2025 (5) TMI 1142 - AT - FEMA

Bank penalized for improper FDI fund utilization, penalty reduced from Rs. 5 crores to Rs. 50 lakhs under Section 10(5) FEMA

The Appellate Tribunal under SAFEMA upheld contravention of Section 10(5) of FEMA against the appellant bank for remitting Rs. 47.3 crores as interest at ... Contravention of Section 10(5) of FEMA for remittance of Rs. 47.3 Crores towards the interest @ 17% - HELD THAT:- The transactions to divert the funds were made after receipt of the amount in the bank account of the appellant bank who remitted the interest despite diversion of the fund and its utilization for the purpose other than for which FDI was taken. The appellant bank has pleaded no control over the affairs of M/s Amrapali and its entities after the amount came to their account ignoring the fact that diversion of the amount out of the bank account was to be in the knowledge of the appellant bank otherwise there was no purpose to seek declaration by the authorized person that the transaction is not for the purpose of contravention of the provisions of the Act of 1999 or Rules and Regulations made thereunder. The plea has been taken that if the CCD was not converted into equities in a period of five years, it could not have been termed to be ECD so as to seek prior permission of the RBI for remittance of the interest amount. The argument raised by the appellant bank cannot be accepted in their hands and otherwise when appellant bank was under obligation to take declaration that transaction would not involve contravention of the provision of the Act of 1999 and Rules and Regulations, it was required to give significance to it thus contravention of Section 10(5) of the Act of 1999 is found in the light of the finding recorded by us. Penalty imposed on the appellant bank which is said to be disproportionate to the contravention and thus the counsel for the appellant bank has prayed for appropriate order - Though at the first instance, the counsel pleaded no contravention of Section 10(5) of the Act of 1999 in the hands of the appellant bank but alternative plea was to make the penalty proportionate to the allegation. We find that the penalty of Rs. 5 Crores has been imposed on the appellant bank while separate penalties have been imposed on the other noticee. Looking to the overall case, we find penalty of Rs. 5 Crores to be disproportionate to the allegation against the appellant bank and accordingly to make it proportionate, we reduce it from Rs. 5 Crores to Rs. 50 lakhs. An amount of Rs. 5 Crores has already been deposited by the appellant bank. Thus, after keeping Rs. 50 lakhs towards the penalty imposed and substituted by us, remaining amount of Rs. 4.50 Crores would be returned to the appellant bank. The appeal is disposed of with the aforesaid. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Appellate Tribunal under the Foreign Exchange Management Act, 1999 (FEMA) are:Whether the appellant bank contravened Section 10(5) of FEMA by remitting Rs. 47.3 Crores as interest at a highly abnormal rate of 17% on Compulsorily Convertible Debentures (CCDs) issued under a Foreign Direct Investment (FDI) agreement, without ensuring that the transaction was not designed to contravene or evade provisions of FEMA or related regulations.Whether the appellant bank had an obligation and sufficient knowledge to refuse or report the transaction under Section 10(5) of FEMA, given the diversion of FDI funds by the investee company and the non-conversion of CCDs into equity within the stipulated five-year period.Whether the remittance of interest prior to conversion of CCDs into equity shares could be treated as External Commercial Borrowings (ECB) requiring prior RBI approval.Whether the penalty of Rs. 5 Crores imposed on the appellant bank was justified and proportionate to the contravention found.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Contravention of Section 10(5) of FEMA by remittance of interest at abnormal rateRelevant legal framework and precedents: Section 10(5) of FEMA mandates that an authorized person (such as a bank) must require declarations and information to reasonably satisfy that any foreign exchange transaction is not designed to contravene or evade FEMA provisions. If unsatisfied, the authorized person must refuse the transaction and report to the Reserve Bank of India (RBI).Court's interpretation and reasoning: The Tribunal noted that the appellant bank remitted Rs. 47.3 Crores as interest @ 17% on CCDs issued by M/s Amrapali to IPFII-S Singapore between 2013 and 2015. The Apex Court had described this interest rate as 'highly abnormal' and found that the FDI funds were diverted from their intended purpose. The Tribunal held that the appellant bank was under an obligation to take such declarations and ensure the transaction was not for contravention or evasion, which it failed to do.Key evidence and findings: The Apex Court's order highlighted that the investee company diverted funds for purposes other than construction and development, including repayment of loans and payments to creditors, which violated FDI norms. The appellant bank remitted interest despite these violations and without raising objections or reporting to RBI.Application of law to facts: The bank's remittance of interest without satisfying itself about the legality of the transaction constituted contravention of Section 10(5). The bank could not act as a 'silent spectator' when the diversion of funds and abnormal interest rate were apparent from the transaction details and related agreements.Treatment of competing arguments: The appellant bank argued that it merely acted on instructions from M/s Amrapali and that the interest payment was as per the agreement, prior to the maturity period for conversion of CCDs into equity. It also contended that the bank had no control over the utilization of funds after disbursal and that RBI had not objected to the remittance. The Tribunal rejected these arguments, emphasizing the bank's statutory duty under Section 10(5) to ensure compliance and not facilitate contraventions.Conclusions: The Tribunal concluded that the appellant bank contravened Section 10(5) of FEMA by remitting interest at a highly abnormal rate without due diligence and without ensuring the transaction was not designed to evade legal provisions.Issue 2: Obligation and knowledge of the appellant bank regarding diversion of funds and non-conversion of CCDsRelevant legal framework and precedents: