Offshore Outsourcing Revisited: The Perspective from India

The global trend of business process outsourcing (BPO) (including outsourcing of IT services, transcription services, word processing, and back-office secretarial support to India) is presently evolving into a new model – BPO is rapidly moving up the value chain to more knowledge intensive industries such as legal services, pharmaceuticals and design. It is therefore not surprising that the projected spending in 2005 for ITES-BPO projects to India is anticipated to be approximately $16.3 billion according to a recent NASSCOM report.

Benefits

There are numerous benefits for BPO projects in India. Some of the well known advantages include working in a country that uses English as a business language, a common-law based federal legal system, highly regarded educational institutions and the benefit of continuous processing as the result of operating in multiple time zones. Further, high quality products and services are provided at a lower cost due to the salary and infrastructure cost differentials between India and the West as well as beneficial tax breaks and other regulatory incentives provided by the Indian Government. India‘s regulatory and legal environment, continues to evolve to meet the needs of increased globalisation as India complies with its WTO and TRIPS obligations, while striving to keep itself competitive and attractive to foreign investors.

Risks

While there are many benefits to outsourcing, there are also several risks. These risks include those of a geo-political nature as well as economic uncertainty where political turmoil can disrupt business and problems can potentially arise with quality and management control. An additional well known risk is the lack of an adequate data protection regime. Most companies tackle these constraints by building in adequate contractual safeguards and processes in written terms and conditions. As outsourcing projects increase in number, there is growing concern over the increase in wages diluting the low cost base that makes the Indian BPO an attractive proposition. There is the additional concern of high attrition that many Indian BPO companies currently face.

Considerations

Given the risks outlined above, careful vendor selection and a considered entry strategy are critical for success. The effect of transfer pricing must also be considered seriously. Companies also need to consider whether their proposed corporate structure amounts to being a ‘permanent establishment’ within the meaning of Indian law which has various tax and regulatory implications. Consideration of labour laws, cultural differences and local infrastructure that affect day-to-day operations cannot be ignored.

Conducive Legal Environment: Local Conditions

Placing a BPO project in a conducive legal environment is crucial to its smooth functioning. India in this regard offers one of the most stable and conducive judicial systems for foreign business. The courts in India have settled precedents and interpretations of various contractual and business situations, which makes understanding the legal position on a number of issues clear. Parties are permitted to select a foreign jurisdiction as the governing law of their contract and foreign judgments and awards are recognised under certain conditions.

Legal, Commercial & Regulatory Considerations: Operating Models

There are various models by which a company may set up their BPO presence in India namely: (a) 100% subsidiary; (b) branch office; (c) joint venture; (d) build operate transfer (BOT) (e) vendor contract. These methods offer varying degrees of flexibility to companies.

a) 100% Subsidiary: This is the preferred route for foreign companies investing in India at the moment. It provides the foreign parent company with a captive set up which offers benefits such as ring-fencing liability, the ability to offer appropriate incentives to employees at a local level and the ability to exercise a high degree of control over management and processes.

b) Branch Office: This structure has certain limitations for doing business in India. The branch office is effectively an arm of the foreign parent company and accordingly this structure is not commonly used due to tax and liability reasons.

c) Joint Venture: This paves the way for foreign customers to access local knowledge and considerably reduces time to market. This is the second most common method of investment. However, companies are cautioned to conduct a thorough due diligence before proceeding to enter into a joint venture and carefully look at exit options.

d) BOT: BOT is a hybrid of the previous structures (a) and (c). The drawback in this structure is the last stage of the transaction ie the ‘transfer’. It remains to be seen how successful this model is in the long term and whether the parties are able to effect this transfer smoothly.

e) Vendor contract: This is equivalent to a third-party, arms- length contract for provision of services and transfer of existing processes to the Indian vendor’s site. The main disadvantage of this type of arrangement is loss of control over the process.

