Competition Act: Status of Director General’s Finding

[The following post is contributed by Akanksha Mehta, a student of Dr. R.M.L. National Law University, Lucknow, who has an interest in competition law]

One of the major loopholes in the present Competition Act, 2002 seems to have found some judicial clarification through COMPAT’s (Competition Appellate Tribunal) order dated 18^th April, 2013.

Section 26 of the Act includes all the orders that the Competition Commission of India (CCI) can pass to carry out the procedure for inquiry under Section 19 of the Act. While this Section explicitly gives CCI the power to direct the Director General (DG) to investigate matters, to close the matter if the DG finds no contravention and to order for a further investigation if the DG finds a contravention in his report, it does not explicitly give CCI the power to disagree with the DG and close the matter even when the DG has found a contravention. Though there have been various cases till now where the CCI has disagreed with the DG and closed the matter therewith but there has also been a dissenting opinion by Member R. Prasad in all these cases stating the inability of the CCI to pass such orders as there is no Section or provision giving CCI such powers. This lacuna in the Act has given rise to ambiguities relating to the powers of the CCI and nature of the DG’s report. Does it remain binding on the CCI? Or is it merely recommendatory in nature?

COMPAT’s latest order in the case of M/S Gulf Oil Corp. Ltd. v. CCI & others has brought some clarity to this vagueness. While determining the question of whether it is mandatory for CCI to pass an order under Section 26(7) for further inquiry after the DG has found a contravention in his report, it stated-

“The report of the DG is only recommendatory in nature and it is not binding on CCI in any manner. It is only if the CCI formulates an opinion on the basis of the report that the DG has either not done full investigation or that the further investigation is necessary then it proceeds under Section 26(7) and not otherwise. Therefore, it is not in every case where the CCI disagrees with the report of the DG, it has to proceed under Sec 26(7).” 

Though this Judgment has brought certainty and clarity in determining the nature of the DG’s report, yet it does not provide an answer to the most fundamental questions of CCI’s power to close the matter while disagreeing with the DG’s report which has found contravention. This ambiguity can be resolved by either a legislative amendment in the Act or by a purposive interpretation of Section 26 by the Judiciary.

- Akanksha Mehta

Petrodel v Prest: Lord Sumption’s Masterly Analysis of the Corporate Veil

When the history of the corporate veil is written, the year 2013 will perhaps be given as much prominence as the year 1897. Today, the UK Supreme Court allowed Mrs Prest’s appeal against the judgment of the Court of Appeal that seven properties in London owned by the Petrodel group of companies are not properties to which the sole controller of the group is ‘entitled, in possession or reversion’. The judgment of Lord Sumption contains a masterly analysis of this difficult area of law and is likely to become the definitive authority on the corporate veil in the years ahead. Along with (and perhaps even more than) VTB Capital v Nutritek Corporation, this is the most important judicial analysis of the corporate veil in recent times. We have commented on the decisions in VTB (Court of Appeal and Supreme Court) and Petrodel, to which readers may refer for an account of the facts and the background. In short, after Mr and Mrs Prest divorced, Moylan J. awarded Mrs Prest a sum of £17.5 million as a fair division of Mr Prest’s assets. In part satisfaction of this sum, the judge ordered three Petrodel group companies to transfer the seven properties in question to Mrs Prest. It was established, inter alia, that Mr Prest was the controller and sole person interested in the Petrodel companies and that he had used the assets of the company to defray personal expenses. The question was whether the court was empowered to grant this order.

At an early stage of his judgment (para 9), Lord Sumption identifies three (and no other) possible bases on which such an order can be validly made against the corporate defendants: (1) ‘piercing the corporate veil’ in order to give effective relief; (2) section 24(1)(a) of the Matrimonial Causes Act, 1973 and (3) the Petrodel companies hold the London properties on trust for the husband (not simply because he is the controller). Our interest here is (1) but we note in passing that Lord Sumption (correctly, it is submitted) rejected the proposition that section 24(1)(a) authorises the court to ignore the corporate entity simply to make a fairer distribution of assets.

