India is one of the largest economies in the World.[1] The world is looking at India as an ideal investment destination with strategic advantages and lucrative commercial incentives. A Foreign retailer looking for investment in India has several operations. If a foreign company does not want to incorporate an entity in India it may set up laison or branch office or may enter into franchise agreements with India partners. If a foreign company instead decides to incorporate an entity under Indian law, the company may form a Joint Venture (hereunafter “JV”).[2]
Transacting business through JVs established with participation of foreign partners, across various industrial sectors gain tremendous significance. While India has progressed in leaps and bounds, it needs a greater degree of exposure to cutting edge technologies and processes. Foreign partners possessing such technologies can consider JVs in India in order to take advantage of local skills and markets.
In this paper the researcher will look at the meaning of Joint venture, as understood in the Indian context. The various types of Joint ventures too will be looked at along with the advantages and drawbacks of the same. Further the documentation involved in formation of JV, manner of constitution of the Board, the method of transfer of shares in a joint venture too will be studied. Lastly, the benefits or advantages of entering in to JVs and what steps should be taken to make it successful would be looked at.
WHAT IS JOINT VENTURE
JV narrowly means, a partnership through which two or more firms create a separate entity to carry out a productive economic activity in which each partner takes active role in decision making. Each party operating a JV makes substantial contribution in form of capital, technology, marketing experience, personnel or physical assets. Thus, JV is a symbiotic business alliance between two or more companies whereby the complimentary resources of the partners are mutually shared and put to use.[3] The venture can be for one specific project only, or a continuing business relationship such as the Fuji Xerox joint venture[4]. A joint venture may be a corporation, limited liability company, partnership or other legal structure, depending on tax and tort liability.
In India, no legal definition as such has been given to joint ventures. However, the Government of India and its agencies prescribe certain guidelines, which distinguish joint ventures from other entities. Indian joint ventures usually comprise two or more individuals/companies, one of whom may be non-resident, who come together to form an Indian private/public limited company, holding agreed portions of its share capital.[5] A joint venture agreement primarily provides for the manner in which the shareholders of the joint venture company may transfer or dispose of their shares. It is also commonly referred to as a shareholder’s agreement.[6]
Joint Ventures by Foreign Companies
A foreign company can invest in an Indian company through a joint venture agreement (or as a wholly owned subsidiary) in the areas which are otherwise not reserved exclusively for the public sector or which are not under the prohibited categories such as real estate, insurance, agriculture and plantation. Foreign investment into India is governed by the Foreign Direct Investment (FDI) policy and the Foreign Exchange Management Act, 1999 (FEMA). The Government has set up a Indian Investment Centre in the Ministry of Finance as a single window agency for authentic information or any assistance that may be required for investments, technical collaborations and joint ventures and advises foreign investors on setting up industrial projects in India by providing information regarding investment environment and opportunities, Government’s industrial and foreign investment policies, taxation laws and facilities and incentives and also assists them in identifying collaborators in India.[7]
For such foreign investments into India, a two tier approval mechanism has been provided:-
Automatic Approval Route- FDI in sectors or activities to the extent permitted under automatic route does not require any prior approval either by Government of India or Reserve Bank of India (RBI). The investors are only required to notify the Regional office concerned of RBI within 30 days of receipt of inward remittances and file the required documents with that office within 30 days of issue of shares to foreign investors.
Foreign Investment Promotion Board (FIPB) Approval Route:- FDI in activities not covered under the automatic approval route requires prior Government approval and are considered by the Foreign Investment Promotion Board (FIPB).It also provides appropriate institutional arrangements, transparent procedures and guidelines for investment promotion and to consider and approve/recommend proposals for foreign investment.
FORMS OF JVs
JVs may be either contractual or structural, or both. The main classification of JVs is as Equity / Corporate JV 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. The parties undertake to provide money or other resources as their contribution to the assets or other capital of that legal entity. This structure is best suited to long-term, broad based JVs. TheContractual JV might be used where the establishment of a separate legal entity is not needed or if such is not feasible. This agreement can be entered into in situations where the project involves a temporary task or a limited activity or is for a limited term. Below are the most common structures employed to constitute a JV.
