Cabinet likely to approve FDI in LLP firms

The Cabinet is likely to approve a proposal to allow foreign direct investment (FDI) in Limited Liability Partnership (LLP) firms tomorrow.

Giving go ahead to FDI in LLPs would enable them to choose among domestic and foreign investors and make these more competitive. This move will also encourage more partnership firms to convert into LLPs.

The Ministry of Corporate Affairs (MCA) is believed to have already given in-principle approval to allow FDI in LLPs.

Earlier, the Department of Industrial Policy and Promotion (DIPP) in the industry ministry had circulated a note across various ministries including MCA and the ministry of finance to discuss the possibility of allowing FDI in LLPs.

The DIPP’s discussion paper floated last year had indicated that at best foreign direct investment in the LLPs be allowed in sectors which are completely open for FDI.

The ministry’s view is that allowing FDI in LLPs would provide flexibility to these firms and make them more competitive globally. This would encourage more partnership firms to convert into LLPs.

The LLP Act, 2008 passed in January 2009 heralds LLP as a new corporate form of business and an alternative to the traditional partnership model, with unlimited personal liability on the one hand and a limited liability company with detailed compliance requirements and restrictions on the other. An LLP structure has features of both a partnership firm and a body corporate and, therefore, helps businesses organize and operate in a flexible, innovative and efficient manner.

The various attributes of the LLP structure such as lower compliance costs, flexibility in operations, better control over management and limited liability make it an attractive alternative.

However, the use of an LLP structure for foreign investments into India was uncertain as there was no clarity on the FDI policy of the GoI. Hence, with a view to formulate FDI policy in case of LLPs, the DIPP has come out with a DP on FDI in LLPs.

Issues in FDI in LLP

a) Should FDI be permitted in LLPs at all?  Can it be argued that given its limited attractiveness for large investments, allowing FDI in LLPs will not significantly accelerate FDI into the country while disproportionately increasing the regulatory burden?  Does the present uncertainty on how this business model will proceed, as well its yet unestablished case law, magnify these concerns?

LLP is an incorporated business form which is new to India. If we look into other jurisdiction, similar business structures are available. In US, LLC started registration from 1977 and now majority of business run as LLC which is similar to LLP in India.

The argument that LLP is suitable for limited investment is wrong. In fact, LLP is the best structure for running large business like company. It is the ideal form of business structure for JV & SPVs as it enables the parties to crystallize their terms and conditions clearly in the LLP agreement. It is because, LLP act have limited control over LLP agreement and partners have the freedom to structure their relationship. In case of company, articles of association can restrict many things but some case it must be within the provision of companies act. So LLP is the best option for JV & SPVs etc, where investors need to protect their interest. Also, this structure will reduce the scope of dispute among the partners as LLP agreement is the final document determine partner™s relationship.

LLP is not a subordinate corporate structure compared to Company. It is a corporate form with all features of a company. It is world vide accepted model and large number of business run LLP like structure.

b) What should be the definition of ˜person resident in India™? The definition provided in the LLP Act or the definition provided in FEMA?

The definition provide in LLP act of ˜person resident in India™ is for the requirements of LLP act and the definition in the FEMA is for that act. Also note that there is no such definition in the Companies Act.

The main purpose of definition of ˜person resident in India™ under LLP act is to ensure compliance of LLP act by resident designated partner. A LLP can be incorporated by two body corporate from a foreign country as partners if one of the body corporate nominate a person in India as designated partners.

FEMA requirement, definition of ˜resident in India™ is relevant for determining investment in India or outside India by a person or entity in India. This is also relevant for investment in LLP by ˜person resident outside in India™.

c) Given the complexity of  some of the issues raised in Section 5, would it be preferable to adopt a calibrated approach to the induction of FDI in LLPs? Initially, should FDI in LLPs be restricted to sectors without caps, conditionalities or entry route restrictions? Should FDI be allowed upto  100%  in these sectors or should there necessarily be an Indian partner ? Should such approval   be confined to the government route?

We can™t agree LLP is complex structure as explained in section 5. The explanation is given in the point f) below. So LLP can be considered in par with company for FDI

d) Should LLPs be mandated not to make downstream investments and should foreign owned or controlled Indian companies be barred from investing downstream in LLPs? Should investment by FII/FVCI or ECBs be prohibited for LLPs?

All facility allowed to a private company can be granted to a LLP. LLP is a body corporate similar to LLC in US.

e) Following the Foreign Exchange Management ( Investment in Firm or Proprietary Concern in India ) Regulations 2000, should it be mandated that foreign participation in the capital structure of LLPs should be on a percentage basis, received only by way of cash consideration by inward remittances through normal banking channels, or by debit to the NRE/FCNR account of the person concerned maintained by an authorised dealer? Should it also be mandated that foreign investments in LLPs engaged in agricultural/plantation activity or real estate are prohibited?

It is advisable to notify new regulation for LLP as it is a body corporate. The nature of LLP is more like a company than firm because of limited liability etc.

It can also mandate foreign participation in the profit only based on the contribution and not based on percentage. This will standardize the capital structure as profit distribution is based on contribution. It is not advisable to fix profit sharing based on percentage as it may lead to a situation where partner with less contribution will be getting more profit share. Moreover, if profit distribution if based on contribution the capital nature will be similar to company.

It can be well addressed in the FEMA regulation restricting investment in LLP only based on contribution and distribution of profit based on percentage of contribution.

