INDIAN CORPORATE LAW

Auxiliary Activities and Permanent Establishments

noreply@blogger.com (V. Niranjan) — Sat, 07 Nov 2009 20:32:00 +0000

We have discussed on several occasions the extent to which a liaison office of an MNC is taxed, and more generally, the concept of a “permanent establishment”. A series of decisions in 2009 has introduced some clarity in the analysis of what constitutes a permanent establishment and what does not. To briefly recapitulate, although s. 9(1) of the Income Tax Act, 1961, enumerates circumstances where income is “deemed to accrue or arise” in India, primarily through a business connection test, several DTAAs provide that income earned in one Contracting State may be taxed in the other Contracting State only if it is attributable to a permanent establishment in that State. Permanent establishment is invariably defined in these treaties, but often excludes entities that only perform “auxiliary activities” in the taxable State. It is thus important to determine what legal principle distinguishes an “auxiliary activity” from other activities, and this question arose most prominently in the context of the taxation of liaison offices.

In February 2009, the Delhi High Court held in UAE Exchange Centre v. Union of India (313 ITR 94) that the exclusionary clause of auxiliary activities must be construed broadly. In that case, the parent company, incorporated in UAE, performed remittance services for NRIs in UAE, where it transferred funds to the NRI’s family in India, on the payment of a fee. The contract was concluded in UAE and payment was received by the company in UAE, denominated in local currency. However, the company also used liaison offices in India to effect the transfer, and the liaison offices consequently had access to the company’s server in the UAE. The liaison office would then download the particulars of the remittance, make the necessary demand draft and despatch it in accordance with the instructions of the remitter. The Revenue argued that the contract was in effect performed by the liaison office – for the essence of the contract was the remittance of money – and that this could consequently not be regarded as “auxiliary”. The AAR had accepted this contention. The Delhi High Court quashed this order, and observed that “but-for” test is inappropriate in construing the exclusionary clause – in other words, the fact that the contract could not have been performed without the aid of the liaison office’s activities is not determinative of its status as an “auxiliary” activity or otherwise. The Court held that the test is broader, and that it was auxiliary because it was in “support” of the main activity entered into in the UAE, for payment in the UAE. In what is likely to be of some importance in subsequent cases, the court also observed that “[o]rganisations and companies operate transnationally. There is an eagerness to bring to tax by States income, by employing deeming fictions so that incomes which ordinarily do not accrue or arise within the taxing State are brought within the States' tax net. It is in this context that the expression "permanent establishment" appearing in the DTAA has to be viewed.” The case is also important for the proposition that the AAR constitutes a “Tribunal” for the purposes of Art. 227 of the Constitution.

This view has been followed. In Cable and Wireless Networks (315 ITR 72), decided in July, a branch office of a UK corporation performed network designing, network management services and other support activities. The AAR held that it did not constitute a permanent establishment since the activity is auxiliary. Similarly, in KT Corporation (181 Taxman 94), a Korean corporation opened a liaison office in New Delhi for the purpose of communicating with Indian banks and other commercial entities. The AAR referred to the OECD Model Commentary’s analysis that the activity must form an “essential and significant part of the enterprise as a whole” and held that the LO did not constitute a PE, relying on Morgan Stanley as well as UAE Exchange. In Hyosung Corporation (314 ITR 343), the AAR reached a tentative conclusion to the same effect.

These decisions are of some importance in enumerating the circumstances under which the head office may be liable to tax exposure on account of the activities of the liaison office. Moreover, the line that the cases have taken – of construing the exclusionary clause of auxiliary activities – appears to be correct and in consonance with the intention of the parties to the DTAA.

Law Firms and Joint Ventures

v.umakanth@gmail.com (Umakanth V.) — Thu, 05 Nov 2009 12:21:00 +0000

A few months ago, we had posted about a paper by Professor Jayanth Krishnan on issues that revolve around the opening up of the Indian legal sector to foreign law firms. He has now released the results of another interesting piece of research titled The Joint Law Venture: A Pilot Study that examines the rate of success or failure of joint ventures between law firms by looking closely at the “joint law venture” model followed over the last decade in Singapore. Here is the abstract:

This pilot study evaluates the effectiveness of law firms entering into joint ventures, an increasingly eyed business model particularly by American and British lawyers seeking to expand into promising financial markets. One country at the center of the joint venture experiment has been Singapore. With the strong encouragement of the Singaporean government (which has long embraced foreign investment), various elite law firms from the United States and Britain have been partnering with domestic Singaporean law firms for over the past decade. Because these foreign firms were traditionally barred from practicing Singaporean law on their own, the ‘joint law venture,’ or JLV as it came to be called, was initiated to provide the Americans and British with an opportunity to access the highly-desired, lucrative local market – through the use of their Singaporean joint venture colleagues. In return, the Singaporean firms were to benefit by gaining international legal contacts, learning ‘best practices’ from their foreign counterparts, and enhancing their reputations by being tied to prestigious law firm powerhouses.

Until now, no work has fully investigated whether these JLVs have actually fared as well as their advocates had hoped. Therefore, based on fieldwork conducted in Singapore, including in-depth interviews of the relevant parties, this project fills this gap – uncovering how due to economic misalignment, cultural misunderstandings, and a sheer breakdown of necessary human relationships, in more cases than not the JLV has been a failed business model. For these reasons, I argue that American and British law firms may wish to think seriously before pursuing the JLV route – not just in Singapore but perhaps even in other markets in which they are already present or are contemplating entering.

E-Voting in Indian Companies

v.umakanth@gmail.com (Umakanth V.) — Wed, 04 Nov 2009 09:52:00 +0000

Public (or retail) shareholders in a company usually exhibit traits that result in “collective action problems”. This refers to the difficulties that arise in achieving consensus among a diffused set of shareholders who do not play an active role in the company. These problems are exacerbated by the heterogeneity of interests and differing levels of information available with these shareholders. For these reasons, public shareholders seldom participate actively in general meetings of the company. In most cases, decisions of general meetings are a foregone conclusion as resolutions proposed by the board and management (with the tacit approval of the majority shareholders) are only put through the formal motion at the meetings. Public or minority shareholders make their appearance in small numbers, and their votes cast are not sufficient to cause any dent to the majority decision. Such problems are compounded because general meetings (which are often held in locations that are not prominent or easily accessible) require shareholders to be present in person or by proxy.

A solution to this problem was devised about a decade ago, which was voting through postal ballot. Section 192A of the Companies Act, 1956 provides that listed companies are required mandatorily to obtain resolution of shareholders through postal ballots on certain matters, and optionally on other matters. However, this has failed to achieve the intended result.

It has now been proposed, as reports (here and here) suggest, that online voting be introduced. There would be no legal or regulatory hurdle to begin with as the explanation to Section 192A states: “For the purposes of this section, "postal ballot" includes voting by electronic mode.” Hence, it is a question of prescribing the appropriate mechanism for electronic voting, which is an exercise reportedly being undertaken by the depositories.

Although it would be difficult to estimate the true extent of change that this proposal would usher in, it is certainly a move in the right direction. Electronic voting may motivate more shareholders (including individuals) to exercise their corporate democratic right with greater convenience, and this may signal greater acceptance of shareholder activism in the Indian context by addressing the collective action problems (at least partially).

Legal Risks and Financial Sector; Capital Controls

v.umakanth@gmail.com (Umakanth V.) — Tue, 03 Nov 2009 10:06:00 +0000

Recent developments in the financial sector have witnessed a sea-change in the nature of legal risks faced by banks and financial institutions. Regulators, banks and financial institutions, as well as their legal advisors (both in-house and external) are required to constantly keep pace with the change. In that context, a recent speech by Shyamala Gopinath, Deputy Governor of the Reserve Bank of India (RBI), contains an interesting account of the legal risks in the present environment, and the steps taken by the RBI to address those risks. The issues highlighted range from those relating to OTC derivatives, enforcement of security arrangements, and the effectiveness of bankruptcy laws (including from a cross-border perspective). While some of the issues carry international implications and have been highlighted due to the financial crisis, others are specific to India.

On a separate note, the Economist has a column that deals with capital controls in emerging economies. Commenting on RBI’s policy, it observes that it is difficult to argue against capital controls, especially given the Indian economy’s resilience in the wake of the global financial crisis: “Having avoided the Asian financial crisis in the 1990s and escaped the worst effects of the most recent meltdown, India’s cautious liberalisers feel they have won the argument this time around. It is hard to disagree.”

The column also describes the undue complexity of India’s capital control regime:

For starters, they are needlessly complex, because India’s policymakers like to retain as much room for manoeuvre as possible. They police capital flows by banning some trades, imposing quotas on others, lifting a price control here or tightening a registration requirement there. This makes life needlessly difficult for foreign investors. The rules are hard to interpret and changes are impossible to predict. One private-equity fund and its investors reckon this confusion and ambiguity cost them $8m in lawyers’ fees. This accomplishes the policymakers’ aim of deterring foreign capital, but not quite in the way they intended. By raising the cost of doing business, the regulatory thicket acts as an implicit tax on investing in India. Its policymakers could achieve the same effect through simple rules and explicit taxes. The $8m that is now spent on lawyers could be given to the Indian government instead.

There is certainly a case for simplification of various rules relating to capital flows. More importantly, the rules ought to be clear with very little left for interpretation.

See also a related report in the Economist.

United States Supreme Court considers a corporation's 'principal place of business'

noreply@blogger.com (Shantanu Naravane) — Fri, 30 Oct 2009 06:04:00 +0000

An important question, with significant implications for contemporary corporate law theory will be heard by the United States Supreme Court on November 10. The matter in question is Hertz Corp. V. Friend (08-1107), which poses the question of which State can be considered to be a corporation’s ‘principal place of business’.

