© 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P in the Vol. 3, No. 3 edition ofthe Bloomberg Law Reports
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Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authorsand do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark ofBloomberg 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 aslegal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax informationcontained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the UnitedStates Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entitiesdo not take responsibility for the content contained in this report and do not make any representation or warranty as to itscompleteness or accuracy.
The Importance of Early Considerations and Exit Strategies inStructuring an International Joint Venture in India
Contributed by Shahana Basu Kanodia, Edwards Angell Palmer & Dodge LLP, andRashi Mittal, Law Clerk to the Massachusetts Superior Court Justices.
Much has been written about establishing an international joint venture ("IJV") in India. Thisarticle 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 largerproportion of foreign firms entering the Indian market have no prior business experience inIndia. Under such circumstances, partnering with a domestic firm and forming an IJV couldbe a good strategic move. Partnering gives foreign companies an insight into the localconsumer and business conditions and access to the Indian partner's pre-establishedmarket and distribution channels. It also brings together complementary skills, know-howand resources of two or more parent firms to accomplish specific objectives. To avoid thepitfalls of forming an IJV, however, foreign firms need to pay attention to some earlyconsiderations 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 aforeign 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 IJVin India. While the FDI rules have been substantially liberalized since the early 1990s, somesectors such as telecommunications, insurance and defense manufacturing still have FDIcaps and necessitate a formation of an IJV through either "automatic" or "governmentalapproval" route. Under the automatic route, to invest in an IJV, an investor does not requireany 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 ofthe Bloomberg Law Reports
–
Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authorsand do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark ofBloomberg 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 aslegal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax informationcontained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the UnitedStates Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entitiesdo not take responsibility for the content contained in this report and do not make any representation or warranty as to itscompleteness or accuracy.
Bank of India ("RBI"). FDI in joint ventures not covered under the automatic route requireprior government approval and the parties have to apply to the FIPB for approval.
B. Choosing a Suitable Partner
The first step to forming a successful IJV is choosing a suitable local partner in India andassessing its capabilities and track record. It is critical that from the outset, the investors becognizant of the significant cultural differences and expectations and utilizes their time toselect a partner who will be the right "fit". The Indian decision-making process is oftenhierarchical, and foreign firms must identify the ultimate decision makers in the Indiancompany and involve them in the process during the early stages of negotiations to avoidwasting time and resources. Additionally, in order to succeed, foreign firms should spendtime to become acquainted with their IJV partners and build a strong and cooperativerelationship. Building informal relationships with the key people at the local firm, which inIndia usually are the owners of the business and their families, is of paramount importanceto 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 shouldalways remember that misaligned expectations and objectives often suggest that the partiesare 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 expectationsand 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 evaluateany 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 complywith regulations or have conducted adventurous interpretations of contracts, legalprovisions, accounting principles, policies or standards; if they have any contingentliabilities; 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 ofthe Bloomberg Law Reports
–
Asia Pacific Law. Reprinted with permission. The views expressed herein are those of the authorsand do not represent those of Bloomberg Finance L.P. Bloomberg Law Reports® is a registered trademark and service mark ofBloomberg 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 aslegal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax informationcontained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the UnitedStates Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entitiesdo not take responsibility for the content contained in this report and do not make any representation or warranty as to itscompleteness 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 commonobjectives, as well as the structure and the form of the IJV. Indian parties often believe thatas circumstances change, the legal contract can easily be amended. Moreover, Indianparties often prefer contractual provisions which delay difficult decision-making by allowingthe parties to negotiate in good faith at the time of occurrence of a foreseeable event. Toavoid blowing up the deal, foreign firms often agree to such provisions. They are keen tostart the IJV relationship as soon as possible and often put thorny issues on a delayed timefuse in the hope that better relations in the future will help resolve these issues in a moreamicable manner. To avoid this "ongoing" nature of negotiations, it is important that the IJVdocumentation addresses all foreseeable issues and leaves little to chance. If matters arenot agreed upon at the negotiation stage, it is likely that the parties will never agree onthose issues, and a dispute will arise in the future. The IJV agreement should include amongother things, the purpose of the IJV; the governing law and jurisdiction; ownershipinterests; the board structure; issues pertaining to management control; exit strategy; anddispute resolution mechanisms for when disputes arise.
E. Management Control
The level of equity participation inevitably influences the level of management control thefirms have in the decision-making process. In India, certain major decisions have to beapproved 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, majorityownership often allows for quick decision-making and thus avoids costly compromises ordeadlocks. It is important to note that at least 75 percent of the shareholders must approvea 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 officeaddress 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 shareholderwith more than 25 percent voting rights would have the ability to block special resolutions.
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