COVID-19 has wreaked havoc on the finances of companies in a wide range of industries and highlighted the challenges of managing an offshore global innovation, captive technology or in-house center (GIC) through a crisis. As noted in The Economic Times on May 29, 2020, “India’s cash rich IT services companies are eying captive technology centers of global corporations, as they gear up to provide IT and back office services at lower costs and offset a demand slowdown from the U.S. and European markets in the wake of the COVID-19 pandemic.” There are over 1,000 captive centers in India employing around 1,000,000 people, and Karl Flinders speculated in Computer Weekly on April 20, 2020, that half of the small ones owned by western multinationals could be sold off to raise cash and boost efficiency. We are already seeing strong indications in our sourcing practice of client and supplier interest in the sale of GICs, and the recent decision by the U.S. government to suspend work visas until the end of this year is expected to lead to more companies having work performed offshore.
As a large number of GICs are located in India, we have asked Sajai Singh, a partner at J. Sagar Associates in Bangalore, who we have had the pleasure of working with in connection with the setup and sale of GICs, to join us in this Client Alert describing some of the key considerations in selling a GIC in India.
The sale of a GIC to an outsourcing vendor typically involves two main components:
In this regard, the transaction will bear some resemblance to how IT outsourcing transactions were structured in the early days of outsourcing during the Savings & Loan crisis of the late 1980s. At that time, outsourcing vendors typically acquired the IT assets at net book value to improve the client’s financials in exchange for securing a long-term services agreement to provide the same services back to the client.
Companies that are looking to maximize the cash infusion from the sale of the GIC should recognize that in many instances the sales price is effectively a loan from the outsourcing vendor that is amortized and repaid through the service fees during the term of the outsourcing services agreement.1 Because the outsourcing vendor will want to be assured of full recovery of the purchase price, there will likely be a higher cost to the company to exit the relationship (e.g., higher termination for convenience fees). In addition, a higher purchase price will require a longer term to the outsourcing arrangement for the economics of the transaction to make sense to both parties.
Companies should carefully balance the near-term benefits of maximizing the cash infusion from the sale of their GIC against the long-term impact on their flexibility under the outsourcing services agreement. This is particularly important for companies that are considering major transformational initiatives (e.g., large migrations to cloud platforms, such as AWS, Azure and Google Cloud) that may impact the scope and volume of services required under the outsourcing services agreement.
India Law Considerations
Sales of GICs need to be undertaken in compliance with the laws and regulations of the jurisdiction in which the GIC is located. There are a labyrinth of legal requirements, customs and practices that need to be addressed in selling a GIC in India.
Form of Transaction
Sales of GICs may be structured as:
The structure of the transaction requires careful consideration as it can have significant HR, tax and regulatory ramifications.
Sales of GICs typically involve the transfer of employees to the purchaser. In a business or asset transfer, there are two options to consider:
Typically, share transfers will not impact employees as there is no actual transfer of employment from one entity to another entity.
Key financial and tax considerations associated with the sale of a GIC include the following:
In some cases, regulatory approvals, such as the mandatory notification to the Competition Committee of India, may be necessary. A share transfer between non-resident and resident entities may trigger reporting requirements with the Reserve Bank of India. In addition, certain regulatory filings are required under the Companies Act, 2013 in connection with a share transfer.
For the promotion of software exports from India, the Indian government set up Software Technology Parks of India (STPI) in less expensive locations. STPIs are exempt from customs duties on imports, may import secondhand equipment, and may import on a loan or lease basis. In 2005, the Special Economic Zone (SEZ) Act was enacted to provide duty free imports, an income tax exemption, and a single window clearance process. An asset or business transfer may trigger consent or notification requirements that should be taken into account in planning deal timelines.
Data Protection and Privacy
The Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011, issued under the Information Technology Act, 2000, provide that if the transfer of a business or assets involves the transfer of personal information or sensitive personal data or information (e.g., financial information, biometric information, Aadhaar, etc.), certain requirements must be met, including obtaining permissions from the provider of the data.
International Law Considerations
We have seen some instances in the past where companies had set up a GIC in India as either a Private Limited Company (PLC) or an Indian Limited Liability Partnership (LLP) to achieve certain international tax or accounting objectives which will need to be reconsidered in connection with a sale transaction. OECD Transfer Pricing Guidelines and other pricing matters will also need to be reconsidered. In addition, the services provided by the GIC may have involved the export of technology, and regulatory actions may be required in connection with the sale of GIC assets. International transactions bring into play a range of regulations and compliance requirements, such as the Foreign Corrupt Practices Act, and experienced international counsel must be consulted.
Sourcing and Technology Considerations
We have also seen some instances in the past where companies viewed the sale of their GIC as primarily an M&A transaction and have given short shrift to structuring the outsourcing relationship. This is the tail wagging the dog. Services provided by GICs are often mission-critical IT and back office services that will have far greater impact on the organization in the long-term than the one-time cash infusion from the sale of the GIC. Companies would be well advised to view the sale of their GIC as primarily an outsourcing and technology services transaction that happens to include a complex sale and transfer of assets and employees to the outsourcing vendor.
Like any large-scale outsourcing, companies should strongly consider seeking competitive bids from outsourcing vendors. We have received indications from the supplier community that there is a high level of interest in acquiring GICs in order to secure new outsourcing engagements. Companies are thus in a good position to leverage competition to achieve favorable outcomes on both the corporate and sourcing aspects of the transaction.
In soliciting proposals from outsourcing vendors, RFPs should include sufficient information about the GIC to enable vendors to provide proposals covering both the acquisition of the GIC and their solution for delivering IT and other technology services back to the company following the acquisition. In addition, companies should look beyond the specific services provided by the GIC to determine whether IT and back office services provided by other parts of the organization (or third party service providers) should be included in the outsourcing due to their nexus to the GIC services or for other reasons. The sale of a GIC can be an opportunity to take a fresh look at the entire service delivery fabric of IT and back office services and to develop a more cost-effective delivery strategy that will better position the company for the future, including the adoption of emerging digital technologies.
In negotiating and structuring an outsourcing services agreement, particular attention should be given to ensuring that it is properly aligned with the purchase agreement for the GIC. M&A agreements often contain representations and warranties on the part of the seller (e.g., the transferred assets are in good condition) that are inconsistent with disclaimers in outsourcing services agreements (e.g., assets are furnished to the vendor in “as is” condition) and could provide unanticipated excuses for poor performance on the part of the outsourcing vendor. As noted above, there is also an inherent tension between maximizing the purchase price for the sale of the GIC and having the flexibility to reduce or modify the scope and volume of services provided by the vendor under the long term outsourcing services agreement. Close coordination between the M&A and the outsourcing technology teams will be required in addressing this and other issues.
The sale of a GIC is a highly complex undertaking that requires an understanding of local law, experienced M&A counsel, experienced international legal experts, and the deepest expertise in outsourcing and technology transactions. Companies would be well served by retaining an integrated team of advisors that can bring together the requisite legal and commercial experience and expertise to help navigate through this complexity to achieve favorable outcomes and minimize risk.
For more information, please reach out to your regular Pillsbury contact or the authors of this Client Alert.
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 An exception would be if there is value to the outsourcing vendor in acquiring the GIC independent of providing services back to the company (e.g., capacity or unique skill sets in the GIC that can be quickly leveraged for other clients).