Since India opened its doors to foreign investment in 1991, the pace of change has quickened dramatically. Foreign investment has come into a wide range of sectors from all over the world, and continues to do so. Indeed, during the last few years India has brought down its debt burden and increased its foreign exchange reserves from US$3.5 billion in 1991-92 to US$26 billion in 1996. Much of the investment has come in the form of joint ventures between foreign companies and local Indian companies.
Legal, regulatory and cultural issues have a significant impact on the successful implementation of such deals. This article examines some of the main issues in putting together a joint venture deal in India.
For a foreign investor, unfamiliar with India, there are clearly significant benefits in partnering with a suitable local company which can provide local expertise, knowledge of the market and guidance on regulatory and other practical issues which would otherwise take an unfamiliar foreign investor years to assimilate and understand.
At the same time, however, the benefits of a joint venture may be matched by the challenge of finding the right partner and putting together and negotiating a deal which meets both parties' expectations, maximises the complementary talents and skills of the partners, and which will endure and flourish.
There is no simple answer to whether to go it alone or to joint venture - it depends in each case on the nature of the business and the local market, the experience and expertise of the foreign investor, and the need for and availability of suitable partners. It may also depend on the local regulatory environment for the particular sector, as it may not be possible to obtain approval for a wholly-overseas controlled joint venture. The critical issues in making a joint venture work can be summed up as:
These may seem obvious on paper but they can be easily overlooked in the early stages of joint ventures.
Partner selection. India has large numbers of top quality companies run by outstanding talented individuals. There is no shortage of potential joint venture partners in most sectors. But the fit must be right for the sum of the parts to be greater than the whole. Time taken to gain familiarity with the market and with each player's business, aspirations, strengths and weaknesses, will be time well spent.
Due diligence. It is critical to look into the background and affairs of the proposed partner, and the proposed joint venture business properly. In some cases significant information will be in the public domain, while for less well known companies the information in the public domain may be little more than what is available from a search at the Registrar of Companies, and other sources and methods will be needed. The due diligence exercise is part of the "getting to know you" process (and is equally important from the perspective of the local Indian company). However, the concept of carrying out an extensive due diligence exercise before committing to an acquisition or a joint venture is relatively uncommon, and the objectives and expectations need to be agreed and understood if it is to be a worthwhile exercise. The desire to obtain and verify information should not be seen as an indication of a suspicion that there is some dark secret lurking in the depths of a filing cabinet, but simply as good practice which any diligent and reputable company would undertake.
Matching expectations and aspirations. Again, too often in India (particularly in the early stages of liberalisation when foreign investors were keen to get in quickly), parties have gone ahead without establishing a clear understanding of what each others aspirations and expectations are, only to find too late that they are wholly or partially incompatible. The process of initial discussion, and preparation and negotiation of a Memorandum of Understanding, should be sufficient to flush out whether there is a synergy. If a MOU is to have any purpose it is this - but frequently they are drafted in such general terms that they fail to bring out fundamental underlying differences, which only surface further down the road.
Proper documentation. No legal document, however well drafted, will make a successful venture out of an unsuccessful one. The documents can only create a framework in which the venture operates; but the process of negotiating the documents should throw up many of the issues the partners need to address in putting that framework in place. There can be a tendency in joint ventures in India for documents to be framed in such broad and conceptual terms that important issues are not brought out; equally nobody wants documents running to hundreds of pages. But there is a balance - and the documents, if properly put together, will strike that balance between containing sufficient detail to ensure that the critical issues have been properly and clearly addressed, while at the same time not being so detailed and voluminous as to obscure the key commercial issues and be unmanageable (see also "Documenting the deal" below).
Cultural issues. Finally, perhaps more important than anything, is a willingness and ability to understand and adapt to a different cultural and business environment. This applies as much to the corporate entity itself as to the individuals handling the venture in India, and will be critical in successfully developing any joint venture in India.
The particular consents and approvals required for any project in India will depend on the nature of the investment and the sector in question. However, there are certain approvals which are common to all joint ventures:
Foreign Investment Promotion Board/Secretariat for Industrial Assistance. This approval will be required if the foreign equity investment exceeds stipulated foreign equity limits (generally 51% or 74% depending on the sector) and does not fall within the automatic approval process for high-priority industries described below. Application is made either on form FC (51A) or in the form of an informal application providing the requisite information which will include details of the proposed business, shareholders and shareholding structure, the level of foreign investment, and projected net foreign exchange inflows or outflows. The application will be judged on its merits taking into account the likely inflow of foreign exchange, the corresponding outflow through dividends, royalties etc, the benefits of any technology transfer, and other benefits likely to accrue to the country such as employment opportunities.