[I] Equity/ Corporate JV
[A company incorporated under the relevant laws (a separate juristic entity)]
Here the parties to the JV would hold shares in a company (JV Co), freshly incorporated or in existence under theCompanies Act, 1956 and would subscribe to the shares of such company in an agreed proportion. The documents of incorporation, i.e. the Memorandum of Association (MoA) and Articles of Association (AoA) of the JV Co. would be suitably drafted so as to reflect the rights, intentions and obligations of the parties. This route is preferred since it allows structural flexibility in terms of creating an entity, which is tailor made to suit the specifications of both the parties. Further, the new investor can collaborate with the promoters of an existing company and convert the same to a JV Co. The MoA and the AoA of the company would be amended accordingly to incorporate the JV Agreement into it.
The advantages of using a corporate vehicle are:
It Gives an independent legal identity to the JV
It puts in place a better management and employee structure
The participants have the benefit of limited liability and the flexibility to raise finance
The company will survive as the same entity despite a change in its ownership
[II] Partnership
[A partnership or any other unincorporated vehicle]
A partnership JV or hybrid models are unincorporated forms of JV which represent the business relationship between the parties with a profit motive. This is reflected in the tax regime, whereby partners are separately assessed even though the profits are computed as if the partnership were a separate entity. A partnership represents a relationship between persons who have agreed to share the profits of business carried on by all or any of them acting for all.[8]
The partners are separately assessed for tax, though the profits are computed as if the partnership were a separate entity. This JV has inherent disadvantages including unlimited liability, limited capital, no separate identity etc. Consequently, partnerships are not normally used for major businesses except by professionals such as solicitors and accountants or where there are specific tax advantages.
The Limited Liability Partnership Act, 2008 introduced limited liability partnerships (LLPs) in India, which is a beneficial business vehicle as it provides the benefits of limited liability to its partners and allows its members the flexibility of organizing their internal structure as a partnership based on an agreement. At the same time a LLP has the basic features of a corporation including separate legal identity.[9]
A non-resident person who wishes to participate in a partnership firm registered in India or a sole proprietorship will be subject to the Foreign Exchange Management (Investment in Firm or Proprietary Concern in India) Regulations, 2000. Any contribution to the capital of a firm or a proprietary concern or any association of persons in India by a person resident outside India is subject to the approval of the Foreign Investment Promotion Board(FIPB) and RBI[10], granted on a case-by case basis. This acts as another impediment to such structures, which is why a corporate entity is generally preferred from a structuring perspective.
[III] Co-operation Agreements/ Strategic Alliances
[A cooperation agreement or a strategic alliance]
In a cooperation agreement or a strategic alliance, the parties agree to collaborate as independent contractors rather than shareholders in a company or partners in a partnership. This type of agreement is ideal where the parties intend not to be bound by the formality and permanence of a corporate vehicle. Such alliances are highly functional constructs that allow companies to acquire products, technology & working capital to increase production capacity and improve productivity. Strategic alliances provide companies an opportunity to establish a de facto geographical presence and aid in accessing new markets, increase market penetration, sales & market share. Co-operation agreements / strategic alliances can be employed for business activities such as Purchasing/ Distribution agreements, Technology transfer agreements, marketing and promotional collaboration, intellectual advice.
The rights, duties and obligations of the parties as between themselves and third parties and the duration of their legal relationship is mutually agreed by the parties under the contract, which will be binding on the parties and breach of it will entitle the other party to seek legal recourse against the defaulter.
