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India – Insurance Laws (Amendment) Ordinance, 2014.

16 January, 2015

 


Background

 
The Insurance Laws (Amendment) Bill, 2008 (the “Insurance Bill”), was introduced before Indian Parliament for the first time in 2008, in order to amend certain provisions of the Insurance Act, 1938 (the “Act”) and to bring in reforms in the insurance sector, including inter alia, facilitating an increase in foreign investment in Indian insurance companies (and intermediaries) from 26% to 49%.

 
As part of the legislative process in India, every bill (such as the Insurance Bill) requires the vote of a majority of both Houses of Indian Parliament, and Presidential assent thereafter, prior to coming into force as enacted law. While consensus could not be achieved on the passage of the Insurance Bill over several Parliamentary sessions, the new Government in India, which assumed office in May 2014, incorporated certain amendments over the previous draft of the Insurance Bill, and the Insurance Bill was re-introduced in Parliament in July 2014. While the Lok Sabha (the lower House of Parliament) voted in favour of the revised Insurance Bill, the Rajya Sabha (the upper House of Parliament) deliberated and discussed the amendments and a select committee was appointed, by the Rajya Sabha, to review the Insurance Bill and recommend changes, if any. The select committee provided its recommendations on December 10, 2014, though the Rajya Sabha was unable to vote on the revised draft during the last Parliamentary session which ended on December 24, 2014.

 
On December 26, 2014, through exercise of limited legislative powers vested in it under the Constitution of India (i.e. during a period when Parliament is not in session), the Government of India introduced the Insurance Laws (Amendment) Ordinance, 2014 (the “Ordinance”) which came into force with immediate effect. The Ordinance would have to be placed before both Houses of Parliament, for approval, within 6 (six) weeks of commencement of the immediately subsequent Parliamentary session. However, if one of the Houses of Parliament does not re-assemble, then the Ordinance continues to be operative till such time that both Houses are jointly in session, and the 6 (six) week period commences on the date on which the later of the two Houses re-assembles (to illustrate, if the Rajya Sabha commences its session on February 1, 2015 and the Lok Sabha commences its session on February 4, 2015, then the 6 (six) week period will be computed from February 4, 2015).

 
What The Ordinance Provides For

 
In terms of the Ordinance:

 
1. Foreign investors are permitted to hold 49% of the paid up equity share capital of an Indian insurance company. Notably, this limit covers investment by portfolio investors, which was previously excluded from computation of foreign direct investment (“FDI”) limits.

 
Notes:

 
a. The definition of an Indian insurance company has been amended to permit FDI up to 49%, “…in such manner as may be prescribed…”. Since the Insurance Regulatory and Development Authority of India (“IRDA”) is the sectoral regulator and has been granted the power under the Act to formulate and prescribe rules and regulations to give effect to the provisions of the Act, it remains to be seen whether the phrase “…in such manner as may be prescribed…” is a reference to enabling rules and regulations that the IRDA may prescribe. Till date however, (i) no such rules have been prescribed by the IRDA; and (ii) there are no indications from the IRDA on whether such enabling rules or regulations will be prescribed or are otherwise being contemplated.


b. As part of the Union Budget speech on February 28, 2014, with respect to fiscal year 2014-15, the Union Finance Minister had stated that the 49% FDI limit would be subject to approval of the Foreign Investment Promotion Board (“FIPB”). However, the Ordinance does not expressly stipulate that the approval of the FIPB would be required.

 
c. In addition to the amendment brought in by way of the Ordinance, a corresponding relaxation of the FDI limit would have to be made under (i) the Foreign Exchange Management Act, 2000 (as amended) and rules and regulations framed thereunder; and (ii) the currently applicable foreign direct investment policy of the Government of India (collectively “Foreign Exchange Laws”). As on date, the necessary amendments to Foreign Exchange Laws have not been brought out. The requirement for prior approval of FIPB, if any, may possibly be prescribed as part of the amendments to the Foreign Exchange Laws.

 
d. Given the above, from a practical standpoint, while the Ordinance permits foreign investors to hold 49% in an Indian insurance company, in the absence of any amendments to the Foreign Exchange Laws and clarity on what regulatory approvals (if any) would be required, acquisition of 49% by new foreign investors or increase to 49% by existing investors in the share capital of Indian insurance companies, does not appear to be implementable at present.

 
2. The Indian insurance company is required to be “…Indian owned and controlled…”. The term “control” has been defined to include the right to appoint a majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.