Section 10(5) requires authorized persons to obtain declarations and information to prevent contraventions. The Apex Court's directions and findings on the diversion of funds and irregularities in the FDI transaction are relevant.Court's interpretation and reasoning: The Tribunal found that the bank could not ignore the Apex Court's observations regarding diversion of funds and abnormal interest rate. The bank was expected to be vigilant and not process transactions that were prima facie in violation of FEMA and FDI norms. The conversion of CCDs into equity was to occur within five years, but this did not absolve the bank of responsibility to ensure compliance at the time of remittance.Key evidence and findings: The diversion of Rs. 85 Crores to an associated entity and Rs. 55 Crores to repay loans and creditors was documented. The Apex Court had also noted connivance between the parties involved. The bank's failure to seek adequate declarations or report suspicious transactions was a critical finding.Application of law to facts: The bank's statutory duty under Section 10(5) was triggered by the nature of the transaction and surrounding circumstances. The bank's failure to discharge this duty amounted to contravention, irrespective of its claim of lack of control over fund utilization post-disbursement.Treatment of competing arguments: The appellant argued that it was not responsible for the diversion of funds after disbursement and relied on Section 10(6) of FEMA for protection. The Tribunal held that while the primary responsibility for diversion lay with the investee company, the bank's failure to exercise due diligence and comply with Section 10(5) was a separate and independent contravention.Conclusions: The bank's knowledge or constructive knowledge of the diversion and abnormal interest rate, coupled with its failure to obtain satisfactory declarations or refuse the transaction, constituted contravention of its obligations under FEMA.Issue 3: Whether remittance of interest prior to conversion of CCDs constitutes ECB requiring RBI approvalRelevant legal framework and precedents: The distinction between FDI and External Commercial Borrowings (ECB) is significant under FEMA regulations. Conversion of CCDs into equity within five years was a condition to maintain FDI status. Non-conversion could reclassify the instrument as ECB, requiring RBI approval for remittances.Court's interpretation and reasoning: The Tribunal rejected the appellant bank's contention that remittance of interest prior to the five-year conversion period could not be treated as ECB. It emphasized that the bank's obligation under Section 10(5) was to ensure the transaction was not designed to contravene the law, which was not fulfilled. The timing of remittance did not absolve the bank from its duty to verify legality.Key evidence and findings: The CCDs were to be converted in 2017, but the interest payments were made between 2013 and 2015. The Apex Court had found the entire transaction structured to evade FEMA provisions.Application of law to facts: The bank's failure to ensure compliance with FEMA before remitting interest, regardless of the timing of conversion, amounted to contravention. The bank could not rely on technicalities to avoid its statutory duties.Treatment of competing arguments: The appellant's argument that remittance was permissible without RBI approval before conversion was dismissed because the bank did not fulfill its obligation to seek declarations and verify the transaction's legality.Conclusions: The remittance of interest prior to conversion did not exempt the bank from its obligations under Section 10(5), and the transaction was in contravention of FEMA.Issue 4: Proportionality and justification of the penalty imposedRelevant legal framework and precedents: Penalties under FEMA must be proportionate to the contravention. The adjudicating authority imposed a penalty of Rs. 5 Crores on the appellant bank.Court's interpretation and reasoning: While upholding the finding of contravention, the Tribunal found the penalty of Rs. 5 Crores disproportionate given the nature of the bank's role and the facts. The Tribunal exercised discretion to reduce the penalty to Rs. 50 lakhs to make it proportionate.Key evidence and findings: The bank had already deposited Rs. 5 Crores. Separate penalties were imposed on other entities involved. The bank's role was limited to remittance on instructions, though it failed in statutory duties.Application of law to facts: The Tribunal balanced the need to penalize contravention with fairness and proportionality, reducing the penalty substantially.Treatment of competing arguments: The appellant bank's plea for reduction was accepted on grounds of proportionality, despite upholding contravention.Conclusions: The penalty was reduced from Rs. 5 Crores to Rs. 50 lakhs, and the excess amount deposited was ordered to be refunded.3. SIGNIFICANT HOLDINGS'As per Section 10(5) of the Act of 1999, the appellant bank was under an obligation to take such declaration and information which may reasonably satisfy that the transaction would not involve and is not designed for the purpose of any contravention or evasion of the provisions of the Act of 1999.''The appellant bank could not have acted as a silent spectator to the events otherwise noticed by the Apex Court and has taken serious view and directed the Enforcement Directorate to cause investigation.''The appellant bank's failure to discharge its statutory duty under Section 10(5) of the Act of 1999 by remitting interest at a highly abnormal rate without due diligence constitutes contravention.''The penalty of Rs. 5 Crores imposed on the appellant bank is disproportionate to the allegation and is accordingly reduced to Rs. 50 lakhs.'Core principles established include the strict obligation of authorized persons under Section 10(5) of FEMA to ensure that foreign exchange transactions are not designed to contravene the Act, the non-derogation of this duty even when acting on instructions, and the necessity of proportionality in imposing penalties under FEMA.Final determinations:The appellant bank contravened Section 10(5) of FEMA by remitting interest without ensuring the transaction's legality.The remittance of interest prior to CCD conversion did not exempt the bank from its obligations or convert the transaction into permissible ECB.The penalty of Rs. 5 Crores was excessive and was reduced to Rs. 50 lakhs, with the balance refunded.