Issues commonly faced by Indian JV Companies

Foreign entities desirous of doing business in India have several options to enter the Indian market; out of which setting up a joint venture with Indian entity is one of the most preferred ways. The benefits of tying up with locals to do business could be significant. Domestic partners often understand the local market and culture better than foreign firms, also they are likely to have the necessary infrastructure in place to produce, distribute or sell products in the country. Despite that not every foreign company has been successful in India as the downsides of such joint ventures also need to be considered. Language and cultural differences, high degree of diversity among customers, dispersed market, high price sensitivity in the market, labour disputes, logistics, infrastructure, tax, regulatory procedure etc. are some of the issues commonly faced by foreign joint venture partners.

Statutory and Contractual Protections to Minority Shareholders

Statutory Protections

Since the minority shareholder in a company does not have much power to influence the management, their interests are sometimes disregarded. However there are certain rights granted by statute to safeguard their interest, such as:

Statutory Rights available to all shareholders:

a) Disclosure and Transparency

Companies Act requires every company to disclose certain key business and financial information to its shareholders. Furthermore, every shareholder, including minority shareholder, is entitled to receive balance sheet along with profit and loss account, directors’ report and auditor’s report, at least twenty one days prior to the annual general meeting.

b) Right to Inspect

As per the Companies Act, every shareholder is entitled to inspect books of accounts, statutory registers and minute books of the company anytime during the business hours.

Statutory Rights available to shareholders holding atleast 25% of the shares in JV Company:

a) Special Majority

Companies Act requires that certain major decisions have to be approved by a special resolution wherein approval is to be obtained from 75% of the shareholders by value. This may be an effective safeguard where the minority shareholders hold at least 25% shares in the joint venture. Some of the matters requiring special resolution are: issue of shares on preferential basis, change in registered office of the company, alteration of charter documents of the company, issue of sweat equity shares, buy-back of shares etc.

Statutory Rights available to minority shareholders:

a) Oppression and Mismanagement

Companies Act intends to provide greater protection to minority shareholders against oppression and mismanagement by allowing minority shareholder to file an application for relief with National Company Law Tribunal (‘NCLT’), when it is of the opinion that management or control of the company is being conducted in a manner prejudicial to the interest of the public, company or such shareholder. Companies Act empowers the tribunal to regulate the affairs of the company, pass orders for removal of managing director or any other director of the company, restricting transfer or allotment of shares etc.

b) Class Action Suits

In addition to remedy available to minority shareholders as explained above, concept of class action suit has been recently introduced under the Companies Act. Class action suit is essentially a representative law suit available to classes of shareholders that seeks to combine people seeking remedies for the same cause of action. It can be instituted against the company as well as the auditors of the company by shareholders if they are of the opinion that the management or affairs of the company are being conducted in a manner prejudicial to the interest of the company or member.

Contractual Protections

Parties when entering into a joint venture, particularly a private limited company, execute a joint venture agreement or shareholders agreement which governs the rights amongst the shareholders and lays down their rights and future obligations in terms of management, conduct of business etc. Given the limitation of protection under the statute, a minority shareholder may seek express contractual protections in the shareholders agreement, such as:

a) Affirmative Rights on Reserved Matters

Reserved or veto or affirmative vote matters or consent rights in favour of minority shareholder are some of the contractually agreed matters, provided in a shareholders agreement, popularly known as ‘Reserved Matters’, on which the decision is taken by the company with the ‘affirmative voting right’ of minority shareholder. Such matters cannot be implemented unless the partner agrees, even if the majority partner has sufficient shareholding to approve them. These matters generally protect the rights of the minority shareholders. Such matters are not day-to-day matters or in the ordinary course of business, but are usually on key issues such as: further issue of shares, modification of rights of existing shareholders, declaration of dividends, entering into indebtedness, mergers and acquisitions, new business etc.

b) Board Representation

Minority shareholder may seek a right to appoint a director as his representative on board of the company to stay informed about the activities of the company. Moreover, it may also require that director so nominated and appointed shall be a necessary part of the quorum. In some of the cases, companies also have an observer who does not have voting rights but his presence assures that there is no irregularity in the process of conducting meetings and the interest of minority shareholder is not being impeded.

c) Right of Pre-emption

In the event of need of additional capital during the life of the joint venture, new shares may be issued by the company which may further dilute the ownership of the minority shareholder. Therefore it is important to address this concern in the joint venture agreement, at the outset. Joint venture agreement may provide for ‘Right of Pre-emption’ to minority shareholder under which minority shareholder will be guaranteed the right to subscribe any new shares issued by the company, in the same proportion, before it is offered to a third party.

d) Right of First Refusal

Normally there is no restriction on shareholders transferring their shares. However, in order to protect the interest of remaining shareholders, shareholders agreement may lay down certain contractual rights such as Right of First Refusal (ROFR). ROFR essentially means that if a shareholder decides to sell its shares in the company, it solicits the offer in the market. On receipt of the offer, selling shareholder offers shares to the remaining shareholder on same terms. Selling shareholder can sell out its shares to the third party only if the remaining shareholder refuses to purchase shares on the same terms.

