- INTRODUCTION
As India goes global, parallelly with the increasing foreign direct investment into India, there has also been a steady rise in overseas investments from India, with the outflow of financial commitments for the period April 2000 to February 2025 aggregating to USD 760 billion (seven hundred sixty billion US Dollars).1 India's overseas investment regime has also been significantly liberalised over this period, introducing multiple 'automatic routes' for Indian companies and individuals looking to acquire shareholding in foreign companies and boosting outbound M&A.
While an Indian acquirer is permitted to acquire up to 100% (hundred per cent) of the ownership and control in foreign companies, joint ventures ("JVs") remain one of the most favoured mechanisms for strategic Indian investors entering unfamiliar markets abroad. Having a reliable joint venture partner mitigates the risks faced in navigating local customs and laws and provides access to existing supply chains, infrastructure and consumer bases. However, the success of a JV depends on a variety of factors, and having upfront discussions on contingencies while setting up the JV helps protect the partnership from future uncertainties.
From a legal perspective, other than negotiations concerning typical aspects of M&A transactions, an Indian JV partner setting up a JV abroad has to be mindful of the restrictions and compliances under the Indian overseas investment regime as well as the foreign direct investment regime of the host country and provide for robust contractual protections concerning governance and control of the JV, especially if the Indian partner has limited on-ground presence in the foreign jurisdiction. We have outlined a few key considerations that may play a significant role in helping the Indian JV partner adapt to unfamiliar territories.
- REGULATORY BACKGROUND
Pursuant to the liberalisation of the foreign exchange regime in India through the introduction of the Foreign Exchange Management Act in 1999 ("FEMA"), overseas investments by persons resident in India were permitted under the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (first introduced in 2000) and Foreign Exchange Management (Acquisition and Transfer of Immovable Property Outside India) Regulations, 2015 (first introduced in 2000) (collectively referred to as "Erstwhile Regime").
Over the next decades, the Erstwhile Regime underwent significant modifications in line with the official government policy of simplifying and liberalising the foreign exchange regime to enhance 'ease of doing business. In a comprehensive overhaul, the current overseas investment regime was introduced in 2022 vide the Foreign Exchange Management (Overseas Investment) Rules, 2022 ("OI Rules"), the Foreign Exchange Management (Overseas Investment) Regulations, 2022 ("OI Regulations") read with the Foreign Exchange Management (Overseas Investment) Directions, 2022 ("OI Directions"), (together the "OI Regime"). Under the OI Regime, subject to limited conditionalities, an Indian entity2 is permitted to invest in, among others, equity capital3 of a foreign entity4, whether listed or unlisted, engaged in a 'bona fide business activity'5, directly or through a step-down subsidiary or special-purpose vehicle. Such investment may be categorised either as 'overseas direct investment'6 or 'overseas portfolio investment'7 depending on the nature of investment and shareholding interest / control acquired in the foreign entity. Since JVs involve both partners acquiring a significant or controlling stake in the JV, for the purposes of this article, we have assumed that the investment in JV shall be in the nature of overseas direct investment.
- KEY STRUCTURING CONSIDERATIONS
3.1 Regulatory Roadblocks
Despite the significant liberalisation of the OI Regime, there remain limited scenarios where overseas investment may be restricted or subject to consent of the Central Government, Reserve Bank of India or relevant Government departments based on, among other things, jurisdiction of the JV (investment in Pakistan or in any other jurisdiction as may be advised by the Central Government)8, business activity proposed to be undertaken (gambling, financial products linked to the Indian rupee, buying and selling of real estate etc.)9 and the total financial commitment (restricted to 400% (four hundred per cent) of the net worth of the Indian entity or USD 1 billion (one billion US Dollars) in a financial year, whichever is lower).10 Further, the Indian JV partner may require a 'no objection certificate' from the lender bank or identified investigative agencies if the Indian JV partner has a non-performing asset account, is classified as a wilful defaulter or is under investigation by a financial service regulator or identified investigative agencies.11 Often, procurement of relevant consents may be a time-consuming process or in certain cases, consents may not be forthcoming. A careful examination of the Indian JV partner and the JV is crucial at the structuring stage to minimise any unexpected roadblocks.
