Foreign Direct Investment In India’s Education Sector:

The Foreign Educational Institutions Bill of 2010, and The Universities for Research and Innovation Bill of 2012

By Vandana Shroff and Ashish Jejurkar

The education sector in India is characterized by an ever growing gap between supply and demand. With a population of about 587 million below the age of 25 years and almost 144 million between the ages of 18 to 23, India has a huge demand for quality education. The supply, however, is woefully inadequate.

According to reports by Ernst & Young (Private Sector Participation in Indian Higher Education, 2011), Grant Thornton (Education in India: Securing the Demographic Dividend, 2010) and PWC (Emerging Opportunities for Private and Foreign Participation in Higher Education, 2010), the value of the Indian pre-school and primary education sector is expected to reach $50 billion in 2015. The higher education sector is expected to grow to over $52.5 billion. Despite the size of the potential market, India is currently unable to meet the demand for education in all sectors. For example, enrollment in public sector schools and colleges (government funded education) is only 219 million children (37%) in primary, secondary and higher education, and roughly 11 million students (0.01%) in college.

The enormous gap between supply and demand in education services in India makes education a sector with considerable potential for growth. This, in turn, presents lucrative investment opportunities for foreign direct investment (“FDI”), in the form of private equity and strategic investing. Investors, however, will face certain regulatory challenges.

The (Over) Regulated Landscape Implications under the FDI Policy

Recognizing the need for greater investment in education, by way of Press Note 2(2000), the Government of India allowed 100% FDI under the automatic route in the education sector. (FDI under the automatic route does not require prior approval either of the Government or the Reserve Bank of India.) Furthermore, the Consolidated FDI Policy (effective from April 10, 2012) issued by the Department of Industrial Policy and Promotion, which sets out the prevailing policy of FDI into India, continues to permit 100% FDI in the education sector subject to compliance with the applicable sectoral regulations.

Since October 2011, education has been exempted from prior requirements for minimum acreage for facilities, minimum capitalization, and restrictions on repatriation of the original investment (all of which are still required of hotels, hospitals, SEZs and construction projects).

Constitutional Right To Education
The regulatory framework pertaining to the education sector in India and the manner in which the regulations are drafted need to be considered in light of the provisions of the Indian Constitution. Whilst Article 21 of the Constitution, which provides that that no person shall be deprived of his life or personal liberty except according to procedure established by law, does not expressly include the right to education, the right to education has been expansively read into the right of “personal liberty” under Article 21 by the Indian Supreme Court.
This interpretation was first expressed by the Indian Supreme Court in the case Mohini Jain v. Union of India [(1992) 3 SCC 666]. Although this expansive interpretation was later narrowed by the Supreme Court in the case of Unnikrishnan v. State of Andhra Pradesh [1993 SCC (1) 645] to the limits of the economic capacity of the state and its development, the right to education remains a fundamental right.

In 2002, the 86th Amendment to the Indian Constitution introduced Article 21-A, which imposed an obligation on the State to provide free and compulsory education to all children of the age of 6 to 14 years in the manner in which the State may by law determine. This fundamental right was given effect by the Right to Education Act, which is enabling legislation that came into force in 2010, to discharge the constitutional obligation of the State, as envisaged under Article 21A.

The right to education is reinforced by Part IV of the Constitution which sets out the directive principles of state policy and provides that the State is obligated, within the limits of its economic capacity, to make effective provision for securing the right to education. The State is also obligated to promote the educational interests of the weaker sections of society.

Although Article 21 provides the foundation for the right to education, the right to establish and administer educational institutions is guaranteed under the Constitution under Articles 19(1)(g), 26, and 30. Article 19(1)(g) guarantees as a fundamental freedom to all citizens, the right to practice any profession, or carry on any occupation, trade or business. Article 26 gives the right to every religious denomination to establish and maintain an institution for religious purposes, which would include an educational institution. In addition, Article 30(1) recognizes the right to religious and linguistic minorities to establish and administer educational institutions of their choice.

