INDIAN CORPORATE LAW

SEBI Clarifies on Schemes of Arrangement

2013-05-22T19:30:00.001+05:30

Following SEBI’s circular of February 4, 2013 imposing stringent requirements for oversight of schemes of arrangement, there were certain issues that required clarification (discussed here and here).

Now, by way of another circular dated May 21, 2013, SEBI has clarified some of the outstanding issues and also made some modifications to the previous circular. In this post, we discuss some of the key items:

1. Applicability of the Circular

SEBI has now clarified that the February 4 circular is applicable to all types of schemes of arrangement including amalgamation, reconstruction and reduction of capital. It is not limited to reverse listings or other schemes that may require an exemption under Rule 19(7) of the Securities Contracts (Regulation) Rules, 1957.

The wide applicability of the circular would mean that all schemes of arrangement will now be closely scrutinized and will require review by the stock exchanges and SEBI.

2. Majority Requirements for Voting

The February 4 circular provided that proposal for a scheme will pass muster only “if the votes cast by public shareholders in favor of the proposal amount to at least two times the number of votes cast by public shareholders against it.” In other words, in addition to the usual majority the scheme must also receive the approval of 2/3rds of the public shareholders. This requirement has now been done away with.

A more stringent majority requirement as well as voting through postal ballot and e-voting and greater disclosure measures are now limited to schemes of arrangement that are undertaken where promoters are a party or are affected by it. Examples of this are where promoters are allotted further shares under the scheme, or where a group company is a party to the transaction. In such cases, there must be a majority of public shareholders voting in favour of the scheme, in addition to the normal majority required by the Companies Act. The stringent majority requirements therefore apply only to related party transactions undertaken through schemes of arrangement and not to all transactions (which are carried out at arm’s length).

It appears that the earlier circular treated all transactions with the same level of circumspection and imposed high burden on companies that would have made obtaining the requisite majority cumbersome, but now that is limited only to related party transactions that require greater protection for minority shareholders.

3. Others

Under the revised circular, while valuation reports are required to be submitted in all types of schemes, they are required to be obtained from an independent chartered accountant only if there is a change in the shareholding of the listed company / resultant company. What amounts to change in shareholding pattern is defined with specificity along with illustrations.

The revised circular achieves two results. On the one hand, it clarifies the scope of applicability of the previous circular. On the other hand, it lessens the stringency of the previous circular by making some of the onerous requirements applicable to specific types of schemes where minority interests are likely to vulnerable rather than to all types of schemes.

Public Shareholding Norms: Consequences of Non-Compliance

2013-05-21T11:10:00.000+05:30

The June 2013 deadline for compliance by listed companies with the minimum public shareholding of 25% is looming closer. The deadline for compliance by public sector (government) listed companies to comply with the 10% minimum public shareholding will follow in August.

Over the last few months, several companies have already reduced their promoter shareholding to meet with these norms. This has been accomplished through various facilities provided by the Government and SEBI to achieve the minimum public shareholding norms. SEBI has also provided specific exemptions and dispensations in certain cases. The latest episode of The Firm has a comprehensive discussion on the manner in which companies have gone about reducing their promoter holdings and the various issues that have arisen in the process.

Despite a rush to achieve these norms, there will certainly be a significant number of companies that are unable to comply with them by the June deadline. SEBI has been steadfast in its stance that it will not extend the time period for compliance.

In these circumstances, a lawyer friend recently raised the issue of the possible consequences of non-compliance by listed companies. In order to consider this, we must note that the minimum public shareholding norms are embodied in Rule 19A of the Securities Contracts (Regulation) Rules, 1957 (SCRR) that was introduced by way of amendment in 2010. In addition, the listing agreement in clause 40A requires companies to comply with Rules 19(2) and 19A of the SCRR.

The first consequence of non-compliance would be a delisting of securities on account a breach of the listing agreement. As we have repeatedly argued before, this would be a paradoxical tool to ensure compliance with listing norms. In case of a delisting, it is the public shareholders who would suffer due to a loss of liquidity and exit opportunity in the markets. Public shareholders would be penalized by failure of the company and promoters to comply with norms that are intended to benefit them. While this regulatory response exists on paper, it must be exercised cautiously after considering the extensive impact it may have.

The second consequence would be penalties levied on the non-compliant companies. Section 23E of the Securities Contracts (Regulation) Act, 1956 (SCRA) provides that in case of failure to comply with the listing conditions, SEBI could impose a penalty not exceeding Rs. 25 crores (rupees 250 million). SEBI could potentially invoke this power in case the public shareholding norms are not met by the deadline.

While these measures exist on the statute books, it is a different matter as to how they might be exercised by SEBI in practice. The past track record indicates certain difficulties in the implementation of corporate and securities laws. For example, when stringent measures of corporate governance were to be introduced by amendments to clause 49 of the listing agreement in 2004, the implementation was delayed several times and they came into effect only on January 1, 2006. These include a tighter definition of board independence and the like. Even thereafter, when SEBI tried to enforce the board independence requirements against several listed companies, primarily in the public (government) sector, it had to drop them subsequently.

To make a comparison, during October and November 2008, SEBI passed a series of orders involving the lack of appointment of the requisite number of independent directors to several government companies, viz. NTPC Limited (Oct. 8), GAIL (India) Limited (Oct. 27), Indian Oil Corporation Limited (Oct. 31) and Oil and Natural Gas Corporation Limited (Nov. 3). The principal ground for dropping the action was that in the case of the government companies involved the articles of association provide for the appointment of directors by the President of India (as the controlling shareholder), acting through the relevant administrative Ministry. SEBI found that despite continuous follow up by the government companies, the appointments did not take effect due to the need to follow the requisite process and hence the failure by those companies to comply with Clause 49 was not deliberate or intentional.

Returning to the public shareholding norms, a lot would depend upon the stance adopted by SEBI for enforcing them after the deadline has expired. While some of it may be known post-June 2013 when the deadline for private sector companies expires, but the real enforcement test may lie if there are violators among the public sector companies, which will be clear subsequently.

Madras High Court on SEBI Circular for Scheme of Arrangement

2013-05-20T15:39:00.000+05:30

A few months ago, I had discussed SEBI’s circular of February 4, 2013, which imposes more stringent oversight by SEBI and the stock exchanges on different types of schemes of arrangement.

Shortly thereafter, our guest contributor Yogesh Chande has pointed to issues relating to the scope of the SEBI circular, and specifically whether the circular applies only to such schemes that require exemption from Rule 19(7) of the Securities Contracts (Regulation) Rules, 1957 (SCRR), which principally relates to reverse listings, or whether it applies more widely to all types of arrangements. This ambiguity is caused because although the SEBI circular applies generally to all types of schemes, including schemes among listed companies and even capital reductions under section 100 of the Companies Act, the genesis for the circular can be related to a 2009 circular which is confined to reverse listings and was also repealed by the February 2013 circular.

In an unreported judgment dated April 1, 2013, the Madras High Court holds that SEBI’s circular is applicable only where an exemption is being sought from Rule 19 of the SCRR and not for other schemes. That case involved a merger of two companies both of which were listed on the stock exchanges. The companies made an application to the court for convening meetings under section 391 of the Companies Act. Since this was not a reverse listing, the court clarified in response that the SEBI circular is not applicable. The relevant portion containing the discussion on the point of law on the issue is extracted below:

5. The learned counsel for the applicant contended that the conditions laid down by the Securities and Exchange Board of India vide circular CIR/CFD/DIL/5/2013 dated 04.02.2013 are not applicable to the case of the applicant, as the applicant is not seeking exemption under Rule 19(7) of the Securities Contracts (Regulation) Rules, 1957, as the transferor company listed its shares in the recognised Stock Exchange after complying with the conditions laid down under the Securities Contracts (Regulation) Rules, 1957.

6. On consideration, I find force in this contention. Rule 19 of the Securities Contracts (Regulation) Rules, 1957 stipulates that a public company as defined under the Companies Act, 1956, desirous of getting securities listed with the recognised Stock Exchange are required to apply for the purpose to the Stock Exchange along with its application, document contained under the Rule.

7. A submitted by the learned counsel for the applicant, this already stood complied with, when the stock was listed with the recognised Stock Exchange.

8. The learned counsel for the applicant is also right that Rule 19(7) gives right to the Securities Exchange Board to waive or relax strict enforcement of any of the rules. In the present case, it is not a case where the applicant is to get the stock listed. In the case in hand, what is being done is that the stock which is already listed is being regulated without seeking any exemption, therefore, for the purpose of amalgamation of the companies, the provisions of Rule 19(7) would not be applicable, as no exemption under the rules is being sought therefore, the circular issued in exercise of power under Rule 19(7) will not be applicable to the applicant.

The court has adopted a narrow view of the circular. While it is understandable that the circular refers to Rule 19(7), that does not explain the wider objective of SEBI that is evident in the circular and also in the fact that it covers other schemes of the arrangement such as capital reduction that does not involve any listing of securities without following the usual disclosure process.

As Yogesh mentions in his post, there is some ambiguity regarding the scope of the circular, and this decision also underscores the type of issues that could arise in practice. Given this ambiguity, it is recommended that SEBI expressly state its intention regarding the scope of the circular. By issuing a clarification or a set of FAQs, possible uncertainties regarding the schemes of arrangement, which are a popular form of a transaction in India, can be avoided.

Update - May 22, 2013: SEBI has since clarified that the circular is applicable to all types of schemes of arrangement and not only those that require an exemption under Rule 19(7).

Enforceability of Put and Call Options: Reality Soon?

2013-05-18T03:52:00.001+05:30

Although put and call options are quite common in investment agreements, its enforceability under Indian law has been in serious doubt due to age-old provisions in securities laws which have not been updated to meet with the requirement of the times. I have discussed the issue in detail in this paper and also called “for a reconsideration of the legal regime so that physically settled options that are customary in investment agreements may be treated as valid and legally enforceable”.

Although this issue has been on the anvil for a long time, now there seems to be some tangible movement towards resolution. News reports indicate that the Law Ministry has, based on a proposal from the Finance Ministry, decided to permit options in investment agreements.

It is not clear how the revisions will be effected. It could be done simply by way of a notification by SEBI amending/repealing its earlier notification of March 1, 2000, which put paid to these options. The other alternative would be to amend the Securities Contracts (Regulation) Act, 1956 (SCRA), which is perhaps both unnecessary and more cumbersome given that the intervention of Parliament will be required.

It is too early to be euphoric because the devil is always in the detail!

Papers published on BALCO

2013-05-17T15:39:00.002+05:30

Ironically, the judgment of the Constitution Bench in BALCO may turn out to be as significant for domestic arbitration as it is for finally shattering the misconception that the omission of the word “only” in section 2(2) of the Arbitration and Conciliation Act 1996 was designed to expand the jurisdiction of the Indian courts in relation to foreign arbitration. Some of these questions have been explored in three articles recently published in the Supreme Court Cases journal, of which the following is a brief summary.

Shantanu and I wrote a paper titled “Three Errors in BALCO” ((2012) 9 SCC J-26) in which we argued that while the Court was entirely right in overruling Bhatia International on the applicability of Part I of the Act to foreign arbitrations, it nevertheless made-as the title of the article suggests-three significant errors on other points. To briefly summarise:

(1) The conclusion in paragraph 96 that section 2(1)(e) of the Act refers to two courts, the court of the seat and the court of the cause of action is, with respect, clearly incorrect. Section 2(1)(e) confers jurisdiction on the court which would have had jurisdiction to entertain a suit forming the subject matter of the arbitration. As the Delhi High Court rightly pointed out in GE Countrywide, this means that a court in which an application under the 1996 Act is instituted must imagine that the arbitration clause does not exist and ascertain whether it would have had jurisdiction to entertain a suit relating to that dispute. So, if two parties from Mumbai and Delhi respectively choose Calcutta as the seat of arbitration, the Calcutta High Court would not have jurisdiction to entertain an application under the 1996 Act unless it was shown that some part of the cause of action arose in Calcutta. Unfortunately, the Supreme Court assumed in paragraph 96 of its judgment that section 2(1)(e) is a reference to two courts (the court of the seat and the court of the cause of action) and has therefore overruled by implication, a consistent view that has prevailed for over seventy years.

