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Risks in Foreign Collaboration Agreements in India

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Risks in Foreign Collaboration Agreements in India

Foreign Collaboration Agreements in India: Managing Structural Risks and Legal Compliance

Foreign collaboration agreements are critical documents between an Indian company and a foreign company. But why do so many joint ventures or technical collaborations fail within two to three years of signing the agreement? The reason is simple: Businesses do not pay enough attention to the drafting of key clauses of the foreign collaboration agreement. Gone are the days when you could get a foreign lawyer to send you a “ready to print” agreement, which you as a business simply accept and sign.

At Corporate Law Firm, we have handled many failed joint ventures or technical collaborations where both parties have approached us when the agreement is already in gridlock because they considered it a “boilerplate agreement”. This article will explain that foreign collaboration agreements are deals of a higher magnitude which tie an Indian business with a foreign company for technology sharing, investment purposes, marketing collaborations or research collaborations. When signing such high-value deals with a foreign company, you as a business should know that Indian regulators take keen interest in such cross-border deals. I, Advocate BK Singh, have had occasions to tell boards of companies that non-compliance with local laws at the time of drafting the foreign collaboration agreement can lead to not only expensive litigations but also significant regulatory fines and even the failure of the deal itself.

Balancing risk & reward

As with every agreement, there is a business side and a legal side to a foreign collaboration agreement. Let’s talk about the legal side of the agreement. Foreign collaboration agreements in India are governed by a plethora of laws such as foreign exchange laws, IP laws, tax laws, arbitration laws, etc. In this detailed guide to Foreign Collaboration Agreements, we at Corporate Law Firm, break down the various legal risks associated with such agreements and how you can mitigate risks and comply with the various statutes while protecting your business interests.

Why Managing Cross-Border Contractual Risks Matters Across India's Commercial Hubs

Running a joint venture through Indian jurisdiction is never a passive investment. Markets across India’s commercial districts of Delhi NCR, Gurugram, Noida, Mumbai, Bengaluru, and others operate at lightning-fast speed. Legal structural gaps can compromise the integrity of your business. When conducting a joint venture, if Indian company or foreign investor signs an international deal that doesn’t factor in legal limitations, you may feel the operational impact immediately.

Your JV contract could leave you with frozen outgoing funds, surprise audits by the income tax department, or even extended standstills on managerial decisions. Competitive markets across Delhi NCR and India leave no time to waste. Contractual errors can suck your business dry of working capital and grind your operations to a halt. “International litigation can tarnish your company’s brand, making it challenging to attract future foreign investments or loans from banks,” says Advocate BK Singh.

The RBI, CCI, and other regulators are also giving attention to joint ventures that don’t abide by legal thresholds for anti-competitive business practices and illegal fund transfers. Crossing these limits can expose your business to severe regulatory repercussions, personal director liability, and a lengthy compounding process. By consulting with Corporate Law Firm during your due diligence, you can identify your terms, draft your contract to include necessary legal protections, and keep your joint venture lawful for years to come.

Quick Facts:

  • Cross-border foreign technical collaborations in India.
  • Regulation by FEMA, Companies Act 2013, Income Tax Act 1961 and IP laws of India.
  • RBI, DPIIT and MCA are the regulators to be primarily complied with.
  • Although technical collaborations (including FDI) are governed by the automatic route, certain sectors which are sensitive in nature need prior approval from Government.
  • Proper licencing terms which are explicit and bound by time to avoid any automatic assignment of trademark/patent to the Indian collaborator on termination of agreement.
  • Withholding tax implication on outbound royalties, technical fees and dividend. Claim of set off with respective DTAA.
  • Disputes are best settled by international commercial arbitration (“ICA”) and cross-border enforcement of award is managed by the Arbitration and Conciliation Act, 1996.

About Foreign Collaboration Agreement

Foreign Collaboration Agreement means an agreement entered into between an Indian company and a foreign entity for setting up a joint venture on the basis of financial contribution, technology or manufacturing support. It clearly defines the split of equity and roles and responsibilities, intellectual property and percentage of royalty between the two parties involved.