The Indian JV partner should also be mindful that similar restrictions or approval requirements may also be applicable under the laws of the host jurisdiction of the JV. Many countries, including major economies such as the United States, the United Kingdom, Germany, Japan and Singapore, require the disclosure of the 'beneficial ownership' of any inbound investment, comparable to the beneficial ownership declarations under the foreign exchange and corporate laws of India. The foreign JV partner should be requested to undertake a parallel analysis of the applicable laws in such foreign jurisdiction to ensure that the JV is permitted to accept investments from the Indian JV partner.
3.2 Arriving at a price
A key consideration when entering or exiting a JV is the price of acquisition or divestment of the equity capital of the JV. The OI Regime requires that all transactions involving equity capital are undertaken at a price arrived at on an arm's length basis.12 The authorised dealer bank ("AD Bank") of the Indian JV partner, before facilitating any investment or divestment transaction, may require the Indian JV partner to provide the basis of the pricing of the transaction in the form of valuation reports as per an internationally accepted pricing methodology.13
It is not clarified to what extent (if any) upward or downward deviation is permitted from what is considered the arm's length value as per the valuation report. It is implied that the transaction is required to be undertaken at the determined fair market value, including a transaction undertaken between the Indian JV partner and the foreign JV partner in extenuating circumstances. For instance, in case of a buyout of the foreign JV partner by an Indian JV partner on account of a material breach on the part of the foreign JV partner, the buyout may not be undertaken at a nominal value (as is usually contemplated in event of default clauses) if the valuation of the JV, despite the occurrence of the material breach, remains above the nominal value. However, the AD Bank is responsible for assessing compliance with arm's length pricing and is guided by its internal policies for making such a determination, and hence, may permit deviations subject to its satisfaction, in extenuating circumstances. Accordingly, co-ordination with the relevant AD Bank to understand their requirements and ensuring that the consideration is adequately supported through documentation is key to a smooth transaction and enforcement of contractual terms.
Indian JV partners should be mindful that Indian entities are not permitted to acquire any foreign equity capital for nil consideration by way of 'gifts' and while a limited exemption is available for Indian resident individuals to receive equity capital by way of gift, such a gift may only be made either by a 'relative', or any other person resident outside India in accordance with the Foreign Contribution (Regulation) Act, 2010.14
3.3 Payment Structures
Once the consideration for entering into a JV has been finalised, it may be paid out by the Indian JV partner through normal banking channels facilitated by an AD Bank. Further, the Indian JV partner has the flexibility to pay the consideration in one or more tranches over a period of time, provided that the foreign securities representing the total equity capital for which the consideration has been determined are issued to the Indian JV partner upfront.15 Note that the period of deferment is required to be definite and recorded in the underlying transaction documentation, and the full consideration finally paid should be compliant with the applicable arm's length pricing.16
Further, pursuant to recent amendments, it has been clarified that the consideration may also be permitted to be paid in the form of a swap of securities,17 where the acquisition of the shares by the foreign JV partner should also comply with the provisions of FEMA governing foreign direct investment into India.18
3.4 Layering and round-tripping
An Indian JV partner is not permitted to make any financial commitment to a foreign entity that has invested or invests in India, resulting in a structure with more than 2 (two) layers of subsidiaries.19 The term subsidiary is interpreted per the provisions of the OI Regime (and not Indian corporate laws) and may include an entity in which the foreign entity has control (which includes voting rights of 10% (ten per cent) or more in an entity).20
While the policy intent behind this restriction is clear (to prevent shell companies and complex structures which can be used for money laundering), the drafting of the law creates ambiguity regarding the manner in which the layers of subsidiaries can be calculated, primarily whether the subsidiaries would include Indian companies, at both ends of the structure. In practice, based on the guidance provided under the reporting instructions for Form FC under the Master Direction — Reporting under Foreign Exchange Management Act, 1999, AD Banks often take the view that the Indian JV partner can be excluded from the structure for the calculation of layers and the subsidiaries are counted from the perspective of the first foreign investee entity. To avoid regulatory scrutiny, any JV structure contemplating further subsidiaries or investments back into India should be carefully examined to ensure compliance with the layering restrictions under the OI Regime.