(2) The Court, with respect, misunderstood the decision of the House of Lords in the Siskina and consequently proceeded on the erroneous premise that an action instituted solely to obtain interim relief in aid of foreign arbitration is alien to the common law. Had the Court appreciated that the common law does recognise such an action, it would then have had the opportunity to consider whether such an action is recognised by Indian law. We suggested that such an inquiry would likely have led the Court to conclude that such an action may be brought under section 151 CPC, addressing one of the major concerns raised by practitioners about the consequences of BALCO.

(3) There was no case whatsoever for overruling Bhatia International prospectively, considering that the dispute related to a point of statutory construction, and in particular a jurisdictional statute. As the House of Lords emphasised in Re Spectrum, the power should be exercised only in wholly exceptional cases, and with particular caution if the point the court is asked to overrule prospectively is one of statutory construction rather than the common law (Lord Scott of Foscote in his dissenting speech thought the power should never be exercised in relation to statutory construction).

A response to this article titled "Not Three but Half an Error in BALCO" ((2013) 1 SCC J-81) was published by Mr SK Dholakia, Senior Advocate and Ms Aarthi Rajan, Advocate in which they sought to support the judgment of the Court. In summary, their contention on section 2(1)(e) was that the “overarching seat theory” was the basis of which BALCO was decided, and led to the conclusion that the territorial court for domestic arbitration is solely the court of the seat, regardless of where the cause of action arises. According to them, in the Mumbai/Calcutta example above, the Calcutta High Court would have exclusive jurisdiction by virtue of being the supervisory court, that is, the court exercising territorial jurisdiction over the chosen seat of arbitration. They make the powerful argument that if two foreign parties choose Chennai as the seat of arbitration, and the cause of action arises entirely outside India, neither the Madras High Court nor any other Indian court would have jurisdiction under section 2(1)(e) even though Part I of the Act applies (by virtue of section 2(2)), which they contend is an anomaly that impedes the growth of arbitration where India is a neutral forum. In relation to our argument on the maintainability of an action for interim relief in aid of foreign arbitrations, they relied on the well-known judgments of the English courts in Castanho and Siskina, and the recent judgment of the High Court in Royal Westminster, to suggest that there can be no “suit” purely for interim relief. They also suggest that section 151 CPC cannot be invoked for this purpose because Order 39 Rule 1 is exhaustive. In relation to prospective overruling, they agree that using arbitration agreements (as opposed to pending petitions or applications, for instance) entered into after 06.09.2012 as the yardstick was erroneous, but support the use of prospective overruling in principle, relying on Patel Engineering.

We have now published a response to this article titled “Three Errors Revisited” ((2013) 4 SCC J-1), explaining our original argument and responding to some of the points raised by Mr Dholakia and Ms Rajan. We point out that the jurisdiction of the Indian courts to supervise arbitration is statutory, not inherent, supporting the view taken by the Delhi High Court in GE Countrywide, and therefore that it is not permissible for an Court to assume jurisdiction not provided by section 2(1)(e) on the basis of the "overarching seat theory". This cause-of-action based system of organising jurisdiction has, for better or worse, been part of Indian law for over seventy years. Whether that should be discarded in favour of a consent-based system of jurisdiction is, we suggest, a decision for Parliament, not the Supreme Court. On the maintainability of an action for interim relief in aid of foreign arbitrations, we demonstrate that the transition from the 1882 CPC to the 1908 CPC contains indications that what is now Order 39 Rule 1 is not exhaustive (indeed, the Calcutta High Court so held in the early 1900s), and that section 151 CPC is a possible basis on which such interim relief may be granted. We also revisit the discussion of the common law and establish that it contains no bar to such an action. Finally, we reiterate that it was not appropriate to overrule Bhatia International prospectively, because the appellants had not established that this was, to quote Lord Nicholls in Re Spectrum, “the wholly exceptional case” in which parties had relied on Bhatia International in organising their affairs. More generally, we suggest that prospective overruling should not be used on a case-by-case analysis of the “justice” of the competing claims but should proceed on the basis of clearly established legal principle, which should distinguish between overruling a point of common law and overruling a point of statutory construction.

Call for Papers – Journal on Governance

2013-05-15T07:44:00.002+05:30

[The following announcement is posted on behalf of the Center for Governance, National Law University, Jodhpur]

Center for Governance, National Law University, Jodhpur, proposes the VII issue of “Journal on Governance,” its annual publication. Journal on Governance offers a forum for critical research on interplay of contemporary corporate governance issues with other disciplines, including, inter alia, law, management and societal studies. Aside to highlighting the problems and the challenges, the Journal attempts to explore and offer workable solutions, which may be helpful in regulatory and policy decisions.

A few of the Center’s such endeavours include comments on the consultative paper on the SEBI’s suggested Clause 49 reforms, followed by a panel discussion involving eminent stalwarts like Padmabhushan Shri D.R. Mehta (Founder Chairman, SEBI), and Ms. Usha Narayanan (Former Executive Director, SEBI, and currently partner, Amarchand & Mangaldas & Suresh A Shroff & Co.).

Previous issues of the Journal boast of scholarly discourses from eminent legal practitioners, academicians, research scholars and students. The articles for publication are selected through a meticulous and intense process of review, edit and refinement. The Journal has received acclaim and appreciation from all contours of the industry and academia. For the forthcoming issue, the Center invites Articles on the following sub-themes under the broad theme of "Governance- the contemporary challenges":

1. Governance in Microfinance Industry

2. SEBI’s Jurisdiction on Corporate Governance- a critical assessment

3. Governance in PPP Model of Infrastructure Projects

4. Corruption and Corporate Citizenship

5. Conflict of Governance and Related Party Transaction

Please note that the submissions must conform to the following requirements:

- The acceptable length of Articles is 5000 words, and of notes and comments is 3000 words, including footnotes.

- All submissions must include an abstract of not more than 300 words, explaining the main idea, objective of the article and the conclusions drawn from it.

- The Article should be on A4 sized paper, in Times New Roman Font Type, font size 12, 1.5 line Spacing and 1 inch margins on each side. Authors should follow Harvard Blue Book Footnoting style. Footnotes should be in font size 10 and with single line spacing.

- Authors should provide their contact details, designation and institutional affiliation in the covering letter for the submission.

- The submission must be the original work of the authors. Any form of plagiarism will lead to direct rejection. The relevant sources should be duly acknowledged as footnotes. The decision of the reviewers in this regard shall be final.

- Authors are requested to send an electronic version of their manuscripts (.doc or .docx format) to journal.governance@gmail.com with the subject as “Submission”. All queries may be addressed to the Editors on the aforementioned email address.

- Submission deadline for the Article, Notes and Comments is on the 31 July 2013.

Extension of Date for Implementation of Modified ESOP Rules

2013-05-14T07:14:00.000+05:30

Earlier this year, SEBI had announced the implementation of amended rules for the issue of employee stock options (ESOPs), which restricted the types of schemes to only those that comply with SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999. Particularly, curbs were imposed on the acquisition of shares in the secondary markets by ESOP trusts. The rationale for these measures was previously discussed on this Blog. These measures were to take effect on June 30, 2013 by which time companies were required to ensure compliance of their ESOP programmes with these requirements.

SEBI has now extended the implementation of these new requirements until December 31, 2013, primarily due to representations received from industry participants. By then, the ESOP schemes of companies must be brought in line with these rules. Failing this, the securities acquired by the ESOP trusts must be divested by that date. It has also been clarified that this revised set of guidelines is applicable to all employee benefit schemes involving the securities of the company provided that the schemes are set up, managed or financed by the company directly or indirectly if any of the following conditions are satisfied:

a) if the company has set up the scheme or the trust/agency managing the  scheme; or

b) if the company has direct or indirect control over the affairs of the scheme  or the trust/agency managing the scheme; or

c) if the company has extended any direct or indirect financial assistance to  the employee benefit schemes or the trust/agency managing such schemes.

In other words, the stringency of these guidelines operates when there is a close nexus between the company and the trust, but not if the trust is set up and managed truly independently. The recent circular also sets out disclosure requirements regarding the operation of the ESOP schemes.

Miscellaneous

2013-05-09T07:59:00.000+05:30

1. Exemption from Takeover Regulations for Gift of Shares to Family Trust

SEBI has granted an exemption to an acquirer from making an open offer under the SEBI Takeover Regulations in the case involving Gujarat Organics Limited (the company). In that case, the promoter Mr. Ashwin S. Dani, owns 71.15% shares in the company, and proposes to transfer it by way of a gift to a private trust HD Trust, of which he is one of the trustees. The beneficiaries of the trust are his family members. The acquirer, HD Trust, does not hold any shares in the company, while Mr. Dani has been shown as a promoter for more than 3 years. SEBI granted the exemption for the transfer because this was an inter se reorganization of holdings that does not alter the control of the company in any way. Moreover, it was a gift and merely a private family arrangement to facilitate succession planning.

This is understandable because there is no change of effective control of the company, and an exemption order was sought from SEBI only because the transaction may not have satisfied the technical requirements for an automatic exemption.

2. Another SEBI Adjudication Order in the IPCL Insider Trading Case

Last month, we had discussed an adjudicating order of SEBI finding that the charges of insider trading were not established against Mr. Manoj H. Modi and Mrs. Smita M. Modi in relation to the trading of shares in Indian Petrochemicals Corporation Limited (IPCL). Now, on a related set of facts and circumstances, another adjudicating order of SEBI has found that a charge of insider trading is sustainable against Reliance Petroinvestments Limited (RPIL), the controlling shareholder of IPCL, and also imposed a fine of Rs. 11 crores on RPIL. The facts relating to the information and announcements are essentially the same as that contained in the previous post, and are not repeated here.

From a legal perspective, SEBI’s assertions are based on two grounds. The first is that RPIL is a “deemed connected person” and second that it is “reasonably expected to have access to unpublished price sensitive information” with respect to IPCL. This is necessary to establish RPIL as an insider with respect to IPCL. On the first count, SEBI found that RPIL and IPCL are companies under the same management as they are under the common control of Reliance Industries Limited, which is a fact-based determination. On the second count, SEBI found that as a controlling shareholder of IPCL, RPIL is naturally said to have access to unpublished price sensitive information (UPSI) relating to IPCL:

25. The above facts establish that RPIL was having control over IPCL. It may therefore, be concluded that by virtue of RPIL having control over IPCL, it was reasonably expected to have access to UPSI of IPCL. Noticee being the promoter having control over the company holding approx. 46% shares of IPCL is inherently expected to have access to UPSI. Noticee being in such a position it is unacceptable that the Noticee was not aware of such major/ important decisions of the company IPCL.

This conclusion suggests that any promoter entity that falls within the definition of a “deemed connected person” would generally have access to UPSI in relation to the investee company and that nothing more needs to be shown.

