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The Importance of Early Considerations and Exit Strategies in

Structuring an International Joint Venture in India


Contributed by Shahana Basu Kanodia, Edwards Angell Palmer & Dodge LLP, and
Rashi Mittal, Law Clerk to the Massachusetts Superior Court Justices.

Much has been written about establishing an international joint venture ("IJV") in India. This
article explicitly focuses on early considerations and exit strategies that are often neglected.
With an increase in the deregulation of foreign direct investment ("FDI") in India, a larger
proportion of foreign firms entering the Indian market have no prior business experience in
India. Under such circumstances, partnering with a domestic firm and forming an IJV could
be a good strategic move. Partnering gives foreign companies an insight into the local
consumer and business conditions and access to the Indian partner's pre-established
market and distribution channels. It also brings together complementary skills, know-how
and resources of two or more parent firms to accomplish specific objectives. To avoid the
pitfalls of forming an IJV, however, foreign firms need to pay attention to some early
considerations outlined below.

Early Considerations

A. Foreign Direct Investment

An IJV is treated as a domestic company in India. A threshold issue in forming an IJV for a
foreign firm is to be aware of the complex and continuously changing FDI regime in India.
The FDI rules are sector specific and dictate the level of ownership of foreign firms in an IJV
in India. While the FDI rules have been substantially liberalized since the early 1990s, some
sectors such as telecommunications, insurance and defense manufacturing still have FDI
caps and necessitate a formation of an IJV through either "automatic" or "governmental
approval" route. Under the automatic route, to invest in an IJV, an investor does not require
any approval either from the Foreign Investment Promotion Board ("FIPB") or the Reserve

© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
Bank of India ("RBI"). FDI in joint ventures not covered under the automatic route require
prior government approval and the parties have to apply to the FIPB for approval. 1

B. Choosing a Suitable Partner

The first step to forming a successful IJV is choosing a suitable local partner in India and
assessing its capabilities and track record. It is critical that from the outset, the investors be
cognizant of the significant cultural differences and expectations and utilizes their time to
select a partner who will be the right "fit". The Indian decision-making process is often
hierarchical, and foreign firms must identify the ultimate decision makers in the Indian
company and involve them in the process during the early stages of negotiations to avoid
wasting time and resources. Additionally, in order to succeed, foreign firms should spend
time to become acquainted with their IJV partners and build a strong and cooperative
relationship. Building informal relationships with the key people at the local firm, which in
India usually are the owners of the business and their families, is of paramount importance
to understanding the core values and levels of professionalization of the local Indian firm.
Essentially, rather than jumping at the first opportunity they see, foreign firms should
always remember that misaligned expectations and objectives often suggest that the parties
are not ideally suited for each other and the IJV is reasonably likely to fail in the future.

C. Due Diligence

Foreign firms should insist on a formal due diligence process to identify the expectations
and limitations of the IJV partners, to test the validity of the partners' business operations,
to assess the legality of the documents produced by the potential partners, and to evaluate
any risk factors associated with the potential partners.

To conduct due diligence, foreign firms should employ a team of independent legal counsel,
technical consultants, and auditors who can conduct a detailed investigation and identify if
the potential Indian partners have concealed facts and figures; if they have failed to comply
with regulations or have conducted adventurous interpretations of contracts, legal
provisions, accounting principles, policies or standards; if they have any contingent
liabilities; and, if they have failed to report any outstanding legal proceedings against them.
The due diligence team should also obtain a declaration or certificate from the potential
© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
Indian partner confirming the completeness of the disclosed information and documents,
and that no material data has been withheld.

