VCCircle

Investment banks and management consultants always complain that it's very difficult to get money out of Indian companies (read lalas) for their work. You know that better.

The Ambanis could be running some of India's largest companies, but it seems they may also not part with money that easily. World's blue-blooded management consultancy firm McKinsey has learnt it the hard way as it has reportedly approached the Bombay High Court against Reliance Industries (run by Mukesh Ambani) and Reliance Communications (of Anil Ambani group) for non-payment of dues of Rs 27 crore ($6.5 million).

This money was believed to be due for McKinsey for their advisory work on the Reliance's telecom rollout. McKinsey had signed an agreement in 2001 with Reliance Industries, which bankrolled Mukesh Ambani's telecom plans (Reliance Infocomm).

Following a split between the two Ambani brothers in 2005, the telecom business went to Anil Ambani Group (Reliance ADAG). McKinsey approached ADAG for payment of dues, which the latter declined since the agreement was between RIL and the consultancy firm. Now McKinsey has filed a winding up petition with Bombay HC against RCom as well as RIL. The court may hear the McKinsey petition on September 6.

The details of the engagement are not known. McKinsey apparently incurred $325,000 a month on the job, and it had set up some six teams to work on this project. Reliance was also expected to pay extra if the telecom business had reached Rs 10,000 crore in turnover. All told the demand is for Rs 27 crore. Will McKinsey get it? Only time can tell.

[By the way, did McKinsey tell Reliance to roll out on CDMA platform and offer mobile service without paying licence fee (using limited mobility loophole)?]

ICICI Venture Funds is reportedly looking at ways to escape the recent tax clause on Indian venture funds. The Mumbai-based private equity firm is looking at structuring the investment in such a way that the shares of the investeee companies will be directly held by the limited partners of the fund. It will be somewhat like a mutual fund where the investors are allotted units for investment.

I am not sure how this can be done. Legal pundits and CA firms can advise on this. Also, what needs to be considered is whether the regulations would allow such a tinkering with the VC fund holding structure.

The Union Budget 2007-08 had restricted the tax benefits (pass-through benefits) enjoyed by the VC funds registered with Securities Exchange Board of India (SEBI). Now they are available only for certain specified sectors such as IT, nanotechnology, biotechnology, drug discovery etc. This will affect those funds like ICICI Venture who have invested in areas like retail and publishing, and infrastructure sector.

There are also other issues. It's not yet clear whether the income of VC/PE funds are treated as "business income" or "capital gains". In the case of former, the tax rate is 30 per cent plus surcharges, while in the latter it's 10 per cent.

Funds like IDFC Private Equity and UTI Bank are looking at setting up offshore funds in places like Mauritius with which India has a "double taxation avoidance treaty".

There is no need for tax exemptions on income accruing from investments in listed companies or in companies at pre-IPO stage. That is not really providing risk capital, and it is just quick buck investing. But those funds who are providing early stage capital can be definitely be spared.

Finance Minister P Chidambaram's idea of taxing VC/PE funds have come a way too early, though.

Related:

Budget Restricts "Pass-Through Benefits" For VCs In Certain Sectors

Restricting Pass Through Benefits: Greater Impact On Domestic VC Funds

Economist Ajay Shah Rubbishes Plans To Tax Venture Capital Funds

How Budget Would Impact VC Funds: Tax Man's Perspective

Will Domestic Funds Now Go To Mauritius To Set Up Offshore Funds?

Pass-Through Effect: UTI Bank Plans $500 Million Fund, But Registered Offshore

The tussle over Hutch deal is far from over. There is a legal battle brewing between the Essar Group and Hutchison Telecom International. The fight is over the Right of First Refusal (RoFR) which Essar Group claims it has. HTIL has outrightly rejected such a claim. Anticipating a legal action by Essar, HTIL has filed a caveat in in Delhi and Mumbai high courts. HTIL has filed the caveat to ensure that it is kept informed about any proceedings initiated by the Ruias regarding the proposed sale of HTIL’s 67 per cent stake in Hutchison Essar Ltd.

