The Hindu Business Line : Press Note 1: Disadvantage, domestic partner

The Government's suggestion, in its latest Press Note 1, that `conflict of interests' clause may be introduced in the JV agreement to safeguard the interests of joint venture partners, which also includes the `foreign partner' itself, is misconceived, and lacks reality, when the general rule is that it is only foreign partner, who has the competitive advantage when compared to local partner.

PRESS Note 18 was substituted by Press Note 1 (2005 Series) on January 12. On October 12, 2004, the author made out a case in this paper that the necessary regulatory safeguard in the erstwhile Press Note 18 prevented only `conflict of interests' and not foreign direct investment (FDI), as was made out.

Interestingly, while diluting the restrictions contained in Press Note 18, the Government recognises the possible ``conflict of interests'' to joint venture partners that may result in the absence of effective regulatory control.

In the new Press Note 1, the Government advises that all JVs formed after the date of this Press Note may embody a `conflict of interests' clause to safeguard the interests of JV partners, in the event of one of the partners desiring to set up another joint venture or a wholly-owned subsidiary in the `same' field of economic activity.

Though the restriction is still continued in the diluted form, the indication with this sort of `advise' could be that, eventually, the restriction may be scrapped.

The net effect of these changes is that, in the Government's opinion, there is no need to have regulatory control, when commercial contracting parties might well have legal risk management to resolve any conflict of interests that may arise between them.

This thinking is flawed, even if it seems one more step towards `self-regulation' and the Government freeing controls; in practice, it would be advantageous for foreign investors and both the domestic partner and the country are at a disadvantageous position.

In most JVs, the foreign partner has the competitive advantage such as premium brand, global experience and the state-of-the-art technology with sound R&D and deep pockets.

With these inherent advantages, for whatever reasons, he elects to do business through a JV (instead of a wholly-owned subsidiary that is nowpermissible), and, thus transfers technology to the JV.

If the foreign investor were to once again invest in India, as a wholly-owned subsidiary or with another JV partner in the same business activity, there would be direct conflict of interest between the existing JV and the new entity. The loyalty to the existing JV can no longer be exclusive and may be diluted or become extinct, contingent upon the foreign investor's commercial interests in its new venture.

In such a situation, the existing JV will be the sufferer as will be the domestic partner and other stakeholders of the existing JV. This was precisely what was sought to be undone by Press Note 18, which required a no-objection certificate from the Indian partner, before the Government cleared approval for foreign investment. This served as an effective mechanism even before investment in India by the foreign partner, to prevent such conflict of interests.

The conflict of interests, according to the current thinking of the Government, is better managed in the legal documents, rather than through regulatory control. But, how far is the legal resolution effective for the domestic partner or the stakeholders?

First, the regulatory fiat is a condition precedent for making investment, and, as such, cannot be breached. It is effective in preventing any conflict situations.

The best of the clauses in any JV agreement could be breached, thereby, making the other party claim only damages for breach or, worse, terminating the existing joint venture agreement, which is suicidal to domestic stakeholders. The recourse is `curative' and, to that extent, ineffective.

Second, there is no regulatory bar in having the needed restriction on FDI in safeguarding domestic interests (every country has this in some form), as FDI is essentially a policy requirement of the Government which, on grounds of `national interests', cannot be challenged. If the same restriction on the foreign partner making investment is contained in the JV agreement, the risk of such a clause viewed as an agreement in `restraint on trade or business', cannot be ruled out.

Third, the foreign partner and the domestic counterpart are not similarly placed. With deep pockets and giant global operations, the Indian stake is relatively smaller for many overseas investors.

Given their preference to resolve legal conflicts through international commercial arbitration, with venue being in a foreign country, they would not hesitate to continue legal battle to its bitter end.

For the local partner, such a remedy would be worse than the disease itself. The cost of litigation abroad is prohibitive enough to make the legal recourse an academic exercise!

Fourth, when intellectual properties of high stakes are involved, often the resolution conflict of interests clauses is accompanied by either party buying the other stake, so as to make the joint venture a wholly-owned subsidiary of any one party or, alternatively, to sell their stake to third-party, with the consent of the JV partner. Here again, when the foreign investor supplies technology, the Indian investor is reduced to a mere financial partner and his buying the shareholding of overseas joint venture partner is theoretical.

Considering the inherent commercial strengths and the helplessness of the Indian partner, if the foreign partner decides not to buy the stake of the domestic party, the available course is to sell the domestic party stake to any other buyer (of course, with the prior consent of foreign partner) or liquidate the company.

The implementation of such provisions in JV agreement is not easy and the Indian party and other stakeholders may end up eroding its value.

Considering the natural weakness of the Indian partner, a level-playing field was ensured in the erstwhile Press Note 18 which, unfortunately, is being progressively being diluted.

(The author is a Chennai-based practising advocate and a fellow of the ICAI.)

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