Rajarshi Chakrabarti, Senior Resident Partner; Aakash Karekar, Associate; and Krati Agarwal, Associate, Kochhar & Co.

In recent years, India has experienced a remarkable surge in the data centre industry, propelled by several key factors that have shaped the country’s digital landscape. One of the primary drivers of this growth is the rapid digital transformation taking place across various sectors such as banking, finance, healthcare, education and government services. As businesses and organisations increasingly rely on digital platforms for operations, customer interaction and data-driven decision-making, the demand for robust data storage, processing capabilities and seamless connectivity has increased. Both international and domestic players have recognised the immense growth potential of India’s data centre market and have made substantial investments in building facilities across the country.

A full-scale analysis of all issues impacting investments in the data centre sector is beyond the scope of this article. Therefore, the authors have restricted the discussion to the legal facets of investments in this sector.

Conducting due diligence

Due diligence serves as the foundation and is an indispensable step in any business transaction or investment endeavour. While there is significant overlap between traditional due diligence and the one tailored for data centres, the latter possesses unique features that distinguish it from conventional assessments. Data centre due diligence focuses more on security protocols, cybersecurity frameworks and infrastructure resilience, as well as an assessment of revenue concentration, contractual terms and relationship strength with key customers. Some critical diligence issues for data centre investments:

  • Real estate
    The effective functioning of a data centre is dependent on numerous factors, among which real estate stands as a pivotal component. It becomes imperative that the due diligence focuses on the authority to sell, transfer or lease land. Additionally, there should not be any encumbrance on the land or any hindrance in case of conversion of agricultural land.
  • Material contracts
    Due diligence of material contracts should include a perusal of the change of control clause, which could enable the benefitting party to assert certain rights when changes occur within the target company. Other contracts such as operations and maintenance (O&M) arrangements have significant impacts on the business. Therefore, it is important that the investor includes the renewal of all third-party O&M contracts as a condition precedent to the transaction.
  • Security issues
    Data centres store and process vast amounts of sensitive information for businesses, governments and individuals, making it crucial for investors to focus on the security parameters of the target. Studying past breaches, their impact assessment and remedial steps taken to contain them can serve as a resourceful guide to ensure the strength of the security in a particular facility.
  • Environmental, health and safety
    Due diligence efforts should focus on ongoing investigations into environmental incidents, such as leaks or hazardous material handling, that may have occurred or could potentially occur at the facility. Assessing electrical systems, fire hazards, chemical storage, equipment failures and personal safety protocols could help mitigate risks and costs for the investor.
  • Licence and permits
    All permits related to construction, occupancy, electrical installations, zoning regulations, etc., should be in place. It will be helpful for the investor to assess the compliance status, potential suspension and revocation circumstances of the permits.
  • Pending litigation
    All pending or threatened litigation should be analysed to identify risks and develop mitigation strategies for the business.
  • Regulatory landscape
    As India positions itself as a data centre hub, regulatory adaptations that promote innovation, ensure data privacy and support sustainable practices will occur. It will be crucial to review these changes and the challenges they may pose to the business in future.

Deal structuring

From a legal perspective, an investment in the data centre sector may be pursued either through asset acquisition or share acquisition, at the discretion of the investor. The choice between an asset deal and a share deal hinges on various factors, including desired levels of control, tax implications and legal liabilities.

An asset deal is preferable when the target business carries significant risks and liabilities, allowing the investor to circumvent such burdens and focus on optimising operations post-acquisition. Novation of contracts, such as leases and power supply agreements, may be necessary in an asset deal. Alternatively, a slump sale presents the option to acquire the entire business as a going concern, inclusive of all assets and liabilities at the time of sale, suitable for investors seeking a running venture.

In contrast, a share deal involves purchasing shares of the target company, offering the seller a clean exit. However, it necessitates a thorough due diligence process by the investor to identify any contractual issues, potential claims or post-acquisition risks. Given that the acquirer assumes the seller’s position and may lack the leverage to negotiate on risks and liabilities, it is crucial to incorporate adequate disclosures, indemnities and guarantees in the transaction documents.

Contracts

Contractual frameworks in data centres serve as indispensable instruments governing the entire life cycle. Considering greenfield projects, where expeditious delivery and cost containment are the primary objectives, the need for robust contractual mechanisms becomes paramount. Findings from a 2019 study by a UK university highlighted the prevalence of disputes, with a staggering 68 per cent attributed to breaches in project timelines. To mitigate such risks, the contracts should meticulously delineate clear protocols for claims and risk management, anchored by well-defined milestones. Furthermore, with regard to third-party service provider contracts, especially those integral to core services, precise stipulations regarding service levels, guaranteed availability, response, troubleshooting times and escalation procedures are imperative.

Central to contractual efficacy is the unequivocal articulation of rights and obligations between data centre providers/landlords and occupants/customers, including delineations on maintenance, repair, replacement and adherence to prescribed standards or schedules. The focus should be on the provisions concerning downtime and its effect on availability, coupled with judicious consideration of limitation of liability clauses.

Foreign direct investment

In the context of foreign direct investment (FDI), regulatory frameworks permit 100 per cent FDI under the automatic route. However, as per the restrictions outlined in Press Note 3 issued by the Department for Promotion of Industry and Internal Trade in 2020, if the investments made by a person, or where the beneficial owner of those investments originates/resides from countries that share land border with India, such investments would require prior approval from the government.

It is to be noted that FDI in an Indian entity, including exit strategies, are subject to the pricing guidelines. Under Indian law, compulsorily convertible instruments are categorised as FDI and non-convertible or optionally convertible instruments are typically treated as debt, subject to pertinent regulations. Moreover, Indian entities seeking funding from abroad must adhere to external commercial borrowing norms that stipulate borrowing limits, interest rates, minimum average maturity period, end-use stipulations and other regulatory constraints.

Concluding thoughts

The data centre industry presents immense opportunities for investments and mergers and acquisitions in India, and prudent decision-making, meticulous planning and adherence to regulatory norms will be key drivers for success. While the overall regulatory environment is conducive for the enhanced growth of the data centre business, it is imperative that operational challenges faced by investors are duly addressed by the central and respective state governments. Effective implementation of single-window clearance mechanisms and a joint centre-state mechanism for the enforcement of data centre policies are some of the measures that can give a significant boost to this sector.

Due diligence serves as the foundation for any business transaction or investment endeavour. Data centre due diligence focuses more on security protocols, cybersecurity frameworks and infrastructure resilience, as well as an assessment of revenue concentration, contractual terms and relationship strength with key customers.