Law firm Amarchand & Mangaldas has filed the caveat on behalf of HTIL.

The real reason is some differences between Essar and Vodafone which acquired the 67 per cent stake of HTIL in Hutch Essar. Reports suggest that the Ruias are seeking joint management rights, a hike in shareholding beyond 33 per cent and a put option from Vodafone. The UK telco is however yet to make up its mind over Essar's demands.

Ruias have argued that they have the ROFR on sale of the 67 per cent whether the buyer is within or outside India. HTIL argues the right is restricted to only a domestic buyer. Vodafone is a UK telco so Essar's right cannot be enforced, HTIL argues.

Although they could be negotiation tactics, both the parties are likely to settle the dispute out of court at some point, and the deal will go through.

(Editor's note: The Union Budget has made a provision to limit pass through benefits (tax exemptions) to venture capital funds who invest only in certain sectors. Shantanu Surpure, Partner at Mumbai-based law firm Economic Law Practice, explains what the step means to venture capital funds. Surpure has been assisted by associate Yashojit Mitra.)

Today’s budget announcement by the Finance Minister included proposed amendments which will be of particular interest to venture capital and private equity funds.

Section 10(23FB) of the Income Tax Act, 1961 (the “IT Act”) provides that in computing the total income of the previous year of a venture capital company/fund, any income of such venture capital company or fund set up to raise funds for investment in a venture capital undertaking shall not be included, i.e., a pass through tax benefit.

"Venture capital undertaking" is defined in clause (c) of the Explanation 1 of Section 10(23FB) to mean a venture capital undertaking referred to in the Securities and Exchange Board of India Regulations.

The proposal is to amend the definition of a "venture capital undertaking" to a domestic unlisted company which is engaged in the business of:

-nanotechnology;

-information technology relating to hardware and software development;

-seed research and development (ie., plants and not seed stage);

-bio-technology;

-research and development of new chemical entities in the pharmaceutical sector;

-production of bio-fuels; or

-building and operating large hotel and convention centers; or

-diary or poultry

This has the impact of making the tax pass through benefits mentioned only to venture capital funds making investments in the above sectors. The definition of venture capital funds in Explanation 1 includes those funds registered with SEBI. According to the SEBI website, there are 88 domestic venture capital funds (“DVCFs”) and 66 foreign venture capital investors (“FVCI”s) currently registered with SEBI.

Pursuant to Section 90(2) of the IT Act, a non-resident assessee based in a country with which India has a tax treaty may choose to either be taxed under the IT Act or the tax treaty, whichever is more beneficial. FVCIs incorporated in a jurisdiction such as Mauritius may therefore still avail of the tax benefits under the Mauritius-India tax treaty and the above amendment may have limited impact on FVCIs. However, the impact on DVCFs may be greater because they are taxed under the IT Act, including proposed amendments such as the above.

While the government may wish to encourage development in certain sectors of the economy, consideration should be given as to whether the removal of tax pass through benefits for funds investing in sectors other than those mentioned in the amendment is the most effective method, particularly when DVCFs seem to be disadvantaged.

Internationally, tax pass through benefits for venture capital funds are well established. In Delaware, for example, many funds are structured as limited partnerships (LPs) where the tax is passed through and the LP itself is not taxed.

Perhaps the emphasis should be more on encouraging the development of the environment for entrepreneurship in India and its accompanying ecosystem rather than tweaking with pass through benefits.

About the author

Shantanu Surpure is a partner at Economic Laws Practice (ELP) in Mumbai. He focuses on venture capital and private equity transactions. Shantanu, who holds a BA from Brown University/London School of Economics, an MA Juris from Oxford University and a Juris Doctor from Columbia Law School, is admitted to practice law in India, California, New York and England and Wales. He can be reached at shantanusurpure@elp-in.com.

This legal column is meant for public discussion and informational purposes only and is not to be construed as legal advice.)

