India: PE Investment In Indian Education Through The FDI Route - Opportunities, Challenges, And Innovative Structures

This article was first featured in the Venture Intelligence Private Equity Pulse on Education Report.

Introduction

This Article first discusses both the constitutional and regulatory frameworks governing the education sector in India. It then looks at the challenges that these throw up for private equity investment in the field, and finally discusses strategies and options available to investors to operate within the parameters set by the legal framework.

Constitutional Framework Of Education In India:

Prior to 1976, education in India was a subject within the competence of the individual states comprising the Union of India. The Constitution (Forty Second Amendment) in 1976 transferred education from the State List to the Concurrent List, thus giving both the Central and State Governments jurisdiction over it.

Following the 1976 Amendment, the National Education Policy, 1986 (as modified in the year 1992) was issued by the Department of Education, Ministry of Human Resource Development (the "NEP"). The NEP identified the union government as the organisation in charge of reinforcing the national and integrated character of education, maintaining quality and standards (including those of the teaching profession at all levels) and studying and monitoring the educational requirements of the country.

The Constitution (Eighty Sixth Amendment) Act, 2002 introduced Article 21A in the Constitution of India imposing an obligation on the state to provide free and compulsory education to all children of the age of six to fourteen years. This Amendment also introduced a new article (51A) which imposed a duty on parents and guardians to provide their children with educational opportunities. Further, through an Amendment to Article 45 of the Constitution, the State Governments have been vested with the responsibility of providing early childhood care and education for all children until they complete the age of six years. Pursuant to these amendments to the Constitution of India in the year 2002, the Government of India passed the Right of Children to Free and Compulsory Education Act in the year 2009 to ensure that every child has a right to be provided full time elementary education of satisfactory and equitable quality in a formal school which satisfies certain essential norms and standards.

Regulations And Regulatory Bodies Governing The Education Sector In India:

Education in India can be broadly categorized into formal (or core) education and informal (or parallel) education. The formal education industry consists of primary or elementary, secondary and higher or technical education imparted by recognised and unrecognized educational institutions. Elementary and secondary education is collectively referred to as K-12 education, comprising of kindergarten and 12 years of schooling. Higher education and technical education deal with undergraduate and graduate level education. The Government of India is responsible for major policy decisions relating to higher education in the country. In addition to determining standards in institutions of higher education, research and scientific and technical institutions, it provides grants to the University Grants Commission (the "UGC") and establishes central universities in the country. The central government is also responsible for declaration of education institutions as "Deemed to be University" on the recommendation of the UGC.

K-12 education is regulated by state boards, Central Board of Secondary Education, the Central Council for the Indian School Certificate Examinations and the international baccalaureate while higher and technical education is governed by the rules and regulations framed by the UGC and the individual regulatory bodies such as the All India Council for Technical Education.

State Governments are responsible for establishment of state universities and colleges, and provide plan grants for their development and non-plan grants for their maintenance. The coordination and cooperation between the Union and the States is brought about in the field of education through the Central Advisory Board of Education (CABE). Several professional councils have been set up for the purpose of awarding recognition of courses, promotion of professional institutions and providing grants to undergraduate programmes and various awards. The technical education system in the country can be broadly classified into three categories – central government funded institutions, state government or state-funded institutions and self-financed institutions.

The informal education industry in India mainly consists of preschool education, vocational education, corporate training, tutoring and test preparation.

In order to be classified as a recognised educational institution, the affiliation or accreditation rules and bye - laws need to be adhered to. The Government has noted that institutions which are not accredited or affiliated to any university are to be considered as fake institutions having no legal personality and the degrees awarded by them cannot be treated as valid for academic or employment purposes. According to the University Grants Commission Act, 1956, the right of conferring or granting degrees shall be exercised only by a university established or incorporated by or under a Central Act, or a State Act, or an institution deemed to be university or an institution specially empowered by an Act of the Parliament to confer or grant degrees. Thus, any institution which has not been created by an enactment of Parliament or a State Legislature or which has not been granted the status of a "Deemed to be University" is not entitled to award a degree.

The Central and state affiliation regulations or bye - laws set out in detail, conditions on the basis of which recognition or affiliation is granted to a school or a college. One of the most important conditions as prescribed in a majority of these affiliations, regulations or bye - laws is the requirement of the school or the college to be established and maintained by a society established under the Societies Registration Act, 1860 or a trust established under the Registration Act, 1908 or a "not - for - profit" company incorporated under section 25 of the Companies Act, 1956.