D. Drafting a Detailed IJV Agreement

At the outset of an IJV's formation, the parties must also identify clear and common
objectives, as well as the structure and the form of the IJV. Indian parties often believe that
as circumstances change, the legal contract can easily be amended. Moreover, Indian
parties often prefer contractual provisions which delay difficult decision-making by allowing
the parties to negotiate in good faith at the time of occurrence of a foreseeable event. To
avoid blowing up the deal, foreign firms often agree to such provisions. They are keen to
start the IJV relationship as soon as possible and often put thorny issues on a delayed time
fuse in the hope that better relations in the future will help resolve these issues in a more
amicable manner. To avoid this "ongoing" nature of negotiations, it is important that the IJV
documentation addresses all foreseeable issues and leaves little to chance. If matters are
not agreed upon at the negotiation stage, it is likely that the parties will never agree on
those issues, and a dispute will arise in the future. The IJV agreement should include among
other things, the purpose of the IJV; the governing law and jurisdiction; ownership
interests; the board structure; issues pertaining to management control; exit strategy; and
dispute resolution mechanisms for when disputes arise.

E. Management Control

The level of equity participation inevitably influences the level of management control the
firms have in the decision-making process. In India, certain major decisions have to be
approved by a special majority of 75 percent or 90 percent of the shareholders by value.
While cooperative decision-making where all the shareholders agree is optimum, majority
ownership often allows for quick decision-making and thus avoids costly compromises or
deadlocks. It is important to note that at least 75 percent of the shareholders must approve
a matter before it is passed as a special resolution. Such matters include capital increases,
alteration in the memorandum and articles of the company, changing the registered office
address of the company from one state to another, change in the name of the company,
buy-back of shares, proposed mergers and liquidation. Therefore, a minority shareholder
with more than 25 percent voting rights would have the ability to block special resolutions.
© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
Accordingly, foreign firms have to think strategically when determining their equity
ownership in the IJV. Foreign firms should be mindful, however, that equity ownership is
only one part of the puzzle; the composition of the IJV board, the presence of local directors
in India who keep an eye on the operations of the company of on behalf of the foreign firm,
contractual veto rights, and possession of core technology are some other important factors
that determine who actually controls the management.

F. Tax Considerations

Foreign firms should seek tax advice even at the initial stages of evaluating an Indian
investment. India has a very low threshold for creating a taxable presence. The proceeds of
a sale of shares in an Indian company are usually taxed in India as capital gains, even if the
seller is not a resident of India. India taxes such capital gains at high, variable rates of
taxation ranging from zero to around 30 percent.2 Hence, foreign partners are generally
advised to invest via an offshore jurisdiction which has a favorable double taxation
agreement with India. India has favorable tax treaties with Mauritius, Cypress, the UAE,
Singapore, and the Netherlands.

Mauritius, however, is by far the most commonly used jurisdiction for inbound investment
into India for the following reasons:

a.) The Double Taxation Avoidance Tax Treaty between India and Mauritius, (the
"Treaty") provides that the foreign company does not have to pay any capital gains
taxes to India or Mauritius when the Mauritius company sells the shares of an Indian
company.
b.) The Treaty also affords protection against the double taxation of dividends. Under
ordinary circumstances, India imposes a 19.5 percent dividend distribution tax on an
Indian company that distributes dividends. However, this dividend distribution tax is
reduced to 5 percent if the Mauritius company holds more than ten percent of the
shares of the Indian company.3 In setting up an intermediate holding company in
Mauritius, foreign firms need to ensure that the control and management of the
Mauritius holding company is not wholly situated in India.

G. Conflict Resolution
© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
Conflict is an inevitable part of a partnership and cultural differences are often responsible
for deadlocks between foreign and Indian firms in an IJV. Accordingly, the parties must
establish an appropriate mechanism for the resolution of such deadlocks. Often, mediation
can assist with deadlocks associated with smaller day to day issues and prevent an early
failure of an IJV. Moreover, due to a large backlog of cases, litigation in India is slow,
making it essential that foreign investors incorporate a well thought out arbitration or
alternative dispute resolution clause in their IJV agreement. The IJV agreement should
clearly address when the arbitration clause would be triggered, the arbitration situs, the
applicable law, the number of arbitrators, and the procedures to be followed by the
arbitrators. Given the potential for conflict inherent in an IJV, foreign firms must focus on
formulating their exit strategies at the time of their initial negotiations with the potential
Indian partner.