The issue has arisen against the backdrop of a class action against the company, for the violation of state wage and labour laws. The suit was filed in a California State Court, in response to which Hertz Corp. removed the action to Federal district court. Before the Federal district Court, the respondents argued that Hertz’s principal place of business was California, hence it was a Californian citizen, and not different from any other plaintiff. On this basis, it was contended that the matter be remanded back to the State Court. The district court, relying on the ‘place of operations’ test, considered several factors like ‘the location of employees, tangible property, production activities, sources of income, and where the sales take place’, and concluded that since Hertz Corp.’s business in California was ‘significantly larger than any other state in which the corporation conducts business’, California was its ‘principal place of business’ in the United States. This decision was affirmed on appeal by the Ninth Circuit, whose decision is available here.

In its petition for certiorari before the Ninth Circuit Court of Appeal, and now before the United States Supreme Court, Hertz contends that the different circuits in the country are applying four different tests to determine the ‘principal place of business’, necessitating some clarity from the Supreme Court about the appropriate test to be used. The Seventh Circuit uses a ‘nerve center’ test focussed on the location of the ‘corporate brain’ or the corporate headquarters; the third circuit looks at the corporation’s center of activity, while some other circuits rely on the totality of the corporation’s activities (the Fifth, Sixth, Eighth, Tenth, and Eleventh Circuits). Of these, for a wide range of reasons, Hertz advocates the use of the ‘nerve center’ approach, according to which, its principal place of business would be New Jersey and not California. It is also supported in this view by the United States Chamber of Commerce. The respondents contend that though the tests being used are different in nomenclature, they result in very similar conclusions. Further, the Congress has specifically preferred the use of ‘principal place of business’ over ‘place of incorporation’ in §1332 of the Class Action Fairness Act of 2005 (“CAFA”). The ‘principal place of business’ being a term of art borrowed from bankruptcy law, it must be decided the way it is in bankruptcy law, i.e., by considering a wide range of factors, and not only the place of incorporation.

This has given rise to issues of whether corporations having a presence in more than one State should be allowed to chose which jurisdiction they can be sued in, and to what extent the theoretical headquarters of a corporation can be given precedence over the practical headquarters of its operations. Thus, the issue is of great significance, not only in the specific context of the CAFA, but also in corporate law theory in general. Particularly, given the similar controversy that has arisen around tax avoidance and multi-national corporations, the hearing on November 10, and the subsequent decision is of great interest. A more detailed discussion of the issues involved is available here, and copies of the briefs in the matter are available here.

Changing Advertising Practices in India - The End of "Puffery"?

noreply@blogger.com (V. Niranjan) — Thu, 29 Oct 2009 14:47:00 +0000

The Government's proposed “Advertising Code” for food and health products is an interesting development , particularly in light of developments in India over the past three years or so on the subject. This blog has discussed emerging trends in India on the norms governing advertising practices.

To briefly recapitulate, the law does not proscribe comparative advertising, which is a near-ubiquitous practice in today’s commercial world. It does not even require that the advertisement be true and accurate in every respect. English law for a long time was that an advertisement that was mere “puffery” could not form the basis for any action in law. This was based on the belief that an advertisement that is so exaggerated as to be clearly untrue is unlikely to cause any reliance on the part of the consumer who sees it, and consequently does not have to be regulated as strictly as advertisements that purport to be factual but are not. For example, an advertisement claiming that drinking a particular soft drink is the route to becoming a millionaire is clearly “puff”, and is less misleading than claiming that the soft drink is superior on account of the fact that competing drinks contain pesticides. This principle was accepted in India as well, until 2008, when the Madras High Court held that the peculiar circumstances of the Indian consumer make the doctrine inappropriate in Indian law. The Supreme Court and the majority of the High Courts had held otherwise, and the only real restriction on comparative advertising was that it could not "disparage" the goods of a competitor.

In this context, it is interesting to note that the Government’s proposal to introduce an Advertising Code appears to primarily tackle misleading and “puffed” advertisements in food and health products. The proposal has emerged under the framework of the Food Safety & Standards Act, 2006 [“the FSSA Act”], under which the Food Safety and Standards Authority of India has been set up [FSSAI]. The FSSA Act prohibits unfair trade practices and “misleading and deceiving advertisements”. The FSSAI notes although commercial advertising is a protected activity Art. 19(1)(a) of the Constitution of India, no law governs it, except guidelines drafted by the Advertising Standards Council of India [“ASCI”]. Those guidelines, however, have no binding force and are intended to function as self-regulation guidelines.

The Code proposes radical changes to existing commercial practices. The restrictions are that advertisements cannot disparage “good dietary practice”, encourage “excessive consumption”, suggest “portion sizes” that may be appropriately consumed and so on. The Code practically makes puffery illegal by prescribing that “advertisements should not mislead consumers…to believe that the consumption of the product advertised will result directly in personal changes in intelligence, physical ability or exceptional recognition, unless supported with adequate scientific evidence”. It also requires that “celebrities or prominent” people not promote food in such a way as to “undermine a healthy diet”. A copy of the entire Code is available here.

The merits of the regulation apart, it is important to consider a few serious questions of enforcement. For one, since the Code, as will inevitably be the case, is phrased in broad terms, it seems more appropriate that this be part of a self-regulation model. If, on the other hand, the FSSAI decides to enforce it, it may have to evolve suitable institutional support to be able to assess not only what advertisements offend the Code, but also whether there is parity in treatment. For example, s. 5(a)(1) of the Federal Trade Commission Act in the United States empowers the FTC to prevent advertisements that are inconsistent with the Act, in addition to the normal remedy of seeking an injunction from a civil court. Similarly, the United Kingdom in 1962 set up the Advertising Standards Authority to regulate advertising. When the ASA finds a particular advertisement to be inconsistent with the guidelines in the UK, the normal practice is for the owner of the advertisement to remove it, thus establishing a model of self-regulation.

Thus, the Madras High Court’s opinion of 2008 appears to have anticipated these developments. After noticing the law in England and the USA, the Court had observed then that “…it is doubtful if false claims by traders, about the superiority of their products, either simplicitor or in comparison with the products of their rivals, is permissible in law. In other words, the law as it stands today, does not appear to tolerate puffery anymore. I do not know if "Puffing" which is only a twin sister of "bluffing", permitted by English courts in the past, still has the sanction of law even in England, after the advent of 'legacy regulators' such as CAP, Oftel, Ofcom, Clearcast etc…”

If the Code becomes law, the interesting question for Indian law will be whether its principles ought to be extended to other areas of commerce as well. Comments on the Code are available here and here.

Powers of SEBI and SEC Compared

v.umakanth@gmail.com (Umakanth V.) — Thu, 29 Oct 2009 02:54:00 +0000

In his column in the Business Standard this week, our guest contributor Somasekhar Sundaresan argues that, if one were to go by the rule book, SEBI has greater powers than the SEC. He lists out several significant powers of SEBI that can be exercised without intervention of the court. Here are some excerpts:

Take the Raj Rajaratnam case itself. The SEC has had to file a complaint before a court (see http://www.sec.gov/ litigation/complaints/2009/comp21255.pdf) asking the court to pass orders to disgorge the alleged gains earned by way of insider trading, to restrain the accused from acting as officers or directors of any issuer of securities, and to pay civil monetary penalties under the US securities laws.In India, SEBI itself is armed with powers to take each of the aforesaid actions in absolute terms — not just as interim measures.

On an almost daily basis, SEBI issues directions under Sections 11 and 11B of the SEBI Act asking people not to deal in securities or to access capital markets or to be associated with capital markets. SEBI has wide powers to issue “such directions as it deems fit” with the only touchstone of rationale being the “interests of the securities market”.
…

Chapter VIA of the SEBI Act, 1992 empowers SEBI to inflict monetary penalties directly without the intervention of any court. Adjudicat-ing Officers, who are employees of SEBI, acting as quasi-judicial officers have the power to impose civil monetary penalties. These penalties can be as high as Rs 25 crore or three times the benefit gained due to the violation.

SEBI has also written subordinate legislation in the form of regulations governing market intermediaries registered with it to impose disciplinary penalties ranging from censure to cancellation of registration.

The only area where SEBI does not have powers for direct action without an intervention of a court is the ability to send people to jail. Section 24 of the SEBI Act requires SEBI to file a complaint before a criminal court to get an accused convicted and jailed for contravention of any provision of the SEBI Act, or rules or regulations made under it.

'Business connection', 'Attribution' and the withdrawal of Circular 23 of 1969

mihircn@gmail.com (Mihir Naniwadekar) — Wed, 28 Oct 2009 21:23:00 +0000

Through Circular No. 7 of 2009, the CBDT has withdrawn Circular No. 23 of 1969 (“Circular 23”). Circular 23 explained the position relating to ‘business connection’ under Section 9 of the Income Tax Act, 1961.

The Circular was relied upon in the arguments in the Morgan Stanley case before the Supreme Court; as also by the Bombay High Court in SET Satellite. These decisions had laid down the broad proposition that in an international transaction, if the non-resident compensates its permanent establishment (“PE”) at arms-length price, no further profits of the non-resident would be attributable to the PE in India.

With the SET Satellite decision set to come up before the Supreme Court, concerns have been raised as to the implications of the withdrawal of this circular. In particular, does the view in Morgan Stanley or SET Satellite need to be reconsidered in light of the withdrawal of the Circulars? Furthermore, what is the extent to which income from a business connection is taxable in India, after the withdrawal of the Circular?