e) Drag along and Tag along Rights

It is common for majority shareholders to include a drag along clause in shareholders’ agreement wherein it stipulates that if a third party offers to purchase all the shares of the company and if it is acceptable to the majority shareholder, all the remaining shareholders will be bound to sell their shares to such third party on same terms. To protect its interest, minority shareholder may also bargain to include tag along clause in the shareholders agreement under which, minority shareholder can force the purchaser to acquire its shares along with the selling shareholder’s shares.

f) Put Option

Inserting ‘Put Option’ in a shareholders agreement gives an exit route to minority shareholder and enables it to sell its shares at fair value. A put option is a right but not an obligation to sell shares upon the occurrence of a specified event at a specified price. Thus, on happening of such event, if the minority shareholder wishes to exit from the company, it may give notice to the dominant shareholder to purchase its shares as per pricing guidelines notified by Reserve Bank of India under Foreign Exchange Management (Transfer or Issue of Security by Persons Resident Outside India) Regulations, 2000, applicable from time to time, and the dominant shareholder shall be obliged to purchase such shares.

g) Information covenant

Minority shareholder may require the company to provide periodical information relating to affairs and performance of the company, for example: balance sheets, cash flow statements projected budgets, business and marketing plans etc.

This is in addition to the statutory rights available to the minority shareholders, they can seek additional protection like the one mentioned in foregoing para under their shareholders contract to protect themselves. It is to be noted that terms of the shareholders agreement should be duly incorporated in Articles of Association of the joint venture company.

Deadlock Situation and Deadlock Resolution Mechanism

One of the main concerns in a joint venture is confronting and resolving deadlock. A deadlock usually arises when two parties having equal control in a joint venture or if any of the parties have affirmative voting rights in any matters of joint venture, have difference of opinion and neither party is convinced with the other party. It is very difficult to completely prevent a deadlock; however safeguards can be taken to reduce its possibility by clearly setting out detailed division of responsibilities and powers of both the parties, business plan of the joint venture etc.

Furthermore it is always helpful to have a deadlock provision and clear mechanism in the joint venture agreement at the outset. Having established which events are likely to trigger the deadlock provisions, the parties must decide what safeguards to include in joint venture agreement to prevent a deadlock situation and explicitly provide mechanism to resolve the same. There are various alternatives for resolving a deadlock situation which may arise during the lifetime of a joint venture, such as:

Third Party References:

One of the popular dispute resolution procedures for shareholders in a joint venture company is to refer disputes to an impartial outsider. Thus, in the event of deadlock, shareholders’ agreements sometimes confer a ‘golden share’ on an outside third party. However, the parties must address the potential costs of a reference to such a third party. If the dispute relates to contractual issue, joint venture parties may also refer the dispute to an expert or arbitrator. Perhaps the best approach is to draw a clear distinction between deadlock situations and disputes and to confine the involvement of arbitrators and experts to disputes.

Escalation Clause:

Under Escalation Clause, it is presumed that each of the shareholders involved in any deadlock situation is a company with several levels of management. If a deadlock cannot be resolved by management at the level that is involved in a corporate joint venture project the problem is then referred to the next level of management. If the managers at that level are not able to resolve the deadlock, it is again referred to the next level of management, and so on.

Russian roulette:

This is a much more drastic solution to deadlock as it inevitably leads to one of the joint venture party departing from the joint venture company. This can be triggered if the conflicts emanating between the joint venture parties affect operation and management of the company and decision-making process of the company is severally compromised. Under this procedure, one of the joint venture parties serves a written notice on the other party declaring its intention to buy its shares stating fair price for the shares. The other party has a stipulated time either to accept the offer or to make an equivalent offer to buy first party’s shares at the same price.

This deadlock resolution mechanism is usually suitable to companies having two shareholders. There are several variations on this procedure, for instance, instead of triggering a ‘buy or bought out’ notice, notice is made by either of the parties to submit sealed bids stating the price at which they intend to sell their shares to the other party. The party stating the lowest price sells its shares to the other party at the bid price.

Termination of joint venture agreement

Deadlock provision sometimes state that if the shareholders do not reach a consensus by a certain deadline, their joint venture agreement must be terminated and the business will be sold. It may have a desired effect of prompting a negotiated agreement, as this is likely to be the last thing that anyone wants.

Dissolution of JV Company and consent of foreign minority shareholders in the same

As per the Companies Act, companies can be wound up voluntarily if the company passes a special resolution for the same. Furthermore, court may wound up the company if it is of the opinion that it is just and equitable to do so. Amongst other eligible applicant, minority shareholder of the company is also entitled to file an application with the court for winding up if it shows that the company’s affairs are being conducted in a manner prejudicial to the interests of the company or its shareholders and it is just and equitable to wind up the company.

