The Indian Supreme Court's 2G Ruling

In order to soften the blow, the Indian Supreme Court delayed its ruling, which voided every license awarded after 2008, for four months, after which the government must publicly auction the licenses in an equitable and transparent manner. Id. at ' 81. According to the ruling, a transparent auction would result in more money for the government. The court wrote: “We have no doubt that if the auction method had been adopted ' the nation would have been enriched by many thousand crores.” Id. at ' 76. (This argument is also supported by the Central Bureau of Investigation's allegation that Minister Raja's fraud cost the Indian government nearly $40 billion in lost revenue. See India's Corruption Scandals, BBC News South Asia (Mar. 17, 2011), www.bbc.co.uk/news/world-south-asia-12769214?.) The ruling was also expected to help prevent fraud by “unscrupulous people who are only interested in garnering maximum financial benefit and have no respect for the constitutional ethos and values.” 2G Ruling ' 76. All licenses granted before 2008 will remain intact because they were not part of the lawsuit. As of the date of this article, the Indian Department of Telecommunications has not yet held the new, court-mandated 2G spectrum auction.

The Indian Supreme Court's ruling potentially reaches far beyond the telecommunications industry. In its explanation of why an auction method is constitutionally fair and transparent, the Indian Supreme Court couched its language in general terms, writing:

When it comes to alienation of scarce natural resources like spectrum, etc., it is the burden of the State to ensure that a non-discriminatory method is adopted for distribution and alienation, which would necessarily result in protection of national/public interest. In our view, a duly publicized auction conducted fairly and impartially is perhaps the best method for discharging this burden and the methods like first-come-first-served ' are likely to be misused.

See Katya Naidu, DoT to Select 2G Auctioneer in July, Business Standard (June 11, 2012), http://business-standard.com/india/news/dot-to-select-2g-auctioneer-in-july/476960/. Other licenses that the Indian government has distributed for “scarce natural resources” on a first-come, first-served (or other non-auction) basis, such as mining, liquor and real estate licenses, might now also be unconstitutional and void. See Rupa Subramanya, Economics Journal: Why the 2G Verdict Is a Win, The Wall Street Journal (Feb. 6, 2012), http://blogs.wsj.com/indiarealtime/2012/02/06/economics-journal-why-the-2g-verdict-is-a-win/. The 2G ruling potentially could lead to years of litigation in other
industries over the years to come.

Takeaways

The 2G ruling has created some regulatory uncertainty that may discourage potential foreign investments in India. The fact remains that India
attracted $50 billion in foreign
direct investment (FDI) in the first 11 months of 2011 ' up 13% from a year earlier. Henry Foy, India still a foreign investment hot spot-E&Y, Reuters
(Jan. 29, 2012), www.reuters.com/article/2012/01/29/india-investment-idUSL4ECR3D920120129. With a projected GDP growth rate of 5.5% for 2012, and the Indian government's plans to double spending on infrastructure in the coming years, the Indian economy is poised to attract significantly more foreign capital regardless of any fallout from the 2G ruling. Moody's Cuts 2012 India's Growth Forecast to 5.5 Per Cent, Blames Policy Mis-steps,” Business Today (Aug. 9, 2012), http://businesstoday.intoday.in/story/moodys-cuts-2012-indias-growth-forecast/1/187056.html. Dealmakers should understand the compliance risks of doing business in India, and all companies should conduct thorough due diligence before making investments.

A robust due diligence and compliance program should be able to identify and escalate to senior management evidence of “red flags” such as atypical payment patterns, lack of transparency in accounting records, unusually high commissions, a history of corruption in the particular industry, and an apparent lack of qualifications or resources to perform the services offered. (Industries such as construction, telecommunications, and power have a especially high risk of corruption, particularly compared to industries such as business process outsourcing. See Kerry Francis, Walt Brown, Hema Hattangady, India and the Foreign Corrupt Practices Act, Deloitte Forensic Center, www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/FAS_ForensicCenter_us_fas-us_dfc/us_dfc_indiaandfcpa_05192011.pdf.) In light of the 2G ruling, due diligence in India should also now include a close examination of any government licensing procedures, as well as a careful backward-looking review of how the Indian entity received any licenses in the past, particularly if the entity's value is highly contingent on the validity of such licenses.

