Key Legal Considerations For Financing Indian Businesses Seeking To Establish A Footprint In The UAE

This article intends to highlight the key legal nuances in relation to local fund raising by Indian businesses setting up their operations in the UAE for both local and Indian end-use

Introduction

India and the United Arab Emirates (UAE) have over the past several decades built a strong foundation for bilateral trade and commerce, with the UAE being India's third-largest trading partner and the second-largest export destination.

Existing Bilateral Trade Arrangements between India and UAE

The Comprehensive Economic Partnership Agreement (CEPA) entered into between India and the UAE in 2022 provides for relaxation or elimination of tariffs of over 90% of total exports into the UAE, streamlines and simplifies existing customs clearance procedures, reduces bottlenecks to trade and commerce as well as any unnecessary red-tape and barriers to trade, and improves transparency in the trade systems. The Comprehensive Economic Partnership Agreement (CEPA) entered into between India and the UAE has been a pivotal driver of growth in the region, and has led to the India-UAE bilateral trade increasing to USD 100 billion in the last financial year, thereby expediting the achievement of the target originally set for the year 2030. This success has served as an encouraging precedent for projects such as the India-Middle East-Europe Economic Corridor (IMEC) and has further strengthened trade relations with countries from the Middle East and Europe, with the UAE playing a central role.

In addition to the introduction of the CEPA, the UAE and India have also penned the Bilateral Investment Treaty (BIT) in 2024, replacing the erstwhile Bilateral Investment Promotion and Protection Agreement (BIPPA) framework formulated back in 2013. The BIT seeks to encourage investments which further fosters international trade and commerce, and sets out the framework for regulation of investments by the two countries, remittance of payments and income, transfer of investments, as well as encourages transparency in reporting of investments and provides for an Investor-State Dispute Settlement (ISDS) through arbitration with mandatory exhaustion of local remedies.

Also, in order to promote mutual economic relations by avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and on capital, the UAE and India have also executed the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion in 2013.

Conducive Environment for Investment

In order to encourage investments in the UAE, the UAE has relaxed restrictions imposed on foreign ownership and control over businesses set up in the UAE. The Federal Law No. 26 of 2020 Amending Certain Provisions of Federal Law No. (2) of 2015 on Commercial Companies has eliminated the requirement of the mandatory 51% (fifty one percent) local ownership requirement for companies being set up onshore in the UAE, thereby allowing for 100% foreign ownership and control of businesses in the UAE.

Additionally, the UAE has also set-up specialised 'free zones' based on activity across all of its cities to encourage cross-border investment by foreign companies to establish their businesses and operations in the UAE through tax exemptions, and processes that are hassle free and cost efficient.

Given the strategic location of the United Arab Emirates (UAE) being close to the Gulf states, Africa and Europe, its pro-business and investment policies, beneficial direct and indirect tax regime, world-class infrastructure, logistics and connectivity, and the geopolitical tensions affecting other countries including India through imposition of tariffs by the United States of America (USA) in recent times, several Indian businesses and promoter families are increasingly setting up their base of operations as well as family offices and investment companies in the UAE.

Regulatory Framework in India allowing overseas investments

Indian businesses and entities are entitled to incorporate and set-up entities in the UAE within the permissible limit of 400% of their net worth as per their audited financials, under the 'automatic route' permitted by the Reserve Bank of India (RBI) through its Overseas Investment (OI) framework under the aegis of the Foreign Exchange Management (Overseas Investment) Directions, 2022, Foreign Exchange Management (Overseas Investment) Regulations, 2022 and the Foreign Exchange Management (Overseas Investment) Rules, 2022. Such businesses and operations also raise financing in the UAE and from other developed jurisdictions at relatively lower lending rates, for funding both capital expenditure and operational expenditure, and to increase their revenues and profitability metrics.

Raising of financing in the UAE, and deployment of funds in India and the UAE

External sources of financing and external commercial borrowings remains a low-interest cost source of fund-raising for financing the growth and expansion of Indian businesses. In fact, India's external debt has grown steadily over the years and has increased by 10% in the last financial year alone as per data made available by the Ministry of Finance, Government of India. Indian businesses and promoter families who have set up their operations in the UAE can obtain financing for projects, capital expenditure and day-to-day business operations and towards meeting working capital needs. Such financing can either be raised by the parent, affiliate or associate in Dubai/UAE for local deployment/end-use in the UAE or for on-lending for deployment towards business operations in India or directly raised by an Indian company from banks, lenders and/or financiers in Dubai/UAE and other developed jurisdictions.

