Cross-border joint ventures - focus India

Introduction
What are JVs? JVs are a form of collaboration between two or more parties. They are most commonly used in the following situations: Rustam Dubash Simon Bickerdike Saionton Basu

This publication aims to provide an overview of some of the main legal and practical considerations that apply to joint ventures (JVs) in a cross-border context. It also considers some of the key areas of risk and provides guidance on ways to mitigate these, so as to give the JV the best opportunity to achieve its business objectives. Cross-border JVs create many new challenges, not least on account of peculiar regulatory terrains that need to be navigated.

Examples of advantages and disadvantages of JVs

Advantages
exploiting new markets sharing resources and risks dealing with competitive pressures combining skills and expertise outsourcing non-core business to cost effective locations reducing fixed costs sharing synergies

Disadvantages
incompatibility of parties differing priorities and interests loss of confidentiality loss of independence and control governance difficulties conflict of interest difficulties for shareholder appointed directors

by businesses looking to expand internationally; by new business start-ups; to ensure compliance with regulatory restrictions on independent operating in certain countries, such as India; where some jurisdictions require, for example, that a certain percentage of the shares in any company are owned by local entities; to make use of an existing local presence in a business sector, or availability of appropriate existing networks; to take advantage of local know-how, skills and expertise; to combine skills and resources in order to achieve cost benefits; by businesses entering into teaming or joint bid arrangements; and where large entities usually outsource non-core areas of their operations such as information technology, facilities management, security, human resources, health care, catering etc.

Rationale for cross-border JVs Cross-border business brings with it a host of opportunities, but also a number of challenges and risks. Some of these are summarised in the table on the left. Structure of JV The form a JV takes varies significantly and they will come in all shapes and sizes. Commonly used JV vehicles include the limited liability company or a hybrid vehicle like a limited liability partnership. However, it is not uncommon to find a partnership structure being used www.penningtons.co.uk

Brian Tempest Chairman, Religare Capital Markets When I joined Ranbaxy Laboratories, the leading Indian pharmaceutical company, in the late 1990s, 80% of the sales were from the Indian domestic marketplace leaving only 20% from countries outside of India. When I retired a decade later, after holding the positions of CEO, Managing Director, Vice Chairman and Chief Mentor, only 20% came from India and the business was truly global. A third of sales came from North/South America, a third from Europe/Africa and a third from Asia. This globalisation out of India was achieved by a mixture of organic growth and inorganic acquisitions.

Early stage planning Careful planning, budgeting, research and due diligence exercises are required to establish the basic foundations of the JV. The parties' respective contributions and rights, governance protocols, budgets, deadlock and dispute resolution mechanisms, exit routes, termination and other fundamental elements will need to be understood at the outset of the venture.
Whilst India has an ancient history going back to the discovery of the zero, the deregulation of the Indian economic system only goes back 25 years or so. Consequently, the private sector has only been in full swing for a limited time. Clearly, as a result the management focus was initially on getting results and, as the Indian companies globalised, the softer skills became more and more important.

Listed companies have a number of additional formalities and requirements to consider prior to entering into a JV, including class tests and other legal requirements which impact on some of the more common provisions used in JVs, such as options and exit provisions. In particular, the following key documents should ideally be put in place before moving too far ahead in the JV formation process: Confidentiality agreement: confidential information disclosed between the parties is bound to be extensive, and needs to be closely governed under the terms of a confidentiality agreement;

in certain jurisdictions. Ultimately, the final vehicle is usually determined after careful consideration of the following factors: tax; limitation of liability; incorporation formalities; exit strategy; nature/culture of the parties; the pros and cons of each jurisdiction; local regulation; and duration.

