Bitter pill to swallow for foreign investors in pharma

By Vikrant Kumar and Anina D’Cunha, L&L Partners
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Partially in response to a number of high-visibility inbound acquisitions in the Indian pharmaceutical sector, the government of India decided to bring brownfield acquisitions completely under the government approval route in November 2011. Greenfield acquisitions, however, remained under the automatic route. While granting approvals, the (then) Foreign Investment Promotion Board began imposing stringent conditions prohibiting non-compete restrictions on Indian parties and requiring the maintenance of status quo on production and supply of drugs and consumables in the national list of essential medicines and R&D expenditure. In the following years, these conditions were formally introduced to the foreign direct investment (FDI) policy. In June 2016, realizing the need to encourage brownfield FDI, the government decided to allow investment of up to 74% under the automatic route.

investors
Vikrant Kumar
Partner
Luthra & Luthra

Last year, the government also brought FDI in companies without operations or downstream investments under the automatic route. This was, however, subject to conditions that the intended activities of such companies should fall under sectors that are allowed under the automatic route and in sectors without foreign investment-linked performance conditions, which was defined as sector-specific conditions for FDI.

This leads to some interesting situations. If a minority Indian partner incorporates a joint venture company and the foreign partner subsequently infuses 74% capital into the venture over a few months, this raises the question whether the investment will be classified as greenfield or brownfield. Logically, one can argue that the investment should be classified as greenfield if the venture has yet to begin operations in earnest at the time of the investment. There is, however, another conundrum. Clearly, FDI in companies not having operations is permitted under automatic route only if intended activities also fall under automatic route and in sectors without FDI-linked performance conditions.

The non-compete restriction is, however, equally applicable to FDI in greenfield and brownfield categories. Given the definition of the term, an FDI-linked performance condition is not limited to only performance but includes any sector-specific conditions. A technical reading would suggest that the induction of foreign capital into the joint venture would require prior approval from the government, even though the investment could be argued to fall under the greenfield category. This is, however, unlikely to have been the intention and a formal clarification would be welcome.

investors
Anina D’Cunha
Asociate
L&L Partners

Consider further scenarios. The joint venture needs a large equity infusion for capacity expansion after some years and the Indian partner is only able to contribute a portion of its pro rata share while the deep-pocketed foreign partner is willing to make up the shortfall. This then begs the question whether the matured venture would be treated as a brownfield investment, and if so, would the incremental investment by the foreign partner and dilution of the Indian partner’s stake to below 26% require government approval? While a plausible view, consider other situations.

The parties began the venture with an 80:20 shareholding ratio and now need to infuse additional equity for capital expenditure and are each able to contribute their respective shares, but the venture has matured and can be viewed as brownfield.

Another situation that the parties could face is that the Indian partner can only contribute a portion of its share and the foreign partner can make up the shortfall. This gives rise to a dilemma. While it could be reasonably argued that the first situation should not be viewed as a case of brownfield investment requiring approval, this is less convincing in the second situation.

This could then lead one to suggest that the parties need to make capital projections for the foreseeable future and inject the required equity before the venture matures if they want to avoid taking the government approval route for additional equity infusion. While projections can quite easily be made, it is difficult to make a viable business case for funding the venture excessively in advance – given the cost of capital and better uses for generating returns.

While a workaround could be evaluated using special purpose vehicles for each expansion project or partly-paid up shares, formal clarifications on these matters would be welcome and allow parties to structure joint ventures with more certainty, including deadlock buyout mechanisms.

Vikrant Kumar is a partner and Anina D’Cunha is an associate at L&L Partners. The views expressed are personal and intended for general information purposes. They are not a substitute for legal advice.

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