Reserve Bank of India automatic approval. If the investment is in one of 36 specified "high-priority" industries listed in Annexure III of India's Industrial Policy 1991 and subsequent notifications, and the foreign equity component is less than the specified amount for the relevant sector (usually 51% or 74%), automatic investment approval is available from the Reserve Bank of India, normally within four to six weeks.
Approval for incorporation of the joint venture company. While this is largely procedural, involving an application with supporting documents to the Registrar of Companies, it does take some time to get the chosen name cleared and the company incorporated, as shelf companies are not available as they are in England and some other countries.
Reserve Bank of India approval for issue of foreign equity. When the joint venture agreement has been signed, the Company incorporated, and the other approvals obtained, the final step before shares can be allotted to the foreign partner is the obtaining of Reserve Bank of India approval for the issue and allotment of those shares. In order to obtain this, the foreign party must pay its share application monies into a designated account, following which the necessary application with supporting papers can be made. Provided the necessary in principle approval to the investment has been secured from the relevant authority (Foreign Exchange Promotion Board/Secretariat for Industrial Assistance/Reserve Bank of India - see above), this final approval is a purely procedural matter.
The documents for a joint venture in India generally follow similar lines to those for UK and other European joint ventures where the legal system and company law is broadly the same. Briefly they will be as follows:
Memorandum of understanding (also known as letter of intent or heads of agreement). This document is commonly used as a starting point on deals in India. It should be a relatively simple statement of the parties' intentions and the manner in which they wish to proceed. However, as mentioned above, it should equally contain sufficient clarity on the principal commercial terms to ensure that if there are fundamental differences they are identified rather than being glossed over. Apart from setting out clearly the commercial principles and intentions, other key questions on the MOU are likely to be:
(For more information on Letters of Intent in European transactions, see EC, 1997, II(2), 30)
Shareholders' agreement. This will set out in detail the relationship between the parties and the manner in which the joint venture company is going to be managed and run, covering such key areas as management control, transfers and issues of shares, sharing of costs, admission of new partners, withdrawal rights, participation in competing ventures and so on. Again, if properly prepared, it will ensure that all contentious issues are addressed and resolved before signing.
Articles of association. This will be the formal constitutional document of the company setting out, in binding legal terms, the contractual relationship between the Company and its shareholders. Again, it will be similar to articles of association for a UK joint venture. The critical issue on the articles is to ensure that the relevant terms of the shareholders' agreement are properly reflected in them (see below).
Other documents which may be required are a Technical Collaboration Agreement (a condensed and simple version of the shareholders' agreement required for submission to the Reserve Bank with application for final approval); a Name Licence (if one or other party's name is to feature prominently in the joint venture company name); and a Technology Transfer Agreement (if there is a technology transfer involved).
Assuming the main commercial terms are resolved in the MOU, drafting the shareholders' agreement and other legal documents to reflect those terms in a clear and balanced manner, should not pose difficulties.
In preparing (or reviewing) the contractual documents, it is however worth bearing in mind the different approach in different countries to contractual documents. In many Western countries the legal documents aim to be as clear, detailed and comprehensive as is practicable, so as to leave no room for ambiguity and no eventualities unaddressed, with a view to setting out the entirety of the relationship. The approach to contractual documents in India is different: they tend to be seen more as the starting point from which the relationship develops, and which have the flexibility to change and develop with it. Hence they tend to leave more open to interpretation, and more to be subject to further agreement and negotiation down the road - in many ways more akin to Heads of Terms.
Neither way is necessarily right or wrong - they reflect different cultures and approaches; but the difference can give rise to tensions in negotiating deals when one party is striving for clarity and detail, and the other prefers to keep things in more general terms. An element of flexibility is frequently required on the part of both sides if a mutually acceptable position is to be reached.
Many of the issues which arise on joint ventures in India are common to those which apply anywhere else in the world. However, there are issues of particular relevance in India, or which cause particular difficulty. These include management control, exchange control, share capital and group structures, deemed public companies, tax structuring, dispute resolution, exit routes and consistency of documentation.
Management control. A key issue on any joint venture, but particularly so in India. While the foreign investor may be coming with the funds and the technology, it is the local partner and its management who know the local market and how to do business there. The local management is likely to be extremely able, and may take the view that they should control the management of the joint venture, even though the local partner may have a minority stake. While there are many ways of structuring appropriate management provisions and providing safeguards for shareholders, the foreign investor is likely nevertheless to find it difficult to accept a lack of management control on its part in a venture in which it has an equal or majority stake. This is the sort of issue which the MOU should flush out at an early stage.