Ridhika Batra Country-Head and Director, Federation of Indian Chambers of Commerce and Industry Common legacy, pluralism, an open society and a free press; all the aforesaid is common lingo used at various India - UK conferences, debates and discussions at the political quarters. The fact is that all these sound more like archaic old melody to the ears of new businesses and entrepreneurs from both India and the UK. They now spend their time and effort producing new music for the market, much to the likes of iTunes' users if you like. Their efforts are now much more bold; striking towards newer paradigms. Increasingly, Indian companies are expanding into international markets and setting up satellite offices, marketing hubs, project and liaison offices and actively competing in the international market. Managing cross-border operations, whether as an SME or a global conglomerate, has its own challenges. The feeling is mutual amongst British businesses that are eager to mark a strategic spot in the busy Indian bazaar. Given this enthusiasm amongst businesses and markets from both sides, one should strictly avoid depending on diplomats and bureaucrats to communicate and address the roadblocks and hurdles. This is not to say the sources mentioned above are unreliable. If one needs to point at a gap needing urgent attention in India, it is the lack of 'mind to market' skills for innovation. Despite its ability to churn out world class scientists and engineers, the Indian R&D space has no recognised innovation cluster equivalent to an Oxford or a Silicon Valley. This space is surely a good spot for the UK innovation companies that produce custom-made technology to suit the requirements of the market.

This article will focus on limited liability companies, as this is the most common structure for long-term JVs. Most English and European businesses entering into JV arrangements in India have tended to use a limited liability company as the JV vehicle.

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JVs - developments for consideration

Ashish Ahuja, Partner, & Vivek Pillai, Associate Wadia Ghandy & co.

A JV with an Indian entity offers a viable route for the foreign investor looking to set up shop in India. However, when structuring the transaction, one should be mindful of the following recent developments. Issue of shares: in a move that would allow greater flexibility to Indian JV companies issuing shares to nonresidents, the Reserve Bank of India has recently permitted Indian companies to issue equity/preference shares under the Foreign Direct Investment Scheme with the prior approval of the Foreign Investment Promotion Board. Shares may be issued against the import of capital goods/machinery (including second-hand machinery), or against pre-operative/pre-incorporation expenses (including payment of rent), subject to compliance with certain conditions, including pricing guidelines. In another positive move, companies can now issue compulsorily convertible preference shares and debentures with the conversion price based on a formulation rather than being determined upfront (providing the conversion price complies with the pricing guidelines applicable at the time of issue of such instruments). Transferability of shares: given the free transferability of shares of a public company provided for in Section 111A of the Companies Act 1956, and the surrounding case law, the position of restrictions on transferability of shares remains unclear. While a recent order of the division bench of the High Court of Judicature at Bombay has upheld the right of individual shareholders to bind themselves in respect of their own property, in light of other conflicting judicial pronouncements, the waters still remain muddy in this regard.

Term sheet/memorandum of understanding/heads of agreement (binding/non-binding): following the early planning and due diligence exercises, the parties should document the principal terms of their proposed JV. This document will usually provide a basis on which further negotiations can take place. As such, the parties will need to ensure the term sheet (or its equivalent) is non-binding, except for certain terms such as the choice of law and the dispute resolution clauses; and Exclusivity agreement: the parties are bound to incur costs and divert resources to negotiating the terms of the JV. They will need to know that each party is committed to the process for a certain period. An exclusivity (or lock-out) agreement ensures that the parties have a period of time in which to negotiate solely with each other. The duration of the agreement varies, but 1-3 months is common.

JV or shareholders' agreement: sets out the basic rights and obligations of the JV parties, defines how the parties intend to govern the JV on an ongoing basis and addresses key issues such as exit, disputes and changes of management; Articles of association: the articles govern the basic constitution of the JV company, and will cover areas such as transfers of shares and meetings of directors and shareholders. Whilst the JV agreement is a confidential document, the articles are not, meaning that any confidential material will need to be set out in the JV or shareholders' agreement. However, in countries such as India, provisions of the JV agreement will mandatorily need to be inserted in the articles of association to ensure that the JV vehicle is bound by them; Guarantees: these may be general, or may relate to a specific issue. They are often given by parent companies to support the obligations of a subsidiary which is a party to a JV. Guarantees may need to be given by the parties to a bank, to support banking facilities; Management agreements: the JV may require management expertise from one or more of the shareholders; www.penningtons.co.uk

Material agreements Beyond the early stage documentation, which sets the ball rolling for the due diligence exercises and commercial negotiations, the following documents will need to be put in place in order to set out the overarching framework of the JV:

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Cross-border ventures in India: trigger factors and safeguards

Hemant K Batra, Managing Partner Kaden Boriss Legal LLP, India & Secretary General, SAARCLAW

