Clarifications On FDI In E-Commerce Sector - The Predicament Of Marketplace Entities In India

In this business milieu when online commerce is successfully taking over market share bit by bit from brick and mortar stores, the Department of Industrial Policy and Promotion ("DIPP") issued press note 2 of 2018 dated December 26, 2018 ("Press Note 2018") wherein it revised, and issued clarifications on, the foreign direct investment policy ("FDI Policy") in the e-commerce sector. The e-commerce sector was earlier regulated by press note 3 of 2016 dated March 29, 2016 ("Press Note 2016"), incorporated in the FDI policy of 2017, which now stands superseded by the Press Note 2018. The provisions of Press Note 2018 have come into effect recently, from February 1, 2019. Despite recommendations from stakeholders to extend the deadline for implementation of Press Note 2018, the DIPP issued a press release to implement the revised e-commerce policy from February 1, 2019.

This article seeks to analyse the effect of the proposed changes in the FDI Policy by the Press Note 2018 in light of the already existing and established e-commerce practices.

A. Drawing parallels between Press Note 2016 and Press Note 2018.

Foreign investment is permitted up to 100% through the automatic route in the e-commerce sector. In terms of Press Note 2016 and Press Note 2018 e-commerce is defined as buying and selling of goods and services (including digital products) over digital and electronic network. The Press Note 2018, as is the case with Press Note 2016, recognizes the following two categories of business models:

• Inventory based Model - wherein, any inventory of goods and services is owned by the e-commerce entity and thus sold directly to the consumer.

• Marketplace based Model - wherein the entity only provides an information technology platform on digital or electronic network to act as a facilitator between the buyer and the seller.

It is pertinent to note that the FDI under automatic route in the e-commerce sector is permitted so long as the entity operates through the marketplace based model and not inventory based model. The entity undertaking e-commerce activities must enter into transactions with sellers on a business to business ("B2B") basis only.

Ownership and control over inventory – Press Note 2016 prohibited an entity offering a marketplace to exercise ownership over the inventory. It further provided that such ownership of the inventory will render the business into inventory based model. Additionally, in terms of Press Note 2016, an e-commerce entity was not permitted to allow more than 25% of the sales on its marketplace through one vendor or its group companies. Press Note 2018, takes it a step further, by disallowing an e-commerce entity from exercising ownership or control over any inventory that is to be sold on such entity's platform as that will convert the business from market place model to the inventory model. The Press Note provides that inventory of seller will be deemed to be controlled by the e-commerce marketplace entity if more than 25% of purchases of such seller are from the marketplace entity or its group companies. The term 'Group company' is defined in the FDI Policy as "two or more enterprises which directly or indirectly, are in a position to exercise 26% or more of voting rights in other enterprise; or appoint more than 50% of members of board of directors in other enterprise".

Prohibition on equity participation - The DIPP has inserted a new restriction through Press Note 2018 which expressly prohibits an entity having equity participation by an e-commerce marketplace entity or its group companies, or having control on its inventory by e-commerce marketplace entity or its group companies, from selling its products on the platform run by such marketplace entity. Therefore, all seller entities that are using the platform for selling their goods and services would not be allowed to sell on the platform if the e-commerce entity or its group companies hold equity or have control on the inventory of such a seller entity. This insertion appears to have a deeper impact on the U.S. giants operating in India such as Amazon and Flipkart (which is owned by Walmart) as they are known to be functioning through selected sellers in whom they have equity participation. Therefore, as per news reports, post Press Note 2018, Amazon India has restructured its business model by offloading the equity held by it in its vendor Cloudtail (which was earlier a part of Amazon group) so as to comply with the Press Note 2018.

Services provided by Entity - The Press Note 2016 allowed marketplace entities to provide support services including warehousing, logistics, payment collection, order fulfillment, call centre and other services to sellers on their platform. However, an e-commerce marketplace entity was prevented from, directly or indirectly, influencing the sale price of the concerned goods and services being sold on its platform. In terms of Press Note 2018, an e-commerce marketplace entity shall continue to ensure that it does not, directly or indirectly, influence the sale price of goods and services and maintain a level playing field at all times. Therefore, services by the e-commerce marketplace entity or its group company to sellers where they have direct or indirect equity participation or common control shall be provided at arm's length basis. For the purpose of this provision, all sellers on the platform have to be placed equally and provided or offered to be provided services by the e-commerce marketplace entity in a manner which is not unfair or discriminatory. This provision in Press Note 2018 clarifies that the provision of services to any vendor on such terms which are not made available to other vendors in similar circumstances will be deemed unfair and discriminatory. This might result in lesser discounts and cashbacks which are offered by the sellers.

