Setting up a business in India is hard. Leaving is even harder.

The American automaker stopped selling cars in the country in 2017 and said in 2020 it was closing its last factory in the South Asian nation. But it wasn’t until last year that GM extricated itself—for the most part—from India.

Its saga is a reminder to American companies of how difficult it remains to do business there.

The retreat from India was part of a strategy to shrink the company’s global presence and focus on profitable markets, analysts said. GM ran into headaches almost immediately.

In 2021, around 1,100 employees at one of the company’s factories countered what GM had thought was a generous severance package with a flurry of lawsuits alleging labor and pay violations. The company also faced tax disputes and the knock-on effects of a geopolitical falling out between India and China.

Labor laws required GM to pay its factory workers about a year’s salary after firing them, in addition to any severance package the company offered. A court also ruled the company had to keep paying the workers half their salaries till the disputes were resolved, though GM appealed that decision and won.

“We didn’t expect that it would go so bad from the start," said Prajot Gaonkar, former head of employee relations at GM in India. “It was crazy, very crazy."

Global companies looking to build factories in India appreciate the country’s vast workforce and its potential as a consumer market, but they are often deterred by bureaucracy. The obstacles aren’t just about setting up a business—where officials have recently tried to smooth the path—but also about closing one down if it doesn’t pan out. Regulations make layoffs difficult, politicians are often loath to see investors leave and courts can issue wildly contrary rulings even when the facts are similar.

“Exit barriers are a key reason for India’s underdeveloped manufacturing sector," said Shoumitro Chatterjee, co-author of a new paper on Indian manufacturing and an assistant professor of international economics at Johns Hopkins University. It “acts as an entry cost and deters potential companies."

As India faces fresh economic pressure from U.S. tariffs of 50%, some say it is more pressing than ever for it to fix roadblocks that hamper its economic potential.

In India, it takes an average of 4.3 years to fully close a factory, according to government data cited in the paper Chatterjee co-wrote. That is compared with one year in Singapore, 15 months in Germany and one to two years in the U.K.

GM’s exit from the Indian market was part of a strategic decision at that time to scale back money-losing international operations to invest in electric vehicles, analysts said. The company had lost over $1 billion over two decades of operating in the country, according to legal filings.

The sale of one plant, in the western Indian state of Gujarat, went off relatively smoothly in 2017 because the company offered to transfer workers to its other factory in Pune, in neighboring Maharashtra state, according to former executives.

The process of unloading the second plant dragged on for four years.

GM first attempted to sell the Pune factory to Chinese automaker Great Wall Motors. That fell apart after New Delhi refused to grant permission following a deadly border conflict with China in June 2020 that soured relations between the two countries.

GM shut down production in December of that year and applied for permission to close that factory. The state labor ministerpromptly rejected the request, declaring that the company could absorb its losses and stage a comeback.

The office of the Maharashtra labor commissioner said in a statement that the law required the state government to refer the dispute to an industrial tribunal once workers raised allegations that GM was trying to skirt labor protections in the process of closing the factory.

The state is committed to fostering a business-friendly environment for domestic and foreign investors, said the office, adding that following established law for difficult processes like plant closures is part of a predictable investment climate.

The employee union declined to negotiate, executives said, instead filing petition after petition with the courts.

Gaonkar, who handled employee relations at GM in India, said the hostility was especially shocking because the company had a good working relationship with its employees for decades and offered a generous severance package including 110 days of salary for every year of service.

Instead, the union demanded that GM either reopen the factory and rehire all the workers, guarantee a new owner would provide them all with jobs, or offer a severancepackage that paid out full-time salaries and medical benefits until retirement age, Gaonkar said.

The labor disputes scared away several interested buyers who didn’t want to inherit any problems, executives said. To allay fears, GM tried to get every single worker to sign an agreement waiving their right to sue in exchange for compensation. That plan failed.

“The labor situation was definitely damaging," Gaonkar said. “A lot of companies decided that we cannot and we don’t want to face this."

The Industrial Tribunal in Pune finally ruled in 2023 that GM had the right to close down.

The union appealed the decision to the Bombay High Court, and several members went on a highly publicized hunger strike along with politicians from the opposition party. The Bombay High Court upheld the industrial tribunal’s decision six months later.

“Having taken the decision to wind down operations in India, GM worked with all relevant authorities to ensure necessary approvals were granted," said GM spokesman George Svigos.

The union finally came to the negotiating table and agreed to withdraw all its lawsuits in exchange for the severance package that GM had offered right from the start, executives said.

Sandeep Bhegade, former union president for the GM factory in Pune, said the automaker had always treated its workers well. But the union fought the closure because its members doubted they could easily find another well-paying factory job. The workers had counted on the good salaries to buy homes and send their children to private school.

“Now most of us are doing work like driving rickshaws and taxis," he said.

South Korean automaker Hyundai, which makes cars in India both for domestic sales and for export, announced shortly after the court decision that it had purchased GM’s factory.

The Maharashtra government said GM’s case “should not be viewed as a cautionary tale about regulatory hurdles," and said the length of time it took to close the GM factory wasn’t due simply to labor rules. A lot of time was lost, it said, because of geopolitical issues that led to the collapse of the planned sale to Great Wall Motors.

“For over two years, the fate of the plant was tied to a commercial transaction that was stalled at the national and international level," said the office of the state labor commissioner.

The whole calculus can change if the local government backs a company’s departure, experts said.

When Ford said in 2021 that it was shutting down its two plants in India, conglomerate Tata purchased its factory in Gujarat, a transaction that was relatively smooth because the Indian company agreed to take on all the workers.

In the city of Chennai, in southern Tamil Nadu state, workers filed several petitions to try to stop the closure of the Ford factory there.

Arun Roy, Tamil Nadu’s industry secretary, said the state government came out in support of Ford in the courts, granted it permission to close and allowed the company to remove some machinery from the factory.

“There’s nothing to be gained in bitter partings," he added. “After all, they’ve invested here, they’ve created jobs here."

Easing the path for departing companies also preserves goodwill for any future deals, Roy said.

Ford retained ownership of its Chennai plant, Roy said, to keep a foothold in India.

In a statement, Ford said that India “remains an important region for us."

The automaker announced plans last year to restart manufacturing for export at its factory in Chennai. The city is also home to a Ford business and tech center employing over 11,000 people, who provide support in areas like software engineering and financial analysis.

Economists see higher rates of factory closures as evidence of a dynamic business environment where less efficient companies are forced out. India’s numbers tell a different story.

The costs of closing in India are so high that only 3% of factories there shutter every year, one of the lowest rates in the world, according to the paper Chatterjee co-wrote. In contrast, over 17% of factories in Vietnam and nearly 10% in China close every year. The figure for U.S. factories is 9%.

According to the paper’s analysis of government data, about 20% of manufacturing companies in India cling on, absorbing capital without producing anything—in effect, zombie firms.

Write to Shan Li at shan.li@wsj.com