In India, the progression of cross-border investments and ventures was initiated by the Government itself when it triggered the economic reforms process in 1991. The origination of the epoch of economic liberalisation, capital market, trade and industry; and foreign direct investment or, in other words the change in the economic policy of India, was the primary and leading factor that facilitated `cross-border ventures and acquisition' within and out of India. Further, in the recent past, increased competition in the global market has prompted Indian companies to focus upon mergers and acquisitions as an imperative strategic alternative. When the reform processes were initiated in India due to liberalisation of the economy, there were conjectures that Indian companies would not be able to compete with foreign investors and that Indian businesses would eventually be acquired by foreign firms. Of course that did happen, but only to a small extent. Sure enough, within a very short period of time, Indian companies started to take over foreign businesses themselves. The Reserve Bank of India laid down suitable Foreign Direct Investment (FDI) limits/norms for different sectors to help facilitate cross-border transactions. Indian corporations now consider M&A to be their best strategy. Indian acquisitions abroad are also driven by the desire to acquire new skills and technology, in order to improve brand value and expand into new markets. Acquisitions give instant access to new products, markets, technologies, distribution network, manpower and well established brands. As I understand from some informal sources, despite the economic slowdown, the total number of M&A deals in India during 2010 stood at 650 with a composite value of approximately $50 billion as against 115 deals amounting to approximately $13 billion in 2009. 2010 also witnessed 286 cross-border transactions predominantly from India to overseas with a total value of approximately $31 billion.

Service agreements: these will document the terms of service for senior directors and other key executives; Secondment agreements: short-term or long-term secondments of employees of the shareholders may be required; Purchase of business and assets agreements: sets out terms on which the parties will transfer certain businesses and assets into the JV; IP/IT agreements: IT systems' supply and support arrangements may be required by, and intellectual property may be licensed to, the JV company by the JV parties or other third parties; Supply agreements: the parties, or third parties, may supply the JV with certain goods and services to enable it to operate and these will need to be documented in a supply agreement; and Option agreements: a put or call option may be granted over the shares of the JV company. These provide parties with the right (and possibly also the obligation) to purchase the shares of another shareholder, or to require another party to purchase its own shares when certain conditions are met or, for example, in the case of disputes. Option agreements should be used with care in jurisdictions such as India, particularly in relation to public companies, as Indian
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courts have tended to disregard such option agreements as a fetter on free transferability of shares. Key issues to address in JV agreements The JV parties will need to consider each of the following issues carefully in light of their commercial objectives: Parties: their particular concerns relating to contracting with overseas companies in terms of identity, capacity, authority, execution requirements, enforcement, jurisdiction (local laws may override the governing law and provisions in the agreement), solvency etc. A thorough due diligence exercise should be conducted to establish each of these areas to the satisfaction of the JV parties;

Conditions precedent: these are conditions that need to be satisfied before the transaction can complete. They commonly include third party consents for key contracts, properties, regulatory and competition approvals. As of 1 June 2011, all JVs and acquisitions satisfying the asset and turnover thresholds in India will need to be approved by the newly empowered Competition Commission of India and as such this will need to be factored into all transaction timelines; Finance: the parties will need to consider how the JV will be financed at the outset, as well as on an ongoing basis. This may include debt or equity provided by the parties, potential future investors, or banks and financial institutions; Acquisition of assets: the JV company will need the resources to operate its business. These may be purchased from one of the JV parties, or from a third party; JV business: the nature of the business and objectives of the parties will need to be clearly understood and documented. The basis on which each JV party receives benefit from the JV should also be clear, and should address management fees, dividends, royalties, fees for supply of goods or services etc; Reserved matters: a list of reserved matters which may only be undertaken by the JV company with the affirmative vote of the shareholders should be agreed upon. They are normally included to protect a minority shareholder. In a deadlock (50:50) company, reserved matters are used to prevent managers acting on matters without obtaining express shareholder approval; Management/governance: a common area of difficulty in a JV lies in the lack of proper governance, management, reporting lines, communication and lack of clear authority levels. A strong statement of the management and governance protocols should be agreed upfront, with an identified structure to elevate certain issues to senior management or the shareholders themselves to prevent operational hitches; New share issues/transfers: the rules on share issues and transfers (i.e. pre-emption rights, lock-in periods, sales to third parties), and circumstances where voluntary transfers are permitted (i.e. to group companies) must be considered. If, in the future, a third party purchaser makes an offer for the majority of the shares in the JV, it is common to have tag-along rights, so that the remaining shareholders can also sell their shares to that purchaser. Drag-along rights are also common, and allow a shareholder who has received a favourable offer for his shares to require the remaining shareholders to sell to the chosen buyer also;