The Supreme Court, in the celebrated cases of Unnikrishnan v. State of Andhra Pradesh and T.M.A. Pai Foundation v. State of Karnataka [AIR 2003 SC 355] recognized the right to establish an educational institution under Article 19(1)(g) of the Constitution. However, the Court also recognized that education is regarded as an activity that is per se charitable in nature. This position was later reiterated and reinforced by the Supreme Court in P.A. Inamdar v. State of Maharashtra [AIR 2005 SC 3226].

Sectoral Regulations
With a view to ensuring education for all, the regulation of “education” including technical education, medical education, universities, and vocational and technical training of labour have been placed under the concurrent list (List III) of the Constitution, i.e. educational institutions will be subject to the regulations and governance of both the Central Government as well as State Governments.

Multiplicity of Regulators

Since education comes under the concurrent list of the Constitution of India and is subject to regulations framed by the central government as well as the state governments, the education sector is governed by multiple bodies. As a consequence, educational institutions are required to obtain multiple approvals and accreditation. To illustrate, in the case of schools, pre-school, primary and secondary education is regulated by the state in which the school isorganized. In addition, the school must be affiliated to either of the two central boards (i.e., the Central Board of Secondary Education [“CBSE”] or the Central Council for the Indian School Certificate Examinations [“ICSE”]) or the state education board of the state in which the school is set up.

Higher education is primarily regulated by the University Grants Commission (“UGC”) which enforces minimum standards. Apart from the UGC, the All India Council for Technical Education (“AICTE”) is responsible for the maintenance of standards of institutions providing technical education (e.g., engineering, architecture, and management) in India. Professional bodies such as the Bar Council of India, the Medical Council of India, the Indian Council for Architecture Research (“ICAR”), among many others, grant approval for the establishment of institutions providing professional courses for law, medicine and architecture, respectively.

“Specified Entity” Restrictions and Not-for-Profit Requirements

Under current regulations, only certain types of entities are permitted to create educational institutions. In relation to schools, the applicable regulations (including the bye-laws of CBSE, the ICSE and the state specific regulations) and the various state laws require that schools be incorporated by a trust, society or a company registered under Section 25 of the Companies Act, 1956 (a “Section 25 Company”), all of which have a “not-for-profit” character.

In relation to universities and colleges, under the UGC’s Establishment of and Maintenance of Standards in Private Universities Regulations, 2003, a private university must be established under a Central or State Act and by a society registered under the Societies Registration Act, 1860, or any other corresponding law in force, in the state where the university is proposed to be set up or by a public trust or a by Section 25 Company. Similarly, under the AICTE Regulations for Entry and Operations of Foreign Universities in India Imparting Technical Education, 2005, an institution seeking an approval from AICTE to establish an educational institution is required to be registered as a society or trust and must be of a not-for-profit character.

These requirements present a peculiar problem for potential foreign investors. Under the FDI Policy, FDI up-to 100% under the automatic route is permitted in the education sector. However, whereas Indian companies can issue shares against FDI, FDI in trusts and entities other than those specified in the FDI Policy is prohibited (with the exception of venture capital funds established as trusts). By implication, entities established as societies would also be prohibited from receiving FDI.

Hence, potential foreign investors are faced with a situation where on the one hand FDI up to 100% is permitted under the automatic route in the education sector, and on the other hand the sector specific regulations applicable to schools/universities provide that entities engaged in the education sector must be organized either as a trust, society or a Section 25 Company, and FDI is not permitted in trusts and societies.
Given the above restriction on societies/trusts, potential investors have sought to explore the option of using a Section 25 Company to invest in the education sector. However this route is fraught with its own set of difficulties.
The sole purpose of a Section 25 company is to promote commerce, art, science, religion, charity or any other useful purpose, and the license granted it by the Central government recognizes it as such. However, any profit generated by a Section 25 Company must be used to promote its purpose and not any other purpose. Moreover, a Section 25 Company is not allowed to distribute its profits as dividend to its members. Compliance with such requirements is likely to restrict the use of a Section 25 company as an investment vehicle because such an entity would not be able to apply its profits towards returns on investment.