3. Interpretation of the MAC Clause in Financing Documentation

The England and Wales High Court passed a ruling, which interprets the material adverse change (MAC) clause in financing documentation. In that case, the lender withheld further funding based, among other things, upon the occurrence of a MAC event that adversely affected the borrowing company. Although the judgment is quite long and involves ascertainment of detailed facts, the interpretation of the MAC clause is summarised in the judgment as follows:

364. In summary, authority supports the following conclusions. The interpretation of a "material adverse change" clause depends on the terms of the clause construed according to well established principles. In the present case, the clause is in simple form, the borrower representing that there has been no material adverse change in its financial condition since the date of the loan agreement. Under such terms, the assessment of the financial condition of the borrower should normally begin with its financial information at the relevant times, and a lender seeking to demonstrate a MAC should show an adverse change over the period in question by reference to that information. However the enquiry is not necessarily limited to the financial information if there is other compelling evidence. The adverse change will be material if it significantly affects the borrower's ability to repay the loan in question. However, a lender cannot trigger such a clause on the basis of circumstances of which it was aware at the time of the agreement. Finally, it is up to the lender to prove the breach.

The MAC clause has been extensively litigated in the last few years following the financial crisis, especially in M&A that is supported by acquisition financing.

Hat tip: Corporate Law and Governance

CSR and Global Supply Chains

2013-05-07T16:57:00.000+05:30

The tragic building collapse in Bangladesh has brought to the fore corporate social responsibility (CSR) issues involving global supply chains as the building is said to have housed factories employing workers manufacturing apparel for well-known global brands. Apart from the focus on local regulations and their enforcement in Bangladesh, the spotlight is now also thrown on the role of the multinational companies (MNCs), most of whom are domiciled in developed nations, as procurers of the products being manufactured in the building. While some of the MNCs have opted to withdraw from Bangladesh, others have vowed to stay on and improve conditions.

All of these give rise to CSR issues, which are not in any way novel. The intense competition and squeeze on margins place emphasis on cost reduction. While the benefits of the cost reduction are enjoyed by shareholders and customers, this leaves the employees vulnerable, as this episode has shown once again. This will only increase the demand for companies to meet “triple bottom line” with focus on workers’ rights, human rights, environment and even anti-corruption.

For a sampling of the debate that this tragedy has evoked, see Forbes, Economist and Reuters.

Shareholder Activism Enters the Boardroom

2013-05-06T07:41:00.000+05:30

Over the last month or so, an interesting debate has surfaced that takes shareholder activism to the next level. As the Deal Professor column notes, two hedge funds have initiated proposals whereby they have promised to pay their nominees, if elected to the board of the investee company, director compensation linked to the profitability of the company as if they were executives. The promised compensation has two parts: one, a fixed retainer/fee; another, a bonus depending upon the financial performance of the company that could extend to a few million dollars. This has the effect of treating institutional shareholder nominees on par with executives for the purpose of compensation. This development raises a number of legal issues pertaining to corporate law and corporate governance. Although the details regarding the issue are only beginning to get fleshed out, a post on the Conglomerate Blog helpfully provides links to the key debates.

Although shareholder activism has taken off quite strongly in India (as noted here and here), it might be some time away before the issue of institutional investor nominees takes such a deep grounding in the Indian context. Nevertheless, it is useful to consider some of the key conceptual issues that this gives rise to:

1. The first issue relates to who pays the compensation to the institutional nominee directors. The current trend seems to suggest that the compensation is paid by the nominator/investor rather than the company itself, which would minimise the effect of the usual issues pertaining to executive compensation if it were to be paid by the company itself.

2. These appointments could create factions on the board, i.e. between the inside directors (executives) and the so-called outsiders (nominees), thereby possibly curbing efficient (if not effective) decision-making. A contrarian approach to this would suggest that such differing views and perspectives may actually be beneficial to the overall well-being of the company and the interest of the shareholders.

3. There could be questions regarding the effectiveness of the nominee directors. For example, given that they are non-executive directors, they may have difficulties in accessing information regarding the business of the company or to other officers in the same way as an executive director can.

4. It is unclear if the nominee directors may be willing to take on the risk of facing liability because they may have responsibilities without the accompanying power or control within the company.

5. As these directors are nominated by the institutional investors (who may have a significant holding in the company), it is unlikely that these directors would be treated as independent directors. Their appointment on the board may tilt the balance of independent and non-independent directors which may make it difficult to comply with the requisite board independence requirements under the corporate governance norms without appointing more independent directors maintain the appropriate balance.

6. Since the nominee directors would owe fiduciary duties to the company, they are in an unenviable position whereby they may have to prefer the interests of the company over those of their nominating investor in case of a conflict between those interests.

These are only some initial thoughts, but a number of other issues and concerns on both sides of the debate are contained in the links provided above.

Update – May 14, 2013: A memo from Wachtell Lipton provides a strong response to the proposal for offer of incentive compensation to investor nominees, and a column by the Deal Professor advocates caution in adopting the incentive compensation approach.

NLSIR Symposium

2013-05-04T15:06:00.001+05:30

(The following announcement comes to us from the National Law School of India Review)

The National Law School of India Review (NLSIR) - the flagship journal of the National Law School of India University (NLSIU), Bangalore is pleased to announce the VI^th NLSIR Symposium on “Mapping the Future of Commercial Arbitration in India” scheduled to be held on May 18 and 19, 2013 at the NLSIU campus. The last three years have witnessed dynamic shifts in the law and practice of Arbitration in India. While there have been steps in the right direction, an unwieldy system continues to weigh down practitioners. Four years after first delving into the nuances of commercial arbitration in India, the Symposium hopes to assess the development of Arbitration law over the last few years.

Confirmed speakers for the symposium include renowned legal luminaries such as Hon’ble Mr. Justice (Retd.) S U Kamdar (Former Justice, Bombay High Court), Mr. Anirudh Krishnan (Advocate, Madras High Court), Mr. Ashwin Shanker (Advocate, Bombay High Court) Mr. Aditya Sondhi (Advocate, Karnataka High Court), Mr. Ajay Thomas (Registrar, London Court of International Arbitration, India), Mr. Vivekananda N. (Head (South Asia) & Counsel, Singapore International Arbitration Centre), Mr. Nangavaram Rajah (Nani Palkhivala Arbitration Centre), Mr. Promod Nair (Partner, J Sagar Associates), Mr. Shreyas Jayasimha (Partner, AZB & Partners), amongst others.

This year, the discussions will be divided into four panels:

Session I: The Implications of BALCO on Arbitration Practice

(Forenoon, May 18, 2013, Saturday)

Session II: Revisiting the Expansive Role of the Indian Judiciary and its Implications

(Afternoon, May 18, 2013, Saturday)

Session III: Determining the Governing Law of the Arbitration Agreement – Arsanovia and Beyond

(Forenoon, May 19, 2013, Sunday)

Session IV: The Way Forward: A Call for Institutional Arbitration?

(Afternoon, May 19, 2013, Sunday)

Registration fee for those who make an advance payment/bank transfer is Rs. 500 for students and Rs. 1000 for others. All those interested are requested to register at:

https://docs.google.com/forms/d/1hXthITsHurIQBClJAkZkiKWdbjkXoKJ4MFRSI0VgGfU/viewform

The registration fee for those who register at the venue is Rs. 750 for students and Rs. 1250 for others.

For more details including the concept note and future updates please visit: http://www.nlsir.in/symposium.html.

For regular updates, also see our Facebook page: http://www.facebook.com/nlsir?fref=ts.

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Competition Law Risks: Non-Compete Clauses in M&A Transactions – Part 2

2013-05-03T07:18:00.000+05:30

[The following post is contributed by Soumya Hariharan, who is a Foreign Lawyer at Rodyk & Davidson LLP’s Corporate & Competition Law Practice in Singapore. Soumya obtained her BSL.LLB degree from ILS Law College and has an LL.M degree (Corporate & Financial Services Law) from the National University of Singapore. She can be reached at soumyahariharan@gmail.com.

These views are personal.

After dealing the general overview of the issues in the previous post, Soumya now discusses the manner in which the CCI has dealt with the issue in India and also provides some pointers to drafting non-compete clauses such as they withstand scrutiny under law]

Treatment of Non-Compete Clauses in India

The merger control regime in India came into force only in 2011 and the CCI in one of its recent decisions, accepted modifications in relation to the non-compete obligations entered into between the parties to the combination.[1] This has been the first time the CCI has provided clarity on how it views non-compete obligations in relation to proposed combinations in India.

Orchid Chemicals and Pharmaceuticals Limited (“Orchid”) and Hospira Healthcare India Private Limited (“Hospira”) filed a notice under Section 6(2) of the Competition Act 2002; pursuant to the execution of a Business Transfer Agreement (“BTA”).

The CCI observed that the BTA contained a non-compete clause, which required Orchid and its promoter not to undertake certain business activities pertaining to the transferred business for a period of eight years and five years, respectively. The non-compete clause also restricted research, development and testing of Penem (including Carbapenem) and Penicillin API’ (Active Pharmaceuticals Ingredients) for injectable formulations. The CCI opined that non-compete obligations if necessary to be incorporated should be reasonable, particularly in respect of (a) the duration over which such restraint is enforceable; and (b) the business activities, geographical areas and person(s) subject to such restraint in order to ensure that such non-compete obligations do not result in an appreciable adverse effect on competition.

The parties to this combination, offered modifications under the provisions of Regulations 19(2) of the Combination Regulations. The parties agreed to (a) limit the duration of the non-compete obligation to four years in relation to the domestic market in India; and (b) provide in the BTA that orchid shall be allowed to conduct research, development and testing on such new molecules, which would result in the development of new Penem (including Carbapenem) and Penicillin API’ for injectable formulations, which are currently not existent worldwide.

The CCI accepted the modifications offered by the parties and also directed them to make the necessary amendments in the BTA to incorporate the modifications. The CCI approved the proposed combination under Section 31(1) of the Competition Act 2002. This decision of the CCI is helpful as it provides a basic framework as to how the CCI interprets non-compete obligations in an Indian context It is possible that the CCI may provide greater clarity in the treatment of non-compete clause in subsequent cases notified before it.

Drafting an Approriate Non-Compete Clause

The trend in Europe indicates that competition law regulators are keeping a keen watch on the use of non-compete clauses in M&A transactions. Non-compete clauses are of great commercial importance and parties must ensure that they are drafted in compliance with competition law.

The cases discussed above also serve to remind that the investigation into the non-compete obligations did not arise from complaints by third parties or competitors but was initiated by the EC itself.

Parties that wish to incorporate non-compete clauses should have a two-fold objective while drafting them i.e. non-compete clauses should be drafted appropriately not only to obtain a favorable merger clearance but also to avoid any anti-competitive concerns arising from the operation of such clauses. As a general rule, for non-compete clauses to be considered ancillary restraints they must be directly related and necessary for the operation of the transaction.

Some of the main points that parties could bear in mind while drafting non-compete clauses, include:

- the duration of the non-compete should be reasonable in length;

- the scope of the non-compete activity must relate to the particular economic activity in order to avoid broad non-compete obligations that prohibit competition outside the scope of the transaction;

- any restrictions imposed by the use of the non-compete clause must be directly related and reasonably necessary for the implementation of the transaction;

- any geographic restrictions imposed by way of non-compete obligations must not operate as market-sharing arrangements; and

- in relation to India, the operation of the non-compete clause does not result in an appreciable adverse effect on competition.

It would be prudent for companies to engage competition lawyers early in the transaction, to carry a competitive analysis on the use of non-compete clauses. The analysis would help companies to identify the geographic coverage, required duration and the legitimate scope of the non-compete to ensure that the non-compete clause is drafted appropriately taking into account the possible anti-competitive effect such an obligation would have on the transaction.

