Monday, 6 June 2011

Two Sisters: Winning Streak of Indian Business

India is the most preferred investment destination for last few years for its conducive environment. Many consider 1991 was a watershed year in Indian economic history. Macro economic reforms measure taken by Dr. Manmohan Singh, the-then Finance Minister of Narsimha Rao government, lift the barriers for the foreign investment in India & as thought of Indian economy took a massive turn thereafter.
India is preferred destination for investment for its political stability, natural resources, a large no. of English speaking population, well regulated financial market and tested legal system and above all investor-friendly attitude of the government. Some statistics might help in understanding the same. Cumulative amount of FDI inflows into India from 2000-2011 is
US$ 1, 94,814 million & amount of investment in 2010-11 is US$ 19,427, though it’s a decline from 2009-10 where the invested amount was US$ 25,834. (FACT SHEET ON FOREIGN DIRECT INVESTMENT From AUGUST 1991 to MARCH 2011 of DIPP)

Countries like USA, UK, Netherlands, Japan, Germany, Singapore, Mauritius, France etc. didn’t waste much time to grab the opportunity to tap the potential market in India. As there were (are) several sectoral caps in the foreign direct investment, most of the initial investment was in form of Joint Ventures. With regular changes in FDI norms, nature of investment too has changed. Still, most preferred route for investment in the potential market is Joint Venture.
To substantiate this fact, we might refer to two cases of recent past; yes, you have rightly guessed, those are:-
‘Cairn-Vedanta deal caught in regulatory hurdles’
‘RIL-BP has struck the biggest ever JV in the context of foreign investment & production sharing’
Let’s see the present legal nitty-gritty of doing business in India by examining these two cases.
Cairn-Vedanta Deal
Vedanta Resources wants to buy a 51% controlling stake in Cairn India for $8.5 billion. Vedanta Resources is in talks with Cairn Energy, which has a 62.4% stake in Cairn India, to buy a controlling stake in the unit. Till date, Cairn-Vedanta deal has not been cleared. As one of the JV partners of Cairn India, ONGC has objected the deal and raised the issue of Royalty payment. It has approached the government not to give ‘go-ahead’ to London-listed Vedanta Resources’ $9.6 billion acquisition of Cairn India until the issue of excess royalty it pays on Rajasthan crude oil is sorted out. Government too has upheld ONGC’s stand and it said, ONGC’s consent is required to sell its majority stake in Cairn India to Vedanta Resources. Earlier, the petroleum ministry was ready to give “in-principle” approval for Vedanta provided 11 preconditions were met. Cairn India is the operator of the Rajasthan block with a 70% participating interest and its joint venture (JV) partner ONGC has a 30% participating interest.
A 50:50 joint venture formed by the RIL-BP for sourcing and marketing gas in India, taking the overall investment in the partnership to $20 billion or Rs 90,000 crore. BP is taking a 30% stake in 23 RIL-operated PSCs in India, including the offshore producing KG D6 block. This is the single-largest foreign direct investment (FDI) flow into India ever and a multi-year commitment. Valuation was justified with analysts having valued RIL’s upstream business at around $30 billion implying $9 billion for a 30% stake.
So, what is a Joint Venture (JV)? Why it’s so important, what’s the purpose behind a JV?
JV as the name suggests is an arrangement between two or more companies either for long term or for completion of a specific project. This is a symbiotic business association whereby the complimentary resources of the partners are mutually shared and put to use. This could be equity-based or contractual. It might be a new business or an existing business which is expected to get benefit from the new partner.
Overall, it is an effective business strategy for enhancing marketing, positioning and client acquisition. The alliance can be a formal contractual agreement or an informal understanding between the parties.