Laws Applicable to International Joint Ventures

Foreign contracts are not created in isolation. They are entered into subject to a web of Indian federal laws. The Foreign Exchange Management Act (“FEMA”), 1999 and RBI regulations promulgated there under is one major source of law that govern foreign partnerships. FEMA regulates the inflow of capital into India, pricing of shares issued to foreign partners, repatriation of royalties or technical charges to a non-resident partner etc. If a clause in a foreign contract requires a party to violate FEMA pricing or reporting requirements, such clause is void ab initio.

Indian companies act (“The Companies Act, 2013”) would regulate matters pertaining to internal management of any joint-venture company formed. Say, limits on permissible shareholding on the board by the foreign partner, voting caps, rights of minority shareholders, corporate governance expectations etc. Any directors nominated by the foreign partner to sit on the Indian company’s board would be subject to fiduciary responsibilities and statutory liabilities under Indian companies law. Tax Advisors often cite “navigating the internal laws of company formations with the external FEMA regulations” as some of the most frequent pitfalls faced in structuring foreign joint ventures.” BK Singh

Foreign trademarks, patents and copyrights would be protected under The Trade Marks Act, 1999, The Patents Act, 1970 and The Copyright Act, 1957 respectively. These acts would regulate usage rights of the foreign party’s intellectual property in India. The Income Tax Act, 1961 and its subsequent amendments would apply to any financial consideration outlined in the agreement. Transfer pricing legislations, general anti avoidance rules and the withholding tax regime would apply to all foreign transactions to value the capital entering the country.

INDIAN PROMOTERS AND STARTUPS: Indian startups or growing businesses looking for investments from foreign investors, importing technical manufacturing expertise to bootstrap operations or licensing their brands from abroad to gain market access.
FOREIGN DIRECT INVESTMENT (FDI): Foreign companies trying to access India’s consumer market through investing in a joint venture, wholly owned subsidiary or sourcing from Indian distributors.
MANUFACTURING/INDUSTRIAL COMPANIES: Indian companies in manufacturing or industrial business such as the auto, pharma, software, technology or solar power industries which depend significantly on technology licensing from foreign companies.
TECHNOLOGY/LICENSE COMPANIES: Indian companies involved in any sort of cross-border source code licensing, software development collaboration or cloud hosting agreements with foreign companies.
COMPANIES’ BOARD OF DIRECTORS AND LEGAL COUNSEL: In-house lawyers or board members responsible for reviewing contracts with foreign companies for compliance and managing risk for the company.

Detailed steps involved for Undertaking an Agency / JV Agreement Validation

  1. Due diligence exercise –

    Prior to working on the clauses of the Agreement, both parties shall undertake extensive due diligence checks on each other. The Indian Party shall confirm the legality of the overseas company along with its ability to pay and clear title to the intellectual property to be shared with the Indian Party. Similarly, the overseas Party shall undertake due diligence on its Indian partner to confirm its track record of compliance with local regulations, titles to its assets, if any, and liabilities.

  2. Commercialization & Funding Structure–

    Subsequent to the due diligence being satisfactorily completed by both parties, their respective legal teams should identify the different financial aspects of the collaboration – notably, an equitable valuation model (aligned to RBI pricing guidelines), a realistic royalty to be paid upon reaching milestones and currency fluctuation risks. It should also be confirmed that all proposed inward/outward payments can be routed through automatic routes/approval from DPIIT.

  3. Inking the Principal Technology/IP/business clauses–

    Subsequent to the commercial framework being agreed upon by the Parties, the lawyers must begin work on the principal clauses of the Agreement. Of utmost importance is the clause dealing with the technology being shared/shared jointly by both parties. Specifically, the lawyers must ensure that the scope of the technology being shared is clearly defined, the permitted use is articulated and necessary safeguards are included to prevent sub-licensing of the technology and its misuse after termination of the Agreement. Similarly, the management clause should lay down specifics on management control, quorum, etc. and seatment of board members.