There have been instances where in the courts have admitted winding up petitions after observing that the parties have lost confidence amongst them and it is not possible to carry out business together. The foregoing para discusses case studies on dissolution of joint ventures:

(a) “International Caterers Pvt. Ltd and Mr. Manmohan Singh Vs. Manor Hotel Pvt. Ltd (2007) 137 CompCas544 (Delhi)”.

A joint venture was formed between M/s TCG Developments (I) Pvt Ltd. and Mr. Manmohan Singh with shareholding in the ratio of 60:40 respectively, for running a hotel business and a joint venture agreement (JVA) was entered between the parties for the same. JVA provided that Mr. Manmohan Singh through its company, International Caterers Pvt. Ltd (ICPL), would provide consultancy services to the company in respect of the renovation, refurbishment and its effective management and in consideration thereof, ICPL will be paid a remuneration of the agreed amount. The renovation and refurbishment of the property was undertaken and the company started running a hotel therein, however it appeared that the company could not run the business successfully. Various conflicts arose between the parties and a deadlock was ensued mainly on the following grounds: (a) dues of ICPL towards consultancy charges were not paid by the Company, and (b) the Company entered into a contract with a third party to run and manage the hotel without the consent of Mr. Manmohan Singh. Thereafter Mr. Manmohan Singh filed winding up petition with the Court.

High Court of Delhi relied on the judgment of Delhi High Court in Nestle S.A and others Vs. I.D. Kansal and others wherein the court opined that “when there were differences between the parties with regard to very basics as to the management of production in factory of the company and on account of these differences deadlock occurred in as much as after agreeing to certain terms on the basis of which amended joint venture agreement was prepared and signed by the petitioner, the respondent declined to sign the agreement, it was proper to wind up the company.”

The High Court also referred the judgment of Supreme Court in Seth Mohan Lal and another Vs. Grain Chambers Limited and others wherein the Supreme Court laid down the parameters which are to be borne in mind while making a winding up order: “In making an order for winding up on the ground that it is just and equitable that a company should be wound up, the court will consider the interests of the shareholders as well as of the creditors. Substratum of the company is said to have disappeared when the object for which it was incorporated has substantially failed, or when it is impossible to carry on the business of the company except at a loss, or the existing and possible assets are insufficient to meet the existing liabilities.”

The High Court also relied on the judgment of Calcutta High Court in the case of Modern Furnishers (Interior Designers) (P) Ltd wherein the following observations were made: “If the parties have lost all confidence amongst them and it is not possible for them to carry on business jointly or provide for an acceptable management, the only way out seems to be to wind up the company and if necessary in the instant case to dissolve the existing partnership. The assets, if any left, will be available to the parties for distribution.”

The High Court admitted the winding up petition and appointed an Official Liquidator to take charge of the assets and records of the company.

(b) Tenneco Mauritius Limited Vs. Bangalore Union Services Limited, Dr. V. Krishnamurthy, K. Jayakar and Hydraulics Private Limited (2003) 2CompLJ315(CLB)

A joint venture was formed by a foreign block and Indian block holding 51% and 49% of the equity shares respectively to carry on the business of manufacturing of automobile components. Shareholders agreement provided that one director from each block should be present in board meetings to constitute quorum. After few years, both the parties decided to induct further equity in the same proportion. Foreign block filed petition before the Company Law Board (CLB) with the allegations that the Indian block had failed to fulfill their financial obligations of infusing proportionate equity share into the Company and had also filed to pay off the Company’s debts which resulted in a situation of deadlock between both the groups. The Indian block filed petition alleging that the foreign block had failed in its commitment to provide management, technology, marketing and board level support to the Company in accordance with the Shareholders Agreement and that the Foreign block supplied unsuitable machinery at huge cost which resulted in high production cost.

Company Law Board observed that “In view of the present disputes and in view of the provisions in the Article relating to quorum in board meeting and fundamental matters requiring special resolution in the general meetings, deadlock in future is a definite possibility due to which the parties are unlikely to carry on the affairs of the company jointly in the best interest of the company. Parting of ways would alone be in the best interest of the company.” The Board ordered both the groups to furnish their bids indicating therein the price per share at which they were prepared to purchase the shares of the other group. It also directed that whichever group acquired the shares of the other group would ensure that all unsecured loans paid by the other group as per the accounts of the company would also be discharged within two months and also would replace the bank guarantees given by the other groups.”

Conclusion

Thus when a foreign entity decides to pair up with a local partner for forming a joint venture to do business in India, consideration must be given to statutory safeguards and rights available to minority shareholders, as well as contractual rights that can be captured in the joint venture agreement. Furthermore planning the exit of joint venture partnerships in advance enable companies to limit their losses, avoid or de-escalate disputes and minimize disruption to their businesses. Thus parties should also contemplate various exit and termination scenarios upfront.