Joint Ventures include Leveraging Resources, Exploiting Capabilities and Expertise, Sharing Liabilities, Market Access & Flexible Business Diversification.
JVs may be classified as equity and contractual JV. An equity JV is an arrangement whereby a separate legal entity is created in accordance with the agreement of two or more parties like in case of RIL-BP. Most common form of Equity JV is 74:26, 51:49 & 50:50, though other forms too are present. Among these 50:50 JV is most dangerous as no single company can pass any resolution without the help of the other partner. In other two cases resolutions can be passed in much easier way. Recently, by issuing a Press Note, government has removed the condition of prior approval in case of existing joint ventures/ technical collaborations in the "same field" for the foreign partners.
The contractual JV is mostly for a limited period where creation of separate legal entity is not needed or feasible. This kind of JV is seen in the areas like:-
• Technology transfer agreements
• Joint product development
• Purchasing agreements
• Distribution agreements
• Marketing and promotional collaboration
• Intellectual advice
• Engineering, Procurement and Construction (EPC) arrangements

In both the above mentioned case, it is equity-based partnership. Unlike RIL-BP deal, Vedanta-Cairn stake sale is facing so much regulatory hurdles as the issue of controlling stake is there. According to SSPA (Share Sale & Purchasing Agreement), acquisition doesn’t need any approval per se. The acquired entity maintains its individuality. But, once a company wants to buy out more than 50% of the equity stake in the target company, it involves a change in the management and control of the company. In the Cairn-Vedanta case, this is exactly the regulatory hurdle. Vedanta wants to 51% controlling stake in Cairn India where change of management is evident.
The terms and conditions on which acquisition takes place are generally Mutual negotiation between the parties without any intervention of the court or other regulator. However if the target company is a listed company, then provisions of the Securities Contract Act, Take Over Code of SEBI etc. may apply in some cases as in Cairn-Vedanta ongoing saga.

Though, Cairn had claimed that its deal with Vedanta was a corporate transaction and not a transfer of stake. So, did not require the permission of government, but reluctantly agreed to it. Moreover, the application did not recognise the rights of partner ONGC. SEBI is yet to give nod on the proposed open offer by the company.
Analysts said the two deals (RIL-BP and Cairn-Vedanta) were completely different. In Reliance, the Indian company was selling a significant minority stake; Reliance will remain in charge of operations and retain a majority stake. On the other hand, Cairn-Vedanta would have involved a transfer of ownership. Besides, the Cairn-Vedanta $9.6-billion deal was a transaction between two London-listed companies and the money would not come into India. The RIL-BP deal, in contrast, will be the single-largest foreign direct investment. Also, there was no company to pre-empt the deal as was the case with ONGC in Cairn.
RIL-BP is important from foreign investment perspective too. Generally, a proposal for joint venture with foreign equity, does not require any approval if it conforms to the industry / product classification and foreign equity limit. But the JVs, which are not satisfying those clauses, fall under the approval route.

Foreign companies come to India as an incorporated entity by floating a company under the Companies Act, 1956 through Joint Ventures or Wholly Owned Subsidiaries. In this case BP requires government nod as it’s a 50-50 JV. According to existing norm, more than 49% investment by a foreign company needs prior approval of FIPB. But RIL doesn’t need any clearance as it is selling only 30% stake to BP & there is no change in management.

Presently there are two ways to invest in India. Those are:-
Automatic Route
Approval Route
Foreign Investment notification is issued by Department of Industrial Policy & Promotion (DIPP) by issuing Press Note annually.

Regardless of the 2 routes, FDI caps for certain sectors are needed to address two main concerns: (i) protection of national security interests (e.g. telecom/broadcasting), and (ii) protection of certain segments of Indian industry and/or Indian consumers (retail/ real estate). Recently 51% investment in multi brand retail is permitted.

FDI is prohibited under Automatic as well as Approval Route for the following sectors:
• Atomic Energy
• Lottery Business including Government /private & online lotteries etc.
• Gambling and Betting
• Agriculture and Plantations (Other than Tea plantations etc;)
• Nidhi company
• Trading in Transferable Development Rights (TDRs)
• Real Estate Business or Construction of Farm Houses

Thus, from the above analysis we can see there is a close connection between the FDI & JV. Companies are exploring Indian market mostly by strategic alliance in form of a JV, where sectoral caps of FDI is taken care of. Vedanta-Cairn cannot discourage other investors as this single case actually involves almost all legal implications. India thus will continue to be the heart of partnership business, be it foreign or domestic.

The Economic Times
The Hindu Business Line
The Business Standard
The Mint (for JV Information)
Website of DIPP
Website of RBI
Website of RIL
Website of BP
Website of Cairn India
Website of Vedanta Resource
Website of ONGC

No comments: