Offshored and Offloaded: A cautionary tale for both Private Equity Investors and Portfolio Companies

Allegations of mismanagement, oppression, and accounting disputes are the common accusations when conflicts arise between private equity funds and shareholders of companies being added to private equity portfolios. These disputes are increasingly being complicated by private equity deals involving companies with offshored entities that have local shareholders in the offshored country. Companies outsourcing via the creation of new foreign entities is not a new phenomenon. However, the activities outsourced to developing countries has shifted from traditional manufacturing and assembly to include more companies in the information technology sectors and even legal processes. Increased offshoring via the creation of satellite entities and the proliferation of private equity deals has increasingly led to instances of local citizen shareholders and partners of the offshored entity being ousted and/or squeezed out of deals.

The global digitization trend has led to an explosion of offshored entities of US companies in India. Fittingly, India has found itself cluttered with western private equity firms in search of potential portfolio companies. Becoming the investee of a private equity deal is generally a positive event for a company and its shareholders. However, it appears that Indian shareholders of these offshored entities can find themselves left out and private equity firms having to engage in unproductive litigation in Indian courts.

Recently, a petition for oppression and mismanagement has been filed in India by Mr. Dominic Thomas Karipaparambil, against, Xcellence Inc. (“XDD USA”), operating under the brand Xact Data Discovery, a US-based provider of eDiscovery, data management and managed review services. The parties to the dispute also include XDD USA’s offshored entity Xact Data Discovery India Private Limited (“XDD India”); JLL Partners Fund VII, L.P. (“JLL Partners”), a US-based private equity firm; and others. Court records show Mr. Karipaparambil, to be the 49% Indian shareholder of XDD India. Additionally, from the records it appears that Mr. Karipaparambil, may have also been the Managing Director of XDD India. Mr. Karipaparambil’s name also appears as the original subscriber to the charter documents of XDD India with Mr. Robert Polus (President & CEO of XDD USA). It seems that Mr. Karipaparambil, Mr. Polus and XDD USA, may have set up XDD India as a joint venture arrangement in the ratio of 51 (Mr. Polus): 49 (Mr. Karipaparambil). At some stage, into the venture, XDD USA seems to have acquired 51% in XDD India from Mr. Polus. US press releases show that JLL Partners acquired ‘Xact Data Discovery’ (XDD USA), shares from Clearview Capital LLC (“Clearview”) in late December 2017 – early January 2018. Past press releases also show that Clearview, another private equity investor, had acquired XDD USA in January 2015.

In court papers, Mr. Karipaparambil, claims that JLL Partners and team attempted to oust him from the board of directors. Furthermore, Mr. Karipaparambil claims that JLL Partners and others have committed a contempt of an order of the concerned court. While Mr. Karipaparambil’s litigation is currently ongoing, the case is significant to both private equity firms and shareholders alike. JLL Partners has now been locked in litigation for almost six months and will potentially be engaged in the litigation for many more years, given the delays in the Indian judicial system. The litigation seems to have commenced in June 2018, barely 6 months after JLL Partner’s acquisition of XDD USA.

A litigation this early into the acquisition clearly raises concerns on the underlying fundamentals of the transaction between JLL Partners and Clearview, as one has to wonder about the knowledge – or lack thereof – of all relevant parties to material issues at play.

From XDD USA’s website, one gets the sense that XDD India may be its sole offshoring entity in India and outside of the USA. A logical conclusion would be that XDD India is vital to the profitability of XDD USA. As with most offshoring models, the Indian entity is responsible for the backend work at cheap rates and the US entity takes advantage of this price arbitrage, booking significant profits and value. The offshored Indian entity’s operations are essentially inseparable for the US entity. As an outcome of this litigation, if XDD India’s operations are stalled; what impact will XDD USA have to its business, profitability and ability to deliver services? Without the cost arbitrage, the offshoring business model itself may not work. The information available from the public domain compels one to consider certain questions:

  • How much was the XDD USA acquisition worth? Did JLL Partners properly assess the importance of XDD India in the scheme of the transaction?
  • Did the JLL Partners team interact with Mr. Karipaparambil prior to concluding the acquisition to assess his comfort? Did Mr. Karipaparambil express reservations prior to JLL Partner’s acquisition?
  • Was sufficient precaution taken prior to the acquisition of XDD USA, to mitigate risks arising from a potentially hostile 49% shareholder in such a critical subsidiary of the target company?
  • It would be callous to have concluded the deal without ensuring proper contractual arrangements between Mr. Karipaparambil and XDD USA. Was JLL Partners diligent in its approach? Or has it wandered perilously close to breaching its fiduciary responsibilities on this deal?
  • Alternatively; were JLL Partners kept in the dark about the nature of the issue with Mr. Karipaparambil, by Mr. Polus and Clearview?
  • Are we going to witness a counter fight between JLL Partners and Clearview for post-acquisition claims?

These questions and many more remain in the saga that is unfolding between Mr. Karipaparambil on one side and JLL Partners / XDD USA on the other. But, irrespective of the outcome of the litigation, the episode has important learnings for private equity funds. Especially those funds looking to make investments in US entities that have significant Indian operations, in partnership with local Indian counterparts. Litigation in the US may be expensive, but it is a familiar forum. On the other hand, litigating in India may be less expensive, but can be time-consuming, but, most importantly, Indian litigation is unchartered territory for US investors. This litigation outcome should be monitored closely by potentially vulnerable shareholders of offshored entities as well as private equity firms.