  4. Decision making norms & dispute resolution clause–

    As mentioned above, it is important to include specific clauses detailing the dead-lock situation, and protecting the interests of the minority party. It would also be prudent to include a dispute resolution clause, which lays down the law/governing jurisdiction and rules of arbitration which would be followed in case of a dispute.

List of Documents

  • Power of Attorney duly executed by the Company Promoters/Board of Directors
  • Patent/Trademark registration certificate duly certified copy
  • Fit and Proper Certificate from Chartered accountant/SEBI registered Merchant banker
  • KYC documents in respect of shareholders and directors
  • Share valuation certificate by Chartered Accountant/SEBI registered Merchant banker (As per RBI share pricing guidelines)
  • Copy of Registered Partnership deed/
  • Permanent Account Number (PAN) & Tax Residency Certificate(TRC) from partner country
  • Form No. 10F duly filed with RBI
  • Letter of approval from DPIIT /Department of Govt(not required if in automatic route)
  • Execution of technical support agreement/Trademark licensing agreement / NDA / Share purchase agreement

Ambiguous Licensing of IP Rights

Foreign collaborations signed by Indian companies often do not distinguish between licensing of technology and actual transfer of technology. Unless explicitly mentioned that the rights being licensed are non-exclusive, revocable and for a specified period, the local company may try to claim irrevocable rights to use the technology beyond the term of the contract, leading to hotly contested litigation regarding ownership of the assets.

Non-Compliance with Local TP and Tax Regulations

Payments between related-party corporate entities across borders are governed by transfer pricing regulations provided under the Income Tax Act, 1961. Often times, royalty rates or technical fees are agreed internally between parties at a commercially convenient rate without considering the arm’s length price. Such errors result in heavy tax adjustments and interest penalties by way of double taxation.

Ambiguous Deadlock/Governance Provisions

The major setback of entering into 50: 50 joint ventures is coming to a complete stand-still on how the business is supposed to be run when there is a disagreement on basic commercial issues. If an agreement does not contemplate specific deadlock- resolution provisions (such as buy sell, casting vote, etc. ), step-by-step grievance redressal mechanisms, the entire business is at a standstill until an exit option is triggered. Instead of winding- up agreements, many companies are forced to file petitions in NCLT for winding-up of companies.

Drafting Errors Causing Foreign Exchange Violations

One error made by companies is not complying with FEMA pricing guidelines around share valuation, asset value cap, and exit restrictions. For example, drafting a share purchase agreement which contains an exit price for the foreign investor. Since this type of guaranteed pricing is prohibited under Indian foreign exchange regulations, the clause would be struck down by ED.

Insufficient Confidential Information Non-Disclosure Language

In a technical licensing agreement, formulae, manufacturing processes and other trade secrets are shared with your Indian partner. Without a well defined nondisclosure provision that survives beyond the term of your agreement, your partner could take your trade secrets and set up a competing business. Caution should be applied if the NDA provisions do not survive beyond the termination of your agreement.

Agreeing to Indefinite or Unenforceable Jurisdictions

Parties often sign agreements which state “ Mumbai Supreme Court India” as the jurisdiction without meaningfully negotiating where disputes will be resolved. If your technology license agreement does not have a proper seat of arbitration ( i.e., New Delhi, Mumbai or Singapore) or law that will govern the contract, then a dispute could play out over years in multiple courts.

Neglecting Provident Fund and Employment Laws

Companies expand to India through joint ventures or technology licensing agreements by sending foreign experts into India. If the sending corporation does not put in place secondment agreements or consider PF laws for foreign nationals, the parent corporation may become liable for employment law violations.

Ignoring Changes in Indian Law

India’s legal framework for businesses is always evolving. Whether it’s the RBI, MCA or Income Tax department making regulatory changes, joint ventures get tripped up when they do not incorporate a provision in their agreement to update the agreement if there are mandatory changes in Indian law.