Furthermore, the Indian judiciary has upheld, from time to time, the not-for-profit nature of entities established as educational institutions. Indian courts have held that fees charged by an educational institution cannot exceed a reasonable revenue surplus, and should be utilized for promoting education and developing the institution. With the focus being on better accessibility of education for all, the regulations relating to higher education also prescribe various restrictions on the fees that can be charged to students by educational institutions. These further restrict bona-fide investments in the education sector.

Remedial Measures Proposed Bills and their Flaws

With a view to remedy some of the difficulties faced by foreign investors investing in the education sector, particularly in higher education, the government has recently proposed two important bills – the Foreign Educational Institutions (Regulation of Entry and Operations) Bill 2010 (“FEI Bill”) and the Universities for Research and Innovation Bill 2012 (“Universities Bill”) – which were expected to relax the regulatory framework for establishing an educational institution in India and thus ease the entry norms for foreign investors in the education sector in India.

The FEI Bill
The FEI Bill lays down a detailed procedure which has to be followed by a foreign educational institution (“FEI”) for establishing its campus in India.
First, there are stringent minimum requirements for a FEI to establish itself in India. The key requirements, which are aimed at ensuring that only reputed and financially stable FEIs meet the criteria, are that the institution have provided educational services for at least 20 years since its establishment or incorporation. The foreign university must maintain a corpus fund of not less than Rs. 500 million ($10 million). A maximum of 75% of any income generated by the fund must be utilized for developing the institution, with the rest being reinvested in the fund.

Second, there is a three-step application process: an application must be made to the Registrar endorsed by the Embassy or High Commission of India in the country where the institution is established. A report must be obtained from the Registrar (Secretary of the UGC) on the fitness of the institution. And notification must be made by the Central Government of the FEI as a foreign education provider. The time frames prescribed under the FEI Bill for completion of each of these steps is cause for concern. The Embassy or High Commission has three months to respond; and the Registrar must submit his report within six months, after which the UGC has 30 days to respond with recommendations to the Central Government as to the fitness of such institution to be recognized and notified as a foreign education provider. The Central Government has a further period of 30 days from the date of receipt of the report of the UGC to issue the notification.

Third, in addition to the cap on the amount that can be utilized from the corpus fund, the FEI Bill prohibits any repatriation outside India of any revenue generated by the FEI in India. Although the FEI Bill gives the Central Government wide powers to grant exemptions, the Central Government is not permitted to exempt any institution from conforming to the requirements of the FEI Bill relating to the prohibition on revenue repatriation.

The Universities Bill

The Universities Bill provides for the setting up of new universities by the government, or by domestic or foreign private bodies or to classify some of the existing universities as research and innovation universities.
The Universities Bill permits only non-profit companies, societies or trusts, and foreign universities of repute that are least 50 years old, to establish a university in India.

In addition to the requirement of being a not-for-profit legal entity, the Universities Bill also states that the surplus in revenue must be used only for the development of the university established in India.

The Bill also prescribes operating conditions including the requirement that at least half of the students admitted need to be citizens of India. New intellectual property created by the university vests in the Central Government if it is in the public interest, for the security of the nation, or if the university fails to disclose its creation.

Neither the FEI Bill nor the Universities Bill contains any measures to do away with the multiplicity of regulatory authorities. Both the Bills have created a number of bureaucratic hurdles and the proposed timelines are likely to cause delays in the establishment of educational institutions. Furthermore, the conditions prescribed under the FEI Bill regarding non-repatriation of profits and the condition relating to ploughing back of income from the corpus fund also raises concerns. The Universities Bill is also characterized by similar difficulties. Restrictions on the types of sponsoring entities, the not-for-profit condition and the requirement for ploughing back profits are unlikely to encourage significant foreign investment.

Notwithstanding the criticism to the FEI Bill and the Universities Bill, one significant implication of both Bills is that the government appears to have recognized the importance of FEIs in developing India’s education sector. Presently, the Bills are still under discussion and it is hoped that the provisions of the Bills are revised with a view to providing necessary impetus to FDI in the education sector.