Negotiating Indian JVs

Mohit Saraf, Senior Partner & Sudipta Routh Partner, Luthra & Luthra Law Offices Non-resident investors (NRs) must traverse a prominent, yet shape-shifting feature of the Indian regulatory landscape. Exchange Control Regulations (ECRs) are invariably imprinted (often involuntarily) into the DNA of every Indian JV Agreement (JVA)/Shareholders' Agreement (SHA). At first glance, India may appear a seemingly promising investment destination. A recent UNCTAD survey projects India as the second most important FDI destination. ECRs are consolidated in a policy document framed (and updated every so often) by the Government (the Policy). The Policy is an overarching sector-specific investment guide detailing a framework of prohibitions, approval requirements, investment caps, investment conditions and exclusions. For example, foreign investment in retail trading is presently prohibited. This has not prevented global retail majors from entering into exploratory JVs (which may not necessarily dovetail with their global business models of pure retailing). These are leading examples of where the investor has demonstrated the ability to find a best-fit solution within a restrictive but fluid regulatory matrix. Presumably, the JVAs/SHAs are malleable enough to accommodate future liberalisation of the retail trading sector. Perhaps they are also sufficiently nuanced to anticipate investment conditions and exclusions that may attend a phased liberalisation. Such examples are prolific in the insurance and banking sectors - to the extent that they have almost become the norm. At the macro level, the Policy is a touchstone for evolving scalable investment strategies. At the more technical level of negotiating JVAs/SHAs, another set of issues arises as a consequence of ECRs. ECRs require adherence to Pricing Guidelines (PGs) which control the price at which shares may be transferred between NRs and residents. In summary, PGs tend to insulate residents against downside commercial risks whilst restricting - to an extent - the NR's ability to participate in upside gains.

Mohit Saraf

Sudipta Routh

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Compulsory share transfers: the agreement will set out the circumstances in which a party will be forced to sell his shares, usually to the remaining shareholders, for example, upon insolvency, material breach of the agreement (or material ancillary agreement) or change of control of a shareholder. The terms governing the value of a share on transfer will usually depend on the circumstances, thus a lower price may be realised if the transfer was triggered by a material breach; Protective covenants: the agreement will set out noncompete and non-solicitation provisions in order to protect the business of the JV; Deadlock: where management becomes deadlocked, it is usual for the agreement to provide for the dispute

Considerations for establishing a JV in India

Satwinder Singh, Partner & Hitesh Sablok, Senior Associate Vaish Associates, Advocates When contemplating the establishment of a JV in India, investors should consider the following factors: Identify the applicable route, i.e. either the 'Automatic Route' (no prior Government approval is required) or the 'Approval Route', under which the proposed investment would qualify. This depends on the sector/activity to be undertaken by the proposed JV; Confirm the sector limit/cap pertaining to the activity being undertaken by the JV; Understand the minimum pricing guidelines for the purpose of investment in India: - For a listed company, the price guidelines are issued by the Securities and Exchange Board of India - For an unlisted company, the minimum threshold price would be based on the valuation arrived at by using the discounted cash flow method If the investor establishes an entity in India only for the purpose of making investments in different companies in India (Holding Company), then any foreign investment in such Holding Company would be subject to prior approval by the Government/Foreign Investment Promotion Board. Further, the downstream investment by such Holding Company would also be subject to the norms prescribed under FDI Policy; Exit mechanism (put options) - recently, the Reserve Bank of India has indicated that 'put options' which are presently available to non-resident investors may not be available as an exit option in the near future; The limits on payments for royalties, lump sum fees for transfer of technology and payments for the use of trademark/brand names have also been removed;

Tax implications should be assessed, keeping in mind the proposed Direct Taxes Code, which introduces the 'General Anti Avoidance Rules' and the provisions with respect to 'Controlled Foreign Corporations'. Further, the Vodafone case has shed some new light on the taxability of transactions. Issues with respect to withholding tax on capital gains, royalty payments and the applicable tax treaties with the respective countries, should also be given due consideration to avoid double taxation; Regulatory restraints on raising foreign loans qualify as 'External Commercial Borrowings' under the Indian foreign exchange laws, and would inter-alia be subject to restrictions pertaining to their 'end use' and 'all-in cost ceilings'; and Other aspects - discuss and finalise the business plan, the funding requirements, representation and warranties, indemnification, arbitration, pre-emptive rights, affirmative rights, exit mechanism, etc.