Standards of Corporate Governance

Many questions have also been raised as to the standards of corporate governance in Indian businesses that are mostly promoter-led and family controlled. Newly listed companies in India and public companies above a certain prescribed size have to comply with Clause 49 of the listing agreement of the stock exchanges. (Companies with a paid up share capital of more than 30 million Rupees or a net worth of over 50 million Rupees at any time in the history of the company have to comply with Clause 49 of the listing agreement. Letter from Parag Basu, Deputy General Manager of the Securities and Exchange Board of India to Directors or Administrators of all the Stock Exchanges regarding Corporate Governance in Listed Companies ' Clause 49 of the Listing Agreement (Oct. 29, 2004), www.sebi.gov.in/circulars/2004/cfdcir0104.pdf (attaching Clause 49 of the listing agreement).) It imposes certain U.S.-style independent director and audit committee requirements. However, the reality is that independent directors in Indian companies do not play the type of proactive role that is common in Europe and the United States and very rarely vote against the promoters. Because private companies are under no obligation under Indian law to install corporate governance mechanisms, it is that much more important to evaluate their internal compliance and control procedures more thoroughly. Additionally, many businesses in India are still structured as family-owned group businesses with great interdependence on one another; consequently, there can be extensive related party transactions which must also be identified and examined.

Conclusion

Despite concerns about regulatory uncertainty after the 2G ruling and potential corruption in certain industries, foreign companies are investing in India at an ever-increasing rate. Thorough due diligence and robust compliance programs are the best way to ensure these investments' success.

Sean Hecker is a partner in the New York office of Debevoise & Plimpton LLP and Aaron M. Tidman is an associate in the firm's Washington, DC, office. They are members of the Litigation Department and White Collar Litigation Practice Group. Parveet Singh Gandoak is an associate in the firm's Hong Kong office and is a member of the Corporate Department. The authors may be reached at [email protected], [email protected], and [email protected].

In response to allegations of fraud and corruption, India's Supreme Court issued an order on Feb. 2, 2012, canceling every 2G mobile phone frequency license that the Indian government has awarded to telecommunication companies since January 2008 ' 122 licenses in total. See James Lamont, James Fontanella-Kahn, James Crabtree, and Daniel Thomas, Indian Court Revokes 122 Mobile Licenses, Financial Times (Feb. 2, 2012), www.fr.com/intl/cms/s/0/460354c8-4d6e-11e1-bb6c-00144feabdc0.html#axzz1ouq5jRVy. This decision highlights the importance of due diligence and anti-bribery compliance programs when companies conduct business in countries that historically present a greater risk of corruption. India, which is in the midst of a prolonged political battle to enact a new anti-corruption law (the Lokpal Bill), has experienced several major corruption scandals involving public officials over the past few years, and ranks 95 out of 183 countries on Transparency International's 2011 Corruption Perceptions Index. See Transparency International, Corruption Perceptions Index (2011), http://cpi.transparency.org/cpi2011/results.) As a consequence of the Indian Supreme Court's ruling, foreign (i.e., non-Indian) companies that formed joint ventures with, or invested in, Indian companies that held licenses, have suddenly found their investments substantially devalued, if not worthless.

The Indian Supreme Court's Ruling

The Centre for Public Interest Litigation and other Indian advocacy groups and individuals petitioned the Indian Supreme Court to cancel the licenses after India's Telecommunications Minister, Andimuthu Raja, and several other government officials and telecommunications company executives were arrested in early 2011 for allegedly selling the cell phone frequency licenses at a reduced price in 2008. See Shefali Anand, India's 2G Ruling Shocks Telecom Industry, The Wall Street Journal (Feb. 2, 2012), http://blogs.wsj.com/indiarealtime/2012/02/02/indias-2g-ruling-shocks-telecom-industry/; see also Lamont et al., note 1, supra. The advocacy groups argued that the system Minister Raja used to award licenses ' a first-come, first-served basis ' was unconstitutionally opaque and arbitrary. Ctr. for Pub. Interest Litig. v. Union of India, (2012) Writ Petition (Civil) No. 423 of 2010 (India) (on file with author) (hereinafter “2G Ruling”). They argued that the system allowed government officials such as Minister Raja to notify their friends before the public and receive kickbacks.

In order to soften the blow, the Indian Supreme Court delayed its ruling, which voided every license awarded after 2008, for four months, after which the government must publicly auction the licenses in an equitable and transparent manner. Id. at ' 81. According to the ruling, a transparent auction would result in more money for the government. The court wrote: “We have no doubt that if the auction method had been adopted ' the nation would have been enriched by many thousand crores.” Id. at ' 76. (This argument is also supported by the Central Bureau of Investigation's allegation that Minister Raja's fraud cost the Indian government nearly $40 billion in lost revenue. See India's Corruption Scandals, BBC News South Asia (Mar. 17, 2011), www.bbc.co.uk/news/world-south-asia-12769214?.) The ruling was also expected to help prevent fraud by “unscrupulous people who are only interested in garnering maximum financial benefit and have no respect for the constitutional ethos and values.” 2G Ruling ' 76. All licenses granted before 2008 will remain intact because they were not part of the lawsuit. As of the date of this article, the Indian Department of Telecommunications has not yet held the new, court-mandated 2G spectrum auction.

