Further FDI policy easing needed to promote LLPs

The recent introduction of foreign direct investment in limited liability partnerships (LLPs) has finally ended the debate initiated in 2009, when this relatively novel concept was introduced in India. LLPs are a hybrid form of doing business, combining the features of a company and a partnership firm.

Two distinguishing features of a LLP are that the partners carry limited liability for acts of the firm and the firm possesses a separate legal personality distinct from its partners. LLPs were introduced to provide an alternative to traditional partnerships, with their unlimited personal liability, and limited liability companies, with their statute-based governance structure.

Efforts made

Since the notification of the Limited Liability Partnership Act, 2008, the LLP as a business entity has not achieved the popularity that was expected. Permitting foreign direct investment (FDI) in LLPs is an effort to confer additional benefits on this legal entity and to promote its popularity as a business and investment vehicle.

This change in the FDI policy is the result of much deliberation between the government and industry participants. In September 2010 the Department of Industrial Policy and Promotion issued a discussion paper on foreign investment in LLPs, which invited suggestions on issues such as ownership, control, downstream investments and valuation. The discussion paper raised issues such as the need for FDI in LLPs; the feasibility of restricting FDI to sectors without caps; conditions and entry route restrictions; and treatment of FDI in LLPs at par with that in limited liability companies.

The government acknowledges that allowing foreign investment in LLPs will generate greater FDI, increase employment opportunities and bring in best international practices. However, the policy makers seem to have faltered in their implementation of this idea.

Phased implementation

FDI in LLPs is to be implemented in a calibrated manner, beginning with open sectors, where monitoring is not required. But while FDI in companies does not require approval under the automatic route, FDI in LLPs will require approval of the Foreign Investment Promotion Board for open sectors. Moreover, LLPs with FDI will not be eligible to make any downstream investments.

In making investment decisions foreign investors tend to opt for sectors and avenues where there is minimal governmental and regulatory influence. Sectors where no prior approvals are required are preferred. Keeping this in mind and given the above-mentioned approval requirements, the LLP form of business entity is not likely to be preferred over a limited liability company where no approval is needed.

The restriction that prohibits LLPs from undertaking downstream investments also raises concern. One possible rationale for this restriction could be difficulties in monitoring such investments and the risk that indirect foreign investment could be channelled into sectors where foreign investment is restricted. This restriction limits the scope of investment avenues for LLPs, further reducing the attractiveness of LLPs to foreign investors.

Positive step

The Limited Liability Partnership Act allows a LLP to have foreign companies as partners along with at least one resident partner. This is a positive step in the direction of encouraging foreign participation in LLPs. But the many restrictions on LLPs continue to be a dampener.

To promote LLPs, investing through a LLP will need to be at par with investing in other forms of business entities, particularly companies. This has not been achieved under the latest amendments to the FDI policy.

Several recent reports, including the United Nations Conference on Trade and Development World Investment Report, have highlighted the decline in FDI inflows into India. This has been attributed to factors such as macroeconomic concerns and delays in approval of large FDI projects. The current FDI policy concerning LLPs, though a step in the right direction, leaves much to be desired.

While it is understandable that the regulators are adopting a cautious approach as LLPs are still in an evolutionary stage in the country, the wide range of restrictions makes it unlikely that LLPs will soon become an attractive vehicle for foreign investment.

Further, detailed guidelines on issues such as pricing methodology for investments and exits, repatriation of surplus or capital from LLPs, and the mechanism for transfer of interests in LLPs to a foreign investor are still awaited. Investors are unlikely to decide their strategy until all the modalities of foreign investment in LLPs are clarified.

From all of the above, it is clear that the restrictions imposed by the policy framers on LLPs could to create impediments in attracting foreign investment and promoting LLPs as a business form.

Raghubir Menon (raghubir.menon@amarchand.com) is a partner and Shubhangi Pathak (shubhangi.pathak@amarchand.com) is a senior associate designate at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the authors and do not reflect those of the firm.