Key Legal Issues

In any outsourcing contract, the key legal issues to consider are contract, data protection, intellectual property rights, tax, labour, and enforcement.

a) Contract: Contracts in India are governed by the Contract Act 1872. Parties need to clearly define clauses dealing with non-compete and confidentiality. With reference to the non-compete these agreements need to pass the test laid down in §27 of the Act, which states that agreements in restraint of trade are illegal. Other clauses that need to be clearly defined are what constitute a breach and the processes to amend the breach. The Act stipulates that payment of damages for breach must be reasonable. This test of reasonableness holds true even if liquidated damages are provided for in the contract itself.

b) Data Protection: Currently there is no statutory framework covering data protection, thereby creating a stumbling block to BPO initiatives. The Indian government is, accordingly, considering an amendment to the Information Technology Act and other connected legislation such as the Indian Contract Act and the Indian Penal Code to remedy this problem. Despite the lack of legislation protecting personal data, many Indian BPO outfits are adhering to appropriate US and European regulations. Further, NASSCOM has announced that it intends to commence a certification process for data security commensurate to international standards, which gives added comfort to foreign customers.

c) Intellectual Property Rights: India has one of the best intellectual property regimes in the world. The Trademarks Act 1999 is in compliance with TRIPs obligations where domestic and international applicants are treated at par and prior use of trademarks is not a prerequisite for protection. Infringements may be remedied through an injunction and payment of damages. The Copyright Act 1961 governs copyright law in India and recognises copyright in software, which is defined as a ‘literary work’. Copyright in India need not be registered and subsists for a term of 60 years from the death of the author. Infringement of copyright laws may result in imprisonment and fines.

d) Tax: The Income Tax Act 1961, as amended in 2001, lays down rules for transfer pricing and requires arms-length pricing of services being rendered. The Income Tax Act also contemplates withholding tax on payments to non-residents. The onus of tax deduction is upon the person responsible for paying the non-resident any money. Indian tax laws allow persons liable to tax to claim benefit under applicable Double Taxation Avoidance Agreements (DTAA) and pay the lower rate of tax, ie the lower of that payable under income tax laws of India and those stipulated under the DTAA.

e) Labour: Labour laws in India are complex and need to be considered carefully. Employment contracts need to include reasonable conditions and terms must be enforceable. The basic concept of ‘Hire and Fire’ is workable for the outsourcing industry in India, subject to certain restrictions such as compliance with prescribed notice and compensation. India is not limited by legislation similar to the UK TUPE and therefore Indian partners may be held entirely responsible for all labour compliances. Benefits under labour laws that a company may be obliged to provide vary from state to state.

f) Enforcement: The last key legal issue is that of enforcement. The jurisdiction of authorities for each governing law must be clearly delineated to enable proper enforcement. Indian law has clear guidelines about the treatment of foreign judgments, interim relief and alternative dispute resolution. Enforcement of foreign awards is permitted under the Arbitration & Conciliation Act 1996. An illustrative example of this development may be seen in recent landmark judgements given by the Supreme Court dealing with enforcement and the effect of public policy under such enforcement. The grounds for challenging a foreign award have been laid down under §48 of the Act. Under this section an award may be challenged inter alia if it is found that it ‘is in conflict with the public policy of India‘. In a landmark judgment (Renusagar Power Co. v General Electric Co. [AIR 1994 SC 860: (1994) CLA Suppl 1(SC)]) the Supreme Court has held that there are three patterns of the operation of the doctrine of ‘public policy’ where the court may refuse recognition and enforcement of foreign arbitral awards. These are if the award is found to be against (a) the ‘fundamental policy of Indian law’, that is to say, if the foreign award involves a violation of Indian law or non-compliance with a court’s orders, (b) the ‘interests of India’ or (c) morality and justice.

Conclusion

From the above it is clear that, though India remains an attractive jurisdiction for BPOs, one needs to be aware of the risks associated with operating in the Indian market place and incorporate and institute appropriate safeguards (both contractual and otherwise) to minimise such risks.

ALMT Legal is a niche Indian law firm with offices in India and a branch in London. The firm provides advice and assistance in relation to IT and Outsourcing projects. For further information contact Shalini Agarwal at sagarwal@almtlegal.com.