- KEY GOVERNANCE CONSIDERATIONS
4.1 Negotiating management rights
The framework for the management and governance of the JV should be mutually discussed and recorded as part of the transaction documents executed at the time of the investment into the JV by the Indian JV partner. Usually, in the case of a JV, it is fairly common across jurisdictions to agree on an equal or proportional management and governance structure to enable each JV partner to contribute towards the operations of the JV.
The set of management and governance rights may vary depending on the shareholding percentage of each JV partner and their involvement in the day-to-day operations of the JV. In certain JVs, the role and contribution of each JV partner is clearly defined, for instance, the Indian JV partner may provide the technology or products, and the local JV partner may be responsible for employees, compliance and distribution. There could be situations which may lead to an 'unequal' distribution of management and governance rights, as the local JV partner may require greater flexibility to undertake on-ground operations. In such a scenario, the focus of the Indian JV partner should be to secure robust information and inspection rights as well as affirmative voting rights regarding key business decisions. Further, the JV partners should consider negotiating a detailed business plan / operational matrix upfront to demarcate the roles and responsibilities of each JV partner and set out their independent spheres of functioning.
In addition to contractual protection, it is also crucial for an Indian JV partner to be aware of the statutory rights available under the laws of the host jurisdiction of the JV. Inputs from a local jurisdictional counsel during the negotiation of the transaction documents helps in ensuring that statutory protections available under local laws are not diluted and that contractual protections can be enforced.
4.2 Protecting Inventory and Intellectual Property
Where an Indian JV partner is supplying inventory to the JV, the supply and purchase arrangement should be supported by comprehensive documentation to ensure that the rights, obligations and liability of the Indian JV partner vis-à-vis the inventory is clearly set out. Terms such as product warranties, claims servicing obligations, shipping terms and return/replacement obligations should be negotiated with the JV on arm's length basis. Do also note that any supply of goods and services to the JV may also be subject to transfer pricing restrictions as well as other compliance requirements under the Indian export and import control regime (for instance, reporting requirements and payment timelines).21
Similarly, where an Indian JV partner is licensing or assigning any intellectual property or know-how to the JV, such arrangements should be supported with comprehensive documentation to ensure that the right of the Indian JV partner to the intellectual property and know-how is not diluted. The AD bank of the Indian JV partner in India may also require such licensing / assignment documentation along with a valuation report substantiating the pricing of the intellectual property being licensed / assigned out of India, for processing any related remittances.
Transactions between the Indian JV partner and the JV may also be treated as 'related party transactions' and the Indian JV partner should ensure that such transactions are compliant with Indian corporate and tax laws.
4.3 Resolving Deadlocks
It is common to have JV partners with equal or substantially equal shareholding (50:50 (fifty-fifty) or 49:51 (forty nine - fifty one), and crucial decision-making rights available to either JV partner being identical, such as an equal number of directors on the board of directors and 'veto' rights through affirmative voting matters. In such structures, in case of differences between the JV partners, key business decisions or even day-to-day operations of the JV are at risk of coming to a standstill.