The principle of Morgan Stanley:

The principle enunciated by the Supreme Court in Morgan Stanley on the question of attribution of income to India is as follows:

“The impugned ruling (of the AAR) is correct in principle insofar as an associated enterprise, that also constitutes a PE, has been remunerated on an arms-length basis taking into account all the risk-taking functions of the enterprise. In such cases, nothing further would be left to be attributed to the PE…”

This was followed by the Bombay High Court in SET Satellite:

“In our opinion considering the judgment, if the correct arm’s length price is applied and paid then nothing further would be left to be taxed in the hands of the foreign enterprise…”

In both these cases, Circular 23 was cited before the Court; yet it did not for part of the Court’s reasoning. In SET Satellite, on this issue, the Bombay High Court directly followed Morgan Stanley (the decision has been previously discussed here). In Morgan Stanley itself, Circular 23 is mentioned in the Supreme Court judgment only when the Supreme Court notes that the AAR placed reliance on the Circular. No reliance is placed on the Circular in the reasoning/conclusion of the Supreme Court itself. The reasoning of the Court is premised on the conceptual relation (and not a relation introduced solely by Circular 23) between a correct transfer pricing analysis and attribution of profits. This relation has been discussed in the previous post on SET Satellite.

Now, if Circular 23 played no part in the actual reasoning of the Court, then the withdrawal of that Circular cannot in any manner require that the principle laid down by the Court be reconsidered. Accordingly, while fears have been expressed that the withdrawal of the Circular will strengthen the Department’s case against SET Satellite in the Supreme Court, it is arguable that those fears are misplaced.

The extent to which income from a business connection can be taxed in India:

Circular 23 stated that “Section 9 does not seek to bring into the tax net the profits of a non-resident which cannot reasonably be attributed to operations carried out in India.” Concerns might be raised as to whether the withdrawal of the Circular changes this basic position.

Circular 23 discussed issues related to extent of taxable income under Section 9. The relevant part of Section 9 provides that all income accruing or arising “directly or indirectly, through or from a business connection in India” is deemed to accrue or arise in India. According to the relevant Explanation 1 to the Section:

“in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India…”

Thus, the position that only that income which is reasonably attributed to India is covered under Section 9, is clarified in the Section itself. This position is thus due to the Explanation to the Section and not due to Circular 23. Circular 23 only clarified how this would apply in practice – it did not, indeed it could not have, deviated from the principle of attribution which is mandated by the Section itself.

Circular 23, in paragraph 1, itself states that it is a consolidation and restatement of previous clarifications (or the scope of the corresponding Section in the 1922 Act). Paragraph 3 of the Circular again clarifies that “The following clarifications would be found useful in deciding questions regarding the applicability of the provisions of section 9 in certain specific situations…” From this, it is evident that the Circular does not even purport to lay down any specific legal principle; it only discusses the application of the principle in Section 9 to various fact situations.

Conclusion:

There is at least an arguable case that the withdrawal of the Circular makes no difference to the legal position – either on attribution to PEs or on extent of income taxable under Section 9. What, then, was the need to ‘withdraw’ the Circular? The CBDT claimed that there was misuse of the Circular which resulted in assessees claiming relief not in accordance with the provisions of Section 9. Perhaps, the CBDT wanted to give the Revenue wider scope for ingenuity in argument; however, in my view, the legal position would remain unchanged.

A Reiteration of Separate Legal Entity

noreply@blogger.com (Shantanu Naravane) — Wed, 28 Oct 2009 06:57:00 +0000

A recent decision of the Punjab and Haryana High Court in CIT v. Panchratan Hotels has re-emphasised the notion of separate legal entity, albeit in the context of the law of taxation.

Here, the assessee was Panchratan Hotels, and had declared losses for the said assessment year. On 31.7.1992, the shareholders of the company had changed, through a transfer of 100% shareholding from the original shareholder to the new shareholders. On this basis, the CIT contended that there had been a succession of business for the purposes of section 170 of the Income Tax Act. Under section 170, in cases of succession, the predecessor is assessed in respect of the income of the previous year in which the succession occurs, up to the date of succession. On this basis, the CIT contended that the assessment for the year 1.4.1992 to 30.7.1992 was required to be made in the hands of the old company and subsequent assessment from the period 31.7.1992 to 31.3.1993 in the hands of the new company.

For deciding this issue, the Court was required to answer two questions-

(a) Whether the transfer of shares amounted to a succession of business under section 170?

(b) Even if it did, whether section 170 applied to the company whose shares had been transferred?

The Court did not answer the first question conclusively, only noting the argument that a transfer of shares may also amount to a succession under section 170. It based its decision more on the second question, since it was of the opinion that section 170 cannot apply to the facts in issue. The Court observed that the transfer of shareholding would only change the identity of the shareholders and not the identity of the company, which is a separate legal entity. Thus, while the concept of succession would apply to the transferor and transferee of the shareholding, it would not apply to the company whose shares are transferred. In the words of the Court-

Even if for the sake of arguments, we accept that the transfer of shares amounts to transfer of capital assets in terms of Section 2(47), then also in our considered view, Section 170 will not apply. A bare reading of Section 170 shows that the transfer of the business should be from one assessee to another. Person under Section 2(31)(iii) of the Income Tax Act includes a company. Under Company Law, a company is a juristic person. The share holders are not the owners of the company. It is the company itself which is its own owner having its own seal and succession. Where shares are transferred, at best this would be a transfer vis-à-vis, the person who was the holder of the shares to the person to whom the shares are transferred. Therefore, individually when Mr. Kapoor has sold his share to M/s.General Sales Limited then it may amount to a transfer when considering the incomes of Mr. Kapoor or M/s.General Sales Limited. Section 170 may be attracted to both the previous and subsequent owner of the shares but cannot apply to the company itself. This is no transfer as far as the assessee, i.e., M/s. Panchratan Hotel is concerned.

...

The company is a juristic person having its distinct legal entity separate from that of the shareholders. The change in the share-holders of the company does not change the legal identity of the company.

On this basis, the Court reversed the finding of the CIT, and held that the transfer of shares did not result in the change of identity of the company, but only resulted in a change of the owners of the company. While this seems a reiteration of an accepted principle of corporate law, it assumes greater significance in light of the ongoing Hutch-Vodafone tax dispute, where the central question is whether the transfer of the shareholding of a company having assets in India amounts to transfer of those assets situated in India. In that context, this decision affirming the concept of a separate corporate entity, especially in a tax context assumes is of considerable interest. A copy of the judgment is available here.

Supreme Court Reaffirms Dharmendra Textiles

noreply@blogger.com (Shantanu Naravane) — Mon, 26 Oct 2009 04:50:00 +0000

Earlier posts here have considered the issue of whether the penalty under section 271(1)(c) of the Income Tax Act, 1961 is a criminal, quasi-criminal or civil liability, which in turn has implications on whether mens rea is needed for awarding penalty under the section. The Supreme Court had held in Dilip Shroff that mens rea is needed for the non-disclosure of penalty to result in penalty, but this was subsequently overruled by the Court in Dharmendra Textiles. This was followed by decisions of some High Courts and Tax Tribunals narrowing the applicability of Dharmendra Textile to facts, making it possible that a subsequent consideration of the issue by the Supreme Court may reverse the position again.

However, having been presented with the opportunity in CIT v. Atul Mohan Bindal, the Supreme Court has specifically reaffirmed Dharmendra, holding that the penalty is a civil liability, and hence no mens rea is required under the provision. The Court held-

A close look at Section 271(1) (c) and Explanation (1) appended thereto would show that in the course of any proceedings under the Act, inter alia, if the Assessing Officer is satisfied that a person has concealed the particulars of his income for furnished inaccurate particulars of such income, such person may be directed to pay penalty. The quantum of penalty is prescribed in Clause (iii). Explanation 1, appended tosection 271(1) provides that if that person fails to offer an explanation or the explanation offered by such person is found to be false or the explanation offered by him is not substantiated and he fails to prove that such explanation is bona fide and that all the facts relating the same and material to the computation of his total income has been disclosed by him, for the purposes ofSection 271(1)(c), the amount added or disallowed in computing the total income is deemed to represent the concealed income. The penalty spoken of in Section 271(1)(c) is neither criminal nor quasi criminal but a civil liability; albeit a strict liability. Such liability being civil in nature, mens rea is not essential.

It had been discussed earlier that the issue before the Court in Dharmendra Textiles was section 11AC, Central Excise Act, and not section 271(1)(c), Income Tax Act. On this basis, there was scope for the argument that the finding on section 271(1)(c) was obiter and could be departed from. However, after the decision in Bindal, this line of argument has been unquestionably foreclosed, and the nature of penalty under section 271(1)(c) is now a strict civil liability, with no requirement of mens rea. A summary of the decision is available here.

UN Corporate Law Tools project: Corporate Structures and Governance and Human Rights

mihircn@gmail.com (Mihir Naniwadekar) — Sat, 24 Oct 2009 11:00:00 +0000

The United Nations has been developing a project on Reports on Corporate Law Tools, which involves leading law firms from across the globe working with UN Special Representative John Ruggie to analyse how corporate structures in different legal systems foster respect for human rights. The idea behind the project is found in this note prepared by the Special Representative.

Reports from several countries are now available, including the report from India prepared by AMSS.

The Indian report consists primarily of answers to the several questions framed. Some of the specific questions include:
+ Briefly explain the broader legal landscape regarding business and human rights.
+ Did incorporation or listing of companies historically, or does it today, require any recognition of a duty to society, including respect for human rights?
+ To whom are directors’ duties generally owed (i.e. to the company, non-shareholders etc.)?
+ Are companies required or permitted to disclose the impacts of their operations (including human right impacts) on non-shareholders, as well as any action taken or intended to address those impacts, whether as part of financial reporting obligations or a separate reporting regime?
+ Are institutional investors, including pension funds, required or permitted to consider such impacts in their investment decisions

According to the executive summary of the report, in relation to the role of directors, “Directors are in a fiduciary relationship vis-à-vis their companies. They are therefore required to act in a bona fide manner for the benefit of the company. In certain circumstances, the directors are required to extend their duty of care to the shareholders and other third parties (including creditors and employees). Whilst the Companies Act does not mandatorily require directors to consider non-business related impacts, the requirement may be read into the duties of directors not to carry out business in a manner which is prejudicial to public interest. Certain environment protection statutes also impose obligations on companies (and their directors) to consider and prevent environmentally harmful activities. Additionally, given that the Courts have been active to condemn cases of grave violation of fundamental rights by companies, it would be advisable for directors to be circumspect of any human rights violations in which their companies could get involved…”

This blog has carried several discussions of directors’ duties; the most recent one is found in the comments to this post. Among other issues raised by the report is the role of institutional investors in India. As the report notes, there is neither any requirement nor any bar on institutional investors to consider human rights or governance impacts in their investment decisions.

