The Hindu Business Line : Press Note 1: An act beyond the contract

Non-compete obligations do not survive a contract. But Press Note 1 imposes a non-compete obligation on foreign partners for a period beyond the term of the contract, exceeding what is permissible under statutory law and its interpretation. Certainly, it needs a re-look.

D. Murali
C. Ramesh

The clamour for a relook at Press Note 1 is getting louder in the wake of more and more multinationals seeking to go it alone in a booming Indian economy. The Government is also reported to be toying with the idea of diluting the tenets of this regulation, which stipulates that a foreign entity with an existing joint venture or technology agreement in the same field cannot make any further investments under the automatic route.

In addition, although Press Note 1 itself does not explicitly state so, the Foreign Investment Promotion Board’s practice is to consider such an application only when accompanied by a ‘no-objection certificate’ (NOC), in writing, from the previous domestic joint venture partner.

Rather than dilute the effect of the Press Note by carving out exceptions to sectors or to specific types of foreign investors, it would be prudent to consider repealing it altogether so as to create a level playing field, says Mr Umakanth Varottil, a corporate lawyer who is currently pursuing a doctoral programme at the National University of Singapore, on the role of independent directors in corporate governance, which will focus on the board structure and director independence from an emerging markets’ perspective.

In an e-mailed interview to Business Line on why he thinks Press Note 1 must go, Mr Varottil, who after completing LL.M in Corporations Law from the New York University School of Law was a corporate lawyer in India with 11 yearsR 17; professional experience with the Amarchand Mangaldas law firm, where he was also a partner, said: “It is important to note that Press Note 1 runs counter to theoretical foundations and empirical analysis on joint ventures, which are relationships essentially dynamic in nature.”

Failing joint ventures

According to him, the scope and objectives of the joint venture and the interpersonal relationships between the partners are likely to alter over a period, with the rate of change correlative to the speed of change in industry and business climate. Stating that joint ventures are inherently unstable — “a survey indicates that 36 per cent of joint ventures result in failure” — he said that studies have established the median time span of a joint venture’s life to be only seven years. “Yet another study shows that in more than 80 per cent of the cases, the joint venture folds up with one partner selling its stake to the other.”

Mr Varottil pointed out that joint ventures may fold up due to a wide range of reasons: Differing objectives and policies, inability to infuse further capital, product line and technology utilisation disputes and even problems in cultural fit. “As differences become insurmountable, and after parties have exhausted available means of reconciliation, they are left with no choice but to part ways. The next logical step is for each of the partners to foray individually into the Indian markets as competitors.”

Given such a backdrop, government regulation should permit parties to design and dissolve joint ventures in the manner most suitable to them. “Imposing restrictions in the form of Press Note 1 makes it difficult for parties to negotiate a clean break.” He added that the inability of foreign partners to carry on their business alone would compel them to continue with troubled joint ventures, “which not only affects foreign partners but also restricts the options available to domestic partners. It prevents unlocking of value in these businesses.” Besides, it results in a situation that is unfair to foreign businesses. Following the break-up of a joint venture, the domestic partner is free to carry on the same business individually but the foreign partner cannot do so unless it obtains the concurrence of the domestic partner.

No valid reasons

According to Mr Varottil, some of the concerns of Indian industry that motivated the introduction of Press Note 1 have ceased to exist.

Earlier, foreign investment was permitted only in a few sectors, with government approval and with outer limits on percentage of foreign shareholding. “There was a fear that small domestic players were being abandoned by large multinational players. But now there has since been a paradigm shift in Indian industry and regulation over the years.”

Pointing out that Indian industry has significantly matured over the last decade, with several companies growing out of infancy and becoming significant players in the global arena, Mr Varottil said that Indian regulation too has undergone a sea-change.

“Foreign investment is currently allowed in almost all sectors (barring certain sensitive ones) without government approval. In this context, Press Note 1 stands out as a provision that neutralises the effect of all the other government efforts towards liberalisation of the economy and globalisation of Indian companies.”

According to him, the restrictions in Press Note 1 also militate against the basic tenet of freedom of contract.

“Joint venture partners possess the prerogative to structure the terms of their relationship, including to deal with matters involving conflicts of interest. It is not uncommon to find non-compete provisions in joint venture agreements. It does not augur well for regulation to erode the freedom of contract in such circumstances.”

Beyond the law

Besides, Press Note 1 imposes restrictions above and beyond those permitted by statutory law, he added. Specifically, the Indian Contract Act, 1872 does not recognise contracts that are in restraint of trade.

Referring to the Supreme Court ruling in the Gujarat Bottling Case, that non-compete provisions between contracting parties are invalid beyond the term of the contract, he said: “In other words, non-compete obligations do not survive the contract. But Press Note 1 imposes a non-compete obligation on foreign partners for the period beyond the term of the contract; hence, it exceeds what is permissible under statutory law and its interpretation.”

This method of regulation introduces opacity in the legal system, thereby hampering smooth conduct of business, he added.

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