The Indian Supreme Court's ruling potentially reaches far beyond the telecommunications industry. In its explanation of why an auction method is constitutionally fair and transparent, the Indian Supreme Court couched its language in general terms, writing:

When it comes to alienation of scarce natural resources like spectrum, etc., it is the burden of the State to ensure that a non-discriminatory method is adopted for distribution and alienation, which would necessarily result in protection of national/public interest. In our view, a duly publicized auction conducted fairly and impartially is perhaps the best method for discharging this burden and the methods like first-come-first-served ' are likely to be misused.

See Katya Naidu, DoT to Select 2G Auctioneer in July, Business Standard (June 11, 2012), http://business-standard.com/india/news/dot-to-select-2g-auctioneer-in-july/476960/. Other licenses that the Indian government has distributed for “scarce natural resources” on a first-come, first-served (or other non-auction) basis, such as mining, liquor and real estate licenses, might now also be unconstitutional and void. See Rupa Subramanya, Economics Journal: Why the 2G Verdict Is a Win, The Wall Street Journal (Feb. 6, 2012), http://blogs.wsj.com/indiarealtime/2012/02/06/economics-journal-why-the-2g-verdict-is-a-win/. The 2G ruling potentially could lead to years of litigation in other
industries over the years to come.

Takeaways

The 2G ruling has created some regulatory uncertainty that may discourage potential foreign investments in India. The fact remains that India
attracted $50 billion in foreign
direct investment (FDI) in the first 11 months of 2011 ' up 13% from a year earlier. Henry Foy, India still a foreign investment hot spot-E&Y, Reuters
(Jan. 29, 2012), www.reuters.com/article/2012/01/29/india-investment-idUSL4ECR3D920120129. With a projected GDP growth rate of 5.5% for 2012, and the Indian government's plans to double spending on infrastructure in the coming years, the Indian economy is poised to attract significantly more foreign capital regardless of any fallout from the 2G ruling. Moody's Cuts 2012 India's Growth Forecast to 5.5 Per Cent, Blames Policy Mis-steps,” Business Today (Aug. 9, 2012), http://businesstoday.intoday.in/story/moodys-cuts-2012-indias-growth-forecast/1/187056.html. Dealmakers should understand the compliance risks of doing business in India, and all companies should conduct thorough due diligence before making investments.

A robust due diligence and compliance program should be able to identify and escalate to senior management evidence of “red flags” such as atypical payment patterns, lack of transparency in accounting records, unusually high commissions, a history of corruption in the particular industry, and an apparent lack of qualifications or resources to perform the services offered. (Industries such as construction, telecommunications, and power have a especially high risk of corruption, particularly compared to industries such as business process outsourcing. See Kerry Francis, Walt Brown, Hema Hattangady, India and the Foreign Corrupt Practices Act, Deloitte Forensic Center, www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/FAS_ForensicCenter_us_fas-us_dfc/us_dfc_indiaandfcpa_05192011.pdf.) In light of the 2G ruling, due diligence in India should also now include a close examination of any government licensing procedures, as well as a careful backward-looking review of how the Indian entity received any licenses in the past, particularly if the entity's value is highly contingent on the validity of such licenses.

Standards of Corporate Governance

Many questions have also been raised as to the standards of corporate governance in Indian businesses that are mostly promoter-led and family controlled. Newly listed companies in India and public companies above a certain prescribed size have to comply with Clause 49 of the listing agreement of the stock exchanges. (Companies with a paid up share capital of more than 30 million Rupees or a net worth of over 50 million Rupees at any time in the history of the company have to comply with Clause 49 of the listing agreement. Letter from Parag Basu, Deputy General Manager of the Securities and Exchange Board of India to Directors or Administrators of all the Stock Exchanges regarding Corporate Governance in Listed Companies ' Clause 49 of the Listing Agreement (Oct. 29, 2004), www.sebi.gov.in/circulars/2004/cfdcir0104.pdf (attaching Clause 49 of the listing agreement).) It imposes certain U.S.-style independent director and audit committee requirements. However, the reality is that independent directors in Indian companies do not play the type of proactive role that is common in Europe and the United States and very rarely vote against the promoters. Because private companies are under no obligation under Indian law to install corporate governance mechanisms, it is that much more important to evaluate their internal compliance and control procedures more thoroughly. Additionally, many businesses in India are still structured as family-owned group businesses with great interdependence on one another; consequently, there can be extensive related party transactions which must also be identified and examined.

Conclusion

Despite concerns about regulatory uncertainty after the 2G ruling and potential corruption in certain industries, foreign companies are investing in India at an ever-increasing rate. Thorough due diligence and robust compliance programs are the best way to ensure these investments' success.

Sean Hecker is a partner in the New York office of Debevoise & Plimpton LLP and Aaron M. Tidman is an associate in the firm's Washington, DC, office. They are members of the Litigation Department and White Collar Litigation Practice Group. Parveet Singh Gandoak is an associate in the firm's Hong Kong office and is a member of the Corporate Department. The authors may be reached at [email protected], [email protected], and [email protected].