Theoretically, institutional investors can exhibit shareholder ‘activism’ in two ways – either by challenging management decisions, or by relying on the markets to immediately exit the company in the event of any governance irregularities. Typically, these are referred to as the ‘voice’ and ‘exit’ strategies. In requiring institutional investors to adopt the ‘voice’ strategy rather than the ‘exit’ strategy, one factor which must be taken into account is that the institutional investor also has a duty to its customers to ensure a good return on the customer’s investment. The practicability of requiring institutional investors to play an ‘activist’ role is therefore problematic, considering that for customers, ‘exit’ may often be economically the best option (at least in the short-term).

Among the other forms of shareholder activism in India highlighted by the AMSS Report is the Investor Protection Fund under Section 205-C of the Companies Act. One step which the proposed Companies Bill seems to have taken in this regard is the formation of the Stakeholders Relationship Committee. Under the proposed Section 158(12), “The Board of Directors of a company having a combined membership of the shareholders, debenture holders and other security holders of more than one thousand at any time during a financial year shall constitute a Stakeholders Relationship Committee consisting of a chairman who shall be a non-executive director and such other members of the Board as may be decided by the Board.” This Committee is to be tasked with “considering and resolving” the grievances of stakeholders. The Report notes that the term ‘stakeholder’ in this context is likely to refer to “… security holders and creditors of the company, rather than other third parties such as representatives of communities affected by the company’s activities…”

The Report highlights the fact that while legislations do exist requiring directors to take into account the interests of some categories of non-shareholders, issues of control over the actions of the management are still unresolved. This is particularly true considering the peculiar relationship between ownership and management in India, which is in practice often not distinct.

RBI extends time limit for Auditors' Certificate for NBFCs - leaves fundamental issues unaddressed

jmthakur@gmail.com (Jayant Thakur, CA) — Fri, 23 Oct 2009 05:12:00 +0000

Auditors of non-banking financial companies (NBFCs) have to submit a certificate every year to the Reserve Bank of India on whether the NBFC is engaged in the business of a non-banking financial institution (NBFI). The certificate also gives the income/asset pattern for making it eligible for classification under various categories. The last date for submission of this certificate for the immediately previous financial year ended on 31st March was 30th June (e.g., the last date for FY ended 31st March 2009 was 30th June 2009). This requirement was under the respective Prudential Norms Directions for deposit accepting and non-deposit-accepting NBFCs.

RBI has now changed this deadline of 30th June. Now, Auditors will need to submit such certificate within one month of the finalization of the balance sheet but in any case not later than 30th December (note that its 30th December and not 31st December). You can find the circular here (the circular contains the amending notifications too).

This extension was obviously needed since otherwise an NBFC would have been, for all practical purposes, required to finalize its accounts by 30th June (actually even earlier).

However, certain fundamental issues remain unresolved. How does an auditor certify whether the NBFC is engaged in the business of an NBFI? For most practical purposes, the legal requirement is that if an NBFC's "principal" business is of certain financial and similar activities, then it is deemed to be engaged in the business of an NBFI. How does one determine what is "principal" business? RBI has issued certain clarifications that one could look at the mathematical majority of assets and income as of the yearend. This has the advantage of mathematical certainty but creates numerous practical problems. Recent upturns and downturns in financial markets have ravaged the income and asset patterns of several NBFCs and yearend positions are often misleading.

RBI's view can be held to be contradictory and beyond the express provisions of the Act particularly if because of a temporary and a mere yearend change, it would mean that the NBFC is no more eligible to retain its certificate of registration. Also, whether a company is an NBFC and whether an NBFC continues to remain an NBFC is an issue that has implications even beyond the RBI Act since there are numerous cross references in other laws.

Of course, the reality also is that RBI does not appear to take a hyper-technical and strict stand and instead of going literally by its own clarification, it does look at the facts. But the NBFC would surely feel insecure when its own auditors may have to certify that it is no more an NBFC merely because of a yearend mathematical position and that too of just one year.

- Jayant Thakur

Corporate Bonds: Clearing and Settlement

v.umakanth@gmail.com (Umakanth V.) — Thu, 22 Oct 2009 02:09:00 +0000

SEBI last week issued a circular prescribing the procedure for clearing and settlement of corporate bonds. This is an important step in the development of a robust corporate bond market that has not yet fully evolved in India, and appears to have been welcomed by the markets.

The SEBI Updates blog has a post describing the history of regulation of the Indian corporate bond markets.

Much Ado About Executive Compensation

v.umakanth@gmail.com (Umakanth V.) — Wed, 21 Oct 2009 07:18:00 +0000

Over the last few weeks, significant attention has been drawn to the issue of executive compensation, following observations by the Minister for Corporate Affairs that there ought to be moderation in CEO salaries in India. Two factors seem to have triggered such attention. One, which carries political overtones, is the Government’s own measure of austerity. The other is the raging debate on CEO pay that is ongoing in countries such as the U.S. and the U.K., partially as a result of the collapse of companies in the banking and insurance sectors. Salil Tripathi has a column in the Wall Street Journal that provides a nice perspective of the issues.

There is, however, one key aspect of management in Indian companies that has been ignored in this debate. In countries such as the U.S. and the U.K., CEOs and other senior managerial personnel rely on compensation received from the companies in the form of salary and other perks. Apart from stock options or some shareholding (usually as a result of exercise of options), CEOs do not hold any significant stake in their companies. Moderating executive compensation in such scenario carries some logic to it. On the other hand, CEOs in India in large measure take on a different character. They are not truly employees of the company; they also control the companies. A substantial part of corporate India, including public listed companies, consists of family-owned businesses. In those cases, the CEOs not only receive compensation from the company in the form of salary, but by virtue of shareholding and control, such CEOs may receive other economic benefits in the company, such as dividend and an appreciation in the value of shares of the company. It is trite to believe that in these circumstances, the CEO is incentivised purely by the salary obtained from the company; rather, it is the benefits of shareholding and control that operate as key incentives.

Given this scenario, too much is being attributed in the Indian context of a CEO here or there agreeing to a significant drop in salary or even giving up salary altogether. Reduction in such CEO salary may, at some level, indicate a sense of austerity, but it may mean less when seen in the overall context of the various commercial incentives of a CEO in a family-owned business. In that sense, the debate of CEO-pay seems misplaced to a large extent in the Indian corporate context. It is perhaps a case of shadow-boxing. Of course, there may be a handful of companies that are truly management-driven, or in the case of Government-owned companies, where CEOs rely solely on compensation received in the form of salaries, but those appear to be more the exception than the rule.

It may augur well for the Government instead to redirect its efforts to ensure that the benefits of control are not abused in such companies so that minority investors are protected, thereby ensuring the robustness of the capital markets.

Corporate Governance Accreditation

v.umakanth@gmail.com (Umakanth V.) — Wed, 21 Oct 2009 06:28:00 +0000

In Singapore, there is a proposal for listed companies to seek voluntary accreditation of their corporate governance processes and framework from an independent body. This is akin to the ISO certification process. As this report suggests, while such accreditation will better inform retail investors regarding corporate governance practices followed in a company, this could also be riddled with difficulties. For example:

Management time and accreditation costs are just two of the key issues.

Another is how effective the body will be in raising corporate governance standards.

Blue chips already have much higher levels of corporate governance than smaller companies. It is possible that having an accreditation body will just reinforce that divide - blue chips get the certification easily while the ones which do need to pull up their socks sit back and do nothing.

Another concern is that investors will start relying on the certification and be lulled into complacency and fail to do their homework.

All it takes is for one bad egg to appear and investors will complain that the accreditation process is a failure.
…

At the end of the day, an accreditation body may just add layers to the upholding of corporate governance standards without significantly improving the end result.

Companies already get detailed guidance from the code of corporate governance. Investors would be better served if companies followed the code in letter and in spirit rather than be distracted by other processes as well.

Looking at a parallel concept, India has witnessed the emergence of corporate governance ratings, which are offered by the leading rating agencies. However, the track record of the concept’s success is dismal, as very few companies have in fact availed of such rating. At a broad level, there exists of the issue of impartiality and independence of any rating or accreditation body, including the question who pays for such rating. More than that, a rating or accreditation process may cause corporate governance to taken on a process-oriented character (more than it already is) and may deviate attention from issues of substance.

The Insider Trading Debate Resurfaces

v.umakanth@gmail.com (Umakanth V.) — Wed, 21 Oct 2009 05:15:00 +0000

With the SEC recently charging hedge fund manager Raj Rajaratnam and others for insider trading, the debate regarding the scope of insider trading and its (un)desirability in capital markets has resurfaced. SEC’s complaint filed in the District Court in New York indicates that Rajaratnam, through his hedge fund Galleon, had traded in stocks of 10 different companies while in possession of inside information that was provided to him by various tippers. The U.S. Justice Department has also filed complaints in the court. This not only raises issues regarding liability of “tippees” under the relevant laws, but also casts light on various trading practices involved in the hedge fund industry.

As we have noted on this blog earlier, it is quite an onerous task on the authorities to prove insider trading, but the difference in the Galleon case is that prosecutors are armed with court-authorised wire-taps. There is nevertheless a great deal of scepticism about the likelihood of the authorities being able to take matters to their logical conclusion. While some observers find that there is very little to distinguish between insider trading and legitimate market research by hedge funds, others argue that the current complaint may be driven largely by political considerations (given the call to rein in hedge fund industry).