(Editor's note: Press notes 1 and 18 once again came to the fore recently, thanks to Danone and Britannia spat on the Avesthagen investment. They are regulations that govern joint ventures between an Indian and foreign company. Our columnist Shantanu Surpure, partner at Economic Laws Practice, a Mumbai-based law firm, explores the topic and contends that even VC and private equity firms are not immune from these regulations.)

The recent dispute between the Wadia Group and French dairy giant Danone has once again highlighted the issues related to Press Note 1 of 2005 (“Press Note 1”) and Press Note 18 of 1998 (“Press Note 18”). Danone and Wadia are joint venture partners in Britannia Foods and Wadia recently alleged that Danone’s investment in Avesthagen, a Bangalore based nutraceutical company, violates Press Note 1. Danone, in response, has refuted this claim.

What are these Press Notes and how do they impact foreign investors including venture capital and private equity funds? Certain acts in India delegate authority to various government bodies such as the Reserve Bank of India (RBI), Department of Industrial Policy and Promotion (DIPP) or the Foreign Investment Promotion Board (FIPB). These delegated entities may then make updates to laws pursuant to circulars or press notes. Such press notes are binding under law. They typically are issued with a number and the year in which they are issued.

The Distinction

Press Note 18 has been infamous as an often cited example of India’s previous hostile attitude towards foreign investment. Press Note 18 denied the use of the automatic investment route (i.e. without government approval) and required a foreign investor who had an existing joint venture, trademark or technology transfer agreement in the “same or allied” field in India to seek FIPB approval for further investments in India.

The foreign investor also had to prove that the new investment would not harm the existing joint venture or its stakeholders and obtain a No Objection Certificate from the Indian partner. Foreign investors often felt that such restrictions held them hostage to their Indian partners. Numerous documented disputes between Indian companies and their foreign joint venture partners include Modi–Xerox, Modi–Walt Disney, TCL–Baron and ITC-British American Tobacco, among others.

With a view to liberalising the effects of Press Note 18, the government issued Press Note 1. There are several key differences between the two press notes:

--Whereas Press Note 18 required government approval for investment in “same or allied” field, Press Note 1 requires government approval only if the foreign investor invests in the “same” field. Press Note 10 of 1999 provides that “same” field means that the nature of business of the company falls under the same four digit National Industrial Classification Code, 1987 (“NIC Code”) and that “allied” field means that the nature of business falls under the same three digit NIC Code.

Therefore, only such proposals for foreign investment which fall under the same four digit classification of the NIC Code with respect to their past or existing joint ventures in India attract Press Note 1. To take a simple example, the manufacture of blankets and shawls other than by hand is under NIC Code 263.2. Therefore, a foreign investor who already has an investment in a company which produces blankets may require FIPB approval for an investment in an Indian company which manufactures shawls.

--While Press Note 18 completely denied the use of automatic route, Press Note 1 permits the automatic route (no need for obtaining FIPB approval) where investments are made by venture capital funds registered with the Securities and Exchange Board of India (“SEBI”) as Foreign Venture Capital Investors or where either of the parties have less than 3% investment in the existing joint venture or where the existing joint venture is defunct.

--Earlier the onus to justify and prove to the satisfaction of the government that the new proposal would not jeopardize the interests of the existing Indian joint venture partner or technology/trademark partner was only on the foreign investors or technology suppliers. However, Press Note 1 provides that the burden of proof now lies equally on the foreign investor/technology supplier and the Indian partner.

--In conjunction with this, Press Note 1 provides that all joint ventures entered into after January 12, 2005 may contain a “conflict of interest” clause in the joint venture agreement. Such a clause is critical because, if drafted well, it essentially provides the foreign investor with a type of no objection from the Indian partner regarding foreign investments in the “same” field.

--It should be noted that Press Note 3 of 2005 has specifically clarified that investments in the information technology sector are exempt from the provisions of Press Note 1.

One of the challenges faced by venture capital and private equity investors in India is that the regulations contemplate that venture capital and private equity investment is in the nature of a joint venture rather than as a financial investment. The regulations do not consider that such investors are providers of risk capital rather than traditional joint venture partners.

