What is a Joint Venture?
A commercial arrangement entered into between two or more parties, who agree to pool their resources, to accomplish an intended project (or other business activity) is referred to as a Joint Venture (“JV”). Effectively, it is a collaboration between two companies. Such collaboration can be either purely financial or technical-cum-financial. In the Indian context, most of the JVs are between a foreign company and an Indian company and are primarily to bring in newer technologies to India.
Types of JVs
JVs can either be greenfield or brownfield. In greenfield JVs, both the parties typically incorporate a new company, fund it as per the agreed ownership ratio, and commence the new business activity as contemplated in the JV agreement. In case of brownfield JVs, the Indian party typically demerges a division or an undertaking by way of slump sale into a separate company, where a foreign partner is inducted at a valuation, not below the fair value determined as per the pricing guidelines specified in rule 21 of the FEM (Non-Debt Instruments) Rules, 2019 (“NDI Rules”). Brownfield JV can also be set up by demerging (through the NCLT route) the relevant division or undertaking under a Scheme of Arrangement as per Sections 230-232 of the Companies Act, 2013.
Historical Evolution of JVs in India
Pre-July 1991, JVs in India could be attributed to sectoral caps prescribed under the Foreign Exchange Regulation Act, 1973 (“FERA”), and the extant Foreign Direct Investment (“FDI”) policy of the Government of India (“GoI”), which left foreign investors no choice but to collaborate with Indian partners. Since July 1991, the GoI has been progressively liberalising the FDI regime. FERA has been replaced with the Foreign Exchange Management Act, 1999 (“FEMA”), with liberal sectoral caps and the opening up of a large number of sectors to foreign investment, which were earlier reserved for domestic investors. In fact, under the latest consolidated FDI Policy,[1] save for print media, defense & aerospace, multi-brand retail trading, civil aviation, etc., 100% FDI is allowed in all other sectors.
Need for JVs
Owing to the synergies that JVs provide – combining of expertise and resources – they are advantageous in nature. Some of the other advantages of entering a JV are:
- Reduced financial burden on businesses with high fixed costs.
- Reduced exposure to, or investment in non-core assets.
- Overcoming any strategic gap in a critical capability, which is either too expensive, or will take too long to develop internally.
- Risk sharing, when starting a business; enhancing the parties’ ability to compete, increasing economies of scale, and allowing access to new markets, distribution channels and technologies, thereby widening the overall customer base of the business group.
Impact of Liberalisation:
With progressive liberalisation of the FDI policy, many foreign companies decided to go solo. They either acquired the Indian partner’s stake or started a new venture with 100% ownership, resulting in the JV legal entity becoming irrelevant and dormant. This resulted in the GoI coming out with the controversial press note 18 (1998 series)[2], which required foreign investors with existing JVs with Indian companies to seek prior GoI approval and justify the need for starting a new entity. In fact, in some instances, foreign investors were also required to get no-objection certificates (“NOCs”) from their Indian partners before starting a new business in the same or aligned field. This led to many inappropriate practices including the practice of foreign partner obtaining NOC upfront from the Indian partner at the stage of signing the JV agreement.
The said Press Note 18 was acting as an irritant to many foreign investors, and finally in January 2005, the GoI repealed the Press Note 18 by a new Press Note 1 (2005 series).[3] The new press note provides for prior approval of GOI only in cases where the foreign investor had an existing JV or technology transfer agreement in the ‘same field’. The onus to provide requisite justification and proof to the satisfaction of GOI that the new proposal would or would not in any way jeopardize the interest of existing JV or technology agreement could be equally on the foreign investor/ technology supplier and the Indian partner. Further, the requirement of prior GOI approval was done away with for new JVs formed on or after 12th January 2005. The Press Note 1 further provides that the JV agreement may embody a ‘conflict of interest’ clause to safeguard the interest of JV partners in the event one of the partners is desirous of setting up another JV or a wholly owned subsidiary in the ‘same field’ of economic activity.