A Comment on Indirect Acquisitions

v.umakanth@gmail.com (Umakanth V.) — Tue, 20 Oct 2009 22:06:00 +0000

(In response to the previous posts by Avinash Balasubramanian and Somasekhar Sundaresan (here and here), we have received the following comment from Tarun Mathur)

In the present case, the most important game is played by the dates of the events which, determines – (1) when does the Ranbaxy Laboratories Ltd. (“RLL”) became the PAC of the acquirer (Daiichi)? and consequently (2) Whether Regulation 20(4)(b) of the Takeover code is at all applicable in the present case for calculation of the offer price?
Facts in brief are as follows:-

i. In January 2008, Ranbaxy Laboratories Ltd. (“RLL”) acquired 44% of the shares of (the target company) ZLL. Consequently, a public offer was made by RLL to the shareholders of ZLL at Rs.160/- per share.

ii. On June 11, 2008, the Acquirer (“Daiichi”) entered into a Share Purchase and Share Subscription Agreement (“SPSSA”) to acquire 129,934134 fully paid up equity shares representing 30.91% of the current issued, subscribed and fully paid up equity share capital of RLL and to subscribe to shares representing 11.00% of the current issued, subscribed and fully paid up equity share capital of RLL and to 23,834,333 warrants of RLL, each warrant exercisable for one equity share of RLL.

iii. Thereafter, the Acquirer made a public offer on June 16 2008 to the remaining shareholders of RLL to acquire shares representing 22.01% of the issued, subscribed and fully paid up equity capital of RRL. Pursuant to the public offer, the Acquirer’s shareholding in RLL increased from 30.91% to 52%, thus, making RLL a subsidiary of Acquirer.

iv. The open offer was consummated/ completed on October 20, 2008 (as per term “offer period” as defined in Regulation 2(1)(f) of Takeover regulations)

v. As on October 20 2008 Ranbaxy Laboratories Ltd. (RLL) held 46.85% of the issued, subscribed and paid-up capital of the Target Company and as a result of the Acquirer’s acquisition/subscription in RLL, on October 20, 2008, the Acquirer indirectly acquired 46.85% of the issued

vi. Since the acquisition of RLL by the Acquirer had also led to an indirect acquisition of ZLL, the Acquirer, after having made the open offer to the shareholders of RLL, decided to make the public offer to the shareholders of ZLL. This was done so on 19 January 2009 as per the requirements of Regulation 14(4) if the Takeover code. The offer price for the said offer to the shareholders of ZLL is Rs.113.62/-.

vii. Now, the grievance of ZLL is that - the Acquirer is bound to make the said offer at Rs.160/- (as had been offered by RLL to the shareholders of ZLL in January 2008) instead of Rs.113.62/.

Views

1. Regulation 20(4) of the Takeover Regulations deals with the requisite offer price which an acquirer should pay to the target company to acquire its shares as per the formula laid down. The offer price should be a fair price and should exhibit the proper valuation of the shares of the target company. The offer price should be such that it does not ultimately lead to the unjust enrichment to the shareholders and it should also not be detrimental to the shareholders. In the present case, the query pertains to the interpretation of Regulation 20(4)(b) for determining this fair and appropriate price for the shares of the target company.

The wording of the Regulation 20(4)(b) is as follows:-

“…(b) price paid by the acquirer or persons acting in concert with him for acquisition, if any during the twenty-six week period prior to the date of public announcement”. Here the word “or” is to be read as a disjunctive word and not be read as “and”.

The application of this provision is confined to any price paid by acquirer or PAC within the 26 weeks prior to the date of PA. Here, I agree with the assertion of Mr. Sundaresan, that the intention of Regulation 20(4) (b) is to calculate the price paid by the acquirer or the PAC individually and/or when they are acting in concert for fulfilling their common objective of acquiring the shares of the target company. Consequent to this provision if we read Regulation 20(12), it puts two situations for determining the offer price of the shares:-

(i) with reference to the date of the PA of the Parent company (here it is 16 June 2008), or

(ii) with reference to the date pf PA for the acquisition of Target company (here it is 19 January 2009)

whichever is higher.

The literal interpretation of this provision leads to the conclusion that- the reference date in this case would be the date of the PA of the Parent company (i.e., 16 June 2008) and as per Regulation 20(4)(b) the price paid by PAC within 26 weeks of the date of PA is to be considered for the calculation of offer price. And in this case, since RLL acquired the shares of ZLL within 26 weeks (i.e., in January 2008)- this date has to be considered to for the calculation of offer price.

This is one set of views.

2. Another set of views is that:-

For the purpose of acquisition under Takeover Regulations the words/entities- ‘the acquirer’ and ‘persons acting in concert’ could be considered to be a composite class, i.e., both the classes have come together for a common objective for the purpose of substantial acquisition of shares or voting rights or gaining control over the target company, pursuant to an agreement or understanding (formal or informal). Also, it may be noted the said ‘acquirer’ and the said ‘persons acting in concert’ are acting as a composite class only for the purpose of the specific takeover transaction. The concerned entities may not be considered as having a relationship of ‘acquirer’ and ‘persons acting in concert’ for any other takeover/acquisition transaction. Now, here the question arises- when does the acquirer (Daiichi) and the PAC (RLL) came together to acquire the target company (ZLL) or more clearly when does RLL became the PAC of ZLL?... 16 June 2008. The answer is – “No”, because-

(1) that at the time of making of the public announcement by the acquirer, in respect of the shares of RLL, RLL was only a target company whose shares were being acquired and therefore, and cannot be taken as a person acting in concert with the acquirer in terms of Regulation 2(1)(e) of the Takeover regulations. It became a PAC of Daiichi Sankyo only on 20 October 2008, when the acquisition of 46.85% shares of RLL was completed- when RLL became the subsidiary company of Daiichi Sankyo.

(2) Also, as on 16 June 2008, the Daiichi Sankyo had no common objective or purpose, with RLL (in terms of Regulation 2(1)(e) of the Takeover code, for substantial acquisition of shares or voting rights of or gaining control over ZLL.

So, since the acquirer and the PAC became a composite class only on 20 October 2008, the reference date for calculation of offer price as per Regulation 20(12) of the SEBI Takeover code should be only 19 January 2009 (which is the date within the three month consummation period) and not the date of the PA of the Parent company, since on 16 June 2008 RLL is only the target company and not the PAC of Daiichi and since the takeover/ substantial acquisition of shares is transaction specific, the date 16 June 2008 holds no relevance. The only relevant date here is 20 October 2008 when RLL finally became the PAC (in form of subsidiary company) of Daiichi for the purpose of acquisition of shares of ZLL. So, therefore, the requirements of Regulation 20(4)(b) are not at all applicable in this case.

To me both these views appears to be even- balanced, it would be interesting to know how would the honorable Supreme Court react to this ambiguity, if in case this case reaches to the apex court.

- Tarun Mathur

SAT on indirect acquisitions - correct in letter and spirit

noreply@blogger.com (Somasekhar Sundaresan) — Sun, 18 Oct 2009 11:37:00 +0000

Earlier this month, the Securities Appellate Tribunal (“SAT”) opined on the computation of the minimum offer price for an indirect takeover of a listed company. An interesting critique of this opinion was published on this blog the next day. The SAT had disposed of two appeals (Appeals No. 137 and 139 of 2009) by a common order. I respectfully disagree with the critique on the blog. In my view, the SAT decision is the correct one, both in letter and spirit of the Takeover Regulations.

(Disclosure: I appeared for the Petitioner in Appeal No. 139, a long-term investor in Zanotech. My client is therefore a beneficiary of the SAT’s opinion, which I believe renders an accurate opinion. My stand ought to be regarded as non-independent because of where I sat during the proceedings. However, the raison de etre of a blog is to debate issues – hence this post should be read subject to this disclosure of interest).

Factual Backdrop:

It would suffice to recap the facts thus: Ranbaxy acquired shares of Zanotech at a price of Rs. 160 per share to take a stake of over 44% in Zanotech in January 2008. Within a period of 26 weeks from the purchase at this price, in June 2008, Daiichi agreed to acquire shares of Ranbaxy by way of purchase from Ranbaxy promoters and by subscription to fresh shares of Ranbaxy. The deal was pathbreaking, was priced at a fantastic premium to the then prevailing price of Ranbaxy (a 31% premium to the previous day’s closing price and an 80% premium to the price that had prevailed a few months prior to the deal), and stunned the world.

Regulatory Provisions

The agreement to effect such a transaction (which would take Daiichi to over 63% ownership of Ranbaxy’s equity) triggered an obligation to make an open offer to shareholders of Ranbaxy for Ranbaxy shares and to shareholders of Zanotech for Zanotech shares. Regulation 14(1) of the Takeover Regulations required Daiichi to make an open offer for Ranbaxy within four days of the agreement. Regulation 14(4) of the Takeover Regulations provided Daiichi a time leeway of three months from the consummation of the Ranbaxy acquisition for making an open offer for Zanotech.

The minimum offer price for Daiichi’s open offer for Zanotech shares was regulated by Regulation 20(4) of the Takeover Regulations, since the shares of this target company were “frequently traded” within the meaning of the term in the Takeover Regulations, and by Regulation 20(12), which regulates the manner of price computation for deferred open offers made in the case of indirect acquisitions.

In a nutshell, in terms of Regulation 20(12), the provisions of Regulation 20(4) have to be applied to the price of the consequential target company (in this case, Zanotech), notionally at two points in time – once at the time of the public announcement for the main company (in this case, the public announcement for Ranbaxy), and then at the time of the public announcement for the consequential target company (Zanotech). The higher of the two computations would be regarded as the minimum offer price.