Another useful way of understanding different types of JVs is by the Anti-trust Route. Five common types of JVs have emerged during anti-trust analysis:
Fully Integrated Joint Ventures
It deals with all aspects of a line of business, which include manufacturing, distribution, marketing and sales. It is viewed as a partial merger of the parent companies and the standards applicable to mergers and acquisitions under Section 7 of the Clayton Act are applicable in these cases. The analysis requires evaluation of the position of the parties as competitors, the relevant markets and competitive effects among others. A case which illustrates this type of JV isUnited States v Ivaco[11], United States v Penn-Olin Chemical Co.[12]
Research and Development Joint Ventures
R&D JVs can provide pro-competitive benefits while maintaining competition among the parent companies, which includes sharing of the economic risks, increasing economies of scale and pooling important research and development information among others. Also, they provide lesser anti-competitive risks due to which they are looked upon favorably. A case which illustrates this point is Addamox Corporation v. Open Software Foundation, Inc.[13]
Production Joint Ventures
Production JVs involve the integration or creation of production facilities. They may or may not be for the purposes of manufacturing a new product altogether. Production JVs increase productive capacities while retaining the same level of competition in the market. One of the most common example is that of New United Motor Manufacturing, Inc. a production JV between Toyota and GM.[14]
Joint Selling & Buying Agreements
A JV may be focused only on selling or marketing activities of the parent companies. As the CC Guidelines suggest, these arrangements may be pro-competitive if they allow the goods or services to reach the marketplace quickly and efficiently. A case which illustrates this point is United States v Columbia Pictures[15], Northwest wholesale stationers v Pacific Stationery and Printing Co.[16]
Network Joint Ventures
They are those in which consumers attach themselves to a physical network. Prime examples of such industries are the power, telecommunications and even the electronic finance and banking industries. The nature of network industries results in cooperation and coordination among the firms that participate in the network, which is essential for the smooth functioning of the network and while it can enhance the efficiencies, it can also lead to acquisition of market power. Usually the courts use the Rule of Reason to analyze these JVs. A case which illustrates this point is United States v Electronic Payment Service[17]
DOCUMENTATION IN A JV
Establishing a JV involves a series of steps and selection of the best partner after proper due diligence is the most significant of all. Once a partner is identified, a memorandum of understanding (“MoU”) or a letter of intent (“LoI”) is signed by the parties expressing the intention to enter into a definitive Joint Venture agreement (“JVA”) in the future and make the relationship formal. JV transactions demand efficient, clear and foolproof documentation. Basic legal documents for establishing a joint venture are:
JVA / shareholders’ agreement (“SHA”); and
Memorandum and Articles of Association of the JV Co.
Miscellaneous agreements such as trade mark licenses and technology transfers.
The most important document is the JVA or SHA. Essentially this provides for the method of formation of the JV company and sets out the mutual rights and obligations of parties for the purposes of conducting the JV and the manner in which the parties will conduct themselves in operating and managing the JV. The JV agreement is between partners and does not bind the JV company unless its terms are included in the AoA of the JV company.[18] Therefore it is necessary to specifically incorporate the JVA or the SHA into the AoA of the JV company.
BOARD AND MANAGEMENT OF THE JV
There are no specific rules relating to board or management structure of joint venture and also no requirement for a two tier board. Under Companies Act, a “private” company must have 2 directors and “public” company should have three. The Act also provides that at least two-thirds of the directors of a public company must be appointed by the shareholders in general meeting and their office must be liable to retirement by rotation. One-third of the “retiring” directors must retire at every AGM.[19] Where the JV is listed, the Board must comprise an optimum combination of “executive” and “non executive” directors. If the chairman is “non executive”, at least one- third of the board should be independent; if the JV has an “executive” chairman, a majority of the board should comprise “independent directors”.
TRANSFER OF SHARES
The enforceability of restrictions on transfer is a complex area under Indian law. The Supreme Court, in the case of VB Rangaraj v. Gopalakrishnan[20], casts doubts over enforceability of agreements between shareholders in an Indian company unless the provisions (especially in relation to transfer of shares) are incorporated into the articles. Even if provisions are incorporated in the articles, there is risk that some of the provisions maybe construed as an unlawful fetter on the statutory provisions of the Company and held unenforceable.
Sec 111A of the Act provides that shares of a “public” company must be “freely transferable”. This requirement has cast further doubt on the validity of restrictions on transfer of shares of a “public” company (even if restrictions are included in the articles). However, not withstanding the above, parties often use contractual restrictions on transfer.[21]
TAX BENEFITS
There are no tax laws or incentive which affect JV specifically, the following maybe relevant to foreign investors:
India has double tax treaties with a number of countries. The treaty with Mauritius is particularly favorable especially as it eases nthe obligation to pay Indian Capital gains tax at the time of exit from Indian JV.
To promote exports from India, the government has introduced some tax incentives under Software Technology Parks (STP) Scheme and the Export Oriented Units (EOU) Scheme. Subject to satisfaction of certain conditions, companies engaged in the export of certain services/goods and are registered under these schemes are entitled to certain tax exemptions.