 
Notes:


a. The relaxation in the FDI limit means that the Indian joint venture partner would continue to own 51% of the paid up share capital of the Indian insurance company. It appears that this should satisfy, for the time being, the requirement for the Indian insurance company to be Indian “owned”.

 
b. The “control” standpoint however, has been a vexed issue under Indian law for sometime now under securities laws, Foreign Exchange Laws and anti-trust laws. The definition of “control” under the Ordinance covers the right to control “… management or policy decisions…” by virtue of “…shareholding … or shareholders agreements…” and has been brought in line with the “control” definition under Foreign Exchange Laws. This effectively covers any negative “control” capable of being exercised through shareholding levels and/or affirmative vote rights (such as approval of business plans etc.). Further, the requirement for the insurance company to be Indian “controlled” suggests that the foreign investor may not be capable of exercising any level of “control”. However, such an interpretation could be anomalous for the following reasons:

 

 

  • The Companies Act, 2013 (and the Companies Act, 1956, to the extent applicable) affords certain statutory protections to all shareholders of companies where the shareholding of such shareholders is above 25% (for instance, further issue of capital by a company cannot be undertaken unless a 26% shareholder has voted in favour of such a resolution). It is unlikely that such statutory protections would be withdrawn. Even if such a proposal is made, the constitutional validity of such proposal could be questioned.
  • The IRDA has, with respect to existing foreign partners currently holding 26% in Indian insurance companies, permitted extensive affirmative vote rights, without which the concerned joint venture companies are not authorized to undertake certain agreed actions. It may be unlikely that such rights would be permitted to be retained by a 26% shareholder but not be permitted to a 49% shareholder. As a corollary, however, if such rights are ultimately not permitted to a 49% shareholder, then it remains to be seen whether dilution of similar rights at the 26% level would also be required (i.e. for foreign joint venture partners who choose not to increase their shareholding to 49%).
  • While there is no bright line test to determine “control”, and the interpretation of “control” may be case specific, foreign investors will now have to exercise caution with regard to the nature of rights acquired when they invest in Indian insurance companies and whether such rights may be construed as them having acquired “control”. Having said that, logic dictates that regulators should harmoniously interpret the term “control” with respect to existing rights available to 26% shareholders, though the number of directors to be nominated to the board of directors of a joint venture company may be slightly skewed in favour of the Indian partner.

 

 

3. Additionally, certain other changes have been introduced under the Ordinance, including inter alia, the following:

 
a. The minimum capitalization requirement for standalone health insurance companies has been set at INR 1bn.

 
b. The IRDA has been empowered to permit, by regulations, forms of capital other than equity shares, though voting rights of shareholders have been restricted to equity shares alone.

 
c. Section 6AA of the Act, which required Indian promoters to divest their shareholding to 26% after a period of 10 (ten) years from the date of commencement of business by the concerned company, has been deleted.

 
d. Section 7 of the Act, which required deposits of prescribed amounts to be maintained with the Reserve Bank of India, has been deleted.
e. Provisions pertaining to permitted investments by insurance companies have been significantly revised. Further, provisions pertaining to permitted levels of commission and manner of computing solvency margins for insurance companies have been made entirely subject to regulations to be prescribed by the IRDA. As on date, regulations pertaining to these subject matters have not been prescribed by the IRDA.

 
f. Penalties, for contravention of the provisions of the Act and rules and regulations framed thereunder, have been significantly increased.

 
What If The Ordinance Lapses?

 
As indicated above, the Ordinance would have to be placed before both Houses of Parliament, for their approval, when both Houses of Parliament re-assemble. The next scheduled session of Parliament is the budget session in February/March though it cannot be predicted with certainty as to whether both Houses of Parliament would re-assemble and consequently, whether the Ordinance can be taken up for consideration.

 
In the event (i) the Ordinance is not passed within the discussed time frame; or (ii) both the Houses of the Parliament do not approve enacting the Ordinance into a legislation, then the Ordinance lapses, and the Act, as was in force prior to coming into effect of the Ordinance, would automatically revive and become applicable. However, for the period during which it remains operational, the Ordinance would have the same force and effect as an Act of Parliament. Further, it is an established legal principle that all actions that are taken during the period in which an ordinance is in force remain valid and binding even after the lapse of such ordinance. An ordinance can also be revived, subject to the President of India being satisfied that circumstances exist which render it necessary for immediate action to be taken in respect of the subject matter of such ordinance.

 
Factually, at the time that the Ordinance lapses (and is not re-promulgated), one would need to consider the stage at which the acquisition process is with respect to the 49% FDI limit. For instance, if the definitive agreements have been executed and relevant approvals obtained (in such form and manner as may be prescribed), but the actual acquisition has not been completed by the time the Ordinance lapses, one interpretation could be that since the law has reverted to the FDI limit of 26%, the acquisition of 49% could not be capable of completion even if relevant regulatory approvals are in place given that the increased FDI limit no longer applies. On a conservative basis, if the entire process of acquisition is completed prior to the lapse of the Ordinance, i.e. definitive agreements are executed, applicable regulatory approvals are received and the foreign investor has become the owner of the underlying shares, one could take a position that the transaction is complete and cannot be unwound, even if the FDI limit has gone back to 26% owing to the lapse of the Ordinance.

 
In the specific context of FDI limits, an increase in FDI has not been implemented through the route of an ordinance. Accordingly, it would be preferable to tread the landscape with caution and to obtain legal advice in the specific context of each acquisition.

 

AZB

 

For further information, please contact:

 

Zia Mody, AZB & Partners
zia.mody@azbpartners.com

 

Rajendra Barot, AZB & Partners

rajendra.barot@azbpartners.com


Ajay Bahl, AZB & Partners

ajay.bahl@azbpartners.com

 

Anil Kasturi, AZB & Partners

anil.kasturi@azbpartners.com

 

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