This risk may be mitigated by having clear spheres of functioning and control for each JV partner, documented in a detailed business plan / operational matrix, as suggested in paragraph 4.1 above. However, to safeguard against an unforeseen eventuality, a deadlock resolution mechanism is critical to ensure the continuance of operations and the fast and efficient resolution of such differences. Usually, a 2 (two) level deadlock resolution mechanism is recommended. First, reference should be made to senior management of both JV partners for resolution within pre-agreed time periods, failing which, reference of the dispute should be made to a neutral third party, such as specialised consultants or arbitrators. It is important to note that the deadlock may not be a legal or contractual dispute and may arise due to differences in the business objectives of the JV partners. At the time of determining the neutral third party, JV partners should ensure that such third party is sufficiently competent to opine on business and operational matters.
4.4 Structuring an Exit
While parties enter into a JV with a view of long-term cooperation, it is important for the transaction documents governing the JV to contemplate certain eventualities, such as unresolved deadlocks and unsuccessful market entries, which may lead to the need for an exit. In the ordinary course, to preserve the JV structure, transaction documents prohibit either JV partner from transferring or otherwise divesting its share in the JV without the consent of the other JV partner. However, extenuating circumstances, categorised as 'events of default', may contractually require that the non-defaulting JV partner is either provided an opportunity to buy out the other JV partner or be provided an exit from the JV by the defaulting JV partner or through sale to a third party. The JV partners should up front agree to eventualities which may be categorised as 'events of default' (such as fraud / negligence or inability to meet agreed financial benchmarks, etc.) as well as the rights available to the non-defaulting party in such cases (such as call, put or drag rights, etc.).
While contractually the JV partners may agree to innovative exit mechanisms to protect the value of their investment in the JV, the implementation of these protections for an Indian JV partner remains subject to the OI Regime in India, significantly, the pricing conditionalities as discussed in paragraph 3.2 above. In addition to the pricing conditionalities, other requirements of the OI Regime shall also become applicable, which impact or restrict an exit, and should be integrated into the exit mechanism, such as a minimum lock-in period (1 (one) year from date of investment),22 clearance of outstanding dues (repayment of all shareholder loans or redemption of debt securities in case of full divestment)23, repatriation of proceeds in the prescribed timeline (90 (ninety) days from the date of disinvestment)24 and reporting of divestment (30 (thirty) days from receipt of divestment proceeds).25
4.5 Governing Law and Dispute Resolution
Any unresolved deadlocks may escalate into disputes between the JV partners, which may be submitted for dispute resolution through arbitration or through judicial determination by a court of competent jurisdiction. To cater to such scenarios, a careful examination of the legal and judicial landscape of the host jurisdiction, along with geo-political considerations, needs to be undertaken to assess the potential impact on the enforceability of commercial constructs. Accordingly, even though it may be costlier than dispute resolution in the host jurisdiction, it is recommended that any dispute resolution should be undertaken by way of arbitration, considering the factors mentioned above, in a neutral jurisdiction.
The language and governing law of the JV agreement may also impact the outcome of the dispute resolution since the laws, the principles for interpretation and judicial precedents may vary greatly from jurisdiction to jurisdiction. If a foreign law is chosen as the governing law of the contract, the Indian JV partner needs to be aware of the potential impact on the enforceability of commercial constructs. For instance, we have observed that restrictive covenants such as non-compete and non-solicit can be enforced across jurisdictions to varying degrees. Certain jurisdictions also require that the JV agreement is incorporated into the constitutional documents of the JV, and such notifications of incorporation are required to be made in the local language, thereby leading to the JV agreement being translated into a different language, which may lead to interpretation issues.
4.6 Liability of Directors and Officers
The representatives of the Indian JV partner who are appointed as the directors and officers of the JV may not be well versed with the legal duties and obligations under the laws of the host jurisdiction, which are attached to their position. Accordingly, it is crucial to understand the legal liability which can be imputed to the representatives of the Indian JV partner on account of their position in the JV as a result of any non compliances by the JV, even where the foreign JV partner is responsible for the compliance functions of the JV.