Exchange control. The impact of exchange control and foreign investment restrictions will run through many of the provisions of the shareholders' agreement. Provisions which, in other joint ventures may be common and workable, may in India pose difficulties for the foreign partner or require qualifications to the wording to make them workable. The principal regulatory hurdles are:
Some of the consequences of this include:
The requirements for exchange control and foreign investment approval impact on many areas of the documentation, and if the documents are to be effective and enforceable it is essential that the thinking behind the provisions, and their drafting, takes this into account.
Share capital. Indian law at present permits only one class of equity shares, so that the commonly used concept in the UK and elsewhere of having different classes of equity (eg. A, B and C Ordinary Shares) with different rights attached, does not work. Hence, for example, in the power sector where foreign exchange protection for the foreign partner is provided in the tariff paid to the project company, that foreign exchange protection cannot be preserved in the income stream to the foreign partner by having two different classes of equity, as would be possible elsewhere. While it is possible to find alternative structures to achieve the same effect, the inability to have different classes of equity frequently demands a greater degree of flexible thinking in putting the right structure together than might otherwise be the case.
Group structures. The corporate structure of many Indian "groups" of companies is frequently complex (involving a network of cross shareholdings of varying percentages with no obvious line of control, and many different intra-group arrangements). Elsewhere groups of companies may have a simple parent with 100% control downwards through a series of wholly-owned (directly or indirectly) subsidiaries. But in India this is far less common, and can make issues such as parent company guarantees, restrictive covenants or non-compete provisions, "affiliate" provisions and confidentiality undertakings problematical. In most joint venture agreements there are certain provisions such as these whose scope extends to cover the "group" - in India identifying and defining that group may not be straightforward.
Deemed public companies. In addition to public and private companies, India has a category of company not found in Europe, called the "deemed public company". Essentially, it is a private company in which 25% or more of the paid-up capital is held by one or more bodies corporate; or which holds 25% or more of the paid-up share capital of a public company; or whose average annual turnover exceeds Rs 100 million; or which accepts deposits from the public; or which is controlled by a company that is listed, (whether in India or overseas). Hence, if a listed UK company acquires a controlling stake in a private Indian company, that company will become a deemed public company and will be required to comply with certain additional requirements under the companies legislation.
Tax structuring. For a number of years many overseas companies have sought to invest into India through a holding company in Mauritius because of the beneficial double taxation treaty (although rulings in cases involving NatWest and AIC had called into question the likelihood of the benefit being available where the structure was put in place purely for the avoidance of tax and for no other purpose).
Recent changes in the Indian tax system have much diminished the advantage of investing through Mauritius (as there is now no withholding tax on dividends paid by Indian companies, but instead a flat 10% tax paid by the company paying the dividend). No doubt other tax advantageous routes will be tried, but it is clear from developments over recent years that the success of these may well depend on being able to show a proper commercial reason for the routing of the investment other than simply a desire to minimise tax.
Dispute resolution. In 1996 India brought in the Arbitration and Conciliation Act 1996. This legislation adopts the UNCITRAL model rules for arbitration, and has done much to set aside (on paper at least) the concerns previously expressed by foreign investors on submitting to arbitration in India. The Act is, however, relatively untested, and while on the face of it many previous difficulties have been resolved, most foreign investors (as they do anywhere) remain more comfortable submitting to arbitration in a neutral jurisdiction.
Exit routes. For many investors, one of the key questions is "can I get my money out, and if so how?" Notwithstanding exchange control, this aspect of investment is relatively straightforward. Most approvals granted for foreign investment in India are granted on a "repatriation" basis which means there is an in principle approval for the repatriation of income and capital, which can thereafter be repatriated subject to compliance with certain procedural formalities (though there is generally no protection against foreign exchange risk on repatriation). It is important to check this is the case on any particular investment.
Consistency of documentation. Finally, it is critical that the articles of association and shareholders' agreement, when finalised, are consistent, and that the provisions of the shareholders' agreement are properly and accurately reflected in the articles.
The Supreme Court of India has held that any restriction on share transfers in a shareholders' agreement (including pre-emption rights) is not enforceable even between members inter se, if it is not reflected in the articles of association of the company (V. B. Rangaraj -v- V. B. Gopalakrish & Others (AIR 1992 S. C. 453)) Although this case related to share transfer provisions, there is no reason to suppose that the same principle could not equally apply to certain other provisions.
Geoffrey Picton-Turbervill is a partner at Ashurst Morris Crisp