- Soumya Hariharan

[Concluded]

[1] Orchid Chemicals/ Hospira Healthcare (C-2012/09/79)

Competition Law Risks: Non-Compete Clauses in M&A Transactions – Part 1

2013-05-02T12:59:00.000+05:30

[The following post is contributed by Soumya Hariharan, who is a Foreign Lawyer in Rodyk & Davidson LLP’s Corporate and Competition Law Practice in Singapore. Soumya obtained her BSL.LL.B degree from ILS Law College and has an LL.M degree (Corporate & Financial Services Law) from the National University of Singapore.

These views are personal.

In this first part, Soumya provides a broad overview of competition law risks arising from non-compete clauses and how they have been dealt with by the European Commission]

Competition law regulators have been actively investigating non-compete clauses in Merger and Acquisition (“M&A”) transactions.[1] Most jurisdictions recognize that certain contractual restrictions in the form of non-compete clauses may be directly related and necessary for the successful implementation of a merger. However there are times when non-compete clauses incorporated in M&A transactions and joint ventures carry the risk of infringing competition law.

Non-compete clauses that carry competition law risks can delay deal timelines and affect the transaction from obtaining a favorable clearance from the competition law regulator. Companies stand a risk of investigation by the competition law regulators and financial penalties can be imposed for illegal non-compete clauses.

This series of posts aims to give a broad overview on how non-compete clauses in M&A transactions carry certain competition law risks, in light of recent decisions rendered by the European Commission (“EC”) and the Competition Commission of India (“CCI”). The article also highlights the importance of drafting non-compete clauses in compliance with competition law.

Ancillary Restraints and Non-Compete Clauses

Non-compete clauses are usually negotiated in most M&A transactions and it is fairly common for the Acquirer to require non-compete obligations from the Vendor. To effect a successful transaction, certain restrictions on competition between the Parties are required to the extent that they are directly related and necessary for the implementation of the merger.

Such restrictions, negotiated by the Parties are referred to as “ancillary restraints” in competition law parlance. The most common examples of ancillary restraints include non-compete clauses, license agreements, purchase and supply agreements.

Usually it is standard business practice to incorporate non-compete obligations for the effective implementation of the proposed merger that allows the Acquirer to obtain full value from the acquired assets including tangible and intangible assets such as know-how and goodwill. In Europe, the 2005 Notice on restrictions directly related and necessary to concentrations (the “Ancillary Restraints Notice”) provides clarity and guidance on the treatment of non-compete clauses.

The EC has been scrutinizing non-compete clauses that may result in a breach of competition law, i.e. cases where the non-compete clause is not directly related and necessary for the implementation of the merger.

Two recent decisions of the EC provide further clarity as to how it interprets non-compete clauses. One of the cases deals with an illegal non-compete entered into by two telecom operators, where the non-compete clause operated as a market sharing agreement. The second case deals with a non-compete clause that was operative post the termination of the joint venture which was considered excessive in scope and duration by the EC. The following cases serve as effective guidance to those companies that plan to incorporate non-compete clauses in their M&A transactions.

Telefónica and Portugal Telecom[2]

In 2011, the EC investigated two large telecom players Telefónica and Portugal Telecom in relation to a non-compete clause in the context of Telefónica’s acquisition of sole control of the Brazilian mobile operator Vivo. They were fined EUR 79 million for a breach of Article 101 of the Treaty on the Functioning of the European Union (TFEU) which prohibits anti competitive agreements.[3]

Article 101 prohibits all agreements, decisions and practices between undertakings and concerted practices which may affect trade within EU member states and which have as their object or effect the prevention, restriction or distortion of competition within the EU market.

In 2010, Telefónica acquired sole control of Vivo which was until then jointly owned by both Telefónica and Portugal Telecom. The parties entered into a non-compete clause in their purchase agreement as a part of the acquisition which required Telefónica and Portugal Telecom not to compete with each other in Spain and Portugal from the end of September 2010.

The EC held that by implementing the non-compete clause, Telefónica and Portugal Telecom deliberately agreed to stay out of each other’s home markets rather than competing with each other. The parties terminated the non-compete agreement in early February 2011 nearly four months into operation by offering commitments to the EC. It is useful to note that in this case, the EC commenced investigations on its own initiative and fined Telefónica and Portugal Telecom notwithstanding the short duration of the infringement.

Siemens and Areva[4]

In 2001 Areva and Siemens established a joint venture Areva NP, which combined their activities in nuclear technology and nuclear power plants. The Shareholders Agreement for the joint venture included a non-compete clause for a period of 11 years from the termination of the joint venture. The non-compete clause covered the core nuclear services of the joint venture as well as non-core products and services in relation to which the joint venture was not active. In 2009, Siemens withdrew from the joint venture and Areva acquired sole control over the joint venture.

In 2010 the EC opened an investigation over the competition concerns relating to the non-compete clause. The EC adopted a preliminary decision in 2011 that Siemens and Areva had infringed Article 101 due to the non-compete obligation being excessive in scope and duration. According to the EC the scope of the non-compete clause was excessive because it prevented Siemens from competing in markets where Areva NP was only a re-seller of Siemens products.

To address the concerns of the EC both Siemens and Areva offered commitments, to limit the scope of the non-compete clause to Areva NP’s core products and services for a period of three years after Siemens exit from the joint venture. Under the commitments the non-compete obligations would only apply to certain core products and services offered by the joint venture company solely controlled by Areva.

- Soumya Hariharan

[1] The European Commission investigated Telefónica and Portugal Telecom in 2011 and investigated Areva and Siemens in 2010.

[2] See Press Release dated 23/01/2013 http://europa.eu/rapid/press-release_IP-13-39_en.htm

[3] The European Commission fined Telefonica and Portugal Telecom EUR 66894000 and EUR 12290000 respectively for agreeing not to compete with each other.

[4] Case COMP/39736 dated 18/06/2012

Call for Papers: Indian Journal of Arbitration Law

2013-05-01T17:44:00.004+05:30

[Announcement]

The Indian Journal of Arbitration Law is pleased to announce its upcoming issue (Volume 2: Issue 2), which is to be published in September this year.

The Board of Editors cordially invites original, unpublished submissions for publication in the following categories:

- Articles

- Notes

- Comments

- Book Reviews

Manuscripts may be submitted via email to editor.cartal@gmail.com latest by 31^st July 2013.

Editorial policy and submission guidelines are available here.

One Person Company – a still-born, half-baked concept?

2013-04-29T17:35:00.001+05:30

The Companies Bill 2012 proposes a new concept of One-person Company (OPC). The obvious objective is to overcome the hurdle of needing a second person to form a company, despite the saying that “two’s company”. This brief post is to highlight its nature, some issues and also questioning the real benefit of an OPC.

OPC, as the term implies, is a company with one and only one shareholder. The need to have two directors also is avoided and only one director is needed. However, unlike a shareholder, the number of directors can be more than one. And the single shareholder need not be the director or any of the directors. A succeeding shareholder will have to be named in case of death of the initial shareholder.

Thus, it is expected to help an individual incorporate himself/herself. The need to find a second shareholder/director for a proprietary business in corporate form is avoided.

Succession/transfer of a business in corporate form is clearly easier than if it owned in a sole proprietary form. And one can delink different businesses in separate OPCs since there is no limit on how many OPCs one single individual can form.

The OPC will have to add the tag One-person Company under its name.

Some other procedural concessions in terms of meetings, etc. are given for obvious reason that there cannot be a “meeting” of a single shareholder/director.

However, beyond a few procedural concessions, and avoidance of the need of second shareholder/director, it is not clear what substantial benefits are available. The relatively long/complicated procedure for formation, maintenance and dissolution of a Company remain without any major relief. The requirement of finding a second shareholder/director is generally not found cumbersome in India where a friend, relative or staff member can easily act as such.

Further, except a few minor procedural concessions, the provisions of accounts, audit, etc. would also apply to an OPC.

Certain businesses like that of finance may face problems if sought to be carried in a Company form. Thus, an individual engaged in business of lending or investments may need prior registration from the Reserve Bank of India, minimum net owned funds of Rs. 2 crores, etc.

Conversion of existing proprietary businesses can create complexities of tax. There is an existing provision in the Income-tax Act, 1961 (section 47(xiv)) which should help in availing relief from capital gains, even if originally it was not framed with an OPC in mind. However, other tax issues may remain. The concern of deemed dividends under Section 2(22)(e), the question of allowability of remuneration to proprietor, etc. are some other challenges an OPC may face. The other challenge will be of stamp duty on transfer of the business to the OPC.

Strangely, it is not clear how an OPC may go to the next logical step of becoming a non-OPC when it wants to introduce more shareholders. Ideally, a simple amendment of its memorandum and articles should have sufficed. However, there are no specific provisions enabling this. The question therefore is whether an OPC is doomed to remain a one shareholder company during its existence?

Conversion from a non-OPC to an OPC has also not been provided for. Thus, an existing private limited company may not be able to convert itself into an OPC.

OPCs should have been useful particularly in case of wholly owned subsidiaries of companies where the parent company would be the sole shareholder. However, there is a requirement that makes one wonder whether a company can be the sole shareholder. The definition of OPC does talk of a “person” being a shareholder. However, it is required that a succeeding shareholder be named in case of death of the initial shareholder. The concept of death is generally understood in sense of natural persons and not companies. Thus, unless one takes a view that this requirement is not a mandatory one or stretch it to include dissolution of a company, the concept of OPC may not be available for forming a WOS.

All in all, it seems that despite the initial enthusiasm that this concept received, it seems that in practice, this by itself is not likely to encourage sole proprietors to convert into a company in large numbers.

Supreme Court on “Market Abuse”

2013-04-29T16:43:00.000+05:30

In a judgment delivered last Friday, the Supreme Court came down heavily on “market abuse” not just on the case at hand but more generally on the practice to the extent prevalent in India.

The case, N. Narayanan v. Adjudicating Officer, SEBI, arose in the form of an appeal from the Securities Appellate Tribunal (SAT) in relation to the appellant who was the whole time director of Pyramid Saimara Theatre Limited (PSTL). The SAT had confirmed an order of the Securities and Exchange Board of India (SEBI) restraining the appellant from dealing in securities for a period of 2 years and also an order of the adjudicating officer of SEBI imposing a monetary penalty of Rs. 50 lacs on the appellant. These orders were in connection with the violation of section 12A of the SEBI Act as well as relevant provisions of the SEBI (Prohibition of Fraudulent and Unfair Trade Practice Relating to Securities Market) Regulations, 2003. It was found that the financial results of the company as disclosed to the stock exchanges were inflated and that they did not represent the true and fair state of affairs of the company. This maintained the stock price of the company high and enabled certain shareholders to raise financing by pledging of shares.

In an unequivocal decision, the Supreme Court upheld the orders of SEBI and the adjudicating officer and found the appellant guilty of violating the SEBI Act as well as the 2003 Regulations. The court found the existence of the required facts that support the holding that the appellant was guilty of violating the requisite provisions of the law.

While the judgment does not appear to lay down any new principles of law, it does place tremendous emphasis on the importance of efficient capital markets that require a strict disclosure regime. The judgment also seems to lament about the current state of affairs regarding regulation of the capital markets through a proper disclosure regime.

Three points emerging from the Supreme Court’s decision are noteworthy:

1. The first is the need for efficient capital markets with a strict disclosure regime. The court noted that where shares of a company are quoted on the stock exchange, it is crucial to have proper disclosure of information for accurate pricing of the companies securities and for the efficient operation of the capital markets. It also noted the prevalence of market abuse in India:

10. … “market abuse” has now become a common practice in the India’ security market and, if not properly curbed, the same would result in defeating the very object and purpose of SEBI Act which is intended to protect the interests of investors in securities and to promote the development of securities market. …

This must also be read with the information requirements under the Companies Act, wherein the books of accounts of the company must be maintained so as to provide a true and fair view of the state of affairs of the company and also to explain significant transactions. This is also consistent with the corporate governance requirements under the listing agreement.

