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FDI In Pharma : New Dimension

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Effect of Press Note 1 of 2014 on Foreign Direct Investment in Pharmaceutical Sector
According to certain sources, India ranks third in the world in terms of value of production and supplies affordable and high quality generic medicines to a number of developing and least developed countries of the world. Around 95% of its domestic demands are met through indigenous production covering almost all therapeutic categories and with imports of only a few high-end technology products. India export drugs to more than 200 countries and the export market grows around the rate of 10% per annum every year. Given this background, it is no surprise to see pharma MNCs making a bee-line for attractive Indian assets resulting in the Indian pharma market seeing a lot of M&A activity in the last couple of years, particularly in the brownfield pharma space. However, many concerns have been raised with respect to permitting unfettered FDI in pharma sector in India. The concerns have been mainly about the possible erosion of the country’s strength in generic drugs
manufacturing on account of M&A involving domestic pharma companies by MNCs. It has been argued that the business model of the pharma MNCs would cripple the generic drugs manufacturing capacity as acquirers would be more interested in promoting their business interests rather than serving public interest, resulting in the drug prices to rise and, possibly, a shortage of generic drugs that will slowly be replaced by costly patented ones. The FDI policy permitted 100 percent investments in greenfield and brownfield pharma projects, thus facilitating a large number of M&A transactions. However, it has been
reported that, FDI inflows have predominantly been in brownfield pharma projects in the country with no substantial qualitative improvement in R&D or capacity creation.
Initial Recommendations To cater to the growing concerns emanating from unbridled M&A activity, the Department of Industrial Policy and Promotion (DIPP) had proposed to impose restrictions on at least 3 (three) categories of pharmaceuticals in addition to bulk drugs — vaccines, injectibles and oncology medicines. DIPPs proposed to limit only 49 percent FDI in brownfield pharma companies as one of its recommendations to the Cabinet. The other conditions include that the R&A or the manufacturing unit of
an acquired brownfield Indian entity must not be shut-down after the M&A deal and mandated an investment equal to 25 percent of the value of the FDI into expanding the existing manufacturing unit, or in a new unit or for R&D, within 3 (three) years. Another notable proposal was to bar the foreign investor from enforcing any non-compete agreement against the exiting Indian promoters. The Change and its Import
Out of the proposed changes, the Government has only accepted the bar on having non–compete agreements with Indian promoters. Press note 1 of 2014 amends the FDI policy by adding a condition that a non–compete will not be allowed except in special circumstances as approved by the Foreign Investment Promotion Board (FIPB). Now the FIPB will look into transactions and permit non-compete agreements on a case to case basis. In the recent past, there have been some form of a non-compete clause in almost all big deals including Daiichi Sankyo’s takeover of Ranbaxy and Abbott’s acquisition of Piramal Healthcare’s domestic formulations. From a contract law perspective, non–compete agreements are completely legal so long as they do not contravene section 27 of the Indian Contract Act, 1872. Section 27 holds that agreements by which anyone
is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. The exception is an agreement for not to carry on business of which goodwill has been sold. This exception caters to M&A activity. The Competition Commission of India (CCI), the anti-trust regulator, has also, in the recent past, dealt with the anti-competitive effects of non-compete clauses embedded in documentation governing M&A
transactions in the pharma sector like the ones in the case of transaction involving Orchid Chemicals and Pharmaceuticals Ltd. and Strides Arcolab Ltd. In the Orchid Chemicals case, the CCI has observed that “non-compete obligations, if deemed necessary to
be incorporated, should be reasonable particularly in respect of (a) the duration over which such restraint is enforceable; and (b) the business activities, geographical areas and person(s) subject to such restraint, so as to ensure that such obligations do not result in an appreciable adverse effect on competition.” The CCI ordered the reduction of the duration of the non-compete in the domestic market to four (4) years and the removal of the restriction on research, development and testing on such new active pharmaceutical
ingredients/molecules (API) which would result in development of injectable formulations which are currently non-existent worldwide. In the Strides Arcolab deal, the non-compete covenant on the promoters was for six (6) years which restricted them from carrying on or engaging, being concerned or interested economically or otherwise in any business of developing, manufacturing, distributing, marketing or selling any injectable, parenteral,
ophthalmic or oncology pharma products for human use, anywhere in the world. The non-compete covenant also placed restrictions on the development of new molecules which are presently non-existent. The CCI ordered reduction in the duration of the non-compete obligations applicable to the Indian market only to a period of four (4) years, restricting the scope of the non-compete as applicable to the Indian market only to the products that each of Agila India and Onco Therapies Ltd. currently manufacture and to pipeline products in development and permitting the promoters to conduct research, development and
testing on such new APIs which would result in development of injectable formulations which are currently non-existent worldwide. While non-compete clauses are viewed as standard industry practice which enable effective implementation of M&A transactions, and help the acquirer in obtaining and, importantly, maintaining full
value of the acquired business or asset, especially in light of the fact that the transferor(s) possess the experience, know-how and technical ability to establish a new competing business, it is also a reality that FDI policies for sensitive sectors like pharma must be fine-tuned to suit every stakeholder. The Government needs to find the right balance in its policies to address the needs of industry on one hand and appreciate the socio-political realities of the country on the other. Efforts like the present ones are considered half-hearted as it will not be difficult to structure alternatives around the restriction to ensure
desired results. Till the time the Government finds this balanced approach, it is needless to say that the new restriction on non-compete in FDI in brownfield pharma projects will impede M&A in the pharma sector by reducing the attractiveness in terms of valuation of the Indian pharma companies.
This update does not constitute legal advice. Please separately seek formal advice for all transactions which may be affected by the matters discussed in this update. VERUS neither assumes nor accepts any responsibility for any loss, harm, or damage, arising to any person acting or refraining from acting on the material contained in
this update. If you have any comments or queries please reach out to the following person at the given co-ordinates:

Jay Parikh
Partner
jay.parikh@verus.net.in
T: + 91 22 22860100 / 22834130
F: +91 22 22834102
+91 98 33818055

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