India has introduced transfer pricing rules which require transactions between a multinational and its Indian subsidiary to be on arm’s length terms. If not, the tax authorities are entitled to impute a price that represents the arm’s length price and tax the transactions accordingly.
CONCLUSION
All joint ventures do not always yield the desired results contemplated by the joint venture parties at the time of starting the joint venture. Despite the various advantages associated with the formation and even after carrying out the compatibility and feasibility studies and taking adequate steps towards the realization of the goals of the joint venture, a considerable number of joint ventures do not succeed, and eventually break-up. While good joint ventures may be highly profitable and hold promise for the future, bad joint ventures can at times get worse than no deal at all. Joint ventures involve dynamic relationships and circumstances, and it may not always be feasible to factor in the underlying conditions that may change with efflux of time, at the time of entering into the joint venture agreement.
The main reasons for failure are human factors like lack of trust, lack of synchronization of objectives, goals of partners, several joint venture partners leading to clash of ideals, cultural differences, family run business vis-à-vis professionally managed company; economic and policy restricting factors like taxation, lack of financial compatibility, physical infrastructure deficiencies, non-feasibility of proposed JV business.
Thus few basic elements may be kept in mind for a successful JV:
Each JV partner should be clear of his organizational goals and the objectives.
Each side should try to recognize and bridge the cultural gaps
JV partners should have a clear idea about the attributes sought in the other partner
JV partners should be committed and focused to the JV goals
No action should seem unilateral and should always have reciprocal agreements
The JV agreement should be as exhaustive as possible and should contain a robust and amicable arbitration or other dispute resolution model.
There should be adequate research and due diligence
Exist options must be such that it does not create burden or huge loss on the remaining JV partners.
Thus JV is one of the most rewarding forms of entering in a new market which welcomes foreign exchange and wants the domestic sector to prosper. However the JV partners should always understand that without mutual trust a JV cannot be successful in long term.
BIBLIOGRAPHY
PRIMARY SOURCES
Acts
Companies Act 1956
Foreign Exchange Management (Investment in Firm or Proprietary Concern in India) Regulation, 2000
Foreign Exchange Management Act, 1999
Indian Partnership Act, 1932
Limited Liability Partnership Act, 2008
SECONDARY SOURCES
Books
A.K. Majumdar and Dr.G.K. Kapoor, Taxman’s Company Law and Practice, 11th Edition, Taxmann Publications (P) Ltd.
Agarwal Raj; Joint Ventures- Law and Management; Bharat Publishing House; India; 2002
Caves, R. E.; Multinational Enterprise and Economic Analysis, 2nd Edition, Cambridge University Press(1996)
Charlesworth and Morse, Company Law, 16th Edn., Sweet and Maxwell, (1999)
Hewitt Ian; Joint Ventures; 4th Ed; Sweet & Maxwell; London; 2008
K. Sekhar, Guide To SEBI Capital Issues, Debentures & Listing, 1996
Seth Dua and Associates, Joint Ventures & M&A (Lexis Nexis, New Delhi, 2005)
Articles
Edmund W. Kitch, The Antitrust Economics of Joint Ventures, 54 ANTITRUST L.J. 957
Ethier, W. J. (1986) The Multinational Firm, Quarterly Journal of Economics, 101(4), Journal of International Business Studies, 22: 479-501.
Frank Partnoy, Shifting Contours of Global Derivatives Contracts 22 U. Pa. J. Int'l Econ. L. 421 (2001).
Gatignon, H. and E. Anderson (1988) The Multinational Corporation’s Degree of Control
Joseph F. Brodley, Antitrust and Joint Ventures, 95 HARv. L. REV. 1521.
K. Sekhar, Guide To SEBI Capital Issues, Debentures & Listing, 1996
L.A. Stout, Betting the Bank: How Derivatives Trading Under Conditions of Uncertainty Can Increase Risks and Erode Returns In Financial Markets 21 Iowa J. Corp. L. 53 (2001).
Mark B. Baker; “Awakening the Sleeping Giant”: India and Foreign Direct Investment in 21st Century; 15 Industrial International & Competition Law Review
Modified Transactions-Cost Analysis Approach, Journal of Marketing, 57(July): 19-38.
