Investors want more say in royalty payment

Earlier this year, FMCG giant Hindustan Unilever proposed to increase royalty payment that it makes to its overseas parent, UK-based Unilever, from 1.40 per cent to 3.15 per cent of its turnover. Swiss food major Nestle too plans to raise royalty from 3.5 per cent to 4.5 per cent of sales in a phased manner from 2014, while fellow Swiss company Holcim, which controls Indian cement makers ACC and Ambuja Cements, has increased technology and know-how charges from 0.6 per cent to 1 per cent of net sales.

The flurry to increase royalty rates may look inconsequential in percentage terms but they result in huge outflow of money from the country every year. Multinational companies have increasingly begun to use the royalty route to extract disproportionate returns from their Indian arms, especially since the government relaxed the curbs on remittances a few years ago.

Minority shareholders bear the brunt of these payments as royalties crimp profits available with the company for distribution in the form of dividends. On the other hand, foreign promoters get a disproportionate share of the income compared to their shareholding.

However, help has come for minority investors from an unlikely quarter amid the changing rupee-dollar dynamics. At a time when the government and the central bank are fighting a sliding rupee, this huge outflow has prompted proposals to bring back caps on royalty. Officials from the department of industrial policy and promotion now say that royalties have resulted in no improvement in technical know-how of a foreign company's Indian partner and are a drain on the economy.

The calls for a cap on royalty are nothing new. In December 2009, the government liberalised the payment for foreign technology collaborations and royalty fees under the automatic route (including lump-sum payments for transfer of technology, payments for the use of trademark and brand name). The rules were relaxed to facilitate inflow of foreign direct investment and technology transfers into the country. It also meant foreign partners of an Indian company no longer had to go through administrative hoops to raise royalty if they wanted to do so.

As a result, royalty payments increased manifold in the ensuing years. According to a recent study by Institutional Investors Advisory Services, royalty and related payments by 25 listed companies (excluding Gulf Oil and Procter & Gamble) increased 23.8 per cent to Rs 4,952 crore in FY13 from Rs 3,999 crore in FY12.

The report also said that growth in royalty payments was higher than the increase in profit in FY12. Royalty payments by top 25 listed companies (in terms of royalty payment) grew 24 per cent while sales and profits grew at 15 and 13 per cent, respectively.

Besides being a burden for the company, higher royalty outgo has consequences for shareholders. Companies such as 3M India, Timken India, Whirlpool of India and Asahi India Glass have paid royalty in the range of 1.2 per cent to 2.6 per cent of net sales to their foreign partners but have not paid any dividends to shareholders since 2008 (excluding one-off dividend payments). Had these companies paid dividends in lieu of royalty to foreign partners, shareholders could have enjoyed the monetary benefits, said the report by Institutional Investors Advisory Services.

Companies justify these payments by arguing that royalties help them strengthen their global research facilities and intellectual property rights, which in turn help in improving their businesses. Some companies such as Nestle have even commissioned a study by McKinsey to suggest optimum royalty rates.

However, small shareholders often find themselves in the dark on the nature of payments, whether they are one-time or periodical. In addition, clubbing the different kind of royalty charges such as mining rights, technical know-how and so on under one head, leaves the investors confused. While in recent years, investor groups have become more vocal in protesting royalty increases, companies often have their way due to their dominant shareholding in the local arms.

Still, they are not in favour of a cap on royalty. Amit Tandon, managing director, Institutional Investors Advisory Services, says he is not in favour of any kind of prescription by the government. Instead, he would prefer more say for the minority shareholders in the matter.

 

"Disclosures with benefits (from royalty payouts) being spelt out and getting shareholders to vote would be my preferred route, not bringing back royalty caps. Further the (royalty) agreement should be for a three-year period, after which it should be put to shareholders for voting again," says Tandon.

JN Gupta, founder, Stakeholders empowerment services, a governance firm. too believes prescribing controls would be a retrograde step.

Meanwhile, the new Companies Act 2013 restricts interested members from voting on any resolutions on related party transactions, including those which are part of "ordinary course of business" if the transactions are not at arm's length. While investors are keen to use these provisions, there is some ambiguity on whether royalty-related resolutions could be considered as part of ordinary course of business.