Structuring Considerations
Given the social imperatives and the need to ensure accessibility of education to all strata of society, any move by the government to liberalize investments into the education sector by making necessary changes to the applicable regulatory framework has thus, far been met with public and political outcry. Despite the enormous potential of India’s education sector, the prevailing regulatory framework deters foreign investors (including private equity investors) from investing in India’s education market, primarily because of the not-for-profit conditions and the restrictions on the types of entities which can establish educational institutions (restricted to trusts, societies and Section 25 Companies). Furthermore, the two Bills appear to contain similar restrictions and have failed to address the long-standing concerns of foreign investors.

Presently, the usual structure for foreign investment in education involves the use of two-to-three different entities. The sponsoring entity that would actually establish and run the school/university would need to be a Section 25 Company (the “Sponsoring Entity”). The other entities would own the brand, provide the management know-how and other services as well as the infrastructure required for operating the school (the “Project Entity”).
The Project Entity would need to be incorporated as a company and would receive the foreign investments. Since the service sector comes under the 100% automatic route, the prior approval of the Foreign Investment Promotion Board (“FIPB”) would not be required. The Project Entity would then enter into various contracts with the Sponsoring Entity, to provide various services such as management services, training services etc. to the educational institution and, in return, the Sponsoring Entity would pay for the services being provided by the Project Entity. Where the proposed foreign investment is a strategic investment, the brands associated with the educational institution abroad would also be owned by the Project Entity and licensed to the Sponsoring Entity for appropriate licensing fees/royalty payments.

The accreditation rules require that the educational institution have possession of the land. However, since ownership of such land is not mandated, the Project Entity could opt to construct the school premises itself or establish an entity which would hold the land and buildings required for establishing the educational institution (“Property Entity”). The Property Entity would thus provide the required land to the educational institution by way of a long term lease agreement with the Sponsoring Entity.

The services contracts entered into between the Project Entity and the Property Entity on the one hand and the Sponsoring Entity on the other hand are typically exclusive in nature with a view to ensure a captive arrangement. In light of the oversight by regulatory bodies such as the AICTE, CBSE, UGC, the transactions between the Sponsoring Entity and the Project Entity should be conducted on an arms-length basis and all regulatory and corporate approvals required under applicable law should be obtained. Since there are no restrictions on repatriation of profits in relation to the Project Entity, the profits earned by the Project Entity can be distributed to shareholders. Investors, however, would need to bear in mind the tax implications of adopting such structures.

Even a cursory glance at India’s education statistics shows that an enormous amount of investment is required in order to meet its people’s demand for quality education. The government seems to be ill-equipped to close this huge gap between supply and demand. Although 100% FDI is permitted in India’s education sector, the present regulatory framework does little to make the sector attractive for private investment (including foreign investors). In order to enhance investment into India’s education sector, there needs to be a sea change in the thinking of regulators who must recognize that they need to afford investors the opportunity of earning a reasonable return on investment, particularly as the education sector is capital intensive and has a long gestation period. India must revise its laws and regulations, particularly the FEI and Universities Bills, to permit foreign investors to repatriate reasonable profits. While it is appropriate to keep the fee structure for students subject to regulatory scrutiny to ensure that social objectives and constitutional imperatives are met, there should also be sufficient incentives for private investment in the education sector.

Under the prevailing framework, foreign and domestic investors in the education sector are hamstrung by onerous regulatory requirements and must structure investments in innovative ways. The suggested amendments will bring about transparency and provide the necessary impetus for greater investment in this vital sector.

Vandana Shroff is a Senior Partner at Amarchand & Mangaldas & Suresh A. Shroff & Co. and specializes in M&A, Private Equity and General Corporate law. She can be contacted at vandana.shroff@amarchand.com

Ashish Jejurkar is a Partner at Amarchand & Mangaldas & Suresh A. Shroff & Co. and specializes in M&A, Private Equity and General Corporate. He can be contacted at ashish.jejurkar@amarchand.com

Advertisements

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s