A fund’s main business is to make investments and funds are often sector specific, i.e. real estate, internet, consumer, manufacturing, etc. and therefore it is possible that investments may be made in the “same” field. It is therefore critical for venture capital and private equity investors to consider the impact of Press Note 1 while making investments in India.

About the author

Shantanu Surpure is a partner at Economic Laws Practice (ELP) in Mumbai. He focuses on venture capital and private equity transactions. He has previously practiced law with a large US law firm in Silicon Valley. Shantanu holds a BA from Brown University/London School of Economics, an MA Juris from Oxford University and a Juris Doctor from Columbia Law School. Shantanu is admitted to practice law in India, California, New York and England and Wales. He can be reached at shantanusurpure@elp-in.com.

This legal column is meant for public discussion and informational purposes only and is not to be construed as legal advice.)

Read Shantanu Surpure's Past Columns

Limited Liability Partnership Bill 2006 In Line With International Practices

Demystifying QIPs

Understanding Shareholder Thresholds

Incorporating A Company In Delaware Vs. India (Part II)

Incorporating A Company In India Made Easier (Part I)

Foreign Investment In Retail May Need Creative Structuring

(Editor's note: The Limited Liability Partnership Bill 2006 is currently under the consideration of Rajya Sabha. Indian industry body Confederation of Indian Industry has called it a path-breaking legislation. A hybrid between a limited liability company and a partnership firm, the new structure as envisaged in the bill - once cleared by the Parliament - is expected to benefit entrepreneurs, professionals and companies immensely.

Here is a guest column by Shantanu Surpure, partner at Economic Laws Practice, a Mumbai-based law firm, on the topic. Yashojit Mitra and Devyani Singh, associates at ELP, have assisted Shantanu in writing this article. This legal column is meant for public discussion and informational purposes only and is not to be construed as legal advice.)

Oudated Partnership Act

As the Indian economy has continued to expand, the features of the traditional partnership governed by the Indian Partnership Act, 1932 (the “Partnership Act”) have increasingly become out-dated. The main problems with the current Partnership Act are that (i) it does not recognise the distinction between a partnership and its members (i.e. the partners); (ii) it restricts the maximum number of partners in a partnership to 20; (iii) and it imposes unlimited liability on each partner for acts committed by any other partner and by the partnership as a whole.

LLP In Delaware

A Limited Liability Partnership (“LLP”) is an alternative corporate entity that provides the benefits of limited liability but allows its members the flexibility of organizing their internal structure as a partnership.

An example is a Delaware limited liability partnership which is governed by the Delaware Revised Uniform Partnership Act (the “Act”). The Act was amended in 1993 to allow for LLPs. Pursuant to Chapter 15 of the Act, by becoming an LLP, the partners of a Delaware general partnership are able to limit their liability. In order to become an LLP, the partnership needs to file a Statement of Qualification with the Delaware Division of Corporations. Examples of LLPs include law firms, accounting firms and other professional services firms.

There is a further distinction between an LLP and a limited partnership (“LP”). In an LP, there must be at least one limited partner and one general partner. Whereas the liability of the general partner is unlimited, the liability of a limited partner is only to the extent of the amount invested by the limited partner. The rights of management and ownership vest with the general partner whereas limited partners generally only have financial interest. The limited partnership structure is often utilized in establishing venture capital funds.

In addition, amendments were enacted in July 2006 to permit limited liability limited partnerships (“LLLPs”) in Delaware which limits the general partner’s liability for the debts and obligations of the limited partnership. This has the effect of making an LP more similar to an LLP.