2. Given the court’s view of the prevalence of market abuse in India, it has called for strict measures to be applied and for more stringent enforcement by the regulator. The court’s “word of caution” or one might say a stern warning can be witnessed in the court’s own words:

43. SEBI, the market regulator, has to deal sternly with companies and their Directors indulging in manipulative and deceptive devices, insider trading etc. or else they will be failing in their duty to promote orderly and healthy growth of the Securities market. Economic offence, people of this country should know, is a serious crime which, if not properly dealt with, as it should be, will affect not only country’s economic growth, but also slow the inflow of foreign investment by genuine investors and also casts a slur on India’s securities market. Message should go that our country will not tolerate “market abuse” and that we are governed by the “Rule of Law”. Fraud, deceit, artificiality, SEBI should ensure, have no place in the securities market of this country and ‘market security’ is our motto. People with power and money and in management of the companies, unfortunately often command more respect in our society than the subscribers and investors in their companies. Companies are thriving with investors’ contributions but they are a divided lot. SEBI has, therefore, a duty to protect investors, individual and collective, against opportunistic behavior of Directors and Insiders of the listed companies so as to safeguard market’s integrity.

3. The court has re-emphasised the principles applicable towards directors’ liability. In this particular case, the appellant raised an argument that although he was a whole-time director of the company, he was only in charge of the human resources department, and was therefore not responsible for the other affairs of the company, including financial matters which were under the overall control of the managing director. The Supreme Court rejected this argument outright. All directors carry the responsibility to ensure that the books of accounts of the company represent a true and fair view of the financial state of the company. That responsibility cannot be passed on either to other directors or even to the auditors of the company. The level of onus laid down by the Supreme Court is as follows:

33. … a Director may be shown to be placed and to have been so closely and so long associated personally with the management of the company that he will be deemed to be not merely cognizant of but liable for fraud in the conduct of business of the company even though no specific act of dishonesty is provide against him personally. He cannot shut his eyes to what must be obvious to everyone who examines the affairs of the company even superficially.

34. The facts in this case clearly reveal that the Directors of the company in question had failed in their duty to exercise due care and diligence and allowed the company to fabricate the figures and making false disclosures. Facts indicate that they have overlooked the numerous red flags in the revenues, profits, receivables, deposits etc. which should not have escaped the attention of a prudent person.

This clearly suggests that directors cannot simply turn a blind eye to the goings on in the company. That apart, the directors appear to have a positive obligation to seek further information and raise further questions once a red flag becomes visible. While this high burden seems to be applicable to an executive director, as was the case on the present facts, it is unlikely that a non-executive director’s burden would be substantially lower than this especially in the presence of a red flag situation. Of course, the present case must be read in the context of executive directors only, but it certainly suggests the attitude of the courts towards duties and liabilities of directors of public listed company.

In all, while the Supreme Court’s decision is based on the facts and circumstances of the specific case and does not lay down any new principle of law, there is overwhelming evidence of the intention of the court to stringently apply securities laws such that the efficiency of the capital markets be maintained. While the Supreme Court does send a message to SEBI, a lot would depend not only on the availability of resources to enable the regulator to carry on a more enhanced role, but it would also depend on the robustness of various laws, particularly the procedural laws, that would equip it to carry on its mandate in an effective manner. One example of this is the high burden of proof that SEBI is expected to discharge in insider trading cases, which it has only been partially successful in discharging on average.

Mandatory imprisonment under Companies Bill 2012

2013-04-29T14:36:00.003+05:30

The Companies Bill 2012 has an innocuously titled chapter titled “Miscellaneous” which provides stringent and perhaps unprecedented punishment.

The Chapter provides for imprisonment and fine for several types of situations. A minimum imprisonment (six months/three years) is also provided.

Clause 447, for example, says that any person found guilty of fraud shall be punishable with imprisonment of at least six months but which may extend to 10 years and fine. The fine shall be at least the amount involved but may extend to 3 times such amount. If the fraud involves the public interest, the minimum imprisonment would be 3 years.

The term fraud is widely and inclusively defined. It has to be in relation to a company/body corporate, public or private, listed or unlisted. There should be an intent to deceive, to gain undue advantage from or to injure the interests of specified persons. There are no requirements of minimum amount, materiality, etc. for such act/omission, etc. to be treated as fraud. The affected person may be the Company, the shareholders, the creditors or any other person. The fraud may be committed by any person. The person need not have gained any amount and the affected person need not have lost any amount.

There are other provisions in the Bill that refer to this clause and deem certain actions to be “fraud” punishable under clause 447. For example, furnishing of false information or suppression of material information in documents filed with the Registrar in relation to registration of a Company amounts to fraud and punishable under clause 447. So is the making certain untrue/misleading information in any prospectus.

Clause 448 refers to intentional making of materially false statement or omitting material facts. These may be in documents such as report, certificate, financial statement, prospectus, or other document required by or for the purposes of the Act or rules. These too will be punishable as fraud under Clause 447.

Clause 449 states that intentional giving of false evidence while being examined on oath or in a solemn affirmation attracts minimum imprisonment of 3 years and which may extend to 7 years.

In view of specific provisions in clause 441, the offences listed above are not compoundable.

While frauds, misstatements, etc. have been of serious concern recently, one wonders whether such stringent, minimum and mandatory punishment for such a broad group of cases is justified and whether it has been adequately debated.

The Scope of the Jurisdiction to Grant Relief against a Penalty Clause

2013-04-27T13:04:00.004+05:30

In Andrews v Australia and New Zealand Banking Group, the High Court of Australia has considered an important question of contract law: is the jurisdiction to grant relief against a penalty clause confined to a sanction triggered by an event that can be characterised as a breach of contract, or does it extend to a sanction triggered by other events? The Supreme Court of India had occasion to consider exactly this question about two years in BSNL v Reliance, but unfortunately did not do so. We have commented on that decision here.

Simplifying the facts for the purposes of analysis, customers of the ANZ Banking Group [“ANZ”] challenged certain payments that they were required to make for banking services. This fell into, mainly, three classes: a late payment fee [“Late Payment Fee”], payable if a customer is late in making a scheduled payment; “honour” fees payable by a customer who overdraws his account and interest on these fees [“Honour Fee”]. At first instance, Gordon J. found that the Late Payment Fee was payable as a consequence of breach of contract by the customer (in not making the scheduled payment), but that the Honour Fee was not. The question was whether this meant that no relief could be granted against the payment of the Honour Fee. In English law, this was traditionally the position, established by the speeches delivered in the House of Lords in Export Credits Guarantee Department v Universal Oil Products [1983] 1 WLR 399. The result was that a sanction triggered by an event that was not a breach of contract did not attract the penalty rules.

The High Court of Australia rejected that analysis in an instructive judgment, of which the following is a brief summary. The word “condition”, like “rescission”, has a variety of meanings in contract law. One meaning, of course, is an important or fundamental term of a contract the breach of which entitles the other party to withhold further performance and terminate the contract. Used in this sense, condition is contrasted with warranties and innominate terms. But the word “condition” is not used in this sense in the cases in which the penalty rules were established. In those cases, there was typically a bond, which would be forfeited on the happening or non-happening of a certain event. That event was called a “condition”. It could be a promise by the other party (in which event the bond would be forfeited on breach) but it could also be an event that was not a promise by the other party. In Campbell v French, Lord Kenyon gave this example: a bond to be forfeited if the “Pope of Rome visits London tomorrow” is perfectly good, since the event is, although unlikely, not impossible. The example demonstrates that “condition”, in this sense, did not mean “promise” and that relief granted against forfeiture, naturally, could not have been confined to a breach of promise. As the High Court points out, equity granted relief provided the non-performance of the condition secured by the bond could be compensated by an award of money. If the bond secured a money condition, the court of equity intervened by ordering the defendant to pay the principal amount, interest and costs; if it secured a non-money condition, the court of equity would direct an issue of quantum damnificatus to assess the loss. In neither case was there any basis for the suggestion that equity would intervene if the bond secured a promise but would not intervene if it secured something else. The High Court points out that the emergence of assumpsit did not introduce the breach limitation, because the relief granted by the common law courts in this action mirrored the relief granted by the courts of equity but did not substitute it. In other words, the equitable relief retained its identity; the common law courts simply gave relief too.

One question that arises from the judgment of the High Court of Australia is this: if the penalty rules are not limited to a breach of contract, when do they not apply? The High Court gives a tentative answer to this, by pointing out that it would be necessary to examine whether the Honour Fee was payable as a security for the performance of an obligation or as the price of “further accommodation” by the ANZ Group. Professor Peel points out in a case note in the Law Quarterly Review ((2013) 129 LQR 152) that this distinction “seems simply to move some of the problems associated with the breach limitation to a different place”.

The Indian law on this point remains unresolved. In BSNL v Reliance, Mr Gopal Subramanium argued that clause 6.4.6 was a payment triggered by an event other than breach and that the penalty rules did not, therefore, apply. As we have discussed in our post, the Supreme Court did not decide this point. Section 74 opens with the words “when a contract is broken”, suggesting that it does not apply to an event other than breach. However, as the authors of the 2^nd edition of Pollock and Mulla point out at page 328, section 74 does not exhaust the equitable jurisdiction of the court to relieve against penalty clauses. That jurisdiction was exercised with respect to some stipulations before section 74 was amended in 1899, and nothing in the amendment suggests that it was taken away. The question, therefore, remains open and one hopes the Supreme Court will answer it when the opportunity next arises.

Good faith in Contract Law

2013-04-25T23:24:00.000+05:30

It is widely assumed that English contract law does not recognise a general duty of good faith. Instead, the law has preferred an incremental, piecemeal approach of solving particular problems as and when they arise; rather than a general overriding notion of ‘good faith’. For instance, Bingham LJ said in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] 1 QB 433, “In many civil law systems, and perhaps in most legal systems outside the common law world, the law of obligations recognizes and enforces an overriding principle that in making and carrying out contracts parties should act in good faith. This does not simply mean that they should not deceive each other, a principle which any legal system must recognise; its effect is perhaps most aptly conveyed by such metaphorical colloquialisms as 'playing fair', 'coming clean' or 'putting one's cards face upwards on the table.' It is in essence a principle of fair open dealing… English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness.”

Examples of these piecemeal solutions are not too hard to find. In White & Carter v. McGregors [1962] AC 413, the House of Lords affirmed that it was open for a contracting party to refuse to accept a repudiatory breach and (if possible to do so without the cooperation of the other contracting party) continue with the contract, and bring an action for the agreed price after the time for performance. Lord Reid however held that there was no notion known to English law which compelled a contracting party to act reasonably while making a choice between accepting or refusing a repudiation. Leaving the door slightly open, however, Lord Reid held “"it might be said that, if a party has no interest to insist on a particular remedy, he ought not to be allowed to insist on it…” This door was pushed further open in a couple of cases (The Puerto Buitrago [1976] 1 Lloyds Rep 250; The Alaskan Trader [1984] 1 All ER 129) but more recently, the position has been summarized in The Aquafaith [2012] 2 Lloyd's Rep 61: “The arbitrator was wrong to regard the comments of Kerr J (and all the subsequent references in the authorities to the need for an extreme case of unreasonableness on the part of the owners to bring in the exception) as a "gloss" on Lord Reid's dictum in White & Carter and to treat Lloyd J's dictum as entitling him to focus on "no legitimate interest", without reference to the degree of unreasonableness. When Lord Reid's speech is read in its entirety, it is clear that the innocent party's right to elect is not trammeled by the need to act reasonably. It requires something beyond that before the courts will interfere and prevent the innocent party insisting on performance of the contract. The effect of the authorities is that an innocent party will have no legitimate interest in maintaining the contract if damages are an adequate remedy and his insistence on maintaining the contract can be described as 'wholly unreasonable', 'extremely unreasonable' or, perhaps, in my words, 'perverse'.”