Availing of financing in the UAE

The entity or affiliate set up in the UAE can borrow money for its own end-use or for on-lending to Indian subsidiaries and/or affiliates for utilization, and deployment towards operations in India. Such financing can be availed from banks and financial institutions based in the UAE, other developed jurisdictions as well as overseas branch offices of banks registered and regulated by the RBI in India. Given that in general inter-bank borrowing/lending rates for short-term and long-term financing as well as derivatives on bonds have lower interest rates in the UAE as compared to India, such financing can be availed at lower interest rates thereby reducing cost of borrowing, ease of access to cheaper capital, and benefiting from various other price arbitrages.

Generally, availing of financing in the UAE and from other developed jurisdictions from foreign banks who have local offices/branches in the UAE and in case of syndicated loans where foreign banks are amongst the lenders, such lenders are likely to follow standardized lending documentation templates which are formulated and updated from time to time by industry associations such as the Loan Market Association (LMA) or Asia Pacific Loan Market Association (APLMA) etc., which are generally governed by English law, while local banks and financial institutions are likely to disburse funds based on their own specific templates. Usage of such documentation templates prescribed by industry associations such as the Loan Market Association (LMA) or Asia Pacific Loan Market Association (APLMA) etc. ensures that market standards are harmonized and recognized by all market participants and such template streamlines negotiations and discussions between lenders and borrowers thereby increasing time and cost efficiency in deal closures. Such standardized templates are however not in vogue for lending transactions in India at present, and lenders/banks typically follow their own individual requirements as per their own internal policies and hence, lending documentation can be largely non-standardized and not always reflective of market standards.

If financing is availed in the UAE by the entity or affiliate set up in the UAE, the proceeds of such financing can be lent onwards for deployment in India, under the External Commercial Borrowings (ECB) route under the 'automatic route' permitted by the RBI. Any lending/investment which cannot be made through the automatic route will require permission of RBI. Such on-lending can be denominated in both foreign currency as well as Indian Rupees and has to comply with requisites with respect to the Minimum Average Maturity Period (MAMP), end-use requirements, all-in-cost requirements, reporting requirements, obtaining of Loan Registration Number (LRN) and Legal Entity Identifier (LEI) registrations etc. as prescribed under the Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations issued by the RBI.

Key differences between LMA/APLMA and Indian market practice in lending documentation

Restrictive covenants for investment grade borrowers v. Non-investment grade borrowers: For borrowers who are generally considered to be investment grade and have strong credit ratings/profiles from reputed credit rating agencies such as S&P or Moody's, lenders/banks are likely to provide greater flexibility in lending terms, prescribing relatively less restrictive covenants/undertakings which impact day-to-day business operations, nominal financial covenants and provide greater ability to avail further financing/funding for legitimate business ventures through 'accordion' provisions included in the financing documentation. Hence, for such borrowers, the base template which is prescribed by LMA/APLMA is likely to be adopted with limited deviations. However, non-investment grade borrowers are likely to be faced with more bespoke contractual protections commensurate with the increased risk of borrowing underwritten by the lender. In an Indian context, given that historically recovery in cases of insolvency and default scenarios has been largely limited and difficult, lenders prescribe restrictive negative covenants which can even restrict day-to-day business operations, and generally expect borrowers to approach them for waivers/concessions on a case-to-case basis to allow for a higher degree of oversight on business operations.