Lord Sumption’s analysis of the corporate veil contains so many important propositions of law that it is best to summarise them, and then consider two or three of them in more detail:

1. The corporate veil has been described as a fiction but it is a fiction which is the whole foundation of the English law of company and insolvency. It also clearly accords with the commercial understanding of companies although, as Goff LJ rightly said, the courts are here “concerned not with economics but with law” (para 8);
2. In some cases, some rule of law has the effect of attributing to the controller the knowledge of the company, or in some other way treating (without ignoring the separate legal entity of the company) as the act of the company an act of some other person. These are not, and should not be, considered as instances of piercing the corporate veil. That is done only when the corporate personality of the company is disregarded (para 16);
3. Most advanced legal systems recognise corporate personality but adopt different ways of introducing some limits to its logical consequences. The civil law countries use the doctrine of ‘abuse of rights’ but the common law knows no such general principle: instead, “it has a variety of specific principles which achieve the same result in some cases”, one of which is that the law, in defining the incidents of a legal relationship, assumes that persons who engage it deal honestly with each other: if not, the same incidents may not necessarily apply (para 18);
4. Much of the case law on the corporate veil “is characterised by incautious dicta and inadequate reasoning”. Many of these cases attribute the doctrine of piercing the veil to the fact that the company is a ‘sham’ or a ‘façade’ but these expressions beg more questions than they answer. In recent times, the law has crystallised around the six principles formulated by Munby J. in Ben Hashem v Shayif, of which the most important is that there must be ‘relevant impropriety’, that is, impropriety in the use of the corporate structure to avoid liability. The one modification made to this by the Court of Appeal in VTB (that the corporate veil can be pierced even if other remedies are available to the claimant) is wrong (para 25);
5. Although the recognition of the veil was obiter in many of these cases, and those in which it was not can be explained by conventional legal principles, the existence of the doctrine is well-established in the authorities: “I would not for my part be willing to explain that consensus out of existence” (para 27);
6. Much of the confusion in the case law has arisen from a failure to distinguish between “the concealment principle” and the “evasion principle” (para 28);
1. The concealment principle is, in fact, not an instance of piercing the veil but is the principle that “the interposition of a company…so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming their identity is legally relevant”.
2. The evasion principle is the only real instance of piercing the veil. This is done if “there is a legal right against the person in control of the company which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement”.
7. Lord Sumption illustrates the difference between the concealment principle and the evasion principle by comparing, on the one hand, Gilford Motor Co v Horne [1933] Ch. 935 and Jones v Lipman [1962] 1 WLR 832 with, on the other, Genco ACP v Dalby [2000] 2 BCLC 734 and Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177). In Trustor and Genco, at the risk of over-simplification, a claim was made that a former director of the claimant was liable in knowing receipt by reason of the receipt by a company under his control of funds belonging to the claimant which the controller had procured the company to receive. In both cases, the claimant succeeded apparently on the basis that the veil was pierced so that it could be said that the former director had received the money. Lord Sumption explains that this is a wrong analysis of the cases: correctly analysed, both cases are instances of the concealment principle, not the evasion principle. This is because there was no legal right or liability on the part of the director independently of the company’s interposition: by attributing his knowledge to the company, the company became directly liable to the claimant, but without losing its corporate personality. As Lord Sumption puts it, the result would have been the same if Mr Dalby had caused his uncle to receive the funds with prior knowledge, instead of the company, and there would have been no doubt about his uncle’s separate existence. On the other hand, the order of injunction made against JM Horne & Co can be explained only on the basis that the company was created by Mr Horne for the purpose of defeating the right that his former employers had against him. That liability existed independently of the company (paras 29-33).
8. This distinction explains why the veil could not be pierced in VTB Capital and indeed in Prest: in VTB, there was no legal right against or liability of Mr Malofeev that existed independently of the role of Nutritek and the other companies. In Prest, there was certainly impropriety, but it had nothing to do with Mr Prest’s obligation to Mrs Prest. This suggests that the result might have been different if Mr Prest had transferred his assets to the companies (beneficially owned by the companies) after the order was made, in order to defeat it (paras 34-36).
9. The principle is best stated in the words of Lord Sumption, at para 35:

35. I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s separate legal personality. The principle is properly described as a limited one, because in almost every case where the test is satisfied, the facts will in practice disclose a legal relationship between the company and its controller which will make it unnecessary to pierce the corporate veil.

There are three important points that arise out of this judgment. First, the point left open by the Supreme Court in VTB—whether at all the court has the power to pierce the veil—has now been decided, although Lord Neuberger appears to have done so with some reluctance, considering (rightly) that the doctrine is anomalous. He demonstrates (para 74) that in some eighty years of its existence, the doctrine of piercing the veil has not been successfully and correctly invoked even once. Secondly, Lord Neuberger (para 62) and Lord Sumption (para 35) agree that there is a ‘necessity’ threshold to cross before the veil can be pierced: that is, contrary to what the Court of Appeal decided in VTB Capital, the veil should not be pierced even where the evasion principle applies, if other appropriate remedies are available to the claimant. Thirdly, Lord Neuberger and Lord Sumption differ in their treatment of the important cases of Gilford Motor Co v Horne and Jones v Lipman. To Lord Sumption, these cases illustrate the evasion principle insofar as an order was made against the company; to Lord Neuberger (para 70), these cases wrongly invoked the doctrine of piercing the veil and the order made against the company can be explained on the basis of agency.