Why do they Break-Up?
Unfortunately, most JVs do not stand the test of time. The average lifespan of JVs is usually 5-7 years from the commencement of their union.[4] In fact, Deloitte conducted a study of JVs in 2010, which indicated the average track record to be only three years.[5] Once the initial honey-moon period is over, 60-70% JVs terminate their relationship.[6] In a study conducted by J.P. Killing in 1982, it was found that 36% of JVs from a sample pool of 37 international JVs, had broken up.[7] Another study conducted by B. Kogut in 1989, with a sample size of 92 JVs based in the US, reflected a 50% termination rate by the sixth year of their venture. Another study conducted in 1996 by the International Finance Corporation (World Bank) in six developing countries including India indicated the termination rate of JVs (from a sample size of 70 JVs) to be at 27%.[8]
There are varied reasons why such JV relationships suffer a break-up. The author of this blog has endeavored to identify the major causes behind the inevitable break-up of such ventures.
Reasons for break-up
Business plan disagreement
One of the principal reasons why many JVs have broken up are the fundamental differences between the two partners on the business plan. Most companies have five-year business plans and annual operating plans. Problems arise due to fundamental differences in business philosophies and the way each partner perceives the future. Additionally, when partners have different risk appetites, it results in major differences in business plans within a few years of setting up of the business. To deal with such issues, many lawyers have recommended having an agreed 5-10 years’ business plan as an annexure to the JV agreement, to avoid differences of opinions at least in the initial phase of the JV. Business plan changes are normally veto items, with each partner having the right to block the resolution. It is, therefore, important that business plans be agreed upon upfront.
Changes in FDI policy: Relaxing sectoral caps
India witnessed the formation of many JVs in the initial phase of industrialisation, until 1991, when there were sectoral caps and foreign participation was restricted to 40% in most sectors. In addition, there were stringent industrial license requirements and exchange control restrictions under FERA. Post liberalisation, in July 1991, many sectoral caps were dismantled or significantly relaxed. Consequentially, foreign investors who had opted for a JV with an Indian partner due to the FDI restrictions chose to part ways and own 100% of the enterprise. In many cases, where the foreign collaborator felt that the Indian partner was not adding any value, they terminated the JV to gain 100% ownership rights over the enterprise. There are several instances of JVs breaking up due to FDI relaxations.
Changes in financial abilities of JV partners
There are several instances of JVs breaking up because the Indian partner could not subscribe to new shares issued by the JV from time to time. Many foreign collaborators in fact use it as a business strategy to tire out the Indian partner by making frequent capital calls. Multinational companies with deep pockets have much better capacity to finance the Indian JV company than the Indian partner. The inability of Indian partners to subscribe to the entitlements in the rights issue, leading to dilution of shares, has led to the breaking up of many JVs.
Different business philosophies or practices/ cultural differences
JVs also break-up because of different business practices and philosophies, and different management styles and systems. There could also be difference in the speed of action and tempo between the foreign and the local partner. The foreign partner could have inadequate knowledge about the history, aspirations, language, customs and culture of the people of the host country. This could result in lack of synergy between the two partners and hence lead to cultural and philosophical differences on how to run the JV. It is important to promote cultural integration to avoid professional differences.
Even if both the foreign and the local partner speak the same language, there could be difficulty in understanding and managing expectations. Both partners could conclude a meeting and interpret the same discussion differently. There may also be differences in work ethics, value systems and the corporate culture within teams and the JV.
Disagreements over disposition of earnings
Distribution of net profits maybe an issue. One party may prefer to distribute as much, and if possible, the entirety of the net profit as dividend. Other may want to conserve the earnings for future needs or distribute 50% of the earnings while saving the rest and keeping it in the JV to strengthen its economic position. There have been many JVs which have broken up due to disagreements over disposition of earnings. Thus, dividend distribution policy should be agreed upfront and be added in the JV agreement to prevent any potential impasse in the future.
