Despite all the dragon-and-elephant comparisons between China and India, Asia’s rising superpowers, the truth is that the two countries could not be more different.Whereas China prides itself on its uncompromising efficiency and clinical growth, India is more often than not perceived as loud, colourful and messy, mired in scams and scandals, and with individual achievements usually tending to happen in spite of the existing system, instead of because of it. The legal sector, then, is not vastly different:
despite the cumbersome nature of the judicial system (it is estimated that the current backlog of cases will take several decades to clear, if matters are disposed of at the current rate), much progress is happening, be it through the efforts of judges, lawmakers and governmental bodies, or through the perseverance of individuals and entities rising above the chaos and the din. And yet, as always seems to be the case in India, much work needs to be done.
Thus, in recent months, we have seen some interesting developments in a variety of sectors in India’s legal scene. In banking and finance, there’s been the rise of the debt market; in projects, energy and infrastructure, there’s been a great deal of activity in power, roads and other areas as the government tries to get its act together; in dispute resolution, mediation is emerging as a strong alternative to both litigation and arbitration; and in tax, the Indian government is taking a much harder line when it comes to cross-border matters. In short, it has been just a regular year in India, a market that despite its obvious flaws, still holds much allure for investors, and continues to be one of the most compelling stories in the world today.
Corporate/M&A: Quantity over size
Akshay Chudasama, a partner with J. Sagar Associates, said that it has been a generally good time for M&As. He noted that while M&A activity has never really returned to the heady days of 2007, there has still been a “lot of activity” in the recent past. According to consulting firm Grant Thornton, the value of merger and acquisition deals involving Indian companies dropped 56 percent year-on-year to $5.91 billion in the third quarter of 2011, but there was an increase in the number of transactions, with the quarter registering a total of 149 deals. Of these, 86 were domestic in nature, with the cross-border deals totaling $4.88 billion, mounting to 80 percent of the total.
Cyril Shroff, managing partner at Amarchand & Mangaldas & Suresh A. Shroff & Co, said that one of the factors behind the increase in the number of M&As has been the financial downturn. “The economic slowdown has placed increased impetus on the need for restructuring and deleveraging books,” he said. “So, there is an uptrend in hiving off non-core assets, restructuring debt and reorganizing business. This, in turn, has added to the M&A momentum. Some examples include the Essar restructuring and the Fortis Hospitals acquisitions.” Chudasama noted a recent trend in consolidation of mutual funds. “This period has really separated the men from the boys,” he said.
Low Kah Keong and Ong Sin Wei, partners at Singaporean firm WongPartnership, said that the sectors in India showing the most promise for foreign investors are telecom, pharma and life sciences. “In particular, a noteworthy deal was Japanese company SoftBank’s $200 million investment in Bangalore-based mobile advertising company InMobi,” they said. “Given the country’s young demographic, these areas have massive potential for growth.”
Shroff said that infrastructure will be a major M&A area in the next year or two. “India is in need of improving its infrastructure – therefore all industries associated with the Indian infrastructure sector is definitely a huge business opportunity in India,” he said, adding that with the possible liberalization of the retail / insurance sectors on the horizon, deals in this space will be on the rise as well. The telecom sector accounted for the maximum M&A deals in August, with other key sectors including mining,
pharma & healthcare, oil & gas and infrastructure. Shroff expects telecom to be at the forefront of M&A activity in the near future too, with banking and fast moving consumer goods becoming key areas as well.
Banking and finance: Rise of bond market
One of the most notable developments in India’s finance sector in recent times has been the way the Reserve Bank of India (RBI) has slowly been opening up the derivatives space. In 2010, it introduced currency options, and this year it drew up final guidelines for credit default swaps (CDS) on corporate bonds, the introduction of which it had first proposed in 2003. “In this respect, the RBI has shown itself to be quite responsive to the needs of the market,” said Piyush Mishra, partner at Luthra & Luthra law offices. “However, it still continues to take a cautious approach to derivatives, with things like exotic structures still prohibited under RBI guidelines.”