It is evident, especially after Petrodel Resources, that the law in India could not be more different: the courts pierce the veil more readily, and do not insist that the fraud or impropriety must be concerned with the use of the corporate structure. However, since the Supreme Court is yet to closely examine this question in the light of recent developments, the scope of the corporate veil remains an open question in India.

Arbitration of Shareholder Disputes

In an article in the Financial Express, my colleague Debashish Sankhari and I have looked at whether disputes of oppression and mismanagement in relation to the affairs of a company can be adjudicated through arbitration. This is an important practical question for many a financial investor (and even a long-term strategic investor) who has agreed to arbitration clauses in the investment/ shareholder agreements, and which may also have been incorporated in the articles of association of the company.

After examining various CLB orders and the Supreme Court judgement in Booz Allen & Hamilton, we come to the conclusion that the test to determine as to whether the matter/ claim of oppression and mismanagement is to be relegated to arbitration is to examine as to whether the allegations of oppression/mismanagement can by adjudicated without reference to the terms of the arbitration agreement. In other words, the nature of the allegations should be such that if established, it could definitely be declared as an act of oppression/ mismanagement. In such cases, the matter cannot be referred to arbitration.

-- Satyajit Gupta

Conflicts between Shareholders Agreements and Articles of a Company

[The following post is contributed by Aditya Swarup, who is an advocate practising in the Bombay High Court. He has a B.A., LL.B (Hons.) degree from NALSAR, Hyderabad and B.C.L. and M.Phil degrees from Oxford]

The issue of conflicting provisions in a Shareholders Agreement (SHA) and the articles of association (Articles) of a company is a never ending debate, and perhaps a rather confounding one in company law. A recent order of the Delhi High Court in World Phone India Pvt. Ltd v. WPI Group Inc USA, [2013] 178 Comp Cas 173 (Del) (also available here), holding that clauses in a SHA which are not repugnant to the Companies Act but not incorporated in the articles of the Company, would be unenforceable, has only added to this confusion. This post is an attempt to expound the law surrounding this decision.

As a background, it would be apt to note that conflicts between SHA and the Articles of a company can be of two types; first, where the conflict relates to the management of the company (affirmative vote, board of directors, accounts, etc.) and second, where the conflict relates to the transferability of shares. The latter has been the subject of extensive case law in the Supreme Court and High Court and has been dealt with in this blog at various instances (e.g. here and here).  As regards the former, two main questions arise;

1)           Whether a provision in a SHA that is contrary to the Articles of the company is valid and enforceable?

2)           What are the possible remedies for a shareholder against breach of a SHA by other shareholders even though such action would not be construed as a breach under the Articles of the company?

Probably the most important case in this regard is that of VB Rangaraj v. VB Gopalakrishnan, (1992) 1 SCC 160 (available here). In that case, while dealing with a conflict between the SHA and the Articles of the company of the latter type, i.e. a conflict dealing with the transferability of shares, the Supreme Court took the view that the provisions of a SHA imposing restrictions even when consistent with the Companies Act, are to be authorised only when they are incorporated in the Articles of the Company.  The decision of the Supreme Court was based on the seemingly settled position that where there is a contradiction between the SHA and the Articles of acompany, the latter will prevail. In IL & FS Trust Co. Ltd. v. Birla Perucchini Ltd., [2004] 121 Comp Cas 335 (available here), the decision in Rangaraj was also held applicable to conflicts in the Articles and SHA not involving transfer of shares.

It is settled law that the Articles of a company would prevail when there is a contradiction between the SHA and the Articles. But assuming that there is a certain provision in the SHA that has not been incorporated in the articles of the Company, would it mean that merely because the articles are silent (not contradictory), the articles will prevail?