The following are the extracts of a few affiliation regulations or bye - laws which state that this requirement is to be followed mandatorily:

1. The Central Board of Secondary Education (CBSE) Affiliation Bye - Laws (with effect from January 28, 1988):

The bye-laws define a private unaided school as a school run by a society, trust duly constituted and registered under the provisions of Central or State Acts, not getting any regular grant-in-aid from any government source(s). Chapter III on the Norms for Affiliation states that the CBSE may grant affiliation to, among others, private, unaided schools established by (i) societies registered, under the Societies Registration Act, 1860, as educational, charitable or religious societies having non - proprietary character or by (ii) trusts.

Further, notification CBSE/AFF/2007/271721-276720, dated October 15, 2007, amended the definition of a private unaided school to include those established and operated by a "not-forprofit" company incorporated in accordance with section 25 of the Companies Act, 1956. However, the "not-for-profit" company has to obtain a no objection certificate from the concerned state government and must have education as one of its objects, and should channelize the funds towards furtherance of education.

2. The Guidelines for Affiliation by the Council for the Indian School Certificate Examinations (with effect from May 2006):

Chapter I of the guidelines provide conditions for provisional affiliation of schools wherein the following requirements, among others, are to be satisfied:

  1. The school should be run by a registered society, trust or a company incorporated under section 25(1)(a) of the Companies Act, 1956 for educational purposes. It must not be run for profit;
  2. The constitution of the society, trust, company running the school should be such that it does not vest control in a single individual or members of the same family; and
  3. The school must have a properly constituted governing body or managing committee, which is responsible to, and under the control of, the society, trust, or a "not-for-profit" company.

It is interesting to note that while most State Governments in India grant affiliation to educational institutions established and maintained by a society, trust or a "not-for-profit" company, the State of Haryana permits a company incorporated under the Companies Act, 1956 to establish and maintain schools. According to Rule 29 (1) of the Haryana School Education Rules, 2003, every individual or association of individuals or firm or society registered under Societies Registration Act, 1860, or trust created under the Indian Trusts Act, 1882, or company registered under the Companies Act, 1956 may apply to the appropriate authority in the prescribed form for setting up primary school, middle school, high school and senior secondary school. Unlike other state and central regulations or bye - laws on affiliation, these rules do not expressly require that a school should be established by a "not–for-profit" entity. It may, however, be noted that most of these schools (i.e. schools set up by "for-profit" companies) are affiliated to the international baccalaureate.

Despite the permission available to "for-profit" companies to establish and maintain schools, most schools in India are established and operated by trusts and / or societies in order to avail tax exemptions and concessions such as lands at concessional rate exclusively available to such entities.

Challenges In Pe Investment In Education In India Through The FDI Route:

Foreign investment essentially refers to an investment in an enterprise by a non - resident. Foreign investment is of two kinds - foreign direct investment (the "FDI") and foreign portfolio investment.

According to the Consolidated FDI Policy (with effect from April 1, 2011) issued by the Department of Industrial Policy and Promotion, Ministry of Commerce and Industry, Government of India, FDI can be made in Indian companies, partnership firms, proprietory concerns, venture capital fund and trusts which are in the form of a venture capital fund. FDI in trusts (other than venture capital funds) and societies is prohibited.

The Government of India has, vide Press Note 2 (2000 series) dated 11.2.2000, issued by the Department of Industrial Policy and Promotion. Ministry of Commerce and Industry permitted foreign direct investment up to 100% under the automatic route in the education sector, subject to the sectoral rules or regulations as may be applicable. Therefore, while FDI is ostensibly permitted in education under the automatic route, the current FDI policy read along with the various affiliation and accreditation rules or bye - laws effectively prohibit foreign investors from investing in a society, trust or "not-for-profit" company permitted to establish and maintain schools in India.

The FDI policy also regulates the receipt of FDI in constructiondevelopment projects including educational institutions. Up to 100% FDI is permitted in development of townships, housing, built-up infrastructure and construction-development projects (including but not restricted to housing, commercial premises, hotels, resorts, hospitals, educational institutions, recreational facilities, city and regional level infrastructure) subject to certain conditions which, among others, include minimum area conditions for the project, minimum amount of capitalisation and time period within which the project has to be completed.

A combined reading of the provisions of the FDI Policy and the various state enactments relating to the establishment of educational institutions in India indicates that:

  1. schools and colleges that are established and run by a society or a trust are not permitted to receive FDI; and
  2. a "not-for-profit" company incorporated under section 25 of the Companies Act, 1956 can receive FDI, however, it cannot apply its profits or other income towards the payment of any dividend to its members.