Mishra said that the most important trend he expects to see in the near future is the rise in importance of India’s still-nascent bond market, something that Goldman Sachs has predicted will grow to $1.5 trillion by 2016. “If you’ve followed the last few years, you will have noticed that bonds have been better performing than loans,” he added. It is a sentiment echoed by Shroff of Amarchand, who noted that the subdued performance of equity markets over the last few months has led to an increase in the number of debt issuances by Indian companies. Mishra said, “In particular, infrastructure bonds show most promise.” Indeed, the Indian government has been doing its best to increase foreign investment into Indian infrastructure debt in recent times, by reducing the lock-up period for foreign entities investing up to $5 billion in infrastructure bonds, and also lifting the limit on foreign holdings of corporate infrastructure bonds to $25 billion from $5 billion.
In September, the RBI raised its key lending rates by 0.25 percentage points to 8.25 percent, its 12th rate increase in the past 18 months, and there was every sign that it would increase this policy lending rate, or “repo rate,” to 8.5 percent by the end of October, as a measure of combating stubbornly high inflation. Shroff of Amarchand said that this has led to corporate preferring to borrow from overseas lenders, or ECBs over domestic banks and financial institutions. Another trend he has noticed is that, given the international economic condition, coupled with the Indian political scenario, both the borrowers as well as the lenders are adopting a “rather cautious approach, and the risk appetite has certainly gone down.” Nevertheless, he said the outlook for the banking sector in the next couple of years is “definitely positive,” with the interest rate regime, the rupee-dollar exchange rate and the continuation of liberalisation of ECBs the most significant areas to watch.
Capital markets: A quiet spell
For the last year or so, a feature of India’s public markets has been how quiet they’ve been. “Public markets have been a bit dull,” said Somasekhar Sundaresan, a partner at J. Sagar Associates. “There have been more filings than closings. Even surveys that look at capital markets have shifted from counting closed deals to counting offering documents that have actually been filed.” He added that the process of accessing public markets remains a cumbersome one. “Also, the time lag between filing an offering document with Securities and Exchange Board of India (SEBI) and actual closing continues to remain a big one,” said Sundaresan. “On the other hand, private placements to qualified institutional buyers, who are ‘big boys’ and for whom disclosure requirements are more linked to materiality rather than volume of disclosure, are easier to transact and close.”
Nikhilesh Panchal, partner at Khaitan & Co, said that the general global economic slowdown has adversely affected the capital markets in India as well. “The number of transactions that have been executed this year has been comparatively lesser than last year and this trend could continue till some recovery in global financial markets is seen,” he said. “Moreover, the introduction of the SME listing process and the rights issue of IDRs is yet to be tested due to the market conditions.”
He added that unstable market conditions have also caused a jump in the number of debt issues. “With investors insisting on an assured return in a bear market,” said Panchal, “this financial year has seen four debt issues (public) as compared to the one debt Issue in the last financial year. We expect this trend to continue as well.” (See the Banking/Finance section of this report for more about the rise of the debt market). Until the markets stabilise, companies will continue to issue debt instruments to raise funds, he said. “We are hopeful that the market will stabilize over the next year and the volume of equity issuances should consequently increase.”
Meanwhile, Sundaresan hopes for greater reforms in the quality of disclosures required under regulations so that lawyers can play a more meaningful role in the capital markets. “Today, the role of merchant bankers and capital markets lawyers is in material part, one of data aggregation and presentation, rather than one of dynamic consideration of facts and circumstances to ensure a more focused and clear disclosure of material facts,” he said. “We want focus as usual on a smaller number of quality transactions rather than try to score league points with the number of deals bagged.”
Tax: Getting tough
The past year has seen Indian tax authorities more aggressive than ever when it comes to cross-border matters, something what Bijal Ajinkya, partner and co-head of Nishith Desai Associates’ tax practice, said is “creating immense uncertainty for foreign investors.” In particular, she cites the examples of the Vodafone and Idea Cellular tax avoidance cases. In Vodafone’s case, the Bombay High Court ruled last year that the operator was liable for taxes on its $11 billion acquisition in 2007 of a majority stake
in Hutchison-Essar, even though the deal was made overseas between two overseas parties, possibly creating the precedent that overseas transactions involving Indian assets would be subject to local taxation.
