Proposed solutions to legal issues raised by SPV model

By Hemant Sahai, HSA Advocates

Implementing smart cities through special purpose vehicles (SPV), as proposed by the Smart City Mission Statement & Guidelines issued by the Ministry of Urban Development, raises several fundamental legal issues. In this column, we examine the feasibility of this model and propose nuanced alternative mechanisms that the states and urban local bodies (ULBs) can adopt to implement their smart city proposals.

Hemant Sahai at HSA Advocates
Hemant Sahai

The guidelines mandate the creation of an SPV, incorporated under the Companies Act, 2013, to implement each smart city proposal. SPVs so created will be responsible for all phases of smart city development projects. Each SPV will be promoted by the state or union territory (UT) government and ULB concerned, with equal shareholding between the two at all times. Private sector entities and financial institutions can take an equity stake in the SPV, provided that the state/UT government and the ULB together maintain a majority and equal shareholding and control of the SPV. Because of these requirements, the SPV – a 50:50 joint venture between the state/UT government and the ULB – will not fall within the definition of a “government company’ under the Companies Act.

Given the proposed implementation structure and existing regulatory framework governing the powers and functions of ULBs, issues that states/ULBs will need to address in implementing a smart city proposal are outlined below.

The guidelines encourage empowering the SPVs by delegating various rights and obligations of the ULB, in relation to the smart city project, to the SPV. The wide delegation contemplated raises various issues, including the constitutionality of the elected ULBs abdicating their functions. While the delegation by a state government of the powers and functions of a ULB to an SPV is constitutionally permitted, such delegation cannot be unfettered resulting in the delegator abdicating its role entirely.

The extent to which a ULB can delegate its powers and functions to the SPV will depend on the specific laws of the relevant state governing ULBs. Therefore, before a ULB delegates any powers to the SPV, the state government will need to analyse extant legislation and map the powers and functions that ULBs can legally delegate to the SPV, alternatively, amend the laws that create and govern the ULBs. The analysis of the existing legislation should be carried out from the perspective of understanding both the permitted process of delegation, and the principles which are to guide the SPV in its exercise of powers delegated to it, so that the delegation cannot be challenged as excessive or arbitrary.

Further, as a ULB’s power depends on enabling legislation passed by the relevant state, ULBs may have powers which vary from state to state. State governments often have delegated the powers and functions of ULBs to various parastatals, such as development authorities, housing boards, etc. There is a danger of an additional administrative entity being introduced into an already complicated network of administrative and regulatory authorities.

The guidelines contemplate that the state government and the ULB will exercise rights and powers and undertake several obligations in relation to smart city projects. It is not clear whether the SPV structure is to be adopted in perpetuity or whether after the smart city proposal is executed, the SPV will hand its functions back to the ULB. Therefore, unless the rights and obligations of the stakeholders are demarcated and recorded, the stakeholders may not own up to their commitments to the project, and delays, conflicts and disputes may arise.

Even though the SPV will be entrusted with significant government funds, it may not fall under the oversight of the Comptroller and Auditor General of India, unless the state governor or UT administrator specifically requires such an audit.

The functions and responsibilities of the SPV, as envisaged in the guidelines, may not require the wide delegation of powers recommended in the guidelines. Instead, the state/UT government and the ULB may consider empowering the SPV to execute the functions and responsibilities envisaged in the guidelines by entering into a master developer agreement (MDA) with the SPV. The SPV (as the master developer) could fulfil the functions of appraising, approving and sanctioning projects comprising the smart city proposal by entering into agreements with private parties under the terms of the MDA.

In relation to the role of parastatals, the MDA can specify and delineate the roles and responsibilities of the SPV and the parastatals (and other stakeholders), thus ensuring that there is no overlap or conflict in their roles and responsibilities. In respect of any deliverables, audits, funding or other functions of the parastatals, the MDA can include specific provisions. The obligations and the responsibilities of the various stakeholders can also be specified under the MDA and thus each stakeholder will have a contractual obligation to perform its duties and responsibilities, and the right to enforce specific provisions of the MDA against others, if required.

HSA is currently working with multilateral agencies and government authorities to design and craft the MDA structure.

Hemant Sahai is the managing partner of HSA Advocates. HSA is a full-service firm with offices in New Delhi, Mumbai and Kolkata, and with a correspondent relationship in Bangalore.

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