Exit Strategies

IJVs are generally structured to have a finite lifespan, and foreign firms should take the
length of such a lifespan seriously. IJVs often fail because the local partners are unable to
invest enough resources to expand the business as quickly as the foreign company had
hoped for or because the local partners have a knowledge advantage in terms of the local
conditions of doing business and have divergent interests from the foreign firms. To avoid
this situation, foreign firms should consider entering into an IJV for a short, finite period.
During this period, the foreign firms should establish a local presence, understand the local
consumers and business conditions, develop relationships with clients and contacts in the
local industry, and assist with monitoring the supply chain and the IJV partners.

Even though it might be counter intuitive, it is absolutely necessary to determine the plan
and timing of the exit from the IJV at the outset. An exit strategy is a mechanism by which
one or both partners may either withdraw from the venture or push the other partner out of
the venture upon a deadlock between the partners or upon the occurrence of certain
predetermined events. Things to consider when formulating an exit strategy includes
determining what will trigger dissolution, for example, changes in business conditions
and/or parties, and what would happen if the goals and objectives of the partners change
with time or if one of the IJV partners is acquired or gets into financial trouble.

© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
The common exit options are: buy-sell agreements, unilateral sale rights, and, put/call
rights. Alternatively, the IJV agreement may also provide for the cessation of operations
and the liquidation and dissolution of the venture. Any of those options can be used
independently or in combination with each other.

A. Buy-Sell Agreements

In a buy-sell agreement, either IJV party will decide to purchase the interest of the other by
sending a buy-sell trigger notice to the other party specifying a cash purchase price at
which the offeror party is willing to buy the assets. If the offeror-party has a greater source
of funds than the other, it might submit a buy-sell offer that is intentionally much lower
than the fair market value of the assets knowing that the other party will not be able to buy
the offeror-party's interest. To avoid this situation, it is important that the IJV agreement
includes a provision about going to an independent and agreed upon appraiser to assess the
fair market value of the assets when either party sends a buy-sell trigger notice.

Because of the finality of the buy-sell agreement, the IJV agreement should also contain a
provision about a lock-out period during which the buy-sell mechanism cannot be triggered.
The lock-out period is necessary to ensure that the venture has the opportunity to succeed
before the buy-sell is triggered. Further, if any major projects are under development, it
may be in the interest of both parties to prohibit the exercise of buy-sell during that period.
Of course, the lock-out provision should be well thought out because in circumstances
where there are deadlocks or one party breaches the material terms of the IJV agreement,
a lock-out may result in more harm than benefit to the company. Accordingly, the lock-out
provisions should be narrowly tailored.

The IJV agreement should also demarcate the rights and obligations of all the partners
during the interim period between the initiation of the buy-sell and closing and how the
major decisions will be made during the buy-sell period. These provisions are important
because at a minimum, the parties would want the business to be operated in the ordinary
course until the sale is finalized, and the buying partner would certainly not want the buy-
sell agreement to negatively affect the company's operations and reputation. Additionally,
the IJV agreement should also provide provisions that will enable the buying partner to have
adequate time to procure the necessary outside financing.
© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
B. Put/Call Rights

Put/call rights are incorporated in an IJV agreement when one partner wants to liquidate as
soon as possible, while the other partner wants to hold the venture assets long-term. A "call
right" would give the foreign firm the right, but not the obligation to buy the IJV from the
local partner at a certain time (triggering event) for a certain price. The seller is obligated to
sell should the buyer so decide. Conversely, a "put right" would force the local partner to
buy its interest when the foreign firm decides that it wants to liquidate. Determining the
price is often difficult and a third-party appraiser should be used for this purpose.

C. Unilateral Sale Rights

Although unilateral sales rights are not so common, in some instances, one or both partners
may have the unilateral right to sell their interest in the venture to a third party.
Alternatively, the partners may decide to bring in a new investor who can provide the
needed capital, expertise and direction. It is essential that the parties consider this option
when drafting the IJV agreement and ensure that trigger points are included for such third-
party assistance.