Another example can be found in the line of cases exemplified in Socimer International Bank v. Standard Bank London [2008] EWCA Civ 116 – where the question is whether a party which contractually enjoys certain discretion must exercise that discretion reasonably. Socimer, and subsequent cases, note that it need not exercise the discretion reasonably: however, the exercise of discretion must not be so unreasonable as to be arbitrary. The threshold is thus rationality (somewhat analogous to the Wednesbury standard which is so familiar to public lawyers). The Court will intervene when the party has taken a perverse view.

This structure of piece-meal solutions may well change if the approach recently adopted by Leggatt J. in Yam Seng PTE v. International Trade Corporation, [2013] EWHC 111 (QB) gains currency. Leggatt J. drew on several established lines of authority on the various ways in which absolute discretions of contracting parties are read down (including the Socimer line, referred to above). These lines indicated to the Judge that the traditional view – that English law looks at good faith with antipathy – is misplaced. The learned Judge then chose to imply a term into the contract between the parties: the term was implied in fact (and not in law: thus, the term was based on the presumed intent of the parties), but the reasoning behind the implication of the term has great significance. The learned judge started from the proposition in Attorney General of Belize v. Belize Telecom [2009] 1 WLR 1988 that implication is part of the broader process of construction of the contract as a whole. He next considered the tests for interpreting a contract: one of which is that the contract must be interpreted as a whole in light of the ‘factual matrix’: Investors Compensation Scheme [1998] 1 WLR 896. Leggatt J. then held – and this proposition appears to me to require further consideration – that this factual matrix includes “shared values” of the parties. One of these shared values was (and, indeed, it will be hard to think of a case where counsel would have instructions to argue to the contrary) was ‘honesty’. If one accepts that Belize laid down a broader test for implication than was traditionally understood, and if one accepts that 'shared values' are part of the background of fact in which a contract must be interpreted, this reasoning may well follow. Both those assumptions are debatable.

Leggatt J. however also indicated that the same result would follow even on the traditional tests of implication. He held that implication of a good faith duty is necessary for the business efficacy of most contracts, and is a term which both parties would have immediately accepted without thinking. This is problematic: while both parties may testily suppress an officious bystander asking “will you act in good faith?” with an “Oh! Of course!", it is unclear if they would do so if the officious bystander elaborated on what he meant by good faith. Was it a duty to not make false statements? Was it a duty to bring all relevant information to the light of the other party? Was it a duty to not give evasive answers if asked by the other party about one aspect? I am not sure whether all contracting parties would immediately agree with these types of obligations. In Socimer, for instance, while Rix LJ does speak of implication on the basis of ‘good faith’, he does point to the narrow content of the duty he has implied: he is careful to draw a distinction between reasonableness in an objective sense, and rationality. The English law of contract has worked fairly well – indeed, is perhaps the law most favoured by businessmen – for centuries without an overarching notion of good faith: what particular business efficacy was lacking is unclear. Ultimately, the concerns over certainty would persist, with no obvious benefit which is not found in the already established lines of authority. The implication of the notion of a duty of good faith on the presumed intention of parties would perhaps allow a back-door entry to the Court imposing its standards of conduct on parties under the guise of presumed intention. For a term to be properly implied, it is not enough to show that there was a presumed intention as to goods faith: what must be shown is a presumed intention as to the content of that good faith norm. One could well argue, therefore, that the judge ought not to have aggregated the several lines of authority to draw a general principle based on implication. Instead, it was best to leave the several lines of authority to chart their own courses.

Leggatt J. also was of the view, “In so far as English law may be less willing than some other legal systems to interpret the duty of good faith as requiring openness of the kind described by Bingham LJ in the Interfoto case as "playing fair'" "coming clean" or "putting one's cards face upwards on the table", this should be seen as a difference of opinion, which may reflect different cultural norms, about what constitutes good faith and fair dealing in some contractual contexts rather than a refusal to recognise that good faith and fair dealing are required.” This, it is respectfully suggested, only highlights the problems with implying a free-standing duty of good faith: it will be impossible to determine what the standards of good faith which were presumably intended by the parties are, and is a license for uncertainty. On the facts, the necessary term to be implied – the duty to not acquiesce in undercutting of prices by other distributors, on the facts in Yam Seng – could perhaps (though this is by no means certain: the point seems arguable both ways) have been implied without having to resort to ‘good faith’. Further, one could also argue that adequate remedies were available under the Misrepresentation Act, 1967 on the facts of the case. It is not clear what the notion of good faith added.

One area of where an idea of ‘good faith’ may be useful, according to the learned Judge, is the law governing long-term contractual relations. “While it seems unlikely that any duty to disclose information in performance of the contract would be implied where the contract involves a simple exchange, many contracts do not fit this model and involve a longer term relationship between the parties which they make a substantial commitment.” While this point has force, it is only an argument to suggest that certain contracts must have certain specific duties implied: it is not an argument for why ‘good faith’ must be implied. In other words, one wonders whether there is any advantage from shifting the question from “should there be a duty of good faith?” to “what is good faith?” Ultimately, it is respectfully (and very tentatively, at this stage) suggested that there is no need for a general implication of a duty of good faith being incorporated into commercial contracts under English law.

GNLU Centre for Corporate and Competition Law (GCCCL): First International Conference

2013-04-23T07:08:00.000+05:30

[The following announcement is posted on behalf of the GNLU Centre for Corporate and Competition Law]

The GNLU Centre for Corporate and Competition Law (GCCCL) announces the first International Conference on, ‘Modern Corporate Laws: Understanding the Dynamism- Within and Beyond the Legal Boundaries’, on 5^th and 6^th of October, 2013.

With the rising competition in the corporate world, the increasing numbers of shareholders, the emerging financial market, the modern corporate world is subject to multifarious issues and concerns. There are endless questions to the issues and challenges to modern corporate laws without any answers. With the aim to grapple with the multifarious concerns and realities for a reform in the corporate governance, emerging dimension of corporate social responsibility, protection of securities market and the challenges to corporate restructuring, the two-day conference is to explore possibilities of convergence and appreciation of divergence, and at times conflicting perceptions and views on the proposed themes.

THEMES & CALL FOR PAPERS:

Following are the themes for the Call for Papers:

1. Corporate Governance- Competing Models and Possibility of Convergence

2. Development of Securities Market: Improving Accessibility, Spreading Prosperity & Inspiring Confidence

3. Corporate Restructuring : Driving factor for Corporate Growth- Revisiting in borders and beyond

IMPORTANT DATES:

- Submission of Abstracts : 5th July, 2013

- Declaration of selection of abstracts : 10th July, 2013

- Submission of full papers : 10th September, 2013

- Registration closes : 25th September, 2013

SUBMISSION FORMAT:

Entries should have a cover page containing the following:

- Full name & Designation

- Institution/Organization/University & Professional/Educational details; and Email address & telephone number.

Entries should be submitted in .doc format with the following specifications:

- Font Type : Garamond

- Spacing : 1.5 inch spacing

- Font Size: Title: 16 points , Sub-title:14 points and Text:12 points.

- Citation Method: Chicago Manual of Style (15th Edition).

- Word Limit: 3000

For the details of the Conference, plse. check the event website,

http://www.gnlu.ac.in/GCCCLweb/index.html

Important Instructions

- Kindly make sure that the soft copy of abstract is sent to centregcccl@gnlu.ac.in

- Full papers to be sent both in hard and soft copies, soft copy to be sent via mail on centregcccl@gnlu.ac.in and the hard copy to be sent at the address given bellow.

- Filled up registration form and Demand Draft (DD) to be sent at the bellow mentioned address.

GNLU Centre for Corporate & Competition Law

Gujarat National Law University

Attalika Avenue, Knowledge Corridor,

Koba, Gandhinagar – 382007, Gujarat (INDIA)

For any further queries, kindly mail us on centregcccl@gnlu.ac.in

SEBI Order in the Art Fund Case

2013-04-18T09:04:00.000+05:30

Earlier this week, SEBI passed an order against Osian’s-Connoisseurs of Art Private Limited holding that the Osian Art Fund falls within the purview of the SEBI Act and the SEBI (Collective Investment Scheme) Regulations, 1999 (the CIS Regulations). Since the art fund had raised investments without registering with SEBI, it was ordered to wind up its scheme and refund monies collected by it and also prohibited from accessing the capital markets.

The Osian Art Fund was set up as a private trust with a trustee, and managed by an investment management company. It had raised monies from investors whose monies were pooled to acquire and manage art works (that were the underlying assets). A few years ago, SEBI began investigation into the affairs of the art fund and specifically on whether it violates the SEBI Act and the CIS Regulations. Osian made several submissions and arguments, including on the interpretation of the law on the issue, following which SEBI passed its order.

SEBI was required to rule on 4 specific issues, which are dealt with separately. First, although the definition of a collective investment scheme in section 11AA(2) of the SEBI Act refers to a scheme or arrangement offered by any “company”, it cannot be read to mean that only funds set up as companies fall within the purview of the legal regime. On the other hand, the substantive provisions in section 12(1B) of the SEBI Act and Reg. 3 of the CIS Regulations provide that no “person” shall carry out a collective investment scheme without registration with SEBI. Adopting this approach, only a company structure can be used to set up a collect investment scheme, and that no other type of structure (including trust) is a permissible one.

Second, although the CIS Regulations were promulgated in the late 1990s following the Dave Committee Report to deal with fraudulent schemes involving plantation/agro companies, they are not limited to that asset class. SEBI found that the Act and the CIS Regulations apply to any asset class. What is important is the nature of the scheme and not the asset class.

Third, while SEBI seemed to accept the legal interpretation that the Act and the CIS Regulations apply only to a “public” offering of securities by a collective investment scheme, on the facts of the Osian case it was found that the units of the art fund were marketed extensively. Relying upon the forceful precedent of the Supreme Court in the Sahara case, SEBI found that the Osian fund was available to more than 50 offerees (the limit stipulated for a public offering in section 67(3) of the Companies Act, 1956). The fact that only sophisticated investors could subscribe to units which had a minimum subscription amount and minimum investment lots would not detract from the fact that this is a public offering.

Finally, SEBI found that the units of the art fund were “securities” as that expression carries a wide connotation under the SEBI Act and the Securities Contracts (Regulation) Act, 1956.

Overall, SEBI order is convincing on all counts, and is supported by principles of interpretation and jurisprudence with reference to securities regulation. The interpretation indicates the fairly wide scope of the CIS Regulations, which serves as a caution to entities that are establishing collective investment schemes (especially those that wish to stay outside the purview of registration with SEBI) and also a source of some comfort to the investors in such schemes.

Amendments to the Combination Regulations

2013-04-17T08:44:00.001+05:30

[The following post is contributed by Karan S. Chandhiok, who is the Managing Associate of the Competition Law Team at Luthra & Luthra Law Offices. Karan graduated from Amity Law School followed by a BCL at Oxford. He currently serves as a Member Executive of the Competition Law Bar Association.

These views are personal.