In other words, the provisions of Regulation 20(4) have to be applied mutatis mutandis at both points in time, and the higher of the two price computations would be the minimum offer price. Regulation 20(4) requires the minimum offer price to be the highest of the following:-

(a) the negotiated price paid by the acquirer;

(b) the price paid by the acquirer or persons acting in concert with him during the 26 weeks preceding the date of the public announcement;

(c) the average of the weekly high and low closing prices during the 26 weeks preceding the date of the public announcement; and

(d) the average of the daily high and low prices during the two weeks prior to the date of the public announcement.

Daiichi’s position was that (a) above had no relevance to the facts of the case – a position that is not really accurate because when it paid a fancy premium to market price to promoters of Ranbaxy, it valued the balance sheet of Ranbaxy, which included the significant holding of over 44% of Zanotech. The promoters of Ranbaxy therefore got paid for this value too. However, it should be fairly stated that this position of Daiichi was not under challenge in the proceedings before the SAT. I will come to the spirit of the Takeover Regulations a bit later and deal with this aspect of the case, to show how the SAT’s opinion states the correct position in law, both in letter and spirit.

The parameters in (c) and (d) above were indeed not relevant for the controversy because the market price was lower than the price offered by Daiichi to shareholders of Zanotech. The issue in controversy before the SAT was therefore the application of Regulation 20(4)(b), which corresponds to (b) above.

Daiichi’s position, which was endorsed by SEBI, was that Regulation 20(4)(b) had no application to the case. Their contention was that the price paid by Ranbaxy for its acquisition of shares of Zanotech ought not to be factored into the computation on the ground that when Ranbaxy had bought a 44% stake in Zanotech in January 2008, Ranbaxy had not been in concert with Daiichi. Their argument was: for applying Regulation 20(4)(b), one would have to determine whether Ranbaxy had donned the cap of a “person acting in concert” with Daiichi when the acquisition in question (in January 2008) had been effected. If the answer were to be in the negative, in their view, the price paid by Ranbaxy for shares of Zanotech ought to be ignored for the open offer for Zanotech by Daiichi, although it was the enjoyment of ownership of this stake that triggered the open offer in the first place.

It should be noted that when Regulation 14(4) was inserted into the Takeover Regulations, the provisions of Regulation 20(12) were correspondingly inserted into the scheme of the Takeover Regulations. Therefore, the position in law was that if one were to give a leeway of time for making an open offer belatedly, the provisions of Regulation 20(4) would have to be notionally applied at two different points of time, with the higher of the two computations being adopted as the minimum offer price.

Moreover, Regulation 20(4) provides that any price paid by a person acting in concert for shares of the target company during the preceding 26 weeks ought to be taken into account. Regulation 20(4) does not condition the application of Regulation 20(4)(b) to the price paid by a “person acting in concert” with the words “provided such person had been acting in concert at the time of such acquisition”. So long as a person is acting in concert when a public announcement is made, any acquisition by him in the preceding 26 weeks would have to be considered as one of the price factors for purposes of Regulation 20(4).

Example of Consequences

The interpretation sought to be provided in the earlier critique on the blog proceeds on the footing that one would have to determine whether the person now acting in concert had been acting in concert at the time he acquired shares – a position not available in the Takeover Regulations, and rightly so. If such a position were to be accepted, any acquirer making an open offer would be at liberty to ignore the price paid by a person now acting in concert, although those very acquisitions led to the open offer threshold being reached, on the simplistic ground that when he acquired shares, he had not acted in concert with the acquirer now making the offer.

An example would make this clearer. Assume Mr. A, Mr. B and Mr. C independently and without any common objective or concerted action acquire shares of varying proportions, each less than 5% of XYZ Ltd., a listed company, between January and March of a calendar year. In April, a merchant banker who sees the opportunity for a deal by bringing them together, invites them for a discussion, and they collectively resolve to form a company called ABC Ltd. to make an open offer for shares of XYZ Ltd. In other words, the concert is born in April.

ABC Ltd. now agrees with a shareholder holding 2% shares in XYZ Ltd. to acquire shares that would take the collective holding to beyond 15% in XYZ Ltd. and therefore makes an open offer under Regulation 10 of the Takeover Regulations. ABC Ltd. could also make a voluntary open offer to acquire shares of XYZ Ltd. In either example, ABC Ltd. would be the acquirer, and each of Mr. A, Mr. B and Mr. C would be persons acting in concert.

If the position endorsed in the earlier critique on this blog, and indeed the position taken by Daiichi and SEBI were to be adopted, the price paid by each of Mr. A, Mr. B and Mr. C would have to be totally ignored on the ground that when they acquired shares taking them up to just below 15%, they had not acted in concert. Therefore, the acquisition of the very shares that took them to the threshold of a trigger under the Takeover Regulations would have to be regarded as wholly irrelevant. Such a position would be a travesty, conflicting with the very purpose of including the criterion of price paid in the preceding 26 weeks – a requirement similar to those found in takeover laws across the globe.

In other words, the very price paid by each of Mr. A, Mr. B and Mr. C would have to be disregarded for an open offer by ABC Ltd., a company formed by them subsequent to their acquisitions – a position that would require infliction of considerable violence to the provision i.e. by reading into the regulation a further proviso (incorporating non-existent words set out in bold italics above). Such an interpretation would require introduction of a requirement to check the state of mind of the person who acquired shares to ascertain existence of concert at the point of acquisition, although such person is currently indeed a person acting in concert.

In the example given above, another consequence would be that since the persons acquiring shares had not been concert when they acquired it, their holding should not be regarded as triggering the requirements of an open offer under Regulation 10 – an absurdity, because the Takeover Regulations do not require consideration of the state of mind when the acquisition was made to trigger an open offer obligation, as indeed they do not require consideration of the state of mind for computation of the minimum offer price for such an open offer.

When a provision of law is crystal clear, it ought to be applied as it is. If a person were to be in concert when the public announcement is made, any and every acquisition made by him in the 26 weeks prior to the public announcement would have to be factored into the computation of the minimum offer price. This is because the collective acquirers (including the person now acting in concert) would enjoy the benefits of the collective ownership, and the price paid for such collective ownership is a fair criterion for inclusion in determination of the minimum offer price.

In the same example given above, if any of Mr. A, Mr. B or Mr. C were to acquire a single share in April after the birth of concert, Daiichi, SEBI and the critique on this blog, would have that price considered for computation of the minimum offer price, but would ignore the prices paid between January and March on the ground that during that period there had been no concert.

There is no leeway in Regulation 20(4)(b) to impose such additional convoluted criteria to determine the state of mind in relation to each historical acquisition to ascertain if there had been concert at the relevant time. Such a position under Regulation 20(4)(b) does not change merely because the acquisition is an indirect acquisition and Regulation 20(12) has been applied.

Mutatis Mutandis Application

Moreover, Regulation 20(12) requires a mutatis mutandis application of Regulation 20(4) at two points in time. If one could legitimately argue that a person who is now in concert was not in concert when he acquired shares within the 26-week period prior to the first public announcement, and therefore the price for those acquisitions should be ignored, one could equally be able to legitimately argue that during the first public announcement the consequential target company was not the target company at all, and therefore Regulation 20(4)(b), which deals with the price of the “target company” ought to have no application.

Since, Zanotech is now the “target company” (in the public announcement made in January 2009), the mutatis mutandis application of Regulation 20(4)(b) would have to be effected as if Zanotech had hypothetically been the target company in June 2008 (when the open offer for Ranbaxy had been announced). Similarly, if Ranbaxy is now a person acting in concert with Daiichi in January 2009, the provisions of Regulation 20(4)(b) would apply to acquisitions by Ranbaxy made in the 26-weeks prior to June 2008 by way of a mutatis mutandis application. Any contrary reading of such hypothetical application would be an absurdity because one could well argue that Zanotech had not been the target company in June 2008 and therefore, its share price movements were irrelevant in June 2008.

It is an admitted fact that Ranbaxy acquired shares of Zanotech at a price of Rs. 160 within the 26 weeks preceding Daiichi’s open offer for Ranbaxy. Daiichi therefore got into the agreement to invest in Ranbaxy in June 2008, with eyes open and fully aware that within a period of 26 weeks preceding its deal, Ranbaxy had made acquisitions at Rs. 160. Had Daiichi done the Ranbaxy deal after 26 weeks of Ranbaxy’s last acquisition of Zanotech shares, indeed, the price paid by Ranbaxy would have become irrelevant because Regulation 20(4) would let only price paid in the preceding 26 weeks to be taken into account. The law is after all about drawing a clear line on the ground and treating people on either side of the line in a specific predictable manner.

Indeed, when Daiichi paid for shares of Ranbaxy, it is presumed to have read Ranbaxy’s balance sheet, which included the 44% holding in Zanotech acquired at a price of Rs. 160 per share, and therefore when it valued Ranbaxy, it did not ignore the value of Zanotech shares in Ranbaxy’s balance sheet. Daiichi is also presumed to have read the Takeover Regulations and the deeming provision imposed by Regulation 20(12) read with Regulation 20(4), when it agreed to take over Ranbaxy in June 2008.

Letter and Spirit Served

Even from a spirit perspective, it is noteworthy that the Takeover Regulations require sharing with the common shareholder the benefits provided to the seller of substantial shareholding. When Daiichi paid the promoters of Ranbaxy the fancy price it paid, it was indeed also paying for Ranbaxy’s holding in Zanotech.

As a matter of administrative convenience, in indirect acquisitions, one does not sparse the value paid for the business of the target company across individual assets forming part of the target company’s business. However, what is clear is that the sellers of Ranbaxy shares fully realized the value of Ranbaxy’s shareholding in Zanotech. Such value was not being assessed for being shared with shareholders of Zanotech. In the circumstances, the least one would do is to apply the provisions of the Takeover Regulations as they are, and take into account the price that was paid by Ranbaxy for the very acquisition of 44% stake in Zanotech. The inclusion of such a price factor, a statutory requirement, was being frustrated, thanks to considerable violence to the plain and logical provisions of Regulation 20(4)(b) by reading non-existent words into it viz. the requirement of determining whether at the time of each prior acquisition, the person who acquired shares had been acting in concert, regardless of him being in full concert when the public announcement is actually made.

