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Sponsored briefing: Key legal mistakes to avoid while investing in or doing business in India

Gandhi & Associates’ Vishal Gandhi outlines the key mistakes to avoid while investing in or doing business in India

This article attempts to highlight the high-level legal mistakes that foreign investors and entrepreneurs (‘investors’) should be aware of, and avoid while investing in and/or doing business in India.

Impact of foreign exchange management laws

From the outset, investors should know that India has a foreign exchange management law in force. As a consequence of this, any monies coming into India and/or leaving India can only be as per prescribed conditions. For example, even if an investor is investing into an Indian company, the investment must be made at a minimum price, and the investment can be sold subject to a maximum price. Another example, is that of issuance of guarantees in favour of an investor. Guarantees cannot be issued unless if they are issued within the framework of permissible guarantees. If any guarantee does not fit within the said framework then a special approval from the Reserve Bank of India (the ‘RBI’) is to be procured.

Also, it may be noted that investment made into an Indian entity by way of shares other than equity shares and/or compulsorily convertible shares would be treated as a loan – and loans by foreign entities are not permissible in all situations and for all purposes. There are many conditions attached to the same. Thus, in effect, due to the said laws, an investor may land up being in violation of Indian laws and/or land up with an unenforceable contract, since at the time of enforcement, of say a guarantee, the RBI may not permit its enforcement and allow monies to leave India, on the basis that the guarantee
is in violation of Indian laws.

Mistakes in the context of joint ventures

A key mistake that is made primarily in the scenario of joint ventures is that the terms of the joint venture are not incorporated into the articles of association of the joint venture company, and when that is not done, then the terms are not enforceable vis-à-vis the joint venture company, although a party may have the right to sue for breach of the joint venture agreement against the joint venture partner.

A related mistake is with regard to imposing restrictions on transfers of shares of a company which is not a private limited company. Thus, in the case of an unlisted public company or
a public listed company, restrictions on the free transferability will not be enforceable against the concerned company. But, like in the case of a joint venture agreement, a party may be able to sue for breach of a contractual obligation.

Imperfect intellectual property rights

In the context of ownership and assignment of intellectual property rights, it should be borne in mind that unless and until certain formalities are complied with and/or certain specific language is incorporated into the intellectual property development contracts, intellectual property such as a copyright may be deemed to be limited within the territory of India only, may be limited to a term of five years only, and may also revert back to the assignor after a year from the assignment. Thus, investors operating in India through subsidiaries, outsourcing companies, independent contractors, etc., and with a focus on development and ownership of intellectual property, need to be very careful of the legal documentation and specific language to be used in the contracts.

Also, it should be noted that no document is admissible in evidence under Indian law, unless it is printed on a special paper known as ‘stamp paper’ or is otherwise considered to be adequately stamped by way of payment of stamp duty through electronic means.

Inability to recover damages

Indian courts do not tend to award a high amount of damages. Thus, where a contract is based on foreseeable losses or damages, it is always prudent to incorporate a liquidated damages clause which is rightly worded. It may also be noted that in spite of such a clause, courts may not award the pre-estimated damages unless if such damages are impossible or difficult to prove and are considered to be a genuine pre-estimate of the loss and not a sum named in terrorem.

Engaging in court proceedings over arbitration

Since India does not recognise all foreign judgments, and also given that the Indian court system is backlogged with millions of cases, it is always prudent for investors to incorporate an arbitration provision in all their contracts for resolution of disputes. This way, in the unfortunate event of being faced, for example, with a breach of a contract by the other party, the Investor may resort to international commercial arbitration which would be must faster as compared to a court proceeding, and also result in an arbitral award which is enforceable provided it is from a convention country i.e. the country in which the said award is made is a signatory and has ratified the international convention on the recognition and enforcement of foreign arbitral awards.

Taxation related traps

There are also several traps for the unwary investor in terms of exposure to direct and indirect taxes if contracts are not structured correctly or if, for example, employees are hired directly by an investor, and not through a subsidiary. Investors must stay away from being in a situation where they are deemed to have constituted a permanent establishment in India which would expose their worldwide income to taxation in India. Appropriate strategy and planning is crucial before an investment is made in India and/or any business is conducted in India.

Vishal Gandhi, founder and managing partner

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