Karan may be contacted at kchandhiok@luthra.com or karanchandhiok@gmail.com]

The Competition Commission of India (Procedure in Regard to the Transaction of Business Relating to Combinations) Regulations, 2011 (the Combination Regulations) came into effect from 1 June 2011. These represent the substance of the merger control regime in India. in order to address some of the reservations that were expressed by the industry and antitrust practitioners alike, the Competition Commission of India (the CCI) introduced a list of exempted transactions, which according to the CCI would “ordinarily not cause an appreciable adverse effect on competition”. These transactions are listed at Schedule I to the Combination Regulations.

Laudably, the CCI has continued its efforts of consulting with stakeholders and has already amended this list twice in the past 15 months to bring it closer to practical realities. The first set of amendments wase introduced in February 2012 (the 2012 Amendments) and can be accessed here.

The latest amendments to the Combination Regulations came into force on 4 April 2013 and the further reduce the regulatory burden of seeking the prior approval of the CCI. These amendments are summarised below:

Creeping Acquisitions

The 2012 Amendments aligned the Combination Regulations with the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the Takeover Code) increasing the limit of exempted shareholding from 15% to 25% so long as such shareholding was acquired as an investment or in the ordinary course of business and did not result in a change of control of the target enterprise. The new category 1A brings the Combination Regulations and the Takeover Code further closer to each other by exempting creeping acquisitions. The new Category 1A now exempts transactions where the acquirer:

- already holds 25% or more but less than 50% of the shares or voting rights in the target enterprise; and

- acquires not more than 5% of the target enterprise in one financial year on a gross basis,

provided that, such acquisition does not lead to the acquisition of sole or joint control.

The CCI has not provided any guidance on the meaning of ‘gross acquisition’, but the Takeover Code states that in the determination of “gross acquisition” any intermittent fall in shareholding or voting rights whether owing to disposal of shares held or dilution of voting rights on account of any fresh issues of shares, shall be disregarded.

The definition of ‘control’ still remains somewhat of an elusive concept. In the SPE/Grandway/Atlas combination (C-2012/06/63), the CCI has offered some guidance on this concept:

Joint control over an enterprise implies control over the strategic commercial operations of the enterprise by two or more persons. In such a case, each of the persons in joint control would have the right to veto/block the strategic commercial decision(s) of the enterprise which could result in a dead lock situation…

Intra-group mergers and amalgamations

The requirement of seeking approval for transactions that are essentially internal restructurings has been debated by stakeholders and practitioners in various forums in India and abroad. The 2012 Amendments provided a limited relief to such transactions by exempting mergers and amalgamations involving enterprises that were wholly owned within the same group.

The new Category 9 broadens the scope of this exemption. Under the new Category 9, exemption is available for mergers or amalgamations involving enterprises, where:

· one enterprise holds more than 50% of the shares or voting rights of the other enterprise; or

· enterprise(s) within the same group hold more than 50% of the shares or voting rights of each enterprise,

provided that, such transactions do not lead to the transfer of joint to sole control.

This exemption is certainly a welcome step. However, it glosses over the fact that family owned companies are often held through various intermediate companies that represent the shareholding of each promoter; and collectively, these intermediate holding companies form part of the ‘promoter group’. The Competition Act, 2002 (the Act) does not recognise the concept of ‘persons acting in concert’ as under the Takeover Code. Under the Act, a single individual is an ‘enterprise’. Therefore, a restructuring amongst the promoter group companies will still require the approval of the CCI as these entities (despite forming part of the same ‘promoter group’) would not be held within the same ‘group’, as defined under the Act.

Note that the original Category 9 exempting the acquisition of ‘current assets’ has now been moved and included in category (5) along with stock-in-trade, raw materials, stores and spares, trade receivables and other similar current assets in the ordinary course of business.

Clarifications on intra-group acquisitions

The Combination Regulations exempted acquisitions of control, shares, voting rights or assets within the same group. It is now clarified that this exemption will not be available where the target enterprise is jointly controlled by enterprises not falling within the same group.

It is hoped that in the next set of amendments, the CCI relooks at the obligation to file a notice with the CCI within the statutory period of 30 days (see section 6(2) of the Act). In a jurisdiction such as India, where a transaction cannot be consummated till it receives the prior approval of the CCI, a time limit for the filing offers limited value. One hopes that the CCI would take a lenient view where parties have not closed a transaction, but have made a belated notice to the CCI for operational reasons or otherwise.

Changes in the Revised FDI Policy of 2013

2013-04-13T10:08:00.001+05:30

[In a previous post, we had drawn attention to the Revised FDI Policy. One of the criticisms of the policy review process was that the changes were not evident from the face of the policy, thereby making it less user-friendly. Fortunately, this gap has been filled in a timely manner by one of our guest contributors below.

The following post is contributed by Parag Bhide, who is a Senior Associate at Universal Legal.]

The Department of Industrial Policy and Promotion, Government of India (“DIPP”), in pursuance of its policy of consolidating all the press releases/press notes, has released 6^th issue of Consolidated FDI Policy (Circular 1 of 2013) effective from 5^th April 2013 (“FDI Policy 2013”). The FDI Policy 2013 supersedes, inter alia, the erstwhile version of the Consolidated FDI Policy (Circular 1 of 2012) dated 9^th April 2012 (“Erstwhile FDI Policy”) and other press notes issued since then.

The key changes brought by the FDI Policy 2013 are as under:

- Investment from Pakistan: It has been specified in para 3.1.1 of the FDI Policy 2013 that a citizen of Pakistan or an entity incorporated in Pakistan can invest subject to Government Approval[1], in sectors/activities other than defence, space and atomic energy sectors/activities prohibited for foreign investment. The above revision has been carried out in pursuance to the Press Note No. 3 (2012 Series) dated 1^st August 2012.

- FDI against import of capital goods/machinery/equipments: Under para 3.4.6 of the FDI Policy 2013, the erstwhile requirement for an independent valuation of the capital goods/machinery/equipment (including second-hand machinery) by a third party entity, (preferably by an independent valuer from the country of import along with production of copies of documents/certificates issued by the customs authorities towards assessment of the fair-value of such imports) has been removed.

- Downstream investment by Banking Companies in certain case: A note has been inserted under para 3.10.4.1 of the FDI Policy 2013, wherein it has been prescribed that downstream investments by a banking company[2] incorporated in India, which is owned and/or controlled by non-residents/non-resident entity(ies), under corporate debt restructuring or other loan restructuring mechanism or in trading books or for acquisition of shares due to default in loans, shall not be counted towards indirect foreign investment. It has been prescribed further that the strategic downstream investments[3], however, shall be counted towards indirect foreign investment. The above revision has been carried out in pursuance to the Press Note No. 2 (2012 Series) dated 31^st July 2012.

- Foreign Investment in Multi Brand Retail Trading: After prolonged discussions and debate, foreign investment in multi brand retail trading, was permitted by DIPP vide issuance of the Press Note No. 5 (2012 Series) dated 20^th September 2012. Accordingly, the list of ‘Prohibited Sectors’ under para 6.1 of the FDI Policy 2013 has been modified to omit the words “Retail Trading (except single brand product retailing)”. Further, para 6.2.16.5 of the FDI Policy 2013 has been amended to give include detailed framework dealing with foreign investments in multi brand retail trading.

- Foreign Investment in teleports, Direct to Home and Mobile TV: The DIPP vide its Press Note No. 7 (2012 Series) dated 20^th September 2012 increased foreign investment limits in teleports and Direct to Home from 49% to 74% (wherein any investment beyond 49% to 74% would be subject to government route). Further, the said press note also permitted foreign investment in Mobile TVs up to 74% (wherein any investment beyond 49% to 74% would be subject to government route). Accordingly, para 6.2.7.1 has been inserted (in modified form) in the FDI Policy 2013 to capture above policy amendments.

- Foreign Investment in Air Transport Services[4]: The investment by foreign airlines in scheduled and non-scheduled air transport services was permitted by DIPP in the year 2012[5] and such investment is subject to Government Approval.[6] Accordingly, para 6.2.9.2 of the FDI Policy 2013 has been amended to include foregoing policy announcements.

- Single brand product retail trading: With effect from 20^th September 2012[7], amendments were announced in the erstwhile policy governing foreign investments in ‘Single brand product retail trading’. Accordingly, it was announced that only one non-resident entities, whether owner of the brand or otherwise, be permitted to undertake single brand product retail trading in the country, for the specific brand, through a legally tenable agreement, with the brand owner for undertaking single brand product retail trading in respect of the specific brand for which approval is being sought. Further, it was also announced that the onus for ensuring compliance with the foregoing condition shall rest with the Indian entity carrying out single brand product retail trading in India and the investing entity shall provide evidence to this effect at the time of seeking approval, including a copy of the licensing/franchise/sub-licence agreement, specifically indicating compliance with the said conditions. It was also prescribed that in respect of proposals involving Foreign Direct Investment (“FDI”) beyond 51%, sourcing of 30% of the value of goods purchased, will be done from India, preferably from micro, small and medium enterprises (MSMEs), village and cottage industries, artisans and craftsmen, in all sectors and the quantum of domestic sourcing will be self-certified by the company, to be subsequently checked, by statutory auditors, from the duly certified accounts which the company will be required to maintain. The said procurement requirement would have to be met, in the first instance, as an average of five years' total value of the goods purchased, beginning l " April of the year during which the first tranche of FDI is received. Thereafter, it would have to be met on an annual basis. For the purpose of ascertaining the sourcing requirement, the relevant entity would be the company, incorporated in India, which is the recipient of FDI for the purpose of carrying out single-brand product retail trading. Accordingly, para 6.2.16.4 of the FDI Policy 2013 has been amended to include the above policy changes related to investment in single brand product retail trading.

- Foreign Investment in Asset Reconstruction Companies: In para 6.2.17 of the FDI Policy 2013, few changes have been included to include policy announcements by Ministry of Finance in December 2012. It has been mentioned that Foreign Institutional Investors (“FIIs”) have been permitted to invest in Asset Reconstruction Companies upto 10% of the total paid-up capital. Further, FIIs limits for investing in Security Receipts have been enhanced to 74% of each tranche of scheme of such Security Receipts. It is also prescribed that such investments should be within the FII limit on corporate bonds prescribed from time to time, and sectoral caps under extant FDI regulations should also be complied with.

- Downstream Investments by foreign owned Non Banking Finance Companies: The DIPP in the year 2012[8], announced policy revisions to permit Non Banking Finance Companies (“NBFCs”) (i) having foreign investment above 75% and below 100% and (ii) with a minimum capitalisation of US$ 50 million, to set up step down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without bringing in additional capital. The foregoing revisions have been included out in para 6.2.17.8.2 of the FDI Policy 2013.

- Foreign Investment in Power Exchanges: Till 20^th September 2012, there was no clarity as regards the foreign investment in power exchanges and hence, the investee companies/investors used to seek clarifications on the matter. Considering the same, on 20^th September 2012, the DIPP vide its Press Note No. 8 (2012 Series) announced a framework governing foreign investments in power exchanges. By virtue of the same, foreign investment upto 49% was permitted in power exchanges (inclusive of limits of 26% and 23% on FDI and FII investments respectively) to put power exchanges at par with commodity exchanges. Further, it was specified that the FII investments shall be restricted to secondary markets only and no non-resident investor (including persons acting in concert) shall hold more than 5% of the equity in power exchanges. A new para 6.2.19 has been added in the FDI Policy 2013 to reflect above policy announcements.

Additionally, specific provisions dealing with conversion of companies with FDI into LLPs have also been included in the FDI Policy 2013.

