By Sundeep Dudeja and Vaibhav Kakkar
The Opening In The Clouds
Cash and capital must be “checked-in” before an aviation player can take off. Aircraft, aviation fuel, employees, training, airport charges and maintenance are only some of the many factors that swell costs, while delaying difficult-to-earn returnsfor airlines the world over. India is no different. The recent debt burden of domestic airlines in India stands at U.S. $14.5 billion. The finances of the airline sector have been reeling. Financial and private equity investors have shown minimal interest in this sector in the past given that India’s regulatory framework did not even permit strategic investment.
Foreign airlines were not allowed to hold an equity stake in an Indian air transport undertaking engaged in operating scheduled and non-scheduled air transport services, except cargo airlines. Foreign Direct Investment (FDI) up to 49% was allowed under the “Automatic Route” (i.e., without obtaining prior approval from the Foreign Investment Promotion Board, Ministry of Finance [FIPB]) in scheduled air transport service/domestic scheduled passenger airlines. In the non-scheduled air transport service, FDI up to 74% was allowed (under the Automatic Route up to 49% and with prior FIPB approval for FDI above 49%).
All this changed on September 20, 2012, when the Department of Industrial Policy & Promotion (DIPP) of the Ministry of Commerce and Industry issued new regulations. DIPP’s “Press Note 6” changed business for good. It allowed foreign airlines to hold capital in Indian companies operating scheduled and non-scheduled air transport services up to 49% of their paid up capital under the Approval Route (i.e., with prior FIPB approval). The Press Note infused fresh breath in the Indian airline space and raised the hopes of domestic carriers that the policy change would revive their sector.
The Government had long delayed this step because of security concerns as well as the fear of acquisition of small players by foreign airlines. The present government’s dependence on support of allied political parties may also have been a factor. While long overdue, this was a welcome move because as strategic alliances were required for achieving consolidation, efficiency and reduction of costs. Such alliances were seen as helping to usher expertise and global practices and standards into India.
The decision paved the way for airlines such asGoAir, SpiceJet, Jet and Kingfisher to explore recapitalisation, restructuring and partnerships with global operators. Further, this bold move, along with the opening of multi-brand retail trade for FDI, helped bolster investor confidence. Before September 2012, the term “policy paralysis” was being associated with the Government.Even Prime Minister Manmohan Singh himself had come under criticism. The new rules cheered global airlines as new opportunities opened up in what they began seeing as India’s huge market.
Some of the important conditions for acquisition of a stake by foreign airlines in Indian carriers, was that a “scheduled operator’s permit can be granted only to a company (i) that is registered and has its principal place of business within India, (ii) whose Chairman and at least two-thirds of the directors are citizens of India and (iii) the substantial ownership and effective control of which is vested in Indian nationals.” The revised policy was not made applicable to Air India which is still owned by the government.
Air Asia Flies Into Turbulent Weather
After Press Note 6 was issued, Malaysia-based budget carrier AirAsia was the first airline to announce a collaboration with the Tatas and Telstra Group to launch a new low-fare airline in India. AirAsia was to have a 49% stake in AirAsia India, and the Tatas and Telstra 30% and 21% respectively. The FIPB gave its approval to the venture in March 2013; but the proposal almost immediately hit turbulence when the Ministry for Civil Aviation pointed out that the language of Press Note 6 only allowed foreign airlines to acquire a stake in existing carriers, not in greenfield airline projects such as AirAsia India. DIPP at the Ministry of Commerce and Industry, however took the position that the policy change envisaged stakes in greenfield projects as well as existing carriers.
According to paragraph 2.1 of Press Note 6 the “Government of India has reviewed the position in this regard and decided to also permit foreign airlines to invest, in the capital of Indian companies, operating scheduled and non-scheduled air transport services, up to the limit of 49% of their paid-up capital.” The FIPB’s interpretation that the rule applied to Greenfield projects was based on the comma placed after the word “companies,” arguing that there is no distinction made in the said language between existing and newly created companies. The Ministry of Civil Aviation, however, insisted on clarification of the language of the Press Note. The differing viewpoints of these two government departments were widely reported.
The issue could have been avoided by constructive dialogue between government departments prior to the meeting of the FIPB in which AirAsia’s proposal was considered. While ultimately, it did not have a bearing on the approval of the proposal by the FIPB, the disagreement showed an inefficient and confusing lack of co-ordination between Government departments and jeopardized investor confidence. Technically, the DIPP is the policy formulator and its view should have settled the issue.
