Opening of an Escrow Account for FDI Transaction

Introduction:

Escrow is derived from the old French term escroue, which refers to a roll of parchment paper or a small scrap of paper held by a third party until the transaction of property or arrangement was made complete by full payment of the agreement. In modern times, the term escrow still has the same base meaning as it did in 15th to 16th century France.

Escrow account in common parlance means a ‘trust account’ held by the third party on behalf of the borrower to pay the insurance premium or property taxes and all. But in the civilization of foreign investment, Escrow account for FDI transactions refers to an account held by authorized dealers (specified in Schedule 1 of RBI) on behalf of non residents Indians(NRIs) for the purpose of acquisition/transfer of shares and convertible debentures of an Indian Companies through open offers, subject to compliance with SEBI regulations and guidelines.

Stimulus To Investment: RBI Guidelines

In the order to encourage and enhance the foreign direct investment in India, RBI relaxed the norms and allowed the overseas investors to raise funds by pledging shares of Indian companies to banks without their permission. RBI has delegated the power to Authorized dealer to allow undertaking of shares of an Indian company held by non-resident investors in accordance with FDI policy. Such transaction has to be within the framework of the FDI Policy.

RBI has further decided to rationalize, liberalize and simplify the processes regarding the inflow of foreign currency in India and reduce the transaction timing.

RBI has further, in an another notification, allowed banks to open and maintain, without its prior approval, escrow accounts on behalf of residents and non-residents, towards payment of share purchase for keeping securities to facilitate FDI transactions.

Until now, non residents could open Escrow accounts only in relation to acquisition of shares pursuant to a takeover open offer or delisting/exit offer. As per the circular issued on 3^rd May,2011, now Escrow accounts for holding funds or securities can be opened for any FDI transaction. Some of the important conditions specified by the RBI are as follows:

1) the accounts must be non interest bearing.

2) the account can be opened for 6 months only. Prior approval of the RBI would be required for maintaining the account beyond 6 months.

3) the 180 days period for issuance/transfer of securities after receipt of consideration would commence from the day on which the funds are transferred from the Escrow account to the bank account of the issuer/transferor.

4) balance funds remaining in the Escrow account can be freely repatriated.

5) only an AD Category I bank (in case of escrow account for funds) and a SEBI authorized DP (in case of escrow account for securities) can be appointed as escrow agents.

The terms of the Escrow account shall be laid down strictly in the Escrow agreement, Share purchase agreement, conditions of issue of shares, etc.

So, the basic purpose of setting up an escrow account by authorized dealer on behalf of foreign investors is to smooth the progress of FDI in cases where the parties to the share purchase agreement  desire to go for legal due diligence which includes the SWOT analysis of a particular transaction before finalizing the agreement.

Need for opening an Escrow Account:

To provide structured flexibility and easiness to the resident/non-resident shareholders of Indian Company, Reserve Bank of India vide its Circular RBI/2010-11/ 498 A. P. (DIR Series) Circular No. 58 dated May 02, 2011 has decided to permit AD category -1 banks to open and maintain, without prior approval of the Reserve Bank, non-interest bearing Escrow accounts in Indian Rupees in India on behalf of residents and/or non-residents, towards payment of share purchase consideration and / or provide Escrow facilities for keeping securities to facilitate FDI transactions subject to the terms and conditions.

Escrow account mechanism gives the foreign investors a chance to reclaim their investment and exit if the local firms fail to comply or meet certain requirements. To put it simple, it is a pledge- an arrangements where the assets held as collateral cannot be pledged to another party until all the requirements are complied with.

Foreign Investors insist on the escrow mechanism because of their past bitter experiences they had when the local party refused to honour the option and buy back the shares. It is not a water tight arrangement; the whole purpose is to provide comfort and security to the foreign investors as well as the local firms. The escrow process provides the peace of mind necessary when transferring valued property.

Even, if we take the FDI in real estate, escrow mechanism plays a pivotal role in facilitating the inflow of foreign currency in the local market. The Reserve Bank Of India has asked banks to put in place the escrow mechanism that can ring fence their loans to real estate firms and keep a close tab on the end use of funds.

Procedure:

It is imperative to lay down the scheme for the formation of semi automated escrow mechanism for any FDI Transaction. It works by the participation of two party working through a third party acting as an escrow agent i.e. an authorized dealer  which has a fiduciary responsibilities in the transfer of collateral security from one party to another.

In a transaction where both parties are honest, the escrow business can essentially be automatic since the buyer gets his shares and approves release of funds, only when there is a dispute does human interaction become necessary. So, the need is felt to provide for a semi automated escrow mechanism i.e. intervention of any human entity in the form of guidelines, notifications or norms issued by RBI or FEMA to resolve the disputes and allow for the repatriation or remittance of funds held in escrow account to either of the parties.

The procedure for allotment of shares of Indian Companies to NRIs is governed by the RBI regulation. It is a two stage reporting procedure.

1. Within 30 days from the receipt of money from the investor, the Indian Company will have to report to the Regional Office of RBI under whose jurisdiction it’s registered office is located.

2. Within 30days from the date of issue of shares, a report in form FC- GPR should be filed with the regional office along with other documents. A certificate from the Company Secretary of the company accepting investment will be issued certifying that all the requirements of the Companies Act have been complied with.

On the other hand, when the shares are transferred to the NRI, the payment is made to the concerned person who was holding the share and not to the company.

Foreign strategic investors on a regular basis enter into an agreement where they keep aside some assets that can be sold from a special account to buy out the shares of the local firm or promoter. The foreign investors can have a put option where they, either, exercise their right to purchase the shares or refuse to make the payment for the said transaction. In such a situation, the asset held in the escrow account act as a security for the local promoters

There could be other situation where the local promoters failed to allot the shares to the foreign investors then the whole amount has to be repatriated back to the foreign investors. The repatriation is done through the escrow account by the authorize dealers as per the directions given by RBI.

Conclusion

The circulation no.58 issued by RBI dated 3^rd May, 2011 regarding the procedure for the opening of an escrow account for FDI transaction is a reflection of a smart move to facilitate the inflow of foreign currency in the Indian economy. When it comes to financing economic growth and development in the Emerging Markets, the overall consensus seems to suggest that this notification will no doubt offer a better and overwhelmingly platform for raising capital globally to finance their economic growth and development in the Emerging Economies. Keeping that in mind, escrow account seems to be a good option as that gives comfort to not only the client but also the providers/designers that if delivered, money is on the table. However importantly the provider is assured of the fact that money is there on the table and client is sure of the fact that it is in safe hands.