Financial Commitment by Equity, Debt, Guarantee and Pledge — and OPI

Financial Commitment explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.

An Indian entity may make financial commitment by equity, by debt, or by non-fund based means. Guarantees, pledges and charges each count towards the limit; a resident individual may not commit by way of debt; and OPI is capped at 50% of net worth.

The three modes

Within the overall limit in Schedule I of the OI Rules and subject to regulation 3, an Indian entity may make financial commitment by way of:

• ODI in equity share capital, as per Schedule I;
• debt, as per regulation 4 of the OI Regulations; and
• non-fund based financial commitment, as per regulations 5, 6 and 7.

Equity share capital

ODI may be made or held by way of: subscription as part of the memorandum of association or purchase of equity capital, listed or unlisted; acquisition through bidding or tender procedure; rights issue or allotment of bonus shares; capitalisation, within the time specified for realisation, of any amount due towards the Indian entity from the foreign entity where the remittance is permitted or needs no prior permission; swap of securities, with both legs of the transaction complying with FEMA; and merger, demerger, amalgamation or any scheme of arrangement under Indian law or the law of the host jurisdiction.

Debt — and who may not use it

Under regulation 4, the AD bank facilitates an outward remittance towards financial commitment by way of debt only after obtaining the necessary agreement or documents for ensuring the bona fides of the transaction. Two prohibitions follow:

• An Indian entity shall not lend directly to its overseas step down subsidiary.
• A resident individual shall not make financial commitment by way of debt.

Permitted debt instruments are government bonds; corporate bonds; all tranches of a securitisation structure which are not the equity tranche; borrowings by firms through loans; and depository receipts whose underlying securities are debt securities.

Financial guarantees

Regulation 5 sets seven rules for financial commitment by way of guarantee:

• For a performance guarantee, the time specified for completion of the contract is its validity period.
• No prior RBI approval is needed to remit funds from India on invocation of a performance guarantee extended in accordance with the rules.
• Any guarantee, to the extent invoked, ceases to be part of the non-fund based financial commitment and becomes financial commitment by way of debt — and the invocation shall be reported in Form FC.
• Roll-over of a guarantee is not a fresh financial commitment, but shall be reported in Form FC.
• A group company may extend a guarantee if it is eligible to make ODI; the guarantee counts towards that group company's own limit and is reported by it.
• A guarantee by a resident individual promoter counts towards the Indian entity's limit and is reported by the Indian entity.
• In computing a group company's limit, any fund-based exposure between the group company and the Indian entity is deducted from the group company's net worth.

Pledge and charge

Under regulation 6, an Indian entity may pledge the equity share capital of a foreign entity or its step down subsidiary, create a charge on its assets in India, or create a charge on the foreign entity's or its step down subsidiary's assets outside India — in favour of an AD bank or public financial institution in India, or an overseas lender for the first and third of those — for availing any fund based or non-fund based facility for the foreign entity or its step down subsidiary.

Financial services and strategic sectors

A foreign entity is treated as engaged in financial services if it undertakes an activity which, if carried out in India, requires registration with or is regulated by a financial sector regulator in India.

In a strategic sector, the Central Government may on application through the RBI permit financial commitment above the limits. The limited liability structure requirement is not mandatory for entities with core activity in a strategic sector, so ODI may be made in unincorporated entities; and an Indian entity may participate in a consortium with international operators to construct and maintain submarine cable systems on a co-ownership basis.

Resident individuals and OPI

Under Schedule III, a resident individual may make ODI or OPI subject to the overall LRS ceiling, by way of: ODI in a foreign entity not engaged in financial services activity and having no subsidiary or step down subsidiary where the individual has control; OPI including by reinvestment; capitalisation of dues; swap of securities on merger, demerger, amalgamation or liquidation; rights issue or bonus shares; gift; inheritance; sweat equity shares; minimum qualification shares for a management post; and shares or interest under an ESOP or Employee Benefits Scheme.

Two carve-outs are worth noting. Acquisition by gift from a resident relative, or by inheritance, is available without any limit and is not reckoned towards the LRS limit nor reportable under LRS. And ESOP or sweat equity shares may be acquired without limit by an employee or director of an Indian office, branch or subsidiary of an overseas entity, provided the scheme is offered globally on a uniform basis.

For an Indian entity, OPI shall not exceed fifty per cent of net worth as on the date of the last audited balance sheet, and a listed Indian company may make OPI including by reinvestment.

NOC, disinvestment and restructuring

• NOC. A person with an account appearing as an NPA, classified as a wilful defaulter, or under investigation by a financial sector regulator or investigative agency must obtain an NOC before making financial commitment or undertaking disinvestment. Where the certificate is not furnished within sixty days, no objection may be presumed. Honouring a guarantee issued before the investigation or classification is not a fresh financial commitment and needs no NOC.
• Disinvestment. On full disinvestment other than by liquidation, the transferor shall not have any dues outstanding from the foreign entity; and on any disinvestment the transferor must have stayed invested for at least one year from the date of making the ODI. Neither applies to a merger, demerger or amalgamation between foreign entities wholly owned by the Indian entity, or where there is no change or dilution in aggregate equity holding.
• Restructuring. Permitted where the foreign entity has been incurring losses for the previous two years as evidenced by audited balance sheets, with the diminution not exceeding the proportionate accumulated losses. Where the original investment exceeds USD 10 million, or the diminution exceeds twenty per cent of outstanding dues, the diminution must be certified on an arm's length basis by a registered valuer under the Companies Act, 2013, or a corresponding valuer or certified public accountant in the host jurisdiction.

Practical checklist

• Identify which of the three modes the proposed financial commitment uses.
• Route group funding through the first-level foreign entity, not the step down subsidiary.
• Remember an individual cannot commit by debt.
• Report invocation and roll-over of guarantees in Form FC.
• Value a pledge at the lesser of pledge value and facility amount.
• Test three years of net profits before any financial-services ODI.
• Keep OPI within 50% of net worth for an Indian entity.
• Obtain the NOC where an NPA, wilful defaulter or investigation flag exists.

Common mistakes

• Lending directly to an overseas step down subsidiary.
• An individual promoter lending to the overseas venture.
• Treating an invoked guarantee as still non-fund based.
• Counting an over-collateralised pledge at full value.
• Disinvesting inside one year of the original ODI.
• Proceeding without an NOC where an investigation is on foot.