Therefore, not only a plain reading of the Takeover Regulations, but also the spirit of the Takeover Regulations loudly and clearly show how the price of Zanotech ought to have been computed. The decision of the SAT, therefore, in my respectful submission, is faultless.

Regulating Derivatives

v.umakanth@gmail.com (Umakanth V.) — Fri, 16 Oct 2009 05:06:00 +0000

According to one school of thought, the excessive use of derivatives, particularly credit default swaps (CDSs) was a key cause of the global financial crisis. Related to this is the argument that progressive liberalisation of rules governing derivatives accelerated their downfall. In an interesting debate titled Regulate OTC Derivatives by Deregulating Them, Professor Lynn Stout traces the history of derivatives regulation:

… In the United States and the United Kingdom, derivatives traditionally were subject to a common-law rule known as the “rule against difference contracts.” … [The rule] allowed you to wager on anything you liked, from sporting contests, to wheat prices, to interest rates. But – here is the catch – the rule did require that if you wanted a court to enforce your wager, you had to demonstrate to the judge’s satisfaction that at least one of the parties to the wager either held title to the underlying thing bet on, or was legally obligated to take title to the underlying. … In other words, the rule against difference contracts required that, in order for a derivative contract to be lgally enforceable, one of the parties to the contract had to be using the contract to hedge against a pre-existing economic risk.

The logic of the common-law courts allowed parties to enter into derivative transactions as hedging mechanisms. Hence, a question arises whether derivatives can be used purely for speculative purposes. Stout argues that this is possible, but only through specific mechanisms:

This didn’t mean derivatives couldn’t be used to speculate. But the rule against difference contracts forced speculators to think about how to make sure their fellow gamblers paid their bets. The answer was for the speculators to set up private exchanges, like the Chicago Mercantile …

In the process, the private exchanges kept derivatives speculation within reasonable limits and under controlled conditions. … But off the exchanges, the old common-law rule against difference contracts served as the primary check against speculation in “over the counter” (OTC) derivatives.

Professor Stout argues that the common-law rule prohibiting speculation through OTC derivatives was gradually dismantled through statute both in the U.K. (through the Financial Services Act of 1986) and in the U.S. (through the Commodities Futures Modernization Act of 2000), which made OTC derivatives legal, whether they were entered into for hedging or speculative purposes. She then goes on to posit that such deregulation gave rise to massive speculation through derivatives such as CDSs causing systemic risk that in turn resulted in the crisis. What is the solution to this problem? Stout suggests that the law should revert to the previous position:

The answer seems obvious: go back to what worked well before. By refusing to devote public resources to enforcing an OTC derivatives contract unless at least one of the parties to the contract either owned or was legally obligated to take ownership of the asset underlying the contract, the common-law rule against difference contracts created an elegant legal sieve the separate socially useful hedging contracts from risk-increasing, purely speculative wagers.

Stout’s position received objections from three finance professors, who make several arguments, including that: (i) the financial crisis was not caused by derivatives, (ii) it is difficult to distinguish hedging from speculation (and, in any event, judges may not be adequately equipped to undertake this task); (iii) speculation may not necessarily be undesirable as it enhances liquidity and price discovery (a market-efficiency based argument). An element of oddity to this debate is that the response to a largely legal question came from three finance professors, which stopped short of considering the legal issues governing derivatives in their entirety.

As far as India is concerned, the common-law position detailed by Stout continues to be the law. In a sense, the common-law has been codified in the form of Section 30 of the Contract Act, which makes contracts of wager void. OTC derivatives, therefore, run the risk of being unenforceable unless at least one of the parties to it has a genuine interest in the underlying. In other words, derivatives for hedging are allowed, while derivatives for pure speculation are not given effect to by courts. At the same time, pure speculation is possible, but only through stock exchanges, and not on an OTC basis. For instance, where derivatives in securities are involved, they can be entered into for speculative purposes on stock exchange, as they are allowed under Section 18A of the Securities Contracts (Regulation) Act, 1956.

The enforceability of OTC derivatives (that were ‘exotic’ in nature) had invoked significant attention of the Indian courts last year, but the final outcome has not disturbed the basic legal principles noted above. For a discussion of this issue in the context of a judgment of the Madras High Court, see this previous post. The cases largely involved a determination of whether given contracts were for hedging or speculative purposes, and the courts were required to apply well-established principles to emerging complex derivatives transactions.

FDI Guidelines to Apply to LLPs

noreply@blogger.com (Shantanu Naravane) — Wed, 14 Oct 2009 06:55:00 +0000

Several posts here have discussed the introduction of the concept of Limited Liability Partnerships (“LLPs”) in India, and its treatment under the Indian legal regime. In another interesting development, the Government is now planning to bring LLPs into the scope of the FDI regime, in order the streamline the establishment of cross-border LLPs. LLPs are structurally more similar to corporate entities than to partnerships, making the applicability of FDI guidelines apposite. The concept of cross-border LLPs is envisaged under the LLP Act, but the guidelines for calculating FDI apply only to companies. The relevant provision is section 59, which reads-

The Central Government may make rules for provisions in relation to establishment of place of business by foreign limited liability partnerships within India and carrying on their business therein by applying or incorporating, with such modifications, as appear appropriate the provisions of the Companies Act, 1956 or such regulatory mechanism with such composition as may be prescribed.

This change, expected to be effected over the next few months, will provide further emphasis to the establishment of larger LLPs, with foreign participation. Another discussion on the proposal is found here.

Derivatives as speculative transactions

noreply@blogger.com (Shantanu Naravane) — Tue, 13 Oct 2009 16:05:00 +0000

A recent post here discussed the decision of the ITAT Special Bench at Kolkata in Shree Capital Services v. ACIT, commenting on its relevance for derivative transactions in India. Another detailed examination of the decision, and of the legal issues surrounding the taxation of derivatives, is now available here.

In sum, the author argues-

“[a] Firstly, prior to the insertion of clause [d] by Finance Act, 2005 w.e.f. 1-4-2006, it is a possible view that transaction in derivatives involve ‘deliveries’ of intangibles and may therefore not be considered as speculative in terms of section 43[5].

[b] Secondly, after the insertion of clause [d], only transactions in derivatives on stock exchanges approved by the Central Government for the purposes of section 43 [5][d] will be treated as ‘non speculative’ and that too from the date of the publication of the notification. Presently, only two stock exchanges have been approved for the purposes of section 43 [5]. Derivative transactions on other non approved stock exchanges will be considered as speculative from Assessment Year 2006-07.”

On the basis of his conclusions, it is contended that the observations made by the Tribunal are inconsistent, and hence the decision requires reconsideration.

The Economics Nobel Prize 2009 and Governance

v.umakanth@gmail.com (Umakanth V.) — Tue, 13 Oct 2009 09:59:00 +0000

This year’s Nobel Prize has been awarded to Professors Elinor Ostrom and Oliver Williamson for their work in the area of “economic governance”. The significance of this year’s award is its recognition of transaction economics despite its decline due to the financial crisis.

Of relevance to our discussion is Williamson’s work, which has triggered academic thought in the area of law and economics, with reference to firms and associations, and more particularly companies. Williamson’s work provides economic insights into the functioning of companies and enables appropriate their regulation. To that extent, the theory has a bearing on principles of corporate governance. As Professor Bainbridge notes, while reviewing one of Williamson’s works:

Transaction cost economics focuses on institutions, in contrast to neoclassical economics' focus on individuals, providing simple models that help us understand how institutions function and how they will respond to regulation. We can analogize transaction costs to friction: they are dead weight losses that reduce efficiency. They make transactions more costly and less likely to occur. Among the most important sources of transaction costs is the limited cognitive power of human decisionmakers. Unlike the Chicago School of law and economics, which posits the traditional concept of rational choice, Williamson asserts that rationality is bounded. Put another way, he assumes that economic actors seek to maximize their expected utility, but also that the limitations of human cognition often result in decisions that fail to maximize utility. Decisionmakers inherently have limited memories, computational skills, and other mental tools, which in turn limit their ability to gather and process information. As he demonstrates, this phenomenon, known as bounded rationality, has pervasive implications for understanding how institutions work.

Accordingly, Williamson's approach provides an analytical framework that is useful not only to economists, but also to lawyers and policymakers. Among other subjects, Williamson tackles such subjects as vertical integration, corporate governance, and industrial organization.

This award has given rise to euphoria in the law and economics academy. See Truth on the Market, The Conglomerate and The Volokh Conspiracy. It comes after similar recognition of another law and economics scholar, Ronald Coase, who was awarded the Nobel Prize for Economics in 1991.

Update: Dhiraj Nayyar has an interesting analysis of the Prize in the Financial Express.

Fiduciary Duties and Non-Executive Directors

mihircn@gmail.com (Mihir Naniwadekar) — Fri, 09 Oct 2009 11:25:00 +0000

An earlier post had discussed a recent Australian judgment on the role and duties of a non-executive director, Australian Securities and Investment Commission v. MacDonald. More recently, according to a report on the Corporate Law and Governance blog, the Inner House of the Court of Session of Scotland has again commented on the role of non-executive directors. (The Court of Session is Scotland’s highest civil Court; an appeal lies directly to the Supreme Court of the United Kingdom [previously the House of Lords]). The case, Commonwealth Oil and Gas Co. Ltd. v. Baxter and Eurasia is available here.

