Is Sri Lanka really open for business?

Friday, 7 February 2020 00:00 -     - {{hitsCtrl.values.hits}}

 One cannot reasonably expect high-level policy makers to be aware of all laws and regulations in Sri Lanka, and one would consider it the duty of the relevant administrative officials to advise them in this regard

 

  • Thoughts on the recent moratorium on incorporating ‘foreign-owned’ companies

At a recent press conference, the newly-appointed ‘Investment Promotion’ Minister Prasanna Ranatunga is quoted as having said that the Government is eyeing $ 2.5 b worth of foreign direct investment (or ‘FDI’) for 20201. 

An ambitious objective, no doubt, especially given that the same news source states that the FDI numbers for the first 11 months of 2019, as per the data provided by the Central Bank of Sri Lanka (CBSL) itself, amounted to only $ 772 m Even the word ‘pitiful’ does not begin to describe this state of affairs, but I digress. 

Whether this ‘objective’ can in fact be achieved is, I believe, a matter for policy makers and economists to discuss and debate, and whether it will actually be achieved is something we ‘hoi polloi’ will actually know (i.e. at least to some degree) once the statistics for 2020 are released. Working as a foreign investment and M&A lawyer in Sri Lanka for some years now, however, I have realised that subjective financial forecasting (whether in the public or private sector) is almost an exercise in the art of ‘doublespeak’, and one that may not necessarily fare as well under a comprehensive independent evaluation as it does in a promotional pitch monologue. 

In these circumstances, I have generally preferred the barometer of ‘action’ as against ‘words’ as a tool of measurement, particularly on the rather sensitive topic of ‘Government policy’. One such action, which ironically appears to conflict with the aforesaid objective of the Government to increase FDI, and is also indicative of the oft-seen dichotomy between ‘stated’ Government policy and action in Sri Lanka, is the unprecedented2 moratorium that has now been imposed by the Department of the Registrar General of companies (“ROC”) on the incorporation of ‘foreign-owned companies’.

Let me elaborate. 

The problem

On 14 January, the ROC posted a notice on its website (www.drc.gov.lk) simply stating that “Incorporation of foreign owned companies in Sri Lanka with Registrar of Companies is temporary held until further notice (except BOI approved companies)” (sic). 

No further explanation or information is given in the aforesaid notice, save that readers are provided with two telephone numbers to call the ‘Incorporation Division’ for more details. To date, my personal attempt to reach any to these numbers have gone unanswered (and given that such attempts have been made on a number of days, in the form of several calls a day, one is inclined to think that their unresponsiveness may be deliberate). 

Inquiries at the ROC itself have indicated that the moratorium has been imposed in accordance with directions given by the Government (in particular, the Presidential Secretariat), although this has not been confirmed. The representatives of the ROC have also indicated (off-record) that the moratorium has been imposed as an interim measure whilst the Government addresses certain vague issues regarding ‘unfair competition’, the circumvention of FDI restrictions in the retail trade sector, as well as environmental conservation, health, safety and security concerns. 

The legal position

The legality of this moratorium (which I understand applies both new incorporations and applications that were being processed at the time it was introduced) is extremely questionable. The Companies Act No. 7 of 2007 (‘Companies Act’) is presently the primary legislation governing the incorporation of companies in Sri Lanka. 

Section 4 of the Companies Act very clearly states that any person or persons may apply to incorporate a company (other than a guarantee company) by making an application in the prescribed form to the Registrar General of Companies (‘Registrar’), along with certain specified documents; Section 5 goes on to state that on receipt of a properly completed application for incorporation in the prescribed form, the Registrar ‘shall’ (and not ‘may’) enter the particulars of the company on the register of companies maintained by him, assign a unique company number and issue a certificate of incorporation. 

Thus, the incorporation process is subject to express and unequivocal procedures, and the incorporation of a company (subject to the receipt of a duly filed application) is an administrative process to be carried out by the ROC and not one that is subject to his discretion. To the best of my knowledge, there is also no provision in the Companies Act that gives discretion to the ROC to impose moratoriums of any kind on the incorporation of companies. In fact, the only grounds under the Companies Act for refusing to accept an application are procedural (e.g. where they do not adhere to the prescribed form, have not been printed or typewritten etc.), or where they do not comply with the provisions of the Companies Act or regulations made thereunder3. 

Of course, the investments made by a person resident outside Sri Lanka into shares in companies incorporated in Sri Lanka, which involves the remittance of foreign exchange into Sri Lanka (i.e. FDI), is subject to certain restrictions imposed under the Foreign Exchange Act No. 12 of 2017 (‘Foreign Exchange Act’) and regulations issued thereunder. These include the requirement to bring in the relevant investment through a special ‘control account’ set up by the investor with a licensed bank in Sri Lanka (presently known as ‘Inward Investment Accounts’ (‘IIA’) and formerly designated a ‘Securities Investment Account’ (‘SIA’) or a ‘Securities Investment External Rupee Account’ (‘SIERA’), and there are certain industry sectors where the approval of the Government and/or the Board of Investment of Sri Lanka (BOI)  is required for foreign investment (and there are also other laws that impact on foreign ownership of companies incorporated in Sri Lanka, including the Land (Restriction on Alienation) Act of 2014), but all other sectors are and have been largely open for 100% foreign ownership since around 1992. 

