A listed Indian company, E-Land Apparel, finds itself in a regulatory bind as it attempts to resolve a financial struggle with its foreign parent, E-Land Singapore. The company received a substantial advance payment of $45 million from its parent between 2016 and 2018 for garment supplies under a long-term contract. However, due to financial difficulties, E-Land Apparel has been unable to fulfill its export obligations, leaving nearly $44.89 million outstanding.
In a bid to convert this liability into equity, E-Land Apparel proposed issuing a single share at a high premium to E-Land Singapore. This unconventional move has raised eyebrows at the Securities and Exchange Board of India (SEBI), prompting a closer examination of the legality and implications of such a transaction.
SEBI Scrutiny and Guidance
Seeking informal guidance from SEBI, E-Land Apparel posed two critical questions. Firstly, does the issuance of equity shares in lieu of export advance repayment align with regulations governing preferential allotment? And secondly, does issuing a single share at a significant premium comply with SEBI norms on pricing?
SEBI’s response shed light on the nuances of the proposed transaction. While the regulator clarified that this particular scenario does not fall under Regulation 163(3), which typically deals with issuing shares for non-cash considerations in the case of a share swap, the question of issuing one equity share at a substantial premium remained unresolved. Gaurav Pingle, a Company Secretary, emphasized the significance of this distinction, noting that the transaction straddled the line between equity issuance and liability settlement.
According to Binoy Parikh, Executive Director of Katalyst Advisors, the issuance of shares to a non-resident above the floor price on a preferential basis is permissible under various regulations. However, the unique nature of E-Land Apparel’s proposal, involving a solitary share at a premium, introduces complexities that could challenge existing frameworks.
Potential Concerns and Implications
Parikh highlighted several potential concerns that may have emerged had SEBI greenlit the transaction. Firstly, under the Foreign Exchange Management Act (FEMA), obtaining prior approval from the Reserve Bank of India (RBI) could be necessary, as the conversion of export advances into equity is not a straightforward process. Secondly, from a taxation perspective, the lack of commercial substance in issuing shares at a steep premium raises questions about the transaction’s treatment under Indian tax laws. Lastly, given the transaction’s intercompany nature, ensuring arm’s-length pricing in line with transfer pricing regulations presents a formidable challenge.
The intricacies of E-Land Apparel’s predicament underscore the complexities that can arise when attempting to navigate financial obligations in a global business landscape. As regulatory bodies like SEBI grapple with novel scenarios, the need for nuanced interpretations and clear guidelines becomes increasingly apparent. E-Land Apparel’s case serves as a poignant reminder of the delicate balance between financial innovation and regulatory compliance in today’s interconnected markets.