New Press Note – an impetus or roadblock for e-commerce

Introduction

With the growth of marketplace e-commerce companies in India, numerous issues have arisen in recent months surrounding their existence and the investment of private equity in these companies. In order to clear uncertainties on FDI in e-commerce, the Department of Industrial Policy & Promotion (“DIPP”) issued guidelines for foreign investment in e-commerce by way of Press Note 3 of 2016, dated March 29, 2016 (“PN3”). Apart from prescribing certain key definitions, which were missing so far, including e- commerce, marketplace based model of e-commerce and inventory based model of e-commerce, the PN3 lays down respective caps for FDI as well. According to PN3, foreign investment is allowed up to 100% under the automatic route (where no prior investment permission is required) in the marketplace model while no foreign participation is permitted in the companies working on the inventory based model.

This bulletin seeks to give an analysis of PN3 highlighting the lack of clarity in it and its practical ramifications on e-commerce business.

1. Elements of PN3

Until the issue of PN3, the consolidated FDI Policy of 2015¹, dated May 12, 2015 (the “FDI Policy”) allowed foreign investment in B2B companies while it was prohibited in B2C. With the introduction of PN3 and specifically in terms of paragraph 1 of PN3, foreign companies are now permitted to invest in B2C companies as well in (a) a manufacturer manufacturing its products in India, (b) a single brand retail trading entity selling its products under a single brand through its brick-and-mortar stores, and (c) an Indian manufacturer who owns the Indian brand and manufactures 70% of its products in-house and sources, at most, 30% from Indian manufacturers.

1.1 Important definitions in PN3

The term E-commerce has been defined in an extremely broad way to bring within its ambit purchase of digital products, goods and services through digital and electronic networks. The phrase digital and electronic network² means buying and selling of products through televisions and mobiles as well. PN3 defines the term E-commerce entity to cover those entities conducting e-commerce business i.e., companies formed under Companies Act, 1956 and Companies Act, 2013 ( the “CA 2013”); a foreign company in terms of Section 2 (42) of the CA, 2013, which means and includes company or body corporate incorporated outside India which has a place of business in India whether by itself or through an agent, physically or an electronic mode ; or any office, branch or agency which is under ownership or control of person resident outside India.

The term inventory based model of e-commerce is that model of e-commerce where products are owned by e-commerce entity and is sold by it directly to the consumers over the digital and electronic network and the term marketplace based model of e-commerce is where an e-commerce entity acts as mere facilitator between the seller and consumer as it provides the technology platform for seller to sell the products directly to consumers. Thus, the main distinguishing feature between the two models is that an e-commerce entity which owns the products falls in the domain of inventory model and which does not own the products falls within the domain of marketplace model.

1.2 Other key features of PN3

PN3 allows the marketplace e-commerce entity: (i) to transact with their registered B2B sellers on B2B basis; and (ii) to enter into support services agreements with sellers registered on its platform for providing support services, such as warehousing, logistics, order fulfillment, call centre, payment collection. It is specifically provided in paragraph 2.3

(iv) of the PN3 that ownership of the product by marketplace e-commerce entity is completely prohibited as ownership will lead to its conversion into inventory based model of e-commerce entity.

PN3 also provides that (i) no vendor or their group companies can alone account for more than 25% of sales through marketplace e-commerce entities; (ii) no marketplace entities shall directly or indirectly influence the sale price of goods or services; and (iii) such entities shall maintain the level playing field. In addition to the above, PN3 restricts marketplace e-commerce entities from issuing warranty/guarantee for goods and services sold by seller; and taking the responsibility of orders fulfillment after the sale of goods.

2.  Analysis

• Distinctions: In our view, the distinction made between manufacturer and Indian manufacturer in PN3 is not needed as foreign investment can only be in an Indian manufacturer. Paragraph 1 (iii) of PN3 permits FDI in only that Indian manufacturer, which owns the Indian brand and manufactures 70% of its products in house. Hence, there must be some reason why the distinction is drawn, but the rationale is unclear and, therefore, to that end, DIPP should issue a clarification on the purpose of the distinction.

• Indian Brand: Further, a foreign company with a wholly-owned subsidiary (“WoS”) or JV company in India cannot be allowed to sell its products through its own e-commerce platform unless it has an Indian brand, which is owned by its WoS or JV company. The matter gets complicated as Indian brand is also not defined in PN3 or FDI Policy and, perhaps, it could potentially mean a brand, which is a registered trademark in India.

• Other expressions: The word at most in paragraph 1 (iii) of PN3 can be interpreted to mean that an Indian manufacturer is at liberty to source remaining 30% of its products from foreign company. DIPP will need to explain whether it intended to allow an Indian company to import 30% of products. The term digital product used in the definition of E-commerce might be a source for new controversy as the term digital product has not been defined in PN3 or FDI Policy and it can be given an expanded meaning to include songs and movies available for download on digital and electronic network. If such expanded meaning is given to the term digital product then no FDI is permitted in those websites or mobile applications, owned by Indian companies, which own and sell music, songs, movies, etc. Surely, that could not be the intent of the policy makers. The reference to services, in the e-commerce definition, means that PN3 is also intended to apply to e-commerce entities engaged in providing services. PN3 makes a specific clarification that FDI up to 100% is permitted in e-commerce ventures operating in the services sector. Thus, those companies which are in the business of providing on-line food ordering service, on-line taxi service, on-line service of hiring of professionals or household workers, will be allowed to avail FDI up to 100% under the automatic route.

• Other Conditions: Some conditions (no single company to account for more than 25% of sales and e-commerce entities to not influence, directly or indirectly, the selling price) in PN3 have been introduced with an aim to ensure that e-commerce business in India moves correctly and predatory price approaches are checked. However, this 25% condition will impact the structure of seller base of those entities who purchase products from primary sellers or allow only primary sellers to display their products on e-commerce platform. It is possible that with the introduction of this 25% condition entities may have to restructure their seller base. Then, the condition of preventing influence of the selling price, directly or indirectly, could lead to end of discounts offerings whereas there is no such restriction on entities operating on the inventory model. There is also no intelligible differentia for making inventory based model as a class distinct from marketplace model.

The restriction on delivery of products by marketplace entities after the sale might become a big issue for them as sale is completed when an order is placed. Section 4(4)³ read with Sections 19⁴ and 20⁵ of the Sale of Goods Act envisage that the sale is concluded upon the transfer of property in specific and deliverable goods to the buyer. Thus, a marketplace e-commerce entity can only provide the service of order fulfillment if its sale condition specifically provides that placing of order is only an agreement to sell and sale ensues on delivery of the product to the buyer. Further, PN3 fails to consider that after sales restrictions could create bottleneck for sellers, which are small enterprises, which do not have the necessary infrastructure for meeting delivery requirements.

Conclusion

PN3 has left open many grey areas, which might be a source of new litigation between various stakeholders. Further, given its immediate implementation from March 29, 2016 and lack of time to existing entities to restructure their business and operation model, businesses could suffer because no entity can reasonably be expected to restructure its business rapidly. The necessary clarifications on marketplace model and inventory model in PN3 might act as impetus for investors, who want to invest in marketplace e-commerce entities. Only time will tell as to whether this press note has been an impetus or roadblock for e-commerce business, but it is indeed a step in direction of regulation of e-commerce industry.

Authored by:
Ritesh Singh