If feasible, to the extent permitted under local laws, the representatives of the Indian JV partner may be appointed in a non-executive capacity. Further, as a practical consideration, the Indian JV partner should require the JV to procure directors and officers liability insurance in accordance with the requirements of local laws to protect its representatives appointed to the JV as directors and officers.
- CONCLUSION
In this article, we have tried to outline certain high-level considerations which should be considered from the perspective of an Indian investor to assess the viability of a foreign JV. There remain various additional nuances to each aspect of an overseas investment or divestment, which should be considered as the JV evolves. Crucially, in addition to the ability of the Indian investor to invest in a JV abroad, the laws of the host jurisdiction are also required to be analysed to assess the permissibility of the receipt of foreign investment from India by the JV. To ensure that a prospective investor is cognisant of all relevant compliances as well as available relaxations, advice from tax, financial and legal advisors should be taken into consideration while structuring the JV to provide the greatest commercial value.
Footnotes
1 Overseas Direct Investment Fact Sheet (June 2024) issued by the Department of Economic Affairs, available at https://dea.gov.in/overseas-direct-investment.
2 'Indian entity' refers to a company defined under the Companies Act, 2013 or a body corporate incorporated by any law for the time being in force or a Limited Liability Partnership formed under the Limited Liability Partnership Act, 2008 or a partnership firm registered under the Indian Partnership Act, 1932.
3 'Equity Capital' refers to equity shares or perpetual capital or instruments that are irredeemable or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible instruments.
4 'Foreign entity' refers to an entity formed or registered or incorporated outside India, including International Financial Services Centre (IFSC) in India, that has limited liability. The requirement of foreign entity to be a 'limited liability' entity is not applicable to foreign entities with core activities in strategic sectors (such as energy and natural resources) and any other sectors notified by the Central Government as well as foreign entities which are recognised as start-ups.
5 'Bonafide Business Activity' means any business activity permissible under any law in force in India and the host country or host jurisdiction.
6 'Overseas Direct Investment' or 'ODI' means investment by way of acquisition of unlisted equity capital of a foreign entity, or subscription as a part of the memorandum of association of a foreign entity, or investment in 10%, or more of the paid-up equity capital of a listed foreign entity or investment with control where investment is less than 10%. of the paid-up equity capital of a listed foreign entity.
7 'Overseas Portfolio Investment' or 'OPI' means investment, other than ODI, in foreign securities, but not in any unlisted debt instruments or any security issued by a person resident in India who is not in an IFSC.
8 Second Proviso to Rule 9 of the OI Rules. OI Rules available at https://rbidocs.rbi.org.in/rdocs/content/pdfs/GazetteRules23082022.pdf.
9 Rule 19 of the OI Rules read with paragraph 4 of the OI Directions. https://rbi.org.in/scripts/BS_ViewMasDirections.aspx?id=12710.
10 Paragraph 3 of Schedule 1 of OI Rules read with paragraph 5 of the OI Directions.
11 Rule 10 of the OI Rules.
12 Rule 16 of the OI Rules. 13 Paragraph 12 of the OI Directions. 14 Paragraph 2 of Schedule 3 under the OI Rules. 15 Regulation 7 of the OI Regulations. OI Regulations available at https://rbi.org.in/scripts/NotificationUser.aspx?Id=12380&Mode=0.
16 Ibid. 17 Paragraph 1(2)(v) of Schedule 1 of the OI Rules read with Regulation 8 of the OI Regulations. 18 Paragraph 21 of the OI Directions. 19 Rule 19(3) of the OI Rules. 20 Paragraphs (c) and (y) of Rule 2 of the OI Rules.
21 Please refer to the Foreign Exchange Management (Export of Goods & Services) Regulations, 2015 read with the Master Direction on Import of Goods and Service into India, updated as of August 29, 2024.
22 Rule 17(4)(ii) of the OI Rules.
23 Rule 17(4)(i) of the OI Rules.
24 Regulation 9(4) of OI Regulations.
25 Regulation 10 of OI Regulations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