Potential Problems with Poorly Negotiated International Agreements

Drafting or negotiating a weak India joint venture agreement could cause your business to fail. If your agreement allows something that is prohibited by Indian law, not only could the transaction be declared void by the RBI (preventing you from sending out royalty payments) but also the directors of your company could be fined under FEMA. Additionally, if a dispute arises with the joint venture partner and you do not have a solid dispute resolution clause, you could find yourself embroiled in years of litigation, spending your company’s profits in court. If your manufacturing process is replicated by your joint venture partner because you did not have a strong intellectual property clause in your agreement, you may have given your competitor the advantage over you. At Corporate Law Firm, we like to tell our clients that although dealing with these problems after they happen may be possible, it is always cheaper to spend a few extra rupees at the beginning on having your India agreement reviewed by an experienced India lawyer.

At What Point Should the Company Board Involve Lawyers?

Ideally, your in-house legal team or transactional counsel should be consulted at the stage before the parties have even executed a term sheet or MoU. This is particularly important in the case of cross-border transactions, which require a lot of strategic planning from the outset. In many cases, parties’ first statements of intent are peppered with provisions that become points of contention further down the line. Counsel can help you assess the legal viability of the deal (including a regulatory due diligence checklist), analyse intellectual property limitations, and ensure that the deal structure is in compliance with extant Indian FDI regulations.

In-house counsel should also step in if and when the parties to a joint venture begin to experience operational conflicts such as disputes over profit sharing, surprise tax audits or accusations of intellectual property theft. Nipping these structural concerns in the bud through legal examination prevents smaller commercial disagreements from snowballing into highly publicized cases before commercial courts or international arbitration forums. “Companies need to continually restructure their cross-border agreements as and when regulation changes to protect their investments in the long run,” says Advocate BK Singh.

Ensuring Seamless Foreign Collaboration with Corporate Law Firm

Corporate Law Firm offer legal consulting services and help in drafting agreements for foreign collaborations in India. We advise Indian businesses and multinational companies on creating a solid joint venture structure, technology transfer or licensing arrangement. At Corporate Law Firm our team of corporate lawyers including Advocate BK Singh help you align all clauses in a foreign collaboration agreement that are legally enforceable, commercially viable and compliant with FEMA, Companies Act, Income tax law and Indian intellectual property laws.

Corporate Law Firm conducts extensive corporate due diligence, helps in navigating through required ministry approvals, tax efficient structuring of transfer pricing and assists in filings required with RBI and guides you through the entire process of setting up an international alliance.

FAQs

How do technical collaborations differ from financial collaborations?

In financial collaborations, the foreign investor makes a direct foreign equity investment into the shares of an Indian company. As equity investors, they assume the equity risk of the company and earn dividend income on their investment. On the other hand, technical collaborations primarily involve sharing or licensing technology to the Indian company on a non-equity basis. In return for granting access to its intellectual property such as patents, trademarks or technical know-how, a foreign company will earn royalty income or single-time lump-sum payments called technical fees. Many joint venture agreements are a hybrid of both financial and technical collaborations.

Is prior approval needed from RBI for foreign collaborations?

Except for specific sectors requiring mandatory prior approval (please refer to our articles on Foreign Direct Investment in India), most technical collaborations and foreign investment agreements are eligible under the automatic route. This means the parties can enter into such agreements without seeking prior approval from the Reserve Bank of India, so long as the agreement follows foreign direct investment limits set for the particular industry sector, as well as the Transfer Pricing and other pricing guidelines of the RBI. If the proposed structure is not available under the automatic route, the parties need to seek approval from DPIIT or the relevant administrative Ministry before carrying out the transaction.

Are technology royalty payments subject to tax?

When an Indian company pays royalty and technical service fees to its foreign parent or partner company, such payments made by the Indian subsidiary will be subject to withholding taxes as per the Indian Income Tax Act, 1961. However, the rate of tax can be lowered if the Double Taxation Avoidance Agreement between India and the foreign company's country of residence allows it. The foreign company would be required to obtain and submit a Tax Residency Certificate to avail of such treaty benefits.