D. Other Considerations

At the heart of the various exit strategies are some common issues such as dealing with the
valuation of the assets at the time of sale and whether such valuation properly accounts for
the company's liabilities (including contingent liabilities), as well as the release of the exiting
party from any guarantees and obligations. If these issues are not addressed in the IJV
agreement, they can be difficult to resolve at the time of exit when parties are likely to be in
the middle of a disagreement.

Furthermore, post-exit non-compete, non-solicitation and confidentiality covenants are also


crucial and should be negotiated while drafting the IJV agreement. The scope and terms of
the non-compete agreements may significantly impact the exiting parties' interest. More
importantly, India's Press Note 1 of 2005 ("PN1") 4 requires that foreign firms that have an
existing collaboration with an Indian firm, receive approval from the Government of India
before they set up their own operations or IJV with another firm in the same line of
© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
business. PN1 advises the collaborators to consider, negotiate, and if agreed, to include a
clause avoiding conflict of interest. While the Indian regulations are continuously changing
and becoming more foreign investor friendly, it is important that foreign firms pay attention
to any such regulations while planning their exit strategy.

Conclusion

While the benefits of entering into an IJV to expand business operations in India are
enormous, it is essential that foreign firms are wary of the cultural nuances that are
associated with doing business in India. To be successful, foreign firms should not only
make an extra effort to understand the local market, culture, needs, and consumers, but
should also do their due diligence in finding a suitable Indian partner and properly research
and negotiate the terms of their IJV agreement.

Shahana Basu Kanodia is a Partner in Edward Angell Palmer & Dodge's Business Law
Department in Boston and Chair of the South Asia Practice Group. Edwards Angell Palmer &
Dodge is a global law firm with 13 offices including offices in the US, UK and Hong Kong.
Ms. Kanodia's practice areas include general corporate matters with a focus on cross border
business transactions, including mergers and acquisitions, joint ventures, private equity and
other strategic investments. Ms. Kanodia is a frequent speaker at domestic and international
events on issues relating to foreign investment, cross border mergers and acquisitions,
international transactions and international public law. Ms Kanodia received a BA (History)
with First Class Honors from Delhi University, a Tripos in Social & Political Sciences with First
Class Honors from Cambridge University, an MA (Sociology) with First Class Honors from
the University of Chicago and a JD from Yale Law School. She currently serves on the
Executive Board of the Yale Law School Association, the Board of the Children's Advocacy
Center for Suffolk County and the Board of the Community Dispute Settlement Center and
is an Overseer of the Peabody Essex Museum. Email: skanodia@eapdlaw.com

Rashi Mittal is a Law Clerk to the Justices at the Massachusetts Superior Court, where she
works extensively with Justices on trials, hearing and motion sessions, and prepares draft
decisions and legal memoranda on a multitude of topics in civil and criminal law. In 2004,
Ms. Mittal received a B.A. in both Public Policy and Economics from Stanford University,
where she graduated with honors. During her time at Stanford, she studied abroad at
Oxford University. In 2008, she received a J.D. from Boston University School of Law, where
she served on the staff of the International Law Journal. She also worked as a legal intern
for the Honorable Joseph L. Tauro of the Massachusetts District Court, Massachusetts State
Senator Jack Hart, and at the Los Angeles office of the Federal Trade Commission. She

© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.
currently serves on the Board of the South Asian Bar Association of Greater Boston as Legal
Relations Co-Chair. Email: rashimitt@gmail.com.

The views expressed in this article are those of the authors and are not to be attributed to
Bloomberg Finance L.P. and the Massachusetts Superior Court or any of its Justices.

1
More detailed information about these routes can be found on the Department of Industrial
Policy and Promotion website (see http://dipp.nic.in).
2
See Section 10(38) and 88E of the Indian Income Tax Act, 1961.
3
See Article 10(2) (a) of the India-Mauritius Tax Treaty.
4
See http://siadipp.nic.in/policy/pressnotes_main.htm.

© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition of
the Bloomberg Law Reports – Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authors
and do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark of
Bloomberg Finance L.P.

The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications,
exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as
legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information
contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United
States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities
do not take responsibility for the content contained in this report and do not make any representation or warranty as to its
completeness or accuracy.