Two amendments which have been brought about in the FDI Policy are as follows: 1. Requirement of obtaining prior approval of the Government for new proposals of investment/technology transfer/technology collaboration/trademark agreement in the same field, in cases where the non-resident investor had an existing JV/technology transfer/trademark agreement, was abolished on 12 January 2005; and 2. Subject to certain conditions under the FDI Policy, foreign direct investment has been allowed in Limited Liability Partnerships. These amendments have been welcomed as they allow more flexibility in making investments in India. In view of the recent policy, regulatory and economic changes, it can be said that India has emerged as one of the preferred foreign investment destinations. The existence of a common law system, which protects the rights and interests of non-resident investors, also helps to make the Indian economy conducive to foreign investment.

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Dispute resolution mechanisms in cross-border JVs

Bhumesh Verma, Partner PKA Advocates Due to the liberalised regulations and government policies, and other advantages, there has been a spree of cross-border JVs in India (particularly, due to caps on FDI, in the industrial/services sectors). However, it is crucial to give adequate thought in advance to the dispute resolution mechanism between the JV parties. The various dispute resolution mechanisms in India are as follows: Company Law Board (CLB); National Company Law Tribunal (NCLT); litigation in India;
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foreign court; Indian arbitration; and arbitration abroad.

Neutral venues for arbitration are becoming more popular day by day for dispute resolution. In JV agreements, the major arbitration forums finding their place are: (i) London Court of International Arbitration (LCIA) and (ii) International Chamber of Commerce (ICC). In India, a significant issue that may arise in respect of both litigation and arbitration is the enforcement of the foreign judgment or award. Therefore, only a judgment or award delivered in reciprocal territories can be enforced in India, on a reciprocal basis. However, even a judgment or award from a reciprocating territory may be challenged in Indian courts on certain grounds. to be escalated through the parties' senior management. If this fails to resolve the issue, provisions are required to determine how the JV will terminate. Options include liquidation, sale of the dissenting party's shares to a third party, Russian Roulette (one party offers to sell its shares to the other at a specified price, the other party must either buy those shares, or sell its shares at the same price), or Mexican/Texan Shootout (both parties submit sealed bids to the middle party and the party who makes the higher bid buys the company at that price); and Employees/immigration issues: where key employees need to be seconded to or placed in the JV vehicle, a careful analysis of their employment contract and possibly also any relevant immigration regime will need to be conducted to ensure that key personnel are able to work in the jurisdiction of choice.

The Isle of Man and International JVs

Stephen Colderwood, New Business Executive & Michael Shimin, Group Chairman Fedelta Trust Limited The Isle of Man was, earlier this year, pleased to announce that it had signed a Tax Information Exchange Agreement (TIEA) with India, thus demonstrating a willingness by both nations to strengthen their relationship. The Isle of Man is a mature and reputable international finance centre which, importantly, is included on the OECD white list and is thus recognised as being co-operative, responsible and transparent with high regulatory standards, whilst Moody's and Standard & Poor's continue to award the Island AAA accreditation. The Island is proud of its stable economy and offers many advantages such as zero corporate tax, no capital taxes, and modern corporate legislation. All these elements form a secure base to facilitate international operations and JVs; for example, numerous companies have successfully launched on the AIM and PLUS UK Public Stock Exchanges utilising the flexible Isle of Man Companies Act 2006. The Hong Kong Stock Exchange has also recently approved the Isle of Man as an Acceptable Overseas Jurisdiction allowing for the possible flotation of Isle of Man holding companies on that exchange. The Isle of Man and India both have their legal systems based on English common law and with both nations having deep rooted cultural links to the UK, Fedelta has found that the usual difficulties of forming international JVs have been minimal when working with our Indian clients and contacts. The use of Isle of Man holding companies and favourable treaty provisions via structures in appropriate jurisdictions ensures that the JV is established efficiently and legitimately.