Proposed Indian LLP

While the government of India has not addressed the issue of LPs or LLLPs, there is currently before the Rajya Sabha a Limited Liability Partnership Bill, 2006 which inter alia incorporates the following features:

--An LLP will be a body corporate with an identity distinct from its partners and will have perpetual existence;

--A minimum of two partners will be required for the formation of an LLP with no limit on the maximum number of partners;

--Every partnership will have at least two designated partners of which one shall be a resident of India. The designated partners shall be answerable for the doing of all acts, matters and things as are required to be done by the LLP in respect of compliance of the provisions of the proposed legislation and be liable for penalties for non- compliance;

--Liability of the partners of an LLP will be limited to the extent of investment made by them in the LLP. A partner shall not be personally liable for the wrongful acts or omission of any other partner except in the case of unauthorized acts, fraud and negligence. The liabilities of an LLP shall be borne out of the property or assets of the LLP; and

--The mutual rights and duties of the partners of an LLP inter se and those of the LLP and its partners shall be governed by a registered agreement between partners or between the LLP and the partners.

The tabling and hopeful eventual passing of this Bill will assist in bringing Indian partnership provisions more in line with international practices.

About the author

Shantanu Surpure is a partner at Economic Laws Practice (ELP) in Mumbai. He focuses on venture capital and private equity transactions. He has previously practiced law with a large US law firm in Silicon Valley. Shantanu holds a BA from Brown University/London School of Economics, an MA Juris from Oxford University and a Juris Doctor from Columbia Law School. Shantanu is admitted to practice law in India, California, New York and England and Wales. He can be reached at shantanusurpure@elp-in.com.

Read Shantanu Surpure's Past Columns

Demystifying QIPs

Understanding Shareholder Thresholds

Incorporating A Company In Delaware Vs. India (Part II)

Incorporating A Company In India Made Easier (Part I)

Foreign Investment In Retail May Need Creative Structuring

Allowing foreign law firms in India is an issue that crops once in a while. Now it seems there is some development on this front. The Financial Express reports that India "has initiated talks with countries, including the UK, on modalities for allowing their law firms limited entry into India".

However, don't expect anthing immediately. For, there isn't a timeframe set yet. But what is significant is the Bar Council of India (BCI), which has been vehemently opposing the idea, has agreed to be part of the negotiations. The chairman and vice-chairman of BCI ar the nominated members of a working group who would their British counterparts later this month.

This meeting would decide on a mechanism for allowing non-practice legal advisory services aimed at enhancing trade and investment in the sector, says the FE report.

It may be noted that several foreign law firms like Linklators are eyeing India. Many of them have referral arrangements with Indian law firms. Recently, Linklators signed a formal referral partnership with Mumbai-based Thawar Thakore & Associates, an upcoming law firm.

Also talks with Britain is significant since it's home to the magic circle law firms - like Allen & Overy, Clifford Chance, Freshfields Bruckhaus Deringer, Linklaters, Slaughter and May

(Editor's note: This guest column is written by Shantanu Surpure, partner at Economic Laws Practice, a Mumbai-based law firm specialised in venture capital, private equity and cross border transactions. Yashojit Mitra and Devyani Singh, associates at ELP, assisted in writing this article. The above guest column is meant for public discussion and informational purposes only and is not to be construed as legal advice.)

We previously discussed the importance of shareholder thresholds in Indian law. This is one area which differs dramatically in Indian law from the US law (such as in Delaware), where shareholder thresholds are not statutorily established. There are areas in Indian law, however, which are moving closer to US law. One such example are the recent SEBI guidelines issued with respect to Qualified Institutional Placements (QIPs) made to Qualified Institutional Buyers (QIBs).

QIPs In The US

US securities laws contain a number of exemptions from the requirement of registering securities with the US Securities & Exchange Commission (SEC). Pursuant to Rule 144A of the Securities Act of 1933, issuers may target private placements of securities to QIBs. Although often referred to as Rule 144A offerings, as a technical matter, transactions must actually involve an initial sale from the issuer to the underwriter and then a resale from the underwriters to the QIBs. A QIB is defined under Rule 144A as having investment discretion of at least $100 million and includes institutions such as insurance agencies, investment companies, banks, etc.

Rule 144A was adopted by the SEC in 1990 in order to make the US private placement market more attractive to foreign issuers who may not wish to make more onerous direct US listings. Whereas the US regulators by enacting Rule 144A sought to make the domestic US capital markets more attractive to foreign issuers, the Indian regulators are seeking to make the domestic Indian capital markets more attractive to domestic Indian issuers.