While point (a) prohibits the receipt of FDI by the society and the trust in entirety; point (b) makes the investment less attractive to any investor seeking to earn profit from the investment made into the company. Several educational institutions have, as a result of this impediment, opted for foreign collaborations wherein certain courses, scholarships, aids, grants in the foreign entity are offered to the students of the educational institutions in India without the involvement of FDI.

Another consequence of the stringent regulations and the need for "not-for-profit" character of educational institutions is that a large chunk of education-focused FDI is being made in the formal and informal education sectors in India unaffiliated to central, state universities or regulatory bodies. These include FDI in the field of online tutorials and online education.

The last decade has seen a sharp rise in private equity investment in the informal or parallel education sector. Entities such as preschool, private coaching and online tutorial enterprises have emerged as high yielding investment avenues for educationfocused private equity and venture capital players.

Innovative Structures:

For those investors who seek to invest in the formal, regulated education sector consisting of recognised or affiliated educational institutions, alternate structures are being explored. These structures typically consist of:

  1. a society, trust or a "not-for-profit" company which establishes and maintains educational institutions;
  2. a management company (usually incorporated as a private limited company) which provides services such as books or transportation to the society, trust or "not-for-profit" company; and
  3. an infrastructure company which provides land and other necessary infrastructure to the society, trust or "not-for-profit" company.

FDI is channeled into the management company which provides services to the society and/or the trust running the educational institution. The society, trust or the not-for-profit company running the educational institution pays fees to the management company and pays rentals to the infrastructure company for the services and the land/ infrastructure provided by them. This structure enables the investor (investing in to the management company) to extract returns on its investment. One must ensure that the transactions between these management companies and the society, trust or "not-for-profit" companies (in terms of pricing) are conducted as arms length basis and proper authorisation is sought from the board of directors of the management companies and the infrastructure companies on one side and the managing committee or the governing council / body of the society, trust or "not-for-profit" companies on the other. The relationship between the management company and the infrastructure company on the one hand and the "not-for-profit" entity setting up and maintaining the educational institutions on the other must be a meaningful one and not be pursued with an intention to mislead the authorities regulating the sector.

While this innovative structure is being commonly used to work within the rules and regulations which are, in principle, against the idea of commercialization, there always exists an element of risk. Hence, most private equity investors instead look to invest in sectors and institutions which do not fall under the purview of various rules and regulations and to a large extent remain unregulated.

Conclusion:

Though FDI is permitted in the education sector under the automatic route, the current affiliation rules and regulations in the formal or core educational institutions are not conducive to the growth of foreign investment. Most educational institutions engaged in imparting K-12 education look to get recognised by, or affiliated with, the relevant affiliation boards, thereby reducing their chances of receiving FDI. This has resulted in FDI being made in the entities imparting informal or parallel education or in private, unaided educational institutions which are not affiliated to the concerned affiliation boards. As private, unaided schools and colleges which are not recognised or affiliated do not follow the norms of fixing fees, payment of salaries to the staff, and various other rules relating to the admission of students and employment of teachers, various affiliation boards insist that the educational institutions be established and operated by "not-for-profit" organisations.

The present day education system in India is based on the values of equality, social justice and democracy, seeking to provide to all including the disadvantaged and the weaker sections of the society an equal opportunity in receiving education and ensuring that the education is provided at high standards of quality, infrastructure. Combined efforts of public and private entities through private public partnerships and grant of aid by government to private institutions are being sought to improve the education system.

While the principle on the basis of which the Government of India and the State Governments insist on "not-for-profit" character of educational institutions is appreciated, one cannot undermine the advantages of permitting private, for-profit players in the industry. The present education system lacks support in the form of basic infrastructure, well trained staff and efficient management and organisation, to say the least. In light of these growing needs, the education system in India cannot be denied the opportunities that "for- profit" or foreign investment can bring.

An objective analysis of the needs of the education sector and the advantages or disadvantages of permitting for profit investors has to be made. To provide better opportunities for students, educational institutions need to be equipped with the basic and world class infrastructure and support. This can be ensured by encouraging a wider participation by private players, joint collaborations between the private players and the central and the state governments. The education sector needs relaxation of current rules and regulations to facilitate its growth. However, one cannot ignore the possibility of imposition of more stringent laws and rules given the nature and sensitivity of the sector.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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