The proposed regulation can mandate investment only from foreign currency and all present applicable restriction on company shall apply to LLP

f) Should FDI policy treat LLPs akin to companies? In such a case, how should the issues relating to ownership, valuation, control, downstream investment and non-cash contributions, raised in Section 5 above, be addressed? Should this be only through the government route?

FDI Policy must treat LLP like company.  See below commends

Section 5.2 Ownership

It is true that in a LLP partner have two rights,

a. Right to receive profit or loss and distribution of assets, ie ownership right and;

b. Right to participate in the management of LLP

Both right are subject to LLP agreement.

As indicated in the section, transfer or assignment of ownership interest does not disassociate a person from an LLP and he continues as partner with same right of voting and management. Also, in an LLP, capital contribution and profit sharing may differ. It is also possible for partners to change the ratio at any time.

Capital structure Requirement for FDI in LLP

The flexibility of capital structure allowed in the LLP can be used for making an LLP FDI friendly within the framework if FEMA. This is explained below points.

1. LLP agreement is the main document governing a LLP. So all LLPs opting for FDI & FEMA regulation complied  LLP agreement.

2. LLP Agreement contain clauses to address following points

a. Profit sharing shall be in the ratio of contribution by each partner.

b. Voting right must be defined in relation to contribution.

i. Like company, every rupee contribution have right to vote on any decision.

ii. It is also possible to create different class of partners with different rights in respect to voting as prevailing in company

c. If a partner transfer his contribution, his voting right also will reduce accordingly.

d. If a partner transfer entire contribution, he ceased to be a partner.

Section 5.3 Valuation

The statement ˜The LLP Act states that every contribution to the capital of the LLP shall have a monetary value, determined by a chartered accountant™ is a wrong statement™. Section.32 of the act says, contribution can be in cash or consideration other than cash. Rule 23(2) of the LLP Rules, if contribution is other than cash, it must be valued by a CA, CWA etc.

Since, LLP act is silent regarding valuation of cash contribution, present valuation guidelines applicable to company can be adopted for LLP. The differences is in company, value is ascertained for each shares and unless LLP agreement divides contribution into unites, value can be ascertained for each rupee of contribution.

Voting Rights and right to receive dividend

Companies act allow, different voting rights to members subject to articles of the company. Also it is possible to assign difference dividend rights to different class o equity shares in a company by articles.

In LLP also, it is possible to have different voting rights for different class of partners by LLP agreement.

The difference between company and LLP in respect of voting rights of partners /members is in case of company, unless articles provides otherwise, all equity capital holders get one vote for every paid up  shares held in the company. In LLP, if LLP agreement is silent regarding voting rights, each partner get one vote irrespective of his contribution.

So, technically,  voting rights of equity share holders in a private company and of a partner in LLP is similar.

Section 5.4 Control

The contention in section 5.4.1 is not correct. Designated Partners can be considered like directors in a company are wrong. As per LLP act, the powers

and responsibilities of Designated partners are limited to compliance of LLP act and they do not have any powers of management.  The extent of voting power of partners to appoint Designated partners cannot be considered for determining control.

The similarity of designated partner and a director in a company is that, only individuals can be appointed to hold office. In LLP, if a body corporate is a partner, they can nominate a person to hold the position of designated partner. Otherwise, only a partner can be appointed as a designated partner in LLP.

So, control in LLP is who hold majority voting power or by agreement who can manage the LLP. It is not like company where who can appoint majority of directors.

Voting rights in LLP

LLP act is silent regarding voting rights of partners. It gives full freedom to partners to defile voting rights in the LLP agreement and if LLP agreement is silent on voting right each partner have one vote in respect of any decision. So for FDI, control and management is ability of a foreign partner to take decision the LLP in terms of LLP agreement.

g) Will treating LLPs akin to companies under FDI policy demand the stipulation of certain features of the LLP agreement? Should this include unambiguous specification of profit /loss sharing percentage; clear specification of the power to appoint Designated Partners; congruence of legal and economic ownership; timely notification of changes including conversion from and to companies/partnerships? Should it be mandated that LLPs cannot have corporate bodies other than companies registered under the companies Act as partners? Is inclusion and coverage of such issues in FDI policy warranted? Would the consequent increase in the regulatory burden be justifiable?

It is not required to specify features of LLP agreement making it akin to company for FDI. The justification is as given below.

1. Profit sharing. There is no confusion in respect of profit sharing in LLP. Like articles of a company, LLP agreement define how profit is distributed among partners. It can be a percentage or can in the ratio of contribution agreed or actually contributed. In company profit entitlement is based on shareholding, usually paid-up capital. It is

also possible to define different entitlement of profit to different class of shares like LLP. So technically,   it is possible for a private company also specify different profit ratio to its shareholders irrespective of their capital contribution. Also note that in the absence a provision in the LLP agreement, regarding profit distribution, all partners have equal share in the profit. So, provisions of LLP act is very clear regarding profit sharing and it does not need any other regulation, except LLP act and rules.

2. Designated Partners and Management. LLP is an owner managed organization, unlike company, where directors are agents. LLP have the flexibility of delegation of management to a single person or to a group like company.

 

h) What additional regulatory safeguards are required to enfold LLPs into FDI policy? Are amendments to any existing regulations required? Should the responsibility for periodic monitoring of compliance with FDI stipulations be allotted to a particular agency?

No need to create any separate authority for monitoring FDI in LLP. It can be combined with FDI in company or separate regulation for FDI in LLP. The periodic compliance must be with RBI