Nabhi, Manual for Foreign Collaboration and Investment in India, 1997
Over Foreign Subsidiaries: An Empirical Test of Transactions Cost Explanation, Journal of
Ownership, Location, and Internalization Factors, Journal of International Business Studies,
Richard J. Hoskins, Antitrust Analysis of Joint Ventures and Competitor Collaborations: A Primer for the Corporate Lawyer, 10 U. MIAMI Bus. L. REV. 119
Ritter, J. R., 1987, The costs of going public, Journal of Financial Economics, 269-281
Robert Pitofsky, Joint Ventures under the Antitrust Laws: Some Reflections on the Significance of Penn-Olin, 82 HARV. L. REV. 1007
Zahra, S., R. D. Ireland, I. Gutierrez and M. Hitt (2000) Privatization and Entrepreneurial Transformation, Academy of Management Review, 525-550
URLs
Joint Ventures, at http://business.gov.in/growing_business/joint_ventures.php
Majmudar & Co., Joint Ventures in India, at www.majmudarindia.com/pdf/Joint%20ventures%20in%20India.pdf
Organisation of Economic Co-operation and Development, Competition Issues in Joint Ventures, available at www.oecd.org/dotooecd/0/33/2379097.pdf
Robert Pitofsky, Joint Venture Guidelines: View from One of the Drafters, available at http://www.ftc.govlspeecheslpitofskyljvg991111.shtm
[1] See, Mark B. Baker; “Awakening the Sleeping Giant”: India and Foreign Direct Investment in 21st Century; 15 Industrial International & Competition Law Review; 389, at 390; 2005 (stating India as the Fourt largest economy in the World in terms of purchasing power parity)
[2] Opening for Business in India- Retailers Option; Suffolk Transnational Law Review; Vol 31; 2007; pg 165-189, at p 170
[3] New Horizons Limitedv. Union of India (UOI) and Ors (1995) 1 SCC 478
[4] Fuji Xerox Co., Ltd. is a joint venture partnership between the Japanese photographic firm Fuji Photo Film Co. (75%) and the American document management company Xerox (25%) to develop, produce and sell xerographic and document-related products and services in the Asia-Pacific region. http://en.wikipedia.org/wiki/Fuji_Xerox
[5] Majmudar & Co., Joint Ventures in India, at www.majmudarindia.com/pdf/Joint%20ventures%20in%20India.pdf
[6] K. Sekhar, Guide To SEBI Capital Issues, Debentures & Listing, 1996, p. 3
[7] Joint Ventures, at http://business.gov.in/growing_business/joint_ventures.php
[8] Sec 4 of the Indian Partnership Act, 1932
[9] The LLP Act permits the conversion of a partnership firm, a private company and an unlisted public company into an LLP, in accordance with specified rules. As a consequence of the conversion, all assets, interests, rights, privileges, liabilities and obligations of the firm or the company may be transferred to the resulting LLP and would continue to vest in such LLP. An LLP is a body corporate formed and incorporated under the LLP Act, 2008.
[10] Reserve Bank of India
[11] 704 F. Supp. 1409 (1989)
[12] 378 US 158 (1964)
[13] 152 F. 3d 48 (1st Circuit, 1998)
[14] New United Motor Manufacturing, Inc. is an automobile manufacturing plant in Fremont, California. The factory was originally a General Motors plant opened in 1962 and shut down in 1982. GM and Toyota reopened the factory as a joint venture in 1984 to manufacture vehicles to be sold under both brands. GM pulled out of the venture in June 2009. Toyota indicated it plans to pull out by March 2010. When it reopened for production in 1984, it was the first automotive joint venture plant in the United States. GM saw this joint venture as an opportunity to learn about the ideas of lean manufacturing from the Japanese company, while Toyota gained its first manufacturing base in North America and a chance to implement its production system in an American labor environment. Many business textbooks mention NUMMI when they discuss joint ventures. Available at http://en.wikipedia.org/wiki/NUMMI
[15] 507 F Supp 412 (SDNY 1980)
[16] M. 2763, 6.12.2002
[17] 1994 2 Trade Case (CCH) 796 (D. Del. 1994)
[18] VB Rangaraj v. VB Gopalkrishnan and Ors 73 Comp Cas 201 (SC) (1992)
[19] Annual General Meeting
[20] AIR 1992 SC 453
[21] Hewitt Ian; Joint Ventures; 4th Ed; Sweet & Maxwell; London; 2008
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