepted pricing methodology on arm's length basis as prevailing on the date of conversion.
Exchange rate:
For the purpose of conversion of ECB into Equity, the exchange rate shall be taken at the rate prevailing on the date of agreement between the parties concerned for such conversion, or lesser rate as may be mutually agreed between the parties.
Period:
The conversion facility is available for ECB whether or not such ECB is due for payment or not. Therefore, if the Indian Company has taken ECB for a period of say 5 years and if it wants to convert the ECB before the expiry of 5 years, the same is possible to be done.
Partial conversion:
The conversion of ECB into Equity may be done partially or fully or even in phases.
Other compliance:
The parties will need to be compliant with the requirements prescribed under any other statute and regulations in force.
Reporting requirements:
For partial conversion into Equity, the converted portion will have to be reported in Form FC-GPR as prescribed for reporting of FDI inflows whereas the non-convertible portion will continue to have to be reported in Form ECB-2 with suitable remarks of "ECB partially converted into Equity."
For full conversion of ECB into Equity, the entire portion will have to be reported in Form FC-GPR as prescribed for reporting of FDI inflows. The form ECB-2 shall be filed with the suitable remarks of "ECB fully converted into Equity." Subsequently the Company is not required to file ECB-2 return.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