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About Penningtons
Penningtons Solicitors LLP is a top 100 UK law firm providing legal services tailored to businesses and individuals. Our main areas of practice are dispute resolution, corporate and commercial, property and private client, provided through our Business Services, Commercial Property and Private Individuals Divisions. We also have several cross-divisional teams concentrating on a variety of industry sectors. The India group at Penningtons blends broad experience of advising Indian clients with an in-depth understanding of the global transactional environment. Our team of lawyers support businesses of all sizes and across many sectors throughout their corporate life cycle, and has particular expertise in complex cross-border transactions. We pride ourselves on providing not just legal advice but also commercial advice in relation to entry and exit strategies for the Indian market and investments from India into the UK and Europe. We have dualqualified lawyers with a detailed understanding of clients' expectations and concerns, enabling us to develop bespoke solutions to meet their business objectives. In addition, we work closely with contacts at top Indian law firms to prepare and assist our international clients with their business plans for India in areas such as JVs, strategic mergers and acquisitions, banking and finance and dispute resolution, as well as a wide range of commercial dealings. With several lawyers who have a strong track record in a wide spectrum of India-related matters, in addition to their international transactional knowledge, and a select network of Indian professional firms with whom we have worked over a significant period of time, we are able to offer a practical and highly effective service to our clients. India group services at a glance: commercial advice including contracts and entry/exit strategies; JVs and mergers and acquisitions; establishment of subsidiaries, businesses, group structures and company secretarial work; onshore and offshore tax planning; AIM; banking and finance; business restructuring, acquisition finance and project finance; commercial, IP and IT; data protection and privacy; international mediation, arbitration and litigation; banking litigation, business structure/shareholder disputes and M&A fallout; immigration, work permits and highly skilled migrants; real estate; and employment.

Strengthening the bonds between the English and Indian legal fraternities
Anne Wittman, International Policy Adviser South Asia and ASEAN, Law Society of England and Wales It is a great pleasure to contribute to Penningtons' publication. As the representative body of over 130,000 solicitors in England and Wales, the Law Society is keen to connect with globally-minded law firms. Engaging with the Indian legal profession is a high priority for the Law Society, because it is a high priority for our members. President Linda Lee visited India in February 2011 for the Commonwealth Law Conference in Hyderabad, and then went on to Delhi to meet with the Law and Justice Minister and the Chair of the Bar Council of India. She also met with corporate counsel at some of India's most dynamic companies. While the issue of foreign lawyers in India gets a great deal of attention, the story of UK-India legal cooperation is, from our perspective, much broader. Whether or not English firms wish to open offices in India, good relationships between Indian and English lawyers are key to serving client needs in the global marketplace. Some of the most exciting work we do at the Law Society is in helping Indian and English legal professionals develop relationships through networking events, conferences and seminars on key issues of interest to the profession. We have had the pleasure of hosting some of India's leading lawyers at Chancery Lane, and we are busy planning future events in India and the UK to further develop these relationships. Indian and English lawyers share a tremendously rich heritage, which includes the common law tradition and a commitment to the rule of law. The strength of Indian legal links to the UK can be seen in the number of Indian firms which have chosen to open offices in London, and the many Indian advocates who have requalified as English solicitors. For further information about the international work of the Law Society, please see http://international.lawsociety.org.uk.

Contact us
Rustam Dubash, Partner t: +44 (0)20 7457 3176 e: rustam.dubash@penningtons.co.uk Simon Bickerdike, Partner t: +44 (0)1483 411460 e: simon.bickerdike@penningtons.co.uk Saionton Basu, Co-head India group t: +44 (0)20 7457 3151 e: saionton.basu@penningtons.co.uk

London t: +44(0)20 7457 3000 f: +44(0)20 7457 3240

Basingstoke t: +44(0)1256 407100 f: +44(0)1256 479425

Godalming t: +44(0)1483 791800 f: +44(0)1483 424177

Penningtons Solicitors LLP is a limited liability partnership registered in England and Wales with registered number OC311575. Specialist advice should be obtained before taking, or refraining from taking, action based on comments in ths publication which is only intended as a brief note.