Meanwhile, in the Idea Cellular case, the Bombay High Court earlier this year supported the Indian Income Tax Department’s contention that taxes were liable from the sale of AT&T’s 16 percent stake in Idea Cellular India to Aditya Birla Nuvo, even though the transaction was routed through AT&T’s Mauritian holding company AT&T Mauritius. The verdict could have far reaching implications on transactions involving Mauritian holding companies, and may impact foreign investment in India in general, as nearly 42 percent of FDI into India is routed through Mauritius, and about 40 percent of the foreign institutional investor fund flow into the country is believed to be routed through the island nation. Companies currently take advantage of the tax treaty between India and Mauritius, which allows them to escape tax altogether.
Meanwhile, the government is also becoming proactive in partnering with the OECD especially on issues such as countering money laundering. India has recently signed a number of Tax Information Exchange Agreements have been signed with tax haven countries, said V. Lakshmi Kumaran, founder and managing partner of Lakshmi Kumaran & Sridharan. The Indian Supreme Court is also taking a hardline view against undisclosed wealth stashed away in tax havens. “If the source of money coming into India is not clear, then the inflow may not be allowed,” he said.
However, Kumaran noted that the tax sector has also seen many positives of late. In particular, he pointed out a radical way in which customs duties are assessed, with importers now allowed to conduct their own assessment. “This has resulted in goods being released much sooner, thus saving companies millions of dollars,” he said. He added that he has also seen a lot less litigation in the tax sphere of late, with companies opting to draft transparent agreements that reduce the possibility of litigation in the future.
Two important bills are looming in the horizon. One is the Direct Taxes Code Bill (DTC), which is currently pending before the Indian parliament, with the government hoping to implement it from financial year 2012. New provisions in the DTC, said Ajinkya, are likely to fundamentally impact the way investors invest and do business with India. On the other hand, the introduction of Goods and Services Tax (GST) will subsume federal and state taxes like excise, customs, service tax, sales tax and VAT. This, said Kumaran, will greatly clarify the taxation of services, while bringing uniformity to indirect taxes.
Dispute resolution: Mediation to the fore
With the massive backlog of cases that India’s judicial system is currently struggling under, it is no surprise that courts have now started to look at extrajudicial means to resolve disputes, and this has led to the growing popularity of mediation in recent times. “The most important developments, which have taken place in India during the last couple of years, have been increasing emphasis on mediation as means of dispute resolution,” said Lalit Bhasin of Bhasin & Co.
He said that a significant factor behind this has been the corresponding decline of arbitration. “Arbitration has become very expensive and prolonged and has not proved as an effective alternative to litigation,” said Bhasin. “It is monopolised by retired judges who charge exorbitant fees. Additionally, there is considerable intervention by the courts in the arbitration process. Effective institutional arbitration is conspicuous by its absence in India. There is also the problem of enforcement of awards due to court intervention.”
It is because of these factors that mediation is being encouraged and promoted by the courts, by the chambers of commerce and some specialized institutions, he said. Mediation centres have been set up in some High Courts in India and these have already begun providing effective mediation to parties. During its six years of existence, the Delhi Mediation Centre had disposed of 38,221 cases until Aug. 31, with a settlement rate of 69.2 percent; a couple of other courts had a settlement rate of close to 80 percent. Similarly, the Bangalore Mediation Centre had mediated 77 percent of the 18,896 cases referred to it until April 1, a little more than four years, with a 62 percent settlement rate.
However, with the slow pace at which litigations move, and given the frustrating arbitration process, Bhasin said that his firm advises clients that “a bad settlement is better than successful litigation.” “We encourage and advise our clients to settle their disputes in a spirit of give and take until and unless some important principle is involved where a legal fight is inevitable,” he said. “This approach has found favour with our clients and the courts for the reason that the clients save considerable money, effort and time.”
Bhasin also sees some significant changes taking place in the dispute resolution sector in the next year or two. “In the High Courts, special benches are being constituted for commercial disputes to be put on a fast track,” he said. “The Competition Commission is also gearing itself to handle matters without undue delay. The disputes relating to shareholders under the Companies Act would also be taken up and decided expeditiously once the dispute resolution mechanism under the Companies Law is put in place.”