The answer to this question might lie in recognition of the legal position that a company is controlled only by its Memorandum and Articles. The Articles are a form of a statutory contract binding all the members of the company as regards the affairs of the company. A company cannot contract outside the Articles in so far as the management of the affairs of the Company is concerned, and any other agreement attempting to bind the company as regards its affairs, not provided for in the Articles and Memorandum of the company, may not be enforceable. For instance, a provision in a SHA giving a casting vote to the Chairman of the Board in case of a tie, not provided in the Articles, will not be enforceable. However, this may also depend on whether the company is a party to the SHA. (See Russell v. Northern Bank Development Corp Ltd, [1992] 1 WLR 588 )

 In World Phone, the Board of Directors of the company passed a resolution approving a rights issue in accordance with the Articles of the company, even though such an action required the affirmative vote of the Appellant in accordance with a SHA entered into between the shareholders of the company. The Company Law Board had held that since the provisions of the SHA granting an affirmative vote to the appellant were not incorporated in the Articles of the company, the said provision is unenforceable and the board resolution approving the rights issue was valid. On appeal, Justice Muralidhar of the Delhi High court held;

“ the legal position is that wherethe articles of association are silent on the existence of an affirmative vote, it will not be possible to hold that a clause in an agreement between shareholders would be binding without being incorporated in the articles of association. The question to be asked is whether the provisions of an agreement, that are not inconsistent with the Act, but are also not part of the articles of association, can be said to be applicable. All that section 9 states is that the clauses in the agreement that that “repugnant” to the Act shall be “void”. This does not mean that the clauses in the agreement which are not repugnant to the Act would be enforceable, notwithstanding that they are not incorporated in the articles of association.”

Thus, the court has held that the provisions of the SHA, though silent in the Articles of the company, and not in contradiction with them, will not be enforceable.  This ruling, as it stands, brings in a lot of confusion to the issue of conflicts between SHAs and Articles of a company- because the issues don’t stand resolved merely with the conflicting provisions being unenforceable. Further issues arise in light of the judgment of the Supreme Court in Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613 (available here), that have not been considered by the Delhi High Court in World Phone.

 In Vodafone, three main observations were made by the Supreme Court on the issue;

a)         That the Supreme Court does not subscribe to the view in Rangaraj that restrictions in a SHA, though consistent with company law, are to be authorised only when they are incorporated in the articles of the Company. (it is still doubtful whether Rangaraj has been overruled as the Court didn’t explicitly say so)

b)         Shareholders can enter into any arrangement in the best interests of the Company, but the only thing is that the provisions of SHA shall not go contrary to the articles of the Company.

c)         Breach ofSHA which does not breach the Articles of a company is a valid corporate action, but the parties agreed can get remedies under the general of the land for breach of any agreement and not under Companies Act.

In light of the above, a logical extension of the judgment in World Phone would be that even though the provisions of an affirmative vote are not incorporated in the Articles of the company, and though the action of the company in providing for a rights issue would be valid under the Companies Act, such an action will still be in breach of the SHA for which the aggrieved shareholder can pursue an action for breach of contract.

This view is also consistent with the position in English law. In Southern Foundries Ltd v. Shirlaw, [1940] AC 701 it was held, “a company cannot be precluded from altering its articles thereby giving itself power to act under the provisions of the altered articles–but so to act may nonetheless be a breach of contract if it is contrary to a stipulation in the contract validly made before the alteration”, and the court awarded damages for wrongful dismissal of the managing director of the Company even though the mode of dismissing was valid under the Articles of the company.  There is considerable opinion to show that the relief may also lie in terms of an injunction to restrain it possible breach of the SHA contract.

On 9^th May, 2013, the Supreme Court refused to admit a SLP in the World Phone case stating the opinion expressed in the order was only as regards interim relief and that the CLB was to decide the issue uninfluenced by the observations of the High Court. This sets the stage for a new round of litigation where it is hoped that issues concerning the conflicts between SHAs and Articles of a company would be finally settled.

- Aditya Swarup

SEBI Order on Public Shareholding Norms

The deadline for compliance by non-government entities of the public shareholding norms went by on June 3, 2013. Immediately thereafter, SEBI yesterday issued an order against 108 companies that have failed to comply with these norms. SEBI’s press release summarizing its order is available here.

A couple of points are noteworthy. The first relates to the rapidity with which SEBI has acted. This is consistent with its strict stance of not delaying the date of compliance and also its intention to enforce this rule very strictly. It is almost as if SEBI had been preparing for this eventuality where some companies would be non-compliant. The second, and more important, aspect of the order (which is interim in nature) is that it seeks to proceed against the promoters and controlling shareholders. The orders passed against them include freezing their corporate rights (such as voting and other corporate benefits such as dividends, rights entitlements, etc.), prohibitions on the promoters from buying and selling shares in those companies and also restraining the promoters from holding any further positions on the board. By proceeding against the promoters rather than the company itself, SEBI has sought to impose greater pressure to ensure compliance. As we had earlier noted, proceeding against the company would adversely affect the minority shareholders and ought not to be pursued.

This saga is likely to continue as some of the companies/promoters may very well appeal against the order of SEBI considering the severity of the consequences visited upon them.