Unperceived market changes and disruptions
Partners usually have different risk profiles and appetites for risks, owing to different backgrounds, experiences and exposure to market risks. If a JV’s controls and risk appetite concerns are left unaddressed, it could undermine its long-term success in the face of unperceived market changes and disruptions. The JV agreement should contain tailored or dynamic terms, cementing its position and that of its shareholders while ensuring efficient decision-making and reduced risks of governance gridlock. Further, establishment of adequate controls and risk management is necessary to avoid deadlock between partners and ensure productivity and growth of the JV.
Macroeconomic uncertainty, geopolitical instability and technological change
Another reason behind JVs parting ways could be geopolitical instability, which could be due to change in the political regime or hostile government policies. A change in investment policies and FDI regulations could lead to breaking up of JVs. For instance, if a government bans investments or exports from/ to another country, then the JV that is in the business of exporting to such countries would naturally break-up. However, such issues could be resolved through discussions on further course of action, which both the partners could undertake to prevent the breaking up of the JV.
Change in strategy and/ or capital allocation policy of a partner
There could also be non-market changes, such as change in strategy or capital allocation policy of a partner, after the formation of a JV. Maintaining an agreement on strategy is not easy, especially if both or either of the partners is moving in a different direction. This could lead to confusion and delay. Differences may arise between partners with respect to financing the JV if one partner makes any changes in the policy without obtaining the consent or approval of the other. A set of guiding principles could be set to keep up with the changing circumstances as it could improve the chances of establishing and maintaining a successful JV.
Change of control
Parent level change of control of multi-national companies is yet another factor contributing to the break-up of JVs in India. The new owner of the parent company may not consider the Indian JV business as relevant to their international operations. Several Indian JVs have parted ways due to parent level change of control.
Concluding Thoughts
Disputes between the JV partner have also arisen at the time of exit on the valuation of shares. If a foreign partner is exiting the JV, the exit price cannot be higher than the fair value of the shares as per the NDI Rules. Conversely, if the Indian partner is exiting the JV, the exit price cannot be lower than the fair value of shares. Disputes can also be on the ownership of jointly owned intellectual property rights and corporate name of the JV company. Globally, JVs have not lasted long, with their average lifespan being about 5-7 years. JV longevity can increase if both partners display maturity, and if the CEO deals with both the partners in equanimity. The Chairman of the JV company plays a critical role, and hence, he/ she should ideally be an independent director, though the GoI has waived the requirement of appointing independent directors on the Boards of JVs vide its Circular dated Sept 5, 2017.[9] So long as no partner tries to dominate the other and believes in fair play, JVs can continue for much longer. The key is to realise that the JV creates a win-win situation for both the parties and both the parties continue to bring value to the JV company.
[1] Consolidated FDI Policy 2020, Department of Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, Government of India (Effective from October 15, 2020) Press Note No (dpiit.gov.in).
[2] Press Note No. 18 (1998 Series), Department of Industrial Policy and Promotion, Ministry of Industry, Government of India, pn12.pdf (dpiit.gov.in)
[3] Press Note No. 1 (2005 Series), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India, pn1_2005_0.pdf (dpiit.gov.in)
[4] Kabiraj, T. and Sengupta, S., 2016, A Theory of Joint Venture Formation and Break-up.
[5] Deloitte, 2020, A Study of Joint Ventures: The Challenging World of Alliance.
[6] Mundkur, P., 2016, Why do Indian Joint Ventures Fail.
[7] Killing, J.P., 1982, How to make a global joint venture work, Harvard Business Review 60, 120-127
[8] Miller, R.R., Glenn, J.D., Jaspersen, F.Z., and Karmakolias, Y., 1996, International joint ventures in developing countries: Happy marriages?, Discussion Paper No. 29, International Finance Corporation, World Bank, Washington, D.C.
[9] General Circular No. 09/2017, Ministry of Corporate Affairs, Government of India, GeneralCircular_05092017.pdf (mca.gov.in)