Floating rate interest structures and risk-free rates: LMA/APLMA templates used to historically provide for floating rate terms based on inter-bank offered rates (IBORs) such as the London Interbank Offered Rate (LIBOR) and the Euro Interbank Offered Rate (EURIBOR). Interbank offered rates (IBORs) such as the London Interbank Offered Rate (LIBOR) have largely been phased out from 2022 onwards as part of the LMA/APLMA standard documentation given that they were susceptible to market manipulation and collusion. Financial regulators in the United Kingdom (UK) and the USA have formulated risk-free rates such as the Secured Overnight Financing Rate (SOFR) (which is generally used for deals denominated in United States Dollars (USD)) and the Sterling Overnight Index Average (SONIA) (which is generally used for deals denominated in British Pound Sterling). These risk-free rates are backward-looking rates which are based on actually concluded short-term overnight financing transactions, while futures and options derivatives transactions are relied upon to also prescribe forward-looking rates such as Term SOFR and Term SONIA which are also used in LMA/APLMA templates. Such risk-free rates are not based on cost of funds or may not be representative of risks specific to certain geographies/markets and hence, a Credit Adjustment Spread (CAS) as well as a margin may be added onto the risk-free rate to arrive at the final interest rate to be levied for a lending transaction. In an Indian context, any floating interest rate is basis the Marginal Cost of Funds based Lending Rate (MCLR) which is prescribed and regulated by the central bank, RBI, which is based on the cost of funds, operating costs and profit margins for each lender/bank.

Increased cost and tax gross-up provisions: LMA/APLMA templates generally include express provisions protecting and indemnifying lenders/banks against 'increased costs' being additional or increased costs which are incurred by lenders/banks during the tenor of the financing due to any changes in law or any changes in compliance with any law or the implementation/application of the 'Basel III' capital regulation norms framed by the Basel Committee on Banking Supervision (BCBS) and similar directives issued by the European Union (EU), as these would alter the cost of lending incumbent on such lenders/banks. Further, LMA/APLMA templates generally provide for grossing-up of tax deductions on interest/coupon payments made during the tenor of the financing. In an Indian context, considering that any increase in cost of lending is already reflected in the MCLR based lending rates prescribed by the RBI, such 'increased cost' related provisions are not included in lending documentation as general market practice in our experience (although if the lender/bank in question has in-turn raised financing offshore these can still be included in lending documentation). Further, in an Indian context, tax gross-up provisions may or may not be insisted upon by lenders/banks on a case-to-case basis.

Dispute resolution procedures: LMA/APLMA templates generally provide English law as the governing law, with institutional arbitration being conducted through an internationally reputed arbitral forum such as the Singapore International Arbitration Centre (SIAC) or the International Court of Arbitration (ICC) or the London Court of International Arbitration (LCIA). In an Indian context, if the lender/bank is a notified lender having recourse to debt recovery or security enforcement mechanisms under specific statutes such as the Recovery of Debts and Bankruptcy Act, 1993 or the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, such disputes would be non-arbitrable in nature as clarified by the Hon'ble Supreme Court of India in the matter of Vidya Drolia v. Durga Trading Corporation¹and hence, specialized tribunals or courts in India would have to be approached for such disputes.

Also, on January 17, 2020, the Government of India notified the UAE as a "reciprocating territory", pursuant to the 'Agreement on Juridical and Judicial Cooperation in Civil and Commercial Matters for the Service of Summons, Judicial Documents, Commissions, Execution of Judgements and Arbitral Awards' signed between India and the UAE on October 25, 1999, thereby recognizing for enforcement and execution in India the judgements passed by the Federal Supreme Court, Federal, First Instance and Appeals Courts in the Emirates, the Abu Dhabi Judicial Department, the Dubai courts, the Ras Al Khaimah Judicial Department, and the courts of the Abu Dhabi Global Markets (ADGM) as well as the Dubai International Finance Center (DIFC), as per Section 44A of the (Indian) Code of Civil Procedure, 1908.

Key Takeaways

As India looks to solidify its contribution in the global economy, the long standing trade relations with UAE and the pro-trade and pro-business approach adopted by both nations, provide Indian businesses and Indian promoters with numerous business and growth opportunities, which makes the UAE a leading contender for overseas investment and foreign direct investment originating from India.

Towards this end, the RBI has recently announced measures to augment availability and accessibility of Indian Rupees to residents of other countries including the UAE, including announcing reference rates for currency conversion to the United Arab Emirates Dirham, which will further bolster and strengthen trade relations between the countries, and deepen the Indian Rupee in global markets, which is in turn beneficial to India's 'balance of payments' position.

Therefore, Indian businesses and Indian promoters should take encouragement from such recent governmental measures and look to further expand their footprint and operations in the UAE, for efficient tax planning, widen their customer base and increased business/investment opportunities.

Footnote

1.Civil Appeal No. 2402 of 2019

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.