TMT: Season of change in Bollywood
The 2011 film Mausam (“Seasons”) might have been a little more than your run-of-the-mill Bollywood tale of love, separation and reunion, except that it was the first film to be partfunded and produced by a private equity firm. Released on Sept. 23, the film received more than 100 million rupees ($2 million), or about a third of its budget, in funding from Vistaar Religare Film Fund, the largest production-focused PE investment in Bollywood. The fund, with a corpus of 2 billion rupees and co-promoted by Indian financial services behemoth Religare, is India’s first SEBI-approved venture capital fund in the sector.
According to Gowree Gokhale, a partner and head of the TMT practice at Nishith Desai Associates, this was one of the major developments in the entertainment industry of late. “Traditionally, producers would be looking to family and friends for funding for their film,” she said. “For the first time we are beginning to see structured financing in the film industry, and it could change the way that films are funded.” She added that this could particularly impact independent cinema, and lead to novel business models to ensure the profitability of a film.
But that’s not the only notable trend in the entertainment industry in recent times, Gokhale said. In the last year or so, major global TV networks have entered or are looking to enter the Indian market through JVs. In March this year, Bertelsmann-owned RTL Group signed an agreement with India’s Reliance Broadcast Networks to first launch English-language channels, and then channels in local languages. It was Reliance’s secondsuch agreement in the last year or so; in 2010, it got into an equal joint venture with U.S. TV network CBS to launch two English entertainment channels and a third youth-oriented channel.
Meanwhile, the telecommunications sector, one of India’s most vibrant sectors, continues to remain in a state of flux, following last year’s 2G spectrum scam, which involved government officials illegally undercharging mobile operators for frequency allocation. “The telecom sector may undergo significant changes due to implementation of 3G, bandwidth allocation, and issuance of fresh 2G licenses,” said Atul Dua, partner at Seth Dua & Associates. “Telecom operators, in order to increase ARPU, may focus on data services and VAS. The telecom industry may see consolidation in terms of the number of operators.”
Projects and energy: Road to better infrastructure
According to Akshay Jaitly, partner at Trilegal, the vast majority of investment in India’s projects and energy space seems to be reserved for the power sector, and this is divided between both renewable and conventional power. “The vast majority of investment in the conventional (thermal power) sector has come from domestic developers such as Lanco, Reliance Energy, Tata Power, GVK etc.,” he said, “while the renewable power sector has seen a fair amount of interest from both Indian and international developers which comprise both funds – including companies backed by private equity – as well as strategic independent power producers such as AES and CLP.” He added that his firm has also seen a growing trend of M&As in this sector both in relation to renewable and conventional power projects. “We expect this trend to continue,” Jaitly said.
Meanwhile, in the infrastructure space, the roads sector has seen the most activity along with some activity in ports and airports. “Again, in addition to the continuing role out of new projects under the National Highway Authority of India (NHAI), some M&A activity is beginning to kick-off particularly with equity lock-in periods of some of the earlier NHAI concession agreements coming to an end,” Jaitly said. Speaking of financing for both power and infrastructure projects, he added that it has been domestic in origin, “though in the recent past international banks, multilaterals and ECAs have also shown an increased willingness in financing renewable energy projects.”
A significant recent development in the projects and energy sector was the introduction of the new Land Acquisition Bill 2011 in early September. Jaitly said this imposes much higher compensation and other ongoing obligations on both the government as well as the ultimate transferees of compulsorily acquired land. “This development has a potentially significant impact for any business looking to use large tracks of land through a compulsory acquisition process,” he added.
Looking ahead, Jaitly said the infrastructure sector in India faces some significant challenges, which, if not mitigated, could lead to a slowdown or at best sub-optimal growth. “These include a business friendly resolution issues arising out of the Land Acquisition Bill issue,” he said, “and introducing a greater degree of flexibility into the basis and time taken for the grant of various approvals and permits, particularly as relates to the environment.” With respect to the thermal power sector, a particular issue of concern, said Jaitly, “is the uncertainty of coal supply, both because of lack of availability and, in many cases, the lack of a firm and bankable coal linkage from the government-owned Coal India. This problem has been exacerbated by recent measures introduced in Indonesia requiring Indonesian coal to be sold overseas at internationally bench-marked prices. These uncertainties will make both debt and equity finance for Indian power projects challenging.”
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