As such, non-residents (foreigners, foreign entities, and non-resident citizens) could incorporate and own companies in Sri Lanka without undue difficulty, under a gradual investment liberalisation exercise that in fact commenced in the late 1970s. The incorporation and ownership of companies engaging in retail trade was also open for ‘foreigners/foreign companies’ since at least 2002, subject to a minimum foreign investment of $ 1 million (which was exponentially, and by all appearances arbitrarily, increased to $ 5 million in 2017). 

Nevertheless, if the provisions of the Foreign Exchange Act (and regulations issued under it), as conditions under other applicable laws and regulations are met, the ROC is legally bound to proceed with the incorporation of a company (whether or not it is subject to foreign ownership in whole or part). 

Accordingly, to impose a blanket moratorium on incorporation of all companies with a foreign shareholding component, based on ‘Government policy’, ‘Government directive’, ‘Government circular’ or any other such administrative measure would, in the absence of legislation (primary or subsidiary) enabling the same, be an ultra vires act on the part of the ROC, which would be open to legal challenge (for instance by way of a fundamental rights petition or writ action; in fact the Companies Act itself contains certain provisions that enable a challenge to the ROC’s actions in this regard). 

Of course investors (and their advisers and other relevant service providers, such as company secretaries) may seek simpler practical solutions, such as incorporating companies with domestic promoters (i.e. initial shareholders) and then transferring the relevant shares to the requisite foreign shareholders (which would be legal and valid, and not require the approval of the ROC, so long as all other applicable laws and regulations are followed).

At a higher level, however, this action is reflective of a series of legally questionable and concerning acts/practices taken (or implemented, as the case may be) by the ROC in the recent past, including the imposition by way of an administrative notice of an ‘Annual Registration Levy’ for companies in 2016 (for which there was no provision in law at the relevant time4, and therefore subsequently addressed by Parliament introducing the Finance Act No. 35 of 2018 – which purely imposed the obligation to pay the levy for 2016), and the continued insistence that companies being incorporated with a foreign shareholding element contain an ‘objects clause’ in their articles of association (which is not required under law, and is a legally futile exercise for private companies given that they can by-pass any such restriction through the written agreement of all shareholders). 

The Registrar appears to consider himself the ‘Charon’ of the Sri Lankan corporate world, ferrying those ‘foreigners’ whom he deems worthy to the other side. Unfortunately for our ‘Charon’, the administration of the provisions of the Foreign Exchange Act (and its regulations) is placed with the CBSL by law (and administratively enforced by its Foreign Exchange Department). So it appears that our ‘Charon’ has appropriated some of the powers of ‘Hades’.

Conclusion and recommendations 

Red-tape, bureaucracy and legally questionable practices seem rampant at the ROC, and all whilst consecutive governments have been trying (or at least publicly proclaiming that they are trying) to improve Sri Lanka’s FDI inflows and ‘ease of doing business’. The responsibility in this case however lies primarily with the Registrar himself, for he should inform the policy-makers of the legality of any directions given to him and his ability (or inability, as the case may be) to implement them. 

One cannot reasonably expect high-level policy makers to be aware of all laws and regulations in Sri Lanka, and one would consider it the duty of the relevant administrative officials to advise them in this regard (although it is acknowledged that the Companies Act also has provision for the establishment of an ‘Advisory Commission’ to advise the Minister on matters or questions relating to companies and the laws applicable to companies which are referred to the latter by the former (as per section 506 of the Companies Act); however I am not aware whether the ‘Advisory Commission’ has been established, presently active, or (in the event both of the aforesaid are answered in the positive) been consulted on this moratorium). If the present Registrar is unable or disinclined (for whatsoever reason) to implement and uphold the provisions of the Companies Act (or is unaware of its provisions) dutifully and diligently, one is compelled to question his suitability for the important office he holds. It is someone no less than the President himself, in his Independence Day celebrations address to the country, who requested every person to “act in accordance with one’s conscience”, and “if your conscience tells you that the Government is moving in the wrong direction, you always have a duty to boldly point this out.”5

Ultimately, arbitrary administrative actions such as this ‘moratorium’, prima facie without any legal grounding, have the potential to significantly dent investor confidence and business planning activities in the short to mid-term and as such, the ability of the country to attract FDI in an increasing global marketplace. These concerns have been raised to me personally by potential investors (both at SME and MNC level), as well as local and international lawyers and other professional advisers. 

Sri Lanka just inched forward one spot in the ‘Doing Business 2020’ report released by the World Bank (which measures the ease of doing business in around 190 countries)6; these sort of actions may not help Sri Lanka’s case when the 2021 report is being compiled. It is of course possible that the Government may have some pertinent concerns regarding the quality and nature of FDI that need to be addressed; however, such concerns should be carefully considered and addressed using the appropriate fora and legal instruments, with input from all relevant stakeholders. In the meantime, one hopes that saner counsel prevails, and this moratorium is lifted at the earliest.

(The writer is an Attorney-at-Law and presently a Partner and head of the Corporate and Commercial Law Department at the law firm Sudath Perera Associates. He was formerly based in Singapore as a corporate and commercial lawyer with a leading international law firm, specialising in cross-border transactions in South and South-East Asia. The views expressed here are his own.)

Footnotes

1 http://www.xinhuanet.com/english/2020-01/28/c_138739250.htm

2 To the best of the writer’s knowledge, having made reasonable enquiries. 

3 As per section 475(2) of the Companies Act. 

4 https://roar.media/english/life/economy/annual-registration-levy-questions-answers/

5 http://www.ft.lk/top-story/President-commits-to-deliver-true-democracy-and-development/26-695089

6 http://thesundayreader.lk/2019/11/04/sri-lanka-improves-position-ease-business-index-eodbi/

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