The Defence Procurement Procedure (DPP) promulgated by the Ministry of Defence (MOD) in 2011 provided that in order to synergise national competence in the defence sector the MOD would collaborate with private firms by way of a creating private consortia or Joint Ventures (JV). In line with this policy the MOD has issued guidelines for the formation of JV’s between Defence Public Sector Undertakings (DPSUs) and private firms. The guidelines provide for clarity with regards to the creation of joint ventures between DPSU and Private Firms and the conditions placed on such JV’s thereof. These are in line with Para 6 of the Defence Production Policy, 2011 and will help foreign defence equipment vendors discharge their offset obligations under the offset policy.
Summary of Guidelines
The following are the guidelines approved by the Government for the formation of joint ventures between DPSU’s and private firms.
- The Joint Venture (JV) shall be a distinct legal entity from the parent companies and shall be operated on an arm’s length basis.
- The formation of the JV shall be limited to the specific products which are to be produced by the JV. Further, the DPSU should limit their exposure only to the minimum amount of time necessary in order to make the JV Viable.
- The preferential treatment of the JV by the DPSU shall be restricted to placing orders in the “Minimum EconomicQuantities”. Placement of orders up to these quantities shall require special authorisation from the board of the DPSU.
- The formation of the JV should not constrain the individual ability of the DPSU to produce and act independently.
- Under the terms of the Shareholders Agreement the Board of Directors of the DPSU should retain the right of prior approval for key decisions regarding the JV. These decisions are:
- Amendment of Memorandum of Association (MoA) or Articles ofAssociation (AoA);
- Approval for the appointment of Chairman and/or Managing Director;
- Approval of Annual Business Plan and any material changes thereto;
- Approval of / and amendment to the Annual Budget;
- Declaration of Dividend;
- Bidding for major contracts;
- Appointment of key managerial personnel;
- Delegation of Authority of any of the powers of the Board of Directorsof the JV Company to any individual or to a committee of its Board ofDirectors;
- Any restructuring, inter-alia, by issue or buy-back of shares and/ orsecurities;
- Sale of substantial assets;
- Decisions on loans and encumbrances; andFormation of further JVs/ subsidiaries by the JV Company.
- Prior Approval of the Government as per applicable rules is required in the event the JV partner is a PSU or the total equity stake of the JV Partner exceeds 50%. Further clearances would be required in the event the JV Partner is a foreign entity.
- The JV shall comply with all the relevant provisions of Indian laws which are applicable to companies including relevant provisions of The Companies Act 1956. It shall further publish financial statements as required by law. In the event the Defence JV is a listed company the reporting requirements for listed companies shall be applicable.
- The JV shall prepare an appropriate exit strategy and any transfer of equity by the private partner during the “lock-in period” would require key approval from the board of the DPSU.
These rules are strictly binding on Defence JV’s and any deviation or relaxation of the guidelines requires prior approval from the Department of Defence Production of the Ministry of Defence, Government of India.
Impact on Offset Obligations
The offset policy of the MOD states that the policy shall be applicable to two kinds of contracts the “Buy (Global) and “Buy and Make with Transfer of Technology”. Buy (Global) refers to outright purchase of equipment from a foreign or Indian vendor. “Buy and Make with Transfer Technology” (hereinafter referred to as Buy&Make) includes contracts where outright purchase is done from a foreign vendor followed by licenced production or indigenous manufacture within the country. In order for the contract to come under the Buy (Indian) category the systems must have a minimum of 30% indigenous content if they are being integrated by an Indian Vendor.
India’s offset policy stipulates a 30% offset in the event of a contract exceeding Rs.300 Crores in value under the Buy (Global) or Buy&Make categories. The Defence Acquisition Council (DAC) has been empowered to increase the offset amount for certain contracts or in special cases reduce the offset amount.
The Foreign Investment Promotion Board (FIPB) via FDI Circular 2/2011 which came into effect on 31.10.2011 allows for foreign direct investment in the defence sector. This investment is capped at 26% and is subject to certain restrictions mentioned in the circular.
Within the prescribed limits, foreign firms may discharge offset obligations by investing in JV’s with DPSUs. Para 2.1 (b) of Appendix D of the Defence Procurement Manual of 2011 states that offset obligations may be discharged directly by
“Direct foreign investment in Indian industries for industrial infrastructure for services, co-development, joint ventures and co-production of eligible products and components”
For the purpose of discharging offset obligations “services” have been defined in Para 2.1(c) of Appendix D of the Defence Procurement Manual of 2011
“For the purpose of discharge of offsets, ‘services’ will mean maintenance, overhaul, upgradation, life extension, engineering, design, testing of eligible products and related software or quality assurance services with reference to eligible products as indicated in Annexure VI and training. Training may include training services and training equipment (e.g. simulators) but exclude civil infrastructure.”
Therefore foreign vendors may fulfil their offset obligations by investing in a JV with a defence PSU. In terms of Para 2.1(e) of Appendix D of the Defence Procurement Manual of 2011 these offset credits may be banked in advance as Para 2.1(e) states that
Foreign vendors could consider creation of offset programmes in anticipation of future obligations. Offset credits so acquired can be banked and discharged against future contracts. Banked offset credits would not be transferable except between the main contractor and his sub-contractors within the same acquisition programme. The main contractor would be required to submit a list of such sub-contractors at the time of signing the contract.
Existing vendors may enter into JVs with DPSUs in order to bank offset credits in the event of future obligations.
The new guidelines proposed by the MOD will facilitate the discharging of offset obligations with regards to foreign vendors. The allowing of fulfilment of offset obligations by the setting up of a JV with a DPSU will make the discharging of offset obligations easier for the vendor . Since the JVs shall be located in India, products manufactured by them shall contribute to the self-sufficiency goal of the Defence Production Policy, 2011.
 A copy of this circular may be obtained at http://dipp.nic.in/English/policies/FDI_Circular_02_2011.pdf