Conclusion: It can be seen from the above, the changes carried out in the FDI Policy 2013 are with respect to the incorporation of the various press notes and circulars issued since the issuance of Erstwhile FDI Policy. Ambiguities expected to be resolved in terms of clarifications on FDI and FII limits in various sectors, lock-in period conditionalities for investments in real estate sector, still remain unaddressed.

- Parag Bhide

[1] Foreign Investment and Promotion Board has been designated as a nodal agency to consider such cases.

[2] As defined under section 5(c) of the Banking Regulation Act, 1949

[3] Like investments in subsidiaries, joint ventures and associates

[4] Air Transport Services includes Domestic Scheduled Passenger Airlines, Non-Scheduled Air Transport Services, helicopter and seaplane services

[5] DIPP Press Note No. 6 (2012 Series) dated 20^th September 2012

[6] Ibid

[7] DIPP Press Note No. 4 (2012 Series) dated 20^th September 2012

[8] DIPP Press Note No. 9 (2012 Series) dated 3^rd October 2012

SEBI Adjudication Order in the IPCL Insider Trading Case

2013-04-11T09:04:00.000+05:30

SEBI’s adjudicating officer yesterday passed an order exonerating Mr. Manoj H. Modi (MHM) and Mrs. Smita M. Modi (SMM) for insider trading charges in connection with the shares of Indian Petrochemicals Corporation Limited (IPCL). It deals with two primary legal questions as they were applied to the facts of the case, i.e. (i) whether MHM and SMM are “insiders” with respect to IPCL; and (ii) whether the trading was when in possession of “unpublished price sensitive information” (UPSI). The adjudicating officer returned negative findings on both counts.

Earlier, SEBI had issued a show cause notice to the parties alleging that they purchased 100,000 shares of IPCL on three dates between February 28, 2007 and March 2, 2007 when in possession of price sensitive information. The allegation was on the basis that MHM was a consultant to Mr. Mukesh Ambani, the chairman of IPCL and therefore an insider, and that SMM being MHM’s wife was also an insider. It was alleged that IPCL issued a notice to the stock exchange on March 2, 2007 indicating its proposal to issue interim dividend, and that it issued another notice on March 7, 2007 that it was considering an amalgamation of IPCL with Reliance Industries Limited. Both the interim dividend and amalgamation proposals are with the definition of UPSI.

After hearing the parties, the adjudicating officer first considered the question of whether MHM was an “insider”. The officer examined the definition of “insider” in Regulation 2(e) of the SEBI (Prohibition of Insider Trading) Regulations, 1992 (the PIT Regulations), which reads as follows:

2 (e). “insider” means any person who, is or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access to unpublished price sensitive information in respect of securities of a company, or has received or has had access to such unpublished price sensitive information;

For this definition to be attracted, two factors must be satisfied cumulatively, i.e. first that the person is connected or deemed to be connected, and second that he is reasonably expected to have access to UPSI. In this particular case, it was found that MHM was only a consultant to Mr. Ambani for new ventures, at that point in time Reliance’ retail venture, and not for all matters generally. Given this, the adjudicating officer found that MHM cannot be reasonably expected to have access to UPSI with reference to IPCL. Since he did not fall within the definition of an insider, his wife SMM cannot be said to be a deemed connected person, and hence she is not an insider either.

While the interpretation applied by the adjudicating officer regarding the two factors to be satisfied for connected or deemed connected persons as insiders is appropriate, one additional test that has been applied by SEBI in the past is to consider from the last limb of the definition above whether a person “has had access to such [UPSI]”. This involves a factual determination of whether the person has in fact received UPSI even without being a connected or deemed connected person. In this case, SEBI did not go down the path of investigating this aspect in greater detail.

Even though the adjudicating officer came to the conclusion that MHM and SMM are not “insiders”, he went further to examine whether the individuals can be said to have traded while in possession of UPSI. Apart from relying upon the parties’ statement that the interim dividend and amalgamation proposals were known only to very few individuals within the company, and that MHM and SMM could not have had access to that, the adjudicating officer went on to pay sufficient regard to whether the information regarding those two proposals were price sensitive. He relied on the general sentiment in the market, following the relevant Budget announcement by the Government, that several companies would declare interim dividend and that this was not unique to IPCL. Moreover, emphasis was placed on the fact that MHM and SMM were regular in carrying on trading in shares and that these trades were not unusual. This is consistent with the observation of the Securities Appellate Tribunal (SAT) in the Manoj Gaur Case.

While on the face of the order, it seems that the evidence was insufficient to pursue insider trading charges, it again indicates the difficulties that regulators face in India in successfully prosecuting insider trading, where the evidentiary burden is unduly onerous on the regulators. Fortunately, these matters are under active consideration by the committee appointed by SEBI to relook at the PIT Regulations, and hopefully a more robust regime would emerge.

CERC Order in the Adani Power Case

2013-04-10T12:04:00.000+05:30

Last week, the Central Electricity Regulatory Commission (CERC) passed an order relating to Adani Power that has significant implications for the power sector in India. Adani Power, which had entered into power purchase agreements (PPAs) with state utilities in Gujarat and Haryana for sale of power, approached the CERC with a request for relief on account of escalation of imported coal prices due to a change in regulations in Indonesia, where its principal fuel source was located. By a 3:1 majority, the CERC granted temporary relief to Adani Power through a “compensatory tariff” to be paid to it. The majority order is available here, while the dissenting order is here.

Facts

Adani Power had entered into separate PPAs with Gujarat Urja Vikas Nigam Limited and two Haryana utilities under which Adani Power had agreed to supply power to these state utilities. Under these arrangements, and the bidding process that preceded them, Adani Power was to assume responsibility to tie up the fuel linkage. Due to issues in procuring fuel from domestic sources, Adani Power established arrangements with entities in Indonesia for supply of coal at reasonable prices. However, in 2010, the Indonesian Government issued a set of regulations stipulating that holders of mining permits in Indonesia will be permitted to sell coal only benchmark prices accepted in the international markets. These Indonesian regulations had a significant impact on export prices of coal from Indonesia, which were higher than the contracted prices, due to which it became unviable for Adani Power to supply power at agreed prices to the state utilities in Gujarat and Haryana. Since this was unforeseen, Adani Power approached the CERC for relief.

Issues

After taking on record the submissions of the parties, the CERC identified three broad issues for consideration:

(i) Whether due to the effect of the Indonesian regulations and the non-availability of domestic coal-linkage, it has become impossible for Adani Power to supply power to the state utilities at the tariff set by the PPAs;

(ii) Whether the situation faced by Adani Power falls within the scope of force majeure or “change in law” in the PPAs thereby requiring relief; and

(iii) Whether the CERC possesses general powers under the Electricity Act, 2003 and the National Electricity Policy and tariff policy to grant the requested relief to Adani Power.

Decision

The first question is largely a factual matter that the CERC considered in detail. It found that the non-availability of coal from domestic sources and the lack of attractiveness of sourcing from the international markets meant that the Indonesian markets were the most feasible. However, due to the Indonesian regulations, the viability of sourcing coal from Indonesia has been put to serious doubt as it has altered the basic premise upon which Adani Power had quoted the tariff to the state utilities.

Given the affirmative response of the CERC to the first question, it became necessary to deal with the legal matters that arose in the second question, i.e. whether the force majeure or “change in law” provisions in the PPAs would be attracted in this case. The CERC interpreted force majeure narrowly such that it can be invoked only “where any event or circumstance or combination of events or circumstances wholly or partly prevents or unavoidably delays the affected parties in the performance of its obligations”. Since there is no prohibition as such on Adani Power buying coal from Indonesian sources, the CERC came to the conclusion that the force majeure clause is not attracted. Mere rise in price of a commodity does not result in impossibility of performance. As regards “change in law”, the CERC interpreted the terms of the PPAs. “Law” was defined to mean the laws in India, and was not meant to include foreign laws. Hence, a change in Indonesian law was not covered by the “change in law” clause. No protection was afforded to Adani Power on account of such measures that would have resulted in a situation akin to a frustration of contract.

That led to the CERC’s determination in the third question of whether it had inherent powers under law to accord relief to Adani Power. The CERC found that since there was no price escalation clause in the PPAs, in its view “ways and means need to be found to compensate [Adani Power] for the loss or additional expenditure incurred by it on account of procurement of coal from Indonesia as the international benchmark price …” [emphasis added]. The CERC analyzed the objective and scheme of the Electricity Act and related laws and policies, and rationalized its decision as follows:

82. The common threads running along the length and breadth of the statutory scheme under the Act and the statutory instruments framed thereunder are the protection of the consumers’ interest and ensuring adequate return on the investments in the sector. The consumers’ interest is protected not only by fixing competitive tariff but it is equally imperative to ensure continuous, uninterrupted and reliable supply of electricity. … Therefore, in the final analysis, the recovery of costs of the investors serves the consumers’ interest by attracting investments in the sector by improving quality of supply of electricity to the consumers. Thus, twin objectives of protection of consumers’ interest and recovery of cost of services provided are complementary. All the authorities established under the Act, have to strive towards achieving these objectives. This Commission as the apex regulatory body for power sector has the additional responsibility for meeting the objectives of law.

Relying upon “its statutory responsibility to balance the interest of the consumers with the interest of the project developers while regulating the tariff of the generating companies”, the CERC granted a compensatory tariff to Adani Power. It also ordered the establishment of a committee to undertake a consultative process to find an acceptable solution in the form of the compensatory tariff.

The dissenting order, however disagrees with the majority on the first issue, i.e. on the impact of the Indonesian regulations on Adani Power’s ability to continue with its obligations under the PPA. However, it agrees with the majority as regards the non-applicability of the force majeure and “change in law” clauses. More importantly, the dissenting view finds that the case primarily involves an adjudication of specific disputes and does not justify a general exercise of regulatory power by the CERC as it “amounts to an invasion on the exercise of free will by the parties”.

Analysis

While the CERC order has enormous implications for the power industry and possibly other infrastructure sectors in India, it also raises important legal questions. First, it erodes the principle of sanctity of contract. While courts and regulators are generally hesitant to interfere in contractual understandings between the parties, in this particular case the CERC has stepped in to alter the contractual relations between the parties. Of course, it can be argued that a PPA is not a plain-vanilla contract, but one that is susceptible to industry regulation, the extent to which freedom of contract can be violated is an open question. This is also a significant point of dissent in the minority opinion.

Second, CERC’s interference comes in not through the contract, but rather through exercise of its general powers as an industry regulator. For example, contractual principles of frustration and their practical manifestations in contracts in the form of force majeure and “change in law” clauses were held inapplicable here. CERC’s use of its general powers to intervene in contractual matters would lend an element of subjectivity to commercial contracting in the sector. In its zeal to resolve a dispute in an existing situation, it remains to be seen whether it has opened a Pandora ’s Box that is likely to cause some uncertainty in the sector. In seeking to protect the commercial viability of the electricity sector and the access to power to the populace in the two states involved, the CERC may very well have dampened the sentiment. If this principle is extended, surely power generators may themselves carry the risk that they might find themselves to be at the wrong end of the CERC interference, which may cause additional concerns to the sector.

Finally, the issue of moral hazard has already been raised. The question remains whether such developments would shift undue risk to the state utilities, and thereby engender excessive risk-taking amongst the power producers. The classic way of addressing risk is through contract, but if the freedom of contract is constantly eroded as it has been in this case, the risk allocation mechanisms will be determined by the regulator rather than left to the wisdom of the parties.

Surely, there are lessons to be drawn from this case. Not the least among them might be the need to capture more details (as is reasonably possible in a cost-effective and timely manner) in contracts regarding the obligations and responsibilities of parties on matters such as fuel linkages.

For more, The Firm – Corporate Law in India has an interesting debate on the CERC order.