Infrastructure India’s Window of Opportunity-Legal Pothole
Infrastructure is the catalyst for creating road networks, improving standards of living and business environment of a country. Any national economic development is linked with its infrastructural development. The two must move in sync to enable integrated development. India has shown immense growth in the last decade, the Indian market has opened up, the foreign investment policy liberalized and the government has been actively pursuing infrastructural development. The sector is vast and includes various sub-sectors such as transportation, water management, telecommunications, industrial and commercial development, power, petroleum, natural gas, etc.
Insufficiency of funds has been a major road block slowing down the progress of this sector. The government is trying to change this situation by providing various initiatives and incentive programmes. It is attempting to bridge the wide gap between the demand for infrastructure and the supply of funds through close partnership between the public and private sectors, with a vital role reserved for foreign as well as Indian investors. This bulletin provides an overview of the recent opportunities while highlighting some of the causes for concern that an investor must bear in mind prior to investing.
1.0 Recent incentives and opportunities
India being an emerging economy, the scope for development through expansion of infrastructure is vast. The government has proposed to spend US$ 1 trillion in the next 5 years in order to bring Indian roads, ports, airports to match world standards.1 With liberalization of foreign direct investment (“FDI”) norms the government is clearly trying to boost this sector to achieve rapid growth. As per the current policy, 100% FDI is permitted for roads, highway construction, power generation, transmission, ports and other key infrastructure areas except aviation. The 2011-12 budget allocates 48% of the government expenditure towards this sector. The allocated fund has risen by 23.3% in comparison with last year’s allocation of US$ 38.5 billion towards infrastructure. This is a positive sign for investors as it should lead to an increase in number of governmental tenders which, in turn, will create more opportunity for investment through private participation. The scope and extent of private participation is determined by the government and can be of varying degrees and the contracts can be BOO or BOT basis. The segments that present the best opportunity are roads, ports, airports and power infrastructure.2
2.0 Some important considerations
Companies engaged in this sector need to be aware as they are likely to face a number of practical problems. All investors must consider and evaluate the following factors and consider them in their proposals and business plans.
2.1 Land Acquisition
Land is an important component for any infrastructure project. India’s Land Acquisition Act allows the government to purchase land from its owner for public purpose3 in exchange for the payment of compensation. Given the primarily agrarian nature of land use, resistance to land acquisition by land owners should be expected. This has the potential of delaying project commencement because land owners often challenge the land acquisition in a court of law after the project is granted. In many cases, the government continues the land acquisition proceedings simultaneously with the bid process. As a consequence, since the government does not complete the land acquisition formalities before completion of the bid process, they are forced to hand over unencumbered land to the bidding private party. This means the winning party has to face the consequence of judicial challenges. Considering the slow pace of the Indian judiciary, this becomes an eminent cause for delay. For example, in the Bangalore Mysore Infrastructure Corridor project4 there was a 13 year delay in the project on account of the acquisition being challenged in court. The courts are, however, not averse to land acquisition and on May 2, 2011 the Supreme Court of India cleared this project, rejecting objections raised by the land owners by giving due consideration to larger public interest. Despite the positive trend of the courts, the delay factor associated with land acquisition cannot be overlooked. Therefore, the bidder must carry out its own due diligence to ensure that the land acquisition formalities have been completed by the government or at least update itself of their status and be informed of the likely hurdles and challenges which can then be factored in the offers.
2.2 Concession Agreements
Concession agreement is the heart of PPP projects. It lays down the rights and obligations of each party i.e., of the concessioning authority (usually the government) and the concessionaire (the Special Purpose Vehicle which has been awarded the project after the bidding process). Through this agreement, the concessioning authority transfers the construction and financing risk of the infrastructure project to the concessionaire. In consideration, the concessionaire gets rights to collect and retain the cash flows generated from such infrastructure projects. For example, in the road projects, the concessionaire is obligated to construct, finance, operate and maintain the road and simultaneously gets the right to collect the toll throughout the concession period.
Since, infrastructure projects are capital intensive the project developer requires external commercial borrowing and financing. At present, in BOT projects the concessionaire has to transfer the land/project to the government after the concessionaire period. In the absence of tangible security, the concessionaire i.e., the borrower in this case is often required to depend on the clauses of the concession agreement pertaining to the assignment of concessionaires, the substitution right and right to receive the termination payment on termination of the agreement to secure financing of his project. Therefore, it becomes very important to ensure that special care is taken while drafting/negotiating the concession agreement with the government to make it a bankable document which gives comfort to the potential lenders and FII’s. While, there is no standard list of requirements, practice indicates that bankability requires clarity with regard to the concessions offered and the ability of the concessionaire to deal with the assets, including creation and enforcement of security interest as well as his ability to perform, complete the project and fulfil his obligations under the agreement.
2.3. Regulatory Environment
Although independent regulatory framework for different sectors has been developed, there is lack of co-ordination between the regulators, since there is no central regulatory body with the power to oversee integrated development of a project. For example, Bangalore’s international airport could have become more user-friendly and profitable for the developers with the simultaneous development of high speed rail and highway projects. Though this was included in the original plan submitted by the developer the same could not be achieved due to the lack of a central body co-ordinating its development. Experts have made out a strong case for having an independent and accountable regulator overseeing the infrastructure sector and till this is done investors need to brace themselves to dealing with various regulatory bodies since project development cannot occur in isolation.
2.4 Judicial Interference
Judicial interference cannot be ruled out with regard to award of projects made by the government which are usually challenged by motivated public interest litigations or by unsuccessful bidders which causes delay in project execution. For example, the case filed by Reliance Industries5 against the current developers of Delhi airports post the award of contract for expansion and modernization caused delay in project execution.
2.5 Environmental clearances
Environment clearance is compulsory for investment above US$ 20 million. If investment is less than US$ 20 million, clearance is not necessary. In order to obtain environmental clearance for projects the investor needs to submit the Environment Impact Assessment report along with the no-objection certificate from the respective State Pollution Control Board. The investors can face problems in obtaining the clearance within a reasonable time frame due to the fact that there is no time limit prescribed within which the concerned agency is required to grant it. This problem can be addressed with the assistance of able legal help and persistent follow-up.
Investors need to understand the operating Indian business environment before planning to join the bandwagon in this sector, since the legal implications can have a major impact on the success of the investment. Nonetheless, it cannot be denied that despite the legal potholes investment in Indian infrastructure is a promising and beneficial platform for investors considering the booming economy, liberalized FDI regime and abundance of opportunities. Reasonable solution to legal hurdles faced by infrastructure companies could be overcome with efficient legal planning. India’s burgeoning infrastructure sector is estimated to be worth around US$ 1 trillion and for prepared investors this sector can turn out to be a window of opportunity.
1 As per Prime Minister’s estimate on infrastructure investment, http://www.financialexpress.com, visited on March 31, 2011
2 Projections of investment in infrastructure during the Eleventh Plan, http://www.planningcommission.nic.in, visited on April 15, 2011.
3 The requirement of public purpose (that is, consideration of public demand) is the determining factor on the question whether or not a particular land should be acquired.
4 This project envisages connecting Bangalore and Mysore (two rapidly growing cities in Karnataka) with an expressway.
5 Reliance Airport Developers Pvt. v. Airport Authority of India and Ors, (2001 (6) SCC 534