In support of the argument that Press Note 6 did not permit foreign airlines to invest in greenfield carriers, senior BJP politician Subramanian Swamyfiled a public interest litigation (PIL) against the deal before the High Court of Delhi. The case is presently being litigated. However, a fundamental aspect which should not be lost sight of here is that under the settled principles of Indian administrative law, Government policy and its interpretation are the executive’s prerogative,which limits judicial review of policy matters. In the context of FDI policy itself, in the judicial decisions of Federation of Associations of Maharashtra v. Union of India ( 63 SCL 77 (Delhi)) and Radio House and Ors. v. Union of India (2008 (2) KarLJ 695), it has been held that the Government decides and interprets the implications of policy. Therefore, it is unlikely that the Delhi High Court will grant Mr. Swamy’s petition given that the FIPB has already cleared the AirAsia India investment, and the DIPP has stated that Press Note 6 is not restricted to investment in existing carriers only.
Jet Airways & Etihad Airways – The Not–So-Smooth Runway For The Big Players
Another deal which lit up the Indian sky in 2013 was Abu Dhabi-based Etihad Airways’ 24% investment in NareshGoyal- owned Jet Airways for approximately $350 million. The investment deal was huge and the first in an existing domestic airline, amongst the existing Indian operators and was at the same time as India and UAE had signed a memorandum of understanding (MoU) on air services for enhancing seat capacity. The deal in whole could lead Jet Airways being able to reduce its debt burden from $2.1 billion to $1.5 billion.
Allegations were made by several politicians, includingSubramanian Swamy, that the Government unduly influenced the deal. Thistransaction, too, is sub-judiceon a plea filed by him to the Supreme Court of India, . The MoU entered into between India and UAE for an increase in the number of seats per week for their airlines, was alleged to have been formulated to specifically facilitate the Jet-Etihad deal. The MoU has been said to impact domestic carriers (other than Jet) and domestic airports, as it would lead to Abu Dhabi becoming a hub for in-bound and out-bound India flights. Nevertheless, the MoU was given ex post facto clearance by the Cabinet in September, 2013.
The Matter Of “Effective Control”
While Press Note 6 mentions that a scheduled operator’s permit may be granted only when the company’s “effective control” is vested in Indian nationals, it does not define “effective control.” The prevalent FDI policy outlined “control” as the power to appoint a majority of directors. Control as stipulated by the Securities and Exchange Board of India (SEBI) Takeover Code includes the right to appoint a majority of directors or to control management or policy decisions, directly or indirectly, including by virtue of shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
As soon as the Etihad investment in Jet was first announced in April 2013, the proposed structure faced scrutiny of the FIPB, SEBI, the Competition Commission of India (CCI) and the Ministry of Corporate Affairs, on the grounds that the proposed documentation appeared to show a shift in effective control of the airline into Etihad’s hands. The regulatory authorities perceived that Etihad was attaining much more than the law permitted, even though the stake proposed to be acquired was a minority 24%. As initially proposed, Etihad was to get three directors on the board, while Jet was to have four, with seven directors being independent. The deal envisaged, among other things, that Etihad could source candidates for senior management positions, network and revenue management functions could be shifted to Abu Dhabi, and the nominations committee could exclusively recommend appointment/removal of independent directors and chief executive officers.
The then existing FDI Policy defined control as simply the power to appoint majority of directors, which was a narrower definition than the definition of control under the SEBI Takeover Code. Practically, however, in the context of FDI also, the Government was applyingsimilar parameters as those envisaged under the SEBI Takeover Code for assessment of control of an entity. FIPB’s assessment of the investment in Tata Sky Ltd. is an example of where various governance rights proposed in the transaction documents were directed to be reduced.
Further, the deal was facing examination by SEBI under the requirements of the Takeover Code itself, which mandates that if an acquisition leads to change in control of an entity listed on any stock exchange—Jet is a listed entity—an open offer is required to be made by the acquirer to the public shareholders of the entity for tendering their shares to the acquirer. SEBI was apprehensive that certain clauses in the proposed structure would give control to Etihad over Jet. SEBI’s concerns, when echoed in the media and other platforms, led, for the first time, to the FIPB seeking specific comments from SEBI and the Ministry of Corporate Affairs on the deal structure before approving it.
These various regulators worked closely among themselvesas well as with Jet-Etihad, to identify those clauses of the proposed shareholders’ agreement, commercial cooperation agreement, etc., that could be interpreted as handing control to Etihad. When finally FIPB cleared the deal in July it did so conditionally. Jet Airways Chairman, NareshGoyal, was to remain executive chairman with a casting vote. Any future changes in the shareholding pattern or shareholders agreement were made subject to prior Government approval. Most importantly, Etihad agreed to two board seats, as opposed to three discussed earlier, with six seats for independent directors. Under the revised terms of the agreement Etihad could only recommend appointments to management. Also, Etihad would not have the right to appoint independent members on the nomination and audit committees and such members could be appointed only if nominated by the board of directors.
The proposal for shifting of revenue management and the network operations office to Abu Dhabi was also dropped. (Source: http://m.financialexpress.com/news/jet-flight-plan-gets-green-signal-after-control-shift/1148298/). Importantly, however, SEBI stated in its assessment that if any other regulator differed in its analysis of the change in Jet Airways’ control, SEBI reserved the option of re-examining the issue of open offers to be made to public shareholders.