In short, e-commerce entities are required to provide the same suite of services or facilities to all sellers under "similar circumstances". While the stated objective of enabling a level playing field is laudable, this requirement will be difficult to comply with. The interpretation of the term "similar circumstances" remains to be seen.

Interestingly, the Press Note 2018 appears to recognize an existing practice of providing 'cash-backs' to customers as long as they are fair and non-discriminatory.

• B.New insertions in Press Note 2018.

Exclusivity - Among the new conditions introduced by Press Note 2018, it is expressly provided that the e-commerce marketplace entity shall not mandate any seller to sell their products exclusively on a single entity's platform alone. However, while many are interpreting this as an end to exclusivity arrangements between brands and the e-commerce entity to sell on the platform exclusively, it is pertinent to note that the provision only limits the entity from mandating any seller to sell exclusively on the platform. Therefore, if a seller so desires, it can choose to partner exclusively with any one entity. However, the seller may also have to ensure that it is making sales through their own website and other brick and mortar stores. As a result of this condition the e-commerce marketplace entities would need to revisit the contractual arrangements with their exclusive sellers and amend such contracts to comply.

Filing requirements - Unlike before, every entity is now required to submit a compliance certificate and a report of statutory auditors to the Reserve Bank of India to certify their compliance with the guidelines and requirements laid down in the Press Note 2018 by September 30, every year, for the preceding year.

• C. Predicament of Entities

The Press Note 2018 has created quite a stir in the e-commerce sector and the board rooms of major entities occupying a large market share in this sphere. The clarifications introduced by the Press Note 2018 have brought about a tectonic change in the manner of doing business by the e-commerce marketplace entities. The e-commerce marketplace entities have to re-evaluate their business models and make changes to comply with the Press Note 2018. We have tried to hereinafter discuss a few issues that are coming to light in terms of the provisions of Press Note 2018:

(i) Entities like Flipkart and Amazon India control a sizable chunk of their inventory, via local vendors. This policy puts restrictions on such tactics by capping the inventory that vendors purchase from their group/ parent companies. It may be noted that there is a cap of 25% on sellers who buy products from Amazon or Flipkart's wholesale companies this means that sellers will now have to source 75% of their products from other sources, which is likely to increase their cost and it might become difficult for such sellers to offer discounts in the future.

(ii) The clarification issued by DIPP on Press Note 2018 dated January 3, 2019 states that the current policy does not restrict the nature of products that can be sold on an e-commerce marketplace – which would include private labels – however, it is currently unclear if this means that private labels owned by e-commerce entities can also be sold on their marketplaces.

(iii) The Press Note requires that an "e-commerce marketplace entity will not mandate any seller to sell any product exclusively on its platform only". This restriction is expected to adversely impact exclusive arrangements between e-commerce marketplaces and telecom or white goods manufacturing companies, to sell products exclusively on their online platforms (e.g. OnePlus sells its popular smartphones only via Amazon India and not any other marketplace).

(iv) There is no guidance on how enforcing authorities would determine if a seller has been "mandated" to sell its products exclusively on an e-commerce platform, or if the seller is choosing to do so voluntarily. For instance, some brands with limited sales in India have made a conscious decision to have an online presence only, to be able to better control costs and reduce logistical challenges around a pan-India offline distribution network. For them, it might make business sense to tie-up with one e-commerce platform.

(v) Entities like Flipkart and Amazon India functioned by purchasing branded goods in bulk from the manufacturers at reduced prices and sell them on their platform through their selected sellers at discounted prices, often offering cash-backs. However, now these selected sellers would not be allowed to sell on the entity's platform owing to the restriction on equity participation.

Comment

The bringing about of Press Note 2018 could seemingly affect the retail sector by levelling the online competition significantly and creating an equal opportunity for homegrown e-commerce businesses and brick and mortar stores. Though the Press Note 2018 has been a pacifier for the Indian trading community, it would be intriguing to see how the Press Note 2018 would be enforced by the Government and if it would in any way affect the e-commerce policy which is being pondered over by the Government of India.

For any clarification or further information, please contact

Priyanka Anand

Associate Partner

E: priyanka.anand@clasislaw.com

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