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Pharmaceutical Sector: DIPP’s Approval required for Non-Compete Clauses

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The Department of Industrial Policy and Promotion (“DIPP“), through Press Note 1 of 2014 issued on 8 January 2014 (“Press Note“), has reviewed the conditions for Foreign Direct Investment in the Pharmaceuticals sector.

The existing limits and routes for Foreign Direct Investment in Pharmaceuticals sector remain the same as earlier. However, the DIPP has through the Press Note, added a condition that “non-compete clause would not be permitted, except in special circumstances with the approval of the Foreign Investment Promotion Board (“FIPB”)”.

The aforesaid condition appears to be applicable to both Brownfield Projects (already under approval route) and Greenfield Projects.

Analysis

Background of this change in policy

This development is the result of a compromise between the divergent views of the government and the DIPP. Concerned about the slew of acquisitions on Indian pharmaceutical companies by foreign entities, which it felt would adversely affect the generic drug industry of the country, the DIPP had proposed a number of measures including a reduction in the FDI cap from 100% to 49% in ‘critical sectors’ of the industry. The DIPP’s concern stems from the acquisitions of two major Indian companies, Ranbaxy and Piramal Healthcare by two foreign pharmaceutical giants, Daiichi Sankyo and Abbott, respectively. However, such fears of the DIPP were waived by the cabinet which retained the existing policy with the additional condition of exclusion of non-compete clause.

This change in position of the government, however, lacks clarity and may present a confusing scenario for foreign investors for both Greenfield and Brownfield projects.

How it will affect Acquisitions

Non-compete clauses, a standard feature in merger and acquisition deals, restrict the promoters of target companies from venturing into the same line of business for a certain numbers of years especially in case of Brownfield pharmaceutical deals. This is done to primarily protect the interests of the buyer, as in the absence of such a stipulation the seller may be able to establish a new entity and conduct the same same business. Thus the main objective of the non-compete clause is to deter the inclusion of other players in the market. For instance, the US-based Abbott Laboratories inserted a non-compete clause in its 2010 agreement to acquire Piramal Healthcare, which prevents promoter Ajay Piramal from entering similar business for eight years (Piramal Healthcare Limited Q2 H1 FY2011 Results Conference Call” October 22, 2010 at http://piramal.com). Such clauses may also restrict any participant in the company from collaborating with a competitor.

It is not yet clear as to what special circumstances will allow for non-compete clauses to be allowed in case of FDI in the Pharmaceutical sector. It is clear to all that this change in policy is a protectionist measure amidst fears that major Indian Pharmaceutical companies will be acquired in the near future, which may, going forward, give rise to a situation which will effect India’s low cost generic medicine industry and make essential medicines expensive in India.

However, such lack of clarity will obviously affect future acquisition activities in this sector in India as non-compete clauses tend to be a significant instrument of protection for investors.

Automatic or Approval- the Greenfield Conundrum

Under the present scenario, in case of Greenfield projects, 100% foreign direct investment is allowed automatically without any need of approval from the FIPB. The foreign company has an option of investing either a full 100% in order to set up a wholly owned subsidiary in India, or even partially in case of a joint venture with an Indian company. However, in case of a joint venture with an Indian entity to set up a green field project in pharmaceutical sector in India, the foreign investor will now face  the strange conflict. Naturally in a capital intensive sector like Pharmaceutical, any foreign JV partner would want to ensure that  its Indian counterpart will be dedicated exclusively to exploring joint opportunities in the sector and would want to restrict  their ability to breach such exclusivity through a non-compete clause in its agreement with such Indian JV partner. However, with the change of position concerning the non-compete clause in such agreements, it would now become mandatory for even Greenfield projects with such clauses to seek approval from the FIPB. This therefore, presents a conflicting situation wherein a foreign company investing under the automatic route would nonetheless have to seek approval from the FIPB, hence defeating the very purpose of the ‘automatic route.’

Conclusion

While the pharmaceutical industry is relieved by the government’s stand to continue with the policy, it is “worried” about the “conditional scrapping” of the non-compete clause. The domestic industry fears that removing this clause would reduce its negotiating powers to get a high valuation, while foreign players are concerned that they (as buyers) would not be able to limit competition.

At a time when the country is liberalising foreign investment in various sectors and need significant capital inflows, such a policy review by DIPP could reduce potential foreign direct investment flows into a key and attractive sector like Pharmaceutical, which has seen a flurry of acquisitions of Indian units by foreign drug-makers in recent years. This approach may also further contribute to the existing confusion with regards to regulations of foreign investments in India, which will affect the reforms drive of the government and affect investor confidence adversely.

Anuj Sahay [anuj.sahay@pxvlaw.com]

Pingal Khan [pingal.khan@pxvlaw.com]

Mohar Majumdar [mohar.majumdar@pxvlaw.com]

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