QIPs In India

Therefore, in order to encourage domestic securities placements (instead of foreign currency convertible bonds (FCCBs) and global or American depository receipts (GDRs or ADRs)), the Securities Exchange Board of India (SEBI) has with effect from May 8, 2006 inserted Chapter XIIIA into the SEBI (Disclosure & Investor Protection) Guidelines, 2000 (the DIP Guidelines), to provide guidelines for Qualified Institutional Placements (the QIP Scheme).

The QIP Scheme is open to investments made by “Qualified Institutional Buyers” (which includes public financial institutions, mutual funds, foreign institutional investors, venture capital funds and foreign venture capital funds registered with the SEBI) in any issue of equity shares/ fully convertible debentures/ partly convertible debentures or any securities other than warrants, which are convertible into or exchangeable with equity shares at a later date (Securities).

Pursuant to the QIP Scheme, the Securities may be issued by the issuer at a price that shall be no lower than the higher of the average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange (i) during the preceding six months; or (ii) the preceding two weeks.

The issuing company may issue the Securities only on the basis of a placement document and a merchant banker needs to be appointed for such purpose. There are certain obligations which are to be undertaken by the merchant banker.

The minimum number of QIP allottees shall not be less than two when the aggregate issue size is less than or equal to Rs 250 crore; and not less than five, where the issue size is greater than Rs 250 crore. However, no single allottee shall be allotted more than 50 per cent of the aggregate issue size.

The aggregate of proposed placement under the QIP Scheme and all previous placements made in the same financial year by the company shall not exceed five times the net worth of the issuer as per the audited balance sheet of the previous financial year.

The Securities allotted pursuant to the QIP Scheme shall not be sold by the allottees for a period of one year from the date of allotment, except on a recognized stock exchange. This provision allows the allottees an exit mechanism on the stock exchange without having to wait for a minimum period of one year, which would have been the lock–in period had they subscribed to such shares pursuant to a preferential allotment.

The Difference

There are some key differences between the SEC’s Rule 144A and the SEBI QIP Scheme such as the SEBI pricing guidelines and the US rule that a private placement under Rule 144 A must be a resale and not a direct issue by the issuer. In addition, the target audience of both regulations is different -while the impetus behind Rule 144A was to encourage non-US issuers to undertake US private placements, the impetus behind the SEBI QIP Scheme was to encourage domestic Indian issuers to undertake domestic Indian private placements. Nonetheless, the intention of both regulations is to encourage private placements in the domestic markets of the US and India, respectively.

About the author

Shantanu Surpure is a partner at Economic Laws Practice (ELP) in Mumbai. He focuses on venture capital and private equity transactions. He has previously practiced law with a large US law firm in Silicon Valley. Shantanu holds a BA from Brown University/London School of Economics, an MA Juris from Oxford University and a Juris Doctor from Columbia Law School. Shantanu is admitted to practice law in India, California, New York and England and Wales. He can be reached at shantanusurpure@elp-in.com.

Read Shantanu Surpure's Past Columns

Understanding Shareholder Thresholds

Incorporating A Company In Delaware Vs. India (Part II)

Incorporating A Company In India Made Easier (Part I)

Foreign Investment In Retail May Need Creative Structuring

Foreign law firms are in India, well, indirectly. A leading global law firm Linklators has formed a referral relationship with a soon-to-be-formed law firm in India. Linklaters and Mumbai-based Thawar Thakore & Associates have agreed to refer work to each other while the Indian firm has also been invited to second lawyers to the magic circle firm, reports Legal Week.

The Mumbai firm will officially launch in January. It's to be headed by AZB & Partners capital markets partner Shobhan Thakore and another leading capital markets lawyer Suresh Talwar (who recently announced his retirement from Indian firm Crawford Bayley & Co).

Linklators's move may be opposed by Indian desi firms who will allege that the British firm is entering India indirectly. Foreign law firms are not allowed to open office in India as of now, although the government has been toying with the idea of opening up the legal sector in line with the WTO norms.