Can you have fixed exit price in a foreign collaboration agreement?

It is illegal for a foreign collaboration agreement to guarantee a fixed exit price, or multiple, of the investment to the foreign investor. As per Indian foreign exchange law, no cross-border agreement can assure a predetermined return on shares sold to a foreign investor. Exit transfers will be subject to RBI pricing guidelines (currently, the price paid for shares must be the fair market value), and penalty under FEMA for violating provisions of the Act. However, parties can negotiate a fixed price for buy-back of shares in joint venture company as per pricing guidelines.

Can you claim damages if your Indian partner is misusing technology?

Yes. In addition to claiming arbitration against the Indian company for breach of contract, the foreign investor can approach a court of law to immediately restrain the Indian company from further misuse of its technology. For this remedy to be available, the technology agreement should have an express post-termination restriction on misuse of technology. Additionally, the JV Agreement should provide for arbitration of disputes at an international arbitral forum.

How do you avoid grid-lock in a joint venture with equal ownership?

In order to avoid gridlock, it is important that the JV agreement includes express provisions for resolution of deadlock. These provisions usually include; a multi-tiered dispute resolution mechanism ending with binding mediation, grant of casting vote to the chairperson of the board for specific decisions or a pre-determined buy-sell mechanism (Russian Roulette clause or Texas Shoot Out clause) which allows one partner to force the other to buy his shares at a pre-agreed price.

Can NCLT be approached for deadlock in joint ventures?

NCLT has been given the jurisdiction to look into disputes between shareholders and companies on grounds of oppression, mismanagement or a deadlock in the management of the company. Hence, in situations of serious mismanagement or governance deadlock in a JV, one of the partners can approach NCLT against the other.

Can Indian courts enforce international arbitration awards?

Foreign arbitral awards (ifs) are recognized in India in accordance with the New York Convention on the Recognition and Enforcement of Foreign Awards, 1956 and the Geneva Convention on Arbitral Awards (1927) subject to such awards being ratified by the Government of India. The party seeking enforcement of an award made in a foreign country would have to initiate proceedings in the High Court of India. Therefore, if you have a provision for arbitration of disputes at an International Arbitral Tribunal in your joint venture agreement, Indian courts would enforce such an award. However, the domestic courts would not enforce awards that violate the public policy of India.

Can transfer pricing laws impact a foreign JV agreement?

Transfer pricing law applies to all transactions between group companies. This includes a foreign parent and its Indian subsidiary. As a result, any agreement between group companies will be scrutinized by the revenue authorities for transfer pricing compliance. To avoid this, the agreement must mention the basis of transfer pricing and how the transaction was at arm’s length.

Can Indian companies be prevented from damaging brand value?

If you want reassurance that your brand is protected against misuse by the local company, we recommend you enter into a separate, well-drafted trademark licensing agreement with the Indian company. The trademark license agreement should make it clear that the local company is only licensed to use the brand name for a limited time and that such license is non-exclusive. The trademark license should also include strict quality control provisions and prevent the Indian company from registering similar marks in India.

Author Bio

Senior Corporate Counsel & Lead Strategy Partner at Corporate Law Firm, Advocate BK Singh has over 20 years of experience in managing cross-border corporate deals, international commercial arbitrations and intricate forex issues in India. He has expertise in drafting foreign collaboration/ joint venture agreements and technology agreements by providing advisory to multinationals and emerging Indian companies on issues related to FEMA laws, Companies Act, and Indian IP laws. Advocate BK Singh has worked with numerous boards of directors in the Delhi NCR region appearing before regulatory bodies for structural issues, high courts and international arbitration forums with a vision to achieve full compliance and maximum protection of assets involved in international alliances.

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Practicing before the Supreme Court, High Courts, and tribunals, we handle Legal matters with strong expertise and a result-oriented approach.

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