In commenting on the Australian decision, I had noted in the previous post that “the Court seems to have imposed a duty of care on non-executive directors which cannot be satisfied simply by relying on information provided to them by others. What exactly is the content of this duty is a question not conclusively answered.”

Commonwealth Oil can be useful in clarifying the content of the duty – the Court held that the contents of duty were the same, whether the director was an executive director or not. Undoubtedly, the executive director may have specific executive functions in specific areas of business which have been delegated to him to perform. But this fact does not alter his status: “he is a director of the company as a whole, and his duties to the company are to manage the general affairs of the company and are not confined to the responsibilities arising from his executive function. A director's fiduciary duty of loyalty is owed to the company as a whole; and the duty to avoid a conflict of interest must be related to the interests of the company as a whole… the fact that he was a non-executive director does not mean that he did not owe to the company the same fiduciary duties as its executive directors owed to it.”

This not an entirely novel proposition of law – for instance, a decision in Dorchester Finance v. Stebbing, [1989] BCLC 498, had also stated that there is no distinction in principle between executive and non-executive directors. The Scotland decision reaffirms this point. More importantly, perhaps, the Scotland decision contains an elaborate discussion of the important case-law on the fiduciary duties of directors more generally. On its facts, the case dealt with the no-conflict rule; a previous post which had discussed the strictness of the no-conflict rule and the corporate opportunity doctrine is available here.

Indirect Acquisitions and Determination of Open Offer Price

v.umakanth@gmail.com (Umakanth V.) — Thu, 08 Oct 2009 11:32:00 +0000

(The following post has been contributed by Avinash Balasubramaniam, who is an alumnus of the ILS Law College and a practising lawyer based in Chennai)

The Securities Appellate Tribunal (SAT) yesterday delivered its verdict in the Zenotech open offer case directing Daichi to offer Rs.160/share to the shareholders of Zenotech. So is Dr. Jayaram Chirugupati, the chief protagonist in the challenge, and the other shareholders of Zenotech shares richer by Rs. 47 per share? They will be if the reasoning of the SAT holds water if the battle is played out in the Supreme Court? Will the reasoning of SAT hold water? My humble opinion is it will not.

Before going any further, let us reflect upon the events leading up until the SAT order. The first act opens with Ranbaxy entering into a share purchase agreement on 3rd October, 2007 with the Promoter of Zenotech to acquire shares in Zenotech at Rs. 160 per shares and in that process triggering the open offer requirement mandated by the Takeover Code. This open offer opened on 24th December and closed on 15th January, 2008 and shareholders of Zenotech who tendered their shares in the open offer received Rs. 160 per share. Consequent to this process Ranbaxy came to hold 44.79% of Zenotech. Subsequently on 11th June, 2008 Daicho Sankyo entered into a share purchase & share subscription agreement with Ranbaxy and its promoters acquiring shares of Ranbaxy at Rs. 737 per share. The quantum acquired by Daichi triggered the requirement to make an open offer to the shareholders of Ranbaxy as also indirectly triggering the open offer to the shareholders of Zenotech. Accordingly Daichi made an open offer to shareholders of Ranbaxy to acquire shares at Rs. 737 per share and this open offer was consummated on 20th October, 2008.

The Zenotech public announcement was made on 19th January, 2009 and the offer was priced at Rs. 113.62. Shareholders of Zenotech felt they deserve Rs. 160 per share and therefore instituted multiple challenges to the open offer price at various adjudicatory forums (SEBI, the Madras High Court, CLB just to name a few) and the lawyers of Daichi were now working overtime to quell the challenge.

The challenge ultimately turned towards the interpretation of the provisions of the Takeover Code in calculating the open offer price, viz, Regulation 20(4) and Regulation 20(12). In terms of Regulation 20(4) the offer price must be the highest of the following:

- the negotiated price paid by the acquirer; (this clause being inapplicable to the facts of the case)

- price paid by the acquirer or persons acting in concert with him for acquisition, if any, during the twenty six week period prior to the date of public announcement; (emphasis supplied) (as we shall see the dispute eventually turned on the question whether Ranbaxy can be said to be a person acting in concert with Daichi and, if it was, Daichi would be required to offer Rs.160, the price which Ranbaxy paid for Zenotech shares)

- the higher of the 26 week average of the weekly high and low of the closing prices or the two week average of high and low prices preceding the date of public announcement.

Regulation 20(12), a provision specific to open offer triggered by indirect acquisition, as was the case with Zenotech, provided that the offer price for indirect acquisition or control must be determined with reference to the date of the public announcement for the parent company and the date of the public announcement for acquisition of shares of the target company, whichever is higher, in accordance with sub-regulation (4) or sub-regulation (5).

What Regulation 20(12) says is that in case of indirect acquisition, the exercise of calculating the offer price must be done twice, one with reference to the date of public announcement of the parent (Ranbaxy in this case) and the second time with reference to the date of public announcement for the target (Zenotech) and the offer price for the target will be the higher of the two. The open offer for Ranbaxy was made on 16th June, 2008 and the open offer for Zenotech was made on 19th January, 2009 (i.e. within three months from consummation of the acquisition of the parent, Ranbaxy, which was on 20th October, 2009). That means the first part of exercise should be as follows: (a) was there a negotiated price; (b) did any person acting in concert with Daichi acquire shares of Zenotech in the 26 week period prior to 16th June, 2008; (c) what is the highest of 26 week or 2 week high and low with reference from 16th June, 2008. The second part of the exercise would involve asking the same questions, but with reference to a different date, i.e., (a) did any person acting with concert with Daichi acquire shares of Zenotech in the 26 week period prior to 19th January, 2009; (b) what is the highest of the 26 week or 2 week high and low with reference from 19th January, 2009. From the facts it is not known if Ranbaxy acquired any shares of Zenotech in the 26 week period preceding 19th January, 2009 and we shall assume that Ranbaxy did not acquire any shares in this period and only acquired Zenotech shares until 28th January, 2008.

So from a plain reading of the provisions of the Takeover Code, the only way Daichi could be required to make an offer at Rs.160 per share (the price at which Ranbaxy acquired Zenotech shares in January, 2008) only if it can be said that in the 26 week period prior to 16th June, 2008 Ranbaxy was acting in concert with Daichi when it acquired shares of Zenotech, keeping with our assumption that there was no acquisition of Zenotech shares by Ranbaxy in the 26 week period prior to 15th January, 2009, the date of public announcement for the Zenotech open offer.

SAT went on to hold that on 20th October, 2008 Ranbaxy became the subsidiary of Daichi and therefore by virtue of Regulation 2(1)(e)(2)(i) was ‘deemed’ to be a person acting in concert with Daichi on 19th January, 2009. So far so good. However, SAT held that since with reference to 19th January, 2009 Ranbaxy is a deemed to be a person acting in concert, this is good enough to conclude that it was acting in concert when acquiring Zenotech shares in January 2008 (which is in fact 52 weeks prior to Daichi’s public announcement to acquire Zenotech shares).

The rationale of the ‘persons of acting in concert’ concept is obviously to prevent group of persons (with a common intention) to sidestep the mandatory open offer requirement by the simple stratagem of individually acquiring shares of the target lesser than the threshold triggering mandatory open offer but their collective acquisition breaches the threshold. What is important is whether at the time of acquisition of the shares they can be said to be persons acting in concert. The Supreme Court in Technip SA vs SMS Holdings Private Limited & Others (2005) 125 CompCas 545(SC) referring to report of Bhagwati Committee report held that “to be acting in concert with an acquirer, persons must fulfill certain 'bright line' tests. They must have commonality of objectives and a community of interest and their act of acquiring the shares or voting rights in company must serve this common objective. The commonality of objective should be established between the acquirer and a shareholder in order to trigger off Regulations 10, 11 and 12”.

The question which SAT should have considered (which it never fully did) was whether at January, 2008 there was in fact this common intention between Ranbaxy and Daichi. It is quite possible that Daichi came knocking at the offices of Malvinder Singh and Shivender Singh only in say March 2008. Can Ranbaxy then be said to be acting in concert with Daichi? To prove that persons are in fact acting in concert is admittedly difficult, but can that justify SAT not answering the relevant question? Can the acquisition of shares in the target be anterior in time to the common intention? The SAT order suggests that this is possible. In other words, the SAT order permits the operation of acquisitions by persons “acting in concert” on a retrospective basis. It does not matter when the parties began acting in concert, but their shareholding acquired prior to that will be taken into account for purposes of determining price under Regulation 20. While the “acting in concert” principle requires two elements: (i) common objective or purpose, and (ii) the act of acquisition of shares or control, the SAT order in Zenotech’s case implicitly seems to recognise that each of these elements can be satisfied at different points in time. Whether that is consistent with the objects and purpose of the Takeover Code is a matter that does not seems to receive adequate support.

So are the shareholders of Zenotech richer by Rs 47 per share? Perhaps not yet.

- Avinash Balasubramaniam

Accounting Standards under the New Companies Bill

noreply@blogger.com (Shantanu Naravane) — Wed, 07 Oct 2009 05:16:00 +0000

Recent posts have discussed the issue of ‘true and fair view’ and whether compliance with accounting standards necessary translated into meeting this standard laid down in the Companies Act.

This makes it interesting to note that the new Companies Bill, apart from specifically stating that Accounting Standards are mandatory (proposed section 117(1)), also provides for them being incorporated in the Act itself. The relevant provision is proposed section 119, which states,

The Central Government may, after consultation with the Advisory Committee, by notification, lay down accounting standards for adoption by companies or class of companies.

This is a departure from the current scheme where the Standards are only recognised under the Act. Their incorporation into the Act would help to resolve issues of conflicts between the Act and the Standards, and also enable timely alterations to the Act through rules in the case of new Accounting Standards.

Given the International Finance Reporting Standards that will be effective in April 2011, and the current debate over the duties and liability of auditors, this proposal seems one of great interest, and significant implications. Another discussion on the same is available here.