The clearance of the investment by the FIPB and subsequently by Cabinet Committee on Economic Affairs was a bright spot, even though it took over six months. There were many authorities involved and the deal can be seen as an example of constructive and productive dialogue between a willing investor and Indian regulators, who are usually perceived by the global community as stringent and reluctant to approve these kinds of complex transactions.
The Jet-Etihad transaction also glided through the scrutiny of the Competition Commission of India which did not see the combination as having an appreciable adverse effect on competition in India. However, in its order of November, 2013, based on its assessment of the investment agreement, the shareholders agreement and commercial co-operation agreement, the Commission concluded that Etihad would be in joint control over Jet under the deal. Given this, SEBI has recently been mulling re-examining the deal to determine whether it is indeed a change of control, which could trigger an open offer. Therefore, the last word on this issue is yet to be heard.
Controlling The “Control”
Around the same time that the Jet-Etihad deal was under consideration, the DIPP revised the FDI policy (in August 2013) to bring the definition of “control” in line with that prevalent under the SEBI Takeover Code. The (Indian) Companies Act, 2013, which has been recently enacted to replace the half-a-century old company law embodied in the (Indian) Companies Act, 1956, also encapsulates a new definition of control which conforms to the one contained in the SEBI Takeover Code.
This is a positive development in the sense that different regulations/guidelines now do not carry contrasting definitions of control. However, certain aspects still remain unresolved. The definition of control under the SEBI Takeover Code has itself been a subject of intense judicial debate and varying interpretation historically, as the same has been interpreted in light of the particular facts of individual cases.As the FDI Policy (post amendment) now carries more or less the same definition of control as in the SEBI Takeover Code, the remaining uncertainty and fluctuations travel here as well.
For instance, in the order in Subhkam Ventures v. SEBI, dated January 15, 2010, of the Securities Appellate Tribunal, it was held that control has to be positive control.Certain rights to prevent a company from taking certain actions (such as affirmative/ protective right of the investor), however, would not amount to control. However, later, the Supreme Court ruled that this order cannot be treated as a precedent, thus leaving open the contours of the definition of control. Another aspect of this issue is that since the definition of control is now similar in the FDI Policy, the SEBI Takeover Code and the Companies Act, 2013, the interpretation given by regulatory and judicial authorities to “control” under one framework, will necessarily affect the interpretation to be given in another.
Better co-ordination among various Government and regulatory wings will be required. Entrusting one agency with the responsibility of assessment of control in a transaction and the determination made by such agency serving as a parameter for other Government departments, would enhance consistency and clarity.
Press Note 6 was a bold step forward. In barely a year, the civil aviation sector has seen three major ventures: Jet-Etihad, Air Asia India and Singapore Airlines-Tata. Clearly, long-overdue policy changes have provided these companies broad avenues and possibilities for structuring and consolidation. The obligation is on the Government now to keep up the liberalization process, eliminate inconsistencies and simplify procedures. This will allow domestic airlines in India to receive a much needed impetus to recover and flourish. Ultimately, the impact of the reforms, if applied consistently and in a coordinated manner willbenefit airlines in terms of increased capitalization, and passengersin terms of competitive fares, more routes and a greater choice of airline.
SundeepDudeja is a Partner in the Corporate and Regulatory Practices Team of Luthra&Luthra Law Offices, New Delhi. Sundeep specializes in foreign investment/exchange laws, securities laws and general corporate laws. He has extensive experience in structuring transactions and advising clients on corporate, regulatory and contractual matters including, cross border mergers & acquisitions, joint ventures and private equity. Sundeep has advised clients from across industry sectors such as infrastructure, pharma and health, retail, real estate, oil and gas, financial services, insurance, information technology, e-commerce, broad casting and telecom. He has also advised various reputed multinational clients on significant and complex corporate matters including setting up their presence in India. Sundeep is a qualified Chartered Accountant and Company Secretary. He also has various notable publications in several leading journals. Sundeep can be reached at email@example.com
VaibhavKakkar is a Partner in the Corporate and Regulatory Practices Team of Luthra&Luthra Law Offices, New Delhi. Having more than seven years of experience, he has a unique mix of extensive regulatory and transactional expertise, and specializes in structuring transactions, and advising on foreign investment/exchange laws, company law and securities laws. He has advised several global corporates on appropriate strategies in relation to investments in India and domestic and multinational clients on significant and complex corporate matters including cross border mergers & acquisitions, joint ventures, private equity. He has in-depth experience with industry-specific legal and regulatory issues in sectors including retail, real estate, telecommunications, gaming, hospitals, pharma, education mutual funds, education and the financial sector (banking and non-banking). He has various notable publications in several leading journals and newspapers. Vaibhav can be reached at firstname.lastname@example.org.